10-Q 1 sol10q.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 JUNE 30, 2004 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 AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). 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 JUNE 30, 2004 ----- ------------- COMMON STOCK, $0.01 PAR VALUE 104,486,639 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 SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- NET SALES ......................................................... $699 $625 $1,342 $1,236 Cost of goods sold................................................. 655 576 1,227 1,118 ---- ---- ------ ------ GROSS PROFIT....................................................... 44 49 115 118 Marketing expenses................................................. 40 40 74 79 Administrative expenses............................................ 33 33 58 63 Technological expenses............................................. 16 11 26 23 Amortization expense............................................... 1 -- 1 1 ---- ---- ------ ------ OPERATING LOSS..................................................... (46) (35) (44) (48) Equity loss from affiliates........................................ (3) (1) (12) (6) Interest expense (a)............................................... (23) (25) (72) (48) Other income, net.................................................. -- 1 -- 8 Loss on debt modification.......................................... -- -- (15) -- Reorganization items, net.......................................... (24) -- (49) -- ---- ---- ------ ------ LOSS BEFORE INCOME TAX EXPENSE (BENEFIT)........................... (96) (60) (192) (94) Income tax expense (benefit)....................................... 2 (22) 6 (39) ---- ---- ------ ------ LOSS FROM CONTINUING OPERATIONS.................................... (98) (38) (198) (55) LOSS FROM DISCONTINUED OPERATIONS, NET OF TAX...................... -- -- -- (2) ---- ---- ------ ------ NET LOSS........................................................... $(98) $(38) $ (198) $ (57) ==== ==== ====== ====== BASIC AND DILUTED LOSS PER SHARE: Loss from Continuing Operations ................................... $(0.94) $(0.36) $(1.90) $(0.52) Net Loss........................................................... $(0.94) $(0.36) $(1.90) $(0.54) BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING.............. 104.5 104.6 104.5 104.6 ===== ===== ===== ===== (a) Interest expense excludes unrecorded contractual interest expense for the three and six months ended June 30, 2004 of $8 and $16, respectively. 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 SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- NET LOSS......................................................... $ (98) $ (38) $ (198) $ (57) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments ................................ 1 6 (1) 43 Minimum pension liability adjustments, net of tax ............... 18 -- 18 -- ------ ------- ------ ----- COMPREHENSIVE LOSS............................................... $ (79) $ (32) $ (181) $ (14) ====== ======= ====== ===== 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)

JUNE 30, DECEMBER 31, 2004 2003 ---- ---- (UNAUDITED) ----------- ASSETS CURRENT ASSETS: Cash and cash equivalents................................................. $ 98 $ 159 Trade receivables, net of allowances of $14 in 2004 and 2003.............. 341 281 Miscellaneous receivables ................................................ 87 84 Inventories............................................................... 248 240 Prepaid expenses and other assets......................................... 28 40 ------ ------ TOTAL CURRENT ASSETS...................................................... 802 804 PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation of $2,628 in 2004 and $2,597 in 2003....................................... 858 909 INVESTMENTS IN AFFILIATES................................................. 193 206 GOODWILL.................................................................. 97 97 IDENTIFIED INTANGIBLE ASSETS, net ........................................ 42 43 OTHER ASSETS.............................................................. 201 387 ------ ------ TOTAL ASSETS.............................................................. $2,193 $2,446 ====== ====== LIABILITIES AND SHAREHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable ......................................................... $ 155 $ 78 Accrued liabilities ...................................................... 264 304 Short-term debt .......................................................... -- 361 ------ ------ TOTAL CURRENT LIABILITIES ................................................ 419 743 LONG-TERM DEBT ........................................................... 599 294 OTHER LIABILITIES ........................................................ 288 313 ------ ------ TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE............................... 1,306 1,350 LIABILITIES SUBJECT TO COMPROMISE ........................................ 2,194 2,221 SHAREHOLDERS' DEFICIT: Common stock (authorized, 600,000,000 shares, par value $0.01) Issued: 118,400,635 shares in 2004 and 2003........................... 1 1 Additional contributed capital........................................ 56 56 Treasury stock, at cost (13,913,996 shares in 2004 and 13,838,717 in 2003) (251) (251) Net deficiency of assets at spin-off...................................... (113) (113) Accumulated other comprehensive loss...................................... (56) (72) Accumulated deficit....................................................... (944) (746) ------ ------ TOTAL SHAREHOLDERS' DEFICIT............................................... (1,307) (1,125) ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT............................... $2,193 $2,446 ====== ====== See accompanying Notes to Condensed Consolidated Financial Statements.

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

SIX MONTHS ENDED JUNE 30, -------- 2004 2003 ---- ---- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS OPERATING ACTIVITIES: Net loss ...................................................................... $ (198) $ (57) Adjustments to reconcile to Cash From Operations: Depreciation and amortization............................................. 64 68 Loss from discontinued operations, net of tax............................. -- 2 Amortization of deferred credits.......................................... (19) (7) Restructuring expenses and other charges.................................. 138 52 Reorganization items, net................................................. 49 -- Other, net................................................................ 3 8 Changes in assets and liabilities: Income and deferred taxes............................................ (2) (42) Trade receivables.................................................... (60) (34) Inventories.......................................................... (8) (7) Accounts payable..................................................... 77 (22) Liabilities subject to compromise.................................... (27) -- Other assets and liabilities......................................... (21) (2) ------- ------ CASH USED IN OPERATING ACTIVITIES--CONTINUING OPERATIONS....................... (4) (41) CASH USED IN OPERATING ACTIVITIES--DISCONTINUED OPERATIONS..................... -- (11) ------- ------ CASH USED IN OPERATING ACTIVITIES.............................................. (4) (52) ------- ------ INVESTING ACTIVITIES: Property, plant and equipment purchases........................................ (22) (46) Acquisition and investment payments............................................ (36) (27) Other investing activities..................................................... -- (1) ------- ------ CASH USED IN INVESTING ACTIVITIES--CONTINUING OPERATIONS....................... (58) (74) CASH PROVIDED BY INVESTING ACTIVITIES--DISCONTINUED OPERATIONS................. -- 477 ------- ------ CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES................................ (58) 403 ------- ------ FINANCING ACTIVITIES: Net change in short-term debt obligations...................................... (361) (239) Proceeds from long-term debt obligations....................................... 300 -- Net change in cash collateralized letters of credit............................ 76 (39) Deferred debt issuance costs................................................... (13) -- Other financing activities..................................................... (1) (1) ------- ------ CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES--CONTINUING OPERATIONS......... 1 (279) CASH USED IN FINANCING ACTIVITIES--DISCONTINUED OPERATIONS..................... -- (5) ------- ------ CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES................................ 1 (284) ------- ------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................... (61) 67 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR.............................................................. 159 17 ------- ------ END OF PERIOD.................................................................. $ 98 $ 84 ======= ====== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for reorganization items (included in other assets and liabilities above)........................................................... $ (16) $ -- ======== ====== 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. and its subsidiaries (referred to herein as "Solutia" or the "Company") make and sell a variety of high-performance chemical-based materials. Solutia is a world leader in performance films for laminated safety glass and after-market applications; process development and scale-up services for pharmaceutical fine chemicals; specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic 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.). On September 1, 1997, Pharmacia distributed all of the outstanding shares of common stock of the Company as a dividend to Pharmacia stockholders (the "spin-off"). As a result of the spin-off, on September 1, 1997, Solutia became an independent publicly-held company listed on the New York Stock Exchange and its operations ceased to be owned by Pharmacia. A net deficiency of assets of $113 resulted from the spin-off. Bankruptcy Proceedings On December 17, 2003, Solutia Inc. and its 14 U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York. 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. Information concerning the status of the ongoing bankruptcy proceedings may be obtained from Solutia's website at www.solutia.com and at www.nysb.uscourts.gov, the official website for the bankruptcy court. The filing was made to restructure the Company's balance sheet by reducing indebtedness to appropriate levels, to streamline operations and reduce costs to allow the Company to emerge from Chapter 11 as a viable going concern, and to obtain relief from the negative financial impact of legacy liabilities. These factors, combined with the weakened state of the chemical manufacturing sector, general economic conditions and continuing high, volatile energy and crude oil costs, have been an obstacle to Solutia's financial stability and success. While Solutia believes it will be able to achieve these objectives through the bankruptcy process, there can be no certainty that it will be successful in doing so. Under Chapter 11, Solutia is operating its businesses as a debtor-in-possession ("DIP") under court protection from creditors and claimants. Since the filing, all orders sufficient to enable Solutia to conduct normal business activities, including the approval of the Company's DIP financing, have been entered by the bankruptcy court. While Solutia is subject to Chapter 11, all transactions outside the ordinary course of business require the prior approval of the bankruptcy court. As a consequence of the Chapter 11 filing, pending litigation against Solutia is generally stayed, and no party may take any action to collect pre-petition claims except pursuant to an order of the bankruptcy court. Solutia believes that its plan of reorganization will result in cancellation of its existing shares of common stock, as well as options and warrants to purchase its common stock, and that it is unlikely that holders of Solutia's common stock, including options and warrants to purchase Solutia's common stock, will receive any consideration for that stock or those options and warrants in such a plan of reorganization. Solutia is unable to predict what recovery such a plan of reorganization will provide to holders of Solutia's outstanding debt securities. While Solutia filed for Chapter 11 in part to gain relief from the legacy liabilities it was required to assume when it was spun off from Pharmacia, the extent to which such relief will be achieved is uncertain at this time. It is also possible that pursuant to a plan of reorganization Solutia will agree to retain a portion of the legacy liabilities. 5 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Basis of Presentation --------------------- These financial statements should be read in conjunction with the audited financial statements and notes to consolidated financial statements included in Solutia's 2003 Annual Report on Form 10-K, filed with the Securities and Exchange Commission ("SEC") on March 15, 2004, and Amendment No. 1 to Form 10-K included in Solutia's Form 10-K/A, filed with the SEC on March 18, 2004 (collectively referred to hereafter as "10-K/A"). 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 of business. Continuation of the Company as a going concern is contingent upon, among other things, Solutia's ability (i) to comply with the terms and conditions of its DIP financing; (ii) to obtain confirmation of a plan of reorganization under the U.S. Bankruptcy Code; (iii) to return to profitability; (iv) to generate sufficient cash flow from operations; and (v) to obtain financing sources to meet the Company's future obligations. These matters create uncertainty about the Company'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 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 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 and six months ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year. Certain reclassifications of prior year's financial information have been made to conform to the 2004 presentation. Condensed Consolidating Financial Statements -------------------------------------------- Condensed consolidating financial statements for Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of June 30, 2004 and December 31, 2003, and for the three and six months ended June 30, 2004 are presented below. These condensed consolidating financial statements include investments in subsidiaries carried under the equity method. 6 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING BALANCE SHEET AS OF JUNE 30, 2004

Solutia and Subsidiaries Subsidiaries Solutia and in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ ASSETS Current assets............................ $ 551 $ 347 $ (96) $ 802 Property, plant and equipment, net........ 724 134 -- 858 Investment in subsidiaries and affiliates. 346 236 (389) 193 Intangible assets, net.................... 102 37 -- 139 Other assets.............................. 151 50 -- 201 ------------------------------------------------------------ TOTAL ASSETS........................... $1,874 $804 $(485) $2,193 ============================================================ LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities....................... $ 407 $195 $(183) $419 Long-term debt............................ 344 255 -- 599 Other liabilities......................... 236 52 -- 288 ------------------------------------------------------------ Total liabilities not subject to compromise 987 502 (183) 1,306 Liabilities subject to compromise......... 2,194 -- -- 2,194 TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,307) 302 (302) (1,307) ------------------------------------------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) ................................ $1,874 $804 $(485) $2,193 ============================================================

CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2003

Solutia and Subsidiaries Subsidiaries Solutia and in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ ASSETS Current assets............................ $ 557 $ 323 $ (76) $ 804 Property, plant and equipment, net........ 771 138 -- 909 Investment in subsidiaries and affiliates. 344 236 (374) 206 Intangible assets, net.................... 102 38 -- 140 Other assets.............................. 340 47 -- 387 ------------------------------------------------------------ TOTAL ASSETS........................... $ 2,114 $ 782 $ (450) $ 2,446 ============================================================ LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities....................... $ 716 $ 341 $ (314) $ 743 Long-term debt............................ 43 251 -- 294 Other liabilities......................... 259 54 -- 313 ------------------------------------------------------------ Total liabilities not subject to compromise 1,018 646 (314) 1,350 Liabilities subject to compromise......... 2,221 -- -- 2,221 TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,125) 136 (136) (1,125) ------------------------------------------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) ................................ $ 2,114 $ 782 $ (450) $ 2,446 ============================================================

7 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004

Solutia and Subsidiaries Subsidiaries Solutia and in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ NET SALES................................. $ 573 $ 223 $ (97) $699 Cost of goods sold........................ 575 183 (103) 655 ------------------------------------------------------------ GROSS PROFIT.............................. (2) 40 6 44 Marketing, administrative and technological expenses.................................. 74 15 -- 89 Amortization expense...................... -- 1 -- 1 ------------------------------------------------------------ OPERATING INCOME (LOSS)................... (76) 24 6 (46) Equity earnings (loss) from affiliates.... 13 (2) (14) (3) Interest expense.......................... (17) (6) -- (23) Reorganization items, net................. (24) -- -- (24) Other income, net......................... 6 -- (6) -- ------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAX EXPENSE .. (98) 16 (14) (96) Income tax expense ....................... -- 2 -- 2 ------------------------------------------------------------ NET INCOME (LOSS)......................... $ (98) $ 14 $ (14) $(98) ============================================================

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004

Solutia and Subsidiaries Subsidiaries Solutia and in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ NET SALES................................. $1,096 $432 $(186) $1,342 Cost of goods sold........................ 1,067 359 (199) 1,227 ------------------------------------------------------------ GROSS PROFIT.............................. 29 73 13 115 Marketing, administrative and technological expenses.................................. 128 30 -- 158 Amortization expense...................... -- 1 -- 1 ------------------------------------------------------------ OPERATING INCOME (LOSS)................... (99) 42 13 (44) Equity loss from affiliates............... (4) -- (8) (12) Interest expense.......................... (59) (13) -- (72) Loss on debt modification................. -- (15) -- (15) Reorganization items, net................. (49) -- -- (49) Other income (expense), net............... 13 (2) (11) -- ------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAX EXPENSE .. (198) 12 (6) (192) Income tax expense ....................... -- 6 -- 6 ------------------------------------------------------------ NET INCOME (LOSS)......................... $(198) $ 6 $ (6) $ (198) ============================================================

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2004

Solutia and Subsidiaries Subsidiaries Solutia and in not in Subsidiaries Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES.................................. $(16) $12 $-- $(4) NET CASH USED IN INVESTING ACTIVITIES....... (48) (10) -- (58) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.................................. (9) 10 -- 1 ------------------------------------------------------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................. (73) 12 -- (61) CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR........................ 125 34 -- 159 ------------------------------------------------------------ END OF YEAR.............................. $ 52 $46 $-- $98 ============================================================

8 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Recently Issued Accounting Standards In May 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. FSP 106-2 provides guidance on the accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide drug benefits. This FSP also requires those employers to provide certain disclosures regarding the effect of the federal subsidy provided by the Act and supercedes existing FASB guidance with respect to the Act; FSP 106-1. Solutia adopted the provisions of FSP 106-2 in the quarter ended June 30, 2004, as further described in Note 10. 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 the Company continues business operations as a debtor-in-possession. These estimated claims are reflected in the Condensed Consolidated Statement of Financial Position as Liabilities Subject to Compromise as of June 30, 2004 and December 31, 2003 and are summarized in the table below. Such claims remain subject to future adjustments. Adjustments may result from actions of the bankruptcy court, negotiations, rejection or assumption of executory contracts, determination as to the value of any collateral securing claims, 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 programs; and (x) pre-petition claims of critical vendors in the ordinary course of business. As applicable, these pre-petition items have been excluded from Liabilities Subject to Compromise as of June 30, 2004 and December 31, 2003. The amounts subject to compromise consisted of the following items:

JUNE 30, DECEMBER 31, 2004 2003 ---- ---- Postretirement benefits (a)............................... $1,135 $1,153 Litigation reserves (b)................................... 146 146 Accounts payable (c)...................................... 122 122 Environmental reserves (d)................................ 84 85 Other miscellaneous liabilities........................... 82 90 6.72% debentures puttable 2004, due 2037(e)............... 150 150 7.375% debentures due 2027(e)............................. 300 300 11.25% notes due 2009 (f)................................. 223 223 ------ ------ 673 673 Unamortized debt discount and debt issuance costs......... (48) (48) ------ ------ TOTAL DEBT SUBJECT TO COMPROMISE.................... 625 625 ------ ------ TOTAL LIABILITIES SUBJECT TO COMPROMISE................... $2,194 $2,221 ====== ====== 9 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) (a) Postretirement benefits include Solutia's domestic (i) qualified pension plan of $425 and $420 as of June 30, 2004 and December 31, 2003, respectively; (ii) non-qualified pension plan of $18 and $23 as of June 30, 2004 and December 31, 2003, respectively; and (iii) other postretirement benefits of $692 and $710 as of June 30, 2004 and December 31, 2003, respectively. Pursuant to bankruptcy court order, Solutia made payments with respect to postretirement obligations of approximately $22 and $42 in the three and six months ended June 30, 2004, respectively. (b) An automatic stay has been imposed against the commencement or continuation of legal proceedings against the Company outside of the bankruptcy court process. Consequently, the Company's accrued liability with respect to pre-petition legal proceedings has been classified as subject to compromise as of June 30, 2004 and December 31, 2003. (c) Pursuant to bankruptcy court order, Solutia made payments of approximately $2 and $17 in the three and six months ended June 30, 2004, respectively. Solutia also reclassified into accounts payable subject to compromise, from balances previously accrued in liability accounts not subject to compromise, approximately $2 and $17 in the three and six months ended June 30, 2004, respectively. (d) Represents remediation obligations related primarily to properties that are not owned or operated by Solutia, including non-owned properties adjacent to current operating sites. Solutia made payments of approximately $1 in the six months ended June 30, 2004 with respect to these environmental obligations subject to compromise. See Note 9 for further disclosure with respect to ongoing legal proceedings concerning environmental liabilities subject to compromise. (e) While operating during the Chapter 11 proceedings, Solutia has ceased recording interest on its 6.72% debentures puttable 2004, due 2037 and its 7.375% debentures due 2027. The amount of contractual interest expense not recorded in the three and six months ended June 30, 2004 was approximately $8 and $16, respectively. (f) Pursuant to bankruptcy court order, Solutia is required to continue payments of the contractual interest for the 11.25% notes due 2009 through January 2005. Whether or not interest is paid on those notes after January 2005 will depend on resolution of several issues, including the nature of the original issue discount on the notes and the amount of the discount attributable to warrants that were issued contemporaneously, and on a determination as to whether the notes are fully secured. The amount of contractual interest paid with respect to these notes was approximately $13 in the six months ended June 30, 2004 and the accrued interest related to these notes was included in Accrued Liabilities classified as not subject to compromise as of both June 30, 2004 and December 31, 2003.

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 SIX MONTHS ENDED JUNE 30, 2004 JUNE 30, 2004 ------------- ------------- Professional fees (a)............................. $ (11) $ (24) Contract rejection and termination costs (b)...... (11) (20) Severance and employee retention costs (c)........ (4) (7) Net gain on settlement of pre-petition claims (d). 2 2 ----- ----- TOTAL REORGANIZATION ITEMS, NET................... $ (24) $ (49) ===== ===== (a) Professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings. (b) Asset write-offs associated with contract rejections and terminations resulting from the ongoing reorganization-related evaluation of the financial viability of the Company's existing contracts. The potential claim amount against Solutia with respect to these contract rejections and terminations cannot be reasonably determined at this point and accordingly no amount has been recorded as of June 30, 2004. (c) Expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the bankruptcy court. (d) Solutia recorded a net gain of $2 representing the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded. The pre-petition obligations were for certain 10 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) retirement benefits and retention obligations involving particular employees severed during the three months ended June 30, 2004.

3. DISCONTINUED OPERATIONS On December 2, 2002, Solutia signed a definitive agreement to sell its resins, additives and adhesives businesses to UCB S.A. for $500 in cash, plus an upfront payment of $10 for a period of exclusivity. On January 31, 2003, the sale was completed resulting in a pre-tax gain of $24. In addition, the operating results of the resins, additives and adhesives businesses were reported separately as discontinued operations in the Condensed Consolidated Statement of Operations. Net sales and loss from discontinued operations for the six months ended June 30, 2003 were as follows: Net sales......................................................... $53 Income before income tax expense.................................. 7 Income tax expense................................................ 9 ---- Loss from discontinued operations................................. $ (2) ==== 4. STOCK OPTION PLANS Effective January 1, 2003, Solutia adopted Statement of Financial Accounting Standard ("SFAS") No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure, which allowed Solutia to continue to follow the guidance of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, for measurement and recognition of stock-based transactions with employees. Accordingly, no compensation cost has been recognized for Solutia's option plans in the Condensed Consolidated Statement of Operations, as all options granted under the plans had an exercise price equal to the market value of the Company's stock on the date of the grant. The following table illustrates the effect on net loss and loss per share if the fair value based method had been applied to all outstanding and unvested awards as follows:

THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- NET LOSS: As reported.................................... $ (98) $ (38) $ (198) $ (57) Deduct: Total stock-based employee compensation expense determined using the Black-Scholes option-pricing model for all awards, net of tax......................... (1) (1) (2) (3) ------ ------ ------ ------ Pro forma...................................... $ (99) $ (39) $ (200) $ (60) ====== ====== ====== ====== LOSS PER SHARE: Basic and diluted - as reported................ $(0.94) $(0.36) $(1.90) $(0.54) Basic and diluted - pro forma.................. $(0.95) $(0.37) $(1.92) $(0.57)

Compensation expense resulting from the fair value method may not be representative of compensation expense to be incurred on a pro forma basis in future years. The fair value of each option grant is estimated on the date of grant by use of the Black-Scholes option-pricing model. In addition, Solutia believes that its plan of reorganization will result in cancellation of its existing shares of common stock, as well as options and warrants to purchase its common stock and that it is unlikely that holders of options to purchase Solutia's common stock will receive any consideration for those options in such a plan of reorganization. 11 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 5. GOODWILL AND OTHER INTANGIBLE ASSETS There were no acquisitions of intangible assets and there have been no changes to amortizable lives or amortization methods in the six months ended June 30, 2004. Annual amortization expense for the net carrying amount of finite-lived intangible assets is estimated to be $2 in both 2004 and 2005, $1 in 2006, and less than $1 in both 2007 and 2008. Goodwill and indefinite-lived intangible assets are assessed annually for impairment in the fourth quarter in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. However, impairment analyses are performed more frequently if changes in circumstances indicate the carrying value may not be recoverable during the intervening period between annual impairment tests. Goodwill and trademarks are allocated to the Performance Products and Services segment which includes the CPFilms and Pharmaceutical Services reporting units. Trademarks are included within Identified Intangible Assets, net in the Condensed Consolidated Statement of Financial Position. The allocation of these items is as follows:

TOTAL PERFORMANCE PHARMACEUTICAL PRODUCTS AND CPFILMS SERVICES SERVICES -------------------------------------------------- Goodwill, December 31, 2003...................... $ 74 $ 23 $ 97 Translation...................................... 1 (1) -- -------------------------------------------------- GOODWILL, JUNE 30, 2004.......................... $ 75 $ 22 $ 97 ================================================== Trademarks, December 31, 2003.................... $ 26 $ 1 $ 27 Translation...................................... -- -- -- -------------------------------------------------- TRADEMARKS, JUNE 30, 2004........................ $ 26 $ 1 $ 27 ==================================================

Amortized identified intangible assets generally include contract-based intangible assets and are summarized in aggregate as follows:

GROSS NET CARRYING ACCUMULATED CARRYING VALUE AMORTIZATION VALUE ------------------------------------------------ Amortized Intangible Assets, December 31, 2003... $ 33 $ (17) $ 16 Amortization..................................... -- (1) (1) ------------------------------------------------ AMORTIZED INTANGIBLE ASSETS, JUNE 30, 2004....... $ 33 $ (18) $ 15 ================================================

6. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS

INVENTORIES JUNE 30, DECEMBER 31, 2004 2003 ---- ---- Finished goods................................................ $ 198 $ 192 Goods in process.............................................. 104 92 Raw materials and supplies.................................... 93 83 -------- -------- Inventories, at FIFO cost..................................... 395 367 Excess of FIFO over LIFO cost................................. (147) (127) -------- -------- TOTAL INVENTORIES............................................. $ 248 $ 240 ======== ========

Inventories at FIFO approximate current cost. 12 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)

JUNE 30, December 31, OTHER ASSETS 2004 2003 ---- ---- Computer software............................................. $ 42 $ 48 Cash underlying collateralized letters of credit (a).......... 29 132 Intangible pension asset...................................... 11 81 Other......................................................... 119 126 -------- ------- TOTAL OTHER ASSETS............................................ $ 201 $ 387 ======== ======= (a) In the first quarter 2004, Solutia settled a $27 pre-petition letter of credit paid by the intermediary financial institution to the letter of credit counterparty. This letter of credit was collateralized by cash that Solutia had disbursed prior to the bankruptcy filing, and accordingly, has been presented as a non-cash transaction with respect to the Condensed Consolidated Statement of Cash Flows in the six months ended June 30, 2004.

JUNE 30, December 31, ACCRUED LIABILITIES 2004 2003 ---- ---- Accrued rebates and sales returns/allowances.................. $ 27 $ 32 Accrued interest.............................................. 25 28 Wages and benefits............................................ 20 24 Astaris keepwell guarantee.................................... 10 51 Other......................................................... 182 169 ------- -------- TOTAL ACCRUED LIABILITIES..................................... $ 264 $ 304 ======= ========

7. RESTRUCTURING RESERVES During the three months ended June 30, 2004, Solutia recorded $12 of restructuring costs to Cost of Goods Sold principally related to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, including $9 for decommissioning and dismantling costs, $1 of severance and retraining costs, and $2 of various other restructuring costs. These restructuring charges were recorded in the Performance Products and Services segment and resulted principally from Solutia's continued strategic evaluation of its businesses. In addition, Solutia recorded $2 of severance costs during the three months ended June 30, 2004 in Reorganization Items, net related to management positions within the corporate unallocated function with respect to workforce reduction initiatives directly associated with the bankruptcy reorganization process. During the six months ended June 30, 2004, Solutia recorded restructuring charges of $17 to cost of goods sold principally related to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, including $10 for decommissioning and dismantling costs, $2 related to non-cancelable operating leases; $2 of severance and retraining costs; and $3 of other various restructuring charges. These restructuring charges were recorded in the Performance Products and Services segment and resulted principally from Solutia's continued strategic evaluation of its businesses. In addition, Solutia recorded $2 of severance costs during the six months ended June 30, 2004 in Reorganization Items, net related to management positions within the corporate unallocated function with respect to workforce reduction initiatives directly associated with the bankruptcy reorganization process. The severance and retraining charges of $3 and $4 recorded in the three and six months ended June 30, 2004, respectively, involved the termination of approximately 90 and 110 positions, respectively. Additionally, Solutia eliminated a modest number of positions through planned attrition in the three and six months ended June 30, 2004. Solutia expects to incur approximately $1 in retraining costs and $1 in severance costs in the third and fourth quarters of 2004 related to workforce reduction initiatives involving approximately 30 positions. However, Solutia cannot forecast the level of future restructuring 13 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) charges beyond this specifically identified $2 of workforce reduction charges due to the inherent uncertainty involved in operating as a debtor-in-possession under Chapter 11 bankruptcy protection. A summary of restructuring activity during the three and six months ended June 30, 2004 is presented as follows:

FUTURE DECON/ LEASE EMPLOYMENT DISMANTLING PAYMENTS REDUCTIONS OTHER COSTS TOTAL ------------------------------------------------------------------------- Balance at December 31, 2003......... $ -- $ 14 $ -- $ 3 $ 17 Charges taken...................... 1 2 1 1 5 Amounts utilized................... (1) -- -- (1) (2) ------------------------------------------------------------------------- BALANCE AT MARCH 31, 2004............ $-- $16 $ 1 $ 3 $ 20 Charges taken...................... 9 -- 3 2 14 Amounts utilized................... (3) (1) -- (2) (6) ------------------------------------------------------------------------- BALANCE AT JUNE 30, 2004............. $6 $15 $4 $ 3 $28 =========================================================================

8. INCOME TAXES The income tax expense of $2 and $6 in the three and six months ended June 30, 2004, respectively, was primarily a result of foreign income taxes. As a result of Solutia's Chapter 11 filing, the Company did not record any U.S. income tax benefit for losses incurred from its domestic operations (including temporary differences) during the three and six months ended June 30, 2004. Consequently, the increases in federal and state deferred tax assets, as a result of the increases in net operating losses generated during the three and six months ended June 30, 2004, were offset by corresponding increases in valuation allowances. See Note 13 of Solutia's 2003 Form 10-K/A for additional information concerning the Company's deferred tax assets and increases in valuation allowances due to Solutia's Chapter 11 filing. 9. CONTINGENCIES Litigation 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 its spin-off 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 case. This estimated unsecured claim amount was classified as a liability subject to compromise as of both June 30, 2004 and December 31, 2003 in the amount of $146. Solutia's 2003 Form 10-K/A described a number of legal proceedings in which Solutia was a named defendant or was defending solely due to its indemnification obligations referred to above. The Company is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, in this and subsequent reports filed with the Securities and Exchange Commission, Solutia will cease reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) Payton v. Monsanto; (iii) other Anniston cases; (iv) the PENNDOT case; and (v) premises based asbestos litigation. 14 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Following is a summary of legal proceedings that Solutia or certain of its equity affiliates continue to manage that could result in an outcome that is material to the condensed consolidated financial statements. Anniston Partial Consent Decree The U.S. District Court for the Northern District of Alabama approved the revised Partial Consent Decree on August 4, 2003 that had been lodged with the court in an action captioned United States of America v. Pharmacia Corporation (f/k/a Monsanto Company) and Solutia. This Partial Consent Decree provides for Pharmacia and Solutia to sample certain residential properties and remove soils found on those properties if polychlorinated biphenyls ("PCBs") are at a level of 1 part per million ("ppm") or above, to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the U.S. Environmental Protection Agency ("EPA") of a cleanup remedy for the Anniston PCB site, and to pay the EPA's past response costs and future oversight costs related to this work. The decree also provided for the creation of an educational trust fund of approximately $3 to be funded over a 12-year period to provide supplemental educational services for school children in West Anniston. On April 19, 2004, the United States District Court for the Northern District of Alabama issued a two sentence order finding that the Anniston Partial Consent Decree enforces police and regulatory powers under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and as a result the automatic stay provisions of the United States Bankruptcy Code are inapplicable to the Company's obligations under the Partial Consent Decree. On April 30, 2004, the United States Bankruptcy Court for the Southern District of New York entered a Stipulation and Agreed Order in which the EPA and the Company stipulate that the automatic stay is applicable to certain of the Partial Consent Decree's requirements. The Company has asked the District Court to reconsider its order and to bring it into accord with the Stipulation and Agreed Order consented to by the EPA and entered by the U.S. Bankruptcy Court. Flexsys Related Litigation Solutia's 2003 Form 10-K/A and its Form 10-Q for the quarter ended March 31, 2004 describe an investigation by antitrust authorities in the United States, Europe and Canada of past commercial practices in the rubber chemicals industry against Flexsys, Solutia's 50/50 joint venture with Akzo Nobel N.V., and other producers of rubber chemicals. Those periodic filings also describe a number of purported class actions that have been filed against Flexsys and other producers of rubber chemicals as well as related shareholder derivative actions and shareholder class actions that have been filed against Solutia and certain of its officers and directors. Set forth below is a description of the material developments in those cases as well as other material litigation developments that have occurred since our first quarter Form 10-Q filing. Actions against Flexsys. A purported class action has been filed in Massachusetts state court against Flexsys and other past and present rubber chemical producers on behalf of all indirect consumers of rubber chemicals for damages sustained as a result of alleged anti-competitive practices in the sale of rubber chemicals. In addition to the Massachusetts case, thirteen state court actions filed by retail tire purchasers against Flexsys and other producers of rubber chemicals remain pending either on appeal or at the trial court level in preliminary motion phases. On July 15, 2004, RBX Industries, Inc. v. Bayer Corp., Flexsys, et al. was filed against Flexsys and other producers of rubber chemicals in the United States District Court for the Western District of Pennsylvania. Plaintiff alleges that during the period 1995 through 2001 the defendants conspired through marketing and sales practices to cause plaintiff to pay supra-competitive prices and seeks treble damages from the defendants. Solutia is not a named defendant in any of these cases. In May 2004, two purported class actions were filed in the Province of Quebec Canada against Flexsys and other rubber chemical producers alleging that collusive sales and marketing activities of the defendants damaged all persons in Quebec during the period July 1995 through September 2001. Statutory damages of (CAD) $14.6 along with exemplary damages of (CAD) $.000025 per person are being sought. A hearing is tentatively scheduled to 15 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) determine which case will be allowed to go forward. Solutia is not a named defendant in either of these class actions. Actions against Solutia. Solutia's 2003 Form 10-K/A and its Form 10-Q for the quarter ended March 31, 2004 describe a consolidated class action in the U.S. District Court in California brought by individuals who allegedly purchased Solutia stock at inflated prices as a result of the incorporation of Solutia's share of Flexsys' financial results which were purportedly inflated as a result of anticompetitive collusion between Flexsys and other rubber chemical producers during the period December 1998 through October 2002. The consolidated action has been automatically stayed with respect to Solutia by virtue of Section 362(a) of the Bankruptcy Code but has not been stayed with respect to the individual defendants. On July 28, 2004, the court granted the individual defendants' motion to dismiss for failure to state a claim but also granting plaintiffs ten days to file an amended compliant. Environmental Liabilities Environmental compliance and remediation costs incurred by the Company generally fall into two broad categories: (i) obligations related to properties currently owned or operated by Solutia and (ii) obligations related to properties that are not owned by Solutia, including non-owned properties adjacent to current operating sites. For the owned and operated sites, Solutia had an accrued liability of $76 and $81 as of June 30, 2004 and December 31, 2003, respectively, for solid and hazardous waste remediation, which represents the Company's best estimate of the underlying obligation. In addition, this balance also includes post-closure costs at certain of the Company'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, the Company will be required to comply with environmental requirements in the conduct of its business, regardless of when the underlying environmental contamination occurred. However, the Company ultimately expects to seek recovery against other potentially responsible parties at certain of these locations. The Company had an accrued liability of $84 and $85 as of June 30, 2004 and December 31, 2003, respectively, primarily for properties not owned or operated by Solutia. This liability is classified as subject to compromise in the Condensed Consolidated Statement of Financial Position as of both June 30, 2004 and December 31, 2003, as the Company currently believes it constitutes a pre-petition claim that will be discharged in the bankruptcy process. The EPA and/or Pharmacia are currently contesting this view (as more fully disclosed in the above Anniston Partial Consent Decree disclosure). In addition, remediation activities are currently being funded by Monsanto for certain of these properties not owned or operated by Solutia. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 case. 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, 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 the Company. Astaris Joint Venture On October 8, 2003, Solutia and Astaris, a 50/50 joint venture with FMC Corporation, amended its external financing agreement to release the Astaris lenders' security interests in certain Solutia assets in exchange for Solutia's posting of a $67 letter of credit, representing fifty percent of the Astaris lenders' outstanding commitments to Astaris. The agreement was also amended to provide for a dollar-for-dollar reduction of the Astaris lenders' commitments with future payments made by Solutia and FMC under their existing support agreements to Astaris. This additional amendment provided a $67 limitation for each of Solutia and FMC on future funding in the event the joint venture continued to fail to meet certain financial benchmarks. Solutia's $67 letter of credit was reduced dollar-for-dollar as payments were made by Solutia under its existing support agreement. Solutia made approximately $36 of investment payments in the six months ended June 30, 2004 to keep the Astaris joint venture in 16 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) compliance with its financial covenants. The remaining commitment to Astaris was $10 and $51 as of June 30, 2004 and December 31, 2003, respectively, and was recorded as a liability in the Condensed Consolidated Statement of Financial Position in these periods accordingly. FMC and Solutia also agreed conceptually to allow Astaris to defer up to approximately $30 of payment obligations to each of FMC and Solutia under existing operating agreements and certain other agreements over the next 12-15 months to provide liquidity assistance to Astaris as it implements its business restructuring. Astaris, FMC and Solutia are currently negotiating a definitive agreement to allow for the deferral of these obligations, including repayment terms and conditions with respect to the deferred amounts. The deferral amount outstanding from Astaris to Solutia was $14 and $2 as of June 30, 2004 and December 31, 2003, respectively. UCB S.A. Dispute On December 2, 2002, Solutia signed a definitive stock and asset purchase agreement ("SAPA") to sell its resins, additives and adhesives businesses to UCB S.A. for $500 in cash, plus an upfront payment of $10 for a period of exclusivity. On January 31, 2003, the sale was completed. During 2003 a number of disputes arose between the parties as to amounts due under various provisions of the SAPA which were unresolved as of Solutia's Chapter 11 filing date. Solutia had approximately $30 recorded for this liability as of both June 30, 2004 and December 31, 2003. As a result of Solutia's Chapter 11 filing, this liability has been classified as subject to compromise in the Condensed Consolidated Statement of Financial Position and will be addressed in conjunction with the ongoing bankruptcy proceedings. 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-filing claims not currently reflected in the condensed consolidated financial statements may be identified through the proof of claim reconciliation process. The amount of pre-filing 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 the Company may retain certain obligations currently classified as subject to compromise in the Condensed Consolidated Statement of Financial Position. 17 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 10. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS Components of Net Periodic Benefit Cost For the three and six months ended June 30, 2004 and 2003, Solutia's pension and healthcare and other benefit costs were as follows:

PENSION BENEFITS ---------------- THREE MONTHS SIX MONTHS ------------ ---------- ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- Service costs for benefits earned........ $ 6 $ 7 $ 13 $ 15 Interest cost on benefit obligation...... 35 28 56 57 Assumed return on plan assets............ (34) (30) (54) (62) Prior service costs ..................... 2 5 6 10 Recognized net (gain)/loss............... 2 (1) 4 (1) Curtailment and settlement net charges .. 62 -- 62 -- ---- --- ---- ---- Total.................................... $ 73 $ 9 $ 87 $ 19 ==== === ==== ====

HEALTHCARE AND OTHER BENEFITS ----------------------------- THREE MONTHS SIX MONTHS ------------ ---------- ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- Service costs for benefits earned........ $ 2 $ 2 $ 5 $ 5 Interest cost on benefit obligation...... 13 10 24 25 Prior service costs ..................... (4) (2) (8) (6) Recognized net loss...................... 2 1 5 3 --- ---- ---- ---- Total.................................... $13 $ 11 $ 26 $ 27 === ==== ==== ====

Pension Curtailments and Settlements ------------------------------------ Solutia amended its U.S. qualified and non-qualified pension plans in the second quarter 2004 to cease future benefit accruals effective July 1, 2004 for non-union participants in these plans. As a result, Solutia recorded a pension curtailment net loss of $63 due to the reduction in anticipated future service of participants in Solutia's U.S. qualified and non-qualified pension plans. In addition, Solutia recorded a pension settlement net gain of $1 resulting from the significant reduction in the number of participants in Solutia's non-qualified pension plan principally resulting from workforce reduction initiatives. Adoption of FSP 106-2 --------------------- On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") was signed into law. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. As a result of the Act's passage, the FASB issued FASB Staff Position ("FSP") No. 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The FSP permitted a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Act. 18 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Accordingly, the Company elected to defer recording the impact of the Act in its consolidated financial statements for the year ended December 31, 2003 in view of the fact that specific authoritative guidance on the accounting for the federal subsidy was pending and that guidance, when issued, could require the Company to change previously reported information. In May 2004, the FASB issued FSP 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). FSP 106-2 provides guidance on the accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide drug benefits. This FSP also requires those employers to provide certain disclosures regarding the effect of the federal subsidy provided by the Act and supercedes FSP 106-1. Solutia adopted the provisions of FSP 106-2 in the three months ended June 30, 2004. The second quarter 2004 adoption of FSP 106-2 resulted in a reduction in the accumulated postretirement benefit obligation ("APBO") related to benefits attributed to past service of approximately $26. In addition, net periodic postretirement benefit expense was reduced by approximately $1 in the three months ended June 30, 2004, reflecting amortization of the actuarial gain with respect to the subsidy, as well as a reduction in current period interest costs due to the subsidy. Employer Contributions Employer Contributions Solutia disclosed in its 2003 Form 10-K/A that it did not expect to be required to make contributions to its qualified domestic pension plan in 2004 according to current IRS funding rules. No contributions have been made to the qualified domestic pension plan in the six months ended June 30, 2004. According to current IRS funding rules, Solutia is not required to make pension contributions in 2004 for its qualified domestic pension plan. However, the Company's current plan, subject to bankruptcy court approval, is to make a voluntary contribution of approximately $11 to the qualified domestic pension plan in the third quarter 2004. This voluntary contribution coupled with the cessation of future benefit accruals, effective July 1, 2004, will result in the reduction in required contributions, as well as the deferral of the timing of future required contributions. 11. LOSS PER SHARE

THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- Loss from Continuing Operations........................... $ (98) $ (38) $ (198) $ (55) Loss from Discontinued Operations, net of tax............. -- -- -- (2) ------ ------ ------- ------ Net Loss.................................................. $ (98) $ (38) $ (198) $ (57) ====== ====== ======= ====== Basic and Diluted Loss per Share: Loss from Continuing Operations...........................$ (0.94) $ (0.36) $ (1.90) $(0.52) ------- ------- ------- ------ Loss from Discontinued Operations, net of tax............. -- -- -- (0.02) ------- ------- ------- ------ Basic and Diluted Loss per Share..........................$ (0.94) $ (0.36) $ (1.90) $(0.54) ======= ======= ======= ====== Basic and Diluted Weighted Average Shares Outstanding (in millions)................................. 104.5 104.6 104.5 104.6 ===== ===== ===== =====

19 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 12. SEGMENT DATA Solutia's management is organized around two strategic business platforms: Performance Products and Services and Integrated Nylon. Solutia's reportable segments and their major products are as follows:

PERFORMANCE PRODUCTS AND SERVICES INTEGRATED NYLON --------------------------------- ---------------- SAFLEX(R) plastic interlayer Nylon intermediate "building block" chemicals Polyvinyl butyral for KEEPSAFE(R), and KEEPSAFE MAXIMUM(R) Merchant polymer and nylon extrusion polymers, laminated window glass including VYDYNE(R) and ASCEND(R) LLUMAR(R), VISTA(R) and GILA(R) professional and Carpet fibers, including the WEAR-DATED(R) and retail window films ULTRON(R) brands VANCEVA(TM) plastic interlayer films Industrial nylon fibers Industrial products, including THERMINOL(R) heat ACRILAN(R) acrylic fibers for apparel, upholstery transfer fluids, DEQUEST(R) water treatment chemicals, fabrics, craft yarns and other applications and SKYDROL(R) aviation hydraulic fluids Services for process research and development, scale-up manufacturing and small volume licensed production for the pharmaceutical industry

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, restructuring and asset impairment 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, certain equity earnings from affiliates, interest expense, 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. 20 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Segment data for the three and six months ended June 30, 2004 and 2003 are as follows:

THREE MONTHS ENDED JUNE 30, --------------------------- 2004 2003 ---------------------- ----------------------- NET PROFIT NET PROFIT SALES (LOSS) SALES (LOSS) --------- ----------- --------- ------------ SEGMENT: Performance Products and Services... $286 $ 27 $268 $ 26 Integrated Nylon.................... 413 5 357 (20) ------- ------- --- ---- SEGMENT TOTALS...................... 699 32 625 6 RECONCILIATION TO CONSOLIDATED TOTALS: Corporate expenses.............. (78) (41) Equity loss from affiliates..... (3) (1) Interest expense................ (23) (25) Reorganization items, net....... -- Other income, net............... -- 1 CONSOLIDATED TOTALS: ---- ---- NET SALES....................... $699 $625 ==== ------ ==== ------ LOSS BEFORE INCOME TAXES........ $ (96) $ (60) ====== ======

SIX MONTHS ENDED JUNE 30, ------------------------- 2004 2003 ---------------------- ----------------------- NET PROFIT NET PROFIT SALES (LOSS) SALES (LOSS) --------- ----------- --------- ------------ SEGMENT: Performance Products and Services... $556 $ 52 $ 518 $ 43 Integrated Nylon.................... 786 (7) 718 (31) ----- ------- ------ ------ SEGMENT TOTALS...................... 1,342 45 1,236 12 RECONCILIATION TO CONSOLIDATED TOTALS: Corporate expenses.............. (89) (56) Equity loss from affiliates..... (12) (7) Interest expense................ (72) (48) Loss on debt modification....... (15) -- Reorganization items, net....... (49) -- Other income, net............... -- 5 CONSOLIDATED TOTALS: ------ ------ NET SALES....................... $1,342 $1,236 ====== ------- ====== ------ LOSS BEFORE INCOME TAXES........ $ (192) $ (94) ======= ======

13. CONSOLIDATING CONDENSED FINANCIAL STATEMENTS CPFilms, Inc., Monchem International, Inc., Monchem, Inc., Solutia Systems, Inc., Solutia Investments, LLC and Solutia Business Enterprises, Inc., wholly-owned subsidiaries of the Company (the "Guarantors"), are guarantors of the holders 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. Accordingly, the 2003 condensed consolidating financial statements below have been restated to reflect the addition of these two new guarantors. The Company's obligations under the October 2003 facility were paid in full with the proceeds of a final DIP facility dated as of January 16, 2004, which payment did not affect the Guarantors' obligations in respect of the Notes. Certain other wholly-owned subsidiaries of the Company (the "DIP Guarantors") guaranteed the final DIP facility (as well as a 21 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 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 June 30, 2004 and December 31, 2003, and for the three and six months ended June 30, 2004 and 2003. 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. 22 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2004

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET SALES................................ $518 $52 $ 226 $ (97) $699 Cost of goods sold....................... 550 23 185 (103) 655 ---------------------------------------------------------------------------- GROSS PROFIT............................. (32) 29 41 6 44 Marketing expenses....................... 26 6 8 -- 40 Administrative expenses.................. 23 2 8 -- 33 Technological expenses................... 15 -- 1 -- 16 Amortization expense..................... -- -- 1 -- 1 ---------------------------------------------------------------------------- OPERATING INCOME (LOSS).................. (96) 21 23 6 (46) Equity earnings (loss) from affiliates... 53 19 (2) (73) (3) Interest expense......................... (33) (1) (13) 24 (23) Other income, net........................ 2 19 8 (29) -- Reorganization items, net................ (24) -- -- -- (24) ---------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES ....... (98) 58 16 (72) (96) Income tax expense ...................... -- -- 2 -- 2 ---------------------------------------------------------------------------- NET INCOME (LOSS)........................ $ (98) $ 58 $ 14 $ (72) $ (98) ============================================================================

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) THREE MONTHS ENDED JUNE 30, 2004

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET INCOME (LOSS)........................ $ (98) $ 58 $ 14 $ (72) $ (98) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments......... 1 -- 5 (5) 1 Minimum pension liability adjustments, net of tax................................... 18 -- -- -- 18 ---------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS).............. $ (79) $ 58 $ 19 $ (77) $ (79) ============================================================================

23 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2003

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET SALES ................................... $ 468 $ 42 $ 199 $ (84) $ 625 Cost of goods sold .......................... 481 19 165 (89) 576 ---------------------------------------------------------------------------- GROSS PROFIT ................................ (13) 23 34 5 49 Marketing expenses........................... 27 5 8 -- 40 Administrative expenses...................... 21 2 10 -- 33 Technological expenses....................... 10 -- 1 -- 11 ---------------------------------------------------------------------------- OPERATING INCOME (LOSS) ..................... (71) 16 15 5 (35) Equity earnings (loss) from affiliates....... 44 3 (1) (47) (1) Interest expense ............................ (39) (1) (13) 28 (25) Other income, net ........................... 3 24 6 (32) 1 ---------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES ........... (63) 42 7 (46) (60) Income tax expense (benefit) ................ (25) 1 2 -- (22) ---------------------------------------------------------------------------- NET INCOME (LOSS) ........................... $ (38) $ 41 $ 5 $ (46) $ (38) ============================================================================

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) THREE MONTHS ENDED JUNE 30, 2003

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET INCOME (LOSS) ........................... $ (38) $ 41 $ 5 $ (46) $ (38) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments ............ 6 6 (11) 5 6 ---------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS) ................. $ (32) $ 47 $ (6) $ (41) $ (32) ===========================================================================

24 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2004

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET SALES.................................. $1,000 $91 $437 $(186) $1,342 Cost of goods sold......................... 1,022 41 363 (199) 1,227 ---------------------------------------------------------------------------- GROSS PROFIT............................... (22) 50 74 13 115 Marketing expenses......................... 47 11 16 -- 74 Administrative expenses.................... 39 4 15 -- 58 Technological expenses..................... 24 1 1 -- 26 Amortization expense....................... -- -- 1 -- 1 ---------------------------------------------------------------------------- OPERATING INCOME (LOSS).................... (132) 34 41 13 (44) Equity earnings (loss) from affiliates..... 68 11 -- (91) (12) Interest expense........................... (91) (1) (28) 48 (72) Other income, net.......................... 6 38 14 (58) -- Loss on debt modification.................. -- -- (15) -- (15) Reorganization items, net.................. (49) -- -- -- (49) ---------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES ......... (198) 82 12 (88) (192) Income tax expense ........................ -- -- 6 -- 6 ---------------------------------------------------------------------------- NET INCOME (LOSS).......................... $(198) $82 $6 $(88) $(198) ============================================================================

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) SIX MONTHS ENDED JUNE 30, 2004

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET INCOME (LOSS).......................... $ (198) $ 82 $ 6 $ (88) $ (198) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments........... (1) (1) 8 (7) (1) Minimum pension liability adjustments, net of tax..................................... 18 -- -- -- 18 ---------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS)................ $ (181) $ 81 $ 14 $ (95) $ (181) ========================================== =================================

25 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) SOLUTIA INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2003

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET SALES ................................... $ 942 $ 75 $ 385 $ (166) $ 1,236 Cost of goods sold .......................... 935 33 326 (176) 1,118 --------------------------------------------------------------------------- GROSS PROFIT ................................ 7 42 59 10 118 Marketing expenses .......................... 54 10 15 -- 79 Administrative expenses ..................... 42 4 17 -- 63 Technological expenses ...................... 21 1 1 -- 23 Amortization expense ........................ -- -- 1 -- 1 --------------------------------------------------------------------------- OPERATING INCOME (LOSS) ..................... (110) 27 25 10 (48) Equity earnings (loss) from affiliates....... 95 23 -- (124) (6) Interest expense ............................ (75) (4) (32) 63 (48) Other income, net ........................... 6 49 20 (67) 8 --------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES ........... (84) 95 13 (118) (94) Income benefit .............................. (29) -- (12) 2 (39) --------------------------------------------------------------------------- INCOME (LOSS) FROM CONTINUING OPERATIONS (55) 95 25 (120) (55) Loss from Discontinued Operations, net of tax (2) (103) (103) 206 (2) --------------------------------------------------------------------------- NET LOSS .................................... $ (57) $ (8) $ (78) $ 86 $ (57) ===========================================================================

CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS) SIX MONTHS ENDED JUNE 30, 2003

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ NET LOSS .................................... $ (57) $ (8) $ (78) $ 86 $ (57) OTHER COMPREHENSIVE INCOME (LOSS): Currency translation adjustments ............ 43 44 19 (63) 43 -------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS) ................. $ (14) $ 36 $ (59) $ 23 $ (14) ==========================================================================

26 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING BALANCE SHEET JUNE 30, 2004

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ ASSETS CURRENT ASSETS:............................. Cash and cash equivalents................... $ 14 $ 36 $ 48 $ -- $ 98 Trade receivables, net...................... 1 198 142 -- 341 Intercompany receivables.................... 196 680 67 (943) -- Miscellaneous receivables................... 65 -- 22 -- 87 Inventories................................. 127 29 106 (14) 248 Prepaid expenses and other current assets... 13 -- 12 3 28 -------------------------------------------------------------------------- TOTAL CURRENT ASSETS........................ 416 943 397 (954) 802 PROPERTY, PLANT AND EQUIPMENT, NET.......... 651 73 134 -- 858 INVESTMENTS IN AFFILIATES................... 2,241 201 34 (2,283) 193 GOODWILL.................................... -- 72 25 -- 97 IDENTIFIED INTANGIBLE ASSETS, NET........... 3 27 12 -- 42 INTERCOMPANY ADVANCES....................... 128 1,238 722 (2,088) -- OTHER ASSETS................................ 151 -- 50 -- 201 -------------------------------------------------------------------------- TOTAL ASSETS................................ $ 3,590 $ 2,554 $ 1,374 $ (5,325) $ 2,193 ========================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable............................ $ 111 $ 9 $ 37 $ (2) $ 155 Intercompany payables....................... 69 33 114 (216) -- Accrued liabilities......................... 160 10 94 -- 264 Intercompany short-term debt................ -- -- 185 (185) -- -------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES................... 340 52 430 (403) 419 LONG-TERM DEBT.............................. 343 -- 256 -- 599 INTERCOMPANY LONG-TERM DEBT................. -- -- 413 (413) -- OTHER LIABILITIES........................... 236 -- 52 -- 288 -------------------------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE. 919 52 1,151 (816) 1,306 LIABILITIES SUBJECT TO COMPROMISE........... 3,978 411 20 (2,215) 2,194 SHAREHOLDERS' EQUITY (DEFICIT): Common stock................................ 1 -- -- -- 1 Additional contributed capital ............. 56 -- -- -- 56 Treasury stock.............................. (251) -- -- -- (251) Net (deficiency) excess of assets at spin-off and subsidiary capital...................... (113) 2,091 203 (2,294) (113) Accumulated other comprehensive loss........ (56) -- -- -- (56) Accumulated deficit......................... (944) -- -- -- (944) -------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY (DEFICIT)........ (1,307) 2,091 203 (2,294) (1,307) -------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)................................... $3,590 $ 2,554 $ 1,374 $ (5,325) $ 2,193 ==========================================================================

27 SOLUTIA INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2003

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents................. $ 105 $ 20 $ 34 $ -- $ 159 Trade receivables, net.................... 8 135 138 -- 281 Intercompany receivables.................. 65 677 100 (842) -- Miscellaneous receivables................. 56 -- 28 -- 84 Inventories............................... 130 24 102 (16) 240 Prepaid expenses and other current assets. 25 1 11 3 40 -------------------------------------------------------------------------- TOTAL CURRENT ASSETS................... 389 857 413 (855) 804 PROPERTY, PLANT AND EQUIPMENT, NET........ 695 75 139 -- 909 INVESTMENTS IN AFFILIATES................. 2,176 29 34 (2,033) 206 GOODWILL.................................. -- 72 25 -- 97 IDENTIFIED INTANGIBLE ASSETS, NET......... 2 27 14 -- 43 INTERCOMPANY ADVANCES..................... 128 1,392 962 (2,482) -- OTHER ASSETS.............................. 340 -- 47 -- 387 -------------------------------------------------------------------------- TOTAL ASSETS........................... $ 3,730 $ 2,452 $ 1,634 $ (5,370) $ 2,446 ========================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable.......................... $ 46 $ 1 $ 33 $ (2) $ 78 Intercompany payables..................... 9 20 87 (116) -- Accrued Liabilities....................... 185 9 110 -- 304 Short-term debt........................... 361 -- -- -- 361 Intercompany short-term debt.............. -- -- 419 (419) -- -------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES................. 601 30 649 (537) 743 LONG-TERM DEBT............................ 43 -- 251 -- 294 INTERCOMPANY LONG-TERM DEBT............... -- -- 574 (574) -- OTHER LIABILITIES......................... 263 -- 50 -- 313 -------------------------------------------------------------------------- TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE................................ 907 30 1,524 (1,111) 1,350 LIABILITIES SUBJECT TO COMPROMISE......... 3,948 412 75 (2,214) 2,221 SHAREHOLDERS' EQUITY (DEFICIT): Common stock.............................. 1 -- -- -- 1 Additional contributed capital ........ 56 -- -- -- 56 Treasury stock......................... (251) -- -- -- (251) Net (deficiency) excess of assets at spin-off and subsidiary capital.......... (113) 2,010 35 (2,045) (113) Accumulated other comprehensive loss...... (72) -- -- -- (72) Accumulated deficit....................... (746) -- -- -- (746) -------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY (DEFICIT)...... (1,125) 2,010 35 (2,045) (1,125) -------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)................................. $ 3,730 $ 2,452 $ 1,634 $ (5,370) $ 2,446 ==========================================================================

28 SOLUTIA, INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2004

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ CASH PROVIDED BY (USED IN) OPERATIONS.... $ 24 $ 15 $(43) $ -- $ (4) --------------------------------------------------------------------------- INVESTING ACTIVITIES: Property, plant and equipment purchases.. (11) (2) (9) -- (22) Other investing activities............... (36) -- -- -- (36) --------------------------------------------------------------------------- CASH USED IN INVESTING ACTIVITIES........ (47) (2) (9) -- (58) --------------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in short-term debt obligations (361) -- -- -- (361) Proceeds from long-term debt obligations 300 -- -- -- 300 Net change in cash collateralized letters of credit................................ 76 -- -- -- 76 Changes in investments and advances from (to) affiliates.......................... (74) 3 71 -- -- Deferred debt issuance costs............. (8) -- (5) -- (13) Other financing activities............... (1) -- -- -- (1) --------------------------------------------------------------------------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES............................... (68) 3 66 -- 1 --------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.............................. (91) 16 14 -- (61) CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR........................ 105 20 34 -- 159 --------------------------------------------------------------------------- END OF PERIOD............................ $ 14 $ 36 $ 48 $ -- $ 98 ===========================================================================

29 SOLUTIA, INC. (DEBTOR-IN-POSSESSION) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2003

Parent Only Non- Consolidated Solutia Inc. Guarantors Guarantors Eliminations Solutia Inc. ------------ ---------- ---------- ------------ ------------ CASH PROVIDED BY (USED IN) OPERATIONS........ $(132) $ 65 $ 15 $-- $ (52) ---------------------------------------------------------------------------- INVESTING ACTIVITIES: Property, plant and equipment purchases ..... (41) (1) (4) -- (46) Acquisition and investment payments, net of cash acquired.......................... (27) -- -- -- (27) Property disposals and investment proceeds .. 170 -- 306 -- 476 ---------------------------------------------------------------------------- CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 102 (1) 302 -- 403 ---------------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in short-term debt obligations ... (113) -- (126) -- (239) Net change in cash collateralized letters of credit................................. (39) -- -- -- (39) Changes in investments and advances from (to) affiliates............................. 209 (64) (145) -- -- Other financing activities .................. (6) -- -- -- (6) ---------------------------------------------------------------------------- CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 51 (64) (271) -- (284) ---------------------------------------------------------------------------- INCREASE IN CASH AND CASH EQUIVALENTS ....... 21 -- 46 -- 67 CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR ........................... -- -- 17 -- 17 ---------------------------------------------------------------------------- END OF PERIOD ............................... $ 21 -- 63 -- $ 84 ============================================================================

30 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 the overall leveraged position of the Company; 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; environmental remediation costs; 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 assumptions. CRITICAL ACCOUNTING POLICIES AND ESTIMATES There have been no changes in the six months ended June 30, 2004 with respect to Solutia's critical accounting policies, as presented on pages 17 through 19 of Solutia's 2003 Form 10-K/A. SUMMARY RESULTS OF OPERATIONS The discussions below and accompanying 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 of business. However, as a result of the Chapter 11 proceedings, such realization of assets and liquidation of liabilities are subject to a significant number of uncertainties. Summary of Significant Second Quarter Events Jeffry N. Quinn was elected President and Chief Executive Officer and James M. Sullivan was elected Senior Vice President and Chief Financial Officer on May 3, 2004 succeeding John C. Hunter, formerly Chairman and Chief Executive Officer and Robert A. Clausen, formerly Vice Chairman and Chief Financial Officer. Mr. Hunter and Mr. Clausen retired from the Company effective May 31, 2004. Mr. Quinn was also elected to the Company's Board of Directors. Mr. Quinn had previously served as Senior Vice President, General Counsel and Chief Restructuring Officer and Mr. Sullivan had previously served as Vice President and Controller. Additionally, Luc De Temmerman, formerly Vice President and General Manager of Solutia's Performance Products division, was elected Senior Vice President and Chief Operating Officer. In conjunction with these changes in senior management, a broader reorganization of the Company's general and administrative functions was completed. In addition to the employee reductions, Solutia amended its U.S. qualified pension plan to cease future benefit accruals effective July 1, 2004 for non-union participants. These actions were taken as the Company continues to reduce its cost position to remain competitive in the markets in which it competes. Also, Solutia has petitioned the bankruptcy court for approval to make a voluntary contribution to the U.S. qualified pension plan in the third quarter 2004. This contribution coupled with the cessation of future benefit accruals will result in a significant reduction in the required future contributions to the pension plan, as well as defer the timing of these contributions. In addition, as part of continued evaluation of its portfolio, during the quarter Solutia decided to close its chlorobenzenes business due to its unprofitable financial performance. Finally, the Company initiated an amendment of its DIP financing agreement to provide greater flexibility to the Company in executing certain actions contemplated in its financial projections. This amendment was approved early in the third quarter. 31 Results of Operations - Second Quarter 2004 Compared with Second Quarter 2003 Net sales and operating losses of Solutia for the three months ended June 30, 2004 and 2003 are as follows:

---------------------------------------------------------------------------------------------------------- (dollars in millions) 2004 2003 ---- ---- Net Sales.................................................................... $ 699 $ 625 ====== ====== Operating Loss: Performance Products and Services Segment Profit......................... $ 27 $ 26 Integrated Nylon Segment Profit (Loss)................................... 5 (20) Less: Corporate Expenses............................................ (78) (41) ------- ------- Operating Loss............................................................... $ (46) $ (35) ======= ======= Charges included in Operating Loss........................................... $ (75) $ (36) ======= ======= ----------------------------------------------------------------------------------------------------------

The $74 million, or 12 percent, increase in net sales as compared to the second quarter 2003 was primarily a result of increased sales volumes of approximately 7 percent, higher average selling prices of approximately 4 percent, and favorable currency exchange rate fluctuations of approximately 1 percent. The $11 million, or 31 percent, increase in operating losses as compared to the second quarter 2003 resulted primarily from higher charges in 2004 as compared to 2003, which are described in greater detail in the Results of Operations section below, as well as higher raw material and energy costs. Partially offsetting this increase in operating losses were higher net sales and favorable manufacturing variances, which were principally due to cost containment activities and higher capacity utilization levels. Results of Operations - Six Months Ended June 30, 2004 Compared with Six Months Ended June 30, 2003 Net sales and operating losses of Solutia for the six months ended June 30, 2004 and 2003 are as follows:

---------------------------------------------------------------------------------------------------------- (dollars in millions) 2004 2003 ---- ---- Net Sales.................................................................... $ 1,342 $ 1,236 ======= ======= Operating Loss: Performance Products and Services Segment Profit......................... $ 52 $ 43 Integrated Nylon Segment Loss............................................ (7) (31) Less: Corporate Expenses............................................ (89) (56) Less: Equity (Earnings) Loss from Affiliates and Other (Income) Expense items included in Segment Profit (Loss)..................... -- (4) ----- ---- Operating Loss............................................................... $(44) $(48) ===== ==== Charges included in Operating Loss........................................... $ (80) $(47) ===== ==== ----------------------------------------------------------------------------------------------------------

The $106 million, or 9 percent, increase in net sales as compared to the six months ended June 30, 2003 was primarily a result of increased sales volumes of approximately 5 percent, higher average selling prices of approximately 2 percent, and favorable currency exchange rate fluctuations of approximately 2 percent. The $4 million improvement in operating losses as compared to the six months ended June 30, 2003 resulted primarily from higher net sales, controlled spending and favorable manufacturing variances, partially offset by higher raw material and energy costs and higher charges in 2004 as compared to 2003, which are described in greater detail in the Results of Operations section below. BANKRUPTCY PROCEEDINGS On December 17, 2003, Solutia Inc. and its 14 U.S. subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York. The cases were consolidated for the purpose of joint administration and were assigned case number 03-17949 (PCB). 32 Solutia's subsidiaries outside the United States were not included in the Chapter 11 filing. Information concerning the status of the ongoing bankruptcy proceedings may be obtained from Solutia's website at www.solutia.com and at www.nysb.uscourts.gov, the official website for the bankruptcy court. The filing was made to restructure Solutia's balance sheet by reducing indebtedness to appropriate levels, to streamline operations and reduce costs to allow the Company to emerge from Chapter 11 as a viable going concern, and to obtain relief from the negative financial impact of legacy liabilities. These factors, combined with the weakened state of the chemical manufacturing sector, general economic conditions and continuing high, volatile energy and crude oil costs, have been an obstacle to Solutia's financial stability and success. While Solutia believes it will be able to achieve these objectives through the bankruptcy process, there can be no certainty that it will be successful in doing so. Under Chapter 11, Solutia is operating its businesses as a debtor-in-possession under court protection from creditors and claimants. Since the filing, all orders sufficient to enable Solutia to conduct normal business activities, including the approval of the Company's DIP financing, have been entered by the bankruptcy court. While Solutia is subject to Chapter 11, all transactions outside the ordinary course of business require the prior approval of the bankruptcy court. 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. Solutia believes that its plan of reorganization will result in cancellation of its existing shares of common stock, as well as options and warrants to purchase its common stock, and that it is unlikely that holders of Solutia's common stock, including options and warrants to purchase Solutia's common stock, will receive any consideration for that stock or those options and warrants in such a plan of reorganization. Solutia is unable to predict what recovery such a plan of reorganization will provide to holders of Solutia's outstanding debt securities. While Solutia filed for Chapter 11 in part to gain relief from the legacy liabilities it was required to assume when it was spun off from Pharmacia, the extent to which such relief will be achieved is uncertain at this time. It is also possible that pursuant to a plan of reorganization Solutia will agree to retain a portion of the legacy liabilities. Going Concern In order to exit Chapter 11 successfully, Solutia must propose and obtain confirmation by the bankruptcy court of a plan of reorganization that satisfies the requirements of the U.S. Bankruptcy Code. Although the Company expects to file a plan of reorganization that provides for Solutia's emergence from bankruptcy as a going concern, there can be no assurance that a plan of reorganization will be confirmed by the bankruptcy court or that any such plan will be implemented successfully. 33 Financial Information Summarized financial information concerning Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of and for the three and six months ended June 30, 2004 is presented as follows:

Solutia and Subsidiaries Solutia and Subsidiaries in not in Subsidiaries (dollars in millions) Reorganization Reorganization Eliminations Consolidated -------------- -------------- ------------ ------------ Three Months Ended June 30, 2004: --------------------------------- Net Sales................................. $ 573 $ 223 $ (97) $ 699 Operating Income (Loss)................... (76) 24 6 (46) Net Income (Loss)......................... (98) 14 (14) (98) Six Months Ended June 30, 2004: ------------------------------- Net Sales................................. $ 1,096 $ 432 $ (186) $ 1,342 Operating Income (Loss)................... (99) 42 13 (44) Net Income (Loss)......................... (198) 6 (6) (198) As of June 30, 2004: -------------------- Total Assets.............................. $ 1,874 $ 804 $ (485) $ 2,193 Liabilities not Subject to Compromise..... 987 502 (183) 1,306 Liabilities Subject to Compromise......... 2,194 -- -- 2,194 Total Shareholders' Equity (Deficit)...... (1,307) 302 (302) (1,307)

RESULTS OF OPERATIONS--SECOND QUARTER 2004 COMPARED WITH SECOND QUARTER 2003 Performance Products and Services

-------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Net Sales.............................................................. $286 $268 ==== ==== Segment Profit ........................................................ $ 27 $ 26 ==== ==== Charges included in Segment Profit................................. $(12) $ (5) ==== ==== --------------------------------------------------------------------------------------------------

The $18 million, or 7 percent, increase in net sales as compared to the second quarter 2003 resulted primarily from higher sales volumes of approximately 6 percent and favorable currency exchange rate fluctuations of approximately 3 percent, partially offset by lower average selling prices of approximately 2 percent. Higher volumes were experienced in SAFLEX(R) and VANCEVA(TM) plastic interlayer products, CPFilms window film and precision coated products, and in the Pharmaceutical Services businesses, partially offset by lower volumes due to the cessation of certain operations beginning in the fourth quarter 2003, including the shut-down of certain chlorobenzenes, feed ingredients and L-Aspartic operations. In addition, net sales were positively affected by the strengthening euro in relation to the U.S. dollar in comparison to the second quarter 2003. Lower average selling prices were experienced primarily in the SAFLEX(R) plastic interlayer products in comparison to second quarter 2003 resulting principally from the completion of new sales contracts in a competitive pricing environment. The $1 million, or 4 percent, increase in segment profit in comparison to the second quarter 2003 resulted primarily from higher net sales and favorable manufacturing variances resulting from cost containment activities and increased capacity utilization, partially offset by higher raw material and energy costs. In addition, segment profit in the second quarter 2004 was affected by $12 million of plant closure costs principally related to Solutia's chlorobenzenes operations, including costs for decommissioning and dismantling activities, asset write-offs, and severance and 34 retraining costs. The second quarter 2003 included restructuring charges of $5 million related to severance and retraining costs, as well as contract termination costs. Integrated Nylon

-------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Net Sales.............................................................. $ 413 $ 357 ===== ===== Segment Profit (Loss).................................................. $ 5 $ (20) ===== ===== Charges included in Segment Profit (Loss).......................... $ -- $ (2) ===== ===== --------------------------------------------------------------------------------------------------

The $56 million, or 16 percent, increase in net sales as compared to the second quarter 2003 resulted primarily from higher average selling prices of approximately 8 percent and increased sales volumes of 8 percent. Higher average selling prices were experienced principally in the intermediate and carpet fibers businesses. Carpet fiber increases resulted from price increases implemented across several product lines, whereas the intermediate chemicals business benefited from formula-based sales contracts tied to raw material costs. Increased sales volumes were experienced principally in carpet fibers and nylon plastics and polymers, while increased volumes in other product lines were predominately offset by restructuring actions taken in 2003 and contract terminations in 2004. The $25 million, or 125 percent, improvement in segment profit in comparison to the second quarter 2003 resulted principally from higher net sales, controlled spending, and favorable manufacturing variances resulting from cost containment activities and increased capacity utilization, partially offset by higher raw material and energy costs of approximately $33 million. Segment loss for the second quarter 2003 included severance charges of $2 million associated with workforce reductions. In addition, an unplanned outage was experienced at the Pensacola, Florida operating facility in late June 2004 that had a modest impact on the segment results in the second quarter 2004. However, it will have a negative impact on segment results in the third quarter 2004 of approximately $5 million. Corporate Expenses

---------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Corporate Expenses........................................................... $ 78 $ 41 ===== ====== Charges included in Corporate Expenses................................... $ (63) $ (29) ====== ======= ----------------------------------------------------------------------------------------------------------

The $37 million, or 90 percent, increase in corporate expenses in comparison to the second quarter 2003 was primarily a result of higher charges. Charges included in the second quarter 2004 were comprised of net pension curtailment charges of $63 million (as more fully described in Note 10 to the accompanying condensed consolidated financial statements), whereas charges included in the second quarter 2003 consisted primarily of a $27 million charge related to the Anniston Consent Decree and $2 million of severance costs related to workforce reductions. In addition, the second quarter 2004 included higher pension expenses, partially offset by lower headcount. 35 Equity Earnings (Loss) from Affiliates

----------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Equity Loss from Affiliates not included in Reportable Segment Profit (Loss).............................................................. $ (3) $ (1) -------- --------- Equity Earnings from Affiliates included in Reportable Segment Profit (Loss)............................................................. $ -- $ -- -------- --------- Equity Loss from Affiliates..................................................... $ (3) $ (1) ======== ========= Charges included in Equity Loss from Affiliates............................ $ (7) $ (3) ======== ========= -----------------------------------------------------------------------------------------------------------

Equity loss from affiliates in the three months ended June 30, 2004 was adversely affected by $7 million of charges including $5 million in asset impairment and severance charges at the Flexsys joint venture and $2 million of severance charges at the Astaris joint venture. These charges in the second quarter 2004 are in comparison to $3 million of restructuring charges in the second quarter 2003 primarily related to severance charges at both the Flexsys and Astaris joint ventures. In addition to these charges in the second quarter 2004, Astaris experienced lower interest expense resulting from lower outstanding debt levels, higher average selling prices and benefits experienced from the shutdown of certain unprofitable businesses, in comparison to the second quarter 2003. Interest Expense

---------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Interest Expense............................................................. $ 23 $ 25 ===== ====== Charges included in Interest Expense.................................... $ -- $ -- ===== ====== ----------------------------------------------------------------------------------------------------------

The $2 million, or 8 percent, decrease in interest expense in the second quarter 2004 in comparison to the second quarter 2003 resulted principally from the Company ceasing to record approximately $8 million of interest on its 6.72% debentures puttable 2004, due 2037 and its 7.375% debentures due 2027 in accordance with SOP 90-7 while under Chapter 11 protection. This $8 million of unrecorded interest was partially offset by the increased interest expense on the Euronotes, which were refinanced in the first quarter 2004. Reorganization Items, net

---------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Reorganization Items, net.................................................... $ (24) $ -- ======= ==== ----------------------------------------------------------------------------------------------------------

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 second quarter 2004 included $11 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $11 million of asset write-offs associated with a contract rejection; $4 million of expense provisions for (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the bankruptcy court; and a $2 million gain representing the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded. 36 Income Tax Expense (Benefit)

--------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED ------------------ JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Income Tax Expense (Benefit) ................................................ $ 2 $ (22) ==== ====== ---------------------------------------------------------------------------------------------------------

The $24 million change in income tax expense (benefit) in the second quarter 2004 in comparison to the comparable period in 2003 was primarily a result of Solutia not recording any U.S. income tax benefit for losses incurred from its domestic operations (including temporary differences) during the second quarter 2004 due to Solutia's Chapter 11 filing. Consequently, the increases in federal and state deferred tax assets resulting from the increases in net operating losses during the second quarter 2004 were offset by corresponding increases in valuation allowances. The $2 million of income tax expense in the second quarter 2004 represents principally taxes on foreign earnings. RESULTS OF OPERATIONS--SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2003 Performance Products and Services

-------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Net Sales.............................................................. $556 $518 ==== ==== Segment Profit ........................................................ $ 52 $ 43 ==== ==== Charges included in Segment Profit................................. $(17) $(11) ==== ==== --------------------------------------------------------------------------------------------------

The $38 million, or 7 percent, increase in net sales as compared to the six months ended June 30, 2003 resulted primarily from higher sales volumes of approximately 5 percent and favorable currency exchange rate fluctuations of approximately 4 percent, partially offset by lower average selling prices of approximately 2 percent. Higher volumes were experienced in SAFLEX(R) and VANCEVA(TM) plastic interlayer products, CPFilms window film and precision coated products, and in the Pharmaceutical Services businesses, partially offset by lower volumes due to the cessation of certain operations beginning in the fourth quarter 2003, including the shut-down of certain chlorobenzenes, feed ingredients and L-Aspartic operations. In addition, net sales were positively affected by the strengthening euro in relation to the U.S. dollar in comparison to the six months ended June 30, 2003. Lower average selling prices were experienced primarily in the SAFLEX(R) plastic interlayer products in comparison to the six months ended June 30, 2003 resulting principally from the completion of new sales contracts in a competitive pricing environment. The $9 million, or 21 percent, increase in segment profit in comparison to the six months ended June 30, 2003 resulted principally from higher net sales and favorable manufacturing variances resulting from cost containment activities and increased capacity utilization, partially offset by higher raw material and energy costs. In addition, segment profit in 2004 was affected by $17 million of plant closure costs principally related to Solutia's chlorobenzenes operations, including costs for decommissioning and dismantling activities, asset write-offs, future costs for non-cancelable operating leases, and severance and retraining costs, whereas 2003 included restructuring charges of $11 million related to severance and retraining costs, as well as contract termination costs. 37 Integrated Nylon

-------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Net Sales.............................................................. $786 $718 ==== ==== Segment Loss........................................................... $ (7) $(31) ==== ==== Charges included in Segment Loss................................... $ -- $ (5) ==== ==== --------------------------------------------------------------------------------------------------

The $68 million, or 9 percent, increase in net sales as compared to the six months ended June 30, 2003 resulted primarily from higher average selling prices of approximately 5 percent and increased sales volume of approximately 4 percent. Higher average selling prices were experienced in the carpet and acrylic fiber businesses resulting from price increases implemented across several product lines, whereas the intermediate chemicals sales benefited from formula-based sales contracts tied to raw material costs. Increased sales volumes were experienced in carpet fibers and nylon plastics and polymers, partially offset by lower volumes in intermediate chemicals and acrylic fibers, while increased volumes in other product lines were predominately offset by restructuring actions taken in 2003 and contract terminations in 2004. The $24 million, or 77 percent, improvement in the segment loss in comparison to the six months ended June 30, 2003 resulted primarily from higher net sales, controlled spending, and favorable manufacturing variances resulting from cost containment activities and increased capacity utilization, partially offset by higher raw material and energy costs of approximately $58 million. Segment loss for the six months ended June 30, 2003 included severance charges of $5 million associated with workforce reductions. In addition, an unplanned outage was experienced at the Pensacola, Florida operating facility in late June 2004 that had a modest impact on segment results in the six months ended June 30, 2004. However, it will have a negative impact on segment results in the third quarter 2004 of approximately $5 million. Corporate Expenses

---------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Corporate Expenses........................................................... $ 89 $ 56 ===== ==== Charges included in Corporate Expenses................................... $ (63) $(31) ===== ==== ----------------------------------------------------------------------------------------------------------

The $33 million, or 59 percent, increase in corporate expenses in comparison to the six months ended June 30, 2003 was primarily a result of higher charges included in corporate expenses. Charges included in the six months ended June 30, 2004 were comprised of net pension curtailment charges of $63 million (as more fully described in Note 10 to the accompanying condensed consolidated financial statements), whereas charges included in the comparable period of 2003 consisted of a $27 million charge related to the Anniston Consent Decree and $4 million of severance costs related to workforce reductions. In addition, the six months ended June 30, 2004 included higher pension expense, mostly offset by lower headcount. 38 Equity Earnings (Loss) from Affiliates

----------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Equity Loss from Affiliates not included in Reportable Segment Profit (Loss). $ (12) $ (7) -------- --------- Equity Earnings from Affiliates included in Reportable Segment Profit (Loss). $ -- $ 1 -------- --------- Equity Loss from Affiliates.................................................. $ (12) $ (6) ======== ========= Charges included in Equity Loss from Affiliates......................... $ (18) $ (9) ======== ========= -----------------------------------------------------------------------------------------------------------

Equity loss from affiliates in the six months ended June 30, 2004 was adversely affected by $18 million of charges including $5 million in contract termination costs, $3 million in dismantling charges, $2 million of severance costs, and $1 million of asset impairments at the Astaris joint venture, as well as $7 million of asset impairment and severance charges at the Flexsys joint venture. These charges in the six months ended June 30, 2004 are in comparison to $9 million of restructuring charges in the comparable period of 2003 related to asset impairment charges at the Flexsys joint venture and severance charges at both the Flexsys and Astaris joint ventures. In addition to these charges in the six months ended June 30, 2004, Astaris experienced lower interest expense resulting from lower outstanding debt levels, higher average selling prices and benefits experienced from the shutdown of certain unprofitable businesses, in comparison to the six months ended June 30, 2003. Interest Expense

---------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Interest Expense............................................................. $ 72 $ 48 ===== ====== Charges included in Interest Expense.................................... $ (25) $ -- ===== ====== ----------------------------------------------------------------------------------------------------------

The $24 million, or 50 percent, increase in interest expense in 2004 in comparison to the six months ended June 30, 2003 resulted principally from the write-off of unamortized debt issuance costs of $25 million related to the October 2003 credit facility and interim DIP facility; both retired in January 2004 with proceeds from the final DIP facility. Higher interest expense was also a result of increased interest expense on the Euronotes, which were refinanced in the first quarter 2004. In addition, while operating as a debtor-in-possession during the Chapter 11 proceedings, the Company has ceased paying interest on its 6.72% debentures puttable 2004, due 2037 and its 7.375% debentures due 2027. The amount of contractual interest not recorded in the first six months of 2004 was $16 million. Reorganization Items, net

---------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Reorganization Items, net.................................................... $ (49) $ -- ======= ====== ----------------------------------------------------------------------------------------------------------

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 six months ended June 30, 2004 included $24 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $20 million of asset write-offs associated with contract rejections and terminations; $7 million of expense provisions for (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees 39 approved by the bankruptcy court; and a $2 million gain representing the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded. Other Income, net

---------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Other Income, net ........................................................... $ -- $ 8 ========= ======== Other Income, net included in Reportable Segment Profit.................. $ -- $ 3 ========= ======== Gain included in Other Income, net........................................... $ -- $ 4 ========= ======== ----------------------------------------------------------------------------------------------------------

During the six months ended June 30, 2003 Solutia realized a benefit of $4 million related to the recovery of certain receivables, established prior to 1997, which had previously been written off. Income Tax Expense (Benefit)

--------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED ---------------- JUNE 30, -------- (dollars in millions) 2004 2003 ---- ---- Income Tax Expense (Benefit) ................................................ $ 6 $ (39) ======== =========== ---------------------------------------------------------------------------------------------------------

The $45 million change in income tax expense (benefit) in 2004 in comparison to the comparable period of 2003 was primarily a result of Solutia not recording any U.S. income tax benefit for losses incurred from its domestic operations (including temporary differences) during the six months ended June 30, 2004 due to Solutia's Chapter 11 filing. Consequently, the increases in federal and state deferred tax assets resulting from the increases in net operating losses during the six months ended June 30, 2004 were offset by corresponding increases in valuation allowances. The $6 million of income tax expense in the six months ended June 30, 2004 represents principally taxes on foreign earnings. 40 Summary of Events Affecting Comparability Charges and gains recorded in the six months ended June 30, 2004 and 2003, and other events affecting comparability have been summarized in the tables below (dollars in millions):

2004 ----------------------------------------------------------------- INCREASE/(DECREASE) PERFORMANCE ----------- PRODUCTS AND INTEGRATED CORPORATE/ ------------ ---------- ---------- SERVICES NYLON OTHER CONSOLIDATED ------------------------------------------- -------- ----- ----- ------------ IMPACT ON: ------------------------------------------- Cost of goods sold.................. $17 $-- $-- $17 (a) 47 47 (b) ---------------------------------------------------------------- Total cost of goods sold......... 17 -- 47 64 Marketing .......................... 4 4 (b) Administrative ..................... 7 7 (b) Technological ...................... 5 5 (b) ---------------------------------------------------------------- OPERATING LOSS IMPACT.......... (17) -- (63) (80) Equity loss from affiliates......... (18) (18) (c) Interest expense.................... (25) (25) (d) Loss on debt modification........... (15) (15) (e) ---------------------------------------------------------------- PRE-TAX INCOME STATEMENT IMPACT (17) -- (121) (138) =============================================== Income tax benefit impact........... (6) (f) ----------------- AFTER-TAX INCOME STATEMENT IMPACT $(132) ================= 2004 EVENTS ----------- a) Restructuring costs related principally to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, including costs for decommissioning and dismantling activities, asset write-offs, future costs for non-cancelable operating leases, and severance and retraining costs ($17 million pre-tax and after-tax - see note (f) below). b) Net pension curtailment charge due to the reduction in anticipated future service of participants in Solutia's U.S. qualified and non-qualified pension plans that resulted from Solutia's plan amendment to cease future benefit accruals for non-union participants in these plans effective July 1, 2004 ($63 million pre-tax and after-tax - see note (f) below). c) The Flexsys and Astaris joint ventures, in each of which the Company has a fifty percent interest, incurred restructuring charges related to contract terminations, dismantling costs, asset impairments and severance charges ($18 million pre-tax and after-tax - see note (f) below). d) Write-off of unamortized debt issuance costs related to the October 2003 and interim DIP credit facilities; both retired in January 2004 with proceeds from the final DIP facility ($25 million pre-tax and after-tax - see note (f) below). e) Loss due to the modification of the Company's Euronotes in January 2004 ($15 million pre-tax and $9 million after-tax). f) With the exception of item (e) above, which relates to ex-U.S. operations, the above items are considered to have like pre-tax and after-tax impact, as the tax benefit realized from the charges is offset by the increase in valuation allowance for U.S. deferred tax assets resulting from uncertainty as to their recovery as a result of the Chapter 11 filing.

41

2003 --------------------------------------------------------------- PERFORMANCE ----------- PRODUCTS AND INTEGRATED CORPORATE/ ------------ ---------- --------- INCREASE/(DECREASE) SERVICES NYLON OTHER CONSOLIDATED --------------------------------------------- -------- ----- ----- ------------ IMPACT ON: ------------------------------------------------------------------------------------------------------------- Cost of goods sold ....................... $6 $5 $ -- $11 (g) 27 27 (h) --------------------------------------------------------------- Total cost of goods sold ................. 6 5 27 38 Marketing ................................ 2 2 (g) Administrative ........................... 2 4 6 (g) Technological ............................ 1 1 (g) --------------------------------------------------------------- OPERATING LOSS IMPACT................ (11) (5) (31) (47) Equity earnings (loss) from affiliates.... (9) (9) (i) Other income (expense) ................... 4 4 (j) --------------------------------------------------------------- PRETAX INCOME STATEMENT IMPACT....... (11) (5) (36) (52) =============================================== Income tax benefit impact ................ (19) ---------------- AFTERTAX INCOME STATEMENT IMPACT $ (33) ================ 2003 EVENTS ----------- g) Restructuring charges for workforce reductions and contract termination costs ($20 million pre-tax and $12 million after-tax). h) Environmental charges related to remediation in Anniston, Alabama ($27 million pre-tax and $17 million after-tax). i) The Flexsys and Astaris joint ventures incurred restructuring charges related to asset impairments and severance charges ($9 million pre-tax and $7 million after-tax). j) The Company recovered certain receivables, established prior to 1997, which had previously been written off ($4 million pre-tax and $3 million after-tax).

42 FINANCIAL CONDITION AND LIQUIDITY As discussed previously, 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 the Company'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 under Chapter 11 protection will likely be very limited. Financial Analysis Solutia utilized its existing cash on-hand to finance operating needs and capital expenditures during the first six months of 2004. Cash used in continuing operations was $4 million in the first six months of 2004, an improvement of $37 million from $41 million used in continuing operations for the comparable period of 2003. This improvement in cash used in continuing operations was primarily attributable to the continued build of post-petition accounts payable balances due to improved vendor terms, partially offset by higher accounts receivable and payments for reorganization related items. Higher accounts receivable was a result of higher net sales in the six months ended June 30, 2004 relative to the comparable period of 2003. FMC and Solutia have agreed conceptually to allow Astaris to defer up to approximately $30 million of payment obligations to each of FMC and Solutia under existing operating agreements and certain other agreements over the next 12-15 months to provide liquidity assistance to Astaris as it implements its business restructuring. The amount deferred and resulting negative impact on cash from operations was $12 million in the six months ended June 30, 2004. Capital spending decreased $24 million to $22 million in the first six months of 2004, compared to $46 million in the comparable period of 2003. This variance was primarily from the mandatory purchase of the co-generation facility in Pensacola, Florida in 2003, for approximately $32 million, whereas the expenditures in the first six months of 2004 were used primarily to fund various minor capital improvements, as well as certain cost reduction projects. During the first six months of 2003, proceeds totaling $474 million from the sale of the resins, additives and adhesives businesses were included in cash provided by discontinued operations. Total debt of $1,224 million as of June 30, 2004, including $599 million not subject to compromise and $625 million subject to compromise, decreased by $56 million as compared to $1,280 million at December 31, 2003, including $625 million subject to compromise and $655 million not subject to compromise. The composition of Solutia's debt changed during the first six months of 2004 with the completion of the final DIP facility in January 2004 and concurrent retirement of the Company's borrowings under the October 2003 and interim DIP credit facilities, which aggregated $361 million outstanding as of December 31, 2003, with proceeds from the final DIP facility and existing cash on-hand. Outstanding borrowings under the final DIP facility were $300 million as of June 30, 2004. In addition, the Euronotes were increased by $15 million during the first six months of 2004 due to the January 2004 modification. As a result of the Chapter 11 filing, Solutia was in default on all its debt agreements as of June 30, 2004, with the exception of its DIP credit facility and Euronotes. Solutia's working capital increased by $322 million to $383 million at June 30, 2004, compared to $61 million at December 31, 2003. The increase in the working capital position primarily resulted from the retirement of all of the short-term debt outstanding as of December 31, 2003 during the first six months of 2004 and the seasonal increase in working capital, partially offset by lower cash on-hand as of June 30, 2004. Solutia had a shareholders' deficit of $1,307 million at June 30, 2004 compared to a deficit of $1,125 million at December 31, 2003. The $182 million increase in shareholders' deficit principally resulted from the $198 million net loss in the first six months of 2004, partially offset by the $18 million decrease in additional minimum pension liability resulting principally from the pension curtailment in 2004 (as more fully described in Note 10 to the accompanying condensed consolidated financial statements). 43 The weighted average interest rate on Solutia's total debt outstanding at June 30, 2004 was approximately 8.7 percent compared to 7.7 percent at June 30, 2003. This increase was primarily a result of the increase in the interest rate for the Euronotes resulting from the January 2004 modification of these notes At June 30, 2004, Solutia's total liquidity was $243 million in the form of $145 million of availability under the final DIP credit facility and approximately $98 million of cash on-hand, of which $46 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 proceedings. At December 31, 2003, all of the Company's liquidity was in the form of cash in the amount of $159 million, of which $34 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 proceedings. Solutia disclosed in its 2003 Form 10-K/A that it did not expect to be required to make contributions to its qualified domestic pension plan in 2004 according to current IRS funding rules. No contributions have been made to the qualified domestic pension plan in the six months ended June 30, 2004. According to current IRS funding rules, Solutia is not required to make pension contributions in 2004 for its qualified domestic pension plan. However, the Company's current plan, subject to bankruptcy court approval, is to make a voluntary contribution of approximately $11 million to the qualified domestic pension plan in the third quarter 2004. This voluntary contribution coupled with the cessation of future benefit accruals (as discussed in Note 10 to the accompanying condensed consolidated financial statements), effective July 1, 2004, will result in the reduction in required contributions, as well as the deferral of the timing of future required contributions. Based upon current actuarial assumptions, these two actions will result in the reduction of future required contributions to the qualified domestic pension plan of approximately $100 million over the next five years. Amendment to DIP Financing Agreement The Company amended its DIP financing agreement on July 20, 2004, after receiving bankruptcy court approval. The amendment provides greater flexibility to the Company in executing certain actions contemplated in its financial projections, provides cost savings through lower requirements of certain letters of credit, and enhances liquidity opportunities through retaining certain potential receipts which were previously required to be used to reduce the commitment amount. No changes were made to the financial covenants contained in the DIP agreement. CONTINGENCIES Litigation 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 its spin-off 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 case. This estimated unsecured claim amount was classified as a liability subject to compromise as of both June 30, 2004 and December 31, 2003 in the amount of $146 million. Solutia's 2003 Form 10-K/A described a number of legal proceedings in which Solutia was a named defendant or was defending solely due to its indemnification obligations referred to above. The Company is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, in this and subsequent reports filed with the Securities and Exchange Commission, Solutia will cease reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) Payton v. Monsanto; (iii) other Aniston cases; (iv) the PENNDOT case; and (v) premises based asbestos litigation. Following is a summary of legal proceedings that Solutia or certain of its equity affiliates continue to manage that could result in an outcome that is material to the condensed consolidated financial statements. 44 Anniston Partial Consent Decree The U.S. District Court for the Northern District of Alabama approved the revised Partial Consent Decree on August 4, 2003 that had been lodged with the court in an action captioned United States of America v. Pharmacia Corporation (f/k/a Monsanto Company) and Solutia. This Partial Consent Decree provides for Pharmacia and Solutia to sample certain residential properties and remove soils found on those properties if polychlorinated biphenyls ("PCBs") are at a level of 1 part per million ("ppm") or above, to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the U.S. Environmental Protection Agency ("EPA") of a cleanup remedy for the Anniston PCB site, and to pay the EPA's past response costs and future oversight costs related to this work. The decree also provided for the creation of an educational trust fund of approximately $3 million to be funded over a 12-year period to provide supplemental educational services for school children in West Anniston. On April 19, 2004, the United States District Court for the Northern District of Alabama issued a two sentence order finding that the Anniston Partial Consent Decree enforces police and regulatory powers under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and as a result the automatic stay provisions of the United States Bankruptcy Code are inapplicable to the Company's obligations under the Partial Consent Decree. On April 30, 2004, the United States Bankruptcy Court for the Southern District of New York entered a Stipulation and Agreed Order in which the EPA and the Company stipulate that the automatic stay is applicable to certain of the Partial Consent Decree's requirements. The Company has asked the District Court to reconsider its order and to bring it into accord with the Stipulation and Agreed Order consented to by the EPA and entered by the U.S. Bankruptcy Court. Flexsys Related Litigation Solutia's 2003 Form 10-K/A and its Form 10-Q for the quarter ended March 31, 2004 describe an investigation by antitrust authorities in the United States, Europe and Canada of past commercial practices in the rubber chemicals industry against Flexsys, Solutia's 50/50 joint venture with Akzo Nobel N.V., and other producers of rubber chemicals. Those periodic filings also describe a number of purported class actions that have been filed against Flexsys and other producers of rubber chemicals as well as related shareholder derivative actions and shareholder class actions that have been filed against Solutia and certain of its officers and directors. Set forth below is a description of the material developments in those cases as well as other material litigation developments that have occurred since our first quarter Form 10-Q filing. Actions against Flexsys. A purported class action has been filed in Massachusetts state court against Flexsys and other past and present rubber chemical producers on behalf of all indirect consumers of rubber chemicals for damages sustained as a result of alleged anti-competitive practices in the sale of rubber chemicals. In addition to the Massachusetts case, thirteen state court actions filed by retail tire purchasers against Flexsys and other producers of rubber chemicals remain pending either on appeal or at the trial court level in preliminary motion phases. On July 15, 2004, RBX Industries, Inc. v. Bayer Corp., Flexsys, et al. was filed against Flexsys and other producers of rubber chemicals in the United States District Court for the Western District of Pennsylvania. Plaintiff alleges that during the period 1995 through 2001 the defendants conspired through marketing and sales practices to cause plaintiff to pay supra-competitive prices and seeks treble damages from the defendants. Solutia is not a named defendant in any of these cases. In May 2004, two purported class actions were filed in the Province of Quebec Canada against Flexsys and other rubber chemical producers alleging that collusive sales and marketing activities of the defendants damaged all persons in Quebec during the period July 1995 through September 2001. Statutory damages of (CAD) $14.6 million along with exemplary damages of (CAD) $25 per person are being sought. A hearing is tentatively scheduled to determine which case will be allowed to go forward. Solutia is not a named defendant in either of these class actions. Actions against Solutia. Solutia's 2003 Form 10-K/A and its Form 10-Q for the quarter ended March 31, 2004 describe a consolidated class action in the U.S. District Court in California brought by individuals who allegedly purchased Solutia stock at inflated prices as a result of the incorporation of Solutia's share of Flexsys' financial results which were purportedly inflated as a result of anticompetitive collusion between Flexsys and other rubber chemical producers during the period December 1998 through October 2002. The consolidated action has 45 been automatically stayed with respect to Solutia by virtue of Section 362(a) of the Bankruptcy Code but has not been stayed with respect to the individual defendants. On July 28, 2004, the court granted the individual defendants' motion to dismiss for failure to state a claim but also granting plaintiffs ten days to file an amended compliant. Environmental Liabilities Environmental compliance and remediation costs incurred by the Company generally fall into two broad categories: (i) obligations related to properties currently owned or operated by Solutia and (ii) obligations related to properties that are not owned by Solutia, including non-owned properties adjacent to current operating sites. For the owned and operated sites, Solutia had an accrued liability of $76 million and $81 million as of June 30, 2004 and December 31, 2003, respectively, for solid and hazardous waste remediation, which represents the Company's best estimate of the underlying obligation. In addition, this balance also includes post-closure costs at certain of the Company'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, the Company will be required to comply with environmental requirements in the conduct of its business, regardless of when the underlying environmental contamination occurred. However, the Company ultimately expects to seek recovery against other potentially responsible parties at certain of these locations. The Company had an accrued liability of $84 million and $85 million as of June 30, 2004 and December 31, 2003, respectively, primarily for properties not owned or operated by Solutia. This liability is classified as subject to compromise in the Condensed Consolidated Statement of Financial Position as of June 30, 2004 and December 31, 2003, as the Company currently believes it constitutes a pre-petition claim that will be discharged in the bankruptcy process. The EPA and/or Pharmacia are currently contesting this view (as more fully disclosed in the above Anniston Partial Consent Decree disclosure). In addition, remediation activities are currently being funded by Monsanto for certain of these properties not owned or operated by Solutia. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 case. 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, 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 the Company. Astaris Joint Venture On October 8, 2003, Solutia and Astaris, a 50/50 joint venture with FMC Corporation, amended its external financing agreement to release the Astaris lenders' security interests in certain Solutia assets in exchange for Solutia's posting of a $67 million letter of credit, representing fifty percent of the Astaris lenders' outstanding commitments to Astaris. The agreement was also amended to provide for a dollar-for-dollar reduction of the Astaris lenders' commitments with future payments made by Solutia and FMC under their existing support agreements to Astaris. This additional amendment provided a $67 million limitation for each of Solutia and FMC on future funding in the event the joint venture continued to fail to meet certain financial benchmarks. Solutia's $67 million letter of credit was reduced dollar-for-dollar as payments were made by Solutia under its existing support agreement. Solutia made approximately $36 million of investment payments in the six months ended June 30, 2004 to keep the Astaris joint venture in compliance with its financial covenants. The remaining commitment to Astaris was $10 million and $51 million as of June 30, 2004 and December 31, 2003, respectively, and was recorded as a liability in the Condensed Consolidated Statement of Financial Position in these periods accordingly. FMC and Solutia also agreed conceptually to allow Astaris to defer up to approximately $30 million of payment obligations to each of FMC and Solutia under existing operating agreements and certain other agreements, as more fully described in the Financial Condition and Liquidity section. UCB S.A. Dispute On December 2, 2002, Solutia signed a definitive stock and asset purchase agreement ("SAPA") to sell its resins, additives and adhesives businesses to UCB S.A. for $500 million in cash, plus an upfront payment of $10 million for a period of exclusivity. On January 31, 2003, the sale was completed. During 2003 a number of disputes 46 arose between the parties as to amounts due under various provisions of the SAPA which were unresolved as of Solutia's Chapter 11 filing date. Solutia had approximately $30 million recorded for this liability as of both June 30, 2004 and December 31, 2003. As a result of Solutia's Chapter 11 filing, this liability has been classified as subject to compromise in the Condensed Consolidated Statement of Financial Position and will be addressed in conjunction with the ongoing bankruptcy proceedings. 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-filing claims not currently reflected in the condensed consolidated financial statements may be identified through the proof of claim reconciliation process. The amount of pre-filing 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 the Company may retain certain obligations currently classified as subject to compromise in the Condensed Consolidated Statement of Financial Position. 47 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS There have been no material changes in market risk exposures during the six months ended June 30, 2004 that affect the disclosures presented in the information appearing under "Derivative Financial Instruments" on pages 28 and 29 of Solutia's Form 10-K/A for the year-ended December 31, 2003. ITEM 4. CONTROLS AND PROCEDURES As of the end of 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). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Solutia's disclosure controls and procedures are effective in timely alerting them to material information relating to Solutia and its consolidated subsidiaries that is required to be included in Solutia's periodic SEC filings. There were no significant changes in Solutia's internal control over financial reporting that occurred during the quarterly period ended June 30, 2004, that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. 48 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Solutia's 2003 Form 10-K/A described a number of legal proceedings in which Solutia was a named defendant or was defending solely due to its indemnification obligations referred to above. The Company is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, in this and subsequent reports filed with the Securities and Exchange Commission, Solutia will cease reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) Payton v. Monsanto; (iii) other Anniston cases; (iv) the PENNDOT case; and (v) premises based asbestos litigation. Flexsys Related Litigation Solutia's 2003 Form 10-K/A and its Form 10-Q for the quarter ended March 31, 2004 describe an investigation by antitrust authorities in the United States, Europe and Canada of past commercial practices in the rubber chemicals industry against Flexsys, Solutia's 50/50 joint venture with Akzo Nobel N.V., and other producers of rubber chemicals. Those periodic filings also describe a number of purported class actions that have been filed against Flexsys and other producers of rubber chemicals as well as related shareholder derivative actions and shareholder class actions that have been filed against Solutia and certain of its officers and directors. Set forth below is a description of the material developments in those cases as well as other material litigation developments that have occurred since our first quarter Form 10-Q filing. Actions against Flexsys. A purported class action has been filed in Massachusetts state court against Flexsys and other past and present rubber chemical producers on behalf of all indirect consumers of rubber chemicals for damages sustained as a result of alleged anti-competitive practices in the sale of rubber chemicals. In addition to the Massachusetts case, thirteen state court actions filed by retail tire purchasers against Flexsys and other producers of rubber chemicals remain pending either on appeal or at the trial court level in preliminary motion phases. On July 15, 2004, RBX Industries, Inc. v. Bayer Corp., Flexsys, et al. was filed against Flexsys and other producers of rubber chemicals in the United States District Court for the Western District of Pennsylvania. Plaintiff alleges that during the period 1995 through 2001 the defendants conspired through marketing and sales practices to cause plaintiff to pay supra-competitive prices and seeks treble damages from the defendants. Solutia is not a named defendant in any of these cases. In May 2004, two purported class actions were filed in the Province of Quebec Canada against Flexsys and other rubber chemical producers alleging that collusive sales and marketing activities of the defendants damaged all persons in Quebec during the period July 1995 through September 2001. Statutory damages of (CAD) $14.6 million along with exemplary damages of (CAD) $25 per person are being sought. A hearing is tentatively scheduled to determine which case will be allowed to go forward. Solutia is not a named defendant in either of these class actions. Actions against Solutia. Solutia's 2003 Form 10-K/A and its Form 10-Q for the quarter ended March 31, 2004 describe a consolidated class action in the U.S. District Court in California brought by individuals who allegedly purchased Solutia stock at inflated prices as a result of the incorporation of Solutia's share of Flexsys' financial results which were purportedly inflated as a result of anticompetitive collusion between Flexsys and other rubber chemical producers during the period December 1998 through October 2002. The consolidated action has been automatically stayed with respect to Solutia by virtue of Section 362(a) of the Bankruptcy Code but has not been stayed with respect to the individual defendants. On July 28, 2004, the court granted the individual defendants' motion to dismiss for failure to state a claim but also granting plaintiffs ten days to file an amended compliant. 49 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS This table provides information with respect to purchases by Solutia of shares of its common stock during the second quarter of 2004: ISSUER'S PURCHASES OF EQUITY SECURITIES*

------------------------------------------------------------------------------------------------------------ TOTAL NUMBER OF APPROXIMATE DOLLAR TOTAL NUMBER AVERAGE SHARES PURCHASED VALUE OF SHARES THAT OF PRICE AS MAY YET BE SHARES PAID PER PART OF PUBLICLY PURCHASED PERIOD PURCHASED** SHARE** ANNOUNCED PLAN UNDER THE PLAN* ------------------------------------------------------------------------------------------------------------ April 1, 2004 through April 30, 2004 -- N/A -- N/A ------------------------------------------------------------------------------------------------------------ May 1, 2004 through May 31, 2004 -- N/A -- N/A ------------------------------------------------------------------------------------------------------------ June 1, 2004 through June 30, 2004 75,279 $0.28 -- N/A ------------------------------------------------------------------------------------------------------------ TOTAL 75,279 $0.28 -- N/A ------------------------------------------------------------------------------------------------------------ * On April 26, 2000, Solutia announced that its Board of Directors authorized the purchase of up to 15 million shares of Solutia's common stock (the "2000 Repurchase Program") in addition to the normal repurchase of shares for Solutia's compensation and benefits programs. There have not been any purchases under the 2000 Stock Purchase Plan since October 2000. Because of Solutia's Chapter 11 filing and the covenants contained in Solutia's DIP financing agreement, there cannot be any further repurchases under the 2000 Repurchase Program. ** These columns reflect the following transaction during the second quarter of 2004: the surrender to Solutia of shares of Solutia common stock to satisfy tax withholding obligations in connection with the vesting of restricted stock awards.

50 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits--See the Exhibit Index at page 53 of this report. (b) Reports filed on Form 8-K during the quarter ended June 30, 2004: On May 5, 2004, we filed with the SEC a Form 8-K. Under Item 5, we filed our press release announcing certain management changes. On May 25, 2004, we furnished to the SEC a Form 8-K. Under Item 9, we furnished unaudited consolidated and consolidating financial statements of Solutia Europe S.A./N.V. and its subsidiaries. 51 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) Date: August 5, 2004 52 EXHIBIT INDEX These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K. EXHIBIT NUMBER DESCRIPTION ------ ----------- 10(a) Amended and Restated Separation Agreement and Release of Claims by and between Solutia Inc. and John C. Hunter III dated as of May 19, 2004 10(b) Amended and Restated Separation Agreement and Release of Claims by and between Solutia Inc. and Robert A. Clausen dated as of May 19, 2004 10(c) Agreement by and between Solutia Inc. and Jeffry N. Quinn dated as of July 19, 2004 10(d) Agreement by and between Solutia Inc. and James M. Sullivan dated as of July 19, 2004 10(e) Agreement by and between Solutia Inc. and John F. Saucier dated as of July 19, 2004 10(f) Amendment No. 2 to Financing Agreement and Waiver dated as of July 20, 2004 by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors, debtors-in-possession and as Borrowers; certain subsidiaries of Solutia Inc. as debtors, debtors-in-possession and as Guarantors; the lenders from time to time party thereto, as Lenders; Citicorp USA, Inc., as Collateral Agent, Administrative Agent and Co-Documentation Agent and Wells Fargo Foothill, LLC, as Co-Documentation Agent 11 Omitted--Inapplicable; see "Condensed Consolidated Statement of Operations" on page 1 31(a) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31(b) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32(a) Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99 Computation of the Ratio of Earnings to Fixed Charges 53