Exhibit 99.2
------------------------------------------------------
FLEXSYS GROUP
Combined Financial Statements as of December 31,
2006 and 2005 and for the years ended December 31,
2006, 2005 and 2004 and Independent Auditors'
Report
------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
To the Shareholders of:
Flexsys Holding BV
Flexsys America LP
Flexsys Rubber Chemicals Ltd.
We have audited the accompanying combined balance sheets of the Flexsys Group
as of December 31, 2006 and 2005, and the related combined statements of
operations, changes in shareholders' equity and comprehensive income (loss)
and cash flows for each of the three years in the period ended December 31,
2006. The combined financial statements of the Flexsys Group include the
accounts of Flexsys Holding B.V. and its subsidiaries, and two related
companies Flexsys America L.P. and Flexsys Rubber Chemicals Ltd. These
companies are under common ownership and common management. These combined
financial statements are the responsibility of the companies' management. Our
responsibility is to express an opinion on these combined financial statements
based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the
companies' internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such combined financial statements present fairly, in all
material respects, the combined financial position of Flexsys Group at
December 31, 2006 and 2005, and the combined results of its operations and its
cash flows for each of the three years in the period ended December 31, 2006,
in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 11 to the financial statements, effective December 31,
2006, the Flexsys Group has adopted Statement of Financial Accounting
Standards No. 158 "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans".
Brussels, Belgium
March 23, 2007
- -----------------------------
DELOITTE REVISEURS D'ENTREPRISES SC SFD SCRL
Represented by
Geert Verstraeten
Partner
2
FLEXSYS GROUP
COMBINED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31,
--------------------------------
2006 2005
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 5,129 $ 20,107
Restricted Cash........................................................... 2,165 --
Trade receivables, net of allowances of $447 in 2006 and $493 in 2005..... 95,123 99,613
Miscellaneous receivables................................................. 32,035 25,587
Inventories............................................................... 98,611 87,024
Prepaid expenses and other assets......................................... 5,471 6,501
---------- -----------
TOTAL CURRENT ASSETS...................................................... 238,534 238,832
PROPERTY, PLANT AND EQUIPMENT, NET........................................ 237,640 220,651
GOODWILL.................................................................. 94,142 92,642
OTHER INTANGIBLE ASSETS, NET.............................................. 7,568 7,637
OTHER ASSETS ............................................................. 3,658 28,685
DEFERRED INCOME TAXES..................................................... 11,640 18,109
---------- -----------
TOTAL ASSETS.............................................................. $ 593,182 $ 606,556
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ......................................................... $ 37,849 $ 31,884
Accrued liabilities ...................................................... 87,560 50,913
Short term debt .......................................................... 13,070 17,971
Current portion of long term debt......................................... 45,854 12,000
Due to affiliates......................................................... 10,281 10,817
---------- -----------
TOTAL CURRENT LIABILITIES ................................................ 194,614 123,585
LONG TERM DEBT............................................................ -- 62,017
LONG TERM INCENTIVES OBLIGATIONS.......................................... -- 40,212
OTHER LIABILITIES ........................................................ 36,329 17,821
---------- -----------
TOTAL LIABILITIES......................................................... 230,943 243,635
SHAREHOLDERS' EQUITY:
Contributed capital....................................................... 414,694 414,694
Accumulated other comprehensive loss...................................... (55,344) (38,328)
Retained earnings / (Accumulated deficit)................................. 2,889 (13,445)
---------- -----------
TOTAL SHAREHOLDERS' EQUITY................................................ 362,239 362,921
---------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................................ $ 593,182 $ 606,556
========== ===========
See accompanying Notes to the Combined Financial Statements.
3
FLEXSYS GROUP
COMBINED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------------
2006 2005 2004
---- ---- ----
NET SALES....................................................... $ 606,314 $ 643,349 $ 526,729
Cost of goods sold.............................................. 451,482 451,737 430,180
----------- ----------- -----------
GROSS PROFIT.................................................... 154,832 191,612 96,549
Marketing and administrative expenses........................... 40,258 74,539 33,934
Research and development expenses............................... 8,002 8,039 7,992
Restructuring charges........................................... 4,850 7,206 22,066
Litigation expenses............................................. 9,676 10,178 46,026
----------- ----------- -----------
OPERATING INCOME / (LOSS)....................................... 92,046 91,650 (13,469)
Interest income................................................. 2,080 2,556 2,206
Interest expense................................................ (4,816) (9,424) (8,737)
Other expense, net.............................................. (3,359) (3,257) (3,767)
----------- ----------- -----------
INCOME / (LOSS) BEFORE INCOME TAXES............................. 85,951 81,525 (23,767)
Income tax expense.............................................. (19,617) (25,175) (12,210)
----------- ----------- -----------
NET INCOME / (LOSS)............................................. $ 66,334 $ 56,350 $ (35,977)
=========== =========== ===========
See accompanying Notes to the Combined Financial Statements.
4
FLEXSYS GROUP
COMBINED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME / (LOSS)
(DOLLARS IN THOUSANDS)
RETAINED ACCUMULATED
EARNINGS / OTHER TOTAL
(ACCUMULATED COMPREHENSIVE SHAREHOLDERS' COMPREHENSIVE
CAPITAL DEFICIT) LOSS EQUITY INCOME / (LOSS)
============================================================================
BALANCE, JANUARY 1, 2004 414,694 (33,818) (60,895) 319,981
Net loss (35,977) (35,977) (35,977)
Foreign currency translation adjustments 8,805 8,805 8,805
Minimum pension liability adjustments (3,554) (3,554) (3,554)
-------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 2004 414,694 (69,795) (55,644) 289,255 (30,726)
========
Net income 56,350 56,350 56,350
Foreign currency translation adjustments (6,759) (6,759) (6,759)
Minimum pension liability adjustments 24,075 24,075 24,075
-------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 2005 414,694 (13,445) (38,328) 362,921 73,666
========
Net income 66,334 66,334 66,334
Foreign currency translation adjustments 18,533 18,533 18,533
Dividend paid (50,000) (50,000)
Incremental effect of adopting SFAS No. 158 (35,549) (35,549)
-------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 2006 $414,694 $ 2,889 $(55,344) $362,239 $ 84,867
======== ======== ======== ======== ========
See accompanying Notes to the Combined Financial Statements.
5
FLEXSYS GROUP
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED
DECEMBER 31,
-----------------------------------------
2006 2005 2004
---- ---- ----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net income / (loss).................................................... $ 66,334 $ 56,350 $ (35,977)
Adjustments to reconcile net income / (loss) to cash provided by (used in)
operations:
Depreciation and amortization................................. 36,070 36,231 38,194
Non-cash litigation contingency............................... 2,000 -- --
Non-cash long term incentive obligation....................... 8,149 41,664 2,800
Impairment and obsolescence of fixed assets .................. 5,095 28 2,638
Deferred income taxes......................................... 6,335 7,381 (3,136)
Other, net.................................................... 656 1,668 2,268
Changes in operating assets and liabilities:
Receivables......................................... 4,324 6,003 14,707
Inventories......................................... (6,666) (5,894) 6,639
Accounts payable and accrued liabilities............ (7,856) (18,091) (14,997)
Litigation contingency reserve...................... 2,165 -- (16,500)
Other assets and liabilities........................ (793) (4,155) (1,531)
----------- ----------- -----------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES........................ 115,813 121,185 (4,895)
----------- ----------- -----------
INVESTING ACTIVITIES:
Property and equipment purchases....................................... (40,809) (32,774) (19,156)
Net change in cash related to escrow balances.......................... (2,165) -- (18,500)
----------- ----------- -----------
CASH USED IN INVESTING ACTIVITIES...................................... (42,974) (32,774) (37,656)
----------- ----------- -----------
FINANCING ACTIVITIES:
Net change in short-term debt obligations.............................. (10,113) (13,808) 12,150
Proceeds from issuance of long term debt obligations................... -- -- 21,204
Dividend paid ................... ..................................... (50,000) -- --
Repayment of long term debt obligations................................ (28,163) (69,897) --
----------- ----------- -----------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES........................ (88,276) (83,705) 33,354
----------- ----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS........... 459 97 586
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....................... (14,978) 4,803 (8,611)
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR...................................................... 20,107 15,304 23,915
----------- ----------- -----------
END OF YEAR............................................................ $ 5,129 $ 20,107 $ 15,304
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest.............................................. $ 2,854 $ 6,085 $ 7,412
Cash paid for income taxes.......................................... 13,449 19,629 21,578
See accompanying Notes to the Combined Financial Statements.
6
1. ORGANIZATION AND NATURE OF OPERATIONS
The Flexsys Group ("Flexsys" or the "Company") is a global rubber chemicals
joint venture between Solutia Inc. and Akzo Nobel N.V. (collectively the
"Parent Companies") which was formed effective January 1, 1995 and commenced
operations on May 1, 1995. Flexsys is a leading producer of chemicals for the
rubber processing and related industries. Flexsys products go into the
production of rubber tires and other rubber articles, as well as the
manufacture of products such as paints, coatings, and adhesives; water
treatment and mining chemicals; and fuel additives. Flexsys' sales and
receivables are concentrated in the tire industry. The five largest customers,
all of whom are international tire manufacturers, comprised approximately 49%,
50% and 48% of total sales in 2006, 2005 and 2004, respectively. The same five
customers comprised approximately 43% and 40% of trade receivables as of
December 31, 2006 and 2005, respectively.
On May 1, 1995, the Parent Companies transferred certain net assets of their
respective rubber chemicals businesses, consisting mainly of property and
equipment, inventories, intangible assets, accounts payable, other liabilities
and ownership interests in certain subsidiary companies to Flexsys. Flexsys
recorded these net assets at the historical carrying values of the Parent
Companies at the time of transfer.
The accompanying combined financial statements include the accounts of Flexsys
Holding B.V., a Dutch holding company and its subsidiaries, Flexsys America
L.P., a United States limited partnership, and Flexsys Rubber Chemicals Ltd.
(United Kingdom). All significant intercompany transactions and balances have
been eliminated in combination.
Solutia Inc. and Solutia Europe N.V. on the one hand and Akzo Nobel Chemicals
International BV on the other hand each own 50% of the 278 outstanding shares
of Flexsys Holding B.V. as of December 31, 2006 and 2005. The outstanding
shares have a par value of 454 Euro each. Total authorized shares as of
December 31, 2006 and 2005 were 875. Flexsys Holding B.V. holds a 100%
ownership interest, directly or indirectly, in the following subsidiaries:
Flexsys N.V. (Belgium)
Flexsys Coordination Center N.V. (Belgium)
Flexsys S.p.A. (Italy)
Flexsys Industria e Comercio Ltda. (Brazil)
Flexsys AG (Switzerland)
Flexsys KK (Japan)
Flexsys Pte. Ltd. (Singapore)
Flexsys America Co. (USA)
Flexsys SARL (France)
Flexsys Verwaltungs- und Beteiligungsgesellschaft (VuB) GmbH (Germany)
Flexsys Distribution GmbH (Germany)
Flexsys Industriepark Nienburg GmbH (Germany)
Flexsys Verkauf GmbH (Germany)
Flexsys Chemicals (M) Sdn Bhd (Malaysia)
Flexsys Asia Pacific Sdn Bhd (Malaysia)
Flexsys America L.P. is a limited partnership between Solutia, Inc. and Akzo
Nobel Chemicals Inc, as limited partners and Flexsys America Co. as general
partner. Pursuant to the terms of the partnership agreement, net income of
Flexsys America L.P. for the years ended December 31, 2006, 2005 and 2004 was
allocated between the following three entities:
Flexsys America Co. 2%
Solutia Inc. 49%
Akzo Nobel Chemicals, Inc. 49%
7
Solutia UK Capital Ltd. and Akzo Nobel Chemicals International BV, each own
50% of the 37,382,000 shares of Flexsys Rubber Chemicals Ltd. (United Kingdom)
that are outstanding as of December 31, 2006. The outstanding shares have a
par value of one sterling pound each. The total authorized shares as of
December 31, 2006 and 2005 were 100,000,000.
On December 17, 2003, Solutia, Inc. announced that it and its 14 U.S.
subsidiaries have filed voluntary petitions for reorganization under Chapter
11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Southern
District of New York (Case No. 0317949). Solutia, Inc. and its 14 U.S.
subsidiaries remain in possession of their assets and properties and continue
to operate their businesses and manage their properties as
"debtors-in-possession" pursuant to Sections 1107(a) and 1108 of the U.S.
Bankruptcy Code. On February 14, 2006, Solutia filed with the U.S. Bankruptcy
Court their Plan of Reorganization (the "Plan") and Disclosure Statement. The
Plan and Disclosure Statement set forth the terms of a global settlement
between Solutia, the Official Committee of Unsecured Creditors, Monsanto
Company and Pharmacia. The Plan and Disclosure Statement are subject to U.S.
Bankruptcy Court approval, the approval of various constituencies in the
Chapter 11 cases and the satisfaction of other contingencies. Since the
February 14, 2006 filing, the U.S. Bankruptcy Court has not moved forward with
the process to approve the Disclosure Statement and confirm the Plan due to
two adversary proceedings filed in the Chapter 11 case. Solutia is in
discussions with the major stakeholders in their Chapter 11 case in an effort
to modify the global settlement and Plan and achieve a confirmable Plan.
Solutia is also continuing to evaluate and explore all other reasonable
alternatives to reorganize the Company in order to maximize the value of the
estate for stakeholders.
On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo
Nobel's stake in Flexsys. Solutia and Akzo Nobel have entered into a letter
agreement committing the parties to execute the definitive agreement upon
completion of consultation with Dutch employee works council representatives.
The proposed transaction is subject to approval by the United States
Bankruptcy Court, receipt of required regulatory approvals, finalizing the
definitive purchase agreement for Akzo Nobel's Crystex manufacturing
operations in Japan and the fulfillment of other customary closing conditions.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies used in the preparation of
the accompanying combined financial statements is as follows:
REVENUES - The Company recognizes revenue when persuasive evidence of a sale
arrangement exists, delivery has occurred, the sales price is fixed and
determinable, and collectibility is reasonably assured. These criteria are met
when finished products are shipped to the customers and both title and the
risks and rewards of ownership are transferred.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include all highly
liquid investments with original maturity dates of three months or less when
purchased.
INVENTORIES - Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out ("FIFO") method of accounting. The
cost of work in process and finished goods comprise all the costs of
conversion and other costs incurred in bringing the inventories to their
present location and condition. The conversion costs include the cost of
production and the related fixed and variable production overhead costs.
CUSTOMER RECEIVABLES - Accounts receivable are stated at face value less a
provision for doubtful receivables determined on a customer specific basis, if
deemed necessary.
PROPERTY AND EQUIPMENT - Property and equipment is recorded at cost and
depreciated over its estimated useful life using the straight-line method. The
estimated useful lives are 20 to 35 years for buildings and land improvements
and range from 3 to 15 years for machinery and equipment. Maintenance and
repairs are charged to expense as incurred.
GOODWILL AND OTHER INTANGIBLE ASSETS - Under Statement of Financial Accounting
Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, goodwill and
other intangibles determined to have an infinite life are no longer amortized;
however, these assets are reviewed for impairment on an annual basis or more
frequently if events or changes in circumstances indicate that the asset might
be impaired. Intangible assets without an infinite life are recorded at cost
less accumulated amortization. Amortization of these assets is over a period
of 10 years.
LONG-LIVED ASSETS - Under SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, long-lived assets, consisting of property,
plant and equipment, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future undiscounted cash
flows expected to be generated by the asset. If such
8
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
recovery amount or fair value, as defined, of the assets. Please see Note 4
for the impact of SFAS No. 144 on the combined financial statements.
RESEARCH AND DEVELOPMENT COSTS - Research and development costs are expensed
when incurred.
LEGAL PROCEEDINGS AND CONTINGENCIES - The Company accrues for contingencies,
including legal proceedings and claims arising out of its business in the
period when it becomes probable that a liability has been incurred and the
amount is reasonably estimable. Amounts are accrued and updated based on
specific circumstances as applicable.
INCOME TAXES - Deferred income taxes are recorded to reflect the tax
consequences on future years of differences between the tax bases of assets
and liabilities and their financial reporting amounts at year-end. A valuation
allowance is established to reduce deferred tax assets if it is `more likely
than not' (based on recognition criteria outlined in SFAS No. 109, Accounting
for Income Taxes), that all, or some portion, of such deferred tax assets will
not be realized.
FINANCIAL INSTRUMENTS - Flexsys enters into foreign exchange forward contracts
to manage its exposure to fluctuations in foreign currency denominated balance
sheet items. This activity is intended to protect Flexsys from adverse
short-term fluctuations in foreign currencies. Gains and losses resulting from
changes in the market value of these contracts are marked-to-market on a
current basis and included in Other Expense - net in the Combined Statement of
Operations.
FOREIGN CURRENCY TRANSLATION - All entities utilize local currencies as their
functional currencies. The entities' asset and liability accounts are
translated into U.S. dollars at current exchange rates and income and expense
accounts are translated at average rates. Any unrealized gains or losses
arising from this translation are charged or credited to the accumulated other
comprehensive loss account included in Shareholders' Equity.
FOREIGN CURRENCY TRANSACTIONS - Transaction gains or losses due to changes in
the exchange rates between a functional currency and the currency in which a
foreign currency transaction is denominated are included in Other Expense -
net in the Combined Statements of Operations. The aggregate net losses
resulting from these transactions were approximately $ 816 in 2006, $ 1,579 in
2005 and $ 5,809 in 2004.
DIVIDENDS - Dividend distributions are payable to the Parent Companies at the
discretion of the Company within the limits of existing bank covenants.
ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported at the date of the financial statements of assets, liabilities,
revenues and expenses and the disclosure of contingencies. Actual results
could differ from those estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS - 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 SFAS No. 5,
Accounting for Contingencies.
FIN 48 is effective for fiscal years beginning after December 15, 2006.
Differences between the amounts recognized in the statements of financial
position prior to the adoption of FIN 48 and the amounts reported after
adoption will be accounted for as a cumulative effect adjustment recorded to
the beginning balance of retained earnings. The cumulative effect adjustment
would not apply to those items that would not have been recognized in
earnings, such as the effect of adopting FIN 48 on tax positions related to
business combinations. Flexsys is currently evaluating the impact of FIN 48 on
the combined financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosure requirements regarding fair value
measurement. Where applicable, SFAS No. 157 simplifies and codifies fair value
related guidance previously issued within generally accepted accounting
principles (GAAP). Although, SFAS No. 157 does not require any new fair value
measurements, its application may, for some entities, change current practice.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.
Flexsys is currently evaluating the impact of SFAS No. 157 on the combined
financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans ("SFAS No. 158"). SFAS
No. 158 requires the recognition of the funded status of pension and other
postretirement benefit plans on the balance sheet. The overfunded or
underfunded status would be recognized as an asset or
9
liability on the balance sheet with changes occurring during the current year
reflected through the comprehensive income portion of equity. Further, SFAS
No. 158 requires the unrecognized transition asset or obligation, gains or
losses, and prior service costs to be recognized as a component of other
comprehensive income, net of tax. SFAS No. 158 will also require the
measurement of the funded status of a plan to match that of the date of the
Company's fiscal-year-end financial statements, eliminating the use of earlier
measurement dates previously permissible. The portions of SFAS No. 158
relating to the recognition of the funded status of a plan and the
unrecognized components of net periodic benefit cost are effective for fiscal
years ending after December 15, 2006. Please see Note 11 for the impact of
SFAS No. 158 on the combined financial statements.
10
3. INVENTORIES
Inventories at December 31 consist of the following:
2006 2005
---- ----
Finished goods and work in process $ 75,895 $ 65,170
Raw materials and supplies 22,716 21,854
------------- -------------
Inventories $ 98,611 $ 87,024
============= =============
4. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net at December 31 consist of the following:
2006 2005
---- ----
Land and land improvements $ 8,379 $ 7,802
Buildings and building improvements 51,730 47,454
Manufacturing equipment 654,154 582,291
Other equipment 31,262 34,564
Construction in process 47,526 29,191
------------ ------------
Total 793,051 701,302
Less : accumulated depreciation (555,411) (480,651)
------------ ------------
Total property, plant and equipment, net $ 237,640 $ 220,651
============ ============
The Company capitalized interest of $ 939 in 2006, $ 377 in 2005 and $ 88 in
2004 related to the construction of assets intended for its own use. The
depreciation expense was $ 36,070 in 2006, $ 36,164 in 2005 and $ 38,074 in
2004.
In 2006 an impairment analysis was completed in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, based upon
indicators of impairment present within certain asset groups in Flexsys
locations in Italy and the United Kingdom. The indicators included declines or
increasing weakness in historical operating results and concerns over future
results given current market and economic conditions. The carrying values of
the assets within these asset groups were compared to undiscounted expected
cash flows. As the carrying value of these assets was higher than the
undiscounted future cash flow amount, this indicated that the assets were
impaired. The assets were written down to fair value determined through the
use of a discounted cash flow model. As a result, in 2006, Flexsys recorded an
impairment charge of $ 5,003 to Cost of Goods Sold for the write down of these
fixed assets.
11
5. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill
Changes in the net carrying value of goodwill for the year ended December 31,
2006 and 2005 are as follows:
NET CARRYING
VALUE
-----
Balance at January 1, 2005 $ 95,256
Effect of foreign currency translation adjustments (2,614)
------------
Balance at December 31, 2005 92,642
Effect of foreign currency translation adjustments 1,564
Impairment of Goodwill (64)
------------
Balance at December 31, 2006 $ 94,142
============
Flexsys tested goodwill for impairment during the fourth quarter of 2006 and
2005 using a present value of future cash flows valuation method. This process
resulted in an impairment of $ 64 in 2006 comprising the total goodwill of the
Primary Accelerators business in Italy. All long-lived assets associated
directly to this business were also fully impaired in 2006. See Note 4 above.
Other Intangible Assets
Other intangible assets are summarized in aggregate as of December 31 as
follows:
2006 2005
--------------------------------------------------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
VALUE AMORTIZATION VALUE VALUE AMORTIZATION VALUE
--------------------------------------------------------------------------
Infinite Life
- -------------
Unpatented technology $ 7,231 $ 7,231 $ 7,231 $ 7,231
Trademarks 247 247 226 226
Finite Life
- -----------
Licenses 900 (810) 90 900 (720) 180
-------- -------- -------- --------- -------- --------
TOTAL OTHER INTANGIBLE ASSETS $ 8,378 $ (810) $ 7,568 $ 8,357 $ (720) $ 7,637
======== ======== ======== ======== ======== ========
There were no material acquisitions of intangible assets and there have been
no changes to amortizable lives or methods during the years ended December 31,
2006 and 2005. Total amortization expense of other intangible assets was $ 90
per annum for the years ended December 31, 2006, 2005 and 2004.
Amortization expense for the net carrying amount of finite-lived intangible
assets is estimated to be $ 90 for 2007 at which point these assets will be
fully amortized.
12
6. ACCRUED LIABILITIES
Accrued liabilities at December 31 consists of the following:
2006 2005
---- ----
Accrued wages and commissions $ 16,400 $ 26,458
Long term incentive plan accrual 51,676 --
Other 19,484 24,455
------------- -------------
Total accrued liabilities $ 87,560 $ 50,913
============= =============
7. SHORT TERM DEBT
Short term debt at December 31 consists of the following:
2006 2005
---- ----
Bank overdrafts $ 3,800 $ 3,909
Multi-currency lines of credit 9,270 14,062
------------ ------------
Total short term debt $ 13,070 $ 17,971
============ ============
At December 31, 2006 and 2005, the group had $ 165,000 of uncommitted
multi-currency lines of credit available with various banks.
8. LONG TERM DEBT
Long term debt at December 31 consists of the following:
2006 2005
---- ----
Amortising Loan Facility (`Facility A') $ 25,854 $ 38,398
Revolving Credit Facility (`Facility B') 20,000 35,619
------------ ------------
Sub-total 45,854 74,017
Less current portion of long term debt (45,854) (12,000)
------------ ------------
Total long term debt $ -- $ 62,017
============ ============
On February 14, 2003, Flexsys signed a $ 200,000 committed multi-currency term
and revolving credit facility. The syndicated facility was available as of
February 14, 2003 for 5 years. The loan was used to re-finance the existing
matured revolving credit facility and for general corporate purposes and
consists of two parts: a $ 50,000 amortizing loan facility ("Facility A") and
a $ 150,000 revolving credit facility ("Facility B"). Interest on these
facilities is payable at LIBOR or EURIBOR rates plus a margin ranging between
0.60% and 1.75%, based upon certain ratios. The weighted average interest rate
as of December 31, 2006 on these facilities is 5.03%. Other fees may be
incurred to reimburse the banks for certain costs incurred or based on the
utilization of Facility B.
The Company is in compliance with its covenants as of December 31, 2006.
Under the terms of the syndicated facility, Flexsys is obliged to advise all
participating banks through the agent bank when there will be a change in the
ownership of shares of any of the borrowing or guaranteeing Flexsys entities
to the syndicated facility. The participating banks would then be required to
confirm their consent to the change of ownership in order for the syndicated
facility to continue. The banks have been notified of the agreement between
Solutia and Akzo Nobel for Solutia to acquire Akzo Nobel's stake in Flexsys
but Flexsys has decided not to seek their approval for the continuation of the
syndicated facility. All borrowings under the syndicated facility will
therefore be required to be repaid during 2007. As a consequence of this, all
Debt has been
13
classified within Current Liabilities at December 31, 2006. Alternative
sources of financing for Flexsys are being established to meet future
borrowing requirements.
9. RESTRUCTURING
The restructuring charges for the years ended December 31 consisted of the
following components:
2006 2005 2004
---- ---- ----
Nitro plant (US) :
Closure of Nitro plant $ -- $ 746 $ 13,288
Other (5) -- 1,335
----------- ----------- -----------
Nitro plant subtotal (5) 746 14,623
Akron (US) :
Severance and related termination costs -- 147 1,074
Queeny plant (US) :
Closure of Queeny plant 3,784 113 --
Ruabon Plant (UK) :
Release of severance and dismantling accrual 23 -- (44)
Newport Plant (UK) :
Severance and other restructuring charges 1,115 6,172 4,101
Brussels Headquarters (Belgium) :
Severance and related termination costs -- -- 3,992
Other restructuring : (67) 28 (1,680)
----------- ----------- -----------
TOTAL RESTRUCTURING CHARGES $ 4,850 $ 7,206 $ 22,066
=========== =========== ===========
14
The following tables reconcile restructuring charges in 2006 and 2005 between
cash and accrual activity. The Ending Accrual balance is included in Accrued
Liabilities in the Combined Balance Sheets in both years.
2006
----
BEGINNING (REVERSAL OF) (CASH OTHER ENDING
ACCRUAL ACCRUAL PAYMENTS) ACCRUAL
----------------------------------------------------------------------------
United States
Nitro/Sterling $ 183 $ (5) $ (178) $ -- $ --
Akron 147 -- (147) -- --
Queeny 3 3,784 (3,759) (28) --
United Kingdom
Ruabon 209 23 (197) (35) --
Newport 2,681 1,115 (3,747) (49) --
Benelux
Brussels HQ 363 -- -- 38 401
Other 65 (67) -- 2 --
------------ ------------ ------------ ------------ ------------
TOTAL $ 3,651 $ 4,850 $ (8,028) $ (72) $ 401
============ ============ ============ ============ ============
2005
----
BEGINNING (REVERSAL OF) (CASH OTHER ENDING
ACCRUAL ACCRUAL PAYMENTS) ACCRUAL
----------------------------------------------------------------------------
United States
Nitro plant $ 4,134 $ 746 $ (4,697) $ -- $ 183
Akron 184 147 (184) -- 147
Queeny -- 113 (110) -- 3
United Kingdom
Ruabon plant 310 -- (101) -- 209
Newport plant 163 6,172 (3,639) (15) 2,681
Benelux
Brussels HQ 1,088 -- (725) -- 363
Other 142 28 -- (105) 65
------------ ------------ ------------ ------------ ------------
TOTAL $ 6,021 $ 7,206 $ (9,456) $ (120) $ 3,651
============ ============ ============ ============ ============
15
United States
- -------------
In March 2003, Flexsys entered into an agreement to cease the
production of a specialty chemical, which was produced at the Nitro, West
Virginia Plant, and purchase this product from a third party producer. In
October 2003, citing excess manufacturing capacity in the global rubber
chemical industry, the Flexsys Supervisory Board approved a plan to close the
Nitro, West Virginia Plant starting from March 2004. Restructuring reserves of
$ 27,075 in 2003, $ 14,623 in 2004 and $ 746 in 2005 were recorded to cover
the write-down of fixed assets, the write-down of spare parts inventory,
employee severance and related termination costs, dismantling and
decontamination costs, toll contract termination expenses and other costs. The
final payments relating to the restructuring of the Nitro, West Virginia Plant
were made in 2006. These amounted to $ 178 and related to severance and
related termination costs.
During 2004, Flexsys recorded a $ 1,074 restructuring charge relating
to the voluntary and involuntary termination of employees at the Akron
location. All of the employees were notified of their termination and left
Flexsys' employment as of December 31, 2004. The recorded charge related to
employee severance costs and outplacement assistance paid by Flexsys.
In January 2005, Solutia informed Flexsys that they (Solutia) had
decided to relocate their Skydrol(R) manufacturing operation from the
J.F. Queeny site to another Solutia site. Flexsys, producing Duralink HTS and
QDI at Queeny, would then become the only party with operations at that site.
As the economics of the Queeny site would not be favorable under this
scenario, Flexsys decided to relocate its operations from Queeny within the
same timeframe as Solutia in a joint exit from the site. Flexsys recorded
accelerated depreciation of $ 1,213 (within Cost of Goods Sold) and related
termination costs of $ 113 as a restructuring charge in 2005. Flexsys
production at the J.F. Queeny site stopped at the end of June 2006. During
2006, a restructuring charge of $ 3,784 was recorded relating to additional
depreciation ($ 28), dismantling and decontamination costs ($ 1,001),
severance ($ 970), write-down of inventory ($ 176) and residual fixed costs
($ 1,609).
United Kingdom
- --------------
On June 13, 2000, Flexsys announced the closure of its Primary Accelerator
manufacturing operations in Ruabon, Wales. The operations related to certain
products were physically shut down during August 2001. Dismantling operations
were substantially completed in 2002. In 2006 and 2005 a further $ 232 and
$ 101, respectively, was spent against the reserve on severance and dismantling
costs.
In 2004, Flexsys recorded a restructuring charge of $ 4,101 relating to the
closure of the IPPD finishing plant in Newport, Wales. This was to cover the
write-down of fixed assets and inventory. Further restructuring charges of
$ 6,172 in 2005 relating to dismantling and decontamination ($ 693), employee
severance ($ 2,257) and residual costs relating to the site Operating
Agreement ($ 3,222), and $ 1,115 in 2006 relating to employee severance were
subsequently recorded relating to this closure. Charges of $ 3,747 were made
against the IPPD reserve in 2006 relating to dismantling costs ($ 146),
employee severance and termination costs ($ 1,951) and residual costs as
defined under the site Operating Agreement ($ 1,651). The reserves for the
Newport closure have been fully utilised.
Benelux Countries
- -----------------
In Belgium, 2004 restructuring charges amounting to $ 3,992 were recorded
relating to employee severance costs. During 2005 and 2004, amounts of $ 2,904
and $ 725 were spent, respectively, against this provision. No charges were
booked against the remaining reserve in 2006. The remaining reserve at
December 31, 2006 is related to expected employee severance payments.
10. TAXES ON INCOME
The components of deferred taxes in the accompanying Combined Balance Sheets
as of December 31 are as follows:
2006 2005
---- ----
Deferred Tax Assets - Current $ 610 $ 200
Deferred Tax Assets - Non Current 11,640 18,109
Deferred Tax Liabilities - Non Current (3,694) (4,372)
------------ ------------
Net Deferred Tax $ 8,556 $ 13,937
============ ============
16
Deferred tax assets primarily arise from the recognition of future tax
benefits resulting from available net operating loss carry forwards,
accelerated capital allowances on fixed assets and provisions. Deferred tax
assets have been reduced by valuation allowances of $ 38,477 and $ 39,031 as
of December 31, 2006 and December 31, 2005, respectively. Net operating loss
carry-forwards available primarily in Belgium and the United Kingdom, amount
to $ 113,309 and $ 126,279 as of December 31, 2006 and 2005, respectively, and
can be carried over without limitation in time in these countries. Flexsys
Rubber Chemicals Ltd surrendered tax losses of $ 21,308 in 2006 and $ 60,162
in 2005 under UK Consortium Relief rules to Akzo Nobel and Solutia for no
consideration. The losses surrendered arose from the claim of capital
allowances for 2004 and prior years. A full valuation allowance has been
provided on all deferred tax assets in this United Kingdom entity.
Deferred tax liabilities primarily arise from temporary differences between
the tax bases of certain assets and liabilities, primarily fixed assets,
goodwill, and deferred charges, and their financial reporting amounts.
The charge for income taxes is as follows:
2006 2005 2004
---- ---- ----
Current tax expense $ 11,751 $ 17,301 $ 15,977
Deferred tax expense / (benefit) 7,866 7,874 (3,767)
----------- ----------- -----------
Net income tax expense $ 19,617 $ 25,175 $ 12,210
=========== =========== ===========
No deferred income taxes are recorded at Flexsys America L.P. since the tax
profits and losses in the limited partnership are reported in the partners'
federal income tax returns. Provision has not been made for undistributed
earnings of international subsidiaries, as those earnings are considered to be
permanently re-invested in the operations of those subsidiaries.
11. EMPLOYEE BENEFIT PLANS
DEFINED BENEFIT PENSION PLANS - Flexsys has defined benefit pension plans
covering substantially all of the employees of the Flexsys entities in the
United Kingdom, Belgium and Germany. Pension accounting is performed based on
independent actuarial calculations in accordance with the provisions of SFAS
No. 87, Employers' Accounting for Pensions. The funded status of the plans at
December 31 is as follows (measurement date is September 30th except for the
United Kingdom where it is December 31st):
2006 2005
---- ----
PLAN STATUS AS OF DECEMBER 31 :
Plan assets at fair value $ 112,799 $ 98,051
Projected benefit obligation (132,215) (117,823)
------------ ------------
Funded status $ (19,416) $ (19,772)
============ ============
Gross prepaid pension asset $ N/A $ 25,290
Gross accrued pension liability N/A (8,155)
PLAN ACTIVITY FOR THE YEAR ENDED DECEMBER 31 :
Employer contributions 1,337 13,043
Participant contributions 582 545
Benefits paid 4,701 4,250
WEIGHTED AVERAGE ASSUMPTIONS AT DECEMBER 31 :
Weighted average discount rate 5.14% 4.97%
Long term rate of return on assets 6.81% 7.77%
Weighted average increase in compensation 3.85% 3.83%
17
2006 2005 2004
---- ---- ----
NET PERIODIC COST FOR THE YEAR ENDED DECEMBER 31:
Total pension cost (net) $ 4,552 $ 4,504 $ 1,930
The accumulated benefit obligation for all defined benefit plans was $ 99,237
in 2006 and $ 86,543 in 2005. A minimum pension liability adjustment to Other
Comprehensive Income of $ 3,554 in 2004 was required for one plan as the
accumulated benefit obligation exceeded the related plan assets and accrued
pension liabilities. The Other Comprehensive Income balance was reduced to
zero during 2005 as a result of a cash contribution of $ 10,805 made by the
Company into the plan.
The assets, projected benefit obligation and accumulated benefit obligation
for the pensions with projected benefit obligations in excess of plan assets,
were $ 103,406, $ 124,512 and $ 92,443 respectively, as of December 31, 2006,
and $ 89,618, $ 110,081 and $ 78,361 respectively, as of December 31, 2005.
The asset allocation for the Company's pension plans as of December 31, 2006
and 2005, and the target allocation for 2007, by asset category, is as
follows:
2007 TARGET 2006 2005
----------- ---- ----
Equity securities 70% 69% 61%
Debt securities 30% 31% 39%
The investment strategy for the Flexsys defined benefit plans is to maintain a
diversified assets allocation in order to minimize the risk of large losses
and to maximise the long-term risk-adjusted rate of return.
The following table sets forth the Company's estimated future benefit payments
regarding its defined pension plans:
2007 $ 4,268
2008 4,277
2009 4,300
2010 4,252
2011 4,479
2012-2016 37,205
----------
TOTAL PAYMENTS $ 58,781
==========
The Company's contribution to be paid in 2007 is estimated at $ 1,516.
POSTRETIREMENT MEDICAL BENEFITS--Flexsys America LP provides for
reimbursement of limited retiree healthcare benefits to certain union and
non-union employees who meet certain eligibility requirements. This program is
unfunded and the accumulated postretirement benefit obligation at December 31,
2006 and 2005 approximated $ 2,853 and $ 2,908 respectively, using discount
rates of 5.75% in 2006 and 2005. The Accumulated Postretirement benefit
obligation was recognized as a liability in the accompanying balance sheets
(measurement date November 1st).
The following table sets forth the Company's postretirement benefit
cost, contributions and benefits paid for the years ended December 31st:
2006 2005 2004
---- ---- ----
Benefit cost $ 270 $ 272 $ 1,097
Employer contribution 266 313
Benefits paid 266 313
18
The following table sets forth the Company's estimated future benefit
payments:
2007 $ 309
2008 270
2009 280
2010 280
2011 275
2012-2016 1,000
----------
TOTAL PAYMENTS $ 2,414
==========
Of the $ 309 expected to be contributed to fund postretirement
medical benefits during 2007, the entire contribution is discretionary, as the
plan is not subject to any minimum regulatory funding requirements. The
contribution is expected to be in the form of cash.
EFFECTS OF ADOPTING SFAS NO. 158
--------------------------------
The following table illustrates the incremental effect of applying
SFAS No. 158 (as it relates to both the Defined Benefit Pension Plans and
Postretirement Medical Benefits) on individual line items in the Combined
Balance Sheet at December 31, 2006:
BEFORE APPLICATION OF ADJUSTMENTS AFTER APPLICATION
--------------------- ----------- -----------------
SFAS NO. 158 OF SFAS NO. 158
------------ ---------------
Other assets $ 26,379 $ (24,689) $ 1,690
Deferred income taxes -- 682 682
Accrued liabilities 197 -- 197
Other liabilities 12,220 11,542 23,762
Accumulated other comprehensive loss -- 35,549 35,549
Accumulated other comprehensive loss at December 31, 2006 consists of
net actuarial losses ($ 32,563) and prior service costs ($ 2,986).
EMPLOYEE SAVINGS PLAN - Flexsys America L.P. provides a savings plan
for substantially all its regular full-time employees for which employee
contributions are matched in part by Flexsys America L.P. Matching
contributions charged to expense approximated $ 713 in 2006, $ 700 in 2005 and
$ 1,200 in 2004.
NONQUALIFIED RETIREMENT PLAN - Flexsys America L.P. provides a
nonqualified defined contribution retirement plan for certain of its
employees. Employee contributions are matched in part by Flexsys. Matching
contributions charged to expense approximated $ 154 in 2006, $ 133 in 2005 and
$ 110 in 2004. The assets of the plan are held in a Rabbi Trust which is in
Flexsys America L.P.'s name. The investments of the trust and related
liability are classified as non-current because they are not for use in the
ordinary course of business.
LONG TERM INCENTIVE PLAN - In 2004, the Company introduced a new Long
Term Incentive Plan. This plan for certain leading employees is based on the
attainment of certain financial goals. The plan covers the financial years
2004 until 2006 and will pay out in 2007. The goals are Return on Capital
Employed ("ROCE") and Earnings before Tax ("EBT"). The pay outs on both the
ROCE and the EBT goals are not capped. As of December 31, 2006, the Company
had accrued an amount of $ 51,676, which is recorded within the line Accrued
Liabilities in the Combined Balance Sheet. The accrual as of December 31, 2005
of $ 40,212 was recorded in the line Long Term Incentives Obligations.
19
12. FINANCIAL INSTRUMENTS
Flexsys has various financial instruments, including cash and cash
equivalents, short-term investments, receivables, payables, short-term bank
borrowings, and foreign currency forward and option contracts. The fair value
of Flexsys' cash and cash equivalents, short-term investments, short-term bank
borrowings, and accounts receivable and payable approximates their carrying
value due to the short-term nature of the items.
Flexsys uses foreign currency forward contracts and foreign currency option
contracts to hedge accounts receivable denominated in foreign currencies.
Gains and losses on the forward contracts are recognized based on changes in
exchange rates, as are offsetting foreign exchange gains and losses on such
accounts receivable. Such contracts are generally in connection with
transactions with maturities of less than six months.
As of December 31, 2006 and 2005, the notional amounts of the Company's
outstanding foreign currency forward buy contracts were $109,426 and $255,459,
respectively. The notional amounts of the Company's foreign currency forward
sell contracts were $110,298 and $256,647 at December 31, 2006 and 2005,
respectively. The carrying value of the Company's outstanding foreign exchange
contracts and options was a net payable of $ 95 and $ 266 at December 31, 2006
and 2005, respectively.
Flexsys is exposed to credit risk to the extent of non-performance of
counter-parties to their foreign currency contracts and options described
above. However, the credit ratings of the counter-parties, which consist of a
diversified group of financial institutions, are regularly monitored and risk
of default is considered remote.
13. TRANSACTIONS WITH PARENT COMPANIES
Flexsys engages in significant transactions with its Parent Companies. These
transactions mainly consist of product sales and other operating revenues, raw
materials purchases, production services, marketing, administrative and
research services.
Amounts included in the combined financial statements for the years ended
December 31:
2006 2005 2004
---- ---- ----
Income Statement Related Transactions
- -------------------------------------
Product Sales to :
Akzo Nobel $ -- $ 334 $ 774
Solutia 49 52 49
Production services and raw materials to:
Solutia -- 2,135 7,808
Production services and raw materials from:
Akzo Nobel 32,291 26,808 26,205
Solutia 21,257 26,285 25,497
Marketing, administrative and research received from:
Akzo Nobel 3,115 3,316 2,960
Solutia 51 67 32
Capital charges for use of facilities from:
Akzo Nobel 426 414 389
Solutia 176 50 58
20
2006 2005
---- ----
Balance Sheet Related Transactions
- ----------------------------------
Purchase of Capital Equipment:
Akzo Nobel $ 615 $ 627
Solutia 1,641 1,863
Accounts receivables from:
Akzo Nobel -- 277
Solutia -- 27
Accounts payables to:
Akzo Nobel 8,267 8,578
Solutia 2,014 2,239
As mentioned in Note 1, on December 17, 2003, Solutia, Inc. and 14 of
its U.S. subsidiaries filed for voluntary petitions for reorganization under
Chapter 11 of the U.S. Bankruptcy Code. As of December 31, 2006, Flexsys has
retained a $163 allowance against pre-petition net receivables due from
Solutia.
14. COMMITMENTS AND CONTINGENCIES
ANTITRUST LITIGATION
Antitrust authorities in the United States, Europe and Canada have been
investigating past commercial practices in the rubber chemicals industry.
Flexsys remains a subject of such investigation and continues to fully
cooperate with the authorities in the ongoing investigation. As a consequence,
a number of purported civil class actions on behalf of consumers have been
filed against Flexsys and other producers of rubber chemicals.
U.S. State court actions against Flexsys.
- ----------------------------------------
Flexsys was a defendant in 22 purported class actions filed in various state
courts against Flexsys and other producers of rubber chemicals. Flexsys was
successful in getting many of these cases dismissed by the competent courts.
In February 2007, Flexsys reached a tentative agreement (not yet signed),
inclusive of fees and costs to settle claims on behalf of all indirect
purchasers in 18 states, plus the District of Columbia. Flexsys has provided
for the potential amount of this settlement in its 2006 results. The
settlement agreement would contain a release on behalf of all class members,
who do not opt out of the settlement, to release all claims against Flexsys
and its parent companies, Akzo Nobel and Solutia and their subsidiaries and
affiliates. The settlement will require court approval.
The settlement would not cover class actions brought by indirect purchasers in
Massachusetts or indirect purchasers in a number of states represented in a
pending multi-state indirect purchaser class action brought in the state court
in Florida. Based on its present understanding of these two outstanding
proceedings, Flexsys believes that it has substantial defenses to these claims
and intends to vigorously assert these defenses. In the event that Flexsys is
found to have violated the applicable antitrust laws, consumer protection or
unfair competition laws, a direct or indirect purchaser may recover treble
damages, the costs of suit and reasonable attorneys' fees. At this point in
time it is not possible to estimate the likelihood or the extent of the
potential liability, if any, in respect of the two outstanding cases in
Massachusetts and Florida and management believes that no amounts need to be
accrued under SFAS No. 5, Accounting for Contingencies. While the ultimate
outcome and impact on Flexsys cannot be predicted with certainty, management
believes that the resolution of the proceedings still outstanding will not
have a material adverse effect on the combined financial position or future
results from operations and cash flows of Flexsys.
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. In 2005 and 2006
similar cases were filed in the provinces Ontario and British Columbia. In
2006, a settlement was negotiated with Plaintiff's counsel and agreement was
reached in principle to settle the class actions in all three provinces
(Quebec, Ontario and British Columbia) for a total amount of C$ 2,325 (US$
2,165) including interest and costs.
21
This is subject to finalizing a formal settlement agreement, which is now
close to completion. The settlement agreement must be approved by the Courts
in each province. The amount has been paid into an escrow account and is shown
as Restricted Cash on the Balance Sheet at December 31, 2006.
Federal court actions by purchasers of rubber chemicals
- -------------------------------------------------------
Eight purported class actions filed in the U.S. District Court for the
Northern District of California on behalf of all individuals and entities that
had purchased rubber chemicals in the United States during the period January
1, 1995 until October 10, 2002, against Flexsys and a number of other
companies producing rubber chemicals were consolidated into a single action
called In Re Rubber Chemicals Antitrust Litigation (the `Class Action'). The
Class Action alleged price-fixing and sought treble damages and injunctive
relief under U.S. antitrust laws on behalf of all the plaintiffs. A settlement
agreement was approved by the Court on June 21, 2005 releasing Flexsys and its
predecessors in interest from any further liability to the members of the
class with respect to the allegations made in the Class Action complaint.
Other than potential claims by two direct purchasers of small amounts of
rubber chemicals from Flexsys, who opted out of the Class, the settlement by
Flexsys, predominantly in 2003 and 2004, of the Class Action (approximately
$ 19,000) along with several private settlements with large customers
(approximately $ 60,000) for all intents and purposes resolves all claims made
in these direct cases by direct U.S. purchasers of rubber chemicals against
Flexsys under U.S. antitrust laws for activities of Flexsys prior to the dates
of the settlements.
Settlements
- -----------
As of December 31, 2006, Flexsys has paid a total of $79,000 in settlements.
In addition, as of December 31, 2006, Flexsys has provided for a total of
$ 4,165 for settlements expected to be made in 2007. Management believes that
the resolution of proceedings still outstanding will not have a material
adverse effect on the combined financial position of the Company or its future
results from operations and cash flows in the reporting periods in which such
matters are resolved.
DIOXIN
As reported in 2005, Flexsys America L.P. is a defendant in a proposed class
action suit against Flexsys and other parties, notably not including Solutia.
The suit alleges that class members have been exposed to potentially harmful
levels of dioxin particles as a result of the production of dioxin at the
Nitro site formerly occupied by Monsanto and later occupied by Flexsys.
Flexsys entered its defense and cross-claimed against Monsanto. Flexsys and
Monsanto have entered into an interim settlement whereby Monsanto has agreed
to conduct and pay for the defense of Flexsys, but has neither accepted nor
rejected the ultimate demand for indemnification.
While the ultimate outcome and impact on Flexsys cannot be predicted with
certainty, management believes that the resolution of proceedings still
outstanding will not have a material adverse effect on the combined financial
position of Flexsys.
PATENT DISPUTES
Flexsys believes that two Chinese companies, Sinorgchem and Xinda, are using
Flexsys process technology in China to produce 4-ADPA and 6PPD. Flexsys has
evidence that one of these companies, Sinorgchem, is exporting these products
into jurisdictions where Flexsys has patents, including Korea and the U.S. More
specifically, Korea Kumho Petrochemical Company ("KKPC") is a Korean company
that purchases 4-ADPA from Sinorgchem and processes it into 6PPD. KKPC then
sells its 6PPD to its sister company, Kumho Tire. Kumho Tire uses the 6PPD to
manufacture tires in Korea, which tires it then exports to the US. For this
reason, Flexsys has initiated certain legal proceedings to prevent imports of
such products manufactured by Sinorgchem and KKPC into these two
jurisdictions.
a) Korea: There are two separate PPD related IP litigation proceedings pending
-----
in Korea.
o Flexsys filed a patent infringement action in a Korean
District Court against KKPC. This is a civil action that
seeks monetary damages and injunctive relief. There was a
formal decision Dec 17, 2004 that denied the Flexsys request
for injunction. The basis of the decision was invalidity of
the patent. Flexsys then appealed the District Court
decision to the civil High Court. On October 12, 2005, the
High Court affirmed the decision of the District Court.
Flexsys has filed a notice of appeal to the Supreme Court of
Korea.
o The second litigation proceeding in Korea is an invalidation
action filed by Sinorgchem against Flexsys before the Korean
Intellectual Property Tribunal ("IPT"). On September 30,
2005, the IPT issued a decision largely, but not
22
entirely, agreeing with Sinorgchem's challenge to the
Flexsys `063 patent. Two dependent claims of the patent were
found to be valid. Flexsys appealed the IPT decision to the
Patent Court of Korea, which appeal Flexsys has won. The
Patent Court thereby confirmed the validity of the Korean
patent in all important respects. Sinorgchem has filed a
notice of appeal to the Supreme Court of Korea.
Both the High Court and Patent Court cases are on appeal to the Korean Supreme
Court. So far, the Supreme Court has handled these cases without formally
consolidating them.
b) U.S.: There are two separate PPD related IP litigation proceedings pending
----
in the US.
o Flexsys filed an International Trade Commission ("ITC") 337
action against Sinorgchem, KKPC, and Sovereign, one of
Sinorgchem's distributors. A preliminary decision by the
Administrative Law Judge has been issued on February 17,
2006, which confirmed the validity of the Flexsys patents
and the infringement by Sinorgchem of those patents. It also
confirmed violation by Sinorgchem and Sovereign of section
337 of the US Tariff Act. The judge found no violation of
said Act by KKPC. Review by the full ITC Board and the
President confirmed the decision of the Administrative Law
Judge. The decision was appealed by Sinorgchem to the US
Court of Appeals for the Federal Circuit. Flexsys and
Sovereign have settled their differences, with Sovereign
admitting the validity of Flexsys patents.
o Flexsys filed a patent infringement civil lawsuit in U.S.
District Court of Ohio against Sinorgchem, KKPC, Kumho Tire
Korea, Kumho Tire US and certain distributors. The suit
seeks monetary damages as well as injunctive relief. This
action had been stayed pending resolution of the ITC
proceeding described above, but the stay has been lifted and
the suit is now proceeding.
Further in the Ohio case, KKPC filed for arbitration based
on arbitration clauses in a joint venture agreement and a
license Agreement, both of which are terminated. Flexsys
filed for a preliminary injunction opposing the arbitration.
The arbitration issue is pending.
Loss or partial loss by Flexsys in these legal proceedings represent a risk to
Flexsys in terms of potential lost sales volumes and gross profit margin as a
result of increased competitive activity.
c) Other claims against Flexsys in the US:
On April 26, 2006, KKPC filed a complaint against Flexsys America L.P. in the
U.S. District Court for the Central District of California bringing claims for
violations of the Sherman Act, breach of contract, breach of the implied
covenant of good faith and fair dealing, declaratory relief, intentional
interference with prospective economic advantage and violations of the
California Business & Professions Code. On July 12, 2006, the Central District
of California granted Flexsys America LP's motion to transfer KKPC's antitrust
action to the U.S. District Court for the Northern District of Ohio.
After transfer, on August 8, 2006, KKPC filed an amended complaint in the
Northern District of Ohio. KKPC's amended complaint added Flexsys N.V.,
Solutia Inc., Akzo Nobel Chemicals International B.V., and Akzo Nobel
Chemicals, Inc. as defendants. KKPC has since filed a second amended complaint
dropping Solutia as a defendant. The presently operative complaint asserts
antitrust claims under Sections 1 and 2 of the Sherman Act, claims under the
antitrust and unfair competition provisions of the California Business and
Professions Code and a claim for intentional interference with prospective
economic advantage. KKPC also seeks attorney's fees and costs.
In response to a KKPC Notice of Potential Tag-Along Action, the case has been
transferred to the U.S. District Court for the Northern District of California
and coordinated with In re Rubber Chemicals Antitrust Litigation. Flexsys and
Akzo have filed a motion to dismiss KKPC's complaint. Flexsys will continue to
vigorously contest the KKPC action. At this stage of the litigation, it is not
possible to estimate the likelihood or extent of Flexsys' potential liability,
if any.
OTHER LAWSUITS, THREATENED LAWSUITS AND CONTINGENCIES
Flexsys is party to lawsuits, threatened lawsuits, tax contingencies and other
claims arising out of the normal course of business. Management is of the
opinion that any liabilities that may result are adequately accrued for at
December 31, 2006, or would not be significant in relation to Flexsys'
financial position at December 31, 2006, or its results of operations for the
year then ended.
Litigation costs related to all of the above mentioned actions and lawsuits
amounted to approximately $ 5,500 in 2006.
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OTHER COMMITMENTS
During fiscal 2000, Flexsys sold its Akron, Ohio facility and subsequently
leased it back under an operating lease. This transaction resulted in a
deferred gain of $ 5,900, which is being amortized over the 15-year lease
term.
Future minimum lease payments under the lease of its Akron, Ohio facility are
as follows:
2007 $ 834
2008 834
2009 834
2010 834
2011 834
Thereafter 2,629
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TOTAL $ 6,799
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Related rent expense was $ 834 for each of the years ended December 31, 2006,
2005 and 2004, respectively.
In addition to the lease of the Akron facility, the Company leases certain
facilities and equipment under operating leases. Total rental expense on these
other operating leases was $ 73, $ 185 and $ 234 for the years ended December
31, 2006, 2005 and 2004, respectively. Future rental expense under current
operating leases is considered immaterial.
At December 31, 2006, Flexsys had various property, plant and equipment and
raw material supply purchase commitments amounting to $ 80,250 which are
scheduled for payment within 12 months.
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