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SOLUTIA INC 10-Q 2011
form_10-q.htm


 

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
 
OR
 

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-13255

SOLUTIA INC.
(Exact name of registrant as specified in its charter)

DELAWARE
43-1781797
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

575 MARYVILLE CENTRE DRIVE, P.O. BOX 66760, ST. LOUIS, MISSOURI
63166-6760
(Address of principal executive offices)
(Zip Code)

(314) 674-1000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  X   No      

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes   X      No      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large Accelerated Filer   X   Accelerated Filer       Non-Accelerated Filer        Smaller Reporting Company ­___ (Do not check if a smaller reporting company).

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      No   X  

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by Court.  Yes  X    No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 
Class
 
Outstanding at
September 30, 2011
Common Stock, $0.01 par value
 
122,102,743


 
 

 
PART I. FINANCIAL INFORMATION

Item 1.  FINANCIAL STATEMENTS


SOLUTIA INC.
 
CONSOLIDATED STATEMENT OF OPERATIONS
 
(Dollars in millions, except per share amounts)
 
(Unaudited)
 
                         
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
                         
   
2011
   
2010
   
2011
   
2010
 
                         
Net Sales
  $ 519     $ 511     $ 1,571     $ 1,461  
Cost of goods sold
    370       353       1,090       996  
Gross Profit
    149       158       481       465  
Selling, general and administrative expenses
    65       62       187       194  
Research and development expenses
    6       5       17       13  
Other operating expense (income), net
    (30 )     3       (43 )     2  
Operating Income
    108       88       320       256  
Interest expense
    (24 )     (35 )     (78 )     (109 )
Other income (loss), net
    -       2       (1 )     15  
Loss on debt extinguishment or modification
    (2 )     -       (4 )     (89 )
Income from Continuing Operations Before Income Tax Expense
    82       55       237       73  
Income tax expense
    6       7       25       26  
Income from Continuing Operations
    76       48       212       47  
Income (Loss) from Discontinued Operations, net of tax
    -       2       -       (13 )
Net Income
    76       50       212       34  
Net income attributable to noncontrolling interest
    1       2       4       3  
Net Income attributable to Solutia
  $ 75     $ 48     $ 208     $ 31  
                                 
Basic Income (Loss) per Share attributable to Solutia:
                               
Income from Continuing Operations
  $ 0.62     $ 0.38     $ 1.74     $ 0.37  
Income (Loss) from Discontinued Operations
    -       0.02       -       (0.11 )
Net Income attributable to Solutia
  $ 0.62     $ 0.40     $ 1.74     $ 0.26  
                                 
Diluted Income (Loss) per Share attributable to Solutia:
                               
Income from Continuing Operations
  $ 0.62     $ 0.38     $ 1.71     $ 0.37  
Income (Loss) from Discontinued Operations
    -       0.02       -       (0.11 )
Net Income attributable to Solutia
  $ 0.62     $ 0.40     $ 1.71     $ 0.26  


CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
 
(Dollars in millions)
 
(Unaudited)
 
                         
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
                         
 
2011
 
2010
 
2011
 
2010
 
                         
Net Income
  $ 76     $ 50     $ 212     $ 34  
Other Comprehensive Income (Loss):
                               
Accumulated currency adjustments
    (79 )     92       2       3  
Postretirement adjustments
    2       -       5       3  
Hedging activity adjustments
    (4 )     (2 )     (6 )     -  
Comprehensive Income (Loss)
    (5 )     140       213       40  
Comprehensive Income attributable to noncontrolling interest
    1       2       4       3  
Comprehensive Income (Loss) attributable to Solutia
  $ (6 )   $ 138     $ 209     $ 37  
                                 
See accompanying Notes to Consolidated Financial Statements.
 

 
2

 

SOLUTIA INC.
 
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
 
(Dollars in millions, except per share amounts)
 
(Unaudited)
 
             
   
September 30,
   
December 31,
 
   
2011
   
2010
 
ASSETS
           
Current Assets:
           
Cash and cash equivalents
  $ 170     $ 191  
Trade receivables, net of allowances of $4 in 2011 and 2010
    240       228  
Miscellaneous receivables
    71       75  
Inventories
    356       275  
Prepaid expenses and other assets
    32       27  
Current assets of discontinued operations
    1       5  
Total Current Assets
    870       801  
Net Property, Plant and Equipment
    917       911  
Goodwill
    742       740  
Net Identified Intangible Assets
    912       938  
Other Assets
    134       147  
Total Assets
  $ 3,575     $ 3,537  
                 
LIABILITIES AND EQUITY
               
Current Liabilities:
               
Accounts payable
  $ 193     $ 173  
Accrued liabilities
    231       235  
Current liabilities of discontinued operations
    5       15  
Total Current Liabilities
    429       423  
Long-Term Debt
    1,337       1,463  
Postretirement Liabilities
    270       308  
Environmental Remediation Liabilities
    230       244  
Deferred Tax Liabilities
    226       238  
Non-current Liabilities of Discontinued Operations
    22       25  
Other Liabilities
    101       97  
                 
Commitments and Contingencies (Note 8)
               
                 
Equity:
               
Common stock at $0.01 par value; (500,000,000 shares authorized, 123,316,852 and
               
122,655,811 shares issued in 2011and 2010, respectively)
    1       1  
Additional contributed capital
    1,653       1,634  
Treasury shares, at cost (1,214,109 in 2011 and 772,686 in 2010)
    (13 )     (6 )
Accumulated other comprehensive loss
    (193 )     (194 )
Accumulated deficit
    (495 )     (703 )
Total Shareholders’ Equity attributable to Solutia
    953       732  
Equity attributable to noncontrolling interest
    7       7  
Total Equity
    960       739  
Total Liabilities and Equity
  $ 3,575     $ 3,537  
                 
See accompanying Notes to Consolidated Financial Statements.
 

 
3

 

SOLUTIA INC.
 
CONSOLIDATED STATEMENT OF CASH FLOWS
 
(Dollars in millions)
 
(Unaudited)
 
   
Nine Months Ended
 
   
September 30,
 
   
2011
   
2010
 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
           
OPERATING ACTIVITIES:
           
Net income
  $ 212     $ 34  
Adjustments to reconcile net income to net cash provided by operations:
               
Loss from discontinued operations, net of tax
    -       13  
Depreciation and amortization
    94       84  
Pension contributions in excess of expense
    (28 )     (51 )
Other postretirement benefit contributions in excess of expense
    (6 )     (13 )
Amortization of debt issuance costs and discount
    3       7  
Deferred income taxes
    (8 )     (13 )
Share-based compensation expense
    13       15  
Other charges:
               
Non-cash loss on deferred debt issuance cost and debt discount write-off
    -       80  
Other (gains) charges, including restructuring expenses
    (21 )     27  
Changes in assets and liabilities:
               
Income taxes payable
    (3 )     11  
Trade receivables
    (17 )     7  
Inventories
    (85 )     (24 )
Accounts payable
    18       (22 )
Environmental remediation liabilities
    (14 )     (10 )
Other assets and liabilities
    (14 )     66  
Cash Provided by Operations – Continuing Operations
    144       211  
Cash Used in Operations – Discontinued Operations
    (10 )     (26 )
Cash Provided by Operations
    134       185  
                 
INVESTING ACTIVITIES:
               
Property, plant and equipment purchases
    (70 )     (28 )
Acquisition related payments, net of cash acquired
    (9 )     (371 )
Asset disposals and investment sales
    60       3  
Other
    1       -  
Cash Used in Investing Activities – Continuing Operations
    (18 )     (396 )
Cash Provided by (Used in) Investing Activities – Discontinued Operations
    1       (3 )
Cash Used in Investing Activities
    (17 )     (399 )
                 
FINANCING ACTIVITIES:
               
Proceeds from long-term debt obligations
    -       1,144  
Payment of long-term debt obligations
    (127 )     (908 )
Payment of short-term debt obligations
    -       (16 )
Debt issuance costs
    -       (27 )
Purchase of treasury shares
    (7 )     (4 )
Dividends attributable to noncontrolling interest
    (4 )     (4 )
Other, net
    (2 )     (9 )
Cash Provided by (Used in) Financing Activities
    (140 )     176  
                 
Effect of Exchange Rate Changes on Cash and Cash Equivalents
    2       (24 )
                 
DECREASE IN CASH AND CASH EQUIVALENTS
    (21 )     (62 )
CASH AND CASH EQUIVALENTS:
               
Beginning of period
    191       243  
End of period
  $ 170     $ 181  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
               
Cash payments for interest
  $ 78     $ 75  
Cash payments for income taxes, net of refunds
  $ 37     $ 28  
                 
Non-Cash Investing Activities:
               
Capital expenditures included in accounts payable
  $ 12     $ 7  
                 
See accompanying Notes to Consolidated Financial Statements.
 

 
4

 

SOLUTIA INC.
 
CONSOLIDATED STATEMENT OF EQUITY
 
(Dollars in millions)
 
(Unaudited)
 
                               
   
Shareholders' Equity attributable to Solutia
         
               
Accumulated
     
Equity
     
       
Additional
     
Other
     
Attributable to
     
   
Common
 
Contributed
 
Treasury
 
Comprehensive
 
Accumulated
 
Noncontrolling
 
Total
 
   
Stock
 
Capital
 
Stock
 
Loss
 
Decifit
 
Interest
 
Equity
 
Beginning Balance – January 1, 2010
  $ 1   $ 1,612   $ (2 ) $ (237 ) $ (781 ) $ 7   $ 600  
Comprehensive income:
                                           
Net income
    -     -     -     -     31     3     34  
Accumulated currency adjustments
    -     -     -     3     -     -     3  
Postretirement adjustments
    -     -     -     3     -     -     3  
Dividends attributable to noncontrolling
   interest
    -     -     -     -     -     (4 )   (4 )
Treasury stock purchases
    -     -     (4 )   -     -     -     (4 )
Share-based compensation expense
    -     15     -     -     -     -     15  
Ending Balance – September 30, 2010
  $ 1   $ 1,627   $ (6 ) $ (231 ) $ (750 ) $ 6   $ 647  
                                             
Beginning Balance – January 1, 2011
  $ 1   $ 1,634   $ (6 ) $ (194 ) $ (703 ) $ 7   $ 739  
Comprehensive income (loss):
                                           
Net income
    -     -     -     -     208     4     212  
Accumulated currency adjustments
    -     -     -     2     -     -     2  
Postretirement adjustments
    -     -     -     5     -     -     5  
Hedging activity adjustments
    -     -     -     (6 )   -     -     (6 )
Dividends attributable to noncontrolling
   interest
    -     -     -     -     -     (4 )   (4 )
Treasury stock purchases
    -     -     (7 )   -     -     -     (7 )
Stock option exercises
    -     4     -     -     -     -     4  
Share-based compensation expense
    -     15     -     -     -     -     15  
Ending Balance – September 30, 2011
  $ 1   $ 1,653   $ (13 ) $ (193 ) $ (495 ) $ 7   $ 960  
                                             
See accompanying Notes to Consolidated Financial Statements.
 

 
5

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)


1.  Basis of Presentation

Basis of Presentation

Unless the context requires otherwise, the terms “Solutia”, “Company”, “we” and “our” in this report refer to Solutia Inc. and its subsidiaries. The accompanying consolidated financial statements have not been audited but have been prepared in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  Therefore, this Report on Form 10-Q should be read in conjunction with Solutia’s Report on Form 10-K for the fiscal year ended December 31, 2010.  In the opinion of management, these unaudited consolidated financial statements contain all adjustments necessary to present fairly our financial position, results of operations and cash flows for the interim periods reported.  Financial information for the first nine months of fiscal year 2011 should not be annualized due to the seasonality of our business.

2.  Acquisitions, Divestitures and Discontinued Operations

Acquisitions

On March 24, 2011, we entered into an agreement to acquire select assets from a leading conductive film manufacturing firm based in Taiwan for $7 with an option to purchase additional assets for $3, which was subsequently exercised.  The combined purchase price of $10, which was paid during the nine months ended September 30, 2011 and classified as a component of property, plant and equipment, represents the estimated fair value of manufacturing capacity used in the production of conductive film used in touch screens, solar applications and e-readers.  Results from the operations of these assets are included in our Performance Films reportable segment.

On April 30, 2010, we purchased 100 percent of the shares of Novomatrix Pte. Ltd. (“Novomatrix”) for $73, which was subsequently adjusted down $1 pursuant to a working capital adjustment. Novomatrix is a leader in branding, marketing and distributing performance window films catering to the premium segment in the automotive and architectural markets.  The Novomatrix acquisition allows us to support our growth strategy for our Performance Films reportable segment by expanding our product offerings and global footprint into key emerging regions through Novomatrix’s well-established network in Southeast Asia and the Middle East.

On June 1, 2010, we purchased 100 percent of the shares of Etimex Solar GmbH (“Vistasolar”) for $294 and $3 of incremental working capital.  Vistasolar is a leading supplier of EVA encapsulants to the photovoltaic market and enables us to expand our Advanced Interlayers product portfolio into each of the dominant photovoltaic encapsulant technologies.

The Novomatrix and Vistasolar acquisitions were accounted for as business combinations, and accordingly, the assets and liabilities of the acquired entities were recorded at their estimated fair value.  The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of both acquisitions:

   
Novomatrix
   
Vistasolar
 
   
April 30, 2010
   
June 1, 2010
 
Assets:
           
Trade receivables
  $ 2     $ 10  
Miscellaneous receivables
    1       -  
Inventories
    9       3  
Property, plant and equipment
    -       16  
Identified intangible assets
    50       119  
Goodwill
    25       187  
Total assets acquired
  $ 87     $ 335  
                 
Liabilities:
               
Accounts payable
  $ 4     $ 2  
Accrued liabilities
    3       1  
Postretirement liabilities
    -       1  
Deferred tax liabilities
    8       34  
Total liabilities assumed
  $ 15     $ 38  


 
6

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)


Goodwill largely consists of expected growth synergies through the application of each company’s innovative technologies and expansion of distribution channels in emerging markets in addition to cost synergies resulting from manufacturing and supply chain work process improvements.  Goodwill resulting from both acquisitions is not deductible for tax purposes.
 
The following table presents the weighted average life in years and the gross carrying value of the identified intangible assets included in net identified intangible assets within the Consolidated Statement of Financial Position on the date of acquisition for the Novomatrix and Vistasolar acquisitions.  The fair value of the identified intangible assets was determined using Level 3 inputs as defined by U.S. GAAP under the fair value hierarchy, which included valuation reports prepared by third party appraisal firms.

 
Novomatrix
 
Vistasolar
 
 
April 30, 2010
 
June 1, 2010
 
 
Weighted
     
Weighted
     
 
Average
 
Carrying
 
Average
 
Carrying
 
 
Life in Years
 
Value
 
Life in Years
 
Value
 
Technology
 
$
 
 20
 
$
 25
 
Customer relationships
 17
   
 29
 
 25
   
 81
 
Other
 5
   
 1
 
 3
   
 5
 
Trademarks
N/A
   
 20
 
N/A
   
 8
 
Total identified intangible assets
 17
 
$
 50
 
 23
 
$
 119
 
                     
Total weighted average life in years
 22
                 
 
Effective May 1, 2010 and June 1, 2010, results from the operations of Novomatrix and Vistasolar, respectively, have been included in our Consolidated Statement of Operations.  In conjunction with these acquisitions, we incurred $7 of costs during the nine months ended September 30, 2010 that were recorded in selling, general and administrative expenses.
 
The following pro forma financial information presents the combined results of operations of Solutia for the prior year presented as if the Novomatrix and Vistasolar acquisitions had occurred at the beginning of  2010.  The pro forma results below are not necessarily indicative of what actually would have occurred had the acquisitions been in effect for the periods presented and should not be taken as representation of our future consolidated results of operations.  Pro forma results are as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2010
   
September 30, 2010
 
Net sales
  $ 511     $ 1,516  
Net income
  $ 50     $ 45  
Net income per basic and dilutive share
  $ 0.42     $ 0.38  
Net income attributable to Solutia
  $ 48     $ 42  
Net income attributable to Solutia per basic and dilutive share
  $ 0.40     $ 0.35  

 
Divestitures
 
Certain Other Rubber Chemicals Businesses>

In the first quarter 2011, we sold certain businesses and selected assets previously included in our Technical Specialties reportable segment whereby we recognized a gain of $17 in other operating expense (income), net during the nine months ended September 30, 2011.  Our decision to exit these businesses is consistent with our strategy of focusing on businesses that are leaders in their global markets and that have sustainable competitive advantages.

 
7

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)



Plastic Products

On September 1, 2010, we sold the remaining portion of our former plastic products business, which was based in Europe, for $3. We recognized a loss of $5 in other operating expense (income), net related to this sale in Unallocated and Other.

Discontinued Operations

Primary Accelerators

On April 22, 2010, due to overcapacity within the industry, a disadvantaged cost position and increasing pressure from Far Eastern producers, we made the decision to exit our Primary Accelerators business and to cease manufacturing of SANTOCURE® primary accelerator products at the Monsanto Company (“Monsanto”) facility in Antwerp, Belgium, where we operated as a guest.  Our decision to exit this business is consistent with our strategy of focusing on businesses that are leaders in their global markets and that have sustainable competitive advantages.  Manufacturing of these products, the financial results of which had previously been included in our Technical Specialties reportable segment, ceased in the third quarter 2010.  Accordingly, we have reported the results of Primary Accelerators as a discontinued operation.

A summary of the net sales and income (loss) from discontinued operations related to our Primary Accelerators business is as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Primary Accelerators:
                       
Operating results:
                       
Net sales
  $ -     $ 12     $ -     $ 46  
Loss before income taxes
  $ -     $ (5 )   $ -     $ (46 )
Income tax benefit
    -       (7 )     -       (16 )
Income (Loss) from discontinued operations, net of tax
  $ -     $ 2     $ -     $ (30 )


 
8

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)
 
Included in the results of discontinued operations are $6 and $44 of pre-tax expenses for the three and nine months ended September 30, 2010 related to the shutdown of this business.  The shutdown expenses for the nine months ended September 30, 2010 include $6 for the impairment of long-lived assets determined using a Level 3 fair value measurement as defined by U.S. GAAP under the fair value hierarchy.
 
The assets and liabilities of our Primary Accelerators business, classified as discontinued operations, consist of the following:
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Assets:
           
Trade and miscellaneous receivables, net
  $ 1     $ 5  
Current assets of discontinued operations
  $ 1     $ 5  
                 
Liabilities:
               
Accounts payable and accrued liabilities
  $ 5     $ 15  
Current liabilities of discontinued operations
  $ 5     $ 15  
                 
Other liabilities
  $ 22     $ 25  
Non-current liabilities of discontinued operations
  $ 22     $ 25  
                 
Total liabilities
  $ 27     $ 40  
                 

Integrated Nylon

On June 1, 2009, we sold substantially all the assets and certain liabilities, including environmental remediation liabilities and pension liabilities of active employees, of our Integrated Nylon business to S.K. Capital Partners II, L.P. (the “Buyer”).  As part of the sale agreement, we retained an ownership interest in the Integrated Nylon business of approximately 2 percent.  At the time of sale, we agreed to reimburse the Buyer for indirect residual costs incurred by them resulting from a disputed contractual matter with a guest at the Integrated Nylon plant in Alvin, Texas.  Accordingly, our estimate of the loss associated with the damages and cost reimbursements associated with this contingent liability was accrued in 2009.  On April 30, 2010, we entered into a settlement agreement that resolved all outstanding matters with the guest in exchange for payment by us of $17.  Separately, we entered into an agreement with the Buyer whereby our liability for indirect residual costs at the plant was settled in exchange for a payment by us of $4.  Each settlement became effective and was paid in 2010.  Based on the terms of the settlements, we recognized a gain of $17 in the second quarter 2010 in the results from discontinued operations.

A summary of the income from discontinued operations related to our Integrated Nylon business is as follows:

 
Nine Months Ended
 
 
September 30,
 
 
2011
 
2010
 
Integrated Nylon:
           
Operating results:
           
Income before income taxes
  $ -     $ 17  
Income tax expense
    -       -  
Income from discontinued operations, net of tax
  $ -     $ 17  

In the third quarter 2011, we sold our remaining 2% ownership interest in Ascend Performance Materials Holdings Inc., previously our Integrated Nylon business, for $31, resulting in a gain of $29 being recorded in other operating expense (income), net for the three and nine months ended September 30, 2011.

3.  Share-Based Compensation

Stock Options

We granted options to purchase a total of 905,617 shares of common stock to eligible employees during the nine months ended September 30, 2011 under our 2007 Management Long-Term Incentive Plan (“2007 Management Plan”).  The options granted (i) have an exercise price equal to the quoted market price of the common stock on the grant date, (ii) become exercisable in four equal installments on the first, second, third and fourth anniversaries of the grant date, subject to the employee’s continued employment and (iii) expire on the tenth anniversary of the grant date.  We did not grant any options under our 2007 Non-Employee Director Stock Compensation Plan (“2007 Director Plan”) during the nine months ended September 30, 2011.

 
9

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)



We determine the fair value of stock options at the grant date using a Black-Scholes model, which requires us to make several assumptions including risk-free interest rate, expected dividends and volatility.  The risk-free rate is based on the U.S. Treasury yield curve in effect for the expected term of the options at the time of grant.  The dividend yield on our common stock is assumed to be zero since we do not pay dividends and have no current plans to do so.  Due to our emergence from bankruptcy in 2008, our historical volatility data and employee stock option exercise patterns were not considered in determining the volatility data and expected life assumptions.  Instead, volatility assumptions were based on (i) historical volatilities of the stock of comparable chemical companies whose shares are traded using daily stock price returns over a term equivalent to the expected term of the options and (ii) implied volatility.  The expected life of an option was determined based on a simplified assumption that the option will be exercised evenly from the time it becomes exercisable to expiration.

The weighted average fair value of options granted during the nine months ended September 30, 2011 was determined based on the following weighted average assumptions:

   
September 30, 2011
 
       
Expected volatility
    38.56 %
Expected term (in years)
    6.3  
Risk-free rate
    2.84 %
Weighted average grant date fair value
  $ 9.77  

A summary of stock option information as of September 30, 2011 is as follows:

 
Options
 
Weighted Average
Exercise Price
 
Weighted Average
Remaining
Contractual Life
 
Aggregate Intrinsic
Value (a)
 
Vested or Expected to Vest at September 30, 2011
3,163,930
 
$
18.59
 
7.8
 
$
-
 
Exercisable at September 30, 2011
1,826,724
 
$
17.41
 
6.8
 
$
-
 
                     
 
(a) Intrinsic value for stock options is calculated based on the difference between the exercise price of the underlying awards and the quoted market price of our common stock as of the reporting date.
 
During the three and nine months ended for both September 30, 2011 and 2010, we recognized $2 and $4 of compensation expense related to our stock options, respectively.  Pre-tax unrecognized compensation expense for stock options, net of estimated forfeitures, was $10 as of September 30, 2011 which will be recognized as expense over a remaining weighted-average period of 2 years.

Restricted Stock Awards

We granted 440,180 shares of restricted stock awards with a weighted average grant date fair value of $25.16 per share to certain employees under our 2007 Management Plan during the nine months ended September 30, 2011.  Half of the 2007 Management Plan shares vest upon completion of a service condition and the remaining half of the shares vest based upon the attainment of certain performance and market conditions (“Performance Shares”). The service condition shares vest in four equal installments on the first, second, third and fourth anniversaries of the grant date and the Performance Shares vest in 2014 if attainment of the performance and market conditions is achieved.  The actual vesting of the Performance Shares could range from zero to 175 percent of the targeted number of shares depending upon actual performance.

 
10

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)



We granted 25,048 shares of restricted stock awards as an annual equity retainer with a weighted average grant date fair value of $24.41 per share to our non-employee directors under the 2007 Director Plan during the nine months ended September 30, 2011.  The shares vest in three equal installments, with the first installment vesting as of the date of the grant and the remaining vesting equally on the first and second anniversary of the grant date.

During the three and nine months ended for both September 30, 2011 and 2010, we recognized $4 and $11 of compensation expense, respectively, related to our restricted stock awards.  Pre-tax unrecognized compensation expense for restricted stock awards, net of estimated forfeitures, was $16 as of September 30, 2011 which will be recognized as expense over a remaining weighted average period of 2 years.

4. Goodwill and Other Intangible Assets

Goodwill

Goodwill by reportable segment is as follows:

 
Advanced
 
Performance
 
Technical
       
 
Interlayers
 
Films
 
Specialties
 
Total
 
Balance at December 31, 2010
  $ 407     $ 186     $ 147     $ 740  
Currency fluctuations
    3       (1 )     -       2  
Balance at September 30, 2011
  $ 410     $ 185     $ 147     $ 742  

We do not have any goodwill that is deductible for tax purposes.

Identified Intangible Assets

Identified intangible assets are summarized in aggregate as follows:

   
September 30, 2011
   
December 31, 2010
 
   
Estimated
                     
Estimated
                   
   
Useful
 
Gross
       
Net
   
Useful
 
Gross
       
Net
 
   
Life in
 
Carrying
 
Accumulated
 
Carrying
   
Life in
 
Carrying
 
Accumulated
 
Carrying
 
   
Years
 
Value
 
Amortization
 
Value
   
Years
 
Value
 
Amortization
 
Value
 
Amortizable intangible assets:
                                               
Customer relationships
 
13 to 27
    $ 609     $ (74 )   $ 535    
13 to 27
    $ 606     $ (56 )   $ 550  
Technology
 
5 to 26
      226       (37 )     189    
5 to 26
      225       (29 )     196  
Trade names
 
10 to 25
      19       (2 )     17    
10 to 25
      20       (1 )     19  
Patents
  13       5       (2 )     3     13       5       (1 )     4  
Other
 
3 to 5
      6       (3 )     3    
3 to 5
      6       (1 )     5  
Non-amortizable intangible assets:
                                                               
Trademarks
            165       -       165               164       -       164  
Total identified intangible assets
          $ 1,030     $ (118 )   $ 912             $ 1,026     $ (88 )   $ 938  
 

 
 
11

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)
 
 
Amortization expense for intangible assets and its allocation to cost of goods sold and selling, general and administrative expenses in the Consolidated Statement of Operations is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2011
 
2010
 
2011
 
2010
 
                         
Cost of goods sold
  $ 3     $ 3     $ 9     $ 8  
Selling, general and administrative expenses
    7       7       21       17  
Total
  $ 10     $ 10     $ 30     $ 25  

We expect to recognize amortization expense for intangible assets of approximately $39 for each of the years ending December 31, 2011 through 2015.

5. Detail of Certain Balance Sheet Accounts

Components of inventories are as follows:

   
September 30,
   
December 31,
 
Inventories
 
2011
   
2010
 
             
Finished goods
  $ 211     $ 163  
Goods in process
    45       36  
Raw materials and supplies
    100       76  
Inventories
  $ 356     $ 275  

On January 1, 2010 we changed our method of accounting for inventories in the United States, excluding supplies, from determining cost using the LIFO method to determining cost using the FIFO method, consistent with all of our other operations.  We believe this change is preferable as the FIFO method better reflects the current value of inventories on the Consolidated Statement of Financial Position and provides a uniform costing method across our global operations.  Prior financial statements were not retroactively adjusted due to immateriality. The cumulative effect of the change in accounting principle of $1 was recorded as an increase to cost of goods sold as of January 1, 2010.

Components of property, plant and equipment are as follows:

   
September 30,
   
December 31,
 
Property, Plant and Equipment
 
2011
   
2010
 
             
Land
  $ 35     $ 35  
Leasehold improvements
    10       10  
Buildings
    216       214  
Machinery and equipment
    835       796  
Construction in progress
    85       54  
Total property, plant and equipment
    1,181       1,109  
Less: Accumulated depreciation
    (264 )     (198 )
Net Property, Plant, and Equipment
  $ 917     $ 911  
 

 
 
12

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)
 
Components of accrued liabilities are as follows:
   
September 30,
   
December 31,
 
Accrued Liabilities
 
2011
   
2010
 
             
Wages and benefits
  $ 41     $ 45  
Foreign currency and interest rate derivative agreements
    25       17  
Restructuring reserves
    4       5  
Environmental remediation liabilities
    29       29  
Accrued income taxes payable
    7       19  
Accrued taxes other than income
    16       27  
Accrued selling expenses
    15       17  
Accrued interest
    15       13  
Other
    79       63  
Accrued Liabilities
  $ 231     $ 235  

6.  Income Taxes

Income Tax Expense

We recorded net income tax expense of $6 and $25 for the three and nine months ended September 30, 2011, respectively, and net income tax expense of $7 and $26 for the three and nine months ended September 30, 2010, respectively.  Our income tax expense is affected by changes in unrecognized tax benefits and the mix of income and losses in the tax jurisdictions in which we operate.  For the three and nine month periods ended September 30, 2011, discrete tax benefits of $5 and $9, respectively, were recognized while for the three and nine month periods ended September 30, 2010, discrete tax benefits of $4 and $10, respectively, were recognized.   Income tax expense recorded in the three and nine months ended September 30, 2011 relates only to foreign jurisdictions because we have a U.S. net operating loss deferred tax asset, against which a full valuation allowance has been provided.  For the three and nine months ended September 30, 2010, we experienced a loss from U.S. operations but no income tax benefit was recognized as a full valuation allowance has been provided against the U.S. deferred tax assets.
  
Unrecognized Tax Benefits

The total amount of unrecognized tax benefits, inclusive of interest and penalties, at September 30, 2011 and December 31, 2010 was $168 and $167, respectively.  Included in the balance at September 30, 2011 and December 31, 2010 were $69 and $68, respectively, of unrecognized tax benefits that, if recognized, would impact the effective tax rate.  The increase in the amount of the unrecognized tax benefits is mainly the effect of tax positions with respect to events in the current year offset by the reevaluation of tax positions not yet settled, the closure of tax audits and currency exchange rate fluctuations.

We file income tax returns in the U.S. and various states and foreign jurisdictions.  With few exceptions, we are no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2002.  With few exceptions, we are no longer subject to foreign income tax examinations by tax authorities for years before 2006.  It is reasonably possible that within the next 12 months as a result of the resolution of federal, state and foreign examinations and appeals, and the expiration of various statutes of limitation that the unrecognized tax benefits that would affect the effective tax rate will decrease by a range of zero to $24 and the unrecognized tax benefits that would not affect the effective tax rate will decrease by a range of zero to $15.

7.  Restructuring Reserves

In an effort to maintain competitiveness across our businesses and the geographic areas in which we operate and to enhance the efficiency and cost effectiveness of our support operations, we periodically initiate certain restructuring activities which result in charges for costs associated with exit or disposal activities, severance and/or impairment of long-lived assets.  Many of these activities are associated with certain strategic divestitures or plant shut-downs executed in order to eliminate non-core products that lack a sustainable competitive advantage.  The region that has historically been most significantly impacted by these actions has been Europe.

 
13

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)


To right-size our support structure in Europe and lower our operating costs in the region, we relocated our European regional headquarters in the second quarter 2011 from a building located in Louvain-la-Neuve, Belgium (“LLN”), which we own, to a multi-tenant building in which we lease office space in Zaventem, Belgium.  Accordingly, we have initiated a process to sell the LLN building and have reclassified this asset as held for sale.  In conjunction with this reclassification, we were required to perform an impairment test of this asset group.  For purposes of testing for impairment and using all available evidence, we estimated the fair value of this asset group by weighting estimated sales proceeds and discounted cash flows that the asset group could be expected to generate through the time of an assumed sale using a Level 3 fair value measurement as defined by U.S. GAAP under the fair value hierarchy.  Our test concluded impairment existed on March 31, 2011 and, accordingly, we recorded a charge of $8 to other operating expense (income), net in the first quarter 2011 to reduce the carrying value of this asset to its estimated fair value and reclassified the asset to prepaid expenses and other current assets.  Further and in addition to the above, we initiated a reduction in support personnel in this region which resulted in charges of $4 to selling, general and administrative for the nine months ended September 30, 2011.  There were no charges related to this project during the third quarter.  A summary of the charges recorded to Unallocated and Other related to this restructuring action for the nine months ended September 30, 2011 are as follows:

       
Impairment of
       
 
Employment
 
Long-Lived
       
 
Reductions
 
Assets
 
Total
 
Nine Months Ended and cumulative through September 30, 2011:
                 
Selling, general and administrative expenses
  $ 4     $ -     $ 4  
Other operating expense (income), net
    -       8       8  
Total
  $ 4     $ 8     $ 12  

A summary of all activity on the restructuring liability during the nine months ended September 30, 2011 is as follows:

   
Contract
         
Impairment of
       
   
Termination
   
Employment
   
Long-Lived
       
   
Payments
   
Reductions
   
Assets
   
Total
 
Balance at December 31, 2010
  $ 2     $ 5     $ -     $ 7  
Charges taken
    -       4       8       12  
Amounts utilized
    -       (6 )     -       (6 )
Non-cash reductions
    -       -       (8 )     (8 )
Currency fluctuations
    -       1       -       1  
Balance at September 30, 2011
  $ 2     $ 4     $ -     $ 6  

We expect $4 of restructuring liabilities as of September 30, 2011 to be utilized within the next twelve months.

8.  Commitments and Contingencies

Litigation

We are a party to legal proceedings, which have arisen in the ordinary course of business and involve claims for monetary damages.  As of September 30, 2011 and December 31, 2010, we had accrued approximately $2 and $3, respectively, for legal costs to defend ourselves in legal matters.

Except for the potential effect of an unfavorable outcome with respect to our Legacy Tort Claims Litigation, it is our opinion that the aggregate of all claims and lawsuits will not have a material adverse impact on our consolidated financial statements.

 
14

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)

 
Legacy Tort Claims Litigation

Pursuant to the Amended and Restated Settlement Agreement effective February 28, 2008, entered into by us and Monsanto in connection with our emergence from Chapter 11 (the “Monsanto Settlement Agreement”), Monsanto is responsible to defend and indemnify us for any Legacy Tort Claims as that term is defined in the Monsanto Settlement Agreement, while we retain responsibility for tort claims, if any, which may arise out of our conduct after our spinoff from Pharmacia, which occurred on September 1, 1997.  We or our fully owned subsidiary, Flexsys, have been named as defendants in the following actions, and have submitted the matters to Monsanto as Legacy Tort Claims.  However, to the extent these matters relate to post Solutia Spinoff conduct or such matters are not within the meaning of Legacy Tort Claims as defined in the Monsanto Settlement Agreement, we could potentially be liable.

Putnam County, West Virginia Litigation.> In December 2004, a purported class action lawsuit was filed in the Circuit Court of Putnam County, West Virginia against Flexsys, Pharmacia, Monsanto and Akzo Nobel (Solutia is not a named defendant) alleging exposure to dioxin from Flexsys’ Nitro, West Virginia facility, which is now closed.  The relevant production activities at the facility occurred during Pharmacia’s ownership and operation of the facility and well prior to the creation of the Flexsys joint venture between Pharmacia (whose interest was subsequently transferred to us in the Solutia Spinoff) and Akzo Nobel.  The plaintiffs are seeking damages for loss of property value, medical monitoring and other equitable relief.  In May 2011, the West Virginia circuit court entered summary judgment in favor of Flexsys in the class action litigation, and dismissed Flexsys with prejudice from the case.  Specifically, the court held that plaintiffs had presented no evidence of contamination or distribution of dioxin by Flexsys during its ownership of the Nitro facility.

Beginning in February 2008, Flexsys, Monsanto, Pharmacia, Akzo Nobel and another third party were named as defendants in approximately seventy-five individual lawsuits, and Solutia was named in two individual lawsuits, filed in various state court jurisdictions by residents or former residents of Putnam County, West Virginia.  The largely identical complaints allege that the residents were exposed to potentially harmful levels of dioxin particles from the Nitro facility.  Plaintiffs did not specify the amount of their alleged damages in their complaints.  In 2009, over fifty additional nearly identical complaints were filed by individual plaintiffs in the Putnam County area, which named Solutia and Flexsys as defendants, and one additional complaint was filed in January 2011.

The claims in this matter concern alleged conduct occurring while Flexsys was a joint venture between us and Akzo Nobel, and any potential damages in these cases would be evenly apportioned between us and Akzo Nobel to the extent such claims are determined not to be Legacy Tort Claims.

Escambia County, Florida Litigation.> In June 2008, a group of approximately fifty property owners and business owners in the Pensacola, Florida area filed a lawsuit in the Circuit Court for Escambia County, Florida against Monsanto, Pharmacia, Solutia and the plant manager at Solutia's former Pensacola plant, an Integrated Nylon asset that was included in the divestiture of our Integrated Nylon business.  The lawsuit, entitled John Allen, et al. v. Monsanto Company, et al., alleges that the defendants are responsible for elevated levels of PCBs in the Escambia River and Escambia Bay due to past and continuing releases of PCBs from the Pensacola plant.  The plaintiffs seek: (1) damages associated with alleged decreased property values caused by the alleged contamination and (2) remediation of the alleged contamination in the waterways.  Plaintiffs did not specify the amount of their alleged damages in their complaint.  Plaintiffs have subsequently amended their complaint twice to add additional plaintiffs to the litigation, such that approximately 150 property and business owners are now named as plaintiffs.

St. Clair County, Illinois and Related Litigation.> In February 2009, a purported class action lawsuit was filed in the Circuit Court of St. Clair County, Illinois against Solutia, Pharmacia, Monsanto and two other unrelated defendants alleging the contamination of the plaintiff’s property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois (including our W.G. Krummrich site in Sauget, Illinois).  The proposed class action is comprised of residents who live within a two-mile radius of the Sauget facilities.  The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of contaminants from their property.  This action is one of several lawsuits (primarily filed by the same plaintiffs’ counsel) over the past year regarding alleged historical contamination from the W.G. Krummrich site.

In addition to the purported class action lawsuit, twenty additional individual lawsuits have been filed since February 2009 against the same defendants (including Solutia) comprised of claims from over one thousand individual residents of Illinois who claim they suffered illnesses and/or injuries as well as property damages as a result of the same PCBs, dioxins, furans and other hazardous substances allegedly emanating from the defendants’ facilities in Sauget.  In June 2010, a group of approximately 1,200 plaintiffs also filed wrongful death claims in a lawsuit in St. Clair County arising out of alleged contamination from the defendants’ facilities.  Moreover, four additional individual lawsuits comprised of claims from twelve plaintiffs were filed between January and April 2010 in Madison County, Illinois, alleging that plaintiffs suffered illnesses resulting from exposure to benzene, PCBs, dioxins, furans and other hazardous substances.  Lastly, in June 2010, a second purported class action lawsuit was filed in the Circuit Court of St. Louis City, Missouri against the same defendants alleging the contamination of the plaintiffs’ property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois and from our now-closed Queeny plant in St. Louis.  The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of alleged contaminants from their property.  The proposed class members include residents exclusively within the state of Missouri.

 
15

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)



Upon assessment of the terms of the Monsanto Settlement Agreement and other defenses available to us, we believe the probability of an unfavorable outcome to us on the Putnam County, West Virginia; Escambia County, Florida; and St. Clair County, Illinois and related litigation against us is remote and, accordingly, we have not recorded a loss contingency.  Nonetheless, if it were subsequently determined these matters are not within the meaning of Legacy Tort Claims, as defined in the Monsanto Settlement Agreement, or other defenses to us were unsuccessful, it is reasonably possible we would be liable for an amount which cannot be estimated but which could have a material adverse effect on our consolidated financial statements.

Resolution of Tax Indemnification

During the second quarter 2010, we received a favorable settlement in a tax indemnification case related to income taxes we paid on a business for periods prior to our acquisition.  The settlement resulted in an $8 gain recorded in other income (loss), net within Unallocated and Other during the nine months ended September 30, 2010.

Environmental Liabilities

In the ordinary course of business, we are subject to numerous environmental laws and regulations covering compliance matters or imposing liability for the costs of, and damages resulting from, cleaning up sites, past spills, disposals and other releases of hazardous substances.  We have incurred, and we may in the future incur, liabilities to investigate and clean up waste or contamination at our current facilities, properties adjacent to our current facilities or facilities operated by third parties at where we may have disposed of waste or other materials.  Under some circumstances, the scope of our liability may extend to damages to natural resources for which we have accrued $2 as of September 30, 2011 and December 31, 2010, which is exclusive of the balances noted below.  In almost all cases, our potential liability arising from historical contamination is based on operations and other events occurring at our facilities or as a result of their operation prior to the Solutia Spinoff.

Further, under terms of the Monsanto Settlement Agreement, we have agreed to share responsibility with Monsanto for the environmental remediation at certain locations outside our plant boundaries in Anniston, Alabama and Sauget, Illinois which were also incurred prior to the Solutia Spinoff (the “Shared Sites”).  Under this cost-sharing arrangement, we are responsible for the funding of environmental liabilities at the Shared Sites from February 28, 2008 (the “Effective Date”) up to a total of $325.  Thereafter, if needed, we and Monsanto will share responsibility equally.  From the Effective Date through September 30, 2011, we have made cash payments of $33 toward remediation of the Shared Sites and have accrued an additional $161 to be paid over the life of the Shared Sites remediation activity.

Reserves for environmental remediation that we believe to be probable and estimable are recorded appropriately as current and long-term liabilities in the Consolidated Statement of Financial Position.  These reserves include liabilities expected to be paid out within fifteen years.  The amounts charged to pre-tax earnings for environmental remediation and related charges are included in cost of goods sold and are summarized below:

   
Total
 
Balance at December 31, 2010
 
$
 273
 
Net charges taken
   
 4
 
Amounts utilized
   
 (19)
 
Currency fluctuations
   
 1
 
Balance at September 30, 2011
 
$
 259
 

   
September 30, 2011
   
December 31, 2010
 
Environmental Remediation Liabilities, current
  $ 29     $ 29  
Environmental Remediation Liabilities, long-term
    230       244  
Total
  $ 259     $ 273  
 

 
 
16

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)
 
In addition to accrued environmental liabilities, there are costs which have not met the definition of probable, and accordingly, are not recorded in the Consolidated Statement of Financial Position.  These loss contingencies are monitored regularly for a change in fact or circumstance that would require an accrual adjustment.  These matters involve significant unresolved issues, including the interpretation of applicable laws and regulations, the outcome of negotiations with regulatory authorities and alternative methods of remediation. Because of these uncertainties, the potential liability for existing environmental remediation may range up to two times the amount recorded, which would be settled through cash payment over an extended period of time.
 
Except as noted below, we believe that these matters, when ultimately resolved, which may be over an extended period of time, will not have a material adverse effect on our Consolidated Statement of Financial Position, but could have a material adverse effect on our Consolidated Statement of Operations in any given period.  Our significant sites are described in more detail below:

Anniston, Alabama.>  On Aug. 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Revised Partial Consent Decree, pursuant to which Pharmacia and Solutia are obligated to perform, among other things, residential cleanup work and a remedial investigation/feasibility study (“RI/FS”) as a result of PCB contamination from our Anniston plant, which occurred prior to the Solutia Spinoff.  The residential cleanup of available properties was completed in 2010.  Furthermore, in 2010 the Anniston Plant Site RI/FS was completed and approved.  On September 29, 2011 the United States Environmental Protection Agency (“USEPA”) issued its interim Record of Decision (“ROD”) setting out the required remedies associated with the plant, which were mainly as the Company proposed in the FS.  Upon negotiation of a Consent Decree with USEPA, Solutia will implement this interim ROD over the next few years and a final ROD will be issued some time after the interim ROD is completed.  The RI/FS for the non-residential properties and the creeks/floodplain are ongoing but it is probable that some level of remediation and/or sediment removal will be required in the future.  We have accrued for this liability based upon our understanding of the level and extent of contamination in these areas, the remedial effort likely to be required by various governmental organizations and estimated costs associated with similar remediation projects.  We may recover some of our investigation and remediation costs from parties, against whom we filed a cost recovery action in July 2003 but because the eventual outcome of these proceedings is uncertain, our environmental liability at September 30, 2011 does not incorporate this potential reimbursement.  State and Federal Natural Resource Damage Trustees have asserted a claim for potential natural resource damage and advised us that they are preparing to undertake an assessment as to the nature and extent of such damages.  These Trustees have requested we consider entering into a cooperative agreement to perform a damage assessment and discussions on potential settlement of the Trustees claims are ongoing.  As of September 30, 2011, we have accrued $107 for all environmental remediation projects in the Anniston, Alabama area which represents our best estimate of the ultimate liability.  Timing of the remediation will not be established until we complete the remaining RI/FS work, a ROD covering the off-plant areas is issued by the United States Environmental Protection Agency (“USEPA”), and a consent decree for each of these RODS is negotiated and entered by the court to cover the selected remediation, which will take several years.

Sauget, Illinois.>  A number of industries, including our W.G. Krummrich Plant, have operated and disposed of wastes in Sauget, Illinois.  Areas of contamination from these industrial operations, which for our W.G. Krummrich Plant occurred prior to the Solutia Spinoff, have been classified as part of either the Sauget Area 1 Sites or the Sauget Area 2 Sites.  We conducted a RI/FS for the Sauget Area 1 Sites under an Administrative Order on Consent issued on January 21, 1999.  Although an extensive removal action for one of the Sauget Area 1 Sites was conducted under a Unilateral Administrative Order issued on May 31, 2000, the cost and timing of any additional required remedial actions will be established only after a ROD is issued by the USEPA, and a consent decree is negotiated and entered by the court to cover the selected remediation.  We have an agreement with two other potentially responsible parties (“PRPs”) to enter into an allocation proceeding upon issuance of the ROD to resolve our respective shares of the liability for the Sauget Area 1 Sites.  With respect to the Sauget Area 2 Sites, we, in coordination with 19 other PRPs, are also required to conduct a RI/FS for the Sauget Area 2 Sites under an Administrative Order on Consent issued effective November 24, 2000.  We submitted the revised RI/FS report with these PRPs based on interim allocations and have agreed, upon issuance of the ROD, to participate in an allocation proceeding to fully resolve each PRP’s share of the liability for the investigation and remediation costs.  For each of the Sauget Area 1 and 2 Sites, we anticipate the USEPA and Illinois Environmental Protection Agency (“IEPA”) to issue a ROD with final action for the landfill/impoundment covers within the next two years.   However, although an interim groundwater remedy has been installed pursuant to a Unilateral Administrative Order issued on October 3, 2002, it is uncertain when the USEPA and IEPA will issue a final remedy for the groundwater operable unit.  Our ultimate exposure at these sites will depend on the final remedial actions to be taken and on the level of contribution from other PRPs.  In addition, several PRPs, including Solutia and Pharmacia, received in June 2009 from the U.S. Department of the Interior, on behalf of various federal and state natural resource trustees, a notice of intent to perform and an invitation to cooperate in a natural resource damage assessment for the Sauget Industrial Corridor.  Our best estimate of the ultimate cost of all remedial measures that will be required at the Sauget, Illinois area sites is $68 which we have accrued as of September 30, 2011.
 
17

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)

 
W. G. Krummrich Site.>  We entered into a Consent Order under the U.S. Resource Conservation and Recovery Act of 1976, as amended, effective May 3, 2000, to investigate and remediate soil and groundwater contamination from our manufacturing operations at the W.G. Krummrich Plant, which occurred prior to the Solutia Spinoff.  We conducted an extensive corrective measures study and a Final Decision was issued by the USEPA in February 2008 setting out the required corrective measures to be completed.  Due to the complexity of the contamination issues at this site, certain of the corrective measures will be performed in phases.  Required pilot testing has been completed and the design/implementation of full scale remediation systems has commenced with operation of these systems expected until at least 2015. Our best estimate of the remaining cost to perform all corrective measures that will be required at the W.G. Krummrich Site is $22, which we have accrued as of September 30, 2011.

We also have accruals for remedial obligations at several of our current or former manufacturing sites which we have owned or operated since the Solutia Spinoff.  Our best estimate of the ultimate cost of all corrective measures that will be required at these sites is $62 which we have accrued as of September 30, 2011.

9.  Debt Obligations

In the first quarter of 2010, we issued $300 of senior unsecured notes at 99.5 percent of par bearing interest at 7.875 percent (“7.875% Notes”), which resulted in net proceeds of $292 after deducting underwriting fees and discounts.  The 7.875% Notes require semi-annual interest payments and are due in 2020.

Also in the first quarter of 2010, we extinguished our previous term loan and revolving credit facility, replacing them with a senior secured credit facility (“Credit Facility”) which consisted of an $850 term loan maturing in March 2017 (“2017 Term Loan”) and a $300 revolving credit facility maturing in 2015 (“2015 Revolver”).  Early extinguishment of our previous term loan and revolving credit facility resulted in the write-off of deferred debt issuance costs associated with this debt in the amount of $80 along with the expense of a $9 prepayment penalty.  These amounts were recorded in loss on debt extinguishment or modification for the nine months ended September 30, 2010.

In the first quarter of 2011, we amended the 2017 Term Loan which resulted in the maturity being extended to August 2017, a reduction in the interest rate of 100 basis points, greater strategic flexibility and the replacement of previous financial covenants with a single senior secured leverage ratio.  In connection with the amendment, we incurred $2 of fees which were recorded in loss on debt extinguishment or modification in the nine months ended September 30, 2011.  After the amendment, the principal amount was $700, which bears interest at one month LIBOR plus 2.75 percent with a 0.75 percent LIBOR floor.  We are required to pay 1 percent of principal annually via quarterly payments.  The 2015 Revolver bears interest, at our option, at LIBOR plus 3.25 percent, with no LIBOR floor, or at the prime rate plus 2.25 percent.  LIBOR-based interest for the 2017 Term Loan is payable each month while interest on the 2015 Revolver is payable on the last day of each relevant interest period (defined as one month, two, three or six months or other periods available to all lenders) and, in the case of any interest period longer than three months, on each successive date three months after the first day of such interest period.  Prime-based interest for the 2015 Revolver is payable quarterly in arrears.  CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc. and future subsidiaries, as defined by the Credit Facility, subject to certain exceptions (the “Credit Facility Guarantors”), are guarantors of our obligations under the Credit Facility.  The Credit Facility and the related guarantees are secured by liens on substantially all of our and the Credit Facility Guarantors’ present and future assets.

Also outstanding at September 30, 2011 and December 31, 2010 were senior unsecured notes, originally issued at par in exchange for $400, bearing interest at 8.75 percent (“8.75% Notes”), which require semi-annual interest payments and are due in 2017.

In the nine months ended September 30, 2011, we made $102 of principal payments on our 2017 Term Loan and $25 million in combined open market repurchases on our 7.875% Notes and 8.75% Notes.  In conjunction with these open market repurchases, we paid a premium of $2, which was recorded in loss on debt extinguishment or modification for the three and nine months ended September 30, 2011.

 
18

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)

 
We had no short-term borrowings at September 30, 2011 and December 31, 2010.  Components of long-term debt are as follows:

   
September 30, 2011
   
December 31, 2010
 
2017 Term Loan
  $ 666     $ 768  
8.75% Notes
    389       400  
7.875% Notes
    286       300  
Total principal amount
    1,341       1,468  
Less: Unamortized debt discount
    (4 )     (5 )
Total
  $ 1,337     $ 1,463  
                 

The weighted average interest rate on our total debt outstanding was 6 percent and 6.4 percent at September 30, 2011 and December 31, 2010, respectively.

The Credit Facility, the 7.875% Notes and the 8.75% Notes include a number of customary covenants and events of default that restrict our ability to, among other things, incur additional debt; make certain investments; pay dividends; repurchase stock; sell certain assets or merge with or into other companies; enter into new lines of business and prepay, redeem or exchange our debt.  The Credit Facility also includes the maintenance of a maximum senior secured indebtedness financial covenant as defined by the Credit Facility.  We were in compliance with all applicable covenants as of September 30, 2011.

Our current subsidiaries CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc., S E Investment LLC and future subsidiaries as defined by the notes, subject to certain exceptions, are guarantors (“Note Guarantors”) of the 7.875% Notes and the 8.75% Notes as of September 30, 2011.

10.  Derivatives and Risk Management

Our business operations give rise to market risk exposures that result from changes in foreign currency exchange rates, interest rates and certain commodity prices.  To manage the volatility relating to these exposures, we periodically enter into various derivative transactions that enable us to mitigate the adverse effects of financial market risk.  We evaluate hedge effectiveness at inception and on an ongoing basis.  If a derivative is no longer expected to be effective or if the hedged transaction is no longer probable of occurring, hedge accounting is discontinued.  Hedge ineffectiveness, if any, is recorded into earnings.

Our approved policies and procedures do not permit the purchase or holding of any derivative financial instruments for trading purposes.  Management of counterparty credit risk is achieved through diversification and credit rating reviews of the firms with whom we transact.

Interest Rate Risk

We occasionally enter into interest rate swap and cap agreements to manage interest rate exposures.  In 2008, we entered into interest rate swap agreements with a total notional amount of $800 (“2008 Swaps”) in order to secure a fixed interest rate on a portion of our then existing floating interest rate term debt.  The 2008 Swaps have declining total notional amounts of $800 to $150 which are operational from the second quarter of 2010 through the first quarter of 2014.  Through the first quarter 2009, we designated the 2008 Swaps as cash flow hedges and any changes in fair value were recorded to accumulated other comprehensive loss, a component of equity.  Thereafter, we discontinued hedge accounting on the 2008 Swaps because these derivatives were no longer expected to be effective and all subsequent changes in fair value are recognized as interest expense in the Consolidated Statement of Operations.  To neutralize the impact to earnings on these changes in fair value, and after assessing existing interest rate market conditions, in the third quarter of 2010, we entered into interest rate swap agreements that offset the 2008 Swaps (“Offsetting Swaps”).   The Offsetting Swaps are operational beginning in the third quarter of 2010 with total notional amounts, operational dates and other terms that effectively mirror the 2008 Swaps.

 
19

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)


Also in the third quarter of 2010, we entered into interest rate swap agreements with a total notional amount of $600 (“2010 Swaps”) that were operational beginning in the third quarter of 2010 in order to secure a fixed interest rate on a portion of the floating interest rate term debt associated with the 2017 Term Loan.  The total notional amount of the 2010 Swaps declines to $200 through the fourth quarter of 2015.  The 2010 Swaps were designated as cash flow hedges and therefore any changes in fair value were recorded to accumulated other comprehensive loss.  In the first quarter 2011, we terminated the 2010 Swaps in conjunction with the debt modification discussed in Note 9 – Debt Obligations and purchased interest rate cap agreements to protect cash flows on a portion of the variable rate term loan against adverse interest rate changes (“2011 Caps”).

 The 2011 Caps became operative in the first quarter 2011 and have notional amounts of $500 in 2011, $400 in 2012 and 2013, $300 in 2014 and $200 in 2015.  Under the 2011 Caps, when the one-month LIBOR rate exceeds 0.75%, we will receive payments from the cap providers.  The combination of the 0.75% LIBOR floor on our 2017 Term Loan along with cash payment on the 2011 Caps results in total payments at a fixed rate of 2.21%, plus the margin of 2.75%, for a total of 4.96% on the notional amounts hedged through 2015.  The 2011 Caps were designated as cash flow hedges and therefore any changes in fair value are recorded to accumulated other comprehensive loss.

Foreign Currency Exchange Rate Risk

We use foreign currency derivative instruments to manage the volatility associated with foreign currency changes in assets and liabilities created in the normal course of business and to protect against exposure related to intercompany financing transactions.  These risks are hedged primarily through the use of forward contracts and purchased options with maturities of less than 18 months.  We have chosen not to designate these instruments as hedges to allow the changes in the fair value of these instruments to largely offset the remeasurement of the underlying assets and liabilities in the Consolidated Statement of Operations.  We had currency forward contracts not designated as hedges to purchase and sell $163 and $104 of currencies comprised principally of the Euro, U.S. Dollar and Malaysian Ringgit as of September 30, 2011 and December 31, 2010, respectively.

We also use foreign currency derivative instruments to manage the volatility associated with cash flows related to sales or purchases denominated in foreign currencies.  These risks are hedged primarily through the use of forward contracts with maturities of less than 18 months. These forward contracts have been designated as cash flow hedges and therefore any changes in fair value are recorded as a component of accumulated other comprehensive loss and reclassified into earnings in the periods during which the hedged transaction affects earnings.  We had currency forward contracts designated as hedges to purchase and sell $50 of currencies comprised principally of the Euro and Brazilian Real as of September 30, 2011 while none were outstanding as of December 31, 2010.  The fair value of these contracts was zero as of September 30, 2011.

Commodity Price Risk

We periodically enter into a limited number of commodity forward contracts in order to reduce cash flow exposure to changes in the price of certain raw materials and energy resources.  At September 30, 2011 and December 31, 2010, we had no such contracts outstanding requiring fair value treatment.

 
20

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)
 
 
Our derivatives recorded at their respective fair values at September 30, 2011 and December 31, 2010 in the Consolidated Statement of Financial Position are summarized as follows:
 
 
September 30, 2011
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Consolidated Statement of Financial Position Presentation
Fair Value
 
Consolidated Statement of Financial Position Presentation
Fair Value
 
Derivatives designated as hedging instruments:
               
Interest rate contracts
Miscellaneous Receivables
  $ -  
Accrued Liabilities
  $ 4  
 
Other Assets
    -  
Other Liabilities
    6  
Total Interest rate contracts
    $ -       $ 10  
                     
                     
Derivative not designated as hedging instruments:
                   
Interest rate contracts
Miscellaneous Receivables
  $ 2  
Accrued Liabilities
  $ 13  
 
Other Assets
    7  
Other Liabilities
    14  
Total Interest rate contracts
      9         27  
Foreign exchange contracts
Miscellaneous Receivables
    1  
Accrued Liabilities
    8  
Total Derivatives
    $ 10       $ 45  
                     
                     
 
December 31, 2010
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Consolidated Statement of Financial Position Presentation
Fair Value
 
Consolidated Statement of Financial Position Presentation
Fair Value
 
Derivatives designated as hedging instruments:
                   
Interest rate contracts
Miscellaneous Receivables
  $ -  
Accrued Liabilities
  $ 3  
 
Other Assets
    6  
Other Liabilities
    -  
Total Interest rate contracts
    $ 6       $ 3  
                     
Derivative not designated as hedging instruments:
                   
Interest rate contracts
Miscellaneous Receivables
  $ -  
Accrued Liabilities
  $ 13  
 
Other Assets
    5  
Other Liabilities
    20  
Total Interest rate contracts
      5         33  
Foreign exchange contracts
Miscellaneous Receivables
    1  
Accrued Liabilities
    1  
Total Derivatives
    $ 12       $ 37  
 

 
 
21

 
SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
(Unaudited)
 
 
A summary of the effect of our derivative instruments for the three and nine months ended September 30, 2011 and 2010 on the Consolidated Statement of Operations and Consolidated Statement of Financial Position is as follows:
 
   
Change in Unrealized Gain (Loss) Recognized in Accumulated Other Comprehensive Loss
   
Amount of Gain (Loss) Recognized in Income
 
Consolidated
Statement of
Operations
Presentation
   
Three Months Ended September 30,
   
Three Months Ended September 30,
   
   
2011
   
2010
   
2011
   
2010
   
Derivatives designated as hedging instruments:
                         
Interest rate contracts
  $ (6 )   $ (4 )   $ -     $ -  
Interest expense
                                   
Derivatives not designated as hedging instruments:
                                 
Interest rate contracts
  $ -     $ -     $ (2 )   $ (5 )
Interest expense (a)
Foreign exchange contracts
    -       -       (7 )     3  
Other income (loss), net
Total Derivatives not designated as hedging instruments
  $ -     $ -     $ (9 )   $ (2 )  
Total Derivatives
  $ (6 )   $ (4 )   $ (9 )   $ (2 )  
   
(a)
We reclassified $2 of losses from accumulated other comprehensive loss to interest expense during each of the three months ended September 30, 2011 and 2010 related to the 2008 and 2010 Swaps.
 
   
Change in Unrealized Gain (Loss) Recognized in Accumulated Other Comprehensive Loss
   
Amount of Gain (Loss) Recognized in Income
 
Consolidated
Statement of
Operations
Presentation
   
Nine Months Ended September 30,
   
Nine Months Ended September 30,
   
   
2011
   
2010
   
2011
   
2010
   
Derivatives designated as hedging instruments:
                         
Interest rate contracts
  $ (12 )   $ (4 )