Exhibit 99.2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the consolidated financial statements and accompanying notes thereto
included in Item 8 of this Form 10-K.
OVERVIEW
Solutia's reportable segments and their major products are as
follows:
PERFORMANCE PRODUCTS INTEGRATED NYLON
-------------------- ----------------
SAFLEX(R) plastic interlayers Nylon intermediate "building block" chemicals
LLUMAR(R), VISTA(R), GILA(R) and Nylon polymers, including VYDYNE(R) and
FORMULA ONE PERFORMANCE ASCEND(R)
AUTOMOTIVE FILM(R) professional and
retail window films Carpet fibers, including the WEAR-DATED(R)
and ULTRON(R) brands
THERMINOL(R) heat transfer fluids
Industrial nylon fibers
SKYDROL(R) aviation hydraulic fluids and
SKYKLEEN(R) brand of aviation solvents
ASTROTURF(R), CLEAN MACHINE(R) and
CLEAR PASS(TM) entrance matting and
automotive spray suppression flaps
Solutia evaluates the performance of its reportable segments based on
segment profit, defined as earnings before interest expense and income taxes
("EBIT"), which includes marketing, administrative, technological and
amortization expenses, gains and losses from asset dispositions and
restructuring charges, certain equity earnings (losses) from affiliates,
reorganization items and other income and expense items that can be directly
attributable to the segment. Certain expenses and other items that are managed
outside of the segments or cannot be directly attributable to the segment are
excluded. These unallocated items consist primarily of corporate expenses,
adjustments to LIFO valuation reserve, equity earnings from affiliates, other
income and expense items, reorganization items, gains and losses from asset
dispositions and restructuring charges that are not directly attributable to
the operating segment. There were no inter-segment sales in the periods
presented below. See Note 22 to the consolidated financial statements for
further information.
Summary of Significant 2006 Events
Senior Management Changes
- -------------------------
Solutia has continued to restructure its senior management team
during 2006. In January 2006, Kent Davies joined Solutia as Senior Vice
President and President, CPFilms. Mr. Davies leads Solutia's CPFilms business
with responsibility for all commercial, operational and strategic aspects of
the business. On February 22, 2006, Jeffry N. Quinn, Solutia's President and
Chief Executive Officer, was elected by the board of directors as Chairman of
the Board of Solutia. In connection with Mr. Quinn's election as Chairman of
the Board, Paul H. Hatfield was named as the lead non-employee director.
Reorganization Strategy
- -----------------------
In 2006, Solutia continued its stated reorganization strategy with a
focus on the principal objectives of (i) managing the businesses to enhance
Solutia's performance; (ii) making changes to Solutia's asset portfolio to
maximize the value of the estate; (iii) achieving reallocation of "legacy
liabilities"; and (iv) negotiating an appropriate capital structure. Solutia
took steps in 2006 to enhance its financial performance including using the
tools of Chapter 11 and making changes to its asset portfolio, as explained
below. Solutia also continues to pursue a reallocation of legacy liabilities
in the Chapter 11 proceeding through negotiations with the other constituents
in the Chapter 11 case. Solutia continues to work to establish a
1
proper capital structure upon emergence from Chapter 11. However, as a result
of the numerous uncertainties and complexities inherent in Solutia's Chapter
11 proceedings, its ability and timing of emergence from Chapter 11 are
subject to significant uncertainty.
PERFORMANCE ENHANCEMENT
Solutia benefited in 2006 from several actions implemented earlier in
the Chapter 11 reorganization process designed to enhance its performance.
These included implementing significant general and administrative expense
reductions; increasing performance-based compensation and benefits programs;
making key senior management changes; initiating a cost reduction program at
Solutia's operating sites focused on actions such as lean manufacturing
techniques, yield improvement, maintenance savings and utilities optimization;
and implementing an enterprise-wide procurement effort.
Solutia amended its DIP credit facility on March 17, 2006 with
Bankruptcy Court approval. This amendment, among other things, (i) increased
the DIP credit facility from $525 million to $825 million; (ii) extended the
term of the DIP credit facility from June 19, 2006 to March 31, 2007; and
(iii) decreased the interest rate on the term loan component of the DIP credit
facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points.
On July 26, 2006, Solutia's indirect 100% owned subsidiary Solutia
Services International S.C.A./Comm. V.A. ("SSI"), a subsidiary of SESA,
entered into a (euro)200 million Facility Agreement (the "Facility Agreement")
that closed on August 1, 2006. SESA used the proceeds from the Facility
Agreement to refinance all of its (euro)200 million of 10 percent Euronotes
due 2008 (the "Euronotes") on August 1, 2006. The refinancing significantly
reduced the fixed interest rate of 10 percent to a lower adjustable rate
structure of EURIBOR plus 275 basis points, which was 6.31 percent at December
31, 2006.
Solutia expects that both of these refinancings will provide greater
flexibility in executing Solutia's reorganization strategy along with
significant interest savings.
A key element of Solutia's reorganization strategy is a significantly
more proactive commercial approach, one that recognizes that the long-term
success of its customers requires a strong and dependable supplier. This new
commercial perspective strives for a true partnership and is not based on the
premise that the suppliers subsidize investments in materials, technology or
people. Solutia's commercial approach has better managed with customers the
risk of movements in the oil and energy markets, in some cases via formula
pricing, to ensure the value chain remains connected to key raw material and
energy cost inputs. Solutia intends to ensure the long term success of our
customers by pricing its products adequately to fund customer-driven
technology and innovation resulting in a stream of highly innovative and
unique products and services. This commercial approach benefited the Company
significantly in 2006, as the Company was able to expand operating margins,
even though raw materials were approximately $91 million higher than 2005.
PORTFOLIO EVALUATION
Solutia's stated strategy is to build a portfolio of high-potential
businesses that can consistently deliver returns in excess of Solutia's cost
of capital. As part of this strategy, Solutia made several changes to re-shape
its asset portfolio in 2006. On March 1, 2006, pursuant to a stock purchase
agreement among Solutia, Vitro and Vitro Plan, a wholly-owned subsidiary of
Vitro, Solutia acquired Vitro Plan's 51 percent stake in Quimica (originally
formed in 1996 as a joint venture between Vitro, Vitro Plan, and Monsanto) for
approximately $20 million in cash. As a result of this acquisition, Solutia
became the sole owner of Quimica and its plastic interlayer plant located in
Puebla, Mexico.
In addition, SESA sold its pharmaceutical services business to
Dishman Pharmaceuticals and Chemicals Ltd. ("Dishman") pursuant to a Stock and
Asset Purchase Agreement on August 22, 2006. Under the terms of the agreement,
Dishman purchased 100 percent of the stock of the pharmaceutical services
business, for $77 million.
On February 27, 2007, Solutia reached a definitive agreement to
purchase Akzo Nobel's stake in the Flexsys joint venture. Solutia and Akzo
Nobel have entered into a letter agreement committing the parties to execute
the definitive agreement upon completion of consultation with Dutch employee
works council representatives. The proposed transaction is subject to approval
by the United States Bankruptcy Court, receipt of required regulatory
approvals, finalizing the definitive purchase agreement for Akzo Nobel's
Crystex manufacturing operations in Japan and the fulfillment of other
customary closing conditions. Solutia will fund the purchase via $150 million
of funding under the January 2007 amended DIP credit facility and additional
funding through Flexsys.
2
In addition, Solutia continues to evaluate its options, including
potential sales, with respect to certain of its non-core businesses and assets
in order to maximize the value of such non-core assets for stakeholders.
REALLOCATION OF LEGACY LIABILITIES
The Plan and Disclosure Statement provide for, among other things,
the reallocation of certain Legacy Liabilities among Solutia, Monsanto and
Pharmacia and sets forth the treatment that various constituencies in the
Chapter 11 Cases would receive under the Plan. See Note 1 to the accompanying
consolidated financial statements for further description of the Plan and
Disclosure Statement, as well as a summary of developments in Solutia's
ongoing Chapter 11 bankruptcy case.
Summary Results of Operations
The discussion below and accompanying consolidated financial
statements have been prepared in accordance with Statement of Position 90-7,
Financial Reporting by Entities in Reorganization Under the Bankruptcy Code
("SOP 90-7"), and on a going concern basis, which assumes the continuity of
operations and reflects the realization of assets and satisfaction of
liabilities in the ordinary course of business. However, as a result of the
Chapter 11 bankruptcy proceedings, such realization of assets and liquidation
of liabilities are subject to a significant number of uncertainties.
Net sales and operating income (loss) of Solutia are as follows for
the years ended December 31:
- ----------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Net Sales.................................................................... $2,795 $2,645 $2,529
====== ====== ======
Operating Income (Loss):
Performance Products Segment Profit (a).................................. $ 130 $ 126 $ 74
Integrated Nylon Segment Loss (a)........................................ (3) (5) (21)
Add: LIFO adjustment................................................ (3) (39) (45)
Add: Corporate Expenses............................................. (41) (64) (89)
Add: Equity (Earnings) Loss from Affiliates, Other (Income) Expense,
and Reorganization Items, net included in Segment Profit (Loss)..... 4 19 --
------ ------ ------
Operating Income (Loss)...................................................... $ 87 $ 37 $ (81)
====== ====== ======
Gains (Charges) included in Operating Income (Loss).......................... $ 7 $ (14) $ (62)
====== ====== ======
- ----------------------------------------------------------------------------------------------------------------------
<FN>
(a) See Note 22 to the accompanying consolidated financial statements for
description of the computation of operating segment profit (loss).
The $150 million, or 6 percent, increase in net sales in 2006
reflects higher average selling prices of approximately 6 percent. Solutia's
net sales for 2005 increased by $116 million, or 5 percent, as compared to
2004. This increase in net sales reflected higher average selling prices of
approximately 11 percent, partially offset by lower sales volumes of
approximately 6 percent.
As indicated in the preceding table, operating results for each year
were affected by various charges which are described in greater detail in the
"Results of Operations" section below. Operating income improved by $50
million in 2006 as compared to 2005 primarily as a result of higher net sales,
controlled spending, and lower adjustments to the Company's LIFO reserve, as
are more fully discussed below, partially offset by higher overall raw
material and energy costs of approximately $91 million. The 2005 results as
compared to the 2004 results improved by $118 million, primarily as a result
of higher net sales and controlled spending, partially offset by higher raw
material and energy costs of approximately $214 million. Solutia's policy of
utilizing a LIFO inventory methodology for domestic inventories results in the
full recognition of increases in raw material costs in the immediate period.
The considerable increases in raw material costs noted above resulted in
substantial adjustments to the Company's LIFO reserve in 2004, 2005, and, to a
lesser extent, 2006.
Financial Information
- ---------------------
Summarized financial information concerning Solutia and subsidiaries
in reorganization and subsidiaries not in reorganization as of and for the
year-ended December 31, 2006 is presented as follows:
3
Solutia and Solutia and
Subsidiaries in Subsidiaries not in Subsidiaries
Reorganization Reorganization Eliminations Consolidated
-------------- -------------- ------------ ------------
Net sales................................. $ 2,360 $ 893 $ (458) $ 2,795
Operating income.......................... 2 61 24 87
Net income................................ 2 86 (86) 2
Total assets.............................. 1,767 849 (557) 2,059
Liabilities not subject to compromise..... 1,209 470 (64) 1,615
Liabilities subject to compromise......... 1,963 -- (114) 1,849
Total shareholders' equity (deficit)...... (1,405) 379 (379) (1,405)
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions in certain circumstances that affect amounts
reported in the accompanying consolidated financial statements and related
footnotes. In preparing these consolidated financial statements, Solutia has
made its best estimates of certain amounts included in these consolidated
financial statements. However, application of these accounting policies
involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, actual results could differ materially from
these estimates. Management has discussed the development, selection and
disclosure of these critical accounting policies and estimates with the Audit
and Finance Committee of Solutia's Board of Directors.
Solutia believes that the estimates, assumptions and judgments
involved in the accounting policies described below have the greatest
potential impact on the consolidated financial statements and require
assumptions that can be highly uncertain at the time the estimate is made.
Solutia considers the following items to be its critical accounting policies:
o Environmental Remediation
o Self-Insurance
o Income Taxes
o Impairment of Long-Lived Assets
o Impairment of Goodwill and Indefinite-Lived Intangible Assets
o Pension and Other Postretirement Benefits
Solutia also has other significant accounting policies. Solutia
believes that, compared to the critical accounting policies listed above, the
other policies either do not generally require estimates and judgments that
are as difficult or as subjective, or are less likely to have a material
impact on the reported results of operations for a given period.
Environmental Remediation
With respect to environmental remediation obligations, Solutia's
policy is to accrue costs for remediation of contaminated sites in the
accounting period in which the obligation becomes probable and the cost is
reasonably estimable. Cost estimates for remediation are developed by
assessing, among other items, (i) the extent of Solutia's contribution to the
environmental matter; (ii) the number and financial viability of other
potentially responsible parties; (iii) the scope of the anticipated
remediation and monitoring plan; (iv) settlements reached with governmental or
private parties; and (v) Solutia's past experience with similar matters.
Solutia's estimates of the environmental remediation reserve requirements
typically fall within a range. If Solutia believes no best estimate exists
within a range of possible outcomes, in accordance with existing accounting
guidance, the minimum loss is accrued. Environmental liabilities are not
discounted, and they have not been reduced for any claims for recoveries from
third parties.
These estimates are critical because Solutia must forecast
environmental remediation activity into the future, which is highly uncertain
and requires a large degree of judgment. Therefore, the environmental reserves
may materially differ from the actual liabilities if Solutia's estimates prove
to be inaccurate, which could materially affect results of operations in a
given period. Uncertainties related to recorded environmental liabilities
include changing governmental policy and regulations, judicial proceedings,
the number and financial viability of other potentially responsible parties,
the method and extent of remediation and future changes in technology. Because
of these uncertainties, the potential liability for existing
4
environmental remediation reserves not subject to compromise may range up to
two times the amounts recorded. These valuations of future environmental costs
do not contemplate the uncertainties inherent in Solutia's bankruptcy
proceedings, as the potential impact of the Chapter 11 proceedings upon future
environmental costs cannot be reasonably determined at this time. Due to these
uncertainties, certain of the environmental liabilities have been classified
as subject to compromise in the Consolidated Statement of Financial Position
as of December 31, 2006, and have been excluded from the aforementioned range
of possible outcomes of existing environmental remediation reserves. The
potential liability for existing environmental remediation reserves classified
as subject to compromise, if ultimately retained by Solutia as part of an
accepted plan of reorganization, could be materially different than amounts
recorded. The estimate for environmental liabilities is a critical accounting
estimate for both reportable segments.
Self-Insurance
Solutia maintains self-insurance reserves to cover its estimated
future legal costs, settlements and judgments related to workers'
compensation, product, general, automobile and operations liability claims
that are less than policy deductible amounts or not covered by insurance.
Self-insured losses are accrued based upon estimates of the aggregate
liability for claims incurred using certain actuarial assumptions followed in
the insurance industry, Solutia's historical experience and certain
case-specific reserves as required, including estimated legal costs. The
maximum extent of the self-insurance provided by Solutia and related insurance
recoveries are dependent upon a number of factors including the facts and
circumstances of individual cases and the terms and conditions of the
commercial policies. Solutia has purchased commercial insurance in order to
reduce its exposure to workers' compensation, product, general, automobile and
property liability claims. Policies for periods prior to the Solutia Spinoff
are shared with Pharmacia. This insurance has varying policy limits and
deductibles. When recovery from an insurance policy is considered probable, a
receivable is recorded. Self-insurance reserve estimates are critical because
changes to the actuarial assumptions used in the development of these reserves
can materially affect earnings in a given period and Solutia must forecast
loss activity into the distant future which is highly uncertain and requires a
large degree of judgment.
Actuarial reserve indications are projections of the remaining future
payments for workers' compensation, product, general, automobile and
operations liability claims for which Solutia is legally responsible. These
projections are made in the context of an uncertain future where variations
between estimated and actual amounts are attributable to many factors,
including changes in operations, changes in judicial environments, shifts in
the types or timing of the reporting of claims, changes in the frequency or
severity of losses and random chance. The actuarial estimates of the reserve
requirements fall within a range. The actuary's best estimate of the liability
is generally near the middle of the actuary's range; accordingly, Solutia has
recorded the liability at this level. The range of outcomes is not material to
the consolidated financial statements for losses that are not stayed by the
Chapter 11 proceedings. These valuations of future self-insurance costs do not
contemplate the uncertainties inherent in Solutia's bankruptcy proceedings, as
the potential impact of the Chapter 11 proceedings upon future self-insurance
costs cannot be reasonably determined at this time. Due to these
uncertainties, certain of the self-insurance liabilities have been classified
as subject to compromise in the Consolidated Statement of Financial Position
as of December 31, 2006, and have been excluded from the range of possible
outcomes of existing self-insurance reserves. The potential liability for
existing self-insurance liabilities classified as subject to compromise, if
ultimately retained by Solutia as part of an accepted plan of reorganization,
could be materially different than amounts recorded. The estimate for
self-insurance liabilities is a critical accounting estimate for both
reportable segments.
Income Taxes
Solutia accounts for income taxes using the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences of temporary differences between the carrying
amounts and tax bases of assets and liabilities at enacted rates. Solutia
bases its estimate of deferred tax assets and liabilities on current tax laws
and rates and, in certain cases, business plans and other expectations about
future outcomes. Solutia records a valuation allowance to reduce its deferred
tax assets to the amount that is more likely than not to be realized. While
Solutia has considered future taxable income and ongoing prudent and feasible
tax planning strategies in assessing the need for the valuation allowance, in
the event Solutia were to determine that it would be able to realize its
deferred tax assets in the future in excess of its net recorded amount, an
adjustment to the deferred tax asset would increase income in the period such
determination was made. Likewise, should Solutia determine that it would not
be able to realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in the period
such determination was made. The consolidated financial statements include
increases in valuation allowances as a result of uncertainty created by
Solutia's Chapter 11 bankruptcy filing.
5
Solutia's accounting for deferred tax consequences represents
management's best estimate of future events that can be appropriately
reflected in the accounting estimates. Changes in existing tax laws,
regulations, rates and future operating results may affect the amount of
deferred tax liabilities or the valuation of deferred tax assets over time.
Impairment of Long-Lived Assets
Impairment tests of long-lived assets, including finite-lived
intangible assets, are made when conditions indicate the carrying value may
not be recoverable. The carrying value of a long-lived asset is considered
impaired when the total projected undiscounted cash flows from such asset are
separately identifiable and are less than its carrying value. Solutia's
estimate of the cash flows is based on information available at that time
including these and other factors: sales forecasts, customer trends, operating
rates, raw material and energy prices and other global economic indicators and
factors. If an impairment is indicated, the asset value is written down to its
fair value based upon market prices or, if not available, upon discounted cash
value, at an appropriate discount rate determined by Solutia to be
commensurate with the risk inherent in the business model. These estimates are
critical because changes to Solutia's assumptions used in the development of
the impairment analyses can materially affect earnings in a given period and
Solutia must forecast cash flows into the future which is highly uncertain and
requires a significant degree of judgment. The consolidated financial
statements do not reflect any adjustments for the impairment of long-lived
assets that may result as part of the approval and implementation of a plan of
reorganization to be submitted as part of the Chapter 11 bankruptcy process.
The estimate for impairment of long-lived assets is a critical accounting
estimate for both reportable segments.
Impairment of Goodwill and Indefinite-Lived Intangible Assets
Goodwill and indefinite-lived intangible assets are reviewed for
impairment annually under the provisions of Statement of Financial Accounting
Standard ("SFAS") No. 142, Goodwill and Other Intangible Assets. However, as
required by SFAS No. 142, impairment analyses are performed more frequently if
changes in circumstances indicate the carrying value may not be recoverable
during the intervening period between annual impairment tests. Solutia
performs the review for impairment at the reporting unit level. The impairment
assessment is completed by determining the fair values of the reporting units
using income and market multiple approaches and comparing those fair values to
the carrying values of the reporting units. If the fair value of a reporting
unit is less than its carrying value, Solutia then allocates the fair value of
the reporting unit to all the assets and liabilities of that reporting unit.
The excess of the fair value of the reporting unit over the amounts assigned
to its assets and liabilities is the implied fair value of the goodwill. If
the carrying value of the reporting unit's goodwill exceeds the implied fair
value of that goodwill, an impairment loss is recognized for this
differential. This valuation process involves assumptions based upon
management's best estimates and judgments that approximate the market
conditions experienced at the time the impairment assessment is made. These
assumptions include but are not limited to earnings and cash flow projections,
discount rate and peer company comparability. Actual results may differ from
these estimates due to the inherent uncertainty involved in such estimates.
The consolidated financial statements do not reflect any adjustments for the
impairment of goodwill and indefinite-lived intangible assets that may result
as part of the approval and implementation of a plan of reorganization to be
submitted as part of the Chapter 11 bankruptcy process. The estimate for
impairment of goodwill and indefinite-lived intangible assets is a critical
accounting estimate for the Performance Products reportable segment. The
Integrated Nylon reportable segment does not have goodwill or indefinite-lived
intangible assets.
Pension and Other Postretirement Benefits
Under the provisions of SFAS No. 87, Employers' Accounting for
Pensions, and SFAS No. 106, Employers' Accounting for Postretirement Benefits
Other Than Pensions, measurement of the obligations under the defined benefit
pension plans and the other postemployment benefit ("OPEB") plans are subject
to several significant estimates. These estimates include the rate of return
on plan assets, the rate at which the future obligations are discounted to
value the liability and health care cost trend rates. Additionally, the cost
of providing benefits depends on demographic assumptions including
retirements, mortality, turnover and plan participation. Solutia typically
uses actuaries to assist it in preparing these calculations and determining
these assumptions. Solutia's annual measurement date is December 31 for both
the pension and OPEB plans.
The expected long-term rate of return on pension plan assets
assumption was 8.75 percent and 9.00 percent in 2006 and 2005, respectively.
The expected long-term rate of return on pension plan assets assumption is
based on the target asset allocation policy and the expected future rates of
return on these assets. A hypothetical 25 basis point change in the assumed
long-term rate of return would result in a change of approximately $2 million
to pension expense.
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The discount rate used to remeasure the pension plans was 5.75 in
2006 and 5.50 percent in 2005, and the discount rates to remeasure the other
postretirement benefit plans were 5.75 percent in 2006 and 5.50 percent in
2005. Solutia establishes its discount rate based upon the internal rate of
return for a portfolio of high quality bonds with maturities consistent with
the nature and timing of future cash flows for each specific plan. A
hypothetical 25 basis point change in the discount rate for Solutia's pension
plans results in a change of approximately $19 million in the projected
benefit obligation and less than a $1 million change in pension expense. A
hypothetical 25 basis point change in the discount rate for Solutia's OPEB
plans results in a change of approximately $8 million in the accumulated
benefit obligation and less than $1 million change to OPEB expense.
Solutia estimated the five-year assumed trend rate for healthcare
costs in 2006 to be 9 percent with the ultimate trend rate for healthcare
costs grading by 1 percent each year to 5 percent by 2010 and remaining at
that level thereafter. A 1 percent change in the assumed health care cost
trend rate would have changed the postretirement benefit obligation by $3
million as of December 31, 2006 and would have had a less than $1 million
change to OPEB expense in 2006. Solutia's costs for postretirement medical
benefits are capped for many current retirees and active employees; therefore,
the impact of this hypothetical change in the assumed health care cost trend
rate is limited.
These valuations of future pension and other postretirement costs do
not include the uncertainties inherent in Solutia's Chapter 11 bankruptcy
proceedings, as the potential impact of the Chapter 11 proceedings upon future
spending for these items cannot be reasonably determined at this time. Due to
these uncertainties, all pension and postretirement liabilities related to
Solutia entities that have filed Chapter 11 bankruptcy have been classified as
subject to compromise in the Consolidated Statement of Financial Position as
of December 31, 2006.
RESULTS OF OPERATIONS
Performance Products
- ----------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Net Sales.................................................................... $1,064 $1,003 $ 941
====== ====== ======
Segment Profit............................................................... $ 130 $ 126 $ 74
====== ====== ======
Net Charges and Reorganization Items, net included in Segment Profit .... $ (12) $ (10) $ (23)
====== ====== ======
- ----------------------------------------------------------------------------------------------------------------
The $61 million, or 6 percent, increase in 2006 net sales compared to
2005 resulted from higher selling prices of approximately 4 percent and
increased sales volumes of approximately 2 percent. Higher average selling
prices were experienced in SAFLEX(R) plastic interlayer products, LLUMAR(R)
and VISTA(R) professional film products and THERMINOL(R) heat transfer fluids.
Increased sales volumes were experienced in SAFLEX(R) plastic interlayer
products, due to increasing demand and inclusion of sales from the Puebla,
Mexico plant for ten months during 2006 as a result of the Quimica acquisition
as further discussed in Note 4, and, LLUMAR(R) and VISTA(R) professional film
products, partially offset by lower volumes in THERMINOL(R) heat transfer
fluids.
The $62 million, or 7 percent, increase in 2005 net sales compared to
2004 resulted from higher selling prices of approximately 4 percent and
increased sales volumes of approximately 3 percent. Higher average selling
prices were experienced in SAFLEX(R) plastic interlayer products, LLUMAR(R)
and VISTA(R) professional window film products and THERMINOL(R) heat transfer
fluids. Increased sales volumes were experienced in SAFLEX(R) plastic
interlayer products and THERMINOL(R) heat transfer fluids, partially offset by
lower volumes due to the cessation of Solutia's chlorobenzenes operations in
2004.
The $4 million, or 3 percent, improvement in 2006 segment profit in
comparison to 2005 resulted principally from higher net sales, partially
offset by higher raw material and energy costs of approximately $25 million
and higher charges. Segment profit in 2006 included $8 million of
reorganization items, which consisted primarily of restructuring charges
related to the shut down of operations at the Queeny Plant in St. Louis,
Missouri and other non-strategic operations, as well as $4 million of
restructuring charges consisting principally of severance costs for non-debtor
entities that was not included within reorganization items. Segment profit in
2005 included $8 million of reorganization items, which consisted primarily of
adjustments to record certain pre-petition claims at estimated amounts of the
allowed claims, as well as $2 million of
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restructuring charges consisting principally of severance costs for non-debtor
entities that was not included within reorganization items.
The $52 million improvement in 2005 segment profit in comparison to
2004 resulted principally from lower charges and higher net sales, partially
offset by higher raw material and energy costs. Segment profit in 2005
included $8 million of reorganization items, which consisted primarily of
adjustments to record certain pre-petition claims at estimated amounts of the
allowed claims, as well as $2 million of restructuring charges consisting
principally of severance costs for non-debtor entities that was not included
within reorganization items. Segment profit in 2004 included $21 million of
charges, including $18 million of restructuring costs related principally to
the closure of Solutia's chlorobenzenes operations as well as certain other
non-strategic operations, and $3 million of asset write-offs and repairs and
maintenance charges resulting from the impact of Hurricane Ivan at the
Martinsville, Virginia plant. Segment profit in 2004 also included $2 million
of reorganization items involving primarily severance related costs incurred
as part of Solutia's overall reorganization process.
Integrated Nylon
- ----------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Net Sales.................................................................... $1,731 $1,642 $1,588
====== ====== ======
Segment Loss................................................................. $ (3) $ (5) $ (21)
====== ====== ======
Net Charges and Reorganization Items, net included in Segment
Loss................................................................... $ (6) $ (21) $ (5)
====== ====== ======
- ----------------------------------------------------------------------------------------------------------------
The $89 million, or 5 percent, increase in 2006 net sales as compared
to 2005 resulted primarily from higher average selling prices of approximately
8 percent, partially offset by lower sales volumes of approximately 3 percent.
Average selling prices increased in all businesses as a result of favorable
market conditions and in response to the escalating cost of raw materials.
Lower sales volumes were experienced within carpet fibers in 2006 and sales
volumes were impacted by the exit from the unprofitable acrylic fibers
operations in the second quarter 2005. These volume reductions were partially
offset by higher sales volumes in intermediate chemicals and nylon plastics
and polymers.
The $54 million, or 3 percent, increase in 2005 net sales as compared
to 2004 resulted primarily from higher average selling prices of approximately
16 percent, partially offset by lower sales volume of approximately 13
percent. Average selling prices increased in all businesses in response to the
escalating cost of raw materials. Sales volumes were negatively affected by
Hurricanes Dennis, Katrina and Rita, which forced certain manufacturing
facilities to reduce production rates due to the shortages of certain raw
materials. Furthermore, Solutia declared force majeure in late September 2005
for certain products within its Integrated Nylon segment as a result of the
these raw material and utility supply limitations some of which are a result
of force majeure declarations by certain of Solutia's suppliers. The force
majeure declaration was removed by Solutia in late November 2005. In addition,
as a precaution for Hurricane Rita, the manufacturing facility in Alvin, Texas
was forced to completely shut down its operations. This production slowdown
did not allow Solutia to fully meet customer demand while certain customers
were unable to take product due to their own operational issues resulting from
the hurricanes. Sales volumes were also adversely affected as a result of
Solutia's shutdown of the acrylic fibers operations in the second quarter 2005
but were partially offset because certain Solutia produced intermediate
chemicals previously supplied to the acrylic fiber operations were sold into
the intermediates merchant market. In addition, sales volumes were negatively
impacted in 2005 as a result of contract rejections and terminations in the
intermediate chemicals business in 2004.
Segment loss decreased $2 million from a segment loss of $5 million
in 2005 to a segment loss of $3 million in 2006 primarily as a result of
higher net sales offset by higher raw material and energy costs of
approximately $99 million and unfavorable manufacturing costs. The unfavorable
manufacturing costs were precipitated by a manufacturing interruption incurred
at the Alvin, Texas facility, resulting in a significant turnaround being
accelerated in its timing, as well as extended in its duration, during the
first quarter of this year. Manufacturing costs were also unfavorably impacted
by fixed cost remaining in the business as a result of exiting the
unprofitable acrylic fibers business in second quarter 2005. In addition, the
shift in product mix from less carpet sales to greater amounts of intermediate
chemicals had a negative impact on the utilization rates of the segment.
Segment loss in 2006 also included reorganization items of $6
million comprised of $3 million of decommissioning and dismantling costs
primarily due to the shut-down of the acrylic fibers business in 2005, $2
million of asset write-downs related to the exiting of various unprofitable
businesses within the segment and $1 million of severance
8
and retraining costs. The reorganization items in 2006 decreased by $15
million from 2005 due to lower shut-down costs as segment profit in 2005
consisted of $20 million principally to shut-down the acrylic fibers business.
Segment losses decreased by $16 million in 2005 as compared to 2004
primarily as a result of higher net sales, partially offset by higher raw
material and energy costs of approximately $189 million. In addition, segment
profitability was affected by the aforementioned hurricanes experienced in
2005. Although Solutia's manufacturing facilities did not suffer significant
physical damage, the manufacturing facility in Alvin, Texas was forced to
completely shut down its operations ahead of Hurricane Rita as a precaution.
Further, reduced availability of key raw material and energy sources affected
the ability of certain plants to operate at normal production levels. As a
result, Solutia experienced significant costs involved in shutting down and
restarting these operations, significant unabsorbed fixed costs and lost sales
volumes. Furthermore, the aforementioned declaration of force majeure by
Solutia and certain of its customers as a result of the hurricanes had a
negative impact on segment profit in 2005. In total, the amount of these
aforementioned hurricane related costs was approximately $36 million in 2005.
The hurricanes also resulted in a significant increase in raw material and
energy prices during 2005; however, Solutia was successful in passing along
these increases in raw materials and energy costs.
Segment profit in 2005 also included reorganization items of $21
million comprised of $20 million principally due to the shut-down of the
acrylic fibers business and $1 million of other restructuring charges. The
shut-down costs included $12 million of asset write-downs, $7 million of
decontamination and dismantling costs and $4 million of severance and
retraining costs, partially offset by a $3 million gain from the sale of
certain acrylic fibers assets. Segment profit in 2004 was affected by $5
million of charges resulting from the impact of Hurricane Ivan at the
Pensacola, Florida and Foley, Alabama manufacturing facilities involving
primarily repairs and maintenance costs, as well as asset write-offs.
Corporate Expenses
- ----------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Corporate Expenses........................................................... $ 41 $ 64 $ 89
====== ====== ======
Net Gains (Charges) included in Corporate Expenses....................... $ 11 $ (13) $ (35)
====== ====== ======
- ----------------------------------------------------------------------------------------------------------------
Corporate expenses decreased by $23 million, or 36 percent, in 2006
as compared to 2005 principally due to lower charges. After consideration of
the net gains and charges recorded in 2006 and 2005, corporate expenses were
comparable year over year. Included in 2006 gains were a $20 million gain that
resulted from the reversal of a litigation reserve with respect to a
litigation matter that was decided favorably (as further described in Note 20
of the accompanying consolidated financial statements), partially offset by a
$9 million environmental charge that was precipitated by the notification by a
third-party of its intent to terminate a tolling agreement at one of Solutia's
facilities outside the U.S. that will likely result in the cessation of
operations at that site. The $13 million charge recorded in 2005 resulted from
curtailment and settlement activities as a result of amendments to Solutia's
pension and postretirement plans (as more fully described in Note 16 to the
accompanying consolidated financial statements).
Corporate expenses decreased by $25 million, or 28 percent, in 2005
as compared to 2004 principally due to lower charges and other declines in
corporate spending. Included in 2005 and 2004 corporate expenses were $13
million and $35 million, respectively, of net pension and other postretirement
benefit plan curtailments and settlements (as more fully described in Note 16
to the accompanying consolidated financial statements). In addition, Solutia
experienced continued benefits in 2005 of cost reduction measures taken in the
second half of 2004 as part of implementing its overall reorganization
strategy, partially offset by a modest increase in legal costs.
9
Equity Earnings (Loss) from Affiliates
- --------------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Flexsys Equity Earnings (Loss)................................................... $ 37 $ 35 $ (20)
Astaris LLC Equity Earnings (Loss)............................................... -- 59 (7)
Other Equity Earnings from Affiliates included in Reportable Segment
Profit (Loss)................................................................ 1 2 1
------- ------- -------
Equity Earnings (Loss) from Affiliates........................................... $ 38 $ 96 $ (26)
======= ======= =======
Gains (Charges) included in Equity Earnings (Loss) from Affiliates........... $ (4) $ 52 $ (49)
======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Equity earnings (loss) from affiliates were affected by various items
in both 2006 and 2005. During 2006, equity earnings from affiliates included
$3 million in restructuring charges related to production asset
rationalization and plant closures and $2 million related to asset impairment
charges, partially offset by a non-operational gain of $1 million due to the
reversal of a litigation reserve related to the Flexsys joint venture. During
2005, equity earnings from affiliates were impacted by a $50 million net gain
realized in the Astaris joint venture from the sale of a majority of its
assets to Israel Chemicals Limited ("ICL"), who purchased substantially all of
the operating assets of Astaris for $255 million. Equity earnings in 2005 also
included $2 million of net gains related to the Flexsys joint venture
comprising a non-operational gain of $5 million, partially offset by $3
million of various restructuring charges. Flexsys earnings for 2006 were
favorably impacted by a reduction in administrative expenses in comparison to
2005.
Equity earnings (loss) from affiliates were affected by various items
in both 2005 and 2004. During 2005, equity earnings from affiliates were
impacted by a $50 million net gain realized in the Astaris joint venture from
the sale of a majority of its assets. Under the terms of the agreement, ICL
purchased substantially all of the operating assets of Astaris for $255
million, subject to certain purchase price adjustments. Equity earnings in
2005 also included $2 million of net gains related to the Flexsys joint
venture comprising a non-operational gain of $5 million, partially offset by
$3 million of various restructuring charges. During 2004, equity loss from
affiliates was negatively affected by $49 million in restructuring and
litigation charges resulting from (i) restructuring charges related to
production asset rationalization and certain plant closures at both the
Flexsys and Astaris joint ventures; (ii) severance charges at both the Flexsys
and Astaris joint ventures; and (iii) charges recorded by the Flexsys joint
venture related to litigation contingencies. Also included in the 2005 results
compared to 2004 were higher earnings from both Astaris and Flexsys. Astaris'
earnings improved as a result of improved product mix due to the 2004
restructuring activities discussed above and higher average net selling
prices. Flexsys' earnings improved primarily due to higher average net selling
prices.
Interest Expense
- --------------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Interest Expense............................................................. $ 100 $ 79 $ 108
======= ======= =======
Charges included in Interest Expense..................................... $ (4) $ -- $ (25)
======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
The $21 million, or 27 percent, increase in interest expense in 2006
in comparison to 2005 resulted principally from higher debt outstanding in
2006 than in 2005, partially offset by lower interest rates due to the March
amendment of its DIP credit facility and the July refinancing of the Euronotes
and subsequent partial pay down. In addition, results in 2006 included a $3
million charge related to SESA's Euronotes refinancing and a $1 million charge
related to the amendment of the DIP credit facility. The amount of annual
contractual interest not recorded was $32 million in both 2006 and 2005.
The $29 million, or 27 percent, decrease in interest expense in 2005
in comparison to 2004 resulted principally from the write-off of unamortized
debt issuance costs of $25 million in 2004. In addition, Solutia amended its
DIP financing agreement on June 1, 2005, which reduced the interest rate on
the term loan component of the DIP credit facility to LIBOR plus 4.25 percent
from the previous interest rate of the greater of the prime rate plus 4.0
percent or 8.0 percent. The amount of annual contractual interest not recorded
was $32 million in both 2005 and 2004.
10
Other Income, net
- --------------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Other Income, net............................................................ $ 16 $ 8 $ --
======= ======= =======
Other Income, net included in Reportable Segment Profit (Loss) .......... $ 9 $ 9 $ 1
======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Other income, net increased $8 million in 2006 as compared to 2005
primarily as a result of increased interest income due to higher cash balances
on hand during 2006. The $8 million increase in other income, net in 2005 as
compared to 2004 primarily resulted from the sale of various non-operating
assets in 2005 coupled with lower currency losses.
Reorganization Items, net
- --------------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Reorganization Items, net ................................................... $ 71 $ 49 $ 73
======= ======= =======
Reorganization Items, net included in Reportable Segment Profit (Loss) .. $ 14 $ 28 $ 2
======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Reorganization Items, net are presented separately in the
Consolidated Statement of Operations and represent items of income, expense,
gain, or loss that are realized or incurred by Solutia because it is in
reorganization under Chapter 11 of the U.S. Bankruptcy Code. Reorganization
items incurred in 2006 included $58 million of professional fees for services
provided by debtor and creditor professionals directly related to Solutia's
reorganization proceedings; $11 million of other reorganization charges
primarily involving costs incurred with exiting certain non-strategic
businesses; $4 million of expense provisions related to (i) employee severance
costs incurred directly as part of the Chapter 11 reorganization process and
(ii) a retention plan for certain Solutia employees approved by the Bankruptcy
Court; and a $2 million net gain from adjustments to record certain
pre-petition claims at estimated amounts of the allowed claims.
Reorganization items incurred in 2005 included $49 million of
professional fees for services provided by debtor and creditor professionals
directly related to Solutia's reorganization proceedings; a $31 million net
gain representing the difference between the settlement amount of certain
pre-petition obligations and the corresponding amounts previously recorded;
$12 million of expense provisions related to (i) employee severance costs
incurred directly as part of the Chapter 11 reorganization process and (ii) a
retention plan for certain Solutia employees approved by the Bankruptcy Court;
$10 million of net charges for adjustments to record certain pre-petition
claims at estimated amounts of the allowed claims; and $16 million of other
reorganization charges primarily involving costs incurred with exiting the
acrylic fibers operations, partially offset by a $7 million gain from the
reversal of the LIFO reserve associated with the inventory sold and/or written
off as part of the business shut down.
Income Tax Expense (Benefit)
- --------------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Income Tax Expense (Benefit) ................................................ $ 18 $ 10 $ (7)
======= ======= =======
Increase in Valuation Allowances included in Income Tax Expense (Benefit) $ 27 $ 12 $ 108
======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------
Solutia's effective income tax expense (benefit) rate was
approximately 47 percent in 2006 compared to approximately 77 percent in 2005.
Decreases in valuation allowances in 2006 were $(4) million, of which $27
million was recorded in Income Tax Expense (Benefit) in the Consolidated
Statement of Operations and $(31) million was recorded in Accumulated Other
Comprehensive Loss in the Consolidated Statement of Comprehensive Income
(Loss), as compared to increases in valuation allowances in 2005 of $21
million, of which $12 million was recorded in Income Tax Expense (Benefit) in
the Consolidated Statement of Operations and $9 million was recorded in Other
Comprehensive Loss in the Consolidated Statement of Comprehensive Income
(Loss). The change in the valuation allowances in both 2006 and 2005 were
provided principally for the U.S. deferred tax assets as a result of Solutia's
Chapter 11 bankruptcy filing (as more fully described in Note 13 to the
accompanying consolidated financial statements).
11
Solutia's effective income tax expense (benefit) rate was
approximately 77 percent in 2005 compared to approximately (2) percent in
2004. The above noted valuation allowance increases in 2005 and 2004 were the
primary differences in comparing the 2005 and 2004 rates.
Discontinued Operations
- --------------------------------------------------------------------------------------------------------------------------
(dollars in millions) 2006 2005 2004
---- ---- ----
Income (Loss) from Discontinued Operations, net of tax......................... $ 58 $ 8 $ (24)
======= ====== =======
- --------------------------------------------------------------------------------------------------------------------------
Income from discontinued operations consists of the results of
Solutia's pharmaceutical services and water treatment phosphonates businesses.
As described in Note 4 and Note 23 to the accompanying consolidated financial
statements, SESA sold its pharmaceutical services business to Dishman on
August 22, 2006 and DEQUEST(R), its water treatment phosphonates business to
Thermphos Trading GmbH on May 31, 2007. Included in the results of
discontinued operations for 2006 is a gain on the sale of the pharmaceutical
services business of $49 million as well as a tax gain of $5 million. The tax
gain resulted from the reversal of a valuation allowance established as a
result of the merger of CarboGen and AMCIS subsidiaries of the pharmaceutical
services business into one legal entity.
Income from discontinued operations increased $32 million in 2005 as
compared to 2004 primarily as a result of impairments in goodwill, long-lived
assets and indefinite-lived intangible assets in the pharmaceutical services
business in 2004 of $23 million, $12 million and $5 million, respectively.
These charges were precipitated by the declining estimates of forecasted
results given current economic and market conditions within the pharmaceutical
services business environment.
Cumulative Effect of Change in Accounting Principle
Asset Retirement Obligations
- ----------------------------
In March 2005, the FASB issued Interpretation No. 47, Accounting for
Conditional Asset Retirement Obligations - an interpretation of FASB Statement
No. 143 ("FIN 47"). FIN 47 clarifies that the term "conditional asset
retirement obligation" as used in Statement of Financial Accounting Standards
No. 143, Accounting for Asset Retirement Obligations ("SFAS No. 143"), refers
to a legal obligation to perform an asset retirement activity in which the
timing and (or) method of settlement are conditional on a future event that
may or may not be within the control of the entity. The obligation to perform
the asset retirement activity is unconditional even though uncertainty exists
about the timing and (or) method of settlement, including those that may be
conditional on a future event. Accordingly, an entity is required to recognize
a liability for the fair value of a conditional asset retirement obligation if
the fair value of the liability can be reasonably estimated. Uncertainty about
the timing and (or) method of settlement should be factored into the
measurement of the liability when sufficient information exists. FIN 47 also
clarifies when sufficient information to reasonably estimate the fair value of
an asset retirement obligation is considered available.
Upon adoption of SFAS No. 143 as of January 1, 2003, Solutia
identified certain conditional asset retirement obligations; however, these
obligations were not recorded due to uncertainties involved with the
determination of settlement timing. With the clarification outlined by FIN 47
for valuation of conditional asset retirement obligations, Solutia reevaluated
the valuation concerns involving settlement timing for these conditional asset
retirement obligations and accordingly reported an asset retirement obligation
of $7 million as of December 31, 2005. These obligations involve various
federal, state and local regulations and/or contractual obligations to
decontaminate and/or dismantle certain machinery and equipment, buildings, and
leasehold improvements at Solutia's various operating locations.
Asset retirement obligations were estimated for each of the Solutia's
operating locations, where applicable, based upon Solutia's current and
historical experience, adjusted for factors that a third-party would consider,
such as overhead, profit and market risk premium. Estimated obligations were
escalated based upon the anticipated timing of the related cash flows using an
assumed inflation rate, and then were discounted using a credit-adjusted,
risk-free interest rate. The impact of adoption resulted in a charge of $3
million recorded as a cumulative effect of change in accounting principle (net
of tax) in the Consolidated Statement of Operations in 2005.
12
Summary of Events Affecting Comparability
Charges and gains recorded in 2006, 2005 and 2004 and other events
affecting comparability have been summarized and described in the table and
accompanying footnotes below (dollars in millions):
2006
--------------------------------------------------------------
PERFORMANCE INTEGRATED CORPORATE/
INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED
-------- ----- ----- ------------
IMPACT ON:
Cost of goods sold.......................... $ -- $ -- $ 9 $ 9 (a)
-- -- (20) (20) (b)
1 -- -- 1 (c)
-------------------------------------------------------------
Total cost of goods sold ................... 1 -- (11) (10)
Marketing .................................. 2 -- -- 2 (c)
Administrative ............................. 1 -- -- 1 (c)
Technological .............................. -- -- -- --
-------------------------------------------------------------
OPERATING INCOME IMPACT..................... (4) -- 11 7
Interest expense............................ -- -- (1) (1) (d)
-- -- (3) (3) (e)
Equity income from affiliates............... -- -- (4) (4) (f)
Loss on debt modification................... -- -- (8) (8) (d)
Reorganization items, net................... (8) (6) (57) (71) (g)
-------------------------------------------------------------
PRE-TAX INCOME STATEMENT IMPACT............. (12) (6) (62) (80)
================================================
Income tax impact........................... (5) (h)
------------
AFTER-TAX INCOME STATEMENT IMPACT........... $ (75)
============
<FN>
2006 EVENTS
-----------
a) Environmental charge in the first quarter 2006 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 $6 million after-tax).
b) 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 20 of the
accompanying consolidated financial statements ($20 million pre-tax
and after-tax - see note (h) below).
c) Restructuring costs related principally to severance and retraining
costs ($4 million pre-tax and $3 million after-tax).
d) Solutia recorded a charge of approximately $8 million (pre-tax and
after-tax - see note (h) below) to record the write-off of debt
issuance costs and to record the DIP credit facility as modified at
its fair value. In addition, $1 million (pre-tax and after-tax - see
note (h) below) of unamortized debt issuance costs associated with
the DIP credit facility were written off at the time of modification
in March 2006.
e) Solutia refinanced its Euronotes in July 2006 and recorded early
extinguishment costs at the time of refinancing ($3 million pre-tax
and $2 million after-tax).
f) Net charges at Flexsys, Solutia's 50 percent owned joint venture,
included charges for restructuring and asset impairments of $5
million, partially offset by a non-operational gain of $1 million
related to the reversal of a litigation reserve ($4 million pre-tax
and after-tax - see note (h) below).
g) Reorganization items, net consist of the following: $58 million of
professional fees for services provided by debtor and creditor
professionals directly related to Solutia's reorganization
proceedings; $11 million of other reorganization charges primarily
involving costs incurred with exiting certain non-strategic
businesses; $4 million of expense provisions related to (i) employee
severance costs incurred directly as part of the Chapter 11
reorganization process and (ii) a retention plan for certain Solutia
employees approved by the Bankruptcy Court; and a $2 million
13
net gain from adjustments to record certain pre-petition claims at
estimated amounts of the allowed claims. ($71 million pre-tax and
after-tax - see note (h) below)
h) With the exception of items (a), (c) and (e) 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.
2005
-----------------------------------------------------------
PERFORMANCE INTEGRATED CORPORATE/
INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED
-------- ----- ----- ------------
IMPACT ON:
Cost of goods sold.......................... $ 1 $ -- $ -- $ 1 (a)
-- -- 9 9 (b)
-----------------------------------------------------------
Total cost of goods sold ................... 1 -- 9 10
Marketing .................................. -- -- 1 1 (b)
Administrative ............................. -- -- 2 2 (b)
Technological .............................. -- -- 1 1 (b)
-----------------------------------------------------------
OPERATING INCOME IMPACT..................... (1) -- (13) (14)
Equity income from affiliates............... -- -- 52 52 (c)
Reorganization items, net................... (7) (21) (21) (49) (d)
-----------------------------------------------------------
PRE-TAX INCOME STATEMENT IMPACT............. $ (8) $ (21) $ 18 (11)
==============================================
Income tax benefit impact................... -- (e)
-------------
AFTER-TAX INCOME STATEMENT IMPACT........... $ (11)
=============
<FN>
2005 EVENTS
-----------
a) Restructuring costs related principally to severance and retraining
costs ($1 million pre-tax and after-tax).
b) Net pension and other postretirement benefit plan curtailments and
settlements, as more fully described in Note 16 to the accompanying
consolidated financial statements ($13 million pre-tax and after-tax
- see note (e) below).
c) Net gains related to Solutia's Flexsys and Astaris joint ventures,
in each of which Solutia has a fifty percent interest. Astaris
included a one-time gain of $50 million related to the sale of
substantially all of its operating assets to ICL, as further
described above. Flexsys included a one-time, non-operational gain
of $5 million, partially offset by $3 million of various
restructuring charges ($52 million pre-tax and after-tax - see note
(e) below).
d) Reorganization items, net consist of the following: $49 million of
professional fees for services provided by debtor and creditor
professionals directly related to Solutia's reorganization
proceedings; a $31 million net gain representing the difference
between the settlement amount of certain pre-petition obligations
and the corresponding amounts previously recorded; $12 million of
expense provisions related to (i) employee severance costs incurred
directly as part of the Chapter 11 reorganization process and (ii) a
retention plan for certain Solutia employees approved by the
Bankruptcy Court; $10 million of net charges for adjustments to
record certain pre-petition claims at estimated amounts of the
allowed claims; and $9 million of other reorganization charges
primarily involving costs incurred with the exit from the acrylic
fibers business. ($49 million pre-tax and after-tax - see note (e)
below).
e) With the exception of item (a) above, which primarily relates 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.
14
2004
-------------------------------------------------------------
PERFORMANCE INTEGRATED CORPORATE/
INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED
-------- ----- ----- ------------
IMPACT ON:
Cost of goods sold................................. $ 18 $ -- $ -- $ 18 (a)
-- -- 26 26 (b)
3 5 -- 8 (c)
1 -- -- 1 (d)
-------------------------------------------------------------
Total cost of goods sold........................... 22 5 26 53
Marketing.......................................... -- -- 2 2 (b)
Administrative..................................... -- -- 4 4 (b)
Technological...................................... -- -- 3 3 (b)
-------------------------------------------------------------
OPERATING LOSS IMPACT.............................. (22) (5) (35) (62)
Equity loss from affiliates........................ -- -- (49) (49) (e)
Interest expense................................... -- -- (25) (25) (f)
Loss on debt modification.......................... -- -- (15) (15) (g)
Reorganization items, net.......................... (1) (1) (71) (73) (h)
-------------------------------------------------------------
PRE-TAX INCOME STATEMENT IMPACT.................... $ (23) $ (6) $(195) (224)
===============================================
Income tax benefit impact.......................... 6 (i)
-------------
AFTER-TAX INCOME STATEMENT IMPACT.................. $(218)
=============
<FN>
2004 EVENTS
-----------
a) Restructuring costs related principally to the closure of Solutia's
chlorobenzenes operations as well as certain other non-strategic
operations, including costs for decommissioning and dismantling
activities, future costs for non-cancelable operating leases, and
severance and retraining costs ($18 million pre-tax and after-tax -
see note (i) below).
b) Net pension and other postretirement benefit plan curtailments and
settlements, as more fully described in Note 16 to the accompanying
consolidated financial statements ($35 million pre-tax and after-tax
- see note (i) below).
c) Losses incurred directly related to the hurricanes experienced in
the U.S. in 2004 resulting in the disruption of operations and
property damage at Solutia's operations in the Integrated Nylon
chain located principally in the Southeastern part of the U.S., and
the Performance Products location in Martinsville, Virginia. These
costs included primarily asset write-offs and repairs and
maintenance costs ($8 million pre-tax and after-tax - see note (i)
below).
d) Loss on the sale of the assets of Axio Research Corporation ($1
million pre-tax and after-tax - see note (i) below).
e) Charges related to the Flexsys and Astaris joint ventures associated
with litigation matters and restructuring activities involving
contract rejections and terminations, dismantling costs, asset
impairments and severance charges ($49 million pre-tax and after-tax
- see note (i) below).
f) Write-off of unamortized debt issuance costs related to the October
2003 and interim DIP credit facilities; both were retired in January
2004 with proceeds from the DIP credit facility ($25 million pre-tax
and after-tax - see note (i) below).
g) Loss due to the modification of Solutia's Euronotes in January 2004
($15 million pre-tax and $9 million after-tax).
h) Reorganization items, net consist of the following: $46 million of
professional fees for services provided by debtor and creditor
professionals directly related to Solutia's reorganization
proceedings; $20 million charge for asset write-offs associated with
contract rejections and terminations resulting from the ongoing
reorganization-related evaluation of the financial viability of
Solutia's existing contracts; $9 million of expense provisions
related to (i) employee severance costs incurred directly as part of
the Chapter 11 reorganization process and (ii) a retention plan for
certain Solutia employees approved by the Bankruptcy Court; and $2
million of net gains for adjustments to record certain pre-petition
claims at estimated amounts of the allowed claims. ($73 million
pre-tax and after-tax - see note (i) below).
15
i) With the exception of item (g) above, which primarily relates 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.
ENVIRONMENTAL MATTERS
Solutia is subject to numerous laws and government regulations
concerning environmental, safety and health matters in the United States and
other countries. U.S. environmental legislation that has a particular impact
on Solutia includes the Toxic Substances Control Act; the Resource
Conservation and Recovery Act; the Clean Air Act; the Clean Water Act; the
Safe Drinking Water Act; and the Comprehensive Environmental Response,
Compensation and Liability Act (commonly known as Superfund). Solutia is also
subject to the Occupational Safety and Health Act and regulations of the
Occupational Safety and Health Administration ("OSHA") concerning employee
safety and health matters. The EPA, OSHA and other federal agencies have the
authority to promulgate regulations that have an impact on Solutia's
operations. In addition to these federal activities, various states have been
delegated certain authority under several of these federal statutes and have
adopted environmental, safety and health laws and regulations. State or
federal agencies having lead enforcement authority may seek fines and
penalties for violation of these laws and regulations. Also, private parties
have rights to seek recovery, under the above statutes or the common law, for
civil damages arising from environmental conditions, including damages for
personal injury and property damage.
Expenditures for environmental capital projects were approximately $9
million in 2006 and $8 million in both 2005 and 2004. Expenditures for the
management of environmental programs and remediation activities were
approximately $60 million, $62 million and $69 million in 2006, 2005 and 2004,
respectively. Included in environmental program management is the operation
and maintenance of current operating facilities for environmental control,
which is expensed in the period incurred, and $10 million, $12 million and $19
million in 2006, 2005 and 2004, respectively, for remediation activity, which
was charged against recorded environmental liabilities. Recoveries from third
parties were less than $1 million for both 2006 and 2005 and $2 million in
2004.
Environmental compliance and remediation costs and other
environmental liabilities incurred by Solutia generally fall into two broad
categories: (a) those related to properties currently owned or operated by
Solutia and (b) those related to properties that are not owned by Solutia,
including non-owned properties adjacent to plant sites and certain owned
offsite disposal locations. For the owned and operated sites, Solutia had an
accrued liability of $78 million and $71 million as of December 31, 2006 and
2005, respectively, for solid and hazardous waste remediation, which
represents Solutia's best estimate of the underlying obligation. In addition,
this balance also includes post-closure costs at certain of Solutia's
operating locations. This liability is not classified as subject to compromise
in the Consolidated Statement of Financial Position because, irrespective of
the bankruptcy proceedings, Solutia will be required to comply with
environmental requirements in the conduct of its business, regardless of when
the underlying environmental contamination occurred. However, Solutia
ultimately expects to seek recovery against other potentially responsible
parties at certain of these locations. Solutia spent $10 million in 2006 for
remediation of these properties. In 2007, Solutia anticipates spending a
similar amount related to these properties currently owned or operated by
Solutia.
Solutia had an accrued liability of $81 million and $82 million as of
December 31, 2006 and 2005, respectively, for properties not owned or operated
by Solutia which was classified as subject to compromise in the Consolidated
Statement of Financial Position. Under the Plan and the Relationship
Agreement, as between Monsanto and Solutia, Monsanto would accept financial
responsibility for environmental remediation obligations at all sites for
which Solutia was required to assume responsibility at the Solutia Spinoff but
which were never owned or operated by Solutia. This includes more than 50
sites with active remediation projects and approximately 200 additional known
sites and off-site disposal facilities, as well as sites that have not yet
been identified. Finally, Monsanto would share financial responsibility with
Solutia for off-site remediation costs in Anniston, Alabama and Sauget,
Illinois. Remediation activities are currently being funded by Monsanto for
all of these properties not owned or operated by Solutia, with the exception
of one off-site remediation project in Sauget, Illinois. Monsanto's funding of
these remediation activities may give rise to a claim against Solutia which
Monsanto may assert in Solutia's Chapter 11 bankruptcy case. In addition,
Solutia has only made minimal adjustments to its recorded environmental
liabilities classified as subject to compromise for ongoing remediation
activities since the inception of Solutia's bankruptcy case to reflect actual
cash expenditures incurred by the Company. Any other adjustments to this
liability are not deemed appropriate by the Company at this time given the
uncertainty regarding any potential claim amount to be asserted by Monsanto.
16
In addition to the bankruptcy proceedings, Solutia's environmental
liabilities are also subject to changing governmental policy and regulations,
discovery of unknown conditions, judicial proceedings, changes in method and
extent of remediation, existence of other potentially responsible parties and
changes in technology. Solutia believes that the known and unknown
environmental matters, including matters classified as subject to compromise
for which Solutia may ultimately assume responsibility, when ultimately
resolved, which may be over an extended period of time, could have a material
effect on the consolidated financial position, liquidity and profitability of
Solutia.
SELF-INSURANCE
As discussed in Item 3 of this Annual Report, because of the size and
nature of its business, Solutia is a party to numerous legal proceedings. Most
of these proceedings have arisen in the ordinary course of business and
involve claims for money damages. In addition, at the time of Solutia's
spinoff from Pharmacia, Solutia assumed the defense of specified legal
proceedings and agreed to indemnify Pharmacia in connection with those
proceedings. Solutia has determined that these defense and indemnification
obligations to Pharmacia are pre-petition obligations under the U.S.
Bankruptcy Code that Solutia is prohibited from performing, except pursuant to
a confirmed plan of reorganization. As a result, Solutia has ceased
performance of these obligations. Solutia's cessation of performance may give
rise to a pre-petition unsecured claim against Solutia which Pharmacia may
assert in Solutia's Chapter 11 bankruptcy case.
Since the spinoff, Solutia has been responsible for bearing the costs
associated with various toxic tort lawsuits related to PCBs, premises-based
asbestos and other chemical exposures from the conduct of the historic
chemical business of Pharmacia. At the time of the Chapter 11 bankruptcy
filing, Solutia was defending approximately 520 asbestos actions (involving an
estimated 3,500 to 4,500 plaintiffs) brought against Pharmacia. In addition,
notwithstanding the settlement of cases relating to the Anniston plant site,
Solutia was defending approximately 30 cases involving alleged exposure from
PCB's manufactured by Pharmacia prior to the spinoff. Solutia was also
defending approximately 100 general and product liability claims brought
against Pharmacia.
Claims for legal matters arising prior to Solutia's Chapter 11
bankruptcy filing will be addressed in the bankruptcy proceedings. As a result
of the Chapter 11 petition, an automatic stay has been imposed against the
commencement or continuation of legal proceedings against Solutia outside of
the bankruptcy court process. Consequently, Solutia's pre-petition accrued
liability for litigation of $111 million and $136 million as of December 31,
2006 and 2005, respectively, has been classified as subject to compromise in
the Consolidated Statement of Financial Position. In general, all claims
against Solutia that seek a recovery of assets of Solutia's estate will be
addressed in the Chapter 11 bankruptcy process and paid only pursuant to the
terms of a confirmed plan of reorganization. However, pursuant to a Bankruptcy
Court order, Solutia made a $5 million payment with respect to pre-petition
legal proceedings in both 2006 and 2005. Solutia cannot forecast the level of
future pre-petition self-insurance spending and anticipated levels of
recoveries based upon the inherent uncertainty underlying the bankruptcy
proceedings.
Solutia had an accrued liability of $11 million and $9 million as of
December 31, 2006 and 2005, respectively, for post-petition self-insurance
liabilities including workers' compensation, product, general, automobile and
operations liability claims. Self-insurance expense was $5 million in 2006 and
$4 million in both 2005 and 2004. Cash payments for self-insurance matters
were $9 million in 2006, $8 million in 2005, and $9 million in 2004, whereas
recoveries from insurance carriers were less than $1 million in 2006, $1
million in 2005, and $7 million in 2004. Included in the 2006, 2005 and 2004
payments was a $5 million scheduled payment with respect to the 2003 Anniston
PCB litigation settlement paid pursuant to a Bankruptcy Court order.
EMPLOYEE BENEFITS
Employee benefits include noncontributory defined benefit pension
plans and OPEB that provide certain health care and life insurance benefits.
Solutia also has stock option plans covering officers and employees and a
non-employee director compensation plan for non-employee members of Solutia's
board of directors.
Under the provisions of SFAS No. 87 and SFAS No. 106, measurement of
the obligations under the defined benefit pension plans and the OPEB plans are
subject to a number of assumptions. These include the rate of return on
pension plan assets, health care cost trend rates and the rate at which the
future obligations are discounted to value the liability at December 31st of
each year presented in the Consolidated Statement of Financial Position. The
amounts reflected in the consolidated financial statements and accompanying
notes do not reflect the impact of any future changes to the benefit plans
that might be contemplated as a result of the bankruptcy filing. Due to the
inherent uncertainty involved with the bankruptcy
17
proceedings, the recorded amounts related to Solutia's debtor pension plans,
as well as other debtor postretirement plans, have been classified as subject
to compromise in the Consolidated Statement of Financial Position as of
December 31, 2006.
Solutia amended its U.S. qualified pension plan in 2004 for non-union
participants and in 2005 for union participants to cease future benefit
accruals effective July 1, 2004 and January 1, 2006, respectively. Further,
Solutia amended its U.S. postretirement plan in 2004 for non-union, active
employees and in 2005 for union, active employees to discontinue all
postretirement benefits after attaining age 65, make changes to certain
eligibility requirements for pre-65 postretirement benefits with the eventual
elimination of these benefits by 2016, and eliminate retiree life insurance
benefits for future retirees. In addition, Solutia amended its U.S.
postretirement plan in 2006 for retiree participants to terminate medical
benefits for certain retirees who are Medicare eligible, and if not Medicare
eligible, to terminate medical benefits on the earlier of (a) the date such
retirees or participants become Medicare eligible if such date is on or after
January 1, 2007 or (b) October 19, 2016.
Pension expense in accordance with SFAS No. 87 was $23 million in
2006 and $29 million in both 2005 and 2004, and expense for OPEB was $30
million in 2006, $42 million in 2005 and $44 million in 2004. In addition,
Solutia did not record any charges resulting from pension and postretirement
benefit plan curtailments and settlements in 2006, while the Company recorded
charges of $13 million in 2005 and $35 million in 2004 (as more fully
described in Note 16 to the accompanying consolidated financial statements).
Pension Plan Funded Status
The majority of Solutia's employees are covered under noncontributory
defined benefit pension plans. The pension plans are funded in accordance with
Solutia's long-range projections of the plan's financial conditions. These
projections take into account benefits earned and expected to be earned,
anticipated returns on pension plan assets and income tax and other
regulations. The amount of pension plan underfunding in the pension plans
decreased to $353 million as of December 31, 2006 from $540 million as of
December 31, 2005.
Solutia actively manages funding of its domestic qualified pension
plan in order to meet the requirements of the IRS and the Pension Benefits
Guarantee Corporation (a U.S. federal agency). Solutia contributed $179
million in 2006 to the qualified pension plan in accordance with IRS funding
rules and made a discretionary contribution of $11 million in 2004 to the
qualified pension plan in order to minimize future required contributions and
to utilize available tax benefits. No contributions were made during 2005 to
the qualified pension plan. According to current IRS funding rules, Solutia
estimates that it will be required to make approximately $100 million in
pension contributions to its U.S. qualified pension plan in 2007. In addition,
Solutia contributed $6 million in 2006, $5 million in 2005 and $4 million in
2004, respectively, to fund its foreign pension plans. Moreover, Solutia
expects to be required to fund a like amount in pension contributions for its
foreign pension plans in 2007.
DERIVATIVE FINANCIAL INSTRUMENTS
Solutia's business operations give rise to market risk exposures that
result from changes in currency exchange rates, interest rates and certain
commodity prices. To manage the volatility relating to these exposures,
Solutia enters into various hedging transactions that enable it to alleviate
the adverse effects of financial market risk. Solutia's hedging transactions
are carried out under policies and procedures approved by the Audit and
Finance Committee of the Board of Directors, which does not permit the
purchase or holding of any derivative financial instruments for trading
purposes. Notes 2 and 8 to the accompanying consolidated financial statements
include further discussion of Solutia's accounting policies for derivative
financial instruments.
Foreign Currency Exchange Rate Risk
Solutia manufactures and sells its products in a number of countries
throughout the world and, as a result, is exposed to movements in foreign
currency exchange rates. Solutia uses foreign currency hedging instruments to
manage the volatility associated with foreign currency purchases of materials
and other assets and liabilities created in the normal course of business.
Solutia primarily uses forward exchange contracts and purchased options with
maturities of less than 18 months to hedge these risks. Solutia also enters
into certain foreign currency derivative instruments primarily to protect
against exposure related to intercompany financing transactions. Corporate
policy prescribes the range of allowable hedging activity and what hedging
instruments Solutia is permitted to use. Because the counterparties to these
contracts are major international financing institutions, credit risk arising
from these contracts is not significant, and Solutia does not anticipate
18
any counterparty losses. Currency restrictions are not expected to have a
significant effect on Solutia's cash flows, liquidity or capital resources.
Major currencies affecting Solutia's business are the U.S. dollar, British
pound sterling, Euro, Canadian dollar, Swiss franc, Brazilian real, Chinese
yuan and the Japanese yen.
At December 31, 2006, Solutia had currency forward contracts to
purchase and sell $181 million of currencies, principally the Euro, Swiss
franc, and U.S. dollar, with average remaining maturities of four months.
Based on Solutia's overall currency rate exposure at December 31, 2006,
including derivatives and other foreign currency sensitive instruments, a 10
percent adverse change in quoted foreign currency rates of these instruments
would result in a change in fair value of these instruments of $15 million.
This is consistent with the overall foreign currency exchange rate exposure at
December 31, 2005.
Interest Rate Risk
Interest rate risk is primarily related to changes in interest
expense from floating rate debt. Solutia believes its current debt structure
mitigates some of the risk associated with changes in interest rates due to
the combination of fixed versus floating rate debt instruments. Further,
periodically, the Company does enter into contracts to further mitigate
interest rate risk. A 1 percent increase in the LIBOR and EURIBOR would have
increased interest expense by approximately $9 million during 2006, assuming
the debt composition at December 31, 2006 was consistent throughout the year.
This is consistent with the overall interest rate exposure at December 31,
2005.
Commodity Price Risk
Certain raw materials and energy resources used by Solutia are
subject to price volatility caused by weather, crude oil prices, supply
conditions, political and economic variables and other unpredictable factors.
Solutia uses forward and option contracts to manage a portion of the
volatility related to anticipated energy purchases. Solutia had commodity
forward contracts with notional amounts of $2 million associated with future
natural gas purchases as of December 31, 2006. Based on Solutia's overall
energy market rate exposure at December 31, 2006, including derivatives and
other commodity sensitive instruments, a 10 percent adverse change in quoted
market rates of these instruments would result in a less than $1 million
decrease in fair value of these instruments. This is consistent with the
overall commodity price exposure at December 31, 2005. In addition, Solutia
mitigates some of its commodity price risks through formula based contractual
pricing for certain products within the Integrated Nylon segment. The use of
these types of arrangements has increased in 2006 compared to previous years.
RESTRUCTURING ACTIVITIES
During 2006, Solutia recorded $3 million of decommissioning and
dismantling costs primarily as a result of the shut-down of its acrylic fibers
business in 2005, and $3 million of asset write-downs. Solutia also recorded
$3 million of future contractual payments related to the termination of a
third party manufacturing agreement. These costs were all recorded within
Reorganization Items, net with $4 million in the Integrated Nylon segment and
$5 million in the Performance Products segment. In addition, Solutia recorded
$8 million of severance and retraining costs in 2006 with $4 million recorded
in Reorganization Items, net and $4 million in Marketing and Administrative
expenses involving headcount reductions within the Integrated Nylon and
Performance Products, as well as the corporate function. Cash outlays
associated with the restructuring actions were funded from operations.
During 2005, Solutia recorded restructuring charges of $13 million in
Reorganization Items, net involving the shut-down of its acrylic fiber
operations and shut-down of its nylon industrial fiber manufacturing unit at
its plant in Pensacola, Florida. This $13 million of net charges from the
closure of these businesses included $12 million of asset write-downs, $7
million of decontamination and dismantling costs and $4 million of severance
and retraining costs, partially offset by a $7 million gain from the reversal
of the LIFO reserve associated with the inventory sold and/or written off as
part of the business shut-down and a $3 million gain from the sale of certain
acrylic fibers assets. In addition, Solutia recorded $5 million of severance
and retraining costs in 2005 with $3 million recorded in Reorganization Items,
net and $2 million in Cost of Goods Sold involving headcount reductions within
the Integrated Nylon and Performance Products segments, as well as the
corporate function. Cash outlays associated with the restructuring actions
were funded from operations.
During 2004, Solutia recorded restructuring and severance charges of
$18 million to Cost of Goods Sold principally related to the closure of
Solutia's chlorobenzenes operations as well as certain other non-strategic
operations, including $10 million for decommissioning and dismantling costs,
$3 million of severance and retraining costs; $2 million related to operating
leases where the underlying services and properties are no longer providing
benefit; and $3 million of various other
19
restructuring charges. In addition, Solutia recorded $4 million of severance
and retraining costs during 2004 in Reorganization Items, net principally
related to workforce reduction initiatives of management positions within the
corporate function directly associated with the bankruptcy reorganization
process. Cash outlays associated with the restructuring actions were funded
from operations.
FINANCIAL CONDITION AND LIQUIDITY
As discussed in Note 1 to the accompanying consolidated financial
statements, Solutia is operating as a debtor-in-possession under Chapter 11 of
the U.S. Bankruptcy Code. As a result of the uncertainty surrounding Solutia's
current circumstances, it is difficult to predict Solutia's actual liquidity
needs and sources. However, based upon current and anticipated levels of
operations during the continuation of the bankruptcy proceedings, Solutia
believes that its liquidity and capital resources will be sufficient to
maintain its normal operations at current levels. Solutia's access to
additional financing while in the Chapter 11 bankruptcy process may be
limited.
Financial Analysis
Solutia used its existing cash on-hand to finance operating needs and
capital expenditures during 2006. Cash used in continuing operations was $187
million in 2006 compared to cash used by continuing operations of $39 million
in 2005. The increase in 2006 as compared to 2005 in cash used in continuing
operations was primarily attributable to higher pension contributions and
increases in working capital items, including a significant increase in trade
receivables resulting from higher net sales and an increase in days sales
outstanding due to a shift in sales mix within the Integrated Nylon segment.
Partially offsetting these uses was the receipt of a dividend from Flexsys in
2006 as compared to no dividend received in the prior year. In 2005, cash used
by continuing operations was $39 million compared to cash provided by
continuing operations of $25 million in 2004. The change in 2005 as compared
to 2004 was primarily attributable to changes in working capital items
including a significant change in accounts payable in 2005 due to the relative
stabilization in accounts payable terms in 2005 compared to 2004 when terms
significantly improved due to Solutia's filing of Chapter 11 bankruptcy in
late 2003.
Solutia's working capital, defined as current assets less current
liabilities, decreased by $319 million to ($253) million at December 31, 2006,
compared to $66 million at December 31, 2005. The change was primarily a
result of higher short-term debt from additional DIP credit facility
borrowings as well as a decrease of $44 million related to the sale of the
pharmaceutical services business, partially offset by higher cash on-hand and
an increase in trade receivables.
Capital spending increased $30 million to $105 million in 2006 as
compared to $75 million in 2005. The expenditures in 2006 were primarily to
fund certain strategic initiatives in the Performance Products and Integrated
Nylon segments, as well as various capital improvements and certain cost
reduction projects. Capital spending increased by $26 million in 2005 as
compared to $49 million in 2004. Expenditures during 2005 were used primarily
to fund certain growth initiatives, as well as various capital improvements
and certain cost reduction projects. In addition, included in 2004 was $5
million of capital spending incurred as a result of damage from Hurricane
Ivan. In 2007, Solutia expects capital spending will be approximately $120
million and will focus on growth initiatives including the continued
expenditures on the new SAFLEX(R) plastic interlayer plant in China expected
to be completed in 2007, the addition of a third SAFLEX(R) line in the plant
in Ghent, Belgium expected to be completed in 2008, and the transformation of
staple carpet lines to plastic polymer lines. Approximately $15 million of
estimated capital requirements were committed at December 31, 2006.
Solutia continued to divest certain non-strategic businesses in order
to focus resources on core businesses. The proceeds from these and other asset
sales generated $77 million in 2006 and $81 million in 2005. Proceeds from
divestitures in 2004 were less than $1 million. During 2006, net proceeds were
primarily comprised of $69 million received from the pharmaceutical services
business divestiture. During 2005, net proceeds included $76 million received
from the Astaris transaction with an additional approximately $20 million
deposited into escrow accounts. Distributions, if any, from the escrow
accounts are expected to be received in 2007, subject to certain terms and
conditions of the asset purchase agreement and the escrow agreements. Solutia
lenders under the DIP credit facility agreed to waive certain prepayment
requirements and allowed Solutia to retain the entire proceeds of the Astaris
sale. In addition, $3 million of proceeds were received in 2005 from the sale
of assets associated with the closure of Solutia's acrylic fibers business in
2005.
Total debt of $1,528 million as of December 31, 2006, including $668
million subject to compromise and $860 million not subject to compromise,
increased by $313 million as compared to $1,215 million at December 31, 2005,
which included $668 million subject to compromise and $547 million not subject
to compromise. This increase in total debt resulted primarily from $350
million of additional borrowings from Solutia's DIP credit facility in 2006,
of which $300
20
million resulted from the March 2006 amendment to the DIP credit facility (as
described below), partially offset by a $51 million payment on SESA's Facility
Agreement (as described below).
The weighted average interest rate on Solutia's total debt
outstanding at December 31, 2006 was 8.4 percent compared to 8.7 percent at
December 31, 2005. Excluding debt subject to compromise, with the exception of
the 11.25 percent notes due 2009 on which the Bankruptcy Court has permitted
continued payments of the contractual interest, the weighted average interest
rate on total debt was 8.9 percent at December 31, 2006 compared to 9.8
percent at December 31, 2005. The reductions in weighted average rates in 2006
are due to the refinancing of the Euronotes and the amendment to the DIP
Financing Agreement. While operating as a debtor-in-possession during the
Chapter 11 proceedings, Solutia has ceased paying interest on its 6.72 percent
debentures due 2037 and its 7.375 percent debentures due 2027. The amount of
annual contractual interest expense not recorded in each of 2006 and 2005 was
approximately $32 million.
As a result of the Chapter 11 bankruptcy filing, Solutia was in
default on all its debt agreements as of December 31, 2006, with the exception
of its DIP credit facility and SESA's Facility Agreement. In addition,
subsequent to Solutia's bankruptcy filing, Moody's Investors Ratings Services
and Standard & Poor's withdrew all ratings for Solutia and its related debt
securities.
Solutia had a shareholders' deficit of $1,405 million at December 31,
2006, compared to a shareholders' deficit of $1,433 million at December 31,
2005. Shareholders' deficit decreased principally due to a $24 million
decrease in additional minimum pension liability and net income of $2 million.
At December 31, 2006, Solutia's total liquidity was $245 million in
the form of $95 million of availability under the final DIP credit facility
and approximately $150 million of cash on-hand, of which $112 million was cash
of Solutia's subsidiaries that are not parties to the Chapter 11 bankruptcy
proceedings. In comparison, at December 31, 2005 Solutia's total liquidity was
$238 million in the form of $131 million of availability under the final DIP
credit facility and approximately $107 million of cash on-hand, of which $89
million was cash of Solutia's subsidiaries that are not parties to the Chapter
11 bankruptcy proceedings.
Solutia contributed $179 million to its U.S. qualified domestic
pension plan in 2006 in accordance with IRS funding rules. According to
current IRS funding rules, Solutia will be required to make approximately $100
million in pension contributions to its U.S. qualified pension plan in 2007.
In addition, Solutia contributed $6 million in 2006 to fund its foreign
pension plans and expects to be required to fund a like amount in pension
contributions for its foreign pension plans in 2007.
Astaris Financing Activities
On October 8, 2003 Solutia and Astaris, a 50/50 joint venture with
FMC Corporation ("FMC"), amended Astaris' external financing agreement to
release the Astaris lenders' security interests in certain Solutia assets in
exchange for Solutia's posting of a $67 million letter of credit, representing
fifty percent of the Astaris lenders' outstanding commitments to Astaris.
Solutia used approximately $36 million in 2004 for investment payments
("keepwell payments") to keep the Astaris joint venture in compliance with its
financial covenants. There were no keepwell payments made in 2005. The
remaining commitment to Astaris was $10 million as of December 31, 2004, which
was subsequently terminated as part of Astaris' refinancing of its credit
facility on February 8, 2005.
Solutia and FMC had also agreed to allow Astaris to defer up to $27
million of payment obligations to each of Solutia and FMC under existing
operating agreements and certain other agreements. The deferral amount
outstanding from Astaris to Solutia was $16 million as of December 31, 2004.
In February 2005, this deferral agreement was terminated and all amounts
outstanding were paid in full in conjunction with the Astaris refinancing.
Amendments to DIP Financing Agreement
On March 17, 2006, Solutia amended its DIP credit facility with
Bankruptcy Court approval. This amendment, among other things, (i) increased
the DIP credit facility from $525 million to $825 million; (ii) extended the
term of the DIP credit facility from June 19, 2006 to March 31, 2007; (iii)
decreased the interest rate on the term loan component of the DIP credit
facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points; (iv)
increased certain thresholds allowing the Debtors to retain more of the
proceeds from certain dispositions and other extraordinary receipts; (v)
approved the disposition of certain assets of the Debtors; (vi) allowed
refinancing of, and certain amendments to, SESA's outstanding Euronotes; and
(vii) amended certain financial and other covenants. The amendment contained a
number of other changes
21
and other modifications required to make the remaining terms of the DIP credit
facility consistent with the amendments set forth above.
On January 25, 2007, Solutia completed the extension and upsizing of
its $1,225 million of DIP credit facility, maturing March 31, 2008 with
Bankruptcy Court approval. This represents a $400 million increase and a one
year extension over Solutia's current DIP credit facility. The increased
availability under the DIP credit facility provides Solutia with additional
liquidity for operations and the ability to fund mandatory pension payments
that are coming due in 2007, as well as funds to partially facilitate the
acquisition of Akzo Nobel's stake in the 50/50 rubber chemical joint venture
Flexsys Holding B.V. The DIP credit facility can be repaid by Solutia at any
time without prepayment penalties.
Euronotes Refinancing
On July 26, 2006, Solutia's indirect 100% owned subsidiary SSI, a
subsidiary of SESA, entered into a Facility Agreement guaranteed by SESA and
CPFilms Vertriebs GmbH, a subsidiary of SESA. Closing of the Facility
Agreement occurred on August 1, 2006. SESA used the proceeds of the Facility
Agreement to refinance all of the Euronotes on August 1, 2006, at a prepayment
premium of 3 percent, as required pursuant to the Euronotes, for a total
redemption amount of approximately (euro)215 million, including accrued
interest. The Euronotes were refinanced to reduce the interest rate, extend
the term of the indebtedness and facilitate certain dispositions by Solutia,
including the sale of its pharmaceutical services business described below.
The Facility Agreement has a five-year term, with a termination date
of July 31, 2011 and an adjustable rate structure of EURIBOR plus 275 basis
points. The margin is subject to adjustment upon the occurrence of certain
events specified in the Facility Agreement or upon SESA and its subsidiaries
attaining certain financial benchmarks. The Facility Agreement consists of a
(euro)160 million term loan and a (euro)40 million term loan. The (euro)40
million term loan was repaid from the proceeds of the sale of Solutia's
pharmaceutical services business during the third quarter 2006 (as further
described in Note 4 to the accompanying consolidated financial statements).
The Facility Agreement is secured by substantially all of the assets of SESA
and its subsidiaries. The Facility Agreement also contains other customary
terms and conditions, including certain financial covenants relating to the
performance of SESA and its subsidiaries.
PENNDOT Letter of Credit
As a result of the favorable ruling in the PENNDOT litigation matter
described in Note 20 to the accompanying consolidated financial statements, in
August 2006, Monsanto released the $20 million letter of credit that Solutia
posted to secure a portion of Pharmacia's obligations with respect to an
appeal bond issued in relation to this case.
Off-Balance Sheet Arrangements
See Note 20 to the accompanying consolidated financial statements for
a summary of off-balance sheet arrangements.
Contingencies
See Note 20 to the accompanying consolidated financial statements for
a summary of Solutia's contingencies as of December 31, 2006.
Commitments
Solutia has entered into agreements with certain customers to supply
a guaranteed quantity of certain products annually at prices specified in the
agreements. In return, the customers have advanced funds to Solutia to cover
the costs of expanding capacity to provide the guaranteed supply. Solutia has
recorded the advances as deferred credits and amortizes the amounts to income
as the customers purchase the associated products. The unamortized deferred
credits were $91 million at December 31, 2006, and $100 million at December
31, 2005.
The obligations of Solutia and Solutia Business Enterprises, Inc., as
borrowers under Solutia's DIP credit facility, are guaranteed by Solutia's
other domestic subsidiaries which own substantially all of Solutia's domestic
assets. These subsidiaries are Axio Research Corporation, Beamer Road
Management Company, CPFilms Inc., Monchem, Inc., Monchem International, Inc.,
Solutia Greater China, Inc., Solutia Inter-America, Inc., Solutia
International Holding, LLC, Solutia Investments, LLC, Solutia Management
Company, Inc., Solutia Overseas, Inc., Solutia Systems, Inc. and Solutia
Taiwan,
22
Inc. The obligations also must be guaranteed by each of Solutia's subsequently
acquired or organized domestic subsidiaries, subject to certain exceptions. In
addition, Solutia and Solutia Business Enterprises, Inc. are jointly and
severally liable with respect to their obligations under the final DIP credit
facility, thus in effect each guaranteeing the other's debt.
The following table summarizes Solutia's contractual obligations and
commercial commitments that are not subject to compromise as of December 31,
2006. Payments associated with liabilities subject to compromise have been
excluded from the table below, as Solutia cannot accurately forecast its
future level and timing of spending given the inherent uncertainties
associated with the ongoing Chapter 11 bankruptcy process. See Note 3 to the
accompanying consolidated financial statements for further disclosure
concerning liabilities subject to compromise.
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OBLIGATIONS DUE BY PERIOD (DOLLARS IN MILLIONS)
---------------------------------------------------------------
CONTRACTUAL OBLIGATIONS 2010- 2012 AND
TOTAL 2007 2008 2009 2011 THEREAFTER
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Credit Facility (a) $650 $650 $-- $ -- $ -- $ --
- ----------------------------------------------------------------------------------------------------------------------
Interest Payments Related to Credit Facility (a) 15 15 -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------
Long-Term Debt 210 -- -- -- 210 --
- ----------------------------------------------------------------------------------------------------------------------
Interest Payments Related to Long-Term Debt 61 13 13 13 22 --
- ----------------------------------------------------------------------------------------------------------------------
Operating Leases 13 6 4 2 1 --
- ----------------------------------------------------------------------------------------------------------------------
Unconditional Purchase Obligations 8 4 2 1 1 --
- ----------------------------------------------------------------------------------------------------------------------
Standby Letters of Credit (b) 76 74 1 -- -- 1
- ----------------------------------------------------------------------------------------------------------------------
Postretirement Obligations(c) 52 6 6 6 13 21
- ----------------------------------------------------------------------------------------------------------------------
Environmental Remediation 78 14 13 13 12 26
- ----------------------------------------------------------------------------------------------------------------------
Other Commercial Commitments(d) 91 8 6 4 8 65
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CONTRACTUAL OBLIGATIONS $1,254 $790 $45 $39 $267 $113
- ----------------------------------------------------------------------------------------------------------------------
<FN>
(a) The DIP credit facility was amended on January 25, 2007 and
increased the term loan to $975 million and is payable upon the
earlier of emergence from Chapter 11 or March 31, 2008. The interest
rate on the amended DIP credit facility is LIBOR plus 300 basis
points. The $15 million of interest payments related to credit
facility assumes the maturity of the current DIP credit facility on
March 31, 2007.
(b) Standby letters of credit contractually expiring in 2007 are
generally anticipated to be renewed or extended by extensions with
existing standby letters of credit providers.
(c) Represents estimated future minimum funding requirements for funded
pension plans classified as not subject to compromise and estimated
future benefit payments for unfunded pension and other
postretirement plans classified as not subject to compromise.
(d) Other commercial commitments represent agreements with Solutia's
customers to supply a guaranteed quantity of certain products
annually at prices specified in the underlying agreements.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 2 to the accompanying consolidated financial statements for
a summary of recently issued accounting standards.
23