10-Q 1 sol10q-0501.txt ============================================================================== 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 MARCH 31, 2007 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 (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 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 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 (CHECK ONE): 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 EXCHANGE ACT). YES NO X --- --- INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE. OUTSTANDING AT CLASS MARCH 31, 2007 ----- -------------- COMMON STOCK, $0.01 PAR VALUE 104,459,578 SHARES ----------------------------- ------------------ PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (DOLLARS AND SHARES IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

THREE MONTHS ENDED MARCH 31, --------- 2007 2006 ---- ---- NET SALES...................................................... $ 727 $ 678 Cost of goods sold............................................. 621 598 ------ ------ GROSS PROFIT................................................... 106 80 Marketing expenses............................................. 32 33 Administrative expenses........................................ 24 21 Technological expenses......................................... 11 12 ------ ------ OPERATING INCOME .............................................. 39 14 Equity earnings from affiliates................................ 9 10 Interest expense (a)........................................... (29) (23) Other income, net ............................................. 3 3 Loss on debt modification ..................................... (7) (8) Reorganization items, net ..................................... (16) (14) ------ ------ LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE................................................... (1) (18) Income tax expense............................................. 7 2 ------ ------ LOSS FROM CONTINUING OPERATIONS................................ (8) (20) Income from Discontinued Operations, net of tax................ -- 4 ------ ------ NET LOSS ...................................................... $ (8) $ (16) ====== ====== BASIC AND DILUTED LOSS PER SHARE: Loss from Continuing Operations................................ $(0.08) $(0.19) Net Loss ...................................................... $(0.08) $(0.15) BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING.......... 104.5 104.5 ===== ===== (a) Excludes unrecorded contractual interest expense of $8 in 2007 and 2006. See accompanying Notes to Condensed Consolidated Financial Statements.

1 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS (DOLLARS IN MILLIONS) (UNAUDITED)

THREE MONTHS ENDED MARCH 31, --------- 2007 2006 ---- ---- NET LOSS............................................................. $ (8) $ (16) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments..................................... 2 2 Net unrealized loss on derivative instruments........................ -- (1) Amortization of prior service gain................................... (4) -- Amortization of actuarial loss....................................... 4 -- ------ ------ COMPREHENSIVE LOSS................................................... $ (6) $ (15) ====== ====== See accompanying Notes to Condensed Consolidated Financial Statements.

2 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

MARCH 31, DECEMBER 31, 2007 2006 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents................................................. $ 168 $ 150 Trade receivables, net of allowances of $7 in 2007 and 2006............... 337 288 Miscellaneous receivables ................................................ 100 105 Inventories............................................................... 314 274 Restricted cash for acquisition........................................... 150 -- Prepaid expenses and other assets......................................... 42 34 ------- ------- TOTAL CURRENT ASSETS...................................................... 1,111 851 PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation of $2,485 in 2007 and $2,518 in 2006....................................... 801 795 INVESTMENTS IN AFFILIATES................................................. 198 193 GOODWILL.................................................................. 89 89 IDENTIFIED INTANGIBLE ASSETS, net ........................................ 31 31 OTHER ASSETS.............................................................. 100 100 ------- ------- TOTAL ASSETS.............................................................. $ 2,330 $ 2,059 ======= ======= LIABILITIES AND SHAREHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable ......................................................... $ 243 $ 228 Accrued liabilities ...................................................... 216 237 Short-term debt .......................................................... 975 650 Liabilities of discontinued operations.................................... -- 1 ------- ------- TOTAL CURRENT LIABILITIES ................................................ 1,434 1,116 LONG-TERM DEBT ........................................................... 213 210 OTHER LIABILITIES ........................................................ 289 289 ------- ------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE............................... 1,936 1,615 LIABILITIES SUBJECT TO COMPROMISE ........................................ 1,807 1,849 SHAREHOLDERS' DEFICIT: Common stock (authorized, 600,000,000 shares, par value $0.01) Issued: 118,400,635 shares in 2007 and 2006........................... 1 1 Additional contributed capital........................................ 56 56 Treasury stock, at cost (13,941,057 shares in 2007 and 2006).......... (251) (251) Net deficiency of assets at spin-off...................................... (113) (113) Accumulated other comprehensive loss...................................... (65) (67) Accumulated deficit....................................................... (1,041) (1,031) ------- ------- TOTAL SHAREHOLDERS' DEFICIT............................................... (1,413) (1,405) ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT............................... $ 2,330 $ 2,059 ======= ======= See accompanying Notes to Condensed Consolidated Financial Statements.

3 SOLUTIA INC. (DEBTOR-IN-POSSESSION) CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)

THREE MONTHS ENDED MARCH 31, --------- 2007 2006 ---- ---- INCREASE IN CASH AND CASH EQUIVALENTS OPERATING ACTIVITIES: Net loss..................................................................... $ (8) $ (16) Adjustments to reconcile to Cash From Operations: Income from discontinued operations, net of tax....................... -- (4) Depreciation and amortization......................................... 25 28 Amortization of deferred credits...................................... (2) (2) Deferred income taxes................................................. 3 (1) Equity earnings from affiliates, net.................................. (9) (10) Restructuring expenses and other charges.............................. 7 18 Changes in assets and liabilities: Income taxes payable............................................. -- 3 Trade receivables................................................ (49) (34) Inventories...................................................... (40) (27) Accounts payable................................................. 22 1 Other assets and liabilities..................................... (26) 3 Liabilities subject to compromise: Pension plan liabilities.................................... (29) (7) Other postretirement benefits liabilities................... (12) (13) Other liabilities subject to compromise..................... (1) (3) ----- ----- CASH USED IN OPERATIONS-CONTINUING OPERATIONS.................................. (119) (64) CASH USED IN OPERATIONS-DISCONTINUED OPERATIONS................................ -- (1) ----- ----- CASH USED IN OPERATIONS........................................................ (119) (65) ----- ----- INVESTING ACTIVITIES: Restricted cash for acquisition................................................ (150) -- Property, plant and equipment purchases........................................ (36) (24) Acquisition and investment payments, net of cash acquired...................... -- (16) Investment proceeds and property disposals, net................................ 4 -- ----- ----- CASH USED IN INVESTING ACTIVITIES-CONTINUING OPERATIONS........................ (182) (40) CASH USED IN INVESTING ACTIVITIES-DISCONTINUED OPERATIONS...................... (1) (1) ----- ----- CASH USED IN INVESTING ACTIVITIES.............................................. (183) (41) ----- ----- FINANCING ACTIVITIES: Net change in short-term debt obligations...................................... 325 350 Debt issuance costs............................................................ (5) (9) ----- ----- CASH PROVIDED BY FINANCING ACTIVITIES.......................................... 320 341 ----- ----- INCREASE IN CASH AND CASH EQUIVALENTS.......................................... 18 235 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR.............................................................. 150 107 ----- ----- END OF PERIOD.................................................................. $ 168 $ 342 ===== ===== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for reorganization items......................................... $ (19) $ (14) ===== ===== See accompanying Notes to Condensed Consolidated Financial Statements.

4 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 1. NATURE OF OPERATIONS AND BANKRUPTCY PROCEEDINGS Nature of Operations Solutia Inc., together with its subsidiaries (referred to herein as "Solutia" or the "Company"), 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 wholly-owned subsidiary of Pfizer, Inc. ("Pharmacia")). 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 Inc. 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 also was 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. On January 16, 2004, pursuant to authorization from the Bankruptcy Court, Solutia entered into a DIP credit facility. This 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 fully-drawn term loan; and (b) a $250 borrowing-based revolving credit facility, which includes a $150 letter of credit subfacility. 5 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 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 fully 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 Creditors' 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. The Bankruptcy Court did not move forward with the process to approve the Disclosure Statement and confirm the Plan. Rather, the Court's focus turned to two adversary proceedings filed in the Chapter 11 case. JPMorgan Chase National Bank N.A. ("JPMorgan"), as indenture trustee of Solutia's debentures due 2027 and 2037, filed an adversary proceeding against Solutia alleging that the debentures are entitled to secured status as opposed to general unsecured status as set forth in the Plan. Trial of this matter commenced on May 23, 2006 and concluded on July 10, 2006. On May 1, 2007, the Bankruptcy Court ruled in favor of Solutia, holding that the 2027 and 2037 Debentures were properly de-securitized under the express terms of the prepetition indenture and its related agreements, that the holders of the 2027 and 2037 Debentures do not have, and are not entitled to, any security interests or liens on any of Solutia's assets and that the holders are not entitled to any equitable relief. The Bankruptcy Court also focused on the adversary proceeding brought by the Official Committee of Equity Security Holders ("Equity Committee") against Pharmacia and Monsanto in the Chapter 11 case. The Equity Committee seeks to avoid certain Legacy Liabilities assumed by Solutia at the time of its spinoff from Pharmacia. A pivotal issue is whether the Equity Committee can pursue this matter as part of the Plan confirmation process. A hearing is scheduled for May 18, 2007, at which the Bankruptcy Court will consider this issue. Basis of Presentation --------------------- These financial statements should be read in conjunction with the audited consolidated financial statements and notes to consolidated financial statements included in Solutia's 2006 Annual Report on Form 10-K ("2006 Form 10-K"), filed with the Securities and Exchange Commission ("SEC") on March 6, 2007. The condensed 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 6 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) of business. 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 condensed 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 confirmed plan of reorganization could materially change amounts reported in the condensed 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. The accompanying unaudited condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the financial position, results of operations, comprehensive income (loss), and cash flows for the interim periods reported. Such adjustments are of a normal, recurring nature. In addition, footnote disclosures which would substantially duplicate the disclosures in the audited consolidated financial statements have been omitted in the accompanying unaudited condensed consolidated financial statements. The results of operations for the three month period ended March 31, 2007 are not necessarily indicative of the results to be expected for the full year. Condensed Consolidating Financial Statements -------------------------------------------- Condensed consolidating financial statements for Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of March 31, 2007 and December 31, 2006, and for the three months ended March 31, 2007 and March 31, 2006 are presented below. These condensed consolidating financial statements include investments in subsidiaries carried under the equity method. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2007

Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET SALES................................. $ 603 $ 259 $(135) $ 727 Cost of goods sold........................ 537 225 (141) 621 ----------------------------------------------------------- GROSS PROFIT.............................. 66 34 6 106 Marketing, administrative and technological expenses................... 51 16 -- 67 ----------------------------------------------------------- OPERATING INCOME.......................... 15 18 6 39 Equity earnings from affiliates........... 17 -- (8) 9 Interest expense.......................... (26) (3) -- (29) Other income (loss), net.................. 10 (1) (6) 3 Loss on debt modification................. (7) -- -- (7) Reorganization items, net................. (16) -- -- (16) ----------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAX EXPENSE.. (7) 14 (8) (1) Income tax expense ....................... 1 5 1 7 ----------------------------------------------------------- NET INCOME (LOSS) ....................... $ (8) $ 9 $ (9) $ (8) ===========================================================

7 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2006

Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ NET SALES................................. $ 557 $ 227 $(106) $ 678 Cost of goods sold........................ 511 199 (112) 598 ----------------------------------------------------------- GROSS PROFIT.............................. 46 28 6 80 Marketing, administrative and technological expenses................... 52 14 -- 66 ----------------------------------------------------------- OPERATING INCOME (LOSS)................... (6) 14 6 14 Equity earnings (loss) from affiliates.... 25 (1) (14) 10 Interest expense.......................... (18) (5) -- (23) Other income, net......................... 8 1 (6) 3 Loss on debt modification................. (8) -- -- (8) Reorganization items, net................. (14) -- -- (14) ----------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAX EXPENSE ............... (13) 9 (14) (18) Income tax expense ....................... 3 -- (1) 2 ----------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS.. (16) 9 (13) (20) Income from discontinued operations, net of tax............................... -- 4 -- 4 ----------------------------------------------------------- NET INCOME (LOSS)......................... $ (16) $ 13 $ (13) $ (16) ===========================================================

8 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING BALANCE SHEET AS OF MARCH 31, 2007

Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ ASSETS Current assets............................ $ 744 $ 476 $ (109) $ 1,111 Property, plant and equipment, net........ 661 140 -- 801 Investment in subsidiaries and affiliates. 465 217 (484) 198 Goodwill and identified intangible assets, net...................................... 100 20 -- 120 Other assets.............................. 59 41 -- 100 ----------------------------------------------------------- TOTAL ASSETS........................... $ 2,029 $ 894 $ (593) $ 2,330 =========================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities....................... $ 1,325 $ 195 $ (86) $ 1,434 Long-term debt............................ -- 213 -- 213 Other liabilities......................... 195 94 -- 289 ----------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 1,520 502 (86) 1,936 LIABILITIES SUBJECT TO COMPROMISE......... 1,922 -- (115) 1,807 TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,413) 392 (392) (1,413) ----------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) .............................. $ 2,029 $ 894 $ (593) $ 2,330 ===========================================================

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............................ $ 500 $ 436 $ (85) $ 851 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.............................. 59 42 (1) 100 ----------------------------------------------------------- TOTAL ASSETS........................... $ 1,767 $ 849 $ (557) $ 2,059 =========================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities....................... $ 1,011 $ 169 $ (64) $ 1,116 Long-term debt............................ -- 210 -- 210 Other liabilities......................... 198 91 -- 289 ----------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE 1,209 470 (64) 1,615 LIABILITIES SUBJECT TO COMPROMISE......... 1,963 -- (114) 1,849 TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,405) 379 (379) (1,405) ----------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) .............................. $ 1,767 $ 849 $ (557) $ 2,059 ===========================================================

9 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2007

Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ Net Cash Provided by (Used in) Operating Activities................................. $ (126) $ 7 $ -- $ (119) Net Cash Used in Investing Activities....... (171) (12) -- (183) Net Cash Provided by Financing Activities... 285 35 -- 320 ----------------------------------------------------------- Net Increase (Decrease) in Cash and Cash Equivalents................................ (12) 30 -- 18 Cash and Cash Equivalents: Beginning of year......................... 38 112 -- 150 ----------------------------------------------------------- End of period............................. $ 26 $ 142 $ -- $ 168 ===========================================================

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2006 Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated --------------- -------------- ------------ ------------ Net Cash Provided by (Used in) Operating Activities................................. $ (84) $ 19 $ -- $ (65) Net Cash Used in Investing Activities....... (39) (2) -- (41) Net Cash Provided by Financing Activities... 338 3 -- 341 ----------------------------------------------------------- Net Increase in Cash and Cash Equivalents... 215 20 -- 235 Cash and Cash Equivalents: Beginning of year......................... 18 89 -- 107 ----------------------------------------------------------- End of period............................. $ 233 $ 109 $ -- $ 342 ===========================================================

Recently Issued Accounting Pronouncements In February 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an Amendment of FASB Statement No. 115 ("SFAS No. 159"). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The provisions of SFAS No. 159 are effective for fiscal years beginning after November 15, 2007. Solutia is currently evaluating the impact of SFAS No. 159 on the condensed consolidated financial statements. 2. 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 Condensed Consolidated Statement of Financial Position as Liabilities Subject to Compromise as of March 31, 2007 and December 31, 2006 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. 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 10 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 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 March 31, 2007 and December 31, 2006, as applicable. The amounts subject to compromise consisted of the following items:

MARCH 31, DECEMBER 31, 2007 2006 ---- ---- Postretirement benefits (a)............................... $ 759 $ 800 Litigation reserves (b)................................... 111 111 Accounts payable (c)...................................... 116 116 Environmental reserves (d)................................ 81 81 Other miscellaneous liabilities........................... 72 73 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................... $1,807 $1,849 ====== ====== (a) Postretirement benefits include Solutia's domestic (i) qualified pension plan liabilities of $276 and $305 as of March 31, 2007 and December 31, 2006, respectively; (ii) non-qualified pension plan liabilities of $19 as of both March 31, 2007 and December 31, 2006; and (iii) other postretirement benefits liabilities of $464 and $476 as of March 31, 2007 and December 31, 2006, respectively. Pursuant to a Bankruptcy Court order, Solutia made payments with respect to other postretirement obligations of approximately $20 in the three months ended March 31, 2007. Solutia also made a $29 contribution to its pension plan pursuant to IRS funding requirements in the three months ended March 31, 2007. (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 March 31, 2007 and December 31, 2006. (c) Pursuant to Bankruptcy Court orders, Solutia is allowed to settle certain accounts payable liabilities subject to compromise, however, no settlements occurred in the first quarter 2007. (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 12 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 contractual interest expense not recorded in the three months ended March 31, 2007 was approximately $8. (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 Unsecured Creditors' Committee has the right at any time, and Solutia has the right at any time after the payment of the contractual interest due in July 2005, to seek to terminate Solutia's obligation to continue making the interest payments. Solutia or the Unsecured 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 bankruptcy case. The amount of contractual interest paid with respect to these notes was approximately $13 in the three months ended March 31, 2007, and the accrued interest related to these notes was included in Accrued Liabilities classified as not subject to compromise as of March 31, 2007 and December 31, 2006. (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.

11 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Reorganization Items, net Reorganization items, net are presented separately in the Condensed 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:

THREE MONTHS ENDED MARCH 31, --------- 2007 2006 ---- ---- Professional fees (a)..................................... $ (15) $ (12) Severance and employee retention costs (b)................ (1) (2) Adjustments to allowed claim amounts (c).................. -- 2 Other .................................................... -- (2) ------ ------ TOTAL REORGANIZATION ITEMS, NET........................... $ (16) $ (14) ====== ====== (a) Professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings. (b) 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. (c) Adjustments to record certain pre-petition claims at estimated amounts of the allowed claims.

3. RETROSPECTIVE APPLICATION OF NEW ACCOUNTING GUIDANCE 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 was effective for fiscal years beginning after December 15, 2006 and requires retrospective application to all prior period results presented. Historically, the Company has accrued for certain major maintenance activities associated with periodic major overhauls and maintenance of equipment under the accrue-in-advance method. Periodically, Solutia conducts a complete shutdown of certain manufacturing units ("turnaround") to perform necessary inspection, repairs, and maintenance. These planned turnarounds generally occur every 2 to 3 years. With the adoption of FSP AUG AIR-1 on January 1, 2007, Solutia implemented the deferral method for costs associated with significant turnarounds, which include estimated costs for material, labor, supplies and contractor assistance. Solutia retrospectively applied the change from the accrue-in-advance method to the deferral method. The following balances in the Condensed Consolidated Statement of Financial Position as of December 31, 2006 and the Condensed Consolidated Statement of Operations for the quarter ended March 31, 2006 have been restated from amounts previously reported as follows: 12 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

AS PREVIOUSLY REPORTED AS ADJUSTED -------- ----------- AT DECEMBER 31, 2006: Prepaid expenses and other assets............................. $ 31 $ 34 Other assets.................................................. 99 100 Accrued liabilities........................................... 245 237 Accumulated deficit........................................... (1,043) (1,031) FOR THE QUARTER ENDED MARCH 31, 2006: Cost of goods sold............................................ $ 604 $ 598 Loss from continuing operations............................... (26) (20) Net Loss...................................................... (22) (16) Loss from continuing operations per basic and diluted share... $ (0.25) $ (0.19) Net loss per basic and diluted share.......................... $ (0.21) $ (0.15)

4. 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 March 31, 2007, approximately 2,285,293 shares from the 2000 Plan and 2,984,756 shares from the 1997 Plan remained available for grants. During the first quarter of 2007, no options were granted to current 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 March 31, 2007. 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 March 31, 2007, 25,174 shares of Solutia's common stock remained available for grants under the plan. There were no options or deferred shares granted in the first quarter of 2007 as all non-employee director compensation is now paid in cash. There were no options granted or exercised during the three months ended March 31, 2007. Accordingly, no compensation cost with respect to such activities was recognized in the Condensed Consolidated Statement of Operations in the three months ended March 31, 2007. The fair value related to options granted prior to January 1, 2006 was fully amortized as of June 30, 2006 in accordance with SFAS No. 123 (revised 2004), Share-Based Payment, therefore, the Condensed Consolidated Statement of Operations and Condensed Consolidated Statement of 13 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Cash Flows did not include any compensation costs or any related effects associated with these options for the three months ended March 31, 2007. 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. A summary of Solutia's stock option plans for the three months ended March 31, 2007 is as follows:

WEIGHTED-AVERAGE AGGREGATE WEIGHTED-AVERAGE REMAINING INTRINSIC OPTIONS EXERCISE PRICE CONTRACTUAL LIFE VALUE (a) --------------------------------------------------------------------- Outstanding at January 1, 2007....... 12,399,230 $15.49 -- -- Granted........................... -- 0.00 -- -- Exercised......................... -- 0.00 -- -- Expired........................... (5,126,171) 16.58 -- -- --------------------------------------------------------------------- Outstanding at March 31, 2007........ 7,273,059 $14.72 2.1 $(107) ===================================================================== Exercisable at March 31, 2007........ 7,197,059 $14.79 2.0 $(106) (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 Solutia's common stock as of the reporting date.

5. DIVESTITURES Discontinued Operations - Pharmaceutical Services Business 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 in 2006. Further, Solutia used $51 of the proceeds from the sale to pay down SESA's (euro)200 million facility agreement. The carrying amounts of assets and liabilities from discontinued operations have been classified as current in the Condensed Consolidated Statement of Financial Position at December 31, 2006 and consisted of the following: 14 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) DECEMBER 31, 2006 ---- ASSETS: Assets of discontinued operations........ $ -- ==== LIABILITIES: Accrued liabilities............................... 1 ---- Liabilities of discontinued operations... $ 1 ==== The operating results of the pharmaceutical services business have been reported separately as discontinued operations, net of tax, in the Condensed Consolidated Statement of Operations for the three months ended March 31, 2006. Net sales and income from discontinued operations for the three months ended March 31, 2006 are as follows: Net sales ........................................ $ 22 Income before income taxes........................ 4 Income tax expense ............................... -- ---- INCOME FROM DISCONTINUED OPERATIONS .............. $ 4 ==== DEQUEST(R) Business On March 11, 2007, Solutia reached a definitive agreement to sell DEQUEST(R), its water treatment phosphonates business ("Dequest") to Thermphos Trading GmbH ("Thermphos"). Under the terms of the agreement, Thermphos will purchase the assets and assume certain of the liabilities of Dequest for $67, subject to a working capital adjustment. The proposed transaction is subject to certain governmental and regulatory approvals and other customary closing conditions. In addition, the sale is subject to approval by the Bankruptcy Court, following completion of a Bankruptcy Court supervised auction process. The Bankruptcy Court has scheduled a hearing to approve the sale on May 18, 2007. Dequest has not been classified as discontinued operations within the condensed consolidated financial statements as it has not met the held for sale criteria defined in SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets as of March 31, 2007. 6. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill Goodwill of $89 at both March 31, 2007 and December 31, 2006 was allocated to the Performance Products segment. There were no changes to the net carrying amount of goodwill during the three months ended March 31, 2007. 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: 15 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

MARCH 31, 2007 DECEMBER 31, 2006 ------------------------------------ ------------------------------------ GROSS NET GROSS NET CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING VALUE AMORTIZATION VALUE VALUE AMORTIZATION VALUE ------------------------------------ ------------------------------------ Amortizable intangible assets............. $ 12 $ (7) $ 5 $ 12 $ (7) $ 5 Trademarks................................ 26 -- 26 26 -- 26 ------------------------------------ ------------------------------------ TOTAL IDENTIFIED INTANGIBLE ASSETS........ $ 38 $ (7) $ 31 $ 38 $ (7) $ 31 ==================================== ====================================

There have been no changes to amortizable lives or methods during the three months ended March 31, 2007. Further, there were no write downs or disposals of Amortizable Assets in 2007. 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. 7. RESTRICTED CASH FOR ACQUISITION Restricted cash for acquisition included in the Condensed Consolidated Statement of Financial Position relates to the portion of the DIP credit facility that has been restricted for a special purpose by the January 2007 amendment (as more fully described in Note 14). Of the $1,225 DIP credit facility, $150 was utilized to partially finance the acquisition of Akzo Nobel's interest in the 50/50 Flexsys joint venture between Solutia and Akzo Nobel. The $150 was invested in cash and cash equivalents prior to the acquisition. 8. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS

INVENTORIES MARCH 31, DECEMBER 31, 2007 2006 ---- ---- Finished goods................................................ $ 245 $ 226 Goods in process.............................................. 175 165 Raw materials and supplies.................................... 107 92 ------- ------- Inventories, at FIFO cost..................................... 527 483 Excess of FIFO over LIFO cost................................. (213) (209) ------- ------- TOTAL INVENTORIES............................................. $ 314 $ 274 ======= =======

Inventories at FIFO approximate current cost.

PROPERTY, PLANT AND EQUIPMENT MARCH 31, DECEMBER 31, 2007 2006 ---- ---- Land.......................................................... $ 18 $ 18 Leasehold improvements........................................ 37 37 Buildings..................................................... 428 435 Machinery and equipment....................................... 2,732 2,757 Construction in progress...................................... 71 66 ------- ------- Total property, plant and equipment........................... 3,286 3,313 Less accumulated depreciation................................. (2,485) (2,518) ------- ------- TOTAL......................................................... $ 801 $ 795 ======= =======

16 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

ACCRUED LIABILITIES MARCH 31, DECEMBER 31, 2007 2006 ---- ---- Wages and benefits............................................ $ 45 $ 61 Accrued selling expenses...................................... 31 32 Accrued interest.............................................. 13 20 Other......................................................... 127 124 ------- ------- TOTAL ACCRUED LIABILITIES..................................... $ 216 $ 237 ======= =======

9. INCOME TAXES 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 Condensed Consolidated Statements of Financial Position prior to the adoption of FIN 48 and the amounts reported after adoption are accounted for as a cumulative effect adjustment recorded to the beginning balance of retained earnings or other appropriate components of equity or net assets in the Condensed Consolidated Statements of Financial Position. The cumulative effect adjustment does 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 adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, Solutia increased its January 1, 2007 accumulated deficit by $3 as a cumulative effect adjustment in the Condensed Consolidated Statements of Financial Position. The total amount of unrecognized tax benefits at January 1, 2007 was $109. Included in the balance at January 1, 2007 were $35 of unrecognized tax benefits that, if recognized, would affect the effective tax rate and $74 million of unrecognized tax benefits that, if recognized, would result in adjustments to other tax accounts. Solutia recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. As of January 1, 2007, Solutia accrued $8 for interest and penalties. No significant interest and penalties were recognized in the Condensed Consolidated Statement of Operations as of March 31, 2007. Solutia files income tax returns in the United States and various states and foreign jurisdictions. With few exceptions, Solutia is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2002. It is not anticipated that any significant changes in the total amounts of unrecognized tax benefits for positions will occur within 12 months of the date of adoption. 10. INVESTMENT IN AFFILIATE At March 31, 2007, Solutia participated in one principal joint venture, Flexsys Group, comprised of interests in Flexsys Holding B.V., Flexsys America L.P. and Flexsys Rubber Chemicals Ltd. (collectively "Flexsys"), for which Solutia applies the equity method of accounting. On May 1, 2007, Solutia acquired Akzo Nobel's stake in Flexsys as further described in Note 16. 17 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Summarized financial information for 100 percent of the Flexsys joint venture is as follows:

THREE MONTHS ENDED MARCH 31, ---------------------------- 2007 2006 ---- ---- Net sales...................................................... $ 158 $ 155 Gross profit .................................................. 38 46 Operating income .............................................. 25 28 Net income .................................................... 19 19

11. RESTRUCTURING RESERVES Solutia recorded $1 of severance and retraining costs during the first quarter 2007 in Costs of Goods Sold involving headcount reductions within the Performance Products segment. A summary of restructuring activity during the three months ended March 31, 2007 is as follows:

FUTURE DECOMMISSIONING/ CONTRACTUAL EMPLOYMENT DISMANTLING PAYMENTS REDUCTIONS TOTAL --------------------------------------------------------------- Balance at December 31, 2006............ $ 1 $ 2 $ 2 $ 5 Charges taken......................... -- -- 1 1 Amounts utilized...................... -- -- (1) (1) --------------------------------------------------------------- BALANCE AT MARCH 31, 2007............... $ 1 $ 2 $ 2 $ 5 ===============================================================

Solutia cannot forecast the level of future restructuring charges due to the inherent uncertainty involved in operating as a debtor-in-possession under Chapter 11 bankruptcy protection. 12. COMMITMENTS AND 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 both March 31, 2007 and December 31, 2006 in the amount of $111. 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 in this category relate to property damage, personal injury, products liability, premises liability or other damages relating to 18 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) exposure to PCB, asbestos and other chemicals manufactured before the Solutia Spinoff. Defense and settlement costs as well as judgments, if any, 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 ability to confirm a plan of reorganization or on its 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 related 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 alleged that the October 8, 2003 refinancing had no effect on the security interests and liens that were created in 2002, and argued 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 intervened in the proceeding in support of Solutia and the Ad Hoc Committee of Solutia Noteholders intervened in the proceeding in support of JPMorgan. The trial commenced on May 23, 2006 and concluded on July 10, 2006. Thereafter, Wilmington Trust Company, which succeeded JPMorgan as Prepetition Trustee, replaced JPMorgan as plaintiff in the proceeding. On May 1, 2007, the Bankruptcy Court ruled in favor of Solutia, holding that the 2027 and 2037 Debentures were properly de-securitized under the express terms of the Prepetition Indenture and its related agreements, that the holders of the 2027 and 2037 Debentures do not have, and are not entitled to any security interests or liens of any of Solutia's assets and that the noteholders are not entitled to any equitable relief. 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 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 19 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) resolution. The adversary proceeding had been stayed indefinitely by the parties pursuant to a standstill agreement which was subject to certain rights of the parties to recommence such proceeding. On April 6, 2007, the Equity Committee provided written notice to Monsanto and Pharmacia terminating the standstill agreement. In addition, the Equity Committee has requested that the Bankruptcy Court schedule the adversary proceeding for trial. A hearing is scheduled for May 18, 2007, at which the Bankruptcy Court will consider the Equity Committee's request. LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE --------------------------------------------------- GE RELATED LITIGATION On March 13, 2007, a purported class action lawsuit, captioned Corlew, et al., v. General Electric Company, Monsanto Company, Pharmacia Corporation, and Solutia Inc., was filed in the Superior Court of New York County, New York ("the GE Litigation"). The plaintiffs are current residents of Schenectady, New York, who seek to represent a class of all individuals who owned and/or occupied property within a five-mile radius of General Electric's Main Plant in Schenectady. The plaintiffs allege that their properties were contaminated by the release of PCBs manufactured by Monsanto, Pharmacia, and/or Solutia (collectively referred to in the Complaint as "Monsanto") that were used in the manufacture of a variety of products at General Electric's Schenectady plant. Plaintiffs allege a series of twenty-five claims including thirteen claims specifically against Monsanto, Pharmacia, and Solutia collectively including negligence, breach of warranty, strict liability, fraudulent concealment, negligent and intentional infliction of emotional distress, nuisance, trespass, unjust enrichment, and willful and wanton misconduct, with each claim seeking between $12,000 and $20,000 in compensatory damages, and an equivalent amount in punitive damages. Solutia believes the GE Litigation is automatically stayed as to Solutia pursuant to Section 362 of the U.S. Bankruptcy Code. Accordingly, Solutia has filed its suggestion of bankruptcy with the trial court. As described in the introduction to this litigation section, at the time of the Solutia Spinoff from Pharmacia, Solutia agreed to defend Pharmacia against, and indemnify Pharmacia for, litigation liabilities related to chemical products formerly manufactured, released or used by Pharmacia prior to the Solutia Spinoff. After filing for Chapter 11 protection, Solutia ceased performance of its defense and indemnification obligations with respect to these litigation liabilities as they are deemed pre-petition obligations under the U.S. Bankruptcy Code. Monsanto is currently managing and funding such litigation liabilities pursuant to its indemnification obligations to Pharmacia. Because Solutia is not managing such litigation, it has ceased updating on the status of those legal proceedings. The GE Litigation falls within the scope of litigation liabilities described above. Monsanto's funding of the GE Litigation may give rise to a claim against Solutia which Monsanto may assert in Solutia's bankruptcy case. FLEXSYS RELATED LITIGATION Since 2002, antitrust authorities in the United States, Europe and Canada have been investigating past commercial practices in the rubber chemicals industry including the practices of Flexsys. The practices being investigated occurred during the period that Flexsys was a 50/50 joint venture between Solutia and Akzo Nobel. The European Commission issued its findings from its investigation in 2005, in which the Commission granted Flexsys full immunity from any potential fines. 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 such purported class actions that have been filed against Flexsys in various state courts in the United States and in four courts in Canada. Except for two cases pending in the United States, all of the cases have been dismissed, or are currently subject to tentative settlements. OTHER LEGAL PROCEEDINGS ----------------------- 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") 20 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 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. Solutia has not 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 against the Solutia Pension Plan and were consolidated in September 2006 with similar cash balance pension plan cases 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 seek 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 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 cases, plaintiffs moved to certify a class only with respect to the claim that termination of interest credits violates ERISA. Briefing on the class certification motions was completed in January, and the court scheduled the motions for a hearing on July 12, 2007. However, on May 3, 2007 the judge presiding over the case recused himself from the proceeding and a new judge was appointed, therefore, it is unclear if the hearing will proceed as scheduled. 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. 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 scheduled for May 22, 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 was removed to the U.S. District Court for the Southern District of New York. 21 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) In March 2005, the District Court dismissed with prejudice three of Solutia's causes of action for breach of contract, but denied FMC's motion to dismiss with respect to Solutia's causes of action for breach of warranty, breach of fiduciary duty, negligent misrepresentation, fraud, and fraud in the inducement. The parties completed their fact discovery on the remaining claims, and submitted cross motions for summary judgment. On July 31, 2006, the Court granted portions of FMC's Motion for Summary Judgment but denied others. Subsequently, the Court scheduled a bench trial of the case which was to begin on April 2, 2007. Prior to the start of trial, Solutia and FMC reached a settlement pursuant to which FMC agreed to pay Solutia $23 in cash, subject to Bankruptcy Court approval. The settlement was approved by the Bankruptcy Court on May 1, 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 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 22 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 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 effective 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). INEOS disputes the overall amount of Solutia Canada's termination costs. Solutia filed this litigation against INEOS for breach of the LTA with respect to such termination costs. On March 26, 2007, INEOS filed a cross-demand against Solutia Canada for $1 (CAD), alleging that Solutia Canada improperly charged INEOS on its October and November 2006 invoices for items which INEOS claims are not actual direct or indirect costs under the LTA. INEOS reserved the right to amend its demand for additional alleged overpayments on any future invoices through the remaining term of the LTA. Solutia Canada denies INEOS' allegation. Texas Commission on Environmental Quality Administrative Enforcement -------------------------------------------------------------------- Proceeding. On August 11, 2006, the Executive Director of the Texas Commission ---------- on Environmental Quality (the "Commission") commenced an administrative enforcement proceeding against Solutia by filing a petition with the Texas Commission on Environmental Quality. The petition alleged certain violations of the State of Texas air quality program. The Executive Director requested that an administrative penalty, the amount of which was de minimis, 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 reached a settlement in principle that includes payment of a de minimis penalty and contribution to an environmentally beneficial project in exchange for mitigation of a portion of the penalty. All required corrective action has been completed. The final settlement orders are subject to approval by the Commission. 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 $77 and $78 as of March 31, 2007 and December 31, 2006, 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 Condensed 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 as of both March 31, 2007 and December 31, 2006 for properties not owned or operated by Solutia which was classified as subject to compromise in the Condensed Consolidated Statement of Financial Position. Under the Plan and the Relationship Agreement, as between Monsanto and Solutia, 23 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Monsanto would accept financial responsibility for environmental remediation obligations at all sites for which Solutia was required to assume responsibility at the Solutia Spinoff but which were never owned or operated by Solutia. This includes more than 50 sites with active remediation projects and approximately 200 additional known sites and off-site disposal facilities, as well as sites that have not yet been identified. Finally, Monsanto would share financial responsibility with Solutia for off-site remediation costs in Anniston, Alabama and Sauget, Illinois. Remediation activities are currently being funded by Monsanto for all of these properties not owned or operated by Solutia, with the exception of one off-site remediation project in Sauget, Illinois. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 bankruptcy case. In addition, Solutia has only made minimal adjustments to its recorded environmental liabilities classified as subject to compromise for ongoing remediation activities since the inception of Solutia's bankruptcy case to reflect actual cash expenditures incurred by the Company. Any other adjustments to this liability are not deemed appropriate by the Company at this time given the uncertainty regarding any potential claim amount to be asserted by Monsanto. 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. 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 condensed 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 condensed 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 Condensed Consolidated Statement of Financial Position. 13. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS Components of Net Periodic Benefit Cost For the three months ended March 31, 2007 and 2006, Solutia's pension and healthcare and other benefit costs were as follows: 24 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

PENSION BENEFITS HEALTHCARE AND OTHER BENEFITS ---------------- ----------------------------- 2007 2006 2007 2006 ---- ---- ---- ---- Service costs for benefits earned.............. $ 1 $ 1 $ 1 $ 1 Interest costs on benefit obligation........... 16 16 6 8 Assumed return on plan assets.................. (17) (15) -- -- Prior service (gains)/costs ................... -- -- (4) (3) Actuarial net loss............................. 2 2 2 1 ----- ----- ----- ----- TOTAL.......................................... $ 2 $ 4 $ 5 $ 7 ===== ===== ===== =====

Employer Contributions According to IRS funding rules, Solutia will be required to make approximately $100 in pension contributions to its U.S. qualified pension plan in 2007. Approximately $29 of these required 2007 contributions were made in the first quarter 2007. Solutia also expects to be required to fund approximately $6 in pension contributions for its foreign pension plans in 2007. 14. DEBT OBLIGATIONS Solutia amended its DIP financing facility on January 25, 2007 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP facility from $825 to $1,225; (ii) extended the term of the DIP facility from March 31, 2007 to March 31, 2008; (iii) decreased the interest rate on the term loan component of the DIP facility from LIBOR plus 350 basis points to LIBOR plus 300 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; and (vi) amended certain financial and other covenants. Of the $1,225 facility, $150 was utilized to partially finance Solutia's acquisition of Akzo Nobel's interest in the 50/50 Flexsys joint venture between Solutia and Akzo Nobel. The remaining increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments due in 2007. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. Solutia analyzed the modifications of the DIP facility in January 2007 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 $7 to record the write-off of debt issuance costs and to record the DIP facility as modified at its fair value. 15. SEGMENT 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. 25 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 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. Segment data for the three months ended March 31, 2007 and 2006 are as follows:

2007 2006 ---------------------- ----------------------- NET PROFIT NET PROFIT SALES (LOSS) SALES (LOSS) ----- ------ ----- ------ SEGMENT: Performance Products................ $301 $ 46 $286 $ 42 Integrated Nylon.................... 426 6 392 (8) ---- ---- ---- ---- SEGMENT TOTALS...................... 727 52 678 34 RECONCILIATION TO CONSOLIDATED TOTALS: Corporate expenses.............. (13) (20) Equity earnings from affiliates. 9 9 Interest expense................ (29) (23) Other income, net............... 3 -- Loss on debt modification....... (7) (8) Reorganization items, net....... (16) (10) CONSOLIDATED TOTALS: ---- ---- NET SALES........................ $727 $678 ==== ---- ==== ---- LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES $ (1) $(18) ==== ====

16. SUBSEQUENT EVENTS On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel's stake in Flexsys. Closing of the sale occurred on May 1, 2007 simultaneous with Flexsys' purchase of Akzo Nobel's Crystex manufacturing operations in Japan for $25. Under the terms of the agreement, Solutia purchased Akzo Nobel's 50% interest in the Flexsys joint venture for $213, subject to debt assumption and certain purchase price adjustments. In conjunction with the acquisition, Flexsys executed a $200, five year debt facility agreement. As is more fully described in Note 12 under the caption Solutia v. FMC Corporation, Solutia and FMC reached a settlement on April 2, 2007 pursuant to which FMC agreed to pay Solutia $23 in cash, subject to Bankruptcy Court approval. The settlement was approved by the Bankruptcy Court on May 1, 2007 with Solutia expecting to receive the proceeds in the second quarter 2007. 26 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 17. 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 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 facility (as well as a smaller, interim DIP 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 Inc. on a parent only basis carrying its investment in subsidiaries under the equity method; Guarantors on a combined, or where appropriate, consolidated basis, carrying investments in subsidiaries 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 March 31, 2007 and December 31, 2006, and for the three months ended March 31, 2007 and 2006. 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. 27 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2007

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET SALES................................ $ 548 $ 54 $ 260 $(135) $ 727 Cost of goods sold....................... 510 25 226 (140) 621 ------------------------------------------------------------------------ GROSS PROFIT............................. 38 29 34 5 106 Marketing expenses....................... 18 6 8 -- 32 Administrative expenses.................. 16 2 6 -- 24 Technological expenses................... 8 1 2 -- 11 ------------------------------------------------------------------------ OPERATING INCOME (LOSS).................. (4) 20 18 5 39 Equity earnings from affiliates.......... 41 7 -- (39) 9 Interest expense......................... (26) -- (15) 12 (29) Other income, net........................ 4 5 11 (17) 3 Loss on debt modification................ (7) -- -- -- (7) Reorganization items, net................ (15) (1) -- -- (16) ------------------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAXES ....... (7) 31 14 (39) (1) Income tax expense ..................... 1 -- 5 1 7 ------------------------------------------------------------------------ NET INCOME (LOSS)........................ $ (8) $ 31 $ 9 $ (40) $ (8) ========================================================================

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) THREE MONTHS ENDED MARCH 31, 2007 Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET INCOME (LOSS)........................ $ (8) $ 31 $ 9 $ (40) $ (8) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments......... 2 2 4 (6) 2 Amortization of prior service gain....... (4) -- -- -- (4) Amortization of actuarial loss........... 4 -- -- -- 4 ------------------------------------------------------------------------ COMPREHENSIVE INCOME (LOSS).............. $ (6) $ 33 $ 13 $ (46) $ (6) ========================================================================

28 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2006

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET SALES................................ $ 507 $ 49 $ 229 $(107) $ 678 Cost of goods sold....................... 487 24 200 (113) 598 ------------------------------------------------------------------------ GROSS PROFIT............................. 20 25 29 6 80 Marketing expenses....................... 19 6 8 -- 33 Administrative expenses.................. 13 2 6 -- 21 Technological expenses................... 11 1 -- -- 12 ------------------------------------------------------------------------ OPERATING INCOME (LOSS).................. (23) 16 15 6 14 Equity earnings (loss) from affiliates... 45 13 (1) (47) 10 Interest expense......................... (18) -- (11) 6 (23) Other income, net........................ 4 4 8 (13) 3 Loss on debt modification................ (8) -- -- -- (8) Reorganization items, net................ (14) -- -- -- (14) ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ..... (14) 33 11 (48) (18) Income tax expense ..................... 2 -- 1 (1) 2 ------------------------------------------------------------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS.......................... (16) 33 10 (47) (20) Income from discontinued operations, net of tax.............. -- -- 4 -- 4 ------------------------------------------------------------------------ NET INCOME (LOSS)........................ $ (16) $ 33 $ 14 $ (47) $ (16) ========================================================================

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) THREE MONTHS ENDED MARCH 31, 2006 Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET INCOME (LOSS)........................ $ (16) $ 33 $ 14 $ (47) $ (16) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments......... 2 2 2 (4) 2 Net unrealized loss on derivative instruments......................... (1) -- -- -- (1) ------------------------------------------------------------------------ COMPREHENSIVE INCOME (LOSS).............. $ (15) $ 35 $ 16 $ (51) $ (15) ========================================================================

29 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF FINANCIAL POSITION MARCH 31, 2007

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents....................... $ 22 $ 4 $ 142 $ -- $ 168 Trade receivables, net.......................... 3 191 143 -- 337 Intercompany receivables........................ 148 759 127 (1,034) -- Miscellaneous receivables....................... 63 1 36 -- 100 Inventories..................................... 171 29 130 (16) 314 Restricted cash for acquisition................. 150 -- -- -- 150 Prepaid expenses and other current assets....... 30 2 8 2 42 ----------------------------------------------------------------------- TOTAL CURRENT ASSETS............................ 587 986 586 (1,048) 1,111 PROPERTY, PLANT AND EQUIPMENT, NET.............. 580 82 139 -- 801 INVESTMENTS IN AFFILIATES....................... 2,434 276 7 (2,519) 198 GOODWILL........................................ -- 72 17 -- 89 IDENTIFIED INTANGIBLE ASSETS, NET............... 2 26 3 -- 31 INTERCOMPANY ADVANCES........................... 128 1,238 1,020 (2,386) -- OTHER ASSETS.................................... 59 -- 41 -- 100 ----------------------------------------------------------------------- TOTAL ASSETS.................................... $ 3,790 $ 2,680 $ 1,813 $(5,953) $ 2,330 ======================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable................................ $ 187 $ 9 $ 49 $ (2) $ 243 Intercompany payables........................... 117 3 187 (307) -- Accrued liabilities............................. 132 14 70 -- 216 Short-term debt................................. 975 -- -- -- 975 Intercompany short-term debt.................... 1 -- 211 (212) -- ----------------------------------------------------------------------- TOTAL CURRENT LIABILITIES....................... 1,412 26 517 (521) 1,434 LONG-TERM DEBT.................................. -- -- 213 -- 213 INTERCOMPANY LONG-TERM DEBT..................... -- -- 676 (676) -- OTHER LIABILITIES............................... 193 1 95 -- 289 ----------------------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE..... 1,605 27 1,501 (1,197) 1,936 LIABILITIES SUBJECT TO COMPROMISE............... 3,598 413 20 (2,224) 1,807 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) 2,240 292 (2,532) (113) Accumulated other comprehensive loss............ (65) -- -- -- (65) Accumulated deficit............................. (1,041) -- -- -- (1,041) ----------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY (DEFICIT)............ (1,413) 2,240 292 (2,532) (1,413) ----------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)...................................... $ 3,790 $ 2,680 $ 1,813 $(5,953) $ 2,330 =======================================================================

30 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF FINANCIAL POSITION DECEMBER 31, 2006

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ 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 current assets....... 23 1 7 3 34 ----------------------------------------------------------------------- TOTAL CURRENT ASSETS............................ 422 970 545 (1,086) 851 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.................................... 58 -- 42 -- 100 ----------------------------------------------------------------------- TOTAL ASSETS.................................... $ 3,582 $ 2,654 $ 1,743 $(5,920) $ 2,059 ======================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable................................ $ 177 $ 8 $ 45 $ (2) $ 228 Intercompany payables........................... 177 13 156 (346) -- Accrued liabilities............................. 146 14 77 -- 237 Short-term debt................................. 650 -- -- -- 650 Intercompany short-term debt.................... 1 -- 195 (196) -- Liabilities of discontinued operations.......... 1 -- -- -- 1 ----------------------------------------------------------------------- TOTAL CURRENT LIABILITIES....................... 1,152 35 473 (544) 1,116 LONG-TERM DEBT.................................. -- -- 210 -- 210 INTERCOMPANY LONG-TERM DEBT..................... -- -- 669 (669) -- OTHER LIABILITIES............................... 196 1 92 -- 289 ----------------------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE..... 1,348 36 1,444 (1,213) 1,615 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............................. (1,031) -- -- -- (1,031) ----------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY (DEFICIT)............ (1,405) 2,205 279 (2,484) (1,405) ----------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)..................................... $ 3,582 $ 2,654 $ 1,743 $(5,920) $ 2,059 =======================================================================

31 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 2007

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ CASH PROVIDED BY (USED IN) OPERATIONS........... $ (104) $ (21) $ 6 $ -- $ (119) ----------------------------------------------------------------------- INVESTING ACTIVITIES: Property, plant and equipment purchases......... (23) (1) (12) -- (36) Restricted cash for acquisition................. (150) -- -- -- (150) Investment proceeds and property disposals, net................................. 3 -- -- -- 3 ----------------------------------------------------------------------- CASH USED IN INVESTING ACTIVITIES............... (170) (1) (12) -- (183) ----------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in short-term debt obligations....... 325 -- -- -- 325 Debt issuance costs............................. (5) -- -- -- (5) Changes in investments and advances from (to) affiliates................................ (47) 12 35 -- -- ----------------------------------------------------------------------- CASH PROVIDED BY FINANCING ACTIVITIES........... 273 12 35 -- 320 ----------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................... (1) (10) 29 -- 18 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR............................... 23 14 113 -- 150 ----------------------------------------------------------------------- END OF PERIOD.................................. $ 22 $ 4 $ 142 $ -- $ 168 =======================================================================

32 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 2006

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ CASH PROVIDED BY (USED IN) OPERATIONS........... $ (79) $ (6) $ 20 $ -- $ (65) ----------------------------------------------------------------------- INVESTING ACTIVITIES: Property, plant and equipment purchases......... (13) (2) (10) -- (25) Acquisition and investment payments, net of cash acquired.................................. (23) -- 7 -- (16) ----------------------------------------------------------------------- CASH USED IN INVESTING ACTIVITIES............... (36) (2) (3) -- (41) ----------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in short-term debt obligations....... 350 -- -- -- 350 Debt issuance costs............................. (9) -- -- -- (9) Changes in investments and advances from (to) affiliates................................ (5) 3 2 -- -- ----------------------------------------------------------------------- CASH PROVIDED BY FINANCING ACTIVITIES........... 336 3 2 -- 341 ----------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................... 221 (5) 19 -- 235 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR............................... 1 15 91 -- 107 ----------------------------------------------------------------------- END OF PERIOD................................... $ 222 $ 10 $ 110 $ -- $ 342 =======================================================================

33 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include all statements regarding expected future financial position, results of operations, profitability, cash flows and liquidity. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements herein include, among others, Solutia's ability to develop, confirm and consummate a Chapter 11 plan of reorganization; Solutia's ability to reduce its overall leveraged position; 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; Solutia's ability to comply with the terms of its debtor-in-possession ("DIP") financing facility; customer response to Solutia's Chapter 11 filing; general economic, business and market conditions; customer acceptance of new products; raw material and energy costs or shortages; limited access to capital resources; currency and interest rate fluctuations; increased competitive and/or customer pressure; gain or loss of significant customers; compression of credit terms with suppliers; exposure to product liability and other litigation; changes in cost of environmental remediation obligations and other environmental liabilities; changes in accounting principles generally accepted in the U.S.; ability to implement cost reduction initiatives in a timely manner; geopolitical instability; and changes in pension and other postretirement assumptions. OVERVIEW Summary of Significant First Quarter 2007 Events Bankruptcy Proceedings ---------------------- On May 1, 2007, in the JPMorgan adversary proceeding (as fully described in Note 1 to the accompanying condensed consolidated financial statements) the Bankruptcy Court ruled in favor of Solutia, holding that the 2027 and 2037 Debentures were properly de-securitized under the express terms of the prepetition indenture and its related agreements, that the holders of the 2027 and 2037 Debentures do not have, and are not entitled to, any security interests or liens on any of Solutia's assets and that the holders are not entitled to any equitable relief. The other significant litigation matter within the bankruptcy proceedings is the adversary proceeding brought by the Official Committee of Equity Security Holders ("Equity Committee") against Pharmacia and Monsanto in the Chapter 11 case. The Equity Committee seeks to avoid certain Legacy Liabilities assumed by Solutia at the time of its spinoff from Pharmacia. A pivotal issue is whether the Equity Committee can pursue this matter as part of the Plan confirmation process. A hearing is scheduled for May 18, 2007, at which the Bankruptcy Court will consider this issue. Solutia anticipates filing an amended Plan and Disclosure Statement during the second quarter and believes that the Bankruptcy Court will thereafter move forward with the Plan confirmation process. Solutia will continue its effort to gain consensus among the major stakeholders in the Chapter 11 case on the terms of the Amended Plan. Reorganization Strategy ----------------------- In the first quarter 2007, 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 2007 to enhance its financial performance including using the tools of bankruptcy and making changes to its asset portfolio, as explained below. Solutia also continues to pursue a reallocation of legacy liabilities in the bankruptcy proceeding through negotiations with the other constituents in the bankruptcy case. Solutia will also be working in 2007 to establish a proper capital structure upon emergence from bankruptcy. However, as a result of the numerous uncertainties and complexities inherent in Solutia's bankruptcy proceedings, its ability and timing of emergence from bankruptcy are subject to significant uncertainty. PERFORMANCE ENHANCEMENT Solutia benefited in the first quarter of 2007 from actions implemented earlier in the Chapter 11 reorganization process designed to enhance its performance as described in previous filings. In the first quarter of 2007, the Company continued to execute 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 financing facility on January 25, 2007 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP facility from $825 million to $1,225 million; (ii) extended the term of the DIP facility from March 31, 2007 to March 31, 2008; (iii) decreased the interest rate on the term loan component of the DIP facility from LIBOR plus 350 basis points to LIBOR plus 300 basis points. Of the $1,225 million facility, $150 million was utilized to partially finance the acquisition of Akzo Nobel's interest in the 50/50 Flexsys joint venture between Solutia and Akzo Nobel. The remaining increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments due in 2007. Solutia expects the refinancing will provide greater flexibility in executing Solutia's reorganization strategy along with significant interest savings. 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 the first quarter of 2007. On February 27, 2007, Solutia entered into a definitive agreement to 34 purchase Akzo Nobel's stake in the Flexsys joint venture. The transaction closed on May 1, 2007 as described in Note 16 to the accompanying condensed consolidated financial statements. On March 11, 2007, Solutia reached a definitive agreement to sell DEQUEST(R), its water treatment phosphonates business ("Dequest") to Thermphos Trading GmbH ("Thermphos"). Under the terms of the agreement, Thermphos will purchase the assets and assume certain of the liabilities of Dequest for $67 million, subject to a working capital adjustment. 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 distribution, if any, that various constituencies in the Chapter 11 Cases would receive under the Plan. See Note 1 to the accompanying condensed 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 condensed 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.

----------------------------------------------------------------------------------------------------- (dollars in millions) 2007 2006 ---- ---- Net Sales.................................................................... $ 727 $ 678 ====== ====== Operating Income: Performance Products Segment Profit...................................... $ 46 $ 42 Integrated Nylon Segment Profit (Loss)................................... 6 (8) Less: Corporate Expenses............................................ (13) (20) Less: Equity Earnings from Affiliates, Other Income and Reorganization Items included in Segment Profit (Loss)............. -- -- ------ ------ Operating Income ............................................................ $ 39 $ 14 ====== ====== Charges included in Operating Income ........................................ $ -- $ (9) ====== ====== -----------------------------------------------------------------------------------------------------

The $49 million, or 7 percent, increase in net sales as compared to the first quarter 2006 was primarily a result of higher average selling prices of 3 percent, higher sales volumes of 3 percent, and favorable currency exchange rate fluctuations of 1 percent. The $25 million increase in operating income as compared to the first quarter 2006 resulted from higher net sales and lower charges, which are described in greater detail in the Results of Operations section below, partially offset by higher raw material and energy costs. 35 Financial Information --------------------- Summarized financial information concerning Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of and for the three months ended March 31, 2007 is presented as follows:

Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ Net sales................................. $ 603 $ 259 $ (135) $ 727 Operating income.......................... 15 18 6 39 Net income (loss)......................... (8) 9 (9) (8) Total assets.............................. 2,029 894 (593) 2,330 Liabilities not subject to compromise..... 1,520 502 (86) 1,936 Liabilities subject to compromise......... 1,922 -- (115) 1,807 Total shareholders' equity (deficit)...... (1,413) 392 (392) (1,413)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES There have been no changes in the first quarter 2007 with respect to Solutia's critical accounting policies, as presented on pages 29 through 32 of Solutia's 2006 Form 10-K. RESULTS OF OPERATIONS--FIRST QUARTER 2007 COMPARED WITH FIRST QUARTER 2006 Performance Products

----------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Net Sales.............................................................. $ 301 $ 286 ===== ===== Segment Profit ........................................................ $ 46 $ 42 ===== ===== Charges and Reorganization Items included in Segment Profit........ $ -- $ (1) ===== ===== -----------------------------------------------------------------------------------------------

The $15 million, or 5 percent, increase in net sales as compared to the first quarter 2006 resulted primarily from favorable currency exchange rate fluctuations of 3 percent, higher sales volumes of 1 percent and higher average selling prices of 1 percent. The favorable exchange rate fluctuations occurred primarily as a result of the weakening U.S. dollar in relation to the Euro in comparison to the first quarter 2006. Higher sales volumes were experienced in LLUMAR(R) and VISTA(R) professional film products and SAFLEX(R) plastic interlayer products, partially offset by lower volumes in DEQUEST(R) water treatment chemicals. Higher average selling prices were experienced in LLUMAR(R) and VISTA(R) professional film products and in THERMINOL(R) heat transfer fluids. The $4 million, or 10 percent, increase in segment profit in comparison to the first quarter 2006 resulted primarily from higher net sales, partially offset by higher raw material costs. The $1 million of reorganization items in the first quarter 2006 consisted primarily of employee severance and retraining costs. 36 Integrated Nylon

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Net Sales.............................................................. $ 426 $ 392 ===== ===== Segment Profit (Loss).................................................. $ 6 $ (8) ===== ===== Charges and Reorganization Items included in Segment Profit (Loss)........................................................ $ -- $ (3) ===== ===== -------------------------------------------------------------------------------------------------

The $34 million, or 9 percent, increase in net sales as compared to the first quarter 2006 resulted primarily from higher average selling prices of 5 percent and higher sales volumes of 4 percent. Average selling prices increased in the intermediate chemicals business as a result of favorable market conditions and in response to the escalating cost of raw materials. Sales volumes increased in intermediate chemicals and nylon plastics and polymers, partially offset by a decrease in carpet fibers. The nylon plastics and polymers volumes increased due to a third quarter 2006 capacity increase as a result of reconfiguration of idle assets. The $14 million increase in segment profit in comparison to the first quarter 2006 resulted primarily from higher sales and higher asset utilization, partially offset by higher raw material and energy costs. The segment incurred higher raw material and energy costs of approximately $7 million during the quarter, which was more than offset by the aforementioned selling price increases. Higher asset utilization was experienced in intermediate chemicals due in part to the manufacturing interruption incurred at the Alvin, Texas plant in the first quarter 2006 and in nylon plastics and polymers due to the aforementioned capacity increase. Solutia recorded approximately $2 million of decommissioning and dismantling costs in the first quarter 2006 as a result of the shut-down of its acrylic fibers business in 2005 and $1 million of asset write-downs. Corporate Expenses

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Corporate Expenses..................................................... $ 13 $ 20 ===== ===== Charges included in Corporate Expenses............................. $ -- $ (9) ===== ===== -------------------------------------------------------------------------------------------------

Corporate expenses decreased by $7 million, or 35 percent, in the first quarter 2007 compared to the first quarter 2006 principally due to lower charges. After consideration of the charges recorded in the first quarter 2006, the change in corporate expenses was also impacted by increased legal and professional development costs. Included in the charges for the first quarter 2006 is an environmental charge 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. Equity Earnings from Affiliates

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Equity Earnings from Affiliates not included in Reportable Segment Profit (Loss)......................................................... $ 9 $ 9 Equity Earnings from Affiliates included in Reportable Segment Profit (Loss)......................................................... -- 1 ----- ----- Equity Earnings from Affiliates........................................ $ 9 $ 10 ===== ===== Charges included in Equity Earnings from Affiliates............... $ -- $ -- ===== ===== -------------------------------------------------------------------------------------------------

37 Equity earnings from affiliates decreased by $1 million in the first quarter 2007 as compared to the first quarter 2006. This decline was primarily a result of the inclusion of results of operations from the Puebla, Mexico plant in the condensed consolidated financial statements for the entire first quarter 2007. The Puebla plant was formerly the primary asset within the Quimica joint venture which was accounted for using the equity method. Solutia purchased the remaining interest in Quimica on March 1, 2006. Interest Expense

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Interest Expense....................................................... $ 29 $ 23 ===== ===== Charges included in Interest Expense.............................. $ -- $ (1) ===== ===== -------------------------------------------------------------------------------------------------

The $6 million, or 26 percent, increase in interest expense in the first quarter 2007 in comparison to the first quarter 2006 resulted principally from higher debt outstanding in the first quarter 2007 than in 2006, partially offset by lower interest rates due to the March 2006 and January 2007 amendments to the DIP credit facility and the July 2006 refinancing of the Euronotes and subsequent partial pay down. In addition, results in the first quarter 2006 included a $1 million charge related to the March 2006 amendment of the DIP credit facility. The amount of contractual interest not recorded was $8 million in both the first quarter 2007 and 2006. Reorganization Items, net

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Reorganization Items, net.............................................. $ 16 $ 14 ===== ===== Reorganization Items, net included in Reportable Segment Profit (Loss).................................................... $ -- $ 4 ===== ===== -------------------------------------------------------------------------------------------------

Reorganization items, net are presented separately in the Condensed 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 the first quarter 2007 included $15 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings and $1 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. Reorganization items incurred in the first quarter 2006 included $12 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $2 million of net gain for adjustments to record certain pre-petition claims at estimated amounts of the allowed claims; $2 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 other reorganization charges primarily involving costs incurred with the shut-down of Solutia's acrylic fibers business. Income Tax Expense

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Income Tax Expense ................................................... $ 7 $ 2 ===== ===== -------------------------------------------------------------------------------------------------

Solutia's income tax expense in the first quarter 2007 and 2006 was primarily a result of foreign income taxes. As a result of Solutia's Chapter 11 filing, Solutia did not record any U.S. income tax expense or benefit for domestic operations (including temporary differences) during the three months ended March 31, 2007 and 2006. 38 Consequently, the changes in federal and state deferred tax assets were offset by corresponding changes in valuation allowances. The $5 million increase in income tax expense in the first quarter 2007 as compared to the first quarter 2006 was the result of higher foreign income and a non-consolidated equity affiliate surrendering a prior year loss in the first quarter 2006 that was used to offset a foreign subsidiary's taxable income in the United Kingdom. Discontinued Operations

------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, --------- (dollars in millions) 2007 2006 ---- ---- Income from Discontinued Operations, net of tax........................ $ -- $ 4 ===== ===== -------------------------------------------------------------------------------------------------

Income from discontinued operations consists of the results of Solutia's pharmaceutical services business. As described in Note 5 to the accompanying condensed consolidated financial statements, on August 22, 2006, SESA sold its pharmaceutical services business to Dishman. Summary of Events Affecting Comparability Charges and gains recorded in the first quarter of 2007 and 2006 and other events affecting comparability have been summarized and described in the table and accompanying footnotes below (dollars in millions):

2007 ------------------------------------------------------------------ INCREASE/(DECREASE) PERFORMANCE INTEGRATED CORPORATE/ PRODUCTS NYLON OTHER CONSOLIDATED -------- ----- ----- ------------ IMPACT ON: Cost of goods sold.......................... $ -- $ -- $ -- $ -- ------------------------------------------------------------------ OPERATING INCOME IMPACT..................... -- -- -- -- Loss on debt modification................... -- -- (7) (7) (a) Reorganization Items, net................... -- -- (16) (16) (b) ------------------------------------------------------------------ PRE-TAX INCOME STATEMENT IMPACT............. $ -- $ -- $ (23) (23) ==================================================== Income tax impact........................... -- (c) -------------- AFTER-TAX INCOME STATEMENT IMPACT........... $(23) ====== 2007 EVENTS ----------- a) Solutia recorded a charge of approximately $7 million (pre-tax and after-tax - see note (c) below) to record the write-off of debt issuance costs and to record the DIP facility as modified at its fair value as of the amendment date. b) Reorganization items, net consist of the following: $15 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings and $1 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. ($16 million pre-tax and after-tax - see note (c) below) c) 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

2006 ------------------------------------------------------------------ INCREASE/(DECREASE) PERFORMANCE INTEGRATED CORPORATE/ PRODUCTS NYLON OTHER CONSOLIDATED -------- ----- ----- ------------ IMPACT ON: Cost of goods sold.......................... $ -- $ -- $ 9 $ 9 (a) ------------------------------------------------------------------ OPERATING INCOME IMPACT..................... -- -- (9) (9) Interest expense ........................... -- -- (1) (1) (b) Loss on debt modification................... -- -- (8) (8) (b) Reorganization Items, net................... (1) (3) (10) (14) (c) ------------------------------------------------------------------ PRE-TAX INCOME STATEMENT IMPACT............. $ (1) $ (3) $(28) (32) ==================================================== Income tax impact........................... 2 (d) -------------- AFTER-TAX INCOME STATEMENT IMPACT........... $(30) ====== 2006 EVENTS ----------- a) Environmental charge 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 $7 million after-tax - see note (d) below). b) Solutia recorded a charge of approximately $8 million (pre-tax and after-tax - see note (d) below) to record the write-off of debt issuance costs and to record the DIP facility as modified at its fair value. In addition, $1 million (pre-tax and after-tax - see note (d) below) of unamortized debt issuance costs associated with the DIP facility were written off at the time of modification in March 2006. c) Reorganization items, net consist of the following: $12 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $2 million of net gains for adjustments to record certain pre-petition claims at estimated amounts of the allowed claims; $2 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 other reorganization charges primarily involving costs incurred with the shut-down of Solutia's acrylic fibers business. ($14 million pre-tax and after-tax - see note (d) below) d) 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.

FINANCIAL CONDITION AND LIQUIDITY As discussed in Note 1 to the accompanying condensed 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 at this time. 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 the first quarter 2007. Cash used in continuing operations was $119 million in the first quarter 2007, a change of $55 million from $64 million used in continuing operations for the comparable period of 2006. This change in cash used in 40 operations was primarily attributable to higher pension contributions and increases in working capital items in comparing the first quarter 2007 and 2006. Capital spending increased $12 million to $36 million in the first quarter 2007, compared to $24 million in the first quarter 2006. The expenditures in the first quarter 2007 were primarily to fund certain growth initiatives in the Performance Products and Integrated Nylon segments, as well as various capital improvements and certain cost reduction projects. Solutia's working capital decreased by $58 million to ($323) million at March 31, 2007, compared to ($265) million at December 31, 2006. The change was primarily a result of higher short-term debt, partially offset by the $150 million restricted cash for acquisition and the seasonal increase in working capital as of March 31, 2007. Total debt of $1,856 million as of March 31, 2007, including $668 million subject to compromise and $1,188 million not subject to compromise, increased by $328 million as compared to $1,528 million at December 31, 2006, including $668 million subject to compromise and $860 million not subject to compromise. This increase in total debt resulted primarily from $325 million of additional borrowings from Solutia's DIP credit facility in the first quarter 2007 related to the January 2007 amendment (as described below). The weighted average interest rate on Solutia's total debt outstanding was approximately 8.2 percent and 8.4 percent at March 31, 2007 and December 31, 2006, respectively. 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 8.5 percent at March 31, 2007 compared to 8.9 percent at December 31, 2006. While operating as a debtor-in-possession during the Chapter 11 proceedings, Solutia has ceased paying interest on its 6.72% debentures due 2037 and its 7.375% debentures due 2027. The amount of contractual interest expense not recorded in each of the first quarter 2007 and 2006 was approximately $8 million. Solutia had a shareholders' deficit of $1,413 million at March 31, 2007 compared to $1,405 million at December 31, 2006. The $8 million increase in shareholders' deficit resulted from the $8 million first quarter 2007 net loss and the $3 million cumulative adjustment related to the adoption of FIN 48; partially offset by the $2 million decrease in accumulated other comprehensive loss. As a result of the Chapter 11 bankruptcy filing, Solutia was in default on all its debt agreements as of March 31, 2007, with the exception of its DIP credit facility and SESA's (euro)200 million 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. At March 31, 2007, Solutia's total liquidity was $347 million in the form of $179 million of availability under the DIP credit facility and approximately $168 million of cash on-hand, of which $142 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 proceedings. In comparison, Solutia's total liquidity at December 31, 2006 was $245 million in the form of $95 million of availability under the 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. The increase in cash on-hand was primarily a result of the DIP amendment in January 2007 as described below. 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. Approximately $29 million of these required 2007 contributions were made in the first quarter 2007. Solutia also expects to be required to fund approximately $6 million in pension contributions for its foreign pension plans in 2007. DIP Amendment Solutia amended its DIP financing facility on January 25, 2007 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP facility from $825 million to $1,225 million; (ii) extended the term of the DIP facility from March 31, 2007 to March 31, 2008; (iii) decreased the interest rate on the term loan component of the DIP facility from LIBOR plus 350 basis points to LIBOR plus 300 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; and (vi) amended certain financial and other covenants. Of the $1,225 million facility, $150 million was utilized to partially finance the acquisition of Akzo Nobel's interest in the 41 50/50 Flexsys joint venture between Solutia and Akzo Nobel. The remaining increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund upcoming mandatory pension payments. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. Acquisition On May 1, 2007, Solutia acquired Akzo Nobel's interest in the 50/50 Flexsys joint venture between Solutia and Akzo Nobel as described in Note 16 to the accompanying condensed consolidated financial statements. Pending Transactions Solutia continued to divest certain non-strategic businesses in order to focus resources on core businesses. On March 11, 2007, Solutia entered into a definitive agreement to sell DEQUEST(R), its water treatment phosphonates business ("Dequest") to Thermphos Trading GmbH ("Thermphos"). Under the terms of the agreement, Thermphos will purchase the assets and assume certain of the liabilities of Dequest for $67 million in cash, subject to a working capital adjustment. The sale is subject to Bankruptcy Court approval following the completion of a Bankruptcy Court-supervised auction process. The Bankruptcy Court has scheduled a hearing to approve the sale on May 18, 2007. The closing of the sale is also subject to certain governmental and regulatory approvals, and other customary closing conditions. The proposed transaction is expected to close in the second quarter 2007 with Solutia receiving estimated net proceeds of $60 million. As is more fully described in Note 12 to the accompanying condensed consolidated financial statements under the caption Solutia v. FMC Corporation, Solutia and FMC reached a settlement on April 2, 2007 pursuant to which FMC agreed to pay Solutia $23 million in cash, subject to Bankruptcy Court approval. The settlement was approved by the Bankruptcy Court on May 1, 2007 with Solutia expecting to receive the proceeds in the second quarter 2007. CONTINGENCIES See Note 12 to the accompanying condensed consolidated financial statements for a summary of Solutia's contingencies as of March 31, 2007. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS There have been no material changes in market risk exposures during the first quarter 2007 that affect the disclosures presented in the information appearing under "Derivative Financial Instruments" on pages 43-44 of Solutia's Form 10-K for the year-ended December 31, 2006. ITEM 4. CONTROLS AND PROCEDURES During the period covered by this Form 10-Q, 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 the end of the period covered by this Form 10-Q, 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 the end of the period covered by this Form 10-Q, 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 quarterly period ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. 42 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE ---------------------------------------------- JP MORGAN ADVERSARY PROCEEDING Solutia's 2006 Form 10-K describes an adversary proceeding filed by JPMorgan, as indenture trustee for Solutia's debentures due 2027 and 2037 (the "Prepetition Indenture"), against Solutia in Solutia's bankruptcy case. In this proceeding, JPMorgan alleged that the Debentures are entitled to secured status as opposed to general unsecured status as set forth in the Plan. On May 1, 2007, the Bankruptcy Court ruled in favor of Solutia, holding that the 2027 and 2037 Debentures were properly de-securitized under the express terms of the Prepetition Indenture and its related agreements, that the noteholders of the 2027 and 2037 Debentures do not have, and are not entitled to any security interests or liens on any of Solutia's assets and that the noteholders are not entitled to any equitable relief. EQUITY COMMITTEE ADVERSARY PROCEEDING AGAINST MONSANTO AND PHARMACIA Solutia's 2006 Form 10-K described the Equity Committee Adversary Proceeding pending in Solutia's bankruptcy case. This Adversary Proceeding had been stayed indefinitely by the parties pursuant to a standstill agreement which was subject to certain rights of the parties to recommence such proceeding. On April 6, 2007, the Equity Committee provided written notice to Monsanto and Pharmacia terminating the standstill agreement. In addition, the Equity Committee requested that the Bankruptcy Court schedule the Adversary Proceeding for trial. A hearing is scheduled for May 18, 2007, at which the Bankruptcy Court will consider the Equity Committee's request. LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE --------------------------------------------------- GE RELATED LITIGATION On March 13, 2007, a purported class action lawsuit, captioned Corlew, et al., v. General Electric Company, Monsanto Company, Pharmacia Corporation, and Solutia Inc., was filed in the Superior Court of New York County, New York ("the GE Litigation"). The plaintiffs are current residents of Schenectady, New York, who seek to represent a class of all individuals who owned and/or occupied property within a five-mile radius of General Electric's Main Plant in Schenectady. The plaintiffs allege that their properties were contaminated by the release of PCBs manufactured by Monsanto, Pharmacia, and/or Solutia (collectively referred to in the Complaint as "Monsanto") that were used in the manufacture of a variety of products at General Electric's Schenectady plant. Plaintiffs allege a series of twenty-five claims including thirteen claims specifically against Monsanto, Pharmacia, and Solutia collectively including negligence, breach of warranty, strict liability, fraudulent concealment, negligent and intentional infliction of emotional distress, nuisance, trespass, unjust enrichment, and willful and wanton misconduct, with each claim seeking between $12 billion and $20 billion in compensatory damages, and an equivalent amount in punitive damages. Solutia believes the GE Litigation is automatically stayed as to Solutia pursuant to Section 362 of the U.S. Bankruptcy Code. Accordingly, Solutia has filed its suggestion of bankruptcy with the trial court. At the time of the Solutia Spinoff from Pharmacia, Solutia agreed to defend Pharmacia against, and indemnify Pharmacia for, litigation liabilities related to chemical products formerly manufactured, released or used by Pharmacia prior to the Solutia Spinoff. After filing for Chapter 11 protection, Solutia ceased performance of its defense and indemnification obligations with respect to these litigation liabilities as they are deemed pre-petition obligations under the U.S. Bankruptcy Code. Monsanto is currently managing and funding such litigation liabilities pursuant to its indemnification obligations to Pharmacia. Because Solutia is not managing such litigation, it has ceased updating on the status of those legal proceedings. The GE Litigation falls within the scope of litigation liabilities described above. Monsanto's funding of the GE Litigation may give rise to a claim against Solutia which Monsanto may assert in Solutia's bankruptcy case. OTHER LEGAL PROCEEDINGS ----------------------- Davis v. Solutia Inc. Employees' Pension Plan; Hammond, et al. v. ----------------------------------------------------------------- Solutia Inc. Employees' Pension Plan. Solutia's 2006 Form 10-K described ------------------------------------ consolidated class action cases filed in the Southern District of Illinois captioned Davis, et al. v. Solutia Inc Employees' Pension Plan and Hammond, et al. v. Solutia Inc. Employees' Pension Plan. The class certification motions filed in late 2006 have been scheduled for hearing on July 12, 2007. However, on May 3, 2007, the judge presiding over the case recused himself from the proceeding and a new judge was appointed, therefore, it is unclear if the hearing will proceed as scheduled. Dickerson v. Feldman. Solutia's 2006 Form 10-K described a purported -------------------- class action captioned Dickerson v. Feldman, et al. 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. Oral arguments on the appeal of the District Court's dismissal of the action based upon lack of standing and failure to state a claim on which relief could be granted have been scheduled for May 22, 2007. 43 Solutia Inc. v. FMC Corporation. Solutia's 2006 Form 10-K described ------------------------------- an action filed by Solutia captioned Solutia Inc. v. FMC Corporation relating to the failure of purified phosphoric acid technology contributed by FMC to Astaris, the former 50/50 joint venture between Solutia and FMC. On April 2, 2007, Solutia and FMC reached a settlement in this litigation pursuant to which FMC agreed to pay Solutia $23 million in cash, subject to Bankruptcy Court approval. Solutia's motion for approval of the settlement was approved by the Bankruptcy Court on May 1, 2007. Solutia Canada Inc. v. INEOS Americas LLC. Solutia's 2006 Form 10-K ----------------------------------------- described an action filed by Solutia Canada captioned Solutia Canada Inc. v. INEOS Americas LLC in Quebec Court for breach of contract by INEOS Americas LLC ("INEOS") of the LaSalle Toll Agreement ("LTA"). On March 26, 2007, INEOS filed a cross-demand against Solutia Canada for $1 million (CAD), alleging that Solutia Canada improperly charged INEOS on its October and November 2006 invoices for items which INEOS claims are not actual direct or indirect costs under the LTA. INEOS reserved the right to amend its demand for additional alleged overpayments on any future invoices through the remaining term of the LTA. Solutia Canada denies INEOS' allegation. Texas Commission on Environmental Quality Administrative Enforcement -------------------------------------------------------------------- Proceeding. Solutia's 2006 Form 10-K described an administrative enforcement ---------- proceeding against Solutia filed by the Texas Commission on Environmental Quality (the "Commission) alleging certain violations of the State of Texas air quality program and seeking assessment of an administrative penalty and the undertaking of corrective actions by Solutia. Solutia and the Commission have reached a settlement in principle that includes payment of a de minimis penalty and a contribution to an environmentally beneficial project in exchange for mitigation of a portion of the penalty. All required corrective action has been completed. The final settlement orders are subject to approval by the Commission. ITEM 5. OTHER INFORMATION On April 11, 2007, the Bankruptcy Court approved Solutia's entry into the Transaction Agreement previously disclosed in Solutia's 2006 Annual Report on Form 10-K, pursuant to which Solutia agreed to purchase, on the terms and subject to the conditions set forth in the agreement, Akzo Nobel's stake in Flexsys, a 50/50 rubber chemicals joint venture between Akzo Nobel and Solutia (the "Flexsys Acquisition") for $213 million, subject to various adjustments. The Flexsys Acquisition was financed by $150 million of funding under the amended DIP credit facility and additional funding through Flexsys. The Flexsys Acquisition closed on May 1, 2007, upon which Solutia became the sole owner of Flexsys. Contemporaneous with the closing of Flexsys Acquisition, Solutia purchased Akzo Nobel's Crystex manufacturing operations in Japan. After the closing, Akzo Nobel and certain of its affiliates will continue providing services to Flexsys at certain sites shared by Flexsys and Akzo Nobel pursuant to services agreements entered into in connection with the Flexsys Acquisition. Combined Financial Statements of Flexsys Group required pursuant to Item 2.01 of the Form 8-K rules are incorporated by reference to Exhibit 99.2 of Solutia's Form 10-K/A filed on March 28, 2007. Pro forma financial information required pursuant to Item 2.01 of the Form 8-K rules will be provided on Form 8-K on or before July 13, 2007. ITEM 6. EXHIBITS See the Exhibit Index at page 46 of this report. 44 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOLUTIA INC. -------------------------- (Registrant) /s/ TIMOTHY J. SPIHLMAN -------------------------- (Vice President and Controller) (On behalf of the Registrant and as Principal Accounting Officer) Dated: May 7, 2007 45 EXHIBIT INDEX These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K. EXHIBIT NUMBER DESCRIPTION ------ ----------- 10.1 Amendment No. 5 to Financing Agreement and Waiver dated as of January 25, 2007 amending the 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 on January 25, 2007) 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 Combined Financial Statements of Flexsys Group (incorporated by reference to Exhibit 99.2 of Solutia's Form 10-K/A filed on March 28, 2007) 46