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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 001-13255
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SOLUTIA INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 43-1781797
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
575 MARYVILLE CENTRE DRIVE, P.O. BOX 66760, ST. LOUIS, MISSOURI 63166-6760
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(314) 674-1000
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
DURING THE PRECEDING TWELVE MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO
SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO .
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER
(AS DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT). YES X NO .
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INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S
CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE.
OUTSTANDING AT
CLASS JUNE 30, 2003
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COMMON STOCK, $0.01 PAR VALUE 104,563,497 SHARES
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOLUTIA INC.
STATEMENT OF CONSOLIDATED INCOME (LOSS)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------- --------------------
2003 2002 2003 2002
------ ----- ------ ------
NET SALES ......................................................... $ 611 $ 585 $1,207 $1,105
Cost of goods sold ................................................ 562 489 1,089 922
------ ----- ------ ------
GROSS PROFIT ...................................................... 49 96 118 183
Marketing expenses ................................................ 40 36 79 71
Administrative expenses ........................................... 33 31 63 63
Technological expenses ............................................ 11 12 23 23
Amortization expense .............................................. -- -- 1 1
------ ----- ------ ------
OPERATING INCOME (LOSS) ........................................... (35) 17 (48) 25
Equity earnings (loss) from affiliates--net of tax ................ -- 4 (2) 12
Interest expense .................................................. (25) (16) (48) (35)
Other income--net ................................................. 1 2 8 9
------ ----- ------ ------
INCOME (LOSS) BEFORE INCOME TAXES ................................. (59) 7 (90) 11
Income taxes (benefit) ............................................ (21) (4) (35) (4)
------ ----- ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE DISCONTINUED
OPERATIONS AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE ....................................................... (38) 11 (55) 15
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX ............ -- 12 (2) 22
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ............... -- -- -- (167)
------ ----- ------ ------
NET INCOME (LOSS) ................................................. $ (38) $ 23 $ (57) $ (130)
====== ===== ====== ======
BASIC EARNINGS (LOSS) PER SHARE:
Income (Loss) from Continuing Operations Before Discontinued
Operations and Cumulative Effect of Change in Accounting
Principle ....................................................... $(0.36) $0.10 $(0.52) $ 0.14
Net Income (Loss) per Share ....................................... $(0.36) $0.22 $(0.54) $(1.24)
DILUTED EARNINGS (LOSS) PER SHARE:
Income (Loss) from Continuing Operations Before Discontinued
Operations and Cumulative Effect of Change in Accounting
Principle ....................................................... $(0.36) $0.10 $(0.52) $ 0.14
Net Income (Loss) per Share ....................................... $(0.36) $0.22 $(0.54) $(1.24)
WEIGHTED AVERAGE EQUIVALENT SHARES (IN MILLIONS):
Basic ......................................................... 104.6 104.8 104.6 104.7
Diluted ....................................................... 104.6 105.1 104.6 105.1
STATEMENT OF CONSOLIDATED COMPREHENSIVE INCOME (LOSS)
(DOLLARS IN MILLIONS)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
NET INCOME (LOSS)................................................ $ (38) $ 23 $ (57) $ (130)
OTHER COMPREHENSIVE INCOME (LOSS):
Currency translation adjustments ................................ 6 87 43 82
Unrealized investment gain (loss), net of tax.................... -- (1) -- --
Net realized loss on derivative instruments, net of tax ......... -- -- -- 1
------ ----- ------ ------
COMPREHENSIVE INCOME (LOSS)...................................... $ (32) $ 109 $ (14) $ (47)
====== ===== ====== ======
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
STATEMENT OF CONSOLIDATED FINANCIAL POSITION
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................................................... $ 84 $ 17
Trade receivables, net of allowances of $17 in 2003 and $16 in 2002............. 304 270
Miscellaneous receivables....................................................... 106 97
Prepaid expenses................................................................ 14 17
Deferred income tax benefit..................................................... 142 108
Inventories..................................................................... 269 262
Assets of Discontinued Operations .............................................. -- 636
------ ------
TOTAL CURRENT ASSETS............................................................ 919 1,407
PROPERTY, PLANT AND EQUIPMENT:
Land............................................................................ 19 19
Buildings....................................................................... 380 375
Machinery and equipment......................................................... 2,997 2,946
Construction in progress........................................................ 24 26
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Total property, plant and equipment............................................. 3,420 3,366
Less accumulated depreciation................................................... 2,496 2,436
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NET PROPERTY, PLANT AND EQUIPMENT............................................... 924 930
INVESTMENTS IN AFFILIATES....................................................... 254 232
GOODWILL........................................................................ 146 144
IDENTIFIED INTANGIBLE ASSETS, NET............................................... 67 66
LONG-TERM DEFERRED INCOME TAX BENEFIT........................................... 305 290
OTHER ASSETS.................................................................... 335 273
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TOTAL ASSETS.................................................................... $2,950 $3,342
====== ======
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable................................................................ $ 212 $ 234
Wages and benefits.............................................................. 29 42
Postretirement liabilities...................................................... 100 93
Miscellaneous accruals.......................................................... 343 314
Short-term debt................................................................. 120 358
Liabilities of Discontinued Operations ......................................... -- 165
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TOTAL CURRENT LIABILITIES....................................................... 804 1,206
LONG-TERM DEBT.................................................................. 863 839
POSTRETIREMENT LIABILITIES...................................................... 1,162 1,164
OTHER LIABILITIES............................................................... 384 382
SHAREHOLDERS' DEFICIT:
Common stock (authorized, 600,000,000 shares, par value $0.01)
Issued: 118,400,635 shares in 2003 and 2002................................. 1 1
Additional Contributed Capital.............................................. 19 19
Treasury stock, at cost (13,837,138 shares in 2003 and 13,659,351 shares in
2002, respectively)....................................................... (251) (251)
Net deficiency of assets at spinoff............................................. (113) (113)
Accumulated other comprehensive loss............................................ (103) (146)
Reinvested earnings............................................................. 184 241
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TOTAL SHAREHOLDERS' DEFICIT..................................................... (263) (249)
------ ------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT..................................... $2,950 $3,342
====== ======
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
STATEMENT OF CONSOLIDATED CASH FLOWS
(DOLLARS IN MILLIONS)
SIX MONTHS ENDED
JUNE 30,
---------------------
2003 2002
----- -----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net loss $ (57) $(130)
Adjustments to reconcile to Cash Provided by (Used in) Operations:
Cumulative effect of change in accounting principle .............................. -- 167
Depreciation and amortization ................................................... 68 67
(Income) Loss from discontinued operations, net of tax ........................... 2 (22)
Amortization of deferred credits.................................................. (7) (7)
Amortization of deferred debt issuance costs and debt discount ................... 8 4
Restructuring expenses and other charges ......................................... 50 --
Net pretax gains from asset disposals............................................. -- (6)
Changes in assets and liabilities:
Income and deferred taxes..................................................... (40) 64
Trade receivables............................................................. (34) (56)
Inventories................................................................... (7) (15)
Accounts payable.............................................................. (22) 24
Other assets and liabilities.................................................. (2) (51)
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CASH PROVIDED BY (USED IN) OPERATIONS--CONTINUING OPERATIONS ......................... (41) 39
CASH PROVIDED BY (USED IN) OPERATIONS--DISCONTINUED OPERATIONS ....................... (11) 10
----- -----
CASH PROVIDED BY (USED IN) OPERATIONS................................................. (52) 49
----- -----
INVESTING ACTIVITIES:
Property, plant and equipment purchases............................................... (46) (27)
Acquisition and investment payments, net of cash acquired ............................ (27) (17)
Property disposals and investment proceeds............................................ (1) 102
----- -----
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES--CONTINUING OPERATIONS ............... (74) 58
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES--DISCONTINUED OPERATIONS ............. 477 (6)
----- -----
CASH PROVIDED BY INVESTING ACTIVITIES................................................. 403 52
----- -----
FINANCING ACTIVITIES:
Net change in short-term debt obligations............................................. (239) (109)
Deferred debt issuance cost .......................................................... -- (1)
Common stock issued under employee stock plans........................................ -- 2
Other financing activities............................................................ (40) (3)
----- -----
CASH USED IN FINANCING ACTIVITIES--CONTINUING OPERATIONS.............................. (279) (111)
CASH USED IN FINANCING ACTIVITIES--DISCONTINUED OPERATIONS............................ (5) --
----- -----
CASH USED IN FINANCING ACTIVITIES..................................................... (284) (111)
----- -----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..................................... 67 (10)
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR..................................................................... 17 23
----- -----
END OF PERIOD......................................................................... $ 84 $ 13
===== =====
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
1. SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Solutia Inc. and its subsidiaries make and sell a variety of
high-performance chemical-based materials. Solutia is a world leader in
performance films for laminated safety glass and after-market applications;
process development and scale-up services for pharmaceutical fine chemicals;
specialties such as water treatment chemicals, heat transfer fluids and
aviation hydraulic fluid and an integrated family of nylon products
including high-performance polymers and fibers.
Prior to September 1, 1997, Solutia was a wholly-owned subsidiary
of the former Monsanto Company (now known as Pharmacia Corporation). On
September 1, 1997, Monsanto distributed all of the outstanding shares of
common stock of the Company as a dividend to Monsanto stockholders (the
spinoff). As a result of the spinoff, on September 1, 1997, Solutia became
an independent publicly-held company listed on the New York Stock Exchange
and its operations ceased to be owned by Monsanto. A net deficiency of
assets of $113 million resulted from the spinoff.
Basis of Consolidation
The consolidated financial statements include the accounts of
Solutia and its majority-owned subsidiaries. Other companies in which
Solutia has a significant interest (20 to 50 percent) are included in
"Investments in Affiliates" in the Statement of Consolidated Financial
Position. Solutia's share of these companies' net earnings or losses is
reflected in "Equity Earnings (Loss) from Affiliates" in the Statement of
Consolidated Income (Loss).
Use of Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and that
affect revenues and expenses during the period reported. Estimates are
adjusted when necessary to reflect actual experience. Significant estimates
were used to account for restructuring reserves, environmental reserves,
self-insurance reserves, employee benefit plans, asset impairments and
contingencies.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and temporary investments
with maturities of three months or less when purchased. The effect of
exchange rate changes on cash and cash equivalents was not material.
Inventory Valuation
Inventories are stated at lower of cost or market. Actual cost is
used to value raw materials and supplies. Standard cost, which approximates
actual cost, is used to value finished goods and goods in process. Standard
cost includes direct labor and raw materials, and manufacturing overhead
based on practical capacity. The cost of certain inventories is determined
by the last-in, first-out (LIFO) method, which generally reflects the
effects of inflation or deflation on cost of goods sold sooner than other
inventory cost methods. The cost of other inventories generally is
determined by the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. The cost of
plant and equipment is depreciated over weighted average periods of 20 years
for buildings and 12 years for machinery and equipment, by the straight-line
method.
Intangible Assets
Effective January 1, 2002, Solutia discontinued the amortization of
goodwill and identifiable intangible assets that have indefinite useful
lives in accordance with Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangible Assets." Intangible assets that have
finite useful lives are amortized on a straight-line basis over their useful
lives, generally periods ranging from 5 to 20 years. Goodwill is assessed
annually for impairment. Fair value measurements of the reporting units are
estimated by a third-party specialist utilizing both an income and market
multiple approach.
Impairment of Long-lived Assets
Impairment tests of long-lived assets are made when conditions
indicate a possible loss. Impairment tests are based on a comparison of
undiscounted cash flows to the recorded value of the asset. If an impairment
is indicated, the asset value is written down to its fair value based upon
market prices or, if not available, upon discounted cash value, at an
appropriate discount rate.
Environmental Remediation
Costs for remediation of waste disposal sites are accrued in the
accounting period in which the obligation is probable and when the cost is
reasonably estimable. Postclosure costs for hazardous waste facilities at
certain U.S. operating locations are accrued over the estimated life of the
facility as part of its anticipated closure cost. Environmental liabilities
are not discounted, and they have not been reduced for any claims for
recoveries from insurance or third parties. In those cases where insurance
carriers or third-party indemnitors have agreed to pay any amounts and
management believes that collectability of such amounts is probable, the
amounts are reflected as receivables in the consolidated financial
statements.
Self-Insurance and Insurance Recoveries
Solutia maintains self-insurance reserves to reflect its estimate
of uninsured losses. Self-insured losses are accrued based upon estimates of
the aggregate liability for uninsured claims incurred using certain
actuarial assumptions followed in the insurance industry, the Company's
historical experience and certain case specific reserves as required,
including estimated legal costs. The maximum extent of the self-insurance
provided by the Company is dependent upon a number of factors including the
facts and circumstances of individual cases and the terms and conditions of
the commercial policies. Solutia has purchased commercial insurance in order
to reduce its exposure to workers' compensation, product, general, auto and
property liability claims. Policies for periods prior to the spinoff are
shared with Monsanto. This insurance has varying policy limits and
deductibles.
Insurance recoveries are estimated in consideration of expected
losses, coverage limits and policy deductibles. When recovery from an
insurance policy is considered probable, a receivable is recorded.
Revenue Recognition
The Company's primary revenue-earning activities involve producing
and delivering goods. Revenues are considered to be earned when the Company
has completed the process by which it is entitled to such revenues. The
following criteria are used for revenue recognition: persuasive evidence of
an arrangement exists, delivery has occurred, selling price is fixed or
determinable and collection is reasonably assured. In the case of the
pharmaceutical services businesses, revenues are primarily recorded on a
percentage of completion method.
Distribution Costs
The Company includes inbound freight charges, purchasing and
receiving costs, inspection costs, warehousing costs, internal transfer
costs and the other costs of our distribution network in the cost of sales
line item.
Derivative Financial Instruments
Currency forward contracts are used to manage currency exposures
for financial instruments denominated in currencies other than the entity's
functional currency. Natural gas contracts are used to manage some of the
exposure for the cost of natural gas. Gains and losses on contracts that are
designated and effective as hedges are included in net income (loss) and
offset the exchange gain or loss of the transaction being hedged.
Major currencies affecting the Company's business are the U.S.
dollar, the British pound sterling, the euro, the Canadian dollar, the
Australian dollar and the Brazilian real. Currency restrictions are not
expected to have a significant effect on Solutia's cash flow, liquidity or
capital resources.
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.
2
Currency Translation
The local currency has been used as the functional currency for
nearly all worldwide locations. The financial statements for most of
Solutia's ex-U.S. operations are translated into U.S. dollars at current or
average exchange rates. Unrealized currency translation adjustments in the
Statement of Consolidated Financial Position are accumulated as a component
of Shareholders' Deficit.
Earnings (Loss) per Share
Basic earnings (loss) per share is a measure of operating
performance that assumes no dilution from securities or contracts to issue
common stock. Diluted earnings (loss) per share is a measure of operating
performance by giving effect to the dilution that would occur if securities
or contracts to issue common stock were exercised or converted.
Stock Option Plans
Effective January 1, 2003, Solutia adopted SFAS No. 148,
"Accounting for Stock-Based Compensation--Transition and Disclosure," which
allowed Solutia to continue following the guidance of Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," for
measurement and recognition of stock-based transactions with employees.
Accordingly, no compensation cost has been recognized for Solutia's option
plans in the Statement of Consolidated Income (Loss), as all options granted
under the plans had an exercise price equal to the market value of the
Company's stock on the date of the grant. The following table illustrates
the effect on net income (loss) and earnings (loss) per share if the fair
value based method had been applied to all outstanding and unvested awards
in each period:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2003 2002 2003 2002
------ ----- ------ ------
NET INCOME (LOSS):
As reported ............................................ $ (38) $ 23 $ (57) $ (130)
Deduct: Total stock-based employee compensation expense
determined using the Black-Scholes option-pricing
model for all awards, net of tax ..................... (1) (2) (3) (4)
------ ----- ------ ------
Pro forma .............................................. $ (39) $ 21 $ (60) $ (134)
====== ===== ====== ======
INCOME (LOSS) PER SHARE:
Basic--as reported ..................................... $(0.36) $0.22 $(0.54) $(1.24)
Basic--pro forma ....................................... $(0.37) $0.20 $(0.57) $(1.28)
Diluted--as reported ................................... $(0.36) $0.22 $(0.54) $(1.24)
Diluted--pro forma ..................................... $(0.37) $0.20 $(0.57) $(1.27)
Compensation expense resulting from the fair value method may not
be representative of compensation expense to be incurred on a pro forma
basis in future years. The fair value of each option grant is estimated on
the date of grant by use of the Black-Scholes option-pricing model.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB)
issued Interpretation No. 46, "Consolidation of Variable Interest Entities."
This Interpretation provides guidance related to identifying variable
interest entities (VIEs) and determining whether such entities should be
consolidated. This Interpretation must be applied immediately to (a) VIEs
created, or (b) interests in VIEs obtained, after January 31, 2003. For
those VIEs created, or interests in VIEs obtained, on or before January 31,
2003, the guidance in this Interpretation must be applied in the first
fiscal year or interim period beginning after June 15, 2003. The Company has
one operating lease related to its corporate headquarters in St. Louis,
Missouri that qualifies as a VIE. Based on the current terms of the lease
agreement and the residual value guarantee the Company provides to the
lessor, the Company is the primary beneficiary of the VIE. As a result,
Solutia will be required to consolidate the assets and liabilities held by
this VIE of approximately $38 million and approximately $43 million,
respectively, and record an approximate charge of $5 million which will be
reported as a cumulative effect of a change in accounting principle in the
third quarter of 2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with
3
Characteristics of Both Liabilities and Equity." This Statement establishes
standards on how to classify and measure certain financial instruments with
characteristics of both liabilities and equity. The Statement also requires
financial instruments within its scope be classified as a liability (or an
asset in some circumstances). This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS No. 150 for financial instruments entered
into or modified after May 31, 2003 did not have a material effect on the
consolidated financial statements of the Company. In addition, the Company
does not expect the adoption of SFAS No. 150 for financial instruments
entered into or modified prior to May 31, 2003 to have a material effect on
the consolidated financial statements.
Reclassifications
Certain reclassifications to prior year's financial information
have been made to conform to the 2003 presentation.
These financial statements should be read in conjunction with the
audited financial statements and notes to consolidated financial statements
included in Solutia's 2002 Annual Report on Form 10-K, filed with the
Securities and Exchange Commission on March 6, 2003.
The accompanying unaudited consolidated financial statements
reflect all adjustments that, in the opinion of management, are necessary to
present fairly the financial position, results of operations, comprehensive
income (loss), and cash flows for the interim periods reported. Such
adjustments are of a normal, recurring nature. The results of operations for
the three-month and six-month periods ended June 30, 2003, are not
necessarily indicative of the results to be expected for the full year.
2. DISCONTINUED OPERATIONS
On December 2, 2002, Solutia signed a definitive agreement to sell
its resins, additives and adhesives businesses to UCB S.A. for $500 million
in cash, plus an upfront payment of $10 million for a period of exclusivity.
On January 31, 2003, the sale was completed resulting in a pretax gain of
$24 million. Total proceeds, including the $10 million exclusivity fee
received in 2002, net of transaction costs were $494 million. The assets and
liabilities of the discontinued operations have been classified as current
in the Statement of Consolidated Financial Position at December 31, 2002. In
addition, proceeds from this divestiture were used to pay down $405 million
of borrowings under the amended credit facility in accordance with bank
agreements. As a result, all borrowings under this facility have been
classified as short-term at December 31, 2002. The Company retained certain
tax liabilities of approximately $40 million related to the divested
businesses and has excluded them from the liabilities identified below. The
carrying amounts of assets and liabilities from discontinued operations at
December 31, 2002, consisted of the following:
DECEMBER 31,
2002
------------
ASSETS:
Receivables and prepaids.......................................... $100
Inventories....................................................... 68
Other current assets.............................................. 36
----
Total Current Assets..................................... 204
----
Property, plant and equipment, net................................ 199
Intangible assets................................................. 205
Other long-term assets............................................ 28
----
Total Assets............................................. $636
====
LIABILITIES:
Accounts payable.................................................. $ 42
Miscellaneous accruals............................................ 51
----
Total Current Liabilities................................ 93
----
Postretirement liabilities........................................ 21
Non-current deferred tax liability................................ 33
Other long-term liabilities....................................... 18
----
Total Liabilities........................................ $165
====
4
The operating results of the resins, additives and adhesives
businesses have been reported separately as discontinued operations in the
Consolidated Financial Statements for periods presented. The operating
results for the three and six months ended June 30, 2002 exclude certain
corporate expenses of $3 million and $4 million, respectively, which had
previously been allocated to the resins, additives and adhesives businesses.
In addition, interest expense of $24 million in 2003 and $9 million in 2002
associated with debt that was repaid with the sales proceeds was allocated
to discontinued operations. The operating results for 2003 include results
of operations for the month of January of 2003. Net sales and income from
discontinued operations are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ---------------------
2003 2002 2003 2002
---- ---- ---- ----
Net sales.................................... $-- $151 $53 $285
Income before income tax expense
(including gain on disposal of $24)........ -- 18 7 32
Income tax expense........................... -- (6) (9) (10)
---- ---- --- ----
Income (loss) from discontinued
operations................................. $-- $ 12 $(2) $ 22
==== ==== === ====
3. ACQUISITIONS
On May 31, 2002, Solutia acquired Axio Research Corporation (Axio)
for approximately $5 million, which was financed with cash from operations.
Axio is a contract research organization providing clinical trial design and
data management. Axio is included in Pharmaceutical Services within the
Performance Products and Services segment. The allocation of the purchase
price to assets and liabilities acquired resulted in current assets of
$1 million, non-current assets of $1 million, goodwill of $4 million and
current liabilities of $1 million. Axio's results of operations were
included in Solutia's results of operations from the acquisition date and
were not material to Solutia's consolidated results of operations for the
six month period ended June 30, 2002.
4. EARNINGS (LOSS) PER SHARE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2003 2002 2003 2002
------ ----- ------ ------
Income (Loss) from Continuing Operations Before Discontinued
Operations and Cumulative Effect of Change in Accounting Principle... $ (38) $ 11 $ (55) $ 15
Income (Loss) from Discontinued Operations, net of tax................. -- 12 (2) 22
Cumulative Effect of Change in Accounting Principle.................... -- -- -- (167)
------ ----- ------ ------
Net Income (Loss)...................................................... $ (38) $ 23 $ (57) $ (130)
====== ===== ====== ======
Basic Earnings (Loss) per Share:
Income (Loss) from Continuing Operations Before Discontinued
Operations and Cumulative Effect of Change in Accounting Principle... $(0.36) $0.10 $(0.52) $ 0.14
Income (Loss) from Discontinued Operations, net of tax ................ -- 0.12 (0.02) 0.21
Cumulative Effect of Change in Accounting Principle.................... -- -- -- (1.59)
------ ----- ------ ------
Basic Earnings (Loss) per Share........................................ $(0.36) $0.22 $(0.54) $(1.24)
------ ----- ------ ------
5
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2003 2002 2003 2002
------ ----- ------ ------
Diluted Earnings (Loss) per Share:
Income (Loss) from Continuing Operations Before Discontinued
Operations and Cumulative Effect of Change in Accounting Principle... $(0.36) $0.10 $(0.52) $ 0.14
Income (Loss) from Discontinued Operations, net of tax ................ -- 0.12 (0.02) 0.21
Cumulative Effect of Change in Accounting Principle.................... -- -- -- (1.59)
------ ----- ------ ------
Diluted Earnings (Loss) per Share...................................... $(0.36) $0.22 $(0.54) $(1.24)
------ ----- ------ ------
Weighted average equivalent shares (in millions):
Basic ............................................................. 104.6 104.8 104.6 104.7
Effect of dilutive securities:
Common share equivalents--common shares issuable upon
exercise of outstanding stock options and warrants........... -- 0.3 -- 0.4
------ ----- ------ ------
Diluted ........................................................... 104.6 105.1 104.6 105.1
====== ===== ====== ======
5. RESTRUCTURING RESERVES
During the second quarter of 2003, Solutia recorded restructuring
charges of $4 million to cost of goods sold and $4 million to marketing,
administrative and technological expenses for costs associated with
workforce reductions and $1 million to cost of goods sold for costs
primarily associated with contract terminations of leased administrative
facilities. The restructuring was part of an enterprise-wide cost reduction
initiative associated with the sale of the resins, additives and adhesives
businesses and other ongoing cost reduction initiatives. As a result of
these actions, Solutia reduced its workforce by approximately 280 positions.
Cash outlays associated with the restructuring actions were funded from
divestiture proceeds and operations. Approximately 90 percent of the
workforce reductions affected North American business and manufacturing
operations, and approximately 10 percent affected European, Asian and Latin
American operations. Management positions represented approximately
20 percent of the workforce reductions. Solutia anticipates additional
severance charges of approximately $5 million for the remainder of 2003 in
the Performance Products and Services segment.
During the first quarter of 2003, Solutia recorded restructuring
charges of $6 million to cost of goods sold and $5 million to marketing,
administrative and technological expenses for costs associated with
workforce reductions. The restructuring was part of an enterprise-wide cost
reduction initiative associated with the sale of the resins, additives and
adhesives businesses and other cost reduction initiatives. As a result of
these actions, Solutia reduced its workforce by approximately 170 positions.
Cash outlays associated with the restructuring actions were funded from
divestiture proceeds and operations. Approximately 90 percent of the
workforce reductions affected North American business and manufacturing
operations, and approximately 10 percent affected European, Asian and Latin
American operations. Management positions represented approximately
40 percent of the workforce reductions.
6
The following table summarizes the restructuring charges, amounts
utilized to carry out those plans and amount remaining at June 30, 2003:
EMPLOYMENT REDUCTIONS OTHER COSTS TOTAL
-------------------------------------- ------------ -----
PERFORMANCE PERFORMANCE
PRODUCTS AND INTEGRATED CORPORATE/ PRODUCTS AND
SERVICES NYLON OTHER SERVICES
------------ ---------- ---------- ------------
Balance at January 1, 2003 ............... $-- $-- $-- $-- $--
Charges taken ............................ 6 3 2 -- 11
Amounts utilized ......................... (3) (3) (1) -- (7)
---- ---- ---- ---- ----
Balance at March 31, 2003 ................ 3 -- 1 -- 4
Charges taken ............................ 4 2 2 1 9
Amounts utilized ......................... (5) -- (2) (1) (8)
---- ---- ---- ---- ----
BALANCE AT JUNE 30, 2003 ................. $ 2 $ 2 $ 1 $-- $ 5
==== ==== ==== ==== ====
During 2000, Solutia decided to exit its resins facility at the
Port Plastics site in Addyston, Ohio. An $8 million charge to cost of goods
sold was recorded to carry out the exit plan. The charge included $2 million
to write down plant assets to their fair value, $2 million of dismantling
costs and $4 million of direct manufacturing, overhead, utilities and
severance costs for which Solutia was contractually obligated under an
operating agreement. Solutia was required to provide 24 months notice of
intent to exit and was required to pay contractually obligated costs for an
additional 18 months thereafter to a third-party operator. Solutia provided
notice of intent to exit on June 30, 2000, and exited the site in June of
2002. Solutia retained the reserve pursuant to the sales agreement for the
resins, additives and adhesives divestiture.
The following table summarizes the restructuring charge, amounts
utilized to carry out those plans and amount remaining at June 30, 2003:
SHUTDOWN
OF ASSET OTHER
FACILITIES WRITE-DOWNS COSTS TOTAL
---------- ----------- ----- -----
Balance at January 1, 2000 ............... $-- $-- $-- $--
Charges taken ............................ 2 2 4 8
Amounts utilized ......................... -- (2) -- (2)
---- ---- ---- ----
Balance at December 31, 2000 ............. 2 -- 4 6
Amounts utilized ......................... -- -- -- --
---- ---- ---- ----
Balance at December 31, 2001 ............. 2 -- 4 6
Amounts utilized ......................... (2) -- -- (2)
---- ---- ---- ----
Balance at December 31, 2002 ............. -- -- 4 4
Amounts utilized ......................... -- -- -- --
---- ---- ---- ----
Balance at March 31, 2003 ................ -- -- 4 4
Amounts utilized ......................... -- -- (2) (2)
---- ---- ---- ----
BALANCE AT JUNE 30, 2003 ................. $-- $-- $ 2 $ 2
==== ==== ==== ====
7
6. INVENTORY VALUATION
The components of inventories as of June 30, 2003, and December 31,
2002, were as follows:
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
Finished goods................................................ $ 197 $ 179
Goods in process.............................................. 103 101
Raw materials and supplies.................................... 91 83
----- -----
Inventories, at FIFO cost..................................... 391 363
Excess of FIFO over LIFO cost................................. (122) (101)
----- -----
TOTAL......................................................... $ 269 $ 262
===== =====
7. REVOLVING CREDIT FACILITY
On June 30, 2003, the Company and its bank syndicate amended its
revolving credit facility to modify the financial covenants through
September 29, 2003. Without the amendment, the Company would not have been
in compliance with the leverage ratio at June 30, 2003. If the amendment
approval had been delayed until the first week of July, the Company would
not have been able to borrow under the facility until the approval was
obtained. Consequently in late June, the Company borrowed additional amounts
to ensure it had sufficient liquidity to meet its obligations during the
amendment approval process. The revolving credit facility matures on
August 13, 2004.
8. CONTINGENCIES
Because of the size and nature of its business, the Company is a
party to numerous legal proceedings. In addition, at the time Solutia became
an independent company, it contractually was required to assume certain
liabilities related to specified legal proceedings from the former Monsanto
Company (now known as Pharmacia Corporation, a wholly owned subsidiary of
Pfizer Inc.). As a result, although Pharmacia remains the named defendant,
the Company is required to manage this legacy litigation and indemnify
Pharmacia for costs, expenses and judgments arising from such litigation.
Solutia is defending a number of lawsuits pending in state and
federal court relating to the alleged release of polychlorinated biphenyls
(PCBs) and other materials from the Anniston, Alabama plant site, which
Solutia now owns and operates and at which Pharmacia formerly produced PCBs.
Following are updates of certain cases as more fully described in Solutia's
2002 Annual Report on Form 10-K, filed with the Securities and Exchange
Commission on March 6, 2003.
(1) Abernathy v. Monsanto: This matter involves four consolidated
cases brought on behalf of approximately 3,500 plaintiffs and
is currently pending in Circuit Court for Etowah County,
Alabama. As of August 11, 2003, the jury had returned
compensatory damage verdicts totaling approximately $101
million to the first 509 of the 907 plaintiffs who have made
property damage and exposure claims, but no final appealable
judgment has been entered with respect to these verdicts. No
claims of personal injury have been tried or presented to the
jury. Trial of this action continues.
(2) Tolbert v. Monsanto: This case involves the claims of
approximately 15,300 plaintiffs brought in the U.S. District
Court for the Northern District of Alabama. This case is
currently in pretrial mediation with the Phase I trial
commencing on October 14, 2003. The Phase I trial will involve
the claims of four plaintiffs, two from each of the two
"disease categories" previously selected by the parties.
(3) Payton v. Monsanto: This action was brought in Circuit Court
for Shelby County, Alabama on behalf of a purported class of
owners, lessees and licensees of property around Lay Lake. On
March 19, 2003, the trial court entered an order certifying a
plaintiff class. A notice of appeal was filed on April 30,
2003 seeking a reversal of the court's certification order. On
August 8, 2003 the Company reached an agreement to settle this
case for $5 million. A significant percentage of this amount
will be
8
recovered under existing commercial insurance policies. This
level of insurance recovery is not necessarily indicative
of future recoveries for other litigation matters. The
settlement must be approved by the court and it is anticipated
this process will take at least 120 days.
Solutia is also defending an action brought against Pharmacia in
the Commonwealth Court of Pennsylvania relating to low levels of PCBs found
in the Transportation & Safety Building owned by the Commonwealth in
Harrisburg, Pennsylvania (Penndot case). Briefing on appeal in this matter
was completed on July 21, 2003. The Company filed a motion on April 14, 2003
asking the Pennsylvania Supreme Court for an expedited argument of this
appeal. The Court denied the motion for expedited argument on July 22, 2003,
without prejudice to the Company's right to renew the motion if oral
argument is ordered.
As of June 30, 2003, the Company had accrued within its
self-insurance reserves approximately $35 million for all Anniston related
PCB cases. This accrual includes estimated legal expenses and probable
losses where the Company has sufficient information to determine a loss
amount. The Company has not accrued for any claims of personal injuries or
the fear of future illness because based upon the advice of counsel, the
Company believes it has meritorious defenses to these claims and will
ultimately prevail in court. The Company has approximately $10 million
accrued within its self-insurance reserves for other PCB litigation,
unrelated to the Anniston cases. This accrual is primarily for estimated
legal expenses. These cases are either in early stages of development, or
the Company believes it has meritorious defenses against these claims.
The verdicts returned as of August 11, 2003 in the Abernathy case
of approximately $101 million are far in excess of amounts the Company had
accrued as of June 30, 2003. Approximately 400 property claims and all of
the personal injury and potential punitive damage claims have yet to be
tried in the case. In addition, plaintiffs' counsel in the Tolbert case have
based their valuation of the case on the Abernathy verdicts. The use of
these verdicts as a basis for valuing the Tolbert case would result in a
valuation in excess of $3 billion. Based upon the advice of counsel, the
Company believes the Abernathy verdicts are seriously flawed and will be
reversed on appeal.
In connection with the external financing agreement for Astaris,
which expires in September of 2005, Solutia and its equal partner in the
venture, FMC Corporation, contractually agreed to provide Astaris with
funding in the event the joint venture fails to meet certain financial
benchmarks. The financial benchmarks were based on forecasted earnings that
were developed when the financing was entered into. Astaris' earnings have
fallen short of the forecast underlying its external financing agreement due
to numerous factors including significantly less than planned productivity
of its purified wet acid technology, lower sales volumes and lower average
selling prices due to the prolonged weak U.S. economy. As a result of these
earnings shortfalls versus the original expectations, Solutia and FMC have
each been required to make additional investments of $26 million during the
second quarter of 2003. These payments have largely been used to reduce debt
outstanding within the venture. Solutia and FMC are evaluating other
financing alternatives for the joint venture. If no new financing
arrangements are obtained, Solutia anticipates that its share of the
additional required contributions will be approximately $35 million for the
remainder of 2003. In addition, the Company expects to make additional
contributions in 2004, although such amounts cannot be determined at this
time. Contributions are recorded in the Investments in Affiliates line on
the Statement of Consolidated Financial Position. Due to the Company's
contractual obligation to fund the joint venture as described above, in
order to amend the Company's revolving credit facility, the Company must
obtain the approval of the Astaris' bank syndicate. Also, a default by the
Company of the financial covenants in its revolving credit facility
constitutes an event of default under Astaris' credit facility.
Solutia's access to the appellate courts in the Abernathy and
Tolbert cases may be years away. Without a dramatic change in circumstances,
the continuing overhang of the PCB litigation and other legacy liabilities
will significantly restrict the Company's alternatives to address both short
term and long term liquidity requirements with respect to the refinancing of
the credit facility, bond maturities and projected contributions to its
pension plans. The Company may not be successful in satisfying these future
liquidity requirements on favorable terms, if at all. The Company is
currently considering all available alternatives to address its legacy
liabilities and future liquidity needs, including a potential reorganization
under Chapter 11 of the U.S. bankruptcy code.
9
9. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, Solutia adopted SFAS No. 142. In
accordance with SFAS No. 142, Solutia discontinued the amortization of
goodwill and identifiable intangible assets that have indefinite useful
lives. This statement also required certain intangible assets that did not
meet the criteria for recognition apart from goodwill, to be subsumed into
goodwill. During the quarter ended March 31, 2002, Solutia subsumed into
goodwill $1 million of intangible assets net of related deferred tax
liabilities representing assembled workforce that did not meet the
separability criteria under SFAS No. 141, "Business Combinations."
Identified intangible assets are as follows:
JUNE 30, 2003
------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
VALUE AMORTIZATION VALUE
-------------- ------------ ------------
Amortized intangible assets:
Contractual customer relationships ............ $23 $ (6) $17
Employment agreements.......................... 5 (3) 2
Other ......................................... 8 (5) 3
Translation ................................... 8 -- 8
--- ---- ---
TOTAL AMORTIZED INTANGIBLE ASSETS ...................... $44 $(14) $30
--- ---- ---
Unamortized intangible assets:
Trademarks..................................... $39 $ (4) $35
Translation.................................... 2 -- 2
--- ---- ---
TOTAL UNAMORTIZED INTANGIBLE ASSETS..................... $41 $ (4) $37
--- ---- ---
TOTAL IDENTIFIED INTANGIBLE ASSETS...................... $85 $(18) $67
=== ==== ===
DECEMBER 31, 2002
------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
VALUE AMORTIZATION VALUE
-------------- ------------ ------------
Amortized intangible assets:
Contractual customer relationships ............ $23 $ (5) $18
Employment agreements.......................... 5 (3) 2
Other.......................................... 8 (5) 3
Translation.................................... 6 -- 6
--- ---- ---
TOTAL AMORTIZED INTANGIBLE ASSETS....................... $42 $(13) $29
--- ---- ---
Unamortized intangible assets:
Trademarks..................................... $39 $ (4) $35
Translation.................................... 2 -- 2
--- ---- ---
TOTAL UNAMORTIZED INTANGIBLE ASSETS..................... $41 $ (4) $37
--- ---- ---
TOTAL IDENTIFIED INTANGIBLE ASSETS ..................... $83 $(17) $66
=== ==== ===
There were no material acquisitions of intangible assets and there
have been no changes to amortizable lives or methods during the first half
of 2003. Amortization expense for the net carrying amount of intangible
assets is estimated to be $3 million in 2003, $3 million in 2004, $3 million
in 2005, $3 million in 2006 and $3 million in 2007.
Goodwill as allocated by reportable segment is as follows:
PERFORMANCE PRODUCTS
AND SERVICES TOTAL
-------------------- -----
Goodwill, December 31, 2002 ................. $144 $144
Translation ................................. 2 2
---- ----
Goodwill, June 30, 2003 ..................... $146 $146
---- ----
10
10. SEGMENT DATA
Solutia's management is organized around two strategic business
platforms: Performance Products and Services and Integrated Nylon. Solutia's
reportable segments and their major products are as follows:
PERFORMANCE PRODUCTS AND SERVICES INTEGRATED NYLON
--------------------------------- ----------------
SAFLEX(R) plastic interlayer Nylon intermediate "building
block" chemicals
Polyvinyl butyral for KEEPSAFE(R), SAFLEX Merchant polymer and nylon
INSIDE(R) (in Europe only) and KEEPSAFE extrusion polymers, including
MAXIMUM(R) laminated window glass VYDYNE(R) and ASCEND(R)
LLUMAR(R), VISTA(R) and GILA(R) professional Carpet fibers, including the
and retail window films WEAR-DATED(R) and ULTRON(R) brands
VANCEVA(TM) films Industrial nylon fibers
Conductive and anti-reflective coated ACRILAN(R) acrylic fibers for
films and deep-dyed films apparel, upholstery fabrics,
craft yarns and other applications
Industrial products, including
THERMINOL(R) heat transfer fluids,
DEQUEST(R) water treatment chemicals,
SKYDROL(R) aviation hydraulic fluids,
SKYKLEEN(R) aviation solvents, and
chlorobenzenes
Services for process research and
development, scale-up manufacturing and
small volume licensed production for
the pharmaceutical industry
Accounting policies of the segments are the same as those used in
the preparation of Solutia's consolidated financial statements. Solutia
evaluates the profitability of its operating segments based on segment
earnings before interest expense and income taxes, which includes marketing,
administrative, technological, and amortization expenses and other
non-recurring charges such as restructuring and asset impairment charges
that can be directly attributable to the operating segment. Certain expenses
and other items that are managed outside of the segments are excluded. These
unallocated items consist primarily of corporate expenses, equity earnings
(loss) from affiliates, interest expense, other income--net and expense
items, and certain non-recurring items such as gains and losses on asset
dispositions and restructuring charges that are not directly attributable to
the operating segments. Solutia accounts for intersegment sales at agreed
upon transfer prices. Intersegment sales are eliminated in consolidation.
Segment assets consist primarily of customer receivables, raw materials and
finished goods inventories, fixed assets, goodwill and identified intangible
assets directly associated with the production processes of the segment
(direct fixed assets). Segment depreciation and amortization are based upon
direct tangible and intangible assets. Unallocated assets consist primarily
of deferred taxes, certain investments in equity affiliates and indirect
fixed assets.
11
Segment data for the three and six months ended June 30, 2003, and
2002 are as follows:
THREE MONTHS ENDED JUNE 30,
----------------------------------------------
2003 2002
------------------ -------------------
NET NET
SALES PROFIT SALES PROFIT
------ ------ ------ ------
SEGMENT:
Performance Products and Services...................... $ 261 $ 26 $ 245 $ 23
Integrated Nylon....................................... 350 (20) 340 10
------ ---- ------ ----
SEGMENT TOTALS......................................... 611 6 585 33
RECONCILIATION TO CONSOLIDATED TOTALS:
Corporate expenses................................. (41) (15)
Equity earnings (loss) from affiliates, net of tax. -- 3
Interest expense................................... (25) (16)
Other income--net.................................. 1 2
CONSOLIDATED TOTALS:
------ ------
NET SALES.......................................... $ 611 $ 585
====== ---- ====== ----
INCOME (LOSS) BEFORE INCOME TAXES ................. $(59) $ 7
==== ====
SIX MONTHS ENDED JUNE 30,
----------------------------------------------
2003 2002
------------------ -------------------
NET NET
SALES PROFIT SALES PROFIT
------ ------ ------ ------
SEGMENT:
Performance Products and Services...................... $ 504 $ 43 $ 469 $ 44
Integrated Nylon....................................... 703 (31) 636 17
------ ---- ------ ----
SEGMENT TOTALS......................................... 1,207 12 1,105 61
RECONCILIATION TO CONSOLIDATED TOTALS:
Corporate expenses................................. (56) (32)
Equity earnings (loss) from affiliates, net of tax. (3) 11
Interest expense................................... (48) (35)
Other income--net ................................. 5 6
CONSOLIDATED TOTALS:
------ ------
NET SALES.......................................... $1,207 $1,105
====== ---- ====== ----
INCOME (LOSS) BEFORE INCOME TAXES ................. $(90) $ 11
==== ====
11. SUBSEQUENT EVENTS
On August 8, 2003 the Company reached an agreement to settle the
Payton v. Monsanto case for $5 million. A significant percentage of this
amount will be recovered under existing commercial insurance policies. This
level of insurance recovery is not necessarily indicative of future
recoveries for other litigation matters. The settlement must be approved by
the court and it is anticipated this process will take at least 120 days.
On August 4, 2003, the U.S. District Court for the Northern
District of Alabama approved a partial consent decree among Solutia,
Pharmacia Corporation, the U.S. Environmental Protection Agency (EPA) and
the U.S. Department of Justice with respect to the Anniston, Alabama site.
Under this decree, Solutia expects to conduct an expedited residential
cleanup of identified properties to achieve the EPA's cleanup standard, and
perform a Remedial Investigation and Feasibility Study (RI/FS). The RI/FS
performed under the partial consent decree will outline the work that will
lead to a comprehensive approach to the cleanup of PCBs in waterways and
commercial properties in the Anniston area. In addition, the partial consent
decree provides for the establishment of an educational fund. Consistent
with accounting requirements for this type of subsequent event, the Company
recorded an environmental charge of approximately $27 million for the three
and six months ended June 30, 2003.
On August 4, 2003, Solutia and Monsanto entered into an amendment
to the Penndot Protocol agreement
12
dated November 15, 2002. Pursuant to the amendment, Monsanto released
Solutia from its obligation to provide Monsanto with a $39.9 million letter
of credit to secure a portion of Monsanto's obligations with respect to an
appeal bond in the Penndot case. As a result of the amendment on August 4,
2003, Monsanto assumed control of any settlement decision but agreed to
consult with Solutia and Pharmacia before agreeing to any settlement.
Solutia continues to provide a $20 million letter of credit to secure a
portion of Monsanto's obligations with respect to the appeal bond.
During July 2003, a purported shareholder class action, Richard
Brazin v. Solutia Inc. et.al., was filed against Solutia, its chief
executive officer, and its chief financial officer in the Federal District
Court for the Northern District of California. The complaint alleges that
from December 16, 1998, to October 10, 2002, Solutia's accounting practices
regarding incorporation of Flexsys's results into Solutia's financial
reports violated federal securities laws by misleading investors as to
Solutia's actual results and causing inflated prices for Solutia's publicly
traded securities. Solutia is aware of three other purported shareholder
class actions filed in the same court against Solutia and certain of its
officers and directors, which we believe are premised on substantially
similar allegations. The Company believes these suits are without merit and
intends to defend these actions vigorously.
12. CONSOLIDATING CONDENSED FINANCIAL STATEMENTS
CPFilms, Inc., Monchem International, Inc., Monchem, Inc., and
Solutia Systems, Inc., wholly-owned subsidiaries of the Company (the
"Guarantors"), are guarantors of the amended credit facility and the senior
secured notes (the "Notes"). The Guarantors fully and unconditionally
guarantee the Notes on a joint and several basis. The following
consolidating condensed financial statements present, in separate columns,
financial information for: Solutia Inc. on a parent-only basis carrying its
investment in subsidiaries under the equity method; Guarantors on a
combined, or where appropriate, consolidated basis, carrying investments in
subsidiaries who do not guarantee the debt (the "Non-Guarantors") under the
equity method; Non-Guarantors on a combined, or where appropriate,
consolidated basis; eliminating adjustments; and consolidated totals as of
June 30, 2003 and December 31, 2002, and for the periods ended June 30, 2003
and 2002. The eliminating adjustments primarily reflect intercompany
transactions, such as interest income and expense, accounts receivable and
payable, advances, short and long-term debt, royalties and profit in
inventory eliminations. The Company has not presented separate financial
statements and other disclosures concerning the Guarantors as such
information is not material and would substantially duplicate disclosures
included elsewhere in this report.
13
SOLUTIA INC.
CONSOLIDATING STATEMENT OF INCOME (LOSS)
THREE MONTHS ENDED JUNE 30, 2003
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ................................... $458 $ 42 $195 $(84) $611
Cost of goods sold .......................... 471 19 161 (89) 562
---- ---- ---- ---- ----
GROSS PROFIT ................................ (13) 23 34 5 49
Marketing expenses........................... 27 5 8 -- 40
Administrative expenses...................... 21 2 10 -- 33
Technological expenses....................... 10 -- 1 -- 11
Amortization expense......................... -- -- -- -- --
---- ---- ---- ---- ----
OPERATING INCOME (LOSS) ..................... (71) 16 15 5 (35)
Equity earnings (loss) from affiliates - net
of tax .................................... 45 5 (1) (49) --
Interest expense ............................ (39) (1) (13) 28 (25)
Other income - net .......................... 3 22 8 (32) 1
---- ---- ---- ---- ----
INCOME (LOSS) BEFORE INCOME TAXES ........... (62) 42 9 (48) (59)
Income taxes (benefit) ...................... (24) 1 2 -- (21)
---- ---- ---- ---- ----
NET INCOME (LOSS) ........................... $(38) $ 41 $ 7 $(48) $(38)
==== ==== ==== ==== ====
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS)
THREE MONTHS ENDED JUNE 30, 2003
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET INCOME (LOSS) ........................... $(38) $ 41 $ 7 $(48) $(38)
OTHER COMPREHENSIVE INCOME (LOSS):
Currency translation adjustments ............ 6 6 (4) (2) 6
---- ---- ---- ---- ----
COMPREHENSIVE INCOME (LOSS) ................. $(32) $ 47 $ 3 $(50) $(32)
==== ==== ==== ==== ====
14
SOLUTIA INC.
CONSOLIDATING STATEMENT OF INCOME
THREE MONTHS ENDED JUNE 30, 2002
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ................................... $451 $ 47 $165 $ (78) $585
Cost of goods sold .......................... 412 20 139 (82) 489
---- ---- ---- ----- ----
GROSS PROFIT ................................ 39 27 26 4 96
Marketing expenses .......................... 24 4 8 -- 36
Administrative expenses ..................... 23 2 6 -- 31
Technological expenses ...................... 11 1 -- -- 12
Amortization expense ........................ -- -- -- -- --
---- ---- ---- ----- ----
OPERATING INCOME (LOSS) ..................... (19) 20 12 4 17
Equity earnings (loss) from affiliates - net
of tax .................................... 56 (2) -- (50) 4
Interest expense ............................ (32) (2) (27) 45 (16)
Other income - net .......................... -- 32 18 (48) 2
---- ---- ---- ----- ----
INCOME BEFORE INCOME TAXES .................. 5 48 3 (49) 7
Income taxes (benefit) ...................... (6) -- 2 -- (4)
---- ---- ---- ----- ----
INCOME FROM CONTINUING OPERATIONS ........... 11 48 1 (49) 11
Income from Discontinued Operations, net of
tax ....................................... 12 11 11 (22) 12
---- ---- ---- ----- ----
NET INCOME .................................. $ 23 $ 59 $ 12 $ (71) $ 23
==== ==== ==== ===== ====
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
THREE MONTHS ENDED JUNE 30, 2002
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET INCOME .................................. $ 23 $ 59 $ 12 $ (71) $ 23
OTHER COMPREHENSIVE INCOME:
Currency translation adjustments ............ 87 88 13 (101) 87
Unrealized investment gain, net of tax ...... (1) -- -- -- (1)
---- ---- ---- ----- ----
COMPREHENSIVE INCOME ........................ $109 $147 $ 25 $(172) $109
==== ==== ==== ===== ====
15
SOLUTIA INC.
CONSOLIDATING STATEMENT OF LOSS
SIX MONTHS ENDED JUNE 30, 2003
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ................................... $ 922 $ 75 $ 376 $(166) $1,207
Cost of goods sold .......................... 915 33 317 (176) 1,089
----- ----- ----- ----- ------
GROSS PROFIT ................................ 7 42 59 10 118
Marketing expenses .......................... 54 10 15 -- 79
Administrative expenses ..................... 42 4 17 -- 63
Technological expenses ...................... 21 1 1 -- 23
Amortization expense ........................ -- -- 1 -- 1
----- ----- ----- ----- ------
OPERATING INCOME (LOSS) ..................... (110) 27 25 10 (48)
Equity earnings (loss) from affiliates - net
of tax .................................... 99 27 -- (128) (2)
Interest expense ............................ (75) (4) (32) 63 (48)
Other income - net .......................... 6 45 24 (67) 8
----- ----- ----- ----- ------
INCOME (LOSS) BEFORE INCOME TAXES ........... (80) 95 17 (122) (90)
Income benefit .............................. (25) -- (12) 2 (35)
----- ----- ----- ----- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS .... (55) 95 29 (124) (55)
Loss from Discontinued Operations, net of tax (2) (103) (103) 206 (2)
----- ----- ----- ----- ------
NET LOSS .................................... $ (57) $ (8) $ (74) $ 82 $ (57)
===== ===== ===== ===== ======
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS)
SIX MONTHS ENDED JUNE 30, 2003
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET LOSS .................................... $ (57) $ (8) $ (74) $ 82 $ (57)
OTHER COMPREHENSIVE INCOME (LOSS):
Currency translation adjustments ............ 43 44 31 (75) 43
----- ----- ----- ----- ------
COMPREHENSIVE INCOME (LOSS) ................. $ (14) $ 36 $ (43) $ 7 $ (14)
===== ===== ===== ===== ======
16
SOLUTIA INC.
CONSOLIDATING STATEMENT OF LOSS
SIX MONTHS ENDED JUNE 30, 2002
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ................................... $ 855 $ 83 $ 321 $(154) $1,105
Cost of goods sold .......................... 777 37 267 (159) 922
----- ----- ----- ----- ------
GROSS PROFIT ................................ 78 46 54 5 183
Marketing expenses .......................... 50 9 12 -- 71
Administrative expenses ..................... 47 4 12 -- 63
Technological expenses ...................... 21 1 1 -- 23
Amortization expense ........................ -- -- 1 -- 1
----- ----- ----- ----- ------
OPERATING INCOME (LOSS) ..................... (40) 32 28 5 25
Equity earnings (loss) from affiliates - net
of tax .................................... (68) (160) -- 240 12
Interest expense ............................ (66) (4) (56) 91 (35)
Other income - net .......................... 16 52 40 (99) 9
----- ----- ----- ----- ------
INCOME (LOSS) BEFORE INCOME TAXES ........... (158) (80) 12 237 11
Income taxes (benefit) ...................... (7) -- 4 (1) (4)
----- ----- ----- ----- ------
INCOME (LOSS) FROM CONTINUING OPERATIONS .... (151) (80) 8 238 15
Income from Discontinued Operations, net of
tax ....................................... 22 22 22 (44) 22
Cumulative Effect of Change in Accounting
Principle, net of tax ..................... (1) -- (166) -- (167)
----- ----- ----- ----- ------
NET LOSS .................................... $(130) $ (58) $(136) $ 194 $ (130)
===== ===== ===== ===== ======
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS)
SIX MONTHS ENDED JUNE 30, 2002
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET LOSS .................................... $(130) $ (58) $(136) $ 194 $ (130)
OTHER COMPREHENSIVE INCOME (LOSS):
Currency translation adjustments ............ 82 81 13 (94) 82
Net realized loss on derivative instruments,
net of tax ................................ 1 -- -- -- 1
----- ----- ----- ----- ------
COMPREHENSIVE INCOME (LOSS) ................. $ (47) $ 23 $(123) $ 100 $ (47)
===== ===== ===== ===== ======
17
SOLUTIA INC.
CONSOLIDATING BALANCE SHEET
JUNE 30, 2003
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................... $ 21 $ -- $ 63 $ -- $ 84
Trade receivables, net ...................... 10 164 130 -- 304
Intercompany receivables .................... 75 630 121 (826) --
Miscellaneous receivables ................... 71 (3) 38 -- 106
Prepaid expenses ............................ 11 -- 3 -- 14
Deferred income tax benefit ................. 115 -- 22 5 142
Inventories ................................. 161 24 98 (14) 269
------ ------ ------ ------- ------
TOTAL CURRENT ASSETS ........................ 464 815 475 (835) 919
PROPERTY, PLANT AND EQUIPMENT:
Land ........................................ 18 -- 1 -- 19
Buildings ................................... 265 25 90 -- 380
Machinery and equipment ..................... 2,502 71 424 -- 2,997
Construction in progress .................... 12 2 10 -- 24
------ ------ ------ ------- ------
Total property, plant and equipment ......... 2,797 98 525 -- 3,420
Less accumulated depreciation ............... 2,105 22 369 -- 2,496
------ ------ ------ ------- ------
NET PROPERTY, PLANT AND EQUIPMENT ........... 692 76 156 -- 924
INVESTMENTS IN AFFILIATES ................... 2,633 (16) 33 (2,396) 254
GOODWILL .................................... -- 72 74 -- 146
IDENTIFIED INTANGIBLE ASSETS, NET ........... 3 27 37 -- 67
LONG-TERM DEFERRED INCOME TAX BENEFIT ....... 290 1 14 -- 305
INTERCOMPANY ADVANCES ....................... 128 1,691 769 (2,588) --
OTHER ASSETS ................................ 307 -- 28 -- 335
------ ------ ------ ------- ------
TOTAL ASSETS ................................ $4,517 $2,666 $1,586 $(5,819) $2,950
====== ====== ====== ======= ======
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
CURRENT LIABILITIES:
Accounts payable ............................ $ 164 $ 13 $ 37 $ (2) $ 212
Intercompany payables ....................... 531 164 131 (826) --
Wages and benefits .......................... 18 -- 11 -- 29
Postretirement liabilities .................. 99 -- 1 -- 100
Miscellaneous accruals ...................... 223 11 109 -- 343
Short-term debt ............................. 120 -- -- -- 120
Intercompany short-term debt ................ 38 48 260 (346) --
------ ------ ------ ------- ------
TOTAL CURRENT LIABILITIES ................... 1,193 236 549 (1,174) 804
LONG-TERM DEBT .............................. 633 -- 230 -- 863
INTERCOMPANY LONG-TERM DEBT ................. 1,521 19 702 (2,242) --
POSTRETIREMENT LIABILITIES .................. 1,132 -- 30 -- 1,162
OTHER LIABILITIES ........................... 301 -- 82 1 384
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock ................................ 1 -- -- -- 1
Additional contributed capital .......... 19 -- -- -- 19
Treasury stock .......................... (251) -- -- -- (251)
Net (deficiency) excess of assets at
spinoff and subsidiary capital ........ (113) 2,411 (7) (2,404) (113)
Accumulated other comprehensive loss ........ (103) -- -- -- (103)
Reinvested earnings ......................... 184 -- -- -- 184
------ ------ ------ ------- ------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ........ (263) 2,411 (7) (2,404) (263)
------ ------ ------ ------- ------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT) ................................. $4,517 $2,666 $1,586 $(5,819) $2,950
====== ====== ====== ======= ======
18
SOLUTIA INC.
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2002
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.................... $ -- $ -- $ 17 $ -- $ 17
Trade receivables, net ...................... 12 146 112 -- 270
Intercompany receivables .................... 28 567 357 (952) --
Miscellaneous receivables ................... 69 -- 28 -- 97
Prepaid expenses ............................ 14 1 2 -- 17
Deferred income tax benefit ................. 82 -- 19 7 108
Inventories ................................. 167 23 92 (20) 262
Current Assets - Discontinued Operations .... 85 10 541 -- 636
------ ------ ------ ------- ------
TOTAL CURRENT ASSETS ........................ 457 747 1,168 (965) 1,407
PROPERTY, PLANT AND EQUIPMENT:
Land ........................................ 17 -- 2 -- 19
Buildings ................................... 266 25 84 -- 375
Machinery and equipment ..................... 2,482 71 393 -- 2,946
Construction in progress .................... 15 1 10 -- 26
------ ------ ------ ------- ------
Total property, plant and equipment ......... 2,780 97 489 -- 3,366
Less accumulated depreciation ............... 2,082 19 335 -- 2,436
------ ------ ------ ------- ------
NET PROPERTY, PLANT AND EQUIPMENT ........... 698 78 154 -- 930
INVESTMENTS IN AFFILIATES ................... 2,990 33 30 (2,821) 232
GOODWILL..................................... -- 72 72 -- 144
IDENTIFIED INTANGIBLE ASSETS, NET ........... 3 26 37 -- 66
LONG-TERM DEFERRED INCOME TAX BENEFIT ....... 278 -- 12 -- 290
INTERCOMPANY ADVANCES ....................... 128 2,126 1,461 (3,715) --
OTHER ASSETS ................................ 241 1 31 -- 273
------ ------ ------ ------- ------
TOTAL ASSETS ................................ $4,795 $3,083 $2,965 $(7,501) $3,342
====== ====== ====== ======= ======
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
CURRENT LIABILITIES:
Accounts payable ............................ $ 191 $ 8 $ 35 $ -- $ 234
Intercompany payables ....................... 463 152 337 (952) --
Wages and benefits .......................... 20 -- 22 -- 42
Postretirement liabilities .................. 92 -- 1 -- 93
Miscellaneous accruals ...................... 179 10 125 -- 314
Short-term debt ............................. 233 -- 125 -- 358
Intercompany short-term debt ................ 201 23 268 (492) --
Current Liabilities - Discontinued Operations 33 -- 132 -- 165
------ ------ ------ ------- ------
TOTAL CURRENT LIABILITIES ................... 1,412 193 1,045 (1,444) 1,206
LONG-TERM DEBT .............................. 630 -- 209 -- 839
INTERCOMPANY LONG-TERM DEBT ................. 1,586 98 1,539 (3,223) --
POSTRETIREMENT LIABILITIES .................. 1,137 -- 27 -- 1,164
OTHER LIABILITIES ........................... 279 -- 104 (1) 382
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock ................................ 1 -- -- -- 1
Additional contributed capital ......... 19 -- -- -- 19
Treasury stock .......................... (251) -- -- -- (251)
Net (deficiency) excess of assets at
spinoff and subsidiary capital ........ (113) 2,792 41 (2,833) (113)
Accumulated other comprehensive loss ........ (146) -- -- -- (146)
Reinvested earnings ......................... 241 -- -- -- 241
------ ------ ------ ------- ------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ........ (249) 2,792 41 (2,833) (249)
------ ------ ------ ------- ------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT) ................................. $4,795 $3,083 $2,965 $(7,501) $3,342
====== ====== ====== ======= ======
19
SOLUTIA INC.
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2003
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
CASH PROVIDED BY (USED IN) OPERATIONS $(132) $ 61 $ 19 $ -- $ (52)
----- ---- ----- ----- -----
INVESTING ACTIVITIES:
Property, plant and equipment purchases ..... (41) (1) (4) -- (46)
Acquisition and investment payments, net of
cash acquired.............................. (27) -- -- -- (27)
Property disposals and investment proceeds .. 171 -- 305 -- 476
----- ---- ----- ----- -----
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 103 (1) 301 -- 403
----- ---- ----- ----- -----
FINANCING ACTIVITIES:
Net change in short-term debt obligations ... (113) -- (126) -- (239)
Other financing activities .................. (45) -- -- -- (45)
Changes in investments and advances from (to)
affiliates ................................ 208 (60) (148) -- --
----- ---- ----- ----- -----
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 50 (60) (274) -- (284)
----- ---- ----- ----- -----
INCREASE IN CASH AND CASH EQUIVALENTS 21 -- 46 -- 67
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR ........................... -- -- 17 -- 17
----- ---- ----- ----- -----
END OF PERIOD ............................... $ 21 $-- $ 63 $ -- $ 84
===== ==== ===== ===== =====
20
SOLUTIA INC.
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002
(DOLLARS IN MILLIONS)
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
CASH PROVIDED BY (USED IN) OPERATIONS $ (39) $ 63 $ 25 $ -- $ 49
----- ---- ----- ----- -----
INVESTING ACTIVITIES:
Property, plant and equipment purchases ..... (15) (4) (12) -- (31)
Acquisition and investment payments, net of
cash acquired.............................. (17) -- -- -- (17)
Property disposals and investment proceeds .. 101 -- (1) -- 100
----- ---- ----- ----- -----
CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES ................................ 69 (4) (13) -- 52
----- ---- ----- ----- -----
FINANCING ACTIVITIES:
Net change in short-term debt obligations ... (157) -- 48 -- (109)
Common stock issued under employee stock
plans ..................................... 2 -- -- -- 2
Other financing activities .................. (4) -- -- -- (4)
Changes in investments and advances from (to)
affiliates ................................ 128 (59) (69) -- --
----- ---- ----- ----- -----
CASH USED IN FINANCING ACTIVITIES ........... (31) (59) (21) -- (111)
----- ---- ----- ----- -----
DECREASE IN CASH AND CASH EQUIVALENTS ....... (1) -- (9) -- (10)
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR ........................... 3 1 19 -- 23
----- ---- ----- ----- -----
END OF PERIOD ............................... $ 2 $ 1 $ 10 $ -- $ 13
===== ==== ===== ===== =====
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This section includes forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. These forward-looking statements include
all statements regarding expected future financial position, results of
operations, profitability, cash flows and liquidity, as well as
forward-looking statements regarding other matters. Important factors that
could cause actual results to differ materially from the expectations
reflected in the forward-looking statements herein include, among others,
general economic, business and market conditions, customer acceptance of new
products, raw material and energy costs or shortages, adverse developments
in the Anniston, Alabama PCB litigation, limited access to capital
resources, currency fluctuations, increased competitive and/or customer
pressure, gain or loss of significant customers, ability to divest existing
businesses, exposure to product liability and other litigation,
environmental remediation costs, changes in accounting principles generally
accepted in the United States of America, ability to implement cost
reduction initiatives in a timely manner, geopolitical instability, and
changes in pension assumptions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
A summary of our critical accounting policies and estimates is
presented on page 14 of our 2002 Annual Report on Form 10-K filed with the
Securities and Exchange Commission on March 6, 2003.
RESULTS OF OPERATIONS--THREE MONTHS ENDED JUNE 30, 2003 COMPARED WITH THREE
MONTHS ENDED JUNE 30, 2002
Net sales for the second quarter of 2003 were $611 million compared
with net sales of $585 million for the second quarter of 2002. The net sales
increase reflected higher average selling prices of approximately 5 percent,
lower sales volumes of approximately 3 percent and favorable currency
exchange rate fluctuations of approximately 2 percent.
Performance Products and Services
Performance Products and Services net sales for the second quarter
of 2003 were $261 million compared with $245 million for the second quarter
of 2002. The sales increase resulted from favorable currency exchange rate
fluctuations of approximately 6 percent and volume gains of approximately
1 percent. Net sales were positively affected by the strengthening euro and
Australian dollar in relation to the U.S. dollar. Sales volumes increases in
SAFLEX(R) plastic interlayer products were partially offset by sales volume
decreases in CPFilms window film and precision coated products. Moderate
increases of average selling prices experienced in chlorobenzenes and
THERMINOL(R) heat transfer fluids were offset by lower average selling
prices experienced in SAFLEX(R) plastic interlayer products.
Segment profit was $26 million for the second quarter of 2003
versus $23 million for the prior year quarter. Segment profit increased
$3 million or 13 percent, primarily due to higher net sales, favorable
manufacturing variances, and lower marketing, administrative and
technological expenses, partially offset by increased raw material and
energy costs and severance charges associated with workforce reductions.
Integrated Nylon
The Integrated Nylon segment had net sales of $350 million for the
second quarter of 2003 compared with $340 million for the same period of the
prior year. The sales increase resulted from higher average selling prices
of approximately 9 percent, partially offset by lower sales volumes of
approximately 6 percent. Price increases occurred in intermediate chemicals
as it benefited from formula-based sales contracts tied to raw material
costs and higher pricing in the merchant acrylonitrile market. In addition,
carpet fibers recorded improvements in average selling prices following an
April 1, 2003 price increase. Carpet fibers volumes were modestly lower
compared to the prior year period and in line with industry trends. Acrylic
fiber volume was down substantially reflecting continuing erosion of the
U.S. textile market.
22
The Integrated Nylon segment experienced a loss of $20 million in
the second quarter of 2003 compared to segment profit of $10 million in the
prior year quarter. Segment profit declined because of higher raw material
and energy costs of approximately $50 million, severance charges associated
with workforce reductions and higher marketing expenses, partially offset by
higher net sales and favorable manufacturing operations. The Company expects
raw material and energy prices to remain at elevated levels for the
remainder of 2003, which will have a negative impact on segment
profitability. In addition, during scheduled downtime for preventative
maintenance at the acrylonitrile facility at the Chocolate Bayou
Intermediates site, the Company discovered conditions which will result in
additional downtime for unscheduled maintenance. This unscheduled additional
downtime could have a material effect on segment profitability in the third
quarter.
Corporate Expenses
Corporate expenses were $41 million for the second quarter of 2003
compared to $15 million in the second quarter of 2002. The increase is due
to an environmental charge of approximately $27 million to recognize the
Company's obligations under a partial consent decree approved on August 4,
2003 related to remediation at Anniston, Alabama.
Operating Income (Loss)
THREE MONTHS
ENDED JUNE 30,
----------------
(dollars in millions) 2003 2002
---- ----
Performance Products and Services Segment Profit .............. $ 26 $ 23
Integrated Nylon Segment Profit/(Loss) ........................ (20) 10
Corporate Expenses ............................................ (41) (15)
Less: Equity Earnings from Affiliates included in
Segment Profit/(Loss) .............................. -- (1)
Less: Other Income items included in Segment
Profit/(Loss) ...................................... -- --
---- ----
Operating Income/(Loss) ....................................... $(35) $ 17
==== ====
Solutia had an operating loss of $35 million in the second quarter
of 2003 compared with operating income of $17 million in the second quarter
of 2002. The decrease in operating income was primarily driven by higher raw
material and energy costs, higher environmental costs, lower sales volumes,
and higher severance costs associated with workforce reductions, partially
offset by improvements in average selling prices, favorable currency
exchange rate fluctuations and favorable manufacturing operations.
Equity Earnings from Affiliates
THREE MONTHS
ENDED JUNE 30,
----------------
(dollars in millions) 2003 2002
---- ----
Equity Earnings from Affiliates ............................... $-- $4
=== ==
Equity Earnings from Affiliates included in Reportable
Segment Profit .......................................... $-- $1
=== ==
Solutia records equity earnings from affiliates net of income
taxes. Equity earnings from affiliates were break even for the three months
ended June 30, 2003, compared to equity earnings from affiliates of
$4 million for the
23
comparable quarter of 2002. Equity earnings from affiliates in 2003 were
negatively affected by $2 million of restructuring charges primarily related
to severance at both the Flexsys and Astaris joint ventures. In addition to
the restructuring charges, Astaris' earnings decreased as a result of lower
sales volumes, lower selling prices and lower revenue from an electricity
sales contract. Flexsys' earnings were lower because of higher raw material
and energy costs.
Income Tax Benefit
Solutia's income tax benefit was $21 million for the second quarter
of 2003 compared to $4 million for the second quarter of 2002. The
significant increase in income tax benefit is due to the decrease in income
on a year over year basis The Company's effective rate, after consideration
of the tax expense included in equity earnings was 36%, compared to 22% for
the prior year period. The increase was due to the utilization of deferred
tax liabilities for the income taxes on distributed foreign earnings.
Restructuring Activities
During the second quarter of 2003, Solutia recorded restructuring
charges of $4 million to cost of goods sold and $4 million to marketing,
administrative and technological expenses for costs associated with
workforce reductions and $1 million to cost of goods sold for costs
primarily associated with contract terminations of leased administrative
facilities. The restructuring was part of an enterprise-wide cost reduction
initiative associated with the sale of the resins, additives and adhesives
businesses and other ongoing cost reduction initiatives. As a result of
these actions, Solutia reduced its workforce by approximately 280 positions.
Cash outlays associated with the restructuring actions were funded from
operations. Approximately 90 percent of the workforce reductions affected
North American business and manufacturing operations, and approximately
10 percent affected European, Asian and Latin American operations. Management
positions represented approximately 20 percent of the workforce reductions.
Solutia anticipates additional severance charges of approximately $5 million
for the remainder of 2003 in the Performance Products and Services segment.
RESULTS OF OPERATIONS--SIX MONTHS ENDED JUNE 30, 2003 COMPARED WITH SIX
MONTHS ENDED JUNE 30, 2002
Net sales for the six-month period ended June 30, 2003 were
$1,207 million compared with net sales of $1,105 million for the six-month
period ended June 30, 2002. The net sales increase reflected higher average
selling prices of approximately 7 percent, lower sales volumes of approximately
1 percent and favorable currency exchange rate fluctuations of approximately
3 percent.
Performance Products and Services
Performance Products and Services net sales for the first six
months of 2003 were $504 million compared with $469 million for the first
six months of 2002. The sales increase of approximately 7 percent resulted
principally due to the strengthening of the euro and Australian dollar in
relation to the U.S. dollar. Moderate increases of average selling prices
experienced in chlorobenzenes and THERMINOL(R) heat transfer fluids were
offset by decreases experienced in SAFLEX(R) plastic interlayer products.
Slight increases of volumes experienced in SAFLEX(R) plastic interlayer
products were offset by decreases in volumes experienced in CPFilms window
film and precision coated products.
Segment profit was $43 million for the first half of 2003 versus
$44 million for the first half of 2002. Segment profit decreased $1 million
or 2 percent primarily due to severance charges associated with workforce
reductions and increased raw material costs, partially offset by higher net
sales and lower administrative expenses.
24
Integrated Nylon
The Integrated Nylon segment had net sales of $703 million for the
six months ended June 30, 2003 compared with $636 million for the same
period of the prior year. The sales increase resulted from higher average
selling prices of approximately 12 percent partially offset by sales volume
declines of approximately 1 percent. Price increases occurred in
intermediate chemicals as it benefited from formula-based sales contracts
tied to raw material costs and higher pricing in the merchant acrylonitrile
market. In addition, modest gains in average selling prices were recorded in
the remaining businesses. Acrylic fiber sales volumes declined due to weak
U.S. demand in the textiles segment. Carpet fibers volumes were down
slightly compare to the prior year period and in line with industry trends.
The largest volume increase was in nylon plastics and polymers, which
benefited from reintegrated marketing responsibilities for the nylon molding
resins business which were previously performed under a marketing alliance
with Dow Plastics, a business unit of Dow Chemical.
The Integrated Nylon segment experienced a loss of $31 million in
the first half of 2003 compared to segment profit of $17 million in the
first half of 2002. Segment profit declined because of higher raw material
and energy costs of approximately $110 million and severance charges
associated with workforce reductions, partially offset by higher net sales,
favorable manufacturing operations and lower incentive expenses. Raw
material and energy costs were higher because of uncertain geopolitical
factors and the declaration of force majeure for supply of propylene, a key
raw material. The Company expects raw material and energy prices to remain
at elevated levels for the remainder of 2003, which will have a negative
impact on segment profitability. In addition, during scheduled downtime for
preventative maintenance at the acrylonitrile facility at the Chocolate
Bayou Intermediates site, the Company discovered conditions which will
result in additional downtime for unscheduled maintenance. This unscheduled
additional downtime could have a material effect on segment profitability in
the third quarter.
Corporate Expenses
Corporate expenses were $56 million for the first half of 2003
compared to $32 million in the first half of 2002. The increase is due to an
environmental charge of approximately $27 million to recognize the Company's
obligation under a partial consent decree approved on August 4, 2003 related
to remediation at Anniston, Alabama.
Operating Income (Loss)
SIX MONTHS
ENDED JUNE 30,
--------------
(dollars in millions) 2003 2002
---- ----
Performance Products and Services Segment Profit ........................... $ 43 $ 44
Integrated Nylon Segment Profit/(Loss) ..................................... (31) 17
Corporate Expenses ......................................................... (56) (32)
Less: Equity Earnings from Affiliates included in Segment Profit/(Loss) (1) (1)
Less: Other Income items included in Segment Profit/(Loss) ............ (3) (3)
---- ----
Operating Income/(Loss) .................................................... $(48) $ 25
==== ====
Solutia had an operating loss of $48 million in the first half of
2003 compared with operating income of $25 million in the first half of
2002. The decrease in operating income was primarily driven by higher raw
material and energy costs, higher environmental costs, lower sales volumes
and higher severance costs associated with workforce reductions, partially
offset by improvements in average selling prices, favorable currency
exchange rate fluctuations, and favorable manufacturing operations.
Equity Earnings (Loss) from Affiliates
SIX MONTHS
ENDED JUNE 30,
--------------
(dollars in millions) 2003 2002
---- ----
Equity Earnings/(Loss) from Affiliates ........................................ $(2) $12
=== ===
Equity Earnings from Affiliates included in Reportable Segment Profit ..... $ 1 $ 1
=== ===
25
Solutia records equity earnings (loss) from affiliates net of
income taxes. Equity loss from affiliates was $2 million for the six months
ended June 30, 2003, compared to equity earnings from affiliates of
$12 million for the comparable period in 2002. Equity loss from affiliates
in 2003 were negatively affected by restructuring charges related to asset
impairments at the Flexsys joint venture and severance charges at both the
Flexsys and Astaris joint ventures. In addition to the restructuring
charges, Astaris' earnings decreased as a result of lower sales volumes,
lower selling prices and lower revenue from an electricity sales contract.
Flexsys' earnings were negatively impacted by higher raw material and energy
costs. Equity earnings from affiliates for the six months ended June 30,
2002, included $2 million of earnings from the Advanced Elastomer Systems
joint venture, which was sold during the first quarter of 2002.
Other Income--Net
SIX MONTHS
ENDED JUNE 30,
--------------
(dollars in millions) 2003 2002
---- ----
Other Income - Net ......................................................... $8 $9
== ==
Other Income - Net included in Reportable Segment Profit ............... $3 $3
== ==
Other income--net for the six months ended June 30, 2003 was
$8 million, compared to other income--net of $9 million for the comparable
period in 2002. During the first half of 2003, Solutia realized a benefit of
$4 million related to the recovery of certain receivables, established prior
to 1997, which had previously been written off. During the first half of
2002, Solutia sold its 50 percent interest in the Advanced Elastomer Systems
joint venture resulting in a gain of $5 million.
Income Tax Benefit
Solutia's income tax benefit was $35 million for the first half
of 2003 compared to $4 million for the first half of 2002. The significant
increase in income tax benefit is due to the decrease in income on a
year-over-year basis. The effective tax rate increased because of the
utilization of deferred tax liabilities for the income taxes on distributed
foreign earnings.
Cumulative Effect of Change in Accounting Principle
Effective January 1, 2002, Solutia adopted SFAS No. 142, "Goodwill
and Other Intangible Assets." In accordance with SFAS No. 142, Solutia
discontinued the amortization of goodwill and identifiable intangible assets
that have indefinite useful lives. This statement also required certain
intangible assets that did not meet the criteria for recognition apart from
goodwill, to be subsumed into goodwill. During the quarter ended March 31,
2002, Solutia subsumed into goodwill $1 million of intangible assets net of
related deferred tax liabilities representing assembled workforce that did
not meet the separability criteria under SFAS No. 141, "Business
Combinations."
Fair value measurements of the reporting units were estimated by a
third-party specialist utilizing both an income and market multiple
approach. Based on this analysis, Solutia recorded an impairment loss of
$167 million during the first quarter of 2002 for the resins and additives
business (which is presented as discontinued operations) due to declining
estimates of future results given current economic and market conditions.
The goodwill impairment charge is non-deductible for tax purposes and is
reflected as the cumulative effect of change in accounting principle in the
accompanying statement of consolidated loss.
26
Restructuring Activities
During the first half of 2003, Solutia recorded restructuring
charges of $10 million to cost of goods sold and $9 million to marketing,
administrative and technological expenses for costs associated with
workforce reductions and $1 million to cost of goods sold for costs
primarily associated with contract terminations of leased administrative
facilities. The restructuring was part of an enterprise-wide cost reduction
initiative associated with the sale of the resins, additives and adhesives
businesses and other ongoing cost reduction initiatives. As a result of
these actions, Solutia reduced its workforce by approximately 450 positions.
Cash outlays associated with the restructuring actions were funded from
divestiture proceeds and operations. Approximately 90 percent of the
workforce reductions affected North American business and manufacturing
operations, and approximately 10 percent affected European, Asian and Latin
American operations. Management positions represented approximately 25
percent of the workforce reductions. Solutia anticipates additional
severance charges of approximately $5 million for the remainder of 2003 in
the Performance Products and Services segment.
Summary of Events Affecting Comparability
Charges and gains recorded in the six months ended June 30, 2003
and 2002, and other events affecting comparability have been summarized in
the tables below (dollars in millions).
2003
------------------------------------------------------------
PERFORMANCE
PRODUCTS AND INTEGRATED CORPORATE/
INCREASE/(DECREASE) SERVICES NYLON OTHER CONSOLIDATED
- ------------------------------------------ ------------ ---------- ---------- ------------
IMPACT ON:
Cost of goods sold ....................... $ 6 $ 5 $ $ 11 (a)
27 27 (b)
---- --- ---- ----
Total cost of goods sold ................. 6 5 27 38
Marketing ................................ 2 2 (a)
Administrative ........................... 2 4 6 (a)
Technological ............................ 1 1 (a)
---- --- ---- ----
OPERATING INCOME (LOSS) IMPACT (11) (5) (31) (47)
Equity earnings (loss) from affiliates,
net of tax ............................. (7) (7) (c)
Other income (expense) ................... 4 4 (d)
---- --- ---- ----
PRETAX INCOME STATEMENT IMPACT $(11) $(5) $(34) (50)
==== === ====
Income tax benefit impact ................ (17)
----
AFTERTAX INCOME STATEMENT IMPACT $(33)
====
2003 EVENTS
- -----------
(a) Restructuring charges for workforce reductions of approximately
450 positions across all world areas and functions of the Company and
contract termination costs ($20 million).
(b) Environmental charges related to remediation in Anniston, Alabama
($27 million).
(c) The Flexsys and Astaris joint ventures, in which the Company has a
50 percent joint interest, incurred restructuring charges during the first
six months of 2003 related to asset impairments and severance charges
($7 million).
(d) The Company recovered certain receivables, established prior to 1997,
which had previously been written off ($4 million).
27
2002
------------------------------------------------------------
PERFORMANCE
PRODUCTS AND INTEGRATED CORPORATE/
INCREASE/(DECREASE) SERVICES NYLON OTHER CONSOLIDATED
- ----------------------------------- ------------ ---------- ---------- ------------
IMPACT ON:
Cost of goods sold ................ $ $ $ $--
--- --- --- ---
Total cost of goods sold .......... -- -- -- --
Marketing, administrative,
technological and amortization
expenses ........................
--- --- --- ---
OPERATING INCOME (LOSS) IMPACT . -- -- -- --
Equity earnings (loss) from
affiliates, net of tax ..........
Other income (expense) ............ 5 5 (d)
--- --- --- ---
PRETAX INCOME STATEMENT IMPACT . $-- $-- $ 5 5
=== === === ===
Income tax impact ................. 2
---
AFTERTAX INCOME STATEMENT
IMPACT........................ $ 3
===
2002 EVENTS
- -----------
(d) Gain resulting from the sale of the Company's 50 percent interest in
the Advanced Elastomer Systems joint venture ($5 million).
FINANCIAL CONDITION AND LIQUIDITY
On December 2, 2002, Solutia signed a definitive agreement to sell
its resins, additives and adhesives businesses to UCB S.A. for $500 million
in cash, plus an upfront payment of $10 million for a period of exclusivity.
On January 31, 2003, the sale was completed. Proceeds from the divestiture
were used to pay down all of the borrowings under the amended credit
facility, provide $39 million cash collateral for certain outstanding
letters of credit and purchase the co-generation facility at Pensacola,
Florida for $32 million in accordance with bank agreements. The Company
retained certain tax liabilities related to the divested businesses and
expects to pay approximately $29 million in the second half of 2003 related
to these liabilities.
Divestiture proceeds and borrowings from the amended credit
facility provided the primary source of funds to finance operating needs and
capital expenditures during the first half of 2003. Cash used in continuing
operations was $41 million during the first half of 2003 compared to cash
provided by continuing operations of $39 million for the comparable period
of 2002. The decrease was primarily attributable to a $60 million income tax
refund received during the first quarter of 2002, lower dividends from
equity affiliates and lower consolidated earnings.
Capital spending increased $19 million to $46 million in the first
half of 2003, compared to $27 million in the first half of 2002. The
increase resulted from the purchase of the co-generation facility in
Pensacola, Florida, for approximately $32 million. The remaining
expenditures were used to fund maintenance and cost reduction projects.
During the first half of 2003, proceeds from the sale of the
resins, additives and adhesives businesses were included in cash provided by
discontinued operations. Proceeds generated in the first half of 2002
included the sale of the Company's 50 percent interest in the Advanced
Elastomer Systems joint venture to ExxonMobil Chemical Company, a subsidiary
of Exxon Mobil Corporation for approximately $102 million.
Total debt decreased by $214 million to $983 million at June 30,
2003, compared to $1,197 million at the end of 2002 and consisted of
borrowings under the amended credit facility, notes, indenture and
debentures. The decrease was driven by the use of divestiture proceeds to
pay down debt.
28
Solutia's working capital from continuing operations increased by
$385 million to $115 million at June 30, 2003, compared to negative
$270 million at December 31, 2002. The increase in the working capital
position primarily resulted from lower short-term debt of $238 million and
an increase in current assets of $148 million. The Company used divestiture
proceeds to pay down short-term debt. The increase in current assets is
primarily due to higher cash and cash equivalents and the seasonal increase
in accounts receivable.
Solutia had a shareholders' deficit of $263 million at June 30,
2003 compared to a shareholders' deficit of $249 million at December 31,
2002. Shareholders' deficit increased because of 2003 losses, partially
offset by favorable currency translation adjustments, principally related to
the increase in value of the euro in relation to the U.S. dollar.
The Company's primary sources of liquidity have been and will
continue to be cash from operations, divestiture proceeds, borrowings under
its revolving credit facility and other external financing sources. At June
30, 2003, after consideration of $118 million of letters of credit
outstanding under the credit facility, the Company had capacity to borrow up
to $62 million. The Company also had $84 million of cash and cash
equivalents available for general corporate purposes and debt repayment.
Subsequent to the second quarter earnings announcement, the Company
experienced modest credit tightening from a key supplier, which will impact
the Company's ability to generate cash from operations in the second half of
this year. On August 4, 2003, Solutia and Monsanto entered into an amendment
to the Penndot Protocol agreement dated November 15, 2002. Pursuant to the
amendment, Monsanto released Solutia from its obligation to provide Monsanto
with a $39.9 million letter of credit to secure a portion of Monsanto's
obligations with respect to an appeal bond in the Penndot case. As a result,
letters of credit outstanding under the credit facility were $78 million on
August 4, 2003.
In anticipation of weaker-than-expected second quarter results, the
Company sought an amendment granting relief from certain of the financial
covenants in its $300 million revolving credit facility for the period June
30, 2003 through September 29, 2003. The Company did not seek an amendment
beyond September 29, 2003 because it anticipated refinancing the facility
within that timeframe. The Company and its bank syndicate amended the
facility on June 30, 2003. If the syndicate's approval of the amendment had
been delayed until the first week of July, the Company would not have been
able to borrow under the facility until the approval was obtained.
Consequently in late June, the Company, in consultation with the bank
syndicate, borrowed additional amounts to ensure it had sufficient liquidity
to meet its obligations during the amendment approval process. The Company
still plans to refinance the revolving credit facility prior to September
30, 2003. If the Company is unable to refinance the facility in this
timeframe, the Company would need to seek further relief from its bank
syndicate in the event it determined it could not comply with its financial
covenants as of September 30, 2003. On July 31, 2003, Standard & Poor's
Ratings Services lowered its corporate credit rating on Solutia to B- from
BB-. On August 8, 2003, Moody's Investors Service lowered its senior implied
credit rating on Solutia to B3 from Ba3.
The weighted average interest rate on Solutia's total debt
outstanding at June 30, 2003, was approximately 7.7 percent compared to
5.7 percent at June 30, 2002. Interest expense was $48 million in the first
half of 2003 compared to $35 million in the comparable period in 2002. The
increase resulted from amortization of deferred debt issuance costs incurred
during the second half of 2002 and higher interest rates associated with the
credit facility and the senior secured notes.
Contingencies
Legacy Liabilities
At the time Solutia was spun-off from former Monsanto Company (now
known as Pharmacia Corporation) in September 1997, the Company was required
to contractually assume certain liabilities from Pharmacia. These legacy
liabilities primarily consist of retiree healthcare and life insurance
costs, environmental compliance and remediation costs and litigation defense
costs and judgments. Since the spin-off, the Company has spent, on average,
approximately $100 million annually to service these legacy liabilities. The
Company expects this amount of spending to continue for the foreseeable
future. A significant majority of the legacy liability costs are
attributable to retiree healthcare costs and environmental compliance and
remediation, as opposed to litigation defense costs and judgments.
29
One of the legacy liabilities Solutia was required to assume from
Pharmacia is the litigation involving the alleged discharge of PCBs from the
Anniston, Alabama plant site, which Solutia now owns and operates and at
which Pharmacia formerly produced PCBs. Although Pharmacia remains the named
defendant in that litigation, the Company is required to manage the
litigation and indemnify Pharmacia from costs, expenses and judgments
arising from such litigation. The most significant of the PCB lawsuits are
the Abernathy and Tolbert cases, more fully described in Solutia's 2002
Annual Report on Form 10-K, filed with the Securities and Exchange
Commission on March 6, 2003. The plaintiffs in these cases are demanding
substantial compensatory and punitive damages under a variety of theories of
recovery.
The verdicts in the property damage phase of the Abernathy case
continued to mount during the second quarter and are continuing to mount
during the third quarter. As of August 11, 2003, the jury in this case had
returned compensatory damage verdicts totaling approximately $101 million to
the first 509 of the 907 plaintiffs who have made property damage and
exposure claims. Approximately 400 property claims and all of the personal
injury and potential punitive damage claims have yet to be tried in the
case. The Abernathy jury continues to apply a formula-based approach in
determining the amount of these verdicts and, as a result, the Company
believes the first 509 verdicts are typical of the verdicts that can be
expected in the remaining property damage cases. Plaintiffs' counsel in the
Tolbert case have based their valuation of that case upon the formula-based
Abernathy verdicts. The use of the Abernathy verdicts as a basis for valuing
the Tolbert case would result in a valuation in excess of $3 billion. Based
upon the advice of counsel, the Company believes the Abernathy verdicts are
seriously flawed and will be reversed on appeal. However, the Company will
not be able to appeal those verdicts until all property damage, personal
injury and punitive damage claims in the Abernathy case are tried and a
final judgment is entered. The Company's access to the appellate courts in
the Abernathy and Tolbert cases may be years away.
During the third quarter of 2003, the Company will reach
significant milestones in the Abernathy and Tolbert cases. The Company
expects the property damage phase of the Abernathy trial to conclude during
the third quarter of 2003. In late August of 2003, the Company expects the
personal injury phase of this case to begin. In the Tolbert case,
dispositive motions are due in late August of 2003, and Phase I of the
personal injury case will start in October of 2003. Although the Company
believes that it has meritorious defenses in these cases, the damages sought
are in an amount that would far exceed its financial capacity. Due to the
magnitude of the damages sought, the Company is considering all alternatives
to address these cases. The Company continues to have discussions with
plaintiffs' counsel to seek a comprehensive resolution of these cases. To
date, those efforts have not resulted in such a resolution.
Astaris Joint Venture
In connection with the external financing agreement for Astaris,
which expires in September of 2005, Solutia and its equal partner in the
venture, FMC Corporation, contractually agreed to provide Astaris with
funding in the event the joint venture fails to meet certain financial
benchmarks. The financial benchmarks were based on forecasted earnings that
were developed when the financing was entered into. Astaris' earnings have
fallen short of the forecast underlying its external financing agreement due
to numerous factors including significantly less than planned productivity of
its purified wet acid technology, lower sales volumes and lower average
selling prices due to the prolonged weak U.S. economy. As a result of these
earnings shortfalls versus the original expectations, Solutia and FMC have
each been required to make additional investments of $26 million during the
second quarter of 2003. These payments have largely been used to reduce debt
outstanding within the venture. Solutia and FMC are evaluating other
financing alternatives for the joint venture. If no new financing
arrangements are obtained, Solutia anticipates that its share of the
additional required contributions will be approximately $35 million for the
remainder of 2003. In addition, the Company expects to make additional
contributions in 2004, although such amounts cannot be determined at this
time. Contributions are recorded in the Investments in Affiliates line on
the Statement of Consolidated Financial Position. Due to the Company's
contractual obligation to fund the joint venture as described above, in
order to amend the Company's revolving credit facility, the Company must
obtain the approval of the Astaris' bank syndicate. Also, a default by the
Company of the financial covenants in its revolving credit facility
constitutes an event of default under Astaris' credit facility.
Second Quarter Business Trends
The Company's business and liquidity position was adversely
impacted by several factors during the second quarter. First, the weakened
state of the manufacturing sector, characterized by significant overcapacity
and persistently high raw material and energy costs, resulted in a decline
in the Integrated Nylon segment during the quarter. Also,
30
the segment outlook for the remainder of 2003 dramatically changed during
the second quarter as it became apparent that raw material prices after the
conclusion of the Iraqi conflict would remain at historically elevated
levels for the foreseeable future. Overcapacity in the sector prevented the
Company from passing along a significant portion of the elevated raw
material costs to customers. In anticipation of weaker-than-expected second
quarter results, the Company sought and received an amendment granting
relief from certain of the financial covenants in its $300 million revolving
credit facility for the period June 30, 2003 through September 29, 2003. The
weakened manufacturing sector also adversely impacted second quarter
operating results of Astaris which will require the Company to make higher
keepwell payments to Astaris than previously expected. These adverse
developments in the Integrated Nylon segment and Astaris negatively impacted
the Company's cash generated from operations for the second quarter.
Outlook
The Company's $300 million credit facility expires on August 13,
2004. The holders of the 6.72% debentures have the right to put $150 million
of debentures to the Company for repayment in October of 2004. The 6.25%
five-year (euro)200 million notes mature in February of 2005. Additionally,
the Company will be required to make quarterly contributions currently
anticipated to be an aggregate of approximately $175 million to its
qualified pension plan during 2005. Without a dramatic change in
circumstances, the continuing overhang of the PCB litigation and other
legacy liabilities will significantly restrict the Company's alternatives to
address these liquidity requirements. Also, without a substantial
improvement in the operating results of the business, cash flow from
operations will not be a significant source of liquidity to meet these
requirements. The Company may not be successful in satisfying these future
liquidity requirements on favorable terms, if at all. The Company is
currently considering all available alternatives to address its legacy
litigation and other legacy liabilities, future liquidity needs and the
recent adverse developments in its business, including, but not limited to,
a potential reorganization under Chapter 11 of the U.S. bankruptcy code.
RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities." This Interpretation provides
guidance related to identifying variable interest entities (VIEs) and
determining whether such entities should be consolidated. This
Interpretation must be applied immediately to (a) VIEs created, or (b)
interests in VIEs obtained, after January 31, 2003. For those VIEs created,
or interests in VIEs obtained, on or before January 31, 2003, the guidance
in this Interpretation must be applied in the first fiscal year or interim
period beginning after June 15, 2003. The Company has one operating lease
related to its corporate headquarters in St. Louis, Missouri that qualifies
as a VIE. Based on the current terms of the lease agreement and the residual
value guarantee the Company provides to the lessor, the Company is the
primary beneficiary of the VIE. As a result, Solutia will be required to
consolidate the assets and liabilities held by this VIE of approximately $38
million and approximately $43 million, respectively, and record an
approximate charge of $5 million which will be reported as a cumulative
effect of a change in accounting principle in the third quarter of 2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
This Statement establishes standards on how to classify and measure certain
financial instruments with characteristics of both liabilities and equity.
The Statement also requires financial instruments within its scope be
classified as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The adoption of SFAS No. 150
for financial instruments entered into or modified after May 31, 2003 did
not have a material effect on the consolidated financial statements of the
Company. In addition, the Company does not expect the adoption of SFAS No.
150 for financial instruments entered into or modified prior to May 31, 2003
to have a material effect on the consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS
There have been no material changes in market risk exposures during
the first six months of 2003 that affect the disclosures presented in the
information appearing under "Derivative Financial Instruments" on pages 31
and 32 of Solutia's Annual Report on Form 10-K for the year ended
December 31, 2002.
31
ITEM 4. CONTROLS AND PROCEDURES
Solutia carried out an evaluation, under the supervision and with
the participation of Solutia's management, including its Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of Solutia's disclosure controls and procedures as of the end of
the second quarter. Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that Solutia's disclosure controls and
procedures are effective in timely alerting them to material information
relating to Solutia and its consolidated subsidiaries that is required to be
included in Solutia's periodic SEC filings. Additionally, there were no
significant changes in Solutia's internal control over financial reporting
or in other factors that could significantly affect this control subsequent
to the date of their evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Solutia's Report on Form 10-K for the year ended December 31, 2002
("2002 Form 10-K"), and its Report on Form 10-Q for the quarter ended March
31, 2003 ("First Quarter 10-Q"), described a number of lawsuits pending in
state and federal court relating to the alleged release of polychlorinated
biphenyls ("PCBs") and other materials from the Anniston, Alabama plant
site, which Solutia now owns and operates and at which Pharmacia formally
produced PCBs.
(1) Abernathy v. Monsanto: This matter involves four consolidated
cases brought on behalf of approximately 3,500 plaintiffs and
is currently pending in Circuit Court for Etoway County,
Alabama. As of August 11, 2003, the jury had returned
compensatory damage verdicts totaling approximately $101
million to the first 509 of the 907 plaintiffs who have made
property damage and exposure claims, but no final appealable
judgment has been entered with respect to these verdicts. No
claims of personal injury have been tried or presented to the
jury. Trial of this action continues. On August 6, 2003, the
court issued, without providing the Company or other defendants
an opportunity to respond to the motions seeking their entry.
The first order
severs and dismisses the Company from the suit immediately
upon a filing by the Company of a petition under Chapter 11 of
the U.S. bankruptcy code. The second order enjoins Pharmacia
and anyone acting in concert with Pharmacia from attempting to
extend the automatic stay under Chapter 11 of the U.S.
bankruptcy code to Pharmacia. On August 7, 2003 the plaintiffs
moved to amend the order to merely provide for the severance,
but not dismissal, of the Company upon such event. The court
granted this motion, again without providing an opportunity
for response. The Company believes both of the original
orders and the amended order are without merit and that the
court's issuance of such orders without allowing a response
or hearing is contrary to law.
(2) Tolbert v. Monsanto: This case involves the claims of
approximately 15,300 plaintiffs brought in the U.S. District
Court for the Northern District of Alabama. As the court
requested, plaintiffs have withdrawn two of their proposed
Phase I plaintiffs. As a result, the Phase I trial, which will
commence on October 14, 2003, will involve the claims of four
plaintiffs, two from each of the two "disease categories"
previously selected by the parties.
(3) Payton v. Monsanto: This action was brought in Circuit Court
for Shelby County, Alabama on behalf of a purported class of
owners, lessees and licensees of property around Lay Lake. On
March 19, 2003, the trial court entered an order certifying a
plaintiff class. A notice of appeal was filed on April 30,
2003 seeking a reversal of the court's certification order. On
August 8, 2003 the Company reached an agreement to settle this
case for $5 million. A significant percentage of this amount
will be recovered under existing commercial insurance policies.
This level of insurance recovery is not necessarily indicative
of future recoveries for other litigation matters. The
settlement must be approved by the court and it is anticipated
this process will take at least 120 days.
Solutia's 2002 Form 10-K referred to other PCB cases pending in
various jurisdictions, including one case pending in state court in West
Virginia and another in federal court in New Jersey. We settled the West
32
Virginia case for a nominal amount in May 2003. In addition, on June 23,
2003 the federal judge in New Jersey granted our motion for summary
judgment, dismissing us from that case.
Solutia's 2002 Form 10-K and its First Quarter 10-Q described a
case pending in the Commonwealth Court of Pennsylvania seeking damages
allegedly resulting from PCBs found in the Transportation and Safety
Building in Harrisburg, Pennsylvania, which was owned by the Commonwealth of
Pennsylvania. Briefing on appeal in this matter was completed by July 21,
2003. The Company filed a motion on April 14, 2003 asking the Pennsylvania
Supreme Court for an expedited argument of this appeal. The Court denied the
motion for expedited argument on July 22, 2003, without prejudice to the
Company's right to renew the motion if oral argument is ordered.
Solutia's 2002 Form 10-K and its First Quarter 10-Q described a
Partial Consent Decree lodged with the United States District Court for the
Northern District of Alabama in an action captioned United States of America
v. Pharmacia Corporation and Solutia Inc. On August 4, 2003, the court
approved the Partial Consent Decree.
Solutia's 2002 Form 10-K described (a) an investigation by
authorities in the United States, Europe and Canada of past commercial
practices in the rubber chemicals industry and (b) a number of purported
class actions filed against producers of rubber chemicals including Flexsys,
our 50/50 joint venture with Akzo Nobel N.V., each seeking actual and treble
damages under state law on behalf of all retail purchasers of tires in the
relevant state since 1994. Solutia's First Quarter 10-Q described two
purported class actions, Rubber Engineering and Development Company and
Standard Rubber Products, filed against a number of companies, including
Solutia and Flexsys. The plaintiffs in those separate cases each allege
price fixing and seek treble damages and injunctive relief under U.S.
antitrust laws on behalf of all individuals and entities that purchased
rubber chemicals in the United States from the defendants, their
predecessors or their controlled subsidiaries from January 1, 1995 until
October 10, 2002. On June 3, 2003, a third purported class action,
Polymerics, Inc. v. Akzo Nobel N.V. et. al. was filed in the same court as
the Rubber Engineering and Standard Rubber cases. This third purported class
action against the same defendants, makes substantially the same allegations
and seeks substantially the same relief as the first two actions. Solutia is
aware of four additional cases (Schlegal Corp. v. Akzo Nobel et. al.,
Precision Associates v. Akzo Nobel et. al., Industrial Rubber Products
L.L.C. v. Crompton Corporation et. al., and Robbins LLC v. Akzo Nobel et.
al.) having been filed in the United States District Court for the Northern
District of California purportedly against the same defendants and making
substantially similar allegations and asking for substantially similar
relief as the first three such actions. Solutia expects that these cases
will all be consolidated into a single class action.
In addition, a purported shareholder class action, Richard Brazin
v. Solutia Inc. et.al., has been filed against Solutia, its chief executive
officer, and its chief financial officer in the Federal District Court for
the Northern District of California. The complaint alleges that from
December 16, 1998, to October 10, 2002, Solutia's accounting practices
regarding incorporation of Flexsys's results into Solutia's financial
reports violated federal securities laws by misleading investors as to
Solutia's actual results and causing inflated prices for Solutia's publicly
traded securities. Solutia is aware of three other purported shareholder
class actions filed in the same court against Solutia and certain of its
officers and directors, which we believe are premised on substantially
similar allegations.
Solutia's 2002 Form 10-K and its First Quarter 10-Q described a
legal proceeding arising from the alleged violations of the Wyoming
Environmental Quality Act, the Wyoming Air Quality Standards and Regulations
and a permit issued by the Wyoming Department of Environmental Quality to
Solutia, the company now known as Pharmacia and P4 Production L.L.C. for a
coal coking facility in Rock Springs, Wyoming. The parties settled this
matter without admitting any liability or any issue of fact and filed a
Stipulation and Order of Judgment with the United States District Court for
the District of Wyoming on April 9, 2003. The court entered the Stipulation
and Order April 23, 2003, and Solutia paid its share of the monetary
penalty, $426,711, on May 27, 2003.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At Solutia's annual meeting of stockholders on April 23, 2003, two
matters were submitted to a vote of stockholders.
33
1. The stockholders elected the following directors for a
three-year term that will expire at the annual meeting of
stockholders in 2006 (or until their respective successors are
elected and qualified, or until their earlier death, resignation or
removal). Votes were cast as follows:
VOTES
VOTES "WITHHOLD
NAME "FOR" AUTHORITY"
---- ----- ----------
Robert A. Clausen 88,331,579 9,019,410
Paul Donovan 91,466,834 5,884,155
Robert H. Jenkins 91,878,375 5,472,614
Frank A. Metz, Jr. 91,624,077 5,726,912
The following directors are continuing terms expiring at the annual
meeting of stockholders in 2004: John C. Hunter III, Philip R.
Lochner, Jr., and John B. Slaughter. The following directors are
continuing terms expiring at the annual meeting of stockholders in
2005: Paul H. Hatfield, J. Patrick Mulcahy, and Sally G. Narodick.
2. The stockholders ratified the appointment by the Audit Committee
of Solutia's Board of Directors of Deloitte & Touche L.L.P. as
principal independent auditors for the year 2003. A total of
91,948,139 votes were cast in favor of ratification, 4,959,905
votes were cast against it, and 442,945 votes were counted as
abstentions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits--See the Exhibit Index at page 38 of this report.
(b) Reports on Form 8-K during the quarter ended June 30, 2003:
On April 24, 2003, we furnished to the SEC a Form 8-K. Under Items
9 and 12, we furnished our earnings press release for the quarter
ended March 31, 2003.*
* We are not incorporating by reference such report into this filing or any
filing under the Securities Act of 1933.
34
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SOLUTIA INC.
--------------------------
(Registrant)
/s/ JAMES M. SULLIVAN
--------------------------
(Vice President and Controller)
(On behalf of the Registrant and as
Principal Accounting Officer)
Date: August 14, 2003
35
EXHIBIT INDEX
These Exhibits are numbered in accordance with the Exhibit Table
of Item 601 of Regulation S-K.
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10(a) Solutia Inc. 2003 Non-Employee Director Compensation Plan
(b) Amendment No. 3, dated as of June 30, 2003, to Second Amended
and Restated Credit Agreement dated as of July 25, 2002, between
Solutia Inc. as Borrower, the initial lenders named therein,
Bank of America, N.A., as Syndication Agent and Citibank, N.A.,
as Administrative Agent
(c) Retention Agreement with John C. Hunter III dated June 30, 2003
(d) Retention Agreement with Robert A. Clausen dated June 30, 2003
(e) Amendment to Protocol Agreement, dated August 4, 2003, by
and among Pharmacia Corporation, Monsanto Company and
Solutia, Inc.
11 Omitted--Inapplicable; see "Statement of Consolidated Income
(Loss)" on page 1
31(a) Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31(b) Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32(a) Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99 Computation of the Ratio of Earnings to Fixed Charges
36