Solutia 10-Q 2012 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-13255

SOLUTIA INC.

(Exact name of registrant as specified in its charter)

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

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

(314) 674-1000

(Registrant’s telephone number, including area code)

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YesNo   X  

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

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

Class	Outstanding at March 31, 2012
Common Stock, $0.01 par value	122,734,778

PART I. FINANCIAL INFORMATION

Item 1.  FINANCIAL STATEMENTS

SOLUTIA INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(Dollars in millions, except per share amounts)

(Unaudited)

	Three Months Ended
	March 31,
	2012			2011
Net Sales	$	498		$	509
Cost of goods sold		340			347
Gross Profit		158			162
Selling, general and administrative expenses		75			62
Research and development expenses		8			6
Other operating income, net		(1	)		(11	)
Operating Income		76			105
Interest expense		(23	)		(28	)
Other loss, net		-			(1	)
Loss on debt modification		-			(2	)
Income from Continuing Operations Before Income Tax Expense		53			74
Income tax expense (benefit)		(1	)		8
Net Income		54			66
Net income attributable to noncontrolling interest		1			1
Net Income attributable to Solutia	$	53		$	65
Basic and Diluted Income per Share attributable to Solutia:
Basic Net Income	$	0.44		$	0.54
Diluted Net Income	$	0.43		$	0.54

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollars in millions)
(Unaudited)
	Three Months Ended
	March 31,
	2012			2011
Net Income		$	54		$	66
Other Comprehensive Income:
Accumulated currency adjustments			27			57
Postretirement adjustments			3			1
Hedging activity adjustments			1			2
Comprehensive Income			85			126
Comprehensive Income attributable to noncontrolling interest			2			1
Comprehensive Income attributable to Solutia		$	83		$	125
See accompanying Notes to Consolidated Financial Statements.

2

SOLUTIA INC.
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Dollars in millions, except per share amounts)
(Unaudited)
	March 31,			December 31,
	2012			2011
ASSETS
Current Assets:
Cash and cash equivalents	$	108		$	113
Trade receivables, net of allowances of $6 in 2012 and 2011		221			236
Miscellaneous receivables		74			75
Inventories		384			335
Prepaid expenses and other assets		28			27
Current assets of discontinued operations		1			1
Total Current Assets		816			787
Net Property, Plant and Equipment		953			945
Goodwill		789			783
Net Identified Intangible Assets		916			916
Other Assets		90			95
Total Assets	$	3,564		$	3,526
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable	$	181		$	186
Accrued liabilities		210			227
Current liabilities of discontinued operations		5			8
Total Current Liabilities		396			421
Long-Term Debt		1,338			1,337
Postretirement Liabilities		287			308
Environmental Remediation Liabilities		219			227
Deferred Tax Liabilities		183			190
Non-current Liabilities of Discontinued Operations		18			18
Other Liabilities		96			98
Commitments and Contingencies (Note 8)
Equity:
Common stock at $0.01 par value; (500,000,000 shares authorized, 124,245,832 and
123,316,852 shares issued in 2012 and 2011, respectively)		1			1
Additional contributed capital		1,672			1,651
Treasury shares, at cost (1,511,054 in 2012 and 1,247,183 in 2011)		(20	)		(13	)
Accumulated other comprehensive loss		(248	)		(279	)
Accumulated deficit		(388	)		(441	)
Total Shareholders’ Equity attributable to Solutia		1,017			919
Equity attributable to noncontrolling interest		10			8
Total Equity		1,027			927
Total Liabilities and Equity	$	3,564		$	3,526
See accompanying Notes to Consolidated Financial Statements.

3

SOLUTIA INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(Unaudited)
	Three Months Ended
	March 31,
	2012			2011
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net income	$	54		$	66
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		30			32
Pension contributions in excess of expense		(18	)		-
Other postretirement benefit contributions in excess of expense		-			(4	)
Amortization of debt issuance costs and discount		1			1
Deferred income taxes		(6	)		6
Share-based compensation expense		6			5
Other charges:
Other (gains) charges, including restructuring expenses		15			(3	)
Changes in assets and liabilities:
Income taxes payable		3			(3	)
Trade receivables		15			(37	)
Inventories		(51	)		(23	)
Accounts payable		6			16
Environmental remediation liabilities		(8	)		(1	)
Other assets and liabilities		(28	)		(6	)
Cash Provided by Operations – Continuing Operations		19			49
Cash Provided by (Used in) Operations – Discontinued Operations		(3	)		3
Cash Provided by Operations		16			52
INVESTING ACTIVITIES:
Property, plant and equipment purchases		(27	)		(17	)
Restricted cash		-			(5	)
Asset disposals and investment sales		-			29
Other		-			1
Cash Provided by (Used in) Investing Activities		(27	)		8
FINANCING ACTIVITIES:
Payment of long-term debt obligations		-			(77	)
Purchase of treasury shares		(7	)		(2	)
Stock option exercises		15			2
Other, net		(4	)		(3	)
Cash Provided by (Used in) Financing Activities		4			(80	)
Effect of Exchange Rate Changes on Cash and Cash Equivalents		2			2
DECREASE IN CASH AND CASH EQUIVALENTS		(5	)		(18	)
CASH AND CASH EQUIVALENTS:
Beginning of period		113			191
End of period	$	108		$	173
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash payments for interest	$	21		$	26
Cash payments for income taxes, net of refunds	$	9		$	14
Cash payments related to the pending merger with Eastman Chemical Company	$	9		$	-
Non-Cash Investing Activities:
Capital expenditures included in accounts payable	$	8		$	7
See accompanying Notes to Consolidated Financial Statements.

4

SOLUTIA INC.

CONSOLIDATED STATEMENT OF EQUITY

(Dollars in millions)

(Unaudited)

	Shareholders' Equity attributable to Solutia
								Accumulated						Equity
			Additional					Other						Attributable to
	Common		Contributed		Treasury			Comprehensive			Accumulated			Noncontrolling		Total
	Stock		Capital		Stock			Loss			Decifit			Interest		Equity
Beginning Balance – January 1, 2011	$	1	$	1,634	$	(6	)	$	(194	)	$	(703	)	$	7	$	739
Comprehensive income:
Net income		-		-		-			-			65			1		66
Accumulated currency adjustments		-		-		-			57			-			-		57
Postretirement adjustments		-		-		-			1			-			-		1
Hedging activity adjustments		-		-		-			2			-			-		2
Treasury stock purchases		-		-		(2	)		-			-			-		(2	)
Stock option exercises		-		2		-			-			-			-		2
Share-based compensation expense		-		5		-			-			-			-		5
Ending Balance – March 31, 2011	$	1	$	1,641	$	(8	)	$	(134	)	$	(638	)	$	8	$	870
Beginning Balance – January 1, 2012	$	1	$	1,651	$	(13	)	$	(279	)	$	(441	)	$	8	$	927
Comprehensive income:
Net income		-		-		-			-			53			1		54
Accumulated currency adjustments		-		-		-			27			-			1		28
Postretirement adjustments		-		-		-			3			-			-		3
Hedging activity adjustments		-		-		-			1			-			-		1
Treasury stock purchases		-		-		(7	)		-			-			-		(7	)
Stock option exercises		-		15		-			-			-			-		15
Share-based compensation expense		-		6		-			-			-			-		6
Ending Balance – March 31, 2012	$	1	$	1,672	$	(20	)	$	(248	)	$	(388	)	$	10	$	1,027
See accompanying Notes to Consolidated Financial Statements.

5

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

1.  Basis of Presentation

Basis of Presentation

Unless the context requires otherwise, the terms “Solutia”, “Company”, “we” and “our” in this report refer to Solutia Inc. and its subsidiaries. The accompanying consolidated financial statements have not been audited but have been prepared in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  Therefore, this Report on Form 10-Q should be read in conjunction with Solutia’s Report on Form 10-K for the fiscal year ended December 31, 2011.  In the opinion of management, these unaudited consolidated financial statements contain all adjustments necessary to present fairly our financial position, results of operations and cash flows for the interim periods reported.  Financial information for the first three months of fiscal year 2012 should not be annualized due to the seasonality of our business.

2.  Merger, Acquisitions, Divestitures and Discontinued Operations

Merger

On January 26, 2012, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Eastman Chemical Company (“Eastman”) and Eagle Merger Sub Corporation (“Merger Sub”), a wholly owned subsidiary of Eastman.  The Merger Agreement provides for the merger of Merger Sub with and into Solutia, with Solutia surviving as a wholly owned subsidiary of Eastman (the “Merger”). At the effective time of the Merger, each outstanding share of common stock, par value $0.01 per share, of  Solutia will be converted into the right to receive (i) $22.00 in cash, without interest, and (ii) 0.12 shares of common stock, par value $0.01 per share of Eastman.

The closing of the merger is subject to a number of conditions precedent described in the Merger Agreement, including (i) approval of the Merger by the stockholders of the Company, (ii) expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of foreign antitrust clearances, (iii) absence of any law or regulation that prohibits the consummation of the Merger, (iv) effectiveness of the registration on Form S-4 to be filed by Eastman with the Securities and Exchange Commission related to the Merger and (v) approval of the shares of Eastman common stock to be issued in the Merger for listing on the New York Stock Exchange. Each party’s obligation to close the Merger is also subject to the material accuracy of the representations and warranties of the other party in the Merger Agreement and the compliance in all material respects with covenants of the other party in the Merger Agreement and the absence of a Material Adverse Effect (as defined in the Merger Agreement) on the other party.

The Merger Agreement includes customary representations, warranties and covenants of the parties. The Merger Agreement contains termination rights of Solutia and Eastman and further provides that we will be required to pay Eastman a termination fee of $102 million under certain specified circumstances of termination of the Merger Agreement.

In conjunction with the Merger Agreement, we incurred $11 of merger-related expenses, including legal, financial advisor and accounting fees, during the three months ended March 31, 2012. These costs were recorded to Unallocated and Other selling, general and administrative expenses.

Acquisitions

On November 23, 2011, we purchased 100 percent of the shares of Southwall Technologies Inc. (“Southwall”) for $113.  Southwall is a leading innovator of energy-saving films and glass products for the automotive and architectural markets.  The Southwall acquisition will enable us to combine Southwall’s state-of-the art manufacturing facilities, proprietary technologies and innovative products with Solutia’s global capabilities and diverse market scope.

The Southwall acquisition was accounted for as a business combination, and accordingly, its assets and liabilities were recorded at their estimated fair value.  The purchase price allocation for Southwall is subject to additional adjustments to recorded fair value relating to (i) completion of valuation reports associated with fixed assets and identified intangible assets, (ii) deferred tax assets and liabilities and (iii) adjustments to the amount of recorded goodwill.  The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition:

6

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

	Southwall
	November 23, 2011
Assets:
Cash and cash equivalents	$	8
Trade receivables		3
Intercompany receivables		6
Miscellaneous receivables		2
Inventories		12
Prepaid expenses and other assets		1
Property, plant and equipment		21
Identified intangible assets		24
Goodwill		52
Total assets acquired	$	129
Liabilities:
Accounts payable	$	4
Accrued liabilities		5
Long-term debt		4
Deferred tax liabilities		2
Other liabilities		1
Total liabilities assumed	$	16

Goodwill largely consists of expected growth synergies through the application of the acquired company’s innovative technologies and cost synergies resulting from manufacturing and supply chain work process improvements.  Goodwill resulting from the Southwall acquisition is not deductible for tax purposes.

The following table presents the weighted average life in years and the gross carrying value of the identified intangible assets included in net identified intangible assets within the Consolidated Statement of Financial Position on the date of acquisition for the Southwall acquisition.  The fair value of the identified intangible assets was determined using Level 3 inputs as defined by U.S. GAAP under the fair value hierarchy, which included valuation reports prepared by third party appraisal firms.

	Southwall
	November 23, 2011
	Weighted Average		Carrying
	Life in Years		Value
Technology		12		$	11
Customer relationships		14			11
Trademarks		N/A			2
Total identified intangible assets		13		$	24

Effective November 23, 2011, results from the operations of Southwall have been included in our Consolidated Statement of Operations.  Financial results in the current period and pro forma information related to the Southwall acquisition are not presented because the impact on the Company’s consolidated results of operations is not considered to be significant.

Divestitures

In the first quarter 2011, we sold certain businesses and selected assets previously included in our Technical Specialties reportable segment whereby we recognized a gain of $17 in other operating income, net.

7

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Discontinued Operations

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

The assets and liabilities of our former Primary Accelerators business, classified as discontinued operations, consist of the following:

	March 31,		December 31,
	2012		2011
Assets:
Trade and miscellaneous receivables, net	$	1	$	1
Current assets of discontinued operations	$	1	$	1
Liabilities:
Accounts payable and accrued liabilities	$	5	$	8
Current liabilities of discontinued operations	$	5	$	8
Other liabilities	$	18	$	18
Non-current liabilities of discontinued operations	$	18	$	18

3.  Share-Based Compensation

Stock Options

We did not grant any options under our 2007 Management Long-Term Incentive Plan or 2007 Non-Employee Director Stock Compensation Plan during the three months ended March 31, 2012.  A summary of stock option information as of March 31, 2012 is as follows:

	Options	Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value (a)
Vested or Expected to Vest at      March 31, 2012	2,215,771	$	18.93	7.5	$	20
Exercisable at March 31,      2012	1,093,121	$	18.07	6.6	$	11

(a)   Intrinsic value for stock options is calculated based on the difference between the exercise price of the underlying awards and the quoted market price of our common stock as of the reporting date.

During each of the three months ended March 31, 2012 and 2011, we recognized $1 of compensation expense related to our stock options.  Pre-tax unrecognized compensation expense for stock options, net of estimated forfeitures, was $8 as of March 31, 2012 which will be recognized as expense over a remaining weighted-average period of 2 years.

8

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Restricted Stock Awards

We did not grant any restricted stock awards under our 2007 Management Plan or 2007 Director Plan during the three months ended March 31, 2012.  During the three months ended March 31, 2012 and 2011, we recognized $5 and $4 of compensation expense related to our restricted stock awards, respectively.  Pre-tax unrecognized compensation expense for restricted stock awards, net of estimated forfeitures, was $11 as of March 31, 2012 which will be recognized as expense over a remaining weighted average period of 1.5 years.

Phantom Stock Awards

We granted 486,598 phantom stock unit awards with a weighted average grant date fair value of $28.15 per unit to certain employees under our 2007 Management Plan during the three months ended March 31, 2012.  These vest upon completion of a service condition in four equal installments upon the first, second, third, and fourth anniversary of the grant date.  Upon that anniversary, the holder is entitled to cash equal to the fair market value of the vested awards at the time vesting occurs. Therefore the grant has been accounted for as a liability award.  During the three months ended March, 31, 2012, the expense recognized on these awards was less than $1.  Pre-tax unrecognized compensation expense for phantom stock awards was $13 as of March 31, 2012 which will be recognized as expense over a remaining weighted average period of 2.5 years.

4. Goodwill and Other Intangible Assets

Goodwill

Goodwill by reportable segment is as follows:

	Advanced			Performance			Technical
	Interlayers			Films			Specialties			Total
Balance at December 31, 2011		$	402		$	234		$	147		$	783
Currency fluctuations			6			-			-			6
Balance at March 31, 2012		$	408		$	234		$	147		$	789

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

Identified Intangible Assets

Identified intangible assets are comprised of (i) amortizable customer relationships, unpatented technology, contract-based intangible assets, trade names and patents and (ii) indefinite-lived trademarks not subject to amortization. These intangible assets are summarized in aggregate as follows:

	March 31, 2012											December 31, 2011
	Estimated											Estimated
	Useful	Gross							Net			Useful	Gross							Net
	Life in	Carrying			Accumulated				Carrying			Life in	Carrying			Accumulated				Carrying
	Years	Value			Amortization				Value			Years	Value			Amortization				Value
Amortizable intangible assets:
Customer relationships	10 to 27		$	621		$	(87	)		$	534	10 to 27		$	614		$	(79	)		$	535
Technology	5 to 26			236			(43	)			193	5 to 26			233			(40	)			193
Trade names	5 to 25			19			(2	)			17	5 to 25			19			(2	)			17
Patents	13			5			(2	)			3	13			5			(2	)			3
Other	1 to 5			6			(4	)			2	1 to 5			6			(3	)			3
Non-amortizable intangible assets:
Trademarks				167			-				167				165			-				165
Total identified intangible assets			$	1,054		$	(138	)		$	916			$	1,042		$	(126	)		$	916

9

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Amortization expense for intangible assets and its allocation to cost of goods sold and selling, general and administrative expenses in the Consolidated Statement of Operations is as follows:

	Three Months Ended
	March 31,
	2012			2011
Cost of goods sold		$	3		$	3
Selling, general and administrative expenses			7			7
Total		$	10		$	10

We expect annual amortization expense for intangible assets to be approximately $41 in 2012 and $38 each year from 2013 through 2016.

5. Detail of Certain Balance Sheet Accounts

Components of inventories are as follows:

	March 31,		December 31,
Inventories	2012		2011
Finished goods	$	220	$	190
Goods in process		63		51
Raw materials and supplies		101		94
Inventories	$	384	$	335

Components of property, plant and equipment are as follows:

	March 31,			December 31,
Property, Plant and Equipment	2012			2011
Land	$	35		$	35
Leasehold improvements		11			8
Buildings		216			209
Machinery and equipment		874			852
Construction in progress		103			101
Total property, plant and equipment		1,239			1,205
Less: Accumulated depreciation		(286	)		(260
Net Property, Plant, and Equipment	$	953		$	945

10

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Components of accrued liabilities are as follows:

	March 31,		December 31,
Accrued Liabilities	2012		2011
Wages and benefits	$	32	$	44
Foreign currency and interest rate derivative agreements		20		22
Restructuring reserves		3		3
Environmental remediation liabilities		29		29
Accrued income taxes payable		10		10
Accrued taxes other than income		12		10
Accrued selling expenses		14		15
Accrued interest		16		13
Other		74		81
Accrued Liabilities	$	210	$	227

6.  Income Taxes

Income Tax Expense

We recorded net income tax benefit of $1 and net income tax expense of $8 for the three months ended March 31, 2012 and 2011, respectively.  Our income tax expense is affected by changes in unrecognized tax benefits and the mix of income and losses in the tax jurisdictions in which we operate.  For the three months ended March 31, 2012 and 2011, discrete tax benefits of $12 and $2, respectively, were recognized.  Most of the discrete tax benefit recognized in the period ended March 31, 2012 was due to the reversal of a deferred tax liability related to the extension of the Company's tax holiday in Malaysia.  The remaining discrete items in both periods were primarily due to the expiration of certain foreign audit periods and the re-measurement of other uncertain tax positions due to events in the current period.  Income tax expense recorded during both periods of 2012 and 2011 relates only to foreign jurisdictions because we have a U.S. net operating loss deferred tax asset, against which a full valuation allowance has been provided.

Unrecognized Tax Benefits

The total amount of unrecognized tax benefits, inclusive of interest and penalties, at March 31, 2012 and December 31, 2011 was $150 and $148, respectively.  Included in the balances at March 31, 2012 and December 31, 2011 were $49 of unrecognized tax benefits that, if recognized, would impact the effective tax rate.  The increase in the amount of the unrecognized tax benefits is mainly the effect of tax positions with respect to events in the current year and currency exchange rate fluctuations, partially offset by statute of limitation expirations.

We file income tax returns in the U.S. and various states and foreign jurisdictions.  With few exceptions, we are no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2002 or foreign income tax examinations by tax authorities for years before 2006.  It is reasonably possible that within the next 12 months as a result of the resolution of federal, state and foreign examinations and appeals, and the expiration of various statutes of limitation that the unrecognized tax benefits that would impact the effective tax rate will decrease by a range of zero to $24 and the unrecognized tax benefits that would not impact the effective tax rate will decrease by a range of zero to $3.

7.  Restructuring Reserves

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

To right-size our support structure in Europe and lower our operating costs in the region, we relocated our European regional headquarters in 2011 from a building located in Louvain-la-Neuve, Belgium (“LLN”), which we own, to a multi-tenant building in which we lease office space in Zaventem, Belgium.  Accordingly, in the first quarter 2011, we initiated a process to sell the LLN building and have reclassified this asset as held for sale.  In conjunction with this reclassification, we were required to perform an impairment test of this asset group.  For purposes of testing for impairment and using all available evidence, we estimated the fair value of this asset group by weighting estimated sales proceeds and discounted cash flows that the asset group could be expected to generate through the time of an assumed sale using a Level 3 fair value measurement as defined by U.S. GAAP under the fair value hierarchy.  Our test concluded impairment existed on March 31, 2011 and, accordingly, we recorded a charge of $8 to other operating income, net to reduce the carrying value of this asset to its estimated fair value and reclassified the asset to prepaid expenses and other current assets.  Further and in addition to the above, we initiated a reduction in support personnel in this region which resulted in charges of $4 to selling, general and administrative for the three months ended March 31, 2011.  These charges related to this restructuring action were recorded to Unallocated and Other.  There was no change in our restructuring liability in the three months ended March 31, 2012.

We expect $3 of restructuring liabilities as of March 31, 2012 to be utilized within the next twelve months.

11

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

8.  Commitments and Contingencies

Litigation

We are a party to legal proceedings, which have arisen in the ordinary course of business and involve claims for monetary damages.  As of March 31, 2012 and December 31, 2011, we had accrued approximately $2 for legal costs to defend ourselves in legal matters.

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

Legacy Tort Claims Litigation

Pursuant to the Amended and Restated Settlement Agreement effective February 28, 2008, entered into by us and Monsanto in connection with our emergence from Chapter 11 (the “Monsanto Settlement Agreement”), Monsanto is responsible to defend and indemnify us for any Legacy Tort Claims as that term is defined in the Monsanto Settlement Agreement, while we retain responsibility for certain tort claims, if any, which may arise out of our conduct after our spinoff from Pharmacia Corporation (“Pharmacia”), which occurred on September 1, 1997 (“Solutia Spinoff”).  There is no maximum amount or other limit with respect to Monsanto’s liability regarding any Legacy Tort Claims.  We or our fully owned subsidiary, Flexsys, have been named as defendants in the following actions, and have submitted the matters to Monsanto as Legacy Tort Claims.  However, to the extent these matters relate to post Solutia Spinoff conduct or such matters are not within the meaning of Legacy Tort Claims as defined in the Monsanto Settlement Agreement, we could potentially be liable.

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

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

In February 2012, Monsanto reached a tentative global resolution with the plaintiffs in the class action and the individual lawsuits.  The court has given tentative approval to the settlement terms, but a fairness hearing has been scheduled for June 2012 for final approval of the settlement.  Pursuant to the terms of the Monsanto  Settlement Agreement, Solutia and Flexsys will have no obligations under the terms of the settlement of these litigation matters.

12

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

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

St. Clair County, Illinois and Related Litigation.In February 2009, a purported class action lawsuit was filed in the Circuit Court of St. Clair County, Illinois against Solutia, Pharmacia, Monsanto and two other unrelated defendants alleging the contamination of the plaintiff’s property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois (including our W.G. Krummrich site in Sauget, Illinois).  The proposed class action is comprised of residents who live within a two-mile radius of the Sauget facilities.  The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of alleged contaminants from their property.  This action is one of several lawsuits (primarily filed by the same plaintiffs’ counsel) filed in 2009 and 2010 regarding alleged historical contamination from the W.G. Krummrich site.

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

Upon assessment of the terms of the Monsanto Settlement Agreement and other defenses available to us, we believe the probability of an unfavorable outcome to us on the Putnam County, West Virginia; Escambia County, Florida; and St. Clair County, Illinois and related litigation against us is remote and, accordingly, we have not recorded a loss contingency.  Nonetheless, if it were subsequently determined these matters are not within the meaning of Legacy Tort Claims, as defined in the Monsanto Settlement Agreement, or other defenses to us were unsuccessful, we could be liable for an amount which could have a material adverse effect on our consolidated financial statements.  We are unable to estimate the amount or range of potential losses associated with these claims i) because no portion of the claims have been determined to be outside the definition of Legacy Tort Claims; ii) because a claim value has not been asserted in any of these matters and iii) because we are not directly involved in these matters due to the fact that Monsanto has accepted the tenders of defense associated with Legacy Tort Claims.

Environmental Liabilities

In the ordinary course of business, we are subject to numerous environmental laws and regulations covering compliance matters or imposing liability for the costs of, and damages resulting from, cleaning up sites, past spills, disposals and other releases of hazardous substances.  We have incurred, and we may in the future incur, liabilities to investigate and clean up waste or contamination at our current facilities, properties adjacent to our current facilities or facilities operated by third parties at where we may have disposed of waste or other materials.  Under some circumstances, the scope of our liability may extend to damages to natural resources for which we have accrued $2 as of March 31, 2012 and December 31, 2011, which is exclusive of the balances noted below.  In almost all cases, our potential liability arising from historical contamination is based on operations and other events occurring at our facilities or as a result of their operation prior to the Solutia Spinoff.

13

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Further, under terms of the Monsanto Settlement Agreement, we have agreed to share responsibility with Monsanto for the environmental remediation at certain locations outside our plant boundaries in Anniston, Alabama and Sauget, Illinois which were also incurred prior to the Solutia Spinoff (the “Shared Sites”).  Under this cost-sharing arrangement, we are responsible for the funding of environmental liabilities at the Shared Sites from February 28, 2008 (the “Effective Date”) up to a total of $325.  Thereafter, if needed, we and Monsanto will share responsibility equally.  From the Effective Date through March 31, 2012, we have made cash payments of $37 toward remediation of the Shared Sites and have accrued an additional $157 to be paid over the life of the Shared Sites remediation activity.

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

	Total
Balance at December 31, 2011	$	256
Net charges taken		2
Amounts utilized		(10	)
Balance at March 31, 2012	$	248

	March 31, 2012		December 31, 2011
Environmental Remediation Liabilities, current	$	29	$	29
Environmental Remediation Liabilities, long-term		219		227
Total	$	248	$	256

In addition to accrued environmental liabilities, there are costs which have not met the definition of probable, and accordingly, are not recorded in the Consolidated Statement of Financial Position.  These loss contingencies are monitored regularly for a change in fact or circumstance that would require an accrual adjustment.  These matters involve significant unresolved issues, including the interpretation of applicable laws and regulations, the outcome of negotiations with regulatory authorities and alternative methods of remediation. Because of these uncertainties, the potential liability for existing environmental remediation may range up to two times the amount recorded, which would be settled through cash payment over an extended period of time.

Although the resolution of these uncertainties, which may be over an extended period of time, may have a material adverse effect on our Consolidated Statement of Operations in the period recognized, management does not believe these uncertainties will have a material adverse effect on our Consolidated Statement of Financial Position and Cash Flows or our liquidity.

14

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Our significant sites are described in more detail below:

Anniston, Alabama.  On Aug. 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Revised Partial Consent Decree (“RPCD”), pursuant to which Pharmacia and Solutia are obligated to perform, among other things, residential cleanup work and a remedial investigation/feasibility study (“RI/FS”) as a result of PCB contamination from our Anniston plant, which occurred prior to the Solutia Spinoff.  The residential cleanup of available properties was completed in 2010.  Additional residences have become available and will be cleaned-up in 2012.  Any future identified residential properties requiring cleanup will be handled under an institutional control program.  Furthermore, in 2010 the Anniston Plant Site RI/FS was completed and approved.  On September 29, 2011 the United States Environmental Protection Agency (“USEPA”) issued its interim Record of Decision (“ROD”) setting out the required remedies associated with the plant, which were mainly as the Company proposed in the FS.  Upon negotiation of a Consent Decree with USEPA, Solutia will implement this interim ROD over the next few years and a final ROD will be issued some time after the interim ROD is completed.  The RI/FS for the non-residential properties and the creeks/floodplain are ongoing but it is probable that some level of remediation and/or sediment removal will be required in the future.  We have accrued for this liability based upon our understanding of the level and extent of contamination in these areas, the remedial effort likely to be required by various governmental organizations and estimated costs associated with similar remediation projects.  We may recover some of our investigation and remediation costs from parties, against whom we filed a cost recovery action in July 2003 but because the eventual outcome of these proceedings is uncertain, our environmental liability at  March 31, 2012 does not incorporate this potential reimbursement.  State and Federal Natural Resource Damage Trustees have asserted a claim for potential natural resource damage and advised us that they are preparing to undertake an assessment as to the nature and extent of such damages.  These Trustees have requested we consider entering into a cooperative agreement to perform a damage assessment and discussions to resolve these damages are ongoing.  As of March 31, 2012, we have accrued $104 for all environmental remediation projects in the Anniston, Alabama area which represents our best estimate of the ultimate liability.  Timing of the remediation will not be established until we complete the RI/FS work, a ROD covering the off-plant areas is issued by the United States Environmental Protection Agency (“USEPA”), and a consent decree for each of these RODS is negotiated and entered by the court to cover the selected remediation, which will take several years.

Sauget, Illinois.  A number of industries, including our W.G. Krummrich Plant, have operated and disposed of wastes in Sauget, Illinois.  Areas of contamination from these industrial operations, which for our W.G. Krummrich Plant occurred prior to the Solutia Spinoff, have been classified as part of either the Sauget Area 1 Sites or the Sauget Area 2 Sites.  We conducted a RI/FS for the Sauget Area 1 Sites under an Administrative Order on Consent issued on January 21, 1999.  Although an extensive removal action for one of the Sauget Area 1 Sites was conducted under a Unilateral Administrative Order issued on May 31, 2000, the cost and timing of any additional required remedial actions will be established only after a Record of Decision is issued by the USEPA, and a consent decree is negotiated and entered by the court to cover the selected remediation.  We have an agreement with two other potentially responsible parties (“PRPs”) to enter into an allocation proceeding upon issuance of the ROD to resolve our respective shares of the liability for the Sauget Area 1 Sites.  With respect to the Sauget Area 2 Sites, we, in coordination with 19 other PRPs, are also required to conduct a RI/FS for the Sauget Area 2 Sites under an Administrative Order on Consent issued effective November 24, 2000.  We are preparing a revised RI/FS report to address agency comments with these PRPs based on interim allocations and have agreed, upon issuance of the ROD, to participate in an allocation proceeding to fully resolve each PRP’s share of the liability for the investigation and remediation costs.  For each of the Sauget Area 1 and 2 Sites, we anticipate the USEPA and Illinois Environmental Protection Agency (“IEPA”) to issue a Record of Decision with final action for the landfill/impoundment covers within the next year to eighteen months.   However, although an interim groundwater remedy has been installed pursuant to a Unilateral Administrative Order issued on October 3, 2002, it is uncertain when the USEPA and IEPA will issue a final remedy for the groundwater operable unit.  Our ultimate exposure at these sites will depend on the final remedial actions to be taken and on the level of contribution from other PRPs.  In addition, several PRPs, including Solutia and Pharmacia, received in June 2009 from the U.S. Department of the Interior, on behalf of various federal and state natural resource trustees, a notice of intent to perform and an invitation to cooperate in a natural resource damage assessment for the Sauget Industrial Corridor.  Our best estimate of the ultimate cost of all remedial measures that will be required at the Sauget, Illinois area sites is $68 which we have accrued as of March 31, 2012.

W. G. Krummrich Site.  We entered into a Consent Order under the U.S. Resource Conservation and Recovery Act of 1976, as amended, effective May 3, 2000, to investigate and remediate soil and groundwater contamination from our manufacturing operations at the W.G. Krummrich Plant, which occurred prior to the Solutia Spinoff.  We conducted an extensive corrective measures study and a Final Decision was issued by the USEPA in February 2008 setting out the required corrective measures to be completed.  Due to the complexity of the contamination issues at this site, certain of the corrective measures will be performed in phases. Required pilot testing has been completed and the design/implementation of full scale remediation systems has commenced with operation of these systems expected until at least 2015. Our best estimate of the remaining cost to perform all of the remaining corrective measures that will be required at the W.G. Krummrich Site is $13, which we have accrued as of March 31, 2012.

We also have accruals for remedial obligations at several of our current or former manufacturing sites which we have owned or operated since the Solutia Spinoff.  Our best estimate of the ultimate cost of all corrective measures that will be required at these sites is $63 which we have accrued as of March 31, 2012.

15

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

9.  Debt Obligations

Our debt obligations currently consist of a senior secured credit facility (“Credit Facility”) which consists of a $700 term loan maturing in 2017 (“2017 Term Loan”) and a $300 revolving credit facility maturing in 2015 (“2015 Revolver”).  Also outstanding at March 31, 2012 and December 31, 2011 were senior unsecured notes with a par value of $300 that were originally issued at 99.5 percent of par and bear interest at 7.875 percent (“7.875% Notes”) and senior unsecured notes with a par value of $400 that were originally issued at par and bear interest at 8.75 percent (“8.75% Notes”).  The 7.875% Notes and 8.75% Notes each require semi-annual interest payments and are due in 2020 and 2017, respectively.

In the first quarter 2011, we paid $77 of principal payments on our 2017 Term Loan.  In the same quarter, we amended the 2017 Term Loan, which resulted in the maturity being extended to August 2017, a reduction in the interest rate of 100 basis points, greater strategic flexibility and the replacement of previous financial covenants with a single senior secured leverage ratio.  In connection with the amendment, we incurred $2 of fees, which were recorded in loss on debt modification during the three months ended March 31, 2011.  The 2017 Term Loan bears interest at one month LIBOR plus 2.75 percent with a 0.75 percent LIBOR floor.  We are required to pay 1 percent of principal annually via quarterly payments, which have been prepaid through the third quarter of 2015 through voluntary principal payments.  The 2015 Revolver bears interest, at our option, at LIBOR plus 3.25 percent, with no LIBOR floor, or at the prime rate plus 2.25 percent.  LIBOR-based interest for the 2017 Term Loan is payable each month while interest on the 2015 Revolver is payable on the last day of each relevant interest period (defined as one month, two, three or six months or other periods available to all lenders) and, in the case of any interest period longer than three months, on each successive date three months after the first day of such interest period.  Prime-based interest for the 2015 Revolver is payable quarterly in arrears.  CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc., Southwall Technologies Inc. and future subsidiaries, as defined by the Credit Facility, subject to certain exceptions (the “Credit Facility Guarantors”), are guarantors of our obligations under the Credit Facility.  The Credit Facility and the related guarantees are secured by liens on substantially all of our and the Credit Facility Guarantors’ present and future assets.

We had no short-term borrowings at March 31, 2012 and December 31, 2011.  Components of long-term debt are as follows:

	March 31, 2012			December 31, 2011
2017 Term Loan	$	666		$	666
8.75% Notes		389			389
7.875% Notes		286			286
Total principal amount		1,341			1,341
Less: Unamortized debt discount		(3	)		(4	)
Total	$	1,338		$	1,337

The weighted average interest rate on our total debt outstanding was 6 percent for both March 31, 2012 and December 31, 2011.

The Credit Facility, the 7.875% Notes and the 8.75% Notes include a number of customary covenants and events of default that restrict our ability to, among other things, incur additional debt; make certain investments; pay dividends; repurchase stock; sell certain assets or merge with or into other companies; enter into new lines of business and prepay, redeem or exchange our debt.  The Credit Facility also includes the maintenance of a maximum senior secured indebtedness financial covenant as defined by the Credit Facility.  We were in compliance with all applicable covenants as of March 31, 2012.  The 7.875% Notes and the 8.75% Notes are redeemable at our option for the entire principal amount plus the Applicable Premium, as that term is defined in the indenture agreements, plus accrued and unpaid interest, if redeemed prior to March 15, 2015, with respect to the 7.875% Notes, and November 1, 2013, with respect to the 8.75% Notes.  Thereafter, we may redeem the notes at declining redemption prices, as stated in the respective indenture agreements.  Additionally, at any time on or prior to March 15, 2013, with respect to the 7.875% Notes, and November 1, 2012, with respect to the 8.75% Notes, we are allowed at our option, on any one or more occasions, to redeem up to 35 percent of the aggregate principal amount of the notes at a redemption price equal to 107.875 percent and 108.75 percent of the principal amount plus accrued and unpaid interest with the net cash proceeds of one or more equity issuances.

Our current subsidiaries CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc., S E Investment LLC, Southwall Technologies Inc. and future subsidiaries as defined by the notes, subject to certain exceptions, are guarantors (“Note Guarantors”) of the 7.875% Notes and the 8.75% Notes as of March 31, 2012.

16

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

10.  Derivatives and Risk Management

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

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

Interest Rate Risk

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

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

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

Foreign Currency Exchange Rate Risk

We use foreign currency derivative instruments to manage the volatility associated with foreign currency changes in assets and liabilities created in the normal course of business and to protect against exposure related to intercompany financing transactions.  These risks are hedged primarily through the use of forward contracts and purchased options with maturities of less than 18 months.  We have chosen not to designate these instruments as hedges to allow the changes in the fair value of these instruments to largely offset the remeasurement of the underlying assets and liabilities in the Consolidated Statement of Operations.  We had currency forward contracts not designated as hedges to purchase and sell $205 and $191 of currencies comprised principally of the Euro, U.S. Dollar and Malaysian Ringgit as of March 31, 2012 and December 31, 2011, respectively.

We also use foreign currency derivative instruments to manage the volatility associated with cash flows related to sales or purchases denominated in foreign currencies.  These risks are hedged primarily through the use of forward contracts with maturities of less than 18 months. These forward contracts have been designated as cash flow hedges and therefore any changes in fair value are recorded as a component of accumulated other comprehensive loss and reclassified into earnings in the periods during which the hedged transaction affects earnings.  We had currency forward contracts designated as hedges to purchase and sell $46  and $63 of currencies comprised principally of the Euro and Brazilian Real as of March 31, 2012 and December 31, 2011.

17

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Our derivatives recorded at their respective fair values at March 31, 2012 and December 31, 2011 in the Consolidated Statement of Financial Position are summarized as follows:

	March 31, 2012
	Asset Derivatives				Liability Derivatives
	Consolidated Statement of Financial Position Presentation	Fair Value			Consolidated Statement of Financial Position Presentation	Fair Value
Derivatives designated as hedging      instruments:
Interest rate contracts	Miscellaneous Receivables		$	-	Accrued Liabilities		$	2
	Other Assets			-	Other Liabilities			5
Total Interest rate contracts			$	-			$	7
Foreign exchange contracts	Miscellaneous Receivables		$	1	Accrued Liabilities		$	-
Derivative not designated as hedging      instruments:
Interest rate contracts	Miscellaneous Receivables		$	8	Accrued Liabilities		$	16
	Other Assets			3	Other Liabilities			6
Total Interest rate contracts				11				22
Foreign exchange contracts	Miscellaneous Receivables		$	1	Accrued Liabilities		$	2
Total Derivatives			$	13			$	31

	December 31, 2011
	Asset Derivatives				Liability Derivatives
	Consolidated Statement of Financial Position Presentation	Fair Value			Consolidated Statement of Financial Position Presentation	Fair Value
Derivatives designated as hedging      instruments:
Interest rate contracts	Miscellaneous Receivables		$	-	Accrued Liabilities		$	3
	Other Assets			-	Other Liabilities			5
Total Interest rate contracts			$	-			$	8
Foreign exchange contracts	Miscellaneous Receivables		$	2	Accrued Liabilities		$	-
Derivative not designated as hedging      instruments:
Interest rate contracts	Miscellaneous Receivables		$	5	Accrued Liabilities		$	15
	Other Assets			5	Other Liabilities			10
Total Interest rate contracts			$	10			$	25
Foreign exchange contracts	Miscellaneous Receivables		$	1	Accrued Liabilities		$	4
Total Derivatives			$	13			$	37

18

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

A summary of the effect of our derivative instruments for the three months ended March 31, 2012 and 2011 on the Consolidated Statement of Operations and Consolidated Statement of Financial Position is as follows:

	Change in Unrealized Gain (Loss) Recognized in Accumulated Other Comprehensive Loss						Amount of Gain (Loss) Recognized in Income								Consolidated Statement of Operations Presentation
	2012			2011			2012				2011
Derivatives designated as hedging instruments:
Interest rate contracts		$	-		$	-		$	-			$	-		Interest expense
Foreign exchange contracts		$	-		$	-		$	1			$	-		Net sales (a)
Derivatives not designated as hedging instruments:
Interest rate contracts		$	-		$	-		$	(2	)		$	(2	)	Interest expense (b)
Foreign exchange contracts		$	-		$	-		$	3			$	1		Other income (loss), net
Total derivatives not designated as hedging instruments		$	-		$	-		$	1			$	(1	)
Total Derivatives		$	-		$	-		$	2			$	(1	)

(a)	We reclassified $1 of gains from accumulated other comprehensive loss to net sales during the three months ended March 31, 2012.
(b)	We reclassified $2 of losses from accumulated other comprehensive loss to interest expense during the three months ended March 31, 2012 and 2011 related to the 2008 and 2010 Swaps.

As of March 31, 2012, deferred losses of $7 related to our interest rate derivatives and deferred gains of $2 related to our foreign currency forward contracts, each designated as hedges and currently classified in accumulated other comprehensive loss, are expected to be reclassified into earnings as interest expense and net sales, respectively, over the next twelve months.

19

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

11.  Fair Value of Financial Instruments

The following tables present our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.

	Fair Value Measurements at March 31, 2012
	Total			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
				(Level 1)			(Level 2)			(Level 3)
Assets:
Derivatives – Foreign Exchange (b)		$	2		$	-		$	2		$	-
Derivatives – Interest Rates (c)			11			-			11			-
Total		$	13		$	-		$	13		$	-
Liabilities:
Derivatives – Foreign Exchange (b)		$	2		$	-		$	2		$	-
Derivatives – Interest Rates (c)			29			-			29			-
Total		$	31		$	-		$	31		$	-

	Fair Value Measurements at December 31, 2011
		Total		Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
				(Level 1)			(Level 2)			(Level 3)
Assets:
Cash Equivalents (a)		$	4		$	4		$	-		$	-
Derivatives – Foreign Exchange (b)			3			-			3			-
Derivatives – Interest Rates (c)			10			-			10			-
Total		$	17		$	4		$	13		$	-
Liabilities:
Derivatives – Foreign Exchange (b)		$	4		$	-		$	4		$	-
Derivatives – Interest Rates (c)			33			-			33			-
Total		$	37		$	-		$	37		$	-

(a)	Includes cash invested in money market funds.
(b)	Includes foreign currency forward and options contracts which are valued using an income approach based on the present value of the forward rate less the contract rate multiplied by the notional amount.
(c)	Includes interest rate cap and swap agreements which are valued using counterparty quotes, which use discounted cash flows and the then-applicable forward interest rates.

The recorded amounts of cash, trade receivables and accounts payable approximate their fair values at both March 31, 2012 and December 31, 2011, due to the short maturity of these instruments.  The estimated fair value of our long-term debt at March 31, 2012 is $1,442 compared to the recorded amount of $1,338.  The estimated fair value of our long-term debt at December 31, 2011 was $1,394 compared to the recorded amount of $1,337.  The fair values are estimated by various banks based upon trading levels on the date of measurement using a Level 2 fair value measurement as defined by U.S. GAAP under the fair value hierarchy.

20

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

12.  Pension Plans and Other Postretirement Benefits

Components of Net Periodic Benefit Cost

For the three months ended March 31, 2012 and 2011, our pension and healthcare and other benefit costs for continuing operations were as follows:

	Pension Benefits								Healthcare and Other Benefits
	Three Months Ended March 31,								Three Months Ended March 31,
	2012				2011				2012				2011
Service costs for benefits earned		$	1			$	1			$	-			$	1
Interest costs on benefit obligation			11				12				2				2
Assumed return on plan assets			(12	)			(13	)			(1	)			(2	)
Amortization of actuarial net loss (gain)			4				3				(1	)			(2	)
Total		$	4			$	3			$	-			$	(1	)

Employer Contributions

 According to the applicable funding rules, we are required to contribute approximately $80 to our pension plans, collectively, in 2012.  For the three months ended March 31, 2012, we contributed $22.

13.  Accumulated Other Comprehensive Loss

The following table presents the balances of related after-tax components of accumulated other comprehensive loss.  There was no tax impact related to the items presented below for any period presented.

	Accumulated Currency Adjustments			Postretirement Adjustments			Hedging Activity Adjustments			Accumulated Other Comprehensive Loss
Beginning Balance - January 1, 2011	$	(66	)	$	(117	)	$	(11	)	$	(194	)
Currency translation adjustments		57			-			-			57
Amortization of net actuarial loss		-			1			-			1
Realized loss on derivative instruments		-			-			2			2
Ending Balance - March 31, 2011	$	(9	)	$	(116	)	$	(9	)	$	(134	)
Beginning Balance - January 1, 2012	$	(90	)	$	(177	)	$	(12	)	$	(279	)
Currency translation adjustments		27			-			-			27
Amortization of net actuarial loss		-			3			-			3
Net realized loss on derivative instruments		-			-			1			1
Ending Balance - March 31, 2012	$	(63	)	$	(174	)	$	(11	)	$	(248	)

21

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

14. Segment Data

 Our operations are reported in three reportable segments consisting of Advanced Interlayers, Performance Films and Technical Specialties. These reportable segments are organized based upon a combination of the products and services offered and the end markets that are served.  Included in our Advanced Interlayers reportable segment are the Saflex and Photovoltaic operating segments that have been aggregated.

The Advanced Interlayers reportable segment is a global manufacturer of interlayers for laminated glass and encapsulants for the photovoltaic market.  The Performance Films reportable segment is a manufacturer of performance films for after-market applications which add functionality to glass.  The Technical Specialties reportable segment is a global manufacturer of specialty chemicals for the rubber, solar energy, process manufacturing and aviation industries.  The major products by reportable segment are as follows:

Reportable Segment	Products
Advanced Interlayers	●	SAFLEX® plastic interlayer
	●	VISTASOLAR® ethyl vinyl acetate encapsulants
	●	Specialty intermediate polyvinyl butyral resin and plasticizer
Performance Films	●	LLUMAR®, VISTA®, GILA®, V-KOOL®, HUPER OPTIK®, XIR® and FORMULAONE® professional and retail window films
	●	FLEXVUE™ precision coated films and other enhanced polymer films for industrial customers
Technical Specialties	●	CRYSTEX® insoluable sulfur
	●	SANTOFLEX® antidegradants
	●	THERMINOL® heat transfer fluids
	●	SKYDROL® aviation hydraulic fluids

The performance of our operating segments is evaluated based on Segment Profit, defined as income from continuing operations attributable to Solutia before interest expense, loss on debt modification, income taxes, depreciation and amortization. Segment Profit includes selling, general and administrative, research and development expenses, other operating income or expenses, gains and losses from asset dispositions and restructuring charges, the reduction for net income attributable to noncontrolling interests and other income and expense items that can be directly attributable to the segment.  Certain operations, expenses and other items that are managed outside the reportable segments are reported as Unallocated and Other.  Unallocated and Other is comprised of corporate expenses, adjustments to our environmental liabilities, other income and expense items including currency gains/losses, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the reportable segments.  There were no inter-segment sales in the periods presented below.

	Three Months Ended March 31,
	2012					2011
	Net		Profit			Net		Profit
	Sales		(Loss)			Sales		(Loss)
Reportable Segments:
Advanced Interlayers	$	203	$	40		$	213	$	49
Performance Films		85		12			76		19
Technical Specialties		210		84			220		98
Reportable Segment Totals		498		136			509		166
Unallocated and Other		-		(31	)		-		(31	)
Total		498		105			509		135
Reconciliation to Consolidated Totals:
Depreciation and amortization				(30	)				(32	)
Interest expense				(23	)				(28	)
Loss on debt modification				-					(2	)
Net income attributable to noncontrolling interest				1					1
Consolidated Totals
Net Sales	$	498				$	509
Income from Continuing Operations Before Income Taxes			$	53				$	74

22

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

15.  Earnings Per Share

The following table presents the net income used in basic and diluted earnings per share and reconciles weighted average number of shares used in the calculations of basic and diluted earnings per share.

(Shares in millions)	Three Months Ended March 31,
	2012		2011
Consolidated Statement of Operations:
Net Income	$	54	$	66
Less: Net Income attributable to noncontrolling interest		1		1
Net Income attributable to Solutia	$	53	$	65
Weighted-average number of shares outstanding used for basic earnings per share		121.2		119.4
Non-vested restricted shares		0.9		1.3
Stock options		0.5		0.5
Weighted average number of shares outstanding and common equivalent shares used for diluted earnings per share		122.6		121.2

During the three months ended March 31, 2012 and 2011, the following shares were not included in the computation of earnings per share since the result would have been anti-dilutive.

	Three Months Ended March 31,
(Shares in millions)	2012		2011
Non-vested restricted shares		-		0.1
Stock options		0.6		1.1
Warrants (a)		4.5		4.5

 (a)   On February 28. 2008, the date we emerged from bankruptcy, we issued warrants to purchase an aggregate of 4.5 shares to certain of the holders of our stock based on such holder's pre-petition stock ownership. These warrants have an exercise price of $29.70 and expire on February 27, 2013.

23

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

16.Condensed Consolidating Financial Statements

In accordance with SEC regulation S-X Rule 3-10 “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered,” we are providing condensed consolidating financial statements as the 8.75% Notes and 7.875% Notes are fully and unconditionally guaranteed on a joint and several basis.  As other comprehensive income is held by the parent, no Statement of Comprehensive Income has been presented below.

The following consolidating financial statements present, in separate columns, financial information for:  (i) Solutia, on a parent-only basis, carrying its investment in subsidiaries under the equity method; (ii) Note Guarantors on a combined basis (“Guarantors”), carrying investments in subsidiaries which do not guarantee the debt (the “Non-Guarantors”) under the equity method; (iii) Non-Guarantors on a combined basis; (iv) eliminating entries and (v) consolidated totals as of March 31, 2012 and December 31, 2011 and for the three months ended March 31, 2012 and 2011.  The eliminating entries 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. 

Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2012
	Parent-Only					Non-						Consolidated
	Solutia			Guarantors		Guarantors			Eliminations			Solutia
Net Sales	$	153		$	115	$	460		$	(230	)	$	498
Cost of goods sold		131			77		367			(235	)		340
Gross Profit		22			38		93			5			158
Selling, general and administrative expenses		40			15		20			-			75
Research and development expenses and other operating      expense, net		2			4		1			-			7
Operating Income		(20	)		19		72			5			76
Equity earnings from affiliates		81			50		-			(131	)		-
Interest expense		(28	)		-		(50	)		55			(23	)
Other income, net		21			14		31			(66	)		-
Income from Continuing Operations Before Income      Tax Expense		54			83		53			(137	)		53
Income tax benefit		-			-		(1	)		-			(1	)
Net Income		54			83		54			(137	)		54
Net Income attributable to noncontrolling interest		-			-		1			-			1
Net Income attributable to Solutia	$	54		$	83	$	53		$	(137	)	$	53

24

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Condensed Consolidating Statement of Operations
Three Months Ended March 31, 2011
	Parent-Only						Non-						Consolidated
	Solutia			Guarantors			Guarantors			Eliminations			Solutia
Net Sales	$	135		$	107		$	465		$	(198	)	$	509
Cost of goods sold		118			69			366			(206	)		347
Gross Profit		17			38			99			8			162
Selling, general and administrative expenses		27			13			22			-			62
Research and development expenses and other operating      expense (income), net		7			(1	)		(11	)		-			(5	)
Operating Income (Loss)		(17	)		26			88			8			105
Equity earnings from affiliates		98			59			-			(157	)		-
Interest expense		(32	)		-			(46	)		50			(28	)
Other income (loss), net		18			13			26			(58	)		(1	)
Loss on debt extinguishment		(2	)		-			-			-			(2	)
Income from Continuing Operations Before      Income Tax Expense		65			98			68			(157	)		74
Income tax expense		-			-			7			1			8
Net Income		65			98			61			(158	)		66
Net Income attributable to noncontrolling interest		-			-			1			-			1
Net Income attributable to Solutia	$	65		$	98		$	60		$	(158	)	$	65

25

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Condensed Consolidating Balance Sheet
March 31, 2012
	Parent-Only					Non-					Consolidated
	Solutia			Guarantors		Guarantors		Eliminations			Solutia
ASSETS
Current Assets:
Cash and cash equivalents	$	30		$	4	$	74	$	-		$	108
Trade receivables, net		33			50		138		-			221
Intercompany receivables		79			697		495		(1,271	)		-
Miscellaneous receivables		19			1		54		-			74
Inventories		77			69		285		(47	)		384
Prepaid expenses and other current assets		3			2		11		12			28
Current assets of discontinued operations		-			-		1		-			1
Total Current Assets		241			823		1,058		(1,306	)		816
Net Property, Plant and Equipment		176			148		629		-			953
Investments in Affiliates		2,703			751		1,239		(4,693	)		-
Goodwill		150			243		396		-			789
Net Identified Intangible Assets		177			312		427		-			916
Intercompany Advances		439			527		2,013		(2,979	)		-
Other Assets		44			2		44		-			90
Total Assets	$	3,930		$	2,806	$	5,806	$	(8,978	)	$	3,564
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable	$	52		$	28	$	101	$	-		$	181
Intercompany payables		755			19		497		(1,271	)		-
Accrued liabilities		102			8		100		-			210
Intercompany short-term debt		69			1		430		(500	)		-
Current liabilities of discontinued operations		-			-		5		-			5
Total Current Liabilities		978			56		1,133		(1,771	)		396
Long-Term Debt		1,338			-		-		-			1,338
Intercompany Long-Term Debt		130			23		2,326		(2,479	)		-
Postretirement Liabilities		210			2		75		-			287
Environmental Remediation Liabilities		202			3		14		-			219
Deferred Tax Liabilities		18			11		154		-			183
Non-Current Liabilities of Discontinued Operations		-			-		18		-			18
Other Liabilities		37			7		52		-			96
Equity:
Common stock		1			-		-		-			1
Additional contributed capital		1,672			2,704		2,024		(4,728	)		1,672
Treasury stock		(20	)		-		-		-			(20	)
Accumulated other comprehensive loss		(248	)		-		-		-			(248	)
Accumulated deficit		(388	)		-		-		-			(388	)
Total Shareholders' Equity attributable to Solutia		1,017			2,704		2,024		(4,728	)		1,017
Equity attributable to noncontrolling interest		-			-		10		-			10
Total Equity		1,017			2,704		2,034		(4,728	)		1,027
Total Liabilities and Equity	$	3,930		$	2,806	$	5,806	$	(8,978	)	$	3,564

26

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Condensed Consolidating Balance Sheet
December 31, 2011
	Parent-Only					Non-					Consolidated
	Solutia			Guarantors		Guarantors		Eliminations			Solutia
ASSETS
Current Assets:
Cash and cash equivalents	$	32		$	7	$	74	$	-		$	113
Trade receivables, net		32			41		163		-			236
Intercompany receivables		46			669		476		(1,191	)		-
Miscellaneous receivables		18			3		54		-			75
Inventories		84			57		234		(40	)		335
Prepaid expenses and other current assets		7			1		9		10			27
Current assets of discontinued operations		-			-		1		-			1
Total Current Assets		219			778		1,011		(1,221	)		787
Net Property, Plant and Equipment		177			149		619		-			945
Investments in Affiliates		2,606			703		1,323		(4,632	)		-
Goodwill		150			243		390		-			783
Net Identified Intangible Assets		179			316		421		-			916
Intercompany Advances		440			512		2,027		(2,979	)		-
Other Assets		47			2		46		-			95
Total Assets	$	3,818		$	2,703	$	5,837	$	(8,832	)	$	3,526
LIABILITIES AND EQUITY
Current Liabilities:
Accounts payable	$	59		$	20	$	107	$	-		$	186
Intercompany payables		718			17		456		(1,191	)		-
Accrued liabilities		116			12		99		-			227
Intercompany short-term debt		43			-		564		(607	)		-
Current liabilities of discontinued operations		-			-		8		-			8
Total Current Liabilities		936			49		1,234		(1,798	)		421
Long-Term Debt		1,337			-		-		-			1,337
Intercompany Long-Term Debt		131			23		2,218		(2,372	)		-
Postretirement Liabilities		224			2		82		-			308
Environmental Remediation Liabilities		210			4		13		-			227
Deferred Tax Liabilities		19			11		160		-			190
Non-Current Liabilities of Discontinued Operations		-			-		18		-			18
Other Liabilities		42			7		49		-			98
Equity:
Common stock		1			-		-		-			1
Additional contributed capital		1,651			2,607		2,055		(4,662	)		1,651
Treasury stock		(13	)		-		-		-			(13	)
Accumulated other comprehensive loss		(279	)		-		-		-			(279	)
Accumulated deficit		(441	)		-		-		-			(441	)
Total Shareholders' Equity attributable to Solutia		919			2,607		2,055		(4,662	)		919
Equity attributable to noncontrolling interest		-			-		8		-			8
Total Equity		919			2,607		2,063		(4,662	)		927
Total Liabilities and Equity	$	3,818		$	2,703	$	5,837	$	(8,832	)	$	3,526

27

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2012
	Parent-Only						Non-					Consolidated
	Solutia			Guarantors			Guarantors			Eliminations		Solutia
Cash Provided by (Used in) Operations	$	(45	)	$	24		$	37		$	-	$	16
INVESTING ACTIVITIES:
Property, plant and equipment purchases		(3	)		(2	)		(22	)		-		(27	)
Cash Used in Investing Activities		(3	)		(2	)		(22	)		-		(27	)
FINANCING ACTIVITIES:
Purchase of treasury shares		(7	)		-			-			-		(7	)
Stock Option Exercises		15			-			-			-		15
Other, net		(4	)		-			-			-		(4	)
Changes in investments and advances from (to) affiliates		42			(25	)		(17	)		-		-
Cash Provided by (Used in) Financing Activities		46			(25	)		(17	)		-		4
Effect of Exchange Rate Changes on Cash and      Cash Equivalents		-			-			2			-		2
Decrease in Cash and Cash Equivalents		(2	)		(3	)		-			-		(5	)
CASH AND CASH EQUIVALENTS:
Beginning of period		32			7			74			-		113
End of period	$	30		$	4		$	74		$	-	$	108

28

SOLUTIA INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or otherwise noted)

(Unaudited)

Condensed Consolidating Statement of Cash Flows
Three Months Ended March 31, 2011
	Parent-Only						Non-					Consolidated
	Solutia			Guarantors			Guarantors			Eliminations		Solutia
Cash Provided by (Used in) Operations	$	(33	)	$	31		$	54		$	-	$	52
INVESTING ACTIVITIES:
Property, plant and equipment purchases		(4	)		(1	)		(12	)		-		(17	)
Other		-			-			1			-		1
Restricted Cash		-			-			(5	)		-		(5	)
Asset disposals		-			3			26			-		29
Cash Used in Investing Activities		(4	)		2			10			-		8
FINANCING ACTIVITIES:
Payment of long-term debt obligations		(77	)		-			-			-		(77	)
Purchase of treasury shares		(2	)		-			-			-		(2	)
Stock Option Exercises		2			-			-			-		2
Other, net		(3	)		-			-			-		(3	)
Changes in investments and advances from (to) affiliates		99			(39	)		(60	)		-		-
Cash Provided by (Used in) Financing Activities		19			(39	)		(60	)		-		(80	)
Effect of Exchange Rate Changes on Cash and      Cash Equivalents		-			-			2			-		2
Increase (Decrease) in Cash and Cash Equivalents		(18	)		(6	)		6			-		(18	)
CASH AND CASH EQUIVALENTS:
Beginning of period		98			7			86			-		191
End of period	$	80		$	1		$	92		$	-	$	173

29

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, our ability to comply with the terms of our financing agreements; our ability to reduce our overall leveraged position; general economic, business and market conditions; customer acceptance of new products; raw material and energy costs or shortages; limited access to capital resources; currency and interest rate fluctuations; increased competitive and/or customer pressure; gain or loss of significant customers; compression of credit terms with suppliers; exposure to product liability and other litigation; changes in cost of environmental remediation obligations and other environmental liabilities; changes in accounting principles generally accepted in the U.S. (“U.S. GAAP”); ability to implement cost reduction initiatives in a timely manner; geopolitical instability and changes in pension and other postretirement benefit assumptions.

Overview

We are a global manufacturer and marketer of a variety of high-performance chemical-based materials that are used across automotive, construction, industrial and consumer applications.  We report our operations in three reportable segments consisting of Advanced Interlayers, Performance Films and Technical Specialties.  Through our Advanced Interlayers segment, we produce Polyvinyl Butyral (“PVB”) and Ethyl Vinyl Acetate (“EVA”) used in the manufacture of laminated glass for automotive, architectural and solar applications.   Our Performance Films segment manufactures, markets and distributes custom-coated window films for aftermarket automotive and architectural applications in addition to the manufacture of specialized technical films for use in a wide variety of industrial applications.  Technical Specialties is our specialty chemicals segment, which includes the manufacture and sale of specialty chemicals for the rubber, solar energy, process manufacturing and aviation industries.  The major products by reportable segment are as follows:

Reportable Segment	Products
Advanced Interlayers	●  ●  ●	SAFLEX® plastic interlayer VISTASOLAR® ethyl vinyl acetate encapsulants Specialty intermediate polyvinyl butyral resin and plasticizer
Performance Films	●  ●	LLUMAR®, VISTA®, GILA®, V-KOOL®, HUPER OPTIK®, XIR® and FORMULAONE® professional and retail window films FLEXVUEÔ precision coated films and other enhanced polymer films for industrial customers
Technical Specialties	●  ●  ●  ●	CRYSTEX® insoluble sulphur SANTOFLEX® antidegradants THERMINOL® heat transfer fluids SKYDROL® aviation hydraulic fluids

See Note 14 to the accompanying consolidated financial statements for further information regarding our reportable segments and for the associated definition of segment profit.

On January 26, 2012, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Eastman Chemical Company (“Eastman”) and Eagle Merger Sub Corporation (“Merger Sub”), a wholly owned subsidiary of Eastman.  The Merger Agreement provides for the merger of Merger Sub with and into Solutia, with Solutia surviving as a wholly owned subsidiary of Eastman (the “Merger”). At the effective time of the Merger, each outstanding share of common stock, par value $0.01 per share, of  Solutia will be converted into the right to receive (i) $22.00 in cash, without interest, and (ii) 0.120 shares of common stock, par value $0.01 per share of Eastman.

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The completion of the Eastman Chemical transaction remains subject to approval by Solutia’s shareholders and receipt of required regulatory approvals as well as other customary closing conditions. The waiting period under the Hart-Scott-Rodino (HSR) Act expired on March 28, 2012. The waiting period under the competition laws of South Korea expired on March 23, 2012, and we expect the Ukraine waiting period to expire on April 26, 2012.  On April 16, 2012, the Anti-Monopoly Bureau of the Ministry of Commerce of the People’s Republic of China granted clearance for this transaction.  The parties also received notification from the European Commission that they formally accepted their filing on April 16, 2012, which will start the waiting period.  The transaction is expected to close in mid-2012.

Consolidated Results of Operations - First Quarter 2012 Compared to First Quarter 2011

	Three Months Ended
		March 31,				Increase			% Increase
(dollars in millions, except per share amounts)	2012			2011		(Decrease)			(Decrease)
Net Sales		$	498	$	509	$	(11	)		(2	) %
Net Income attributable to Solutia		$	53	$	65	$	(12	)		(18	) %
Adjusted EBITDA (a)		$	126	$	135	$	(9	)		(7	) %
Adjusted EPS (a)		$	0.55	$	0.50	$	0.05			10	%

(a)   Non-GAAP financial measure. See below for discussion and a reconciliation to GAAP measures

In the first quarter 2012, we reported net sales of $498 million, a 2 percent decrease as compared to $509 million reported in the first quarter 2011.  The decrease was driven by lower sales volumes of $22 million or 4 percent and unfavorable currency exchange rate fluctuations of $3 million or 1 percent, partially offset by higher selling prices of $14 million or 3 percent.   Net income attributable to Solutia of $53 million for first quarter 2012 represents a decrease of $12 million as compared to net income of $65 million reported in the same period in 2011.  Significantly impacting our results are net charges of $15 million and net gains of $5 million for the three months ended March 31, 2012 and 2011, respectively, which are more fully discussed within the Summary of Events Affecting Comparability section.  After consideration of these items, net income improved by $8 million on lower income tax, interest, depreciation and amortization expense, partially offset by lower Adjusted EBITDA of $9 million, as further discussed below.

Adjusted EBITDA for the first quarter of 2012 was $126 million as compared to $135 million for the same period in 2011, which represents a $9 million or a 7 percent decrease.  The decrease in Adjusted EBITDA was driven by higher raw materials of $20 million, as partially recovered through $14 million in higher selling prices, and lower sales volumes, which negatively impacted Adjusted EBITDA by $9 million, as partially offset by $5 million in lower operating expenses and $1 million in favorable currency exchange fluctuations.  Lower operating expenses were predominantly driven by better raw material and utility yields, higher fixed cost absorption as partially offset by higher R&D expenditures.

Adjusted Earnings Per Share for the first quarter of 2012 was $0.55 as compared to $0.50 for the same period in 2011, which represents a $0.05 or a 10 percent improvement.  The Adjusted Earnings Per Share impact from lower Adjusted EBITDA was more than offset by lower interest expense, resulting from the debt reduction achieved in 2011, and a lower income tax expense.  The lower income tax expense was driven predominantly by the reversal of a deferred tax liability related to the extension of the Company's tax holiday in Malaysia.

Outlook

As previously announced, in 2012, Solutia expects to generate annual revenue between $2.125 billion and $2.275 billion.  

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Non-GAAP Financial Measures

Management’s Discussion and Analysis (“MD&A”) includes financial information prepared in accordance with U.S. generally accepted accounting principles (GAAP), as well as three other financial measures including Adjusted EBITDA, Adjusted Earnings and Adjusted Earnings per Share, that are considered “non-GAAP financial measures.”  Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP.  The presentation of Adjusted EBITDA, Adjusted Earnings and Adjusted Earnings per Share are intended to supplement investors’ understanding of our operating performance.  These non-GAAP financial measures are not intended to be performance measures that should be regarded as an alternative to, or more meaningful than other GAAP measures and may not be comparable to similarly titled measures presented by other companies.

Adjusted EBITDA is defined as income from continuing operations attributable to Solutia before interest expense, loss on debt modification, income taxes, depreciation and amortization, certain gains and losses that affect comparability and non-cash share-based compensation expense.  Adjusted Earnings is defined as income from continuing operations attributable to Solutia excluding certain gains and losses, net of tax, that affect comparability.  Adjusted Earnings per Share is defined as Adjusted Earnings divided by weighted average diluted shares outstanding.  We believe Adjusted EBITDA, Adjusted Earnings and Adjusted Earnings per Share assist us in comparing our performance over various reporting periods and against our peers on a consistent basis because it removes from our operating results the impact of items that do not reflect our core operating performance.  Further, we believe Adjusted EBITDA, Adjusted Earnings and Adjusted Earnings per Share are useful to investors.  The compensation committee of our board of directors determines the annual incentive compensation for certain members of our management based, in part, using each of these financial measures.

See the Non-GAAP Reconciliations section of this MD&A for reconciliations of these non-GAAP financial measures to their most comparable measure calculated and presented in accordance with GAAP.

Critical Accounting Policies and Estimates

There were no changes in the three months ended March 31, 2012 with respect to our critical accounting policies, as presented in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2011 Form 10-K filed on February 24, 2012.

Results of Operations - First Quarter 2012 Compared to First Quarter 2011

Advanced Interlayers

(dollars in millions)	Three Months Ended
	March 31,				Increase			% Increase
	2012		2011		(Decrease)			(Decrease)
Net Sales	$	203	$	213	$	(10	)		(5	) %
Segment Profit	$	40	$	49	$	(9	)		(18	) %
Charges included in Segment Profit	$	-	$	-

The decrease in net sales in the first quarter 2012 resulted from lower sales volumes of $9 million or 5 percent and unfavorable currency exchange rate fluctuations of $3 million or 1 percent, partially offset by higher average selling prices of $2 million or 1 percent. The increase in selling prices is the result of price increases on annual customer contracts related to our SAFLEX® plastic interlayer, partially offset by price decreases on VISTASOLAR® EVA encapsulants.  Lower sales volumes were most significantly experienced by sales of VISTASOLAR® EVA encapsulants and, to a lesser extent, sales of SAFLEX® plastic interlayer in automotive markets, predominantly Europe, as partially offset by higher sales volumes of SAFLEX® plastic interlayer in architectural markets, predominantly Asia Pacific. The unfavorable currency impact was driven most notably by the weakening of the Euro versus the U.S. dollar, in comparison to the same period in 2011, due to our strong market positions in Europe.

The decrease in segment profit in the first quarter 2012 resulted primarily from higher raw material costs of $8 million, partially offset by higher selling prices, and lower sales volumes.

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Performance Films

(dollars in millions)	Three Months Ended
	March 31,					Increase			% Increase
	2012			2011		(Decrease)			(Decrease)
Net Sales	$	85		$	76	$	9			12	%
Segment Profit	$	12		$	19	$	(7	)		(37	) %
Charges included in Segment Profit	$	(4	)	$	-

The increase in net sales in the first quarter 2012 resulted from higher sales volumes of $9 million or 12 percent, as driven by higher window film sales volumes within the automotive market as partially offset by lower sales volumes experienced on precision coated films.

The decrease in segment profit in the first quarter 2012 resulted primarily from higher raw material costs of $3 million, higher fixed manufacturing and selling costs, and higher charges as discussed in the Summary of Events Affecting Comparability, as partially offset by higher sales volumes.

Technical Specialties

(dollars in millions)	Three Months Ended
	March 31,				Increase			% Increase
	2012		2011		(Decrease)			(Decrease)
Net Sales	$	210	$	220	$	(10	)		(5	) %
Segment Profit	$	84	$	98	$	(14	)		(14	) %
Gains included in Segment Profit	$	-	$	17

The decrease in net sales in the first quarter 2012 resulted from lower sales volumes of $22 million or 10 percent, partially offset by higher average selling prices of $12 million or 5 percent. Lower sales volumes of $6 million or 3 percent were due to the impact of the divestiture of various other rubber chemical businesses with the remaining decrease due to lower demand for CRYSTEX® insoluble sulfur and SANTOFLEX® antidegradants, particularly within the Asia Pacific and Europe markets, as partially offset by higher sales of THERMINOL® heat transfer fluids.

The decrease in segment profit in comparison to the first quarter 2011 resulted primarily from higher raw material costs of $9 million, lower sales volumes and higher R&D expenditures, as partially offset by higher selling prices, better raw material and utility yields and higher fixed cost absorption.

Unallocated and Other

(dollars in millions)	Three Months Ended
	March 31,						Increase		% Increase
Components of Unallocated and Other	2012			2011			(Decrease)		(Decrease)
Corporate Expenses	$	(12	)	$	(15	)
Share-based Compensation Expense		(6	)		(5	)
Other Unallocated Expense, net		(13	)		(11	)
Unallocated and Other results	$	(31	)	$	(31	)	$	-		-	%
Charges Included in Unallocated and Other
Corporate Expenses	$	-		$	(4	)
Other Unallocated Expense, net		(11	)		(8	)
Charges Included in Unallocated and Other results	$	(11	)	$	(12	)

Unallocated and Other results were unchanged for the first quarter 2012 as compared to the same period in 2011.  

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Interest Expense

(dollars in millions)	Three Months Ended
	March 31,				Increase			% Increase
	2012		2011		(Decrease)			(Decrease)
Interest expense	$	23	$	28	$	(5	)		(18	) %

Interest expense decreased in the first quarter 2012, as compared to the same period in 2011, predominately due to a lower average debt balance and a lower average interest rate.  During the quarter ended March 31, 2012, our average debt balance was $1.3 billion compared to $1.5 billion for the same period in 2011.  Our average interest rate dropped from 6.1 percent for the quarter ended March 31, 2011 to 6.0 percent for the same period in 2012 as a result of the modification to our debt facility as discussed in Note 9 in the accompanying consolidated financial statements.

Loss on Debt Modification

(dollars in millions)	Three Months Ended
	March 31,				Increase			% Increase
	2012		2011		(Decrease)			(Decrease)
Loss on debt modification	$	-	$	2	$	(2	)		(100	) %

The loss on debt modification for the first quarter 2011 resulted from the modification of our $700 million senior term loan facility (“2017 Term Loan”) as discussed in the Summary of Events Affecting Comparability.  As a result of the modification, we incurred $2 million of fees.

Income Tax Expense

(dollars in millions)	Three Months Ended
	March 31,					Increase			% Increase
	2012			2011		(Decrease)			(Decrease)
Income tax expense (benefit)	$	(1	)	$	8	$	(9	)		(113	) %

Income tax expense decreased in the first quarter 2012, as compared to the same time period in 2011, due to an increase in discrete tax benefits and, to a lesser extent, the change in the mix of income and losses in the tax jurisdictions in which we operate.  In the three months ended March 31, 2012, discrete tax benefits of $12 million were recognized compared to $2 million in the same period in 2011.  Most of the discrete tax benefit recognized in the period ended March 31, 2012 was due to the reversal of a deferred tax liability due to the extension of a Malaysian tax holiday.  The remaining discrete items in both periods were primarily due to the expiration of certain foreign audit periods and the re-measurement of other uncertain tax positions due to events in the current period.  Also impacting our income tax expense for the three months ended March 31, 2011 is income tax benefit of $2 million associated with certain unusual or infrequently occurring items, as described in the Summary of Events Affecting Comparability section.  After consideration of the discrete tax benefits and the income tax benefits on the events affecting comparability, tax expense was $11 million and $12 million in the three months ended March 31, 2012 and 2011, respectively.  The decrease in income tax expense is the result of an overall decrease in foreign earnings in the first quarter of 2012 from the same period in 2011, partially offset by an increase in earnings in jurisdictions with relatively high tax rates.  Income tax expense recorded in both periods relates only to foreign jurisdictions.

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Financial Condition and Liquidity

As of March 31, 2012, our total liquidity was $387 million which was comprised of $279 million available under our $300 million revolving credit facility (“2015 Revolver”) and $108 million in cash and cash equivalents.  As of March 31, 2012, we had no draws against our 2015 Revolver but availability was reduced by letters of credit of $21 million.

For the remainder of 2012, our anticipated use of cash includes fulfillment of our interest, postretirement, environmental, tax and restructuring obligations, along with approximately $125 million in capital expenditures for new initiatives, capacity expansion and productivity enhancement along with those for maintenance and safety requirements.  To the extent it is necessary to fund growth initiatives and/or certain seasonal demands of our operations, an additional use of cash may be needed for working capital.  Finally, an additional use of cash will be on costs associated with our agreement and plan of merger with Eastman Chemical Company, as more fully described in Note 2 to our Consolidated Financial Statements, which are estimated to be $25 million only upon closing of the merger.

Cash flows from continuing operations are estimated to be our most significant source of cash for 2012.  In summary, we expect our current liquidity resources, along with future cash flows from continuing operations, will be adequate to meet projected cash requirements.  Additional liquidity, if necessary, would include additional lines of credit, financing of customer receivables and/or other assets and asset sales, all of which are allowable, with certain limitations, under our existing credit agreements and our Merger Agreement.

Cash Flows - Continuing Operations

Our cash flows from continuing operations attributable to operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows, are summarized in the following table:

	Three Months Ended
Cash Flow Summary - Continuing Operations	March 31,						Increase
(dollars in millions)	2012			2011			(Decrease)
Cash provided by operating activities	$	19		$	49		$	(30	)
Cash provided by (used in) investing activities		(27	)		8			(35	)
Cash provided by (used in) financing activities		4			(80	)		84
Effect of exchange rate changes on cash		2			2			-
Net change in cash for period attributable to           continuing operations	$	(2	)	$	(21	)	$	19

Operating activities:  In the first three months of 2012, we generated less cash from continuing operations than we did for the same period of 2011 primarily due to lower operating income, higher payments on our postretirement obligations and higher working capital requirements as partially offset by lower interest payments and lower tax payments.  Also negatively impacting our cash flow from operating activities are payments of $9 million related to our pending merger with Eastman Chemical Company.

Investing activities:  Cash used in investing activities of $27 million in the three months ended March 31, 2012, comprised entirely of capital expenditures, represents a $35 million change as compared to cash provided by investing activities of $8 million in the same period of 2011.  This difference is predominantly due to cash proceeds of $29 million received in 2011 on the sale of certain businesses and selected assets within our Technical Specialties segment along with an increase in capital expenditures in 2012.  The increase in capital expenditures in 2012 is most significantly driven by certain expansions at our Ghent, Belgium and Suzhou, China plants.  Furthermore, cash used in the first three months of 2011 include the payment of $5 million into a restricted cash fund related to cash collateral required by our foreign subsidiaries.

Financing activities:  Cash provided by financing activities of $4 million in the first three months of 2012 results primarily from $15 million of cash received from the exercise of stock options, as partially offset by $7 million in treasury stock purchases and $5 million in dividends paid on our common stock.  Cash used by financing activities of $80 million in the first three months of 2011 results primarily from $77 million in payments on our then existing senior term loan facility along with $2 million in fees associated with the refinancing of this debt completed in order to lower our interest rate and modify the terms allowing the Company additional strategic and financial flexibility.

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Working Capital – Continuing Operations

Working capital used for continuing operations is summarized as follows:

Working Capital - Continuing Operations	March 31,		December 31,			Increase
(dollars in millions)	2012		2011			(Decrease)
Cash and cash equivalents	$	108	$	113
Trade receivables, net		221		236
Inventories		384		335
Other current assets		102		102
Total current assets	$	815	$	786
Accounts Payable	$	181	$	186
Accrued Liabilities		210		227
Total current liabilities	$	391	$	413
Working Capital	$	424	$	373	$	51

Our working capital increased $51 million in the first three months of 2012 due to higher inventory levels and lower accrued liabilities, as partially offset by lower trade receivables on improvements in  cash collection.  Higher inventory levels were driven by a strategic increase in advance of planned start-ups of the Saflex® Suzhou, China sheet expansion and the Ghent, Belgium Saflex® acoustic line in the second quarter of 2012.  In addition, inventory levels of Therminol in Technical Speccialties are higher in preparation for delivery of large concentrating solar projects starting in early 2013.  The remainder of the increase in inventory was due to normal seasonality.  Lower accrued liabilities were predominantly due to the payment of our 2011 annual incentive plan in the first quarter of 2012.  

From time to time we sell trade receivables without recourse to third parties.  These trade receivables were removed from our Consolidated Statement of Financial Position and reflected as cash provided by operating activities in the Consolidated Statement of Cash Flows at the time of sale to the third party.  Uncollected trade receivables sold under these arrangements and removed from the Consolidated Statement of Financial Position were $15 million and $14 million at March 31, 2012 and December 31, 2011, respectively.  The average monthly amounts of trade receivables sold were $9 million for the three months ended March 31, 2012.

Cash Flows – Discontinued Operations

	Three Months Ended
Cash Flow Summary - Discontinued Operations	March 31,					Increase
(dollars in millions)	2012			2011		(Decrease)
Cash provided by (used in) operating activities	$	(3	)	$	3	$	(6	)
Net change in cash for period attributable to           discontinued operations	$	(3	)	$	3	$	(6	)

Cash used in discontinued operations of $3 million for the three months ended March 31, 2012 is comprised of exit related payments associated with our Primary Accelerators shutdown, which ceased manufacturing in the third quarter 2010.  For the same period in 2011, cash provided by discontinued operations of $3 million represents cash proceeds from the monetization of Primary Accelerators working capital.

Capital Expenditures

Capital expenditures are projected to be approximately $150 million for the year ended December 31, 2012, of which $90 million to $100 million of this estimate is attributable to new products and expansion and productivity projects.  The remainder is attributable to maintenance and right-to-operate projects.

Pension Funding

We sponsor several defined benefit pension plans into which we made cash contributions of $22 million in the first three months of 2012.  We expect to contribute additional cash to these pension plans in the range of $55 million to $60 million during 2012. Actual contributions to the plans and satisfaction of these outstanding liabilities may differ and will depend on numerous variables, including future changes in actuarial assumptions, legislative changes to pension funding laws, and market conditions.

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Supplementary Information - First Quarter 2012 Compared to First Quarter 2011

Summary of Events Affecting Comparability

Charges and gains recorded in the three months ended March 31, 2012 and 2011 and other events affecting comparability have been summarized and described in the table and accompanying footnotes below (dollars in millions):

2012 Events

Increase/(Decrease)	Advanced Interlayers		Performance Films			Technical Specialties		Unallocated/ Other			Consolidated
Impact on:
Cost of goods sold	$	-	$	2		$	-	$	-		$	2		(a)
Selling, general and administrative      expenses		-		2			-		11			13		(b)
Pre-tax Income Statement Impact	$	-	$	(4	)	$	-	$	(11	)	$	(15	)
Income tax benefit												-		(c)
After-tax Income Statement Impact											$	(15	)

(a)    Inventory step-up related to the Southwall acquisition ($2 million pre-tax and after-tax).

(b)    Acquisition related expenses on the Southwall acquisition and the pending Eastman merger of $2 million and $11 million, respectively ($13 million pre-tax and after-tax).

(c)    Income tax impact has been provided on gains and charges in the quarter recognized at the tax rate in the jurisdiction in which they have been or will be realized.

2011 Events

Increase/(Decrease)	Advanced Interlayers		Performance Films		Technical Specialties			Unallocated/ Other			Consolidated
Impact on:
Selling, general and administrative      expenses	$	-	$	-	$	-		$	4		$	4		(a)
Other operating income, net		-		-		-			8			8		(a)
		-		-		(17	)		-			(17	)	(b)
Operating Income Impact	$	-	$	-	$	17		$	(12	)	$	5
Loss on debt modification		-		-		-			(2	)		(2	)	(c)
Pre-tax Income Statement Impact	$	-	$	-	$	17		$	(14	)	$	3
Income tax benefit												(2	)	(d)
After-tax Income Statement Impact											$	5

(a)    Severance and other charges related to the relocation of our European regional headquarters ($12 million pre-tax and $8 million after-tax).

(b)    Gain on certain other rubber chemicals divestitures ($17 million pre-tax and $15 million after-tax).

(c)    Charges related to the modification of our 2017 Term Loan ($2 million pre-tax and after-tax).

(d)    Income tax impact has been provided on gains and charges at the tax rate in the jurisdiction in which they have been or will be realized.

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Non-GAAP Reconciliations

Reconciliations of our non-GAAP measures to GAAP measures are included below.  Amounts are stated in millions, except per share figures.

	Three Months Ended
	March 31,
Adjusted EBITDA	2012			2011
Net Income attributable to Solutia	$	53		$	65
Plus:
Income tax expense (benefit)		(1	)		8
Interest expense		23			28
Loss on debt modification		-			2
Depreciation and amortization		30			32
Subtotal	$	105		$	135
Plus:
Events affecting comparability (a)	$	15		$	(5	)
Non-cash share-based compensation expense		6			5
Adjusted EBITDA	$	126		$	135

(a) See Summary of Events Affecting Comparability for operating income impact.

	Three Months Ended
	March 31,
Adjusted Earnings and Adjusted EPS	2012		2011
Net Income attributable to Solutia	$	53	$	65
Plus: Events affecting comparability, net of tax (a)		15		(5	)
Adjusted Earnings	$	68	$	60
Weighted average diluted shares outstanding		122.6		121.2
Adjusted Earnings per Share	$	0.55	$	0.50

(a) See Summary of Events Affecting Comparability.

Contingencies

See Note 8 to the accompanying consolidated financial statements for a summary of our contingencies as of March 31, 2012.

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS

There have been no material changes in market risk exposures during the three months ended March 31, 2012 that affect the disclosures presented in the information appearing under Item 7a. Quantitative and Qualitative Disclosures about Market Risk as presented in our 2011 Form 10-K.

Item 4.  CONTROLS AND PROCEDURES

During the period covered by this Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)).  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Form 10-Q, our disclosure controls and procedures are effective.  Further, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarterly period ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Our 2011 Form 10-K describes a purported class action lawsuit which was filed in the Circuit Court of Putnam County, West Virginia against Flexsys, Pharmacia, Monsanto and Akzo Nobel (Solutia is not named as a defendant) alleging exposure to dioxin from Flexsys Nitro, West Virginia facility which is now closed.  In February 2012, Monsanto reached a tentative global resolution with the plaintiffs in the class action and the individual lawsuits.  The court has given tentative approval to the settlement terms, but a fairness hearing has been scheduled for June 2012 for final approval of the settlement.  Pursuant to the terms of the Monsanto-Solutia Settlement Agreement, Solutia and Flexsys will have no obligations under the terms of the settlement of these litigation matters.

Our 2011 Form 10-K describes four purported stockholder class action complaints filed as a result of the announcement of our pending merger with Eastman Chemical Company.  Three of the actions were filed in Delaware (collectively, the “Delaware Action”) and one was filed in Missouri (the “Missouri Action”).  On March 5, 2012, the plaintiff in the Missouri Action agreed to stay the litigation in deference to the Delaware Action and agreed to dismiss the Missouri Action once there is a final resolution of the Delaware Action.  On March 22, 2012, plaintiffs in the Delaware Action filed a consolidated amended complaint.  The complaint names as defendants Solutia, the Individual Defendants, Eastman, and Merger Sub.  The complaint generally alleges, among other things, that the Individual Defendants breached their fiduciary duties by failing to take steps to maximize the value of Solutia to its public shareholders, failing to properly value Solutia, agreeing to allegedly preclusive deal protection devices, and vesting themselves with benefits that are not shared with the public shareholders, and that Solutia, Eastman, and Merger Sub aided and abetted these purported breaches of fiduciary duties.  Additionally, the complaint alleges that the Individual Defendants breached their fiduciary duty of disclosure by allegedly omitting material information regarding the proposed Merger in the Form S-4 Registration Statement filed with the SEC on March 7, 2012.  The relief sought includes, among other things, an injunction prohibiting the consummation of the Merger, rescission of the Merger (to the extent the Merger has already been consummated), and attorneys’ fees and costs. Solutia believes the plaintiffs’ allegations lack merit and will vigorously contest them.  On May 3, 2012, the parties to the Delaware Action reached an agreement to settle the Delaware Action, the terms of which are reflected in a Memorandum of Understanding (“MOU”) entered into by the parties on that date.  The MOU was filed with the Delaware Court of Chancery on May 7, 2012.  Pursuant to the MOU, defendants have agreed to make certain additional disclosures in Eastman’s next filing of the Form S-4 Registration Statement.  Consummation of the proposed settlement is subject to, among other things, the consummation of the proposed transaction with Eastman and the completion of reasonable good faith confirmatory discovery satisfactory to Plaintiffs’ counsel in the Delaware Action.  Pursuant to the MOU, the parties to the Delaware Action will present the settlement to the Court for hearing and approval as soon as reasonably practicable following dissemination of appropriate notice to class members.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Our Credit Facility and our indentures for the 8.75% Notes and 7.875% Notes include restrictive covenants that limit our ability to repurchase stock and pay dividends.

(c ) Purchases of Equity Securities by the Issuer

Period	Total Number of Shares Purchased (1)		Average Price Paid Per Share (2)			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value (in millions) that May Yet Be Purchased Under the Plans or Programs
January 1-31, 2012		-		$	-		-		$	-
February 1-28, 2012		254,593		$	27.77		-		$	-
March 1-31, 2012		43		$	28.08		-		$	-
Total		254,636		$	27.77		-		$	-

(1)	Shares surrendered to the Company by an employee to satisfy individual tax withholding obligations upon vesting of previously issued shares of restricted common stock. Shares surrendered are held in treasury.
(2)	Average price paid per share reflects the closing price of Solutia common stock on the business date the shares were surrendered by the employee stockholder to satisfy individual tax withholding obligations upon vesting of restricted common stock.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.  OTHER INFORMATION

ITEM 6.  EXHIBITS

See the Exhibit Index at page 41 of this report.

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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/Christopher J. Bray

(Vice President and Controller)

(On behalf of the Registrant and as

Principal Accounting Officer)

Dated:  May 8, 2012
 

40

EXHIBIT INDEX

These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K.

EXHIBIT NUMBER	DESCRIPTION
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	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
32.2	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
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Label Linkbase Document
101.PRE	XBRL Taxonomy Presentation Linkbase Document

41