Solutia 10-Q 2008 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

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

Commission file number001-13255

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 or15(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. Yesþ Noo

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero	Accelerated filerþ	Non-accelerated filero	Smaller reporting companyo
		(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). Yeso Noþ

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

	Outstanding at
Class	September 30, 2008
Common Stock, $0.01 par value	94,343,610 shares

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1. FINANCIAL STATEMENTS
		CONSOLIDATED STATEMENT OF OPERATIONS
		CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
		CONSOLIDATED STATEMENT OF OPERATIONS
		CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
		CONSOLIDATED STATEMENT OF FINANCIAL POSITION
		CONSOLIDATED STATEMENT OF CASH FLOWS
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS
	Item 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 1A. RISK FACTORS
	ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
	ITEM 5. OTHER EVENTS
	ITEM 6. EXHIBITS
SIGNATURE
EXHIBIT INDEX
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

SOLUTIA INC.

CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions, except per share amounts)
(Unaudited)

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended
	September 30,			September 30,
	2008			2007
Net Sales	$	587		$	454
Cost of goods sold		432			342
Gross Profit		155			112
Selling, general and administrative expenses		76			59
Research, development and other operating expenses, net		3			6
Operating Income		76			47
Interest expense (a)		(39	)		(20	)
Other income, net		4			2
Reorganization items, net		—			(152	)
Income (Loss) from Continuing Operations Before Income Tax Expense		41			(123	)
Income tax expense		17			11
Income (Loss) from Continuing Operations		24			(134	)
Income (Loss) from Discontinued Operations, net of tax		(31	)		23
Net Loss	$	(7	)	$	(111	)
Basic and Diluted Loss per Share:
Income (Loss) from Continuing Operations	$	0.32		$	(1.28	)
Income (Loss) from Discontinued Operations		(0.41	)		0.22
Net Loss	$	(0.09	)	$	(1.06	)

(a) Predecessor excludes unrecorded contractual interest expense of $8 in the three months ended September 30, 2007.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(Dollars in millions)
(Unaudited)

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended
	September 30,			September 30,
	2008			2007
Net Loss	$	(7	)	$	(111	)
Other Comprehensive Income (Loss):
Currency translation adjustments		(62	)		16
Unrealized loss on derivative instruments		(13	)		1
Amortization of prior service gain		—			(4	)
Amortization of actuarial loss		—			5
Comprehensive Loss	$	(82	)	$	(93	)

See accompanying Notes to Consolidated Financial Statements.

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SOLUTIA INC.

CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions, except per share amounts)
(Unaudited)

	Successor			Predecessor
	Seven Months			Two Months			Nine Months
	Ended			Ended			Ended
	September 30,			February 29,			September 30,
	2008			2008			2007
Net Sales	$	1,346		$	335		$	1,151
Cost of goods sold		1,065			242			859
Gross Profit		281			93			292
Selling, general and administrative expenses		165			42			155
Research, development and other operating expenses, net		4			3			17
Operating Income		112			48			120
Equity earnings from affiliates		—			—			12
Interest expense (a)		(99	)		(12	)		(51	)
Other income, net		9			2			30
Loss on debt modification		—			—			(7	)
Reorganization items, net		—			1,433			(185	)
Income (Loss) from Continuing Operations Before Income Tax Expense		22			1,471			(81	)
Income tax expense		17			214			24
Income (Loss) from Continuing Operations		5			1,257			(105	)
Income (Loss) from Discontinued Operations, net of tax		(58	)		197			42
Net Income (Loss)	$	(53	)	$	1,454		$	(63	)
Basic and Diluted Income (Loss) per Share:
Income (Loss) from Continuing Operations	$	0.08		$	12.03		$	(1.00	)
Income (Loss) from Discontinued Operations		(0.87	)		1.88			0.40
Net Income (Loss)	$	(0.79	)	$	13.91		$	(0.60	)

(a) Predecessor excludes unrecorded contractual interest expense of $5 in the two months ended February 29, 2008 and $24 in the nine months ended September 30, 2007.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(Dollars in millions)
(Unaudited)

	Successor			Predecessor
	Seven Months			Two Months			Nine Months
	Ended			Ended			Ended
	September 30,			February 29,			September 30,
	2008			2008			2007
Net Income (Loss)	$	(53	)	$	1,454		$	(63	)
Other Comprehensive Income (Loss):
Currency translation adjustments		(40	)		32			19
Unrealized loss on derivative instruments		(9	)		—			1
Amortization of prior service gain		—			(3	)		(12	)
Amortization of actuarial loss		—			2			14
Actuarial loss arising during the two months ended February 29, 2008, net of tax of $2		—			(64	)		—
Prior service gain arising during the two months ended February 29, 2008		—			109			—
Fresh-start accounting adjustment		—			(30	)		—
Comprehensive Income (Loss)	$	(102	)	$	1,500		$	(41	)

See accompanying Notes to Consolidated Financial Statements.

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SOLUTIA INC.

CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Dollars in millions, except per share amounts)
(Unaudited)

	Successor			Predecessor
	September 30,			December 31,
	2008			2007
ASSETS
Current Assets:
Cash and cash equivalents	$	38		$	173
Trade receivables, net of allowances of $0 in 2008 and $2 in 2007		303			293
Miscellaneous receivables		117			114
Inventories		354			268
Prepaid expenses and other assets		96			43
Assets of discontinued operations		1,167			808
Total Current Assets		2,075			1,699
Property, Plant and Equipment, net of accumulated depreciation of $40 in 2008 and $1,102 in 2007		978			619
Goodwill		511			149
Identified Intangible Assets, net		851			57
Other Assets		181			116
Total Assets	$	4,596		$	2,640
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Accounts payable	$	224		$	180
Accrued liabilities		276			239
Short-term debt, including current portion of long-term debt		39			982
Liabilities of discontinued operations		289			294
Total Current Liabilities		828			1,695
Long-Term Debt		1,365			359
Postretirement Liabilities		415			80
Environmental Remediation Liabilities		286			56
Deferred Tax Liabilities		216			45
Other Liabilities		118			78
Liabilities Subject to Compromise		—			1,922
Commitments and Contingencies (Note 10)
Shareholders’ Equity (Deficit):
Successor common stock at $0.01 par value; (500,000,000 shares authorized, 94,391,972 shares issued in 2008)		1			—
Predecessor common stock at $0.01 par value; (600,000,000 shares authorized, 118,400,635 shares issued in 2007)		—			1
Additional contributed capital		1,469			56
Predecessor stock held in treasury, at cost, 13,941,057 shares in 2007		—			(251	)
Predecessor net deficiency of assets at spin-off		—			(113	)
Accumulated other comprehensive loss		(49	)		(46	)
Accumulated deficit		(53	)		(1,242	)
Total Shareholders’ Equity (Deficit)		1,368			(1,595	)
Total Liabilities and Shareholders’ Equity (Deficit)	$	4,596		$	2,640

See accompanying Notes to Consolidated Financial Statements.

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SOLUTIA INC.

CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(Unaudited)

	Successor			Predecessor
	Seven Months			Two Months			Nine Months
	Ended			Ended			Ended
	September 30, 2008			February 29, 2008			September 30, 2007
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS OPERATING ACTIVITIES:
Net income (loss)	$	(53	)	$	1,454		$	(63	)
Adjustments to reconcile net income (loss) to net cash used in operations:
(Income) Loss from discontinued operations, net of tax		58			(197	)		(42	)
Depreciation and amortization		64			11			41
Revaluation of assets and liabilities, net of tax		—			(1,383	)		—
Discharge of claims and liabilities, net of tax		—			100			—
Other reorganization items, net		—			52			185
Pension expense less than contributions		(40	)		(18	)		(67	)
Other postretirement benefits expense less than contributions		—			(6	)		(25	)
Amortization of deferred debt issuance costs		10			—			2
Deferred income taxes		(22	)		5			—
Equity earnings from affiliates		—			—			(12	)
Other (gains) charges including restructuring expenses		67			(2	)		(3	)
Gain on sale of assets		(8	)		—			—
Changes in assets and liabilities:
Income taxes payable		14			5			13
Trade receivables		14			(24	)		(31	)
Inventories		(20	)		(34	)		(17	)
Accounts payable		21			31			15
Restricted cash to fund payment of legacy liabilities		12			—			—
Environmental remediation liabilities		(7	)		(1	)		—
Other assets and liabilities		17			(4	)		(8	)
Cash Provided by (Used in) Continuing Operations before Reorganization Activities		127			(11	)		(12	)
Reorganization Activities:
Establishment of VEBA retiree trust		—			(175	)		—
Establishment of restricted cash for environmental remediation and other legacy payments		—			(46	)		—
Payment for allowed secured and administrative claims		—			(79	)		—
Professional service fees		(29	)		(31	)		(53	)
Other reorganization and emergence related payments		(1	)		(17	)		(5	)
Cash Used in Reorganization Activities		(30	)		(348	)		(58	)
Cash Provided by (Used in) Operations — Continuing Operations		97			(359	)		(70	)
Cash Provided by (Used in) Operations — Discontinued Operations		(124	)		(53	)		4
Cash Used in Operations		(27	)		(412	)		(66	)
INVESTING ACTIVITIES:
Property, plant and equipment purchases		(52	)		(15	)		(61	)
Acquisition and investment payments		(2	)		—			(120	)
Restricted cash		—			—			4
Investment proceeds and property disposals		53			—			7
Cash Used in Investing Activities-Continuing Operations		(1	)		(15	)		(170	)
Cash Provided by (Used in) Investing Activities-Discontinued Operations		(27	)		(14	)		23
Cash Used in Investing Activities		(28	)		(29	)		(147	)
FINANCING ACTIVITIES:
Net change in lines of credit		28			—			25
Proceeds from long-term debt obligations		—			1,600			75
Net change in long-term revolving credit facilities		(3	)		190			(78	)
Proceeds from stock issuance		422			250			—
Proceeds from short-term debt obligations		—			—			325
Payment of short-term debt obligations		—			(966	)		(53	)
Payment of long-term debt obligations		(434	)		(366	)		—
Payment of debt obligations subject to compromise		—			(221	)		—
Debt issuance costs		(1	)		(136	)		(11	)
Other financing activities		(2	)		—			—
Cash Provided by Financing Activities		10			351			283
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(45	)		(90	)		70
CASH AND CASH EQUIVALENTS:
Beginning of period		83			173			150
End of period	$	38		$	83		$	220
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash payments for interest	$	85		$	43		$	102
Cash payments for income taxes	$	15		$	4		$	18

See accompanying Notes to Consolidated Financial Statements.

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SOLUTIA INC.

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

1. Background

Nature of Operations

Solutia Inc., together with its subsidiaries, is a global manufacturer and marketer of a variety of high-performance chemical-based materials. Solutia is a world leader in performance films for laminated safety glass and after-market applications; and specialty products such as chemicals for the rubber industry, heat transfer fluids and aviation hydraulic fluids.

Prior to September 1, 1997, Solutia was a wholly-owned subsidiary of the former Monsanto Company (now known as Pharmacia Corporation, a 100% owned subsidiary of Pfizer, Inc.). On September 1, 1997, Pharmacia distributed all of the outstanding shares of common stock of Solutia as a dividend to Pharmacia stockholders (the “Solutia Spinoff”). As a result of the Solutia Spinoff, on September 1, 1997, Solutia became an independent publicly held company and its operations ceased to be owned by Pharmacia.

Unless the context requires otherwise, the terms “Solutia”, “Company”, “we”, and “our” in this report refer to Solutia Inc. and its subsidiaries. The financial information set forth in this report, unless otherwise expressly set forth or as the context otherwise indicates, reflects the consolidated results of operations and financial condition of Solutia Inc. and its subsidiaries for the periods following March 1, 2008 (“Successor”), and of Solutia Inc. and its subsidiaries for the periods through February 29, 2008 (“Predecessor”).

Emergence from Chapter 11 Proceedings

On February 28, 2008 (the “Effective Date”), we consummated our reorganization under Chapter 11 of the U.S. Bankruptcy Code (the “Bankruptcy Code”) and emerged from bankruptcy pursuant to our Fifth Amended Joint Plan of Reorganization which was confirmed by the U.S. Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) on November 29, 2007 (the “Plan”). We and our 14 U.S. subsidiaries (the “Debtors”) had filed voluntary petitions for Chapter 11 protection on December 17, 2003 (the “Chapter 11 Case”). Our subsidiaries outside the United States were not included in the Chapter 11 filing. The filing was made to restructure our balance sheet, to streamline operations and to reduce costs, in order to allow us to continue operations as a viable going concern. The filing also was made to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain post-retirement benefits (the “Legacy Liabilities”) and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff.

On the Effective Date, all of our existing shares of common stock (the “Old Common Stock”) were canceled pursuant to the Plan. We also issued the following shares of common stock, par value $0.01 per share, (the “New Common Stock”) of the newly reorganized Solutia in satisfaction of creditor claims and stockholder interests: (1) 29,024,446 shares of New Common Stock to our general unsecured creditors and to noteholders who held our then outstanding 7.375% Notes due October 15, 2027 and 6.72% Notes due October 15, 2037, 825,743 of which shares are being held in a disputed claims reserve for the benefit of holders of disputed claims whose claims are subsequently allowed and any shares left over after all disputed claims have been resolved shall be distributed pro rata to holders of allowed claims; (2) 1,221,492 shares of New Common Stock to fund a retiree trust, which qualifies as a Voluntary Employees’ Beneficiary Association (VEBA); (3) 597,186 shares of New Common Stock, representing 1% of the total New Common Stock, to holders of at least 175 shares of the Old Common Stock; (4) 15,916,059 shares of New Common Stock to general unsecured creditors and noteholders pursuant to the creditor rights offering (the “Creditor Rights Offering”); (5) 2,833,003 shares of New Common Stock to the backstop investors (the “Backstop Investors”) in the Creditor Rights Offering; (6) 7,667,523 shares of New Common Stock to holders of at least 11 shares of Old Common Stock pursuant to an equity rights offering (the “Equity Rights Offering”); and (7) 2,489,977 shares of New Common Stock, representing the shares of New Common Stock that were unsubscribed for in the Equity Rights Offering, to Monsanto Company (“Monsanto”). The total amount of the general unsecured claims pool was approximately $820. In addition, we issued warrants (the “Warrants”) to purchase an aggregate of 4,481,250 shares of New Common Stock to holders of Old Common Stock based on a holder’s pre-petition stock ownership, provided that such holder held at least 24 shares of the Old Common Stock.

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SOLUTIA INC.

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

Subject to the terms of the Warrant Agreement, Warrant holders are entitled to purchase shares of New Common Stock at an exercise price of $29.70 per share. The Warrants have a five-year term and will expire on February 27, 2013. The Warrants may be exercised for cash or on a net issuance basis.

On the Effective Date we entered into financing agreements to borrow up to $2.05 billion from a syndicate of lenders (the “Financing Agreements”). The Financing Agreements consisted of (i) a $450 senior secured asset-based revolving credit facility which is comprised of a U.S. Facility and a Belgium Facility (“Revolver”), (ii) a $1.2 billion senior secured term loan facility (“Term Loan”) and (iii) a $400 senior unsecured bridge facility (“Bridge”). The Bridge has subsequently been retired in full as more fully described in Note 13.

2. Fresh Start Consolidated Statement of Financial Position

On the Effective Date, we adopted fresh-start accounting in accordance with the American Institute of Certified Public Accountants’ Statement of Position 90-7,Financial Reporting by Entities in Reorganization Under the Bankruptcy Code(“SOP 90-7”) as amended by Financial Accounting Standards Board (“FASB”) Staff Position No. SOP 90-7-1,An Amendment of AICPA Statement of Position 90-7. This resulted in our becoming a new reporting entity on March 1, 2008, which has a new capital structure, a new basis in the identifiable assets and liabilities assumed and no retained earnings or accumulated losses. Accordingly, the Consolidated Financial Statements on or after March 1, 2008 are not comparable to the Consolidated Financial Statements prior to that date.

Fresh-start accounting reflects our value as determined in the confirmed Plan. Under fresh-start accounting, our asset values are re-measured using fair value and are allocated in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations (“SFAS No. 141”). The excess of reorganization value over the fair value of tangible and identifiable intangible assets is recorded as goodwill. In addition, fresh-start accounting also requires that all liabilities, other than deferred taxes, should be stated at fair value or at the present values of the amounts to be paid using appropriate market interest rates. Deferred taxes are determined in conformity with SFAS No. 109,Accounting for Income Taxes(“SFAS No. 109”).

To facilitate the calculation of the enterprise value of the Successor, management developed a set of financial projections using a number of estimates and assumptions. The enterprise value, and corresponding equity value, was based on these financial projections in conjunction with various valuation methods, including (i) a comparison of us and our projected performance to comparable companies; (ii) a review and analysis of several recent transactions of companies in similar industries to ours; and (iii) a calculation of the present value of our future cash flows under our projections. Utilizing these methodologies, the enterprise value was determined to be within a certain range and, using the mid-point of the range, the equity value of the Successor was estimated to be $1.0 billion.

All estimates, assumptions, valuations, appraisals and financial projections, including the fair value adjustments, the financial projections, the enterprise value and equity value, are inherently subject to significant uncertainties and the resolution of contingencies beyond our control. Accordingly, there can be no assurance that the estimates, assumptions, valuations, appraisals and the financial projections will be realized and actual results could vary materially. In accordance with generally accepted accounting principles, the preliminary allocation of the enterprise value is subject to additional adjustment within one year after emergence from bankruptcy when additional or improved information on valuations becomes available. As further described in Note 4, our Integrated Nylon reportable segment has been classified as discontinued operations during the third quarter of 2008 and the Fresh Start Consolidated Statement of Financial Position reflects this classification.

The adjustments set forth in the following Fresh Start Consolidated Statement of Financial Position in the columns captioned “Effect of Plan” and “Revaluation of Assets and Liabilities” reflect the effect of the consummation of the transactions contemplated by the Plan, including the settlement of various liabilities, securities issuances, incurrence of new indebtedness and cash payments, and the revaluation of our assets and liabilities to reflect their fair value under fresh-start accounting. The adjustments resulted in a pre-tax net effect of discharge of claims and liabilities of $(104) under the Plan and a gain of $1,801 resulting from the revaluation of our assets and liabilities, of which $212 is recognized in Income (Loss) from Discontinued Operations on the Consolidated Statement of Operations.

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SOLUTIA INC.

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

The effects of the Plan and fresh-start accounting on our Consolidated Statement of Financial Position at February 29, 2008 are as follows:

	Predecessor						Revaluation of			Successor
	February 29,			Effect of			Assets and			February 29,
	2008			Plan			Liabilities			2008
ASSETS
Current Assets:
Cash and cash equivalents	$	180		$	(97	)(a)	$	—		$	83
Trade receivables, net		317			—			—			317
Miscellaneous receivables		128			(3	)(a)		(1	)(d)		124
Inventories		302			—			98	(d)		400
Prepaid expenses and other assets		56			30	(a)(b)		(5	)(d)		81
Assets of discontinued operations		863			—			218	(d)		1,081
Total Current Assets		1,846			(70	)		310			2,086
Property, Plant and Equipment		629			—			406	(d)		1,035
Goodwill		150			—			370	(e)		520
Identified Intangible Assets, net		56			—			825	(d)		881
Other Assets		113			112	(a)(b)		(3	)(d)		222
Total Assets	$	2,794		$	42		$	1,908		$	4,744
LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current Liabilities:
Accounts payable	$	234		$	—		$	—		$	234
Accrued liabilities		234			17	(a)		15	(d)		266
Short-term debt, including current portion of long-term debt		1,098			(1,085	)(b)		—			13
Liabilities of discontinued operations		297			—			2	(d)		299
Total Current Liabilities		1,863			(1,068	)		17			812
Long-Term Debt		386			1,410	(b)		—			1,796
Postretirement Liabilities		86			369	(a)		—			455
Environmental Remediation Liabilities		55			207	(a)		29	(d)		291
Deferred Tax Liabilities		47			(12	)(a)		194	(d)		229
Other Liabilities		83			34	(a)		7	(d)		124
Total Liabilities not Subject to Compromise		2,520			940			247			3,707
												��
Liabilities Subject to Compromise		1,962			(1,962	)(a)		—			—
Shareholders’ Equity (Deficit):
Successor common stock at $0.01 par value		—			1	(c)		—			1
Predecessor common stock at $0.01 par value		1			—			(1	)(c)		—
Additional contributed capital		56			1,036	(c)		(56	)(c)		1,036
Predecessor stock held in treasury, at cost		(251	)		—			251	(c)		—
Predecessor net deficiency of assets at spin-off		(113	)		—			113	(c)		—
Accumulated other comprehensive income (loss)		(97	)		127	(a)		(30	)(c)		—
Accumulated deficit		(1,284	)		(100	)(c)		1,384	(c)		—
Total Shareholders’ Equity (Deficit)		(1,688	)		1,064			1,661			1,037
Total Liabilities and Shareholders’ Equity (Deficit)	$	2,794		$	42		$	1,908		$	4,744

(a)	To record the discharge and payment of liabilities subject to compromise, payment of accrued post-petition interest, the re-establishment of liabilities to be retained by Successor, the defeasance of a substantial amount of our postretirement liabilities and the establishment of SFC LLC, a fund restricted to the payment of certain Legacy Liabilities.
(b)	To record the extinguishment of Predecessor debt and the write-off of any related unamortized debt financing costs and the establishment of Successor debt financing and related financing costs pursuant to our Financing Agreements.
(c)	To record the net effect of discharge of claims and liabilities subject to compromise, gain on the revaluation of assets and liabilities, cancellation of Predecessor common stock, close out of remaining equity balances of Predecessor in accordance with fresh-start accounting, and the issuance of Successor common stock and warrants to purchase common stock.
(d)	To adjust assets and liabilities to fair value.
(e)	The goodwill of Predecessor has been eliminated and the reorganization value in excess of amounts allocable to identified tangible and intangible assets has been classified as goodwill.

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SOLUTIA INC.

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

Liabilities Subject to Compromise

Liabilities subject to compromise refers to pre-petition obligations that were impacted by the Chapter 11 Case. The amounts represented our estimate of known or potential obligations to be resolved in connection with our Chapter 11 Case. The following table summarizes the components of liabilities subject to compromise included in our Consolidated Statement of Financial Position as of December 31, 2007:

	Predecessor
	December 31,
	2007
Postretirement benefits	$	664
Litigation reserves		106
Accounts payable		102
Environmental reserves		80
Other miscellaneous liabilities		311
Subtotal		1,263
Debt Subject to Compromise:
6.72% debentures due 2037		150
7.375% debentures due 2027		300
11.25% notes due 2009		223
		673
Unamortized debt discount and debt issuance costs		(14	)
Subtotal		659
Total Liabilities Subject to Compromise	$	1,922

Reorganization Items, net

Reorganization items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain or loss that we realized or incurred due to our reorganization under Chapter 11 of the U.S. Bankruptcy Code.

Reorganization items, net consisted of the following items:

	Predecessor
	Two Months			Three Months			Nine Months
	Ended			Ended			Ended
	February 29,			September 30,			September 30,
	2008			2007			2007
Discharge of claims and liabilities (a)	$	(104	)	$	—		$	—
Revaluation of assets and liabilities (b)		1,589			—			—
Professional fees (c)		(52	)		(18	)		(50	)
Severance and employee retention costs (d)		—			(1	)		(4	)
Settlements of pre-petition claims (e)		—			1			3
Adjustments to allowed claim amounts (f)		—			(134	)		(134	)
Total Reorganization Items, net	$	1,433		$	(152	)	$	(185	)

(a)	The discharge of claims and liabilities primarily relates to allowed general, unsecured claims in our Chapter 11 proceedings, such as (1) claims due to the rejection or modification of certain executory contracts, (2) claims relating to changes in postretirement healthcare benefits and the rejection of our non-qualified retirement plans, and (3) claims relating to the restructuring of financing arrangements.
(b)	We revalued our assets and liabilities at estimated fair value as a result of fresh-start accounting. This resulted in a $1,801 pre-tax gain, of which $212 is recognized in Income (Loss) from Discontinued Operations on the Consolidated Statement of Operations, primarily reflecting the fair value of newly recognized intangible assets, the elimination of our LIFO reserve and the increase in the fair value of tangible property and equipment.
(c)	Professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings.
(d)	Expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain of our employees approved by the Bankruptcy Court.
(e)	Represents the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded.
(f)	Adjustments to record certain pre-petition claims at estimated amounts of the allowed claims.

- 8 -

SOLUTIA INC.

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

We did not incur any additional reorganization items, net in the three or seven months ended September 30, 2008.

3. Significant Accounting Policies

Basis of Presentation

These financial statements should be read in conjunction with the audited consolidated financial statements and notes to consolidated financial statements included in our 2007 Annual Report on Form 10-K (“2007 Form 10-K”), as re-casted and filed with the Securities and Exchange Commission (“SEC”) in a Form 8-K on July 25, 2008 to reflect our segment reporting change as described in Note 14.

The consolidated financial statements for the period in which we were in bankruptcy were prepared in accordance with SOP 90-7 and on a going concern basis, which assumes the continuity of operations and reflects the realization of assets and satisfaction of liabilities in the ordinary course of business.

In accordance with SOP 90-7, we adopted fresh-start accounting as of the Effective Date. However, due to the proximity of the Effective Date to the February month end, for accounting convenience purposes, we have reported the effects of fresh-start accounting as if they occurred on February 29, 2008. Furthermore, as a result of the adoption of fresh-start accounting and as noted below, certain of our significant accounting policies have been updated. See Note 2 for further details on the adoption of fresh-start accounting.

Reclassifications

Upon emergence, we changed the classification of certain items in our Consolidated Statement of Operations. We also reclassified prior period amounts to conform to current period presentation. These changes have no impact on net income (loss) in any period prior to or subsequent to our emergence. These reclassifications are as follows for the three and nine months ended September 30, 2007:

Marketing expenses:We reclassified $38 and $105 of expenses for the three and nine months ended September 30, 2007, respectively, previously presented separately as marketing expenses on the Consolidated Statement of Operations to selling, general and administrative expenses.

	Three Months		Nine Months
	Ended		Ended
	September 30,		September 30,
	2007		2007
Selling, general and administrative expenses	$	27	$	71
Income (Loss) from Discontinued Operations	$	11	$	34

- 9 -

SOLUTIA INC.

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

Administrative expenses:We reclassified $27 and $74 of expenses for the three and nine months ended September 30, 2007, respectively, previously presented as administrative expenses on the Consolidated Statement of Operations as follows:

	Three Months			Nine Months
	Ended			Ended
	September 30,			September 30,
	2007			2007
Selling, general and administrative expenses	$	29		$	78
Research, development and other operating expenses, net	$	(1	)	$	(2	)
Income (Loss) from Discontinued Operations	$	(1	)	$	(2	)

Technological expenses:We reclassified $12 and $33 of expenses for the three and nine months ended September 30, 2007, respectively, previously presented as technological expenses on the Consolidated Statement of Operations as follows:

	Three Months		Nine Months
	Ended		Ended
	September 30,		September 30,
	2007		2007
Selling, general and administrative expenses	$	2	$	5
Research, development and other operating expenses, net	$	7	$	19
Income (Loss) from Discontinued Operations	$	3	$	9

Amortization expense:We reclassified $1 of expense for the nine months ended September 30, 2007, previously presented as amortization expense on the Consolidated Statement of Operations to selling, general and administrative expenses.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements which affect revenues and expenses during the period reported. Estimates are adjusted when necessary to reflect actual experience. Significant estimates were used to account for fresh-start accounting, restructuring reserves, environmental reserves, employee benefit plans, intangible assets, income taxes, asset impairments and contingencies. Actual results could materially differ from those estimates.

Inventory Valuation

Inventories are stated at cost or market, whichever is less. Actual cost is used to value raw materials and supplies. Standard cost, when it approximates actual cost, is used to value finished goods and goods in process. Variances, exclusive of unusual volume and operating performance, are capitalized into inventory. Standard cost includes direct labor and raw materials, and manufacturing overhead based on practical capacity. Prior to March 1, 2008, the cost of continuing operations related inventories in the United States, excluding supplies and the inventories of the CPFilms and rubber chemicals operations (33 percent as of December 31, 2007) was determined by the last-in, first-out (“LIFO”) method, which generally reflects the effects of inflation or deflation on cost of goods sold sooner than other inventory cost methods and all remaining inventories were determined by the first-in, first-out (“FIFO”) method. As of March 1, 2008, the cost of all continuing operations related inventories in the United States, excluding supplies (33 percent as of September 30, 2008) is determined by the LIFO method. The cost of inventories outside the United States, as well as supplies inventories in the United States, is determined by the FIFO method.

- 10 -

SOLUTIA INC.

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

Property, Plant and Equipment

Property, plant and equipment are recorded at cost and depreciated on a straight-line method over their respective estimated useful lives. In connection with our adoption of fresh-start accounting, we adjusted the net book values of property and equipment to their estimated fair values and revised the estimated useful life of machinery and equipment. The estimated useful lives for major asset classifications are as follows:

	Estimated Useful Lives
Asset Classification	Successor	Predecessor
Buildings and Improvements	5 to 35 years	5 to 35 years
Machinery and Equipment	5 to 20 years	3 to 15 years

Periodically, we conduct a complete shutdown of certain manufacturing units (“turnaround”) to perform necessary inspections, repairs and maintenance. Costs associated with significant turnarounds, which include estimated costs for material, labor, supplies and contractor assistance, are deferred and amortized ratably during the period between each planned activity, which generally occurs every 2 to 3 years.

Goodwill and Intangible Assets

Goodwill reflects the excess of the reorganization value of the Successor over the fair value of tangible and identifiable intangible assets from our adoption of fresh-start accounting. Goodwill and other intangible assets with indefinite lives are not amortized but are tested for impairment in the fourth quarter of each year or more frequently when an event occurs or circumstances change such that it is reasonably possible that an impairment may exist.

We test goodwill for impairment by first comparing the carrying value of each reporting unit, including goodwill, to its fair value. The fair value of the reporting unit is determined using an estimate of future cash flows of the reporting unit and a risk-adjusted discount rate to compute a net present value of future cash flows. If the fair value is determined to be less than carrying value, a second step is performed to compute the amount of the impairment, if any. Impairment of goodwill is measured as the excess of the carrying amount of goodwill over the net fair values of recognized and unrecognized assets and liabilities of the reporting unit. We test intangible assets with indefinite lives for impairment through comparison of the fair value of the intangible asset with its carrying amount. The fair value of intangible assets with indefinite lives is determined using an estimate of future cash flows attributable to the asset and a risk-adjusted discount rate to compute a net present value of future cash flows. The shortfall of the fair value below carrying value represents the amount of impairment.

Intangible assets that have finite useful lives are amortized over their determinable useful lives and assessed for impairment in accordance with our Impairment of Long-Lived Assets accounting policy. The estimated useful lives are as follows:

	Estimated Useful Lives
	Successor	Predecessor
Finite-Lived Intangible Assets	5 to 27 years	5 to 25 years

On a quarterly basis, the useful lives of these assets are evaluated to determine whether events or circumstances warrant a revision to the remaining period of amortization. If an estimate of an intangible’s useful life is changed, the remaining carrying amount of the asset will be amortized prospectively over the revised remaining useful life.

Derivative Financial Instruments

In accordance with SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), as amended, all derivatives which do not qualify for exceptions under SFAS No. 133, whether designated for hedging relationships or not, are recognized in the Consolidated Statement of Financial Position at their fair value.

- 11 -

SOLUTIA INC.

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

Currency forward and option contracts are used to manage currency exposures for financial instruments denominated in currencies other than the entity’s functional currency. We have chosen not to designate these instruments as hedges and to allow the gains and losses that arise from marking the contracts to market to be included in Other Income, net in the Consolidated Statement of Operations.

Interest rate caps and swaps are used to manage interest rate exposures on variable rate debt instruments. These market instruments are designated as cash flow hedges. The mark-to-market gain or loss on qualifying hedges is included in Accumulated Other Comprehensive Income in the Consolidated Statement of Financial Position to the extent effective, and reclassified into Interest Expense in the Consolidated Statement of Operations in the period during which the hedged transaction affects earnings. The mark-to-market gains or losses on ineffective portions of hedges are recognized in Interest Expense immediately.

Natural gas forward and option contracts are used to manage some of the exposure for the cost of natural gas. These market instruments are designated as cash flow hedges. The mark-to-market gain or loss on qualifying hedges is included in Accumulated Other Comprehensive Income in the Consolidated Statement of Financial Position to the extent effective, and reclassified into Cost of Goods Sold in the Consolidated Statement of Operations in the period during which the hedged transaction affects earnings. The mark-to-market gains or losses on ineffective portions of hedges are recognized in Cost of Goods Sold immediately.

Recently Issued Accounting Standards

In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, (“SFAS No. 161”). SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 and requires entities to provide enhanced qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair values and amounts of gains and losses on derivative contracts, and disclosures about credit-risk-related contingent features in derivative agreements. The provisions of SFAS No. 161 are effective for fiscal years beginning after November 15, 2008. We are currently evaluating the impact of SFAS No. 161 on the consolidated financial statements.

4. Discontinued Operations

Integrated Nylon Business — Held for Sale

During the three months ended September 30, 2008, we conducted a review of strategic alternatives for our Integrated Nylon business and concluded a sale of the business is probable. Accordingly, the assets and liabilities and the operating results of Integrated Nylon have been classified as discontinued operations on the consolidated financial statements. We were required to perform an impairment test of the Integrated Nylon asset group in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. For purposes of testing for impairment, we estimated the fair value of this asset group by weighting certain market information and discounted cash flows that the asset group could be expected to generate over its useful life. Our test concluded that no impairment existed at September 30, 2008.

The carrying amounts of assets and liabilities from Integrated Nylon have been classified as current in the Consolidated Statement of Financial Position and consisted of the following:

	Successor		Predecessor
	September 30,		December 31,
	2008		2007
Assets:
Trade receivables, net	$	185	$	155
Miscellaneous receivables		11		19
Inventories		450		149
Prepaid expenses and other assets		14		9
Property, plant and equipment, net		457		433
Identified intangible assets, net		—		1
Other assets		50		35
Assets of discontinued operations	$	1,167	$	801
Liabilities:
Accounts payable	$	143	$	162
Accrued liabilities		80		58
Environmental remediation liabilities		9		5
Other liabilities		57		63
Liabilities of discontinued operations	$	289	$	288

- 12 -

SOLUTIA INC.

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

The operating results of Integrated Nylon have been reported separately as discontinued operations, net of tax, in the Consolidated Statement of Operations for each period presented. The operating results for Integrated Nylon reflect adjustments to our LIFO Inventory reserve associated with this operating segment and interest expense associated with debt which is anticipated to be repaid with sales proceeds which had not previously been allocated to the results of this segment. In addition, certain corporate expenses and reorganization items, net are excluded from the operating results which had previously been allocated to Integrated Nylon. The net sales and income (loss) from discontinued operations are as follows:

	Successor			Predecessor		Successor			Predecessor
	Three Months			Three Months		Seven Months			Two Months		Nine Months
	Ended			Ended		Ended			Ended		Ended
	September 30,			September 30,		September 30,			February 29,		September 30,
	2008			2007		2008			2008		2007
Operating results:
Net sales	$	506		$	507	$	1,174		$	318	$	1,423
Income before income taxes	$	(30	)	$	23	$	(57	)	$	197	$	14
Income tax expense		1			—		1			—		1
Income (Loss) from discontinued operations	$	(31	)	$	23	$	(58	)	$	197	$	13

Water Treatment Phosphonates Business — Divestiture

On May 31, 2007, we sold DEQUEST^®, our water treatment phosphonates business (“Dequest”) to Thermphos Trading GmbH (“Thermphos”). Under the terms of the agreement, Thermphos purchased the assets and assumed certain of the liabilities of Dequest for $67, subject to a working capital adjustment. As part of the closing of the sale, our affiliated companies and Thermphos entered into a ten year lease and operating agreement under which we will continue to operate the Dequest production facility for Thermphos at our plant in Newport, Wales, United Kingdom. We do not consider the cash flows generated by the lease and operating agreement to be direct cash flows of Dequest since we have not retained any risk or reward in the business.

Dequest was a component of the Performance Products segment (prior to segment realignment further described in Note 14) prior to the classification as discontinued operations. We recorded a gain on the sale of Dequest of $34.

Net sales and income from discontinued operations for the three and nine months ended September 30, 2007 are as follows:

	Three Months		Nine Months
	Ended		Ended
	September 30,		September 30,
	2007		2007
Net sales	$	—	$	43
Income before income taxes	$	—	$	34
Income tax expense		—		5
Income from discontinued operations	$	—	$	29

- 13 -

SOLUTIA INC.

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

5. Share-Based Compensation

Predecessor

In accordance with the Plan, all existing equity interests, including shares authorized for grant and options outstanding under the Solutia Inc. 2000 Stock-Based Incentive Plan and the Solutia Inc. 1997 Stock-Based Incentive Plan, and the underlying plans, were cancelled upon the Effective Date.

Successor

On the Effective Date, we adopted the Solutia Inc. 2007 Management Long-Term Incentive Plan (“2007 Management Plan”). The 2007 Management Plan authorizes up to 7,200,000 shares of our common stock for grants of non-qualified and incentive stock options, stock appreciation rights, restricted stock, restricted stock units and other stock awards. The shares used may be newly issued shares, treasury shares or a combination. As of September 30, 2008, 2,861,739 shares from the 2007 Management Plan remained available for grants.

Also on the Effective Date, we adopted the Solutia Inc. 2007 Non-Employee Director Stock Compensation Plan (“2007 Director Plan”). The 2007 Director Plan authorizes up to 250,000 shares of our common stock for grants of stock options, stock appreciation rights, restricted stock, restricted stock units and other stock awards. The shares used may be newly issued shares, treasury shares or a combination. As of September 30, 2008, 203,840 shares from the 2007 Director Plan remained available for grants.

Stock Options

We granted options to purchase a total of 2,940,542 shares of common stock to eligible employees under the 2007 Management Plan during the seven months ended September 30, 2008. The options (i) have an exercise price of not less than 100 percent of the fair market value of the common stock on the grant date, (ii) become exercisable in three equal installments on the first, second, and third anniversary of the grant date, subject to the employee’s continued employment and (iii) expire on the tenth anniversary of the grant date.

The fair value of stock options is determined at the grant date using a Black-Scholes model, which requires us to make several assumptions. The risk-free rate is based on the U.S. Treasury yield curve in effect for the expected term of the options at the time of grant. The dividend yield on our common stock is assumed to be zero since we do not pay dividends and have no current plans to do so. Due to our Chapter 11 Case, our historical volatility data and employee stock option exercise patterns were not considered in determining the volatility data and expected life assumptions. The volatility assumptions were based on (i) historical volatilities of the stock of comparable chemical companies whose shares are traded using daily stock price returns equivalent to the expected term of the options and (ii) implied volatility. The expected life of an option was determined based on a simplified assumption that the option will be exercised evenly from the time it becomes exercisable to expiration, as allowed by SEC Staff Accounting Bulletin No. 110.

The weighted-average fair value of options granted during the seven months ended September 30, 2008 was determined based on the following weighted-average assumptions:

	Successor
	September 30,
	2008
Expected volatility		26.1	%
Expected term (in years)		6
Risk-free rate		4.24	%
Weighted-average grant date fair value	$	5.91

- 14 -

SOLUTIA INC.

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

A summary of stock option information as of September 30, 2008 is as follows:

					Weighted-Average		Aggregate
			Weighted-Average		Remaining		Intrinsic
	Options		Exercise Price		Contractual Life		Value (a)
Vested or Expected to Vest at September 30, 2008		2,724,351	$	17.30		9.4	$	(9	)
Exercisable at September 30, 2008		66,667	$	17.33		9.4	$	—

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

During the three and seven months ended September 30, 2008, we recognized $1 and $2 of compensation expense related to our stock options, respectively, of which, $0 and $1 are allocated to discontinued operations. Pre-tax unrecognized compensation expense for stock options, net of estimated forfeitures, was $14 as of September 30, 2008 and will be recognized as expense over a remaining weighted-average period of 5.4 years.

Restricted Stock Awards

We granted 1,506,414 shares and 46,160 shares of restricted stock awards to eligible employees under the 2007 Management Plan and to our non-employee directors under the 2007 Director Plan, respectively, during the seven months ended September 30, 2008. The weighted-average grant date fair value of restricted stock awards granted during the seven months ended September 30, 2008 was $17.21 per share.

During the three and seven months ended September 30, 2008, we recognized $3 and $6 of compensation expense related to our restricted stock awards, respectively, of which, $1 for both periods is allocated to discontinued operations. Pre-tax unrecognized compensation expense for restricted stock awards, net of estimated forfeitures, was $18 as of September 30, 2008 and will be recognized as expense over a remaining weighted-average period of 2.0 years.

6. Goodwill and Other Intangible Assets

Goodwill

As a result of applying fresh-start accounting, the Successor recorded goodwill of $520 as of February 29, 2008. During the seven months ended September 30, 2008, we realized tax benefits attributable to certain pre-emergence net operating loss carryforwards and deductible temporary differences which were fully reserved at the Effective Date by entities in the United Kingdom. Realization of these tax benefits and the reduction of valuation allowance resulted in the reduction of goodwill of $9 in accordance with SOP 90-7. Goodwill by reportable segment is as follows:

	Successor
	September 30,
	2008
SAFLEX®	$	205
CPFilms		159
Technical Specialties		147
Total	$	511

- 15 -

SOLUTIA INC.

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

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. The value assigned to the identified intangible assets upon the adoption of fresh-start accounting represents our best estimates of fair value based on internal and external valuations. These intangible assets are summarized in aggregate as follows:

	Successor									Predecessor
	September 30, 2008									December 31, 2007
	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		23 to 27	$	495	$	(11	)	$	484		12	$	1	$	(—	)	$	1
Technology		5 to 26		203		(6	)		197		15 to 25		18		(1	)		17
Trade names		25		13		(—	)		13		16 to 25		2		(—	)		2
Patents		13		5		(—	)		5		5 to 10		2		(—	)		2
Contract-based				—		(—	)		—		5 to 20		18		(8	)		10
Non amortizable intangible assets:
Trademarks				152		—			152				26		—			26
Total Identified Intangible Assets			$	868	$	(17	)	$	851			$	67	$	(9	)	$	58

During the three and seven months ended September 30, 2008, we recognized $8 and $18, respectively, of amortization expense. Amortization expense is allocated to cost of goods sold and selling, general and administrative expenses in the Consolidated Statement of Operations as follows:

	Three Months		Seven Months
	Ended		Ended
	September 30,		September 30,
	2008		2008
Cost of goods sold	$	3	$	6
Selling, general and administrative expenses	$	5	$	12

We expect amortization expense for intangible assets to be approximately $25 in 2008 and $30 from 2009 through 2012.

7. Detail of Certain Balance Sheet Accounts

	Successor		Predecessor
	September 30,		December 31,
Inventories	2008		2007
Finished goods	$	221	$	188
Goods in process		48		39
Raw materials and supplies		85		76
Inventories, at FIFO cost		354		303
Excess of FIFO over LIFO cost		—		(35	)
Total Inventories	$	354	$	268

- 16 -

SOLUTIA INC.

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

In connection with the adoption of fresh-start accounting, inventories were recorded at fair value resulting in the elimination of the LIFO reserve and a step-up in basis of $67 at the Effective Date. The $67 step-up in basis was charged to Cost of Goods Sold in the Successor Consolidated Statement of Operations during the four months ended June 30, 2008.

	Successor			Predecessor
	September 30,			December 31,
Property, Plant and Equipment	2008			2007
Land	$	34		$	33
Leasehold improvements		7			23
Buildings		211			338
Machinery and equipment		717			1,279
Construction in progress		49			48
Total property, plant and equipment		1,018			1,721
Less accumulated depreciation		(40	)		(1,102	)
Total	$	978		$	619

	Successor		Predecessor
	September 30,		December 31,
Accrued Liabilities	2008		2007
Wages and benefits	$	59	$	84
Environmental remediation liabilities		34		15
Accrued income and other taxes payable		41		20
Accrued selling expenses		23		19
Accrued interest		10		24
Other		109		77
Total Accrued Liabilities	$	276	$	239

8. Income Taxes

Income Tax Expense

We recorded income tax expense of $17 for both the three and seven months ended September 30, 2008. We recorded income tax expense of $11 and $24 in the three and nine months ended September 30, 2007, respectively.

Our income tax expense or benefit is affected by the mix of income and losses in the tax jurisdictions in which we operate. For the three and seven months ended September 30, 2008 and the three and nine months ended September 30, 2007, our effective tax rate differs from the U.S. statutory rate because in some jurisdictions in which we experience losses, predominately the U.S., we have recorded a valuation allowance against the tax benefit.

We recorded income tax expense for the two months ended February 29, 2008 of $214 which is predominantly comprised of deferred tax expense on the revaluation of our inventory, fixed assets and identified intangible assets and income tax expense on increases in our unrecognized tax benefit liabilities recorded in conjunction with our emergence from bankruptcy and the adoption of fresh-start accounting. We also recorded income tax expense on earnings of ex-U.S. operations for the two months ended February 29, 2008. Our effective tax rate was lower than the U.S. statutory rate, predominantly due to our mix of earnings, including U.S. reorganization items, in tax jurisdictions where no tax expense is provided due to the release of valuation allowances.

Unrecognized Tax Benefits

The total amount of unrecognized tax benefits at September 30, 2008 and December 31, 2007 was $164 and $146, respectively. The increase in this amount is mainly the result of currency exchange rate fluctuations and tax positions related to events in the current year. Included in the balance at September 30, 2008 and December 31, 2007 were $66 and $50, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax.

- 17 -

SOLUTIA INC.

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

We file income tax returns in the United States and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2002. It is reasonably possible that within the next 12 months as a result of the resolution of Federal, state and foreign examinations and appeals, and the expiration of various statutes of limitation that the unrecognized tax benefits that would affect the effective tax rate will decrease by a range of $0 to $17 and the unrecognized tax benefits that would not affect the effective tax rate will decrease by a range of $0 to $8.

Net Operating Loss and Valuation Allowance

As a result of the issuance of New Common Stock upon emergence from bankruptcy, we realized a change of ownership for purposes of Section 382 of the Internal Revenue Code. We do not currently expect this change to significantly limit our ability to utilize our U.S. net operating loss carryforward, which we estimate to be approximately $1.2 billion on the date of emergence.

9. Restructuring Costs

On May 21, 2008, we announced the planned exit of our manufacturing facility in Ruabon, Wales, United Kingdom (the “Ruabon Facility”) within the Technical Specialties segment. We expect to cease our manufacturing at the Ruabon Facility by the end of 2008 with a final closure by the end of 2011. The decision to cease manufacturing of the three product lines at the Ruabon Facility is the result of an over-supplied market from predominantly Far Eastern producers, resulting in the Ruabon Facility no longer being cost competitive on a global scale. We expect to incur charges ranging from $45 to $60 over the next four years. Estimates of the total cost we expect to incur for each major type of cost are: (i) $17 to $22 for severance and retraining, (ii) $13 to $16 for indirect residual costs which we are contractually obligated to incur to continue providing third party operations at the site for the next two years, and (iii) $15 to $22 for other costs including clean-out and demolition costs. During the three and seven months ended September 30, 2008, $8 and $9 of restructuring costs, respectively, were recorded for the exit of the Ruabon Facility in Cost of Goods Sold. The costs were related to severance, contract termination costs related to the shutdown of one of the product lines during the current quarter and other restructuring costs.

A summary of restructuring activity during the two months ended February 29, 2008 and the seven months ended September 30, 2008 is as follows:

	Future						Other
	Contractual			Employment			Restructuring
	Payments			Reductions			Costs			Total
Predecessor
Balance at December 31, 2007	$	3		$	5		$	—		$	8
Amounts utilized		—			(1	)		—			(1	)
Currency fluctuations		—			1			—			1
Balance at February 29, 2008		3			5			—			8
Successor
Charges taken		3			5			2			10
Amounts utilized		(1	)		(3	)		(2	)		(6	)
Change in estimates		2			(2	)		—			—
Balance at September 30, 2008	$	7		$	5		$	—		$	12

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SOLUTIA INC.

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

10. Commitments and Contingencies

Litigation

Because of the size and nature of our business, we are a party to numerous legal proceedings, those of which are potentially material, are summarized below. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. Certain of these matters relate to Flexsys, which became a 100% owned subsidiary on May 1, 2007 upon our acquisition of the 50% interest owned by Akzo Nobel. All claims in the Flexsys antitrust and tort litigation matters described below concern alleged conduct occurring while Flexsys was a joint venture of Solutia and Akzo Nobel, and any potential damages in these cases would be evenly apportioned between Solutia and Akzo Nobel.

Except for the potential effect of an unfavorable outcome with respect to our Legacy Tort Litigation (which we believe is remote as described below), it is our opinion that the aggregate of all claims and lawsuits will not have a material adverse impact on our consolidated financial statements.

Legal Proceedings Resolved in Our Chapter 11 Process

With respect to the matter captioned asSavings and Investment Plan Litigationin the 2007 Form 10-K,in December 2007, the parties to the Savings and Investment Plan bankruptcy claim and litigation reached a global settlement of all outstanding issues and subsequently entered into a formal settlement agreement to that effect. The amount of the settlement to be paid in New Common Stock is $7 from the disputed claims reserve established for such matter. The United States District Court, Southern District of New York entered an order on September 24, 2008, which formally approved the terms of the settlement.

Legal Proceedings Ongoing Post-Chapter 11

Flexsys Patent and Related Litigation

Flexsys holds various patents covering inventions in the manufacture of rubber chemicals, including patents describing and claiming a manufacturing process for 4-aminodiphenylamine (“4-ADPA”), a key building block for the manufacture of 6PPD and IPPD, as well as a manufacturing process for 6PPD and IPPD, which function as anti-degradants and are used primarily in the manufacture of rubber tires. Flexsys is engaged in litigation in several jurisdictions to protect and enforce its patents.

Legal Proceedings in the United States

The ITC-1 proceeding. In February 2005, Flexsys filed a complaint with the U.S. International Trade Commission (“ITC”), requesting that the ITC initiate an investigation against Sinorgchem Co. Shangdong, a Chinese entity (“Sinorgchem”), Korea Kumho Petrochemical Company, a Korean company (“KKPC”), and third party distributors of Sinorgchem. Flexsys claims the process Sinorgchem uses to make 4-ADPA and 6PPD, its sale of 6PPD for importation into the United States, and Sinorgchem’s sale of 4-ADPA to KKPC and KKPC’s importation of 6PPD into the United States are covered by Flexsys’ patents. Accordingly, Flexsys requested that the ITC issue a limited exclusion order prohibiting the importation into the United States of 4-ADPA and 6PPD originating from these entities. In February 2006, an Administrative Law Judge (“ALJ”) of the ITC determined that Flexsys’ patents were valid, that the process used by Sinorgchem to make 4-ADPA and 6PPD was covered by Flexsys’ patents, and that Sinorgchem and its distributor, but not KKPC, had violated section 1337 of the U.S. Tariff Act. In July 2006, the ITC substantially upheld the ALJ’s decision on the basis of literal infringement, and subsequently issued a limited exclusion order against Sinorgchem and its distributor prohibiting them from importing 4-ADPA and 6PPD manufactured by Sinorgchem into the United States.

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SOLUTIA INC.

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

Sinorgchem appealed the ITC decision to the United States Court of Appeals for the Federal Circuit. On December 21, 2007, a three-judge panel of the Federal Circuit overruled the ITC’s finding that Sinorgchem had literally infringed Flexsys’ patent and remanded the matter to the ITC to determine whether Sinorgchem’s processes infringe Flexsys’ patent on other grounds set forth by Flexsys. The limited exclusion order was lifted, and the matter is currently before the ALJ for consideration of the infringement claim on these other grounds. This action involves enforcement of Flexsys’ patents, and does not involve any claims for damages against Flexsys.

The ITC-2 proceeding.In May 2008, Flexsys filed a second complaint with the ITC, requesting that the ITC initiate an investigation against Sinorgchem, KKPC, Kumho Tire Co. Inc., and Kumho Tire USA, Inc., based upon allegations that Sinorgchem violated Flexsys’ patents for producing intermediate materials used to make 4-ADPA. Flexsys’ complaint requests that the ITC issue a limited exclusion order prohibiting the importation into the United States of 4-ADPA and 6PPD originating from these entities. The ITC formally instituted an investigation pursuant to this complaint on July 3, 2008. However, in September 2008, the ALJ entered an order in favor of the respondents, thereby terminating the investigation. Flexsys has subsequently filed a petition with the ITC seeking review of the ALJ’s decision. A decision from the ITC is expected in late 2008. This action involves enforcement of Flexsys’ patents, and does not involve any claims for damages against Flexsys.

United States Civil Patent Infringement Litigation. In January 2005, Flexsys filed suit in United States District Court for the Northern District of Ohio for patent infringement against Sinorgchem, KKPC, Kumho Tire Korea and Kumho Tire USA, affiliates of KKPC, and certain other tire distributors seeking monetary damages as well as injunctive relief. This action is currently stayed pending resolution of theITC-1matter described above.

In re Rubber Chemicals Antitrust Litigation. In April 2006, KKPC filed suit against Flexsys in the United States District Court for the Central District of California for alleged violations of the Sherman Act, breach of contract, breach of the implied covenant of good faith and fair dealing, declaratory relief, intentional interference with prospective economic advantage, disparagement and violations of the California Business & Professions Code. This matter was subsequently transferred to the United States District Court, Northern District of California. The court dismissed KKPC’s initial complaint, but granted KKPC the right to refile an amended complaint, which KKPC filed in September 2007. The court dismissed the amended complaint in part, with the exception of two state law claims for unfair competition and tortious interference. The court granted KKPC the right to refile another amended complaint, which KKPC filed in April 2008. Flexsys’ motion to dismiss the latest amended complaint is pending. In the meantime, KKPC has moved the court to supplement its complaint again with additional claims. KKPC has not specified the amount of its alleged damages in its complaints, and Solutia believes the likelihood of a material judgment against Flexsys to be remote.

Legal Proceedings in Europe, Korea, and China.Various parties, including Sinorgchem and other competitors of Flexsys, have filed other, separate actions in patent courts in Europe, Korea, and China seeking to invalidate certain of Flexsys’ patents issued in those jurisdictions. Flexsys has also filed a patent infringement action in Korea to enforce its patents against KKPC. None of these cases involve claims for damages against Flexsys.

Legacy Tort Litigation

Pursuant to the Amended and Restated Settlement Agreement dated February 28, 2008, entered into by Solutia and Monsanto in connection with our emergence from Chapter 11 (the “Monsanto Settlement Agreement”), Monsanto is responsible to defend and indemnify Solutia for any Legacy Tort Claims as that term is defined in the agreement, while Solutia retains responsibility for tort claims arising out of exposure occurring after the Solutia Spinoff. Solutia and Flexsys have been named as defendants in the following actions, and have tendered the matters to Monsanto as Legacy Tort Claims. Solutia and Flexsys would potentially be liable with respect to these matters to the extent they relate to post Solutia Spinoff exposure or such matters are not within the meaning of “Legacy Tort Claims” within the Monsanto Settlement Agreement.

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

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SOLUTIA INC.

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

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 Inc. 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 (then known as Monsanto, 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.

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 Putnam County, West Virginia, by residents of that county. 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.

Escambia County, Florida Litigation.On June 6, 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 Pensacola plant. The lawsuit, entitledJohn Allen, et al. v. Monsanto Company, et al., alleges that the defendants are responsible for elevated levels of PCBs in the Escambia River and Escambia Bay due to past and allegedly 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 complaints.

Cash Balance Plan Litigation

Since October 2005, current and former participants in the Solutia Inc. Employees’ Pension Plan (the “Pension Plan”) have filed three class actions alleging that the Pension Plan is discriminatory based upon age and that the lump sum values of individual account balances in the Pension Plan have been, and continue to be, miscalculated. Solutia has not been named as a defendant in any of these cases. Two of these cases, captionedDavis, et al. v. Solutia, Inc. Employees’ Pension PlanandHammond, et al. v. Solutia, Inc. Employees’ Pension Plan, are still pending in the Southern District of Illinois, and have been consolidated with similar cases against Monsanto Company and the Monsanto Company Pension Plan (Walker et al. v. The Monsanto Pension Plan, et al.) and the Pharmacia Cash Balance Pension Plan, Pharmacia Corporation, Pharmacia and Upjohn, Inc., and Pfizer Inc. (Donaldson v. Pharmacia Cash Balance Pension Plan, et al.). The plaintiffs in the Pension Plan cases seek to obtain injunctive and other equitable relief (including money damages awarded by the creation of a common fund) on behalf of themselves and the nationwide putative class of similarly situated current and former participants in the Pension Plan.

A Consolidated Class Action Complaint (the “Complaint”) was filed by all of the plaintiffs in the consolidated case on September 4, 2006. The Complaint alleged three separate causes of action against the Pension Plan: (1) the Pension Plan violates the Employee Retirement Income Security Act (“ERISA”) by terminating interest credits on prior plan accounts at the age of 55; (2) the Pension Plan is improperly backloaded in violation of ERISA; and (3) the Pension Plan is discriminatory on the basis of age. In September 2007, the second and third of these claims were dismissed by the court.

By consent of the parties, the court certified a class with respect to the Pension Plan on plaintiffs’ claim that the Pension Plan discriminated against employees on the basis of their age by only providing interest credits on prior plan accounts through age 55. Summary judgment motions have been filed in the case, and are currently pending.

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SOLUTIA INC.

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

Department of Justice Investigations

We received two grand jury subpoenas from the Antitrust Division of the United States Department of Justice (the “DOJ”). The first subpoena, which we received in April 2006, relates to the DOJ’s investigation of potential antitrust violations in the adipic acid industry. The second subpoena, which we received in September 2007, pertains to the DOJ’s investigation of potential antitrust violations in the sodium tripoloyphosphate (“STPP”) industry. During the relevant time period of the subpoena, we were an owner of Astaris LLC, a 50/50 joint venture with FMC Corporation, which manufactured and marketed phosphorus-based products, including STPP. We and our joint venture partner sold substantially all of the assets of Astaris in November 2005 to Israel Chemicals Limited. We have not engaged in the STPP business since the sale of our interest in the Astaris assets. We are fully cooperating with the DOJ in both investigations, which are ongoing.

LaSalle Termination Litigation

Solutia Canada Inc. (“SOCAN”) filed suit in Quebec Court in December 2006, alleging breach of contract by INEOS Americas LLC (“INEOS”). In late 2002, we negotiated a Stock and Asset Purchase Agreement for the sale of our Resimenes & Additives business to UCB S.A. (“UCB”). As part of this agreement, we agreed to exclude the LaSalle assets from the agreement and entered into the LaSalle Toll Agreement (“LTA”) with UCB. The LTA passed through all the benefits and risks of ownership of the LaSalle operations to UCB, other than pre-closing environmental liabilities. In the LTA, SOCAN agreed to operate its LaSalle Plant for the benefit of UCB and to provide all the necessary services to convert UCB’s raw materials on a cost-neutral basis. Thus, UCB would pay SOCAN for all of its actual, direct and indirect costs incurred in connection with the performance or supply of services under the LTA or in holding itself ready to perform or supply those services. In the years after its execution, the LTA was assigned by UCB to Cytec Industries, Inc., then to INEOS.

On January 31, 2006, INEOS notified SOCAN of its intention to terminate the LTA effective January 31, 2008, in compliance with the terms of the LTA. INEOS’ decision to terminate the LTA has triggered the shutdown of all activities at the LaSalle Plant, resulting in termination costs recoverable by SOCAN against INEOS. INEOS disputed and refused to pay SOCAN’s termination costs under the LTA.

We filed this litigation against INEOS in December 2006 for breach of the LTA with respect to such termination costs. On June 4, 2008, SOCAN submitted an amended claim to the Court, clarifying and amending SOCAN’s damages claim against INEOS based on actual costs incurred in connection with the cessation of operations. SOCAN’s revised claim alleges approximately $40 in unpaid damages. INEOS has filed a cross-demand against SOCAN for $1, alleging SOCAN improperly charged INEOS on its October and November 2006 invoices for items which INEOS claims are not actual direct or indirect costs under the LTA. Discovery is expected to conclude in late 2008. No trial date has been scheduled, but Solutia does not believe a trial will likely occur prior to 2010.

Concluded matters

The matters referred to in our 2007 Form 10-K and Form 10-Q for the period ended March 31, 2008, as theFerro Antitrust Investigationand theTexas Commission on Environmental Quality Administrative Enforcement Proceedinghave concluded pursuant to the terms described in those filings, and are no longer deemed pending contingencies. In the third quarter of 2008, the litigation matter captioned Savings and Investment Plan Litigation concluded and is no longer deemed a pending contingency.

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 which we may have disposed of waste or other materials. Under some circumstances, the scope of our liability may extend to damages to natural resources. 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.

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SOLUTIA INC.

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

Further, under terms of the Monsanto Settlement Agreement and our Plan of Reorganization, 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 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 the Effective Date up to a total of $325. Thereafter, if needed, we and Monsanto will share responsibility equally. The effect of the Monsanto Settlement Agreement and the Plan of Reorganization, along with the application of fresh-start accounting, was an increase in our environmental reserve at the Effective Date of $257. To partially fund our environmental liabilities, a portion of the proceeds from stock issued by us on the Effective Date was set aside and restricted for this purpose. As of September 30, 2008, $34 of these proceeds remains available to fund future allowable environmental expenditures.

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 approximately 15 - 20 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
Predecessor
Balance at December 31, 2007	$	71
Charges taken		257
Amounts utilized		(1	)
Currency fluctuations		—
Balance at February 29, 2008		327
Successor
Charges taken		6
Amounts utilized (a)		(12	)
Currency fluctuations		(1	)
Balance at September 30, 2008	$	320
Environmental Remediation Liabilities, current	$	34
Environmental Remediation Liabilities, long-term		286
Balance at September 30, 2008	$	320

(a) For the seven months ended September 30, 2008, allowable expenditures of $12 were reimbursed to us by a special purpose entity established with proceeds of stock issued by us on the Effective Date.

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.

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SOLUTIA INC.

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

Except as noted below, we believe that these matters, when ultimately resolved, which may be over an extended period of time, will not have a material adverse effect on our Consolidated Statement of Financial Position, but could have a material adverse effect on Consolidated Statement of Operations in any given period. Our significant sites are described in more detail below:

Anniston, Alabama: On Aug. 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Revised Partial Consent Decree, pursuant to which Pharmacia and Solutia are obligated to perform residential cleanup work and a remedial investigation/feasibility study (RI/FS) as a result of PCB contamination from our Anniston plant, among other things, committed prior to the Solutia Spinoff. The residential cleanup is proceeding and should be completed within the next two years. Some level of remediation of non-residential properties and creek floodplains and/or sediment will be required in the future and we have accrued for this liability based upon our understanding of the level and extent of contamination in these areas, the remedial effort required by various governmental organizations and using estimated costs associated with similar remediation projects. We may recover some of our investigation and remediation costs from other potentially responsible parties (PRPs) against whom we filed a cost recovery action in July, 2003 but because the eventual outcome of these proceedings is uncertain, our environmental liability at September 30, 2008 does not incorporate this potential reimbursement. State and Federal Natural Resource Damage Trustees have asserted a claim for potential natural resource damage but have yet to undertake an assessment as to the nature and extent of such damages. As of September 30, 2008, we have accrued $120 for all environmental remediation projects in the Anniston, Alabama area which represents our best estimate of the final cost liability. Timing of the remediation will not be established until we complete the RI/FS, a Record of Decision is issued by the United States Environmental Protection Agency (USEPA), and a consent decree 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 have been classified as part of either the Sauget Area 1 Sites or the Sauget Area 2 Sites. We are conducting 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 we complete the RI/FS, 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, which is expected within the next two years. We have an agreement with two other PRPs to enter into an allocation proceeding upon issuance of the Record of Decision to resolve our respective shares of the liability for the Sauget Area 1 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 conducting the RI/FS with other PRPs based on interim allocations and have agreed, upon issuance of the Record of Decision, to participate in an allocation proceeding to fully resolve each PRP’s share of the liability for the investigation and remediation costs. An interim groundwater remedy has been installed pursuant to a Unilateral Administrative Order issued on October 3, 2002, and the RI/FS was submitted in early 2008. We anticipate that USEPA will issue a Record of Decision sometime in late 2009 or early 2010. 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. Our best estimate of the ultimate cost of all corrective measures that will be required at the Sauget, Illinois area is $82 which we have accrued as of September 30, 2008.

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. 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 with the final remediation approach and timing for some of the corrective measures being determined only after investigation and pilot testing phases are completed. Our best estimate of the ultimate cost of all corrective measures that will be required at the W.G. Krummrich Site is $27 which we have accrued as of September 30, 2008.

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SOLUTIA INC.

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

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 $91 which we have accrued as of September 30, 2008.

11. Fair Value of Financial Instruments

We adopted SFAS No. 157,Fair Value Measurements(“SFAS No. 157”), on January 1, 2008, with the exception of the application of the statement to non-recurring nonfinancial assets and liabilities which has been deferred until January 1, 2009 by FASB Staff Position 157-2,Effective Date of Statement 157. Other than new disclosure, there was no impact to our consolidated financial statements upon adoption of SFAS No. 157.

In accordance with SFAS No. 157, we have categorized our financial assets and liabilities, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

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 September 30, 2008
			Quoted Prices in Active Markets				Significant
			for Identical		Significant Other		Unobservable
			Assets		Observable Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Derivatives — Commodities (a)	$	2	$	—	$	2	$	—
Derivatives — Interest Rates (b)		2		—		2		—
Derivatives — Foreign Exchange (c)		1		—		1		—
Total	$	5	$	—	$	5	$	—
Liabilities:
Derivatives — Commodities (a)	$	6	$	—	$	6	$	—
Derivatives — Interest Rates (b)		4		—		4		—
Derivatives — Foreign Exchange (c)		7		—		7		—
Total	$	17	$	—	$	17	$	—

(a)	Includes commodity forward contracts which are valued using a pricing model with inputs that are observable in the market, such as quoted forward prices of commodities, or that can be derived from or corroborated by observable market data.
(b)	Includes interest rate caps and swaps which are valued using counterparty quotes, which use discounted cash flows and the then-applicable forward interest rates.
(c)	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.

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SOLUTIA INC.

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

12. Pension Plans and Other Postretirement Benefits

During our Chapter 11 Case, we amended our U.S. qualified pension plan in 2004 and 2005 to cease future benefit accruals for union and non-union participants, respectively, in these plans which eliminated service costs for benefits earned as a pension benefit cost. Furthermore, we amended our U.S. postretirement plan in accordance with the Plan for retiree participants and established a VEBA retiree trust at the Effective Date. The postretirement plan amendment, which became effective on the Effective Date, reduces the eligible charges covered by the postretirement plan and establishes a lifetime maximum benefit. This action resulted in a curtailment of the U.S. postretirement plan, as defined by SFAS No. 106,Employers’ Accounting for Postretirement Benefits Other Than Pensions(“SFAS No. 106”), due to the changes in medical benefits provided to retiree participants in our U.S. postretirement plan. The net result of this action was a $109 gain recorded in Accumulated Other Comprehensive Loss in the Consolidated Statement of Financial Position as of February 29, 2008. As described in Note 2, upon the adoption of fresh-start accounting, the balance in Accumulated Other Comprehensive Loss in the Consolidated Statement of Financial Position was reduced to zero and charged to Reorganization Items, net. The VEBA retiree trust, valued at $195 as of February 29, 2008 as funded by proceeds from the sale of New Common Stock and a contribution of the retirees’ allowed unsecured claim, effectuates defeasance of a substantial amount of the remaining healthcare and other benefits liabilities assumed by us at the Solutia Spinoff.

Components of Net Periodic Benefit Cost

For the three months ended September 30, 2008 and 2007, the two months ended February 29, 2008 and the seven and nine months ended September 30, 2008 and 2007, respectively, our pension and healthcare and other benefit costs, which are recognized in continuing and discontinued operations, were as follows:

	Pension Benefits
	Successor			Predecessor			Successor			Predecessor
	Three Months			Three Months			Seven Months			Two Months			Nine Months
	Ended			Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			February 29,			September 30,
	2008			2007			2008			2008			2007
Service costs for benefits earned	$	2		$	2		$	3		$	1		$	4
Interest costs on benefit obligation		17			17			40			12			51
Assumed return on plan assets		(16	)		(19	)		(41	)		(13	)		(54	)
Actuarial net loss		—			4			—			2			9
Settlement charge		—			—			—			1			—
Total	$	3		$	4		$	2		$	3		$	10

	Healthcare and Other Benefits
	Successor			Predecessor			Successor			Predecessor
	Three Months			Three Months			Seven Months			Two Months			Nine Months
	Ended			Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			February 29,			September 30,
	2008			2007			2008			2008			2007
Service costs for benefits earned	$	1		$	1		$	3		$	1		$	3
Interest costs on benefit obligation		4			7			9			4			19
Assumed return on plan assets		(2	)		—			(4	)		—			—
Prior service credits		—			(4	)		—			(3	)		(12	)
Actuarial (gain) loss		(1	)		1			(1	)		—			5
Total	$	2		$	5		$	7		$	2		$	15

Settlements

We recorded a pension settlement charge of $1 in the two months ended February 29, 2008 resulting from the significant amount of lump sum distributions from our Belgium retirement plan.

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SOLUTIA INC.

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

Employer Contributions

According to IRS funding rules, we will make approximately $57 in pension contributions to our U.S. qualified pension plan in 2008. We made $19 and $31 of these required 2008 contributions during the two months ended February 29, 2008 and seven months ended September 30, 2008, respectively. We also expect to be required to fund approximately $5 in pension contributions to our foreign pension plans in 2008.

13. Debt Obligations

Our long-term debt consisted of the following as of September 30, 2008 and December 31, 2007:

	Successor			Predecessor
	September 30,			December 31,
	2008			2007
Senior secured term loan facility due 2014	$	1,191		$	—
Senior secured asset-based revolving credit facility due 2013		186			—
Facility Agreement due 2011		—			231
Flexsys term loan due 2012		—			76
Flexsys revolving credit facility due 2012		—			47
6.72% debentures due 2037		—			150
7.375% debentures due 2027		—			300
11.25% notes due 2009		—			223
Maryville notes due 2022		—			20
Total principal amount		1,377			1,047
Unamortized net discount (a)		—			—
		1,377			1,047
Less current portion of long-term debt		(12	)		(15	)
Less debt subject to compromise (Note 2)		—			(673	)
Total	$	1,365		$	359

(a) Unamortized net discount of $14 as of December 31, 2007 is included in liabilities subject to compromise, as further described in Note 2.

Financing Agreements

On the Effective Date, we entered into the Financing Agreements to borrow up to $2.05 billion from the Lenders. Proceeds from the Financing Agreements and existing cash were used to (i) repay the DIP credit facility, (ii) retire Solutia Services International S.C.A./Comm. V.A.’s (“SSI”) Facility Agreement due 2011, (iii) retire the Flexsys term loan and revolving credit facility due 2012, (iv) pay certain secured and administrative claims, and (v) provide additional liquidity for operations.

The Financing Agreements consisted of (i) a $450 senior secured asset-based revolving credit facility which is comprised of a U.S Facility and a Belgium Facility (“Revolver”), (ii) a $1.2 billion senior secured term loan facility (“Term Loan”) and (iii) a $400 senior unsecured bridge facility (“Bridge”). In the third quarter 2008, proceeds from the sale of 33,021,976 shares of common stock were used to fully repay our Bridge.

The Revolver bears interest, at our option, at LIBOR or the prime rate plus an applicable margin. As of September 30, 2008, the applicable margin for the LIBOR and prime rate loans in the Revolver are 2.00 percent and 1.00 percent, respectively. The Term Loan bears interest at LIBOR, with a floor of 3.50 percent through the fourth anniversary of the Effective Date, plus 5.00 percent. Of the amount outstanding on the Term Loan at September 30, 2008, $900 is protected by a LIBOR cap of 4.25 percent until April 2010. Interest for the Revolver and Term Loan is payable (i) with respect to LIBOR loans, on the last day of each relevant interest period (defined as one, two, three or six months or any longer period available to all Lenders under each facility) 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, and (ii) with respect to prime rate loans, quarterly in arrears.

- 27 -

SOLUTIA INC.

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

Our current subsidiaries CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Business Enterprises Inc., Solutia Inter-America, Inc., Solutia Overseas, Inc., Solutia Systems, Inc., Beamer Road Management Company, S E Investment LLC and future subsidiaries as defined by the Financing Agreements, subject to certain exceptions (the “Guarantors”) are guarantors of our obligations under the Financing Agreements. The Financing Agreements and the related guarantees are secured by liens on substantially all of our and the Guarantors’ present and future assets.

We are required to make mandatory repayments of the Financing Agreements in connection with asset sales, equity issuance and certain other events subject to certain exceptions. We are required to pay 1 percent of the principal of the Term Loan annually via quarterly payments. In addition, on an annual basis and subject to our leverage position at December 31^st of each year, we are required to repay the Term Loan with a portion of excess cash flow generated during the year as defined in the Financing Agreements. If net leverage is less than 3.0x or greater than or equal to 3.0x, then we are required to repay 25 percent or 50 percent, respectively, of excess cash flow generated during the year. Excess cash flow is generally defined as EBITDA less interest, capital expenditures, taxes, and amortization of debt, plus or minus working capital changes and other adjustments. Any portion of the Term Loan that is repaid through mandatory prepayments or voluntarily repaid may not be reborrowed. Furthermore, voluntary prepayments or amendments to the Term Loan are subject to a prepayment premium or fee of 3 percent of the principal amount prepaid or principal amount outstanding, respectively, prior to the first anniversary of the Effective Date, 2 percent after the first anniversary and prior to the second anniversary of the Effective Date and 1 percent after the second anniversary and prior to the third anniversary of the Effective Date. We are not subject to any prepayment premiums or fees for amendments after the third anniversary of the Effective Date.

The Financing Agreements include a number of customary covenants and events of default, including the maintenance of certain financial covenants 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; make capital expenditures; and prepay, redeem or exchange our debt. The financial covenants are (i) total leverage ratio, (ii) fixed charge coverage ratio and (iii) a capital expenditure cap as defined by the Financing Agreements. We were in compliance with all applicable covenants as of September 30, 2008.

Maryville Notes

On June 24, 2008, we completed the sale and leaseback of our corporate headquarters for $43 and repaid the balance outstanding on the Maryville Notes from the sale proceeds.

14. Segment Data

We are a global manufacturer and marketer of a variety of high-performance chemical-based materials, which are used in a broad range of consumer and industrial applications. Prior to the first quarter of 2008, we managed our businesses in the following four operating segments: CPFilms, Other Performance Products (“OPP”), Rubber Chemicals and Integrated Nylon. As allowed by SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information,the CPFilms, OPP and Rubber Chemicals operating segments were aggregated into one reportable segment titled Performance Products. In the first quarter of 2008, we realigned the OPP operating segment whereby SAFLEX^® was disaggregated and evaluated discretely and the aviation and heat transfer products were combined with the Rubber Chemicals business and titled Technical Specialties. These changes were made to accommodate the revised reporting requirements of our chief operating decision maker. Concurrent with this realignment, we ceased the aggregation of the above operating segments into the Performance Products reportable segment and initiated reporting the operating segments separately. In the third quarter of 2008, we classified our Integrated Nylon business as discontinued operations as described in Note 4. Therefore, beginning in the third quarter of 2008, we report our businesses consistent with our three operating segments: SAFLEX^®, CPFilms and Technical Specialties.

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SOLUTIA INC.

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

The SAFLEX^® reportable segment is a global manufacturer of performance films for laminated safety glass. The CPFilms 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 products such as chemicals for the rubber industry, heat transfer fluids and aviation hydraulic fluids. The major products by reportable segment are as follows:

Reportable Segment	Products
SAFLEX®	•	SAFLEX® plastic interlayer
	•	Specialty intermediate Polyvinyl Butyral resin and plasticizer
CPFilms	•	LLUMAR®, VISTA®, GILA® and FORMULA ONE PERFORMANCE AUTOMOTIVE FILMS® professional and retail window films
	•	Other enhanced polymer films for industrial customers
Technical Specialties	•	CRYSTEX® insoluble sulphur
	•	SANTOFLEX® antidegradants
	•	SANTOCURE® and PERKACIT® primary accelerators
	•	THERMINOL® heat transfer fluids
	•	SKYDROL® aviation hydraulic fluids
	•	SKYKLEEN® brand of aviation solvents

The performance of our operating segments is evaluated based on segment profit, defined as earnings before interest expense, income taxes, depreciation and amortization, and reorganization items, net (“EBITDA”). Prior to the first quarter of 2008, segment profit was defined as earnings before interest expense and income taxes (“EBIT”). Segment profit includes selling, general and administrative, research, development and other operating expenses, gains and losses from asset dispositions and restructuring charges, and other income and expense items that can be directly attributable to the segment. Certain 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 LIFO valuation reserve, equity earnings from affiliates, other income and expense items, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the reportable segments in addition to operating segments that do not meet the quantitative threshold for determining reportable segments. All prior periods have been retroactively presented for the changes in reportable segments and measurement of segment profit. There were no inter-segment sales in the periods presented below.

Segment data for the three months ended September 30, 2008 and 2007, the two months ended February 29, 2008 and the seven and nine months ended September 30, 2008 and 2007, respectively are as follows:

	Successor					Predecessor
	Three Months					Three Months
	Ended					Ended
	September 30,					September 30,
	2008					2007
	Net		Profit			Net		Profit
	Sales		(Loss)			Sales		(Loss)
Reportable Segments:
SAFLEX®	$	221	$	35		$	173	$	27
CPFilms		63		15			59		14
Technical Specialties		294		74			214		44
Reportable Segment Totals		578		124			446		85
Unallocated and Other		9		(16	)		8		(20	)
Total		587		108			454		65
Reconciliation to Consolidated Totals:
Depreciation and amortization				(28	)				(16	)
Interest expense				(39	)				(20	)
Reorganization items, net				—					(152	)
Consolidated Totals:
Net Sales	$	587				$	454
Income (Loss) from Continuing Operations Before Income Taxes			$	41				$	(123	)

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SOLUTIA INC.

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

	Successor					Predecessor
	Seven Months					Two Months					Nine Months
	Ended					Ended					Ended
	September 30,					February 29,					September 30,
	2008					2008					2007
	Net		Profit			Net		Profit			Net		Profit
	Sales		(Loss)			Sales		(Loss)			Sales		(Loss)
Reportable Segments:
SAFLEX®	$	509	$	57		$	125	$	17		$	531	$	86
CPFilms		157		34			39		9			184		50
Technical Specialties		657		125			164		40			409		72
Reportable Segment Totals		1,323		216			328		66			1,124		208
Unallocated and Other		23		(31	)		7		(5	)		27		(12	)
Total		1,346		185			335		61			1,151		196
Reconciliation to Consolidated Totals:
Depreciation and amortization				(64	)				(11	)				(41	)
Interest expense				(99	)				(12	)				(51	)
Reorganization items, net				—					1,433					(185	)
Consolidated Totals:
Net Sales	$	1,346				$	335				$	1,151
Income (Loss) from Continuing Operations Before Income Taxes			$	22				$	1,471				$	(81	)

The effects of fresh-start accounting created a material change in total assets by segment when compared to December 31, 2007. Total assets by segment at September 30, 2008 and December 31, 2007 are as follows:

	Successor		Predecessor
	September 30,		December 31,
	2008		2007
	Assets		Assets
Reportable Segments:
SAFLEX®	$	1,372	$	525
CPFilms		632		255
Technical Specialties		1,018		635
Reportable Segment Totals		3,022		1,415
Reconciliation to consolidated totals:
Discontinued Operations		1,167		808
Unallocated and Other		407		417
Consolidated Totals	$	4,596	$	2,640

- 30 -

SOLUTIA INC.

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

15. Earnings (Loss) Per Share

The following table presents the net income (loss) used in the basic and diluted earnings (loss) per share and reconciles weighted-average number of shares used in the basic earnings (loss) per share calculation to the weighted-average number of shares used to compute diluted earnings (loss) per share.

	Successor			Predecessor			Successor			Predecessor
	Three Months			Three Months			Seven Months			Two Months		Nine Months
	Ended			Ended			Ended			Ended		Ended
	September 30,			September 30,			September 30,			February 29,		September 30,
	2008			2007			2008			2008		2007
Consolidated Statement of Operations Results:
Income (Loss) from continuing operations	$	24		$	(134	)	$	5		$	1,257	$	(105	)
Income (Loss) from discontinued operations		(31	)		23			(58	)		197		42
Net income (loss)	$	(7	)	$	(111	)	$	(53	)	$	1,454	$	(63	)
Weighted-average number of shares outstanding used for basic earnings (loss) per share		76.0			104.5			66.8			104.5		104.5
Non-vested restricted shares		—			—			—			—		—
Stock options		—			—			—			—		—
Warrants		—			—			—			—		—
Weighted-average number of shares outstanding and common equivalent shares used for diluted earnings (loss) per share		76.0			104.5			66.8			104.5		104.5

Stock options and Warrants to purchase approximately 2.9 million shares and 4.5 million shares, respectively, and non-vested restricted shares of 1.5 million were not included in the computation of earnings (loss) per share since the result would have been antidilutive for the three and seven months ended September 30, 2008.

- 31 -

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.; ability to implement cost reduction initiatives in a timely manner; geopolitical instability; and changes in pension and other postretirement assumptions.

Overview

We are a leading global manufacturer and marketer of a variety of high-performance chemical-based materials that are used in a broad range of consumer and industrial applications. In the first quarter of 2008, we consummated our reorganization under the Bankruptcy Code and emerged from bankruptcy concurrent with entering into financing agreements with certain lenders to borrow up to $2.05 billion.

We report our operations in three segments: SAFLEX^®, CPFilms and Technical Specialties. The major products by reportable segment are as follows:

Reportable Segment	Products
SAFLEX®	•	SAFLEX® plastic interlayer
	•	Specialty intermediate Polyvinyl Butyral resin and plasticizer
CPFilms	•	LLUMAR®, VISTA®, GILA® and FORMULA ONE PERFORMANCE AUTOMOTIVE FILMS® professional and retail window films
	•	Other enhanced polymer films for industrial customers
Technical Specialties	•	CRYSTEX® insoluble sulphur
	•	SANTOFLEX® antidegradants
	•	SANTOCURE® and PERKACIT® primary accelerators
	•	THERMINOL® heat transfer fluids
	•	SKYDROL® aviation hydraulic fluids
	•	SKYKLEEN® brand of aviation solvents

See Note 14 to the accompanying consolidated financial statements for further information regarding our reportable segments.

Significant Developments and Strategic Actions — Third Quarter 2008

In the third quarter 2008, we conducted a review of strategic alternatives for our Integrated Nylon business and concluded a sale of the business is probable. We have classified the assets and liabilities of Integrated Nylon as held for sale and reported the operating results as discontinued operations on the consolidated financial statements.

Consistent with our strategy of establishing an appropriate capital structure, we conducted two common stock offerings in August 2008 resulting in net proceeds of $422 million, which were used to repay our $400 million senior unsecured bridge facility (“Bridge”) and provide additional liquidity for operations. The Bridge had a fixed interest rate of 15.50% and its repayment will result in approximately $60 million in annual interest expense savings.

- 32 -

Combined Quarterly Financial Results of the Predecessor and Successor

Our emergence from bankruptcy resulted in our adoption of fresh-start accounting on February 29, 2008. In accordance with Generally Accepted Accounting Principles, the accompanying Consolidated Statements of Operations and Cash Flows presents the results of operations and the sources and uses of cash for (i) the two months ended February 29, 2008 of the Predecessor and (ii) the seven months ended September 30, 2008 of the Successor. However, for purposes of management’s discussion and analysis of the results of operations and the sources and uses of cash in this Form 10-Q, we have combined the current year results of operations for the Predecessor and the Successor. The results of operations of the Predecessor and Successor are not comparable due to the change in basis resulting from the emergence from bankruptcy. This combined presentation is being made solely to explain the changes in results of operations for the periods presented in the financial statements. We then compare the combined results of operations and the sources and uses of cash for the nine months ended September 30, 2008 with the corresponding period in the prior year.

An additional impact to comparability of segment profit resulting from our emergence from bankruptcy and the implementation of fresh-start accounting is the change in depreciation and amortization and the elimination of Chapter 11 reorganization expenses on a post-emergence basis. Therefore, effective with the first quarter of 2008, management evaluated the performance of our operating segments based on segment profit, defined as earnings before interest expense, income taxes, depreciation and amortization, and reorganization items (“EBITDA”) which includes selling, general and administrative, research, development and other operating expenses, gains and losses from asset dispositions and restructuring charges, and other income and expense items that can be directly attributable to the segment. To the extent each segment’s EBITDA is materially impacted by fresh-start accounting or other differences exist between Predecessor and Successor, these differences are identified in the discussion of results.

We believe the combined results of operations for the nine months ended September 30, 2008 provide management and investors with a more meaningful perspective on our ongoing financial and operational performance and trends than if we did not combine the results of operations of the Predecessor and the Successor in this manner. Further, the use of EBITDA as the earnings metric allows for meaningful analysis across both periods.

Summary Results of Operations

In the third quarter of 2008, we reported sales of $587 million, a 29 percent increase over $454 million reported in the third quarter of 2007. The increase was driven by higher selling prices, higher sales volumes and favorable currency exchange rate fluctuations. Our third quarter of 2008 gross profit of $155 million, a 38 percent increase versus the same period in 2007, and our gross profit margin of 26.4 percent, an increase from 24.7 percent versus the same period in 2007, were both benefited by higher net sales, as described above, improved plant performance in our Technical Specialties and SAFLEX^® reporting segments, partially offset by higher raw material, energy and freight costs and higher depreciation and amortization costs due to fresh-start accounting. Selling, general and administrative expenses remained at approximately 13 percent of sales, consistent with 2007. In total, this quarter’s operating income results include $1 million of positive impacts from non-operational or non-recurring items.

In the nine months ended September 30, 2008, we reported sales of $1,681 million, a 46 percent increase over $1,151 million reported in the same period in 2007. The increase was driven by acquisitions, higher selling prices, higher demand, and favorable currency exchange rate fluctuations. Gross profit of $374 million in the nine months ended September 30, 2008 was 28 percent higher than the same period in 2007. The significant increase is a result of the Flexsys acquisition and the combination of higher selling prices, increased demand, and favorable currencies, partially offset by higher raw material, energy and freight costs and the impacts of fresh-start accounting. Gross profit margin in the nine months ended September 30, 2008 decreased to 22.2 percent from 25.4 percent in the prior year period, due to the impacts of fresh-start accounting. Selling, general and administrative expenses decreased to 12 percent of sales from 13 percent due to the significant increase in net sales and cost containment actions. The nine months ended September 30, 2008 operating income results also include $67 million of negative impacts from our step-up in inventory value required by the adoption of fresh-start accounting as of the Effective Date and other non-operational or non-recurring items.

We used $439 million of cash from operations in the nine months ended September 30, 2008 as compared to usage of $66 million in the same period in 2007. The increase in cash used from operations in 2008 was due to $378 million in cash outflows required to facilitate our emergence from bankruptcy and $177 million of cash outflows from discontinued operations as partially offset by $116 million of cash provided by continuing operations. This compares to $58 million in cash outflows associated with bankruptcy reorganization issues and $12 million of cash outflows from continuing operations as partially offset by $4 million of cash inflows from discontinued operations in the same period of 2007. Our liquidity at the end of the third quarter was $227 million in the form of $189 million of availability under the Revolver and $38 million of cash on-hand.

Outlook

The challenges facing us in the fourth quarter of 2008 and continuing into 2009 have been heightened by the significant crisis in the U.S. credit markets which rapidly deteriorated in September and continue to experience unprecedented dislocation through the current date. This credit crisis has spread rapidly across the globe, and appears to be impacting both individuals and businesses. Despite unprecedented governmental intervention, businesses have seen their access to capital severely constrained or eliminated, affecting their ability to invest and effectively plan for the future. Individuals and businesses alike have experienced a significant drop in confidence which will undoubtedly affect future spending patterns. While the roots of this on-going credit crisis can be traced to the rapid meltdown of the sub-prime market in the U.S., the economic conditions that plagued the U.S. for most of 2008 are now being experienced to some degree in all world economies.

- 33 -

Approximately 70% of our sales are into the global automotive and construction industries. We believe that these industries, particularly the domestic and European markets, will experience minimal or negative growth in 2009. Further, the emerging markets will continue to grow, but at slower rates in 2009 versus growth realized in recent years. These factors will have a negative impact on our ability to increase revenue and expand margins, even though feedstock and energy prices are likely to continue to fall due to weakened demand.

We believe we will be able to mitigate some of the impact of weakened demand due to our leading market positions, new product applications, proprietary technologies and process know-how, end market diversity and our large-scale, low-cost global manufacturing footprint. Further, we are focused on ensuring we have adequate internal sources of liquidity through active management of capital expenditures and working capital in light of lower demand and lower feedstock costs, and reducing discretionary program spending. Due to this focus, we believe we will generate positive cash from operations less capital spending in this period of economic uncertainty.

Despite this challenging environment, we expect our full year 2008 earnings performance to be in-line with previous management estimates. In addition, we expect the fourth quarter to be significant in terms of cash generation, and anticipate our net debt level to be reduced to approximately $1.3 billion as of December 31, 2008.

Critical Accounting Policies and Estimates

As a result of our emergence from bankruptcy and the discharge of many of our legal proceedings in accordance with the Plan (as described in Note 10 to the accompanying consolidated financial statements), we no longer consider Self-Insurance to be a critical accounting policy as we believe it is less likely to have a material impact on our reported results of operations in future periods. There have been no other changes in 2008 with respect to our critical accounting policies, as presented in our 2007 Form 10-K, as re-casted and filed with the Securities and Exchange Commission (“SEC”) in a Form 8-K on July 25, 2008, to reflect our segment reporting change as described in Note 14 to the accompanying consolidated financial statements.

Results of Operations—Third Quarter 2008 Compared with Third Quarter 2007

Consolidated Results

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended					%
	September 30,			September 30,			Increase		Increase
(dollars in millions)	2008			2007			(Decrease)		(Decrease)
Net Sales	$	587		$	454		$	133		29	%
Operating Income:
Reportable Segment Profit	$	124		$	85		$	39		46	%
Unallocated and Other		(16	)		(20	)		4		20	%
Less: Depreciation and Amortization		(28	)		(16	)
Less: Other Income included in Segment Profit and Unallocated and Other		(4	)		(2	)
Operating Income	$	76		$	47		$	29		62	%
Net Gains (Charges) included in Operating Income	$	1		$	(7	)

The increase in net sales in the third quarter 2008 as compared to the same period in 2007 resulted from increased selling prices of $74 million or 16 percent, higher sales volumes of $35 million or 8 percent and the effect of favorable exchange rate fluctuations of $24 million or 5 percent. Higher average selling prices were experienced across all reporting segments in response to an escalating raw material profile and, with respect to Technical Specialties, in conjunction with generally favorable supply/demand structure in certain specialty chemical markets. The favorable currency benefit was driven most notably by the increased strength of the Euro versus the U.S. dollar, in comparison to the prior year, due to our strong market positions in Europe by the SAFLEX^® and Technical Specialties reporting segments. Higher sales volumes were realized by all of our reporting segments, but most notably in the SAFLEX^® and Technical Specialties reporting segments.

The increase in operating income in the third quarter 2008 as compared to the same period in 2007 resulted from higher net sales, as described above, improved plant performance in our Technical Specialties and SAFLEX^® reporting segments and higher net gains of $8 million, partially offset by higher raw material and energy costs of approximately $50 million, higher corporate expenses, predominantly share-based compensation and higher depreciation and amortization due to fresh-start accounting. The increases in raw material and energy costs are primarily driven by continued tight supply of these materials as well as the substantial increases in oil prices when compared with the prior year period.

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SAFLEX^®

	Successor		Predecessor
	Three Months		Three Months
	Ended		Ended				%
	September 30,		September 30,		Increase		Increase
(dollars in millions)	2008		2007		(Decrease)		(Decrease)
Net Sales	$	221	$	173	$	48		28	%
Segment Profit	$	35	$	27	$	8		30	%

The increase in net sales as compared to the third quarter 2007 was a result of higher sales volumes of $25 million or 14 percent, higher average selling prices of $12 million or 7 percent and favorable currency exchange rate fluctuations of $11 million or 7 percent. The favorable exchange rate fluctuations occurred primarily as a result of the weakening U.S. dollar in relation to the Euro in comparison to the third quarter 2007. Higher sales volumes were experienced in targeted growth markets of Europe and Asia Pacific while sales volumes held steady in the domestic market. The increased sales in Asia Pacific were a result of the continued expanding demand for laminated glass in that market, which was partially supported by our new SAFLEX^® plant in Suzhou, China which opened in late third quarter 2007. The increase in selling prices is related to our global price increase on SAFLEX^® and Polyvinyl Butyral resin in response to higher raw material costs.

The increase in segment profit in comparison to the third quarter 2007 resulted primarily from higher net sales as described above, and, to a lesser extent, improved plant performance, partially offset by higher raw material costs of $11 million and an increase in sales and marketing programs, particularly in growth markets.

CPFilms

	Successor		Predecessor
	Three Months		Three Months
	Ended		Ended				%
	September 30,		September 30,		Increase		Increase
(dollars in millions)	2008		2007		(Decrease)		(Decrease)
Net Sales	$	63	$	59	$	4		7	%
Segment Profit	$	15	$	14	$	1		7	%

The increase in net sales as compared to the third quarter 2007 resulted primarily from higher sales volumes of $2 million or 3 percent, higher average selling prices of $2 million or 3 percent and, to a lesser extent, favorable currency exchange rate fluctuations. The increase in sales volumes primarily resulted from strong growth in CPFilms’ international window film markets, most notably Russia and Central and South America, and continued growth of the industrial business, partially offset by declines in North America.

The increase in segment results in comparison to the third quarter 2007 resulted primarily from increased net sales as described above, partially offset by higher raw material costs of $1 million.

Technical Specialties

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended					%
	September 30,			September 30,			Increase		Increase
(dollars in millions)	2008			2007			(Decrease)		(Decrease)
Net Sales	$	294		$	214		$	80		37	%
Segment Profit	$	74		$	44		$	30		68	%
Net charges included in Segment Profit	$	(1	)	$	(3	)

The increase in net sales as compared to the third quarter 2007 resulted from higher average selling prices of $60 million or 28 percent, higher sales volumes of $8 million or 4 percent and favorable currency exchange rate fluctuations of $12 million or 5 percent. Higher average selling prices were experienced in all product lines but were more pronounced within CRYSTEX^® insoluble sulphur and, to a lesser extent, with SANTOFLEX^® Antidegradants, SANTOCURE^® and PERKACIT^® primary accelerators and THERMINOL^® heat transfer fluids. The higher average selling prices are in response to higher raw material costs across all products within Technical Specialties in addition to a favorable supply/demand profile in certain specialty chemical markets. Higher sales volumes were primarily experienced in SANTOFLEX^® antidegradants and THERMINOL^® heat transfer fluids, partially offset by declines in CRYSTEX^® insoluble sulphur along with products manufactured at our Ruabon, Wales, United Kingdom manufacturing facility (the “Ruabon Facility”). We expect complete cessation of Solutia manufacturing at the Ruabon Facility in the fourth quarter 2008. The higher sales volumes were experienced predominantly in the targeted growth market of Asia Pacific with modest increases in Europe, partially offset by slightly weaker demand in North America. The favorable exchange rate fluctuations occurred primarily as a result of the weakening U.S. dollar in relation to the Euro in comparison to the third quarter 2007.

- 35 -

The increase in segment profit in comparison to the third quarter 2007 resulted primarily from increased net sales, as described above, higher asset utilization and lower net charges, partially offset by increased raw material costs. The increased selling prices more than offset the $36 million increase in raw material costs, predominantly sulphur and process oil. Segment profit in the third quarter of 2008 was further impacted negatively on charges of $7 million related to the announced closure of the Ruabon Facility as partially offset by a gain of $6 million recognized upon termination of a natural gas contract supplying the same facility. Segment profit in the third quarter 2007 was negatively impacted by $2 million of severance and retraining costs and $1 million of charges resulting from the step-up in basis of Flexsys’ inventory related to the acquisition.

Unallocated and Other

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended					%
	September 30,			September 30,			Increase		Increase
(dollars in millions)	2008			2007			(Decrease)		(Decrease)
Unallocated and Other results	$	(16	)	$	(20	)	$	4		20	%
Net gains (charges) included in Unallocated and Other	$	2		$	(4	)

Unallocated and Other results improved due to higher gains on foreign currency and higher net gains, partially offset by higher corporate expenses, lower interest income and lower segment profit from other operations. Corporate expenses increased $6 million, $3 million of which is due to share-based compensation expense on management incentive and director stock compensation plans adopted upon our emergence from bankruptcy. The remaining increase is associated with higher legal costs on items stayed during bankruptcy and higher facility costs due to the sale/leaseback of our corporate headquarters. With respect to net charges in the third quarter 2008, we recognized (i) a $3 million gain resulting from a surplus land sale; and (ii) a $1 million charge resulting from the relocation of our plastic products business from our manufacturing facility in Ghent, Belgium to Oradea, Romania. In the third quarter 2007, a $4 million restructuring charge was recorded due to the termination of a third-party agreement at one of our facilities. Other income, net increased by $4 million primarily due to higher gains on foreign currency, partially offset by lower interest income.

Interest Expense

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended					%
	September 30,			September 30,			Increase		Increase
(dollars in millions)	2008			2007			(Decrease)		(Decrease)
Interest Expense	$	39		$	20		$	19		95	%
Charges included in Interest Expense	$	(1	)	$	(2	)

The increase in interest expense in the third quarter 2008 in comparison to the third quarter 2007 resulted principally from higher debt outstanding with higher interest rates in the third quarter 2008 than in 2007. Average debt not subject to compromise outstanding increased $387 million or 29 percent, due to the emergence from Chapter 11 funding requirements. Included in our debt to fund our emergence from Chapter 11 is the Bridge, which was subsequently repaid late in the third quarter of 2008. The higher interest rates are a result of a changed interest rate profile of our debt structure due to the replacement of the debtor-in-possession (“DIP”) credit facility with the Financing Agreements. In addition, $4 million and $14 million of interest expense was allocated to discontinued operations for the three months ended September 30, 2008 and 2007, respectively, contributing to the increase in interest expense.

The third quarter 2008 results include a $1 million charge related to the repayment of the Bridge. In addition, the third quarter 2007 results included a $2 million interest expense charge related to claims recognized as allowed secured claims through settlements approved by the Bankruptcy Court.

- 36 -

Reorganization Items, net

	Successor		Predecessor
	Three Months		Three Months
	Ended		Ended					%
	September 30,		September 30,			Increase		Increase
(dollars in millions)	2008		2007			(Decrease)		(Decrease)
Reorganization Items, net	$	—	$	(152	)	$	152		N.M.

Reorganization items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain, or loss that are realized or incurred by us because we were in reorganization under Chapter 11 of the U.S. Bankruptcy Code. We did not record any charges in reorganization items in the third quarter 2008 due to our emergence from Chapter 11 on February 28, 2008.

Income Tax Expense

	Successor		Predecessor
	Three Months		Three Months
	Ended		Ended				%
	September 30,		September 30,		Increase		Increase
(dollars in millions)	2008		2007		(Decrease)		(Decrease)
Income Tax Expense	$	17	$	11	$	6		55%

Our tax expense or benefit is affected by the mix of income and losses in the tax jurisdiction in which we operate. We recorded income tax expense of $17 million for the three months ended September 30, 2008 primarily attributable to earnings in ex-U.S. tax jurisdictions which were higher than in the comparable period in 2007. Our U.S. operations experienced a pre-tax loss in the third quarter 2008 but no income tax benefit was recognized during the quarter as a full valuation allowance has been provided against the U.S. deferred tax assets.

We recorded income tax expense for the three months ended September 30, 2007 of $11 million on earnings in ex-U.S. tax jurisdictions combined with an increase in unrecognized tax benefits.

Upon emergence from bankruptcy, Successor has an estimated U.S. tax net operating loss carryforward (“NOL”) of approximately $1.2 billion as of March 1, 2008. As a result of the issuance of new common stock upon emergence, we realized a change of ownership for purposes of Section 382 of the Internal Revenue Code. We do not currently expect this change to significantly limit our ability to utilize our NOL in the carryforward period and do not expect to be in a cash paying tax position in relation to U.S. taxes for the foreseeable future.

Discontinued Operations

	Successor			Predecessor
	Three Months			Three Months
	Ended			Ended					%
	September 30,			September 30,		Increase			Increase
(dollars in millions)	2008			2007		(Decrease)			(Decrease)
Income (Loss) from Discontinued Operations, net of tax	$	(31	)	$	23	$	(54	)		N.M.

Income (loss) from discontinued operations consists of the results of our Integrated Nylon business. In the third quarter 2008, income from discontinued operations decreased $54 million in comparison to the third quarter 2007 due to higher raw material costs of approximately $84 million, lower sales volumes, higher charges and lower asset utilization resulting from the effects of Hurricane Ike and lower carpet demand/volumes, partially offset by increased selling prices. The raw material cost profile of Integrated Nylon was significantly impacted during the third quarter 2008 by continued increases in propylene, ammonia, benzene and natural gas, key feedstocks for the segment. Average selling prices increased significantly in the majority of the intermediate chemicals, carpet fibers and, to a lesser extent, the nylon plastics and polymers businesses in response to the escalating cost of raw materials. Sales volumes decreased primarily in intermediate chemicals and carpet fibers, partially offset by increases in nylon plastics and polymers. Income (loss) from discontinued operations was significantly impacted in the third quarter 2008 by the affects of Hurricane Ike, which forced our manufacturing facility in Alvin, Texas to completely shut down its operations. The impact on operations of this event was the incurrence of approximately $10 million in repairs and maintenance costs and an incremental $8 million due to lower asset utilization and costs to restart the operations. Income (loss) from discontinued operations in the third quarter 2007 benefited from $22 million of revenue being recognized upon the termination of a customer contract and the immediate recognition of previously deferred revenue and a gain of $3 million from the sale of surplus land.

- 37 -

The income (loss) from discontinued operations for Integrated Nylon reflects adjustments to our LIFO Inventory reserve associated with this segment, interest expense associated with debt which is anticipated to be repaid with sales proceeds and share-based compensation associated with Integrated Nylon which had not previously been allocated to the results of this segment. In addition, certain corporate expenses and reorganization items are excluded from the operating results which had previously been allocated to this segment. The adjustments applicable for these periods are (i) $4 million and $14 million of interest expense for the three months ended September 30, 2008 and 2007, respectively; (ii) $1 million of share-based compensation expense for the three months ended September 30, 2008; (iii) $1 million and $3 million of certain corporate expenses for the three months ended September 30, 2008 and 2007, respectively; and (iv) $2 million of reorganization items for the three months ended September 30, 2007.

Combined Results of Operations—Nine Months Ended September 30, 2008 Compared with Nine Months Ended September 30, 2007

Consolidated Results

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended						%
	September 30,			September 30,			Increase			Increase
(dollars in millions)	2008			2007			(Decrease)			(Decrease)
Net Sales	$	1,681		$	1,151		$	530			46	%
Operating Income:
Reportable Segment Profit	$	282		$	208		$	74			36	%
Unallocated and Other		(36	)		(12	)		(24	)		(200	%)
Less: Depreciation and Amortization		(75	)		(41	)
Less: Equity Earnings from Affiliates, Other Income and Loss on Debt Modification included in Segment Profit and Unallocated and Other		(11	)		(35	)
Operating Income	$	160		$	120		$	40			33	%
Charges included in Operating Income	$	(67	)	$	(10	)

The increase in net sales as compared to the nine months ended September 30, 2007 resulted from our acquisition of Akzo Nobel’s 50 percent interest in the Flexsys joint venture, which was completed on May 1, 2007 (the “Flexsys Acquisition”), increased selling prices, higher sales volumes and the effect of favorable currency exchange rate fluctuations. Prior to our acquisition on May 1, 2007, the results of Flexsys were accounted for using the equity method and recorded as Equity Earnings from Affiliates on the Consolidated Statement of Operations. Net sales increased $281 million or 24 percent in the nine months ended September 30, 2008 as a result of the Flexsys Acquisition. The remaining $249 million or 22 percent increase in net sales was a result of higher average selling prices of $109 million or 10 percent, higher sales volumes of $77 million or 7 percent and favorable currency exchange rate fluctuations of $63 million or 5 percent. Higher average selling prices were experienced across all reporting segments in response to an escalating raw material profile and, with respect to Technical Specialties, in conjunction with generally favorable supply/demand profile in these markets. The favorable currency benefit was driven most notably by the continued strengthening of the Euro versus the U.S. dollar, in comparison to the prior year. Other currency movements against the U.S. dollar also benefited our net sales, however, given the strong market positions in Europe within SAFLEX^® and Technical Specialties, movements in the Euro versus the U.S. dollar had the most significant impact on our revenues. The higher sales volumes were experienced in our SAFLEX^®, Technical Specialties and CPFilms reporting segments, given the continued growing global demand for these products.

- 38 -

The increase in operating income as compared to the nine months ended September 30, 2007 resulted from the Flexsys Acquisition, increased net sales and higher asset utilization in our SAFLEX^® and Technical Specialties reporting segments, partially offset by higher raw material and energy costs of approximately $80 million and higher charges of $57 million. As indicated in the preceding table, operating results were affected by various charges which are described in greater detail within this section below. The raw material impacts were most impactful within the SAFLEX^® and Technical Specialties reporting segments, with the key increases experienced in sulfur. The increases in these raw materials are primarily driven by continued tight supply of these materials, as well as the substantial increases in oil prices when compared with the prior year.

SAFLEX^®

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended					%
	September 30,			September 30,		Increase			Increase
(dollars in millions)	2008			2007		(Decrease)			(Decrease)
Net Sales	$	634		$	531	$	103			19	%
Segment Profit	$	74		$	86	$	(12	)		(14	%)
Charges included in Segment Profit	$	(37	)	$	—

The increase in net sales as compared to the same period in 2007 was a result of higher sales volumes of $40 million or 8 percent, higher average selling prices of $24 million or 4 percent and favorable currency exchange rate fluctuations of $39 million or 7 percent. The favorable currency exchange rate fluctuations occurred primarily as a result of the weakening U.S. dollar in relation to the Euro in comparison to the same period in 2007. Higher sales volumes were experienced in targeted growth markets of Europe and Asia Pacific and sales volumes into the domestic market were lower than the prior year. The increased sales in Asia Pacific were a result of the continued expanding demand for laminated glass in that market, which was partially supported by our new SAFLEX^® plant in Suzhou, China which opened in the third quarter 2007. The increase in selling prices is related to our global price increase on SAFLEX^®, Polyvinyl Butyral resin and plasticizer in response to higher raw material costs.

The decrease in segment profit in comparison to the same period in 2007 resulted primarily from the $36 million charge in the nine months ended September 30, 2008 associated with the amortization of the step-up in basis of our inventory in accordance with fresh-start accounting. In addition to the inventory step-up, segment profit included a charge of $1 million for severance and retraining costs. Offsetting these charges was overall improvement in segment profit due to increased net sales as described above, improved asset utilization and lower manufacturing costs. The segment also experienced approximately $25 million of higher raw material costs in comparison to the prior year, of which $24 million or 96 percent was recovered through increased selling prices. The remaining increase in raw material costs was more than offset through improved manufacturing performance and higher sales volumes.

CPFilms

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended					%
	September 30,			September 30,		Increase			Increase
(dollars in millions)	2008			2007		(Decrease)			(Decrease)
Net Sales	$	196		$	184	$	12			7	%
Segment Profit	$	43		$	50	$	(7	)		(14	%)
Charges included in Segment Profit	$	(10	)	$	—

The increase in net sales as compared to the nine months ended September 30, 2007 resulted from higher sales volumes of $6 million or 3 percent, higher average selling prices of $5 million or 3 percent and favorable currency exchange rate fluctuations of $1 million or 1 percent. The increase in sales volumes primarily resulted from strong growth in CPFilms’ international window film markets, most notably Russia, South Africa and the Middle East, and continued growth of the industrial business, partially offset by overall lower demand in North America in the nine months ended September 30, 2008 due to the challenging macro-economic conditions specific to this market.

- 39 -

The decrease in segment results in comparison to the same period in 2007 resulted primarily from the $10 million charge in the nine months ended September 30, 2008 associated with the amortization of the step-up in basis of our inventory in accordance with fresh-start accounting. Partially offsetting the inventory step-up, was higher gross profit in comparison to the prior year, which was partially offset by increased investment in sales and marketing infrastructure and in market development programs globally. We believe continued investment in the sales and marketing infrastructure for this segment will expand the overall global window film market along with our participation.

Technical Specialties

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended					%
	September 30,			September 30,			Increase		Increase
(dollars in millions)	2008			2007			(Decrease)		(Decrease)
Net Sales	$	821		$	409		$	412		101	%
Segment Profit	$	165		$	72		$	93		129	%
Charges included in Segment Profit	$	(27	)	$	(5	)

The increase in net sales as compared to the same period in 2007 resulted primarily from the Flexsys Acquisition. Prior to our acquisition on May 1, 2007, the results of Flexsys were accounted for using the equity method and were not recorded within the Technical Specialties reportable segment. The Flexsys Acquisition resulted in an increase in net sales of $281 million or 69 percent. The remaining increase in net sales of $131 million or 32 percent was a result of higher average selling prices of $80 million or 20 percent, higher sales volumes of $29 million or 7 percent and favorable currency exchange rate fluctuations of $22 million or 5 percent. Higher sales volumes and average selling prices were experienced primarily in CRYSTEX^® insoluble sulphur, SANTOFLEX^® antidegradants and THERMINOL^® heat transfer fluids. The higher average selling prices are in response to higher raw material costs across all products within Technical Specialties in addition to a favorable supply/demand profile in certain specialty chemical markets. The higher sales volumes were experienced predominantly in the targeted growth market of Asia Pacific with modest increases in Europe, partially offset by slightly weaker demand in North America. The favorable currency exchange rate fluctuations occurred primarily as a result of the weakening U.S. dollar in relation to the Euro in comparison to the same period in 2007.

The increase in segment profit in comparison to the same period in 2007 resulted primarily from the Flexsys Acquisition, increased net sales as described above and improved manufacturing performance, partially offset by increased raw material costs, higher charges and unfavorable currency exchange rate fluctuations. The increased selling prices more than offset the increase of $49 million in raw material costs primarily related to sulphur. Improved manufacturing performance was a result of higher asset utilization due to the increased volumes in this segment. The unfavorable currency exchange rate fluctuation is a result of a significant portion of Technical Specialties manufacturing capacity being located in Europe and the strengthening of the Euro versus the U.S. Dollar. The higher charges include a $20 million charge in the nine months ended September 30, 2008 associated with the amortization of the step-up in basis of our inventory in accordance with fresh-start accounting. In addition to the inventory step-up, segment profit included charges related to the announced closure of the Ruabon Facility, which resulted in charges of $13 million. The charges were partially offset by a $6 million gain related to the termination of a natural gas purchase contract associated with the same facility. Segment profit in the comparable period in 2007 was negatively impacted by $3 million of charges resulting from the step-up in basis of Flexsys’ inventory related to the acquisition and $2 million of severance and retraining costs.

Unallocated and Other

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended						%
	September 30,			September 30,			Increase			Increase
(dollars in millions)	2008			2007			(Decrease)			(Decrease)
Unallocated and Other results	$	(36	)	$	(12	)	$	(24	)		(200	%)
Net gains included in Unallocated and Other	$	11		$	10

- 40 -

Unallocated and Other results decreased due to lower equity earnings from affiliates, higher corporate expenses and lower interest income, partially offset by higher gains on foreign currency and higher net gains. With respect to net gains, in the nine months ended September 30, 2008, we recorded (i) a $6 million gain resulting from surplus land sales; (ii) a gain of $3 million related to joint settlements with Monsanto of legacy insurance policies with insolvent insurance carriers; (iii) a $4 million gain resulted from the settlement of emergence related incentive accruals; (iv) a $1 million charge resulting from the relocation of our plastic products business from our manufacturing facility in Ghent, Belgium to Oradea, Romania; and (v) a $1 million charge resulting from the step-up in basis of our inventory in accordance with fresh-start accounting. In the same period in 2007, we recorded (i) a gain on a litigation matter of $21 million; (ii) a charge of $7 million recorded to write-off debt issuance costs and to record the DIP credit facility as modified at its fair value as of the amendment date; and (iii) a $4 million restructuring charge due to the termination of a third-party agreement at one of our facilities. Corporate expenses increased $6 million primarily due to share-based compensation expense on management incentive and director stock compensation plans adopted upon our emergence from bankruptcy and higher legal costs, partially offset by lower Integrated Nylon costs retained by continuing operations. Share-based compensation expense in 2007 was zero. The decrease in equity earnings from affiliates of $12 million is a result of the Flexsys Acquisition completed on May 1, 2007. Other income, net decreased by $1 million due to lower interest income partially offset by gains on foreign currency.

Interest Expense

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended					%
	September 30,			September 30,			Increase		Increase
(dollars in millions)	2008			2007			(Decrease)		(Decrease)
Interest Expense	$	111		$	51		$	60		118	%
Charges included in Interest Expense	$	(1	)	$	(2	)

The increase in interest expense in the nine months ended September 30, 2008 in comparison to the same period in 2007 resulted principally from higher debt outstanding with higher interest rates in 2008 than in 2007. Average debt outstanding increased $520 million or 48 percent to fund the Flexsys Acquisition, as only a portion of debt utilized to acquire Flexsys was incurred prior to the end of the first quarter of 2007, and our emergence from Chapter 11 on the Effective Date. Included in our debt to fund our emergence from Chapter 11 is the Bridge, which was subsequently repaid late in the third quarter of 2008. The higher interest rates are a result of a changed interest rate profile of our debt structure due to the replacement of the DIP credit facility with the Financing Agreements. In addition, $18 million and $41 million of interest expense was allocated to discontinued operations for the nine months ended September 30, 2008 and 2007, respectively, contributing to the increase in interest expense. The charges included in interest expense are the same described in the “Results of Operations—Third Quarter 2008 Compared with Third Quarter 2007” section above.

Reorganization Items, net

	Combined		Predecessor
	Nine Months		Nine Months
	Ended		Ended					%
	September 30,		September 30,			Increase		Increase
(dollars in millions)	2008		2007			(Decrease)		(Decrease)
Reorganization Items, net	$	1,433	$	(185	)	$	1,618		N.M.

Reorganization items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain, or loss that are realized or incurred by us because we were in reorganization under Chapter 11 of the U.S. Bankruptcy Code. Reorganization items incurred in the nine months ended September 30, 2008 included a $104 million charge on the settlement of liabilities subject to compromise, $1,589 million gain from fresh-start accounting adjustments, which excludes the gain allocated to discontinued operations or $212 million, and $52 million of professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings. The increase in reorganization items, net as compared to the nine months ended September 30, 2007 is due to the aforementioned effects of settling the liabilities subject to compromise and adopting fresh-start accounting.

- 41 -

Income Tax Expense

	Combined		Predecessor
	Nine Months		Nine Months
	Ended		Ended				%
	September 30,		September 30,		Increase		Increase
(dollars in millions)	2008		2007		(Decrease)		(Decrease)
Income Tax Expense	$	231	$	24	$	207		N.M.

Our tax expense or benefit is affected by the mix of income and losses in the tax jurisdictions in which we operate. The income tax expense recorded for the nine months ended September 30, 2008 was primarily attributable to emergence and the effect of adopting fresh-start accounting, which accounted for $202 million of the total. The remaining $29 million of income tax expense for the nine months ended September 30, 2008 was primarily related to earnings in ex-U.S. tax jurisdictions.

We recorded income tax expense for the nine months ended September 30, 2007 of $24 million, entirely attributable to earnings in ex-U.S. tax jurisdictions combined with an increase in unrecognized tax benefits.

The change in income tax expense for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007 was primarily the result of the emergence in the nine months ended September 30, 2008.

Upon emergence from bankruptcy, Successor has an estimated NOL of approximately $1.2 billion as of March 1, 2008. As a result of the issuance of new common stock upon emergence from bankruptcy, we realized a change of ownership for purposes of Section 382 of the Internal Revenue Code. We do not currently expect this change to significantly limit our ability to utilize our NOL in the carryforward period and do not expect to be in a cash paying tax position in relation to U.S. taxes for the foreseeable future.

Discontinued Operations

	Combined		Predecessor
	Nine Months		Nine Months
	Ended		Ended				%
	September 30,		September 30,		Increase		Increase
(dollars in millions)	2008		2007		(Decrease)		(Decrease)
Income from Discontinued Operations, net of tax	$	139	$	42	$	97		231	%
Reorganization items included in income from discontinued operations	$	212	$	—

Income from discontinued operations consists of the results of our Integrated Nylon and Dequest businesses. Included in the results of discontinued operations in the nine months ended September 30, 2007 is a gain on sale of the Dequest business of $34 million, partially offset by income taxes of $5 million.

Income from discontinued operations increased $97 million in comparison to the same period in 2007 due to the implementation of fresh-start accounting as a result of our emergence from bankruptcy, higher average selling prices, as partially offset by higher raw material costs of approximately $228 million, lower sales volumes, higher manufacturing and logistic costs, higher charges and lower asset utilization. The reorganization items related to fresh-start accounting consist primarily of the reversal of our LIFO reserve on our Integrated Nylon business of $204 million. Average selling prices increased significantly in the majority of the intermediate chemicals, carpet fibers and, to a lesser extent, the nylon plastics and polymers businesses in response to the escalating cost of raw materials. The raw material cost profile of Integrated Nylon was significantly impacted during the nine months ended September 30, 2008 by increases in propylene, ammonia, benzene and natural gas, key feedstocks for the business. Although sales volumes increased significantly in nylon plastics and polymers, they were more than offset by decreases in carpet fibers and intermediate chemicals. Higher manufacturing costs and lower asset utilization were a result of Hurricane Ike as described above and scheduled maintenance shutdowns in intermediate chemicals at the Decatur, Alabama and Alvin, Texas plants and carpet fibers at the Greenwood, South Carolina plant in the nine months ended September 30, 2008. Discontinued operations in 2008 were further impacted negatively by charges of $7 million resulting from the step-up in basis of our inventory in accordance with fresh-start accounting. Discontinued operations in 2007 benefited from a gain of $22 million realized upon the termination of a customer contract and the immediate recognition of previously deferred revenue and gains of $10 million from the sales of surplus land.

- 42 -

As described in the “Results of Operations—Third Quarter 2008 Compared with Third Quarter 2007” section above, the operating results for Integrated Nylon have been adjusted from prior reporting. The adjustments applicable for these periods are (i) $18 million and $41 million of interest expense for the nine months ended September 30, 2008 and 2007, respectively; (ii) increase in the LIFO Inventory reserve of $25 million for the nine months ended September 30, 2007; (iii) $2 million of share-based compensation expense for the nine months ended September 30, 2008; (iv) $3 million and $9 million of certain corporate expenses for the nine months ended September 30, 2008 and 2007, respectively; and (v) $3 million of reorganization items for the nine months ended September 30, 2007.

Summary of Events Affecting Comparability

Charges and gains recorded in the nine months ended September 30, 2008 and 2007 and other events affecting comparability have been summarized and described in the table and accompanying footnotes below (dollars in millions):

2008 Events

							Technical			Unallocated
Increase/(Decrease)	SAFLEX®			CPFilms			Specialties			/Other			Consolidated
Impact on:
Cost of goods sold	$	36		$	10		$	20		$	1		$	67	(a)
		—			—			13			—			13	(b)
		—			—			(6	)		—			(6	)(c)
		—			—			—			(3	)		(3	)(d)
		1			—			—			1			2	(e)
Research, development and other operating expenses		—			—			—			(6	)		(6	)(f)
Operating Income Impact		(37	)		(10	)		(27	)		7			(67	)
Interest expense		—			—			—			(1	)		(1	)(g)
Other income, net		—			—			—			4			4	(h)
Reorganization Items, net		—			—			—			1,433			1,433	(i)
Pre-tax Income Statement Impact	$	(37	)	$	(10	)	$	(27	)	$	1,443			1,369
Income tax impact														187	(j)
After-tax Income Statement Impact													$	1,182

(a)	Charges resulting from the step-up in basis of our inventory in accordance with fresh-start accounting ($67 million pre-tax and $52 million after-tax).
(b)	Charges related to the announced closure of the Ruabon Facility ($13 million pre-tax and after-tax).
(c)	Gain related to the termination of a natural gas purchase contract related to the announced closure of the Ruabon Facility ($6 million pre-tax and after-tax).
(d)	Gain resulting from settlements of legacy insurance policies with insolvent insurance carriers ($3 million pre-tax and after-tax).
(e)	Restructuring costs related principally to severance and retraining costs ($2 million pre-tax and after-tax).
(f)	Gain resulting from surplus land sales ($6 million pre-tax and after-tax).
(g)	Unamortized debt issuance costs associated with the repayment of the Bridge ($1 million pre-tax and after-tax).
(h)	Gain resulting from the settlement of emergence related incentive accruals ($4 million pre-tax and after-tax).
(i)	Reorganization items, net consist of the following: $104 million charge on the settlement of liabilities subject to compromise, $1,589 million gain from fresh-start accounting adjustments, and $52 million of professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings ($1,433 million pre-tax and $1,231 million after-tax).
(j)	Income tax expense 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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2007 Events

					Technical			Unallocated
Increase/(Decrease)	SAFLEX®		CPFilms		Specialties			/Other			Consolidated
Impact on:
Cost of goods sold		—		—		—			4			4	(a)
		—		—		3			—			3	(b)
		—		—		2			—			2	(c)
Operating Income Impact		—		—		(5	)		(4	)		(9	)
Interest Expense		—		—		—			(2	)		(2	)(d)
Other income, net		—		—		—			21			21	(e)
Loss on debt modification		—		—		—			(7	)		(7	)(f)
Reorganization Items, net		—		—		—			(185	)		(185	)(g)
Pre-tax Income Statement Impact	$	—	$	—	$	(5	)	$	(177	)		(182	)
Income tax impact												(3	)(h)
After-tax Income Statement Impact											$	(179	)

(a)	Restructuring charge resulting from the termination of a third-party agreement in the third quarter at one of our facilities ($4 million pre-tax and $3 million after-tax — see note (h) below).
(b)	Charge resulting from the step-up in basis of Flexsys’ inventory in accordance with purchase accounting ($3 million pre-tax and $2 million after-tax — see note (h) below).
(c)	Restructuring costs related principally to severance and retraining costs ($2 million pre-tax and $1 million after-tax — see note (h) below).
(d)	Charge resulting from recognition of interest expense on claims recognized as allowed secured claims through settlements approved by the Bankruptcy Court in the third quarter ($2 million pre-tax and after-tax — see note (h) below)
(e)	Settlement gain, net of legal expenses in the second quarter ($21 million pre-tax and after-tax — see note (h) below).
(f)	We recorded a charge of approximately $7 million (pre-tax and after-tax — see note (h) below) in the first quarter to record the write-off of debt issuance costs and to record the DIP facility modification.
(g)	Reorganization items, net consist of the following: $134 million net charge from adjustments to record certain pre-petition claims at estimated amounts of the allowed claims, $50 million of professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings; $4 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain of our employees approved by the Bankruptcy Court; offset by a $3 million gain realized from a claim settlement ($185 million pre-tax and after-tax — see note (h) below).
(h)	With the exception of item (a), (b), and (c) above, which related to operations not in reorganization, the above items were considered to have like pre-tax and after-tax impact as the tax benefit or expense realized from these events is offset by the change in valuation allowance for U.S. deferred tax assets resulting from uncertainty as to their recovery due to our Chapter 11 bankruptcy filing.

Financial Condition and Liquidity

Concurrent with our emergence from bankruptcy under our plan of reorganization, we initiated a complete recapitalization of the Company. On the Effective Date, all of the existing shares of common stock were cancelled and shares of common stock in newly reorganized Solutia were issued in satisfaction of creditor claims and stockholder interest. Also on the Effective Date, we issued New Common Stock with gross proceeds of $250 million and entered into Financing Agreements to borrow up to $2.05 billion from the Lenders. The proceeds from the stock issuance were used to establish a VEBA retiree trust and a restricted cash fund for the purpose of partially funding certain Legacy Liabilities. The proceeds from the Financing Agreements, which consisted of (i) a $450 million senior secured asset-based revolving credit facility (ii) a $1.2 billion senior secured term loan facility and (iii) a $400 million senior unsecured bridge facility (“Bridge”), were used to repay certain Predecessor liabilities, as more fully discussed below, in addition to providing additional liquidity for Successor operations.

In the third quarter of 2008, proceeds from the completion of two stock offerings, more fully discussed below, were used to retire the Bridge. The Bridge had a fixed interest rate of 15.50% and its retirement will result in approximately $60 million in annual interest expense savings.

Cash Flow

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended
	September 30,			September 30,			Increase
(dollars in millions)	2008			2007			(Decrease)
Continuing Operations
Cash used in operating activities	$	(262	)	$	(70	)	$	(192	)
Cash used in investing activities	$	(16	)	$	(170	)	$	154
Cash provided by financing activities	$	361		$	283		$	78

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Cash used in operating activities for continuing operations increased $192 million in the first nine months of 2008 as compared to the same period in 2007 predominantly due to a $320 million increase in reorganization payments required to fund our emergence from bankruptcy as partially offset by an increase in cash provided by continuing operations of $128 million. The increase in cash provided by continuing operations was driven by higher earnings and lower funding of our domestic pension and other postretirement plans. Reorganization payments in 2008 include cash used to establish a VEBA retiree trust and a restricted cash fund for the purpose of partially funding certain Legacy Liabilities.

Cash used in investing activities for continuing operations decreased $154 million in period-over-period comparison primarily due to our Flexsys Acquisition of $115 million included in 2007 in contrast to the cash generated by the sale of our corporate headquarters building in 2008 for $43 million.

Cash provided by financing activities increased $78 million in the first nine months of 2008 compared to the same period in 2007 primarily due to the recapitalization of our short-term and long-term debt as a result of our emergence from bankruptcy. On the Effective Date and concurrent with our emergence from bankruptcy, cash proceeds from our Financing Agreements, were used to (i) repay the short-term DIP credit facility, (ii) retire SSI’s Facility Agreement due 2011, (iii) retire the Flexsys term loan and revolving credit facility due 2012, (iv) pay certain secured and administrative claims, and (v) provide additional liquidity for operations. Also on the Effective Date, $250 million in proceeds from issuance of common stock were used to establish certain restricted funds for the payment of Legacy Liabilities. Subsequent to emergence from bankruptcy, we completed a sale and leaseback on our corporate headquarters and two common stock offerings comprised of 22,307,692 shares of common stock at $13 per share and 10,714,284 shares of common stock at $14 per share, respectively (“the Offerings”). Proceeds from the sale of our corporate headquarters were used to repay $19 million in debt outstanding on the building. Net proceeds of $422 million from the Offerings were used to repay our Bridge and provide additional liquidity for operations. The cash provided by financing activities in the nine months ended September 30, 2007 resulted primarily from $325 million of additional borrowings from our DIP credit facility and $22 million of net borrowings under the Flexsys term loan and revolving credit facility, partially offset by a pay down of $53 million to the DIP credit facility from the proceeds of the Dequest sale.

Working Capital

	Successor		Predecessor
	September 30,		December 31,			Increase
(dollars in millions)	2008		2007			(Decrease)
Continuing Operations
Current assets	$	908	$	891
Current liabilities		539		1,401
Working Capital	$	369	$	(510	)	$	879

Our working capital used in continuing operations increased primarily as a result of the payoff of our DIP credit facility on the Effective Date in the amount of $951 million in conjunction with our emergence from bankruptcy, the elimination of a $35 million LIFO reserve in accordance with fresh-start accounting, establishment of a fund restricted to the payment of certain Legacy Liabilities, and seasonal increases in working capital, partially offset by a decrease in cash to fund our emergence from Chapter 11. In addition to seasonality, inventories and accounts payable each increased due to higher raw material costs and the effects of the weaker U.S. dollar versus relevant currencies. Accounts receivable increased in conjunction with us consistently raising prices in reaction to a rising raw material trend along with a similar affect attributable to a weaker U.S. dollar.

Discontinued Operations

	Combined			Predecessor
	Nine Months			Nine Months
	Ended			Ended
	September 30,			September 30,		Increase
(dollars in millions)	2008			2007		(Decrease)
Discontinued Operations
Cash provided by (used in) operating activities	$	(177	)	$	4	$	(181	)
Cash provided by (used in) investing activities	$	(41	)	$	23	$	(64	)

Cash used in operating activities for discontinued operations increased due to lower earnings from our Integrated Nylon business, as discussed in the “Combined Results of Operations—Nine Months Ended September 30, 2008 Compared with Nine Months Ended September 30, 2007” section above and increases in working capital. Increases in working capital for our Integrated Nylon business are partially due to seasonality but more significantly attributable to significantly higher raw material costs on key inventory feedstocks. The decrease in cash provided by investing activities is due to the sale of the Dequest business and sales of surplus land in Integrated Nylon in the nine months ended September 30, 2007 of $54 million and $10 million, respectively.

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Debt and Liquidity

Total debt of $1,404 million as of September 30, 2008 decreased by $596 million as compared to $2,000 million at December 31, 2007, including $659 million subject to compromise and $1,341 million not subject to compromise. This decrease in total debt resulted from the settlement of debt subject to compromise through stock and cash settlements and the retirement of all debt facilities not subject to compromise at December 31, 2007. The payments were funded by the Financing Agreements and the sale of our corporate headquarters building in the second quarter 2008 for $43 million.

The weighted average interest rate on our total debt outstanding was approximately 7.9 percent at both September 30, 2008 and December 31, 2007.

At September 30, 2008, our total liquidity was $227 million in the form of $189 million of availability under the Revolver and $38 million of cash on-hand. Based upon current and anticipated levels of operations during the fiscal year, we believe that our liquidity and capital resources will be sufficient to maintain our normal operations at current levels.

The Financing Agreements include a number of customary covenants and events of default, including the maintenance of certain financial covenants 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; make capital expenditures; and prepay, redeem or exchange our debt. The financial covenants for the measurement period ended September 30, 2008 are (i) limitation of maximum leverage ratio comprised of gross debt to trailing twelve-month continuing operations Adjusted EBITDA or earnings from continuing operations before interest, income taxes, depreciation and amortization, reorganization items, non-cash stock compensation expense and unusual gains and charges (as that term is defined in the Financing Agreements) ratio to no more than 5.25 to 1.00; and (ii) maintenance of a minimum fixed charge coverage ratio comprised of trailing twelve-month continuing operations Adjusted EBITDA, as reduced by trailing twelve-month continuing operations capital expenditures, to Fixed Charges (as defined in the Financing Agreements, as the sum of annualized cash interest expense, net, trailing twelve months cash income taxes and annualized debt amortization under our Term Loan) ratio to no less than 1.00 to 1.00. We were in compliance with all applicable covenants for the measurement period ended September 30, 2008 with our calculated leverage ratio being 3.57 to 1.00 and our calculated fixed charge coverage ratio being 1.50 to 1.00. Over time, our maximum leverage ratio decreases and our minimum fixed charge coverage ratio increases. We are also subject to a maximum annual capital expenditure cap on continuing operations which is $175 million for the period ending December 31, 2008.

Pension Funding

According to current IRS funding rules, we will make approximately $57 million in pension contributions to our U.S. qualified pension plan in 2008. Approximately $50 million of these required 2008 contributions were made in the nine months ended September 30, 2008. We also expect to fund approximately $5 million in pension contributions to our foreign pension plans in 2008.

Contingencies

See Note 10 to the accompanying consolidated financial statements for a summary of our contingencies as of September 30, 2008.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS

There have been no material changes in market risk exposures during the nine months ended September 30, 2008 that affect the disclosures presented in the information appearing under “Derivative Financial Instruments” as presented in our 2007 Form 10-K, as re-casted and filed with the SEC in a Form 8-K on July 25, 2008, to reflect our segment reporting change as described in Note 14 to the accompanying consolidated financial statements, except as denoted below.

Historically, we have partially mitigated interest rate risk through our debt structure, which was a mix of fixed and floating rate debt instruments. During the third quarter of 2008, our mix of fixed and floating rate debt instruments changed materially due to repayment of our $400 million senior unsecured bridge facility, bearing a fixed interest rate of 15.50%. Substantially all of the remaining debt outstanding as of September 30, 2008, comprised of a $1.2 billion senior secured term loan and a $450 million senior secured asset-based revolving credit facility, bear interest at a floating rate. To partially mitigate this risk, we have in place a LIBOR cap on $900 million of floating rate debt through April 2010. Beyond 2010, the Company has in place other derivative instruments that mitigate a portion of the floating rate debt through the first quarter of 2014.

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 design and operation of 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 in timely alerting them to material information relating to us and our consolidated subsidiaries that is required to be included in our periodic SEC filings. The Chief Executive Officer and Chief Financial Officer also concluded that, as of the end of the period covered by this Form 10-Q, our disclosure controls and procedures are effective to provide reasonable assurance that we record, process, summarize, and report the required disclosure information within the specified time periods. 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 September 30, 2008 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

Legal Proceedings Resolved in Our Chapter 11 Process

With respect to the matter captioned asSavings and Investment Plan Litigationin the 2007 Form 10-K,in December 2007, the parties to the Savings and Investment Plan bankruptcy claim and litigation reached a global settlement of all outstanding issues and subsequently entered into a formal settlement agreement to that effect. The amount of the settlement to be paid in New Common Stock is $7 million from the disputed claims reserve established for such matter. The United States District Court, Southern District of New York entered an order on September 24, 2008, which formally approved the terms of the settlement.

Legal Proceedings Ongoing Post-Chapter 11

The following is a summary of legal proceedings in which there have been developments since our last periodic filing. These matters relate to Flexsys, which became a 100% owned subsidiary on May 1, 2007 upon our acquisition of the 50% interest owned by Akzo Nobel.

Flexsys Patent and Related Litigation

Flexsys holds various patents covering inventions in the manufacture of rubber chemicals, including patents describing and claiming a manufacturing process for 4-aminodiphenylamine (“4-ADPA”), a key building block for the manufacture of 6PPD and IPPD, as well as a manufacturing process for 6PPD and IPPD, which function as anti-degradants and are used primarily in the manufacture of rubber tires. Flexsys is engaged in litigation in several jurisdictions to protect and enforce its patents.

Legal Proceedings in the United States

The ITC-2 proceeding.In May 2008, Flexsys filed a second complaint with the U.S. International Trade Commission (“ITC”), requesting that the ITC initiate an investigation against Sinorgchem Co. Shangdong, a Chinese entity (“Sinorgchem”), Korea Kumho Petrochemical Company, a Korean company (“KKPC”), Kumho Tire Co. Inc., and Kumho Tire USA, Inc. Flexsys’ complaint requests that the ITC issue a limited exclusion order prohibiting the importation into the United States of 4-ADPA and 6PPD originating from these entities. The May 2008 ITC complaint alleges that Sinorgchem violated Flexsys’ patents for producing intermediate materials used to make 4-ADPA. The ITC formally instituted an investigation pursuant to this complaint on July 3, 2008. However, in September 2008, the ALJ entered an order in favor of the respondents, thereby terminating the investigation. Flexsys has subsequently filed a petition with the ITC seeking review of the ALJ’s decision. A decision from the ITC is expected in late 2008. This action involves enforcement of Flexsys’ patents, and does not involve any claims for damages against Flexsys.

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ITEM 1A. RISK FACTORS

You should consider carefully all of the information set forth in this report and, in particular, the risk factors described below and those described in our Annual Report on Form 10-K for the year ended December 31, 2007 and certain of our other filings with the SEC. Those risks being described below, elsewhere in this report onForm 10-Q and our other SEC filings are not the only ones we face, but are considered to be the most material. There may be other unknown or unpredictable economic, business, competitive, regulatory or other factors that could have material adverse effects on our future results. Past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.

Our actual financial results may vary significantly from the projections filed with the Bankruptcy Court.

In connection with the Plan of Reorganization process, we were required to prepare projected financial information to demonstrate to the Bankruptcy Court the feasibility of the Plan of Reorganization and our ability to continue operations upon emergence from bankruptcy. We filed projected financial information with the Bankruptcy Court most recently on October 22, 2007 and furnished it to the SEC, and as part of the disclosure statement approved by the Bankruptcy Court. The projections reflect numerous assumptions concerning anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary from those contemplated by the projections for a variety of reasons, including the fact that given our recent emergence from bankruptcy we have adopted the provisions of AICPA SOP 90-7,Financial Reporting by Entities in Reorganization under the Bankruptcy Code(“SOP 90-7”), regarding fresh-start accounting. As indicated in the disclosure statement, the projections applied fresh-start accounting provisions. However, these projections were limited by the information available to us as of the date of the preparation of the projections. Therefore variations from the projections may be material. The projections have not been incorporated by reference into this report and neither these projections nor any version of the disclosure statement should be considered or relied upon in connection with the purchase of our New Common Stock.

Because our consolidated financial statements reflect fresh-start accounting adjustments made upon emergence from bankruptcy, and because of the effects of the transactions that became effective pursuant to the Plan of Reorganization, financial information in our future financial statements will not be comparable to our financial information from prior periods.

Upon our emergence from Chapter 11, we adopted fresh-start accounting in accordance with SOP 90-7, pursuant to which our reorganization value, which represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, has been allocated to the fair value of assets in conformity with Statement of Financial Accounting Standards No. 141,Business Combinations, using the purchase method of accounting for business combinations. We stated liabilities, other than deferred taxes, at a present value of amounts expected to be paid. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets is reflected as goodwill, which is subject to periodic evaluation for impairment. In addition, under fresh-start accounting the accumulated deficit has been eliminated. In addition to fresh-start accounting, our consolidated financial statements reflect all effects of the transactions contemplated by the Plan of Reorganization. Thus, our future statements of financial position and statements of operations data will not be comparable in many respects to our consolidated statements of financial position and consolidated statements of operations data for periods prior to our adoption of fresh-start accounting and prior to accounting for the effects of the reorganization. The lack of comparable historical information may discourage investors from purchasing our New Common Stock.

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Continued Extreme Disruption in Global Financial Markets and Sustained Weakening in our Markets Could Significantly Impact our Results of Operations, Liquidity and Long Term Anticipated Growth Rate.

As widely reported, financial markets in the United States, Europe and Asia have been experiencing extreme disruption recently, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that include severely restricted credit and declines in real estate values. Although our total revenues remained strong for the third quarter of 2008, the current tightening of credit in financial markets adversely affects the ability of customers and suppliers to obtain financing for significant purchases and operations and could result in a decrease in or cancellation of orders for our products. Our global business is also adversely affected by decreases in the general level of economic activity, such as decreases in business and consumer spending that impact the construction, home furnishings, automotive, rubber chemicals and aviation and transportation markets. The weakening of these markets, if not temporary, could significantly impact our results of operations and our long-term anticipated growth rate. Further, stemming from our recent emergence from bankruptcy, the carrying amount of our goodwill and intangible assets was established at fair value as of February 28, 2008 and therefore is more susceptible to impairment if business operation results and/or macroeconomic conditions deteriorate. We are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions in the U.S. and other countries. However, if macroeconomic conditions continue to worsen, it is possible these factors could result in a decline in our future profitability and cash from operating activities.

We Have and Will Continue to Have Significant Indebtedness.

We have and will continue to have a significant amount of indebtedness. Our significant indebtedness could have important consequences, including the following:

• We will have to dedicate a significant portion of our cash flow to making interest and principal payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions or other general corporate purposes.

• Levels of indebtedness may make us less attractive to potential acquirors or acquisition targets.

• Levels of indebtedness may limit our flexibility to adjust to changing business and market conditions, and make us more vulnerable to downturns in general economic conditions as compared to competitors that may be less leveraged.

• As described in more detail below, the credit facilities contain restrictive covenants that may limit our financing and operational flexibility.

Furthermore, our ability to satisfy our debt service obligations will depend, among other things, upon fluctuations in interest rates, our future operating performance and our ability to refinance indebtedness when necessary. These factors depend partly on economic, financial, competitive and other factors beyond our control. We have hedged a significant portion of our variable rate debt with derivative instruments. We may not be able to generate sufficient cash from operations to meet our debt service obligations as well as fund necessary capital expenditures, pension funding obligations and investments in research and development. In addition, if we need to refinance our debt, obtain additional financing or sell assets or equity, we may not be able to do so on commercially reasonable terms, if at all. Finally, counterparties to our derivative instruments may not be able to honor their contractual obligations.

Our Operations Are Restricted by Our Credit Facilities and Could be Impacted by the Failure of Our Lenders to Perform.

Our credit facilities include a number of significant restrictive covenants. These covenants could impair our financing and operational flexibility and make it difficult for us to react to market conditions and satisfy our ongoing capital needs and unanticipated cash requirements. Specifically, such covenants restrict our ability and, if applicable, the ability of our subsidiaries to, among other things:

• incur additional debt;

• make certain investments and acquisitions;

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• enter into certain types of transactions with affiliates;

• limit dividends or other payments by us and certain of our subsidiaries;

• use assets as security in other transactions;

• pay dividends on our common stock or repurchase our equity interests;

• sell certain assets or merge with or into other companies;

• guarantee the debts of others;

• enter into new lines of business;

• make capital expenditures;

• prepay, redeem or exchange our debt;

• form any joint ventures or subsidiary investments.

In addition, our current credit facilities require us to satisfy certain financial covenants. These financial covenants and tests could limit our ability to react to market conditions or satisfy extraordinary capital needs and could otherwise restrict our financing and operations.

Our ability to comply with the covenants and other terms of our debt obligations will depend on our future operating performance. If we fail to comply with such covenants and terms, we would be required to obtain waivers from our lenders to maintain compliance with our debt obligations. If we are unable to obtain any necessary waivers and the debt is accelerated, a material adverse effect on our financial condition and future operating performance would result.

Our current revolving credit facility is a syndicated credit agreement in which each lender is severally liable for only its agreed part of the loan commitments. Although all lenders have performed their individual obligations under the terms of the revolving credit agreement to date, there can be no assurance that this will continue given the current turmoil in the financial services industry. One or more lender’s failure to perform on their obligations could have a material adverse effect on the Company’s ability to fund its ongoing operations and other commitments.

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

(c ) Purchases of Equity Securities by the Issuer

					Total Number of		Approximate Dollar
					Shares Purchased as		Value (in millions)
	Total Number				Part of Publicly		that May Yet Be
	of Shares		Average Price Paid		Announced Plans or		Purchased Under the
Period	Purchased (1)		Per Share (2)		Programs		Plans or Programs
July 1-31, 2008		0	$	0.00		0	$	0
August 1-31, 2008		31,429	$	15.50		0	$	0
September 1-30, 2008		0	$	0.00		0	$	0
Total		31,429	$	15.50		0	$	0

(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.
(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 5. OTHER EVENTS

Pursuant to the Company’s By-Laws, any submission to the Company by a stockholder of a proposal for possible inclusion in the Company’s Proxy Statement for its 2009 Annual Meeting of Stockholders or notice to the Company to otherwise conduct business at the 2009 Annual Meeting of Stockholders must be received by the Company no later than the close of business on the tenth day following the day on which the date of the annual meeting is publicly announced. It is anticipated that a public announcement of the date of the 2009 Annual Meeting of Stockholders will be made in late November. The deadline set forth above shall apply to (i) stockholder proposals submitted in accordance with Rule 14a-8 of Regulation 14A under the Securities Exchange Act of 1934 which among other eligibility criteria, provides that a stockholder must send notice of the proposal to the Company so that the Company receives it in a reasonable time before it begins printing and mailing the Proxy Statement and (ii) stockholder nominations of directors or proposals submitted other than pursuant to Rule 14a-8. Stockholder proposals should be addressed to the Corporate Secretary at Solutia Inc., P.O. Box 66760, St. Louis, MO 63166-6760.

ITEM 6. EXHIBITS

See the Exhibit Index at page 54 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/ TIMOTHY J. SPIHLMAN  

(Vice President and Controller) 

(On behalf of the Registrant and as
Principal Accounting Officer) 

Dated: October 30, 2008

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EXHIBIT INDEX

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

EXHIBIT
NUMBER		DESCRIPTION
	3.1	Second Amended and Restated Certificate of Incorporation of Solutia Inc. (incorporated by reference to Exhibit 3.1 to Solutia’s Form 8-K filed on March 4, 2008)
	3.2	Amended and Restated Bylaws of Solutia Inc. (incorporated by reference to Exhibit 3.2 to Solutia’s Form 8-K filed on March 4, 2008)
	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

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