10-Q 1 sol10q.txt FORM 10-Q FOR SOLUTIA INC. ============================================================================= FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 (MARK ONE) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002 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 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, 2002 ----- -------------- COMMON STOCK, $0.01 PAR VALUE 104,779,372 SHARES ============================================================================= PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SOLUTIA INC. STATEMENT OF CONSOLIDATED INCOME (LOSS) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

THREE MONTHS ENDED MARCH 31, --------------------- 2002 2001 ------ ------ NET SALES................................................... $ 654 $ 747 Cost of goods sold.......................................... 532 619 ------ ------ GROSS PROFIT................................................ 122 128 Marketing expenses.......................................... 43 46 Administrative expenses..................................... 36 36 Technological expenses...................................... 15 17 Amortization expense........................................ 1 8 ------ ------ OPERATING INCOME............................................ 27 21 Equity earnings from affiliates--net of tax................. 8 4 Interest expense............................................ (25) (22) Other income--net........................................... 7 31 ------ ------ INCOME BEFORE INCOME TAXES.................................. 17 34 Income taxes................................................ 3 12 ------ ------ INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE................................................. 14 22 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE......... (167) -- ------ ------ NET INCOME (LOSS)........................................... $ (153) $ 22 ====== ====== BASIC EARNINGS PER SHARE: INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE................................................. $ 0.13 $ 0.21 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE......... $(1.59) $ -- ------ ------ NET INCOME (LOSS)........................................... $(1.46) $ 0.21 ====== ====== DILUTED EARNINGS PER SHARE: INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE................................................. $ 0.13 $ 0.21 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE......... $(1.59) $ -- ------ ------ NET INCOME (LOSS)........................................... $(1.46) $ 0.21 ====== ====== Weighted average equivalent shares (in millions): Basic................................................... 104.7 103.4 Effect of dilutive securities: Common share equivalents--common shares issuable upon exercise of outstanding stock options........ 0.4 1.4 ------ ------ Diluted................................................. 105.1 104.8 ====== ======

STATEMENT OF CONSOLIDATED COMPREHENSIVE LOSS (DOLLARS IN MILLIONS) THREE MONTHS ENDED MARCH 31, --------------------- 2002 2001 ------ ------ NET INCOME (LOSS)........................................... $ (153) $ 22 OTHER COMPREHENSIVE LOSS: Currency translation adjustments............................ (5) (36) Unrealized investment gains, net of tax..................... 1 -- Net realized (gain) loss on derivative instruments, net of tax.................................................... 1 (2) ------ ------ COMPREHENSIVE LOSS.......................................... $ (156) $ (16) ====== ====== See accompanying Notes to Consolidated Financial Statements.

1 SOLUTIA INC. STATEMENT OF CONSOLIDATED FINANCIAL POSITION (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents....................................... $ 19 $ 23 Trade receivables, net of allowance of $22 in 2002 and $22 in 2001............................................... 390 352 Miscellaneous receivables....................................... 85 105 Prepaid expenses................................................ 14 15 Deferred income tax benefit..................................... 123 123 Inventories..................................................... 314 303 ------ ------ TOTAL CURRENT ASSETS............................................ 945 921 PROPERTY, PLANT AND EQUIPMENT: Land............................................................ 58 58 Buildings....................................................... 425 425 Machinery and equipment......................................... 3,009 3,006 Construction in progress........................................ 43 51 ------ ------ Total property, plant and equipment............................. 3,535 3,540 Less accumulated depreciation................................... 2,415 2,397 ------ ------ NET PROPERTY, PLANT AND EQUIPMENT............................... 1,120 1,143 INVESTMENTS IN AFFILIATES....................................... 223 313 GOODWILL, net................................................... 291 386 IDENTIFIED INTANGIBLE ASSETS, net............................... 69 194 LONG-TERM DEFERRED INCOME TAX BENEFIT........................... 239 254 OTHER ASSETS.................................................... 188 197 ------ ------ TOTAL ASSETS.................................................... $3,075 $3,408 ====== ====== LIABILITIES AND SHAREHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable................................................ $ 236 $ 233 Wages and benefits.............................................. 46 56 Postretirement liabilities...................................... 93 82 Miscellaneous accruals.......................................... 350 362 Short-term debt................................................. 603 683 ------ ------ TOTAL CURRENT LIABILITIES....................................... 1,328 1,416 LONG-TERM DEBT.................................................. 623 627 POSTRETIREMENT LIABILITIES...................................... 933 947 OTHER LIABILITIES............................................... 458 531 SHAREHOLDERS' DEFICIT: Common stock (authorized, 600,000,000 shares, par value $0.01) Issued: 118,400,635 shares in 2002 and 2001................... 1 1 Net deficiency of assets at spinoff........................... (113) (113) Treasury stock, at cost (13,621,263 shares in 2002 and 13,921,604 shares in 2001).................................. (251) (257) Unearned ESOP shares............................................ -- (1) Accumulated other comprehensive loss............................ (147) (144) Reinvested earnings............................................. 243 401 ------ ------ SHAREHOLDERS' DEFICIT........................................... (267) (113) ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT..................... $3,075 $3,408 ====== ====== See accompanying Notes to Consolidated Financial Statements.

2 SOLUTIA INC. STATEMENT OF CONSOLIDATED CASH FLOW (DOLLARS IN MILLIONS)

THREE MONTHS ENDED MARCH 31, ------------------ 2002 2001 ----- ---- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS OPERATING ACTIVITIES: Net income (loss)........................................... $(153) $ 22 Adjustments to reconcile to Cash From Operations: Cumulative effect of change in accounting principle..... 167 -- Depreciation and amortization........................... 38 45 Amortization of deferred credits........................ (3) (3) Net pretax gains from asset disposals................... (5) (28) Changes in assets and liabilities: Income and deferred taxes........................... 57 (2) Trade receivables................................... (38) (20) Inventories......................................... (11) (14) Accounts payable.................................... 3 (39) Other assets and liabilities........................ (64) (32) ----- ---- CASH FROM OPERATIONS........................................ (9) (71) ----- ---- INVESTING ACTIVITIES: Property, plant and equipment purchases..................... (13) (24) Acquisition and investment payments, net of cash acquired... -- (1) Property disposals and investment proceeds.................. 98 31 ----- ---- CASH FROM INVESTING ACTIVITIES.............................. 85 6 ----- ---- FINANCING ACTIVITIES: Net change in short-term debt obligations................... (81) 53 Common stock issued under employee stock plans.............. 1 5 Other financing activities.................................. -- (2) ----- ---- CASH FROM FINANCING ACTIVITIES.............................. (80) 56 ----- ---- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ (4) (9) CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR........................................... 23 19 ----- ---- END OF PERIOD............................................... $ 19 $ 10 ===== ==== See accompanying Notes to Consolidated Financial Statements.

3 SOLUTIA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS) 1. BASIS OF PRESENTATION Solutia Inc. and its subsidiaries make and sell a variety of high-performance chemical-based materials. Solutia is a world leader in performance films for laminated safety glass and after-market applications; resins and additives for high-value coatings; process development and scale-up services for pharmaceutical fine chemicals; specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic fluid and an integrated family of nylon products including high-performance polymers and fibers. These financial statements should be read in conjunction with the audited financial statements and notes to consolidated financial statements included in Solutia's 2001 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 7, 2002. A summary of our critical accounting policies is presented on page 13 of our most recent Form 10-K. There have been no material changes in the accounting policies followed by Solutia during fiscal year 2002 except for those changes described in Footnote 5. The accompanying unaudited consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the financial position, results of operations, comprehensive loss, and cash flows for the interim periods reported. Such adjustments are of a normal, recurring nature. The results of operations for the three-month period ended March 31, 2002, are not necessarily indicative of the results to be expected for the full year. Certain reclassifications to prior year's financial information have been made to conform to the 2002 presentation. 2. RESTRUCTURING RESERVES As part of the integration of Vianova Resins with Solutia's resins businesses, Solutia identified excess production capacity for certain Solutia resins products that will allow for the consolidation of production facilities. As a result, Solutia decided to exit its operations at the Port Plastics site in Addyston, Ohio. An $8 million ($5 million aftertax) charge to cost of goods sold was recorded in the second quarter of 2000 to carry out the exit plan. The charge included $2 million to write down plant assets to their fair value of approximately $1 million, $2 million of dismantling costs and $4 million of estimated costs for which Solutia is contractually obligated under an operating agreement. Fair value was determined by discounting future cash flows using an appropriate discount rate. Under the operating agreement, Solutia is required to provide 24 months notice of intent to exit and to pay contractually obligated costs for an additional 18 months thereafter to a third-party operator. Solutia provided notice of intent to exit on June 30, 2000, and will exit the site in June of 2002. The contractually obligated costs represent direct manufacturing, overhead, utilities and severance. The financial impact will not be material to Solutia as production will be shifted to other production facilities. The following table summarizes the 2000 restructuring charge and amounts utilized to carry out those plans:

SHUTDOWN OF ASSET WRITE- OTHER FACILITIES DOWNS COSTS TOTAL ----------- ------------ ----- ----- Balance at January 1, 2000.................... $-- $-- $-- $-- Charges taken............................. 2 2 4 8 Amounts utilized.......................... -- (2) -- (2) ---- ---- ---- ---- Balance at December 31, 2000.................. 2 -- 4 6 Amounts utilized.......................... -- -- -- -- ---- ---- ---- ---- Balance at December 31, 2001.................. 2 -- 4 6 Amounts utilized.......................... -- -- -- -- ---- ---- ---- ---- BALANCE AT MARCH 31, 2002..................... $ 2 $-- $ 4 $ 6 ==== ==== ==== ====

4 3. INVENTORY VALUATION The components of inventories as of March 31, 2002, and December 31, 2001, were as follows:

MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ Finished goods................................ $ 216 $ 209 Goods in process.............................. 109 107 Raw materials and supplies.................... 101 100 ----- ----- Inventories, at FIFO cost..................... 426 416 Excess of FIFO over LIFO cost................. (112) (113) ----- ----- TOTAL......................................... $ 314 $ 303 ===== =====

4. CONTINGENCIES Because of the size and nature of its business, Solutia is a party to numerous legal proceedings. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. In addition, at the time of the spinoff, Solutia assumed from Monsanto, under a distribution agreement, liabilities related to specified legal proceedings. As a result, although Monsanto remains the named defendant, Solutia is required to manage the litigation and indemnify Monsanto for costs, expenses and judgments arising from the litigation. Such matters arise out of the normal course of business and relate to product liability; government regulation, including environmental issues; employee relations and other issues. Certain of the lawsuits and claims seek damages in very large amounts. Although the results of litigation cannot be predicted with certainty, management's belief is that the final outcome of such litigation, except as noted below, will not have a material adverse effect on Solutia's consolidated financial position, liquidity or profitability in any one year. Solutia's Annual Report on Form 10-K for the year ended December 31, 2001, describes four consolidated cases, sometimes referred to as Abernathy v. Monsanto or Bowie v. Monsanto, which have been in trial in Circuit Court for Etowah County, Alabama. The trial court departed from its announced schedule and did not submit the issue of compensatory damages for the 17 Phase I trial plaintiffs to the jury for determination. Instead the court has proceeded to hear damages evidence for all plaintiffs making property damage claims. In addition the court has completed hearing evidence on plaintiffs' claims for an injunction directing defendants to implement a cleanup in Anniston and has referred the matter to a Special Master for a recommendation. On March 25, 2002, the United States Environmental Protection Agency ("EPA") filed a Partial Consent Decree ("the Decree") in U.S. District Court for the Northern District of Alabama. Pursuant to the Decree Solutia has agreed to conduct a Remedial Investigation and Feasibility Study which will provide the information upon which the EPA will base its decision on the appropriate remedial action in Anniston. We have argued that the filing of the Decree has preempted the state court's jurisdiction over any cleanup in Anniston. Solutia, Monsanto Company, and Pharmacia Corporation are named as defendants in an action called Oliver v. Monsanto, filed on behalf of a single plaintiff in U.S. District Court for the Northern District of Alabama. Plaintiff alleges that she has been exposed to PCBs from the Anniston plant and that PCBs are present on her property. Plaintiff seeks compensatory and punitive damages in an unspecified amount, and claims entitlement to medical monitoring. Solutia is vigorously defending this action. Management does not believe that the ultimate resolution of the matters related to Anniston, Alabama will have a material adverse impact on its consolidated financial position or liquidity. However, it is possible that a resolution of these cases may have a material adverse impact on Solutia's net income in a given year, although it is impossible at this time to estimate the range or amount of any such liability. 5. GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, Solutia adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, Solutia discontinued the amortization of goodwill and identifiable intangible assets that have indefinite useful lives. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. Goodwill will be assessed annually for 5 impairment. This statement also required certain intangible assets that did not meet the criteria for recognition apart from goodwill, to be subsumed into goodwill. During the quarter ended March 31, 2002, Solutia subsumed into goodwill $74 million of intangible assets net of related deferred tax liabilities representing assembled workforce and noncontractual customer relationships that did not meet the separability criteria under SFAS No. 141, "Business Combinations." Net income (loss) and earnings (loss) per share for the first quarter of 2002 and 2001, adjusted to exclude the non-amortization provisions of SFAS No. 142, net of tax, are as follows:

MARCH 31, MARCH 31, 2002 2001 --------- --------- Net income: Income before cumulative effect of change in accounting principle............................................ $ 14 $ 22 Goodwill amortization.................................. -- 5 Subsumed intangible assets amortization................ -- 1 Equity method goodwill and trademark amortization...... -- 1 Cumulative effect of change in accounting principle.... (167) -- ------ ------ ADJUSTED NET INCOME (LOSS).................................. $ (153) $ 29 ====== ======

MARCH 31, MARCH 31, 2002 2001 --------- --------- Basic earnings (loss) per share: Income before cumulative effect of change in accounting principle............................................. $ 0.13 $ 0.21 Goodwill amortization................................... -- 0.05 Subsumed intangible assets amortization................. -- 0.01 Equity method goodwill and trademark amortization....... -- 0.01 Cumulative effect of change in accounting principle..... (1.59) -- ------ ------ ADJUSTED BASIC EARNINGS (LOSS) PER SHARE.................... $(1.46) $ 0.28 ====== ======

MARCH 31, MARCH 31, 2002 2001 --------- --------- Diluted earnings (loss) per share: Income before cumulative effect of change in accounting principle............................................. $ 0.13 $ 0.21 Goodwill amortization................................... -- 0.05 Subsumed intangible assets amortization................. -- 0.01 Equity method goodwill and trademark amortization....... -- 0.01 Cumulative effect of change in accounting principle..... (1.59) -- ------ ------ ADJUSTED DILUTED EARNINGS (LOSS) PER SHARE.................. $(1.46) $ 0.28 ====== ======

6 Identified intangible assets are as follows:

GROSS MARCH 31, 2002 NET CARRYING ACCUMULATED CARRYING VALUE AMORTIZATION VALUE -------- -------------- -------- Amortized intangible assets: Contractual customer relationships................ $ 23 $ (3) $ 20 Patents........................................... 6 (2) 4 Employment agreements............................. 5 (1) 4 Other............................................. 6 (4) 2 ---- ---- ---- TOTAL AMORTIZED INTANGIBLE ASSETS..................... $ 40 $(10) $ 30 ---- ---- ---- Unamortized intangible assets: Trademarks........................................ $ 45 $ (6) $ 39 ---- ---- ---- TOTAL UNAMORTIZED INTANGIBLE ASSETS................... $ 45 $ (6) $ 39 ---- ---- ----

GROSS DECEMBER 31, 2001 NET CARRYING ACCUMULATED CARRYING VALUE AMORTIZATION VALUE -------- ----------------- -------- Intangible assets: Customer relationships............................ $149 $(14) $135 Trademarks........................................ 45 (6) 39 Assembled workforce............................... 10 (2) 8 Patents........................................... 7 (2) 5 Employment agreements............................. 5 -- 5 Other............................................. 6 (4) 2 ---- ---- ---- TOTAL INTANGIBLE ASSETS............................... $222 $(28) $194 ==== ==== ====

There were no acquisitions of intangible assets during the first quarter of 2002. Intangible asset amortization expense was $1 million for the first quarter of 2002. As a result of adoption of SFAS No. 142, there have been no changes to amortizable lives or methods. Amortization expense for the net carrying amount of intangible assets is estimated to be $4 million in 2002, $4 million in 2003, $4 million in 2004, $4 million in 2005 and $4 million in 2006. Goodwill as allocated by reportable segment is as follows:

PERFORMANCE SPECIALTY INTEGRATED FILMS PRODUCTS NYLON TOTAL ----------- --------- ---------- ----- Gross goodwill, December 31, 2001................ $ 84 $ 347 $-- $ 431 Accumulated amortization......................... (11) (34) (45) ---- ----- ---- ----- Net goodwill, December 31, 2001.................. $ 73 $ 313 $-- $ 386 Intangible assets subsumed: Noncontractual customer relationships........ -- 114 -- 114 Assembled workforce.......................... -- 8 -- 8 Deferred tax liabilities..................... -- (48) -- (48) Impairment loss.................................. -- (167) -- (167) Translation...................................... -- (2) -- (2) ---- ----- ---- ----- Goodwill, March 31, 2002......................... $ 73 $ 218 $-- $ 291 ==== ===== ==== =====

Fair value measurements of the reporting units were estimated by a third-party specialist utilizing both an income and market multiple approach. Based on this analysis, Solutia recorded an impairment loss of $167 million for the Resins and Additives business in the Specialty Products segment due to declining estimates of future 7 results given current economic and market conditions. This goodwill is non-deductible for tax purposes. The impairment charge is reflected as the cumulative effect of change in accounting principle in the accompanying statement of consolidated income (loss). 6. INVESTMENTS IN AFFILIATES During the first quarter of 2002, Solutia sold its 50 percent interest in the Advanced Elastomer Systems joint venture to ExxonMobil Chemical Company, a division of Exxon Mobil Corporation and Exxon Chemical Asset Management Partnership, a subsidiary of Exxon Mobil Corporation for approximately $102 million. The sale resulted in a gain of $5 million ($3 million aftertax). 7. SEGMENT DATA Solutia's management is organized around four strategic business platforms: Performance Films, Resins and Additives, Specialties and Integrated Nylon. Resins and Additives and Specialties have been aggregated into the Specialty Products reportable segment because of their similar economic characteristics, as well as their similar products and services, production processes, types of customers and methods of distribution. Solutia's reportable segments and their major products are as follows:

PERFORMANCE FILMS SPECIALTY PRODUCTS INTEGRATED NYLON ----------------- ------------------ ---------------- SAFLEX(R) plastic interlayer Resins and additives, Nylon intermediate "building including ALFTALAT(R) block" chemicals KEEPSAFE(R), SAFLEX polyester resins, INSIDE(R) (in Europe only) RESIMENE(R) and MAPRENAL(R) Merchant polymer and nylon and KEEPSAFE MAXIMUM(R) crosslinkers, SYNTHACRYL(R) extrusion polymers, glass for residential acrylic resins and GELVA(R) including VYDYNE(R) and security and hurricane pressure-sensitive adhesives ASCEND(R) protection windows LLUMAR(R), VISTA(R) and Industrial products, including Carpet fibers, including the GILA(R) professional and THERMINOL(R) heat transfer WEAR-DATED(R) and ULTRON after-market window films fluids, DEQUEST(R) water VIP(R) brands treatment chemicals, VANCEVA(TM) design, enhanced SKYDROL(R) hydraulic fluids Industrial nylon fibers security and sound and SKYKLEEN(R) cleaning attenuation films fluids for aviation and chlorobenzenes Conductive and anti-reflective Pharmaceutical services, ACRILAN(R) acrylic fibers for coated films and deep-dyed including process research, apparel, upholstery fabrics, films process development craft yarns and other services, scale-up applications capabilities and small scale manufacturing for the pharmaceutical industry

Accounting policies of the segments are the same as those used in the preparation of Solutia's consolidated financial statements. Solutia evaluates the performance of its operating segments based on segment earnings before interest expense and income taxes (EBIT), which includes marketing, administrative, technological, and amortization expenses and other non-recurring charges such as restructuring and asset impairment charges that can be directly attributable to the operating segment. Certain expenses and other items that are managed outside of the segments are excluded. These unallocated items consist primarily of corporate expenses, equity earnings (loss) from affiliates, interest expense, other income--net and expense items, and certain non-recurring items such as gains and losses on asset dispositions and restructuring charges that are not directly attributable to the operating segment. Solutia accounts for intersegment sales at agreed upon transfer prices. Intersegment sales are eliminated in consolidation. Segment assets consist primarily of customer receivables, raw materials and finished goods inventories, fixed assets, goodwill and identified intangible assets directly associated with the production processes of the segment (direct fixed assets). Segment depreciation and amortization are based upon direct tangible and intangible assets. Unallocated assets consist primarily of deferred taxes, certain investments in equity affiliates and indirect fixed assets. 8 Segment data for the three months ended March 31, 2002, and 2001 are as follows:

THREE MONTHS ENDED MARCH 31, --------------------------------------------------------------------------------- 2002 2001 ------------------------------------ ------------------------------------ NET INTERSEGMENT NET INTERSEGMENT SALES SALES PROFIT SALES SALES PROFIT ----- ------------ ------ ----- ------------ ------ SEGMENT: Performance Films................ $ 142 $-- $ 19 $ 151 $-- $ 16 Specialty Products (a)........... 216 -- 20 251 -- 49 Integrated Nylon................. 296 -- 7 345 -- (5) ------ ---- ---- ------ ---- ---- SEGMENT TOTALS..................... 654 -- 46 747 -- 60 RECONCILIATION TO CONSOLIDATED TOTALS: Corporate expenses............... (17) (10) Equity earnings from affiliates, net of tax..................... 8 5 Interest expense................. (25) (22) Other income--net (b)............ 5 1 CONSOLIDATED TOTALS: ------ ---- ------ ---- NET SALES........................ $ 654 $-- $ 747 $-- ====== ==== ---- ====== ==== ---- INCOME BEFORE INCOME TAXES....... $ 17 $ 34 ==== ==== (a) Specialty Products profit for the three months ended March 31, 2001, includes a gain from an insurance settlement associated with the explosion and fire that destroyed the Vianova printing inks and phenolics production facility in Wiesbaden, Germany ($28 million pretax, $17 million aftertax). (b) Other income--net for the three months ended March 31, 2002, includes a gain from the sale of Solutia's 50 percent interest in the Advanced Elastomer Systems joint venture to ExxonMobil Chemical Company, a division of Exxon Mobil Corporation and Exxon Chemical Asset Management Partnership, a subsidiary of Exxon Mobil Corporation ($5 million pretax, $3 million aftertax).

9 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, liquidity and financing. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements herein include, among others, general economic, business and market conditions, customer acceptance of new products, raw material and energy pricing, currency fluctuations, increased competitive and/or customer pressure, ability to divest existing businesses, ability and cost to refinance debt, exposure to product liability and other litigation and cost of environmental remediation, changes in accounting principles generally accepted in the United States of America and ability to implement cost reduction initiatives in a timely manner. CRITICAL ACCOUNTING POLICIES A summary of our critical accounting policies is presented on page 13 of our 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 7, 2002. RESULTS OF OPERATIONS--FIRST QUARTER 2002 COMPARED WITH FIRST QUARTER 2001 Net sales for the first quarter of 2002 decreased by 12 percent as compared with the first quarter of 2001. The net sales decrease reflected lower average selling prices, lower volumes and unfavorable currency exchange rate fluctuations. Performance Films Net sales in the Performance Films segment for the first quarter of 2002 decreased by 6 percent over the same period of the prior year. Net sales decreased primarily because of lower average selling prices than those of the year-ago quarter due to competitive pricing pressures. Also, to a lesser extent, net sales were negatively affected by unfavorable currency exchange rate fluctuations in the Saflex business primarily due to the devaluation of the euro and Japanese yen in relation to the U.S. dollar. Increased demand for SAFLEX(R) plastic interlayer products by European automotive glass manufacturers was offset by lower specialty films sales into the electronic display market. Segment profit for the three-month period ended March 31, 2002, increased 19 percent over the three-month period ended March 31, 2001, primarily due to lower raw material costs, lower marketing, administrative and technological spending, lower personnel expense associated with restructuring activities carried out during 2001 and lower amortization expense due to the adoption of SFAS No. 142. Specialty Products Net sales in the Specialty Products segment decreased 14 percent for the first quarter 2002 over the comparable quarter of the prior year. The decrease in net sales was primarily caused by lower sales volumes in the Resins and Additives business because of decreased demand by European customers and lower sales of chlorobenzenes. Also, to a lesser extent, businesses in this segment experienced lower average selling prices than those of the year-ago quarter primarily because of competitive pressures and unfavorable currency exchange rate fluctuations due to the devaluation of the euro in relation to the U.S. dollar. Segment profit for the Specialty Products segment decreased 59 percent for the quarter ended March 31, 2002, over the year-ago quarter. Excluding the gain of $28 million ($17 million aftertax) recorded in the first quarter of 2001 from an insurance settlement associated with the explosion and fire that destroyed the Vianova printing inks and phenolics production facility in Wiesbaden, Germany, segment profit decreased 5 percent. The effects of lower net sales described above were partially offset by lower raw material costs, lower personnel expense associated with restructuring activities carried out during 2001 and lower amortization expense due to the adoption of SFAS No. 142. Integrated Nylon Net sales for the first quarter of 2002 in the Integrated Nylon segment decreased 14 percent from the first quarter of 2001. The effects of a weak U.S. economy continue to unfavorably impact the Integrated Nylon segment. The decrease in sales occurred primarily because of declines in average selling prices in all businesses in 10 this segment. Sales volume increases in intermediate chemicals and ACRILAN(R) acrylic fibers were partially offset by volume declines in nylon industrial products and unfavorable product mix in carpet fiber. Price decreases in intermediate chemicals primarily resulted from contracts with formula pricing tied to raw material costs. Price decreases in the remaining businesses were due to competitive pricing pressures. Higher sales volumes in intermediate chemicals resulted from increased merchant acrylonitrile sales to Asian and European customers. Sales volumes for acrylic fibers increased because of higher export sales to Asian and Latin American customers. Sales volumes for nylon industrial products decreased because of the slowdown in the U.S. automotive industry. The Integrated Nylon segment's profit was $7 million for the quarter ended March 31, 2002, compared to a loss in the first quarter of 2001 of $5 million. The increase in segment profitability resulted primarily from lower raw material and energy prices and to a lesser extent, lower marketing, administrative and technological spending and lower personnel expense associated with restructuring activities carried out during 2001. Operating Income Operating income for the first quarter of 2002 was $27 million compared with $21 million in the first quarter of 2001. Excluding the effects of amortization expense from operating results in the first quarter of 2001 associated with the adoption of SFAS No. 142 (see Footnote 5), operating income in the first quarter of 2002 decreased $1 million from the prior year. The negative impact of lower net sales in the operating segments was partially offset by lower raw material and energy costs and lower marketing and technological expenses. The decrease in marketing and technological expenses can be attributed principally to lower personnel costs resulting from restructuring activities carried out during 2001. Operating income was also negatively affected by a year-over-year increase in corporate expenses of approximately $5 million due to protracted litigation in Anniston, Alabama. Equity Earnings From Affiliates For the three months ended March 31, 2002, equity earnings from affiliates were $8 million compared to $4 million for the same time period in 2001 because of higher earnings from the Astaris joint venture, and to a lesser extent, higher earnings from the Flexsys joint venture. Higher equity earnings were partially offset by having only two months of equity earnings from the Advanced Elastomer Systems joint venture. Other Income--Net For the three months ended March 31, 2002, other income--net includes a $5 million ($3 million aftertax) gain from the sale of Solutia's 50 percent interest in the Advanced Elastomer Systems joint venture to ExxonMobil Chemical Company, a division of Exxon Mobil Corporation and Exxon Chemical Asset Management Partnership, a subsidiary of Exxon Mobil Corporation. For the quarter ended March 31, 2001, other income--net includes a gain of $28 million ($17 million aftertax) from an insurance settlement recorded in the Specialty Products segment. Cumulative Effect of Change in Accounting Principle Effective January 1, 2002, Solutia adopted SFAS No. 142, "Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, Solutia discontinued the amortization of goodwill and identifiable intangible assets that have indefinite useful lives. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. Goodwill will be assessed annually for impairment. This statement also required certain intangible assets that did not meet the criteria for recognition apart from goodwill, to be subsumed into goodwill. During the quarter ended March 31, 2002, Solutia subsumed into goodwill $74 million of intangible assets net of related deferred tax liabilities representing assembled workforce and noncontractual customer relationships that did not meet the separability criteria under SFAS No. 141, "Business Combinations." Fair value measurements of the reporting units were estimated by a third-party specialist utilizing both an income and market multiple approach. Based on this analysis, Solutia recorded an impairment loss of $167 million for the Resins and Additives business in the Specialty Products segment due to declining estimates of future results given current economic and market conditions. This goodwill is non-deductible for tax purposes. The impairment charge is reflected as the cumulative effect of change in accounting principle in the accompanying statement of consolidated income (loss). 11 FINANCIAL CONDITION AND LIQUIDITY During the first quarter of 2002, Solutia sold its 50 percent interest in the Advanced Elastomer Systems joint venture to ExxonMobil Chemical Company, a division of Exxon Mobil Corporation and Exxon Chemical Asset Management Partnership, a subsidiary of Exxon Mobil Corporation for approximately $102 million. The sale resulted in a gain of $5 million ($3 million aftertax). In March of 2002, the "Job Creation and Worker Assistance Act" was enacted which allowed for, among other things, a five-year carryback of net operating losses. As a result of this new law, Solutia received a $30 million income tax refund from the United States taxing authorities in addition to its $30 million anticipated income tax refund during the first quarter of 2002. Solutia used the net proceeds from the sale of its 50 percent interest in the Advanced Elastomer Systems joint venture and the income tax refunds to pay down debt, fund operations and for other general corporate purposes. Solutia's debt obligations include borrowings against the $800 million, five-year revolving credit facility ($800 million facility) with a syndicate of commercial banks, notes and debentures. At March 31, 2002, debt maturing in one year consisted primarily of borrowings of $450 million from the $800 million facility and $150 million of 6.5 percent notes due in October of 2002. The $800 million credit facility matures in August of 2002 and $150 million of 6.5 percent notes mature in October of 2002. Solutia plans to refinance both maturities with a combination of long-term notes, a secured term loan and a secured revolving credit facility. Interest rates will be commensurate with Solutia's credit rating and market conditions at the time of the refinancing. Based on Solutia's credit ratings and current market conditions, Solutia expects the interest rates on these new facilities to be higher than the interest rates on Solutia's current debt. Solutia anticipates that the refinancing of both maturities will require additional collateral. Proceeds of the refinancing will be used to repay outstanding borrowings under the $800 million facility and $150 million of 6.5 percent notes and for other general corporate purposes. The refinancing is expected to be completed in the first half of 2002. Inability to complete this refinancing or a similar financing vehicle prior to August 2002 would have a material adverse affect on Solutia's liquidity. In 1993, a co-generation facility was constructed at the Pensacola, Florida manufacturing site to provide the plant with electricity and steam. Solutia financed the construction by placing the co-generation facility in a trust that was funded by a syndicate of commercial banks. Solutia makes monthly operating lease payments and the lease term expires in August 2002. Solutia expects that the lease term of this facility will be extended to be co-terminous with the refinanced secured revolving credit facility. In connection with the completion of the external financing agreement for Astaris which expires in September of 2005, Solutia contractually agreed to provide Astaris with funding in the event the joint venture fails to meet certain financial benchmarks. Solutia anticipates that a contribution of up to $25 million will be required in 2002. Solutia believes that this obligation is not likely to have a significant impact on its consolidated financial position, liquidity or profitability. Solutia believes that its cash flow from operations, available borrowing capacity under the $800 million facility and the anticipated refinancing provide sufficient resources to finance its operations and planned capital needs for the next 12 months. RECENTLY ISSUED ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The statement addresses accounting and reporting requirements for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement obligations. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Solutia is evaluating SFAS No. 143 to determine the effects, if any, on its consolidated financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS There have been no material changes in market risk exposures during the first three months of 2002 that affect the disclosures presented in the information appearing under "Derivative Financial Instruments" on pages 26 and 27 of Solutia's Annual Report on Form 10-K for the year ended December 31, 2001. 12 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Solutia's Annual Report on Form 10-K for the year ended December 31, 2001, describes four consolidated cases, sometimes referred to as Abernathy v. Monsanto or Bowie v. Monsanto, which have been in trial in Circuit Court for Etowah County, Alabama. The trial court departed from its announced schedule and did not submit the issue of compensatory damages for the 17 Phase I trial plaintiffs to the jury for determination. Instead the court has proceeded to hear damages evidence for all plaintiffs making property damage claims. In addition the court has completed hearing evidence on plaintiffs' claims for an injunction directing defendants to implement a cleanup in Anniston, and has referred the matter to a Special Master for a recommendation. On March 25, 2002, the United States Environmental Protection Agency ("EPA") filed a Partial Consent Decree ("the Decree") in U.S. District Court for the Northern District of Alabama. Pursuant to the Decree Solutia has agreed to conduct a Remedial Investigation and Feasibility Study which will provide the information upon which the EPA will base its decision on the appropriate remedial action in Anniston. We have argued that the filing of the Decree has preempted the state court's jurisdiction over any cleanup in Anniston. Solutia, Monsanto Company, and Pharmacia Corporation are named as defendants in an action called Oliver v. Monsanto, filed on behalf of a single plaintiff in U.S. District Court for the Northern District of Alabama. Plaintiff alleges that she has been exposed to PCBs from the Anniston plant and that PCBs are present on her property. Plaintiff seeks compensatory and punitive damages in an unspecified amount, and claims entitlement to medical monitoring. Solutia is vigorously defending this action. Solutia's Annual Report on Form 10-K for the year ended December 31, 2001, describes administrative and judicial proceedings brought by the U.S. Environmental Protection Agency against Solutia, Monsanto Company (now known as Pharmacia Corporation), and P4 Production L.L.C. These proceedings arose out of alleged environmental violations at a coal coking facility in Rock Springs, Wyoming, currently owned by P4 Production. On March 29, 2002, the United States District Court for the District of Wyoming entered an order denying both the companies' and the United States' motions for summary judgment in the declaratory judgment action filed by the companies. On April 19, 2002, the companies filed a petition to certify the court's order for an interlocutory appeal and stay of proceedings. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits--See the Exhibit index at page 15 of this report. (b) A Form 8-K announcing Solutia's financial results for the fourth quarter and the full year of 2001 was filed on January 25, 2002. 13 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOLUTIA INC. ----------------------------------- (Registrant) /s/ JAMES M. SULLIVAN ----------------------------------- (Vice President and Controller) (On behalf of the Registrant and as Principal Accounting Officer) Date: April 25, 2002 14 EXHIBIT INDEX These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K. EXHIBIT NUMBER DESCRIPTION ------- ----------- 10 Letter Agreement between Solutia Inc. and Russell J. Belle dated January 14, 2002 11 See "Statement of Consolidated Income (Loss)" on page 1. 99 Computation of the Ratio of Earnings to Fixed Charges 15