-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PP7+aW09yfs+Mn+MHB3+K/hJNiMUAj/JqVyVvv0arO093gqWZ601lVbpGjw+QulU gyALDhNViGfeD2VWMoSDhg== 0001068800-07-000607.txt : 20070306 0001068800-07-000607.hdr.sgml : 20070306 20070306120808 ACCESSION NUMBER: 0001068800-07-000607 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20061231 FILED AS OF DATE: 20070306 DATE AS OF CHANGE: 20070306 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOLUTIA INC CENTRAL INDEX KEY: 0001043382 STANDARD INDUSTRIAL CLASSIFICATION: CHEMICALS & ALLIED PRODUCTS [2800] IRS NUMBER: 431781797 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-13255 FILM NUMBER: 07673916 BUSINESS ADDRESS: STREET 1: 575 MARYVILLE CENTRE DRIVE STREET 2: P O BOX 66760 CITY: ST. LOUIS STATE: MO ZIP: 63166-6760 BUSINESS PHONE: 3146741000 MAIL ADDRESS: STREET 1: P O BOX 66760 CITY: ST. LOUIS STATE: MO ZIP: 63166-6760 FORMER COMPANY: FORMER CONFORMED NAME: QUEENY CHEMICAL CO DATE OF NAME CHANGE: 19970804 10-K 1 sol10k.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006 ----------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to _________________ Commission file number 001-13255 --------- SOLUTIA INC. -------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 43-1781797 - ------------------------------- ------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 575 Maryville Centre Drive, P.O. Box 66760, St. Louis, Missouri 63166-6760 -------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (314) 674-1000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - -------------------- ----------------------------------------- None None Securities registered pursuant to section 12(g) of the Act: Title of each class ------------------- $.01 par value Common Stock Preferred Stock Purchase Rights Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [ ] Yes [X] No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. [ ] Yes [X] No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 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. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act). Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No The aggregate market value of the registrant's common stock held by non-affiliates, as of the last business day of the registrant's most recently completed second fiscal quarter, June 30, 2006, based upon the value of the last sales price of these shares as quoted on the OTC Bulletin Board, was approximately $47.0 million. NOTE.--If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: 104,459,578 shares of common stock, $.01 par value, outstanding as of the close of business on February 28, 2007. CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS Solutia makes statements in this Annual Report on Form 10-K that are considered forward-looking statements under the federal securities laws. Solutia considers all statements regarding anticipated or future matters, including the following, to be forward-looking statements: o effects of Solutia's pending bankruptcy proceeding; o Solutia's expected future financial position, liquidity, results of operations, profitability and cash flows; o financing plans; o competitive position; o business strategy; o budgets; o projected cost reductions; o results of litigation; o plans and objectives of management for future operations; o contractual obligations; o off-balance sheet arrangements; o growth opportunities for existing products and services; o price increases; o benefits from new technology; and o effect of changes in accounting standards. Forward-looking statements are not guarantees of Solutia's future performance. They represent Solutia's estimates and assumptions only on the date they are made. There are risks, uncertainties and other important factors that could cause Solutia's actual performance or achievements to be materially different from those it may project. These risks, uncertainties and factors include: o Solutia's ability to develop, confirm and consummate a Chapter 11 plan of reorganization; o Solutia's ability to reduce its overall leveraged position; o the potential adverse impact of Solutia's Chapter 11 filing on its operations, management and employees, and the risks associated with operating businesses under Chapter 11 protection; o Solutia's ability to comply with the terms of its debtor-in-possession ("DIP") credit facility and (euro) 200 million Facility Agreement or to increase, extend or refinance the facilities; o customer and vendor response to Solutia's Chapter 11 proceeding; o general economic, business and market conditions; o currency fluctuations; o interest rate fluctuations; o price increases or shortages of raw materials and energy; o disruption of operations; o exposure to product liability and other litigation, environmental remediation obligations and other environmental liabilities; o lower prices for Solutia's products or a decline in Solutia's market share due to competition or price pressure by customers; o ability to implement cost reduction initiatives in a timely manner; o ability to divest existing businesses; o efficacy of new technology and facilities; o limited access to capital resources; o changes in U.S. and foreign laws and regulations; o geopolitical instability; and o changes in pension and other post-retirement benefit plan assumptions. 2 PART I ITEM 1. BUSINESS OVERVIEW Solutia Inc., together with its subsidiaries ("Solutia"), is a global manufacturer and marketer of a variety of high-performance chemical-based materials that are used in a broad range of consumer and industrial applications. As used herein, the "Company" and terms such as "we" and "our" refers to Solutia unless the context requires otherwise. Solutia reports its business in two segments: Performance Products and Integrated Nylon. Solutia's Performance Products segment is comprised of six product lines. The product lines are generally managed based on the markets into which these products are sold. o Solutia's SAFLEX(R) plastic interlayers are used for laminated safety glass, primarily in automotive manufacturing and architectural applications. Solutia markets its plastic interlayers to the automotive industry for use in automobile windshields and side, rear and roof windows of vehicles. SAFLEX(R) markets its plastic interlayers to the commercial and residential architectural markets via several sub-brands. o Solutia's LLUMAR(R), VISTA(R), GILA(R) and FORMULA ONE PERFORMANCE AUTOMOTIVE FILM(R) brands of window films are custom coated and used primarily for aftermarket automotive and architectural applications. LLUMAR(R) and GILA(R) window films are marketed for both automotive and architectural applications, with LLUMAR(R) marketed to the professional aftermarket, and GILA(R) marketed to the do-it-yourself retail market. VISTA(R) window films are marketed for professional architectural applications, and FORMULA ONE PERFORMANCE AUTOMOTIVE FILM(R) automotive window films are marketed to the professional automotive aftermarket. o Solutia's DEQUEST(R) water treatment phosphonates are used to enhance water quality for industrial and domestic use. o Solutia's THERMINOL(R) heat transfer fluids are used in systems that provide for indirect heating or cooling of industrial and chemical processes. o Solutia's SKYDROL(R) brand aviation hydraulic fluids and SKYKLEEN(R) brand of aviation solvents are supplied across the aviation industry. o Solutia's plastic products include entrance matting and automotive spray suppression flaps sold under the brands ASTROTURF(R), CLEAN MACHINE(R), and CLEAR PASS(TM). Solutia's Integrated Nylon segment is comprised of an integrated family of nylon products. o Solutia's chemical intermediates are used internally as feedstock for nylon polymer and fiber production and also are sold in the merchant market. o Solutia's VYDYNE(R) and ASCEND(R) nylon polymers are sold to the engineered thermoplastic, apparel, textile and industrial fiber markets. o Solutia's nylon fibers are sold in carpet and industrial markets. Carpet fibers are sold under the WEAR-DATED(R) brand for residential carpet and the ULTRON(R) brand for commercial carpet, as well as under private labels. Solutia was incorporated in Delaware in April 1997 to hold most of the chemical businesses of the former Monsanto Company, now known as Pharmacia Corporation, a wholly owned subsidiary of Pfizer Inc. ("Pharmacia"). On September 1, 1997, Pharmacia spun off Solutia (the "Solutia Spinoff") by distributing Solutia's shares as a dividend to its stockholders. Solutia became an independent publicly held company as a result of the Solutia Spinoff. 3 CHAPTER 11 PROCEEDINGS On December 17, 2003, Solutia and its 14 U.S. subsidiaries (the "Debtors") filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Chapter 11 Cases") in the U.S. Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"). The cases were consolidated for the purpose of joint administration and were assigned case number 03-17949 (PCB). Solutia's subsidiaries outside the United States were not included in the Chapter 11 filing. The filing was made to restructure Solutia's balance sheet, to streamline operations and to reduce costs, in order to allow Solutia to emerge from Chapter 11 as a viable going concern, and to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain post-retirement benefits (the "Legacy Liabilities"), and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff. These factors, combined with the weakened state of the chemical manufacturing sector, general economic conditions and continuing high, volatile energy and crude oil costs were an obstacle to Solutia's financial stability and success. Under Chapter 11, Solutia is operating its businesses as a debtor-in-possession ("DIP") under court protection from creditors and claimants. Since the Chapter 11 filing, orders sufficient to enable Solutia to conduct normal business activities, including the approval of Solutia's DIP financing, have been entered by the Bankruptcy Court. While Solutia is subject to Chapter 11, all transactions not in the ordinary course of business require the prior approval of the Bankruptcy Court. Under the U.S. Bankruptcy Code, Solutia had the exclusive right to propose a plan of reorganization for 120 days following the Chapter 11 filing date. The Bankruptcy Court has subsequently approved extensions of this exclusivity period. The exclusivity period continues until the order disposing of the current motion is entered on the Bankruptcy Court's docket. On January 16, 2004, pursuant to authorization from the Bankruptcy Court, Solutia entered into a DIP credit facility. The DIP credit facility has subsequently been amended from time to time, with Bankruptcy Court approval. The DIP credit facility, as amended, currently consists of: (a) a $975 million fully-drawn term loan; and (b) a $250 million borrowing-based revolving credit facility, which includes a $150 million letter of credit subfacility. Of the $1,225 million facility, $150 million must be utilized to acquire Akzo Nobel's 50% interest in the Flexsys joint venture between Solutia and Akzo Nobel. For additional information regarding the DIP financing and the Flexsys acquisition, see "Management's Discussion and Analysis" in Item 7 below and Note 14 to the accompanying consolidated financial statements. As a consequence of the Chapter 11 filing, pending litigation against Solutia is generally stayed, and no party may take any action to collect its pre-petition claims except pursuant to an order of the Bankruptcy Court. November 30, 2004 was the last date by which holders of pre-petition date claims against the Debtors could file such claims. Any holder of a claim that was required to file such claim by November 30, 2004 and did not do so may be barred from asserting such claim against the Debtors and, accordingly, may not be able to participate in any distribution on account of such claim. Differences between claim amounts identified by the Debtors and claims filed by claimants will be investigated and resolved in connection with the Debtors' claims resolution process, and only holders of claims that are ultimately allowed for purposes of the Chapter 11 case will be entitled to distributions. Solutia has not yet completed its analysis of all the proofs of claim. Since the settlement terms of allowed claims are subject to a confirmed plan of reorganization, the ultimate distribution with respect to allowed claims is not presently ascertainable. On February 14, 2006, the Debtors filed with the Bankruptcy Court a Plan of Reorganization (the "Plan") and Disclosure Statement (the "Disclosure Statement"). The Plan and Disclosure Statement along with the Relationship Agreement (as defined below) and the Retiree Settlement Agreement, entered into among Solutia, the Official Committee of Unsecured Creditors (the "Unsecured Creditor's Committee") and Official Committee of Retirees appointed in the Chapter 11 Cases (the "Retirees' Committee"), Monsanto Company ("Monsanto"), certain retirees and the other parties thereto (the "Retiree Settlement"), set forth the terms of a global settlement (the "Global Settlement") between Solutia, the Unsecured Creditors' Committee, the Retirees' Committee, Monsanto and Pharmacia. The Global Settlement provides for, among other things, a reallocation of certain Legacy Liabilities among Solutia, Monsanto and Pharmacia and the treatment that various constituencies in the Chapter 11 Cases would receive under the Plan. The reallocation of liabilities between Solutia and Monsanto is set forth in a Relationship Agreement (the "Relationship Agreement") which would be entered into between Solutia and Monsanto upon confirmation of the Plan. Since the February 14, 2006 filing, the Bankruptcy Court has not moved forward with the process to approve the Disclosure Statement and confirm the Plan. There are two adversary proceedings ongoing in our Chapter 11 case. JPMorgan, as indenture trustee of Solutia's debentures due 2027 and 2037, filed litigation against Solutia claiming that such debentures are entitled to secured status as 4 opposed to general unsecured status as set forth in the Plan. In addition, the Official Committee of Equity Security Holders ("Equity Committee") in Solutia's bankruptcy case has filed litigation against Pharmacia and Monsanto, arguing that holders of Solutia's existing equity are entitled to a distribution in the Chapter 11 case. For additional information regarding these litigation matters, see "Legal Proceedings" in Item 3 below. Solutia is in discussions with the major stakeholders in our Chapter 11 case in an effort to modify the Global Settlement and Plan and achieve a confirmable Plan. In addition, Solutia continues to evaluate and explore all other reasonable alternatives to reorganize the Company, such as a sale of the reorganized Company's equity or a sale of certain of its businesses or assets, that may present a means of maximizing the value of the estate for stakeholders. RECENT DEVELOPMENTS On January 25, 2007, Solutia completed the extension and upsizing of its debtor-in-possession ("DIP") financing. This amendment increased the size of the DIP credit facility to $1,225 million, representing a $400 million increase, and extended the facility one year to March 31, 2008. The increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments that are coming due in 2007, as well as funds to partially facilitate the acquisition of Akzo Nobel's stake in the Flexsys joint venture. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. The Bankruptcy Court entered an order approving this DIP amendment on January 23, 2007. On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel N.V.'s ("Akzo Nobel") stake in Flexsys, the 50/50 rubber chemical joint venture between Solutia and Akzo Nobel (the "Flexsys joint venture"). Solutia and Akzo Nobel have entered into a letter agreement committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The proposed transaction is subject to approval by the United States Bankruptcy Court, receipt of required regulatory approvals, finalizing the definitive purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase via $150 million of funding under the amended DIP credit facility and additional funding through Flexsys. SEGMENTS; PRINCIPAL PRODUCTS Solutia's reportable segments are: o Performance Products; and o Integrated Nylon. The tabular and narrative information contained in Note 22 to the accompanying consolidated financial statements appearing on pages 94-96 is incorporated by reference into this section. 5
Performance Products Segment - -------------------------------------------------------------------------------------------------------------------------------- Major End-Use Major End-Use Products & Major Major Raw Markets Major Products Applications Competitors Materials Major Plants (a) - -------------------------------------------------------------------------------------------------------------------------------- CONSTRUCTION AND HOME SAFLEX(R) laminated Products to DuPont; Butyraldehyde; Ghent, Belgium; FURNISHINGS window glass; LLUMAR(R) increase the Kuraray; ethanol; polyvinyl Martinsville, VA; and VISTA(R) safety, security, Sekisui; 3M; alcohol; vinyl Springfield, MA; professional window sound attenuation, Madico acetate monomer; Trenton, MI; films and GILA(R) energy efficiency polyester film Puebla, Mexico retail window films and ultraviolet protection of architectural glass for residential and commercial structures; after-market films for solar control, security and safety - -------------------------------------------------------------------------------------------------------------------------------- ASTROTURF(R) and Entrance matting Sanddud; Polyethylene Ghent, Belgium; CLEAN MACHINE(R) Baltplast; St. Louis, MO door mats Time Packaging - -------------------------------------------------------------------------------------------------------------------------------- VEHICLES SAFLEX(R) plastic Products to DuPont; Butyraldehyde; Ghent, Belgium; interlayer for increase the Sekisui; ethanol; Martinsville, windshields and for safety, security, Bekaert, polyvinyl VA; Puebla, side, roof and rear sound attenuation Johnson alcohol; vinyl Mexico; windows of vehicles; and ultraviolet Laminating; acetate monomer; Springfield, MA; LLUMAR(R), protection of Garware polyester film Trenton, MI FORMULA ONE automotive glass PERFORMANCE AUTOMOTIVE and give vehicles a FILMS(R) and GILA(R) custom appearance retail window films - -------------------------------------------------------------------------------------------------------------------------------- CLEAR PASS(TM) spray Spray suppression Fichet; Wegu; Polyethylene Ghent, Belgium suppression systems systems for trucks Austi; Ex-Spray - -------------------------------------------------------------------------------------------------------------------------------- INDUSTRIAL APPLICATIONS Metallized films; Window films; 3M; ATI; Polyester film Martinsville, VA; AND ELECTRONICS sputtered films; tapes; automotive Intellicoat; Runcorn, U.K. release liners and badging; optical Mitsubishi deep-dyed films and colored filters; shades; reprographics; packaging - -------------------------------------------------------------------------------------------------------------------------------- Performance films; Computer Bekaert; OCLI; Polyester film; Canoga Park, CA; conductive and touch-screens; Southwall Indium tin; Martinsville, VA; anti-reflective coated electroluminescent precious metals Runcorn, U.K. films displays for hand-held electronics and watches; cathode ray tube and LCD monitors - -------------------------------------------------------------------------------------------------------------------------------- DEQUEST(R) water Industrial water Bayer; Rhodia Phosphorus Newport, Wales treatment chemicals treatment; trichloride (U.K.) detergents; cleaners; oil field chemicals - -------------------------------------------------------------------------------------------------------------------------------- CAPITAL EQUIPMENT THERMINOL(R) heat Heat transfer fluids Dow Chemical Co. Benzene; phenol Alvin, TX; transfer fluids Anniston, AL; Newport, Wales (U.K.) - -------------------------------------------------------------------------------------------------------------------------------- AVIATION/ SKYDROL(R) aviation Hydraulic fluids ExxonMobil Phosphate esters Anniston, AL; TRANSPORTATION hydraulic fluids; for commercial St. Louis, MO (b) SKYKLEEN(R) aviation aircraft; solvents environmentally friendly solvents for aviation maintenance - -------------------------------------------------------------------------------------------------------------------------------- (a) Major plants are comprised of those facilities at which each of the identified major products conclude their respective manufacturing processes. The major products may pass through other of Solutia's plants prior to the final sale to customers. (b) Operations in the St. Louis, MO plant were transferred to Anniston, Alabama in the second quarter of 2006.
6
Integrated Nylon Segment - -------------------------------------------------------------------------------- ------------------------------------- Major End-Use Major End-Use Products & Markets Major Products Applications Major Competitors Major Raw Materials Major Plants (a) - -------------------------------------------------------------------------------- ------------------------------------- CONSTRUCTION AND Nylon carpet WEAR-DATED(R) Invista; Shaw Adipic acid; Foley, AL; HOME FURNISHINGS staple; nylon bulk residential and Industries; hexamethylenediamine Greenwood, SC; continuous ULTRON(R) Rhodia Pensacola, FL filament; ASCEND(R) commercial nylon polymer carpet; non-woven reinforcement and linings - ---------------------------------------------------------------------------------------------------------------------- PERSONAL PRODUCTS ASCEND(R) nylon Knit apparel; Invista; Rhodia; Adipic acid; Greenwood, SC; polymer half-hose; Radici hexamethylenediamine Pensacola, FL active wear; apparel; dental floss; intimate apparel - ---------------------------------------------------------------------------------------------------------------------- VEHICLES Nylon filament; Tires; airbags; Acordis; BASF; Adipic acid; Greenwood, SC; VYDYNE(R) nylon automotive DuPont; Invista; hexamethylenediamine Pensacola, FL; molding resins; interior, Rhodia Foley, AL ASCEND(R) nylon exterior and polymer under-the-hood molded parts - ---------------------------------------------------------------------------------------------------------------------- INDUSTRIAL ASCEND(R) nylon Conveyer belts; Kordsa; Invista; Propylene; natural Decatur, AL; APPLICATIONS polymer; nylon film Shenma gas; cyclohexane; Greenwood, SC; industrial nylon cooking bags; ammonia Pensacola, FL fiber specialized food packaging; sewing thread; backpacks; cots; tents - ---------------------------------------------------------------------------------------------------------------------- INTERMEDIATE Adipic acid; Nylon and Asahi Chemical; Propylene; natural Alvin, TX; CHEMICALS hexamethylenediamine acrylic fiber; Invista; Rhodia; gas; cyclohexane; Decatur, AL; acrylonitrile nylon and ABS BASF; Ineos ammonia Pensacola, FL plastics; synthetic resins; synthetic lubricants; paper chemicals; plasticizers - ---------------------------------------------------------------------------------------------------------------------- (a) Major plants are comprised of those facilities at which each of the identified major products conclude their respective manufacturing processes. The major products may pass through other of Solutia's plants prior to the final sale to customers.
7 PRINCIPAL EQUITY AFFILIATES As of December 31, 2006, Solutia participated in one principal joint venture, its Flexsys joint venture with Akzo Nobel. The Flexsys joint venture is comprised of interests in Flexsys Holding B.V., Flexsys America L.P. and Flexsys Rubber Chemicals Ltd. Flexsys, headquartered in Brussels, Belgium, is a leading global supplier of a broad range of rubber processing chemicals to the rubber industry used in the production of tires and other general rubber products such as automotive belts, hoses, bumpers and window seals and in mining, agriculture and oil refining applications. Its product line includes a number of performance-enhancing products, including branded accelerators (SANTOCURE(R), THIOFIDE(TM) and THIOTAX(TM)), pre-vulcanization inhibitors (SANTOGARD(R) PVI), antidegradants (SANTOFLEX(R)), antioxidants (FLECTOL(R)) and insoluble sulphur (CRYSTEX(TM)). In February 2007, Solutia and Akzo Nobel reached a definitive agreement for Solutia to purchase Akzo Nobel's interest in the Flexsys joint venture. Prior to November 4, 2005, Solutia participated in another joint venture, Astaris. Astaris was formed in April 2000 as a joint venture between Solutia and FMC Corporation ("FMC"). Solutia and FMC each held 50 percent of the equity interests in Astaris. On November 4, 2005, Solutia, FMC and Astaris sold substantially all of Astaris' assets to Israel Chemicals Limited ("ICL") for $255 million in cash (subject to certain purchase price adjustments) and the assumption by ICL of certain related liabilities. Certain of the assets and liabilities of Astaris that were not included in the sale to ICL were transferred to Solutia and FMC. Generally, these assets and liabilities consist of property originally contributed to the joint venture by Solutia and FMC, as well as certain pre-closing liabilities relating to Astaris, including certain pre-closing environmental liabilities. In addition, certain non-operating assets and liabilities remained in the Astaris joint venture as part of the transaction. Further, the name of the joint venture which holds these remaining assets and liabilities was changed from Astaris LLC to Siratsa LLC. Solutia's equity earnings (loss) from affiliates were $38 million in 2006, $96 million in 2005 and $(26) million in 2004. For additional information about the Flexsys joint venture and Siratsa, see "Management's Discussion and Analysis" in Item 7 below and Note 9 to the accompanying consolidated financial statements. SALE OF PRODUCTS Solutia sells its products directly to end users in various industries, principally by using its own sales force, and, to a lesser extent, by using distributors. Solutia's marketing and distribution practices do not result in unusual working capital requirements on a consolidated basis. Solutia maintains inventories of finished goods, goods in process and raw materials to meet customer requirements and Solutia's scheduled production. In general, Solutia does not manufacture its products against a backlog of firm orders; it schedules production to meet the level of incoming orders and the projections of future demand. However, in the Performance Products segment, a large portion of sales for 2007 will be pursuant to volume commitments. Solutia does not have material contracts with the government of the United States or any state, local or foreign government, however, sales to the carpet mill industry represent a significant portion of Solutia's net sales. In 2006, no single customer or customer group accounted for 10 percent or more of Solutia's net sales. However, for the year ended December 31, 2005, Shaw Industries, Inc., a customer of the Integrated Nylon segment, accounted for approximately 11 percent of Solutia's consolidated net sales. Mohawk Industries, Inc. was a significant customer of the Integrated Nylon segment in 2006 and 2005, accounting for approximately 9 percent and 8 percent of Solutia's consolidated net sales respectively. Solutia's second and third quarters are typically stronger than its first and fourth quarters because sales of carpet and window films are stronger in the spring and fall. COMPETITION The global markets in which Solutia's businesses operate are highly competitive. Solutia expects competition from other manufacturers of the same products and from manufacturers of different products designed for the same uses as Solutia's products to continue in both U.S. and international markets. Depending on the product involved, Solutia encounters various types of competition, including price, delivery, service, performance, product innovation, product recognition and quality. Overall, Solutia regards its principal product groups as competitive with many other products of other producers and 8 believes that Solutia is an important producer of many of these product groups. For additional information regarding competition in specific markets, see the charts under "Segments; Principal Products" above. RAW MATERIALS AND ENERGY RESOURCES Solutia buys large amounts of commodity raw materials and energy resources, including propylene, cyclohexane, benzene, vinyl acetate, polyvinyl alcohol, 2-ethyl hexanol and natural gas. Solutia typically buys major requirements for key raw materials pursuant to contracts with average contractual periods of one to four years. Solutia obtains certain important raw materials from a few major suppliers. In general, in those cases where Solutia has limited sources of raw materials, it has developed contingency plans to the extent practicable to minimize the effect of any interruption or reduction in supply. However, Solutia also purchases raw materials from some single source suppliers in the industry and in the event of an interruption or reduction in supply, might not be able to mitigate any negative effects. While temporary shortages of raw materials and energy resources may occasionally occur, these items are generally sufficiently available to cover Solutia's current and projected requirements. However, their continuing availability and price may be affected by unscheduled plant interruptions and domestic and world market conditions, political conditions and governmental regulatory actions. Due to the significant quantity of some of these raw materials and energy resources used by Solutia, a minor shift in the underlying prices for these items can result in a significant impact on Solutia's consolidated financial position and results of operations. PATENTS AND TRADEMARKS Solutia owns a large number of patents that relate to a wide variety of products and processes and has pending a substantial number of patent applications. In addition, Solutia is licensed under a small number of patents owned by others. Solutia owns a considerable number of established trademarks in many countries under which Solutia markets its products. These patents and trademarks in the aggregate are of material importance to Solutia's operations and to Solutia's Performance Products and Integrated Nylon segments. Patents and trademarks owned by Solutia and its domestic subsidiary CPFilms Inc. have been pledged as part of the collateral for the DIP credit facility. The holders of Solutia's 11.25 percent Senior Secured Notes due 2009 have a junior security interest in these patents and trademarks. Solutia Europe S.A./N.V.'s ("SESA") patents and trademarks of have been pledged to the holders of SESA's (euro)200 million Facility Agreement. For additional information on the (euro)200 million Facility Agreement, please see "Management's Discussion and Analysis" in Item 7 below. RESEARCH AND DEVELOPMENT Research and development constitute an important part of Solutia's activities. Solutia's expenses for research and development amounted to $38 million in 2006, $41 million in 2005 and $40 million in 2004, or about 1.4 percent of sales on average. Solutia focuses its expenditures for research and development on process improvements and selected product development. Solutia's research and development programs in the Performance Products segment include new products and processes for the window glazing and specialty chemicals markets. Significant progress was achieved in developing a new acoustic safety interlayer, improved window films that mitigate or enhance the reception of electronic signals through windows, a new aviation fluid and environmentally friendly water treatment products. Several process technologies were developed to support the construction of SAFLEX(R) plants. Solutia's Integrated Nylon segment continues to focus on internal process improvements to mitigate increasing raw material prices and to commercialize new products to address customer needs and improve product mix. ENVIRONMENTAL MATTERS The narrative information appearing under "Environmental Matters" beginning on page 41 below is incorporated here by reference. 9 EMPLOYEE RELATIONS On December 31, 2006, Solutia had approximately 5,100 employees worldwide, 632 of whom work in Europe. Approximately 450 of the European employees are represented by the union delegation. Approximately 14 percent of Solutia's U.S. workforce is currently represented by various labor unions with local agreements that expire between November 23, 2007 and March 31, 2010, at the following Solutia sites: Anniston, Alabama; Sauget, Illinois; Springfield, Massachusetts; and Trenton, Michigan. In the U.S., local agreements cover wages and working conditions. Each of Solutia's U.S. labor unions ratified new five-year collective bargaining agreements in 2005 which set pension and health and welfare benefits for Solutia's employees who are represented by labor unions. These agreements expire on December 31, 2010. INTERNATIONAL OPERATIONS Solutia and its subsidiaries are engaged in manufacturing, sales and research and development in areas outside the United States. Approximately 46 percent of Solutia's consolidated sales from continuing operations in 2006 were made into markets outside the United States, including Europe, Canada, Latin America and Asia. Solutia's Performance Products segment is increasingly dependent on its international operations as Solutia is currently building a plant for the manufacturing of SAFLEX(R) in Suzhou, China to provide more exposure in Asia for Performance Products. The plant in China will also expose the Performance Products segment to more competition. Approximately 69 percent of the 2006 sales of the Performance Products segment were made into markets outside the United States. Operations outside the United States are potentially subject to a number of risks and limitations that are not present in domestic operations, including trade restrictions, investment regulations, governmental instability and other potentially detrimental governmental practices or policies affecting companies doing business abroad. Operations outside the United States are also subject to fluctuations in currency values. The functional currency of each of Solutia's non-United States operations is generally the local currency. Exchange rates between these currencies and U.S. dollars have fluctuated significantly in recent years and may continue to do so. In addition, Solutia generates revenue from export sales and operations conducted outside the United States that may be denominated in currencies other than the relevant functional currency. INTERNET ACCESS TO INFORMATION Solutia's Internet address is www.solutia.com. Solutia makes available free of charge through Solutia's Internet website its annual report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission ("SEC"). All of these materials may be accessed from the "Investors" section of Solutia's website, www.solutia.com. These materials may also be accessed through the SEC's website (www.sec.gov) or in the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. 10 ITEM 1A. RISK FACTORS IN EVALUATING SOLUTIA, CAREFUL CONSIDERATION SHOULD BE GIVEN TO THE RISK FACTORS SET FORTH BELOW, AS WELL AS THE OTHER INFORMATION SET FORTH IN THIS ANNUAL REPORT ON FORM 10-K. ALTHOUGH THESE RISK FACTORS ARE MANY, THESE FACTORS SHOULD NOT BE REGARDED AS CONSTITUTING THE ONLY RISKS ASSOCIATED WITH OUR BUSINESSES. EACH OF THESE RISK FACTORS COULD ADVERSELY AFFECT OUR BUSINESS, OPERATING RESULTS AND/OR FINANCIAL CONDITION. IN ADDITION TO THE FOLLOWING DISCLOSURES, PLEASE REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT INCLUDING THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES. CERTAIN BANKRUPTCY CONSIDERATIONS PROLONGED CONTINUATION OF THE CHAPTER 11 CASES MAY HARM THE DEBTORS' BUSINESSES The prolonged continuation of the Chapter 11 Cases could adversely affect our businesses and operations. So long as the Chapter 11 Cases continue, our senior management will be required to spend a significant amount of time and effort dealing with our reorganization instead of focusing exclusively on business operations. Prolonged continuation of the Chapter 11 Cases may also make it more difficult to attract and retain management and other key personnel necessary to the success and growth of our businesses. In addition, the longer the Chapter 11 Cases continue, the more likely it is that our customers, suppliers, distributors and agents will lose confidence in our ability to successfully reorganize our businesses and seek to establish alternative commercial relationships. Furthermore, so long as the Chapter 11 Cases continue, we will be required to incur substantial costs for professional fees and other expenses associated with the proceedings. The prolonged continuation of the Chapter 11 Cases may also require us to seek additional financing, either as part of the DIP credit facility or otherwise, in order to service our debt and other obligations. We may not be able to obtain additional financing during the pendency of the Chapter 11 Cases on commercially favorable terms or at all. If we were to require additional financing during the Chapter 11 Cases and were unable to obtain the financing on favorable terms or at all, it is unlikely that we could successfully reorganize. WE MAY NOT BE ABLE TO OBTAIN CONFIRMATION OF THE PLAN To successfully emerge from Chapter 11 bankruptcy protection as a viable entity, Solutia, like any debtor, must obtain approval of a plan of reorganization from its creditors, confirmation of the plan through the Bankruptcy Court and successfully implement this confirmed plan. The foregoing process requires Solutia to (i) meet certain statutory requirements with respect to the adequacy of disclosure with respect to any proposed plan, (ii) solicit and obtain creditor acceptances of the proposed plan, and (iii) fulfill other statutory conditions with respect to plan confirmation. With regard to any proposed plan of reorganization we may not receive the requisite acceptances to confirm a plan. Even if the requisite acceptances of a proposed plan are received, the Bankruptcy Court may not confirm the plan as proposed. A dissenting holder of a claim against us could challenge the balloting procedures and results as not being in compliance with the Bankruptcy Code. Finally, even if the Bankruptcy Court determined that the balloting procedures and results were appropriate, the Bankruptcy Court could still decline to confirm a proposed plan if it found that any of the statutory requirements for confirmation had not been met. Specifically, section 1129 of the Bankruptcy Code sets forth the requirements for confirmation and requires, among other things, a finding by the Bankruptcy Court that (i) the debtor's plan "does not unfairly discriminate" and is "fair and equitable" with respect to any non-accepting classes, (ii) confirmation of the debtor's plan is not likely to be followed by a liquidation or a need for further financial reorganization, and (iii) the value of distributions to non-accepting holders of claims within a particular class under the debtor's plan will not be less than the value of distributions such holders would receive if the debtor was liquidated under Chapter 7 of the Bankruptcy Code. The Bankruptcy Court may determine that a proposed plan does not satisfy one or more of these requirements, in which case the proposed plan would not be confirmed by the Bankruptcy Court. If Solutia's Plan filed on February 14, 2006, or an amended version of that plan is not confirmed by the Bankruptcy Court, it is unclear whether Solutia would be able to reorganize its businesses and what, if any, distributions holders of claims against or equity interests in Solutia ultimately would receive with respect to their claims or equity interests. There also can be no assurance that Solutia will be able to successfully develop, prosecute, confirm, and consummate an alternative plan of reorganization with respect to the chapter 11 cases that is acceptable to the Bankruptcy Court and Solutia's creditors, equity holders and other parties in interest. There can be no assurance that such an alternative plan of reorganization would preserve 11 the reallocation of the Legacy Liabilities that is achieved in the Plan, which eliminates legacy tort liability exposure, reduces environmental obligations, and significantly reduces Solutia's exposure with regard to retiree obligations. Additionally, it is possible that third parties may seek and obtain approval to terminate or shorten the exclusivity period during which only Solutia may propose and confirm a plan of reorganization. Finally, Solutia's emergence from bankruptcy is not assured. While we expect to emerge from bankruptcy in the future, there can be no assurance that we will successfully reorganize, or when this reorganization will occur. THE CHANGE OF CONTROL PRODUCED BY OUR RESTRUCTURING MAY RESULT IN A LIMITATION ON OR LOSS OF NET OPERATING LOSSES FOR FEDERAL INCOME TAX PURPOSES Our issuance of common stock in a reorganized Solutia, along with the cancellation of existing equity interests may cause us to undergo an ownership change upon emergence from Chapter 11. As a result, Section 382 of the Internal Revenue Code ("IRC") may apply to limit our use of consolidated net operating losses upon emergence. Additionally, our ability to use any remaining capital loss carryforwards and tax credits may be limited. The annual limitation imposed by the particular provision of Section 382 of the IRC that reorganized Solutia expects to apply to its ownership change generally equals the product of (i) the fair market value of the net equity value of our stock at the time of the ownership change, taking into account the increase in value of the corporation as a result of the surrender or cancellation of creditor's claims in the transaction (rather than the value without taking into account such increases, as is the case under the general rule for non-bankruptcy ownership changes) multiplied by (ii) the long-term tax-exempt rate in effect for the month in which the ownership change occurs. The long-term tax-exempt rate is published monthly by the IRS and is intended to reflect current interest rates on long-term tax-exempt debt obligations. Accordingly, under this rule the Section 382 limitation would generally reflect the increase in the value of reorganized Solutia's stock resulting from the conversion of debt to equity in the proceeding. Section 383 of the IRC applies a similar limitation to a capital loss carryforward and tax credits. Although it is impossible to predict with absolute certainty the net equity value of reorganized Solutia immediately upon emergence from Chapter 11, reorganized Solutia's use of its net operating losses is expected to be substantially limited after an ownership change. RISKS RELATED TO OUR BUSINESS AND INDUSTRY THE PRICES OF RAW MATERIALS AND ENERGY REQUIRED FOR US TO PRODUCE OUR PRODUCTS ARE VOLATILE AND CANNOT ALWAYS BE PASSED ON TO CUSTOMERS We purchase large amounts of commodity raw materials, including natural gas, propylene, cyclohexane and benzene. Temporary shortages of these raw materials and energy sources may occasionally occur. In addition, we typically purchase major requirements for key raw materials under medium-term contracts. Pricing under these contracts may fluctuate as a result of unscheduled plant interruptions, United States and worldwide market conditions and government regulation. Given our competitive markets, it is not always possible to pass all of these increased costs on to our customers. In addition, natural gas prices and other raw material and energy costs are currently more than double the average ten-year levels. Elevated raw material and energy costs could significantly reduce our operating margins in the future. WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY THAT INCLUDES COMPETITORS WITH GREATER RESOURCES THAN OURS The markets in which we compete are highly competitive. Competition in these markets is based on a number of factors, such as price, product quality and service. Some of our competitors may have greater financial, technological and other resources than we do and may be better able to withstand changes in market conditions. In addition, some of our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than us. Consolidation of our competitors or customers may also adversely affect our businesses. Furthermore, global competition and customer demands for efficiency will continue to make price increases difficult. WE OPERATE IN CYCLICAL BUSINESS SEGMENTS AND OUR FINANCIAL RESULTS ARE LIKELY TO FLUCTUATE ACCORDINGLY We operate in cyclical business segments. Specifically, a substantial portion of our sales are to customers involved, directly or indirectly, in the housing and automotive industries, both of which are, by their nature, cyclical industries. A downturn in either or both of these industries would result in lower demand for our products among customers involved in those industries and a reduced ability to pass on cost increases to those customers. 12 TURNOVER IN THE SENIOR MANAGEMENT TEAM AND LOSSES OF OTHER KEY PERSONNEL COULD HAVE A SIGNIFICANT ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS AND ABILITY TO EMERGE FROM CHAPTER 11 The services of our senior management team, as well as other key personnel, have been integral in our improving results during the Chapter 11 Cases and will be critical to the implementation of our business strategies going forward and our success. If our emergence from the Chapter 11 Cases is delayed, our financial results diminish, the terms of incentive compensation programs are not adequate or any other adverse events occur in the Chapter 11 Cases, we may have difficulty retaining current senior management and other key personnel and be unable to hire qualified personnel to fill any resulting vacancies, which could have a significant adverse effect on our results of operations and ability to emerge from Chapter 11. OUR OPERATIONS ARE RESTRICTED BY THE TERMS OF OUR CURRENT CREDIT FACILITIES Our current credit facilities include a number of significant restrictive covenants. These covenants could impair our financing and operational flexibility and make it difficult for us to react to market conditions and satisfy our ongoing capital needs and unanticipated cash requirements. Specifically, such covenants restrict our ability and, if applicable, the ability of our subsidiaries to, among other things: o incur additional debt; o make certain investments; o enter into certain types of transactions with affiliates; o limit dividends or other payments by Solutia and certain subsidiaries; o use assets as security in other transactions; o pay dividends on our common stock or repurchase our equity interests; o sell certain assets or merge with or into other companies; o guarantee the debts of others; o enter into new lines of business; o make capital expenditures; o prepay, redeem or exchange our debt; o form any joint ventures or subsidiary investments. In addition, our current DIP credit facility requires us to periodically meet minimum capital expenditures on a consolidated bases and minimum EBITDA levels on a consolidated basis and for a certain business segment. Our (euro)200 million Facility Agreement requires us to periodically meet leverage ratios, interest coverage ratios, capital expenditures, and cash flow to debt service ratios on a SESA stand alone basis. These financial covenants and tests could limit our ability to react to market conditions or satisfy extraordinary capital needs and could otherwise restrict our financing and operations. Our ability to comply with the covenants and other terms of our debt obligations will depend on our future operating performance. If we fail to comply with such covenants and terms, we would be required to obtain waivers from our lenders to maintain compliance with our debt obligations. If we are unable to obtain any necessary waivers and the debt is accelerated, it would have a material adverse effect on our financial condition and future operating performance. 13 WE HAVE AND WILL CONTINUE TO HAVE SIGNIFICANT INDEBTEDNESS We have and will continue to have a significant amount of indebtedness. Solutia's significant indebtedness could have important consequences, including the following: o We will have to dedicate a significant portion of our cash flow to making interest and principal payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions or other general corporate purposes. o Levels of indebtedness may make us less attractive to potential acquirors or acquisition targets. o Levels of indebtedness may limit our flexibility to adjust to changing business and market conditions, and make us more vulnerable to downturns in general economic conditions as compared to competitors that may be less leveraged. o As described in more detail above, the documents providing for our indebtedness contain restrictive covenants that may limit our financing and operational flexibility. Furthermore, our ability to satisfy our debt service obligations will depend, among other things, upon our future operating performance and ability to refinance indebtedness when necessary. These factors depend partly on economic, financial, competitive and other factors beyond our control. We may not be able to generate sufficient cash from operations to meet our debt service obligations as well as fund necessary capital expenditures, pension funding obligations and investments in research and development. In addition, if we need to refinance our debt, obtain additional financing or sell assets or equity, we may not be able to do so on commercially reasonable terms, if at all. LEGAL PROCEEDINGS, INCLUDING PROCEEDINGS RELATED TO ENVIRONMENTAL OBLIGATIONS, COULD IMPOSE SUBSTANTIAL COSTS ON US As a manufacturer of chemical-based materials, we have been subject to various lawsuits involving environmental, hazardous waste, personal injury and product liability claims. We are named in a number of legal proceedings primarily relating to former operations, including claims for personal injury and property damage arising out of releases of or alleged exposure to materials that are classified as hazardous substances under federal environmental law or alleged to be hazardous by plaintiffs. Adverse judgments in these legal proceedings, or the filing of additional environmental or other damage claims against us, may have a negative impact on our future results of operations. Additionally, administrative and legal costs associated with defending or settling large claims, or large numbers of claims, could have a negative impact on our future results of operations. It is possible that the Bankruptcy Court could disagree with our treatment of those claims. It is also possible that third parties, including the U.S. federal government, state regulatory agencies, or others, may challenge the dischargeability of these claims. If these litigation matters or claims are not treated as contemplated in our Plan, as filed, or if the actual costs are materially greater than estimates associated with those claims, it could have a material adverse effect on our financial condition and future operating performance. THE APPLICABILITY OF NUMEROUS ENVIRONMENTAL LAWS TO OUR MANUFACTURING FACILITIES COULD CAUSE US TO INCUR MATERIAL COSTS AND LIABILITIES We are subject to extensive federal, state, local and foreign environmental, safety and health laws and regulations concerning, among other things, emissions to the air, discharges to land and water and the generation, handling, treatment and disposal of hazardous waste and other materials. Under certain environmental laws, we can be held strictly liable for hazardous substance contamination of any real property we have ever owned, operated or used as a disposal site or for natural resource damages associated with such contamination. We are also required to maintain various environmental permits and licenses, many of which require periodic modification and renewal. Our operations entail the risk of violations of those laws and regulations, many of which provide for substantial fines and criminal sanctions for violations. In addition, these requirements and their enforcement may become more stringent in the future. Non-compliance could subject us to material liabilities, such as government fines, third-party lawsuits or the suspension of non-compliant operations. We may also be required to make significant site or operational modifications at substantial cost. Future developments could also restrict or eliminate our ability to continue to manufacture certain products or could require us to make modifications to our products. 14 At any given time, we are involved in litigation, administrative proceedings and investigations of various types in a number of jurisdictions involving potential environmental liabilities, including clean-up costs associated with hazardous waste disposal sites, natural resource damages, property damages and personal injury. We may be required to spend substantial sums to defend or settle these actions, to pay any fines levied against us or satisfy any judgments or other rulings rendered against us. Liability under environmental laws relating to contaminated sites can be imposed retroactively and on a joint and several basis. One liable party could be held responsible for all costs at a site, regardless of fault, percentage of contribution to the site or the legality of the original disposal. We may also face liability for violations under environmental laws occurring prior to the date of our acquisition of properties subject thereto. We could incur significant costs, including cleanup costs, natural resources damages, civil or criminal fines and sanctions and third-party claims as a result of past or future violations of, or liabilities under, environmental laws. WE HAVE SUBSTANTIAL ENVIRONMENTAL AND REGULATORY COMPLIANCE COSTS Due to the nature of our business, we make substantial expenditures for environmental and regulatory compliance. During 2006, we spent approximately $9 million on capital projects for various environmental matters, $60 million for the management of environmental programs, including the operation and maintenance of facilities for environmental control, and $10 million for remediation activities. Monsanto currently funds a number of the environmental remediation sites as required under the Plan. However, if the Plan or any other plan is not approved, we could become responsible for some of the sites previously funded by Monsanto and these unexpected expenses could affect our results of operations and financial condition. The substantial amounts that we may be required to spend on environmental capital projects and programs could cause substantial cash outlays and, accordingly, may limit our financial and operating flexibility. In addition, although we believe that we have correctly budgeted and, to the extent appropriate under applicable accounting principles, reserved for these amounts, factors beyond our control may render these budgeted and reserved amounts inadequate. These factors include changing governmental policies and regulations, the commencement of new governmental proceedings or third party litigation regarding environmental remediation, hazardous waste or personal or property damage resulting from environmentally harmful activity, the discovery of unknown conditions and unforeseen problems encountered in environmental remediation programs. PROBLEMS ENCOUNTERED IN OPERATING OUR PRODUCTION FACILITIES COULD ADVERSELY IMPACT OUR BUSINESS Our production facilities are subject to hazards associated with the manufacture, handling, storage and transportation of chemical materials and products, including leaks and ruptures, explosions, fires, inclement weather and natural disasters, unscheduled down time and environmental hazards. From time to time in the past, we have had incidents that have temporarily shut down or otherwise disrupted our manufacturing, causing production delays and resulting in liability for workplace injuries and fatalities. We are dependent upon the continued safe operation of our production facilities. In addition, some of our products involve the manufacture or handling of a variety of reactive, explosive and flammable materials. Use of these products by our employees, customers and contractors could result in liability to us if an explosion, fire, spill or other accident were to occur. LABOR DISRUPTIONS WITH THE UNIONIZED PORTION OF OUR WORKFORCE COULD HAVE A NEGATIVE EFFECT As of December 31, 2006, approximately 14 percent of our U.S. employees located in the Performance Products business segment were unionized. They are represented by various labor unions with local agreements set to expire between November 2007 and March 2010. While we believe that our relations with our employees are good, we may not be able to negotiate these or other collective bargaining agreements on the same or more favorable terms as the current agreements, or at all, and without production interruptions, including labor stoppages. A prolonged labor dispute, which could include a work stoppage, could impact our ability to satisfy our customers' requirements and negatively affect our financial condition. 15 WE FACE CURRENCY AND OTHER RISKS ASSOCIATED WITH INTERNATIONAL SALES We generate revenue from export sales, as well as from operations conducted outside the United States. For example, approximately 46 percent of our consolidated sales in 2006 were made into markets outside the United States, including Europe, Canada, Latin America and Asia. Approximately 69 percent of the sales of the Performance Products segment were made into markets outside the United States. Operations outside the United States expose us to risks which would adversely affect our results of operations and financial conditions including fluctuations in currency values, trade restrictions, tariff and trade regulations, foreign tax laws, shipping delays, and economic and political instability. The functional currency of each of our non-United States operations is generally the local currency. Exchange rates between some of these currencies and U.S. dollars have fluctuated significantly in recent years and may do so in the future. It is possible that fluctuations in foreign exchange rates will have a negative effect on our results of operations. MANY OF OUR PRODUCTS AND MANUFACTURING PROCESSES ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND OUR BUSINESS WILL SUFFER IF WE FAIL TO KEEP PACE Many of our products (and their corresponding manufacturing processes) participate in markets that are subject to rapid technological change and new product introductions and enhancements. We must continue to enhance our existing products and to develop and manufacture new products with improved capabilities to continue to be a market leader. We must also continue to make improvements in our manufacturing processes and productivity to maintain our competitive position. When we invest in new technologies, processes or production facilities, we will face risks related to construction delays, cost over-runs and unanticipated technical difficulties related to start-up. Our inability to anticipate, respond to, capitalize on or utilize changing technologies could have an adverse effect on our consolidated results of operations, financial condition and cash flows in any given period. IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR SALES AND FINANCIAL PERFORMANCE COULD BE ADVERSELY AFFECTED We own a large number of patents that relate to a wide variety of products and processes and have a substantial number of patent applications pending. We own a considerable number of established trademarks in many countries under which we market our products. These patents and trademarks in the aggregate are of material importance to our operations and to our Performance Products and Integrated Nylon segments. Our performance may depend in part on our ability to establish, protect and enforce such intellectual property and to defend against any claims of infringement, which involve complex legal, scientific and factual questions and uncertainties. In the future, we may have to rely on litigation to enforce our intellectual property rights and contractual rights. In addition, we may face claims of infringement that could interfere with our ability to use technology or other intellectual property rights that are material to our business operations. If litigation that we initiate is unsuccessful, we may not be able to protect the value of some of our intellectual property. In the event a claim of infringement against us is successful, we may be required to pay royalties or license fees to continue to use technology or other intellectual property rights that we had been using or we may be unable to obtain necessary licenses from third parties at a reasonable cost or within a reasonable period of time. If we are unable to obtain licenses on reasonable terms, we may be forced to cease selling or using any of our products that incorporate the challenged intellectual property, or to redesign or, in the case of trademark claims, rename our products to avoid infringing the intellectual property rights of third parties, which may not be possible and may be time-consuming. Any litigation of this type, whether successful or unsuccessful, could result in substantial costs to us and diversions of some of our resources. Our intellectual property rights may not have the value that we believe them to have, which could result in a competitive disadvantage or adversely affect our business and financial performance. SIGNIFICANT PAYMENTS MAY BE REQUIRED TO MAINTAIN THE FUNDING OF SOLUTIA'S DOMESTIC QUALIFIED PENSION PLAN We maintain a qualified pension plan under which certain of our employees and retirees are entitled to receive benefits. Although we have frozen future benefit accruals under the U.S. pension plan, significant liabilities still remain. In order to fund the pension plan, we have made significant contributions to the pension plan in 2006 amounting to approximately $179 million and will have to fund more going forward. We may be unable to obtain financing to make these pension plan contributions. In addition, even if financing for these contributions is obtained, the funding obligations and the carrying costs of debt incurred to fund the obligations could have a significant adverse effect on our results of operations. 16 In addition, we are party to certain litigation with respect to our domestic pension plan as more fully described in Part I, Item 3 - Legal Proceedings. It is not known what funding liabilities may be required of Solutia under the Employee Retirement Income Security Act (ERISA) 26 U.S.C. ss. 412, 29 U.S.C. ss. 1082 and any other applicable law if a judgment is entered against our pension plan in this litigation, given that we are the sponsor of the Solutia Pension Plan. If a final judgment is entered against the Solutia pension plan, the liability resulting from such judgment could have a material adverse effect on our financial results and continuing operations. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES Solutia's general offices are located in St. Louis County, Missouri, on land owned by Solutia in a facility which is the subject of a synthetic lease (see Note 11 to the accompanying consolidated financial statements). Solutia's principal European offices are located in Louvain-la-Neuve, Belgium, on land leased from the University of Louvain. Information about Solutia's major manufacturing locations worldwide and segments that used these locations on February 1, 2007, appears under "Segments; Principal Products" in Item 1 of this report and is incorporated here by reference. Solutia's principal plants are suitable and adequate for their use. Utilization of these facilities varies with seasonal, economic and other business conditions. None of Solutia's principal plants is substantially idle. Solutia's facilities generally have sufficient capacity for existing needs and expected near-term growth. Solutia owns most of its principal plants. However, at Antwerp, Belgium and Sao Jose dos Campos, Brazil, both of which are sites belonging to the current Monsanto Company, Solutia owns certain buildings and production equipment and leases the underlying land. Monsanto and Solutia have operating agreements with respect to each of the two Monsanto facilities listed above and with respect to Solutia's Chocolate Bayou facility in Alvin, Texas and its facility in Ghent, Belgium. Under these operating agreements, Solutia is the guest at the facility and Monsanto is the operator of the facility, except at the Alvin, Texas and Ghent facilities at which Monsanto is the guest and Solutia is the operator. The initial term of each of the operating agreements has 11 years remaining. After the initial term, the operating agreements continue indefinitely unless either party terminates on at least 24 months' prior written notice. Each of the operating agreements also provides that, under certain circumstances, either the operator or the guest may terminate the operating agreement before the expiration of its initial term. Solutia operates several facilities for other third parties on its sites, principally within the Alvin, Texas; Sauget, Illinois; Pensacola, Florida; Newport, Wales (U.K.); and Springfield, Massachusetts sites under long-term lease and operating agreements. Mortgages on Solutia's plants at the following locations constitute a portion of the collateral securing Solutia's DIP credit facility: Decatur, Alabama; Springfield, Massachusetts; Trenton, Michigan; Greenwood, South Carolina; Alvin (Chocolate Bayou), Texas; Pensacola, Florida; and Martinsville, Virginia. The holders of Solutia's 11.25 percent Senior Secured Notes due 2009 hold second mortgages on each of these plants. Holders of SESA's (euro)200 million Facility Agreement hold mortgages on Solutia's facilities in Ghent, Belgium and Louvain-la-Neuve, Belgium. As a result of the Chapter 11 filing, Solutia has received notices of mechanics' liens from a number of contractors seeking payment of pre-petition claims. While contractors are permitted to take certain actions required to perfect their liens after the commencement of the Chapter 11 case, such as filing written notice, the automatic stay under Section 362 of the U.S. Bankruptcy Code prevents them from taking any further action to enforce a lien against Solutia's property unless they obtain court approval to lift the stay for that purpose, and Solutia does not expect the filing of these mechanics' liens to have any adverse effect on the operation of Solutia's plants. 17 ITEM 3. LEGAL PROCEEDINGS Because of the size and nature of Solutia's business, Solutia is a party to numerous legal proceedings. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. In addition, at the time of its spinoff from Pharmacia, Solutia assumed the defense of specified legal proceedings and agreed to indemnify Pharmacia for obligations arising in connection with those proceedings. Solutia has determined that these defense and indemnification obligations to Pharmacia are pre-petition obligations under the U.S. Bankruptcy Code that Solutia is prohibited from performing, except pursuant to a confirmed plan of reorganization. As a result, Solutia has ceased performance of these obligations. Solutia's cessation of performance may give rise to a pre-petition unsecured claim against Solutia which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case. The estimated unsecured claim amount was classified as a liability subject to compromise as of December 31, 2006 and December 31, 2005 in the amount of $111 million and $136 million, respectively. Monsanto also indemnified Pharmacia with respect to a number of legal proceedings described in Solutia's 2003 Form 10-K/A in which Solutia was a named defendant or was defending solely due to its Pharmacia related indemnification obligations referred to above. Solutia is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, Solutia has ceased reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) ----------------- Payton v. Monsanto; (iii) other Anniston cases; and (iv) premises based - ------------------ asbestos litigation. Legal proceeding activities are currently being funded by Monsanto for these matters. Monsanto's funding of these legal activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's bankruptcy case. Following is a summary of legal proceedings that Solutia or its equity affiliate continue to manage that, if resolved unfavorably, could have a material adverse effect on Solutia's results of operation and financial position. LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE - ---------------------------------------------- JPMORGAN ADVERSARY PROCEEDING On May 27, 2005, JPMorgan, as indenture trustee for Solutia's debentures due 2027 and 2037 (the "Prepetition Indenture"), filed an adversary proceeding against Solutia in Solutia's bankruptcy case. In the proceeding, JPMorgan asserted five causes of action seeking declaratory judgments to establish the validity and priority of the purported security interest of the holders of the 2027 and 2037 debentures, and one cause of action pursuant to section 363 of the Bankruptcy Code asserting that the alleged security interests lacked adequate protection. The proceeding relates to Solutia's 2002 and 2003 refinancings of its credit facilities. When Solutia refinanced its credit facilities in 2002, the 2027 and 2037 Debentures obtained a pro rata secured interest in certain of Solutia's assets as a result of the application of the "equal and ratable" provisions of the Prepetition Indenture. On October 8, 2003, Solutia restructured its credit facilities, reduced its outstanding secured indebtedness below the threshold level that initially triggered the "equal and ratable" provisions of the Prepetition Indenture and, as a result, the 2027 and 2037 Debentures returned to their original unsecured status. JPMorgan alleges that the October 8, 2003 refinancing had no effect on the security interests and liens that were created in 2002, and argues further that, even if it did, those liens should be reinstated as a matter of equity. The Unsecured Creditors' Committee and the Ad Hoc Solutia Trade Claims Committee have intervened in the proceeding in support of Solutia and the Ad Hoc Committee of Solutia Noteholders has intervened in the proceeding in support of JPMorgan. Trial concluded on July 10, 2006. Post-trial briefs were submitted by the parties in August 2006. The Bankruptcy Court has not made a ruling. EQUITY COMMITTEE ADVERSARY PROCEEDING AGAINST MONSANTO AND PHARMACIA On March 7, 2005, the Equity Committee in Solutia's bankruptcy case filed a complaint against Pharmacia and Monsanto and objections to the proofs of claim filed by Pharmacia and Monsanto in Solutia's bankruptcy case. Solutia was not named as a defendant. In its complaint, the Equity Committee seeks to avoid certain obligations assumed by Solutia at the time of its spinoff from Pharmacia. The complaint alleges, among other things, that the Solutia Spinoff was a fraudulent transfer under the Bankruptcy Code because Pharmacia forced Solutia to assume excessive liabilities and insufficient assets such that Solutia was destined to fail from its inception. Pharmacia and Monsanto filed a motion to dismiss the complaint or, in the alternative, to stay the adversary proceeding. On August 4, 2005, the Debtors filed with the Bankruptcy Court their Statement and Reservation of Rights in Response to the complaint and Objection to Claims, in which the Debtors expressed 18 their view that the issues and disputes raised in the complaint would be resolved through the Plan confirmation process. During a hearing held on April 11, 2006, the Bankruptcy Court issued a bench ruling denying Pharmacia and Monsanto's motion to dismiss the complaint. The Ad Hoc Committee of Solutia Noteholders and the Ad Hoc Solutia Trade Claims Committee have intervened in this adversary proceeding in support of the Equity Committee. Solutia and the Unsecured Creditors' Committee have intervened in this adversary proceeding as neutral parties due to the importance of this proceeding with respect to Solutia's bankruptcy case. On September 14, 2006, the Court ruled that while the Equity Committee did not have standing to pursue these claims on behalf of the Debtors, it had standing to pursue its own objections to the claims of Monsanto and Pharmacia. This matter was submitted to mediation but the parties were unable to reach a consensual resolution. The adversary proceeding has been stayed indefinitely by the parties, subject to certain rights of the parties to recommence such proceeding. LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE - --------------------------------------------------- ANNISTON PARTIAL CONSENT DECREE On August 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Partial Consent Decree in an action captioned United States of America v. Pharmacia Corporation (p/k/a Monsanto Company) and Solutia. This Partial Consent Decree provides for Pharmacia and Solutia to sample certain residential properties and remove soils found on those properties if PCBs are at a level of 1 part per million (ppm) or above, to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the Environmental Protection Agency ("EPA") of a cleanup remedy for the Anniston, Alabama PCB site, and to pay EPA's past response costs and future oversight costs related to this work. The decree also provided for the creation of an educational trust fund of approximately $3 million to be funded over a 12-year period to provide supplemental educational services for school children in west Anniston. A subsequent dispute arose between the EPA and Solutia regarding the scope and application of the automatic stay arising as a result of Solutia's Chapter 11 filing to the remaining obligations under the Partial Consent Decree. On April 19, 2004, the District Court held that the Partial Consent Decree enforces police and regulatory powers under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and, as a result, the automatic stay provisions of the U.S. Bankruptcy Code are inapplicable to Solutia's obligations under the Partial Consent Decree. On April 30, 2004, the United States Bankruptcy Court for the Southern District of New York entered a Stipulation and Agreed Order in which the EPA and Solutia stipulated that the automatic stay is applicable to certain of the Partial Consent Decree's requirements. Solutia filed a motion asking the District Court to reconsider its order and to bring it into accord with the Stipulation and Agreed Order consented to by the EPA and entered by the Bankruptcy Court. On September 9, 2004, the District Court denied Solutia's motion and declared that the automatic stay is inapplicable to Solutia's obligations under the Consent Decree to perform site work. Solutia appealed this ruling to the Eleventh U.S. Circuit Court of Appeals, which dismissed the appeal for lack of jurisdiction. On June 30, 2005, the United States District Court for the Northern District of Alabama issued an order (the "PCB Order") authorizing co-defendants Pharmacia and Solutia to "suspend" performance of the PCB clean-up at the Anniston site under the Anniston Consent Decree, upon the filing of a motion by either defendant requesting that relief. The PCB Order found that Solutia and Pharmacia entered into the Anniston Consent Decree, and that the court approved that Anniston Consent Decree, based on the understanding that the defendants' rights to pursue other liable parties for contribution would not be impaired by the EPA. The PCB Order further found that the EPA's planned settlements with certain Anniston foundries would thus deprive the defendants of one of the material considerations for entering into the Anniston Consent Decree. In July 2006, Solutia and Pharmacia reached an agreement with EPA that clarifies the extent of remaining obligations under the Anniston Consent Decree and the coordination of that work with the lead site clean-up being performed by others, and by which Solutia and Pharmacia will forego the opportunity to suspend their obligations under the Anniston Consent Decree pursuant to the PCB Order. Solutia and Pharmacia preserved their rights under this agreement to continue to argue that the contribution protection afforded certain other potentially responsible parties performing lead site clean-up should not be effective as to Solutia and Pharmacia. 19 PENNDOT CASE Solutia's Annual Report on Form 10-K/A for the year ended December 31, 2003 described a case then pending in the Commonwealth Court of Pennsylvania by the Commonwealth of Pennsylvania against Pharmacia seeking damages for PCB contamination in the Transportation and Safety Building ("T&S Building") in Harrisburg, Pennsylvania, that it claimed necessitated the demolition of the T&S Building. Solutia was not a named defendant in this litigation and therefore took no action to stay the litigation in connection with its Chapter 11 proceedings. Solutia assumed the defense of this litigation at the time of its spin-off from Pharmacia. Solutia determined that its obligation to defend and indemnify Pharmacia with regard to this litigation was a pre-petition obligation that Solutia was prohibited from performing, except pursuant to a confirmed plan of reorganization. Therefore, Solutia ceased defending Pharmacia with respect to this litigation. Solutia did, however, provide a $20 million letter of credit to secure a portion of Pharmacia's obligations with respect to an appeal bond issued with respect to the case. On May 25, 2006 the Supreme Court of Pennsylvania issued its ruling on the appeal in this case, reversing in whole and remanding in part the decision of the trial court against Pharmacia. As a result of this ruling, the $20 million letter of credit that Solutia had committed to partially secure the appeal bond was released. With the release of the bond, Solutia recognized a gain in its Consolidated Statement of Operations during the second quarter 2006 from the reversal of a significant portion of the existing litigation reserve with respect to this matter. FLEXSYS RELATED LITIGATION Since 2002, antitrust authorities in the United States, Europe and Canada are continuing to investigate past commercial practices in the rubber chemicals industry including the practices of Flexsys, Solutia's joint venture with Akzo Nobel. The European Commission issued its findings from its investigation in 2005, without levying any fines against Flexsys. Investigations regarding the industry may still be on-going in the United States and Canada, but to date, no findings have been made against Flexsys in either country. In addition, a number of purported civil class actions have been filed against Flexsys and other producers of rubber chemicals on behalf of indirect purchasers of rubber chemical products. Solutia is aware of a series of these purported class actions which had been filed against Flexsys in various state courts in the United States and in at least four courts in Canada. Except for two cases pending in the United States, all of the remaining cases have been dismissed, or are currently subject to tentative settlements. CASH BALANCE PLAN LITIGATION Davis v. Solutia Inc. Employees' Pension Plan; Hammond, et al. v. ----------------------------------------------------------------- Solutia Inc. Employees' Pension Plan. Since October 2005, current or former - ------------------------------------ participants in the Solutia Inc. Employees' Pension Plan (the "Pension Plan") have filed three class actions alleging that the Pension Plan is discriminatory based upon age and that the lump sum values of individual account balances in the Pension Plan have been, and continue to be, miscalculated. None of the Debtors, and no individual or entity other than the Pension Plan, has been named as a defendant in any of these cases. Two of these cases, captioned Davis, et al. v. Solutia, Inc. Employees' Pension Plan and Hammond, et al. v. Solutia, Inc. Employees' Pension Plan, are still pending in the Southern District of Illinois against Monsanto Company and Monsanto Company Pension Plan (Walker et al. v. The Monsanto Pension Plan, et al.) and Pharmacia Cash Balance Pension Plan, Pharmacia Corporation, Pharmacia and Upjohn, Inc., and Pfizer Inc. (Donaldson v. Pharmacia Cash Balance Pension Plan, et al.). The plaintiffs in the Pension Plan cases sought to obtain injunctive and other equitable relief (including money damages awarded by the creation of a common fund) on behalf of themselves and the nationwide putative class of similarly situated current and former participants in the Pension Plan. A Consolidated Class Action Complaint (the "Complaint") was filed by all of the plaintiffs in the consolidated case on September 4, 2006. The plaintiffs in the Complaint alleged three separate causes of action against the Pension Plan: (1) the Pension Plan violates ERISA by terminating interest credits on prior plan accounts at the age of 55; (2) the Pension Plan is improperly backloaded in violation of ERISA; and (3) the Pension Plan is discriminatory on the basis of age. Motions for class certification were filed in late 2006 by the plaintiffs against each of the defendants. With respect to the Pension Plan, plaintiffs moved to certify a class only on their first claim: i.e., that the Pension Plan discriminated against employees on the basis of their age by only providing interest credits on prior plan accounts through age 55. Briefing on the class certification motions was completed in January 2007 and the motion is still pending before the court. 20 OTHER LEGAL PROCEEDINGS - ----------------------- Dickerson V. Feldman. On October 7, 2004, a purported class action -------------------- captioned Dickerson v. Feldman; et al. was filed in the United States District Court for the Southern District of New York against a number of defendants, including former officers and employees of Solutia and Solutia's Employee Benefits Plans Committee and Pension and Savings Funds Committee. Solutia was not named as a defendant. The action alleged breach of fiduciary duty under ERISA and sought to recover alleged losses to the Solutia Inc. Savings and Investment Plan ("SIP Plan") during the period December 16, 1998 to the date the action was filed. The investment of SIP Plan assets in Solutia's common stock is alleged to have been imprudent because of the risks and liabilities related to Solutia's legacy environmental and litigation liabilities and because of Flexsys' alleged involvement in the matters described above under "Flexsys Related Litigation." The action sought monetary payment to the SIP Plan to recover the losses resulting from the alleged breach of fiduciary duties, as well as injunctive and other appropriate equitable relief, reasonable attorney's fees and expenses, costs and interest. In addition, the plaintiff in this action filed a proof of claim for $269 million against Solutia in the Bankruptcy Court. On March 30, 2006, the District Court granted the defendants' motion to dismiss on grounds that the Dickerson plaintiffs lacked standing to sue and that the complaint failed to state a claim on which relief could be granted. The dismissal of Dickerson's cause of action resulted in dismissal of the entire purported class action, including claims asserted on behalf of the unnamed purported class members. On April 3, 2006, Dickerson filed an appeal of this dismissal with the United States Court of Appeals for the Second Circuit. The parties have fully briefed the appeal, and oral arguments are expected to be held in mid 2007. Solutia Inc. v. FMC Corporation. On October 14, 2003, Solutia filed ------------------------------- an action captioned Solutia Inc. v. FMC Corporation ("FMC") in Circuit Court in St. Louis County, Missouri, against FMC over the failure of purified phosphoric acid technology provided by FMC to Astaris, the 50/50 joint venture formed by Solutia and FMC. On February 20, 2004, Solutia voluntarily dismissed the state court action and filed an adversary proceeding against FMC in the Bankruptcy Court. FMC filed with the Bankruptcy Court a motion to withdraw the reference. The motion was granted, and, as a result, the matter is now pending in the U.S. District Court for the Southern District of New York. FMC did not allege a counterclaim against Solutia or Astaris. FMC filed a motion to dismiss Solutia's action based upon an alleged lack of standing. On March 29, 2005, the New York District Court granted in part and denied in part FMC's motion to dismiss. Specifically, the court dismissed with prejudice three of Solutia's causes of action for breach of contract. The New York District Court denied FMC's motion to dismiss Solutia's other causes of action for breach of warranty, breach of fiduciary duty, negligent misrepresentation, fraud and fraud in the inducement. The parties have completed all fact discovery and submitted cross motions for Summary Judgment. On July 31, 2006, the District Court entered its Memorandum Opinion and Order on the Motions. It granted portions of FMC's Motion for Summary Judgment by ruling that Solutia cannot attempt to establish its breach of fiduciary duty claim by maintaining that the parties were in a joint venture or had a special relationship prior to April 2000. The District Court, however, denied FMC's Motion for Summary Judgment on the breach of fiduciary duty claim and held that Solutia will be permitted to prove at trial that FMC had special knowledge concerning its technology which can give rise to a fiduciary duty. The District Court further overruled the parties' Motion for Summary Judgment on the remaining claims. The District Court ruled Solutia may still be entitled to punitive damages in addition to its claims for out-of-pocket and lost profit damages. A bench trial on the four claims noted above is scheduled to begin in April 2007. Ferro Antitrust Investigation. Competition authorities in Belgium and ----------------------------- several other European countries are investigating past commercial practices of certain companies engaged in the production and sale of butyl benzyl phthalates ("BBP"). One of the BBP producers under investigation by the Belgian Competition Authority ("BCA") is Ferro Belgium sprl, a European subsidiary of Ferro Corporation ("Ferro"). Ferro's BBP business in Europe was purchased from Solutia in 2000. Solutia received an indemnification notice from Ferro and has exercised its right, pursuant to the purchase agreement relating to Ferro's acquisition of the BBP business from Solutia, to assume and control the defense of Ferro in proceedings relating to these investigations. On July 7, 2005, the BCA Examiner issued a Statement of Objections regarding its BBP investigation in which SESA, a European non-Debtor subsidiary of Solutia, along with Ferro Belgium sprl and two other producers of BBP, is identified as a party under investigation with respect to its ownership of the BBP business from 1997 until the business was sold to Ferro in 2000. SESA's written comments to the Statement of Objections were submitted on August 31, 2005 and presented at an oral hearing before the BCA on September 6, 2005. The Examiner submitted its 21 Reasoned Report to the BCA on December 22, 2005. Solutia is not named as a party under investigation in the Reasoned Report. SESA will have an opportunity to submit comments to the BCA on the Reasoned Report in writing and at a subsequent oral hearing on a date that has not yet been determined by the BCA. Solutia and SESA are fully cooperating with the BCA in this investigation. Department of Labor Investigation of Solutia Inc. Savings and ------------------------------------------------------------- Investment Plan. Solutia was contacted in 2005 by the Department of Labor - --------------- ("DOL"), through the Employee Benefits Security Administration, informing Solutia that it wanted to conduct an investigation of Solutia's SIP Plan. Solutia fully cooperated with the DOL throughout the investigation. On December 6, 2006, the DOL issued a letter stating that, based on facts gathered, it appeared that Solutia, through its fiduciaries, breached its fiduciary obligations and violated provisions of ERISA with respect to the SIP Plan. Specifically, the DOL stated that it found no evidence that: (1) the Pension and Savings Funds Committee ("PSFC") sufficiently monitored the Solutia Stock Fund option within the SIP Plan to determine if the Solutia Stock Fund continued to be a prudent investment for the SIP Plan prior to December 15, 2003; and (2) the Solutia Board of Directors, CEO, and PSFC, prior to December 15, 2003, adequately monitored the SIP Plan fiduciaries, including the PSFC, the Employee Benefits Plan Committee, and the Northern Trust Company of Connecticut. The DOL did not assert in its letter that the SIP Plan or its participants had been harmed by these alleged breaches. Further, the DOL did not find that the offering of the Solutia Stock Fund as an investment option in the SIP Plan was itself a violation of ERISA, or that it caused any participant to suffer investment losses. Further, the DOL did not assert any monetary fines or penalties against the Company based on its findings to date. The DOL stated in the letter that its findings were subject to the possibility that additional information could lead the DOL to revise its views. The DOL did not choose to file suit against the Solutia fiduciaries, instead offering Solutia the opportunity to voluntarily discuss how the alleged violations may be corrected. Solutia has submitted additional information to the DOL to support the Company's request for reconsideration of the DOL's findings. Solutia Canada Inc. v. INEOS Americas LLC. Solutia Canada Inc. ----------------------------------------- ("Solutia Canada") filed suit in Quebec Court in December 2006, alleging breach of contract by INEOS Americas LLC ("INEOS"). In late 2002, Solutia negotiated a Stock and Asset Sale Agreement for the sale of its Resimenes & Additives business to UCB S.A ("UCB"). As part of this agreement, Solutia agreed to exclude the LaSalle assets from the agreement and entered into the LaSalle Toll Agreement ("LTA") with UCB. The LTA passed through all the benefits and risks of ownership of the LaSalle operations to UCB, other than pre-closing environmental liabilities. In the LTA, Solutia Canada agreed to operate its LaSalle Plant for the benefit of UCB and to provide all the necessary services to convert UCB's raw materials on a cost-neutral basis. Thus, UCB would pay Solutia Canada for all of its actual, direct and indirect costs incurred in connection with the performance or supply of services under the LTA or in holding itself ready to perform or supply those services. In the years after its execution, the LTA was assigned by UCB to Cytec Industries, Inc., then to INEOS. On January 31, 2006, INEOS notified Solutia Canada of its intention to terminate the LTA as of January 31, 2008, in compliance with the terms of the LTA. INEOS' decision to terminate the LTA will likely trigger the shutdown of all activities at the LaSalle Plant, resulting in termination costs recoverable by Solutia Canada against INEOS. Solutia Canada estimates that the overall termination costs associated with the termination of the LTA and the shutdown of the LaSalle Plant will total approximately $31 million (CAD). Solutia Canada provided INEOS with an estimate of the expected termination costs prior to the notice of termination. INEOS has disputed the overall amount of Solutia Canada's termination costs. Under the detailed dispute resolution procedures in the LTA, Solutia Canada and INEOS were required to engage in negotiation and other means of dispute resolution prior to filing any litigation. In compliance with these obligations, Solutia Canada and INEOS negotiated extensively throughout 2006 to reach a resolution regarding the termination costs, but were unsuccessful. After the period for mandatory alternative dispute resolution expired, Solutia filed suit against INEOS in Quebec Court on December 8, 2006, for breach of the LTA with respect to termination costs. The case is pending. 22 Texas Commission on Environmental Quality Administrative Enforcement -------------------------------------------------------------------- Proceeding. On August 11, 2006, the Executive Director of the Texas Commission - ---------- on Environmental Quality commenced an administrative enforcement proceeding against Solutia by filing a petition with the Texas Commission on Environmental Quality. The petition alleges certain violations of the State of Texas air quality program. The Executive Director requests that an administrative penalty, the amount of which is immaterial, be assessed and that Solutia undertake corrective actions to ensure compliance with the Texas Health and Safety Code and the rules of the Commission in connection with alleged self-reported unauthorized emission events and deviations of air permits. Solutia answered the petition on September 1, 2006, asserted affirmative defenses and requested a contested enforcement case hearing. Solutia and the Commission have agreed to settle and are negotiating settlement terms. The hearing date has been continued pending settlement. For information about certain environmental proceedings involving Solutia, see "Environmental Matters" on page 41. RISK MANAGEMENT Solutia has evaluated risk retention and insurance levels for product liability, workplace health and safety, property damage and other potential areas of risk. Solutia's management determines the amount of insurance coverage to acquire from unaffiliated companies and the appropriate amount of risk to retain and/or co-insure based on the cost and availability of insurance and the likelihood of a loss. Management believes that the levels of risk that Solutia has retained are consistent with those of other companies in the chemical industry. Solutia shares certain of these policies with Pharmacia. There can be no assurance that Solutia will not incur losses beyond the limits, or outside the coverage, of its insurance. For additional information, see "Self-Insurance" on page 30. Solutia will continue to devote significant effort to maintaining and improving safety and internal control programs, which reduce its exposure to certain risks. Solutia actively participates in the safety and health Voluntary Protection Program ("VPP") administered by the Occupational Safety and Health Administration ("OSHA") for most sites in the United States, and implements the program at most sites outside the United States. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Solutia did not submit any matters to its security holders during 2006. 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER'S PURCHASES OF EQUITY SECURITIES MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS On December 17, 2003, following Solutia's Chapter 11 bankruptcy filing, the New York Stock Exchange ("NYSE") halted trading in Solutia's common stock. On February 27, 2004, Solutia's common stock was delisted from the NYSE. Solutia's common stock is currently being quoted under the ticker symbol "SOLUQ" on the Pink Sheets Electronic Quotation Service maintained by The Pink Sheets LLC and on the OTC Bulletin Board. Under the Plan, Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock, will be cancelled and holders of Solutia's common stock, including options and warrants to purchase Solutia's common stock, will not receive any consideration for that stock or those options and warrants. The following table shows the high and low sales prices for Solutia's common stock for each quarter during 2006 and 2005 as quoted on the Pink Sheets Quotation Service or the OTC Bulletin Board, as applicable.
- --------------------------------------------------------------------------------------------- 2006 HIGH LOW 2005 HIGH LOW - --------------------------------------------------------------------------------------------- First Quarter $0.50 $0.28 First Quarter $1.69 $0.63 - --------------------------------------------------------------------------------------------- Second Quarter 0.50 0.35 Second Quarter 1.37 0.33 - --------------------------------------------------------------------------------------------- Third Quarter 0.52 0.33 Third Quarter 0.86 0.53 - --------------------------------------------------------------------------------------------- Fourth Quarter 0.75 0.39 Fourth Quarter 0.70 0.34 - ---------------------------------------------------------------------------------------------
On February 28, 2007, Solutia had 28,890 registered shareholders. No dividends were paid in 2006 or 2005. Solutia is currently prohibited by both the U.S. Bankruptcy Code and the DIP credit facility from paying dividends to shareholders. 24 ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL SUMMARY - ------------------------------------------------------------------------------------------------------------------ (Dollars and shares in millions, except per share amounts) 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- OPERATING RESULTS: - ------------------ NET SALES $2,905 $2,759 $2,637 $2,379 $2,243 GROSS PROFIT 381 322 221 83 353 As percent of net sales 13% 12% 8% 3% 16% MARKETING, ADMINISTRATIVE, AND TECHNOLOGICAL EXPENSES 278 273 279 339 310 As percent of net sales 10% 10% 11% 14% 14% OPERATING INCOME (LOSS)(1) 102 48 (59) (259) 42 As percent of net sales 4% 2% (2)% (11)% 2% INCOME (LOSS) BEFORE TAXES (29) 19 (286) (502) (15) INCOME (LOSS) FROM CONTINUING OPERATIONS (2) (47) 7 (284) (900) (5) INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX 58 4 (32) (82) 21 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF TAX -- (3) -- (5) (167) NET INCOME (LOSS) 11 8 (316) (987) (151) PER SHARE DATA: - --------------- BASIC AND DILUTED EARNINGS (LOSS) PER SHARE FROM CONTINUING OPERATIONS (2) $(0.45) $0.07 $(2.72) $(8.60) $(0.05) WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 104.5 104.5 104.5 104.6 104.7 DIVIDENDS PER SHARE -- -- -- -- 0.04 COMMON STOCK PRICE: HIGH 0.75 1.69 1.39 4.89 13.20 LOW 0.28 0.33 0.15 0.23 2.81 CLOSE 0.75 0.45 1.17 0.37 3.63 FINANCIAL POSITION - CONTINUING OPERATIONS: - ------------------------------------------- TOTAL ASSETS $ 2,055 $ 1,915 $ 1,995 $ 2,339 $ 2,512 LIABILITIES NOT SUBJECT TO COMPROMISE 1,622 1,236 1,306 1,320 3,388 LIABILITIES SUBJECT TO COMPROMISE 1,849 2,176 2,187 2,220 -- LONG-TERM DEBT (3) 210 247 285 294 839 SHAREHOLDERS' DEFICIT (1,417) (1,454) (1,444) (1,125) (249) OTHER DATA FROM CONTINUING OPERATIONS: - -------------------------------------- WORKING CAPITAL (4) $ (275) $ (5) $ (7) $ 57 $ (270) INTEREST EXPENSE (5) 104 84 113 119 82 INCOME TAX EXPENSE (BENEFIT) (6) 18 12 (2) 398 (10) DEPRECIATION AND AMORTIZATION 111 111 120 127 125 CAPITAL EXPENDITURES 106 77 51 72 51 EMPLOYEES (YEAR-END) 5,100 5,400 5,700 6,300 7,300 - ------------------------------------------------------------------------------------------------------------------ (1) Operating income (loss) includes net restructuring (gains)/charges and other items of ($7 million) in 2006, $14 million in 2005, $62 million in 2004, $228 million in 2003 and $22 million in 2002. (2) Income (loss) from continuing operations includes net restructuring charges and other (gains)/charges of $3 million, or ($0.03) per share in 2006, ($37) million, or ($0.35) per share in 2005, $146 million, or $1.40 per share in 2004, $793 million, or $7.58 per share in 2003, and $15 million, or $0.14 per share in 2002. (3) Long-term debt excludes $668 million as of December 31, 2006, 2005 and 2004 and $625 million as of December 31, 2003 of debt classified as subject to compromise in accordance with Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, as a result of Solutia's Chapter 11 bankruptcy filing in 2003. (4) Working capital is defined as total current assets less total current liabilities. (5) Interest expense includes the write-off of debt issuance costs of $8 million in 2006, $25 million in 2004 and $14 million in 2003 due to the early refinancing of the underlying debt facilities. (6) Income tax expense (benefit) includes an increase in valuation allowances of $24 million in 2006, $12 million in 2005, $108 million in 2004, and $542 million in 2003.
See Management's Discussion and Analysis of Financial Condition and Results of Operations under Item 7 for more information. 25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes thereto included in Item 8 of this Form 10-K. OVERVIEW Solutia's reportable segments and their major products are as follows: PERFORMANCE PRODUCTS - -------------------- SAFLEX(R) plastic interlayers LLUMAR(R), VISTA(R), GILA(R) and FORMULA ONE PERFORMANCE AUTOMOTIVE FILM(R) professional and retail window films THERMINOL(R) heat transfer fluids DEQUEST(R) water treatment chemicals SKYDROL(R) aviation hydraulic fluids and SKYKLEEN(R) brand of aviation solvents ASTROTURF(R), CLEAN MACHINE(R) and CLEAR PASS(TM) entrance matting and automotive spray suppression flaps INTEGRATED NYLON - ---------------- Nylon intermediate "building block" chemicals Nylon polymers, including VYDYNE(R) and ASCEND(R) Carpet fibers, including the WEAR-DATED(R) and ULTRON(R) brands Industrial nylon fibers Solutia evaluates the performance of its reportable segments based on segment profit, defined as earnings before interest expense and income taxes ("EBIT"), which includes marketing, administrative, technological and amortization expenses, gains and losses from asset dispositions and restructuring charges, and other income and expense items that can be directly attributable to the segment. Certain expenses and other items that are managed outside of the segments are excluded. These unallocated items consist primarily of corporate expenses, equity earnings from affiliates, other income and expense items, reorganization items, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the operating segment. There were no inter-segment sales in the periods presented below. See Note 22 to the consolidated financial statements for further information. Summary of Significant 2006 Events Senior Management Changes - ------------------------- Solutia has continued to restructure its senior management team during 2006. In January 2006, Kent Davies joined Solutia as Senior Vice President and President, CPFilms. Mr. Davies leads Solutia's CPFilms business with responsibility for all commercial, operational and strategic aspects of the business. On February 22, 2006, Jeffry N. Quinn, Solutia's President and Chief Executive Officer, was elected by the board of directors as Chairman of the Board of Solutia. In connection with Mr. Quinn's election as Chairman of the Board, Paul H. Hatfield was named as the lead non-employee director. 26 Reorganization Strategy - ----------------------- In 2006, Solutia continued its stated reorganization strategy with a focus on the principal objectives of (i) managing the businesses to enhance Solutia's performance; (ii) making changes to Solutia's asset portfolio to maximize the value of the estate; (iii) achieving reallocation of "legacy liabilities"; and (iv) negotiating an appropriate capital structure. Solutia took steps in 2006 to enhance its financial performance including using the tools of Chapter 11 and making changes to its asset portfolio, as explained below. Solutia also continues to pursue a reallocation of legacy liabilities in the Chapter 11 proceeding through negotiations with the other constituents in the Chapter 11 case. Solutia continues to work to establish a proper capital structure upon emergence from Chapter 11. However, as a result of the numerous uncertainties and complexities inherent in Solutia's Chapter 11 proceedings, its ability and timing of emergence from Chapter 11 are subject to significant uncertainty. PERFORMANCE ENHANCEMENT Solutia benefited in 2006 from several actions implemented earlier in the Chapter 11 reorganization process designed to enhance its performance. These included implementing significant general and administrative expense reductions; increasing performance-based compensation and benefits programs; making key senior management changes; initiating a cost reduction program at Solutia's operating sites focused on actions such as lean manufacturing techniques, yield improvement, maintenance savings and utilities optimization; and implementing an enterprise-wide procurement effort. Solutia amended its DIP credit facility on March 17, 2006 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP credit facility from $525 million to $825 million; (ii) extended the term of the DIP credit facility from June 19, 2006 to March 31, 2007; and (iii) decreased the interest rate on the term loan component of the DIP credit facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points. On July 26, 2006, Solutia's indirect 100% owned subsidiary Solutia Services International S.C.A./Comm. V.A. ("SSI"), a subsidiary of SESA, entered into a (euro)200 million Facility Agreement (the "Facility Agreement") that closed on August 1, 2006. SESA used the proceeds from the Facility Agreement to refinance all of its (euro)200 million of 10 percent Euronotes due 2008 (the "Euronotes") on August 1, 2006. The refinancing significantly reduced the fixed interest rate of 10 percent to a lower adjustable rate structure of EURIBOR plus 275 basis points, which was 6.31 percent at December 31, 2006. Solutia expects that both of these refinancings will provide greater flexibility in executing Solutia's reorganization strategy along with significant interest savings. A key element of Solutia's reorganization strategy is a significantly more proactive commercial approach, one that recognizes that the long-term success of its customers requires a strong and dependable supplier. This new commercial perspective strives for a true partnership and is not based on the premise that the suppliers subsidize investments in materials, technology or people. Solutia's commercial approach has better managed with customers the risk of movements in the oil and energy markets, in some cases via formula pricing, to ensure the value chain remains connected to key raw material and energy cost inputs. Solutia intends to ensure the long term success of our customers by pricing its products adequately to fund customer-driven technology and innovation resulting in a stream of highly innovative and unique products and services. This commercial approach benefited the Company significantly in 2006, as the Company was able to expand operating margins, even though raw materials were approximately $91 million higher than 2005. PORTFOLIO EVALUATION Solutia's stated strategy is to build a portfolio of high-potential businesses that can consistently deliver returns in excess of Solutia's cost of capital. As part of this strategy, Solutia made several changes to re-shape its asset portfolio in 2006. On March 1, 2006, pursuant to a stock purchase agreement among Solutia, Vitro and Vitro Plan, a wholly-owned subsidiary of Vitro, Solutia acquired Vitro Plan's 51 percent stake in Quimica (originally formed in 1996 as a joint venture between Vitro, Vitro Plan, and Monsanto) for approximately $20 million in cash. As a result of this acquisition, Solutia became the sole owner of Quimica and its plastic interlayer plant located in Puebla, Mexico. 27 In addition, SESA sold its pharmaceutical services business to Dishman Pharmaceuticals and Chemicals Ltd. ("Dishman") pursuant to a Stock and Asset Purchase Agreement on August 22, 2006. Under the terms of the agreement, Dishman purchased 100 percent of the stock of the pharmaceutical services business, for $77 million. On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel's stake in the Flexsys joint venture. Solutia and Akzo Nobel have entered into a letter agreement committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The proposed transaction is subject to approval by the United States Bankruptcy Court, receipt of required regulatory approvals, finalizing the definitive purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase via $150 million of funding under the January 2007 amended DIP credit facility and additional funding through Flexsys. In addition, Solutia continues to evaluate its options, including potential sales, with respect to certain of its non-core businesses and assets in order to maximize the value of such non-core assets for stakeholders. REALLOCATION OF LEGACY LIABILITIES The Plan and Disclosure Statement provide for, among other things, the reallocation of certain Legacy Liabilities among Solutia, Monsanto and Pharmacia and sets forth the treatment that various constituencies in the Chapter 11 Cases would receive under the Plan. See Note 1 to the accompanying consolidated financial statements for further description of the Plan and Disclosure Statement, as well as a summary of developments in Solutia's ongoing Chapter 11 bankruptcy case. Summary Results of Operations The discussion below and accompanying consolidated financial statements have been prepared in accordance with Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code ("SOP 90-7"), and on a going concern basis, which assumes the continuity of operations and reflects the realization of assets and satisfaction of liabilities in the ordinary course of business. However, as a result of the Chapter 11 bankruptcy proceedings, such realization of assets and liquidation of liabilities are subject to a significant number of uncertainties. Net sales and operating income (loss) of Solutia are as follows for the years ended December 31:
- ---------------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Net Sales.................................................................... $2,905 $2,759 $2,637 ====== ====== ====== Operating Income (Loss): Performance Products Segment Profit (a).................................. $ 133 $ 126 $ 89 Integrated Nylon Segment Profit (Loss) (a)............................... 9 (26) (59) Add: Corporate Expenses............................................. (45) (64) (89) Add: Equity (Earnings) Loss from Affiliates, Other (Income) Expense, and Reorganization Items, net included in Segment Profit (Loss)..... 5 12 -- ------ ------ ------ Operating Income (Loss)...................................................... $ 102 $ 48 $ (59) ====== ====== ====== Gains (Charges) included in Operating Income (Loss).......................... $ 7 $ (14) $ (62) ====== ====== ====== - ---------------------------------------------------------------------------------------------------------------------- (a) See Note 22 to the accompanying consolidated financial statements for description of the computation of operating segment profit (loss).
The $146 million, or 5 percent, increase in net sales in 2006 reflects higher average selling prices of approximately 6 percent, partially offset by lower sales volumes of approximately 1 percent. Solutia's net sales for 2005 increased by $122 million, or 5 percent, as compared to 2004. This increase in net sales reflected higher average selling prices of approximately 11 percent, partially offset by lower sales volumes of approximately 6 percent. As indicated in the preceding table, operating results for each year were affected by various charges which are described in greater detail in the "Results of Operations" section below. Operating income improved by $54 million in 2006 as compared to 2005 primarily as a result of higher net sales and controlled spending, partially offset by higher overall raw 28 material and energy costs of $91 million. The 2005 results as compared to the 2004 results improved by $107 million, primarily as a result of higher net sales and controlled spending, partially offset by higher raw material and energy costs of $220 million. Financial Information - --------------------- Summarized financial information concerning Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of and for the year-ended December 31, 2006 is presented as follows:
Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ Net sales................................. $ 2,388 $ 975 $ (458) $ 2,905 Operating income.......................... 13 65 24 102 Net income................................ 11 85 (85) 11 Total assets.............................. 1,763 849 (557) 2,055 Liabilities not subject to compromise..... 1,217 470 (64) 1,623 Liabilities subject to compromise......... 1,963 -- (114) 1,849 Total shareholders' equity (deficit)...... (1,417) 379 (379) (1,417)
CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related footnotes. In preparing these consolidated financial statements, Solutia has made its best estimates of certain amounts included in these consolidated financial statements. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ materially from these estimates. Management has discussed the development, selection and disclosure of these critical accounting policies and estimates with the Audit and Finance Committee of Solutia's Board of Directors. Solutia believes that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on the consolidated financial statements and require assumptions that can be highly uncertain at the time the estimate is made. Solutia considers the following items to be its critical accounting policies: o Environmental Remediation o Self-Insurance o Income Taxes o Impairment of Long-Lived Assets o Impairment of Goodwill and Indefinite-Lived Intangible Assets o Pension and Other Postretirement Benefits Solutia also has other significant accounting policies. Solutia believes that, compared to the critical accounting policies listed above, the other policies either do not generally require estimates and judgments that are as difficult or as subjective, or are less likely to have a material impact on the reported results of operations for a given period. Environmental Remediation With respect to environmental remediation obligations, Solutia's policy is to accrue costs for remediation of contaminated sites in the accounting period in which the obligation becomes probable and the cost is reasonably estimable. Cost estimates for remediation are developed by assessing, among other items, (i) the extent of Solutia's contribution to the environmental matter; (ii) the number and financial viability of other potentially responsible parties; (iii) the scope of the anticipated remediation and monitoring plan; (iv) settlements reached with governmental or private parties; and (v) Solutia's past experience with similar matters. Solutia's estimates of the environmental remediation reserve requirements typically fall within a range. If Solutia believes no best estimate exists within a range of possible outcomes, in accordance with existing 29 accounting guidance, the minimum loss is accrued. Environmental liabilities are not discounted, and they have not been reduced for any claims for recoveries from third parties. These estimates are critical because Solutia must forecast environmental remediation activity into the future, which is highly uncertain and requires a large degree of judgment. Therefore, the environmental reserves may materially differ from the actual liabilities if Solutia's estimates prove to be inaccurate, which could materially affect results of operations in a given period. Uncertainties related to recorded environmental liabilities include changing governmental policy and regulations, judicial proceedings, the number and financial viability of other potentially responsible parties, the method and extent of remediation and future changes in technology. Because of these uncertainties, the potential liability for existing environmental remediation reserves not subject to compromise may range up to two times the amounts recorded. These valuations of future environmental costs do not contemplate the uncertainties inherent in Solutia's bankruptcy proceedings, as the potential impact of the Chapter 11 proceedings upon future environmental costs cannot be reasonably determined at this time. Due to these uncertainties, certain of the environmental liabilities have been classified as subject to compromise in the Consolidated Statement of Financial Position as of December 31, 2006, and have been excluded from the aforementioned range of possible outcomes of existing environmental remediation reserves. The potential liability for existing environmental remediation reserves classified as subject to compromise, if ultimately retained by Solutia as part of an accepted plan of reorganization, could be materially different than amounts recorded. The estimate for environmental liabilities is a critical accounting estimate for both reportable segments. Self-Insurance Solutia maintains self-insurance reserves to cover its estimated future legal costs, settlements and judgments related to workers' compensation, product, general, automobile and operations liability claims that are less than policy deductible amounts or not covered by insurance. Self-insured losses are accrued based upon estimates of the aggregate liability for claims incurred using certain actuarial assumptions followed in the insurance industry, Solutia's historical experience and certain case-specific reserves as required, including estimated legal costs. The maximum extent of the self-insurance provided by Solutia and related insurance recoveries are dependent upon a number of factors including the facts and circumstances of individual cases and the terms and conditions of the commercial policies. Solutia has purchased commercial insurance in order to reduce its exposure to workers' compensation, product, general, automobile and property liability claims. Policies for periods prior to the Solutia Spinoff are shared with Pharmacia. This insurance has varying policy limits and deductibles. When recovery from an insurance policy is considered probable, a receivable is recorded. Self-insurance reserve estimates are critical because changes to the actuarial assumptions used in the development of these reserves can materially affect earnings in a given period and Solutia must forecast loss activity into the distant future which is highly uncertain and requires a large degree of judgment. Actuarial reserve indications are projections of the remaining future payments for workers' compensation, product, general, automobile and operations liability claims for which Solutia is legally responsible. These projections are made in the context of an uncertain future where variations between estimated and actual amounts are attributable to many factors, including changes in operations, changes in judicial environments, shifts in the types or timing of the reporting of claims, changes in the frequency or severity of losses and random chance. The actuarial estimates of the reserve requirements fall within a range. The actuary's best estimate of the liability is generally near the middle of the actuary's range; accordingly, Solutia has recorded the liability at this level. The range of outcomes is not material to the consolidated financial statements for losses that are not stayed by the Chapter 11 proceedings. These valuations of future self-insurance costs do not contemplate the uncertainties inherent in Solutia's bankruptcy proceedings, as the potential impact of the Chapter 11 proceedings upon future self-insurance costs cannot be reasonably determined at this time. Due to these uncertainties, certain of the self-insurance liabilities have been classified as subject to compromise in the Consolidated Statement of Financial Position as of December 31, 2006, and have been excluded from the range of possible outcomes of existing self-insurance reserves. The potential liability for existing self-insurance liabilities classified as subject to compromise, if ultimately retained by Solutia as part of an accepted plan of reorganization, could be materially different than amounts recorded. The estimate for self-insurance liabilities is a critical accounting estimate for both reportable segments. Income Taxes Solutia accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities at enacted rates. Solutia bases its estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, business plans and other expectations about future outcomes. Solutia records a valuation 30 allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While Solutia has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event Solutia were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should Solutia determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. The consolidated financial statements include increases in valuation allowances as a result of uncertainty created by Solutia's Chapter 11 bankruptcy filing. Solutia's accounting for deferred tax consequences represents management's best estimate of future events that can be appropriately reflected in the accounting estimates. Changes in existing tax laws, regulations, rates and future operating results may affect the amount of deferred tax liabilities or the valuation of deferred tax assets over time. Impairment of Long-Lived Assets Impairment tests of long-lived assets, including finite-lived intangible assets, are made when conditions indicate the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such asset are separately identifiable and are less than its carrying value. Solutia's estimate of the cash flows is based on information available at that time including these and other factors: sales forecasts, customer trends, operating rates, raw material and energy prices and other global economic indicators and factors. If an impairment is indicated, the asset value is written down to its fair value based upon market prices or, if not available, upon discounted cash value, at an appropriate discount rate determined by Solutia to be commensurate with the risk inherent in the business model. These estimates are critical because changes to Solutia's assumptions used in the development of the impairment analyses can materially affect earnings in a given period and Solutia must forecast cash flows into the future which is highly uncertain and requires a significant degree of judgment. The consolidated financial statements do not reflect any adjustments for the impairment of long-lived assets that may result as part of the approval and implementation of a plan of reorganization to be submitted as part of the Chapter 11 bankruptcy process. The estimate for impairment of long-lived assets is a critical accounting estimate for both reportable segments. Impairment of Goodwill and Indefinite-Lived Intangible Assets Goodwill and indefinite-lived intangible assets are reviewed for impairment annually under the provisions of Statement of Financial Accounting Standard ("SFAS") No. 142, Goodwill and Other Intangible Assets. However, as required by SFAS No. 142, impairment analyses are performed more frequently if changes in circumstances indicate the carrying value may not be recoverable during the intervening period between annual impairment tests. Solutia performs the review for impairment at the reporting unit level. The impairment assessment is completed by determining the fair values of the reporting units using income and market multiple approaches and comparing those fair values to the carrying values of the reporting units. If the fair value of a reporting unit is less than its carrying value, Solutia then allocates the fair value of the reporting unit to all the assets and liabilities of that reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of the goodwill. If the carrying value of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized for this differential. This valuation process involves assumptions based upon management's best estimates and judgments that approximate the market conditions experienced at the time the impairment assessment is made. These assumptions include but are not limited to earnings and cash flow projections, discount rate and peer company comparability. Actual results may differ from these estimates due to the inherent uncertainty involved in such estimates. The consolidated financial statements do not reflect any adjustments for the impairment of goodwill and indefinite-lived intangible assets that may result as part of the approval and implementation of a plan of reorganization to be submitted as part of the Chapter 11 bankruptcy process. The estimate for impairment of goodwill and indefinite-lived intangible assets is a critical accounting estimate for the Performance Products reportable segment. The Integrated Nylon reportable segment does not have goodwill or indefinite-lived intangible assets. Pension and Other Postretirement Benefits Under the provisions of SFAS No. 87, Employers' Accounting for Pensions, and SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, measurement of the obligations under the defined benefit pension plans and the other postemployment benefit ("OPEB") plans are subject to several significant estimates. These estimates include the rate of return on plan assets, the rate at which the future obligations are discounted to value the liability and health care cost trend rates. Additionally, the cost of providing benefits depends on demographic assumptions including 31 retirements, mortality, turnover and plan participation. Solutia typically uses actuaries to assist it in preparing these calculations and determining these assumptions. Solutia's annual measurement date is December 31 for both the pension and OPEB plans. The expected long-term rate of return on pension plan assets assumption was 8.75 percent and 9.00 percent in 2006 and 2005, respectively. The expected long-term rate of return on pension plan assets assumption is based on the target asset allocation policy and the expected future rates of return on these assets. A hypothetical 25 basis point change in the assumed long-term rate of return would result in a change of approximately $2 million to pension expense. The discount rate used to remeasure the pension plans was 5.75 in 2006 and 5.50 percent in 2005, and the discount rates to remeasure the other postretirement benefit plans were 5.75 percent in 2006 and 5.50 percent in 2005. Solutia establishes its discount rate based upon the internal rate of return for a portfolio of high quality bonds with maturities consistent with the nature and timing of future cash flows for each specific plan. A hypothetical 25 basis point change in the discount rate for Solutia's pension plans results in a change of approximately $19 million in the projected benefit obligation and less than a $1 million change in pension expense. A hypothetical 25 basis point change in the discount rate for Solutia's OPEB plans results in a change of approximately $8 million in the accumulated benefit obligation and less than $1 million change to OPEB expense. Solutia estimated the five-year assumed trend rate for healthcare costs in 2006 to be 9 percent with the ultimate trend rate for healthcare costs grading by 1 percent each year to 5 percent by 2010 and remaining at that level thereafter. A 1 percent change in the assumed health care cost trend rate would have changed the postretirement benefit obligation by $3 million as of December 31, 2006 and would have had a less than $1 million change to OPEB expense in 2006. Solutia's costs for postretirement medical benefits are capped for many current retirees and active employees; therefore, the impact of this hypothetical change in the assumed health care cost trend rate is limited. These valuations of future pension and other postretirement costs do not include the uncertainties inherent in Solutia's Chapter 11 bankruptcy proceedings, as the potential impact of the Chapter 11 proceedings upon future spending for these items cannot be reasonably determined at this time. Due to these uncertainties, all pension and postretirement liabilities related to Solutia entities that have filed Chapter 11 bankruptcy have been classified as subject to compromise in the Consolidated Statement of Financial Position as of December 31, 2006.
RESULTS OF OPERATIONS Performance Products - ---------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Net Sales.................................................................... $1,174 $1,117 $1,049 ====== ====== ====== Segment Profit............................................................... $ 133 $ 126 $ 89 ====== ====== ====== Net Charges and Reorganization Items, net included in Segment Profit .... $ (12) $ (10) $ (23) ====== ====== ====== - ----------------------------------------------------------------------------------------------------------------
The $57 million, or 5 percent, increase in 2006 net sales compared to 2005 resulted from higher selling prices of approximately 4 percent and increased sales volumes of approximately 1 percent. Higher average selling prices were experienced in SAFLEX(R) plastic interlayer products, LLUMAR(R) and VISTA(R) professional film products and THERMINOL(R) heat transfer fluids. Increased sales volumes were experienced in SAFLEX(R) plastic interlayer products, due to increasing demand and inclusion of sales from the Puebla, Mexico plant for ten months during 2006 as a result of the Quimica acquisition as further discussed in Note 4, and, LLUMAR(R) and VISTA(R) professional film products, partially offset by lower volumes in DEQUEST(R) water treatment chemicals and THERMINOL(R) heat transfer fluids. The $68 million, or 6 percent, increase in 2005 net sales compared to 2004 resulted from higher selling prices of approximately 4 percent and increased sales volumes of approximately 2 percent. Higher average selling prices were experienced in SAFLEX(R) plastic interlayer products, LLUMAR(R) and Vista(R) professional window film products and THERMINOL(R) heat transfer fluids. Increased sales volumes were experienced in SAFLEX(R) plastic interlayer products and THERMINOL(R) heat transfer fluids, partially offset by lower volumes due to the cessation of Solutia's chlorobenzenes operations in 2004. 32 The $7 million, or 6 percent, improvement in 2006 segment profit in comparison to 2005 resulted principally from higher net sales, partially offset by higher raw material and energy costs of $22 million and higher charges. Segment profit in 2006 included $8 million of reorganization items, which consisted primarily of restructuring charges related to the shut down of operations at the Queeny Plant in St. Louis, Missouri and other non-strategic operations, as well as $4 million of restructuring charges consisting principally of severance costs for non-debtor entities that was not included within reorganization items. Segment profit in 2005 included $8 million of reorganization items, which consisted primarily of adjustments to record certain pre-petition claims at estimated amounts of the allowed claims, as well as $2 million of restructuring charges consisting principally of severance costs for non-debtor entities that was not included within reorganization items. The $37 million improvement in 2005 segment profit in comparison to 2004 resulted principally from lower charges and higher net sales, partially offset by higher raw material and energy costs. Segment profit in 2005 included $8 million of reorganization items, which consisted primarily of adjustments to record certain pre-petition claims at estimated amounts of the allowed claims, as well as $2 million of restructuring charges consisting principally of severance costs for non-debtor entities that was not included within reorganization items. Segment profit in 2004 included $21 million of charges, including $18 million of restructuring costs related principally to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, and $3 million of asset write-offs and repairs and maintenance charges resulting from the impact of Hurricane Ivan at the Martinsville, Virginia plant. Segment profit in 2004 also included $2 million of reorganization items involving primarily severance related costs incurred as part of Solutia's overall reorganization process.
Integrated Nylon - ---------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Net Sales.................................................................... $1,731 $1,642 $1,588 ====== ====== ====== Segment Profit (Loss)........................................................ $ 9 $ (26) $ (59) ====== ====== ====== Net Charges included in Segment Profit (Loss)............................ $ (6) $ (14) $ (5) ====== ====== ====== - ----------------------------------------------------------------------------------------------------------------
The $89 million, or 5 percent, increase in 2006 net sales as compared to 2005 resulted primarily from higher average selling prices of approximately 8 percent, partially offset by lower sales volumes of approximately 3 percent. Average selling prices increased in all businesses as a result of favorable market conditions and in response to the escalating cost of raw materials. Lower sales volumes were experienced within carpet fibers in 2006 and sales volumes were impacted by the exit from the unprofitable acrylic fibers operations in the second quarter 2005. These volume reductions were partially offset by higher sales volumes in intermediate chemicals and nylon plastics and polymers. The $54 million, or 3 percent, increase in 2005 net sales as compared to 2004 resulted primarily from higher average selling prices of approximately 16 percent, partially offset by lower sales volume of approximately 13 percent. Average selling prices increased in all businesses in response to the escalating cost of raw materials. Sales volumes were negatively affected by Hurricanes Dennis, Katrina and Rita, which forced certain manufacturing facilities to reduce production rates due to the shortages of certain raw materials. Furthermore, Solutia declared force majeure in late September 2005 for certain products within its Integrated Nylon segment as a result of the these raw material and utility supply limitations some of which are a result of force majeure declarations by certain of Solutia's suppliers. The force majeure declaration was removed by Solutia in late November 2005. In addition, as a precaution for Hurricane Rita, the manufacturing facility in Alvin, Texas was forced to completely shut down its operations. This production slowdown did not allow Solutia to fully meet customer demand while certain customers were unable to take product due to their own operational issues resulting from the hurricanes. Sales volumes were also adversely affected as a result of Solutia's shutdown of the acrylic fibers operations in the second quarter 2005 but were partially offset because certain Solutia produced intermediate chemicals previously supplied to the acrylic fiber operations were sold into the intermediates merchant market. In addition, sales volumes were negatively impacted in 2005 as a result of contract rejections and terminations in the intermediate chemicals business in 2004. Segment profit increased $35 million from a segment loss of $26 million in 2005 to a segment profit of $9 million in 2006 primarily as a result of higher net sales and lower charges, partially offset by higher raw material and energy costs of approximately $70 million and unfavorable manufacturing costs. The unfavorable manufacturing costs were precipitated by 33 a manufacturing interruption incurred at the Alvin, Texas facility, resulting in a significant turnaround being accelerated in its timing, as well as extended in its duration, during the first quarter of this year. Partially offsetting this impact is favorable manufacturing variances experienced in the second half of 2006 due to 2005 operations being negatively impacted by Hurricanes Katrina and Rita as discussed below. Segment profit in 2006 also included reorganization items of $6 million comprised of $3 million of decommissioning and dismantling costs primarily due to the shut-down of the acrylic fibers business in 2005, $2 million of asset write-downs related to the exiting of various unprofitable businesses within the segment and $1 million of severance and retraining costs. The reorganization items in 2006 decreased by $8 million from 2005 due to lower shut-down costs as segment profit in 2005 consisted of $13 million principally to shut-down the acrylic fibers business as discussed below. Segment losses decreased $33 million in 2005 as compared to 2004 primarily as a result of higher net sales, partially offset by higher raw material and energy costs of approximately $176 million. In addition, segment loss was affected by the aforementioned hurricanes experienced in 2005. Although Solutia's manufacturing facilities did not suffer significant physical damage, the manufacturing facility in Alvin, Texas was forced to completely shut down its operations ahead of Hurricane Rita as a precaution. Further, reduced availability of key raw material and energy sources affected the ability of certain plants to operate at normal production levels. As a result, Solutia experienced significant costs involved in shutting down and restarting these operations, significant unabsorbed fixed costs and lost sales volumes. Furthermore, the aforementioned declaration of force majeure by Solutia and certain of its customers as a result of the hurricanes had a negative impact on segment profit in 2005. In total, the amount of these aforementioned hurricane related costs was approximately $36 million in 2005. The hurricanes also resulted in a significant increase in raw material and energy prices during 2005. Solutia was successful in passing along a portion of these increases in raw materials and energy costs; however, approximately $19 million of these costs were directly absorbed by the Integrated Nylon segment. Further, it is anticipated segment profit in the first quarter 2006 will be negatively impacted by higher than expected costs experienced as part of a planned shut-down at the manufacturing facility in Alvin, Texas. Segment profit in 2005 also included reorganization items of $14 million comprised of $13 million principally due to the shut-down of the acrylic fibers business and $1 million of other restructuring charges. The shut-down costs included $12 million of asset write-downs, $7 million of decontamination and dismantling costs and $4 million of severance and retraining costs, partially offset by a $7 million gain from the reversal of the LIFO reserve associated with the inventory sold and/or written off as part of the business shut-down and a $3 million gain from the sale of certain acrylic fibers assets. In addition, segment profit in 2004 was affected by $5 million of charges resulting from the impact of Hurricane Ivan at the Pensacola, Florida and Foley, Alabama manufacturing facilities involving primarily repairs and maintenance costs, as well as asset write-offs.
Corporate Expenses - ---------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Corporate Expenses........................................................... $ 45 $ 64 $ 89 ====== ====== ====== Net Gains (Charges) included in Corporate Expenses....................... $ 11 $ (13) $ (35) ====== ====== ====== - ----------------------------------------------------------------------------------------------------------------
Corporate expenses decreased by $19 million, or 30 percent, in 2006 as compared to 2005 principally due to lower charges. After consideration of the net gains and charges recorded in 2006 and 2005, the change in corporate expenses was also impacted by a year over year increase in the Company's LIFO reserve, partially offset by controlled spending in the corporate function. Included in 2006 gains were a $20 million gain that resulted from the reversal of a litigation reserve with respect to a litigation matter that was decided favorably (as further described in Note 20 of the accompanying consolidated financial statements), partially offset by a $9 million environmental charge that was precipitated by the notification by a third-party of its intent to terminate a tolling agreement at one of Solutia's facilities outside the U.S. that will likely result in the cessation of operations at that site. The $13 million charge recorded in 2005 resulted from curtailment and settlement activities as a result of amendments to Solutia's pension and postretirement plans (as more fully described in Note 16 to the accompanying consolidated financial statements). Corporate expenses decreased by $25 million, or 28 percent, in 2005 as compared to 2004 principally due to lower charges and other declines in corporate spending. Included in 2005 and 2004 corporate expenses were $13 million and $35 million, respectively, of net pension and other postretirement benefit plan curtailments and settlements (as more fully 34 described in Note 16 to the accompanying consolidated financial statements). In addition, Solutia experienced continued benefits in 2005 of cost reduction measures taken in the second half of 2004 as part of implementing its overall reorganization strategy, partially offset by a modest increase in legal costs.
Equity Earnings (Loss) from Affiliates - ----------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Flexsys Equity Earnings (Loss)...................................................$ 37 $ 35 $ (20) Astaris LLC Equity Earnings (Loss)............................................... -- 59 (7) Other Equity Earnings from Affiliates included in Reportable Segment Profit (Loss).............................................................. 1 2 1 ------ ------ ------ Equity Earnings (Loss) from Affiliates...........................................$ 38 $ 96 $ (26) ====== ====== ====== Gains (Charges) included in Equity Earnings (Loss) from Affiliates...........$ (4) $ 52 $ (49) ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------
Equity earnings (loss) from affiliates were affected by various items in both 2006 and 2005. During 2006, equity earnings from affiliates included $3 million in restructuring charges related to production asset rationalization and plant closures and $2 million related to asset impairment charges, partially offset by a non-operational gain of $1 million due to the reversal of a litigation reserve related to the Flexsys joint venture. During 2005, equity earnings from affiliates were impacted by a $50 million net gain realized in the Astaris joint venture from the sale of a majority of its assets to Israel Chemicals Limited ("ICL"), who purchased substantially all of the operating assets of Astaris for $255 million. Equity earnings in 2005 also included $2 million of net gains related to the Flexsys joint venture comprising a non-operational gain of $5 million, partially offset by $3 million of various restructuring charges. Flexsys earnings for 2006 were favorably impacted by a reduction in administrative expenses in comparison to 2005. Equity earnings (loss) from affiliates were affected by various items in both 2005 and 2004. During 2005, equity earnings from affiliates were impacted by a $50 million net gain realized in the Astaris joint venture from the sale of a majority of its assets. Under the terms of the agreement, ICL purchased substantially all of the operating assets of Astaris for $255 million, subject to certain purchase price adjustments. Equity earnings in 2005 also included $2 million of net gains related to the Flexsys joint venture comprising a non-operational gain of $5 million, partially offset by $3 million of various restructuring charges. During 2004, equity loss from affiliates was negatively affected by $49 million in restructuring and litigation charges resulting from (i) restructuring charges related to production asset rationalization and certain plant closures at both the Flexsys and Astaris joint ventures; (ii) severance charges at both the Flexsys and Astaris joint ventures; and (iii) charges recorded by the Flexsys joint venture related to litigation contingencies. Also included in the 2005 results compared to 2004 were higher earnings from both Astaris and Flexsys. Astaris' earnings improved as a result of improved product mix due to the 2004 restructuring activities discussed above and higher average net selling prices. Flexsys' earnings improved primarily due to higher average net selling prices.
Interest Expense - ----------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Interest Expense............................................................. $ 104 $ 84 $ 113 ====== ====== ====== Charges included in Interest Expense..................................... $ (4) $ -- $ (25) ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------
The $20 million, or 24 percent, increase in interest expense in 2006 in comparison to 2005 resulted principally from higher debt outstanding in 2006 than in 2005, partially offset by lower interest rates due to the March amendment of its DIP credit facility and the July refinancing of the Euronotes and subsequent partial pay down. In addition, results in 2006 included a $3 million charge related to SESA's Euronotes refinancing and a $1 million charge related to the amendment of the DIP credit facility. The amount of annual contractual interest not recorded was $32 million in both 2006 and 2005. The $29 million, or 26 percent, decrease in interest expense in 2005 in comparison to 2004 resulted principally from the write-off of unamortized debt issuance costs of $25 million in 2004. In addition, Solutia amended its DIP financing agreement on June 1, 2005, which reduced the interest rate on the term loan component of the DIP credit facility to LIBOR 35 plus 4.25 percent from the previous interest rate of the greater of the prime rate plus 4.0 percent or 8.0 percent. The amount of annual contractual interest not recorded was $32 million in both 2005 and 2004.
Other Income, net - ----------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Other Income, net............................................................ $ 14 $ 8 $ -- ====== ====== ====== Other Income, net included in Reportable Segment Profit (Loss) .......... $ 8 $ 8 $ 1 ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------
Other income, net increased $6 million in 2006 as compared to 2005 primarily as a result of increased interest income due to higher cash balances on hand during 2006. The $8 million increase in other income, net in 2005 as compared to 2004 primarily resulted from the sale of various non-operating assets in 2005 coupled with lower currency losses.
Reorganization Items, net - ----------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Reorganization Items, net ................................................... $ 71 $ 49 $ 73 ====== ====== ====== Reorganization Items, net included in Reportable Segment Profit (Loss) .. $ 14 $ 22 $ 2 ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------
Reorganization Items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain, or loss that are realized or incurred by Solutia because it is in reorganization under Chapter 11 of the U.S. Bankruptcy Code. Reorganization items incurred in 2006 included $58 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $11 million of other reorganization charges primarily involving costs incurred with exiting certain non-strategic businesses; $4 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; and a $2 million net gain from adjustments to record certain pre-petition claims at estimated amounts of the allowed claims. Reorganization items incurred in 2005 included $49 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; a $31 million net gain representing the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded; $12 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; $10 million of net charges for adjustments to record certain pre-petition claims at estimated amounts of the allowed claims; and $9 million of other reorganization charges primarily involving costs incurred with exiting the acrylic fibers operations.
Income Tax Expense (Benefit) - ----------------------------------------------------------------------------------------------------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Income Tax Expense (Benefit) ................................................ $ 18 $ 12 $ (2) ====== ====== ====== Increase in Valuation Allowances included in Income Tax Expense (Benefit) $ 24 $ 12 $ 108 ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------
Solutia's effective income tax expense (benefit) rate was approximately 64 percent in 2006 compared to approximately 63 percent in 2005. Decreases in valuation allowances in 2006 were $(7) million, of which $24 million was recorded in Income Tax Expense (Benefit) in the Consolidated Statement of Operations and $(31) million was recorded in Accumulated Other Comprehensive Loss in the Consolidated Statement of Comprehensive Income (Loss), as compared to increases in valuation allowances in 2005 of $21 million, of which $12 million was recorded in Income Tax Expense (Benefit) in the Consolidated Statement of Operations and $9 million was recorded in Other Comprehensive Loss in the Consolidated Statement of Comprehensive Income (Loss). The change in the valuation allowances in both 2006 and 2005 were provided principally 36 for the U.S. deferred tax assets as a result of Solutia's Chapter 11 bankruptcy filing (as more fully described in Note 13 to the accompanying consolidated financial statements). Solutia's effective income tax expense (benefit) rate was approximately 63 percent in 2005 compared to approximately (1) percent in 2004. The above noted valuation allowance increases in 2005 and 2004 were the primary differences in comparing the 2005 and 2004 rates.
Discontinued Operations - ------------------------------------------------------------------------------------------ ---------------------- (dollars in millions) 2006 2005 2004 ---- ---- ---- Income (Loss) from Discontinued Operations, net of tax $ 58 $ 4 $ (32) ====== ====== ====== - ------------------------------------------------------------------------------------------ ----------------------
Income from discontinued operations consists of the results of Solutia's pharmaceutical services business. As described in Note 4 to the accompanying consolidated financial statements, on August 22, 2006, SESA sold its pharmaceutical services business to Dishman. Included in the results of discontinued operations for 2006 is a gain on the sale of $49 million as well as a tax gain of $5 million. The tax gain resulted from the reversal of a valuation allowance established as a result of the merger of CarboGen and AMCIS subsidiaries of the pharmaceutical services business into one legal entity. Income from discontinued operations increased $36 million in 2005 as compared to 2004 primarily as a result of impairments in goodwill, long-lived assets and indefinite-lived intangible assets in the pharmaceutical services business in 2004 of $23 million, $12 million and $5 million, respectively. These charges were precipitated by the declining estimates of forecasted results given current economic and market conditions within the pharmaceutical services business environment. Cumulative Effect of Change in Accounting Principle Asset Retirement Obligations - ---------------------------- In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143 ("FIN 47"). FIN 47 clarifies that the term "conditional asset retirement obligation" as used in Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations ("SFAS No. 143"), refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement, including those that may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and (or) method of settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when sufficient information to reasonably estimate the fair value of an asset retirement obligation is considered available. Upon adoption of SFAS No. 143 as of January 1, 2003, Solutia identified certain conditional asset retirement obligations; however, these obligations were not recorded due to uncertainties involved with the determination of settlement timing. With the clarification outlined by FIN 47 for valuation of conditional asset retirement obligations, Solutia reevaluated the valuation concerns involving settlement timing for these conditional asset retirement obligations and accordingly reported an asset retirement obligation of $7 million as of December 31, 2005. These obligations involve various federal, state and local regulations and/or contractual obligations to decontaminate and/or dismantle certain machinery and equipment, buildings, and leasehold improvements at Solutia's various operating locations. Asset retirement obligations were estimated for each of the Solutia's operating locations, where applicable, based upon Solutia's current and historical experience, adjusted for factors that a third-party would consider, such as overhead, profit and market risk premium. Estimated obligations were escalated based upon the anticipated timing of the related cash flows using an assumed inflation rate, and then were discounted using a credit-adjusted, risk-free interest rate. The impact of adoption resulted in a charge of $3 million recorded as a cumulative effect of change in accounting principle (net of tax) in the Consolidated Statement of Operations in 2005. 37 Summary of Events Affecting Comparability Charges and gains recorded in 2006, 2005 and 2004 and other events affecting comparability have been summarized and described in the table and accompanying footnotes below (dollars in millions):
2006 ------------------------------------------------------------- PERFORMANCE INTEGRATED CORPORATE/ INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED -------- ----- ----- ------------ IMPACT ON: Cost of goods sold.......................... $-- $-- $ 9 $ 9 (a) -- -- (20) (20) (b) 1 -- -- 1 (c) ------------------------------------------------------------- Total cost of goods sold ................... 1 -- (11) (10) Marketing .................................. 2 -- -- 2 (c) Administrative ............................. 1 -- -- 1 (c) Technological .............................. -- -- -- -- ------------------------------------------------------------- OPERATING INCOME IMPACT..................... (4) -- 11 7 Interest expense............................ -- -- (1) (1) (d) -- -- (3) (3) (e) Equity income from affiliates............... -- -- (4) (4) (f) Loss on debt modification................... -- -- (8) (8) (d) Reorganization items, net................... (8) (6) (57) (71) (g) ------------------------------------------------------------- PRE-TAX INCOME STATEMENT IMPACT............. (12) (6) (62) (80) =============================================== Income tax impact........................... (5) (h) ----------- AFTER-TAX INCOME STATEMENT IMPACT........... $ (75) =========== 2006 EVENTS ----------- a) Environmental charge in the first quarter 2006 precipitated by the notification by a third-party of its intent to terminate a tolling agreement at one of Solutia's facilities outside the U.S. that will likely result in the cessation of operations at that site ($9 million pre-tax and $6 million after-tax). b) Gain resulting from the reversal of a litigation reserve with respect to a litigation matter that was decided favorably in the second quarter 2006, as further described in Note 20 of the accompanying consolidated financial statements ($20 million pre-tax and after-tax - see note (h) below). c) Restructuring costs related principally to severance and retraining costs ($4 million pre-tax and $3 million after-tax). d) Solutia recorded a charge of approximately $8 million (pre-tax and after-tax - see note (h) below) to record the write-off of debt issuance costs and to record the DIP credit facility as modified at its fair value. In addition, $1 million (pre-tax and after-tax - see note (h) below) of unamortized debt issuance costs associated with the DIP credit facility were written off at the time of modification in March 2006. e) Solutia refinanced its Euronotes in July 2006 and recorded early extinguishment costs at the time of refinancing ($3 million pre-tax and $2 million after-tax). f) Net charges at Flexsys, Solutia's 50 percent owned joint venture, included charges for restructuring and asset impairments of $5 million, partially offset by a non-operational gain of $1 million related to the reversal of a litigation reserve ($4 million pre-tax and after-tax - see note (h) below). g) Reorganization items, net consist of the following: $58 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $11 million of other 38 reorganization charges primarily involving costs incurred with exiting certain non-strategic businesses; $4 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; and a $2 million net gain from adjustments to record certain pre-petition claims at estimated amounts of the allowed claims. ($71 million pre-tax and after-tax - see note (h) below) h) With the exception of items (a), (c) and (e) above, which primarily relate to ex-U.S. operations, the above items are considered to have like pre-tax and after-tax impact as the tax benefit or expense realized from these events is offset by the change in valuation allowance for U.S. deferred tax assets resulting from uncertainty as to their recovery due to Solutia's Chapter 11 bankruptcy filing.
2005 ------------------------------------------------------------- PERFORMANCE INTEGRATED CORPORATE/ INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED -------- ----- ----- ------------ IMPACT ON: Cost of goods sold.................. $ 1 $-- $-- $ 1 (a) -- -- 9 9 (b) ------------------------------------------------------------- Total cost of goods sold ........... 1 -- 9 10 Marketing .......................... -- -- 1 1 (b) Administrative ..................... -- -- 2 2 (b) Technological ...................... -- -- 1 1 (b) ------------------------------------------------------------- OPERATING INCOME IMPACT............. (1) -- (13) (14) Equity income from affiliates....... -- -- 52 52 (c) Reorganization items, net........... (7) (14) (28) (49) (d) ------------------------------------------------------------- PRE-TAX INCOME STATEMENT IMPACT..... $ (8) $ (14) $ 11 (11) =============================================== Income tax expense impact........... -- (e) ------------ AFTER-TAX INCOME STATEMENT IMPACT... $ (11) ============ 2005 EVENTS ----------- a) Restructuring costs related principally to severance and retraining costs ($1 million pre-tax and after-tax). b) Net pension and other postretirement benefit plan curtailments and settlements, as more fully described in Note 16 to the accompanying consolidated financial statements ($13 million pre-tax and after-tax - see note (e) below). c) Net gains related to Solutia's Flexsys and Astaris joint ventures, in each of which Solutia has a fifty percent interest. Astaris included a one-time gain of $50 million related to the sale of substantially all of its operating assets to ICL, as further described above. Flexsys included a one-time, non-operational gain of $5 million, partially offset by $3 million of various restructuring charges ($52 million pre-tax and after-tax - see note (e) below). d) Reorganization items, net consist of the following: $49 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; a $31 million net gain representing the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded; $12 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; $10 million of net charges for adjustments to record certain pre-petition claims at estimated amounts of the allowed claims; and $9 million of other reorganization charges primarily involving costs incurred with the exit from the acrylic fibers business. ($49 million pre-tax and after-tax - see note (e) below). e) With the exception of item (a) above, which primarily relates to ex-U.S. operations, the above items are considered to have like pre-tax and after-tax impact as the tax benefit or expense realized from these events is offset by the change in valuation allowance for U.S. deferred tax assets resulting from uncertainty as to their recovery due to Solutia's Chapter 11 bankruptcy filing.
39
2004 ------------------------------------------------------------- PERFORMANCE INTEGRATED CORPORATE/ PRODUCTS NYLON OTHER CONSOLIDATED -------- ----- ----- ------------ INCREASE/(DECREASE) IMPACT ON: Cost of goods sold........................... $ 18 $ -- $ -- $ 18 (a) -- -- 26 26 (b) 3 5 -- 8 (c) 1 -- -- 1 (d) ------------------------------------------------------------ Total cost of goods sold..................... 22 5 26 53 Marketing.................................... -- -- 2 2 (b) Administrative............................... -- -- 4 4 (b) Technological................................ -- -- 3 3 (b) ------------------------------------------------------------ OPERATING LOSS IMPACT........................ (22) (5) (35) (62) Equity loss from affiliates.................. -- -- (49) (49) (e) Interest expense............................. -- -- (25) (25) (f) Loss on debt modification.................... -- -- (15) (15) (g) Reorganization items, net.................... (1) (1) (71) (73) (h) ------------------------------------------------------------ PRE-TAX INCOME STATEMENT IMPACT.............. $(23) $(6) $ (195) $(224) ============================================= Income tax benefit impact.................... 6 (i) --------------- AFTER-TAX INCOME STATEMENT IMPACT............ $(218) =============== 2004 EVENTS ----------- a) Restructuring costs related principally to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, including costs for decommissioning and dismantling activities, future costs for non-cancelable operating leases, and severance and retraining costs ($18 million pre-tax and after-tax - see note (i) below). b) Net pension and other postretirement benefit plan curtailments and settlements, as more fully described in Note 16 to the accompanying consolidated financial statements ($35 million pre-tax and after-tax - see note (i) below). c) Losses incurred directly related to the hurricanes experienced in the U.S. in 2004 resulting in the disruption of operations and property damage at Solutia's operations in the Integrated Nylon chain located principally in the Southeastern part of the U.S., and the Performance Products location in Martinsville, Virginia. These costs included primarily asset write-offs and repairs and maintenance costs ($8 million pre-tax and after-tax - see note (i) below). d) Loss on the sale of the assets of Axio Research Corporation ($1 million pre-tax and after-tax - see note (i) below). e) Charges related to the Flexsys and Astaris joint ventures associated with litigation matters and restructuring activities involving contract rejections and terminations, dismantling costs, asset impairments and severance charges ($49 million pre-tax and after-tax - see note (i) below). f) Write-off of unamortized debt issuance costs related to the October 2003 and interim DIP credit facilities; both were retired in January 2004 with proceeds from the DIP credit facility ($25 million pre-tax and after-tax - see note (i) below). g) Loss due to the modification of Solutia's Euronotes in January 2004 ($15 million pre-tax and $9 million after-tax). h) Reorganization items, net consist of the following: $46 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $20 million charge for asset write-offs associated with contract rejections and terminations resulting from the ongoing reorganization-related evaluation of the financial viability of Solutia's existing contracts; $9 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; and $2 million of net gains for adjustments to 40 record certain pre-petition claims at estimated amounts of the allowed claims. ($73 million pre-tax and after-tax - see note (i) below). i) With the exception of item (g) above, which primarily relates to ex-U.S. operations, the above items are considered to have like pre-tax and after-tax impact as the tax benefit or expense realized from these events is offset by the change in valuation allowance for U.S. deferred tax assets resulting from uncertainty as to their recovery due to Solutia's Chapter 11 bankruptcy filing.
ENVIRONMENTAL MATTERS Solutia is subject to numerous laws and government regulations concerning environmental, safety and health matters in the United States and other countries. U.S. environmental legislation that has a particular impact on Solutia includes the Toxic Substances Control Act; the Resource Conservation and Recovery Act; the Clean Air Act; the Clean Water Act; the Safe Drinking Water Act; and the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as Superfund). Solutia is also subject to the Occupational Safety and Health Act and regulations of the Occupational Safety and Health Administration ("OSHA") concerning employee safety and health matters. The EPA, OSHA and other federal agencies have the authority to promulgate regulations that have an impact on Solutia's operations. In addition to these federal activities, various states have been delegated certain authority under several of these federal statutes and have adopted environmental, safety and health laws and regulations. State or federal agencies having lead enforcement authority may seek fines and penalties for violation of these laws and regulations. Also, private parties have rights to seek recovery, under the above statutes or the common law, for civil damages arising from environmental conditions, including damages for personal injury and property damage. Expenditures for environmental capital projects were approximately $9 million in 2006 and $8 million in both 2005 and 2004. Expenditures for the management of environmental programs and remediation activities were approximately $60 million, $62 million and $69 million in 2006, 2005 and 2004, respectively. Included in environmental program management is the operation and maintenance of current operating facilities for environmental control, which is expensed in the period incurred, and $10 million, $12 million and $19 million in 2006, 2005 and 2004, respectively, for remediation activity, which was charged against recorded environmental liabilities. Recoveries from third parties were less than $1 million for both 2006 and 2005 and $2 million in 2004. Environmental compliance and remediation costs and other environmental liabilities incurred by Solutia generally fall into two broad categories: (a) those related to properties currently owned or operated by Solutia and (b) those related to properties that are not owned by Solutia, including non-owned properties adjacent to plant sites and certain owned offsite disposal locations. For the owned and operated sites, Solutia had an accrued liability of $78 million and $71 million as of December 31, 2006 and 2005, respectively, for solid and hazardous waste remediation, which represents Solutia's best estimate of the underlying obligation. In addition, this balance also includes post-closure costs at certain of Solutia's operating locations. This liability is not classified as subject to compromise in the Consolidated Statement of Financial Position because, irrespective of the bankruptcy proceedings, Solutia will be required to comply with environmental requirements in the conduct of its business, regardless of when the underlying environmental contamination occurred. However, Solutia ultimately expects to seek recovery against other potentially responsible parties at certain of these locations. Solutia spent $10 million in 2006 for remediation of these properties. In 2007, Solutia anticipates spending a similar amount related to these properties currently owned or operated by Solutia. Solutia had an accrued liability of $81 million and $82 million as of December 31, 2006 and 2005, respectively, for properties not owned or operated by Solutia which was classified as subject to compromise in the Consolidated Statement of Financial Position. Under the Plan and the Relationship Agreement, as between Monsanto and Solutia, Monsanto would accept financial responsibility for environmental remediation obligations at all sites for which Solutia was required to assume responsibility at the Solutia Spinoff but which were never owned or operated by Solutia. This includes more than 50 sites with active remediation projects and approximately 200 additional known sites and off-site disposal facilities, as well as sites that have not yet been identified. Finally, Monsanto would share financial responsibility with Solutia for off-site remediation costs in Anniston, Alabama and Sauget, Illinois. Remediation activities are currently being funded by Monsanto for all of these properties not owned or operated by Solutia, with the exception of one off-site remediation project in Sauget, Illinois. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 bankruptcy case. In addition, Solutia has only made minimal adjustments to its recorded environmental liabilities classified as subject to compromise for ongoing remediation activities since the inception of Solutia's bankruptcy 41 case to reflect actual cash expenditures incurred by the Company. Any other adjustments to this liability are not deemed appropriate by the Company at this time given the uncertainty regarding any potential claim amount to be asserted by Monsanto. In addition to the bankruptcy proceedings, Solutia's environmental liabilities are also subject to changing governmental policy and regulations, discovery of unknown conditions, judicial proceedings, changes in method and extent of remediation, existence of other potentially responsible parties and changes in technology. Solutia believes that the known and unknown environmental matters, including matters classified as subject to compromise for which Solutia may ultimately assume responsibility, when ultimately resolved, which may be over an extended period of time, could have a material effect on the consolidated financial position, liquidity and profitability of Solutia. SELF-INSURANCE As discussed in Item 3 of this Annual Report, because of the size and nature of its business, Solutia is a party to numerous legal proceedings. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. In addition, at the time of Solutia's spinoff from Pharmacia, Solutia assumed the defense of specified legal proceedings and agreed to indemnify Pharmacia in connection with those proceedings. Solutia has determined that these defense and indemnification obligations to Pharmacia are pre-petition obligations under the U.S. Bankruptcy Code that Solutia is prohibited from performing, except pursuant to a confirmed plan of reorganization. As a result, Solutia has ceased performance of these obligations. Solutia's cessation of performance may give rise to a pre-petition unsecured claim against Solutia which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case. Since the spinoff, Solutia has been responsible for bearing the costs associated with various toxic tort lawsuits related to PCBs, premises-based asbestos and other chemical exposures from the conduct of the historic chemical business of Pharmacia. At the time of the Chapter 11 bankruptcy filing, Solutia was defending approximately 520 asbestos actions (involving an estimated 3,500 to 4,500 plaintiffs) brought against Pharmacia. In addition, notwithstanding the settlement of cases relating to the Anniston plant site, Solutia was defending approximately 30 cases involving alleged exposure from PCB's manufactured by Pharmacia prior to the spinoff. Solutia was also defending approximately 100 general and product liability claims brought against Pharmacia. Claims for legal matters arising prior to Solutia's Chapter 11 bankruptcy filing will be addressed in the bankruptcy proceedings. As a result of the Chapter 11 petition, an automatic stay has been imposed against the commencement or continuation of legal proceedings against Solutia outside of the bankruptcy court process. Consequently, Solutia's pre-petition accrued liability for litigation of $111 million and $136 million as of December 31, 2006 and 2005, respectively, has been classified as subject to compromise in the Consolidated Statement of Financial Position. In general, all claims against Solutia that seek a recovery of assets of Solutia's estate will be addressed in the Chapter 11 bankruptcy process and paid only pursuant to the terms of a confirmed plan of reorganization. However, pursuant to a Bankruptcy Court order, Solutia made a $5 million payment with respect to pre-petition legal proceedings in both 2006 and 2005. Solutia cannot forecast the level of future pre-petition self-insurance spending and anticipated levels of recoveries based upon the inherent uncertainty underlying the bankruptcy proceedings. Solutia had an accrued liability of $11 million and $9 million as of December 31, 2006 and 2005, respectively, for post-petition self-insurance liabilities including workers' compensation, product, general, automobile and operations liability claims. Self-insurance expense was $5 million in 2006 and $4 million in both 2005 and 2004. Cash payments for self-insurance matters were $9 million in 2006, $8 million in 2005, and $9 million in 2004, whereas recoveries from insurance carriers were less than $1 million in 2006, $1 million in 2005, and $7 million in 2004. Included in the 2006, 2005 and 2004 payments was a $5 million scheduled payment with respect to the 2003 Anniston PCB litigation settlement paid pursuant to a Bankruptcy Court order. EMPLOYEE BENEFITS Employee benefits include noncontributory defined benefit pension plans and OPEB that provide certain health care and life insurance benefits. Solutia also has stock option plans covering officers and employees and a non-employee director compensation plan for non-employee members of Solutia's board of directors. 42 Solutia amended its U.S. qualified pension plan in 2004 for non-union participants and in 2005 for union participants to cease future benefit accruals effective July 1, 2004 and January 1, 2006, respectively. Further, Solutia amended its U.S. postretirement plan in 2004 for non-union, active employees and in 2005 for union, active employees to discontinue all postretirement benefits after attaining age 65, make changes to certain eligibility requirements for pre-65 postretirement benefits with the eventual elimination of these benefits by 2016, and eliminate retiree life insurance benefits for future retirees. In addition, Solutia amended its U.S. postretirement plan in 2006 for retiree participants to terminate medical benefits for certain retirees who are Medicare eligible, and if not Medicare eligible, to terminate medical benefits on the earlier of (a) the date such retirees or participants become Medicare eligible if such date is on or after January 1, 2007 or (b) October 19, 2016. Pension expense in accordance with SFAS No. 87 was $23 million in 2006 and $29 million in both 2005 and 2004, and expense for OPEB was $30 million in 2006, $42 million in 2005 and $44 million in 2004. In addition, Solutia did not record any charges resulting from pension and postretirement benefit plan curtailments and settlements in 2006, while the Company recorded charges of $13 million in 2005 and $35 million in 2004 (as more fully described in Note 16 to the accompanying consolidated financial statements). Pension Plan Funded Status The majority of Solutia's employees are covered under noncontributory defined benefit pension plans. The pension plans are funded in accordance with Solutia's long-range projections of the plan's financial conditions. These projections take into account benefits earned and expected to be earned, anticipated returns on pension plan assets and income tax and other regulations. The amount of pension plan underfunding in the pension plans decreased to $353 million as of December 31, 2006 from $540 million as of December 31, 2005. Solutia actively manages funding of its domestic qualified pension plan in order to meet the requirements of the IRS and the Pension Benefits Guarantee Corporation (a U.S. federal agency). Solutia contributed $179 million in 2006 to the qualified pension plan in accordance with IRS funding rules and made a discretionary contribution of $11 million in 2004 to the qualified pension plan in order to minimize future required contributions and to utilize available tax benefits. No contributions were made during 2005 to the qualified pension plan. According to current IRS funding rules, Solutia estimates that it will be required to make approximately $100 million in pension contributions to its U.S. qualified pension plan in 2007. In addition, Solutia contributed $6 million in 2006, $5 million in 2005 and $4 million in 2004, respectively, to fund its foreign pension plans. Moreover, Solutia expects to be required to fund a like amount in pension contributions for its foreign pension plans in 2007. DERIVATIVE FINANCIAL INSTRUMENTS Solutia's business operations give rise to market risk exposures that result from changes in currency exchange rates, interest rates and certain commodity prices. To manage the volatility relating to these exposures, Solutia enters into various hedging transactions that enable it to alleviate the adverse effects of financial market risk. Solutia's hedging transactions are carried out under policies and procedures approved by the Audit and Finance Committee of the Board of Directors, which does not permit the purchase or holding of any derivative financial instruments for trading purposes. Notes 2 and 8 to the accompanying consolidated financial statements include further discussion of Solutia's accounting policies for derivative financial instruments. Foreign Currency Exchange Rate Risk Solutia manufactures and sells its products in a number of countries throughout the world and, as a result, is exposed to movements in foreign currency exchange rates. Solutia uses foreign currency hedging instruments to manage the volatility associated with foreign currency purchases of materials and other assets and liabilities created in the normal course of business. Solutia primarily uses forward exchange contracts and purchased options with maturities of less than 18 months to hedge these risks. Solutia also enters into certain foreign currency derivative instruments primarily to protect against exposure related to intercompany financing transactions. Corporate policy prescribes the range of allowable hedging activity and what hedging instruments Solutia is permitted to use. Because the counterparties to these contracts are major international financing institutions, credit risk arising from these contracts is not significant, and Solutia does not anticipate any counterparty losses. Currency restrictions are not expected to have a significant effect on Solutia's cash flows, liquidity or capital resources. Major currencies affecting Solutia's business are the U.S. dollar, British pound sterling, Euro, Canadian dollar, Swiss franc, Brazilian real, Chinese yuan and the Japanese yen. At December 31, 2006, Solutia had currency forward contracts to purchase and sell $181 million of currencies, principally the Euro, Swiss franc, and U.S. dollar, with average remaining maturities of four months. Based on Solutia's 43 overall currency rate exposure at December 31, 2006, including derivatives and other foreign currency sensitive instruments, a 10 percent adverse change in quoted foreign currency rates of these instruments would result in a change in fair value of these instruments of $15 million. This is consistent with the overall foreign currency exchange rate exposure at December 31, 2005. Interest Rate Risk Interest rate risk is primarily related to changes in interest expense from floating rate debt. Solutia believes its current debt structure mitigates some of the risk associated with changes in interest rates due to the combination of fixed versus floating rate debt instruments. Further, periodically, the Company does enter into contracts to further mitigate interest rate risk. A 1 percent increase in the LIBOR and EURIBOR would have increased interest expense by approximately $9 million during 2006, assuming the debt composition at December 31, 2006 was consistent throughout the year. This is consistent with the overall interest rate exposure at December 31, 2005. Commodity Price Risk Certain raw materials and energy resources used by Solutia are subject to price volatility caused by weather, crude oil prices, supply conditions, political and economic variables and other unpredictable factors. Solutia uses forward and option contracts to manage a portion of the volatility related to anticipated energy purchases. Solutia had commodity forward contracts with notional amounts of $2 million associated with future natural gas purchases as of December 31, 2006. Based on Solutia's overall energy market rate exposure at December 31, 2006, including derivatives and other commodity sensitive instruments, a 10 percent adverse change in quoted market rates of these instruments would result in a less than $1 million decrease in fair value of these instruments. This is consistent with the overall commodity price exposure at December 31, 2005. In addition, Solutia mitigates some of its commodity price risks through formula based contractual pricing for certain products within the Integrated Nylon segment. The use of these types of arrangements has increased in 2006 compared to previous years. RESTRUCTURING ACTIVITIES During 2006, Solutia recorded $3 million of decommissioning and dismantling costs primarily as a result of the shut-down of its acrylic fibers business in 2005, and $3 million of asset write-downs. Solutia also recorded $3 million of future contractual payments related to the termination of a third party manufacturing agreement. These costs were all recorded within Reorganization Items, net with $4 million in the Integrated Nylon segment and $5 million in the Performance Products segment. In addition, Solutia recorded $8 million of severance and retraining costs in 2006 with $4 million recorded in Reorganization Items, net and $4 million in Marketing and Administrative expenses involving headcount reductions within the Integrated Nylon and Performance Products, as well as the corporate function. Cash outlays associated with the restructuring actions were funded from operations. During 2005, Solutia recorded restructuring charges of $13 million in Reorganization Items, net involving the shut-down of its acrylic fiber operations and shut-down of its nylon industrial fiber manufacturing unit at its plant in Pensacola, Florida. This $13 million of net charges from the closure of these businesses included $12 million of asset write-downs, $7 million of decontamination and dismantling costs and $4 million of severance and retraining costs, partially offset by a $7 million gain from the reversal of the LIFO reserve associated with the inventory sold and/or written off as part of the business shut-down and a $3 million gain from the sale of certain acrylic fibers assets. In addition, Solutia recorded $5 million of severance and retraining costs in 2005 with $3 million recorded in Reorganization Items, net and $2 million in Cost of Goods Sold involving headcount reductions within the Integrated Nylon and Performance Products segments, as well as the corporate function. Cash outlays associated with the restructuring actions were funded from operations. During 2004, Solutia recorded restructuring and severance charges of $18 million to Cost of Goods Sold principally related to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, including $10 million for decommissioning and dismantling costs, $3 million of severance and retraining costs; $2 million related to operating leases where the underlying services and properties are no longer providing benefit; and $3 million of various other restructuring charges. In addition, Solutia recorded $4 million of severance and retraining costs during 2004 in Reorganization Items, net principally related to workforce reduction initiatives of management positions within the corporate function directly associated with the bankruptcy reorganization process. Cash outlays associated with the restructuring actions were funded from operations. 44 FINANCIAL CONDITION AND LIQUIDITY As discussed in Note 1 to the accompanying consolidated financial statements, Solutia is operating as a debtor-in-possession under Chapter 11 of the U.S. Bankruptcy Code. As a result of the uncertainty surrounding Solutia's current circumstances, it is difficult to predict Solutia's actual liquidity needs and sources. However, based upon current and anticipated levels of operations during the continuation of the bankruptcy proceedings, Solutia believes that its liquidity and capital resources will be sufficient to maintain its normal operations at current levels. Solutia's access to additional financing while in the Chapter 11 bankruptcy process may be limited. Financial Analysis Solutia used its existing cash on-hand to finance operating needs and capital expenditures during 2006. Cash used in continuing operations was $186 million in 2006 compared to cash used by continuing operations of $34 million in 2005. The increase in 2006 as compared to 2005 in cash used in continuing operations was primarily attributable to higher pension contributions and increases in working capital items, including a significant increase in trade receivables resulting from higher net sales and an increase in days sales outstanding due to a shift in sales mix within the Integrated Nylon segment. Partially offsetting these uses was the receipt of a dividend from Flexsys in 2006 as compared to no dividend received in the prior year. In 2005, cash used by continuing operations was $34 million compared to cash provided by continuing operations of $35 million in 2004. The change in 2005 as compared to 2004 was primarily attributable to changes in working capital items including a significant change in accounts payable in 2005 due to the relative stabilization in accounts payable terms in 2005 compared to 2004 when terms significantly improved due to Solutia's filing of Chapter 11 bankruptcy in late 2003. Solutia's working capital, defined as current assets less current liabilities, decreased by $314 million to ($276) million at December 31, 2006, compared to $38 million at December 31, 2005. The change was primarily a result of higher short-term debt from additional DIP credit facility borrowings as well as a decrease of $44 million related to the sale of the pharmaceutical services business, partially offset by higher cash on-hand and an increase in trade receivables. Capital spending increased $29 million to $106 million in 2006 as compared to $77 million in 2005. The expenditures in 2006 were primarily to fund certain strategic initiatives in the Performance Products and Integrated Nylon segments, as well as various capital improvements and certain cost reduction projects. Capital spending increased by $26 million in 2005 as compared to $51 million in 2004. Expenditures during 2005 were used primarily to fund certain growth initiatives, as well as various capital improvements and certain cost reduction projects. In addition, included in 2004 was $5 million of capital spending incurred as a result of damage from Hurricane Ivan. In 2007, Solutia expects capital spending will be approximately $120 million and will focus on growth initiatives including the continued expenditures on the new SAFLEX(R) plastic interlayer plant in China expected to be completed in 2007, the addition of a third SAFLEX(R) line in the plant in Ghent, Belgium expected to be completed in 2008, and the transformation of staple carpet lines to plastic polymer lines. Approximately $16 million of estimated capital requirements were committed at December 31, 2006. Solutia continued to divest certain non-strategic businesses in order to focus resources on core businesses. The proceeds from these and other asset sales generated $77 million in 2006 and $81 million in 2005. Proceeds from divestitures in 2004 were less than $1 million. During 2006, net proceeds were primarily comprised of $69 million received from the pharmaceutical services business divestiture. During 2005, net proceeds included $76 million received from the Astaris transaction with an additional approximately $20 million deposited into escrow accounts. Distributions, if any, from the escrow accounts are expected to be received in 2007, subject to certain terms and conditions of the asset purchase agreement and the escrow agreements. Solutia lenders under the DIP credit facility agreed to waive certain prepayment requirements and allowed Solutia to retain the entire proceeds of the Astaris sale. In addition, $3 million of proceeds were received in 2005 from the sale of assets associated with the closure of Solutia's acrylic fibers business in 2005. Total debt of $1,528 million as of December 31, 2006, including $668 million subject to compromise and $860 million not subject to compromise, increased by $313 million as compared to $1,215 million at December 31, 2005, which included $668 million subject to compromise and $547 million not subject to compromise. This increase in total debt resulted primarily from $350 million of additional borrowings from Solutia's DIP credit facility in 2006, of which $300 million resulted from the March 2006 amendment to the DIP credit facility (as described below), partially offset by a $51 million payment on SESA's Facility Agreement (as described below). 45 The weighted average interest rate on Solutia's total debt outstanding at December 31, 2006 was 8.4 percent compared to 8.7 percent at December 31, 2005. Excluding debt subject to compromise, with the exception of the 11.25 percent notes due 2009 on which the Bankruptcy Court has permitted continued payments of the contractual interest, the weighted average interest rate on total debt was 8.9 percent at December 31, 2006 compared to 9.8 percent at December 31, 2005. The reductions in weighted average rates in 2006 are due to the refinancing of the Euronotes and the amendment to the DIP Financing Agreement. While operating as a debtor-in-possession during the Chapter 11 proceedings, Solutia has ceased paying interest on its 6.72 percent debentures due 2037 and its 7.375 percent debentures due 2027. The amount of annual contractual interest expense not recorded in each of 2006 and 2005 was approximately $32 million. As a result of the Chapter 11 bankruptcy filing, Solutia was in default on all its debt agreements as of December 31, 2006, with the exception of its DIP credit facility and SESA's Facility Agreement. In addition, subsequent to Solutia's bankruptcy filing, Moody's Investors Ratings Services and Standard & Poor's withdrew all ratings for Solutia and its related debt securities. Solutia had a shareholders' deficit of $1,417 million at December 31, 2006, compared to a shareholders' deficit of $1,454 million at December 31, 2005. Shareholders' deficit decreased principally due to a $24 million decrease in additional minimum pension liability and net income of $11 million. At December 31, 2006, Solutia's total liquidity was $245 million in the form of $95 million of availability under the final DIP credit facility and approximately $150 million of cash on-hand, of which $112 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 bankruptcy proceedings. In comparison, at December 31, 2005 Solutia's total liquidity was $238 million in the form of $131 million of availability under the final DIP credit facility and approximately $107 million of cash on-hand, of which $89 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 bankruptcy proceedings. Solutia contributed $179 million to its U.S. qualified domestic pension plan in 2006 in accordance with IRS funding rules. According to current IRS funding rules, Solutia will be required to make approximately $100 million in pension contributions to its U.S. qualified pension plan in 2007. In addition, Solutia contributed $6 million in 2006 to fund its foreign pension plans and expects to be required to fund a like amount in pension contributions for its foreign pension plans in 2007. Astaris Financing Activities On October 8, 2003 Solutia and Astaris, a 50/50 joint venture with FMC Corporation ("FMC"), amended Astaris' external financing agreement to release the Astaris lenders' security interests in certain Solutia assets in exchange for Solutia's posting of a $67 million letter of credit, representing fifty percent of the Astaris lenders' outstanding commitments to Astaris. Solutia used approximately $36 million in 2004 for investment payments ("keepwell payments") to keep the Astaris joint venture in compliance with its financial covenants. There were no keepwell payments made in 2005. The remaining commitment to Astaris was $10 million as of December 31, 2004, which was subsequently terminated as part of Astaris' refinancing of its credit facility on February 8, 2005. Solutia and FMC had also agreed to allow Astaris to defer up to $27 million of payment obligations to each of Solutia and FMC under existing operating agreements and certain other agreements. The deferral amount outstanding from Astaris to Solutia was $16 million as of December 31, 2004. In February 2005, this deferral agreement was terminated and all amounts outstanding were paid in full in conjunction with the Astaris refinancing. Amendments to DIP Financing Agreement On March 17, 2006, Solutia amended its DIP credit facility with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP credit facility from $525 million to $825 million; (ii) extended the term of the DIP credit facility from June 19, 2006 to March 31, 2007; (iii) decreased the interest rate on the term loan component of the DIP credit facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points; (iv) increased certain thresholds allowing the Debtors to retain more of the proceeds from certain dispositions and other extraordinary receipts; (v) approved the disposition of certain assets of the Debtors; (vi) allowed refinancing of, and certain amendments to, SESA's outstanding Euronotes; and (vii) amended certain financial and other covenants. The amendment contained a number of other changes and other modifications required to make the remaining terms of the DIP credit facility consistent with the amendments set forth above. 46 On January 25, 2007, Solutia completed the extension and upsizing of its $1,225 million of DIP credit facility, maturing March 31, 2008 with Bankruptcy Court approval. This represents a $400 million increase and a one year extension over Solutia's current DIP credit facility. The increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments that are coming due in 2007, as well as funds to partially facilitate the acquisition of Akzo Nobel's stake in the 50/50 rubber chemical joint venture Flexsys Holding B.V. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. Euronotes Refinancing On July 26, 2006, Solutia's indirect 100% owned subsidiary SSI, a subsidiary of SESA, entered into a Facility Agreement guaranteed by SESA and CPFilms Vertriebs GmbH, a subsidiary of SESA. Closing of the Facility Agreement occurred on August 1, 2006. SESA used the proceeds of the Facility Agreement to refinance all of the Euronotes on August 1, 2006, at a prepayment premium of 3 percent, as required pursuant to the Euronotes, for a total redemption amount of approximately (euro)215 million, including accrued interest. The Euronotes were refinanced to reduce the interest rate, extend the term of the indebtedness and facilitate certain dispositions by Solutia, including the sale of its pharmaceutical services business described below. The Facility Agreement has a five-year term, with a termination date of July 31, 2011 and an adjustable rate structure of EURIBOR plus 275 basis points. The margin is subject to adjustment upon the occurrence of certain events specified in the Facility Agreement or upon SESA and its subsidiaries attaining certain financial benchmarks. The Facility Agreement consists of a (euro)160 million term loan and a (euro)40 million term loan. The (euro)40 million term loan was repaid from the proceeds of the sale of Solutia's pharmaceutical services business during the third quarter 2006 (as further described in Note 4 to the accompanying consolidated financial statements). The Facility Agreement is secured by substantially all of the assets of SESA and its subsidiaries. The Facility Agreement also contains other customary terms and conditions, including certain financial covenants relating to the performance of SESA and its subsidiaries. PENNDOT Letter of Credit As a result of the favorable ruling in the PENNDOT litigation matter described in Note 20 to the accompanying consolidated financial statements, in August 2006, Monsanto released the $20 million letter of credit that Solutia posted to secure a portion of Pharmacia's obligations with respect to an appeal bond issued in relation to this case. Off-Balance Sheet Arrangements See Note 20 to the accompanying consolidated financial statements for a summary of off-balance sheet arrangements. Contingencies See Note 20 to the accompanying consolidated financial statements for a summary of Solutia's contingencies as of December 31, 2006. Commitments Solutia has entered into agreements with certain customers to supply a guaranteed quantity of certain products annually at prices specified in the agreements. In return, the customers have advanced funds to Solutia to cover the costs of expanding capacity to provide the guaranteed supply. Solutia has recorded the advances as deferred credits and amortizes the amounts to income as the customers purchase the associated products. The unamortized deferred credits were $91 million at December 31, 2006, and $100 million at December 31, 2005. The obligations of Solutia and Solutia Business Enterprises, Inc., as borrowers under Solutia's DIP credit facility, are guaranteed by Solutia's other domestic subsidiaries which own substantially all of Solutia's domestic assets. These subsidiaries are Axio Research Corporation, Beamer Road Management Company, CPFilms Inc., Monchem, Inc., Monchem International, Inc., Solutia Greater China, Inc., Solutia Inter-America, Inc., Solutia International Holding, LLC, Solutia Investments, LLC, Solutia Management Company, Inc., Solutia Overseas, Inc., Solutia Systems, Inc. and Solutia Taiwan, Inc. The obligations also must be guaranteed by each of Solutia's subsequently acquired or organized domestic subsidiaries, 47 subject to certain exceptions. In addition, Solutia and Solutia Business Enterprises, Inc. are jointly and severally liable with respect to their obligations under the final DIP credit facility, thus in effect each guaranteeing the other's debt. The following table summarizes Solutia's contractual obligations and commercial commitments that are not subject to compromise as of December 31, 2006. Payments associated with liabilities subject to compromise have been excluded from the table below, as Solutia cannot accurately forecast its future level and timing of spending given the inherent uncertainties associated with the ongoing Chapter 11 bankruptcy process. See Note 3 to the accompanying consolidated financial statements for further disclosure concerning liabilities subject to compromise.
- ---------------------------------------------------------------------------------------------------------------------- OBLIGATIONS DUE BY PERIOD (DOLLARS IN MILLIONS) ------------------------------------------------------------- CONTRACTUAL OBLIGATIONS 2010- 2012 AND TOTAL 2007 2008 2009 2011 THEREAFTER - ---------------------------------------------------------------------------------------------------------------------- Credit Facility (a) $650 $650 $ -- $ -- $ -- $ -- - ---------------------------------------------------------------------------------------------------------------------- Interest Payments Related to Credit Facility (a) 15 15 -- -- -- -- - ---------------------------------------------------------------------------------------------------------------------- Long-Term Debt 210 -- -- -- 210 -- - ---------------------------------------------------------------------------------------------------------------------- Interest Payments Related to Long-Term Debt 61 13 13 13 22 -- - ---------------------------------------------------------------------------------------------------------------------- Operating Leases 13 6 4 2 1 -- - ---------------------------------------------------------------------------------------------------------------------- Unconditional Purchase Obligations 8 4 2 1 1 -- - ---------------------------------------------------------------------------------------------------------------------- Standby Letters of Credit (b) 76 74 1 -- -- 1 - ---------------------------------------------------------------------------------------------------------------------- Postretirement Obligations(c) 52 6 6 6 13 21 - ---------------------------------------------------------------------------------------------------------------------- Environmental Remediation 78 14 13 13 12 26 - ---------------------------------------------------------------------------------------------------------------------- Other Commercial Commitments(d) 91 8 6 4 8 65 - ---------------------------------------------------------------------------------------------------------------------- TOTAL CONTRACTUAL OBLIGATIONS $1,254 $790 $45 $39 $267 $113 - ---------------------------------------------------------------------------------------------------------------------- (a) The DIP credit facility was amended on January 25, 2007 and increased the term loan to $975 million and is payable upon the earlier of emergence from Chapter 11 or March 31, 2008. The interest rate on the amended DIP credit facility is LIBOR plus 300 basis points. The $15 million of interest payments related to credit facility assumes the maturity of the current DIP credit facility on March 31, 2007. (b) Standby letters of credit contractually expiring in 2007 are generally anticipated to be renewed or extended by extensions with existing standby letters of credit providers. (c) Represents estimated future minimum funding requirements for funded pension plans classified as not subject to compromise and estimated future benefit payments for unfunded pension and other postretirement plans classified as not subject to compromise. (d) Other commercial commitments represent agreements with Solutia's customers to supply a guaranteed quantity of certain products annually at prices specified in the underlying agreements.
RECENTLY ISSUED ACCOUNTING STANDARDS See Note 2 to the accompanying consolidated financial statements for a summary of recently issued accounting standards. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information appearing under "Derivative Financial Instruments" on page 43 is incorporated here by reference. 48 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FINANCIAL SECTION - TABLE OF CONTENTS Page Number --------------- Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP 50 Consolidated Statement of Operations 51 Consolidated Statement of Comprehensive Income (Loss) 51 Consolidated Statement of Financial Position 52 Consolidated Statement of Cash Flows 53 Consolidated Statement of Shareholders' Deficit 54 Notes to Consolidated Financial Statements 55 49 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Solutia Inc.: We have audited the accompanying consolidated statements of financial position of Solutia Inc. and subsidiaries (Debtor-In-Possession) (the "Company") as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income (loss), cash flows and shareholders' deficit for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company has filed for reorganization under Chapter 11 of the United States Bankruptcy Code. The accompanying financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings. In particular, such financial statements do not purport to show (1) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (2) as to pre-petition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof; (3) as to shareholder accounts, the effect of any changes that may be made in the capitalization of the Company; or (4) as to operations, the effect of any changes that may be made in its business. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company's recurring losses from operations, negative working capital, and shareholders' deficit raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also discussed in Note 1 to the financial statements. The financial statements do not include adjustments that might result from the outcome of this uncertainty. As discussed in Note 2 and Note 12, respectively, to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, and Financial Accounting Standards Board Interpretation No. 47, Accounting for Conditional Retirement Obligations - an interpretation of FASB Statement No. 143, effective December 31, 2006 and December 31, 2005, respectively. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2006, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework and our report dated March 1, 2007 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting. St. Louis, Missouri March 1, 2007 50 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENT OF OPERATIONS (DOLLARS AND SHARES IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, ------------------------------------------------- 2006 2005 2004 ---- ---- ---- NET SALES....................................................... $2,905 $2,759 $2,637 Cost of goods sold.............................................. 2,524 2,437 2,416 --------- --------- --------- GROSS PROFIT.................................................... 381 322 221 Marketing expenses.............................................. 136 136 139 Administrative expenses......................................... 97 92 96 Technological expenses.......................................... 45 45 44 Amortization of intangible assets............................... 1 1 1 --------- --------- --------- OPERATING INCOME (LOSS)......................................... 102 48 (59) Equity earnings (loss) from affiliates.......................... 38 96 (26) Interest expense (a)............................................ (104) (84) (113) Other income, net............................................... 14 8 -- Loss on debt modification....................................... (8) -- (15) Reorganization items, net....................................... (71) (49) (73) --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT).............................................. (29) 19 (286) Income tax expense (benefit).................................... 18 12 (2) --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS........................ (47) 7 (284) Income (Loss) from Discontinued Operations, net of tax.......... 58 4 (32) --------- --------- --------- INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE........................................... 11 11 (316) Cumulative Effect of Change in Accounting Principle, net of tax. -- (3) -- --------- --------- --------- NET INCOME (LOSS)............................................... $ 11 $ 8 $ (316) ========= ========= ========= BASIC AND DILUTED INCOME (LOSS) PER SHARE: Income (Loss) from Continuing Operations.......................... $ (0.45) $ 0.07 $ (2.72) Net Income (Loss)................................................. $ 0.11 $ 0.08 $ (3.02) BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 104.5 104.5 104.5 (a) Interest expense excludes unrecorded contractual interest expense of $32 in 2006, 2005 and 2004. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) (DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, ------------------------------------------------- 2006 2005 2004 ---- ---- ---- NET INCOME (LOSS)................................................ $ 11 $ 8 $ (316) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments................................. (12) (11) 15 Net unrealized gain (loss) on derivative instruments............. 1 (1) -- Minimum pension liability adjustments, net of tax of $4 in 2006, $(2) in 2005 and $3 in 2004...................................... 24 (6) (18) --------- --------- --------- COMPREHENSIVE INCOME (LOSS)...................................... $ 24 $ (10) $ (319) ========= ========= =========
See accompanying Notes to Consolidated Financial Statements. 51 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENT OF FINANCIAL POSITION (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
AS OF DECEMBER 31, ------------------------------------- 2006 2005 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents................................................. $ 150 $ 107 Trade receivables, net of allowances of $7 in 2006 and 2005............... 288 246 Miscellaneous receivables ................................................ 105 95 Inventories............................................................... 274 254 Prepaid expenses and other assets......................................... 31 34 Assets of discontinued operations......................................... -- 69 ------ ------ TOTAL CURRENT ASSETS...................................................... 848 805 PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation of $2,518 in 2006 and $2,482 in 2005.................................... 795 770 INVESTMENTS IN AFFILIATES................................................. 193 205 GOODWILL.................................................................. 89 76 IDENTIFIED INTANGIBLE ASSETS, NET ........................................ 31 28 OTHER ASSETS.............................................................. 99 100 ------ ------ TOTAL ASSETS.............................................................. $2,055 $1,984 ====== ====== LIABILITIES AND SHAREHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable ......................................................... $ 228 $ 218 Accrued liabilities ...................................................... 245 223 Short-term debt .......................................................... 650 300 Liabilities of discontinued operations ................................... 1 26 ------ ------ TOTAL CURRENT LIABILITIES ................................................ 1,124 767 LONG-TERM DEBT ........................................................... 210 247 OTHER LIABILITIES ........................................................ 289 248 ------ ------ TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE............................... 1,623 1,262 LIABILITIES SUBJECT TO COMPROMISE ........................................ 1,849 2,176 SHAREHOLDERS' DEFICIT: Common stock (authorized, 600,000,000 shares, par value $0.01) Issued: 118,400,635 shares in 2006 and 2005........................... 1 1 Additional contributed capital............................................ 56 56 Treasury stock, at cost (13,941,057 shares in 2006 and 2005).............. (251) (251) Net deficiency of assets at spinoff....................................... (113) (113) Accumulated other comprehensive loss...................................... (67) (93) Accumulated deficit....................................................... (1,043) (1,054) ------ ------ TOTAL SHAREHOLDERS' DEFICIT............................................... (1,417) (1,454) ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT............................... $2,055 $1,984 ====== ======
See accompanying Notes to Consolidated Financial Statements. 52 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, -------------------------------------- 2006 2005 2004 ---- ---- ---- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS OPERATING ACTIVITIES: Net income (loss)............................................................... $ 11 $ 8 $ (316) Adjustments to reconcile to Cash From Operations: Cumulative effect of change in accounting principle, net of tax........ -- 3 -- (Income) Loss from discontinued operations, net of tax................. (58) (4) 32 Depreciation and amortization.......................................... 111 111 120 Amortization of deferred credits....................................... (9) (9) (33) Deferred income taxes.................................................. 4 8 (4) Equity (earnings) loss from affiliates, net............................ (38) (46) 26 Gain on sale of Astaris assets......................................... -- (50) -- Restructuring expenses and other charges .............................. 5 15 103 Other, net............................................................. (2) (3) 4 Changes in assets and liabilities: Income taxes payable......................................... 4 (17) (7) Trade receivables............................................ (43) 33 (8) Inventories.................................................. (14) (32) 6 Accounts payable............................................. 12 19 118 Other assets and liabilities................................. 138 (59) 28 Liabilities subject to compromise: Pension plan liabilities........................... (196) 56 20 Other postretirement benefits liabilities.......... (102) (48) (83) Other liabilities subject to compromise............ (9) (19) 29 --------- --------- --------- CASH PROVIDED BY (USED IN) OPERATIONS--CONTINUING OPERATIONS.................... (186) (34) 35 CASH PROVIDED BY OPERATIONS--DISCONTINUED OPERATIONS............................ 2 10 6 --------- --------- --------- CASH PROVIDED BY (USED IN) OPERATIONS........................................... (184) (24) 41 --------- --------- --------- INVESTING ACTIVITIES: Property, plant and equipment purchases......................................... (106) (77) (51) Acquisition and investment payments, net of cash acquired....................... (16) -- (36) Investment proceeds and property disposals, net................................. 5 81 (1) --------- --------- --------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES--CONTINUING OPERATIONS.......... (117) 4 (88) CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES--DISCONTINUED OPERATIONS........ 69 (4) (9) --------- --------- --------- CASH USED IN INVESTING ACTIVITIES............................................... (48) -- (97) --------- --------- --------- FINANCING ACTIVITIES: Net change in short-term debt obligations....................................... 350 -- (361) Proceeds from issuance of long-term debt obligations............................ -- -- 300 Payments on long-term debt obligations.......................................... (51) -- -- Net change in cash collateralized letters of credit............................. -- 17 87 Deferred debt issuance costs.................................................... (17) (1) (14) Other, net...................................................................... (7) -- -- --------- --------- --------- CASH PROVIDED BY FINANCING ACTIVITIES--CONTINUING OPERATIONS.................... 275 16 12 --------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................ 43 (8) (44) CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR............................................................... 107 115 159 --------- --------- --------- END OF YEAR..................................................................... $ 150 $ 107 $ 115 ========= ========= =========
See accompanying Notes to Consolidated Financial Statements. 53 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, ---------------------------------------------- 2006 2005 2004 ---------------------------------------------- COMMON STOCK: BALANCE, JANUARY 1.................................................. $ 1 $ 1 $ 1 --------- --------- --------- BALANCE, DECEMBER 31................................................ $ 1 $ 1 $ 1 --------- --------- --------- ADDITIONAL CONTRIBUTED CAPITAL: BALANCE, JANUARY 1.................................................. $ 56 $ 56 $ 56 --------- --------- --------- BALANCE, DECEMBER 31................................................ $ 56 $ 56 $ 56 --------- --------- -------- NET DEFICIENCY OF ASSETS AT SPINOFF: BALANCE, JANUARY 1.................................................. $ (113) $ (113) $ (113) --------- --------- --------- BALANCE, DECEMBER 31................................................ $ (113) $ (113) $ (113) --------- --------- --------- TREASURY STOCK: BALANCE, JANUARY 1.................................................. $ (251) $ (251) $ (251) Shares purchased under employee stock plans - (0 shares in 2006 and 2005 and (102,340) shares in 2004)........................ -- -- -- --------- --------- --------- BALANCE, DECEMBER 31................................................ $ (251) $ (251) $ (251) --------- --------- --------- ACCUMULATED OTHER COMPREHENSIVE LOSS: ACCUMULATED CURRENCY ADJUSTMENT: BALANCE, JANUARY 1............................................. $ 40 $ 51 $ 36 Accumulated currency adjustments............................... (12) (11) 15 --------- --------- --------- BALANCE, DECEMBER 31........................................... $ 28 $ 40 $ 51 --------- --------- --------- PENSION AND OTHER POSTRETIREMENT ITEMS: BALANCE, JANUARY 1............................................. $ (132) $ (126) $ (108) Minimum pension liability adjustments.......................... 24 (6) (18) Incremental effect of adopting SFAS No. 158.................... 13 -- -- --------- --------- --------- BALANCE, DECEMBER 31........................................... $ (95) $ (132) $ (126) --------- --------- --------- DERIVATIVE INSTRUMENTS: BALANCE, JANUARY 1............................................. $ (1) $ -- $ -- Net unrealized gains (losses) on derivative instruments........ 1 (1) -- --------- --------- --------- BALANCE, DECEMBER 31........................................... $ -- $ (1) $ -- --------- ---------- --------- BALANCE, DECEMBER 31................................................ $ (67) $ (93) $ (75) --------- --------- --------- ACCUMULATED DEFICIT: BALANCE, JANUARY 1.................................................. $ (1,054) $ (1,062) $ (746) Net income (loss)............................................... 11 8 (316) --------- --------- --------- BALANCE, DECEMBER 31................................................ $ (1,043) $ (1,054) $ (1,062) --------- --------- --------- TOTAL SHAREHOLDERS' DEFICIT......................................... $ (1,417) $ (1,454) $ (1,444) --------- --------- ---------
See accompanying Notes to Consolidated Financial Statements. 54 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1. NATURE OF OPERATIONS AND BANKRUPTCY PROCEEDINGS Nature of Operations Solutia is a global manufacturer and marketer of a variety of high-performance chemical-based materials. Solutia is a world leader in performance films for laminated safety glass and after-market applications; specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic fluids; and an integrated family of nylon products including high-performance polymers and fibers. Prior to September 1, 1997, Solutia was a wholly-owned subsidiary of the former Monsanto Company (now known as Pharmacia Corporation, a 100% owned subsidiary of Pfizer, Inc.). On September 1, 1997, Pharmacia distributed all of the outstanding shares of common stock of Solutia as a dividend to Pharmacia stockholders (the "Solutia Spinoff"). As a result of the Solutia Spinoff, on September 1, 1997, Solutia became an independent publicly held company and its operations ceased to be owned by Pharmacia. A net deficiency of assets of $113 resulted from the Solutia Spinoff. Bankruptcy Proceedings Overview -------- On December 17, 2003, Solutia and its 14 U.S. subsidiaries (the "Debtors") filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Chapter 11 Cases") in the U.S. Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"). The cases were consolidated for the purpose of joint administration and were assigned case number 03-17949 (PCB). Solutia's subsidiaries outside the United States were not included in the Chapter 11 filing. The filing was made to restructure Solutia's balance sheet, to streamline operations and to reduce costs, in order to allow Solutia to emerge from Chapter 11 as a viable going concern. The filing was also made to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain post-retirement benefits (the "Legacy Liabilities"), and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff. These factors, combined with the weakened state of the chemical manufacturing sector, general economic conditions and continuing high, volatile energy and crude oil costs were an obstacle to Solutia's financial stability and success. Under Chapter 11, Solutia is operating its businesses as a debtor-in-possession ("DIP") under court protection from creditors and claimants. Since the Chapter 11 filing, orders sufficient to enable Solutia to conduct normal business activities, including the approval of Solutia's DIP financing, have been entered by the Bankruptcy Court. While Solutia is subject to Chapter 11, all transactions not in the ordinary course of business require the prior approval of the Bankruptcy Court. Under the U.S. Bankruptcy Code, Solutia had the exclusive right to propose a plan of reorganization for 120 days following the Chapter 11 filing date. The Bankruptcy Court has subsequently approved extensions of this exclusivity period. The exclusivity period continues until the order disposing of the current motion is entered on the Bankruptcy Court's docket. On January 16, 2004, pursuant to authorization from the Bankruptcy Court, Solutia entered into a DIP credit facility. The DIP credit facility has subsequently been amended from time to time, with Bankruptcy Court approval. The DIP credit facility, as amended, currently consists of: (a) a $975 million fully-drawn term loan; and (b) a $250 million borrowing-based revolving credit facility, which includes a $150 million letter of credit subfacility. Of the $1,225 million facility, $150 million must be utilized to acquire Akzo Nobel's 50% interest in the Flexsys joint venture between Solutia and Akzo Nobel. For additional information regarding the DIP financing and the Flexsys acquisition, see Note 14 to the accompanying consolidated financial statements. As a consequence of the Chapter 11 filing, pending litigation against Solutia is generally stayed, and no party may take any action to collect its pre-petition claims except pursuant to an order of the Bankruptcy Court. November 30, 2004 was the last date by which holders of pre-petition date claims against the Debtors could file such claims. Any holder of a claim that was required to file such claim by November 30, 2004 and did not do so may be barred from asserting such claim against the Debtors and, accordingly, may not be able to participate in any distribution on account of such claim. Differences between claim amounts identified by the Debtors and claims filed by claimants will be investigated and resolved in 55 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) connection with the Debtors' claims resolution process, and only holders of claims that are ultimately allowed for purposes of the Chapter 11 case will be entitled to distributions. Solutia has not yet completed its analysis of all the proofs of claim. Since the settlement terms of allowed claims are subject to a confirmed plan of reorganization, the ultimate distribution with respect to allowed claims is not presently ascertainable. On February 14, 2006, the Debtors filed with the Bankruptcy Court a Plan of Reorganization (the "Plan") and Disclosure Statement (the "Disclosure Statement"). The Plan and Disclosure Statement along with the Relationship Agreement (as defined below) and the Retiree Settlement Agreement, entered into among Solutia, the Official Committee of Unsecured Creditors (the "Unsecured Creditor's Committee") and Official Committee of Retirees appointed in the Chapter 11 Cases (the "Retirees' Committee"), Monsanto Company ("Monsanto"), certain retirees and the other parties thereto (the "Retiree Settlement"), set forth the terms of a global settlement (the "Global Settlement") between Solutia, the Unsecured Creditors' Committee, the Retirees' Committee, Monsanto and Pharmacia. The Global Settlement provides for, among other things, a reallocation of certain Legacy Liabilities among Solutia, Monsanto and Pharmacia and the treatment that various constituencies in the Chapter 11 Cases would receive under the Plan. The reallocation of liabilities between Solutia and Monsanto is set forth in a Relationship Agreement (the "Relationship Agreement") which would be entered into between Solutia and Monsanto upon confirmation of the Plan. Since the February 14, 2006 filing, the Bankruptcy Court has not moved forward with the process to approve the Disclosure Statement and confirm the Plan. There are two adversary proceedings ongoing in our Chapter 11 case. JPMorgan, as indenture trustee of Solutia's debentures due 2027 and 2037, filed litigation against Solutia claiming that such debentures are entitled to secured status as opposed to general unsecured status as set forth in the Plan. In addition, the Official Committee of Equity Security Holders ("Equity Committee") in Solutia's bankruptcy case has filed litigation against Pharmacia and Monsanto, arguing that holders of Solutia's existing equity are entitled to a distribution in the Chapter 11 case. For additional information regarding these litigation matters, see Note 20 to the accompanying consolidated financial statements. Solutia is in discussions with the major stakeholders in our Chapter 11 case in an effort to modify the Global Settlement and Plan and achieve a confirmable Plan. In addition, Solutia continues to evaluate and explore all other reasonable alternatives to reorganize the Company, such as a sale of the reorganized Company's equity or a sale of certain of its businesses or assets that may present a means of maximizing the value of the estate for stakeholders. Going Concern - ------------- Solutia is currently operating under Chapter 11 of the U.S. Bankruptcy Code and continuation of Solutia as a going concern is contingent upon, among other things, Solutia's ability to (i) comply with the terms and conditions of its DIP financing; (ii) obtain confirmation of a plan of reorganization under the U.S. Bankruptcy Code; (iii) return to profitability; (iv) generate sufficient cash flow from operations; and (v) obtain financing sources to meet Solutia's future obligations. These matters create substantial doubt about Solutia's ability to continue as a going concern. The consolidated financial statements do not reflect any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of these uncertainties. Additionally, a plan of reorganization could materially change amounts reported in the consolidated financial statements, which do not give effect to all adjustments of the carrying value of assets and liabilities that are necessary as a consequence of reorganization under Chapter 11 bankruptcy. Consolidating Financial Statements - ---------------------------------- Consolidating financial statements for Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004 are presented below. These consolidating financial statements include investments in subsidiaries carried under the equity method. 56 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2006 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET SALES ................................ $ 2,388 $ 975 $ (458) $ 2,905 Cost of goods sold........................ 2,159 846 (481) 2,524 ----------------------------------------------------------- GROSS PROFIT ............................. 229 129 23 381 Marketing, administrative and technological expenses................................. 215 63 -- 278 Amortization of intangible assets......... 1 1 (1) 1 ----------------------------------------------------------- OPERATING INCOME.......................... 13 65 24 102 Equity earnings (loss) from affiliates.... 129 (7) (84) 38 Interest expense.......................... (83) (21) -- (104) Other income, net......................... 37 3 (26) 14 Loss on debt modification................. (8) -- -- (8) Reorganization items, net................. (70) (1) -- (71) ----------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE.............. 18 39 (86) (29) Income tax expense........................ 8 11 (1) 18 ----------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS.. 10 28 (85) (47) Income from discontinued operations, net of tax............................... 1 57 -- 58 ----------------------------------------------------------- NET INCOME................................ $ 11 $ 85 $ (85) $ 11 =========================================================== CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET SALES ................................ $ 2,266 $ 894 $ (401) $ 2,759 Cost of goods sold........................ 2,106 759 (428) 2,437 ----------------------------------------------------------- GROSS PROFIT ............................. 160 135 27 322 Marketing, administrative and technological expenses................................. 213 60 -- 273 Amortization of intangible assets......... 1 -- -- 1 ----------------------------------------------------------- OPERATING INCOME (LOSS) .................. (54) 75 27 48 Equity earnings (loss) from affiliates.... 150 (6) (48) 96 Interest expense.......................... (61) (23) -- (84) Other income, net......................... 26 7 (25) 8 Reorganization items, net................. (45) (4) -- (49) ----------------------------------------------------------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE....................... 16 49 (46) 19 Income tax expense........................ 4 8 -- 12 ----------------------------------------------------------- INCOME FROM CONTINUING OPERATIONS 12 41 (46) 7 Income (Loss) from discontinued operations, net of tax............................... (3) 7 -- 4 ----------------------------------------------------------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE.................. 9 48 (46) 11 Cumulative effect of change in accounting principle, net of tax.................... (1) (2) -- (3) ----------------------------------------------------------- NET INCOME................................ $ 8 $ 46 $ (46) $ 8 =========================================================== 57 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2004 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET SALES................................. $ 2,180 $ 832 $ (375) $2,637 Cost of goods sold........................ 2,110 701 (395) 2,416 ----------------------------------------------------------- GROSS PROFIT.............................. 70 131 20 221 Marketing, administrative and technological expenses................................. 222 58 (1) 279 Amortization of intangible assets......... 1 -- -- 1 ----------------------------------------------------------- OPERATING INCOME (LOSS)................... (153) 73 21 (59) Equity loss from affiliates............... (33) (14) 21 (26) Interest expense.......................... (89) (24) -- (113) Other income (expense), net............... 29 (8) (21) -- Loss on debt modification................. -- (15) -- (15) Reorganization items, net................. (73) -- -- (73) ----------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT)...... (319) 12 21 (286) Income tax expense (benefit).............. (5) 3 -- (2) ----------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS.. (314) 9 21 (284) Loss from discontinued operations, net of tax............................... (2) (30) -- (32) ----------------------------------------------------------- NET LOSS ................................. $ (316) $ (21) $ 21 $ (316) =========================================================== 58 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2006 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ ASSETS Current assets............................ $ 497 $ 436 $ (85) $ 848 Property, plant and equipment, net........ 660 135 -- 795 Investment in subsidiaries and affiliates. 448 216 (471) 193 Goodwill and identified intangible assets, net...................................... 100 20 -- 120 Other assets.............................. 58 42 (1) 99 ----------------------------------------------------------- TOTAL ASSETS........................... $ 1,763 $ 849 $ (557) $ 2,055 =========================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities....................... $ 1,019 $ 169 $ (64) $ 1,124 Long-term debt............................ -- 210 -- 210 Other liabilities......................... 198 91 -- 289 ----------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 1,217 470 (64) 1,623 LIABILITIES SUBJECT TO COMPROMISE......... 1,963 -- (114) 1,849 TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,417) 379 (379) (1,417) ----------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)................................ $ 1,763 $ 849 $ (557) $ 2,055 =========================================================== CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2005 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ ASSETS Current assets............................ $ 447 $ 430 $ (72) $ 805 Property, plant and equipment, net........ 674 96 -- 770 Investment in subsidiaries and affiliates. 388 213 (396) 205 Goodwill and identified intangible assets, net...................................... 100 4 -- 104 Other assets.............................. 62 38 -- 100 ----------------------------------------------------------- TOTAL ASSETS........................... $ 1,671 $ 781 $ (468) $ 1,984 =========================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities....................... $ 644 $ 176 $ (53) $ 767 Long-term debt............................ -- 247 -- 247 Other liabilities......................... 201 47 -- 248 ----------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 845 470 (53) 1,262 LIABILITIES SUBJECT TO COMPROMISE......... 2,280 -- (104) 2,176 TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,454) 311 (311) (1,454) ----------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)................................ $ 1,671 $ 781 $ (468) $ 1,984 =========================================================== 59 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2006 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES................................. (241) $ 57 $ -- $ (184) NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES................................. (90) 42 -- (48) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES................................. 351 (76) -- 275 ----------------------------------------------------------- NET INCREASE IN CASH AND CASH EQUIVALENTS... 20 23 -- 43 CASH AND CASH EQUIVALENTS: Beginning of year......................... 18 89 -- 107 ----------------------------------------------------------- End of year............................... $ 38 $ 112 $ -- $ 150 =========================================================== CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2005 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES................................. $ (87) $ 63 $ -- $ (24) NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES................................. 20 (20) -- -- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES................................. 35 (19) -- 16 ----------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................. (32) 24 -- (8) CASH AND CASH EQUIVALENTS: Beginning of year......................... 50 65 -- 115 ----------------------------------------------------------- End of year............................... $ 18 $ 89 $ -- $ 107 =========================================================== CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2004 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES................................. $ (17) $ 58 $ -- $ 41 NET CASH USED IN INVESTING ACTIVITIES....... (73) (24) -- (97) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES................................. 15 (3) -- 12 ----------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................ (75) 31 -- (44) CASH AND CASH EQUIVALENTS: Beginning of year......................... 125 34 -- 159 ----------------------------------------------------------- End of year............................... $ 50 $ 65 $ -- $ 115 ===========================================================
2. SIGNIFICANT ACCOUNTING POLICIES Financial Statement Presentation The consolidated financial statements have been prepared in accordance with Statement of Position 90-7 ("SOP 90-7"), Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, and on a going concern basis, which assumes the continuity of operations and reflects the realization of assets and satisfaction of liabilities in the ordinary course of business. However, as a result of the Chapter 11 bankruptcy proceedings, such realization of assets and satisfaction of liabilities are subject to a significant number of uncertainties that have not been reflected in the consolidated financial statements. 60 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Basis of Consolidation The consolidated financial statements include the accounts of Solutia and its majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Companies in which Solutia has a significant interest but not a controlling interest are accounted for under the equity method of accounting and included in Investments in Affiliates in the Consolidated Statement of Financial Position. Solutia's proportionate share of these companies' net earnings or losses is reflected in Equity Earnings (Loss) from Affiliates in the Consolidated Statement of Operations. In accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 46, Consolidation of Variable Interest Entities, as amended, variable interest entities in which Solutia is the primary beneficiary are consolidated within the consolidated financial statements. 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 which 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, intangible assets, income taxes, asset impairments and contingencies. Actual results, particularly with respect to those matters affected by the Chapter 11 bankruptcy proceedings, could materially differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents consist of cash and temporary investments with maturities of three months or less when purchased. Inventory Valuation Inventories are stated at cost or market, whichever is less. 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 inventories in the United States, excluding supplies and CPFilms' inventory in the United States (73 percent as of both December 31, 2006, and 2005) 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 inventories outside the United States, as well as supplies inventories in the United States, 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 5 to 35 years for buildings and improvements and 3 to 15 years for machinery and equipment, by the straight-line method. Periodically, Solutia conducts a complete shutdown of certain manufacturing units ("turnaround") to perform necessary inspections, repairs and maintenance. Costs associated with significant turnarounds, which include estimated costs for material, labor, supplies and contractor assistance, are accrued ratably during the period between each planned activity, which generally occurs every 2 to 3 years. 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 and indefinite-lived intangible assets are assessed annually for impairment in the fourth quarter, or more frequently if changes in the circumstances indicate they may not be recoverable. 61 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 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. Environmental liabilities are not discounted, and they have not been reduced for any claims for recoveries from third parties. In those cases where third-party indemnitors have agreed to pay any amounts and management believes that collection of such amounts is probable, the amounts are reflected as receivables in the consolidated financial statements. 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 claims incurred using certain actuarial assumptions followed in the insurance industry, Solutia's historical experience and certain case specific reserves as required, including estimated legal costs. The maximum extent of the self-insurance provided by Solutia 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, automobile and property liability claims. Policies for periods prior to the spinoff are shared with Pharmacia. 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 Solutia's primary revenue-earning activities involve producing and delivering goods. Revenues are considered to be earned when Solutia has completed the process by which it is entitled to such revenues. The following criteria are used for revenue recognition: persuasive evidence that an arrangement exists, delivery has occurred, selling price is fixed or determinable and collection is reasonably assured. Allowance for Doubtful Accounts The provisions for losses on uncollectible trade receivables are determined primarily on the basis of past collection experience applied to ongoing evaluations of Solutia's receivables and evaluations of the risks of uncollectibility. Distribution Costs Solutia includes inbound freight charges, purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs and the other costs of its distribution network in Cost of Goods Sold in the Consolidated Statement of Operations. Shipping and Handling Costs Amounts billed for shipping and handling are included in Net Sales and the costs incurred for these activities are included in Cost of Goods Sold in the Consolidated Statement of Operations. 62 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Derivative Financial Instruments In accordance with Statement of Financial Accounting Standard ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"), as amended, all derivatives, whether designated for hedging relationships or not, are recognized in the Consolidated Statement of Financial Position at their fair value. Currency forward and option contracts are used to manage currency exposures for financial instruments denominated in currencies other than the entity's functional currency. Solutia has chosen not to designate these instruments as hedges and to allow the gains and losses that arise from marking the contracts to market to be included in Other Income, net in the Consolidated Statement of Operations. Natural gas forward and option contracts are used to manage some of the exposure for the cost of natural gas. These market instruments are designated as cash flow hedges. The mark-to-market gain or loss on qualifying hedges is included in Accumulated Other Comprehensive Loss in the Consolidated Statement of Financial Position to the extent effective, and reclassified into Cost of Goods Sold in the Consolidated Statement of Operations in the period during which the hedged transaction affects earnings. The mark-to-market gains or losses on ineffective portions of hedges are recognized in Cost of Goods Sold immediately. Income Taxes Solutia accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities at enacted rates. Solutia determines the appropriateness of valuation allowances in accordance with the "more likely than not" recognition criteria outlined in SFAS No. 109, Accounting for Income Taxes. 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 are included in Accumulated Other Comprehensive Loss in the Consolidated Statement of Financial Position. 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 As of January 1, 2006, Solutia adopted SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123(R). The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. Additionally, Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options to purchase Solutia's common stock will receive any consideration in our Chapter 11 Cases for their equity based compensation. 63 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Recently Issued Accounting Standards In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, ("FIN 48"). FIN 48 creates a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 eliminates income taxes from the scope of SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative effect adjustment recorded to the beginning balance of retained earnings. The cumulative effect adjustment would not apply to those items that would not have been recognized in earnings, such as the effect of adopting FIN 48 on tax positions related to business combinations. Solutia is currently evaluating the impact of FIN 48 on the consolidated financial statements. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS No. 157 simplifies and codifies fair value related guidance previously issued within generally accepted accounting principles (GAAP). Although, SFAS No. 157 does not require any new fair value measurements, its application may, for some entities, change current practice. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Solutia is currently evaluating the impact of SFAS No. 157 on the consolidated financial statements. In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans ("SFAS No. 158"). SFAS No. 158 requires the recognition of the funded status of pension and other postretirement benefit plans on the balance sheet. The overfunded or underfunded status would be recognized as an asset or liability on the balance sheet with changes occurring during the current year reflected through the comprehensive income portion of equity. Further, SFAS No. 158 requires the unrecognized transition asset or obligation, gains or losses, and prior service costs to be recognized as a component of other comprehensive income, net of tax. SFAS No. 158 will also require the measurement of the funded status of a plan to match that of the date of the Company's fiscal-year-end financial statements, eliminating the use of earlier measurement dates previously permissible. The portions of SFAS No. 158 relating to the recognition of the funded status of a plan and the unrecognized components of net periodic benefit cost are effective for fiscal years ending after December 15, 2006. See Note 16 for the impact of SFAS No. 158 on the consolidated financial statements. In September 2006, the FASB issued FASB Staff Position AUG AIR-1, Accounting For Planned Major Maintenance Activities ("FSP AUG AIR-1"), that eliminates the acceptability of the accrue-in-advance method of accounting for planned major maintenance activities. This staff position is effective for fiscal years beginning after December 15, 2006 and requires retrospective application to all prior period results presented. The Company has been accruing for certain major maintenance activities associated with periodic major overhauls and maintenance of equipment under the accrue-in-advance method. The anticipated impact upon adoption of FSP AUG AIR-1 on Solutia's consolidated financial statements is estimated to be an approximate $13 increase in beginning retained earnings. 3. LIABILITIES SUBJECT TO COMPROMISE AND REORGANIZATION ITEMS, NET Liabilities Subject to Compromise Under Chapter 11 of the U.S. Bankruptcy Code, certain claims against Solutia in existence prior to the filing of the petitions for relief under the federal bankruptcy laws are stayed while Solutia continues business operations as debtor-in-possession. These estimated claims are reflected in the Consolidated Statement of Financial Position as Liabilities Subject to Compromise as of December 31, 2006 and 2005 and are summarized in the table below. Such claims remain subject to future adjustments. Adjustments may result from actions of the Bankruptcy Court, negotiations with claimants, rejection or acceptance of executory contracts, determination of value of any collateral securing claims, reconciliation of proofs of claim or other events. 64 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Solutia has received approval from the Bankruptcy Court to pay or otherwise honor certain of its pre-petition obligations, including (i) certain pre-petition compensation to employees and employee-equivalent independent contractors; (ii) business expenses of employees; (iii) obligations under employee benefit plans; (iv) employee payroll deductions and withholdings; (v) costs and expenses incident to the foregoing payments (including payroll-related taxes and processing costs); (vi) certain pre-petition workers' compensation claims, premiums and related expenses; (vii) certain pre-petition trust fund and franchise taxes; (viii) pre-petition claims of certain contractors, freight carriers, processors, customs brokers and related parties; (ix) customer accommodation programs; and (x) pre-petition claims of critical vendors in the ordinary course of business. Accordingly, these pre-petition items have been excluded from Liabilities Subject to Compromise as of December 31, 2006 and 2005, as applicable. The amounts subject to compromise consisted of the following items: DECEMBER 31, ------------ 2006 2005 ---- ---- Postretirement benefits (a)........................... $ 800 $1,098 Litigation reserves (b)............................... 111 136 Accounts payable (c).................................. 116 118 Environmental reserves (d)............................ 81 82 Other miscellaneous liabilities....................... 73 74 6.72% debentures due 2037(e).......................... 150 150 7.375% debentures due 2027(e)......................... 300 300 11.25% notes due 2009 (f)............................. 223 223 Other (g)............................................. 43 43 ------ ------ 716 716 Unamortized debt discount and debt issuance costs..... (48) (48) ------ ------ TOTAL DEBT SUBJECT TO COMPROMISE................ 668 668 ------ ------ TOTAL LIABILITIES SUBJECT TO COMPROMISE............... $1,849 $2,176 ====== ====== (a) Postretirement benefits include Solutia's domestic (i) qualified pension plan of $305 and $501 as of December 31, 2006 and December 31, 2005, respectively; (ii) non-qualified pension plan of $19 as of both December 31, 2006 and 2005; and (iii) other postretirement benefits of $476 and $578 as of December 31, 2006 and December 31, 2005, respectively. Pursuant to a Bankruptcy Court order, Solutia made payments with respect to other postretirement obligations of $96 and $85 in 2006 and 2005, respectively. Solutia also made contributions of $179 to its qualified pension plan pursuant to IRS funding requirements in 2006. (b) An automatic stay has been imposed against the commencement or continuation of legal proceedings against Solutia outside of the bankruptcy court process. Consequently, Solutia's accrued liability with respect to pre-petition legal proceedings has been classified as subject to compromise as of December 31, 2006 and 2005. During the second quarter 2006, Solutia transferred out of liabilities subject to compromise $20 of litigation reserves related to the PENNDOT litigation matter that were no longer deemed uncertain as a result of a favorable court ruling (as further described in Note 20). Pursuant to a Bankruptcy Court order, Solutia made annual scheduled payments of $5 in both 2006 and 2005 with respect to the Anniston litigation settlement reached in 2003. (c) Pursuant to Bankruptcy Court orders, Solutia settled certain accounts payable liabilities subject to compromise in 2006 and 2005. (d) Represents remediation obligations related primarily to properties that are not owned or operated by Solutia, including non-owned properties adjacent to plant sites and certain owned offsite disposal locations. See Note 20 for further disclosure with respect to ongoing legal proceedings concerning environmental liabilities subject to compromise. (e) While operating during the Chapter 11 bankruptcy proceedings, Solutia has ceased recording interest on its 6.72% debentures due 2037 and its 7.375% debentures due 2027. The amount of annual contractual interest expense not recorded was approximately $32 in both 2006 and 2005. (f) Pursuant to a Bankruptcy Court order, Solutia is required to continue payments of the contractual interest on its 11.25% notes due 2009 as a form of adequate protection under the U.S. Bankruptcy Code; provided, however, that Solutia's official committee of unsecured creditors (the "Creditors' Committee") has the right at any time, and Solutia has the right at any time after the payment of the contractual interest made in July 2005, to seek to terminate Solutia's obligation to continue making the interest payments. Solutia or the Creditors' Committee could successfully terminate all or part of Solutia's interest payment obligations only after a showing that the noteholders are not entitled to adequate protection, which would depend, among other things, on the value of the collateral securing the notes as of December 17, 2003, and whether that value is decreasing during the course of Solutia's 65 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) bankruptcy case. The amount of annual contractual interest paid with respect to these notes was approximately $25 in both years ended December 31, 2006 and 2005, and the accrued interest related to these notes was included in Accrued Liabilities classified as not subject to compromise as of December 31, 2006 and 2005. (g) Represents the debt obligation incurred upon the consolidation of the assets and liabilities of a synthetic lease structure consolidated as part of the adoption of FASB Interpretation No. 46, Consolidation of Variable Interest Entities. The obligation represents the synthetic lease arrangement with respect to Solutia's headquarters building. Reorganization Items, net Reorganization items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain or loss that are realized or incurred by Solutia because it is in reorganization under Chapter 11 of the U.S. Bankruptcy Code. Reorganization items, net consisted of the following items:
YEAR ENDED DECEMBER 31, ----------------------- 2006 2005 2004 ---- ---- ---- Professional fees (a)............................................. $ 58 $ 49 $ 46 Contract rejection and termination costs (b)...................... -- -- 20 Severance and employee retention costs (c)........................ 4 12 9 Adjustments to allowed claim amounts (d) ......................... (2) 10 -- Settlement of pre-petition claims (e)............................. -- (31) (2) Other............................................................. 11 9 -- ------ ------ ------ TOTAL REORGANIZATION ITEMS, NET................................... $ 71 $ 49 $ 73 ====== ====== ====== (a) Professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings. (b) Asset write-offs associated with contract rejections and terminations resulting from the ongoing reorganization-related evaluation of the financial viability of Solutia's existing contracts. (c) Expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court. (d) Adjustments to record certain pre-petition claims at estimated amounts of the allowed claims. (e) Represents the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded.
4. ACQUISITIONS AND DIVESTITURES On March 1, 2006, pursuant to a stock purchase agreement among Solutia, Vitro S.A. de C.V. ("Vitro") and Vitro Plan S.A. de C.V. ("Vitro Plan"), a 100% owned subsidiary of Vitro, Solutia acquired Vitro Plan's 51 percent stake in Quimica M, S.A. de C.V. ("Quimica") (originally formed in 1996 as a joint venture between Vitro, Vitro Plan, and Monsanto) for approximately $20 in cash. As a result of this acquisition, Solutia became the sole owner of Quimica and its plastic interlayer plant located in Puebla, Mexico. Pursuant to the purchase agreement, Solutia also entered into supply agreements with Vitro Flex S.A. de C.V. and Vitro Automotriz S.A. de C.V. to provide their requirements for most SAFLEX(R) plastic interlayer products for up to five years. This acquisition reflects Solutia's commitment to meet the growing global demand for its SAFLEX(R) plastic interlayer products. The allocation of purchase price to the assets acquired and liabilities assumed resulted in Solutia's acquisition or assumption of total current assets of $18, non-current assets of $32, goodwill of $5, amortizable contract-based intangible assets of $4, current liabilities of $11 and non-current liabilities of $7. The contract-based intangible assets are being amortized over their estimated useful lives of 5 years. Results of operations for Quimica were included in Solutia's results of operations from the acquisition date in the Performance Products segment. The results of operations for the acquired business were not material to Solutia's consolidated results of operations. Astaris, a 50/50 joint venture with FMC Corporation ("FMC"), divested substantially all of its operating assets in the fourth quarter 2005. Under the terms of the agreement, Israel Chemicals Limited ("ICL") purchased substantially all of the operating assets of Astaris for $255, subject to certain purchase price adjustments. As a result of this divestiture of assets, 66 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Solutia realized a $50 net gain on sale recorded in Equity Earnings (Loss) from Affiliates in the Consolidated Statement of Operations. In addition, certain of the assets and liabilities of Astaris that were not included in the sale to ICL were transferred to Solutia and FMC. Generally, these assets and liabilities consist of property originally contributed to the joint venture by Solutia and FMC, as well as associated liabilities. In December 2004, Solutia sold the assets of Axio Research Corporation ("Axio") for less than $1, resulting in a loss on sale of $1. Discontinued Operations On August 22, 2006, Solutia's 100% owned subsidiary Solutia Europe S.A./N.V. ("SESA"), sold its pharmaceutical services business to Dishman Pharmaceuticals & Chemicals Ltd. ("Dishman"). Under the terms of the sale, Dishman purchased 100 percent of the stock of the pharmaceutical services business, as well as certain other assets used in the pharmaceutical services business, for $77, subject to certain purchase price adjustments. Dishman also assumed substantially all of the liabilities relating to the pharmaceutical services business, other than certain liabilities that arose prior to the closing of the transaction and liabilities under certain employment agreements. SESA agreed, subject to certain exceptions, that for a period of three years after the closing of the transaction neither it nor its affiliates will compete with the pharmaceutical services business or solicit for employment certain employees of the pharmaceutical services business and their current affiliates. The pharmaceutical services business was a component of the Performance Products segment prior to the classification as discontinued operations. Solutia recorded a gain on the sale of the pharmaceutical services business of $49. Further, Solutia used $51 of the proceeds from the sale to pay down SESA's (euro)200 million credit facility (as described in Note 14). The carrying amounts of assets and liabilities from discontinued operations have been classified as current in the Consolidated Statement of Financial Position and consisted of the following:
DECEMBER 31, DECEMBER 31, 2006 2005 ---- ---- ASSETS: Trade receivables............................................ $ -- $ 7 Miscellaneous receivables.................................... -- 1 Inventories.................................................. -- 13 Prepaid expenses and other assets............................ -- 1 Property, plant and equipment, net........................... -- 34 Identified intangible assets, net............................ -- 7 Other assets................................................. -- 6 ----- ---- Assets of discontinued operations................... $ -- $ 69 ===== ==== LIABILITIES: Accounts payable............................................. $ -- $ 4 Accrued liabilities.......................................... 1 17 Other liabilities............................................ -- 5 ----- ---- Liabilities of discontinued operations.............. $ 1 $ 26 ===== ====
67 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) The operating results of the pharmaceutical services business have been reported separately as discontinued operations, net of tax, in the Consolidated Statement of Operations for each period presented. Net sales and income from discontinued operations are as follows:
YEAR ENDED DECEMBER 31, ----------------------- 2006 2005 2004 ---- ---- ---- Net sales .................................... $ 42 $66 $ 60 Income (loss) before income taxes............. 54 5 (36) Income tax expense (benefit) ................. (4) 1 (4) ---- --- ---- INCOME (LOSS) FROM DISCONTINUED OPERATIONS ... $ 58 $ 4 $(32) ==== === ====
Solutia recorded a gain on the sale of the pharmaceutical services business of $49. The gain on sale was exempt from tax outside the United States and no gain was realized for United States tax purposes. 5. INCOME (LOSS) PER SHARE
YEAR ENDED DECEMBER 31, ----------------------- 2006 2005 2004 ---- ---- ---- Income (Loss) from Continuing Operations.......................... $ (47) $ 7 $ (284) Income (Loss) from Discontinued Operations, net of tax............ 58 4 (32) ------ ------ ------ Income (Loss) Before Cumulative Effect of Change in Accounting Principle........................................................ 11 11 (316) Cumulative Effect of Change in Accounting Principle, net of tax... -- (3) -- ------ ------ ------ Net Income (Loss)................................................. $ 11 $ 8 $ (316) ====== ====== ====== Basic and Diluted Income (Loss) per Share: Income (Loss) from Continuing Operations.......................... $(0.45) $ 0.07 $(2.72) Income (Loss) from Discontinued Operations, net of tax............ 0.56 0.04 (0.30) ------ ------ ------ Income (Loss) Before Cumulative Effect of Change in Accounting Principle........................................................ 0.11 0.11 (3.02) Cumulative Effect of Change in Accounting Principle, net of tax... -- (0.03) -- ------ ------ ------ Basic and Diluted Income (Loss) per Share......................... $ 0.11 $ 0.08 $(3.02) ------ ------ ------ Basic and Diluted Weighted Average Shares Outstanding (in millions) 104.5 104.5 104.5 ----- ----- -----
6. RESTRUCTURING RESERVES During 2006, Solutia recorded $3 of decommissioning and dismantling costs primarily as a result of the 2005 shut-down of its acrylic fibers business, and $3 of asset write-downs. Solutia also recorded $3 of future contractual payments related to the termination of a third party manufacturing agreement. These costs were all recorded within Reorganization Items, net with $4 in the Integrated Nylon segment and $5 in the Performance Products segment. In addition, Solutia recorded $8 of severance and retraining costs in 2006 with $4 recorded in Reorganization Items, net and $3 in Marketing and Administrative expenses and $1 in Cost of Goods Sold involving headcount reductions within the Integrated Nylon and Performance Products segments. Cash outlays associated with the restructuring actions were funded from operations. During 2005, Solutia recorded restructuring charges of $13 in Reorganization Items, net involving the shut-down of its acrylic fiber operations at its plant in Decatur, Alabama and the shut-down of its nylon industrial fiber manufacturing unit at its plant in Pensacola, Florida. This $13 of net charges from the closure of these businesses included $12 of asset write-downs, $7 of decontamination and dismantling costs and $4 of severance and retraining costs, partially offset by a $7 gain from the reversal of the LIFO reserve associated with the inventory sold and/or written off as part of the business shut-down 68 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) and a $3 gain from the sale of certain acrylic fibers assets. In addition, Solutia recorded $4 of severance and retraining costs in 2005 with $2 recorded in Reorganization Items, net and $2 in Cost of Goods Sold involving headcount reductions within the Integrated Nylon and Performance Products segments, as well as the corporate function. Cash outlays associated with the restructuring actions were funded from operations. The following table summarizes the above noted restructuring charges, amounts utilized to carry out those plans and amount remaining at December 31, 2006:
DECOMMISSIONING/ FUTURE CONTRACTUAL EMPLOYMENT ASSET DISMANTLING PAYMENTS REDUCTIONS WRITE-DOWNS TOTAL --------------------------------------------------------------------------------- Balance at January 1, 2005.......... $ 5 $ 12 $ -- $ -- $ 17 Charges taken..................... 7 -- 8 12 27 Amounts utilized.................. (10) (12) (6) (12) (40) --------------------------------------------------------------------------------- Balance at December 31, 2005........ $ 2 $ -- $ 2 $ -- $ 4 CHARGES TAKEN..................... 3 3 8 3 17 AMOUNTS UTILIZED.................. (4) (1) (8) (3) (16) --------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2006........ $ 1 $ 2 $ 2 $ -- $ 5 =================================================================================
Restructuring reserves of less than $1 as of December 31, 2006 were included in Liabilities Subject to Compromise in the Consolidated Statement of Financial Position. See Note 3 for further description of Solutia's Liabilities Subject to Compromise. In addition, Solutia expects the majority of the $5 of restructuring liabilities classified as not subject to compromise as of December 31, 2006 to be utilized within the next twelve months. Given the inherent uncertainties associated with the bankruptcy process, Solutia cannot forecast its level of future spending for restructuring reserves classified as subject to compromise. 7. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill Goodwill of $89 and $76 at December 31, 2006 and 2005, respectively, was allocated to the Performance Products segment. This $13 increase in goodwill was a result of the Quimica acquisition (as further described in Note 4), of which $5 resulted from the 2006 acquisition and $8 resulted from the original acquisition in 1996 that was previously accounted for under the equity method of accounting. There were no impairments to the net carrying amount of goodwill during the year ended December 31, 2006. Identified Intangible Assets Identified intangible assets generally are comprised of (i) amortizable contract-based intangible assets with finite useful lives, and (ii) indefinite-lived trademarks not subject to amortization. These intangible assets are summarized in aggregate as follows:
DECEMBER 31, ----------------------------------------------------------------------------- 2006 2005 ------------------------------------- ------------------------------------ GROSS NET GROSS NET CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING VALUE AMORTIZATION VALUE VALUE AMORTIZATION VALUE ------------------------------------- ------------------------------------ Amortizable intangible assets (a)......... $ 12 $ (7) $ 5 $ 8 $ (6) $ 2 Trademarks................................ 26 -- 26 26 -- 26 ------------------------------------- ------------------------------------ TOTAL IDENTIFIED INTANGIBLE ASSETS........ $ 38 $ (7) $ 31 $ 34 $ (6) $ 28 ===================================== ==================================== (a) The $4 increase in Gross Carrying Value was a result of the Quimica acquisition (as further described in Note 4). Further, there were no write downs or disposals of Amortizable Intangible Assets in 2006.
69 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) There were no changes to amortizable lives or methods during the year ended December 31, 2006. In addition, amortization expense for the net carrying amount of finite-lived intangible assets is estimated to be $1 annually from 2007 through 2010 and less than $1 in 2011. 8. RISK MANAGEMENT ACTIVITIES Solutia's business operations give rise to market risk exposures that result from changes in currency exchange rates, interest rates and certain commodity prices. To manage the volatility relating to these exposures, Solutia enters into various hedging transactions that enable it to alleviate the adverse effects of financial market risk. Designation is performed on a specific exposure basis to support hedge accounting. The changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the fair value or cash flows of the underlying exposures being hedged. Solutia's hedging transactions are carried out under policies and procedures approved by the Audit and Finance Committee of the Board of Directors, which does not permit the purchase or holding of any derivative financial instruments for trading purposes. Foreign Currency Exchange Rate Risk Solutia manufactures and sells its products in a number of countries throughout the world and, as a result, is exposed to movements in foreign currency exchange rates. Solutia uses foreign currency hedging instruments to manage the volatility associated with foreign currency purchases of materials and other assets and liabilities created in the normal course of business. Solutia primarily uses forward exchange contracts and purchased options to hedge these risks with maturities of less than 18 months. Solutia also enters into certain foreign currency derivative instruments primarily to protect against exposure related to intercompany financing transactions. Solutia has chosen not to designate these instruments as hedges and to allow the gains and losses that arise from marking the contracts to market to be recorded in Other Income, net in the period. There was a net loss of $3, $1, and $3 recorded in the years ended December 31, 2006, 2005 and 2004. Solutia had currency forward and option contracts to purchase and sell $181 and $365 of currencies as of December 31, 2006 and 2005, respectively, comprised principally of the Euro, British Pound-Sterling, Swiss Franc and U.S. Dollar. Interest Rate Risk Interest rate risk is primarily related to changes in interest expense from floating rate debt. Solutia believes its current debt structure mitigates some of the risk associated with changes in interest rates due to the combination of fixed versus floating rate debt instruments. Further, periodically, the Company does enter into contracts to further mitigate interest rate risk. Commodity Price Risk Certain raw materials and energy resources used by Solutia are subject to price volatility caused by weather, crude oil prices, supply conditions, political and economic variables and other unpredictable factors. Solutia uses forward and option contracts to manage a portion of the volatility related to anticipated energy purchases with maturities up to 6 months. These market instruments are designated as cash flow hedges. The mark-to-market gain or loss on qualifying hedges is included in Accumulated Other Comprehensive Loss to the extent effective, and reclassified into Cost of Goods Sold in the period during which the hedged transaction is settled. The mark-to-market gains or losses on ineffective portions of hedges are recognized in Cost of Goods Sold immediately. As of December 31, 2006, less than $1 of after-tax unrealized net losses on derivative instruments was recorded in Accumulated Other Comprehensive Loss and is expected to be reclassified into Cost of Goods Sold in the first quarter of 2007. The actual purchases of energy, which are expected to occur during the next 3 months, will necessitate the reclassification of the derivative losses into Cost of Goods Sold. There were no gains or losses recorded in Cost of Goods Sold as a result of the ineffectiveness of any hedging contacts, and no cash flow hedges were discontinued during 2006 or 2005 due to changes in expectations on the original forecasted transactions. Solutia had commodity forward contracts with notional amounts of $2 and $9 as of December 31, 2006 and 2005, respectively. 70 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Credit Risk Credit risk arising from the inability of a counterparty to meet the terms of Solutia's financial instrument contracts is generally limited to the amounts, if any, by which the counterparty's obligations exceed the obligations of Solutia. It is Solutia's policy to enter into financial instruments with a number of creditworthy counterparties. Therefore, Solutia does not expect to incur material credit losses on its risk management or other financial statement instruments. 9. INVESTMENTS IN AFFILIATES As further described in Note 4, Astaris divested substantially all of its operating assets in the fourth quarter 2005. Pursuant to this transaction, there were certain assets and liabilities of Astaris that were not included in the sale to ICL which were transferred to Solutia and FMC. Generally, these assets and liabilities consisted of property originally contributed to the joint venture by Solutia and FMC, as well as certain pre-closing liabilities relating to Astaris, including certain pre-closing environmental liabilities. In addition, certain non-operating assets and liabilities remained in the Astaris joint venture as part of the transaction. Further, the name of the joint venture which holds these remaining assets and liabilities was changed from Astaris LLC to Siratsa LLC. At December 31, 2006, Solutia's investments in affiliates consisted principally of its 50 percent interests in the Flexsys and Siratsa joint ventures for which Solutia applies the equity method of accounting. Summarized combined financial information for 100 percent of the Flexsys and Siratsa joint ventures is as follows:
YEAR ENDED DECEMBER 31, ----------------------- 2006 2005 2004 ---- ---- ---- RESULTS OF OPERATIONS: Net sales............................ $606 $963 $878 Gross profit ........................ 155 233 140 Operating income (loss).............. 91 108 (18) Net income (loss).................... 66 192 (46) DECEMBER 31, ------------ 2006 2005 ---- ---- FINANCIAL POSITION: Current assets....................... $267 $271 Non-current assets................... 355 368 Current liabilities.................. 170 143 Non-current liabilities.............. 72 133
Solutia's investment in Flexsys as of December 31, 2006 and 2005 exceeded Solutia's proportionate share of the underlying equity of Flexsys by $5 and $1, respectively, primarily due to goodwill recorded by Solutia at inception of the joint venture. Solutia received a $25 dividend from Flexsys during the third quarter 2006, while there were no dividends from either Flexsys or Siratsa during 2005. 71 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 10. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
DECEMBER 31, ------------ INVENTORIES 2006 2005 ---- ---- Finished goods................................................ $ 226 $ 236 Goods in process.............................................. 165 131 Raw materials and supplies.................................... 92 93 ------ ------ Inventories, at FIFO cost..................................... 483 460 Excess of FIFO over LIFO cost................................. (209) (206) ------ ------ TOTAL......................................................... $ 274 $ 254 ====== ====== Inventories at FIFO approximate current cost. DECEMBER 31, ------------ PROPERTY, PLANT AND EQUIPMENT 2006 2005 ---- ---- Land.......................................................... $ 18 $ 19 Leasehold improvements........................................ 37 37 Buildings..................................................... 435 412 Machinery and equipment....................................... 2,757 2,734 Construction in progress...................................... 66 50 ------ ------ Total property, plant and equipment........................... 3,313 3,252 Less accumulated depreciation................................. (2,518) (2,482) ------ ------ TOTAL......................................................... $ 795 $ 770 ====== ====== DECEMBER 31, ------------ ACCRUED LIABILITIES 2006 2005 ---- ---- Wages and benefits............................................ $ 61 $ 54 Accrued selling expenses...................................... 32 34 Accrued interest.............................................. 20 23 Other......................................................... 132 112 ------ ------ TOTAL......................................................... $ 245 $ 223 ====== ======
11. VARIABLE INTEREST ENTITIES Solutia has a synthetic lease related to its corporate headquarters in St. Louis, Missouri, entered into in 1999, that qualifies as a variable interest entity ("VIE"). Based on the terms of the lease agreement and the residual value guarantee Solutia provides to the lessor, Solutia concluded it is the primary beneficiary of the VIE and is consolidated in accordance with FASB Interpretation No. 46, Consolidation of Variable Interest Entities. As a result, the property, plant and equipment of $32 and long-term debt of $43 held by the VIE are included in the Consolidated Statement of Financial Position. 12. ASSET RETIREMENT OBLIGATIONS In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143 ("FIN 47"). FIN 47 clarifies that the term "conditional asset retirement obligation" as used in SFAS No. 143, Accounting for Asset Retirement Obligations ("SFAS No. 143"), refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement, including those that may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional 72 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and (or) method of settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when sufficient information to reasonably estimate the fair value of an asset retirement obligation is considered available. Upon adoption of SFAS No. 143 as of January 1, 2003, Solutia identified certain conditional asset retirement obligations; however, these obligations were not recorded due to uncertainties involved with the determination of settlement timing. With the clarification outlined by FIN 47 for valuation of conditional asset retirement obligations, Solutia reevaluated the valuation concerns involving settlement timing for these conditional asset retirement obligations and accordingly reported an asset retirement obligation of $7 as of December 31, 2005. These obligations involve various federal, state and local regulations and/or contractual obligations to decontaminate and/or dismantle certain machinery and equipment, buildings, and leasehold improvements at Solutia's various operating locations. Asset retirement obligations were estimated for each of Solutia's operating locations, where applicable, based upon Solutia's current and historical experience, adjusted for factors that a third-party would consider, such as overhead, profit and market risk premium. Estimated obligations were escalated based upon the anticipated timing of the related cash flows using an assumed inflation rate, and then were discounted using a credit-adjusted, risk-free interest rate. The impact of adoption resulted in a charge of $3 recorded as a cumulative effect of change in accounting principle (net of tax of $1) in the Consolidated Statement of Operations in 2005. The pro-forma effects of the application of FIN 47 for the years ended December 31, 2005 and 2004 for these specific conditional asset retirement obligations are presented below:
AS OF AND FOR THE YEAR ---------------------- ENDED DECEMBER 31, ------------------ Pro-forma amounts assuming the accounting change is applied 2005 2004 retroactively net of tax: ---- ---- Net income (loss).................................................. $ 8 $ (317) Net income (loss) per basic and diluted share...................... $ 0.08 $(3.03) Pro-forma amounts of liability for asset retirement obligation at beginning of period............................................... $ 4 $ 4 ------ ------ Pro-forma amounts of liability for asset retirement obligation at end of period..................................................... $ 5 $ 4 ------ ------
At December 31, 2006 and 2005, the Company had a liability pertaining to the asset retirement obligation in Other Liabilities on the Consolidated Statement of Financial Position. The following is a reconciliation of the beginning and ending carrying amount of the Company's asset retirement obligation and the related assets:
2006 2005 ---- ---- Asset retirement obligation, beginning of period................... $ 5 $ -- Cumulative effect of change in accounting principle................ -- 7 Asset retirement obligation reclassed to liabilities of discontinued operations........................................... -- (2) Accretion expense.................................................. -- -- ------ ------ Asset retirement obligation, end of period......................... $ 5 $ 5 ====== ======
The net book value of the related long-lived assets is less than $1 for both 2006 and 2005. 73 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 13. INCOME TAXES The components of income (loss) from continuing operations before income taxes were:
YEAR ENDED DECEMBER 31, ----------------------------------------------- 2006 2005 2004 ---- ---- ---- United States.................................. $ (66) $ (30) $ (300) Outside United States.......................... 37 49 14 ------- ------- ------- TOTAL.......................................... $ (29) $ 19 $ (286) ======= ======= =======
The components of income tax expense (benefit) recorded in continuing operations were:
YEAR END DECEMBER 31, ----------------------------------------------- 2006 2005 2004 ---- ---- ---- Current: U.S. federal............................... $ -- $ -- $ (5) U.S. state................................. -- -- (1) Outside United States...................... 13 4 10 ------- ------- ------- 13 4 4 Deferred: U.S. federal............................... -- -- -- U.S. state................................. -- -- -- Outside United States...................... 5 8 (6) ------- ------- ------- 5 8 (6) ------- ------- ------- Total.......................................... $ 18 $ 12 $ (2) ======= ======= =======
Income tax (benefit) expense differed from the amounts computed by applying the U.S. Federal income tax rate of 35% to income from continuing operations before income taxes as a result of the following:
YEAR END DECEMBER 31, ----------------------------------------------- 2006 2005 2004 ---- ---- ---- DOLLARS IN MILLIONS Income Tax at federal statutory rate........... $ (10) $ 7 $ (100) Increase (reduction) in income taxes due to: U.S. state income taxes..................... (3) (3) (11) Export tax benefit.......................... (2) (3) (3) Taxes related to foreign earnings........... 6 8 1 Valuation allowances........................ 24 12 108 Income from equity affiliates............... (10) (9) (3) Surrendered losses from equity affiliate (a) (4) (11) -- Reorganization costs........................ 12 13 13 Tax contingency adjustment.................. 8 -- (6) Other....................................... (3) (2) (1) ------- ------- ------- INCOME TAX EXPENSE (BENEFIT) .................. $ 18 $ 12 $ (2) ======= ======= ======= (a) During 2006, a non-consolidated equity affiliate surrendered a prior year loss that was used to offset a foreign subsidiary's taxable income in the United Kingdom. During 2005, a non-consolidated equity affiliate surrendered prior years losses that were used to offset a foreign subsidiary's taxable income in the United Kingdom.
74 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Deferred income tax balances were related to:
DECEMBER 31, -------------------------------- 2006 2005 ---- ---- Postretirement benefits.................................... $ 318 $ 421 Environmental liabilities.................................. 53 51 Inventory.................................................. 16 16 Insurance reserves......................................... 43 50 Miscellaneous accruals..................................... 15 18 Equity affiliates.......................................... 8 15 Net operating losses....................................... 412 295 Other...................................................... 51 48 ------ ------ TOTAL DEFERRED TAX ASSETS 916 914 Less: Valuation allowances................................. (698) (705) ------ ------ DEFERRED TAX ASSETS LESS VALUATION ALLOWANCES 218 209 ------ ------ Property................................................... (146) (159) Accrued interest........................................... (39) (26) Other...................................................... (20) (15) ------ ------ TOTAL DEFERRED TAX LIABILITIES (205) (200) ------ ------ NET DEFERRED TAX ASSETS.................................... $ 13 $ 9 ====== ======
At December 31, 2006, research and development tax credit carryforwards available to reduce possible future U.S. income taxes amounted to approximately $5, all of which will expire in 2019 through 2022. At December 31, 2006, various federal, state and foreign net operating loss carryforwards are available to offset future taxable income. These net operating losses expire from 2007 through 2026 or have an indefinite carryforward period. Valuation allowances have been provided for the tax credit and net operating loss carryforwards that are not likely to be utilized. Income taxes and remittance taxes have not been recorded on $87 of undistributed earnings of subsidiaries because Solutia intends to reinvest those earnings indefinitely. Solutia reduced the valuation allowances by $(7) in 2006 of which $24 was recorded in Income Tax Expense (Benefit) in the Consolidated Statement of Operations and $(31) was recorded in Accumulated Other Comprehensive Loss in the Consolidated Statement of Comprehensive Income (Loss). The valuation allowances are principally provided for the U.S. deferred tax assets as Solutia continues to no longer believe that the "more likely than not" recognition criteria outlined in SFAS No. 109, Accounting for Income Taxes, were appropriate given a combination of factors surrounding Solutia's Chapter 11 bankruptcy filing including: (i) the possibility that all or a substantial portion of the loss and credit carryforwards and tax bases of assets could be reduced to the extent of cancellation of indebtedness occurring as part of a reorganization plan; (ii) the possibility that all or a substantial portion of the loss and credit carryforwards could become limited if a change in ownership occurs as a result of a reorganization plan; and (iii) updated expectations regarding near-term taxable income. As of December 31, 2006, the Internal Revenue Service ("IRS") had completed its examination of the income tax returns of Solutia through 2001. No other years are currently being examined by the IRS. In addition, Solutia is subject to audits in several state and foreign jurisdictions. Solutia believes that it has adequate contingency reserves established for probable adjustments resulting from these audits. During 2006, Solutia increased its tax contingency reserves by $8 based on expected outcomes of income tax audits in various jurisdictions. The tax contingency reserves were adjusted by less than $(1) in 2005. 14. DEBT OBLIGATIONS As of December 31, 2006, Solutia's debt obligations include borrowings from its DIP credit facility, notes and debentures. The weighted average interest rate on Solutia's total debt outstanding at December 31, 2006 was 8.4 percent compared to 8.7 percent at December 31, 2005. Excluding debt subject to compromise, with the exception of the 11.25 percent notes due 2009 on which the Bankruptcy Court has permitted continued payments of the contractual interest (see 75 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Note 3 for further description of these notes due 2009), the weighted average interest rate on total debt was 8.9 percent at December 31, 2006, compared to 9.8 percent at December 31, 2005. The weighted average interest rate on Solutia's short-term debt outstanding at December 31, 2006, was 9.0 percent as compared to 8.5 percent at December 31, 2005. As a result of the Chapter 11 filing, Solutia was in default on all its debt agreements as of December 31, 2006, with the exception of its DIP credit facility and SESA's (euro)200 million Facility Agreement ("Facility Agreement"). While operating as a debtor-in-possession during the Chapter 11 bankruptcy proceedings, Solutia has ceased recording interest on all unsecured pre-petition indebtedness in accordance with SOP 90-7, with the exception of the 11.25 percent notes due 2009. The amount of contractual interest not recorded was $32 in 2006, 2005 and 2004. Contractual interest is payable semiannually in January and July for the 11.25 percent notes due 2009. The DIP credit facility had $650 of borrowings at December 31, 2006 and $300 at December 31, 2005 and was classified as a current liability at both reporting dates. At both December 31, 2006 and 2005, Solutia had $95 and $131, respectively, of availability under the DIP credit facility due to borrowings and amounts outstanding under letter of credit facilities. Long-term debt consisted of the following as of December 31, 2006 2005 ---- ---- 6.72% debentures due 2037........................ 150 150 10.00% Euro notes due 2008 ...................... -- 247 Facility Agreement due 2011 ..................... 210 -- 11.25% notes due 2009............................ 223 223 7.375% debentures due 2027....................... 300 300 Other............................................ 43 43 ------ ------ Total principal amount..................... 926 963 Unamortized net discount (a)..................... -- -- ------ ------ 926 963 Less amounts subject to compromise (Note 3)...... (716) (716) ------ ------ TOTAL............................................ $ 210 $ 247 ====== ====== (a) Unamortized net discount of $48 as of both December 31, 2006 and December 31, 2005 is included in liabilities subject to compromise, as further described in Note 3. Amendments to DIP Financing Agreement Solutia amended its DIP credit facility on March 17, 2006 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP credit facility from $525 to $825; (ii) extended the term of the DIP credit facility from June 19, 2006 to March 31, 2007; (iii) decreased the interest rate on the term loan component of the DIP credit facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points; (iv) increased certain thresholds allowing the Debtors to retain more of the proceeds from certain dispositions and other extraordinary receipts; (v) approved the disposition of certain assets of the Debtors; (vi) allowed refinancing of, and certain amendments to, SESA's outstanding Euronotes; and (vii) amended certain financial and other covenants. Note 23 describes an additional amendment to the DIP financing agreement made subsequent to December 31, 2006. Solutia analyzed the modifications of the DIP credit facility in March 2006 in accordance with the provisions of Emerging Issues Task Force ("EITF") No. 02-04, Determining Whether a Debtor's Modification or Exchange of Debt Instruments is within the Scope of FASB Statement No. 15, and EITF No. 96-19, Debtor's Accounting for a Modification or Exchange of Debt Instruments, and recorded a charge of approximately $8 to record the write-off of debt issuance costs and to record the DIP credit facility as modified at its fair value. In addition, $1 of unamortized debt issuance costs associated with the DIP credit facility were written off at the time of modification in March 2006. Solutia amended its DIP financing agreement on June 1, 2005 and received Bankruptcy Court approval on July 25, 2005. The amendment reduced the interest rate on the term loan component of the DIP credit facility to LIBOR plus 4.25 percent from the previous interest rate of the greater of the prime rate plus 4.0 percent or 8.0 percent, extended the maturity date of the current facility to June 19, 2006 from the previous December 19, 2005 maturity date, and made other minor 76 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) modifications. No changes were made to the financial covenants contained in the DIP agreement aside from extending the financial covenant requirements to be commensurate with the new maturity date of the DIP agreement. Euronotes Refinancing On July 26, 2006, Solutia's indirect 100% owned subsidiary Solutia Services International S.C.A./Comm. V.A ("SSI"), a subsidiary of SESA, entered into a Facility Agreement guaranteed by SESA and CPFilms Vertriebs GmbH, a subsidiary of SESA. Closing of the Facility Agreement occurred on August 1, 2006. SESA used the proceeds of the Facility Agreement to refinance all of its (euro)200 million of 10 percent Senior Secured Notes (the "Euronotes") on August 1, 2006 at a prepayment premium of 3 percent, as required pursuant to the Euronotes, for a total redemption amount of approximately (euro)215 million, including accrued interest. The Euronotes were refinanced to reduce the interest rate, extend the term of the indebtedness and facilitate certain dispositions by Solutia, including the sale of its pharmaceutical services business as described in Note 4. The Facility Agreement has a five-year term, with a termination date of July 31, 2011 and an adjustable rate structure which is EURIBOR plus 275 basis points. The margin is subject to adjustment upon the occurrence of certain events specified in the Facility Agreement or upon SESA and its subsidiaries attaining certain financial benchmarks. The Facility Agreement consists of a (euro)160 million term loan and a (euro)40 million term loan. The (euro)40 million term loan was repaid from the proceeds of the sale of Solutia's pharmaceutical services business (as further described in Note 4). The Facility Agreement is secured by substantially all of the assets of SESA and its subsidiaries. The Facility Agreement also contains other customary terms and conditions, including certain financial covenants relating to the performance of SESA and its subsidiaries. 15. FAIR VALUES OF FINANCIAL INSTRUMENTS The recorded amounts of cash, trade receivables, third-party guarantees, accounts payable and short-term debt approximate their fair values at both December 31, 2006 and 2005, respectively. The estimated fair value of Solutia's long-term debt not subject to compromise was $214 at December 31, 2006 and $248 as of December 31, 2005. These estimates compare with the recorded amount of $210 in 2006 and $247 in 2005. Fair value of the debt subject to compromise cannot be fairly determined due to the inherent uncertainties underlying the valuation assumptions affected by the Chapter 11 bankruptcy proceedings. The estimated fair value of Solutia's foreign currency forward and option contracts on intercompany financing transactions was $1 at December 31, 2006 and less than $1 at December 31, 2005. Notional amounts for these forward and option contracts to purchase and sell foreign currencies were $181 at December 31, 2006, and $365 at December 31, 2005. The estimated fair value of Solutia's commodity forward contracts was less than a $1 and an approximate $1 loss at December 31, 2006 and 2005, respectively. Notional amounts for these commodity forward contracts were $2 and $9 at December 31, 2006 and 2005, respectively. Fair values are estimated by the use of quoted market prices; estimates obtained from brokers and other appropriate valuation techniques and are based upon information available as of both December 31, 2006, and December 31, 2005. The fair-value estimates do not necessarily reflect the values Solutia could realize in the current market. 16. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS Pension benefits generally are based on the employee's age, years of service and/or compensation level. The domestic qualified pension plan is funded in accordance with Solutia's long-range projections of the plan's financial conditions. These projections take into account benefits earned and expected to be earned, anticipated returns on pension plan assets and income tax and other regulations. Solutia amended its U.S. qualified pension plan in 2005 for union participants and in 2004 for non-union participants to cease future benefit accruals effective January 1, 2006 and July 1, 2004, respectively (as further described below). Prior to the spinoff, the majority of Solutia's employees participated in 77 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Pharmacia's noncontributory pension plans. In conjunction with the spinoff, Solutia assumed pension liabilities and received related assets from those plans for its applicable active employees and for certain former employees who left Pharmacia in earlier years. Further, Solutia terminated certain domestic, non-qualified pension plans in 2005. Certain employees also participate in benefit programs that provide certain health care and life insurance benefits for retired employees. All regular, full-time U.S. employees and certain employees in other countries who were employed by Solutia on or before December 31, 1998, may become eligible for these benefits if they reach retirement age while employed by Solutia and have the required years of service. These postretirement benefits are unfunded and are generally based on the employee's age, years of service and/or compensation level. The costs of postretirement benefits are accrued by the date the employees become eligible for the benefits. Solutia amended its U.S. postretirement plan in 2005 for union, active employees and in 2004 for non-union, active employees (as further described below). In connection with the Solutia Spinoff, Solutia assumed retiree medical liabilities for its applicable active employees and for approximately two-thirds of the retired U.S. employees of Pharmacia. Solutia uses a measurement date of December 31 for the majority of its pension and other postretirement benefit plans. The amounts disclosed below do not reflect the impact of any changes to the benefit plans that might be contemplated as a result of the bankruptcy filing. In addition, the accrued liabilities for domestic pension and other postretirement obligations have been classified as liabilities subject to compromise as of December 31, 2006 and 2005 (see Note 3). Net Periodic Cost For the years ended December 31, 2006, 2005, and 2004, Solutia's pension and healthcare and other benefit costs were as follows:
PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2006 2005 2004 2006 2005 2004 ---- ---- ---- ---- ---- ---- Service costs for benefits earned.............. $ 4 $ 6 $ 14 $ 5 $ 5 $ 8 Interest cost on benefit obligation............ 65 68 77 29 33 42 Assumed return on plan assets.................. (60) (61) (75) -- -- -- Prior service costs ........................... -- 2 6 (11) (10) (13) Actuarial net (gain)/loss...................... 14 14 7 7 14 7 Net curtailment and settlement charges/(gains). -- 17 73 -- (4) (38) ----- ------ ------ ------ ------ ------ TOTAL.......................................... $ 23 $ 46 $ 102 $ 30 $ 38 $ 6 ===== ====== ====== ====== ====== ======
Curtailments and Settlements ---------------------------- Solutia amended its U.S. postretirement plan in 2006 for retiree participants to be effective January 1, 2007. The changes terminate medical benefits for certain retirees who are Medicare eligible, and if not Medicare eligible, to terminate medical benefits on the earlier of (a) the date such retirees or participants become Medicare eligible if such date is on or after January 1, 2007 or (b) October 19, 2016. This action resulted in a curtailment of the U.S. postretirement plan, as defined by SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, due to the termination of medical benefits provided to retiree participants in Solutia's U.S. postretirement plan. The net result of this action in 2006 was a $40 gain due primarily to the required recognition of prior service gains that were expected to be amortized into earnings over the estimated future service period of the plan participants. Solutia amended its U.S. qualified pension plan in 2005 to cease benefit accruals for domestic union participants to be effective January 1, 2006. This action resulted in a curtailment of the U.S. qualified pension plan, as defined by SFAS No. 88, Employees Accounting for Settlements and Curtailments of Defined Pension Plans and for Termination Benefits, due to the reduction in anticipated future service of union participants in Solutia's U.S. qualified pension plan. The net result of this action in 2005 was a $7 loss due primarily to the required recognition of unrecognized losses that were expected to be amortized into earnings over the estimated future service period of the plan participants. Solutia also amended in 2005 its U.S. postretirement plan for union, active employees to be effective January 1, 2006. These changes included discontinuation of all postretirement benefits after attaining age 65, changes to certain 78 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) eligibility requirements for pre-65 postretirement benefits with the eventual elimination of these benefits by 2016, and significant reduction of retiree life insurance benefits for future retirees. This action resulted in a curtailment of the U.S. postretirement plan, as defined by SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, due to the reduction in anticipated future service of union participants in Solutia's U.S. postretirement plan. The net result of this action in 2005 was a $4 gain due primarily to the required recognition of unrecognized gains that were expected to be amortized into earnings over the estimated future service period of the plan participants. Solutia terminated certain domestic, non-qualified pension plans in 2005, which were effectively frozen since Solutia's bankruptcy filing on December 17, 2003. The termination of these plans resulted in a pension settlement in accordance with SFAS No. 88. However, no adjustments were made to the recorded amount of $19 for these plans since this amount represents the best proxy for the allowed claim amount in accordance with SOP 90-7. An adjustment to this amount will be made if the allowed claim is deemed to be different through the claims resolution process. The amount has been presented as a reduction to the overall pension obligation in 2005, as the amount no longer represent a pension obligation, but instead general unsecured claims against Solutia. Solutia amended its U.S. qualified and non-qualified pension plans in 2004 to cease future benefit accruals effective July 1, 2004 for non-union participants in these plans. As a result, Solutia recorded a pension curtailment net loss of $63 in 2004 due to the reduction in anticipated future service of participants in Solutia's U.S. qualified and non-qualified pension plans. In addition, Solutia recorded a pension settlement net gain of $1 resulting from the significant reduction in the number of participants in Solutia's non-qualified pension plan principally resulting from workforce reduction initiatives. Solutia amended its U.S. postretirement plan for non-union, active employees during 2004. These changes, effective September 1, 2004, include discontinuation of all postretirement benefits after attaining age 65, changes to certain eligibility requirements for pre-65 postretirement benefits with the eventual elimination of these benefits by 2016, and elimination of retiree life insurance benefits for future retirees. As a result, Solutia recorded a curtailment gain of $38 in 2004 due to the reduction in anticipated future service of non-union participants in Solutia's U.S. postretirement plan. Solutia recorded pension settlement charges of $10 in both 2005 and 2004 resulting principally from the significant amount of lump sum distributions from Solutia's U.S. qualified pension plan during each of those years relating primarily to headcount reductions. In addition, Solutia recorded a curtailment loss of $1 during 2004 due to the reduction in anticipated future service of participants in Solutia's Canadian pension plan resulting from headcount reductions. Actuarial Assumptions --------------------- The significant actuarial assumptions used to determine net periodic cost for Solutia's principal pension, healthcare and other benefit plans were as follows:
PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2006 2005 2006 2005 ---- ---- ---- ---- Discount rate.................................... 5.50% 5.50% 5.50% 5.25% Expected return on plan assets................... 8.75% 9.00% N/A N/A Rate of compensation increase (a)................ 4.00% 4.00% N/A N/A Assumed trend rate for healthcare costs ......... N/A N/A 9.00% 8.00% Ultimate trend rate for healthcare costs......... N/A N/A 5.00% 5.00% (a) The rate of compensation increase in 2006 and 2005 relates specifically to Solutia's foreign pension plans. The rate of compensation increase is not applicable to the valuation of U.S. pension plans as of December 31, 2006 and 2005 due to the aforementioned cessation of future benefit accruals in 2005 and 2004 for participants in the U.S. pension plans.
Solutia establishes its discount rate based upon the internal rate of return for a portfolio of high quality bonds with maturities consistent with the nature and timing of future cash flows for each specific plan. The expected long-term rate of return on pension plan assets assumption is based on the target asset allocation policy and the expected future rates of return on these assets. 79 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) A 1 percent change in the assumed health care cost trend rates would have the following effect as of December 31, 2006:
1-PERCENTAGE- 1-PERCENTAGE- POINT INCREASE POINT DECREASE -------------- -------------- Effect on postretirement benefit obligation................... $ 3 $ (3) Effect on total service and interest cost components ......... -- --
Solutia's costs for postretirement medical benefits are capped for many current retirees and for active employees; therefore, the impact of this hypothetical change in the assumed health care cost trend rate is limited. Benefit Obligations Components of the changes in the benefit obligation of Solutia's principal pension, healthcare and other benefit plans were as follows:
PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2006 2005 2006 2005 ---- ---- ---- ---- CHANGES IN BENEFIT OBLIGATION Benefit obligation at January 1............... $1,240 $1,319 $ 579 $ 717 Service costs................................. 4 6 5 5 Interest cost................................. 65 68 29 33 Contributions................................. 2 1 21 23 Actuarial (gain) losses....................... -- 44 (6) (81) Foreign currency ............................. 17 (14) -- -- Plan amendments .............................. -- (19) (40) (10) Federal subsidy on benefits paid ............. -- -- 7 -- Benefits paid................................. (148) (165) (110) (108) ------ ------ ------ ------ BENEFIT OBLIGATION AT DECEMBER 31............. $1,180 $1,240 $ 485 $ 579 ====== ====== ====== ======
The accumulated benefit obligation was $1,157 and $1,217 as of December 31, 2006 and 2005, respectively. The significant actuarial assumptions used to estimate the projected benefit obligation for Solutia's principal pension, healthcare and other benefit plans were as follows:
PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2006 2005 2006 2005 ---- ---- ---- ---- Discount rate................................... 5.75% 5.50% 5.75% 5.50% Expected return on plan assets.................. 8.75% 9.00% N/A N/A Rate of compensation increase (a)............... 4.00% 4.00% N/A N/A Assumed trend rate for healthcare costs ........ N/A N/A 8.00% 9.00% Ultimate trend rate for healthcare costs........ N/A N/A 5.00% 5.00% (a) The rate of compensation increase in 2006 and 2005 relates specifically to Solutia's foreign pension plans. The rate of compensation increase is not applicable to the valuation of U.S. pension plans as of December 31, 2006 and 2005 due to the aforementioned cessation of future benefit accruals in 2005 and 2004 for participants in the U.S. pension plans.
80 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Plan Assets Components of the changes in fair value of plan assets of Solutia's pension plans were as follows:
PENSION BENEFITS ---------------- 2006 2005 ---- ---- CHANGES IN FAIR VALUE OF PLAN ASSETS Fair value of plan assets at January 1.......... $ 700 $ 811 Actual return on plan assets.................... 76 59 Contributions................................... 186 5 Foreign currency................................ 13 (10) Benefits paid................................... (148) (165) ------ ------ FAIR VALUE OF PLAN ASSETS AT DECEMBER 31........ $ 827 $ 700 ------ ------
The other postretirement benefits plans are unfunded as of December 31, 2006 and 2005. The asset allocation for Solutia's pension plans as of December 31, 2006 and 2005, and the target allocation for 2007, by asset category, follows.
PERCENTAGE OF PLAN ASSETS AT DECEMBER 31, ----------------------------------------- ASSET CATEGORY 2007 TARGET ALLOCATION 2006 2005 -------------- ---------------------- ---- ---- Equity securities 67% 68% 67% Debt securities 30 29 29 Other 3 3 4 --- --- --- Total 100% 100% 100%
The Solutia defined benefit plan investment strategy is to maintain an asset allocation that is diversified among multiple asset classes, and among multiple managers within each asset class, in order to minimize the risk of large losses and to maximize the long-term risk-adjusted rate of return. Funded Status The funded status of Solutia's principal pension, healthcare and other benefit plans at December 31, 2006, and 2005 and the related amounts recognized in the Consolidated Statement of Financial Position was as follows:
PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2006 2005 2006 2005 ---- ---- ---- ---- Fair value of plan assets....................... $ 827 . $ 700 $ -- $ -- Projected benefit obligation.................... 1,180 1,240 485 579 ------ ------ ------ ----- FUNDED STATUS................................... $ (353) $ (540) $ (485) $ (579) Unrecognized actuarial loss..................... N/A . 167 N/A 54 Unrecognized prior service costs (gains)........ N/A 1 N/A (59) ------ ------ ------ ------- ACCRUED NET LIABILITY AT DECEMBER 31............ N/A $ (372) N/A $ (584) ====== ====== ====== =======
81 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2006 2005 2006 2005 ---- ---- ---- ---- Prepaid benefit cost............................ N/A $ 18 N/A $ -- Current liability............................... -- N/A (79) N/A Long-term liability............................. (353) N/A (405) N/A Accrued benefit cost............................ N/A (530) N/A (584) Intangible asset................................ N/A 1 N/A N/A ACCUMULATED OTHER COMPREHENSIVE LOSS: Minimum pension liability....................... N/A 139 N/A N/A Net actuarial (gain)/loss....................... 143 N/A 40 N/A Prior service (gain)/cost....................... 1 N/A (88) N/A ------ ------ ------ ------ ACCRUED NET LIABILITY........................... N/A $ (372) N/A $ (584) ====== ====== ====== ======
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the pension plans with projected benefit obligation in excess of plan assets and for the pension plans with accumulated benefit obligations in excess of plan assets were as follows as of December 31:
PROJECTED BENEFIT OBLIGATION ACCUMULATED BENEFIT EXCEEDS THE FAIR VALUE OF OBLIGATION EXCEEDS THE FAIR PLAN ASSETS VALUE OF PLAN ASSETS ----------- -------------------- 2006 2005 2006 2005 ---- ---- ---- ---- Projected benefit obligation.................... $1,180 $ 1,240 1,142 1,204 Accumulated benefit obligation.................. 1,157 1,217 1,126 1,187 Fair value of plan assets....................... 827 700 790 668
The accumulated postretirement benefit obligation exceeds plan assets for all of Solutia's other postretirement benefit plans. Solutia actively manages funding of its domestic qualified pension plan in order to meet the requirements of the IRS and the Pension Benefits Guarantee Corporation (a U.S. federal agency). Solutia contributed $179 in 2006 to the qualified pension plan in accordance with IRS funding rules and made a discretionary contribution of $11 in 2004 to the qualified pension plan in order to minimize future required contributions and to utilize available tax benefits. No contributions were made during 2005 to the qualified pension plan. According to current IRS funding rules, Solutia estimates that it will be required to make approximately $100 in pension contributions to its U.S. qualified pension plan in 2007. In addition, Solutia contributed $6 in 2006, $5 in 2005 and $4 in 2004, respectively, to fund its foreign pension plans. Moreover, Solutia expects to be required to fund a like amount in pension contributions for its foreign pension plans in 2007. Effects of Adopting SFAS No. 158 The following table illustrates the incremental effect of applying SFAS No. 158 on individual line items in the Consolidated Statement of Financial Position at December 31, 2006:
- ---------------------------------------------------------------------------------------------------------------- Before Application of After Application of SFAS No. 158 Adjustments SFAS No. 158 ------------ ----------- ------------ - ---------------------------------------------------------------------------------------------------------------- Investments in affiliates $ 211 $ (18) $ 193 - ---------------------------------------------------------------------------------------------------------------- Other assets 112 (13) 99 - ---------------------------------------------------------------------------------------------------------------- Other liabilities 283 6 289 - ---------------------------------------------------------------------------------------------------------------- Liabilities subject to compromise 1,899 (50) 1,849 - ---------------------------------------------------------------------------------------------------------------- Accumulated other comprehensive loss 80 (13) 67 - ----------------------------------------------------------------------------------------------------------------
82 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Estimated Future Benefit Payments Estimated benefit payments expected to be made over the next five years and the cumulative five year period thereafter are as follows: PENSION HEALTHCARE AND BENEFITS OTHER BENEFITS -------- -------------- 2007............................. $ 114 $ 71 2008............................. 112 65 2009............................. 107 61 2010............................. 107 58 2011............................. 101 55 2012-2016........................ 455 203 17. EMPLOYEE SAVINGS PLANS Substantially all U.S. employees of Solutia are eligible to participate in the Solutia Savings and Investment Plan ("SIP"), a 401(k) plan. Effective December 15, 2003, all matching contributions are invested in the same manner as participants' personal SIP contributions. Company cash contributions related to the employer match were $15 in 2006 and 2005, respectively, and $10 in 2004, and were invested in accordance with participants' personal investment elections. In addition, effective January 1, 2005, Solutia increased its SIP matching contribution percentage to 100 percent on the first 7 percent of a participant's qualified contributions from 60 percent on the first 8 percent, previously. 18. STOCK OPTION PLANS Solutia has two stock-based incentive plans under which awards are available for grants to officers and employees; the Solutia Inc. 2000 Stock-Based Incentive Plan ("2000 Plan") and the Solutia Inc. 1997 Stock-Based Incentive Plan ("1997 Plan"). The 2000 Plan authorizes up to 5,400,000 shares and the 1997 Plan up to 7,800,000 shares of Solutia common stock for grants of non-qualified and incentive stock options, stock appreciation rights, restricted stock awards and bonus stock awards. The shares used may be newly issued shares, treasury shares or a combination. Under both plans, the exercise price of a stock option must be no less than the fair market value of Solutia's common stock on the option grant date. Additionally, the plans provide that the term of any stock option granted may not exceed 10 years. At December 31, 2006, approximately 2,240,193 shares from the 2000 Plan and 2,414,464 shares from the 1997 Plan remained available for grants. During 2006, no options were granted to named executive officers and other senior executives as a group, or to other employees. Total shares covered by options granted under the plans to current executive officers and other senior executives as a group totaled 3,011,000, and those to other employees totaled 10,016,592, through December 31, 2006. The options granted to Solutia's executive officers and other senior executives are primarily performance options that become exercisable upon the earlier of achievement of specified share price targets or the ninth anniversary of the option grant. The options granted to the other management employees are time-based. They generally become exercisable in thirds, one-third on each of the first three anniversaries of the option grant date. The Solutia Inc. Non-Employee Director Compensation Plan provides incentives to non-employee members of Solutia's board of directors. This plan authorizes up to 400,000 shares for grants of non-qualified stock options and for grants of deferred shares in payment of all or a portion of the annual retainer for the non-employee directors. Only treasury shares may be used. Under this plan, the exercise price of a stock option must be no less than the fair market value of Solutia's common stock on the grant date and the term of any stock option granted under the plan may not exceed 10 years. At December 31, 2006 and 2005, 25,174 shares of Solutia's common stock remained available for grants under the plan. There were no options or deferred shares granted in 2006 as all non-employee director compensation is paid in cash. 83 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) As of January 1, 2006, Solutia adopted SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123(R). The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. Additionally, Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options to purchase Solutia's common stock will receive any consideration in our Chapter 11 Cases for their equity based compensation. There were no options granted or exercised during 2006. Accordingly, no compensation cost with respect to such activities was recognized in the Consolidated Statement of Operations. However, to the extent that the remaining service periods of unvested options granted prior to January 1, 2006 extend past the adoption date of SFAS No. 123(R), the residual unamortized fair value originally calculated for footnote disclosures required under SFAS No. 123, net of estimated forfeitures, is now recognized on a straight-line basis over such remaining periods. Compensation cost and all related effects within the Consolidated Statement of Operations and Consolidated Statement of Cash Flows associated with these unvested options was less than $1 during 2006. Additionally, there was less than $1 of total unrecognized compensation cost related to these unvested options as of December 31, 2006 to be recognized over a weighted-average recognition period of less than one year. Prior to January 1, 2006, Solutia applied SFAS No. 123 as amended by SFAS No. 148, which allowed Solutia to continue following the guidance of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, for measurement and recognition of stock-based transactions with employees. Accordingly, no compensation cost was recognized for Solutia's option plans in the Consolidated Statement of Operations during such periods, as all options granted under the plans had an exercise price equal to the market value of Solutia's stock on the date of the grant. The effect would have been less than $1 on net income and no change on income per share had the determination of compensation cost for these plans been based on the fair value at the grant dates for awards under these plans, consistent with SFAS No. 123, for 2006. A summary of the status of Solutia's stock option plans for years ended December 31, 2006, 2005 and 2004 follows:
OUTSTANDING ----------------------------------------------- EXERCISABLE WEIGHTED-AVERAGE OPTIONS OPTIONS EXERCISE PRICE ---------------------------------------------------------------------- December 31, 2003............. 20,838,155 23,500,239 $15.31 ---------------------------------------------------------------------- Granted.................... -- $0.00 Exercised.................. -- 0.00 Expired.................... (3,886,064) 13.41 ---------------------------------------------------------------------- December 31, 2004............. 18,646,490 19,614,175 $15.69 ---------------------------------------------------------------------- Granted.................... -- $0.00 Exercised.................. -- 0.00 Expired.................... (2,290,624) 14.84 ---------------------------------------------------------------------- December 31, 2005............. 16,938,707 17,323,551 $15.80 ---------------------------------------------------------------------- Granted.................... -- $0.00 Exercised.................. -- 0.00 Expired.................... (4,924,321) 16.57 ====================================================================== December 31, 2006............. 12,236,430 12,399,230 $15.49 ======================================================================
84 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) The following table summarizes information about stock options outstanding at December 31, 2006:
OPTIONS OUTSTANDING: WEIGHTED-AVERAGE RANGE OF REMAINING WEIGHTED-AVERAGE EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE - ----------------------------------------------------------------------------------------------------------- $ 0 to 2.99................. 707,500 5.8 $ 1.26 3 to 7.99................. 49,233 6.0 3.89 8 to 11.99................. 1,140,667 3.0 10.32 12 to 15.99................. 2,402,530 2.3 13.83 16 to 18.99................. 4,508,343 0.1 16.39 19 to 22.99................. 3,441,809 1.0 19.73 23 to 29.99................. 149,148 0.9 27.87 ----------------------------------------------------------------------- $ 0 to 29.99................. 12,399,230 1.4 $15.49 ======================================================================= OPTIONS EXERCISABLE: RANGE OF WEIGHTED-AVERAGE EXERCISE PRICES NUMBER EXERCISE PRICE - -------------------------------------------------------------------------------- $ 0 to 2.99................. 620,700 $ 1.26 3 to 7.99................. 9,233 3.87 8 to 11.99................. 1,128,667 10.32 12 to 15.99................. 2,378,530 13.83 16 to 18.99................. 4,508,343 16.39 19 to 22.99................. 3,441,809 19.73 23 to 29.99................. 149,148 27.87 ---------------------------------------------- $ 0 to 29.99................. 12,236,430 $15.64 ==============================================
19. CAPITAL STOCK On December 17, 2003, following the announcement that Solutia had filed for Chapter 11 bankruptcy protection, the New York Stock Exchange ("NYSE") halted trading in Solutia's common stock. Solutia's common stock was delisted from the NYSE on February 24, 2004. Solutia's common stock is currently being quoted under the ticker symbol SOLUQ on the Pink Sheets Electronic Quotation Service maintained by The Pink Sheets LLC and on the OTC Bulletin Board. No dividends were paid in 2006 or 2005. Solutia is currently prohibited by both the U.S. Bankruptcy Code and the DIP credit facility from paying dividends to shareholders. Solutia's board of directors declared a dividend of one preferred stock purchase right for each share of Solutia's common stock issued in the distribution of shares by Pharmacia to its shareholders on the effective date of the spinoff and authorized the issuance of one right for each share of common stock issued after the effective date of the spinoff until the earlier of the date the rights become exercisable or the termination date of the rights plan. If a person or group acquires beneficial ownership of 20 percent or more, or announces a tender offer that would result in beneficial ownership of 20 percent or more, of Solutia's outstanding common stock, the rights become exercisable. Then, for every right held, the owner will be entitled to purchase one one-hundredth of a share of a series of preferred stock for $.000125. If Solutia is acquired in a business combination transaction while the rights are outstanding, for every right held the holder will be entitled to purchase, for $.000125, common shares of the acquiring company having a market value of $.000250. In addition, if a person or group acquires beneficial ownership of 20 percent or more of Solutia's outstanding common stock, for every right held, the holder (other than such person or members of such group) will be entitled to purchase, for $.000125, a number of shares of Solutia's common stock having a market value of $.000250. Furthermore, at any time after a person or group acquires beneficial ownership of 20 percent or more (but less than 50 percent) of Solutia's outstanding common stock, Solutia's board of directors may, at its option, exchange part or all of the rights (other than rights held by the acquiring person or group) for shares of Solutia's common stock on a one-share-for-every-one-right basis. At any time prior to the acquisition 85 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) of such a 20 percent position, Solutia can redeem each right for $.00000001. The board of directors is also authorized to reduce the 20 percent thresholds described above to not less than 10 percent. The rights expire in the year 2007. However, Solutia believes that its plan of reorganization will result in cancellation of its existing shares of common stock, as well as options and warrants to purchase its common stock and that it is unlikely that holders of Solutia's common stock, including options and warrants to purchase Solutia's common stock, will receive any consideration for that stock or those options and warrants in such a plan of reorganization. Consequently, this preferred stock purchase right plan would be cancelled if the underlying common stock were to be cancelled. Solutia has 10 million shares of preferred stock, par value $0.01 per share, authorized. As of December 31, 2006, there were no preferred shares issued or outstanding. 20. COMMITMENTS AND CONTINGENCIES Commitments Commitments, principally in connection with uncompleted additions to property, were approximately $16 at December 31, 2006 and 2005. In addition, as of December 31, 2006 and 2005, Solutia was contingently liable under letters of credit totaling $76 and $98, respectively, of which $2 and $1, respectively, were cash collaterized, primarily related to environmental remediation and various insurance related activities. The cash underlying these collateralized letters of credit is contractually restricted and accordingly is excluded from cash and cash equivalents and recorded in Other Assets within the Consolidated Statement of Financial Position as of December 31, 2006 and 2005. Solutia's future minimum payments under operating leases and various unconditional purchase obligations are $10 for 2007, $6 for 2008, $3 for 2009, $2 for 2010, and $0 for 2011 and thereafter. The amounts of these commitments have not been adjusted to reflect any potential impact that the bankruptcy proceedings may have upon the timing and valuation of such commitments. Solutia has entered into agreements with certain customers to supply a guaranteed quantity of certain products annually at prices specified in the agreements. In return, the customers have advanced funds to Solutia to cover the costs of expanding capacity to provide the guaranteed supply. Solutia has recorded the advances as deferred credits and amortizes the amounts to income as the customers purchase the products. The unamortized deferred credits were $91 at December 31, 2006 and $100 at December 31, 2005. No single customer or customer group accounted for 10 percent or more of Solutia's net sales for the years ended December 31, 2006 and 2004. For the year ended December 31, 2005, Shaw Industries, Inc., a single customer within the Integrated Nylon segment, accounted for approximately 11 percent of Solutia's consolidated net sales. The more significant concentrations in Solutia's trade receivables at December 31, 2006 and 2005 were:
2006 --------------------------------------------------------- NORTH EUROPE/ LATIN ASIA AMERICA AFRICA AMERICA PACIFIC TOTAL ------- ------ ------- ------- ----- Glass..................... $13 $65 $15 $15 $108 Nylon Polymers............ 25 10 -- 32 67 Chemicals................. 37 16 1 7 61 2005 --------------------------------------------------------- NORTH EUROPE/ LATIN ASIA AMERICA AFRICA AMERICA PACIFIC TOTAL ------- ------ ------- ------- ----- Glass..................... $19 $58 $9 $14 $100 Nylon Polymers............ 15 4 -- 19 38 Chemicals................. 29 15 1 6 51
Management does not anticipate losses on its trade receivables in excess of established allowances. 86 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Contingencies Litigation ---------- Because of the size and nature of Solutia's business, Solutia is a party to numerous legal proceedings. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. In addition, at the time of its spinoff from Pharmacia, Solutia assumed the defense of specified legal proceedings and agreed to indemnify Pharmacia for obligations arising in connection with those proceedings. Solutia has determined that these defense and indemnification obligations to Pharmacia are pre-petition obligations under the U.S. Bankruptcy Code that Solutia is prohibited from performing, except pursuant to a confirmed plan of reorganization. As a result, Solutia has ceased performance of these obligations. Solutia's cessation of performance may give rise to a pre-petition unsecured claim against Solutia which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case. The estimated unsecured claim amount was classified as a liability subject to compromise as of December 31, 2006 and December 31, 2005 in the amount of $111 and $136, respectively. Monsanto also indemnified Pharmacia with respect to a number of legal proceedings described in Solutia's 2003 Form 10-K/A in which Solutia was a named defendant or was defending solely due to its Pharmacia related indemnification obligations referred to above. Solutia is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, Solutia has ceased reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) Payton v. Monsanto; (iii) other Anniston cases; and (iv) premises based asbestos litigation. Legal proceeding activities are currently being funded by Monsanto for these matters. Monsanto's funding of these legal activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's bankruptcy case. Following is a summary of legal proceedings that Solutia or its equity affiliate continue to manage that, if resolved unfavorably, could have a material adverse effect on Solutia's results of operation and financial position. LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE - ---------------------------------------------- JP MORGAN ADVERSARY PROCEEDING On May 27, 2005, JPMorgan, as indenture trustee for Solutia's debentures due 2027 and 2037 (the "Prepetition Indenture"), filed an adversary proceeding against Solutia in Solutia's bankruptcy case. In the proceeding, JPMorgan asserted five causes of action seeking declaratory judgments to establish the validity and priority of the purported security interest of the holders of the 2027 and 2037 debentures, and one cause of action pursuant to section 363 of the Bankruptcy Code asserting that the alleged security interests lacked adequate protection. The proceeding relates to Solutia's 2002 and 2003 refinancings of its credit facilities. When Solutia refinanced its credit facilities in 2002, the 2027 and 2037 Debentures obtained a pro rata secured interest in certain of Solutia's assets as a result of the application of the "equal and ratable" provisions of the Prepetition Indenture. On October 8, 2003, Solutia restructured its credit facilities, reduced its outstanding secured indebtedness below the threshold level that initially triggered the "equal and ratable" provisions of the Prepetition Indenture and, as a result, the 2027 and 2037 Debentures returned to their original unsecured status. JPMorgan alleges that the October 8, 2003 refinancing had no effect on the security interests and liens that were created in 2002, and argues further that, even if it did, those liens should be reinstated as a matter of equity. The Unsecured Creditors' Committee and the Ad Hoc Solutia Trade Claims Committee have intervened in the proceeding in support of Solutia and the Ad Hoc Committee of Solutia Noteholders has intervened in the proceeding in support of JPMorgan. Trial concluded on July 10, 2006. Post-trial briefs were submitted by the parties in August 2006. The Bankruptcy Court has not made a ruling. EQUITY COMMITTEE ADVERSARY PROCEEDING AGAINST MONSANTO AND PHARMACIA On March 7, 2005, the Equity Committee in Solutia's bankruptcy case filed a complaint against Pharmacia and Monsanto and objections to the proofs of claim filed by Pharmacia and Monsanto in Solutia's bankruptcy case. Solutia was not named as a defendant in its complaint, the Equity Committee seeks to avoid certain obligations assumed by Solutia at the 87 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) time of its spinoff from Pharmacia. The complaint alleges, among other things, that the Solutia Spinoff was a fraudulent transfer under the Bankruptcy Code because Pharmacia forced Solutia to assume excessive liabilities and insufficient assets such that Solutia was destined to fail from its inception. Pharmacia and Monsanto filed a motion to dismiss the complaint or, in the alternative, to stay the adversary proceeding. On August 4, 2005, the Debtors filed with the Bankruptcy Court their Statement and Reservation of Rights in Response to the complaint and Objection to Claims, in which the Debtors expressed their view that the issues and disputes raised in the complaint would be resolved through the Plan confirmation process. During a hearing held on April 11, 2006, the Bankruptcy Court issued a bench ruling denying Pharmacia and Monsanto's motion to dismiss the complaint. The Ad Hoc Committee of Solutia Noteholders and the Ad Hoc Solutia Trade Claims Committee have intervened in this adversary proceeding in support of the Equity Committee. Solutia and the Unsecured Creditors' Committee have intervened in this adversary proceeding as neutral parties due to the importance of this proceeding with respect to Solutia's bankruptcy case. On September 14, 2006, the Court ruled that while the Equity Committee did not have standing to pursue these claims on behalf of the Debtors, it had standing to pursue its own objections to the claims of Monsanto and Pharmacia. This matter was submitted to mediation but the parties were unable to reach a consensual resolution. The adversary proceeding has been stayed indefinitely by the parties, subject to certain rights of the parties to recommence such proceeding. LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE - --------------------------------------------------- ANNISTON PARTIAL CONSENT DECREE On August 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Partial Consent Decree in an action captioned United States of America v. Pharmacia Corporation (p/k/a Monsanto Company) and Solutia. This Partial Consent Decree provides for Pharmacia and Solutia to sample certain residential properties and remove soils found on those properties if PCBs are at a level of 1 part per million (ppm) or above, to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the Environmental Protection Agency ("EPA") of a cleanup remedy for the Anniston, Alabama PCB site, and to pay EPA's past response costs and future oversight costs related to this work. The decree also provided for the creation of an educational trust fund of approximately $3 to be funded over a 12-year period to provide supplemental educational services for school children in west Anniston. A subsequent dispute arose between the EPA and Solutia regarding the scope and application of the automatic stay arising as a result of Solutia's Chapter 11 filing to the remaining obligations under the Partial Consent Decree. On April 19, 2004, the District Court held that the Partial Consent Decree enforces police and regulatory powers under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and, as a result, the automatic stay provisions of the U.S. Bankruptcy Code are inapplicable to Solutia's obligations under the Partial Consent Decree. On April 30, 2004, the United States Bankruptcy Court for the Southern District of New York entered a Stipulation and Agreed Order in which the EPA and Solutia stipulated that the automatic stay is applicable to certain of the Partial Consent Decree's requirements. Solutia filed a motion asking the District Court to reconsider its order and to bring it into accord with the Stipulation and Agreed Order consented to by the EPA and entered by the Bankruptcy Court. On September 9, 2004, the District Court denied Solutia's motion and declared that the automatic stay is inapplicable to Solutia's obligations under the Consent Decree to perform site work. Solutia appealed this ruling to the Eleventh U.S. Circuit Court of Appeals, which dismissed the appeal for lack of jurisdiction. On June 30, 2005, the United States District Court for the Northern District of Alabama issued an order (the "PCB Order") authorizing co-defendants Pharmacia and Solutia to "suspend" performance of the PCB clean-up at the Anniston site under the Anniston Consent Decree, upon the filing of a motion by either defendant requesting that relief. The PCB Order found that Solutia and Pharmacia entered into the Anniston Consent Decree, and that the court approved that Anniston Consent Decree, based on the understanding that the defendants' rights to pursue other liable parties for contribution would not be impaired by the EPA. The PCB Order further found that the EPA's planned settlements with certain Anniston foundries would thus deprive the defendants of one of the material considerations for entering into the Anniston Consent Decree. In July 2006, Solutia and Pharmacia reached an agreement with EPA that clarifies the extent of remaining obligations under the Anniston Consent Decree and the coordination of that work with the lead site clean-up being performed by others, and by which Solutia and Pharmacia will forego the opportunity to suspend their obligations under the Anniston Consent Decree pursuant to the PCB Order. Solutia and Pharmacia preserved their rights under this agreement to continue to 88 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) argue that the contribution protection afforded certain other potentially responsible parties performing lead site clean-up should not be effective as to Solutia and Pharmacia. PENNDOT CASE Solutia's Annual Report on Form 10-K/A for the year ended December 31, 2003 described a case then pending in the Commonwealth Court of Pennsylvania by the Commonwealth of Pennsylvania against Pharmacia seeking damages for PCB contamination in the Transportation and Safety Building ("T&S Building") in Harrisburg, Pennsylvania, that it claimed necessitated the demolition of the T&S Building. Solutia was not a named defendant in this litigation and therefore took no action to stay the litigation in connection with its Chapter 11 proceedings. Solutia assumed the defense of this litigation at the time of its spin-off from Pharmacia. Solutia determined that its obligation to defend and indemnify Pharmacia with regard to this litigation was a pre-petition obligation that Solutia was prohibited from performing, except pursuant to a confirmed plan of reorganization. Therefore, Solutia ceased defending Pharmacia with respect to this litigation. Solutia did, however, provide a $20 letter of credit to secure a portion of Pharmacia's obligations with respect to an appeal bond issued with respect to the case. On May 25, 2006 the Supreme Court of Pennsylvania issued its ruling on the appeal in this case, reversing in whole and remanding in part the decision of the trial court against Pharmacia. As a result of this ruling, the $20 letter of credit that Solutia had committed to partially secure the appeal bond was released. With the release of the bond, Solutia recognized a gain in its Consolidated Statement of Operations during the second quarter 2006 from the reversal of a significant portion of the existing litigation reserve with respect to this matter. FLEXSYS RELATED LITIGATION Since 2002, antitrust authorities in the United States, Europe and Canada are continuing to investigate past commercial practices in the rubber chemicals industry including the practices of Flexsys, Solutia's joint venture with Akzo Nobel. The European Commission issued its findings from its investigation in 2005, without levying any fines against Flexsys. Investigations regarding the industry may still be on-going in the United States and Canada, but to date, no findings have been made against Flexsys in either country. In addition, a number of purported civil class actions have been filed against Flexsys and other producers of rubber chemicals on behalf of indirect purchasers of rubber chemical products. Solutia is aware of a series of these purported class actions which had been filed against Flexsys in various state courts in the United States and in at least four courts in Canada. Except for two cases pending in the United States, all of the remaining cases have been dismissed, or are currently subject to tentative settlements. CASH BALANCE PLAN LITIGATION Davis v. Solutia Inc. Employees' Pension Plan; Hammond, et al. v. ----------------------------------------------------------------- Solutia Inc. Employees' Pension Plan. Since October 2005, current or former - ------------------------------------ participants in the Solutia Inc. Employees' Pension Plan (the "Pension Plan") have filed three class actions alleging that the Pension Plan is discriminatory based upon age and that the lump sum values of individual account balances in the Pension Plan have been, and continue to be, miscalculated. None of the Debtors, and no individual or entity other than the Pension Plan, has been named as a defendant in any of these cases. Two of these cases, captioned Davis, et al. v. Solutia, Inc. Employees' Pension Plan and Hammond, et al. v. Solutia, Inc. Employees' Pension Plan, are still pending in the Southern District of Illinois against Monsanto Company and Monsanto Company Pension Plan (Walker et al. v. The Monsanto Pension Plan, et al.) and Pharmacia Cash Balance Pension Plan, Pharmacia Corporation, Pharmacia and Upjohn, Inc., and Pfizer Inc. (Donaldson v. Pharmacia Cash Balance Pension Plan, et al.). The plaintiffs in the Pension Plan cases sought to obtain injunctive and other equitable relief (including money damages awarded by the creation of a common fund) on behalf of themselves and the nationwide putative class of similarly situated current and former participants in the Pension Plan. A Consolidated Class Action Complaint (the "Complaint") was filed by all of the plaintiffs in the consolidated case on September 4, 2006. The plaintiffs in the Complaint alleged three separate causes of action against the Pension Plan: (1) the Pension Plan violates ERISA by terminating interest credits on prior plan accounts at the age of 55; (2) the Pension Plan is improperly backloaded in violation of ERISA; and (3) the Pension Plan is discriminatory on the basis of age. 89 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Motions for class certification were filed in late 2006 by the plaintiffs against each of the defendants. With respect to the Pension Plan, plaintiffs moved to certify a class only on their first claim: i.e., that the Pension Plan discriminated against employees on the basis of their age by only providing interest credits on prior plan accounts through age 55. Briefing on the class certification motions was completed in January 2007 and the motion is still pending before the court. OTHER LEGAL PROCEEDINGS - ----------------------- Dickerson V. Feldman. On October 7, 2004, a purported class action -------------------- captioned Dickerson v. Feldman; et al. was filed in the United States District Court for the Southern District of New York against a number of defendants, including former officers and employees of Solutia and Solutia's Employee Benefits Plans Committee and Pension and Savings Funds Committee. Solutia was not named as a defendant. The action alleged breach of fiduciary duty under ERISA and sought to recover alleged losses to the Solutia Inc. Savings and Investment Plan ("SIP Plan") during the period December 16, 1998 to the date the action was filed. The investment of SIP Plan assets in Solutia's common stock is alleged to have been imprudent because of the risks and liabilities related to Solutia's legacy environmental and litigation liabilities and because of Flexsys' alleged involvement in the matters described above under "Flexsys Related Litigation." The action sought monetary payment to the SIP Plan to recover the losses resulting from the alleged breach of fiduciary duties, as well as injunctive and other appropriate equitable relief, reasonable attorney's fees and expenses, costs and interest. In addition, the plaintiff in this action filed a proof of claim for $269 against Solutia in the Bankruptcy Court. On March 30, 2006, the District Court granted the defendants' motion to dismiss on grounds that the Dickerson plaintiffs lacked standing to sue and that the complaint failed to state a claim on which relief could be granted. The dismissal of Dickerson's cause of action resulted in dismissal of the entire purported class action, including claims asserted on behalf of the unnamed purported class members. On April 3, 2006, Dickerson filed an appeal of this dismissal with the United States Court of Appeals for the Second Circuit. The parties have fully briefed the appeal, and oral argument will be held on February 12, 2007. Solutia Inc. v. FMC Corporation. On October 14, 2003, Solutia filed ------------------------------- an action captioned Solutia Inc. v. FMC Corporation ("FMC") in Circuit Court in St. Louis County, Missouri, against FMC over the failure of purified phosphoric acid technology provided by FMC to Astaris, the 50/50 joint venture formed by Solutia and FMC. On February 20, 2004, Solutia voluntarily dismissed the state court action and filed an adversary proceeding against FMC in the Bankruptcy Court. FMC filed with the Bankruptcy Court a motion to withdraw the reference. The motion was granted, and, as a result, the matter is now pending in the U.S. District Court for the Southern District of New York. FMC did not allege a counterclaim against Solutia or Astaris. FMC filed a motion to dismiss Solutia's action based upon an alleged lack of standing. On March 29, 2005, the New York District Court granted in part and denied in part FMC's motion to dismiss. Specifically, the court dismissed with prejudice three of Solutia's causes of action for breach of contract. The New York District Court denied FMC's motion to dismiss Solutia's other causes of action for breach of warranty, breach of fiduciary duty, negligent misrepresentation, fraud and fraud in the inducement. The parties have completed all fact discovery and submitted cross motions for Summary Judgment. On July 31, 2006, the District Court entered its Memorandum Opinion and Order on the Motions. It granted portions of FMC's Motion for Summary Judgment by ruling that Solutia cannot attempt to establish its breach of fiduciary duty claim by maintaining that the parties were in a joint venture or had a special relationship prior to April 2000. The District Court, however, denied FMC's Motion for Summary Judgment on the breach of fiduciary duty claim and held that Solutia will be permitted to prove at trial that FMC had special knowledge concerning its technology which can give rise to a fiduciary duty. The District Court further overruled the parties' Motion for Summary Judgment on the remaining claims. The District Court ruled Solutia may still be entitled to punitive damages in addition to its claims for out-of-pocket and lost profit damages. A bench trial on the four claims noted above is scheduled to begin in April 2007. Ferro Antitrust Investigation. Competition authorities in Belgium and ----------------------------- several other European countries are investigating past commercial practices of certain companies engaged in the production and sale of butyl benzyl phthalates ("BBP"). One of the BBP producers under investigation by the Belgian Competition Authority ("BCA") is Ferro Belgium sprl, a European subsidiary of Ferro Corporation ("Ferro"). Ferro's BBP business in Europe was purchased from Solutia in 90 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 2000. Solutia received an indemnification notice from Ferro and has exercised its right, pursuant to the purchase agreement relating to Ferro's acquisition of the BBP business from Solutia, to assume and control the defense of Ferro in proceedings relating to these investigations. On July 7, 2005, the BCA Examiner issued a Statement of Objections regarding its BBP investigation in which SESA, a European non-Debtor subsidiary of Solutia, along with Ferro Belgium sprl and two other producers of BBP, is identified as a party under investigation with respect to its ownership of the BBP business from 1997 until the business was sold to Ferro in 2000. SESA's written comments to the Statement of Objections were submitted on August 31, 2005 and presented at an oral hearing before the BCA on September 6, 2005. The Examiner submitted its Reasoned Report to the BCA on December 22, 2005. Solutia is not named as a party under investigation in the Reasoned Report. SESA will have an opportunity to submit comments to the BCA on the Reasoned Report in writing and at a subsequent oral hearing on a date that has not yet been determined by the BCA. Solutia and SESA are fully cooperating with the BCA in this investigation. Department of Labor Investigation of Solutia Inc. Savings and ------------------------------------------------------------- Investment Plan. Solutia was contacted in 2005 by the Department of Labor - --------------- ("DOL"), through the Employee Benefits Security Administration, informing Solutia that it wanted to conduct an investigation of Solutia's SIP Plan. Solutia fully cooperated with the DOL throughout the investigation. On December 6, 2006, the DOL issued a letter stating that, based on facts gathered, it appeared that Solutia, through its fiduciaries, breached its fiduciary obligations and violated provisions of ERISA with respect to the SIP Plan. Specifically, the DOL stated that it found no evidence that: (1) the Pension and Savings Funds Committee ("PSFC") sufficiently monitored the Solutia Stock Fund option within the SIP Plan to determine if the Solutia Stock Fund continued to be a prudent investment for the SIP Plan prior to December 15, 2003; and (2) the Solutia Board of Directors, CEO, and PSFC, prior to December 15, 2003, adequately monitored the SIP Plan fiduciaries, including the PSFC, the Employee Benefits Plan Committee, and the Northern Trust Company of Connecticut. The DOL did not assert in its letter that the SIP Plan or its participants had been harmed by these alleged breaches. Further, the DOL did not find that the offering of the Solutia Stock Fund as an investment option in the SIP Plan was itself a violation of ERISA, or that it caused any participant to suffer investment losses. Further, the DOL did not assert any monetary fines against the Company based on its findings to date. The DOL stated in the letter that its findings were subject to the possibility that additional information could lead the DOL to revise its views. The DOL did not choose to file suit against the Solutia fiduciaries, instead offering Solutia the opportunity to voluntarily discuss how the alleged violations may be corrected. Solutia has submitted additional information to the DOL to support the Company's request for reconsideration of the DOL's findings. Solutia Canada Inc. v. INEOS Americas LLC. Solutia Canada Inc. ----------------------------------------- ("Solutia Canada") filed suit in Quebec Court in December 2006, alleging breach of contract by INEOS Americas LLC ("INEOS"). In late 2002, Solutia negotiated a Stock and Asset Sale Agreement for the sale of its Resimenes & Additives business to UCB S.A ("UCB"). As part of this agreement, Solutia agreed to exclude the LaSalle assets from the agreement and entered into the LaSalle Toll Agreement ("LTA") with UCB. The LTA passed through all the benefits and risks of ownership of the LaSalle operations to UCB, other than pre-closing environmental liabilities. In the LTA, Solutia Canada agreed to operate its LaSalle Plant for the benefit of UCB and to provide all the necessary services to convert UCB's raw materials on a cost-neutral basis. Thus, UCB would pay Solutia Canada for all of its actual, direct and indirect costs incurred in connection with the performance or supply of services under the LTA or in holding itself ready to perform or supply those services. In the years after its execution, the LTA was assigned by UCB to Cytec Industries, Inc., then to INEOS. On January 31, 2006, INEOS notified Solutia Canada of its intention to terminate the LTA as of January 31, 2008, in compliance with the terms of the LTA. INEOS' decision to terminate the LTA will likely trigger the shutdown of all activities at the LaSalle Plant, resulting in termination costs recoverable by Solutia Canada against INEOS. Solutia Canada estimates that the overall termination costs associated with the termination of the LTA and the shutdown of the LaSalle Plant will total approximately $31 (CAD). Solutia Canada provided INEOS with an estimate of the expected termination costs prior to the notice of termination. INEOS has disputed the overall amount of Solutia Canada's termination costs. Under the detailed dispute resolution procedures in the LTA, Solutia Canada and INEOS were required to engage in negotiation and other means of dispute resolution prior to filing any litigation. In compliance with these obligations, Solutia 91 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Canada and INEOS negotiated extensively throughout 2006 to reach a resolution regarding the termination costs, but were unsuccessful. After the period for mandatory alternative dispute resolution expired, Solutia filed suit against INEOS in Quebec Court on December 8, 2006, for breach of the LTA with respect to termination costs. The case is pending. Texas Commission on Environmental Quality Administrative Enforcement -------------------------------------------------------------------- Proceeding. On August 11, 2006, the Executive Director of the Texas Commission - ---------- on Environmental Quality commenced an administrative enforcement proceeding against Solutia by filing a petition with the Texas Commission on Environmental Quality. The petition alleges certain violations of the State of Texas air quality program. The Executive Director requests that an administrative penalty, the amount of which is immaterial, be assessed and that Solutia undertake corrective actions to ensure compliance with the Texas Health and Safety Code and the rules of the Commission in connection with alleged self-reported unauthorized emission events and deviations of air permits. Solutia answered the petition on September 1, 2006, asserted affirmative defenses and requested a contested enforcement case hearing. Solutia is pursuing settlement discussions with the Commission. No date has yet been set for a hearing. Environmental Liabilities - ------------------------- Environmental compliance and remediation costs and other environmental liabilities incurred by Solutia generally fall into two broad categories: (a) those related to properties currently owned or operated by Solutia and (b) those related to properties that are not owned by Solutia, including non-owned properties adjacent to plant sites and certain owned offsite disposal locations. For the owned and operated sites, Solutia had an accrued liability of $78 and $71 as of December 31, 2006 and 2005, respectively, for solid and hazardous waste remediation, which represents Solutia's best estimate of the underlying obligation. In addition, this balance also includes post-closure costs at certain of Solutia's operating locations. This liability is not classified as subject to compromise in the Consolidated Statement of Financial Position because, irrespective of the bankruptcy proceedings, Solutia will be required to comply with environmental requirements in the conduct of its business, regardless of when the underlying environmental contamination occurred. However, Solutia ultimately intends to seek recovery against other potentially responsible parties at certain of these locations. Solutia had an accrued liability of $81 and $82 as of December 31, 2006 and 2005, respectively, for properties not owned or operated by Solutia which was classified as subject to compromise in the Consolidated Statement of Financial Position. Under the Plan and the Relationship Agreement, as between Monsanto and Solutia, Monsanto will accept financial responsibility for environmental remediation obligations at all sites for which Solutia was required to assume responsibility at the Solutia Spinoff but which were never owned or operated by Solutia. This includes more than 50 sites with active remediation projects and approximately 200 additional known sites and off-site disposal facilities, as well as sites that have not yet been identified. Finally, Monsanto will share financial responsibility with Solutia for off-site remediation costs in Anniston, Alabama and Sauget, Illinois. Remediation activities are currently being funded by Monsanto for all of these properties not owned or operated by Solutia, with the exception of one off-site remediation project in Sauget, Illinois. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 bankruptcy case. In addition, Solutia has only made minimal adjustments to its recorded environmental liabilities classified as subject to compromise for ongoing remediation activities since the inception of Solutia's bankruptcy case to reflect actual cash expenditures incurred by the Company. Any other adjustments to this liability are not deemed appropriate by the Company at this time given the uncertainty regarding any potential claim amount to be asserted by Monsanto. In addition to the bankruptcy proceedings, Solutia's environmental liabilities are also subject to changing governmental policy and regulations, discovery of unknown conditions, judicial proceedings, method and extent of remediation, existence of other potentially responsible parties and future changes in technology. Solutia believes that the known and unknown environmental matters, including matters classified as subject to compromise for which Solutia may ultimately assume responsibility, when ultimately resolved, which may be over an extended period of time, could have a material effect on the consolidated financial position, liquidity and profitability of Solutia. Astaris Joint Venture - --------------------- On October 8, 2003 Solutia and Astaris, a 50/50 joint venture with FMC, amended Astaris' external financing agreement to release the Astaris lenders' security interests in certain Solutia assets in exchange for Solutia's posting of a $67 letter of credit, representing fifty percent of the Astaris lenders' outstanding commitments to Astaris. Solutia used 92 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) approximately $36 in 2004 for investment payments ("keepwell payments") to keep the Astaris joint venture in compliance with its financial covenants. There were no keepwell payments made in 2005. The remaining commitment to Astaris was $10 as of December 31, 2004, which was subsequently terminated as part of Astaris' refinancing of its credit facility on February 8, 2005. Solutia and FMC had also agreed to allow Astaris to defer up to $27 of payment obligations to each of Solutia and FMC under existing operating agreements and certain other agreements. The deferral amount outstanding from Astaris to Solutia was $16 as of December 31, 2004. In February 2005, this deferral agreement was terminated and all amounts outstanding were paid in full in conjunction with the Astaris refinancing. Impact of Chapter 11 Proceedings - -------------------------------- During the reorganization process, substantially all pending litigation against Solutia and its subsidiaries that filed for reorganization under Chapter 11 ("Debtors") is stayed, as well as the majority of all other pre-petition claims. Exceptions would generally include pre-petition claims addressed by the Bankruptcy Court, as well as fully secured claims. Such claims may be subject to future adjustments. Adjustments may result from actions of the Bankruptcy Court, negotiations, assumption or rejection of executory contracts, determination as to the value of any collateral securing claims, proofs of claims or other events. Additional pre-petition claims not currently reflected in the consolidated financial statements may be identified through the proof of claim reconciliation process. The amount of pre-petition claims ultimately allowed by the Bankruptcy Court with respect to contingent claims may be materially different from the amounts reflected in the consolidated financial statements. Generally, claims against Debtors arising from actions or omissions prior to their filing date may be subject to compromise in connection with the plan of reorganization. The ultimate resolution of all of these claims may be settled through negotiation as compared to court proceedings, with the result being that Solutia may retain certain obligations currently classified as subject to compromise in the Consolidated Statement of Financial Position. 93 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 21. SUPPLEMENTAL DATA Supplemental income statement and cash flow data from continuing operations were:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------ Income Statement: 2006 2005 2004 - ---------------- ------------------------------------------------------------------ Raw material and energy costs ......................... $1,652 $1,540 $1,418 Employee compensation and benefits .................... 523 502 588 Depreciation expense .................................. 101 101 108 Amortization of capitalized computer software.......... 9 10 11 Taxes other than income................................ 67 58 75 Rent expense .......................................... 19 20 21 Provision for doubtful accounts (net of recoveries).... 1 5 1 Research and development .............................. 38 41 40 Interest expense: Total interest cost ................................ $108 $87 $116 Less capitalized interest .......................... 4 3 3 ------------------------------------------------------------------ Net interest expense .................................. $104 $84 $113 Cash Flow: - --------- Cash payments for interest (net of amounts capitalized) $102 $84 $86 Cash payments for income taxes......................... 4 10 11 Cash payments for reorganization items (a)............. 65 65 44 The effect of exchange rate changes on cash and cash equivalents was not significant. (a) Cash payments for reorganization items were included in Cash Provided by (Used in) Operations in the Consolidated Statement of Cash Flows in 2006, 2005 and 2004.
22. SEGMENT AND GEOGRAPHIC DATA Solutia, together with its subsidiaries, is a global manufacturer and marketer of a variety of high-performance chemical-based materials, which are used in a broad range of consumer and industrial applications. Solutia manages its business in three operating segments: CPFilms, Other Performance Products ("OPP") and Integrated Nylon. The CPFilms and OPP operating segments are aggregated into the Performance Products reportable segment pursuant to SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Performance Products reportable segment is a world leader in performance films for laminated safety glass and after-market applications, and specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic fluid. The Integrated Nylon reportable segment consists of an integrated family of nylon products including high-performance polymers and fibers. The major products and services by reportable segment are as follows: 94 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) PERFORMANCE PRODUCTS -------------------- SAFLEX(R) plastic interlayer LLUMAR(R), VISTA(R), GILA(R) and FORMULA ONE PERFORMANCE AUTOMOTIVE FILMS(R) professional and retail window films THERMINOL(R) heat transfer fluids DEQUEST(R) water treatment chemicals SKYDROL(R) aviation hydraulic fluids and SKYKLEEN(R) brand of aviation solvents ASTROTURF(R), CLEAN MACHINE(R), and CLEAR PASS(TM). entrance matting and automotive spray suppression flaps INTEGRATED NYLON ---------------- Nylon intermediate "building block" chemicals Nylon polymers, including VYDYNE(R) and ASCEND(R) Carpet fibers, including the WEAR-DATED(R) and ULTRON(R) brands Industrial nylon fibers Solutia evaluates the performance of its operating segments based on segment profit, defined as earnings before interest expense and income taxes ("EBIT"), which includes marketing, administrative, technological and amortization expenses, gains and losses from asset dispositions and restructuring charges, and other income and expense items that can be directly attributable to the segment. Certain expenses and other items that are managed outside the segments are excluded. These unallocated items consist primarily of corporate expenses, equity earnings (losses) from affiliates, other income and expense items, reorganization items, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the operating segment. There were no inter-segment sales in the periods presented below. Solutia's 2006, 2005 and 2004 segment information follows:
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 2006 2005 2004 ---------------------------------------------------------------------- NET NET PROFIT NET PROFIT SALES PROFIT SALES (LOSS) SALES (LOSS) ----- ------ ----- ------ ----- ------ SEGMENT: Performance Products......... $1,174 $ 133 $1,117 $ 126 $1,049 $ 89 Integrated Nylon............. 1,731 9 1,642 (26) 1,588 (59) ------ ------ ------ ------ ------ ------ SEGMENT TOTALS.................. 2,905 142 2,759 100 2,637 30 RECONCILIATION TO CONSOLIDATED TOTALS: Corporate expenses.......... (45) (64) (89) Equity earnings (loss) from affiliates............ 37 94 (27) Interest expense............ (104) (84) (113) Other income (expense), net........................ 6 -- (1) Loss on debt modification... (8) -- (15) Reorganization items, net... (57) (27) (71) CONSOLIDATED TOTALS: ------ ------ ------ NET SALES................... $2,905 $2,759 $2,637 ====== ------ ====== ------ ====== ------ INCOME (LOSS) BEFORE INCOME TAXES ............. $ (29) $ 19 $ (286) ====== ====== ======
95 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
AS OF AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------------------ 2006 2005 2004 ------------------------------------------------------------------------------------------------------ DEPRECIATION DEPRECIATION DEPRECIATION CAPITAL AND CAPITAL AND CAPITAL AND ASSETS EXPENDITURES AMORTIZATION ASSETS EXPENDITURES AMORTIZATION ASSETS EXPENDITURES AMORTIZATION ------ ------------ ------------ ------ ------------ ------------ ------ ------------ ------------ SEGMENT: Performance Products..... $ 814 $ 52 $ 43 $ 770 $ 48 $ 38 $ 788 $ 34 $ 38 Integrated Nylon......... 717 50 63 668 26 69 713 15 76 ------ ------ ------ ------ ------ ------ ------ ------ ------ SEGMENT TOTALS............... $1,531 $ 102 $ 106 $1,438 $ 74 $ 107 $1,501 $ 49 $ 114 RECONCILIATION TO CONSOLIDATED TOTALS: Discontinued Operations -- 69 81 Unallocated amounts ..... 524 4 5 477 3 4 494 2 6 ------ ------ ------ ------ ------ ------ ------ ------ ------ CONSOLIDATED TOTALS.......... $2,055 $ 106 $ 111 $1,984 $ 77 $ 111 $2,076 $ 51 $ 120 ====== ====== ====== ====== ====== ====== ====== ====== ======
Solutia's geographic information for the year ended December 31, 2006, 2005 and 2004 follows:
PROPERTY, PLANT AND NET SALES EQUIPMENT, NET ------------------------------------ ------------------------ 2006 2005 2004 2006 2005 ---- ---- ---- ---- ---- North America.................... $1,612 $1,695 $1,606 $ 665 $ 683 Europe/Africa.................... 610 552 520 80 74 Asia Pacific..................... 587 420 416 27 6 Latin America.................... 96 92 95 23 7 ------ ------ ------ ------ ------ CONSOLIDATED TOTALS.............. $2,905 $2,759 $2,637 $ 795 $ 770 ====== ====== ====== ====== ======
23. SUBSEQUENT EVENTS On January 25, 2007, Solutia completed the extension and upsizing of its $1,225 of debtor-in-possession ("DIP") financing, maturing March 31, 2008. This represents a $400 increase and a one year extension over Solutia's current DIP credit facility. The increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments that are coming due in 2007, as well as funds to partially facilitate the acquisition of Akzo Nobel's stake in the 50/50 rubber chemical joint venture Flexsys Holding B.V. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. The Bankruptcy Court entered an order approving this amendment on January 23, 2007. On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel's stake in the Flexsys joint venture. Solutia and Akzo Nobel have entered into a letter agreement committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The proposed transaction is subject to approval by the United States Bankruptcy Court, receipt of required regulatory approvals, finalizing the definitive purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase via $150 of funding under the January 2007 amended DIP credit facility (as described above) and additional funding through Flexsys. 96 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 24. QUARTERLY DATA -- UNAUDITED
FIRST SECOND THIRD FOURTH TOTAL QUARTER QUARTER QUARTER QUARTER YEAR - --------------------------------------------------------------------------------------------------------------------------- Net Sales........................................ 2006 $678 $765 $738 $724 $2,905 2005 $714 $730 $661 $654 $2,759 Gross Profit..................................... 2006 74 130 103 74 381 2005 102 101 77 42 322 Income (Loss) from Continuing Operations......... 2006 (26) 24 (6) (39) (47) 2005 19 13 (16) (9) 7 Income from Discontinued Operations, net of tax.. 2006 4 4 50 -- 58 2005 2 1 1 -- 4 Income (Loss) before Cumulative Effect of Change in Accounting Principle......................... 2006 (22) 28 44 (39) 11 2005 21 14 (15) (9) 11 Cumulative Effect of Change in Accounting Principle, net of tax........................... 2005 -- -- -- (3) (3) Net Income (Loss)................................ 2006 (22) 28 44 (39) 11 2005 21 14 (15) (12) 8 Basic and Diluted Income (Loss) per share: Income (Loss) from Continuing Operations......... 2006 (0.25) 0.23 (0.06) (0.37) (0.45) 2005 0.18 0.12 (0.15) (0.09) 0.07 Income from Discontinued Operations, net of tax.. 2006 0.04 0.04 0.48 -- 0.56 2005 0.02 0.01 0.01 -- 0.04 Cumulative Effect of Change in Accounting Principle, net of tax........................... 2005 -- -- -- (0.03) (0.03) Net Income (Loss)................................ 2006 (0.21) 0.27 0.42 (0.37) 0.11 2005 0.20 0.13 (0.14) (0.11) 0.08 Common Stock Price: 2006............................... HIGH 0.50 0.50 0.52 0.75 0.75 LOW 0.28 0.35 0.33 0.39 0.28 2005............................... High 1.69 1.37 0.86 0.70 1.69 Low 0.63 0.33 0.53 0.34 0.33
In 2006 and 2005 certain events affecting comparability were recorded in Reorganization Items, net in the Consolidated Statement of Operations. A comparison of reorganization items for these periods respectively is provided in Note 3. Charges and gains recorded in 2006 and 2005 and other events affecting comparability recorded outside of reorganization items have been summarized below. 97 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net loss in the first quarter of 2006 included charges of $9 for an environmental charge at one of Solutia's facilities outside the U.S. and $9 for the write-off of debt issuance costs and recording of the DIP credit facility as modified at its fair value. Net income in the second quarter of 2006 included a gain of $20 resulting from the reversal of a litigation reserve; charges of $1 related principally to severance and retraining costs and $1 for restructuring charges at the Flexsys joint venture. Net income in the third quarter of 2006 included charges of $3 from early extinguishment costs for the refinancing of SESA's Euronotes, $1 related principally to severance and retraining costs and $1 for restructuring charges at the Flexsys joint venture. Net loss in the fourth quarter of 2006 included $2 for restructuring charges related principally to severance and retraining costs. The Flexsys joint venture had net charges comprised of $2 for asset impairments and $1 for restructuring, partially offset by a $1 non-operational gain related to the reversal of a litigation reserve. In the first quarter of 2005, there were no events, other than those recorded in Reorganization Items, net within the Consolidated Statement of Operations that significantly affected comparability. Net income in the second quarter of 2005 included charges of $1 for various restructuring charges principally related to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations; and $5 for a non-operational gain incurred by the Flexsys joint venture. Net loss in the third quarter of 2005 included a $3 loss from the net pension and other postretirement benefit plan curtailments and settlements. Net loss in the fourth quarter of 2005 included $1 for restructuring charges related principally to severance and retraining costs; $3 for restructuring charges at the Astaris and Flexsys joint ventures; a $50 net gain on sale as a result of the Astaris joint venture divestiture of assets; and $10 of net pension settlement charges. Under SFAS No. 128, Earnings per Share, the quarterly and total year calculations of basic and diluted loss per share are based on weighted average shares outstanding for that quarterly or total year period, respectively. As a result, the sum of basic and diluted income (loss) per share for the quarterly periods may not equal total year income (loss) per share. 25. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS CPFilms, Inc., Monchem International, Inc., Monchem, Inc., Solutia Systems, Inc., Solutia Investments, LLC and Solutia Business Enterprises, Inc., 100% owned subsidiaries of Solutia (the "Guarantors"), are guarantors of Solutia's 11.25% Senior Secured Notes due 2009 (the "Notes"). In connection with the completion of the October 2003 credit facility, Solutia Investments, LLC and Solutia Business Enterprises, Inc. became guarantors of the Notes through cross-guarantor provisions. Solutia's obligations under the October 2003 facility were paid in full with the proceeds of the DIP credit facility dated January 16, 2004, which payment did not affect the Guarantors' obligations in respect of the Notes. Certain other 100% owned subsidiaries of Solutia (the "DIP Guarantors") guaranteed the final DIP credit facility (as well as a smaller, interim DIP credit facility put in place as of December 19, 2003), but the DIP Guarantors were not required by the cross-guarantor provisions to guarantee the Notes. The Guarantors fully and unconditionally guarantee the Notes on a joint and several basis. The following condensed consolidating financial statements present, in separate columns, financial information for: Solutia on a parent only basis carrying its investment in subsidiaries under the equity method; Guarantors on a combined, or where appropriate, consolidated basis, carrying investments in subsidiaries which do not guarantee the debt (the "Non-Guarantors") under the equity method; Non-Guarantors on a combined, or where appropriate, consolidated basis; eliminating adjustments; and consolidated totals as of December 31, 2006 and December 31, 2005, and for the years ended December 31, 2006, 2005 and 2004. The eliminating adjustments primarily reflect intercompany transactions, such as interest income and expense, accounts receivable and payable, advances, short and long-term debt, royalties and profit in inventory eliminations. Solutia has not presented separate financial statements and other disclosures concerning the Guarantors as such information is not material and would substantially duplicate disclosures included elsewhere in this report. 98 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATING STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2006
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- NET SALES............................... $2,191 $ 192 $ 980 $ (458) $2,905 Cost of goods sold...................... 2,058 97 850 (481) 2,524 ------------------------------------------------------------------------ GROSS PROFIT............................ 133 95 130 23 381 Marketing expenses...................... 75 24 37 -- 136 Administrative expenses................. 65 9 23 -- 97 Technological expenses.................. 39 2 4 -- 45 Amortization of intangible assets....... -- -- 1 -- 1 ------------------------------------------------------------------------ OPERATING INCOME (LOSS)................. (46) 60 65 23 102 Equity earnings (loss) from affiliates.. 174 80 (7) (209) 38 Interest expense........................ (84) -- (55) 35 (104) Other income, net....................... 20 15 38 (59) 14 Loss on debt modification............... (8) -- -- -- (8) Reorganization items, net............... (68) (2) (1) -- (71) ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT).................. (12) 153 40 (210) (29) Income tax expense (benefit)............ (23) 30 12 (1) 18 ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS......................... 11 123 28 (209) (47) Income from discontinued operations, net of tax............................. -- -- 58 -- 58 ------------------------------------------------------------------------ NET INCOME.............................. $ 11 $ 123 $ 86 $ (209) $ 11 ======================================================================== CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME YEAR ENDED DECEMBER 31, 2006 Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- NET INCOME.............................. $ 11 $ 123 $ 86 $ (209) $ 11 OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments........ (12) (19) (16) 35 (12) Net realized gain on derivative instruments........................ 1 -- -- -- 1 Minimum pension liability adjustments, net of tax......................... 24 -- (9) 9 24 ------------------------------------------------------------------------ COMPREHENSIVE INCOME.................... $ 24 $ 104 $ 61 $ (165) $ 24 ========================================================================
99 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATING STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2005
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- NET SALES............................... $2,084 $ 176 $ 899 $ (400) $2,759 Cost of goods sold...................... 2,017 83 763 (426) 2,437 ------------------------------------------------------------------------ GROSS PROFIT............................ 67 93 136 26 322 Marketing expenses...................... 80 23 33 -- 136 Administrative expenses................. 60 8 24 -- 92 Technological expenses.................. 40 3 2 -- 45 Amortization of intangible assets....... -- -- 1 -- 1 ------------------------------------------------------------------------ OPERATING INCOME (LOSS)................. (113) 59 76 26 48 Equity earnings (loss) from affiliates.. 195 44 (7) (136) 96 Interest expense........................ (62) -- (49) 27 (84) Other income, net....................... 10 15 35 (52) 8 Loss on debt modification............... (1) -- -- 1 -- Reorganization items, net............... (44) -- (5) -- (49) ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT).................. (15) 118 50 (134) 19 Income tax expense (benefit)............ (27) 30 9 -- 12 ------------------------------------------------------------------------ INCOME FROM CONTINUING OPERATIONS 12 88 41 (134) 7 Income (loss) from discontinued operations, net of tax............. (3) -- 8 (1) 4 Cumulative effect of change in accounting principle, net of tax ............. (1) -- (2) -- (3) ------------------------------------------------------------------------ NET INCOME.............................. $ 8 $ 88 $ 47 $ (135) $ 8 ======================================================================== CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) YEAR ENDED DECEMBER 31, 2005 Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- NET INCOME.............................. $ 8 $ 88 $ 47 $ (135) $ 8 OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments........ (11) (14) (20) 34 (11) Net realized loss on derivative instruments........................ (1) -- -- -- (1) Minimum pension liability adjustments, net of tax......................... (6) -- 4 (4) (6) ------------------------------------------------------------------------ COMPREHENSIVE INCOME (LOSS) ............ $ (10) $ 74 $ 31 $ (105) $ (10) ========================================================================
100 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATING STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2004
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- NET SALES............................... $2,008 $ 164 $ 839 $ (374) $2,637 Cost of goods sold...................... 2,019 85 707 (395) 2,416 ------------------------------------------------------------------------ GROSS PROFIT (LOSS)..................... (11) 79 132 21 221 Marketing expenses...................... 86 22 31 -- 139 Administrative expenses................. 62 8 26 -- 96 Technological expenses.................. 40 2 2 -- 44 Amortization of intangible assets....... 1 -- -- -- 1 ------------------------------------------------------------------------ OPERATING INCOME (LOSS)................. (200) 47 73 21 (59) Equity earnings (loss) from affiliates.. 43 (22) (14) (33) (26) Interest expense........................ (153) -- (53) 93 (113) Other income, net....................... 18 75 22 (115) -- Loss on debt modification............... -- -- (15) -- (15) Reorganization items, net............... (73) -- -- -- (73) ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT).................. (365) 100 13 (34) (286) Income tax expense (benefit)............ (51) 45 4 -- (2) ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS......................... (314) 55 9 (34) (284) Loss from Discontinued Operations, net of tax............................. (2) -- (30) -- (32) ------------------------------------------------------------------------ NET INCOME (LOSS)....................... $ (316) $ 55 $ (21) $ (34) $ (316) ======================================================================== CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) YEAR ENDED DECEMBER 31, 2004 Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- NET INCOME (LOSS)....................... $ (316) $ 55 $ (21) $ (34) $ (316) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments........ 15 14 28 (42) 15 Minimum pension liability adjustments, net of tax......................... (18) -- (9) 9 (18) ------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS)............. $ (319) $ 69 $ (2) $ (67) $ (319) =========================================================================
101 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATING BALANCE SHEET DECEMBER 31, 2006
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- ASSETS CURRENT ASSETS: Cash and cash equivalents................. $ 23 $ 14 $ 113 $ -- $ 150 Trade receivables, net.................... 2 144 142 -- 288 Intercompany receivables.................. 157 782 134 (1,073) -- Miscellaneous receivables................. 69 1 35 -- 105 Inventories............................... 148 28 114 (16) 274 Prepaid expenses and other assets......... 20 1 7 3 31 Assets of discontinued operations......... -- -- -- -- -- ---------------------------------------------------------------------- TOTAL CURRENT ASSETS................... 419 970 545 (1,086) 848 PROPERTY, PLANT AND EQUIPMENT, NET........ 578 82 135 -- 795 INVESTMENTS IN AFFILIATES................. 2,394 266 7 (2,474) 193 GOODWILL.................................. -- 72 17 -- 89 IDENTIFIED INTANGIBLE ASSETS, NET......... 2 26 3 -- 31 INTERCOMPANY ADVANCES..................... 128 1,238 994 (2,360) -- OTHER ASSETS.............................. 57 -- 42 -- 99 ---------------------------------------------------------------------- TOTAL ASSETS........................... $3,578 $2,654 $1,743 $(5,920) $2,055 ====================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable.......................... $ 177 $ 8 $ 45 $ (2) $ 228 Intercompany payables..................... 177 13 156 (346) -- Accrued liabilities....................... 154 14 77 -- 245 Short-term debt........................... 650 -- -- -- 650 Intercompany short-term debt.............. 1 -- 195 (196) -- Liabilities of discontinued operations.... 1 -- -- -- 1 ---------------------------------------------------------------------- TOTAL CURRENT LIABILITIES................. 1,160 35 473 (544) 1,124 LONG-TERM DEBT............................ -- -- 210 -- 210 INTERCOMPANY LONG-TERM DEBT............... -- -- 669 (669) -- OTHER LIABILITIES......................... 196 1 92 -- 289 ---------------------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 1,356 36 1,444 (1,213) 1,623 LIABILITIES SUBJECT TO COMPROMISE......... 3,639 413 20 (2,223) 1,849 SHAREHOLDERS' EQUITY (DEFICIT): Common stock.............................. 1 -- -- -- 1 Additional contributed capital ........... 56 -- -- -- 56 Treasury stock............................ (251) -- -- -- (251) Net (deficiency) excess of assets at spinoff and subsidiary capital.......... (113) 2,205 279 (2,484) (113) Accumulated other comprehensive loss...... (67) -- -- -- (67) Accumulated deficit....................... (1,043) -- -- -- (1,043) ------------------------------------------------------------------------ TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,417) 2,205 279 (2,484) (1,417) ------------------------------------------------------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)............................... $3,578 $2,654 $1,743 $(5,920) $2,055 ========================================================================
102 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONSOLIDATING BALANCE SHEET DECEMBER 31, 2005
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- ASSETS CURRENT ASSETS: Cash and cash equivalents................. $ 1 $ 15 $ 91 $ -- $ 107 Trade receivables, net.................... 7 118 121 -- 246 Intercompany receivables.................. 115 754 89 (958) -- Miscellaneous receivables................. 67 -- 28 -- 95 Inventories............................... 142 31 94 (13) 254 Prepaid expenses and other assets......... 23 -- 8 3 34 Assets of discontinued operations......... -- -- 69 -- 69 ---------------------------------------------------------------------- TOTAL CURRENT ASSETS................... 355 918 500 (968) 805 PROPERTY, PLANT AND EQUIPMENT, NET........ 589 84 97 -- 770 INVESTMENTS IN AFFILIATES................. 2,291 209 13 (2,308) 205 GOODWILL.................................. -- 72 4 -- 76 IDENTIFIED INTANGIBLE ASSETS, NET......... 2 26 -- -- 28 INTERCOMPANY ADVANCES..................... 128 1,238 704 (2,070) -- OTHER ASSETS.............................. 62 -- 38 -- 100 ---------------------------------------------------------------------- TOTAL ASSETS........................... $3,427 $2,547 $1,356 $(5,346) $1,984 ====================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable.......................... $ 167 $ 9 $ 43 $ (1) $ 218 Intercompany payables..................... 108 12 111 (231) -- Accrued liabilities....................... 143 13 67 -- 223 Short-term debt........................... 300 -- -- -- 300 Intercompany short-term debt.............. -- -- 182 (182) -- Liabilities of discontinued operations.... 1 -- 25 -- 26 ---------------------------------------------------------------------- TOTAL CURRENT LIABILITIES................. 719 34 428 (414) 767 LONG-TERM DEBT............................ -- -- 247 -- 247 INTERCOMPANY LONG-TERM DEBT............... -- -- 402 (402) -- OTHER LIABILITIES......................... 201 -- 47 -- 248 ---------------------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 920 34 1,124 (816) 1,262 LIABILITIES SUBJECT TO COMPROMISE......... 3,961 407 21 (2,213) 2,176 SHAREHOLDERS' EQUITY (DEFICIT): Common stock.............................. 1 -- -- -- 1 Additional contributed capital ........... 56 -- -- -- 56 Treasury stock............................ (251) -- -- -- (251) Net (deficiency) excess of assets at spinoff and subsidiary capital.......... (113) 2,106 211 (2,317) (113) Accumulated other comprehensive loss...... (93) -- -- -- (93) Accumulated deficit....................... (1,054) -- -- -- (1,054) ---------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,454) 2,106 211 (2,317) (1,454) ---------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)............................... $3,427 $2,547 $1,356 $(5,346) $1,984 ======================================================================
103 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2006
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- CASH PROVIDED BY (USED IN) OPERATIONS..... $ (277) $ 35 $ 58 $ -- $ (184) ------------------------------------------------------------------------ INVESTING ACTIVITIES: Property, plant and equipment purchases... (66) (6) (37) -- (109) Acquisition and investment payments....... (23) -- 7 -- (16) Property disposals and investment proceeds 5 -- 72 -- 77 ------------------------------------------------------------------------ CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES.............................. (84) (6) 42 -- (48) ------------------------------------------------------------------------ FINANCING ACTIVITIES: Net change in short-term debt obligations 350 -- -- -- 350 Payments on long-term debt obligations.... -- -- (51) -- (51) Deferred debt issuance costs.............. (8) -- (9) -- (17) Other financing activities................ -- -- (7) -- (7) Changes in investments and advances from (to) affiliates......................... 41 (30) (11) -- -- ------------------------------------------------------------------------ CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.............................. 383 (30) (78) -- 275 ------------------------------------------------------------------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. 22 (1) 22 -- 43 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR......................... 1 15 91 -- 107 ------------------------------------------------------------------------ END OF YEAR............................... $ 23 $ 14 $ 113 $ -- $ 150 ========================================================================
104 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2005
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- CASH PROVIDED BY (USED IN) OPERATIONS..... $ (150) $ 62 $ 64 $ -- $ (24) ------------------------------------------------------------------------ INVESTING ACTIVITIES: Property, plant and equipment purchases... (46) (13) (22) -- (81) Property disposals and investment proceeds 79 -- 2 -- 81 ------------------------------------------------------------------------ CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES.............................. 33 (13) (20) -- -- ------------------------------------------------------------------------ FINANCING ACTIVITIES: Net change in cash collateralized letters of credit............................... 17 -- -- -- 17 Changes in investments and advances from (to) affiliates......................... 59 (41) (18) -- -- Deferred debt issuance costs ............. (1) -- -- -- (1) ------------------------------------------------------------------------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.............................. 75 (41) (18) -- 16 ------------------------------------------------------------------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. (42) 8 26 -- (8) CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR......................... 43 7 65 -- 115 ------------------------------------------------------------------------ END OF YEAR............................... $ 1 $ 15 $ 91 $ -- $ 107 ========================================================================
105 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2004
Parent Only Non- Consolidated Solutia Guarantors Guarantors Eliminations Solutia ------- ---------- ---------- ------------ ------- CASH PROVIDED BY (USED IN) OPERATIONS..... $ (53) $ 91 $ 3 $ -- $ 41 ---------------------------------------------------------------------------- INVESTING ACTIVITIES: Property, plant and equipment purchases... (27) (10) (24) -- (61) Acquisition and investment payments, net of cash acquired........................ (36) -- -- -- (36) ----------------------------------------------------------- ---------------- CASH USED IN INVESTING ACTIVITIES......... (63) (10) (24) -- (97) ---------------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in short-term debt obligations. (361) -- -- -- (361) Proceeds from issuance of long-term debt obligations............................. 300 -- -- -- 300 Net change in cash collateralized letters of credit............................... 87 -- -- -- 87 Changes in investments and advances from (to) affiliates......................... 37 (94) 57 -- -- Deferred debt issuance costs.............. (9) -- (5) -- (14) ---------------------------------------------------------------------------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.............................. 54 (94) 52 -- 12 ---------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. (62) (13) 31 -- (44) CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR......................... 105 20 34 -- 159 ---------------------------------------------------------------------------- END OF YEAR............................... $ 43 $ 7 $ 65 $ -- $ 115 ============================================================================
106 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of December 31, 2006, Solutia carried out an evaluation, under the supervision and with the participation of Solutia's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Solutia's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange Act")). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2006, 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. The Chief Executive Officer and Chief Financial Officer also concluded that, as of December 31, 2006, Solutia's disclosure controls and procedures are effective to provide reasonable assurance that Solutia records, processes, summarizes, and reports the required disclosure information within the specified time periods. Further, there were no changes in Solutia's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING MANAGEMENT REPORT Management of Solutia Inc. and its subsidiaries (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Solutia's internal control over financial reporting is a process designed by, or under the supervision of, Solutia's principal executive and principal financial officers and effected by Solutia's board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Solutia's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Solutia; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Solutia are being made only in accordance with authorizations of management and directors of Solutia; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Solutia's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of Solutia's internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. Based on our assessment and those criteria, management believes that Solutia maintained effective internal control over financial reporting as of December 31, 2006. Solutia's independent auditors have issued an attestation report on management's assessment of Solutia's internal control over financial reporting. This report appears on page 108. 107 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Solutia Inc.: We have audited management's assessment, included in the accompanying Management Report, that Solutia Inc. and subsidiaries (Debtor-In-Possession) (the "Company") maintained effective internal control over financial reporting as of December 31, 2006, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2006 of the Company and our report dated March 1, 2007, expressed an unqualified opinion on those financial statements and financial statement schedule, and included explanatory paragraphs regarding the Company's filing for reorganization under Chapter 11 of the United States Bankruptcy Code, substantial doubt about the Company's ability to continue as a going concern, and change in accounting principle for the adoption of Statement of Financial Accounting Standard No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, effective December 31, 2006. St. Louis, Missouri March 1, 2007 108 ITEM 9B. OTHER INFORMATION On February 27, 2007, Solutia announced that it had reached a definitive agreement (the "Transaction Agreement") to purchase Akzo Nobel's stake in Flexsys, the 50%/50% rubber chemicals joint venture between Akzo Nobel and Solutia. Solutia and Akzo Nobel have entered into a letter agreement, attached hereto as Exhibit 10(ss), committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The following description of the Transaction Agreement sets forth a brief summary of certain material terms of that agreement. However, this description does not purport to be complete and is qualified in its entirety by reference to the specific terms of the Transaction Agreement, attached to this Annual Report on Form 10-K as Exhibit 10(rr). The Transaction Agreement provides for the sale by Akzo Nobel of its interest in the Flexsys joint venture to Solutia for an initial purchase price of $212.5 million subject to various adjustments. The purchase will make Solutia the sole owner of Flexsys. This transaction is subject to approval by the Bankruptcy Court, receipt of required regulatory approvals, finalizing the purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase through a combination of sources, including a portion of its DIP financing package as described in "Management's Discussion and Analysis" in Item 7 above. Pursuant to the Transaction Agreement, Akzo Nobel has agreed, subject to certain limitations and exclusions, to indemnify, defend and hold harmless Flexsys, Solutia, their affiliates and representatives from and in respect of any losses and liabilities arising out of any breaches of the representations, warranties or covenants contained in the Transaction Agreement. Solutia and Flexsys have agreed, subject to certain limitations and exclusions, to indemnify, defend and hold harmless Akzo Nobel and its affiliates from and in respect of any losses and liabilities arising out of any breaches of the representations, warranties or covenants contained in the Transaction Agreement. Akzo Nobel has agreed, subject to certain exceptions, that for a period of five years after the closing of the Transaction Agreement, neither it nor its affiliates will compete with the Flexsys business and for a period of three years after the closing of the Transaction Agreement, Akzo Nobel will not solicit for employment certain employees of Flexsys. In addition to customary termination rights, the Transaction Agreement may be terminated prior to closing by Akzo Nobel or Solutia if the closing has not occurred on or before May 25, 2007. 109 PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE DIRECTORS The following table shows information about Solutia's directors on March 1, 2007:
- ---------------------------------------------------------------------------------------------------------------------------------- Name, Age, Year First Became Principal Occupation and Other Business a Solutia Director Other Directorships Experience Since At Least January 1, 2002 - ---------------------------------------------------------------------------------------------------------------------------------- Jeffry N. Quinn, 48 None President, Chief Executive Officer and Director since May 2004. 2004 Named Chairman of the Board on February 22, 2006. Mr. Quinn previously served as Solutia's Senior Vice President, General Counsel and Chief Restructuring Officer from 2003 to 2004. Prior to joining Solutia, Mr. Quinn served from 2000 to 2002 as Executive Vice President, Chief Administrative Officer and General Counsel of Premcor Inc., one of the largest independent petroleum refiners and suppliers of unbranded transportation fuels, heating oil, petrochemical feedstocks, petroleum coke and other petroleum products in the United States. Premcor Inc. is now owned by Valero Energy Corp. - ---------------------------------------------------------------------------------------------------------------------------------- Paul H. Hatfield, 71 Bunge Limited; Maritz, Principal of Hatfield Capital Group, a private investment company. 1997 Inc.; Penford Corporation Previously, Mr. Hatfield served as Chairman of the Board, President and Chief Executive Officer of Petrolite Corporation, a specialty chemical company offering integrated technologies with products and services which are used primarily in energy-related industries, including chemical treatment programs, performance-enhancing additives, process equipment, engineering services and polymers used as additives in a wide range of industrial and consumer product applications, from 1995 through 1997. Petrolite Corporation is now known as Baker Petrolite, a division of Baker Hughes. - ---------------------------------------------------------------------------------------------------------------------------------- Robert H. Jenkins, 63 AK Steel Holdings Retired Chairman of the Board and Chief Executive Officer, Sundstrand 1997 Corporation; CLARCOR Corporation. Previously, Mr. Jenkins served as Chairman of the Board Inc.; Jason Inc.; and Chief Executive Officer of Sundstrand Corporation, a multinational ACCO Brands organization engaged in the design, manufacture, and sale of a variety of proprietary, technology-based components and systems for diversified international markets, from 1997 through 1999. - ---------------------------------------------------------------------------------------------------------------------------------- Frank A. Metz, Jr., 73 None Retired Senior Vice President, Finance and Planning and Chief 1997 Financial Officer, International Business Machines Corporation. Previously served as Senior Vice President, Finance and Planning and Chief Financial Officer, International Business Machines Corporation (IBM), the world's largest information technology company, business and technology services company, consulting services organization, information technology research organization, and financier of information technology, from 1986 through 1993 and as a Director of IBM from 1991 through 1993. - ---------------------------------------------------------------------------------------------------------------------------------- J. Patrick Mulcahy, 63 Energizer Holdings, Chairman, Energizer Holdings, Inc., one of the world's largest 1999 Inc.; Hanesbrands Inc. manufacturers of primary batteries, flashlights and men's and women's wet-shave products. Mr. Mulcahy previously served as Chief Executive Officer of Energizer Holdings, Inc. from 2000 through 2005. - ---------------------------------------------------------------------------------------------------------------------------------- Sally G. Narodick, 61 Cray Inc.; Penford Retired President, Narodick Consulting, an educational technology and 2000 Corporation; Puget e-learning consulting firm, from 2000 through 2004. Ms. Narodick Energy, Inc., and its previously served as Chief Executive Officer of Apex Learning, Inc., wholly owned subsidiary, an educational software company, from its founding in 1998 until 2000. Puget Sound Energy, Inc.; SumTotal Systems, Inc. - ---------------------------------------------------------------------------------------------------------------------------------- John B. Slaughter, 72 None President and Chief Executive Officer, National Action Council for 1997 Minorities in Engineering, Inc. (a non-profit corporation). Mr. Slaughter previously served as the Irving R. Melbo professor of leadership in education at the University of Southern California and President Emeritus of Occidental College from 1999 through 2000. - ----------------------------------------------------------------------------------------------------------------------------------
110 Philip R. Lochner resigned from our board of directors effective January 31, 2007 and as a result, his information is not included above. His resignation was not due to any disagreement with Solutia with respect to its operations, policies or practices. All the directors were elected prior to Solutia's Chapter 11 filing. Solutia has not held an annual shareholders' meeting during its Chapter 11 case. OFFICERS The following table shows information about Solutia's executive officers on March 1, 2007:
- ---------------------------------------------------------------------------------------------------------------------------------- Name, Age and Position with Year First Became an Other Business Experience Since At Least January 1, 2002 Solutia Executive Officer of Solutia - ---------------------------------------------------------------------------------------------------------------------------------- Jeffry N. Quinn, 48 2003 President, Chief Executive Officer and Director since May President, Chief Executive 2004. Named Chairman of the Board on February 22, 2006. Mr. Officer and Chairman of the Quinn previously served as Solutia's Senior Vice President, Board General Counsel and Chief Restructuring Officer from 2003 to 2004. Prior to joining Solutia, Mr. Quinn served from 2000 to 2002 as Executive Vice President, Chief Administrative Officer and General Counsel of Premcor Inc., one of the largest independent petroleum refiners and suppliers of unbranded transportation fuels, heating oil, petrochemical feedstocks, petroleum coke and other petroleum products in the United States. Premcor Inc. is now owned by Valero Energy Corp. - ---------------------------------------------------------------------------------------------------------------------------------- Kent J. Davies, 43 2006 Senior Vice President and President, CPFilms since January Senior Vice President and 2006. Mr. Davies previously served as Senior Vice President, President, CPFilms Marketing, R&D and Regulatory, for United Industries Corp., a global consumer products company, from 2002 through 2005 and Senior Vice President, Marketing of United Industries Corp., from 2001 through 2002. - ---------------------------------------------------------------------------------------------------------------------------------- Luc De Temmerman, 52 2003 Senior Vice President and President, Performance Products since Senior Vice President and 2005. Mr. De Temmerman is a long-time Solutia employee who has President, Performance Products previously served as Senior Vice President and Chief Operating Officer from 2004 through 2005; Vice President and General Manager, Performance Products, from 2003 through 2004; Worldwide Commercial Director for Laminated Glazing Products and Services, from 2001 through 2002. - ---------------------------------------------------------------------------------------------------------------------------------- Rosemary L. Klein, 39 2004 Senior Vice President, General Counsel and Secretary since Senior Vice President, General 2004. Ms. Klein served as Solutia's Vice President, Secretary Counsel and Secretary and General Counsel, Corporate and External Affairs in 2004 and Assistant General Counsel in 2003. Ms. Klein served as Assistant General Counsel and Secretary of Premcor Inc., one of the largest independent petroleum refiners and suppliers of unbranded transportation fuels, heating oil, petrochemical feedstocks, petroleum coke and other petroleum products in the United States, from 2000 through 2003. Premcor Inc. is now owned by Valero Energy Corp. - ---------------------------------------------------------------------------------------------------------------------------------- James M. Sullivan, 46 2004 Senior Vice President, Chief Financial Officer and Treasurer Senior Vice President, Chief since 2004. Mr. Sullivan served as Solutia's Vice President Financial Officer and Treasurer and Controller from 1999 through 2004. - ---------------------------------------------------------------------------------------------------------------------------------- James R. Voss, 40 2005 Senior Vice President, Business Operations since 2005. Mr. Senior Vice President, Busines Voss served as Senior Vice President and Chief Administrative Operations Officer of Premcor Inc., one of the largest independent petroleum refiners and suppliers of unbranded transportation fuels, heating oil, petrochemical feedstocks, petroleum coke and other petroleum products in the United States, from 2000 through 2005. Premcor Inc. is now owned by Valero Energy Corp. - ---------------------------------------------------------------------------------------------------------------------------------- Jonathon P. Wright, 47 2005 Senior Vice President and President, Integrated Nylon since Senior Vice President and 2005. Mr. Wright served as a Vice President for Charles River President, Integrated Nylon Associates, an international economic and business consulting firm, from 2002 through 2005 where he worked extensively in the petrochemical, specialty chemical and related process industries. Mr. Wright was a Managing Director of Arthur D. Little's North American Strategy and Organizational Consulting business from 1997 through 2002. - ----------------------------------------------------------------------------------------------------------------------------------
The above listed individuals are elected to the offices set opposite their names to hold office until their successors are duly elected and have qualified, or until their earlier death, resignation or removal. AUDIT AND FINANCE COMMITTEE; AUDIT COMMITTEE FINANCIAL EXPERT The members of Solutia's Audit and Finance Committee, which met nine times in 2006, are Mr. Metz, chairman; Mr. Mulcahy, Mrs. Narodick and Dr. Slaughter. Solutia's board of directors has concluded that each member of the committee is independent within the meaning of Rule 10A-3 of the Exchange Act of 1934 and the New York Stock Exchange's listing standards. The board has also concluded that Mr. Metz is an audit committee financial expert, as that term is defined in the rules issued under the Sarbanes-Oxley Act of 2002. 111 The purpose of the committee is to assist the board in overseeing the integrity of Solutia's financial statements, Solutia's compliance with legal and regulatory requirements, the qualifications and independence of the independent auditor, the performance of the independent auditor and Solutia's internal audit function, and Solutia's systems of disclosure controls and internal controls over financial reporting, and to prepare the report required by the rules of the U.S. Securities and Exchange Commission. Among the committee's responsibilities is the selection of Solutia's independent auditor. The committee's written charter sets out the functions the committee is to perform, in light of the Sarbanes-Oxley Act of 2002 and the rules of the New York Stock Exchange. COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Section 16(a) of the Securities Exchange Act of 1934 requires Solutia's directors and executive officers to file reports of holdings and transactions in Solutia's common stock with the Securities and Exchange Commission. During 2006, all reports required by Solutia's directors and executive officers under Section 16(a) of the Securities Exchange Act of 1934 were made in a timely manner. CODE OF ETHICS Solutia's board of directors has adopted a Code of Ethics for Senior Financial Officers. This code applies to Solutia's chief executive officer and the other senior officers who have financial responsibilities, including Solutia's chief financial officer, treasurer, controller and general counsel. This code is filed as an exhibit to this Annual Report on Form 10-K. Any person who wishes to obtain a copy of our Code of Ethics may do so by writing to Investor Relations, Solutia Inc., 575 Maryville Centre Drive, St. Louis, Missouri 63141. LEGAL PROCEEDINGS For a description of litigation pending against certain former officers of Solutia see the first paragraph under "Other Legal Proceedings" on page 21 above. 112 ITEM 11. EXECUTIVE COMPENSATION COMPENSATION DISCUSSION AND ANALYSIS COMPENSATION PHILOSOPHY AND OBJECTIVES The Executive Compensation and Development Committee of our Board of Directors (the "ECDC") establishes our compensation philosophy and enacts and administers programs consistent with that philosophy. The ECDC does this in consultation with our Chief Executive Officer and our senior-level human resources personnel. The ECDC functions pursuant to a designation of authority from the full Board of Directors and in accordance with a written charter which was approved by the ECDC and the full Board of Directors. The ECDC has endorsed a pay-for-performance philosophy for our executives, including our Chief Executive Officer, designed to support our efforts to create a high performance culture within the Company. The key objectives of this philosophy are to: o Attract, retain and motivate executive officers by maintaining programs which offer competitive total compensation opportunities ( as compared to similarly situated companies) but which provide the potential for recognition of outstanding performance and penalties for performance that is not competitive; o Promote and incent the achievement of short-term and long-term operating and financial objectives that will maximize the value of Solutia's bankruptcy estate for our constituents; and o Avoid creation of an entitlement mentality by sufficiently differentiating between high-performers who drive the Company's performance and those who do not. The ECDC believes that the programs in place are well-designed to achieve the above stated compensation philosophy; however, certain of its decisions with respect to executive compensation matters are subject to Bankruptcy Court approval. As part of the court approval process, these ECDC determinations are subject to objections by constituents in our Chapter 11 case. In the opinion of the ECDC often the perspectives of these various constituents may be motivated by their own pecuniary interest, which in some cases, may not be consistent with the Board's obligations to maximize the value of our estate for the benefit of all constituents. In addition, as a result of being in Chapter 11, the Company has been unable to offer effective broad-based long-term compensation programs. The absence of the ability to offer any equity-based long term compensation has been especially troubling in effecting the above stated compensation philosophy. Due to these dynamics, during our bankruptcy case, the ECDC has not been able to, and in the future, may not be able to, fully implement executive compensation changes to meet the objectives stated above. The ECDC believes that the current aggregate compensation opportunities for many of the Company's executives, including its senior executives, may fall short of the objectives stated above. As a result, the Company may experience difficulty attracting or retaining executive officers, which could have the effect of delaying or preventing our emergence from Chapter 11 or our failure to achieve operating and financial objectives. To mitigate this issue, to the extent possible, the Company has requested bankruptcy court approval to make certain changes in its compensation programs with respect to the terms and conditions of employment for its senior executives. Specifically the company has requested approval of changes to the employment contracts of the CEO and certain other senior executives, a change in the base compensation of the CEO, and the approval of the 2007 annual incentive plan. These matters are scheduled for hearing before the Bankruptcy Court on March 12, 2007. ESTABLISHING COMPENSATION PROGRAMS AND COMPENSATION LEVELS Our Chief Executive Officer, Jeffry N. Quinn (the "CEO"), plays a significant role in the compensation process, other than with respect to his own compensation. Our CEO participates in ECDC meetings at the ECDC's request to provide: o Background information regarding our operating and financial objectives; o His evaluation of the performance of the senior executive officers; and o Compensation and professional development recommendations as to senior executive officers (other than himself). The ECDC evaluates the performance of the CEO and, subject to Bankruptcy Court approval, makes all compensation decisions related to the CEO and other members of the executive leadership team. 113 To assist the ECDC in making decisions regarding compensation program design and appropriate compensation levels, the ECDC employs Mercer HR Consulting, an internationally recognized compensation consulting firm. Mercer provides the ECDC with company specific compensation market data from their review of the public filings of certain peer companies. They advise the ECDC on program design and competitive compensation levels. The ECDC established two peer groups to be used in evaluating the overall competitiveness of our compensation program (the "Peer Groups"). The Peer Groups were chosen based on a number of factors, including similar lines of business and the overall size and value of the peer companies. One of the Peer Groups consists of chemical companies while the second peer group includes similarly situated companies currently in Chapter 11. The Peer Groups are evaluated and updated at least once a year and more often if necessary. The ECDC annually compares the compensation program for our executive officers, including our CEO, Chief Financial Officer ("CFO"), and our three other most highly paid executive officers named in the Summary Compensation Table (collectively, the "Named Executive Officers"), to programs of companies in the Peer Groups. COMPONENTS OF EXECUTIVE COMPENSATION The principal components of our current executive compensation program, including our Named Executive Officers, are: o Base salary; o Annual bonus; and o For certain of our senior executives, including our Named Executive Officers, a bonus related to emergence from Chapter 11. Each of these elements is discussed more fully below. Currently our executive compensation program does not include any long-term compensation. Our equity based incentive plan was suspended upon our Chapter 11 filing. Without such a plan, our executives do not have the opportunity to be rewarded for the achievement of long term performance goals. Consequently, the total compensation our executives can earn is significantly impaired as compared to executives at companies within Solutia's Peer Groups, that have long term incentive plans. Long term incentive compensation, particularly in the form of equity based compensation creates an ownership mentality, encourages retention and helps balance longer term strategic goals with shorter-term operating and financial goals. The absence of such incentives is a significant shortcoming in our current programs, especially with respect to our senior executives for whom, under competitive market practices, long term compensation would normally constitute a significant part of total compensation. ANNUAL COMPENSATION Mix of Compensation Components Annual cash compensation for our employees and executives, including our Named Executive Officers, is comprised of a mixture of base salary and an annual performance-based bonus. The exact mix between fixed compensation (base pay) and variable compensation (annual bonuses) varies based upon an employee's role in the organization. In allocating annual compensation opportunity between base salary and annual bonus, our ECDC believes that the compensation of our most senior management personnel - those levels of management having the greatest ability to influence our performance - should be weighted more heavily to variable compensation tied to the Company's performance. As position and responsibility increase, the ECDC believes that an increasing portion of an employee's total compensation should be performance based, and contingent upon the achievement of the company's financial and operating objectives. As a result, while almost all of our employees have an annual bonus opportunity, those at senior management levels receive a greater percentage of their annual cash compensation opportunity in the form of a bonus and therefore a greater amount of their total annual compensation is at risk. The ECDC believes that such structure creates a strong incentive for our senior executives to drive high levels of performance. Base Salary Base salary is a critical element of executive compensation as it is the only element of compensation that provides our executives with an assured annual cash compensation amount. We generally attempt to maintain base salaries for senior executives at approximately the 50th percentile of companies in our Peer Groups. In determining the appropriate base salary level, the ECDC considers a number of factors including: 114 o the executive's qualifications, past performance and experience; o the scope of the executive's responsibilities; o salary practices at other companies within our Peer Group for similar positions; o our internal equity considerations; and o our overall performance. Base salaries are reviewed on an annual basis, and may be adjusted from time to time based on the above criteria. See the Summary Compensation Table on page 119 for more information about the 2006 base salaries of our Named Executive Officers. Annual Bonus Our annual bonus plan, which was approved for 2006 by the Bankruptcy Court on September 25, 2006, is the Solutia Annual Incentive Program (the "AIP"). The AIP is a broad-based plan that applies to almost all of our employees. The AIP serves as an integral component of annual compensation for employees and fosters our pay-for-performance philosophy. The AIP is designed to deliver a significant portion of the executive's annual overall compensation opportunity in the form of a cash bonus based on achievement of key financial and operating objectives. The ECDC administers the AIP. The following is a discussion of the principal concepts embedded in the AIP. TARGET BONUSES Each participant in the AIP has a set target bonus. Target bonuses are based upon both external and internal considerations. The ECDC's philosophy is that from an external perspective, target bonuses are set such that median performance will result in median annual compensation and that performance above or below median levels will result in compensation above or below median levels. From an internal perspective, target bonuses are determined primarily by salary grade level within the organization. Salary grade levels are reflective of an individual's job and level of responsibility. In general, those with direct profit-and-loss responsibility have a higher target bonus opportunity than another participant at the same salary grade level that does not have direct profit-and-loss responsibility. BONUS POOLS The AIP is based upon a bonus pool concept. There are separate bonus pools determined for enterprise-level participants and the participants in each business unit in the following manner. Each year the ECDC establishes financial and operating performance metrics for the enterprise and for each business unit and a weighting for each metric. These determinations are based on the advice and recommendation of management. For each metric, a threshold (0.50x), target (1.0x), and maximum (3.0x) funding level is determined by the ECDC. Under the AIP these funding levels are referred to as funding factors. If the threshold performance level is not met with respect to any particular performance metric there is no funding of the bonus pool with respect to that metric. The target level funding or a 1.0x funding factor is the aggregate of all target bonuses for participants in the AIP. These determinations by the ECDC in effect establish a correlation between performance and funding for bonuses. For example, if only threshold level performance was achieved for all metrics, the funding factor would be 0.50x and total bonus pool would be only 50% of the sum of all participants' target bonuses. Conversely, if maximum performance levels were achieved for all metrics the funding factor would be 3.0x and the total bonus pool would be 300% of the sum of all participants' target bonuses. At the end of the year, the performance of the Company and its business units against the pre-established metrics is measured and the ECDC determines the funding factor for each bonus pool. FUNDING HISTORY OF BONUS POOLS The enterprise and each business unit achieved at least the threshold level of performance during the previous three years and during that period, the average overall annual funding of the bonus pools has been 42.6% of the maximum. Overall funding of the AIP for 2006 was approved by the ECDC at 47.3% of maximum. 115 2006 PERFORMANCE METRICS The performance metrics for 2006 for each incentive pool are as set forth in the following chart:
- -------------------------------------------------------------------------------------------------------------------------- BONUS POOL MEASURE WEIGHT MEASURE WEIGHT MEASURE WEIGHT - -------------------------------------------------------------------------------------------------------------------------- Enterprise Enterprise Pool EBITDAR(1) 45% Free Cash Flow 55% N/A N/A - -------------------------------------------------------------------------------------------------------------------------- Integrated Nylon Pool EBITDA(2) 50% Free Cash Flow 50% N/A N/A - -------------------------------------------------------------------------------------------------------------------------- Saflex Pool EBITDA 33-1/3% Free Cash Flow 33-1/3% Gross Margin % 33-1/3% - -------------------------------------------------------------------------------------------------------------------------- CPFilms Pool EBITDA 50% Free Cash Flow 50% N/A N/A - -------------------------------------------------------------------------------------------------------------------------- Chemicals Pool Free Cash Flow 100% N/A N/A N/A N/A - -------------------------------------------------------------------------------------------------------------------------- Plastic Products Pool Free Cash Flow 100% N/A N/A N/A N/A - -------------------------------------------------------------------------------------------------------------------------- (1) In general, "EBITDAR" means EBITDA plus, in accordance with United States generally accepted accounting principles ("GAAP") and subject to historical internal reporting standards, reorganization items. (2) In general, "EBITDA" means consolidated net income (loss) determined on a consolidated basis in accordance with GAAP and subject to historical internal reporting standards, excluding certain items specified in the 2006 AIP.
BONUS DETERMINATIONS Once the bonus pools are established, individual bonuses are determined as part of our performance management process. Individual bonuses are comprised of an objective portion and a subjective portion. Forty-five percent (45%) of each bonus pool is paid out on a straight objective basis to participants in that pool. This is the objective portion of a participant's bonus. Forty-five percent (45%) of each bonus pool is allocated to individual participants within the pool based upon on individual performance versus set goals and individual performance versus peer performance. The remaining ten percent (10%) of each bonus pool are aggregated to constitute an enterprise discretionary pool which can be allocated to any participant in the AIP. Allocations from these discretionary funds constitute the discretionary portion of a participant's bonus. Each participant's target bonus is multiplied by the relevant funding factor (the same funding factor that was used to determine the size of the bonus pool from which the participant's bonus is paid). By definition, the sum of all performance adjusted target bonuses for all participants in one of the bonus pools equals the total bonus pool. As a result, an individual is in effect guaranteed 45% of their target adjusted performance bonus except in cases of extreme individual performance issues. The discretionary portion of an individual's bonus can range from zero upward, which is limited only by the total funding of the relevant bonus pool. However, the ECDC has determined, as an administrative policy matter, that except in extreme cases, the maximum bonus an individual can receive under the AIP is 200% of their performance adjusted target bonus. The aggregate of all bonuses paid from each of the bonus pools can not exceed the amount of the pool except, any discretionary bonus paid to the CEO in excess of 50% of his performance adjusted target bonus, does not, at the discretion of the ECDC, diminish the pool available for bonus to other participants. BONUS RANGES The concepts described above in effect determine the range of potential bonus for a participant in any given year. If threshold performance levels are not met, there would be no bonus pool, and there would be no bonuses. If a bonus pool is funded, except in extreme performance situations, a participant would be eligible to receive a minimum bonus of 45% of their performance adjusted target bonus to a maximum bonus of two times their performance adjusted target bonus. Since the maximum funding factor that can be achieved is 3.0x (if the maximum performance is achieved) a participant's maximum performance adjusted bonus would be three times their target bonus and the maximum bonus they could receive is two times this amount or six times their target bonus. 116 BONUSES OF NAMED EXECUTIVE OFFICERS The bonuses of our CEO and other Named Executive Officers are determined in accordance with the above plan concepts. The ECDC determines the bonus for our CEO. The ECDC also reviews and approves our CEO's recommendations for bonus awards to our executive leadership team including the other Named Executive Officers. For 2006 Our Named Executive Officers were eligible to receive awards from the following incentive pools, in addition to the enterprise discretionary bonus pool:
------------------------------------------------------------------------------------------------------- Named Executive Officer Bonus Pools ------------------------------------------------------------------------------------------------------- J. N. QUINN ENTERPRISE POOL ------------------------------------------------------------------------------------------------------- J. M. SULLIVAN ENTERPRISE POOL ------------------------------------------------------------------------------------------------------- L. DE TEMMERMAN CHEMICALS POOL; PLASTIC PRODUCTS POOL; AND SAFLEX POOL ------------------------------------------------------------------------------------------------------- J.R. VOSS ENTERPRISE POOL ------------------------------------------------------------------------------------------------------- J.P. WRIGHT INTEGRATED NYLON POOL -------------------------------------------------------------------------------------------------------
The target annual bonus for the Named Executive Officer is in accordance with the Named Executive Officer's employment agreement with the Company as described in "Employment Agreements with Named Executive Officers" on page 122. Based upon the performance achieved by the Company in 2006 and the funding of the incentive pools, among other factors, the following items were considered by the ECDC in determining the amount of the discretionary bonus for our CEO and in approving the recommendations made by the CEO regarding senior executives. o The significant improvement in the Company's financial performance despite such challenges as continuously escalating raw material costs, unplanned downtime at our Alvin, Texas plant and managing the competing demands of the Chapter 11 process. o The improved safety performance of the Company; o The continued growth in our Saflex business and completion of, or progress towards, such strategic initiatives in Saflex as the acquisition of our joint venture partner's 51% stake in Quimica resulting in our sole ownership of Quimica's plant located in Puebla, Mexico, the construction of our PVB plant in China and a third extrusion line at our Ghent plant; o The continued transformation of our Nylon business as evidenced by the conversion of carpet fiber lines at the Company's Pensacola facility to produce nylon plastics; o The development and implementation of a new business model in our CP Films business; o The successful launch of an operations excellence initiative; o The significant progress in our Chapter 11 case including the filing of a plan of reorganization in February 2006 and completing a trial on the JPMorgan litigation matter; o The exploration of all possible avenues to reach a confirmable plan of reorganization, including the possibility of selling the equity of the reorganized company or certain of the Company's businesses or assets; o The successful amendment and upsizing of our debtor-in-possession financing; o The continued upgrading of the Company portfolio as evidenced by the disposition of the Company's pharmaceutical services business at an attractive valuation, and the agreement to acquire the remainder of the Flexsys joint venture; and o The strong leadership of the executive team that has been successful in retaining management talent for the Company, kept morale high and the organization focused notwithstanding the challenges of the Chapter 11 proceeding. Please see the "Grants of Plan Based Awards Table" on page 120 for estimated payouts under the AIP at threshold, target and maximum payout levels for each Named Executive Officer for the fiscal year ended December 31, 2006. The actual bonus amount paid under the AIP to each Named Executive Officer can be found in the Summary Compensation Table on page 119. 117 Long Term Incentives and Emergence Bonus EQUITY BASED INCENTIVES Use of our long-term equity based incentive plan was suspended upon our Chapter 11 filing and no awards have been made under it since that time. Although suspended, our long-term incentive plan previously included a stock incentive plan under which stock options, restricted stock or other awards of stock-based compensation could be granted. Certain of our Named Executive Officers hold fully-vested stock options that were granted prior to the suspension of our long-term incentive plan. Solutia's existing shares of common stock, as well as options and warrants to purchase common stock, will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options, including the Named Executive Officers, will receive any consideration in our Chapter 11 case for their equity based compensation. See the "Outstanding Equity Awards at Fiscal Year-End Table" on page 120 for more information regarding the stock options owned by our Named Executive Officers. EMERGENCE BONUS Pursuant to their employment agreements and under certain circumstances, each of our Named Executive Officers is entitled to receive an emergence bonus when we emerge from Chapter 11. When we entered into these employment agreements in 2004 and 2005, the ECDC believed that the inclusion of an emergence bonus would provide a strong incentive for our Named Executive Officers to achieve our emergence from Chapter 11 as soon as reasonably practicable and provide long-term compensation that would serve as a reasonable substitute for the lack of any other long-term compensation program. However, the delay in our emergence from Chapter 11, which has been caused by factors outside the control of senior management, and other program design issues, have diminished the annualized value of potential awards under this plan. See "Employment Agreements with Named Executive Officers" on page 122 for a description of the emergence bonuses that each Named Executive Officer may be entitled to receive. TERMINATION/SEVERANCE AGREEMENTS All executives, including our Named Executive Officers, are parties to employment agreements with us which specify payments upon termination for various causes. In the event of a "not for cause" termination (as defined in the respective employment agreements), our Named Executive Officers are entitled to receive various amounts based on multiples of their base salaries. Executives are also entitled to four months continuation of health insurance at active employee contribution rates and executive outplacement services. No specific "change in control" provisions or tax gross-up provisions are provided in the agreements. See "Employment Agreements with Named Executive Officers" on page 122 and the "Potential Payments Under Employment Agreements" on page 124 for a description of the terms of the employment agreements and an estimate of the benefits that our Named Executive Officers would be entitled to receive pursuant to their respective employment agreements under various employment termination scenarios. BENEFITS AND OTHER PERQUISITES Executives participate in the same benefit programs provided for other Solutia employees. There are no supplemental retirement programs. The only additional perquisite the executives are provided is company paid financial and tax preparation services not to exceed $7,000.00 per year. This benefit is provided for the executive given our belief that good financial planning and tax preparation by a professional reduces the time and attention the executive would otherwise spend on their personal financial affairs and affords them more time to focus on their executive responsibilities with Solutia. RETIREMENT PLANS We froze our pension plan as of June 30, 2004 in connection with our Chapter 11 reorganization and, as a result, only interest credits are being applied to the accounts. See "Pension Plans" on page 121 for more information about our retirement plan and the benefits that our Named Executive Officers would be entitled to receive thereunder. COMPENSATION COMMITTEE REPORT The Executive Compensation and Development Committee has reviewed and discussed the Compensation Discussion and Analysis with management and based on the review and discussions, the ECDC recommended to the Board of Directors that the Compensation Discussion and Analysis be included in Solutia's annual report on Form 10-K for 2006. J. PATRICK MULCAHY (CHAIR) ROBERT H. JENKINS FRANK A. METZ, JR. 118 SUMMARY COMPENSATION TABLE The following table shows information about the compensation of Solutia's chief executive officer, chief financial officer and the three most highly compensated executive officers other than the chief executive officer and chief financial officer who were serving as executive officers at December 31, 2006. Certain columns have been omitted where inapplicable.
- ------------------------------------------------------------------------------------------------------------------------ (a) (b) (c) (d) (e) (f) (g) (h) (i) Changes in Pension Value and Non-Equity Nonqualified Incentive Deferred Name and Stock Option Plan Compensation All Other Principal Salary Awards Awards Compensation Earnings Compensation Position Year ($) ($) ($) ($)(1) ($)(2) ($)(3) Total - ------------------------------------------------------------------------------------------------------------------------ J. N. Quinn 2006 $500,000 -0- -0- $2,700,000 $317 $16,780 $3,217,000 President, Chief Executive Officer and Chairman of the Board - ------------------------------------------------------------------------------------------------------------------------ J. M. Sullivan 2006 360,000 -0- -0- 700,000 2,486 16,297 1,078,783 Senior Vice President, Chief Financial Officer and Treasurer - ------------------------------------------------------------------------------------------------------------------------ L. De Temmerman 2006 377,000 -0- -0- 845,000(4) 201,548 112,045(5) 1,535,593 Senior Vice President and President, Performance Products - ------------------------------------------------------------------------------------------------------------------------ J. R. Voss 2006 320,000 -0- -0- 580,000 -0- 31,003(6) 931,003 Senior Vice President, Business Operations - ------------------------------------------------------------------------------------------------------------------------ J. P. Wright 2006 375,000 -0- -0- 412,500 -0- 16,366 803,866 Senior Vice President and President, Integrated Nylon - ------------------------------------------------------------------------------------------------------------------------ (1) Included in this column as 2006 Non-Equity Incentive Plan Compensation are awards under the 2006 Solutia Annual Incentive Program as described under "Annual Bonus" in the Compensation Discussion and Analysis above. (2) Amounts represent the actuarial increase in the present value of the Named Executive Officer's benefits under Solutia's defined benefit plan. (3) Includes Solutia contributions to thrift/savings plans, as follows: Mr. Quinn, $15,400; Mr. Sullivan, $15,400; Mr. Voss, $14,467 and Mr. Wright, $15,400. Mr. De Temmerman does not participate in the Company's thrift/savings plan. Also includes the dollar value of insurance premiums paid by Solutia with respect to life insurance as follows: Mr. Quinn - $1,380; Mr. Sullivan - $897; Mr. De Temmerman - $1,549; Mr. Voss - $468; and Mr. Wright - $966. (4) Mr. De Temmerman is a Belgian employee under assignment to the United States pursuant to the letter agreement identified in the Exhibit Index to this Annual Report on Form 10-K. Mr. De Temmerman's bonus for 2006 was paid in Euros. His bonus has been converted into U.S. dollars at the December 31, 2006 exchange rate of 1.3147 U.S. dollars to 1 Euro. (5) Includes $50,850 for a housing allowance; $24,254 for a home leave allowance; $14,951 for tax equalization payments, net of taxes, pursuant to the letter agreement; $10,381 for a children's allowance provided under Belgian law; and $10,606 for a customary Belgian representation allowance. (6) Includes relocation related tax gross-ups of $16,068.
119 GRANTS OF PLAN-BASED AWARDS TABLE The amounts indicated below are non-equity incentive payouts under Solutia's 2006 Annual Incentive Plan. For a complete discussion of the 2006 AIP, please see "Annual Bonus" in the Compensation Discussion and Analysis above.
-------------------------------------------------------------------------------- ESTIMATED POSSIBLE PAYOUTS UNDER NON-EQUITY INCENTIVE PLAN AWARDS -------------------------------------------------------------------------------- Grant date Threshold Target Maximum Name ($)(1) ($)(2) ($)(3) -------------------------------------------------------------------------------- J. N. Quinn N/A $375,000 750,000 4,500,000 -------------------------------------------------------------------------------- J. M. Sullivan N/A 135,000 270,000 1,620,000 -------------------------------------------------------------------------------- L. De Temmerman N/A 188,500 377,000 2,262,000 -------------------------------------------------------------------------------- J.R. Voss N/A 120,000 240,000 1,440,000 -------------------------------------------------------------------------------- J. P. Wright N/A 187,500 375,000 2,250,000 -------------------------------------------------------------------------------- (1) Represents amounts awarded if the performance adjusted target bonus of 0.50x funding level is achieved. (2) Represents amounts awarded if the performance adjusted target bonus of 1.0x funding level is achieved. (3) Represents amounts awarded if the performance adjusted target bonus of 3.0x funding level is achieved.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE The following table sets forth information for each of the Named Executive Officers regarding the number of shares subject to both exercisable and unexercisable stock options as of December 31, 2006.
- -------------------------------------------------------------------------------------------------------- OPTION AWARDS - -------------------------------------------------------------------------------------------------------- (a) (b) (c) (d) (e) (f) Equity Incentive Plan Awards: Number of Number of Number of Securities Securities Securities Underlying Underlying Underlying Unexercised Unexercised Unexercised Unearned Option Options (#) Options (#) Options Exercise Price Option Name Exercisable Unexercisable (#) ($)(1) Expiration Date - -------------------------------------------------------------------------------------------------------- J. N. Quinn 25,000 - -0- $1.22 7/24/2013 - -------------------------------------------------------------------------------------------------------- - 40,000 (1) $3.90 1/28/2013 - -------------------------------------------------------------------------------------------------------- J. M. Sullivan 25,000 - $19.25 9/15/2007 - -------------------------------------------------------------------------------------------------------- 10,000 - $20.594 8/31/2009 - -------------------------------------------------------------------------------------------------------- - 12,000 (2) $14.032 7/5/2010 - -------------------------------------------------------------------------------------------------------- - 12,000 (3) $13.85 9/3/2011 - -------------------------------------------------------------------------------------------------------- - 12,000 (4) $10.35 1/7/2012 - -------------------------------------------------------------------------------------------------------- 6,000 - $8.63 5/21/2012 - -------------------------------------------------------------------------------------------------------- 25,000 - $1.48 4/21/2013 - -------------------------------------------------------------------------------------------------------- 10,000 - $1.22 7/24/2013 - -------------------------------------------------------------------------------------------------------- L. De Temmerman 25,000 - $19.25 9/15/2007 - -------------------------------------------------------------------------------------------------------- 10,000 - $20.594 8/31/2009 - -------------------------------------------------------------------------------------------------------- 10,000 - $14.032 7/5/2010 - -------------------------------------------------------------------------------------------------------- 10,000 - $13.85 9/3/2011 - -------------------------------------------------------------------------------------------------------- 10,000 - $10.35 1/7/2012 - -------------------------------------------------------------------------------------------------------- - 50,000 (5) $1.22 7/24/2013 - -------------------------------------------------------------------------------------------------------- J.R. Voss - - -0- N/A - -------------------------------------------------------------------------------------------------------- J. P. Wright - - -0- N/A - -------------------------------------------------------------------------------------------------------- 120 1. Performance options vest upon the earlier of (i) the achievement of certain percentage increases in the Fair Market Value (as defined below) of Solutia common stock over the Fair Market Value on the date of grant, or (ii) 1/29/2012. 2. Performance options vest upon the earlier of (i) the achievement of certain percentage increases in the Fair Market Value (as defined below) of Solutia common stock over the Fair Market Value on the date of grant, or (ii) 7/6/2009. 3. Performance options vest upon the earlier of (i) the achievement of certain percentage increases in the Fair Market Value (as defined below) of Solutia common stock over the Fair Market Value on the date of grant, or (ii) or 9/4/2010. 4. Performance options vest upon the earlier of (i) the achievement of certain percentage increases in the Fair Market Value (as defined below) of Solutia common stock over the Fair Market Value on the date of grant, or (ii) 1/8/2011. 5. Performance options vest upon the earlier of (i) the achievement of certain percentage increases in the Fair Market Value (as defined below) of Solutia common stock over the Fair Market Value on the date of grant, or (ii) 1/1/2007. % Increase in Fair Market % of Option Value from Option Grant Date Exercisable ---------------------------- ----------- 20% 25% 30 50 50 75 75 100
For purposes of the vesting of performance options, "Fair Market Value" means, as of any given date, the average of the highest and lowest sales prices of Solutia common stock reported as the New York Stock Exchange-Composite Transactions for such day, or if the Common Stock was not traded on the New York Stock Exchange on such day, then on the next preceding day on which the Common Stock was traded, all as reported by The Wall Street Journal under the heading New York Stock Exchange-Composite Transactions or by such other source as the Executive Compensation and Development Committee may select. For each stock option reported above, the "Fair Market Value" at the date of grant is equal to the exercise price. AGGREGATED OPTION EXERCISES IN 2006 AND STOCK VESTED There were no options exercised by the Named Executive Officers during 2006, and none of the options held by them at the end of 2006 were "in the money." Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock, will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options to purchase Solutia's common stock, including the Named Executive Officers, will receive any consideration in our Chapter 11 case for their equity based compensation. PENSION PLANS SOLUTIA PENSION BENEFITS - ----------------------------------------------------------------------------------------------------------
Number of Years Present Value of of Credited Accumulated Payments During Service Benefit Last Fiscal Year Name Plan Name ($) ($) ($) - ---------------------------------------------------------------------------------------------------------- J. N. Quinn Solutia Inc. Employees' 1.46 24,357 -0- Pension Plan (U.S.) - ---------------------------------------------------------------------------------------------------------- J. M. Sullivan Solutia Inc. Employees' Pension Plan (U.S.) 20.93 256,110 -0- - ---------------------------------------------------------------------------------------------------------- L. De Temmerman Solutia Retirement Plan (Belgium) 22.33 1,011,589 -0- - ---------------------------------------------------------------------------------------------------------- J.R. Voss N/A - Not eligible for any pension plan - - -0- - ---------------------------------------------------------------------------------------------------------- J. P. Wright N/A - Not eligible for - - -0- any pension plan - ----------------------------------------------------------------------------------------------------------
We froze our pension plan as of June 30, 2004 in connection with our Chapter 11 reorganization and as a result, only interest credits are being applied to accounts. To the extent Named Executive Officers participated in the pension plan prior to the freezing of the plan, they are eligible for benefits payable under the defined benefit pension plans applicable to Solutia's regular full-time employees. An executive's benefits are based on his service, if any, with Pharmacia prior to the spinoff of Solutia and service with Solutia since the spinoff. Solutia's defined benefit pension plans for its U.S. employees consist of two accounts: a "Prior Plan Account" (for those employees who earned benefits under Pharmacia's pension plan before the spinoff) and a "Cash Balance Account." The opening balance of the Prior Plan Account was the December 31, 1996 present value of the executive's lump sum retirement benefit earned prior to January 1, 1997, under Pharmacia's defined benefit pension plans, calculated using the assumption that the monthly benefit would be 121 payable at age 55 with no reduction for early payment. The formula used to calculate the opening balance was based on average final compensation (as defined in the pension plan) multiplied by years of service (as defined in the pension plan). Until June 30, 2004, for each year of the executive's continued employment with Solutia (including all of 1997), the executive's Prior Plan Account increased by 4% to recognize that prior plan benefits would have grown as a result of pay increases. As a result of the plan freeze, the 4% annual increases to the Prior Plan Account were eliminated for service after June 30, 2004. The Prior Plan Account is credited with 8.5% interest each year until the executive reaches age 55. Until June 30, 2004, for each year during which the executive was employed by Solutia, 3% of annual compensation (salary and annual bonus) in excess of the Social Security wage base and a percentage, ranging from 3% to 7% based on age, of annual compensation were credited to the Cash Balance Account. In addition, the Cash Balance Account of executives who earned benefits under Pharmacia's defined benefit pension plans before 1997 was credited each year (for up to ten years based on prior years of service with Pharmacia before 1997) during which the executive was employed by Solutia (including all of 1997) with an amount equal to a percentage, ranging from 2% to 6% based on age, of annual compensation. As a result of the plan freeze, all credits to the Cash Balance Account that are based on annual compensation were eliminated for compensation earned after June 30, 2004. The Cash Balance Account was credited with interest each year based on the 30-year treasury rate. In light of the discontinuance of the 30-year treasury rate, the Cash Balance Account is currently credited with an interest rate determined and published by the Internal Revenue Service to serve as a proxy for the 30-year treasury rate. U.S. Pension The December 31, 2006 account balances were projected to age 65. The Prior Plan account was projected at 8.5% interest to age 55, and 0% from age 55 to age 65, according to the plan rules. The Cash Balance Account was projected to age 65 using the current interest crediting rate in effect for 2006 and 2007, which is 5%. The balances were then discounted back from age 65 to December 31, 2006 using the discount rate of 5.75% to determine the present value. Because the U.S. Pension Plan is frozen as of June 30, 2004, compensation earned by the Named Executive Officers after this date is not considered in the calculation of pension benefits. Prior to June 30, 2004, the pensionable pay included base pay and annual incentive bonus payments. The account balances in the U.S. Pension Plan are payable upon termination of employment, or the executive can choose to defer the receipt of benefits to a later date and earn interest on the Cash Balance Account and Prior Plan Account as described above. Belgian Retirement Plan Mr. De Temmerman is a Belgian employee and as such, participates in Solutia's Belgian Retirement Plan. His accrued benefit was calculated as of December 31, 2006 based on the final average earnings, the credited service, and the average social security ceiling as of December 31, 2006. The accrued benefit is equal to a lump sum payable at age 60 based on final average earnings (as defined in the plan) and credited service (as defined in the plan). The present value of the accrued benefit as of December 31, 2006 was determined by discounting the accrued benefit from age 60 to December 31, 2006 using a discount rate of 4.50%. This amount was converted to U.S. dollars using a conversion rate of $1.31470 per Euro as of December 31, 2006. Only base salary is used in calculating earnings under the Belgian Retirement Plan. The Belgian Pension benefit is payable at age 60 with an actuarial reduction applied to the benefit for earlier retirement or termination. The Chapter 11 filing does not impact the operation of the Belgian Retirement Plan in any respect. NONQUALIFIED DEFERRED COMPENSATION Solutia does not offer nonqualified deferred compensation to any employees at this time. EMPLOYMENT AGREEMENTS WITH NAMED EXECUTIVE OFFICERS The descriptions below are only summaries of the agreements that Solutia has with its Named Executive Officers and are qualified in their entirety by the actual agreements, copies of which have been filed with the Securities and Exchange Commission and are identified in the Exhibit Index to this Annual Report on Form 10-K. Effective July 19, 2004, Solutia entered into Senior Executive Agreements with Mr. Quinn, Mr. De Temmerman and Mr. Sullivan which were approved by our Board and the Bankruptcy Court. On April 21, 2005, upon Bankruptcy Court approval, we entered into amended and restated employment agreements with Mr. Quinn and Mr. Sullivan, each dated July 19, 2004. Subsequently the Company entered similar agreements with Mr. Voss and Mr. Wright which were approved by the Bankruptcy Court on August 1, 2005. Each of these agreements has a term beginning on the date such agreement was effective and expiring on the date which is six-months from the date on which Solutia emerges from bankruptcy. These agreement as amended and restated are collectively referred to as the "Senior Executive Agreements". 122 BASE SALARY The Senior Executive Agreements provide for a minimum annual base salary for each of the executives until the six month anniversary of the Emergence Date (as described below) as follows: Mr. Quinn $500,000 Mr. De Temmerman $350,000 Mr. Sullivan $325,000 Mr. Voss $300,000 Mr. Wright $350,000 Mr. De Temmerman's minimum salary is actually expressed as 289,519 Euros. The above dollar figure represents the U.S. Dollar equivalent at an exchange rate of 1.2089. TARGET BONUS OPPORTUNITY AND OTHER BENEFITS Each of these executives is entitled to participate in Solutia's annual incentive program with each having a target annual bonus opportunity of a percentage of his annual base salary as follows: Mr. Quinn 150% Mr. De Temmerman 100% Mr. Wright 100% Mr. Sullivan 75% Mr. Voss 75% Each of the executives is also entitled to participate in all long-term and other incentive plans or programs applicable to senior executive officers of Solutia and its subsidiaries and in the applicable savings, retirement, welfare benefit and vacation plans. EMERGENCE INCENTIVE PROGRAM Pursuant to the Senior Executive Agreements each of the Named Executive Officers participates in the Solutia Inc. Emergence Incentive Bonus Program ("Emergence Incentive Bonus Program") under which the executives would be entitled to a bonus on such date that the Bankruptcy Court shall have confirmed a plan of reorganization of Solutia Inc. under Chapter 11 of the U.S. Bankruptcy Code and such plan shall have become effective (the "Emergence Date"). Eligibility for such bonus is dependent upon the Named Executives being employed by Solutia (or any of our subsidiaries) on the Emergence Date. If the executives are employed on the six-month anniversary of the Emergence Date, or shall have been terminated without Cause (as defined in the Senior Executive Agreements), or shall have resigned for Good Reason (as defined in the Senior Executive Agreements), or shall have died or been terminated for Disability (as defined in the Senior Executive Agreements), they shall be entitled to receive a special emergence bonus to be paid from a pool. If the executive voluntarily terminates his employment other than for Good Reason or is terminated for Cause between the Emergence Date and the six-month anniversary thereof, then he shall forfeit his right to receive the special emergence bonus. Funding of the bonus pool will depend upon the achievement of three performance measures: EBITDA, Enterprise Value and Unsecured Creditor Recoveries (all as defined and described in the Emergence Incentive Bonus Program). Our Board, in its discretion, may elect to pay the bonuses in shares of Reorganized Solutia common stock in lieu of cash. The maximum pool that can be achieved under the Emergence Incentive Bonus Program is $10,000,000 with the Named Executive Officers being entitled to receive a fixed percentage of such pool as follows: Mr. Quinn 37.5% Mr. Sullivan 15.0% Mr. De Temmerman 22.5% Mr. Wright 15.0% Mr Voss 10.0% SEVERANCE AND NON-COMPETE PROVISIONS If, during the Employment Period, any of the Named Executives is terminated other than for Cause, or any of these executives terminates his employment for Good Reason, we will pay such executive: (a) any unpaid but accrued base salary through the Date of Termination (as defined in the Senior Executive Agreements), (b) any unpaid annual bonus earned with respect to the previous year, and 123 (c) any unpaid accrued vacation pay (collectively, "Accrued Obligations"). In addition, if the Date of Termination occurs before the Emergence Date, Mr. De Temmerman, would receive an amount equal to 125% of his annual base salary immediately prior to his Date of Termination, and Mr. Quinn, Mr. Sullivan, Mr. Wright or Mr. Voss would receive an amount equal to 200% of his respective annual base salary immediately prior to his respective Date of Termination, provided that they waive any and all claims against Solutia and its subsidiaries. The executives will also be entitled to any other benefits or amounts, excluding severance or separation pay or benefits, for which they are eligible under any plan, program, or policy of Solutia and its subsidiaries, such as any vested benefit under any qualified defined benefit or defined contribution retirement plan in which they participate (collectively, "Other Benefits"). If employment terminates because of death or Disability, the executive or his estate, as applicable, will receive Accrued Obligations and Other Benefits. The Senior Executive Agreements also contain provisions relating to non-competition, protection of Solutia's confidential information and non-solicitation of Solutia employees. POTENTIAL PAYMENTS UPON TERMINATION The table below sets forth estimates of the amounts to which each Named Executive Officer would be entitled, other than accrued but unpaid base salary and benefits payable under broad-based employee benefit plans and programs, in the event of a termination of the officer's employment other than for Cause, or by the executive for Good Reason, on December 31, 2006. The amounts would be payable under the Senior Executive Agreements are as follows:
------------------------------------------------------------------------------------------------------- Name Severance Payment (1) Benefits (2) Outplacement Services (3) ------------------------------------------------------------------------------------------------------- J.N. Quinn $1,000,000 $1005 $25,000 ------------------------------------------------------------------------------------------------------- J. M. Sullivan 720,000 2955 25,000 ------------------------------------------------------------------------------------------------------- L. De Temmerman 471,250 2611 25,000 ------------------------------------------------------------------------------------------------------- J.R. Voss 640,000 No Coverage 25,000 ------------------------------------------------------------------------------------------------------- J. P. Wright 750,000 3116 25,000 ------------------------------------------------------------------------------------------------------- (1) Severance Payment based on fiscal 2006 salary. (2) Consists of health, dental and vision insurance coverage. The value is based upon the type of insurance coverage we carried for each executive officer as of January 1, 2007 and is valued at the premiums in effect on January 1, 2007. (3) At the request of the Named Executive Officer, we will provide outplacement services for up to twelve months post termination in an amount not to exceed $25,000 per Named Executive Officer.
COMPENSATION OF DIRECTORS The following table describes the compensation arrangements with our non-employee directors for the 2006 fiscal year.
------------------------------------------------------------------------------------------------------ Name Fees Stock Option Changes in All Other Total Earned or Awards Awards Pension Value Compensation ($) Paid in ($)(2) ($)(2) and Cash Nonqualified ($)(1) Deferred Compensation Earnings ------------------------------------------------------------------------------------------------------ Paul H. Hatfield $200,250 -0- -0- -0- -0- $200,250 ------------------------------------------------------------------------------------------------------ Robert H. Jenkins 124,376 -0- -0- -0- -0- 124,376 ------------------------------------------------------------------------------------------------------ Philip R. Lochner (3) 119,334 -0- -0- -0- -0- 119,334 ------------------------------------------------------------------------------------------------------ Frank A. Metz, Jr. 143,793 -0- -0- -0- -0- 143,793 ------------------------------------------------------------------------------------------------------ J. Patrick Mulcahy 140,751 -0- -0- -0- -0- 140,751 ------------------------------------------------------------------------------------------------------ Sally G. Narodick 127,334 -0- -0- -0- -0- 127,334 ------------------------------------------------------------------------------------------------------ John B. Slaughter 136,793 -0- -0- -0- -0- 136,793 ------------------------------------------------------------------------------------------------------ (1) The fees earned include attendance fees for Board and Committee meetings. During 2006, the Board met 15 times, the Audit and Finance Committee, the ECDC and the Governance Committee met 9, 5 and 5 times, respectively. 124 (2) Solutia did not grant any stock or option awards to directors or employees in 2006. Solutia previously granted deferred stock units to non-employee directors prior to filing for reorganization under Chapter 11. The number of deferred stock units credited to each non-employee director and options outstanding as of December 31, 2006 are as follows:
---------------------------------------------------------------------------------- Name options outstanding deferred stock units ---------------------------------------------------------------------------------- Paul H. Hatfield 21,334 24,202 ---------------------------------------------------------------------------------- Robert H. Jenkins 21,334 24,202 ---------------------------------------------------------------------------------- Philip R. Lochner 10,833 2,859 ---------------------------------------------------------------------------------- Frank A. Metz, Jr. 21,334 12,103 ---------------------------------------------------------------------------------- J. Patrick Mulcahy 17,500 20,348 ---------------------------------------------------------------------------------- Sally G. Narodick 15,167 16,426 ---------------------------------------------------------------------------------- John B. Slaughter 21,334 12,103 ----------------------------------------------------------------------------------
Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock, together with deferred stock units, will be canceled upon our emergence from Chapter 11. It is highly unlikely that its directors and executive officers will receive any consideration in our Chapter 11 case for their equity based compensation. (3) Philip R. Lochner resigned from our Board of Directors effective January 31, 2007. His resignation was not due to any disagreement with Solutia with respect to its operations, policies or practices. The following table displays all components of compensation for non-employee directors in fiscal year 2006. In June 2006, the board of directors approved an increase in compensation based on the recommendation of the Governance Committee.
------------------------------------------------------------------------------- FORM OF COMPENSATION AMOUNT OF COMPENSATION ------------------------------------ Jan-May 2006 June-Dec 2006 $ $ ------------------------------------------------------------------------------- Annual Board Retainer 60,000 70,000 ------------------------------------------------------------------------------- Chairman of the Board Retainer 75,000 - ------------------------------------------------------------------------------- Lead Director Retainer - 50,000 ------------------------------------------------------------------------------- Annual Retainer for Committee Chairman 5,000 7,500 ------------------------------------------------------------------------------- Board Attendance Fee (each meeting) 2,000 2,500 ------------------------------------------------------------------------------- Committee Attendance Fee (each meeting) 2,000 2,500 -------------------------------------------------------------------------------
Directors who are Solutia employees do not receive payment for their services as directors. Jeffry N. Quinn, the current Chairman of the Board is also our President and Chief Executive Officer. The Lead Director retainer is paid to the lead non-employee director if the Chairman of the Board is an employee of Solutia. The current Lead Director is Paul Hatfield and he receives the Lead Director retainer. Non-employee directors do not have a retirement plan, nor do they participate in Solutia's benefit plans. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Executive Compensation and Development Committee is comprised of three directors: Mr. Mulcahy, Chair, and Messrs. Metz and Jenkins. None of these individuals is a current or former officer or employee of Solutia or any of its subsidiaries, nor did any of these individuals have any reportable transactions with Solutia or any of its subsidiaries during 2006. During 2006, none of Solutia's executive officers served as a director or member of the compensation committee (or equivalent thereof) of another entity, any of whose executive officers served as a director of Solutia. 125 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS OWNERSHIP BY DIRECTORS AND NAMED EXECUTIVE OFFICERS The following table shows Solutia common stock owned beneficially by Solutia's directors and executive officers as of December 31, 2006, including those deferred stock units credited to the account of each non-employee director that are payable in stock. Solutia's existing shares of common stock as well as options and warrants to purchase its common stock as well as deferred stock units will be cancelled upon our emergence from Chapter 11. It is highly unlikely that our directors and executive officers will receive any consideration in our Chapter 11 case for their equity based compensation. In general, "beneficial ownership" includes those shares a person has the power to vote, or the power to transfer, and stock options that are exercisable currently or become exercisable within 60 days. Except as otherwise noted, each person has sole voting and investment power over his or her shares.
- ------------------------------------------------------------------------------------------------------ Shares of Common Stock Shares Underlying Beneficially Owned Options Exercisable Name (a) Within 60 Days (b) Total - ------------------------------------------------------------------------------------------------------ Luc De Temmerman 50(c) 81,999 82,049 - ------------------------------------------------------------------------------------------------------ Paul H. Hatfield 31,602 21,334 52,936 - ------------------------------------------------------------------------------------------------------ Robert H. Jenkins 24,372 (d) 21,334 45,706 - ------------------------------------------------------------------------------------------------------ Philip R. Lochner, Jr. 2,859 10,833 13,692 - ------------------------------------------------------------------------------------------------------ Frank A. Metz, Jr. 13,912 21,334 35,246 - ------------------------------------------------------------------------------------------------------ J. Patrick Mulcahy 31,348 17,500 48,848 - ------------------------------------------------------------------------------------------------------ Sally G. Narodick 16,426 15,167 31,593 - ------------------------------------------------------------------------------------------------------ Jeffry N. Quinn 40,000(e) 25,000 65,000 - ------------------------------------------------------------------------------------------------------ John B. Slaughter 13,903(f) 21,334 35,237 - ------------------------------------------------------------------------------------------------------ James M. Sullivan 2,050(g) 108,938 110,988 - ------------------------------------------------------------------------------------------------------ James R. Voss 0 0 0 - ------------------------------------------------------------------------------------------------------ Jonathon P. Wright 0 0 0 - ------------------------------------------------------------------------------------------------------ All directors and executive officers 176,522 536,773 713,295 (16 persons) - ------------------------------------------------------------------------------------------------------ (a) The number of shares shown includes those deferred stock units credited to the account of each non-employee director that are scheduled to be paid out in the form of stock, as follows: ------------------------------------------------------------------- Mr. Hatfield 24,202 ------------------------------------------------------------------- Mr. Jenkins 24,202 ------------------------------------------------------------------- Mr. Lochner 2,859 ------------------------------------------------------------------- Mr. Metz 12,103 ------------------------------------------------------------------- Mr. Mulcahy 20,348 ------------------------------------------------------------------- Mrs. Narodick 16,426 ------------------------------------------------------------------- Dr. Slaughter 12,103 ------------------------------------------------------------------- The non-employee directors have no current voting or investment power over these deferred shares. (b) The shares shown represent stock options granted under Solutia's incentive plans, including stock options resulting from the conversion of Pharmacia stock options at the time of the spinoff of Solutia by Pharmacia in 1997. (c) Mr. De Temmerman and his wife own these shares jointly. (d) The number of shares shown for Mr. Jenkins includes 170 shares owned jointly by Mr. Jenkins and his wife. (e) The number of shares shown for Mr. Quinn includes 20,000 shares owned in trust by Mr. Quinn's wife. Mr. Quinn expressly disclaims beneficial ownership of these shares. (f) The number of shares shown for Dr. Slaughter includes 137 shares owned by Dr. Slaughter's wife. Dr. Slaughter expressly disclaims beneficial ownership of these shares. (g) The number of shares shown for Mr. Sullivan includes 2,050 shares owned jointly by Mr. Sullivan and his wife.
The total share holdings reported above for all directors and executive officers as a group equal less than 1% of the number of shares of Solutia common stock outstanding on December 31, 2006. No director or executive officer holds more than 1% of these shares. 126 OWNERSHIP BY CERTAIN BENEFICIAL OWNERS The following table shows all persons or entities that Solutia knows were "beneficial owners" of more than five percent of Solutia common stock on February 23, 2007.
- ----------------------------------------------------------------------------------------------------------- Amount and Nature of Beneficial Name and Address of Beneficial Owner Ownership of Solutia Common Stock Percent of Class - ----------------------------------------------------------------------------------------------------------- Ardsley Advisory Partners (1) 7,303,500 6.99% 262 Harbor Drive Stamford, Connecticut 06902 - ----------------------------------------------------------------------------------------------------------- (1) This information is based on a Schedule 13G that Ardsley Advisory Partners filed with the SEC on February 14, 2007 on behalf of itself and its affiliates Ardsley Partners I, Philip J. Hempelman, Ardsley Offshore Fund Ltd., Ardsley Partners Fund II, L.P. and Ardsley Partners Institutional Fund, L.P. Includes 7,303,500 shares (6.99% of Solutia's common stock) beneficially owned by Ardsley Advisory Partners, 4,776,300 shares (4.57% of Solutia's common stock) beneficially owned by Ardsley Partners I, 7,303,500 shares (6.99% of Solutia's common stock) beneficially owned by Philip J. Hempelman, 2,436,200 shares (2.33% of Solutia's common stock) beneficially owned by Ardsley Offshore Fund Ltd., 3,194,300 shares (3.06% of Solutia's common stock) beneficially owned by Ardsley Partners Fund II, L.P., and 1,582,000 shares (1.51% of Solutia's common stock) beneficially owned by Ardsley Partners Institutional Fund, L.P. Ardsley Partners I serves as the general partner of Ardsley Partners I, Ardsley Partners II, L.P. and Ardsley Partners Institutional Fund, L.P. Ardsley Advisory Partners serves as investment manager of Ardsley Offshore Fund Ltd. and as investment advisor of Ardsley Partners II, L.P. and Ardsley Institutional Fund, L.P. and certain managed accounts with respect to the Solutia common stock directly owned by Ardsley Offshore Fund Ltd., Ardsley Partners II, L.P., Ardsley Institutional Fund, L.P. and the managed accounts. Philip J. Hempelman is the managing partner of Ardsley Advisory Partners and Ardsley Partners I. Mr. Hempelman disclaims beneficial ownership of all shares of Solutia common stock held or controlled by Ardsley Partners I, Ardsley Offshore Fund Ltd., Ardsley Partners Fund II, L.P. and Ardsley Partners Institutional Fund, L.P. except to the extent of the 612,000 of such shares which relate to his individual economic interest in Ardsley Partners II, L.P.
EQUITY COMPENSATION PLAN INFORMATION The following table summarizes information about Solutia's equity compensation plans as of December 31, 2006. Solutia's existing shares of common stock as well as options and warrants to purchase its common stock will be cancelled upon our emergence from Chapter 11. It is highly unlikely that its directors or executive officers will receive any consideration in our chapter 11 case for their equity based compensation.
- ------------------------------------------------------------------------------------------------------------------ Number of Securities Remaining Number of Securities to Weighted-Average Available for Future Issuance be Issued upon Exercise Exercise Price of under Equity Compensation Plans of Outstanding Options, Outstanding Options, (Excluding Securities Reflected Warrants, and Rights Warrants, and Rights in Column (a)) Plan Category (a) (b) (c) - ------------------------------------------------------------------------------------------------------------------ Equity compensation plans approved by security holders 12,270,394 15.50 4,654,657(1) - ------------------------------------------------------------------------------------------------------------------ Equity compensation plans not approved by security holders (2) 247,320(3) 14.59(4) 25,174 - ------------------------------------------------------------------------------------------------------------------ Total 12,517,714 15.49 4,679,831 - ------------------------------------------------------------------------------------------------------------------ (1) There have been no grants of options or appreciation rights nor awards of restricted or unrestricted stock since the filing of the Chapter 11 case nor is it anticipated that any grants or awards will be made prior to emergence from Chapter 11 under either the Solutia Inc. 2000 Stock Based Incentive Plan or the Solutia Inc. 1997 Stock Based Incentive Plan. (2) In 2003, the Board of Directors adopted the 2003 Non Employee Director Compensation Plan which provided that all compensation paid to non-employee directors be in the form of cash. Prior to the adoption of this Plan, Solutia had in place a non-employee director compensation plan which provided for an initial grant of stock options upon election to the Board and annual stock option grants thereafter on the date of the Company's annual meeting of shareholders. In addition, this plan provided that 50 percent of a non-employee director's annual retainer be paid in the form of deferred stock units. Each director could elect to receive 127 the other half of the annual retainer in cash or defer all or a part into deferred stock units. This plan was not approved by Solutia stockholders. It authorized the use of up to 400,000 treasury shares to be used for option grants and deferred stock units under the plan. The stock options and deferred stock units granted under the plan will be canceled upon our emergence from Chapter 11. It is highly unlikely that Solutia's directors will receive any consideration in the Chapter 11 case for their equity based compensation. (3) This number includes options to purchase 128,836 shares of Solutia common stock and 118,484 deferred stock units to be paid out in shares of Solutia common stock, however, these options and deferred stock units will be cancelled upon our emergence from Chapter 11. It is highly unlikely that Solutia's directors will receive any consideration in the Chapter 11 case for their equity based compensation. (4) This weighted average exercise price of outstanding options excludes deferred stock units, which do not have an exercise price.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE RELATED PARTY TRANSACTION POLICY AND PROCEDURES Solutia has a written related party transaction policy and procedures. The Audit and Finance Committee of the Board of Directors is responsible for approving and ratifying related party transactions under the Company's policy and procedures. The Audit and Finance Committee reviews the material facts of all Interested Transactions (as defined in the Policy) that require the Audit and Finance Committee's approval and either approves or disapproves of the entry into the Interested Transaction. If advance pre-approval of an Interested Transaction is not feasible, the Audit and Finance Committee considers the Interested Transaction at its next regularly scheduled meeting and if appropriate, the Interested Transaction is ratified. Under the policy, certain Interested Transactions have standing pre-approval including (i) employment of executive officers, (ii) director compensation, (iii) transactions where all shareholders receive proportional benefits, (iv) transactions involving competitive bids, (v) certain transactions with other companies where the related party's only relationship is as an employee (other than an executive officer), director, or beneficial owner of less than 10% of that company's shares, if the aggregate amount involved does not exceed $1,000,000 or 2% of that company's total annual revenues, (vi) regulated transactions and (vii) certain banking related services. The Chair of the Audit and Finance Committee also has authority to pre-approve or ratify any Interested Transaction with a related party in which the aggregate amount involved is expected to be less than $250,000. No director may participate in the approval of an Interested Transaction for which he or she is a related party. If an Interested Transaction will be ongoing, the Audit and Finance Committee may establish guidelines for Solutia to follow in its ongoing dealings with the related party. Thereafter, the Audit and Finance Committee, on a regular basis, will review and assess ongoing relationships with the related party to assess whether they are in compliance with the Committee's guidelines, if any, and that the Interested Transaction remains appropriate. Mr. Sullivan and one other executive officer, who is not a "named executive officer" for reporting purposes, have unsecured claims as creditors in Solutia's Chapter 11 case by virtue of their participation in Solutia's 401(k) excess benefit plan and/or non-qualified defined benefit pension plan. Vested amounts owed to them under these plans at the time that Solutia filed for Chapter 11 are as follows:
- ------------------------------------- ----------------------------------- ----------------------------------- Executive Officer 401(k) Excess Benefit Plan Non-Qualified Pension Plan - ------------------------------------- ----------------------------------- ----------------------------------- J. M. Sullivan $ 33,164 $ 6,384 - ------------------------------------- ----------------------------------- ----------------------------------- Other Executive Officer 4,126 ------- - ------------------------------------- ----------------------------------- -----------------------------------
In addition, each non-employee director is an unsecured creditor of Solutia with respect to deferred compensation that was payable in cash in the following amounts: Mr. Hatfield, $37,500; each other current director, $18,750. Each director and executive officer has also filed a proof of claim for benefits under Solutia's director and officer and fidelity insurance and for any right he or she may have to corporate indemnification. Each director and executive officer also has, by virtue of Solutia's Chapter 11 filing, a claim for shares of Solutia common stock held by the director and for the value of deferred stock units that were payable in shares of Solutia's common stock. 128 DIRECTOR INDEPENDENCE Solutia's board of directors has determined that all its non-employee directors as of December 31, 2006 - Messrs. Hatfield, Jenkins, Metz, Mulcahy, Mrs. Narodick and Dr. Slaughter - are independent under the board's categorical independence standards. Mr. Phillip R. Lochner, who resigned from the board on January 31, 2007, was also determined by the board to be independent. A copy of these standards is attached to this report as Exhibit 99.1. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES FEES PAID TO INDEPENDENT AUDITOR The Audit and Finance Committee of Solutia's board of directors appointed Deloitte & Touche LLP as principal independent auditors to examine the consolidated financial statements of Solutia and its subsidiaries for 2006 and 2005. The following table displays the aggregate fees billed to Solutia for the fiscal years ended December 31, 2006 and 2005, by Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates. - ------------------------------------------------------------------------------ TYPE OF FEE 2006 2005 - ------------------------------------------------------------------------------ Audit Fees $2,294,000 $2,266,000 - ------------------------------------------------------------------------------ Audit-Related Fees (1) 62,000 77,000 - ------------------------------------------------------------------------------ Tax Fees (2) 398,000 606,000 - ------------------------------------------------------------------------------ All Other Fees (3) 188,000 203,000 - ------------------------------------------------------------------------------ (1) Audit-Related Fees include fees for audits of employee benefit plans; agreed-upon or expanded audit procedures related to accounting records required to respond to or comply with financial, accounting or regulatory reporting matters; consultations on the accounting or disclosure treatment of transactions or events and/or the actual or potential impact of final or proposed rules, standards or interpretations by the Securities and Exchange Commission, FASB or other regulatory or standard-setting bodies; and attest services not required by statute or regulation. (2) Tax Fees include fees for domestic tax planning and advice; domestic tax compliance; international tax planning and advice; international tax compliance; and review of federal, state, local and international income, franchise and other tax returns. (3) All Other Fees include fees for expatriate tax return preparation, international assignment services and various other permitted services. PRE-APPROVAL POLICIES AND PROCEDURES Consistent with the Sarbanes-Oxley Act of 2002 and the SEC's rules relating to auditor independence, the Audit and Finance Committee has adopted a policy to pre-approve all audit and permissible non-audit services provided by Solutia's independent auditor, Deloitte & Touche LLP. Under this policy, the committee or its designated member must pre-approve services before a specified service is begun. Each approval includes a specified range of fees for the approved service. If approval is by the designated member, the decision is reported to the committee at its next meeting. Requests for pre-approval are submitted to the committee or its designated member by both the independent auditor and either the chief financial officer, treasurer or controller, with a joint statement as to whether, in their view, the request is consistent with the Securities and Exchange Commission's rules on auditor independence. The Audit and Finance Committee pre-approved all services for which the fees shown above were paid. 129 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE (a) Documents filed as part of this Form 10-K: 1. Financial Statements--See the Index to Consolidated Financial Statements and Financial Statement Schedule at page 49 of this report. 2. The following supplemental schedule for the years ended December 31, 2006, 2005 and 2004 II--Valuation and Qualifying Accounts 3. Exhibits--See the Exhibit Index beginning at page 133 of this report. For a listing of all management contracts and compensatory plans or arrangements required to be filed as exhibits to this report, see the exhibits listed under Exhibit Nos. 10(a) and 10(d) through 10 (v) on page 133 and 134 of the Exhibit Index. The following exhibits listed in the Exhibit Index are filed with this Form 10-K: 10(rr) Transaction agreement by and among Akzo Nobel Chemicals International B.V., Akzo Nobel Chemicals Inc., Akzo Nobel N.V., Flexsys Holding B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc. 10(ss) Works council side letter by and among Akzo Nobel N.V., Akzo Nobel Chemicals International B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc., dated as of February 27, 2007. 12 Computation of the Ratio of Earnings to Fixed Charges 14 Solutia Inc. Code of Ethics for Senior Financial Officers 21 Subsidiaries of the Registrant 23 Consent of Independent Registered Public Accounting Firm 24(a) Powers of Attorney 24(b) Certified copy of board resolution authorizing Form 10-K filing using powers of attorney 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 99.1 Solutia's Categorical Independence Standards for Non-Employee Directors 130 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOLUTIA INC. By: /s/ Timothy J. Spihlman ------------------------------ Timothy J. Spihlman Vice President and Controller (Principal Accounting Officer) Dated: March 6, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
- --------------------------------------------------------------------------------------------------------------- Signature Title Date --------- ----- ---- - --------------------------------------------------------------------------------------------------------------- /s/ Jeffrey N. Quinn President, Chief Executive Officer and March 6, 2007 -------------------- Chairman of the Board Jeffry N. Quinn - --------------------------------------------------------------------------------------------------------------- /s/ James M. Sullivan Senior Vice President and Chief Financial March 6, 2007 --------------------- Officer James M. Sullivan - --------------------------------------------------------------------------------------------------------------- /s/ Timothy J. Spihlman Vice President and Controller (Principal March 6, 2007 ----------------------- Accounting Officer) Timothy J. Spihlman - --------------------------------------------------------------------------------------------------------------- *Paul H. Hatfield Director March 6, 2007 - -------------------------------------------------------------------------------------------------------------- *Robert H. Jenkins Director March 6, 2007 - -------------------------------------------------------------------------------------------------------------- *Frank A. Metz, Jr. Director March 6, 2007 - -------------------------------------------------------------------------------------------------------------- *J. Patrick Mulcahy Director March 6, 2007 - -------------------------------------------------------------------------------------------------------------- *Sally G. Narodick Director March 6, 2007 - -------------------------------------------------------------------------------------------------------------- *John B. Slaughter Director March 6, 2007 - --------------------------------------------------------------------------------------------------------------- * Rosemary L. Klein, by signing her name hereto, does sign this document on behalf of the above noted individuals, pursuant to powers of attorney duly executed by such individuals which have been filed as an Exhibit to this Form 10-K. /s/ Rosemary L. Klein ---------------------- Rosemary L. Klein, Attorney-in-Fact
131 EXHIBIT INDEX These exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K. Exhibit No. Description - ----------- ----------- 2(a) Distribution Agreement (incorporated by reference to Exhibit 2 of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997) 2(b) Amendment to Distribution Agreement, dated as of July 1, 2002, by and among Pharmacia Corporation, Solutia Inc., and Monsanto Company (incorporated by reference to Exhibit 2 of Solutia's Form 10-Q for the quarter ended June 30, 2002) 2(c) Joint Venture Agreement between Solutia Inc. and FMC Corporation(1) (incorporated by reference to Exhibit 2(i) of Solutia's Form 8-K filed on April 27, 2000) 2(d) First Amendment to Joint Venture Agreement between Solutia Inc. and FMC Corporation (incorporated by reference to Exhibit 2(ii) of Solutia's Form 8-K filed on April 27, 2000) 2(e) Second Amendment to Joint Venture Agreement between Solutia Inc. and FMC Corporation (incorporated by reference to Exhibit 2(iii) of Solutia's Form 8-K filed on April 27, 2000) 2(f) Third Amendment to Joint Venture Agreement between Solutia Inc. and FMC Corporation (incorporated by reference to Exhibit 2(iv) of Solutia's Form 8-K filed on April 27, 2000) 3(a) Restated Certificate of Incorporation of Solutia (incorporated by reference to Exhibit 3(a) of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997) 3(b) By-Laws of Solutia Inc., as amended February 26, 2003 (incorporated by reference to Exhibit 3(b) of Solutia's Form 10-K for the year ended December 31, 2003) 4(a) Rights Agreement (incorporated by reference to Exhibit 4 of Solutia's Registration Statement on Form 10 filed on August 7, 1997) 4(b) Amendment to the Rights Agreement (incorporated by reference to Exhibit 4.4, of Solutia's Registration Statement on Form S-3 (333-75812) filed December 21, 2001) 4(c) Indenture dated as of October 1, 1997, between Solutia Inc. and The Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.1 of Solutia's Form 10-Q for the quarter ended September 30, 1997) 4(d) 7.375% Debentures due 2027 in the principal amount of $200,000,000 (incorporated by reference to Exhibit 4.3 of Solutia's Form 10-Q for the quarter ended September 30, 1997) 4(e) 7.375% Debentures due 2027 in the principal amount of $100,000,000 (incorporated by reference to Exhibit 4.4 of Solutia's Form 10-Q for the quarter ended September 30, 1997) 4(f) 6.72% Debentures due 2037 in the principal amount of $150,000,000 (incorporated by reference to Exhibit 4.5 of Solutia's Form 10-Q for the quarter ended September 30, 1997) 4(g) Indenture dated as of July 9, 2002, between SOI Funding Corp. and HSBC Bank USA, as Trustee (incorporated by reference to Exhibit 4.2 of Solutia's Form S-4 (333-99699) filed September 17, 2002) 4(h) First Supplemental Indenture, dated as of July 25, 2002, among Solutia Inc., SOI Funding Corp., the Subsidiary Guarantors and HSBC Bank USA, as Trustee (incorporated by reference to Exhibit 4.3 of Solutia's Form S-4 (333-99699) filed September 17, 2002) 4(i) Second Supplemental Indenture, dated as of October 24, 2002, among Solutia Inc., the subsidiary guarantors named therein and HSBC Bank USA (incorporated by reference to Exhibit 4 of Solutia's Form 10-Q for the quarter ended September 30, 2002) 4(j) Third Supplemental Indenture, dated as of October 8, 2003, among Solutia Inc., the subsidiary guarantors named therein and HSBC Bank USA (incorporated by reference to Exhibit 4(c) of Solutia's Form 10-Q for the quarter ended September 30, 2003) 4(k) Amended, Restated and Novated Junior Intercreditor Agreement, dated as of October 8, 2003, among Solutia Inc., Solutia Business Enterprises, Inc., each of the subsidiary guarantors named therein, Ableco Finance LLC and HSBC Bank USA (incorporated by reference to Exhibit 4(a) of Solutia's Form 10-Q for the quarter ended September 30, 2003) 4(l) Amended, Restated and Novated Junior Security Agreement, dated as of October 8, 2003, among Solutia Inc., Solutia Business Enterprises, Inc., each of the subsidiary guarantors named therein, Ableco Finance LLC and HSBC Bank USA (incorporated by reference to Exhibit 4(b) of Solutia's Form 10-Q for the quarter ended September 30, 2003) 9 Omitted--Inapplicable 10(a) Financial Planning and Tax Preparation Services Program for the Executive Leadership Team (incorporated by reference to Exhibit 10(a) of Solutia's Form 10-K for the year ended December 31, 1997) 132 10(b) Employee Benefits Allocation Agreement (incorporated by reference to Exhibit 10(a) of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997) 10(c) Tax Sharing and Indemnification Agreement (incorporated by reference to Exhibit 10(b) of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997) 10(d) Solutia Inc. Management Incentive Replacement Plan as amended in 1999 (incorporated by reference to Exhibit 10(2) of Solutia's Form 10-Q for the quarter ended June 30, 1999) 10(e) Solutia Inc. 1997 Stock-Based Incentive Plan as amended in 1999 and 2000 (incorporated by reference to Exhibit 10(1) of Solutia's Form 10-Q for the quarter ended June 30, 2000) 10(f) Solutia Inc. 2000 Stock-Based Incentive Plan (incorporated by reference to Appendix A of the Solutia Inc. Notice of Annual Meeting and Proxy Statement dated March 9, 2000) 10(g) Solutia Inc. Non-Employee Director Compensation Plan, as amended in 1999, 2000, and 2001 (incorporated by reference to Exhibit 10 of Solutia's Form 10-Q for the quarter ended June 30, 2001) 10(h) Solutia Inc. 2003 Non-Employee Director Compensation Plan (incorporated by reference to Exhibit 10(a) of Solutia's Form 10-Q for the quarter ended June 30, 2003) 10(i) 2006 Solutia Annual Incentive Plan (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K, filed September 28, 2006) 10(j) Solutia Inc. Deferred Compensation Plan, as amended in 2002 (incorporated by reference to Exhibit 10(l) of Solutia's Form 10-K for the year ended December 31, 2002) 10(k) Solutia Inc. 2002-2006 Long-Term Incentive Plan (incorporated by reference to Appendix A of the Solutia Inc. Notice of Annual Meeting and Proxy Statement dated March 14, 2002) 10(l) Form of Retention Agreement between Solutia Inc. and other named Executive Officers (incorporated by reference to Exhibit 10(q) of Solutia's Form 10-K for the year ended December 31, 2003, filed March 15, 2004) 10(m) Agreement by and between Solutia Inc. and Rosemary L. Klein (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed April 27, 2005) 10(n) Amended and Restated Agreement by and between Solutia Inc. and Jeffry N. Quinn (incorporated by reference to Exhibit 99.3 of Solutia's Form 8-K filed April 27, 2005) 10(o) Amended and Restated Agreement by and between Solutia Inc. and James M. Sullivan (incorporated by reference to Exhibit 99.4 of Solutia's Form 8-K filed April 27, 2005) 10(p) Agreement by and between Solutia Inc. and Luc De Temmerman dated as of July 19, 2004 (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed January 18, 2005) 10(q) Letter Agreement between Solutia Inc. and Luc De Temmerman effective as of July 19, 2004 (incorporated by reference to Exhibit 99.3 of Solutia's Form 8-K filed January 18, 2005) 10(r) Retention Agreement, dated as of June 17, 2004, by and between Solutia Inc. and Rosemary L. Klein (incorporated by reference to Exhibit 10(aa) of Solutia's Form 10-K for the year ended December 31, 2004) 10(s) Agreement by and between Solutia Inc. and James R. Voss, dated as of August 1, 2005 (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended June 30, 2005) 10(t) Agreement by and between Solutia Inc. and Jonathon P. Wright, dated as of August 1, 2005 (incorporated by reference to Exhibit 10.2 of Solutia's Form 10-Q for the quarter ended June 30, 2005) 10(u) Form of Retention Agreement between Solutia Inc. and Key Employees (incorporated by reference to Exhibit 10(bb) of Solutia's Form 10-K for the year ended December 31, 2004) 10(v) Form of Agreement by and between Solutia Inc., CPFilms, Inc. and Kent J. Davies (incorporated by reference to Exhibit 10(y) of Solutia's Form 10-K for the year ended December 31, 2005) 10(w) Protocol Agreement, dated as of July 1, 2002, by and among Pharmacia Corporation, Solutia Inc., and Monsanto Company (incorporated by reference to Exhibit 10(b) of Solutia's Form 10-Q for the quarter ended June 30, 2002) 10(x) Protocol Agreement, dated as of November 15, 2002, by and among Pharmacia Corporation, Solutia Inc. and Monsanto Company (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed November 18, 2002) 10(y) Amendment to Protocol Agreement, dated as of March 3, 2003, by and among Pharmacia Corporation, Solutia Inc. and Monsanto Company (incorporated by reference to Exhibit 10(t) of Solutia's Form10-K for the year ended December 31, 2003) 10(z) Amendment to Protocol Agreement, dated August 4, 2003, by and among Pharmacia Corporation, Monsanto Company and Solutia Inc. (incorporated by reference to Exhibit 10(e) of Solutia's Form 10-Q for the quarter ended June 30, 2003) 133 10(aa) Financing Agreement, dated as of January 16, 2004, by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors and debtors-in-possession, as Borrowers, certain subsidiaries of Solutia Inc. listed as a Guarantor, as debtors and debtors-in-possession, as Guarantors, the lenders from time to time party thereto, as Lenders, Citicorp USA, Inc., as Collateral Agent, Administrative Agent and Documentation Agent (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed January, 23, 2004) 10(bb) Amendment No. 1 to Financing Agreement and Waiver, dated as of March 1, 2004, by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors, debtors-in-possession and as Borrowers; certain subsidiaries of Solutia Inc., as debtors, debtors-in-possession and as Guarantors; the lenders from time to time party thereto, as Lenders; Citicorp USA, Inc., as Collateral Agent, Administrative Agent and Co-Documentation Agent and Wells Fargo Foothill, LLC, as Co-Documentation Agent (incorporated by reference to Exhibit 10(y) of Solutia's Form 10-K for the year ended December 31, 2004) 10(cc) Amendment No. 2 to Financing Agreement and Waiver dated as of July 20, 2004 by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors, debtors-in-possession and as Borrowers; certain subsidiaries of Solutia Inc. as debtors, debtors-in-possession and as Guarantors; the lenders from time to time party thereto, as Lenders; Citicorp USA, Inc., as Collateral Agent, Administrative agent and Co-Documentation Agent and Wells Fargo Foothill, LLC, as Co-Documentation Agent (incorporated by reference to Exhibit 10(f) of Solutia's Form 10-Q for the quarter ended June 30, 2004) 10(dd) Amendment No. 3 to the $525,000,000 Debtor-in-Possession Financing Agreement dated January 16, 2004 (as amended) between Solutia Inc., Solutia Business Enterprises, Inc. and the other parties thereto (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed July 27, 2005) 10(ee) Amendment No. 4 to Financing Agreement and Waiver dated as of March 17, 2006 amending the Debtor-in-Possession Financing Agreement dated January 16, 2005 (as amended) between Solutia Inc., Solutia Business Enterprises, Inc. and the other parties thereto (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed March 17, 2006) 10(ff) Waiver and Consent dated as of October 31, 2005 by and among Solutia, Solutia Business Enterprises, Inc., each subsidiary of Solutia listed on the signature pages thereto, the lenders party thereto, Citicorp USA, Inc. and Wells Fargo Foothill, LLC (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed December 5, 2005) 10(gg) Asset Purchase Agreement by and among FMC Corporation, Solutia Inc., Astaris LLC, Israel Chemicals Limited and ICL Performance Products Holding Inc. dated as of September 1, 2005 (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended September 30, 2005) 10(hh) Toll Manufacturing Agreement by and between Solutia Inc. and Phosphorus Derivatives Inc. dated November 4, 2005 (incorporated by reference to Exhibit 10.2 of Solutia's Form 10-Q for the quarter ended September 30, 2005) 10(ii) Owners Agreement by and between Solutia Inc. and FMC Corporation dated as of September 1, 2005 (incorporated by reference to Exhibit 10.3 of Solutia's Form 10-Q for the quarter ended September 30, 2005) 10(jj) Stock Purchase Agreement, dated as November 23, 2005 by and between Solutia Inc., Vitro S.A. de C.V., and Vitro Plan S.A. de C.V. (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed on December 21, 2005) 10(kk) Debtors' Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code (incorporated by reference to Exhibit 99.1 of Solutia's Form 8-K filed on February 21, 2006) 10(ll) Debtors' Disclosure Statement Pursuant to Section 1125 of the Bankruptcy Code (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed on February 21, 2006) 10(mm) Revised Exhibit D to Debtors' Disclosure Statement Pursuant to Section 1125 of the Bankruptcy Code (incorporated by reference to Exhibit 99.1 of Solutia's Form 8-K filed on February 27, 2006) 10(nn) Share and Asset Purchase Agreement entered into on May 23, 2006 between Solutia Europe S.A./N.V. and Dishman Pharmaceuticals & Chemicals Ltd. (incorporated by reference to Exhibit 10.2 of Solutia's Form 10-Q for the quarter ended June 30, 2006) 10(oo) Amendment to Share and Asset Purchase Agreement entered into on August 22, 2006 between Solutia Europe S.A./N.V. and Dishman Pharmaceuticals & Chemicals Ltd.(1) (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended September 30, 2006) 10(pp) (euro)200,000,000 Facility Agreement dated July 26, 2006 between Solutia Europe S.A./N.V., Solutia Services International S.C.A./Comm. V.A., the guarantors listed therein, Citigroup Global Markets Limited, as mandated lead arranger, the financial institutions listed therein, as the original lenders, Citibank International plc as agent for the finance parties and Citibank N.A. as security agent for the secured parties (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended June 30, 2006) 10(qq) (euro)200,000,000 Facility Agreement dated July 26, 2006 between Solutia Europe S.A./N.V., Solutia Services International S.C.A./Comm. V.A., the guarantors listed therein, Citigroup Global Markets Limited, as mandated lead arranger, the financial institutions listed therein, as the original lenders, Citibank International plc as agent for the finance parties and Citibank N.A. as security agent for the secured parties (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended June 30, 2006) and amendment and restatement thereof dated September 15, 2006 filed herewith (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended September 30, 2006) 10(rr) Transaction agreement by and among Akzo Nobel Chemicals International B.V., Akzo Nobel Chemicals Inc., Akzo Nobel N.V., Flexsys Holding B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc. 10(ss) Works council side letter by and among Akzo Nobel N.V., Akzo Nobel Chemicals International B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc., dated as of February 27, 2007. 11 Omitted--Inapplicable; see "Consolidated Statement of Operations" on page 51. 134 12 Computation of the Ratio of Earnings to Fixed Charges (see page 137) 14 Solutia Inc. Code of Ethics for Senior Financial Officers 16 Omitted--Inapplicable 18 Omitted--Inapplicable 21 Subsidiaries of the Registrant 22 Omitted--Inapplicable 23 Consent of Independent Registered Public Accounting Firm 24(a) Powers of Attorney 24(b) Certified copy of board resolution authorizing Form 10-K filing utilizing powers of attorney 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 99.1 Solutia's Categorical Independence Standards for Non-Employee Directors (1) Confidential treatment has been granted for a portion of this exhibit. 135
SCHEDULE II SOLUTIA INC. VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (Dollars in Millions) COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E ---------------------------------- -------------- --------------------------- ----------- -------------- Additions --------------------------- (1) Balance at Charged to (2) beginning of costs and Charged to Balance at end Description year expenses other accounts Deductions of period ---------------------------------- -------------- ----------- -------------- ----------- -------------- YEAR ENDED DECEMBER 31, 2006 Valuation accounts for doubtful receivables $ 7 $ 1 $ (1) $ - $ 7 Restructuring reserves 4 17 - 16 5 YEAR ENDED DECEMBER 31, 2005 Valuation accounts for doubtful receivables $ 11 $ 5 $ (9) $ - $ 7 Restructuring reserves 17 27 - 40 4 YEAR ENDED DECEMBER 31, 2004 Valuation accounts for doubtful receivables $ 14 $ 2 $ (5) $ - $ 11 Restructuring reserves 18 22 - 23 17
136 EX-10.RR 2 ex10rr.txt EXHIBIT 10(rr) EXECUTION VERSION TRANSACTION AGREEMENT by and among AKZO NOBEL CHEMICALS INTERNATIONAL B.V., AKZO NOBEL CHEMICALS INC., AKZO NOBEL N.V., FLEXSYS HOLDING B.V., FLEXSYS AMERICA LP, FLEXSYS RUBBER CHEMICALS LTD. and SOLUTIA INC. dated as of [________] [__], 2007 TABLE OF CONTENTS Page ---- ARTICLE I TRANSFER OF ACQUIRED INTERESTS......................................1 Section 1.1 Sale and Purchase of the Acquired Interests...............1 Section 1.2 Consideration.............................................2 Section 1.3 The Closing...............................................2 Section 1.4 Determination and Allocation of Initial Purchase Price....4 Section 1.5 Post-Closing Adjustment...................................5 Section 1.6 Further Assurances........................................7 ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE AKZO NOBEL ENTITIES..........7 Section 2.1 Ownership of the Acquired Interests.......................7 Section 2.2 Organization..............................................8 Section 2.3 Authorization, Etc........................................8 Section 2.4 No Approvals or Conflicts.................................8 Section 2.5 No Brokers' or Other Fees.................................9 Section 2.6 Affiliate Agreements......................................9 Section 2.7 No Other Representations or Warranties....................9 ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE COMPANY ENTITIES...........10 Section 3.1 Organization.............................................10 Section 3.2 Authorization, Etc.......................................10 Section 3.3 No Approvals or Conflicts................................10 Section 3.4 Financial Capacity.......................................11 Section 3.5 No Brokers' or Other Fees................................11 ARTICLE IV REPRESENTATIONS AND WARRANTIES OF SOLUTIA.........................11 Section 4.1 Organization.............................................11 Section 4.2 Authorization, Etc.......................................11 Section 4.3 No Approvals or Conflicts................................12 Section 4.4 Financial Capacity.......................................12 Section 4.5 No Brokers' or Other Fees................................13 ARTICLE V CONDITIONS TO THE OBLIGATIONS OF THE AKZO NOBEL ENTITIES...........13 Section 5.1 Representations and Warranties...........................13 Section 5.2 Performance..............................................13 Section 5.3 Officer's Certificate....................................13 Section 5.4 Consents and Approvals; Competition Laws.................13 Section 5.5 Bankruptcy Approvals.....................................13 Section 5.6 No Injunction............................................13 Section 5.7 Certain Transaction Documents............................14 Section 5.8 Kashima Transaction......................................14 ARTICLE VI CONDITIONS TO THE OBLIGATIONS OF THE BUYER ENTITIES...............14 Section 6.1 Representations and Warranties...........................14 Section 6.2 Performance..............................................14 Section 6.3 Officer's Certificates...................................14 Section 6.4 Consents and Approvals; Competition Laws.................14 Section 6.5 Bankruptcy Approvals.....................................14 Section 6.6 No Injunction............................................15 Section 6.7 No Material Adverse Change...............................15 Section 6.8 Financing................................................15 Section 6.9 Certain Transaction Documents............................15 Section 6.10 Kashima Transaction......................................15 ARTICLE VII COVENANTS AND AGREEMENTS.........................................15 Section 7.1 Conduct of Business by the Company Entities; Legacy Transaction Costs.................................15 Section 7.2 Access to Books and Records; Cooperation.................16 Section 7.3 Filings and Consents.....................................17 Section 7.4 Cooperation..............................................18 Section 7.5 Tax Matters..............................................18 Section 7.6 Employees; Benefit Plans.................................19 Section 7.7 Labor Matters............................................20 Section 7.8 Covenant to Satisfy Conditions...........................21 Section 7.9 Termination of Affiliate Agreements......................21 Section 7.10 Noncompetition; No Hire..................................21 Section 7.11 Financing................................................23 Section 7.12 Disentanglement Transactions and Continuing Services.....23 Section 7.13 Bankruptcy Filings, Covenants and Agreements.............25 Section 7.14 Updates; Changes in Circumstance.........................25 Section 7.15 Termination of Joint Venture Agreement...................25 Section 7.16 Cooperation with Joint Defense Proceedings...............26 Section 7.17 Transferred Intellectual Property........................27 ARTICLE VIII TERMINATION.....................................................27 Section 8.1 Termination..............................................27 Section 8.2 Procedure and Effect of Termination......................28 ARTICLE IX INDEMNIFICATION...................................................29 Section 9.1 Indemnification by the Akzo Nobel Entities...............29 Section 9.2 Indemnification by the Buyer Entities....................30 Section 9.3 Indemnification Calculations.............................31 Section 9.4 Survival.................................................32 Section 9.5 Notice and Opportunity to Defend.........................32 Section 9.6 Environmental Indemnification............................33 Section 9.7 Payment..................................................40 Section 9.8 Investigation............................................41 Section 9.9 Exclusive Remedy.........................................41 2 ARTICLE X MISCELLANEOUS......................................................41 Section 10.1 Fees and Expenses........................................41 Section 10.2 Governing Law............................................41 Section 10.3 Amendment................................................42 Section 10.4 No Assignment............................................42 Section 10.5 Waiver...................................................42 Section 10.6 Notices..................................................42 Section 10.7 Complete Agreement.......................................44 Section 10.8 Counterparts.............................................44 Section 10.9 Publicity................................................44 Section 10.10 Interpretive Provisions..................................44 Section 10.11 Headings.................................................54 Section 10.12 Severability.............................................54 Section 10.13 No Third Party Beneficiaries.............................54 Section 10.14 Dispute Resolution.......................................54 Section 10.15 CONSENT TO JURISDICTION..................................55 Section 10.16 WAIVER OF JURY TRIAL.....................................55 Section 10.17 Specific Enforcement.....................................56 3 SCHEDULES AND EXHIBITS SCHEDULES - --------- Schedule 1.4(a)(i) -- Company Indebtedness Schedule 1.4(a)(iv)(A) -- Company Transaction Costs Schedule 1.4(a)(iv)(B) -- Legacy Transaction Costs Schedule 2.1 -- Ownership of the Acquired Interests Schedule 2.4 -- No Approvals or Conflicts Schedule 2.6 -- No Transactions with Affiliates Schedule 3.3 -- No Approvals or Conflicts Schedule 4.3 -- No Approvals or Conflicts Schedule 5.4 -- Consents and Approvals Schedule 6.4 -- Consents and Approvals Schedule 7.6(c) -- Pension/OPEB Liability Methodologies and Assumptions Schedule 7.9 -- Continuing Affiliate Agreements Schedule 7.12(a) -- Disentanglement Transactions Schedule 7.12(c) -- Continuing Services Schedule 7.16 -- Joint Defense Proceedings Schedule 7.17 -- Transferred Intellectual Property Schedule 9.6(a) -- Facilities Schedule 9.6(b)(i) -- Phase II Sites Schedule 9.6(b)(ii) -- Site with Pre-Existing Conditions Schedule 10.10(a) -- Rubber Chemicals 4 DEFINED TERMS SECTIONS Acquired Interests...........................................Recitals Affiliate Agreement..........................................Section 2.6 Affiliate(s).................................................Section 10.10(a) After-Acquired Facilities....................................Section 9.6(a) Agreement....................................................Preamble Akzo Nobel...................................................Preamble Akzo Nobel Contributed Facilities............................Section 10.10(a) Akzo Nobel Entities .........................................Preamble Akzo Nobel Netherlands Participants..........................Section 7.6(b) Akzo Nobel Netherlands Pension Plan..........................Section 7.6(b) Allocation Schedule..........................................Section 1.4(c) ANC..........................................................Preamble ANCI.........................................................Preamble Appraisal....................................................Section 7.5(a) Approval Orders..............................................Section 10.10(a) Approved Response Action.....................................Section 9.6(d)(ii) Assumed Legacy Cost..........................................Section 7.1(b) Bankruptcy and Equity Exception..............................Section 2.3 Bankruptcy Code..............................................Section 10.10(a) Bankruptcy Court.............................................Section 10.10(a) Basket.......................................................Section 9.1(b)(i) Business Day ................................................Section 10.10(a) Buyer Entities...............................................Preamble Buyer Indemnified Persons....................................Section 9.1(a) Cap..........................................................Section 9.1(b)(ii) Cash ........................................................Section 10.10(a) CERCLA ......................................................Section 10.10(a) Chapter 11 Cases ............................................Section 10.10(a) Chemetall Acquisition Costs..................................Section 10.10(a) Closing......................................................Section 1.3(a) Closing Date.................................................Section 1.3(a) Closing Date Cash Amount.....................................Section 10.10(a) Closing Date Indebtedness Amount.............................Section 10.10(a) Closing Statement............................................Section 1.5(a) Company Divestiture..........................................Section 9.6(e) Company Divestiture Buyer....................................Section 9.6(e) Company Divestiture Sellers..................................Section 9.6(e) Company Financing Amount.....................................Section 3.4 Company Employees ...........................................Section 10.10(a) Company Entities.............................................Preamble Company Indebtedness.........................................Section 10.10(a) Company Indemnified Persons..................................Section 9.1(a) Company Netherlands Pension Plan.............................Section 7.6(b) 5 DEFINED TERMS SECTIONS Company Subsidiaries.........................................Section 10.10(a) Company Transaction Costs....................................Section 10.10(a) Competing Business...........................................Section 7.10(a) Competition/Investment Law...................................Section 2.4 Completion Deadline..........................................Section 9.6(b)(i) Conclusive Closing Statement.................................Section 1.5(c) Conclusive Initial Purchase Price Statement..................Section 1.4(b) Consent......................................................Section 10.10(a) Construction Activities......................................Section 9.6(d)(vi) Consultant Retention Deadline................................Section 9.6(b)(i) Controlling Interest.........................................Section 10.10(a) Continuing Affiliate Agreement...............................Section 7.9 Continuing Services Facilities...............................Section 9.6(a) DIP Approval Order...........................................Section 10.10(a) DIP Financing Agreement......................................Section 10.10(a) Disentanglement Cost.........................................Section 7.12(a) Disentanglement Transaction(s)...............................Section 7.12(a) Disentanglement Transaction Documents........................Section 7.12(a) Dispute......................................................Section 10.14 Disputed Items...............................................Section 1.5(b) Effective Time...............................................Section 10.10(a) Encumbrance..................................................Section 10.10(a) Environmental Laws...........................................Section 10.10(a) Environmental Liabilities....................................Section 9.6(d) Equity Interests.............................................Section 10.10(a) Estimated Closing Date Cash Amount...........................Section 1.4(a) Estimated Closing Date Indebtedness Amount...................Section 1.4(a) Estimated Company Transaction Amount.........................Section 1.4(a) Estimated Legacy Transaction Amount..........................Section 1.4(a) Exhaustion of Solvay Remedies................................Section 9.6(f) Field of Agreement...........................................Section 10.10(a) Final Closing Date Cash Amount...............................Section 1.5(a) Final Closing Date Company Transaction Amount................Section 1.5(a) Final Closing Date Indebtedness Amount.......................Section 1.5(a) Final Closing Date Legacy Transaction Amount.................Section 1.5(a) Final Order..................................................Section 10.10(a) Financing Amount.............................................Section 3.4 Flexsys America..............................................Preamble Flexsys Change of Control....................................Section 10.10(a) Flexsys Holding..............................................Preamble Flexsys UK...................................................Preamble GAAP.........................................................Section 10.10(a) Governing Documents..........................................Section 10.10(a) Governmental Authority.......................................Section 10.10(a) 6 DEFINED TERMS SECTIONS Governmental Order...........................................Section 5.6 Hazardous Materials..........................................Section 10.10(a) Incentive Plan(s)............................................Section 10.10(a) Indebtedness.................................................Section 10.10(a) Indemnity Claim..............................................Section 9.3(a) Indemnified Party............................................Section 9.3(a) Indemnifying Party...........................................Section 9.3(a) Independent Pension Consultant...............................Section 10.10(a) Initial Purchase Price.......................................Section 1.2(a) Initial Purchase Price Statement.............................Section 1.4(a) Intellectual Property........................................Section 10.10(a) Intellectual Property Assignment Documents...................Section 10.10(a) Intercompany Debt............................................Section 10.10(a) Internal Revenue Code........................................Section 10.10(a) Joint Defense Proceedings....................................Section 7.16(b) Joint Venture Agreement......................................Section 10.10(a) Kashima Purchase Agreements..................................Section 10.10(a) Law .........................................................Section 10.10(a) Legacy Transaction Costs.....................................Section 10.10(a) Losses.......................................................Section 9.1(a)(i) Master Operating Agreement...................................Section 10.10(a) Material Adverse Effect......................................Section 10.10(a) Minimum Claim Amount.........................................Section 9.1(b)(i) Model Procedure..............................................Section 10.14(a) Netherlands Pension Transfer Date............................Section 7.6(b) Neutral Arbitrator...........................................Section 1.5(c) Other Parties................................................Section 7.16(a) Outside Date.................................................Section 8.1(b) Paid Legacy Cost.............................................Section 7.1(b) Pension/OPEB Plans...........................................Section 10.10(a) Person.......................................................Section 10.10(a) Phase II Conditions..........................................Section 9.6(d)(iii) Phase II Environmental Investigations........................Section 7.2(c) Phase II Facilities..........................................Section 9.6(b)(i) Post-Closing Tax Period......................................Section 10.10(a) Post-Closing Tax Period Liabilities..........................Section 10.10(a) Post-Closing Taxes...........................................Section 10.10(a) PPD2 Litigation..............................................Section 10.10(a) Pre-Closing Tax Period.......................................Section 10.10(a) Pre-Closing Tax Period Liabilities...........................Section 10.10(a) Pre-Closing Taxes............................................Section 10.10(a) Preliminary Allocation.......................................Section 9.6(a)(ii) Proceeding...................................................Section 10.10(a) Purchase Price Adjustment Amount.............................Section 1.5(d) 7 DEFINED TERMS SECTIONS Purchase Price Component(s)..................................Section 1.4(a) Release......................................................Section 10.10(a) Remedial Actions.............................................Section 10.10(a) Representative(s)............................................Section 7.2(a) Resolution Period............................................Section 1.5(b) Rubber Chemicals.............................................Section 10.10(a) Rubicon Litigation...........................................Section 10.10(a) Sellers......................................................Preamble Seller Indemnified Persons...................................Section 9.2(a) Services Agreement...........................................Section 10.10(a) Solutia......................................................Preamble Solutia Contributed Facilities...............................Section 10.10(a) Solutia Financing Amount.....................................Section 4.4 Solutia Indemnified Persons..................................Section 9.1(a) Solvay Recovery..............................................Section 9.6(a)(ii) Straddle Period..............................................Section 10.10(a) Straddle Period Taxes........................................Section 10.10(a) Subsidiary...................................................Section 10.10(a) Tax..........................................................Section 10.10(a) Tax Benefit..................................................Section 9.3(a) Tax Return...................................................Section 10.10(a) Termination Agreement........................................Section 10.10(a) Territory....................................................Section 7.10(a) Third Party Claim............................................Section 9.5(b) Time and Dollar Limitations..................................Section 9.6(e) Transaction Approval Order...................................Section 10.10(a) Transaction Documents........................................Section 10.10(a) Transactions.................................................Section 10.10(a) Transfer Taxes...............................................Section 7.5(b) Transferred Employees........................................Section 10.10(a) Transferred Intellectual Property............................Section 10.10(a) Transition Services Agreement................................Section 10.10(a) Treasury Regulations.........................................Section 10.10(a) UK Pension Plan..............................................Section 10.10(a) Underfunded Pension/OPEB Amount..............................Section 10.10(a) Voluntary Actions............................................Section 9.6(d)(iii) 8 TRANSACTION AGREEMENT This Transaction Agreement (this "Agreement"), dated as of --------- [________], 2007, is entered into by and among Akzo Nobel Chemicals International B.V., a private limited liability company formed under the laws of the Netherlands ("ANCI"), Akzo Nobel Chemicals Inc., a corporation formed ---- under the laws of Delaware ("ANC" and, together with ANCI, the "Sellers"), --- ------- Akzo Nobel N.V., a public limited liability company formed under the laws of the Netherlands ("Akzo Nobel" and, together with ANCI and ANC, the "Akzo Nobel ---------- ---------- Entities"), Flexsys Holding B.V., a private limited liability company formed - -------- under the laws of the Netherlands ("Flexsys Holding"), Flexsys America LP, a --------------- limited partnership formed under the laws of Delaware ("Flexsys America"), --------------- Flexsys Rubber Chemicals Ltd., a private limited company formed under the laws of England and Wales ("Flexsys UK" and, together with Flexsys Holding and ---------- Flexsys America, the "Company Entities"), and Solutia Inc., a corporation ---------------- formed under the laws of Delaware ("Solutia" and, together with the Company ------- Entities, the "Buyer Entities"). Certain capitalized terms used herein are -------------- defined in Section 10.10(a). ---------------- RECITALS WHEREAS, the Sellers own the Equity Interests in each of the Company Entities as set forth on Schedule 2.1 to this Agreement (such Equity ------------ Interests, collectively, the "Acquired Interests"); ------------------ WHEREAS, the Sellers wish to sell, and the Company Entities wish to acquire, the Acquired Interests, upon the terms and subject to the conditions set forth in this Agreement; and WHEREAS, it is a condition to the closing of the Transactions and the other Transaction Documents that, among other things, the transactions contemplated by the Kashima Purchase Agreements shall have been consummated in accordance with the terms of the Kashima Purchase Agreements; NOW, THEREFORE, in consideration of the promises and the mutual representations, warranties and covenants contained herein, the parties hereto agree as follows: ARTICLE I TRANSFER OF ACQUIRED INTERESTS SECTION 1.1 SALE AND PURCHASE OF THE ACQUIRED INTERESTS. On ------------------------------------------- the Closing Date and subject to the terms and conditions set forth in this Agreement: (a) ANCI shall sell, transfer, convey and deliver to Flexsys Holding, and Flexsys Holding shall repurchase from ANCI, all of the outstanding shares of ordinary shares and preferred shares of Flexsys Holding owned by ANCI, free and clear of all Encumbrances; (b) ANC shall sell, transfer, convey and deliver to Flexsys America, and Flexsys America shall repurchase from ANC, all of the outstanding partnership interests in Flexsys America owned by ANC, free and clear of all Encumbrances; and (c) ANCI shall sell, transfer, convey and deliver to Flexsys UK, and Flexsys UK shall lawfully repurchase from ANCI, in accordance with the United Kingdom Companies Act 1985 (as amended) and in accordance with the articles of association of Flexsys UK, all of the issued ordinary shares of Flexsys UK owned by ANCI, free and clear of all Encumbrances. SECTION 1.2 CONSIDERATION. ------------- (a) As used in this Agreement, "Initial Purchase Price" ---------------------- shall mean an amount determined based on the following formula: (i) $212,500,000.00; (ii) minus 50% of each of the Underfunded Pension/OPEB ----- Amounts for each Pension/OPEB Plan, as determined in accordance with Section 7.6(c); ------------------- (iii) minus 50% of each of (A) the Estimated Closing ----- Date Indebtedness Amount of each Company Entity and its Subsidiaries and (B) the Estimated Legacy Transaction Amount of each Company Entity and its Subsidiaries, as determined in accordance with Section 1.4; ----------- (iv) plus 50% of the Estimated Company Transaction ---- Amount, as determined in accordance with Section 1.4; and ----------- (v) plus 50% of the Estimated Closing Date Cash Amount ---- of each Company Entity and its Subsidiaries. (b) On the Closing Date and subject to the terms and conditions set forth in this Agreement, in consideration of the sale, transfer, conveyance and delivery of the Acquired Interests to the Company Entities, as applicable, each Company Entity shall pay to the applicable Seller the allocable portion of the Initial Purchase Price as shown on the Allocation Schedule prepared by the parties pursuant to Section 1.4(c) hereto -------------- by wire transfer of immediately available funds to the accounts designated by the Sellers by notice to the Buyer Entities not less than two (2) Business Days prior to the Closing Date. (c) Each party agrees that neither it nor any of its Affiliates will take any position inconsistent with the allocations set forth on the Allocation Schedule on any financing statement, Tax Return, Tax filing or in any other matter related to Taxes. SECTION 1.3 THE CLOSING. ----------- (a) Closing. Unless this Agreement shall have been ------- terminated and the Transactions shall have been abandoned pursuant to Article ------- VIII, the consummation of the sale and transfer to the Company Entities of the - ---- Acquired Interests contemplated by this 2 Agreement (the "Closing") shall take place at the offices of Kirkland & Ellis ------- LLP, Citigroup Center, 153 East 53rd Street, New York, New York 10022, on the third (3rd) Business Day following the date on which all of the conditions set forth in Article V and Article VI (other than those conditions which by their --------- ---------- nature are to be satisfied concurrently with the Closing) are satisfied or waived in accordance with the terms of this Agreement (the "Closing Date"), or ------------ at such other place and time as may be agreed upon in writing by the Akzo Nobel Entities, Solutia and the Company Entities, and shall be effective as of the Effective Time; provided that the Closing and the Closing Date shall be -------- delayed until two (2) Business Days after the date on which Solutia and the Akzo Nobel Entities agree on the Conclusive Initial Purchase Price Statement. (b) Deliveries by the Akzo Nobel Entities. At or prior to ------------------------------------- the Closing, the Akzo Nobel Entities shall deliver or cause to be delivered to or for the benefit of the Buyer Entities, in the case of documents, duly executed by each applicable party, the following: (i) the Transaction Documents to which any Akzo Nobel Entity or any of its Subsidiaries is a party; (ii) the certificates required by Section 6.3; ----------- (iii) written resignations, effective as of the Closing Date, of the Akzo Nobel Entities' representatives who are directors, officers or any foreign equivalents of any Company Entity or Company Subsidiary; (iv) an acknowledgement from the Sellers of receipt by or on behalf of the Sellers of the Initial Purchase Price; (v) certificates, if any, evidencing all of the Acquired Interests, duly endorsed in blank or accompanied by instruments of transfer or assignment duly executed in blank and dated the Closing Date, in proper form for transfer; (vi) ANC shall deliver a non-foreign affidavit dated as of the Closing Date, sworn under penalty of perjury and in form and substance as required under the Treasury Regulations issued pursuant to Section 1445 of the Internal Revenue Code, stating that it is not a "foreign person" as defined in Section 1445 of the Internal Revenue Code; and (vii) such other documents and certificates required to be delivered by any of the Akzo Nobel Entities pursuant to the terms of this Agreement. (c) Deliveries by the Buyer Entities. At the Closing, -------------------------------- each of the Buyer Entities shall deliver or cause to be delivered to or for the benefit of the Akzo Nobel Entities, in the case of documents, duly executed, the following: (i) its allocable portion of the Initial Purchase Price by wire transfer of immediately available funds in accordance with the Allocation Schedule; 3 (ii) copies of the resolutions of the board of directors (or comparable governing body) of each Company Entity authorizing and approving this Agreement and the Transaction Documents to which such Company Entity or any of its Subsidiaries is a party and the transactions and agreements contemplated hereby and thereby, certified by the corporate secretary (or local equivalent) of such Company Entity or its Subsidiary to be correct and complete and in full force and effect and unmodified as of the Closing Date; (iii) the Transaction Documents to which any Buyer Entity or any of its Subsidiaries is a party; (iv) the certificates required by Section 5.3; ----------- (v) a receipt from each Company Entity for the Acquired Interests delivered to such Company Entity; (vi) copies of the Approval Orders; and (vii) such other documents and certificates required to be delivered by any of the Buyer Entities pursuant to the terms of this Agreement. SECTION 1.4 DETERMINATION AND ALLOCATION OF INITIAL PURCHASE ------------------------------------------------ PRICE. - ----- (a) At least fifteen (15) Business Days prior to the anticipated Closing Date, the Company Entities shall prepare and deliver to the Akzo Nobel Entities and Solutia, a statement (the "Initial Purchase Price ---------------------- Statement") setting forth in reasonable detail, with respect to each Company - --------- Entity and its Subsidiaries, (i) the Company Entities' good faith estimate of the Closing Date Indebtedness Amount (such amount, the "Estimated Closing Date ---------------------- Indebtedness Amount"), (ii) the Company Entities' good faith estimate of the - ------------------- Closing Date Cash Amount (such amount, the "Estimated Closing Date Cash --------------------------- Amount"), (iii) the Company Entities' good faith estimate of the total amount - ------ of unpaid Legacy Transaction Costs (the "Estimated Legacy Transaction ---------------------------- Amount"), and (iv) the Company Entities' good faith estimate of the Company - ------ Transaction Costs (such amount, the "Estimated Company Transaction Amount") ------------------------------------ (the amounts set forth in clauses (i) through (iv), each, a "Purchase Price -------------- Component" and collectively, the "Purchase Price Components"). Each Purchase - --------- ------------------------- Price Component shall be stated as an absolute number. The Initial Purchase Price allocable to each Company Entity shall also be (x) increased by the amount of Intercompany Debt owed to such Company Entity and its Subsidiaries and (y) decreased by the amount of Intercompany Debt owed by such Company Entity and its Subsidiaries. The Initial Purchase Price shall also reflect the Underfunded Pension/OPEB Amount allocable to each Company Entity, as determined in accordance with Section 7.6(c), which amounts shall not be -------------- subject to review pursuant to Section 1.4(b) or subject to adjustment pursuant -------------- Section 1.5. Thirty percent (30%) of the amounts in Sections 1.2(a)(i) shall - ----------- ------------------ be allocable to Flexsys America and seventy percent (70%) of such amounts shall be allocable between Flexsys Holding and Flexsys UK. In no event shall the allocable amount of the Initial Purchase Price to any Company Entity be less than $1.00. (b) The Company Entities shall, and shall cause the Company Subsidiaries to, cooperate with the Akzo Nobel Entities and Solutia in their review of the Initial 4 Purchase Price Statement and provide them with full access to all of the books, records, work papers, facilities, employees, accountants, advisors and other representatives of the Company Entities and Company Subsidiaries in connection with the review of the Initial Purchase Price Statement. In the event that Solutia or any Akzo Nobel Entity disagrees with any Purchase Price Component set forth in the Initial Purchase Price Statement, the parties shall work together in good faith to resolve any such disagreement as soon as possible. As part of their review of the Initial Purchase Price Statement, Solutia and the Akzo Nobel Entities shall agree on the allocation of the Estimated Legacy Transaction Amount and the Estimated Company Transaction Amount as between the Company Entities. The final Initial Purchase Price Statement (including the allocation of the Estimated Legacy Transaction Amount and the Estimated Company Transaction Amount), as agreed upon by the Akzo Nobel Entities and Solutia, shall be the "Conclusive Initial Purchase Price --------------------------------- Statement", and the Purchase Price Components set forth in such Conclusive - --------- Initial Purchase Price Statement shall be final and binding on the parties to this Agreement, subject only to the adjustment set forth in Section 1.5 ----------- hereof. (c) Once the Conclusive Initial Purchase Price Statement has been agreed upon, Solutia and Akzo Nobel shall promptly prepare an allocation schedule to reflect the Purchase Price Components and the calculation of the allocable portion of the Initial Purchase Price being paid by each Company Entity in exchange for the applicable Acquired Interests (such schedule, the "Allocation Schedule"). ------------------- SECTION 1.5 POST-CLOSING ADJUSTMENT. ----------------------- (a) Within thirty (30) calendar days after the Closing Date, the Buyer Entities shall prepare and deliver to the Akzo Nobel Entities a statement (the "Closing Statement") setting forth the Buyer Entities' good ----------------- faith determination of the Closing Date Indebtedness Amount, the Closing Date Cash Amount, the Legacy Transaction Costs and the Company Transaction Amount of each Company Entity and its Subsidiaries, in each case, as of immediately prior to the Closing (such amounts, respectively, the "Final Closing Date ------------------ Indebtedness Amount", the "Final Closing Date Cash Amount", the "Final Closing - ------------------- ------------------------------ ------------- Date Legacy Transaction Amount" and the "Final Closing Date Company - ------------------------------ -------------------------- Transaction Amount"). - ------------------ (b) After receipt of the Closing Statement, the Akzo Nobel Entities will have thirty (30) calendar days to review the Closing Statement. During such thirty (30) calendar day period, the Buyer Entities shall provide the Akzo Nobel Entities with reasonable access to the relevant books, records, employees and advisors of the Buyer Entities to the extent reasonably necessary to review the Closing Statement. Unless the Akzo Nobel Entities deliver a written notice to the Buyer Entities setting forth the specific items disputed by the Akzo Nobel Entities on or prior to the thirtieth (30th) calendar day after their receipt of the Closing Statement, the Akzo Nobel Entities will be deemed to have accepted and agreed to the Closing Statement and such statement (and the amounts contained therein) will be final, binding and conclusive. If the Akzo Nobel Entities notify the Buyer Entities of their objections to specific items contained in the Closing Statement (or specific calculations contained therein) within such thirty (30) day period, the Akzo Nobel Entities and the Buyer Entities shall, within thirty (30) calendar days following the delivery of such notice by the Akzo Nobel Entities to the Buyer Entities (the "Resolution Period"), attempt in ----------------- good faith to resolve their differences with respect to the disputed items (or calculations) specified in the notice (the "Disputed Items"), and all other -------------- 5 items (and all calculations relating thereto) in the Closing Statement will be final, binding and conclusive. Any resolution by the Akzo Nobel Entities and the Buyer Entities during the Resolution Period as to any Disputed Item shall be set forth in writing and will be final, binding and conclusive. (c) If the Akzo Nobel Entities and the Buyer Entities do not resolve all Disputed Items by the end of the Resolution Period, then all Disputed Items remaining in dispute will be submitted to a U.S. national independent accounting firm mutually acceptable to the Akzo Nobel Entities and the Buyer Entities (the "Neutral Arbitrator"). The Neutral Arbitrator shall ------------------ act as an arbitrator to determine only those Disputed Items remaining in dispute, consistent with this Section 1.5(c), and shall request a statement -------------- from the Akzo Nobel Entities and the Buyer Entities regarding such Disputed Items. All fees and expenses relating to the work, if any, to be performed by the Neutral Arbitrator will be allocated between the Akzo Nobel Entities and the Buyer Entities in the same proportion that the aggregate amount of the Disputed Items so submitted to the Neutral Arbitrator that is unsuccessfully disputed by each such party (as finally determined by the Neutral Arbitrator) bears to the total amount of such Disputed Items so submitted. In addition, the Akzo Nobel Entities and the Buyer Entities shall give the Neutral Arbitrator access to all documents, records, work papers, facilities and personnel of such party and its Subsidiaries as reasonably necessary to perform its function as arbitrator. The Neutral Arbitrator will deliver to the Akzo Nobel Entities and the Buyer Entities a written determination (such determination to include a work sheet setting forth all material calculations used in arriving at such determination and to be based solely on information provided to the Neutral Arbitrator by the Akzo Nobel Entities and the Buyer Entities) of the Disputed Items submitted to the Neutral Arbitrator within thirty (30) calendar days of receipt of such Disputed Items, which determination will be final, binding and conclusive. The final, binding and conclusive Closing Statement based either upon agreement or deemed agreement by the Akzo Nobel Entities and the Buyer Entities or the written determination delivered by the Neutral Arbitrator in accordance with this Section 1.5(c), -------------- will be the "Conclusive Closing Statement." If any party fails to submit a ---------------------------- statement regarding any Disputed Item submitted to the Neutral Arbitrator within the time determined by the Neutral Arbitrator or otherwise fails to give the Neutral Arbitrator access as reasonably requested, then the Neutral Arbitrator shall render a decision based solely on the evidence timely submitted and the access afforded to the Neutral Arbitrator by the Buyer Entities and the Akzo Nobel Entities. (d) Upon agreement or deemed agreement by the parties of the Conclusive Closing Statement or the delivery by the Neutral Arbitrator of the Conclusive Closing Statement, the parties shall calculate the Purchase Price Adjustment Amount for each Company Entity and its Subsidiaries. As used in this Agreement, "Purchase Price Adjustment Amount" means, with respect to -------------------------------- each Company Entity and its Subsidiaries, an amount equal to (i) 50% of the Estimated Closing Date Cash Amount for such Company Entity and its Subsidiaries as set forth in the Conclusive Initial Purchase Price Statement, minus (ii) 50% of the Estimated Closing Date Indebtedness Amount for such - ----- Company Entity and its Subsidiaries as set forth in the Conclusive Initial Purchase Price Statement, plus (iii) 50% of the Estimated Company Transaction ---- Amount for such Company Entity and its Subsidiaries as set forth in the Conclusive Initial Purchase Price Statement, minus (iv) 50% of the Estimated ----- Legacy Transaction Amount of such Company Entity and its Subsidiaries as set forth in the Conclusive Initial Purchase Price Statement, minus (v) 50% of the ----- Final Closing Date Cash Amount for such 6 Company Entity and its Subsidiaries as set forth in the Conclusive Closing Statement, plus (vi) 50% of the Final Closing Date Indebtedness Amount for ---- such Company Entity and its Subsidiaries as set forth in the Conclusive Closing Statement, minus (vii) 50% of the Final Closing Date Company ----- Transaction Amount for such Company Entity and its Subsidiaries as set forth in the Conclusive Closing Statement and plus (viii) 50% of the Final Closing ---- Date Legacy Transaction Amount of such Company Entity and its Subsidiaries as set forth in the Conclusive Closing Statement. If the Purchase Price Adjustment Amount for a Company Entity and its Subsidiaries is a positive number, the applicable Seller shall pay to such Company Entity, as an adjustment to the Initial Purchase Price allocable to such Company Entity, an amount in cash equal to the Purchase Price Adjustment Amount by wire transfer to such accounts designated by the Buyer Entities which payment in the case of Flexsys UK shall be lawfully made, in accordance with the United Kingdom Companies Act 1985 (as amended) and in accordance with the articles of association of Flexsys UK consistent with the payment of the Initial Purchase Price by Flexsys UK. If the Purchase Price Adjustment Amount for a Company Entity and its Subsidiaries is a negative number, such Company Entity shall pay to the applicable Seller, as an adjustment to the Initial Purchase Price allocable to such Company, an amount in cash equal to the Purchase Price Adjustment Amount by wire transfer to such accounts designated by the Akzo Nobel Entities. If the Purchase Price Adjustment Amount is zero with respect to any Company Entity and its Subsidiaries, no payment shall be required and no adjustment pursuant to this Section 1.5(d) shall be made to the Initial -------------- Purchase Price allocable to such Company Entity. Any Purchase Price Adjustment Amount for any Company Entity whose allocable Initial Purchase Price Amount was $1.00 shall be paid by or paid to Flexsys Holding. (e) All payments to be made pursuant to Section 1.5(d) -------------- will be made on the second (2nd) Business Day following the date on which the Akzo Nobel Entities and the Buyer Entities agree or are deemed to have agreed to, or the Neutral Arbitrator delivers, the Conclusive Closing Statement. SECTION 1.6 FURTHER ASSURANCES. After the Closing, each ------------------ party hereto shall from time to time, at the request of another party, execute and deliver such other instruments of conveyance and transfer and take such other actions as may be reasonably necessary in order to consummate the Transactions and to vest in each Company Entity good and valid title to the Acquired Interests acquired by such Company Entity. ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE AKZO NOBEL ENTITIES The Akzo Nobel Entities hereby, jointly and severally, represent and warrant to the Buyer Entities, as of February 26, 2007, as follows: SECTION 2.1 OWNERSHIP OF THE ACQUIRED INTERESTS. Each Seller ----------------------------------- is the legal and beneficial owner of, and has good and valid title to, the Acquired Interests set forth next to such Seller's name on Schedule 2.1, free ------------ and clear of all options, pledges, mortgages, security interests, liens, restrictions on voting or transfer, or other Encumbrances of any nature (except for transfer restrictions arising under the applicable securities laws, the Governing Documents of the Company Entities and the Joint Venture Agreement), and such good and valid title will be transferred to the applicable Buyer Entity on the Closing Date, free and clear of all options, 7 pledges, mortgages, security interests, liens, restrictions on voting or transfer, or other Encumbrances of any nature (except for transfer restrictions arising under the applicable securities laws, the Governing Documents of the Company Entities and the Joint Venture Agreement). Other than the Acquired Interests set forth on Schedule 2.1, the Sellers own no Equity ------------ Interest in any Company Entity or any Company Subsidiary. None of the Sellers is a party to, or bound by, any arrangement, agreement, instrument or order (i) relating to the issuance, transfer, sale, disposition, pledge or acquisition of any Equity Interests of any of the Company Entities or Company Subsidiaries or (ii) relating to the dividend or voting rights of any Equity Interests of any of the Company Entities or Company Subsidiaries. SECTION 2.2 ORGANIZATION. Each Akzo Nobel Entity is duly ------------ incorporated, formed or organized (as applicable), validly existing and in good standing (where such concept is applicable) under the laws of its jurisdiction of incorporation, formation or organization (as applicable), and (where applicable) is duly qualified or licensed to do business and is in good standing in the jurisdictions in which the ownership of its property or the conduct of its business requires such qualification or license, except jurisdictions in which the failure to be so qualified or licensed would not be reasonably expected to have a material adverse effect on the ability of the Akzo Nobel Entity to consummate the Transactions and the Transaction Documents to which it is a party. SECTION 2.3 AUTHORIZATION, ETC. Each Akzo Nobel Entity has ------------------ full corporate or similar power and authority to execute and deliver this Agreement and each of the Transaction Documents to which such Akzo Nobel Entity is a party, and to carry out and consummate the transactions contemplated hereby and thereby that are to be carried out and consummated by it. The execution, delivery and performance by each Akzo Nobel Entity of this Agreement and each Transaction Document to which such Akzo Nobel Entity is a party, have been duly and validly authorized by all necessary corporate or similar actions or proceedings on the part of such Akzo Nobel Entity and no other corporate or similar action or proceeding by such Akzo Nobel Entity is necessary to authorize the execution, delivery and performance of this Agreement and each Transaction Document to which it is a party. This Agreement has been duly and validly executed by each Akzo Nobel Entity and, assuming this Agreement constitutes the legal, valid and binding agreement of the other parties hereto, constitutes a legal, valid and binding agreement of each Akzo Nobel Entity, enforceable against each Akzo Nobel Entity in accordance with its terms, subject to the effects of bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally, general equitable principles (whether considered in a proceeding in equity or at law) and an implied covenant of good faith and fair dealing (the "Bankruptcy and Equity Exception"). At or ------------------------------- prior to the Closing, each Akzo Nobel Entity shall have duly and validly executed and delivered each Transaction Document to which such Akzo Nobel Entity is a party, and assuming each Transaction Document constitutes the legal, valid and binding agreement of the other parties thereto, each Transaction Document shall constitute a legal, valid and binding agreement of each Akzo Nobel Entity who is a party to such agreement, enforceable against such Akzo Nobel Entity in accordance with its terms, subject to the Bankruptcy and Equity Exception. SECTION 2.4 NO APPROVALS OR CONFLICTS. The execution, ------------------------- delivery and performance by each Akzo Nobel Entity of this Agreement and the Transaction Documents to which it is a party, and the consummation by such Akzo Nobel Entity of the transactions 8 contemplated hereby and thereby to be carried out and consummated by it will not (i) violate, conflict with or result in a breach by such Akzo Nobel Entity of any provision of any Governing Document of such Akzo Nobel Entity, (ii) violate, conflict with or result in a breach of any provision of, or constitute a default by such Akzo Nobel Entity (or create an event which, with notice or lapse of time or both, would constitute such a default) or give rise to any right of termination, cancellation, modification or acceleration under, or result in the creation of any options, pledges, mortgages, security interests, liens, restrictions on voting or transfer, or other Encumbrances of any nature upon any of the properties of such Akzo Nobel Entity under any material note, bond, mortgage, indenture, deed of trust, license, franchise, permit, lease, contract, agreement or other instrument or understanding to which such Akzo Nobel Entity is party or by which any of its properties, assets or business activities may be bound, (iii) conflict with, violate or result in a breach in any material respect of any Law applicable to such Akzo Nobel Entity or any of its properties, assets or business activities, or (iv) except for applicable requirements of any Law that is designed or intended to prohibit, restrict or regulate foreign investment or mergers and acquisitions, antitrust, monopolization, restraint of trade or competition ("Competition/Investment Law"), which are set forth on Schedule 2.4, require -------------------------- ------------ any material order, Consent, clearance, approval or authorization of, or notice to, or declaration, filing, application, qualification or registration with, any Governmental Authority or other Person, except in each case with respect to subclauses (ii), (iii) and (iv), where such violation, conflict, breach, default, right, option, pledge, mortgage, security interest, lien, restriction on voting or transfer, or other encumbrance of any nature or requirement would not be reasonably expected to have a material adverse effect on the ability of the Akzo Nobel Entities to consummate the Transactions. SECTION 2.5 NO BROKERS' OR OTHER FEES. In connection with ------------------------- the Transactions, none of the Akzo Nobel Entities has incurred any liability or obligation to pay fees or commissions to brokers, finders, investment bankers, attorneys, consultants or other representatives for which any of the Buyer Entities or their respective Affiliates would be responsible. SECTION 2.6 AFFILIATE AGREEMENTS. Schedule 2.6 sets forth a -------------------- ------------ true and complete list of each and every material written contract, agreement, commitment or other arrangement material to any Company Entity between any Company Entity, Company Subsidiary or any Affiliate thereof, on the one hand, and Akzo Nobel or any of its Affiliates, on the other hand (each such contract, agreement, commitment or other arrangement set forth on Schedule -------- 2.6, an "Affiliate Agreement"), other than any contracts, agreements, - --- ------------------- commitments or other arrangements governing relationships between Akzo Nobel or any of its Affiliates and a Company Entity, Company Subsidiary or Affiliate thereof that are conducted on an arm's-length basis. Except as set forth on Schedule 2.6, there are no Affiliate Agreements. - ------------ SECTION 2.7 NO OTHER REPRESENTATIONS OR WARRANTIES. -------------------------------------- Notwithstanding anything to the contrary set forth herein, the express representations and warranties set forth in this Article II and in the ---------- Transaction Documents are the only representations and warranties concerning the Akzo Nobel Entities, the Company Entities and the Company Subsidiaries made to the Buyer Entities by the Akzo Nobel Entities. Each Buyer Entity hereby acknowledges and agrees that none of the Akzo Nobel Entities makes any representations or warranties to any 9 Buyer Entity, express or implied, other than those representations and warranties set forth in Article II and in the Transaction Documents. ---------- ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE COMPANY ENTITIES The Company Entities hereby, jointly and severally, represent and warrant to Solutia and the Akzo Nobel Entities, as of February 26, 2007, as follows: SECTION 3.1 ORGANIZATION. Each Company Entity is duly ------------ incorporated, formed or organized (as applicable), validly existing and in good standing (where such concept is applicable) under the laws of its jurisdiction of incorporation, formation or organization (as applicable), and (where applicable) is duly qualified or licensed to do business and is in good standing in the jurisdictions in which the ownership of its property or the conduct of its business requires such qualification or license, except jurisdictions in which the failure to be so qualified or licensed would not be reasonably expected to have a material adverse effect on the ability of the Company Entity to consummate the Transactions and the Transaction Documents to which it is a party. SECTION 3.2 AUTHORIZATION, ETC. Each Company Entity has full ------------------ corporate or similar power and authority to execute and deliver this Agreement and each of the Transaction Documents to which such Company Entity is a party, and to carry out and consummate the transactions contemplated hereby and thereby that are to be carried out and consummated by it. The execution, delivery and performance by each Company Entity of this Agreement and each Transaction Document to which such Company Entity is a party, have been duly and validly authorized by all necessary corporate or similar actions or proceedings on the part of such Company Entity and no other corporate or similar action or proceeding by such Company Entity is necessary to authorize the execution, delivery and performance of this Agreement and each Transaction Document to which it is a party. This Agreement has been duly and validly executed by each Company Entity and, assuming this Agreement constitutes the legal, valid and binding agreement of the other parties hereto, constitutes a legal, valid and binding agreement of each Company Entity, enforceable against each Company Entity in accordance with its terms, subject to the Bankruptcy and Equity Exception. At or prior to the Closing, each Company Entity shall have duly and validly executed and delivered each Transaction Document to which such Company Entity is a party, and assuming each Transaction Document constitutes the legal, valid and binding agreement of the other parties thereto, each Transaction Document shall constitute a legal, valid and binding agreement of each Company Entity who is a party to such agreement, enforceable against such Company Entity in accordance with its terms, subject to the Bankruptcy and Equity Exception. SECTION 3.3 NO APPROVALS OR CONFLICTS. The execution, ------------------------- delivery and performance by each Company Entity of this Agreement and the Transaction Documents to which it is a party, and the consummation by such Company Entity of the transactions contemplated hereby and thereby to be carried out and consummated by it will not (i) violate, conflict with or result in a breach by such Company Entity of any provision of any Governing Document of such Company Entity, (ii) violate, conflict with or result in a breach of any provision of, or constitute a default by such Company Entity (or create an event which, with 10 notice or lapse of time or both, would constitute such a default) or give rise to any right of termination, cancellation, modification or acceleration under, or result in the creation of any options, pledges, mortgages, security interests, liens, restrictions on voting or transfer, or other Encumbrances of any nature upon any of such Company Entity's properties and assets under any material note, bond, mortgage, indenture, deed of trust, license, franchise, permit, lease, contract, agreement or other instrument or understanding to which such Company Entity is a party or by which any of its properties, assets or business activities may be bound, (iii) conflict with, violate or result in a breach in any material respect of any Law applicable to such Company Entity or any of its properties, assets or business activities, or (iv) except for applicable requirements of any Competition/Investment Law, which are set forth on Schedule 3.3, require any material order, Consent, clearance, approval or ------------ authorization of, or notice to, or declaration, filing, application, qualification or registration with, any Governmental Authority or other Person, except in each case with respect to subclauses (ii), (iii) and (iv), where such violation, conflict, breach, default, right, option, pledge, mortgage, security interest, lien, restriction on voting or transfer, or other encumbrance of any nature or requirement would not be reasonably expected to have a material adverse effect on the ability of the Company Entities to consummate the Transactions. SECTION 3.4 FINANCIAL CAPACITY. As of February 26, 2007, ------------------ none of the Company Entities is aware of any fact or circumstance that would prevent the Company Entities from financing a sufficient amount (the "Company ------- Financing Amount" and, together with the Solutia Financing Amount, the - ---------------- "Financing Amount") which, together with the Solutia Financing Amount, will be ---------------- sufficient to pay the Initial Purchase Price, as adjusted in accordance with Article I hereof, and all related fees and expenses. SECTION 3.5 NO BROKERS' OR OTHER FEES. In connection with ------------------------- the Transactions, other than the Legacy Transaction Costs, none of the Company Entities has incurred any liability or obligation to pay fees or commissions to brokers, finders, investment bankers, attorneys, consultants or other representatives for which any of the Akzo Nobel Entities or Solutia or their respective Affiliates would be responsible. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF SOLUTIA Solutia hereby represents and warrants to the Akzo Nobel Entities, as of February 26, 2007, as follows: SECTION 4.1 ORGANIZATION. Subject to the pendency of the ------------ Chapter 11 Cases, Solutia is duly incorporated, formed or organized, validly existing and in good standing under the laws of the State of Delaware, and is duly qualified or licensed to do business and is in good standing in the jurisdictions in which the ownership of its property or the conduct of its business requires such qualification or license, except jurisdictions in which the failure to be so qualified or licensed would not be reasonably expected to have a material adverse effect on the ability of Solutia to consummate the Transactions and the Transaction Documents to which it is a party. SECTION 4.2 AUTHORIZATION, ETC. Subject to the Transaction ------------------ Approval Order being a Final Order at the time of Closing, (i) Solutia has full corporate or similar power and 11 authority to execute and deliver this Agreement and each of the Transaction Documents to which it is a party, and to carry out and consummate the transactions contemplated hereby and thereby that are to be carried out and consummated by it, and (ii) the execution, delivery and performance by Solutia of this Agreement and each Transaction Document to which it is a party, have been duly and validly authorized by all necessary corporate actions or proceedings on the part of Solutia and no other corporate action or proceeding by Solutia is necessary to authorize the execution, delivery and performance of this Agreement and each Transaction Document to which it is a party. This Agreement has been duly and validly executed by Solutia and, assuming this Agreement constitutes the legal, valid and binding agreement of the other parties hereto and subject to the Transaction Approval Order being a Final Order at the time of Closing, constitutes a legal, valid and binding agreement of Solutia, enforceable against Solutia in accordance with its terms, subject to the Bankruptcy and Equity Exception. At or prior to the Closing, Solutia shall have duly and validly executed and delivered each Transaction Document to which it is a party, and assuming each Transaction Document constitutes the legal, valid and binding agreement of the other parties thereto and subject to the Transaction Approval Order being a Final Order at the time of Closing, each Transaction Document shall constitute a legal, valid and binding agreement of Solutia, enforceable against Solutia in accordance with its terms, subject to the Bankruptcy and Equity Exception. SECTION 4.3 NO APPROVALS OR CONFLICTS. Subject to the ------------------------- Transaction Approval Order being a Final Order at the time of Closing, the execution, delivery and performance by Solutia of this Agreement and the Transaction Documents to which it is a party, and the consummation by Solutia of the transactions contemplated hereby and thereby to be carried out and consummated by it will not (i) violate, conflict with or result in a breach by Solutia of any provision of any of its Governing Documents, (ii) violate, conflict with or result in a breach of any provision of, or constitute a default by Solutia (or create an event which, with notice or lapse of time or both, would constitute such a default) or give rise to any right of termination, cancellation, modification or acceleration under, or result in the creation of any options, pledges, mortgages, security interests, liens, restrictions on voting or transfer, or other Encumbrances of any nature upon any of Solutia's properties and assets under any material note, bond, mortgage, indenture, deed of trust, license, franchise, permit, lease, contract, agreement or other instrument or understanding to which it is a party or by which any of its properties, assets or business activities may be bound, (iii) conflict with, violate or result in a breach in any material respect of any Law applicable to Solutia or any of its properties, assets or business activities, or (iv) except for the applicable requirements of any Competition/Investment Law, which are set forth on Schedule 4.3, require any ------------ material order, Consent, clearance, approval or authorization of, or notice to, or declaration, filing, application, qualification or registration with, any Governmental Authority or other Person, except in each case with respect to subclauses (ii), (iii) and (iv), where such violation, conflict, breach, default, right, option, pledge, mortgage, security interest, lien, restriction on voting or transfer, or other encumbrance of any nature or requirement would not be reasonably expected to have a material adverse effect on the ability of Solutia to consummate the Transactions. SECTION 4.4 FINANCIAL CAPACITY. As of February 26, 2007 and ------------------ assuming that the Closing occurs by May 25, 2007, Solutia is not aware of any fact or circumstance that would prevent Solutia from financing up to $150,000,000.00 of the Initial Purchase Price (the "Solutia Financing ----------------- Amount"), which, together with the Company Financing Amount, will be - ------ sufficient to 12 pay the Initial Purchase Price, as adjusted in accordance with Article I hereof, and all related fees and expenses. SECTION 4.5 NO BROKERS' OR OTHER FEES. In connection with ------------------------- the Transactions, Solutia has not incurred any liability or obligation to pay fees or commissions to brokers, finders, investment bankers, attorneys, consultants or other representatives for which any of the Akzo Nobel Entities or their respective Affiliates would be responsible. ARTICLE V CONDITIONS TO THE OBLIGATIONS OF THE AKZO NOBEL ENTITIES The obligations of each Akzo Nobel Entity to effect the Closing under this Agreement is subject to the satisfaction, at or prior to the Closing, of each of the following conditions, unless validly waived in writing by each of the Akzo Nobel Entities: SECTION 5.1 REPRESENTATIONS AND WARRANTIES. Each of the ------------------------------ representations and warranties of the Buyer Entities contained in this Agreement that is qualified by a materiality standard shall be true and correct as of February 26, 2007 and as of the Closing as if made on and as of the Closing (other than any such representation or warranty that is made by its terms as of a specified date, which shall be true and correct as of such specified date) and each of the representations and warranties of the Buyer Entities contained in this Agreement that is not qualified by a materiality standard shall be true and correct in all material respects as of February 26, 2007 and as of the Closing as if made on and as of the Closing (other than any such representation or warranty that is made by its terms as of a specified date, which shall be true and correct in all material respects as of such specified date). SECTION 5.2 PERFORMANCE. Each Buyer Entity shall have ----------- performed and complied in all material respects with all agreements and obligations required by this Agreement to be so performed or complied with by it prior to the Closing. SECTION 5.3 OFFICER'S CERTIFICATE. Each Buyer Entity shall --------------------- have delivered to the Akzo Nobel Entities a certificate, dated as of the Closing Date and executed by an executive officer of such Buyer Entity, certifying to the fulfillment of the conditions specified in Section 5.1 and ----------- Section 5.2. - ----------- SECTION 5.4 CONSENTS AND APPROVALS; COMPETITION LAWS. Each ---------------------------------------- Consent listed on Schedule 5.4 shall have been obtained and shall not have ------------ expired or been withdrawn as of the Closing. All applicable waiting periods (including any extensions thereof) and any required merger clearances under any Competition/Investment Law listed on Schedule 5.4 shall have expired or ------------ been received. SECTION 5.5 BANKRUPTCY APPROVALS. The Bankruptcy Court shall -------------------- have entered the Transaction Approval Order as a Final Order. SECTION 5.6 NO INJUNCTION. On the Closing Date, there shall ------------- not be in effect any Law or any judgment, order, writ, injunction, decree, stipulation, agreement, determination or award entered or issued by or with any Governmental Authority (each, a "Governmental Order") which materially ------------------ restrains, prohibits or declares illegal the consummation of the 13 Transactions and no Governmental Authority of competent jurisdiction shall have instituted a Proceeding seeking to impose any such restraint or prohibition. SECTION 5.7 CERTAIN TRANSACTION DOCUMENTS. Each of the ----------------------------- Disentanglement Transaction Documents, each of the Services Agreements and the Transition Services Agreement, in form and substance reasonably satisfactory to the Akzo Nobel Entities, shall have been duly executed and delivered by the Company Entities party thereto and shall be in full force and effect. SECTION 5.8 KASHIMA TRANSACTION. The transactions ------------------- contemplated by the Kashima Purchase Agreements shall have been consummated on the terms and subject to the conditions set forth in the Kashima Purchase Agreements. ARTICLE VI CONDITIONS TO THE OBLIGATIONS OF THE BUYER ENTITIES The obligation of each Buyer Entity to effect the Closing under this Agreement is subject to the satisfaction, at or prior to the Closing, of each of the following conditions, unless validly waived in writing by each of the Buyer Entities: SECTION 6.1 REPRESENTATIONS AND WARRANTIES. Each of the ------------------------------ representations and warranties of the Akzo Nobel Entities contained in this Agreement that is qualified by a materiality standard shall be true and correct as of February 26, 2007 and as of the Closing as if made on and as of the Closing (other than any such representation or warranty that is made by its terms as of a specified date, which shall be true and correct as of such specified date) and each of the representations and warranties of the Akzo Nobel Entities contained in this Agreement that is not qualified by a materiality standard shall be true and correct in all material respects as of February 26, 2007 and as of the Closing as if made on and as of the Closing (other than any such representation or warranty that is made by its terms as of a specified date, which shall be true and correct in all material respects as of such specified date). SECTION 6.2 PERFORMANCE. Each Akzo Nobel Entity shall have ----------- performed and complied in all material respects with all agreements and obligations required by this Agreement to be so performed or complied with by it at or prior to the Closing. SECTION 6.3 OFFICER'S CERTIFICATES. Each Akzo Nobel Entity ---------------------- shall have delivered to the Buyer Entities a certificate, dated as of the Closing Date and executed by one of its executive officers, certifying to the fulfillment by it of the conditions specified in Section 6.1 and Section 6.2 ----------- ----------- to be fulfilled by it. SECTION 6.4 CONSENTS AND APPROVALS; COMPETITION LAWS. Each ---------------------------------------- Consent listed on Schedule 6.4 shall have been obtained and shall not have ------------ expired or been withdrawn as of the Closing. All applicable waiting periods (including any extensions thereof) and any required merger clearances under any Competition/Investment Law listed on Schedule 6.4 shall have expired or ------------ been received. SECTION 6.5 BANKRUPTCY APPROVALS. The Bankruptcy Court shall -------------------- have entered the Transaction Approval Order as a Final Order. 14 SECTION 6.6 NO INJUNCTION. On the Closing Date, there shall ------------- not be in effect any Law or any Governmental Order which materially restrains, prohibits or declares illegal the consummation of the Transactions and no Governmental Authority of competent jurisdiction shall have instituted a Proceeding seeking to impose any such restraint or prohibition. SECTION 6.7 NO MATERIAL ADVERSE CHANGE. No fact, event or -------------------------- circumstance shall have occurred which has had or would reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect. SECTION 6.8 FINANCING. The Buyer Entities shall have --------- obtained an amount of financing not less than the Company Financing Amount upon terms reasonably satisfactory to the Buyer Entities and the Solutia Financing Amount shall not have been refunded pursuant to the DIP Financing Agreement as a result of the expiration of the one-hundred twenty day period beginning on the date the Solutia Financing Amount was funded under the DIP Financing Agreement (or Solutia shall have arranged replacement financing for the Solutia Financing Amount or the Buyer Entities shall have arranged replacement financing for the Company Financing Amount, as applicable, on terms reasonably satisfactory to Solutia and Akzo Nobel). SECTION 6.9 CERTAIN TRANSACTION DOCUMENTS. Each of the ----------------------------- Disentanglement Transaction Documents, each of the Services Agreements and the Transition Services Agreement, in form and substance reasonably satisfactory to the Buyer Entities, shall have been duly executed and delivered by the Akzo Nobel Entities party thereto and shall be in full force and effect. SECTION 6.10 KASHIMA TRANSACTION. The transactions ------------------- contemplated by the Kashima Purchase Agreements shall have been consummated on the terms and subject to the conditions set forth in the Kashima Purchase Agreements. ARTICLE VII COVENANTS AND AGREEMENTS SECTION 7.1 CONDUCT OF BUSINESS BY THE COMPANY ENTITIES; -------------------------------------------- LEGACY TRANSACTION COSTS. - ------------------------ (a) During the period commencing on the date of this Agreement and ending on the Closing Date, each of Solutia and the Akzo Nobel Entities shall cause the Company Entities to, and each party hereto shall cause the Company Subsidiaries to, use commercially reasonable efforts to (i) preserve intact the present business organization of the Company Entities and Company Subsidiaries and operate the businesses of the Company Entities and Company Subsidiaries in the ordinary course consistent with past practice, (ii) maintain and preserve intact the businesses, assets and properties of the Company Entities and Company Subsidiaries and maintain satisfactory relationships with licensors, suppliers, creditors, distributors, customers, key executive employees and others having material business relationships with their business, (iii) maintain the books of account, records and files of the Company Entities and Company Subsidiaries, all in the ordinary course of business and consistent with past practice, and (vi) manage the Cash and net working capital of the businesses in a manner consistent with past practices and not take any action that would or would reasonably be expected to artificially increase or decrease the amount of Cash or net working capital. As soon as reasonably practicable after the date hereof, but in no event later than ten (10) days prior to the Closing 15 Date, the Company Entities will deliver to Solutia and the Akzo Nobel Entities a balance sheet of Flexsys Holding, as of December 31, 2006, prepared in accordance with the generally accepted accounting principles in the Netherlands. (b) Notwithstanding anything to the contrary in this Agreement, each of the parties hereto agrees that prior to the Closing it shall act in good faith to reduce or otherwise limit (including by means of negotiation with the relevant entities) the Legacy Transaction Costs. Solutia shall provide the Akzo Nobel Entities with written notice on or before the date which is fifteen (15) Business Days prior to the Closing Date with respect to each Legacy Transaction Cost that, as of the date of such notice, remains unpaid of its election to either (i) have such Legacy Transaction Cost paid by the Company Entities in connection with the Closing (each, a "Paid ---- Legacy Cost") or (ii) continue to negotiate with the relevant entity with - ----------- respect to such Legacy Transaction Cost (each, an "Assumed Legacy Cost"). For ------------------- each Paid Legacy Cost (1) the parties will cease all negotiations to reduce or otherwise limit the fees and expenses payable by the Company Entities, (2) the full amount outstanding with respect to such Paid Legacy Cost will be paid by the Company Entities on or prior to the Closing Date and, if unpaid as of the Closing Date, will be taken into account for purposes of Sections 1.2(a)(iii), -------------------- 1.4(a)(iii) and 1.5 of the Agreement and the Company Entities shall pay such - ---------- --- Paid Legacy Cost within thirty (30) calendar days of the Closing, and (3) the Akzo Nobel Entities will be released and discharged from any and all further obligations with respect to such Paid Legacy Cost. For each Assumed Legacy Cost, (x) the Buyer Entities will release and discharge the Akzo Nobel Entities from any and all obligations with respect to such Assumed Legacy Cost, (y) the Buyer Entities will indemnify and hold the Akzo Nobel Entities harmless from any Losses incurred by the Akzo Nobel Entities after the Closing arising out of such Assumed Legacy Cost, and (z) such Assumed Legacy Cost will not be taken into account for purposes of Sections 1.2(a)(iii), 1.4(a)(iii) or ------------------- ---------- 1.5 of the Agreement. - --- SECTION 7.2 ACCESS TO BOOKS AND RECORDS; COOPERATION. ---------------------------------------- (a) Each party hereto shall cause the books and records, contracts, documents and other information (in whatever form) of each Company Entity and Company Subsidiary to be in the sole possession and control of the Company Entities or Company Subsidiaries on or before the Closing. Subject to (i) all applicable Laws, including Competition/Investment Laws, and (ii) bona fide concerns regarding attorney-client privilege, each party agrees that from the Closing Date and until the tenth (10th) anniversary of the Closing Date, during normal business hours, each party shall permit the other parties (at no cost to such other parties) and their respective officers, directors, employees, accountants, counsel, consultants, advisors and agents ("Representatives") to have reasonable access upon reasonable advance notice, --------------- to the Representatives, properties, books, records and contracts in the possession of or accessible by such party and its Affiliates (in each case without disruption of the business of such party or its Subsidiaries) to the extent related to the business of the Company Entities and Company Subsidiaries, and the right (at the requesting party's expense) to make copies and extracts from such books, records, accountant work papers, and contracts, in each case to the extent reasonably necessary to investigate, prosecute, pursue or defend, as the case may be, any threatened or actual Proceeding, prepare and file Tax Returns and defend audits thereof, and satisfy other bona fide business needs, in each case relating to any Company Entity or Company Subsidiary prior to the Closing Date. 16 (b) Each party agrees that it shall not, and shall cause its Affiliates not to, destroy at any time any files or records which are subject to Section 7.2(a) without giving written notice to each other party, ------------- and giving each other party thirty (30) calendar days following receipt of such notice to request in writing that all or a portion of the records intended to be destroyed be delivered to such other party at such other party's expense. (c) Subject to all applicable Laws, including Competition/Investment Laws, during the period commencing on the date of this Agreement and ending on the Closing Date, the Company Entities will, and will cause the Company Subsidiaries to, upon reasonable request, afford to Solutia, the Akzo Nobel Entities, and their respective Representatives full access at all reasonable times upon reasonable advance notice, to the Representatives, properties, books, records, accountant work papers and contracts of each Company Entity and Company Subsidiary, and the right to make copies and extracts from such books, records, accountant work papers and contracts, and to furnish Solutia and the Akzo Nobel Entities with all financial, operating, environmental and other data and information concerning any Company Entity or Company Subsidiary as such Persons and their respective Representatives may reasonably request; provided that none of the Akzo Nobel Entities or Solutia -------- shall be allowed to perform any invasive or destructive sampling or testing of structures or environmental media ("Phase II Environmental Investigations") ------------------------------------- except as expressly permitted in Section 9.6(b) of this Agreement. -------------- (d) On and after the Closing Date until the second (2nd) anniversary of the Closing Date, each Akzo Nobel Entity will hold, and will use reasonable efforts to cause its respective Representatives and Affiliates to hold, in confidence, unless compelled to disclose by any applicable Law or Governmental Order, all confidential documents and information concerning the Company Entities and Company Subsidiaries, except to the extent that such information is (i) in the public domain through no violation of this Section ------- 7.2(d) by any Akzo Nobel Entity or any of its Representatives or Affiliates, - ------ (ii) later lawfully acquired by an Akzo Nobel Entity on a non-confidential basis from sources other than the Buyer Entities or any of their respective Affiliates, or (iii) independently developed by the Akzo Nobel Entities and/or their Affiliates without reference to any confidential information of the Company Entities or the Company Subsidiaries. The obligation of an Akzo Nobel Entity to hold any such information in confidence shall be satisfied if it exercises the same care with respect to such information as such Akzo Nobel Entity would take to preserve the confidentiality of its own similar information. SECTION 7.3 FILINGS AND CONSENTS. Except as set forth in -------------------- Section 7.13, each of Solutia, the Company Entities and the Akzo Nobel - ------------ Entities shall, and shall cause their respective Affiliates to, use commercially reasonable efforts to obtain and to cooperate in obtaining any governmental approval or other Consent required in connection with the execution, delivery or performance of this Agreement or any Transaction Document. The parties agree to cause to be made all appropriate filings under any Competition/Investment Law as promptly as practicable following the date of this Agreement and to diligently pursue termination of the waiting periods under any Competition/Investment Law (including promptly responding to any requests for additional information). Each party shall use its commercially reasonable efforts to cooperate with the other parties' efforts to obtain any Consents and approvals of parties to contracts with any Company Entity or Company Subsidiary as are required in connection with the consummation of the Transactions. Solutia, on the one hand, and the Akzo Nobel Entities, on 17 the other hand, shall each pay 50% of the filing fees related to compliance with any Competition/Investment Law. SECTION 7.4 COOPERATION. In connection with the efforts ----------- referenced in Section 7.3, each of Solutia, the Company Entities and the Akzo ----------- Nobel Entities shall, and shall cause their respective Affiliates to, obtain all requisite material approvals and authorizations for the Transactions under any Competition/Investment Law, and use its commercially reasonable efforts to (i) cooperate in all respects with each other in connection with any filing or submission and in connection with any investigation or other inquiry, (ii) promptly inform the other parties of any communication received by such party from, or given by such party to, any Governmental Authority, (iii) permit the other parties to review any written communication from any Governmental Authority and permit the other parties to review, before submission, any written communication to any Governmental Authority, and (iv) consult with each other in advance of any meeting or conference with any Governmental Authority and, to the extent permitted by such Governmental Authority, give the other parties the opportunity to attend and participate; provided, -------- however, that nothing contained in this Agreement will require or obligate any - ------- Buyer Entity to (A) initiate, pursue or defend any litigation (or threatened litigation) to which any Governmental Authority is a party; (B) to agree or otherwise become subject to any material limitations on (x) the right of any Buyer Entity to control or operate its assets or businesses as of the date hereof, (y) the right of the Buyer Entities or their respective Affiliates to acquire, directly or indirectly, the Acquired Interests, or (z) the right of Solutia to exercise full rights of ownership (whether directly or indirectly) of the Company Entities and Company Subsidiaries or all or any material portion of their respective assets or properties; or (C) sell or otherwise dispose of, hold separate (through the establishment of a trust or otherwise), or divest all or any portion of the business, assets or operations of any Buyer Entity or any of its Affiliates. Each Akzo Nobel Entity hereby agrees that no representation, warranty or covenant of any of the Buyer Entities shall be breached or deemed breached as a result of the failure by such Persons to take any of the actions specified in the proviso of the preceding sentence. SECTION 7.5 TAX MATTERS. ----------- (a) Each party shall, and shall cause its Affiliates and Representatives to, reasonably cooperate with each other (i) in preparing and filing all Tax Returns of or with respect to the Company Entities and Company Subsidiaries, including maintaining and making available to each other all records necessary in connection with Taxes of or with respect to the Company Entities and Company Subsidiaries, (ii) in resolving all disputes and audits with respect to all taxable periods relating to Taxes of or with respect to the Company Entities and Company Subsidiaries and (iii) in the preparation of an appraisal of the assets of Flexsys America (the "Appraisal"). Fifty percent --------- (50%) of the costs and expenses incurred after the Closing in connection with the preparation and filing of Tax Returns for any Pre-Closing Tax Period shall be borne by the Sellers. One hundred percent (100%) of the costs and expenses incurred in connection with the preparation of the Appraisal shall be borne by Solutia. (b) Notwithstanding any provision of this Agreement to the contrary, all Transfer Taxes incurred in connection with this Agreement and the Transactions shall be borne 50% by the Sellers and 50% by the Company Entities. Each Akzo Nobel Entity and each Buyer Entity shall cooperate in timely making all filings, Tax Returns, reports and forms as may 18 be required to comply with the provisions of such Transfer Tax laws. For purposes of this Agreement, "Transfer Taxes" means transfer, stamp, -------------- documentary, sales, use, value added, revenue, registration and other similar Taxes (including all applicable real estate transfer Taxes). (c) Each Company Entity shall prepare or cause to be prepared, consistent with past practice, and timely and properly file or cause to be filed with the appropriate taxing authorities, all Tax Returns of such Company Entity and its Subsidiaries, and deliver to each Seller a Schedule K-1 and any similar Tax Return as required by any federal, state, local or foreign law for any Pre-Closing Tax Period. The applicable Seller shall have the right to review and comment on all such Tax Returns. Each Company Entity will accept and incorporate into each such Tax Return all reasonable comments received from the applicable Seller. No party shall take a position on any Tax Return that is inconsistent with the Appraisal, unless required pursuant to a final determination (as defined in Section 1313 of the Internal Revenue Code). (d) Without such Seller's prior written consent (which consent may not be unreasonably withheld, conditioned or delayed), no Company Entity or Company Subsidiary shall (i) file or cause to be filed an amended Tax Return or claim for Tax refund, (ii) compromise or settle any Tax liability or (iii) make or cause any change in any Tax election, in the case of each of clauses (i), (ii) and (iii) if such action would have the effect of increasing the Tax liability or reducing any Tax assets of a Seller in respect of its interest in such Company Entity for any Pre-Closing Tax Period. (e) Each Seller will provide its consent and cooperate with Solutia and the relevant Company Entities to obtain any Tax Refunds resulting from any consortium relief, group relief or similar provision of Law with respect to any Pre-Closing Tax Period. SECTION 7.6 EMPLOYEES; BENEFIT PLANS. ------------------------ (a) Communications. The Company Entities shall and shall -------------- cause the Company Subsidiaries to, where and to the extent required by the relevant local Law or custom, inform and consult with employees, trade unions, works councils or other employee representatives regarding the repurchase of the Acquired Interests and shall fulfill any and all obligations to notify any statutory or other authority about the repurchase of the Acquired Interests; provided, however, that the Company Entities shall not engage in any such - -------- ------- communication described in the preceding sentence except with the prior written consent of both Solutia and Akzo Nobel. (b) Netherlands Pension Plan. Transferred Employees ------------------------ participating in the Reglement Stichting Pensioenfonds Akzo Nobel (the "Akzo ---- Nobel Netherlands Pension Plan," such participating employees referred to - ------------------------------ herein as the "Akzo Nobel Netherlands Participants") will cease to participate ----------------------------------- and cease to accrue benefits under the Akzo Nobel Netherlands Pension Plan as of a date to be agreed by Solutia and Akzo Nobel, which date will be no more than twelve (12) months from the date hereof (such date, the "Netherlands ----------- Pension Transfer Date"). Prior to the Netherlands Pension Transfer Date, the - --------------------- Company Entities will establish, or cause a Company Subsidiary to establish, a plan (the "Company Netherlands Pension Plan") providing retirement benefits to -------------------------------- Akzo Nobel Netherlands Participants. Where agreed among the Akzo 19 Nobel Entities and the Buyer Entities, the accrued benefit of the Akzo Nobel Netherlands Participants as of the Netherlands Pension Transfer Date will be transferred to the Company Netherlands Pension Plan. The transfer value, effective as of the Netherlands Pension Transfer Date, will be calculated in accordance with the provisions of the Akzo Nobel Netherlands Pension Plan effective at the date of the transfer value calculation; provided that such -------- transfer value is sufficient to cover accrued time proportionate rights and future liabilities (e.g., indexation) that will be incurred in respect of these accrued rights. (c) Determination of Underfunded Pension/OPEB Amount. ------------------------------------------------ From the date hereof, each party shall use its commercially reasonable efforts to cooperate with the Independent Pension Consultant and cause such Independent Pension Consultant to determine, no later than five (5) Business Days prior to the Closing Date, the Underfunded Pension/OPEB Amount for each Pension/OPEB Plan as of the Closing Date, in each case in accordance with the assumptions set forth on Schedule 7.6(c) hereto. The Company Entities shall --------------- have primary responsibility for directing the Independent Pension Consultant in preparation of the necessary analysis and calculations described in this Section 7.6, but shall ensure that Akzo Nobel and Solutia are provided with - ----------- reasonable access to the Independent Pension Consultant and its interim and final work product so that Akzo Nobel and Solutia have sufficient information to verify that the calculations are proper and consistent with the assumptions set forth on Schedule 7.6. In the event the Independent Pension Consultant ------------ proposes to use any assumption in addition to or inconsistent with the assumptions set forth on Schedule 7.6(c) hereto, such additional or --------------- inconsistent assumptions shall not be used unless and until both Solutia and Akzo Nobel have consented to such use in writing and have amended Schedule -------- 7.6(c) in accordance therewith. From the date hereof until the Closing Date, - ------ each party shall use its commercially reasonable efforts to minimize the Underfunded Pension/OPEB Amount. As soon as reasonably practicable after the Closing, but in no event later than the tenth (10th) Business Day after the Closing, the Buyer Entities shall contribute to the trust or other funding mechanism associated with the UK Pension Plan, an amount in cash equal to 50% of the Underfunded Pension/OPEB Amount for such Pension/OPEB Plan determined in accordance with this Section 7.6(c). -------------- (d) Payments Under the Incentive Plan. Payments due to --------------------------------- the participants under the Incentive Plan shall be paid on or about March 15, 2007 by the Company Entities. (e) No Third Party Beneficiaries. The provisions of this ---------------------------- Section 7.6 are for the sole benefit of the parties to this Agreement and - ----------- their respective permitted successors and assigns, and nothing herein, expressed or implied, is intended or shall be construed to confer upon or give to any Person, other than the parties hereto and their respective permitted successors and assigns, any legal or equitable or other rights or remedies (with respect to the matters provided for in this Section 7.6) under or by ----------- reason of any provision of this Agreement. Without limiting the foregoing, no provision of this Agreement is intended to be, or shall be construed as, an amendment of an employee benefit plan, program, policy or arrangement nor shall any provision of this Agreement be interpreted to modify, waive or supplement the provisions of any employee benefit plan, program, policy or arrangement. SECTION 7.7 LABOR MATTERS. The parties shall cooperate in ------------- connection with any required notification to, or any required consultation with work councils, unions, labor 20 boards or other employee representatives and relevant government agencies concerning the Transactions with respect to the Company Employees who are employed outside the United States. SECTION 7.8 COVENANT TO SATISFY CONDITIONS. Each party ------------------------------ hereto agrees to use its commercially reasonable efforts to cause the conditions set forth in Article V and Article VI to be satisfied (but not --------- ---------- waived) and the Transactions to be consummated as promptly as practicable insofar as such matters are within the control of such party, and to advise the other parties promptly if such party determines that any condition precedent to its obligations hereunder will not be satisfied in a timely manner. SECTION 7.9 TERMINATION OF AFFILIATE AGREEMENTS. Other than ----------------------------------- the Affiliate Agreements set forth on Schedule 7.9 hereto, which shall ------------ continue in full force and effect (each such Affiliate Agreement, a "Continuing Affiliate Agreement"), prior to the Closing the Akzo Nobel ------------------------------ Entities and the Company Entities shall terminate or cause to be terminated each Affiliate Agreement. SECTION 7.10 NONCOMPETITION; NO HIRE. ----------------------- (a) Noncompetition. Each Akzo Nobel Entity covenants and -------------- agrees that until the fifth (5th) anniversary of the Closing, such Akzo Nobel Entity shall not, and shall cause its Affiliates not to, directly or indirectly, as a stockholder, owner, equityholder, manager, operator, consultant, member, partner, agent or in any other capacity, engage in, or provide any financing or lease any assets to any Person that engages or, to the knowledge of Akzo Nobel, intends to engage in, the business of developing, manufacturing, producing, distributing, licensing, marketing or selling any products falling within the Field of Agreement (such business or enterprise, the "Competing Business") anywhere in the world (the "Territory"); provided, ------------------ --------- -------- however, that none of the Akzo Nobel Entities is hereby prevented from: - ------- (i) investing in or acquiring any equity or debt securities in a Person which, directly or indirectly, develops, manufactures, produces, distributes, licenses, markets or sells products falling within the Field of Agreement if (A) the investment in such Person is for passive investment purposes only without any participation in the management of such Person and (B) such Person's gross revenues that are related to the Competing Business account for no more than twenty percent (20%) of such Person's total gross revenue; (ii) investing in or acquiring any equity or debt securities in a Person which has a class of securities that are publicly traded on a stock exchange if (A) the investment is for passive investment purposes only without any participation in the management of such Person and (B) the securities owned by such Akzo Nobel Entity (together with the securities owned by its Affiliates) do not comprise more than ten percent (10%) of the total issued and outstanding debt or equity securities of such Person, as applicable; (iii) acquiring a Controlling Interest in a company or business having not more than fifty percent (50%) of its gross revenue in its last fiscal year 21 attributable to a Competing Business; provided that, unless the gross -------- revenue attributable to the Competing Business constitutes less than the greater of (x) three percent (3%) of the gross revenue of such company or business or (y) $5,000,000.00, Tthe Akzo Nobel Entity acquiring the Controlling Interest in such company or business shall divest the Competing Business within 15 months of the closing of the acquisition of such Controlling Interest; or (iv) developing, manufacturing or producing for the purposes of selling or distributing, or licensing, selling or marketing, any product to the Company Entities or the Company Subsidiaries that Akzo Nobel or any of its Subsidiaries currently provides to the Company Entities or the Company Subsidiaries pursuant to an agreement (or any renewals thereof) existing on the date hereof. Notwithstanding the foregoing, the prohibitions in this Section 7.10 shall not ------------ apply to any Person (or its Affiliates) that acquires any Akzo Nobel Entity. (b) No Hire. Each Akzo Nobel Entity agrees that from and ------- after the Closing Date and until the third (3rd) anniversary of the Closing Date, it will not, and will cause its Affiliates not to, without the prior written consent of Solutia, (i) cause or seek to cause any employees of any Company Entity or Company Subsidiary to leave the employ of such Company Entity or Company Subsidiary or (ii) hire any person who was an employee of any Company Entity or Company Subsidiary at or within the twelve (12) months preceding the Closing or who was an employee of any Company Entity or Company Subsidiary at any point in the twelve (12) months following the Closing; provided, however, that the foregoing provision will not prevent the Akzo - -------- ------- Nobel Entities or their respective Affiliates from (x) soliciting through a general solicitation or advertisement or (y) soliciting or hiring any secretarial, clerical or other non-managerial employee (other than professionals, engineers, technicians, supervisors or sales employees). (c) Remedies. The covenants and agreements contained in -------- this Section 7.10 are each independent of any other provision of this ------------ Agreement, and the existence of any claim which any party may allege against any other party to this Agreement, whether based on this Agreement or otherwise, shall not prevent the enforcement of these covenants. Each Akzo Nobel Entity acknowledges that the Buyer Entities are purchasing the Acquired Interests in reliance on the goodwill of the business of the Company Entities and Company Subsidiaries and the covenants and agreements contained in this Section 7.10 are essential to the protection of the legitimate business - ------------ interests of the Buyer Entities and their respective Subsidiaries, and that Buyer Entities would not purchase the Acquired Interests but for these covenants. Each of the parties hereto, on behalf of itself and its Subsidiaries, (i) acknowledges and agrees that the monetary damages for any material breach of this Section 7.10 would be inadequate, (ii) agrees and ------------ consents that without intending to limit any additional remedies that may be available, temporary and permanent injunctive and other equitable relief may be granted without proof of actual damage or the inadequacy of legal remedy in any Proceeding that may be brought to enforce any of the provisions of this Section 7.10, and (iii) hereby waives any and all defenses it may have on the - ------------ ground of damages as an adequate remedy at law. 22 (d) Tolling; Blue Penciling. The length of time for which ----------------------- the covenants contained in this Section 7.10 shall be in force shall not ------------ include any period of violation. In the event that the covenants contained in this Section 7.10 shall be determined by any court of competent jurisdiction ------------ to be unenforceable by reason of its extending for too long a period of time or over too large a geographical area or by reason of its being too extensive in any other respect, it shall be interpreted to extend only over the longest period of time for which it may be enforceable, and/or over the largest geographical area as to which it may be enforceable and/or to the maximum extent in all other respects as to which it may be enforceable, all as determined by such court in such action. SECTION 7.11 FINANCING. As soon as practicable following the --------- date hereof, the Buyer Entities shall use commercially reasonable efforts to arrange financing in an amount not less than the Company Financing Amount, including using commercially reasonable efforts to (i) negotiate commitment letters and/or definitive financing agreements with respect thereto, (ii) satisfy on a timely basis all conditions applicable to the Buyer Entities in any commitment letters or definitive financing agreements that are within their control and (iii) consummate at or before Closing the financing contemplated by any definitive financing agreements. Each Buyer Entity shall use commercially reasonable efforts to perform all obligations required to be performed by it in accordance with and pursuant to the terms of any commitment letters or definitive financing agreements it enters into and to maintain any such commitment letters and definitive financing agreements in full force and effect in accordance with their terms. The Buyer Entities agree to notify the Akzo Nobel Entities promptly of any breach by any party of any term of any commitment letter or definitive financing agreement that they know of, and of any termination of the financing contemplated by any commitment letter or definitive financing agreement or following the receipt by any Buyer Entity of notification from any financing source under any commitment letter or definitive financing agreement of such source's inability or refusal to provide the financing contemplated thereby. The Buyer Entities shall keep the Akzo Nobel Entities fully informed on a reasonably current basis in reasonable detail of any significant developments relating to the proposed financing and the status of their efforts to arrange the financing, including delivery of commitment letters and/or definitive financing agreements with respect to such financings within two Business Days of receipt of such documents. SECTION 7.12 DISENTANGLEMENT TRANSACTIONS AND CONTINUING ------------------------------------------- SERVICES. - -------- (a) From the date hereof until the Closing, each party shall, and shall cause its Affiliates to, use reasonable best efforts to consummate each of the transactions described on Schedule 7.12(a) and any --------------- exhibits thereto (each such transaction, a "Disentanglement Transaction" and --------------------------- collectively, the "Disentanglement Transactions") prior to the Closing, in ---------------------------- each case within the estimated "single occurrence cost" set forth opposite such Disentanglement Transaction on Schedule 7.12(a) (such cost, the ---------------- "Disentanglement Cost"), including to the extent necessary to (i) entering -------------------- into agreements, documents and instruments, including, if applicable, amendments to existing agreements, documents and instruments, in form and substance reasonably satisfactory to Solutia and the Akzo Nobel Entities with respect to the Disentanglement Transactions (such agreements, documents, instruments and amendments, the "Disentanglement Transaction Documents"), (ii) ------------------------------------- giving any notices to, making any filings with and obtaining any consents, approvals or authorizations from, any third party, including any Governmental Authority, necessary or appropriate to effectuate the Disentanglement 23 Transactions and (iii) complying with all provisions of Law with respect to the Disentanglement Transactions. (b) To the extent a Disentanglement Transaction (or portion thereof) is not completed prior to Closing, (i) each party shall, and shall cause their respective Affiliates to, use reasonable best efforts to consummate such Disentanglement Transaction (or portion thereof) as promptly as practicable after the Closing and (ii) the Akzo Nobel Entities shall reimburse the Company Entities for 50% of the Disentanglement Costs incurred after the Closing or incurred but not paid as of immediately prior to the Closing. Notwithstanding the foregoing, in no event shall (i) the amount for which the Akzo Nobel Entities are required to reimburse the Company Entities for any such Disentanglement Transaction pursuant to the immediately preceding sentence exceed 50% of the difference between the Disentanglement Cost set forth on Schedule 7.12(a) opposite such Disentanglement Transaction and the amounts paid pre-closing with respect to such Disentanglement Transaction by the Company Entities and (ii) Akzo Nobel be liable for any Disentanglement Costs incurred after the first anniversary of the Closing. Any payment due to the Company Entities pursuant to this Section 7.12(b) shall be made promptly (and in any event within ten (10) Business Days) following the date on which the Akzo Nobel Entitles are notified in writing of the amount of any Disentanglement Cost incurred after the Closing or incurred but not paid as of immediately prior to the Closing, together with documents or other instruments, if any, reasonably evidencing the existence and amount of such Disentanglement Cost. (c) Schedule 7.12(c) lists (i) each facility at which an ---------------- Akzo Nobel Entity or an Affiliate thereof will continue to provide services or products to a Company Entity or Company Subsidiary following the Closing pursuant to the applicable Services Agreement, (ii) services or products that such Akzo Nobel Entity or Affiliate thereof shall, on the terms and subject to the conditions which are more fully set forth in the applicable Services Agreement, provide at each such facility and (iii) the basis on which the costs for providing such services or products will be allocated to the relevant Company Entity or Company Subsidiary, as more fully set forth in the applicable Services Agreements. (d) Notwithstanding the foregoing, the parties will negotiate the terms of the Services Agreements and, to the extent applicable, the Disentanglement Transaction Documents, in accordance with the following principles: (i) except to the extent expressly modified or amended by this Agreement (including Schedule 7.12(c)) or another Transaction ---------------- Document, each such agreement shall have substantially similar terms as the Master Operating Agreement with respect to the services and products provided to any facility thereunder immediately prior to the Closing, except as modified to reflect the Disentanglement Transactions and modifications to any lease of real property contained therein to incorporate customary terms that are no less favorable in any material respect to the Company Entities; (ii) subject to any agreed upon modifications resulting from any change in the scope and nature of services or products provided as a result of the Disentanglement Transactions (including as specified in Schedule 7.12(c)), any services and ---------------- products provided under a Services Agreement will generally be provided on the 24 same economic terms as such services and products are provided under the Master Operating Agreement immediately prior to Closing, including any price escalation provisions; and (iii) the aggregate cost of the services and products provided under the applicable Services Agreement will be no greater than the current aggregate cost of the services and products provided by the Akzo Nobel Entities or their Affiliates to the Company Entities and the Company Subsidiaries under the Master Operating Agreement for any facility immediately prior to Closing (subject to the application of any price escalation provisions when and if triggered); (e) Sections 7.12(c) and (d) shall terminate and have no ---------------- --- further force or effect as of the Closing. SECTION 7.13 BANKRUPTCY FILINGS, COVENANTS AND AGREEMENTS. -------------------------------------------- Solutia shall file a motion with the Bankruptcy Court seeking the issuance and entry by the Bankruptcy Court of the Transaction Approval Order promptly following execution of this Agreement, but in no event later than the date necessary to have such motion heard by the Bankruptcy Court at the first regularly scheduled hearing in the Chapter 11 Cases following the execution of the Agreement, unless the date of such hearing is less than 20 days from the date of this Agreement, in which case Solutia shall file such motion with the Bankruptcy Court no later than the date necessary to have such motion heard by the Bankruptcy Court at the next succeeding regularly schedule hearing in the Chapter 11 Cases, and shall use its commercially reasonable efforts to have the Bankruptcy Court issue and enter the Transaction Approval Order as soon as practicable. Solutia agrees to promptly take any action reasonably necessary or appropriate, and each Akzo Nobel Entity and each Company Entity agrees, upon the request of Solutia, to take any action reasonably necessary or appropriate, in each case to obtain the issuance and entry of the Transaction Approval Order, including furnishing affidavits or other documents or information for filing with the Bankruptcy Court. SECTION 7.14 UPDATES; CHANGES IN CIRCUMSTANCE. Each party to -------------------------------- this Agreement agrees that it shall promptly notify in writing the other parties hereto if such notifying party becomes aware of any breach of, or inaccuracy in, or of any fact or circumstances constituting or resulting in the breach of, or inaccuracy in, any representation, warranty or covenant of such notifying party, and such notifying party shall contemporaneously provide the others with true and complete copies of any and all information or documents relating to, and will use commercially reasonable efforts to cure before the Closing, any event, transaction or circumstance occurring after the date of this Agreement that causes or will cause any such covenant or agreement under this Agreement to be breached or that renders or will render untrue any such representation or warranty contained in this Agreement as if the same were made on or as of the date of such event, transaction or circumstance. No notice given (or any failure to give notice) pursuant to this Section 7.14 shall have any effect on (a) the representations, warranties, - ------------ covenants or agreements contained in this Agreement for purposes of determining the satisfaction of any condition contained herein or (b) any right to indemnity hereunder. SECTION 7.15 TERMINATION OF JOINT VENTURE AGREEMENT. The -------------------------------------- parties acknowledge and agree that the Joint Venture Agreement shall automatically terminate as of the 25 Effective Time and thereafter, no Akzo Nobel Entity or any Buyer Entity shall have any rights, interests, remedies, including any rights as a third party beneficiary, or any duties, obligations or liabilities, under the Joint Venture Agreement. Notwithstanding the foregoing, the parties acknowledge and agree that the termination of the Joint Venture Agreement shall have no effect on any of the Transaction Documents, the Services Agreements, the Continuing Affiliate Agreements, the Governing Documents of the Company Entities and Company Subsidiaries or any other document or agreement between any of the parties hereto or between any of the parties hereto and any of the Company Subsidiaries. SECTION 7.16 COOPERATION WITH JOINT DEFENSE PROCEEDINGS. ------------------------------------------ (a) From and after the Closing, with respect to the Joint Defense Proceedings (as defined below), the Akzo Nobel Entities, on the one hand, and the Buyer Entities, on the other hand (for purposes of this Section ------- 7.16, the Akzo Nobel Entities and the Buyer Entities, with respect to each - ---- other, the "Other Parties"), shall and shall cause their respective Affiliates ------------- and their successors and assigns to, provide reasonable cooperation and assistance to each other as may be requested from time to time, including, to the extent relevant to the Joint Defense Proceedings, (A) access to information and records (including the right to take copies and, if required, originals and use any such material in any Proceeding, inquiry, hearing trial or settlement), (B) access to any premises and any computer/information systems, whether existing before or after the Closing Date, (C) access to current and (to the extent within their power) former Representatives of any Akzo Nobel Entity or any Buyer Entity, as the case may be, including making available such Representatives to provide witness statements and appear as witnesses at any Proceeding, inquiry, hearing or trial, (D) access to any customers, suppliers or other persons of any Akzo Nobel Entity or any Buyer Entity, as the case may be, and (E) serving as a party to and signing any proceeding, pleading, claim, statement, affidavit, settlement, offer, document or other material as the Akzo Nobel Entities or the Buyer Entities may require; provided, that the foregoing cooperation provisions do not obligate -------- any party to produce data, documents, information or Persons to the Other Parties on account of a third party discovery request (including subpoenas, orders, letters rogatory, interrogatories, requests for production of documents and things) directed to such Other Parties, and all parties reserve their rights under applicable Laws and international agreements related to any such discovery. (b) Each party acknowledges and agrees that after the Closing, with respect to (x) the Rubicon Litigation and the antitrust claims of the PPD2 Litigation, and (y) any Proceedings, claims, inquiries, hearings, trials, settlements and obligations arising after the Closing Date that relate to or arise out of the same facts and circumstances that gave rise to the Rubicon Litigation except those proceedings, claims, inquiries, hearings, trials, settlements and obligations relating to Taxes ((x) and (y) together, the "Joint Defense Proceedings"), the Akzo Nobel Entities and the Buyer ------------------------- Entities shall (A) jointly control and jointly conduct all matters relating thereto, including the negotiation, settlement (including any request or application for leniency, immunity or amnesty from any Governmental Authority), compromise or discharge of any liabilities (including any fine, penalty or imposition) and the making of any offer regarding the foregoing, and neither the Akzo Nobel Entities nor the Buyer Entities shall do any of the foregoing without the prior written consent of the Other Parties or unless expressly requested in writing by such Other Parties, (B) promptly provide the Other Parties with all notices, requests, inquiries, minutes of meetings, correspondence, documents, claims, court papers and any other 26 material received which is relevant to the Joint Defense Proceedings, including any such material received from any Governmental Authority, (C) not engage in any correspondence, meeting or any other communication with any Governmental Authority, adverse party or plaintiff relating to or in connection with the Joint Defense Proceedings without the prior consent of the Other Parties, (D) follow the reasonable directions of the Other Parties in dealing with any of the matters set forth in paragraphs (c) and (d) below and generally in connection with the Joint Defense Proceedings, and (E) comply with any requirements and conditions under any amnesty, immunity, leniency, or settlement agreements or arrangements with any Governmental Authority or third party. (c) Without prejudice to the generality of Section ------- 7.16(a), each party acknowledges that its cooperation and assistance will from - ------- time to time be required in order to assist the Other Parties to comply with obligations and undertakings arising from rules or court orders, which may contain deadlines or time limits. Each party acknowledges that its cooperation and assistance will not be reasonable if it is not forthcoming in sufficient time for the Other Parties to comply with such orders, deadlines and time limits. (d) All information and matters relating to the Joint Defense Proceedings, including the requests for cooperation and assistance and the actual cooperation and assistance provided, shall be treated strictly confidential in accordance with Section 7.2(d). Each party shall not, and -------------- shall cause its Representatives and Affiliates not to, disclose such confidential information to any third party without the prior written consent of the other parties. SECTION 7.17 TRANSFERRED INTELLECTUAL PROPERTY. After the --------------------------------- Closing, the Akzo Nobel Entities shall, and shall cause their Affiliates to, from time to time, at the request of any Company Entity and/or Company Subsidiary, (i) execute and deliver such other documents, agreements and other instruments of conveyance, assignment and transfer as are necessary or appropriate to evidence, record or implement the conveyance, assignment and transfer of the Transferred Intellectual Property, and (ii) take any and all other action as may be reasonably necessary or appropriate to vest in each Company Entity and/or Company Subsidiary good and valid title (including the registration or recording of such title with the appropriate Governmental Entity or other Person) to the Transferred Intellectual Property, including in connection with (x) the prosecution or defense of any infringement or other Proceedings that may arise in connection with any Transferred Intellectual Property (including testifying as to any facts relating to any Transferred Intellectual Property) and (y) the recordation or implementation of the conveyance, assignment and transfer of the Transferred Intellectual property; provided that all costs and expenses of such actions shall be borne by the - -------- Company Entities. ARTICLE VIII TERMINATION SECTION 8.1 TERMINATION. This Agreement may be terminated ----------- and the Transactions may be abandoned at any time prior to the Closing: (a) by the mutual written consent of the Akzo Nobel Entities and Solutia (on behalf of itself and the Company Entities); 27 (b) by the Akzo Nobel Entities, on the one hand, or Solutia (on behalf of itself and the Company Entities), on the other hand, upon written notice to the other parties, if the Closing has not occurred on or before May 25, 2007 (the "Outside Date"); ------------ (c) by the Akzo Nobel Entities, on the one hand, or Solutia (on behalf of itself and the Company Entities), on the other hand, upon written notice to the other parties, if any court or Governmental Authority of competent jurisdiction shall have issued an order, decree or ruling or taken any other action enjoining or otherwise prohibiting the Transactions and such order, decree or ruling or other action shall have become final and nonappealable; (d) by the Akzo Nobel Entities, on the one hand, or Solutia (on behalf of itself and the Company Entities), on the other hand, if the Transaction Approval Order shall not have been entered by the Bankruptcy Court within ninety (90) days following the date of this Agreement; or (e) by the Akzo Nobel Entities, if the Buyer Entities do not obtain (i) binding commitment letters and/or (ii) definitive financing agreements, with respect to the Company Financing Amount by February 28, 2007; SECTION 8.2 PROCEDURE AND EFFECT OF TERMINATION. In the ----------------------------------- event of the termination of this Agreement and the abandonment of the Transactions pursuant to Section 8.1, written notice thereof shall forthwith ----------- be given to the other parties by the terminating party. If this Agreement is terminated and the Transactions are abandoned as provided herein: (a) each party will redeliver all documents, work papers and other material of any other party relating to the Transactions, whether so obtained before or after the execution of this Agreement, to the party furnishing the same; and (b) no party to this Agreement will have any liability under this Agreement to any other party, except (i) that nothing herein shall relieve any party from any liability for any breach of any of the representations, warranties, covenants and agreements set forth in this Agreement, (ii) the provisions of Article X other than Section 10.16 shall --------- ------------- survive such termination and (iii) Solutia shall reimburse the Company Entities for all costs and expenses incurred by the Company Entities with respect to, and shall indemnify and hold the Seller Indemnified Persons harmless from and in respect of any Losses incurred by a Seller Indemnified Person arising out of relating to, any Company Entity entering into, or intending to enter into, a commitment letter and/or definitive financing agreements with respect to the Company Financing Amount or any replacement financing as contemplated by Section 6.8. All such costs and expenses required to be reimbursed to the Company Entities pursuant to clause (iii) of the immediately preceding sentence shall be paid within ten (10) Business Days following termination of this Agreement. 28 ARTICLE IX INDEMNIFICATION SECTION 9.1 INDEMNIFICATION BY THE AKZO NOBEL ENTITIES. ------------------------------------------ (a) General Indemnification. Subject to the terms, ----------------------- conditions and limits set forth in this Article IX, from and after the ---------- Closing, the Akzo Nobel Entities shall, jointly and severally, indemnify, defend and hold (x) the Company Entities and their respective Subsidiaries, officers, directors, employees, agents and representatives (the "Company ------- Indemnified Persons") and (y) Solutia and its Affiliates, officers, directors, - ------------------- partners, equityholders, stockholders, employees, agents and representatives (the "Solutia Indemnified Persons" and, together with the Company Indemnified --------------------------- Persons, the "Buyer Indemnified Persons") harmless from and in respect of: ------------------------- (i) any and all actual losses, claims, liabilities, obligations, damages, fines, penalties, settlements, costs, in each case including reasonable out-of-pocket expenses (including reasonable fees and expenses of counsel, experts and accountants) (collectively, "Losses") incurred by the Buyer Indemnified Persons ------ arising out of any breach of any representation or warranty of any Akzo Nobel Entity set forth in this Agreement; (ii) any and all Losses incurred by the Buyer Indemnified Persons arising out of any breach of any covenant of any Akzo Nobel Entity contained in this Agreement; (iii) 50% of all Losses incurred by the Company Indemnified Persons arising out of the Joint Defense Proceedings; and (iv) 50% of all Pre-Closing Taxes except such Taxes incurred as the result of any transactions outside the ordinary course of business undertaken on the Closing Date but after the Closing. (b) Limitations. Notwithstanding anything to the ----------- contrary contained herein: (i) none of the Buyer Indemnified Persons shall assert or be entitled to recover from any Akzo Nobel Entity for any claim for indemnity hereunder in respect of Losses under Section 9.1(a)(i) ----------------- unless and until the total amount of all such claims against the Akzo Nobel Entities in respect of such Losses exceeds one million dollars ($1,000,000) (the "Basket"), and in such event the Buyer Indemnified ------ Persons shall be entitled to be indemnified for all Losses from the first dollar of Losses; provided that no such claim may be asserted -------- until the Losses attributable to any claim or set of related claims equals or exceeds two hundred fifty thousand dollars ($250,000) (the "Minimum Claim Amount"); and -------------------- (ii) the Buyer Indemnified Persons shall not assert or be entitled to recover from the Akzo Nobel Entities, nor shall the Akzo Nobel Entities be 29 responsible to pay, more than twenty one million two hundred fifty thousand dollars ($21,250,000) (the "Cap") for any and all --- indemnifiable claims for indemnity in respect of Losses arising under Section 9.1(a)(i); provided, however, that none of the Basket, the ----------------- -------- ------- Cap or the Minimum Claim Amount shall apply with respect to any amounts payable in respect of Losses for breaches under Sections 2.1, ------------ 2.2, 2.3, 2.4 or 2.5 or with respect to any amounts payable in --- --- --- --- respect of Losses under Section 9.1(a)(ii), (iii) or (iv), or in ------------------ ----- ---- respect of fraud or knowing misrepresentations. For purposes of determining any breach of, or calculating the amount of Losses incurred by the Buyer Indemnified Persons arising out of or resulting from, any breach of a representation by any Akzo Nobel Entity, the references to materiality or other correlative terms shall be disregarded. SECTION 9.2 INDEMNIFICATION BY THE BUYER ENTITIES. ------------------------------------- (a) General Indemnification. Subject to the terms, ----------------------- conditions and limits set forth in this Article IX, from and after the ---------- Closing, the Buyer Entities shall, jointly and severally, indemnify, defend and hold each of the Akzo Nobel Entities and their respective Affiliates, officers, directors, partners, equityholders, employees, agents and representatives (the "Seller Indemnified Persons") harmless from and in -------------------------- respect of: (i) any and all Losses incurred by the Seller Indemnified Persons arising out of any breach of any representation or warranty (x) of Solutia set forth in this Agreement and (y) of the Company Entities set forth in Section 3.2 hereof; ----------- (ii) any and all actual Losses incurred by the Seller Indemnified Persons arising out of any breach of any covenant of Solutia contained in this Agreement; (iii) any and all actual Losses incurred by the Seller Indemnified Parties arising out of the UK Pension Plan; (iv) any and all actual Losses incurred by the Seller Indemnified Persons arising out of the conduct of business of any Company Entity or Company Subsidiary after the Closing Date, other than Losses for which the Buyer Indemnified Persons are entitled to indemnification pursuant to Section 9.6; and ----------- (v) any and all Post-Closing Taxes, including any Taxes incurred as the result of any transactions outside the ordinary course of business undertaken on the Closing Date but after the Closing. (b) Limitations. Notwithstanding anything to the ----------- contrary contained herein: (i) none of the Seller Indemnified Persons shall assert or be entitled to recover from the Buyer Entities for any claim for indemnity in respect of Losses arising under Section ------- 9.2(a)(i) unless and until the total amount of all such claims --------- against the Buyer Entities in respect of such Losses exceeds the Basket, and in such event the Seller Indemnified Persons shall be entitled to be indemnified for all Losses from the first dollar of Losses; provided that no such claims may be asserted until the Losses -------- 30 attributable to any claim or set of related claims equal or exceed the Minimum Claim Amount; (ii) the Seller Indemnified Persons shall not assert or be entitled to recover from the Buyer Entities, nor shall the Buyer Entities be responsible to pay, more than the Cap for any and all indemnifiable claims for indemnity in respect of Losses arising under Section 9.2(a)(i); provided, however, that none of the Basket, ----------------- -------- ------- the Cap or the Minimum Claim Amount shall apply with respect to any amounts payable in respect of Losses for breaches under Sections 4.1, ------------ 4.2, 4.3 or 4.5 or with respect to any amounts payable in respect of --- --- --- Losses under Section 9.2(a)(ii), (iii), (iv) or (v), or in respect of ------------------ ----- ---- --- fraud or knowing misrepresentations. For purposes of determining any breach of, or calculating the amount of Losses incurred by the Seller Indemnified Persons arising out of or resulting from, any breach of a representation by any Buyer, the references to materiality or other correlative terms shall be disregarded. (iii) Solutia shall have no obligation to indemnify the Seller Indemnified Persons in respect of Section 9.2(a)(i)(y) for -------------------- any claim made after a Flexsys Change of Control. SECTION 9.3 INDEMNIFICATION CALCULATIONS. ---------------------------- (a) The amount of any Losses for which indemnification is provided under this Article IX shall be computed net of any third-party ---------- insurance proceeds and recoveries in respect of third party indemnification obligations actually received by the party or parties seeking indemnification (the "Indemnified Party") in connection with such Losses. The Indemnified ----------------- Party shall use commercially reasonable efforts to obtain recovery in respect of any Losses from any insurer or other third party indemnity in respect of such Losses. If an Indemnified Party receives such insurance proceeds or indemnification recoveries in connection with Losses for which it has received indemnification hereunder, such party shall refund to the party or parties that have provided indemnification hereunder (the "Indemnifying Party") the ------------------ amount of such insurance proceeds or recovery when received, up to the amount of indemnification received hereunder with respect to such Losses. If any Loss with respect to which an Indemnified Party has actually been indemnified under this Article IX (an "Indemnity Claim") gives rise to a Tax Benefit to such ---------- --------------- Indemnified Party, such Indemnified Party shall refund to the Indemnifying Party the amount of such Tax Benefit when, as and if, and only to the extent actually realized and recognized; provided, however, that such obligation of -------- ------- the Indemnified Party to refund to the Indemnifying Party the amount of any Tax Benefit shall only apply to the extent that such Tax Benefit is actually realized and recognized within seven (7) years following the date on which such Indemnity Claim is made. For the purposes of this Section 9.3(a), a "Tax -------------- --- Benefit" to an Indemnified Party means an amount by which the Tax liability of - ------- such Indemnified Party (or such group of entities that files a consolidated, combined or unitary Tax Return that includes such Indemnified Party) currently payable in cash is actually reduced by deduction or credit, net of any increase in such Indemnified Party's Tax liability as a result of its receipt of payment in respect of such Indemnity Claim (but in any case, not below zero), calculated as if such deduction or credit was the last item taken into account by such Indemnified Party (or such group of entities that files a consolidated, combined or unitary Tax 31 Return that includes such Indemnified Party) in calculating its Tax liability for each relevant taxable period. (b) The parties agree that any indemnification payments made pursuant to this Agreement shall be treated for Tax purposes as an adjustment to the Purchase Price, unless otherwise required by applicable Law. (c) Each Indemnified Party shall take all commercially reasonable steps to mitigate any Loss in respect of which a claim could be made under this Article IX or any other provision of this Agreement. ---------- (d) No party shall be entitled to recover for more than the full amount of any Loss under the provisions of this Agreement in respect of any such Loss. SECTION 9.4 SURVIVAL. -------- (a) Except for the representations and warranties of the Company Entities in Article III of this Agreement (other than Section 3.2), ----------- ----------- which shall terminate upon the Closing, the respective representations and warranties of the Akzo Nobel Entities and Solutia will survive the Closing and will remain in full force and effect thereafter until eighteen (18) months following the Closing Date; provided that the representations and warranties -------- set forth in Section 2.1 (Ownership of Acquired Interests), Section 2.2 ----------- ----------- (Organization), Section 2.3 (Authorization, Etc.), Section 2.5 (No Brokers' or ----------- ----------- Other Fees), Section 3.2 (Authorization), Section 4.1 (Organization), Section ----------- ----------- ------- 4.2 (Authorization, Etc.), Section 4.5 (No Brokers or Other Fees) will survive - --- ----------- in perpetuity. Any claim for indemnification made by a party under Section ------- 9.1(a)(i) or Section 9.2(a)(i) in accordance with the terms of this Article IX - --------- ----------------- ---------- prior to the expiration of the survival period for the relevant representation or warranty will survive beyond such period until finally and conclusively resolved. (b) The covenants and agreements contained herein shall survive indefinitely unless a shorter period is provided by the terms of any specific covenant or agreement, in which case such shorter term shall apply solely to such covenant or agreement. SECTION 9.5 NOTICE AND OPPORTUNITY TO DEFEND. -------------------------------- (a) If there occurs an event which a party asserts is an indemnifiable event pursuant to Section 9.1, Section 9.2 or Section 9.6, the ----------- ----------- ----------- Indemnified Party shall notify the Indemnifying Party promptly in writing specifying the facts constituting the basis for such claim and the amount, to the extent known, of the claim asserted. (b) If any event described in Section 9.5(a) (other than -------------- any claim, inquiry or Proceeding that constitutes a Joint Defense Proceeding) involves (a) any Person other than a party hereto or (b) the commencement of any Proceeding by any Person other than a party hereto (any such claim or Proceeding being hereinafter referred to as a "Third Party Claim"), the ----------------- Indemnified Party shall give such Indemnifying Party prompt written notice of such Third Party Claim which specifies the facts constituting the basis of such Third Party Claim and the amount, to the extent known, of such Third Party Claim; provided, however, that the failure to provide prompt notice as -------- ------- provided herein will relieve the Indemnifying Party of its obligations hereunder 32 only to the extent that such failure prejudices the Indemnifying Party hereunder. The Indemnifying Party shall be entitled to participate in such Third Party Claim and to assume the defense thereof with counsel selected by the Indemnifying Party; provided that the Indemnifying Party notifies the -------- Indemnified Party in writing of its election to assume such defense within ten (10) calendar days of receipt of notice from the Indemnified Party of such Third Party Claim. After notice from the Indemnifying Party to the Indemnified Party that the Indemnifying Party has elected to assume the defense of any Third Party Claim, the Indemnifying Party shall not, except as expressly permitted in this Section 9.5(b), be liable for any legal, investigative or -------------- other fees or expenses subsequently incurred by the Indemnified Party in connection with the defense thereof; provided that, after such notice, the -------- Indemnifying Party, regardless of whether it is otherwise required to indemnify the Indemnified Party hereunder with respect to such Third Party Claim, shall be responsible for the costs and fees of its attorneys and related litigation expenses incurred by it in the defense of such Third Party Claim. Notwithstanding the Indemnifying Party's election to assume the defense of any such Third Party Claim, the Indemnified Party shall have the right to employ separate counsel (including local counsel) and participate in (but not control) such defense. In the event that the Indemnified Party elects to employ separate counsel in such defense, the Indemnifying Party shall bear reasonable fees and expenses of such separate counsel only if (x) the defendants in any such Proceeding include both the Indemnified Party and the Indemnifying Party and the Indemnified Party has legal defenses available to it that are different from or in addition to those available to the Indemnifying Party, or (y) counsel for the Indemnifying Party shall have given written authorization for the Indemnified Party to employ separate counsel at the expenses of the Indemnifying Party; provided that with respect to each -------- Indemnified Party in such circumstance, the Indemnifying Party shall not be required to bear the fees and expenses of more than one firm of attorneys, other than one firm of local counsel in each jurisdiction where the primary counsel is not admitted to practice and where local counsel is necessary. Subject to bona fide concerns for confidentiality and attorney-client privilege, the Indemnifying Party and the Indemnified Party agree to cooperate fully with each other and their respective counsel in connection with the defense, negotiation or settlement of any such Third Party Claim, including providing reasonable access to any relevant books and records, properties and Representatives, regardless of whether the Indemnifying Party has assumed the defense thereof. If the Indemnifying Party assumes the defense of a Third Party Claim, no settlement or compromise thereof may be effected (A) by the Indemnifying Party without the written consent of the Indemnified Party (which consent shall not be unreasonably withheld, conditioned or delayed) or (B) by the Indemnified Party without the consent of the Indemnifying Party (which consent shall not be unreasonably withheld, conditioned or delayed). In the conduct of the defense of any Third Party Claim, the Indemnifying Party shall represent the interests of the Indemnified Party in good faith and in a competent and diligent manner. If the Indemnifying Party elects not to assume the defense of a Third Party Claim, the Indemnified Party shall undertake the defense of any such Third Party Claim with counsel selected by the Indemnified Party, and the Indemnifying Party shall bear reasonable fees and expenses of such counsel. In no event shall an Indemnifying Party be liable for any settlement effected without its written consent (which consent shall not be unreasonably withheld, conditioned or delayed). For the avoidance of doubt, this Section 9.5(b) shall not apply to any claim, inquiry or Proceeding that -------------- constitutes a Joint Defense Proceeding. 33 SECTION 9.6 ENVIRONMENTAL INDEMNIFICATION. ----------------------------- (a) Indemnification. Schedule 9.6(a) sets forth a list of --------------- --------------- (i) the Solutia Contributed Facilities, (ii) the Akzo Nobel Contributed Facilities, (iii) certain sites and entities acquired by any Company Entity or Company Subsidiary after the Effective Date (as defined in the Joint Venture Agreement) (the "After-Acquired Facilities") and (iv) the subset of Akzo Nobel ------------------------- Contributed Facilities which shall be subject to a Services Agreement (the "Continuing Services Facilities"). Subject to the presumptions and limitations ------------------------------ set forth in this Section 9.6, from and after the Closing: ----------- (i) the Buyer Entities shall jointly and severally indemnify, defend and hold the Seller Indemnified Persons harmless from and in respect of any and all Losses arising out of (A) any event or condition involving the Release of Hazardous Materials occurring prior to the Closing Date at, on or from any of the Solutia Contributed Facilities, (B) any offsite disposal or arrangement for disposal of Hazardous Materials generated at or upon any of the Solutia Contributed Facilities to the extent of any such disposal or arrangement for disposal occurring prior to the Closing Date, (C) any violation of Environmental Laws occurring at or relating to any of the Solutia Contributed Facilities occurring prior to the Closing Date, (D) any event or condition involving the Release of Hazardous Materials occurring after the Closing Date at, on or from any of the Solutia Contributed Facilities , and (E) any event or condition involving the Release of Hazardous Materials occurring after the Closing Date at, on or from any of the Continuing Service Facilities solely to the extent caused by the Buyer Entities, except, solely in the cases of (A), (B) and (C) above, to the extent the Buyer Entities can demonstrate, by clear and convincing evidence, that events occurring or conditions existing prior to the date on which a Solutia Contributed Facility was contributed to a Company Entity or Company Subsidiary were an insubstantial cause of any Losses subject to this Section 9.6(a)(i), in which case the Buyer Entities shall only ----------------- indemnify the Seller Indemnified Persons for 50% of such Losses; (ii) the Akzo Nobel Entities shall jointly and severally indemnify, defend and hold the Buyer Indemnified Persons harmless from and in respect of any and all Losses (subject, with respect to the Nienburg and Sete Akzo Nobel Contributed Facilities, to the last three sentences of this Section 9.6(a)(ii)) arising out of (A) any event or condition involving the Release of Hazardous Materials occurring prior to the Closing Date at, on or from any of the Akzo Nobel Contributed Facilities, (B) any offsite disposal or arrangement for disposal of Hazardous Materials generated at or upon any of the Akzo Nobel Contributed Facilities to the extent of any such disposal or arrangement for disposal occurring prior to the Closing Date, (C) any violation of Environmental Laws occurring at or relating to any of the Akzo Nobel Contributed Facilities occurring prior to the Closing Date, and (D) any event or condition involving the Release of Hazardous Materials occurring after the Closing Date at, on or from any of the Akzo Nobel Contributed Facilities (including, for the avoidance of doubt, the Continuing Service Facilities) caused by any of the Akzo Nobel Entities except, solely in the cases of (A), (B) and (C) above, to the extent the Akzo Nobel Entities can demonstrate, by clear and convincing evidence, that events occurring or conditions existing prior to the date on which an Akzo Nobel Contributed Facility was contributed to a Company Entity or Company Subsidiary were an insubstantial cause of any Losses subject to this Section ------- 9.6(a)(ii), in which case the Akzo Nobel Entities shall only ---------- 34 indemnify the Buyer Indemnified Persons for 50% of such Losses. Notwithstanding anything to the contrary in this Section 9.6(a)(ii), prior to the Exhaustion of Solvay Remedies, solely with respect to the Sete and Nienburg Akzo Nobel Contributed Facilities, the Akzo Nobel Entities shall only be obligated to indemnify the Buyer Indemnified Persons for 75% of any Losses required to be indemnified pursuant to this Section 9.6(a)(ii) (the "Preliminary Allocation"). ---------------------- Upon the Exhaustion of Solvay Remedies in respect of any given Loss, the Buyer Indemnified Persons shall notify the Akzo Nobel Entities in writing of the amount, if any, actually recovered as a result of the Exhaustion of Solvay Remedies less any fees or expenses reasonably incurred by the Buyer Indemnified Persons in obtaining such amount (a "Solvay Recovery"), which notice shall include documents or other --------------- instruments, if any, reasonably evidencing the existence and amount of such Solvay Recovery. If, in respect of such Loss, the sum of (1) the actual amount paid by the Akzo Nobel Entities to the Buyer Indemnified Entities in satisfaction of the Preliminary Allocation plus (2) the Solvay Recovery is (A) less than the total amount of ---- such Losses, then the Akzo Nobel Entities shall pay to the Buyer Indemnified Persons the amount of such deficit or (B) greater than the total amount of such Losses, then the Buyer Indemnified Persons shall pay to the Akzo Nobel Entities the amount of such excess up to the total amount actually paid by the Akzo Nobel Entities to the Buyer Indemnified Parties in satisfaction of the Preliminary Allocation; and (iii) the Akzo Nobel Entities and the Buyer Entities shall jointly and severally indemnify, defend and hold harmless the Buyer Indemnified Persons and the Seller Indemnified Persons, respectively, from and in respect of fifty percent (50%) of any and all Losses arising out of (A) any event or condition involving the Release of Hazardous Materials occurring prior to the Closing Date at, on or from any of the After-Acquired Facilities, (B) any offsite disposal or arrangement for disposal of Hazardous Materials generated at or upon any of the After-Acquired Facilities to the extent of any such disposal or arrangement for disposal occurring prior to the Closing Date, and (C) any violation of Environmental Laws occurring at or relating to any of the After-Acquired Facilities occurring prior to the Closing Date; provided that the Akzo Nobel Entities -------- shall, prior to the Exhaustion of Solvay Remedies, have no obligation to indemnify the Buyer Indemnified Persons pursuant to this Section ------- 9.6(a)(iii) for any Losses arising out of or relating to any of the ----------- matters referred to in clauses (A), (B) or (C) above at the Industriepark Nienburg GmbH After-Acquired Facility. Upon the Exhaustion of Solvay Remedies with respect to any given Loss, the Buyer Indemnified Persons shall notify the Akzo Nobel Entities in writing of the amount of the Solvay Recovery, which notice shall include documents or other instruments, if any, reasonably evidencing the existence and amount of such Solvay Recovery. If, in respect of such Loss, the Solvay Recovery is less than 50% of the total amount of such Losses, then the Akzo Nobel Entities shall pay to the Buyer Indemnified Persons the amount of such deficit. (b) Phase II Environmental Investigations; Certain ---------------------------------------------- Presumptions. - ------------ (i) Within 30 days following the date hereof (the "Consultant Retention Deadline"), Solutia and the Akzo Nobel Entities ----------------------------- shall retain a mutually acceptable consulting firm to conduct Phase II Environmental Investigations and 35 environmental compliance reviews at the sites set forth on Schedule -------- 9.6(b)(i) (such sites, the "Phase II Facilities"), the cost of which --------- ------------------- shall be shared equally by, and paid directly to the consulting firm by, Solutia and the Akzo Nobel Entities. Such Phase II Environmental Investigations and environmental compliance reviews shall be conducted in accordance with a scope of work mutually agreed upon by the parties prior to the Consultant Retention Deadline and shall be completed by the date which is six months after the Consultant Retention Deadline (the "Completion Deadline"). The scope of work for ------------------- the Phase II Environmental Investigations shall direct the consultants to not only identify existing environmental conditions, but also to set forth the nature and extent of such conditions to the extent practicable and reasonable. The Completion Deadline may be extended for such additional three month periods as are reasonably necessary to complete such successive phases of Phase II Environmental Investigations or environmental compliance reviews as are reasonably necessary to establish and describe environmental conditions at the Phase II Facilities. The parties hereto shall cooperate with each other in connection with such Phase II Environmental Investigations and environmental compliance reviews. For purposes of any indemnification claim pursuant to this Section ------- 9.6 (x) to the extent the Losses for which indemnification is sought --- pursuant to this Section 9.6 arise out of an event or condition ----------- identified in the Phase II Environmental Investigations or environmental compliance review conducted pursuant to this Section ------- 9.6(b), such Losses shall conclusively be deemed to have resulted ------ from events occurring or conditions existing prior to the Closing Date, and (y) to the extent the Losses for which indemnification is sought relate to or arise out of an event or condition not identified in the Phase II Environmental Investigations or environmental compliance reviews, such Losses shall be presumed to have resulted from events occurring or conditions created after the Closing Date; (ii) With respect to any claim for indemnification pursuant to this Section 9.6, other then Section 9.6(a)(i)(E) or ----------- Section 9.6(a)(ii)(D), to the extent the Losses for which indemnification is sought relate to or arise out of the site described on Schedule 9.6(b)(ii), such Losses shall conclusively be ------------------- deemed to have resulted from events occurring or conditions existing prior to the date on which the relevant site was contributed to a Company Entity or Company Subsidiary. The Seller Indemnified Persons shall have no right to indemnification pursuant to Section 9.6(a)(i)(E) hereof and the Buyer Indemnified Persons shall have no right to indemnification pursuant to Section 9.6(a)(ii)(D) hereof, in either case with respect to the site described on Schedule 9.6(b)(ii) ------------------- unless the party seeking indemnification can demonstrate, by clear and convincing evidence, that events occurring or conditions existing prior to the Closing Date were an insubstantial cause of the relevant Losses. (c) Limitations. Notwithstanding any of the other ----------- provisions contained in this Section 9.6, no Indemnified Person shall be ----------- entitled to recover under this Section 9.6, and no Indemnifying Person shall ----------- have any obligation with respect to such claim to the extent the Losses for which indemnification is sought: (i) arise from costs and expense incurred by an Indemnified Person in connection with Remedial Actions that are not (x) affirmatively required by Environmental Laws or by a Governmental Authority, including a court of relevant 36 jurisdiction, acting within the lawful scope of its authority, pursuant to Environmental Laws or (y) reasonably conducted in response to a Third Party Claim for which reasonable prior written notice has been provided to such Indemnifying Person; or (ii) are ordinary costs of any post-Closing construction, demolition, excavation, disturbance, renovation, expansion or refurbishment of any facilities owned, leased or operated by any Company Entity or Company Subsidiary, including any asbestos abatement obligations arising from such activities; provided -------- that such activities are not otherwise required pursuant to an investigation, remediation, removal or other response action required by a Governmental Authority or required pursuant to Environmental Law or required to resolve in good faith a Third Party Claim for which reasonable prior written notice has been provided to the Indemnifying Party. (d) Control, Cooperation; Change of Use. In addition to ----------------------------------- procedures governing the defense of Third Party Claims contained in Section ------- 9.5, the conduct of any environmental investigation, Remedial Action or other - --- response action (and any negotiation with Governmental Authorities regarding same) arising from any claim pursuant to this Section 9.6 shall be subject to ----------- the following (with any inconsistency between this Section 9.6(d) and Section -------------- ------- 9.5 to be resolved in favor of this Section 9.6(d)): - --- --------------- (i) prior to first incurring material costs with respect to such action, the Indemnified Party shall promptly notify each Indemnifying Party of such claim in a reasonably detailed written communication and shall afford each Indemnifying Party a reasonable opportunity to evaluate the conditions giving rise to such claim, provided that the Indemnified Party shall not be in breach of -------- its obligations under this Section 9.6(d)(i) if such notice or ----------------- opportunity to evaluate cannot be practicably given and the Indemnified Party is required prior to such time to undertake any reasonable emergency investigation, remediation, removal or response action which is necessary to prevent a material threat to public or employee health, safety, or material injury to property, or any imminent and substantial endangerment to the environment; (ii) except as provided in subparagraph (iii), the Buyer Entities shall have control over any environmental investigation, Remedial Action or other response action (and any negotiation with Governmental Authorities regarding same) undertaken after the Closing subject to an obligation to (a) in all cases consult in good faith with, and seek and reasonably incorporate the comments and input of, the Akzo Nobel Entities in connection therewith; and (b) except as to such response actions which could unreasonably interfere with the continued operation of the relevant real property for industrial purposes, obtain the consent of the Akzo Nobel Entities (not to be unreasonably withheld, conditioned or delayed), upon the receipt of which consent as to any particular response action (an "Approved Response Action"), for which the Akzo ------------------------ Nobel Entities are obligated to indemnify the Buyer Indemnified Persons under this Section 9.6, the Akzo Nobel Entities will directly ----------- bear, and pay to third party vendors, future direct costs with respect to such Approved Response Action; (iii) the Akzo Nobel Entities shall have the right to undertake and control, at its sole cost and expense, Remedial Actions (and any negotiation with 37 Governmental Authorities regarding same) to address conditions identified in the Phase II Environmental Investigations ("Phase II -------- Conditions"); provided all such Remedial Actions are initiated by the ---------- -------- Akzo Nobel Entities within nine months after completion of the Phase II Environmental Investigations and provided, as to any particular Phase II Condition, Akzo Nobel's indemnification obligations under this Section 9.6 have, by virtue of the limitations on such ---------------- obligation set forth in Section 9.6(c)(i) hereof, not yet been ----------------- triggered, and provided further that, at such time as the limitations set forth in Section 9.6(c)(i) cease to apply to any particular Phase ----------------- II Condition, this Section 9.6(d)(iii) shall cease to be applicable ------------------- and any Remedial Action with respect to such Phase II Condition shall thereafter be governed solely by Section 9.6(d)(ii) hereof. Such ------------------ qualifying Remedial Actions shall hereinafter be referred to as "Voluntary Actions". Notwithstanding previous language in this ----------------- subparagraph, in the event that the Akzo Nobel Entities have timely initiated Remedial Action to address Phase II Conditions, which Remedial Actions would otherwise constitute Voluntary Actions hereunder, the limitations set forth in Section 9.6(c)(i) shall not ----------------- cease to apply solely by virtue of the fact that such Remedial Actions are, as a condition to receiving Governmental Authority approval for such Remedial Action, embodied or memorialized in a consent agreement, consent order or consent decree between an Akzo Nobel Entity and such Governmental Authority; provided that, should -------- any Buyer Entity be named a party to any such consent agreement, consent order or consent decree which imposes upon any Buyer Entity any obligation or liability to conduct or fund any Remedial Action, such limitations in Section 9.6(c)(i) shall cease to apply. The Akzo ----------------- Nobel Entities shall provide reasonable notice to, consult in good faith with, seek and reasonably incorporate the comments and input of, and shall obtain the consent (not to be unreasonably withheld, conditioned or delayed) of, the Buyer Entities before initiating Voluntary Actions. The Akzo Nobel entities shall ensure that the Voluntary Actions do not interfere with the operations at the facility where Voluntary Actions are undertaken; (iv) the Buyer Indemnified Persons, on the one hand, and the Seller Indemnified Persons, on the other hand, shall exchange information relevant to this Section 9.6 pursuant to the protection ----------- of a joint defense agreement and shall otherwise reasonably cooperate, acting in good faith, to facilitate the cost-effective resolution of any claim or matter subject to this Section 9.6. ----------- Without limiting the generality of the foregoing, upon receipt of any reasonable request of the other party, provide such other party with copies of all relevant environmental reports, investigations, audits, assessments, tests, sampling data, memoranda, reviews, studies and other analyses conducted in relation to each site that is implicated in such claim or matter, the conduct of business at such site, and any other documents materially bearing on environmental liabilities relating to such site, which are in the possession, custody or control of the party requested to supply such material; (v) where conducive to achieving the purposes of this Section 9.6, to the extent that any one of them has the legal ----------- capacity to do so and provided it would not have a material adverse effect on the industrial use or operation of any real property subject to this Section 9.6 or require any Buyer Indemnified Person ----------- to incur material unindemnifiable costs, the Buyer Indemnified Persons shall, at the relevant Indemnifying Party's reasonable request, impose reasonable environmental deed or use 38 restrictions, and/or accept the relevant Indemnifying Party's installation and maintenance of engineering controls on any real property subject to this Section 9.6; ----------- (vi) with respect to any construction, demolition, excavation, disturbance, renovation or refurbishment activity at or upon any such Akzo Nobel Contributed Facility, Solutia Contributed Facility or After-Acquired Facility (collectively "Construction ------------ Activities"), the Buyer Indemnified Persons shall provide reasonable ---------- advance written notice to the relevant Indemnifying Party of any planned Construction Activities which would extend into the subsurface beyond the existing "footprint" of buildings and other structures upon the real property subject to this Section 9.6 and ----------- consult in good faith with the relevant Indemnifying Party with respect to the planning and implementation of any such Construction Activities; (vii) no Indemnifying Party shall have any obligation to indemnify any Indemnified Party under this Section 9.6 for any ----------- Losses constituting costs of any remedial, removal or other response action taken in order to meet a more stringent cleanup standard (in comparison to the standard in effect as of the Closing Date) triggered by a change in land use from such use in effect as of the Closing Date. For avoidance of doubt, in connection with any remedial, removal or other response action required in connection with any such change in use, the Indemnifying Party shall be responsible for Losses to achieve the original standard and the Indemnified Party shall be responsible for incremental additional Losses, if any, necessary to achieve the more stringent standard; and (viii) any claim for indemnification submitted under this Section 9.6 by an Indemnified Party to an Indemnifying Party ----------- shall be in writing and shall specify in reasonable detail the facts upon which such claim is based. Notwithstanding any provision of this Agreement to the contrary, the provisions of this Section 9.6 constitute the sole remedy of any Indemnified ----------- Party against any Indemnifying Party regarding Losses, whether arising under statutory or common law, at law or at equity, relating to Environmental Laws (including CERCLA), any Release of Hazardous Materials or any offsite disposal or arrangement for disposal of Hazardous Materials (such Losses, "Environmental Liabilities"), and each Indemnified Person hereby waives all ------------------------- other rights or causes of action against the applicable Indemnifying Party with respect to Environmental Liabilities, including under any prior agreement among the parties hereto. (e) Most Favored Nation Treatment. In the event that ----------------------------- Solutia and/or its Affiliates, prior to the seventh (7th) anniversary of the Closing Date, enters into a transaction, or a series of transactions, to sell, transfer or otherwise dispose of any of the Equity Interests in any Company Entity (a "Company Divestiture"), and, in connection with such Company ------------------- Divestiture, the sellers of the Equity Interests or any of their respective Affiliates (the "Company Divestiture Sellers") agree to indemnify the buyer in --------------------------- such transaction and/or its affiliates (collectively, the "Company Divestiture ------------------- Buyer") against Environmental Liabilities, and the indemnification obligations - ----- of the Company Divestiture Sellers with respect to such Environmental Liabilities as of the consummation of such Company Divestiture are narrower either in terms of (i) the survival period of such indemnification obligations or (ii) the cap on 39 such obligations ((i) and (ii) above, together, the "Time and Dollar --------------- Limitations") then, effective as of the consummation of such transaction or - ----------- series of transactions, the corresponding indemnification obligations of the Akzo Nobel Entities pursuant to this Section 9.6 shall be deemed to have been ----------- automatically amended upon the consummation of such Company Divestiture to reflect any such narrower Time and Dollar Limitations, for the avoidance of doubt the parties agreeing that where a Time and Dollar Limitation applies on a limited basis to one or a class of facilities or issues such automatic amendment shall apply on a similarly limited basis. In addition, and without limiting the generality of the foregoing, if in connection with any Company Divestiture, the Company Divestiture Sellers agree to indemnify the Company Divestiture Buyer or any of their respective Affiliates against Environmental Liabilities and such indemnity is, with respect to the Solutia Contributed Facilities as a class, narrower with respect to Time and Dollar Limitations than the indemnity against Environmental Liabilities the Company Divestiture Sellers provide to the Company Divestiture Buyer or any of its Affiliates with respect to the Akzo Nobel Contributed Facilities as a class, then the corresponding indemnification obligations of the Akzo Nobel Entities pursuant to this Section 9.6 shall be deemed to have been automatically amended upon ----------- the consummation of such Company Divestiture to reflect any such narrower Time and Dollar Limitations, for the avoidance of doubt the parties agreeing that where a Time and Dollar Limitation applies on a limited basis to one or a class of Solutia Contributed Facilities or issues at Solutia Contributed Facilities, such automatic amendment shall apply on a similarly limited basis. Notwithstanding the foregoing, the terms of any indemnification against Environmental Liabilities provided by the Company Divestiture Sellers with respect to the site described on Schedule 9.6(b)(ii) shall not be taken into account in any determination of the breadth of the indemnification provided by the Company Divestiture Sellers for purposes of this Section 9.6(e). -------------- (f) Exhaustion of Remedies. With respect to the Sete and ---------------------- Nienburg Akzo Nobel Contributed Facilities and the Industriepark Nienburg GmbH After-Acquired Facilities, the Buyer Entities shall use their reasonable best efforts to pursue any contractual right or remedy that any Buyer Entity or Company Subsidiary may have against Solvay Deutschland GmbH or Kali-Chemie Aktiengesellschaft, as applicable, under any contract or agreement relating to such facilities and to maximize the amount of any recovery (including reasonable fees and expenses of counsel and experts) under any such contractual right or remedy. In pursuing such rights and remedies, the Buyer Entities will consult in good faith with, and reasonably incorporate the comments and input of, the Akzo Nobel Entities. Such rights and remedies shall be deemed to be exhausted (such exhaustion, an "Exhaustion of Solvay Remedies" ----------------------------- hereunder) upon the satisfaction by the Buyer Entities of their obligations set forth in the immediately preceding sentence and (i) the entry of a final order, judgment, decree or ruling of a court of competent jurisdiction or a binding ruling or determination of an arbitrator that no such right or remedy is available to the relevant Buyer Entity or Company Subsidiary, (ii) the receipt by a Buyer Entity or a Company Subsidiary of a Solvay Recovery or (iii) a determination, after consulting in good faith with Akzo Nobel, by the Buyer Entities that no such right or remedy exists based upon the circumstances of a particular Loss or that Losses are not otherwise reasonably recoverable (including by virtue of the insolvency or dissolution of any relevant Person other than a Buyer Entity or a Company Subsidiary). SECTION 9.7 PAYMENT. On each occasion that any Indemnified ------- Party shall be entitled to indemnification or reimbursement under this Article ------- IX, the Indemnifying Party shall, - -- 40 at each such time, promptly pay the amount of such indemnification or reimbursement. All claims for indemnification made by any Indemnified Party against Solutia under this Article IX during the pendency of the Chapter 11 ---------- Cases shall, to the extent due and payable, be treated as allowed administrative expense claims under Section 503(b)(1)(A) of the Bankruptcy Code and shall not be subject to discharge pursuant to Section 1141 of the Bankruptcy Code or otherwise. SECTION 9.8 INVESTIGATION. No right to indemnification under ------------- this Article IX or any other rights under this Agreement shall be limited or ---------- waived by reason of (i) any investigation or audit conducted before or after the Closing by any party hereto or (ii) the fact that such party knew or should have known of any inaccuracy or breach of any representation, warranty, agreement or covenant by the other party at any time, or the decision by such party to consummate the Closing. Notwithstanding anything to the contrary in this Agreement, (a) no investigation, inquiry or examination by the Buyer Entities or the Akzo Nobel Entities or their respective Representatives shall affect the representations, warranties and covenants of the other parties under this Agreement, (b) such representations, warranties and covenants shall not be affected or deemed waived by reason of the fact that the Buyer Entities or the Akzo Nobel Entities knew or should have known that any of the same is or might be inaccurate or breached in any respect, and (c) each of the Buyer Entities and Akzo Nobel Entities shall have the right, irrespective of any knowledge of or investigation by such party, to rely fully on the representations, warranties and covenants of the other parties contained in this Agreement. SECTION 9.9 EXCLUSIVE REMEDY. Except as otherwise provided ---------------- in Section 7.1(b), Section 7.10(c), Section 8.2(b), Section 10.17 or this ------------------------------- ------------- Section 9.9 and notwithstanding anything to the contrary in any other - ----------- agreements between the parties hereto (including, with respect to the matters addressed in Section 9.6 only, any Continuing Affiliate Agreement and Services ----------- Agreement) the indemnification provided for in this Article IX, subject to the ---------- limitations set forth herein, shall be the exclusive post-Closing remedy available to any party in connection with any Losses arising out of the matters set forth in this Agreement or the Transactions (including any such remedy arising under CERCLA or any other Environmental Laws as provided under Section 9.6); provided, however, that nothing herein will limit in any way any - ----------- -------- ------- such party's remedies in respect of fraud, or intentional breach of a representation, warranty or covenant. ARTICLE X MISCELLANEOUS SECTION 10.1 FEES AND EXPENSES. Except as otherwise provided ----------------- in this Agreement, each of the parties hereto shall bear its own expenses in connection with the preparation and negotiation of this Agreement and the Transaction Documents and the consummation of the Transactions and the Transaction Documents. The notarial fees and costs and expenses relating to the notarial deed to be recorded in the Netherlands with respect to the Acquired Interests of Flexsys Holding will be paid fifty percent (50%) by the Buyer Entities and fifty percent (50%) by the Akzo Nobel Entities. SECTION 10.2 GOVERNING LAW. This Agreement shall be ------------- construed under and governed by the laws of the State of Delaware, without giving effect to any choice or conflict of 41 laws provisions or rules that would cause the application of laws of any jurisdiction other than the State of Delaware. SECTION 10.3 AMENDMENT. This Agreement may not be amended, --------- modified or supplemented except upon the execution and delivery of a written agreement executed by each of the parties hereto. SECTION 10.4 NO ASSIGNMENT. Neither this Agreement nor any ------------- of the rights, interests or obligations hereunder shall be assigned by any party hereto without the prior written consent of Solutia, in the case of assignment by any Akzo Nobel Entity, of each Akzo Nobel Entity, in the case of assignment by Solutia, or of Solutia and each Akzo Nobel Entity, in the case of assignment by any Company Entity (it being understood that the consent of a Company Entity shall not be required for any assignment by any other party). SECTION 10.5 WAIVER. Any of the terms or conditions of this ------ Agreement which may be lawfully waived may be waived in writing at any time by each party which is entitled to the benefits thereof. Any waiver of any of the provisions of this Agreement by any party hereto shall be binding only if set forth in an instrument in writing signed on behalf of such party. No failure to enforce any provision of this Agreement shall be deemed to or shall constitute a waiver of such provision and no waiver of any of the provisions of this Agreement shall be deemed to or shall constitute a waiver of any other provision hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. SECTION 10.6 NOTICES. Any notice, demand, or communication ------- required or permitted to be given by any provision of this Agreement shall be deemed to have been sufficiently given or served for all purposes if (a) personally delivered, (b) mailed by certified first class mail, prepaid with return receipt requested to the recipient at the address below indicated, (c) sent by a nationally recognized overnight courier service, to the recipient at the address below indicated or (d) delivered by facsimile to the recipient at the facsimile number below indicated, which is confirmed in writing by sending a copy of such facsimile to the recipient thereof pursuant to clause (a) or (c) above: If to the Akzo Nobel Entities: Akzo Nobel N.V. Velperweg 76, PO Box 9300 6800 SB Arnhem The Netherlands Attention: General Counsel 011 31 26 366 3240 (facsimile) 011 31 26 366 2730 (telephone) With a copy (which shall not constitute --------------------------------------- notice to the Akzo Nobel Entities) to: ------------------------------------- Baker Botts L.L.P. 30 Rockefeller Plaza New York, NY 10112-4998 Attention: Lee D. Charles, Esq. Jonathan Gordon, Esq. (212) 259-2505 (facsimile) (212) 408-2500 (telephone) 42 If to any of the Buyer Entities: Solutia Inc. 575 Maryville Centre Drive P.O. Box 66760 St. Louis, Missouri 63166 Attention: General Counsel (314) 674-8703 (facsimile) (314) 674-5362 (telephone) With a copy (which shall not constitute --------------------------------------- notice to the Buyer Entities) to: -------------------------------- Kirkland & Ellis LLP Citigroup Center 153 East 53rd Street New York, NY 10022 Attention: Thomas W. Christopher, Esq. Jeffrey Symons, Esq. (212) 446-6460 (facsimile) (212) 446-4800 (telephone) If to the Company Entities prior to the Closing: Flexsys Coordination Centre NV Woluwedal Graden Woluwedal 24/3 B-1932 Sint Stevens-Woluwe Belgium Attention: General Counsel 011 32 0 2 714 33 95 (facsimile) 011 32 0 2 714 32 40 (telephone) and with a copy to both the Akzo Nobel entities and --------------------------------------------------- Solutia as provided above (including copies to ---------------------------------------------- their respective counsel), ------------------------ or to such other address as any party hereto may, from time to time, designate in a written notice given in like manner. All such notices, demands, or communications shall be deemed to have been given and received on the date delivered by hand or facsimile (if received prior to 5:00 pm (local time of the recipient) on a Business Day (or otherwise on the next Business Day)), or if mailed, five (5) days after mailing (one (1) Business Day in the case of express mail or overnight courier service), except that any notice of a change of address shall be effective only upon actual receipt thereof. 43 SECTION 10.7 COMPLETE AGREEMENT. This Agreement, the ------------------ Transaction Documents and the other documents and writings referred to herein or delivered pursuant hereto contain the entire understanding of the parties with respect to the subject matter hereof and thereof and supersede all prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof and thereof. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns (other than Solutia and its successors and permitted assigns). This Agreement shall be binding upon and shall inure to the benefit of Solutia and its successors and permitted assigns, subject to the Transaction Approval Order having been entered as a Final Order at the time of Closing. SECTION 10.8 COUNTERPARTS. This Agreement may be executed in ------------ one or more counterparts, all of which shall be considered one and the same agreement and each of which shall be deemed an original. SECTION 10.9 PUBLICITY. Each of the parties hereto will --------- consult with each other and will mutually agree upon any publication or press release of any nature with respect to this Agreement or the Transactions and shall not issue any such publication or press release prior to such consultation and agreement except as may be required by applicable Law or by obligations pursuant to any listing agreement with any securities exchange or any securities exchange regulation, in which case the party proposing to issue such publication or press release shall make all reasonable efforts to consult in good faith with the other party or parties before issuing any such publication or press release and shall provide a copy thereof to the other party or parties prior to such issuance. SECTION 10.10 INTERPRETIVE PROVISIONS. ----------------------- (a) Certain Definitions. As used in this Agreement, the ------------------- following terms have the following meanings: "Affiliate" means, with respect to any specified Person, any --------- other Person that directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, such specified Person; provided that for purposes of this Agreement, at any time prior to the -------- Closing, (i) none of the Akzo Nobel Entities or any of their respective Subsidiaries shall be deemed an Affiliate of Solutia, a Company Entity, or any of their respective Subsidiaries, (ii) none of Solutia, the Company Entities, or any of their respective Subsidiaries shall be deemed an Affiliate of any Akzo Nobel Entity or any Subsidiary of an Akzo Nobel Entity, and (iii) none of the Company Entities or Company Subsidiaries shall be deemed an Affiliate of Solutia, an Akzo Nobel Entity, or any of their respective Subsidiaries. "Akzo Nobel Contributed Facilities" means the sites --------------------------------- contributed by Akzo Nobel and its Affiliates to the Company Entities and Company Subsidiaries pursuant to the Joint Venture Agreement, whether or not currently in operation. 44 "Approval Orders" means, collectively, the Transaction --------------- Approval Order and the DIP Approval Order. "Bankruptcy Code" means title 11 of the United States Code, ---------------- as applicable to the Chapter 11 Cases. "Bankruptcy Court" means the United States Bankruptcy Court ---------------- for the Southern District of New York, which has jurisdiction over the Chapter 11 Cases and, to the extent of the withdrawal of any reference under Section 157 of title 28 of the United States Code, the United States District Court for the Southern District of New York. "Business Day" means a day, other than a Saturday or Sunday, ------------ on which commercial banks in New York City are open for the general transaction of business. "Cash" means the sum of cash, cash equivalents and liquid ---- investments, plus all deposited but uncleared bank deposits and less all outstanding underdrawn checks of the Company Entities and the Company Subsidiaries. "CERCLA" means the federal Comprehensive Environmental ------ Response, Compensation and Liability Act, as amended as of the Closing Date. "Chapter 11 Cases" means the chapter 11 cases pending for ---------------- Solutia and certain of its Affiliates in the Bankruptcy Court. "Chemetall Acquisition Costs" means all costs, expenses, --------------------------- fees and any amounts of the purchase price or any other consideration paid by a Company Entity or a Company Subsidiary prior to the Closing Date in connection with the acquisition by a Company Entity or a Company Subsidiary of certain customer lists, technologies and inventories of Chemetall GmbH and its Affiliates. "Closing Date Cash Amount" means, with respect to any ------------------------ Company Entity, the total amount of Cash (excluding any Cash received by such Company Entity and/or any of its Subsidiaries from the Akzo Nobel Entities or their Affiliates as payment for any Indebtedness, Underfunded Pension/OPEB Amount or Legacy Transaction Cost, if any) residing at such Company Entity and its Subsidiaries as of immediately prior to the Closing. "Closing Date Indebtedness Amount" means, with respect to -------------------------------- any Company Entity, the total amount of Company Indebtedness of such Company Entity and its Subsidiaries outstanding as of immediately prior to the Closing. "Company Employees" means the present or former employees of ----------------- any Company Entity or Company Subsidiary. "Company Indebtedness" means for any Company Entity and its -------------------- Subsidiaries the items of indebtedness specified on Schedule 1.4(a)(i) hereto. ------------------ "Company Subsidiaries" means the direct and indirect -------------------- Subsidiaries of the Company Entities. 45 "Company Transaction Costs" means the sum of (A) any amounts ------------------------- paid by any Company Entity or Company Subsidiary prior to Closing for fees, costs or expenses (1) arising out of the DIP Financing Agreement, any other financing by Solutia or any financing by the Company Entities in connection with the Transactions and (2) incurred in connection with the Transactions, in each case, other than the Legacy Transaction Costs and any such fees, costs and expenses associated with the items set forth on Schedule 1.4(a)(iv)(A), ---------------------- and (B) any Chemetall Acquisition Costs. "Consent" means each governmental and other consent, ------- approval, authorization, waiver, certificate, exemption, order, registration, declaration, clearance, filing or notice of, with or to any Person, or the expiration or termination of the waiting period under any Competition/Investment Law. "Controlling Interest" means (i) the beneficial ownership by -------------------- any Person or any group of Persons acting together which would constitute a "group" for purposes of Section 13(d) of the Securities Exchange Act of 1934, as amended, or any successor provisions thereto, of more than fifty percent (50%) of the aggregate voting power of all classes of voting securities of any company or business or (ii) or the power to direct or cause the direction of the management and policies of such Person, whether by contract or otherwise. "DIP Approval Order" means an order from the Bankruptcy ------------------ Court approving the Fifth Amendment to the DIP Financing Agreement for purposes of effecting the Solutia Financing Amount. "DIP Financing Agreement" means that certain Financing ----------------------- Agreement, dated as of January 16, 2004, as amended on March 1, 2004, July 20, 2004, June 1, 2005, March 14, 2006 and January 25, 2007, among Solutia and Solutia Business Enterprises, as borrowers, all of the Debtors (as defined in the Financing Agreement), as guarantors, Citicorp USA Inc., as administrative, collateral and documentation agent, and Citibank, N.A., as Issuer, and the lenders party thereto. "Effective Time" means 11:59 P.M. Eastern Standard Time on -------------- the Closing Date. "Encumbrance" means any option, pledge, mortgage, security, ----------- interest, lien, charge, claim, conditional sale agreement or other title retention agreement, lease, restriction on voting or transfer, preemptive right, right of first refusal, right of way, easement, conditions or other encumbrances or matters of title of any nature (including the filing of, or agreement to give, any financing statement under the Uniform Commercial Code or Law of any jurisdiction). "Environmental Laws" means all applicable Laws relating to ------------------ pollution or protection of the environment (for the avoidance of doubt including any relating to workplace health or safety). "Equity Interests" means (i) the shares of capital stock of ---------------- a corporation, (ii) the general or limited partnership interests of any partnership, (iii) the membership or other ownership interest of any limited liability company, (iv) the equity securities of or other ownership interests of any other legal entity, or (v) any option, warrant or other right to convert 46 into or otherwise receive any of the foregoing, in any such case, whether owned or held beneficially or legally. "Field of Agreement" means the research, development, ------------------ manufacture, marketing and sale of Rubber Chemicals, including the marketing and sale of Rubber Chemicals to customers outside the rubber industry. Notwithstanding the foregoing, the Field of Agreement shall not include (i) the development, manufacture, marketing or sale of any thermoplastic elastomer product or elastomer concentrate product or any product based on silicas and silicates, natural and synthetic clays, organically modified natural and synthetic clays, and cyclic and linear polysulphides being low molecular weight block-type copolymers (above 1000 MW) consisting of inorganic and organic blocks; (ii) the development, manufacture, marketing or sale of any product for herbicidal or other agricultural use; (iii) the development, manufacture, marketing or sale of carbon disulfide (CS2) and methylamines; (iv) any process utilizing nucleophilic substitution for hydrogen technology for applications other than in Rubber Chemicals; (v) the development, manufacture, marketing or sale of white fillers and peroxides; (vi) any process utilizing homogeneous catalytic oxidative coupling of organic compounds by pure or diluted oxygen for applications other than in Rubber Chemicals; (vii) any process for the formation of an imide by the coupling of an amine and an anhydride in a solvent for applications other than in Rubber Chemicals; and (viii) any process for the production of CS2 derivatives utilizing a high-pressure tubular reactor system and purification by CS2 for applications other than in Rubber Chemicals. "Final Order" means any order, the operation or effect of ----------- which is not stayed, and for which the time to appeal or seek review or rehearing has expired, and as to which no appeal or petition for review or motion for rehearing, reconsideration or reargument has been taken or been made and is pending. "Flexsys Change of Control" means (i) the acquisition by any ------------------------- Person or any group of Persons acting together which would constitute a "group" for purposes of Section 13(d) of the Securities Exchange Act of 1934, as amended, or any successor provisions thereto, of beneficial ownership of at least 50% of the aggregate voting power of all classes of voting securities of any Company Entity, or (ii) the reorganization, merger or consolidation of any Company Entity with respect to which all of the Persons who were the respective beneficial owners of the voting securities of such Company Entity immediately prior to such reorganization, merger or consolidation do not, following such reorganization, merger or consolidation, beneficially own, directly or indirectly, more than 50% of the aggregate voting power of all classes of voting securities of such Company Entity resulting from such reorganization, merger or consolidation. "GAAP" means United States generally accepted accounting ---- principles, consistently applied during the periods involved. "Governing Documents" means with respect to any Person, such ------------------- Person's certificate or articles of incorporation or formation (as applicable) and the by-laws or limited partnership or limited liability company agreement (as applicable) or any similar document or instrument. 47 "Governmental Authority" means any United States or foreign ---------------------- federal, state, provincial or local government or other political subdivision thereof, any entity, authority or body exercising executive, legislative, judicial, regulatory or administrative functions of any such government or political subdivision, and any supranational organization of sovereign states exercising such functions for such sovereign states. "Hazardous Materials" means all materials, substances or ------------------- wastes defined or regulated as "hazardous substances", "hazardous wastes," "pollutants," or "contaminants or any other term of similar meaning and effect under any Environmental Law in existence in the jurisdiction in which the event or condition requiring the application of this definition arises, and shall include, but not be limited to, petroleum (including crude oil or any fraction thereof), friable asbestos, and polychlorinated biphenyls. "Incentive Plan" means the Long Term Benefit LTB Plan -------------- maintained for the 2004-2006 performance period. "Indebtedness" as applied to any Person, means, without ------------ duplication, (i) all indebtedness for borrowed money, (ii) all obligations evidenced by a note, bond, debenture or similar instrument, (iii) that portion of obligations with respect to capital leases that is properly classified as a liability on a balance sheet in conformity with GAAP (and, with respect to the Company Entities and the Company Subsidiaries, applied on a consistent basis with their financial statements) and (iv) any obligation owed for all or any part of the deferred purchase price for the purchase of a business. "Independent Pension Consultant" means a working group at ------------------------------ Towers, Perrin, Forster & Crosby, Inc. that is mutually acceptable to Solutia and Akzo Nobel. "Intellectual Property" means all (i) issued and pending --------------------- patents (including any extensions, continuations, divisions, reexaminations or reissues or equivalents or counterparts thereof), (ii) trade secrets, including inventions, discoveries, technology, processes, methods, formulas, compositions, and know-how, whether or not patented or patentable, (iii) trademarks, service marks, trade names, trade dress, slogans, logos and Internet domain names together with all goodwill associated therewith, (iv) copyrights and other copyrightable works, data, databases and computer software, and (v) all registrations and applications for registration of any of the foregoing. "Intellectual Property Assignment Documents" means all ------------------------------------------ instruments and other documents in forms that are acceptable to the Buyer Entities, sufficient to effectuate and record with the applicable Government Authorities the assignment of all of the Transferred Intellectual Property to the Company Entities, to the extent that the applicable Company Entities are not listed as owners of record of such Transferred Intellectual Property as of the date hereof. "Intercompany Debt" means any Indebtedness owed by a Company ----------------- Entity or any of its Subsidiaries to another Company Entity or any of such other Company Entity's Subsidiaries. The Intercompany Debt amount shall be determined as of the month-end preceding the preparation of the Initial Purchase Price Statement. "Internal Revenue Code" means the Internal Revenue Code of --------------------- 1986, as amended. 48 "Joint Venture Agreement" means that certain Joint Venture ----------------------- Agreement, dated December 7, 1994, between Solutia, as assignee of Monsanto Company, and Akzo Nobel, as amended from time to time. "Kashima Purchase Agreements" mean (i) that certain equity --------------------------- purchase agreement to be entered into by and between Akzo Nobel K.K. and Flexsys Japan K.K. concerning the purchase of all of the equity of Crystex Japan K.K. and (ii) that certain asset purchase agreement to be entered into by and between Akzo Nobel Kashima K.K. and Flexsys Japan K.K. concerning the purchase of all the assets relating to Akzo Nobel Kashima K.K.'s Crystex business. "Law" means any order, injunction, judgment, ruling, --- constitution, treaty, statute, law, rule, regulation, code, decree or rule of common law. "Legacy Transaction Costs" means the fees and expenses of ------------------------ the Company Entities and Company Subsidiaries incurred in connection with (i) the attempted sale of all of the Equity Interests in the Company Entities to one or more Persons other than the Buyer Entities and (ii) the Transactions (other than the Company Transaction Costs), the categories of which are set forth on Schedule 1.4(a)(iv)(B) hereto. ---------------------- "Master Operating Agreement" means, collectively, the Master -------------------------- Operating Agreement, effective as of January 1, 2005, between Solutia, as assignee of Monsanto Company, and Akzo Nobel, and all appendices, schedules, exhibits thereto and any other ancillary agreements, documents and instruments relating thereto. "Material Adverse Effect" means any circumstance, event, ----------------------- occurrence, state of affairs which, individually or in the aggregate, is or is reasonably likely to be materially adverse to the business, condition (financial or otherwise), results of operations, assets or liabilities of the Company Entities and the Company Subsidiaries, taken as a whole, except that a "Material Adverse Effect" does not include any effect caused by (i) events or occurrences affecting generally the United States or the global economy or the capital or financial markets, (ii) conditions in the industries in which the Company Entities and the Company Subsidiaries and their customers and suppliers conduct business, (iii) changes in Laws or GAAP, or in the authoritative interpretations thereof or in regulatory guidance related thereto, (iv) earthquakes or similar catastrophes, or acts of war sabotage, terrorism, hostilities, military action or any escalation or worsening thereof (other than actual, uninsured damage or casualty loss to the Company Entities or the Company Subsidiaries or their properties or assets), (v) the execution and delivery of this Agreement, the announcement thereof or the consummation of the Transactions, and (vi) any action taken by the Company Entities, Solutia or their respective Affiliates or agents; provided, however, that in -------- ------- the case of clauses (i), (ii), (iii) and (iv) above, such circumstance, event, occurrence or state of affairs does not impact the Company Entities and Company Subsidiaries in a materially disproportionate fashion. "Pension/OPEB Plans" means (i) the Flexsys Deferred ------------------ Compensation Plan, (ii) the Flexsys America L.P. Salaried Employees Retirement Premium Reimbursement Plan, (iii) the Flexsys America L.P. Monongahela Hourly Employees Retirement Premium Reimbursement Plan, (iv) the UK Pension Plan, (v) the Belgian Solutia Pension Fund (Vereniging voor het 49 pensioneplan van Solutia), (vi) the Belgian TCN Plan (AXA Groepsverzekering), (vii) the German Solvay Plan (Versorgungsordnung Solvay Deutschland), (viii) the German Jubilee Plan (Dienstjubilaen), and (ix) the German Altersteilzeitgesetz (Tarifvertrag zur Forderung der Altersteilzeit) and (x) the Italian TFR Plan; provided, however, that only the portions of each plan -------- ------- identified in items (i) through (x) above which provide benefits to (A) employees or retirees of the Company Entities or (B) Transferred Employees shall be considered a Pension/OPEB Plan for purposes of this Agreement. "Person" means any individual, partnership, firm, ------ corporation, association, trust, unincorporated organization, joint venture, limited liability company, Governmental Authority or other entity. "Post-Closing Tax Period" means (i) all Taxable periods ----------------------- commencing after the Closing Date and (ii) the portion of any Straddle Period beginning after the Closing Date. "Post-Closing Tax Period Liabilities" means all Taxes (or ----------------------------------- the liabilities arising from the non-payment thereof) of any Company Entity or Company Subsidiary for any Taxable period commencing after the Closing Date. "Post-Closing Taxes" means (i) Post-Closing Tax Period ------------------ Liabilities and (ii) Straddle Period Taxes allocable to any Post-Closing Tax Period. "PPD2 Litigation" means any and all liabilities and --------------- obligations to the extent arising out of the Proceedings, claims, inquiries, hearings, trials and settlements identified on Schedule 7.16(b). ---------------- "Pre-Closing Tax Period" means (i) all Taxable periods ---------------------- ending on or before the Closing Date and (ii) the portion of any Straddle Period up to and including the Closing Date. "Pre-Closing Tax Period Liabilities" means all Taxes (or the ---------------------------------- liabilities arising from the non-payment thereof) of any Company Entity or Company Subsidiary for any Taxable period ending on or before the Closing Date. "Pre-Closing Taxes" means (i) Pre-Closing Tax Period ----------------- Liabilities and (ii) Straddle Period Taxes allocable to any Pre-Closing Tax Period. "Proceeding" means any suit, action, investigation or other ---------- proceeding. "Release" has the meaning provided in 42 U.S.C. Section ------- 9601(22). "Remedial Actions" means all actions to (a) clean up, ---------------- remove, treat or handle in any other way Hazardous Materials in the environment, (b) restore or reclaim the environment or natural resources, (c) prevent the Release of Hazardous Materials so that they do not migrate, endanger or threaten to endanger public health or the environment or (d) perform remedial investigations, feasibility studies, corrective actions, closures and postremedial or postclosure studies, investigations, operations, maintenance and monitoring on, about or in any property. 50 "Rubber Chemicals" means the products listed on Schedule ---------------- -------- 10.10(a) and additives for natural and synthetic rubber which are intended to - -------- affect the processing (including mixing, shaping, curing or vulcanization) or the properties of the rubber, including vulcanization accelerators, ultra accelerators, prevulcanization inhibitors, post-vulcanization stabilizers, anti-reversion agents, antidegradants, reinforcing agents, bonding agents, antiozonants/antiflex agents, antiozonant/antiflexblends, antioxidants, insoluble sulfur, chemical intermediates 4-NDPA/PPD2 (4-nitrodiphenylamine), 4-ADPA (4-aminodiphenylamine), Sodium MBT (sodium mercaptobenzothiazole solution), TBA (tertiary butylamine), sodium dithio carbamates, and BTH (benzothiazole), and other chemical intermediates that may be marketed in the future exclusively or primarily to the rubber industry. For the avoidance of doubt, EPDM (ethylene propylene diene monomer) is not considered a synthetic rubber and organometallic catalysts and co-catalysts used in the manufacture of EPDM are not considered "Rubber Chemicals." "Rubicon Litigation" means any and all liabilities and ------------------ obligations to the extent arising out of the Proceedings, claims, inquiries, hearings, trials and settlements identified on Schedule 7.16(a). ---------------- "Services Agreements" means the agreements, documents, ------------------- instruments and amendments that are to be entered into with respect to each facility listed on Schedule 7.12(c) to give effect to the on-going provision ---------------- of services and products, or the leasing of space from, by an Akzo Nobel Entity or an Affiliate thereof to a Company Entity or a Company Subsidiary in accordance with Section 7.12. ------------ "Solutia Contributed Facilities" means the sites contributed ------------------------------ by Solutia and its Affiliates to the Company Entities and Company Subsidiaries pursuant to the Joint Venture Agreement, whether or not currently in operation. "Straddle Period" means any Taxable period that includes --------------- (but does not end on) the Closing Date. "Straddle Period Taxes" means, with respect to any Straddle --------------------- Period (i) for any Taxes based on or measured by income or receipts, the amount of such Taxes as determined based on an interim closing of the books as of the close of business on the Closing Date and (ii) the amount of other Taxes the amount determined by multiplying the amount of such Tax for the entire Taxable period by a fraction, the numerator of which is the number of days in Pre-Closing Taxable Period or Post-Closing Taxable Period (as applicable) and the denominator of which is the total number of days in the Straddle Period. "Subsidiary" means with respect to any Person, any ---------- corporation, limited liability company, partnership, association, or other Person of which (i) if a corporation, a majority of the total voting power of shares of stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers, or trustees (or similar Persons) thereof is at the time owned or controlled, directly or indirectly, by that Person or one or more of the other Subsidiaries of that Person or a combination thereof or (ii) if a limited liability company, partnership, association, or other Person (other than a corporation), a majority of partnership or other similar ownership interests thereof having the power to govern or elect a majority of members of the applicable governing body of such entity is at the time owned or 51 controlled, directly or indirectly, by that Person or one or more subsidiaries of that Person or a combination thereof; and the term "Subsidiary" shall include all subsidiaries of such subsidiary. "Tax" or "Taxes" means all (i) United States federal, state --- ----- or local or non-United States taxes, assessments, charges, duties, levies or other similar governmental charges of any nature, including all income, franchise, profits, capital gains, capital stock, transfer, sales, use, occupation, property, excise, severance, windfall profits, stamp, stamp duty reserve, license, payroll, withholding, ad valorem, value added, alternative minimum, environmental, customs, social security (or similar), unemployment, sick pay, disability, registration and other taxes, assessments, charges, duties, fees, levies or other similar governmental charges of any kind whatsoever, whether disputed or not, together with all estimated taxes, deficiency assessments, additions to tax, penalties and interest; and (ii) any liability for the payment of any amount of a type described in clause (i) arising as a result of being or having been a member of any consolidated, combined, unitary or other group or being or having been included or required to be included in any Tax Return related thereto. "Tax Return" means any return, report or statement or other ---------- filing required to be filed with any Governmental Authority with respect to Taxes, including any schedule or attachment thereto or amendment thereof. "Termination Agreement" means the agreement to be entered --------------------- into between Solutia and Akzo Nobel regarding the termination of the Joint Venture Agreement at Closing. "Transaction Approval Order" means an order from the -------------------------- Bankruptcy Court approving the Transactions. "Transaction Documents" means (i) with respect to the --------------------- Acquired Interests, such instruments of sale, conveyance, transfer and assignment (including a notarial deed to be recorded in the Netherlands by a notary public with respect to the Acquired Interests of Flexsys Holding), and such other agreements or documents, if any, in each case in form and substance reasonably satisfactory to the Sellers and the Company Entities, as shall be necessary in order to transfer all right, title and interest of the Sellers in the Acquired Interests in accordance with the terms hereof, (ii) the Transition Services Agreement, (iii) the Disentanglement Transaction Documents, (iv) the Intellectual Property Assignment Documents and (v) the Termination Agreement. "Transactions" means the transactions contemplated by this ------------ Agreement and the Transaction Documents. "Transferred Employees" means employees who are employed by --------------------- any of the Akzo Nobel Entities as of the date of this Agreement and who become employees of any of the Company Entities or Company Subsidiaries in connection with the Transactions and any Transaction Documents. "Transferred Intellectual Property" means all worldwide --------------------------------- right, title and interest in and to all Intellectual Property that has been conveyed, assigned or otherwise transferred by any of the Akzo Nobel Entities or any of their Affiliates to any of the Company Entities or Company Subsidiaries pursuant to (i) the Joint Venture Agreement, or (ii) any other written agreement 52 between any Akzo Nobel Entity or an Affiliate thereof and any Company Entity or Company Subsidiary, which as of the date of this Agreement is on record with the applicable Governmental Authorities as owned by an Akzo Nobel Entity and/or an Affiliate of an Akzo Nobel Entity for which title will need to be updated pursuant to the Intellectual Property Assignment Documents required to be delivered by the Akzo Nobel Entities pursuant to Section 1.3(b)(i) and/or ----------------- Section 7.17 to reflect the applicable Company Entity and/or Company - ------------ Subsidiary as owner of record, including the items set forth on Schedule 7.17. ------------- "Transition Services Agreement" means the Transition ----------------------------- Services Agreement, to be entered into by and the among ANC, ANCI and the Company Entities at or prior to the Closing. "Treasury Regulations" means the Treasury Regulations -------------------- promulgated under the Internal Revenue Code. "UK Pension Plan" means the Flexsys Rubber Chemicals Limited --------------- Retirement Benefits Scheme. "Underfunded Pension/OPEB Amount" means, (A) with respect to ------------------------------- each Pension/OPEB Plan other than the UK Pension Plan, the excess, if any, of the aggregate value of the benefits accrued under such Pension/OPEB Plan as of the Closing Date, over the fair value, determined as of the Closing Date, of assets held in segregated trusts, escrow accounts, rabbi trusts, insurance contracts or other funding mechanisms trust or escrow account established or maintained by any Company Entity or any Company Subsidiary exclusively for the purpose of funding the liabilities under such Pension/OPEB Plan, and (B) with respect to the UK Pension Plan, an amount equal to the aggregate liability that the Company Entities and Company Subsidiaries participating in the UK Pension Plan as determined by the Independent Pension Consultant in accordance with the relevant assumptions set forth on Schedule 7.6(c) hereto. --------------- (b) Interpretive Provisions. The words "hereof," "herein" ----------------------- and "hereunder" and words of similar import when used in this Agreement refer to this Agreement as a whole (including any Schedules and Exhibits hereto) and not to any particular provision of this Agreement, and all Article, Section, Schedule and Exhibit references are to this Agreement unless otherwise specified. The words "include," "includes" and "including" will be deemed to be followed by the phrase "without limitation." The word "if" means "if and only if." The meanings given to terms defined herein will be equally applicable to both the singular and plural forms of such terms. Whenever the context may require, any pronoun includes the corresponding masculine, feminine and neuter forms. Except as otherwise expressly provided herein, all references to "dollars" or "$" will be deemed references to the lawful money of the United States of America. Matters reflected on any Schedule to this Agreement are not necessarily limited to matters required by the Agreement to be reflected therein. Such additional matters are set forth for informational purposes and do not necessarily include other matters of a similar informational nature. Any disclosure of a fact or circumstance on a Schedule shall not establish, or constitute an admission of, the materiality of such fact or such circumstance or such fact's or circumstance's consequence or relevance to any determination of materiality, to any determination regarding materiality or a determination with respect to whether or not an action constitutes an action taken in the ordinary course of business of any Person. Headings (other than numerical references to sections and subsections of the Agreement) have been inserted in 53 some of the Schedules for convenience of reference only, and such headings shall not have the effect of amending or changing the express description of the Schedule as set forth in the Agreement. If any individual Schedule to this Agreement discloses an item or information in such a way as to make its relevance to the information called for by another Schedule readily apparent, that item or information shall be deemed to have been included in such other Schedule, notwithstanding the omission of an appropriate cross-reference to such Schedule. (c) Computation of Time. In computing any period of time ------------------- prescribed or allowed with respect to any provision of this Agreement that relates to the Chapter 11 Cases (including any provision that refers to the Approval Order), Rule 9006(a) of the Federal Rules of Bankruptcy Procedure shall apply. SECTION 10.11 HEADINGS. The headings contained in this -------- Agreement are for reference only and shall not affect in any way the meaning or interpretation of this Agreement. SECTION 10.12 SEVERABILITY. Any provision of this Agreement ------------ which is invalid, illegal or unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity, illegality or unenforceability, without affecting in any way the remaining provisions hereof in such jurisdiction or rendering that or any other provision of this Agreement invalid, illegal or unenforceable in any other jurisdiction. SECTION 10.13 NO THIRD PARTY BENEFICIARIES. Nothing herein, ---------------------------- expressed or implied, is intended or shall be construed to confer upon or give to any Person (other than the parties hereto, their respective permitted successors or assigns and any Buyer Indemnified Persons and Seller Indemnified Persons) any legal, equitable or other rights or remedies under or by reason of any provision of this Agreement. SECTION 10.14 DISPUTE RESOLUTION. The parties hereto shall, ------------------ and shall cause their respective Affiliates to, resolve any dispute, controversy or claim whatsoever between the Akzo Nobel Entities, on the one hand, and the Buyer Entities, on the other hand, arising out of or in connection with this Agreement, the Transaction Documents, the Transactions (a "Dispute") in accordance with the following procedures: ------- (a) Within thirty (30) Business Days after any party has served written notice on the other parties pursuant to Section 10.6 setting ------------ forth in reasonable detail the nature of the Dispute, such Dispute shall be submitted to mediation under the supervision of and in accordance with the Model Mediation Procedure of the Centre for Effective Dispute Resolution (the "Model Procedure") as in effect on the date hereof. The language of the --------------- mediation shall be English. Any foreign language documents presented during the mediation shall be accompanied by an English translation. The mediation shall take place in New York, New York. Notwithstanding anything contained in this Agreement, any Transaction Document or the Model Procedure to the contrary, in no event will any party be obligated to participate in any mediation for more than thirty (30) calendar days. (b) If a party to a mediation commenced pursuant to Section 10.14(a) desires to seek other binding resolution outside of such - ---------------- mediation, then such party, in accordance with the procedural rules of such mediation, may only seek to have such Dispute finally 54 and exclusively settled by arbitration under the rules of the London Court of International Arbitration as in effect on the date hereof by one arbitrator appointed in accordance with said rules. The place of the arbitration shall be New York, New York, and the language of the arbitration shall be English. By agreeing to arbitration of any Dispute in accordance with this Section ------- 10.14(b), the parties hereto irrevocably waive their right to any form of - -------- appeal, review or recourse to any state court or other judicial authority with respect to such Dispute, insofar as such waiver may be validly made. (c) Any discovery of documents shall be on the basis of and in accordance with the 1999 International Bar Association Rules on the taking of evidence in international commercial arbitration. (d) Notwithstanding anything to the contrary in any of the Transaction Documents or documents delivered pursuant thereto, the parties hereto hereby agree that any and all disputes arising out of or in connection with the Transaction Documents and such documents shall be settled exclusively on the basis of the procedure set forth in this Section 10.14; provided that ------------- -------- (i) any party may seek equitable relief from a court of competent jurisdiction with respect to any Dispute or as provided in Section 10.17 to which such ------------- other party may otherwise be entitled to under this Agreement, and (ii) this Section 10.14 shall not limit the ability of any party to resort, apply to, or - ------------- file any motion or other pleading with, the Bankruptcy Court in connection with any Dispute arising out of or relating to the Approval Order. (e) Each party hereto does, and shall cause its relevant Affiliates to, irrevocably submit to the non-exclusive jurisdiction of any State or Federal court located within the area encompassed by the Southern District of the State of New York (including the Bankruptcy Courts thereof) to support and assist the arbitration process pursuant to Section 10.14(b), ---------------- including if necessary the grant of interlocutory relief pending the outcome of that process. SECTION 10.15 CONSENT TO JURISDICTION. THE PARTIES HERETO ----------------------- HEREBY CONSENT TO THE JURISDICTION OF ANY STATE OR FEDERAL COURT LOCATED WITHIN THE AREA ENCOMPASSED BY THE SOUTHERN DISTRICT OF THE STATE OF NEW YORK (INCLUDING THE BANKRUPTCY COURTS THEREOF) AND IRREVOCABLY AGREE THAT ANY AND ALL ACTIONS OR PROCEEDINGS ARISING OUT OF OR RELATING TO THIS AGREEMENT THAT ARE NOT SUBJECT TO THE PROCEDURES SET FORTH IN SECTION 10.14 SHALL BE ------------- LITIGATED IN SUCH COURTS. THE PARTIES HERETO EACH ACCEPT FOR ITSELF AND IN CONNECTION WITH ITS RESPECTIVE PROPERTIES, GENERALLY AND UNCONDITIONALLY, THE EXCLUSIVE JURISDICTION AND VENUE OF THE AFORESAID COURTS AND WAIVE ANY DEFENSE OF FORUM NON CONVENIENS, AND IRREVOCABLY AGREE TO BE BOUND BY ANY NONAPPEALABLE JUDGMENT RENDERED THEREBY IN CONNECTION WITH THIS AGREEMENT. SECTION 10.16 WAIVER OF JURY TRIAL. TO THE FULLEST EXTENT -------------------- PERMITTED BY LAW, THE PARTIES HERETO HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY DEALINGS BETWEEN THEM 55 RELATING TO THE SUBJECT MATTER OF THIS TRANSACTION. THE PARTIES HERETO ALSO WAIVE ANY BOND OR SURETY OR SECURITY UPON SUCH BOND WHICH MIGHT, BUT FOR THIS WAIVER, BE REQUIRED OF ANY OF THE OTHER PARTIES. THE SCOPE OF THIS WAIVER IS INTENDED TO BE ALL ENCOMPASSING OF ANY AND ALL DISPUTES THAT MAY BE FILED IN ANY COURT AND THAT RELATE TO THE SUBJECT MATTER OF THIS AGREEMENT, INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW AND STATUTORY CLAIMS. THE PARTIES HERETO ACKNOWLEDGE THAT THIS WAIVER IS A MATERIAL INDUCEMENT TO ENTER INTO A BUSINESS TRANSACTION, THAT EACH HAS ALREADY RELIED ON THE WAIVER IN ENTERING INTO THIS AGREEMENT AND THAT EACH WILL CONTINUE TO RELY ON THE WAIVER IN THEIR RELATED FUTURE DEALINGS. THE PARTIES HERETO FURTHER WARRANT AND REPRESENT THAT EACH HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL, AND THAT EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. THIS WAIVER IS IRREVOCABLE, MEANING THAT IT MAY NOT BE MODIFIED EITHER ORALLY OR IN WRITING, AND THE WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS AGREEMENT OR TO ANY OTHER DOCUMENTS OR AGREEMENTS RELATING TO THE TRANSACTIONS CONTEMPLATED HEREBY. IN THE EVENT OF LITIGATION, THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. SECTION 10.17 SPECIFIC ENFORCEMENT. Each party acknowledges -------------------- and agrees that the other party would be irreparably damaged if any of the provisions of this Agreement are not performed in accordance with their specific terms and that any breach of this Agreement by any Akzo Nobel Entities or Buyer Entities could not be adequately compensated in all cases by monetary damages alone. Accordingly, in addition to any other right or remedy to which any party may be entitled under this Agreement, at law or in equity, it shall be entitled to enforce any provision of this Agreement by a decree of specific performance and to temporary, preliminary and permanent injunctive relief to prevent breaches or threatened breaches of any of the provisions of this Agreement, without posting any bond or other undertaking. **SIGNATURE PAGE FOLLOWS** 56 IN WITNESS WHEREOF, the undersigned have caused this Agreement to be executed by its duly authorized officer, in each case as of the day and year first above written. AKZO NOBEL N.V. By: ------------------------------- Name: Title: By: ------------------------------- Name: Title: AKZO NOBEL CHEMICALS INTERNATIONAL B.V. By: ------------------------------- Name: Title: By: ------------------------------- Name: Title: AKZO NOBEL CHEMICALS INC. By: ------------------------------- Name: Title: By: ------------------------------- Name: Title: FLEXSYS HOLDING B.V. By: ---------------------------------- Name: Title: By: ---------------------------------- Name: Title: FLEXSYS AMERICA LP BY: FLEXSYS AMERICA CO., ITS GENERAL PARTNER By: ---------------------------------- Name: Title: FLEXSYS RUBBER CHEMICALS LTD. By: ---------------------------------- Name: Title: SOLUTIA INC. By: ---------------------------------- Name: Title: EX-10.SS 3 ex10ss.txt EXHIBIT 10(ss) AKZO NOBEL N.V. VELPERWEG 76, PO BOX 9300 6800 SB ARNHEM THE NETHERLANDS CONFIDENTIAL DELIVERED BY HAND Flexsys Holding B.V. Flexsys America LP Flexsys Rubber Chemicals Ltd. Solutia Inc. 27 February 2007 RE: PROPOSED SALE AND PURCHASE OF AKZO NOBEL'S INTEREST IN THE FLEXSYS COMPANIES Dear Sirs, We refer to the terms and conditions of the draft Transaction Agreement among Akzo Nobel N.V., Akzo Nobel Chemicals International B.V., and Akzo Nobel Chemicals Inc. (collectively "AKZO NOBEL"), Flexsys Holding B.V., Flexsys America LP, and Flexsys Rubber Chemicals Ltd. (collectively "FLEXSYS"), and Solutia Inc. ("SOLUTIA"), including all Schedules, attachments and other related documents, all of which are attached hereto (the "AGREEMENT") and our discussions in relation thereto (the "PROPOSED TRANSACTION") (Akzo Nobel, Flexsys and Solutia are collectively referred to herein as the "PARTIES"). We irrevocably commit to signing the Agreement in accordance with the terms and conditions contained in the Agreement (the "OFFER") upon your acceptance of the same and we confirm that signing shall not be conditional, unless explicitly set out otherwise in the Agreement or this letter. Solutia's execution of this letter shall constitute its acceptance of the Offer. Subject only to the provisions on employee consultation set forth below, you irrevocably commit to signing the Agreement in accordance with the Offer. You confirm that signing shall not be conditional upon any matter other than the provisions on employee consultation set forth below. EMPLOYEE CONSULTATION We acknowledge that Flexsys Holding B.V. cannot accept the Offer until the employee consultations in the Netherlands required for the Proposed Transaction to be completed prior to the signing of the Agreement have been completed as set out below: (a) the advice has been given by the relevant works council, such advice to be requested by Flexsys Holding B.V. and (b) the consultation with the unions and the notice to the Secretary of the Social and Economic Council by the relevant Parties jointly has taken place. We agree with you that we will discuss how we will participate in and contribute to the works council consultation processes referred to under (a) and how we will jointly carry out the consultations referred to under (b). EXCLUSIVITY Upon the signing for acknowledgement by you of this letter and until the later of (i) the signing of the Agreement and (ii) the conclusion of the employee consultations set forth below, but in any event no later than May 25, 2007, or, if earlier, the date this Offer is cancelled or rescinded in accordance with the terms of this letter, we will grant you exclusivity in relation to the sale and acquisition of Akzo Nobel's interests in Flexsys. We therefore undertake not to accept any bid from any third party or otherwise engage in discussions or commitments concerning the Proposed Transaction in whole or in part during the period indicated in the previous sentence, provided that this undertaking shall terminate, and at its sole election Akzo Nobel may rescind this Offer, if Solutia and Flexsys do not obtain binding commitment letters and/or definitive financing agreements with respect to the Company Financing Amount (as defined in the Agreement) by February 28, 2007. We confirm that during this period of exclusivity, our Offer (subject to the terms of this letter) is irrevocable and will not be changed. PRESS RELEASE AND CONFIDENTIALITY Following the signing for acknowledgement of this letter by all Parties, all Parties agree to abide by the provisions of Section 10.9 of the Agreement which are incorporated herein by reference. AGREEMENT The Parties shall execute the Agreement within three Business Days from the later of the date on which (i) the notice to the Secretary of the Social and Economic Counsel has been sent, (ii) the consultations with the trade unions have, to the extent required, taken place, and (iii) the relevant works council of Flexsys Holding B.V. has rendered the advice required under Dutch law in respect of the Proposed Transaction. In the event the employee consultation process results in (a) a negative advice or (b) any suggestions or conditions relating to the terms of the Proposed Transaction which have an impact on the Offer in such a manner that it could not be expected from a reasonable purchaser or seller to pursue the Proposed Transaction, then the Parties will discuss in good faith (without any binding obligation to agree any changes) whether and to what extent the Proposed Transaction can be altered to accommodate the relevant employee body. Changes to the Agreement shall only relate to the outcome of the employee consultation process, and, if any such changes are agreed, the Parties shall be bound to enter into the Agreement as so amended. If the Parties cannot agree on changes to the Proposed Transaction to accommodate the relevant employee body's suggestions or conditions, then you will inform the relevant employee body accordingly, in which case the Agreement will be executed as soon as: 2 (a) the period as set out in article 25 paragraph 6 of the Dutch Works Council Act shall have lapsed, without such employee body having initiated legal proceedings as set out in article 26 of the Dutch Works Council Act; or (b) in the event that the legal proceedings as set out in article 26 of the Dutch Works Council Act have been initiated, Flexsys Holding B.V. shall have received a final order from the Enterprise Section of the Amsterdam Court of Appeal ('Ondernemingskamer') dismissing the relevant employee body's appeal. In the event that the relevant Dutch court referred to under (b) above, in a final order decides in favor of the relevant employee body and this has an impact on the Offer in such a manner that it could not be expected from a reasonable purchaser or seller to pursue the Proposed Transaction, you shall not be obligated to sign the Agreement and we may decide to rescind and/or cancel the Offer. MISCELLANEOUS From and after the date of the execution of this letter, the Parties agree that they will be bound by the terms of and subject to all of the obligations under Sections 7.3, 7.6, 7.11, 7.12, and 7.13 of the Agreement; provided, that -------- no Disentanglement Transaction (as defined in the Agreement) shall be consummated in the Netherlands until the conclusion of the employee consultations set forth herein. In the event the Agreement is not signed on or before May 25 2007 (other than by reason of default of one of the Parties), we may decide to rescind and/or cancel the Offer, or you may decide to rescind and/or cancel your acceptance of the Offer. In either such case, the party electing to rescind the Offer or acceptance, as applicable, must do so in writing to the other parties, at which time none of the parties will have any obligations under this letter. Notwithstanding the foregoing, no such action to rescind or cancellation shall relieve any party from any liability for any breach of any of its obligations under Sections 7.3, 7.6, 7.11, 7.12 (with respect to obligations outside of the Netherlands) or 7.13 of the Agreement and Solutia shall be obligated to comply with Section 8.2(b)(iii) of the Agreement. This letter shall be governed by and construed in accordance with the laws of the Netherlands. Any disputes arising hereunder, if not resolved amicably, shall be settled in accordance with the Dispute Resolution provisions set forth in Section 10.14 of the Agreement, which are incorporated herein by reference. 3 Yours sincerely, AKZO NOBEL N.V. By: /s/ D.W. Welch ------------------------------- Name: D.W. Welch Title: Director Corporate Strategy By: /s/ Graham White ------------------------------- Name: Graham White Title: Deputy Director Corporate Strategy AKZO NOBEL CHEMICALS INTERNATIONAL B.V. By: /s/ D.W. Welch ------------------------------- Name: D.W. Welch Title: Attorney in Fact By: /s/ Graham White ------------------------------- Name: Graham White Title: Deputy Director Corporate Strategy AKZO NOBEL CHEMICALS INC. By: /s/ D.W. Welch ------------------------------- Name: D.W. Welch Title: Attorney in Fact By: /s/ Graham White ------------------------------- Name: Graham White Title: Deputy Director Corporate Strategy 4 ACKNOWLEDGED AND AGREED FOR ON BEHALF OF: FLEXSYS HOLDING B.V. By: /s/ Peter Schneider - ---------------------------------- Name: Peter Schneider Title: Director Flexsys Holding B.V. By: /s/ W. Kymmell - ---------------------------------- Name: W. Kymmell Title: General Counsel FLEXSYS AMERICA LP By: Flexsys America Co., its General Partner By: /s/ W. Kymmell - ---------------------------------- Name: W. Kymmell Title: General Counsel FLEXSYS RUBBER CHEMICALS LTD. By: /s/ W. Kymmell - ---------------------------------- Name: W. Kymmell Title: General Counsel SOLUTIA INC. By: /s/ Rosemary L. Klein - ---------------------------------- Name: Rosemary L. Klein Title: Senior Vice President 5 EX-12 4 ex12.txt
EXHIBIT 12 SOLUTIA INC. COMPUTATION OF THE RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN MILLIONS) 2002 2003 2004 2005 2006 ------------- ------------- -------------- ------------- -------------- Income (loss) from continuing operations, before income taxes and equity earnings (loss) from affiliates (1) ........... (28) (419) (360) (77) (67) Add: Fixed charges............................... 98 131 125 95 114 Amortization of capitalized interest........ 7 6 7 5 4 Dividends from affiliated companies......... 25 - - - 25 Less: Interest capitalized........................ (1) (1) (3) (3) (4) ------------- ------------- -------------- ------------- -------------- Income as adjusted....................... 101 (283) (231) 20 72 ============= ============= ============== ============= ============== Fixed charges Interest expensed and capitalized........... 85 121 116 87 108 Estimate of interest within rental expense.................................. 13 10 9 8 6 ------------- ------------- -------------- ------------- -------------- Fixed charges......................... 98 131 125 95 114 ============= ============= ============== ============= ============== Ratio of Earnings to Fixed Charges (2)............ 1.03 (2.16) (1.86) 0.21 0.63 (1) Includes restructuring charges and other (gains)/charges of $(1) million for the year ended December 31, 2006, $15 million for the year ended December 31, 2005, $97 million for the year ended December 31, 2004, $238 million for the year ended December 31, 2003, and $17 million for the year ended December 31, 2002. (2) Earnings for the years ended December 31, 2006, 2005, 2004, and 2003, would have to be $42 million, $75 million, $356 million, and $414 million higher, respectively, in order to achieve a one-to-one ratio.
EX-14 5 ex14.txt EXHIBIT 14 SOLUTIA INC. CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS INTRODUCTION. - ------------ This Code of Ethics for Senior Financial Officers has been adopted by the Board of Directors of Solutia Inc. to promote honest and ethical conduct, proper disclosure of financial information in the Company's periodic reports, and compliance with applicable laws, rules, and regulations by the Company's senior officers who have financial responsibilities. Compliance with this Code, together with Solutia's Guidelines for Employee Conduct applicable to all employees, including Senior Financial Officers, is mandatory. APPLICABILITY. - ------------- As used in this Code, the term Senior Financial Officer means the Company's Chief Executive Officer, Chief Financial Officer, General Counsel, Treasurer and Controller and other senior financial officers performing similar functions who have been identified by the CEO (collectively "Senior Financial Officers"). POLICY AND PRINCIPLES. - --------------------- In addition to being bound by all other provisions of the Guidelines for Employee Conduct, the Senior Financial Officers are subject to the following additional specific policies: (1) The Senior Financial Officers shall avoid actual or apparent conflicts of interest between personal and business relationships, such as holding a substantial equity, debt, or other financial interest in any competitor, supplier or customer of the Company, or having a personal financial interest in any transaction involving the purchase or sale by the Company of any products, materials, equipment, services or property, other than through Company-sponsored programs. Any such actual or apparent conflicts of interest shall be brought to the attention of the General Counsel or the CEO. (2) The Senior Financial Officers are responsible for full, fair, accurate, timely and understandable disclosure in the reports and documents that the Company files with, or submits to, the Securities and Exchange Commission and in other public communications made by the Company. Accordingly, it is the responsibility of the each Senior Financial Officer promptly to bring to the attention of the General Counsel or the CEO any material information of which he or she may become aware that affects the disclosures made by the Company in its public filings. (3) The Senior Financial Officers shall act with honesty and integrity and in good faith, responsibly, with due care, competence and diligence without misrepresenting material facts or allowing one's judgment to be subordinated and, in the performance of his or her duties at the Company, shall comply with laws, rules and regulations of federal, state and local governments and other public regulatory agencies that affect the conduct of the Company's business and the Company's financial reporting. (4) The Senior Financial Officers shall not unduly or fraudulently influence, coerce, manipulate, or mislead any authorized audit or interfere with any auditor engaged in the performance of an internal or independent audit of the Company's financial statements or accounting books and records. (5) The Senior Financial Officers shall promptly bring to the attention of the General Counsel or the CEO any information he or she may have concerning evidence of a material violation of the securities or other laws, rules or regulations applicable to the Company and the operation of its business, by the Company or any agent thereof, or any violation of this Code of Ethics. After reasonable investigation, the General Counsel or the CEO must address the potential violation with the Audit and Finance Committee of the Board of Directors. (6) In the event that a Senior Financial Officer has reason to believe that the General Counsel or the CEO is involved in the matter for which notification is required under this Code, the Senior Financial Officer should make the required notification directly to the Audit and Finance Committee of the Board of Directors. COMPLIANCE AND ACCOUNTABILITY. - ----------------------------- The Audit and Finance Committee of the Board of Directors or a designee thereof shall determine, on a case by case basis, appropriate actions to be taken in the event of violations of this Code of Ethics by any Senior Financial Officer. Such actions shall be reasonably designed to deter wrongdoing and to promote accountability for adherence to this Code of Ethics, and may include written notice of violation as determined by the Audit and Finance Committee, censure by the Board, demotion or re-assignment of duties, suspension with or without pay or benefits or termination of the individual's employment. WAIVER. - ------ Any request for a waiver of any provision of this Code must be in writing and addressed to the Board of Directors, in care of the Chairman, Audit and Finance Committee. Any waiver of this Code granted by the Board of Directors will be disclosed promptly on the Company's website or by any other means approved by the Securities and Exchange Commission. Last updated: December 14, 2006 2 EX-21 6 ex21.txt EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT The following is a list of Solutia's subsidiaries as of December 31, 2006, except for unnamed subsidiaries that, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary. Percentage of Voting Power Owned by Solutia ------------- CPFilms Inc............................................................100% Monchem, Inc...........................................................100% Monchem International, Inc. ...........................................100% Solchem Netherlands C.V................................................100% Solutia Brasil Ltda....................................................100% Solutia Canada Inc.....................................................100% Solutia Europe S.A./N.V................................................100% Solutia Greater China, Inc.............................................100% Solutia Netherlands Holdings B.V.......................................100% Solutia Services International SCA/Comm, VA............................100% Solutia Systems, Inc...................................................100% Solutia Therminol Co., Ltd............................................. 60% Solutia U.K. Holdings Limited..........................................100% Solutia U.K. Investments Limited.......................................100% Solutia U.K. Limited...................................................100% EX-23 7 ex23.txt EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statements Nos. 333-34587, 333-34593, 333-34683, 333-35689, 333-51081, 333-74463, and 333-39972 on Form S-8 and Registration Statements Nos. 333-75812, 333-89818, and 333-99705 on Form S-3 of our reports dated March 1, 2007 (which report expresses an unqualified opinion and includes explanatory paragraphs referring to Solutia Inc.'s filing for reorganization under Chapter 11 of the United States Bankruptcy Code, substantial doubt about Solutia Inc.'s ability to continue as a going concern and change in accounting principle), relating to the consolidated financial statements and financial statement schedule of Solutia Inc. and management's report on the effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K of Solutia Inc. for the year ended December 31, 2006. /s/ Deloitte & Touche LLP St. Louis, Missouri March 1, 2007 EX-24.A 8 ex24a.txt Exhibit 24(a) POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS: Each undersigned director and/or officer of Solutia Inc. (the "Company"), a Delaware corporation, does hereby appoint Rosemary L. Klein and Miriam R. Singer, each of them with full power to act without the other, as true and lawful attorneys-in-fact, to sign on his or her behalf (a) the Annual Report on Form 10-K and any Amendments thereto to be filed with the Securities and Exchange Commission (the "Commission") under the Securities Exchange Act of 1934; (b) any amendments to Registration Statements Nos. 333-75812, 333-89818, and 333-99705, all on Form S-3, which have previously been filed with the Commission under the Securities Act of 1933 (the "Securities Act"), covering the registration of securities of the Company and guarantees of certain of the Company's subsidiaries; and (c) any amendments to Registration Statements Nos. 333-34587, 333-34593, 333-34683, 333-35689, 333-51081, 333-74463, and 333-39972, all on Form S-8, which have previously been filed with the Commission under the Securities Act, covering the registration of securities of the Company; giving and granting unto those attorneys full power and authority to do and perform such actions as fully as he or she might have done or could do if personally present and executing any of said documents. IN WITNESS WHEREOF, each undersigned director and/or officer has signed this Power of Attorney as of this 21 day of February, 2007. /s/ Jeffry N. Quinn /s/ Frank A. Metz, Jr. - ----------------------------------------- ---------------------------- Jeffry N. Quinn, Chairman of the Board, Frank A. Metz, Jr., Director Chief Executive Officer, and President (Principal Executive Officer) /s/ James M. Sullivan /s/ J. Patrick Mulcahy - ----------------------------------------- ---------------------------- James M. Sullivan, Senior Vice President J. Patrick Mulcahy, Director and Chief Financial Officer (Principal Financial Officer) /s/ Timothy J. Spihlman /s/ Sally G. Narodick - ----------------------------------------- ---------------------------- Timothy J. Spihlman, Vice President and Sally G. Narodick, Director Controller (Principal Accounting Officer) /s/ Paul H. Hatfield /s/ John B. Slaughter - ----------------------------------------- ---------------------------- Paul H. Hatfield, Lead Director John B. Slaughter, Director /s/ Robert H. Jenkins - ----------------------------------------- Robert H. Jenkins, Director EX-24.B 9 ex24b.txt EXHIBIT 24(b) SOLUTIA INC. CERTIFICATE I, Rosemary L. Klein, Senior Vice President, Secretary and General Counsel of Solutia Inc. (the "Company"), hereby certify that the following is a full, true and correct copy of a resolution adopted by the Board of Directors of the Company on February 28, 2007, at which meeting a quorum was present and acting throughout: FURTHER RESOLVED, that each officer and director who may be required to sign and execute the 2006 Annual Report on Form 10-K or any document in connection therewith (whether for and on behalf of the Company, or as an officer or director of the Company, or otherwise), be and hereby is authorized to execute a power of attorney appointing Rosemary L. Klein and Miriam R. Singer, or either of them acting alone, his or her true and lawful attorney or attorneys to sign in his or her name, place and stead in any such capacity such Annual Report on Form 10-K and any and all amendments thereto and documents in connection therewith, and to file the same with the Commission or any other governmental body, each of said attorneys to have power to act with or without the others, and to have full power and authority to do and perform, in the name and on behalf of each of said officers and directors, every act whatsoever which such attorneys, or any one of them, may deem necessary, appropriate or desirable to be done in connection therewith as fully and to all intents and purposes as such officers or directors might or could do in person. IN WITNESS WHEREOF, I have hereunto set my hand in my official capacity and affixed the corporate seal of the Company this 2nd day of March, 2006. /s/ Rosemary L. Klein --------------------- Rosemary L. Klein Senior Vice President, General Counsel and Secretary SEAL EX-31.A 10 ex31a.txt EXHIBIT 31(a) Certification of Chief Executive Officer Pursuant to Section 302 Of the Sarbanes-Oxley Act of 2002 I, Jeffry N. Quinn, certify that: 1. I have reviewed this Annual Report on Form 10-K of Solutia Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: March 6, 2007 /s/ Jeffry N. Quinn ------------------- Jeffry N. Quinn President, Chief Executive Officer and Chairman of the Board EX-31.B 11 ex31b.txt EXHIBIT 31(b) Certification of Chief Financial Officer Pursuant to Section 302 Of the Sarbanes-Oxley Act of 2002 I, James M. Sullivan, certify that: 1. I have reviewed this Annual Report on Form 10-K of Solutia Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: March 6, 2007 /s/ James M. Sullivan --------------------- James M. Sullivan Senior Vice President and Chief Financial Officer EX-32.A 12 ex32a.txt EXHIBIT 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 I, Jeffry N. Quinn, Chief Executive Officer of Solutia Inc. (the "Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that to the best of my knowledge: (1) the Annual Report on Form 10-K of the Company for the fiscal year ended December 31, 2006 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 6, 2007 /s/ Jeffry N. Quinn ------------------- Jeffry N. Quinn Chief Executive Officer A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Solutia Inc. and will be retained by Solutia Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.B 13 ex32b.txt EXHIBIT 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 I, James M. Sullivan, Chief Financial Officer of Solutia Inc. (the "Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that to the best of my knowledge: (1) the Annual Report on Form 10-K of the Company for the fiscal year ended December 31, 2006 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 6, 2007 /s/ James M. Sullivan --------------------- James M. Sullivan Chief Financial Officer A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Solutia Inc. and will be retained by Solutia Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-99.1 14 ex99p1.txt Exhibit 99.1 ================================================================================ - -------------------------------------------------------------------------------- SOLUTIA'S CATEGORICAL INDEPENDENCE STANDARDS FOR NON-EMPLOYEE DIRECTORS The Board shall have a majority of "independent directors" as defined in Section 303A of the New York Stock Exchange Listed Company Manual (as amended from time to time). The Board makes an affirmative determination regarding the independence of each director annually. A Director may be deemed independent only if the Board affirmatively determines the Director has no material relationship with the Company (either directly or as a partner, stockholder or officer of an organization that has a relationship with the Company). Material relationships may include commercial, industrial, banking, consulting, legal, accounting, charitable and financial relationships or any other relationships the Board deems material. The Board of Directors has adopted the following categorical standards to assist it in determining whether Directors are independent. A Director shall not be deemed independent if the Director: 1) is or has, during the last three years, been an employee of the Company; 2) is a current partner or a current employee of the Company's internal or external auditor or within the last three years was (but is no longer) a partner or employee of such firm and personally worked on the Company's audit within that time; 3) is or has, during the last three years, been employed as an executive officer by a company for which an executive officer of the Company concurrently served as a member of such company's compensation committee; 4) has an immediate family member (as defined below) who falls within the foregoing criteria; provided, however, that with respect to employment by the Company's internal or external auditor, the Director's immediate family member may be currently employed by the Company's auditor but may not participate in the firm's audit, assurance or tax compliance practice (participation in the tax planning practice is not covered by this standard) and, with respect to employment by the Company, the Director's immediate family member may serve or may have served as an employee but not as an executive officer of the Company during the last three years; 5) has received, or has an immediate family member who has received, more than $100,000 in direct compensation from the Company in any 12-month period during the last three years (other than director and committee fees; pension or other deferred compensation for prior service, provided that such compensation is not contingent in any way on continued service; and compensation paid to a Director's immediate family member for service as an employee, other than as an executive officer, of the Company); 6) is a current employee of, or has an immediate family member who is a current executive officer of, a company that made payments to, or received payments from, the Company for property or services in any of the last three years in an amount which, in any single fiscal year, exceeds the greater of $1 million, or 2% of such other company's consolidated gross revenues; or 7) is or has been, or has an immediate family member who is or has been, an executive officer, trustee or director of a tax exempt or non-profit organization to which the Company's contributions exceeded the greater of $1 million or 2% of such organization's consolidated gross revenues during the last three years. - -------------------------------------------------------------------------------- ================================================================================ -----END PRIVACY-ENHANCED MESSAGE-----