Document oJ7QQ97N35DM4kgVKNOVaBjR

SO LUT I A * Applied Chemistry, Creative Solutions SAR000i LAM018741 Contents To Our Shareholders Page 2 A New Beginning Page 5 Financial Section Page 18 Businesses and Products Page 50 Locations and Management Leaders Page 54 Board of Directors Page 56 Shareholder Information Inside Back Cover About The Cover With strong positions in a variety of markets, manv of Solutia's products probably touch your life every day: Skydrol hydraulic fluids are the #1 choice of commercial aviation professionals around the world. Our Wear-Dated brand is one of North America's most recognized trademarks for carpet fibers and upholstery fabrics. We also make Saflex plastic interlayer - used in highperformance laminated glass for buildings, and automotive windshields and side windows. "SOLUTIA", die Solutia logo and "Applied Chemistry, Creative Solutions" are trademarks of Solutia Inc. Other trademarks of Solutia Inc. are designated throughout in italics, (sec page 50). About Our Businesses Solutia's portfolio includes ten business units. We compete in three broad segments. Fibers Segment Acrilan Acrylic fibers. We are North America's largest producer of acrylic fiber, which is used to make finished products such as apparel, craft yarns, upholstery fabrics, and brake fibers. Carpet Fibers. We are the world's largest producer of nylon staple fiber and a major supplier of nylon BCF used to make car peting and rugs under the WearDated and Ultron VIP brands. Nylon Industrial Fibers. We pro duce industrial-strength nylon fibers, which customers use to make finished products such as dental floss, cargo slings, auto airbags and tire cords. Chemicals Segment Industrial Products. We are a leading manufacturer of high perfor mance specialty industrial fluids, including Skydrol hydraulic fluids for aviation, Therminol heat transfer fluids, and Dequest water treat ment chemicals. Intermediates. We manufacture more than three dozen "building block" chemicals that serve as feed stocks for our various manufacturing processes, or are sold to external customers on the merchant market. Phosphorus Derivatives. We are a world leader in developing applications for phosphorus chem istry, including ingredients used in foods and beverages, personal care products and industrial cleaners. Polymers and Resins Segment Nylon Plastics & Polymers. We manufacture nylon 6,6 resin for the engineering thermoplastic and polymer merchant markets, where our products add performance characteristics to finished goods. Polymer Modifiers. We manufac ture a line of polymer modifiers and specialty plasticizers that help improve the performance of flooring products, sealants, caulks, adhesives and other finished goods. Resins. Our line of specialty resins covers a broad range of products such as crosslinkers, flow modifiers, pressure sensitive adhesives, paper surface size, and plastic products. Sajlex Plastic Interlayer. We are the world's leading producer of polyvinyl butyral, a plastic inter layer used to make laminated glass for automotive and architectural applications. SAR 0002 LAM018742 1997 Financial Highlights (Dollars in millions, except per share) Net Sales................................................................................................. Net Income*21.......................................................................................... Per Share, assuming dilution: Net Income*11....................................................................................... Dividends*41........................................................................................ Depreciation and Amortization............................................................. Capital Expenditures.............................................................................. Percent of Total Debt to Total Capitalization......................................... Number of Registered Stockholders (year-end).................................. Share Outstanding (year-end, thousands).............................................. Employees (year-end)............................................................................. 10 The unaudited pro forma financial information gives effect to the spinoff and Solutia s 1997 debt offering as if the spinoff and the offering had occurred as of the beginning of the periods presented. The pro forma information is presented for illustrative purposes only and may not be indicative of the results that would have been obtained had the transactions actually occurred on the date assumed, nor is it necessarily indicative of future consolidated results of operations. <2>Net income includes charges for changes in estimates for environmental liabili ties of $+6 million, or $0.-37 per share, and other net unusual items of S7 mil- Unaudited Pro Forma**1 1997 1996 $2,960 $2,962 $ 157 $ 17 1997 Historical 1996 $ 2,969 S2,977 $ 192 S 32 $ 1.27 - $ 142 - - - S 0.14 - S 166 - - $ 1.55 $ 0.01 $ 142 $ ' 165 120% 57,894 117,408 8,800 S 0.27 - S 166 S 192 - - lion, or SO.06 per share, in 1997 and SI64 million, or 51.37 per share, of restructuring charges in 1996. <9 For periods ended prior to the spinoff, the number of Monsanto weighted aver age shares outstanding and common share equivalents were adjusted for the dis tribution ratio in the spinoff' of one share of Solutia s common stock for every five shares of Monsanto common stock. I4) Because Solutia was not formed as an independent public companv until September 1, 1997, only one quarterly dividend was paid in 1997. About Your Stake In Solutia Solutia Inc. (NYSE: SOI) is one of the newest names in the stock market, but we are a company built on almost a century of success. Formerly the applied chemistry busi nesses of Monsanto Company, Solutia became an indepen dent, publicly traded enter prise on September 1, 1997, as the result of the spinolf of those businesses by Monsanto. Shareholders received one share of Solutia stock for every five shares of Monsanto com mon stock they owned on August 20, 1997, the record date for the spinoff.* Why was Solutia spun ofTfrom Monsanto?The primary reason was to create shareholder value. In 1996, Monsanto's Board of Directors determined that its life sciences and applied chemistry businesses w ould have the best opportunities to achieve their potential if they were managed as two sepa rate enterprises. Monsanto's Board considered several alternatives, including the sale of the applied chemistry busi nesses to other companies, asset swaps, mergers, and other options. In the end, the Board chose a spinoff as the best way to generate long term value for shareowners, as well as to serve the best interests of our customers and our employees. SAR 0003 In Solutia's case, independence means that we have the chance to optimize the performance of ten strong, technologybased business units serving three attractive segments Chemicals, Fibers, and Polymers & Resins. Our portfolio consists of proven performers. All of Solutia's businesses meet a specific profile: Leading technology and/or cost position Strong share of the served market Experienced management A solutions-driven relation ship with customers. Solutia starts out, then, on a solid foundation. VVe are a new company, but we have strengths few start-up enterprises can match. Our vision - our commitment - is to make these good businesses even better. In the process, we intend to meet expectations for growth in the value of Solutia's stock. * Stock certificates were not issued to shareholders unless specifically requested; instead, the new shares were distributed through a book entry system. Under this system, your own ership of shares Is listed in records maintained by our stock transfer agent. First Chicago Trust Company of New York. For more information on how to contact First Chicago, please see Shareholder Information inside the back cover of this report. LAIVI018743 S I eptember 1, 1997, was independence dav for Solutia profitable, market-leading businesses. We expect to carrv this S-- the first official dav in business for a strong, estab approach forward as an independent companv because wc lished competitor in attractive markets. It was a day think it's the best wav for Solutia to produce consistent worth celebrating for Solutia's leadership team and our increases in our stock price over time. 8,800 employees worldwide. Whv? Because we now have the In this letter, we will explain our targets and plans in more chance to spread our wings. detail, including a look at our five priorities for the path for We are running successful businesses we know very well, ward. But first, let's review Solutia's 1997 financial results. but our entire outlook has changed. As an Financial Performance. Solutia produced independent companv, we are no longer sim ply generating cash for investment in other portions of a corporate portfolio. We have been given the opportunitv to create value for We are focused on growth of earnings per share, strong financial results in 1997 as it began its operations as an independent companv. The improved operations were printarilv attrib uted to significant cost reductions. The com shareowners in our own right. Solutia's people feel energized bv this chal lenge, and with good reason. Wc are an oddson favorite to succeed. After all, we are not a tvpical start-up companv: Solutia draw s on 96 cash flow generation, and stock price appreciation. bination of improved operating results and improved working capital management resulted in verv strong cash flow subsequent to the spinoff. This solid 1997 performance is all the vears of experience in applied more remarkable given the circumstances chemistrv. Our businesses, all proven per under which it was achieved. Despite the verv real distrac formers, combined to produce approximatelv tions of the spinoff, our people didn't miss a beat in 1997. S3.0 billion in sales in 1997. We kept our businesses humming, kept our customers happv, Clearlv, we have products and and kept profits growing - even as we went about the con technologies that customers siderable task of creating a new independent companv. ^ want and need. Just as impor- Two elements of our financial performance are particu f tant, we have strong relation larly notevvorthv: the progress we made in strengthening our ships in everv market wc serve. In balance sheet, and our EPS performance. fact, we consider those relationships With regard to the balance sheet, Solutia faced a challenge so vital that wc paid them tribute in at the time of the spinoff. In exchange for our independence, our new name. we took on more than SI billion in debt and over SI billion We start out, then, with enviable in liabilities for postretirement benefits from Monsanto strengths. That's not an accident. Companv, resulting in negative equity of SI 39 million. Over the past decade, we've This opening position made one thing crvstal clear: made disciplined manage Solutia would have to earn the right to succeed bv rigorous- Solutia Chairman and CEO Robert C. Potter (left), and President and Chief Operating Officer John C. Hunter Hi ment decisions to exit underperforming product lines and to build our portfolio around Iv focusing on cash flow. Wc made substantial progress earlv, generating enough cash to pav oil approximatelv S2+0 mil lion of debt bv vear's end. SAR 0004 LAM018744 S o l u tia Inc. EPS performance was another bright spot, once we put projects that promise attractive returns. In the process, Solutia our hands on the steering wheel. Our target is to generate at is building a reputation as a willing deal maker. We are not least 10 percent compound annual growth in EPS. It's a bound by tradition. Our industry peers are learning that we demanding goal, but we're determined to make it happen. will consider almost any opportunity that demonstrably adds How will we get there? Our strategy is to shareowner value, whether it's an alliance, a grounded in a handful of priorities that drive everything we do. The Path Forward. At the top of the list is meeting customer commitments. One of the What makes Solutia different? Our joint venture, or a marketing partnership. The fourth key element of our strategy is to engage the full potential of our people. With the spinoff, we put an organization in reasons Solutia's businesses have been success ful is that we're verv good at giving customers exactly what thev need. We usually hit our tar get - whether it's performance, quality, deliv ers', technical support, price or whatever other strengths include a proven portfolio of businesses, the discipline to place designed to do just that. Our ten mar ket-focused business units are served bv a cen tralized staff, which increases efficiency and allows us to mobiliz.e people quicklv around emerging opportunities. measure is important to customers. Another priority is to meet financial expec tations consistently. It's an advantage here to be running well-established businesses. We know what level of sales and income they're capable manage them for consistent profits and cashflow, and a keen eye We are also using our newly found indepen dence as a chance to rethink and reengineer our basic business processes. A major initiative, called WWOF (for Worldwide Operations and Finance), is now under wav to change how of producing, so we can - and will - manage them with an esc tow ard controlling costs and maximizing cash (low. In addition, as in the past, we'll actively manage the portfolio to for partnerships that add value to the enterprise. work gets done across Solutia. It will integrate procurement, order entry, manufacturing, ship ping, and billing. This initiative, supported by software licensed from SAP AG, will dramati ensure that we participate only in markets and cally improve the efficiency of our operations, product areas where we can reasonably expect to exercise even as it supports our final separation from Monsanto and leadership and capture value for our shareowners. addresses most of the company's "Year 2000" computer issues. The third part of our strategy is to deliver profitable long Along with the new structures and systems we've put in term growth. The kev word here is profitable. We have no place, we are engaging Solutia's people by rewarding superior interest in speculative, blue-sky products or projects. Our performance with a healthy measure of variable compensation. development efforts will be focused on answering identified And at every level of the company, employees achieve their market needs, and on securing cost reductions that enhance greatest earning potential onlv when Solutia hits aggressive our ability to compete long term. annual targets for both cash flow generation and EPS growth. What's more, we will be pragmatic about investing in Our fifth priority is to operate responsibly. This is really growth. We don't have to own the technology or make all the nothing new for the people of Solutia. We have a long track cash investments ourselves. As you'll learn later in this report, record of doing the right thing, not only in terms of running we are taking a creative approach to launching several capital safe plants and respecting the environment, but also when it SAR 0005 LAMO18745 comes to drawing on people with diverse backgrounds and experience, and supporting the communities where we work. Our commitments in all of these areas will continue. Taken together, these five priorities should help explain what Solutia is all about. We hope they also show you what makes us different from our peers, and what sets Solutia apart as an investment opportunity Dividend Policy. The Board of Directors declared a quar terly dividend of one cent per share. This verv modest divi dend policy was implemented so that Solutia stock could be held bv funds and institutions that consider dividends a pre requisite for investment. For the foreseeable future, our intention is to use stock repurchases as the primary vehicle for returning cash to shareholders. This approach will give Solutia the maximum flexibility in managing our cash flow to satisfy our debt oblig ations, to make future investments and to reward our own ers. The Board has set a target of returning up to 35 percent of net income to shareholders through the combination of dividends and stock buy-backs. We delivered on that com mitment in 1997, and turned in a performance which saw our market capitalization grow from $2.3 billion on September 1, 1997, to S3.1 billion on December 31, 1997. A Look Ahead. Heading into our first full year as an inde pendent enterprise, we are determined and confident determined to compete and win in the marketplace; confi dent that we have the people, the portfolio and the plan we need to succeed. For all of us who work here, this new com pany is the opportunity of a lifetime. We're already hard at work, turning Solutia's bright potential into solid and con tinuing increases in the value of vour investment. Robert G. Potter Chairman and Chief Executive Officer CL John C. Hunter III President and Chief Operating Officer A New Name. A World of Possibilities. Selecting a new name and logo was one -a commitment amplified by our tagline: of our first important decisions as an inde *Applied Chemistry, Creative Solutions." pendent company. We wanted our corpo Our new logo surrounds the name rate identity to communicate with a shape that suggests concisely what the company both a molecule and the is all about: Transforming the ordinary into the indispens able through chemistry. We chose the name Solutia SOLUTIA * * Applied Chemistry, Creative Solutions ~ infinity symbol, emphasiz ing our strong foundation in applied chemistry and our forward-looking approach because it says a lot about the way we to new opportunities. think and work. It tells you we're in busi Although our corporate name is ness to solve problems for our customers new, Solutia still owns many well- recognized trademarks, including Wear-Dated fiber for upholstery and residential carpets, Saflex plastic interlayer for automotive windshields and laminated architectural glass. Acrilan acrylic fiber for apparel, uphol stery and craft yarns, and dozens of other well-respected brand names in industrial markets such as food pro cessing, aviation, plastics manufactur ing, construction materials, and per sonal care products. Saf*0006 0 LAM018746 SAR 0007 A New Beginning... A Clear Path Forward Solutia has many advantages over most start-up companies, not the least of which is a track record of success stretching back almost a century. IVe are proud of our past. At the same time, we embrace independence, and the chance it gives us to build something new. That spirit ofpurpose is captured in Solutia's mission and corporate priorities. We will increase shareowner value by applying our knowledge of chemistry to provide creative solu tionsfor our customers. We will accomplish this by: 1. Meeting customer commitments. 2. Meeting financial expectations. 3. Delivering long-term, profitable growth. 4. Engaging our people, and rewarding them. 5. Being a responsible company. Throughout 1997, we made significant progress on all five counts. In this report, well review the highlights of our performance. New Products. Aggressive Marketing Strategies. Successful Partnerships. All Strengthen Solutia's Links To Its Customers. here are good reasons why Solutia ranks # 1 tectural glazing. In recent years, our customers have Tor #2 in sales to most of our targeted mar introduced new manufacturing processes for lami kets. We make and sell quality products. We nated glass, developing techniques such as vacuum consistently meet our customers' expectations fobrag systems to remove air delivery and service. And we back up the products we sell with expert technical support that helps to give customers a competitive edge in the market place. In short, we're good at adding value to each customer's business. between the glass and PVB lay ers. (The traditional process uses nip-rollers to squeeze air out during lamination.) New laminating techniques Solutia helps customers develop a market for It's a relatively simple formula for success - and are important to our cus windows we carried it out well in 1997, despite the distrac tions of the spinoft. Our businesses and manufac turing processes ran at high utilization rates throughout the year. We met our commitments on product quality and delivery, even as wc went tomers because they reduce manufacturing costs, and permit new shapes or bends in the finished glass product. Although our existing PVB in homes and offices that offer hurricane about the considerable task of splitting assets and interlayer worked well with protection. An improved Saflexproduct systems, changing or invent ing new work routines, and preparing for our future as an the nip-roll process, it was less effective when used with the vacuum laminating processes. To improve our product's performance, solves manu facturing problems for independent company. A Commitment To Growth. Bevond hitting operating tar gets, one of Solutia's most Solutia in 1997 introduced, and began to commer cialize, Sajlex 1IIG. The new product offers an improved chemical formulation, which enhances lam ination processing and laminate long-term stability. customers; important customer commit Sajlex IIIG doesn't just solve process problems creates new markets for laminated ments is to provide technolo gy, products, and marketing strategies that generate new sales. A case in point: Our for customers. It also improves the performance of the laminated glass, offering greater edge stability, improved moisture insensitivity, and reduced delam ination. As a result, Sajlex IIIG makes it possible for glass. Sajlex business, where wc glass laminators to offer automakers new "exposed- developed a reformulated edge" products, such as flush-mounted windshields product to enhance performance and where we and laminated side windows. helped to create two promising new markets for laminated glass. Along with new products, Solutia is also work ing to develop new markets for laminated glass. In Sajlex is Solutia's brand name for polvvinvl the United Kingdom, for example, wc teamed up butyral (PVB), a plastic interlayer that adds safety, with law enforcement agencies and the insurance security, solar and sound control leatures to glass for industry to establish a security standard for auto applications such as automotive w indows and archi side and rear windows. In the United States, wc arc SAR 0008 0 LAMO18748 working with federal safetv ofiicials to set rules for auto windows that would reduce passenger ejec tions during accidents. We are also helping our customers market the new auto window products dircctlv to automakers. These efforts are starting to pav off: Car models such as the Audi AS, die BMW 750iL and the Mercedes 500 Series now offer laminated side and rear glass. Other major manufacturers are testing production models that feature laminated side and rear glass. Tvpicallv, such applications can triple die amount of laminated glass installed in each vehicle. Hurricane Protection. In the architectural market, Solutia is placing a kev role in creating demand for laminated glass as a wav to minimize hurricane dam age. Windows in homos and offices are usuallv the weak link during tierce storms. Thcv can he pene trated bv fix ing debris, allowing wind to rush in and LAM018749 0 Priority Number 1 Meeting Customer Commitments, pressurize the structure, leading to catastrophic fail ure of the roof and walls. Windows laminated with PVB offer an excellent first line of defense. The glass Improved mav be broken by debris, but dyeing tech nologies lead to exciting the interlayer remains intact J preventing the in-rush of damaging winds. In the wake of Hurricane Andrew, we opportunities began working with officials for commer cial carpet fibers. in South Florida to make win dow protection a require ment in new construction. This effort has led to new building code provisions in Dade Count)-, Broward County, Monroe County and Palm Beach in Florida that mandate protection in the form of shutters, prccut 3/4 inch plywood sheets or laminated glass. Of the available protection devices, laminated glass windows are quicklv becoming the preferred option, for obvious reasons: They are more attractive, more cost-effective, and require no storage or emergency installation. Other hurricane-threatened areas of the countrv arc learning from South Florida's experience. New laws in Texas, Hawaii and New York require insur ance companies to provide premium discounts for homes and buildings equipped with laminated glass windows. As we continue to encourage such legisla tion in other at-risk regions, Solutia is providing technical and marketing support to help window manufacturers introduce products that satisfy this newly emerging demand. Adding Vibrancy To The Carpet Market. Our customer commitment created new opportunities in the carpet fibers business, too. In 1997, we enhanced one dyeing technology and introduced another to help commer cial carpet makers reap additional sales. Solutia significantly expanded the color palette for our line of solution-dyed nylon fibers. With this prod uct line, pigments are integrated into (rather than applied onto) the carpet yarns, so that the colors stand up to cleaning agents, ultraviolet light, and other per ils in offices, hotels and similar settings. Solutia now markets the industry's widest range of solution-dved nylon fibers for contract carpet makers -- 116 differ ent colors in all. We also support the product line with customer-pleasing extras, such as a quick-ship pro gram that guarantees five-day availability on the most popular hues. At a major trade show in 1997, Solutia won orders for solution-dyed fibers that will be used to make 70 new grades of commercial carpet - our best year ever in the contract carpet market. The year's other big news in carpet fibers is a revolutionary dyeing technique which we're calling Dyenamix. This new technology offers two key advantages for carpet makers: cleaner, more vibrant colors, and compatibility with our customers' new continuous dve range processes. These new techniques are more efficient and produce more consistent col ors than the batch dyeing A Therminol processes they replace. Two major customers - Milliken and Interface Group - have already announced new carpet product lines based on our joint venture in China ensures responsive Dyenamix technology. Turning Knowledge Into Profits. Strong customer relationships are critical to other parts of our business, as well. For example, ness - and profitable sales to global chemical manufacturers know that we provide world-class cus customers. tomer support for our Therminol brand of heat transfer fluids - and this reputation has created attractive opportunities for us in the People's Republic of China. Solutia is a world leader in liquid-phase heat transfer fluid systems. (Liquid-phase technology offers chemical manufacturers cost, efficiency and safety advantages over vapor-phase systems, which must be operated under pressure.) Several vears 0 SAR 0010 LAM018750 ago, we used our strong background in liquid-phase technology to help forge a partnership with Jiangsu Chemical Pesticide Group, the leading vapor-phase heat transfer fluid producer in China. Today, Solutia and Jiangsu own and operate a highly successful Joint venture in Suzhou. The joint venture was profitable in 1996, its first full year of operation, and increased its profitability- in 1997. In addition, its sales are growing significantly faster than the market overall, thanks both to the perfor mance of our Thcrminol products and to the engi neering support we provide to our global cus tomers who are designing and building process manufacturing plants in Asia. LA/VJ018751 SAR 0011 Priority Number 2 Meeting Financial Expectations We Are Ahead Of Schedule In Improving Our Post-Spinoff Financial Condition And In Returning Value To Shareholders. At the time of our spinoff from Monsanto /\ Company, we faced some significant financial _L _A_ challenges: Solutia took on about Si bil lion of debt; we assumed about SI billion in postre tirement medical, insurance, and pension liabilities; and we started out in a negative equitv position. Despite the obvious hurdles imposed by our bal ance sheet, it has proven to be something of a tonic as well: Right from the start, wc have had to focus on producing cash. We've communicated that mes sage throughout the Solutia organization, and it's had an immediate impact. Reducing Debt. By the end of 1997, Solutia had reduced its debt burden to about S790 million, reaching the level manv observers did not expect us to achieve for several vears. Debt reduction is ahead of expectations, This rapid progress was made possible by strong results from business operations and bv improvements in Solutia's significantly cash management worldwide. strengthening Solutia's balance sheet. Solutia employees clcarlv under stand the critical role thev plav in ensuring the companv's long term success, and thcv're acting accordingly Thev arc treating Solutia's cash as if it were their own. Trimming Costs. The companv's cost-reduction initiatives are contributing to the overall improve ment in our financial condition, too. By the vear 2000, we expect to cut $200 million annuallv (in pretax dollars) from Solutia's total expenses, through a combination of business enhancements, process improvements, and staff reductions. The savings won't come all at once. The first phase of our cost-reduction effort (including most of the expected stall cuts) began in 1997, with the full benefit to be reflected by 1999. The second phase, which involves capital projects to expand capacitv, implement new process technologies and reduce manufacturing costs, will pro duce cost-saving benefits begin ning in the vear 2000. In the interim, Solutia will incur pro ject expenses associated with those new capital projects required to produce the expect ed cost benefits. Returning Value. It's impor Cost-cutting initiatives are expected to trim $200 million in ongoing expenses tant to note that we haven't by 2000. focused exclusivelv on debt reduction and cost savings. Solutia also made signif icant headway in returning cash to shareholders dur ing 1997. In October, the company's Board of Directors announced that share repurchases would be the primarv vehicle for rewarding the owners of Solutia stock. After onlv four months of existence, Solutia has repurchased approximately 1.4 million shares of common stock under this share repurchase program. In addition, Solutia paid its first dividend in December of 1997. Total Return To Shareholders SAR 0012 LAM018752 Delivering Profitable Growth Solutia Is Finding Creative Ways To Invest In The Future Of Our Businesses And Compete Effectively In Attractive Growth Markets. rofitable growth is essential to the long-term itable growth bv finding practical, and often creative, Phealth of anv business. For Solutia, the prob wavs to invest in our businesses. lem isn't finding attractive new markets to Nylon Industrial Fiber Plant Expansion.This past Julv, enter, or new technologies to pursue. Rather, ourSolutia brought a new industrial nvlon fiber production challenge is to invest in profitable growth while con unit on stream at our plant in Greenwood, South tinuing to meet our considerable financial obliga Carolina. The new unit was needed to bring Solutia's tions and commitments. spinning technology up to world-class standards, so that It's a challenge we met with extraordinary success our high-tenacity nvlon industrial varns could be sold in 1997. During the vear, we developed or launched into high-growth markets such as automotive air bags. two major projects that promise to provide attractive We had two choices in planning this expansion to growth opportunities lor Solutia well into the next keep our business competitive: We could invest time, centurv. In each case, we laid die foundation for prof money and expertise to develop our own state-of- the-art spinning technology; or we could license a world-class technology, and get into the business sooner, with far less capital outlay. We chose the licensing option, purchasing technology rights from Toray Industries, the largest and most successful fiber producer in Japan. The unit started up flawlessly, less than one year after we broke ground on the project. It's now pro ducing approximately 20 million pounds of additional fibers annually, targeting the most attractiye segments of the industrial nylon market. Phenol Production Technology. In December, Solutia's Board agreed that we should actively seek a partner for a project to commercialize a revolution ary process for manufacturing phenol, a chemical intermediate that we will use as a feedstock for our various nylon businesses. The new phenol technology promises to drive sig nificant raw material cost reductions for all of Solutia's nylon businesses. But this groundbreaking technology is noteworthy on a number of other counts, as well.The new one-step process is environmentally friendly, pro ducing only minor quantities of aqueous wastes, and no acetone bv-product - both improvements over the two-step processes used bv Solutia finds creative ways to invest in projects that other phenol manufacturers. Best of all, the new process is highly efficient, prosiding a 98 percent yield, compared with the 93 percent yield from tra will lead to increased sales and profits. ditional two-step phenol manu facturing techniques. The new phenol technologs is based on catalyst research done at the Boreskov Institute of Catalysis in Russia. Solutia nosy osvns the worldwide rights outside of the former Soviet Union, and we've applied for patents on the elements of the process wc developed internally. As an added benefit, the ness phenol process will let us put a svastc stream to work. It uses nitrous GU oxide, svhich is produced as a bv-product from our adipic Licensed acid process. We nosv inciner ate this stream in order to avoid releasing it to the atmosphere. Solutia's board of directors technology positions us to compete in has approved an investment to high-growth commercialize the one-step phenol process. In addition, we have reached an agreement in principle with a partner who industrial nylon fibers markets. will provide upfront payments that will be used to partially fund the cost of con struction and start-up. In return, the partner will have the right to purchase phenol from Solutia at a beneficial price under a long-term contract. We expect to bring the new phenol process on-stream during the second half of 2001. Acrylonitrile Plant Expansion. Solutia ranks as the world's leading consumer of acrylonitrile (AN), a major feedstock used to make nylon carpet fibers, acrvlic fibers, nvion industrial fibers, and other prod ucts. Currently, about half the AN we need is manu factured at our plant in Chocolate Bavou, Texas. The remainder is purchased. In 1997, we finalized plans for a project to double our AN production capacity. The project will signifi cantly reduce our cost to acquire this key feedstock bv allowing us to produce the vast majority of our AN requirements internally. We will break ground on the project in the second quarter of 1998, with the new AN unit coming on stream by mid year 2000. To partially fund the cost of construction and start-up, we are securing up-front payments from several customers in return for long-term supply contracts. Nov us International Inc. has agreed to pro vide an advance payment for a by-product of the AN process, which they use to make a feed ingredient for poultry.Two other customers will purchase a portion of the actual AN volume: Bayer Corp., for their ABS plastics business, and a leading Japanese chemical company, for sale into the merchant market. SAR 0014 a n/irt 07c/i e We're Winning In The Marketplace, Thanks To An Efficient Enterprise Design, World-Class Work Processes, And Targeted Incentives. ne of our key opportunities in 1997 was to particular project misses the mark, then we move O design an organization that would be wellequipped to compete and win in our target on, shifting development resources to other opportunities. There's no shortage of good ideas at markets. The goal was simple: to build a Solutia thaSt olutia: At year's end, we had several hundred could draw on knowledge and experience from growth projects at various stages of incubation, across the enterprise, and that would operate as effi assessment or commercialization. ciently as possible. World-Class Business Processes. In addition to VVc did it bv organizing our new company launching Solutia with a lean, market-focused man around ten business units - all served bv a single, agement structure, we are also using the spinoff as an shared headquarters staff. As a result, we don't have opportunity to rethink and redesign our basic business any resource-wasting duplica processes. Internally, this initiative is called YVWOF, We've rebuilt tion inside Solutia. Instead, or Worldwide Operations and Finance. It amounts to our organiza tion to empha size speed, our encrgv and attention are focused on winning in the marketplace - winning as a single, successful enterprise. a complete overhaul of the company's supplv chain and business processes, covering everything from pro curement and production systems to sales, customer service, and accounting. efficiency and Solutia's new Commercial Todav, such functions are handled differentia- at innovation. Development organization pro vides a gOood illustration of how a market-focused structure will add value as we move ahead. Commercial Development combines a number ol technologv and marketing functions into a new, enterprise-level team. just about every Solutia site, a legacy of the hundreds of different computer systems that were installed or acquired over the past several decades. With the rollout of WWOF, Solutia will move to a single, Our business process re engineering Betore, all our technologv and marketing people integrated business system at initiative will were located in different business units, with relative ly little opportunity for interaction. Todav, these kev employees are networked through Commercial Development, where thev can draw on each others' all of our plants and offices worldwide. Four manufactur ing plants and several Solutia business units have already integrate plants and offices expertise and share best practices more effectively. converted to the new svstem. worldwide. The new organization has already dramaticallv Our target is to have WWOF improved the company's abilitv to coordinate and implemented at all sites worldwide bv 1999. prioritize growth activities. All Solutia businesses A New Spirit.The spinoff, and the changes we're arc now using the same process to analyze growth making in the way we do business, have had an projects. The projects that receive development extraordinary effect on the people who work at funding are reviewed regularh to determine Solutia. It's not an exaggeration to sav that a new, whether they're hitting expected benchmarks. If a more entrepreneurial culture took root over the SAR 0016 LAM018756 SAR 0017 course of 1997. For proof, just consider how we've generated cash, allowing us to accelerate our debt repavment schedule. Solutia's people act as if thev own the business because, in a sense, thev do.The members ot Solutia's executive leadership team are required to own signif icant amounts of the companv's stock. Almost everv Solutia emplovec has stock options, and most also own Solutia shares through the companv's 401 (k) sav ings plan. In addition, all Solutia emplovees partici pate in an incentive compensation program. Incentive pavouts depend on the achievement of the companv's annual goals lor both free cash flow generation and earnings per share growth. We chose to include these provisions in our vari ous compensation programs, because \\c wanted to align the interests of shareholders and emplovees. We believe that giving emplovees a personal stake in the business is an outstanding wav to encourage long term growth in the price ot the companv's stor k. LAMOl8757 Priority Number 5 Being A Responsible Company We Create Value Through Our Commitments To Workplace Safety, Respect For The Environment, And Community Responsiveness. he leading companies in our industry under Tstand that operating responsibly isn't just a matter of regulator)' compliance. It's a strate gic business issue. Over time, responsible companies can, and do, build a competitive advantage when they effectively manage the whole range of emironmental, safety, health, emplovment and community issues. Such com panies continue to earn the right to operate from their neighbors. Thev reduce risks and control operating costs. Thev mav even find new business opportunities in their ability to use resources more efficiently. VPP "Star" Status. Historically, each of Solutia's busi nesses has lit the profile of a responsible company. Ten of our manufacturing sites in the United States hare achieved "Star" status, a rating that indicates full com pliance with standards set bv the U.S. Occupational Safety and Health Administration's Voluntary Protection Program (VPP).Two European plants have achieved similar standards under comparable local programs. Other Solutia manu Operating responsibly creates a competitive facturing sites are working toward VPP certification. These voluntary certification activities are proof of the com mitment we have made to work advantage for place safety and to the safety of Solutia, and may lead to new business our communities over many decades. We have also consis tently worked to strengthen our employee and management opportunities. teams by including people of diverse backgrounds and experi ence. Our people have long been active, contributing members of their communities around the world. Since the 19S0s, our businesses have led the industry in vol untary waste reductions, in disclosing emissions data, and in cleaning up abandoned waste sites. This tradition of responsible performance is impor tant on two counts. First, it means that the majority of the spending on environmental matters is behind us. Second, it means that Solutia is well-positioned to improve on that performance continuously as an indepen dent enterprise. We have a solid foundation in place, and we intend to build on it. Solutia emphasizes safety, people Solutia's businesses have development, already made many of the investments required to meet our stewardship obligations. (See graph on this page.) In environmental stewardship, and community addition, we took aftertax involvement. charges of S46 million in the fourth quarter of 1997 to increase our environmental reserves. Approximately S22 million of these charges reflect revised estimates for previously known envi ronmental matters. The remaining S24 million was due to a modification of our accounting practices to reflect the company's obligations under the Resource Conservation and Recovery Act. We believe that whenever possible, tomorrow's earnings should not be penalized by a legacy of environmental costs asso ciated with yesterday's products.These charges should reduce the impact of environmental remediation on Solutia's earnings over the next several vears. Solutia Environmental Remediation Expenditures LAM018758 A SAR 0018 SAR 0019 Our Environmental Commitments. In late 1997, the Governance Committee of Solutia's Board of Directors approved a set of six commitments to environment, safetv and health. These statements combine to express the company's future direction and framework for operating responsibly. We will ensure that our operations and distribution systems are safe for employees, visitors, site contrac tors, communities and the environment. We will make products that are safe when used responsibly. We will keep our operations open to our communi ties and foster open communications with all of our stakeholders, We will continuously improve our raw material and energy utilization efficiencies, to reduce our impact on the environment and to improve the sustainabil ity of our businesses. We will encourage active participation in and posi tive contributions to safety, health and environmen tal stewardship by our cmplovecs. We will search worldwide for new technologies that bring environmental, safety and health value to all of our stakeholders. By carrying out these commitments, Solutia expects to match the best practices of our peer companies, and to adhere to the Responsible Care program developed by the Chemical Manufact urers Association. We consider the commitments a fundamental part of our company. Thev are integral to our strategv, and they contribute to our business goals. LAMO18759 S o i u tia Inc. Management Report * V Audit and Finance Committee Report Management is responsible for the preparation of Solutia Inc.'s con solidated financial statements and all of the related information appearing in this annual report in accordance with generally accept ed accounting principles. Where necessary, this information reflects estimates that are based upon currently available information and management's judgments. Management is also responsible for maintaining a system of internal accounting controls with the objectives of proriding rea sonable assurance that Solutia's assets are safeguarded against mate rial loss from unauthorized use or disposition and that authorized transactions are properly recorded to permit the preparation of accurate financial information. Cost/benefit judgments are an important consideration in this regard.The effectiveness of internal controls is maintained by personnel selection and training, division of responsibilities, establishment and communication of policies and ongoing internal review programs and audits. Management believes that Solutia's svstem of internal account ing controls as of December 31, 1997, was effective and adequate to accomplish the objectives described above. The Audit and Finance Committee, composed of three nonemploy ee members of the board of directors, met three times during 1997. The Committee reviews and monitors Solutia's internal accounting controls, financial reports, accounting practices and the scope and effectiveness of the audits performed by the independent auditors and internal auditors. The Committee also recommends to the full board of directors the appointment of Solutia's principal indepen dent auditors, and it approves in advance all significant audit and nonaudit services provided by such auditors. Deloitte & Touche LLP was appointed independent auditor to examine, and to express an opinion as to the fair presentation of, the consolidated financial statements. This report follows. The Committee discusses audit and financial reporting matters with representatives of the company's financial management, its internal auditors, and Deloitte & Touche LLP. The internal auditors and Deloitte & Touche LLP meet with the Committee, with and without management representatives present, to discuss the results of their examinations, the adequacy of Solutia's internal accounting controls, and the quality of its financial reporting. The Committee encourages the internal auditors and Deloitte & Touche LLP to communicate directly with the Committee. The Audit and Finance Committee also reviews and monitors the company's financial policies, planning and structure so that they will conform to the company's requirements for growth and sound operation. The Audit and Finance Committee has reviewed the financial sec tion of this annual report. Pursuant to the recommendation of the Committee, the board ofdirectors has approved the financial section. Frank A. Metz Jr. Chairman, Audit and Finance Committee February 25, 1998 SAR 0020 lam018760 Report of independent Auditors To the stockholders of Solutia Inc.: We have audited the accompanying statements of consolidated financial position of Solutia Inc. and subsidiaries as of December 31, 1997 and 1996, and the related statements of con solidated income, stockholders' equity (deficit) and cash flow for each of the three years in the period ended December 31,1997. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial state ments based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examin ing, on a test basis, evidence supporting the amounts and disclosures in the financial state ments. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Solutia Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. As discussed in Note 16 to the financial statements, the company changed its method of accounting for environmental obligations under the Resource Conservation and RecoveryAct in 1997. Deloitte & Touche LLP St. Louis, Missouri February 25, 1998 SAR 0021 LAW1018761 on S o i u t i a Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Solutia Inc. is an international producer and marketer of a range of high performance chemical-based mate rials that are used by its customers to make consumer, household, automotive and industrial products.These products include nylon and acrylic fibers, intermedi ates, Saflex plastic interlayer, phosphorus derivatives, and specialty chemicals. The company's strategic focus is built on four key technology strengths: polymer chemistry, phospho rus chemistry, fiber technology, and process engi neering expertise.These technologies are used in var ious combinations to create value-added products in three operating segments: Chemicals - comprised of the intermediates, phosphorus derivatives and industrial products business units; Fibers - comprised of carpet fibers, nylon industrial fibers and Acrilan acrylic fibers business units, and; Polymers & Resins - comprised of Saflex plastic interlayer, nylon plastics & polymers, resins and poly mer modifier business units. In 1997, the Chemicals, Fibers and Polymers & Resins segments accounted for approximately 32 per cent, 33 percent and 35 percent, respectively, of the company's consolidated net sales. Solutia reported all of these businesses as one segment prior to its adop tion of Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information," effective December 31, 1997.The discussion of the company's results that follows has been prepared on the basis of one segment. As permitted by this new standard, information for years prior to 1997 was not restated to conform to the new disclosure requirements because it was impracticable to do so. Prior to September 1, 1997, the businesses that form the company were wholly owned by Monsanto Company ("Monsanto"). On September 1, 1997, Monsanto distributed all of the outstanding shares of common stock of the company as a dividend to Monsanto stockholders (the "SpinofF").The distribu tion resulted in the issuance of one share of the compa ny's common stock for every' five shares of Monsanto common stock held of record as of August 20, 1997. As a result of the Spinoff on September 1, 1997, the company became an independent publicly-held com pany listed on the New York Stock Exchange, and its operations ceased to be owned by Monsanto. Financial data included in the company's consoli dated financial statements for periods prior to the Spinoff were prepared on a combined basis. They reflect an estimate of what the historical assets, liabil ities and operations would have been if Solutia had been organized as a separate legal entity, owning cer tain net assets of Monsanto. Management believes that the assumptions underlying these financial state ments are reasonable. These historical consolidated financial statements, however, may not necessarily reflect the results of operations, cash flows or finan cial position of the company in the future, or what the results of operations, cash flows or financial position would have been had the company been a separate stand-alone public entity. For periods subsequent to the Spinoff, Solutia's consolidated financial statements have been prepared on a basis that reflects the historical value of the assets, liabilities, and operations of the businesses that were contributed to Solutia by Monsanto. See Note 1 of the "Notes to Consolidated Financial Statements" for a detailed discussion of the basis of presentation used in the preparation of Solutia's consolidated financial statements. Solutia produced strong financial results in 1997 as it began its operations as an independent company. The improved operations were primarily attributed to significant cost reductions. The combination of improved operating results and improved working capital management resulted in very strong cash flow subsequent to the Spinoff. These factors allowed the company to reduce significantly the debt burden of S1.029 billion that it assumed in the Spinoff to $790 million at year end and to make significant progress liol SAR 0022 LAM018762 SAR 0023 S g l uIia Inc. on its share repurchase program. The following sec tion provides a detailed discussion of the company's results of operations in 1997. Results of Operations 1997 Compared with 1996 In 1997, the company's net sales of $2.97 billion were down slightly when compared with net sales of $2.98 billion in 1996. The decrease was principally attrib uted to the effects of unfavorable currency exchange rates, and was partially offset by approximately $12 million of higher sales volumes. The effect of higher average selling prices was minimal. Sales volumes increased for the nylon plastics & polymers and the Sajlex plastic interlayer business units. These increas es were principally the result of higher demand.These sales increases were offset by the combination of unfa vorable currency exchange rates and lower sales vol umes of intermediates and carpet staple. The use of alternative floor coverings and competition from lower priced polyester staple had a negative effect on sales into the residential carpet market. Combined net sales of the other business units decreased slightly compared with net sales in 1996. While currency exchange rates had a negative effect on Solutia's net sales in 1997, the effect on company's 1997 operating income was minimal because ex-U.S. sales are sourced primarily from ex-U.S. operations. Solutia's operating income in 1997 increased sig nificantly from operating income in 1996. However, operating income was affected by unusual items in both years. In 1997, operating income included a first quarter charge of $ 10 million ($6 million aftertax, or $0.05 per share) associated with the adoption of the American Institute of Certified Public Accountants' Statement of Position ("SOP") 96-1, "Environmental Remediation Liabilities," which is further discussed in Note 16 of the "Notes to Consolidated Financial Statements." Operating income in the second quarter of 1997 included a charge of $ 10 million ($6 million aftertax, or $0.05 per share) for environmental-relat ed litigation associated with the Brio Superfund site near Houston,Texas. In addition, operating income in the second quarter of 1997 included S8 million ($5 million aftertax, or $0.04 per share) of reversals of excess restructuring reserves from prior years. The excess was primarily the result of lower exit costs associated with the sale and closure of nonstrategic facilities included in 1995 restructuring actions. Operating income in the fourth quarter of 1997 included charges of $72 million ($46 million after tax, or SO. 37 per share) associated with environ mental remediation liability changes. These charges are discussed further in Note 16 of the "Notes to Consolidated Financial Statements." Operating income in 1996 included a net charge of $248 million (Si56 million aftertax, or $1.30 per share) for restructuring and other actions, primarily for the costs of work force reductions, asset write-offs, and facility rationalizations. The increase in operating income in 1997 can be attributed primarily to the effect of cost reductions. The cost reductions were realized principally through the restructuring actions that were taken during 1997. Significant progress was made on this restructuring plan. During 1997, employment was reduced by approximately 600 people. The effect of these cost sav ings was the primary driver behind the reductions in the company's marketing and administrative expenses in 1997. In addition, Solutia's operations in 1997 received lower cost allocations from Monsanto. As fur ther described in Note 1 of the "Notes to Consolidated Financial Statements," on April 1, 1997, Monsanto dis continued its allocations ofcorporate expenses for gen eral and administrative services that it had previously been providing. Solutia's 1997 administrative expenses consisted of three months of Monsanto allocations and nine months of stand-alone staff expenses. If Solutia had operated as a stand-alone entity in 1996 and 1997, management estimates that general and administrative services would have been lower by approximately S39 million in 1996 and higher by S13 million in 1997 in order to reflect the cost of replacing the services rep resented by these allocations. The increase in "Earnings from equity affiliates" was driven by the Flexsys L.P. ("Flexsys") and Advanced Elastomer Systems L.P. ("AES") joint ven tures. Solutia's share of the combined 1997 earnings for these ventures increased approximately 40 percent over the combined earnings from these ventures in LAM018763 Management's iscusston an 1996. Solutia has a 50 percent ownership interest in each of these joint ventures. The companv is affected by economic conditions, particularlv as they relate to the housing industry in the United States and the automotive industry both in the United States and internationally, which are cycli cal businesses. In addition, global competition and cus tomer demands for efficiency will continue to make sustained price increases difficult. The prices of pur chased raw materials used bv the company fluctuate in the short term and are affected by factors such as plant outages, oil prices, and supply and demand. However, in the long term, the company believes that the addi tion of ness worldsvide capacity should exert doss nsvard pressure on purchased raw material costs. 1996 Compared with 1995 The company's net sales increased SI3 million in 1996. Hosvevcr, as further discussed in Note 4 of the "Notes to Consolidated Financial Statements," prior year operations reflect four months of sales and oper ating income from the rubber chemicals business that was contributed in Mav 1995 to the formation of the Flcxsys joint venture. Sales and operating results for the rubber chemicals business are no longer included in the company's consolidated totals. If the sales from this business were excluded in 1995, the company's sales would have increased S f 5 3 million, or 5 percent, in 1996. Approximatelv $204 million of the increase can be attributed to higher sales volumes and an improved sales mix.This increase was partially offset by the effect of lower average selling prices, which totaled approximately S 51 million. Most of the sales growth was driven by increased sales for fibers products, primarily because of high er sales volumes of nvlon and acrylic fibers. Nylon fiber sales were considerably higher than sales in 1995 because of higher demand in the carpet indus try. Increased demand in U.S. markets and higher export sales, particularly into China, drove the sales volume growth for acrylic fibers. A decline in aver age selling prices partially offset the increase in nylon and acrylic fiber sales. Nylon polymer sales also contributed to the sales increase on the strength of higher sales volumes. Sales of intermediates and phosphorus and derivative products were essentially even with the prior year. Sales of industrial products in 1996 were up moderately from those in 1995, principally because of higher sales volumes, led byhigher sales volumes for Therminol heat transfer flu ids. Higher sales volumes, partially offset by lower average selling prices, resulted in a modest increase in the net sales of Saflex plastic interlayer in 1996. Polymer modifier sales declined slightly in 1996, primarily because of lower sales volumes. In 1996, operating income for the company decreased S225 million from operating income in 1995. However, profitability in both years was affected by unusual items. Operating income in 1996 included a net charge of $248 million ($156 million, or $1.30 per share) for restructuring and other actions, primarily for the costs of work force reductions, asset write-offs, and facility rationaliza tions. Operating income in 1995 was reduced by $46 million ($39 million aftertax, or $0.34 per share), principally as the result of restructuring charges for employment reductions and the costs to close several facilities. The positive effect of higher sales volumes and lower raw material costs on operating income was off set by lower average selling prices, by significantly higher administrative expenses, and by higher manu facturing costs. The manufacturing cost increase was principally associated with maintenance downtime and capacity expansion projects. Worldwide competi tive pressures limited the company's pricing flexibility on most of its products. Future reductions or increas es in average selling prices will continue to be contin gent upon these demands and pressures. The 1996 increase in administrative expenses was principally due to higher costs associated with various employee incentive programs, as well as an increase in alloca tions related to Monsanto's business and organization al development initiatives. The increase in "Earnings from equity affiliates" was principally attributed to higher earnings for the Flexsvs and AES joint ventures. Net of restructuring charges that are detailed in Note 4 of the "Notes to Consolidated Financial Statements," the increase in "Other income (expense) - net" resulted primarily from the combination of LAW1018764 SAR 0024 S o i u ria Inc. lower expense allocations from Monsanto and higher gains on the sale of certain assets. The 1996 effective income tax rate of 3 percent compared with the federal statutory rate of 55 percent can be attributed primarily to the joint venture after tax earnings included in "Earnings from equity affili ates" and benefits from the foreign sales corporation. It is expected that the effective income tax in future periods will be significantly higher and will approxi mate the U.S. federal statutory rate. Liquidity and Capital Resources Historically, the company has generated sufficient cash from its operations to fund its capital needs, including working capital. Capital expenditures were Si65 million in 1997. These expenditures were used to fund various maintenance and capacity expansion projects. The company expects that its capital requirements will be in the range of S250 million to $350 million annually over the next few years, principally as a result of capacity expansion and cost reduction projects. A portion of these cap ital expenditures will be funded from up-front pay ments received from third parties participating in these projects. Environmental remediation expendi tures were S 39 million in 1997, and the companv anticipates that these expenditures will approximate this amount annually over the next several years. Solutia's working capital as of December 31, 1997, decreased to $106 million from $121 million at December 31, 1996, primarily because of the increase in short-term debt, principally commercial paper, the proceeds of which Solutia used to repay debt assumed with the Spinoff. The decrease in working capital was partially offset by increases in cash, receivables and inventories. As of December 31, 1997, Solutia had negative equity of SI31 million.This deficit position resulted primarily from the assumption of S1.029 billion of debt and $1,018 billion of postretirement liabilities from Monsanto in conjunction with the Spinolf. Effective with the Spinoff, Solutia assumed approx imately SI.029 billion of debt from Monsanto, pri marily assumable commercial paper. The assumable commercial paper was guaranteed by Monsanto until SAR 0025 repaid or refinanced by Solutia at maturity, which was up to 30 days following the Spinolf. In October of 1997, the company consummated the sale of debt securities in the amount of $600 million having matu rities of 5 to 40 years. The proceeds of the offering were used to refinance a portion of the company's commercial paper as it matured. In the four months following the Spinolf, the companv has reduced its debt outstanding by approximated $240 million. Solutia's debt securities were rated "BBB/Baa2"by the major rating agencies. As of December 31,1997, Solutia had a five-year revolving credit facility of $800 million with a syndi cate of banks to support its commercial paper. The credit facility is also available for working capital and other general corporate purposes. No borrowings were outstanding under this credit facility as of December 31, 1997. This credit facility gives Solutia the financing flexibility to take advantage of invest ment opportunities that mav arise and to satisfy future funding requirements. In September 1997, the company's board of direc tors authorized the purchase of up to 5 million shares of the company's common stock. During 1997, the company acquired approximately 1.4 million shares at a cost of approximately $32 million. The company expects to substantially complete these purchases over the next year. This repurchase program is in addition to the normal repurchase of shares for compensation and benefits programs. The company believes that its cash flow from operations, supplemented by periodic additional borrowings, provides it with sufficient resources to finance its operations and planned capital needs for the next 12 months. Environmental Matters Solutia continues to make a strong commitment to comply with various laws and government regula tions concerning environmental matters and employ ee safety and health in the United Sates and other countries. U.S. federal env ironmental legislation that has a particular impact on the companv includes the Toxic Substances Control Act; the Resource Conservation and Recovery Act ("RCRA"); the Clean Air Act; the Clean Water Act; the Safe Drinking Water M/V707876K Management's Discussion and Analysis f Financial Condition and Results of Operations Act; and the Comprehensive Environmental Response, Compensation and Liability Act CCERCLA," commonly known as "Superfund"), as amended by the Superfund Amendments and Reauthorization Act. The company is also subject to the Occupational Safety and Health Act and regulations of the Occupational Safety and Health Administration ("OSHA") concerning employee safety and health matters. The U.S. Environmental Protection Agency ("EPA"), OSHA, and other federal agencies have the authority to promulgate regulations that have an impact on the company's operations. In addition to these federal activities, various states have been dele gated certain authority under the aforementioned federal statutes. Many state and local governments have adopted environmental and employee safety and health laws and regulations, some of which are similar to federal requirements. State and federal authorities may seek fines and penalties for violation of these laws and regulations. Solutia is dedicated to long-term environmental protection and compliance programs that reduce and monitor emissions of hazardous materials into the envi ronment as well as to the remediation of identified existing environmental concerns. The company is among the leaders in the chemical industry's Responsible Care performance enhancement program. Expenditures in 1997 were approximately SIO million for environmental capital projects and approx imately S7S million for the management of environ mental programs, including the operation and mainte nance of facilities for environmental control.The com pany estimates that a total of approximately $25 mil lion will be spent during 1998 and 1999 on addition al capital projects for environmental protection and that expenses for the management of environmental programs in 1998 and 1999 will continue at levels comparable to 1997. With respect to environmental remediation obligations, the company's policy is to accrue costs for remediation of contaminated sites in the accounting period in which the obligation is proba ble and the cost is reasonably estimable. Significant adjustments to these obligations included the 1997 fourth quarter charges ol approximately $ 34 million ($22 million aftertax, or $0.18 per share) to increase the company's environmental reserves.This action was required in order to reflect revised esti mates for changed circumstances relating to the ulti mate outcome of previously known environmental matters. These revised estimates were based upon further discussions with environmental authorities and the availability of new information from recent ly completed environmental studies. These events and activities help to define better and to quantify the company's ultimate liability for these matters. In addition, effective January 1, 1997, Solutia adopted SOP 96-1 which establishes authoritative guidance regarding the recognition, measurement and disclosure of environmental remediation liabilities. A charge of approximately $ 10 million ($6 million after tax, or S0.05 per share) was recorded in the first quar ter of 1997 associated with the adoption of SOP 96-1. The timing of this charge was predicated upon an application of SOP 96-1 in which liabilities arising under RCRA should be recorded when a RCRA cor rective measures study ("CMS") is completed. Subsequently, the company reassessed its application of SOP 96-1 and concluded that these liabilities would be recorded over a continuum of events leading up to and including a CMS. As a result, the company record ed in the fourth quarter of 1997, additional charges of approximately S38 million ($24 million aftertax, or $0.19 per share) associated with these RCRA envi ronmental liabilities. Monsanto has intermittently received notices from the EPA alleging that it is a potentially responsible party ("PRP") with respect to Superfund at specific sites. In 1997, no such notices were received. With respect to many of the past notices, Monsanto has resolved disputes, entered partial and complete con sent decrees, and executed administrative orders with the EPA settling a portion or all of Monsanto's liabili ty at various sites. Remediation pursuant to such set tlements is ongoing. At the time of the Spinoff, the company assumed from Monsanto, pursuant to a dis tribution agreement, liabilities related to specified Superfund proceedings. As a result, while Monsanto remains the named PRP or defendant for actions that occurred prior to September 1, 1997, the company LAM018766 SAR 0026 NC. will manage proceedings and litigation indemnifying Monsanto for costs, expense and judgments arising from these assumed liabilities. The company's estimates of its liabilities for Superfund sites are based on evaluations of currently available facts with respect to each individual site and take into consideration factors such as existing tech nology, laws and agency policy, and prior experience in remediation of contaminated sites. As assessments and remediation activities progress at individual sites, these liabilities are reviewed periodically and adjusted to reflect additional technical, engineering and legal information that becomes available. The company has an accrued liability of S48 million as of December 31, 1997 for Superfund sites. Major Superfund sites in this category include the noncompany-owned sites at Brio and MOTCO in Texas, Fike/Artel in West Virginia and Woburn in Massachusetts, which account for $33 million of the accrued amount. The company spent approximately S12 million in 1997 for remedi ation of Superfund sites. Similar amounts can be expected in future years. The company had an accrued liability of $88 mil lion as of December 31, 1997, for shut-down plants and third-party sites for which the company assumed responsibility pursuant to a distribution agreement entered into with Monsanto. The company's estimate of its liability related to these sites is based on evalua tions of currently available facts with respect to each individual site and takes into consideration factors such as existing technology, laws and agency policy and prior experience in remediation of contaminated sites. The company spent $ 11 million in 1997 for remediation of these sites. Similar amounts can be expected in the future. The company had an accrued liability of $81 million as of December 31,1997 for solid and hazardous waste remediation, and post-closure costs at the company's operating locations. The company recognizes certain post-closure costs over the estimated remaining useful life of the related facilities. The company spent S16 mil lion in 1997 for remediation of these facilities. Uncertainties related to all of the company's envi ronmental liabilities are evolving government regula tions, the method and extent of remediation and SAR 0027 future changes in technology. Because of these uncer tainties, the company estimates that potential future expenses associated with these liabilities could be an additional $20 million to $30 million. Although the ultimate costs and results of remediation of contami nated sites cannot be predicted with certainty, they are not expected to result in a material adverse effect on Solutia's consolidated financial position, liquidity, or profitability in any one year. The Year 2000 Issue The year 2000 ("Y2K") issue refers to the inability of a date-sensitive computer program to recognize a two-digit date field designated as "00" as the year 2000. Mistaking"00" for 1900 could result in a system failure or miscalculations causing disruptions to oper ations, including manufacturing, a temporary inability to process transactions, send invoices, or engage in other normal business activities. This is a significant issue for most, if not all companies, with far reaching implications, some of which cannot be anticipated or predicted with any degree of certainty. Solutia has completed an assessment of the magni tude ofitsY2K issue and has determined that it will be required to modify or replace significant portions of its software so that its computer systems will be able to function properly beyond December 31,1999. The majority of the company'sY2K issue will be addressed though its worldwide implementation of new soft ware licensed from SAP AG which isY2K compliant. Issues that are not covered by the SAP implementation will have to be addressed individually and mav require software replacement, reprogramming or other remedial action.The company is communicating with its suppliers and customers to determine the extent of the company's vulnerability to the failure of third par ties to remediate their ovvnY2K issue. In conjunction with this assessment, the companv is finalizing its action plans to address the Y2K issue, including contingencies to address unforeseen problems.The company plans to use both internal and exter na] resources to complete Y2K reprogramming, soft ware replacement and testing. Preliminary plans antici pate completion of the SAP implementation andY2K remedial work by mid-1999.To date, the company has LAM018767 HU Management Discussion and Analysis nl Financial Condition and 3 e s u I s ci OM^iions incurred approximately $3 million related to the Y2K remedial work.The total remaining cost of the Y2K remedial work is estimated to be S5 million and will be expensed as incurred over the next two years. The costs ofY2K remedial work exclude the cost of SAP implementation. The costs of the project and the date on which the company plans to complete theY2K remediation work arc based on management's best estimates, which were derived from numerous assumptions about future events, including the availability of certain resources, third-party modification plans, and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could dif fer materially from those plans. Specific factors that might cause material differences include, but are not limited to, the availability and cost of personnel trained in this area and the ability to identify and cor rect all relevant computer codes. Derivative Financial Instruments The company is exposed to market risk, including changes in interest rates, currency exchange rates, and certain commodity priccs.To manage the volatility- relat ing to these exposures, the company enters into various derivative transactions pursuant to the company's poli cies.The company does not purchase or hold any deriv ative financial instruments for trading purposes. The tests discussed below for exposure to interest rate and currency rate exposures arc based on a vari ance/covariance value at risk model using a one-year horizon and a 95 percent confidence level.The model assumes that financial returns are normallv distributed.The value at risk model takes into account cor relations and diversification across market factors, including currencies and interest rates. Estimates of volatility and correlations or market factors are drawn from the JP Morgan RiskMctricsTM dataset as of December 31, 1997. In cases where data is unavail able, a reasonable approximation is included. The effect of these estimates did not significantly change the total value at risk. Foreign Currency Exchange Rate Risk Currency forward contracts are used to manage cur rency exposures for financial instruments denominat ed in currencies other than the entity's functional cur rency. Gains and losses on contracts that are designat ed and effective as hedges are included in net income and offset the exchange gain or loss of the transaction being hedged. Corporate policy prescribes the range of allowable hedging activity and the instruments per mitted for use. Because the counterparties to these contracts are major international financing institu tions, credit risk arising from these contracts is not significant and Solutia does not anticipate any coun terparty losses. This hedging activity is intended to protect the company from adverse fluctuations in for eign currency exchange rates. As of December 31, 1997, Solutia had currency forward contracts to purchase $22 million and to sell S22 million of other currencies with average maturi ties of 2 months, principally the Belgian franc and the British pound sterling. Net unrealized hedging losses as of December 31,1997 were not material. Based on the company's overall currency rate exposure at December 31, 1997, including derivative and other foreign currency sensitive instruments, a near-term change in currency rates within a 95 per cent confidence level based on historical currency rate movements, would not materially affect the consoli dated financial position, results of operations, or cash flows of the company. Interest Rate Risk Interest rate risk is primarily related to the changes in fair value on fixed-rate, long-term debt and short term, floating rate debt. Based on the company's over all interest rate exposure at December 31, 1997, a near-term change in interest rates, within a 95 percent confidence level based on historical interest rate movements, would not materially affect the consoli dated financial position, results of operations, or cash flows of the company. Commodity Price Risk Certain raw materials are subject to price volatility' caused by weather, petroleum prices, and other unpre dictable factors. The company employs commodityprice swaps to hedge this exposure. The commodity price risk is not material to the company's consolidated financial position, results of operations, or cash flow. LAMO18768 SAR 0028 S o t n t i a Inc. Unaudited Pro Forma Condensed Consolidated Statements of Income (Dollars in millions, except per share) The following unaudited pro forma condensed consolidated state ments of income for the years ended December 31,1997 and 1996 give effect to the Spinoff and Solutia's 1997 debt offering as if the SpinofT and the offering had occurred as ofthe beginning of the peri ods presented. The pro forma information is presented for illustra tive purposes only and may not be indicative of the results that would have been obtained had the transactions actuallv occurred on the date assumed, nor is it necessarily indicative of future consoli dated results of operations. The unaudited pro forma condensed consolidated financial statements should be read in conjunction with the historical financial statements and the related notes thereto included elsewhere in this annual report. Net Sales .............. Cost of Goods Sold Gross Profit........................... Marketing, Administrative, and Technological Expenses ......... Restructuring Expenses - net ................... Operating Income..................................... Interest Expense........................................... Other Income (Expense) - net................... Income Before IncomeTaxes................. Income Taxes ................................................ Net Income................................................. Earnings per Share ................................... Earnings per Share, assuming dilution . Weighted Average Shares - Basic................. Weighted Average Shares - Diluted ............. For the Year Ended December 31,1997 Historical Solutia Pro Forma Adjustments Solutia $ 2,969 $ (9)<ai S 2,960 2,316 2,313 I (C> 6S3 (6) 647 363 14 m 393 (9)D> 25 p> 290 (41) 41 290 98 $ 192 $ 1.63 $ 1.55 (36) (19)pi (55) (20)<c> $ (35) $ (0.30) $ (0.28) 254 (60) 41 235 78 $ 157 $ 1.33 $ 1.27 117.7 123.7 For theYear Ended December 31,1996 Historical Solutia S 2,977 2,325 Pro Forma Adjustments Solutia S (15)<A> S 2,962 3 <>> 2,313 3 (ci (1 S)'0> 652 (3) 649 427 192 33 (36) 36 33 1 S 32 S 0.28 S 0.27 14 w (67)<Di 46 pi 4 (28)<(> (24) (9)w S (15) S (0.13) S (0.13) 420 192 37 (64) 36 9 (8) S 17 S 0.15 S 0.14 116.2 119.8 Notes (A>To record the estimated effect of new selling prices and arrangements on former intercompany sales from Solutia to Monsanto. !lii To record the assumed increase in retiree medical and pension costs as a result of the SpinolT. <c>To record the estimated effect of transactions with the P4 joint venture formed bv Monsanto in conjunction with the SpinofT. in> [o reverse the historical Monsanto corporate expense allocation to the company because the company is no longer subject to the allocation of corporate expenses from Monsanto following the Spinoff. Because the company is no longer subject to this corporate expense allocation, a pro forma adjustment was made to record estimated general corporate costs that the company believes it would have incurred had the companv been a sep arate public company for the periods presented. Pi To record additional interest expense as a result of the companv's assumption of debt from Monsanto and the borrowings of Solutia's 1997 public debt offering. (G) lb record the estimated provision for income tax as a result of the pro forma adjustments referred to in Notes (A) through (F) above at an estimated com bined U.S. federal income and state income tax rate of 36 percent. SAR 0029 LA^1 87q9 0 S ciu r i a In Statement of Consolidated Income (Dollars in millions, except per share) Net Sales..................................................................... Cost of goods sold....................................................... Gross Profit................................................................ Marketing expenses.................................................... Administrative expenses.............................................. Technological expenses............................................... Restructuring expenses-net....................................... Operating Income.................................................... Equity earnings from affiliates.................................... Interest expense.......................................................... Other income (expense)--net.................................... Income Before Income Taxes................................. Income taxes................................................................. Net Income................................................................. Earnings per Share.................................................. Earnings per Share, assuming dilution................ See accompanying Notes to Consolidated Financial Statements. Key Financial Statistics (Unaudited) As a Percent of Net Sales: Gross profit..................................................................... Marketing, administrative and technological expenses. Operating income.......................................................... Net income..................................................................... Effective Income Tax Rate......................................... 1997 $2,969 2,316 653 Year Ended December 31, 1996 1995 52,977 S 2,964 2,325 2,243 652 721 143 172 179 133 167 136 87 88 95 - 192 53 290 33 258 31 (41) 10 290 98 $ 192 21 (36) 15 33 1 S 32 15 (36) (6) 231 84 $ 147 $ 1.63 S 0.28 5 1.30 $ 1.55 $ 0.27 $ 1.27 1997 22% 12 10 6 34 1996 22% 14 1 1 3 1995 24% 14 9 5 36 S^R 0030 LAM018770 S Q l u t i a. Inc. Statement of Consolidated Financial Position (Dollars in mi/liom, except per share) Assets Current Assets: Cash and cash equivalents................................................................... Trade receivables, net of allowances of $6 in 1997 and $7 in 1996 Miscellaneous receivables and prepaid expenses.............................. Deferred income tax benefit............................................................... Inventories ........................................................................................... Total Current Assets.......................................................................... Property, Plant and Equipment: Land...................................................................................................... Buildings................................................................................................ Machinery and equipment .................................................................. Construction in progress..................................................................... Total property, plant and equipment.................................................. Less accumulated depreciation........................................................... Net Property, Plant and Equipment............................................. Investments in Affiliates.................................................................. Long-Term Deferred IncomeTax Benefit .................................. Other Assets........................................................................................ Total Assets......................................................................................... Liabilities and Stockholders' Equity (Deficit) Current Liabilities: Accounts payable.................................................................................. Wages and benefits.............................................................................. Restructuring reserves........................................................................ Miscellaneous accruals ........................................................................ Short-term debt................................................................................... Total Current Liabilities................................................................. Long-Term Debt................................................................................ Postretirement Liabilities................................................................ Other Liabilities................................................................................ Stockholders' Equity (Deficit): Monsanto Company Equity................................................................ Common stock (authorized, 600,000,000 shares par value $0.01) Issued: 118,400,635 shares in 1997................................................ Additional contributed capital.......................................................... Treasury stock, at cost (992,828 shares in 1997)......................... Minimum pension liability adjustment.............................................. Unearned ESOP shares ...................................................................... j Accumulated currency adjustment ................................................... j Reinvested earnings............................................................................ Total Stockholders' Equity (Deficit) ........................................... Total Liabilities and Stockholders' Equity (Deficit) ................ j See accompanying Notes to Consolidated Financial Statements. i i LAM018771 SAR 0031 As of December 31, 1997 1996 $ 24 425 136 91 325 1,001 $ 412 80 108 291 891 17 357 2,707 107 3,188 2,265 923 423 300 121 $ 2,768 18 367 2,622 121 3,128 2,217 911 366 194 121 $ 2,483 $ 221 106 40 335 193 895 597 958 449 $ 223 1S6 79 312 770 634 423 - 1 (119) (22) (7) (31) 19 28 (131) $ 2,768 656 _ 656 $ 2,483 Statement of Consolidated Cash Flow (fXi/fun in millions) Increase {Decrease) In Cash and Cash Equivalents Operating Activities: Net income.............................................................................. Adjustments to reconcile to Cash Provided by Operations: Items that did not use (provide) cash: Deferred income taxes...................................................... Depreciation and amortization.......................................... Restructuring expenses - net........................................... Other................................................................................... Working capital changes that provided (used) cash: Accounts receivable........................................................... Inventories........................................................................... Accounts payable and accrued liabilities......................... Other................................................................................... Other items........................................................................... Total Cash Provided by Operations................................. Year Ended December 31, 1997 1996 199S $192 $ 32 $147 32 142 (39) (9) (32) (115) (45) 33 159 (45) 166 192 43 (43) 20 (33) 24 (20) 336 25 162 53 I 64 (78) (61) (13) 20 320 Investing Activities: Capital expenditures................................................................ Acquisition and investment payments................................. Investment and property disposal proceeds......................... Cash Used in Investing Activities...................................... (165) (2) 9 (158) (192) (17) 4 (205) (179) (51) 51 (179) Financing Activities: Net transactions with Monsanto Company prior to Spinoff Long-term debt proceeds....................................................... Repavmcnt of debt obligations............................................... Treasury stock purchases....................................................... Dividend payments ............................................................... Common stock issued under employee stock plans............. Other financing activities....................................................... Cash Provided by (Used in) Financing Activities......... Increase (Decrease) In Cash and Cash Equivalents...... 292 600 (840) (35) (1) 13 (6) 23 24 (131) - (131) (141) - (141) Cash and Cash Equivalents: Beginning of year................................................................. End ofyear............................................................................. $ 24 S- S- See accompanying Notes to Consolidated Financial Statements. The effect of exchange rate changes on cash and cash equivalents was not material. Cash payments for interest (net of amounts capitalized) ucre S3 million in 1997. Cash payments for income taxes were S 30 million in 1997. SAR 0032 LAM018772 S o i u x\ a l ;i c Statement of Consolidated Stockholders' Equity (Deficit) (Dollar* in millions) Monsanto Company Equity: Balance, Jan. 1............................................................................................................ Net income................................................................................................................. Translation adjustments............................................................................................ Net transactions with Monsanto Company prior to Spinoff................................ 1997 activity to date of Spinoff: Net income.............................................................................................................. Translation adjustments ....................................................................................... Net transactions with Monsanto Company......................................................... Elimination of Monsanto Company Equity at Spinoff........................................... Balance, Dec. 11......................................................................................................... 1997 $ 656 Year Ended December 31, 1996 S 755 32 (131) 1995 S 7-4-1 147 8 (141) 163 13 292 (1,124) S- $656 S755 Common Stock: Balance, Jan. 1 .......................................................................................................... Issuance of 118,371,280 shares at Spinoff ............................................................ Issuance of 29,355 shares for stock option exercises .......................................... Balance, Dec. 31......................................................................................................... s1 S1 S$- SS- Additional Contributed Capital: Balance, Jan. 1............................................................................................................ Net liability transfer to Solutia at Spinoff ............................................................. Post-Spinoff adjustments.......................................................................................... Employee stock plans and ESOP............................................................................ Balance, Dec. 31 ..................................................................................................... $(101) 02) (6) 5(119) Ss- ss- Treasury Stock: Balance, Jan. I............................................................................................................ Shares purchased (1,569,800 shares in 1997)....................................................... Net shares issued under employee stock option plans (576,972 shares in 1997) Balance, Dec. 31........................................................................................................ $() 13 S (22) s$- ss- Minimum Pension Liability Adjustment: Balance, Jan. 1............................................................................................................ Post-Spinoff adjustment............................................................................................ Balance, Dec. 31........................................................................................................ 5(7) S (7) $$- ss- Unearned ESOP Shares: Balance, Jan. 1............................................................................................................ Transfer of ESOP reserve balance to Solutia at Spinoff........................................ Amortization of ESOP balance............................................................ .................. Balance, Dec. 31......................................................................................................... i Accumulated Currency Adjustment: Balance, Jan. 1............................................................................... Balance transferred to Solutia at Spinoff.................................... Translation adjustments............................................................... Balance, Dec. 31............................................................................ SO') $ (31) s11 8 $ 19 $$$$- sSss- Reinvested Earnings: Balance, Jan. 1............................................................................... Net income from date of Spinoff through December 31, 1997 Dividends........................................................ Balance, Dec. 31.............................................. Total Stockholders' Equity (Deficit)........ LAW018773 Sec accompanying Notes to Consolidated Financial Stan SAR 0033 S29 0) S 28 5(13') s- $$656 S- s$755 h Notes To Consolidated Financial Statements (Dollars in millions, except per share) 1. Basis of Presentation Solutia Inc. is an international producer and marketer of a range of high performance chemical-based materials that are used by its cus tomers to make consumer, household, automotive and industrial products. Prior to September 1, 1997, the businesses that form the company were wholly owned by Monsanto Company ("Monsanto"). On September 1, 1997, Monsanto distributed all of the outstanding shares of common stock of the company as a dividend to Monsanto stockholders (the "Spinoff"). The distribution resulted in the issuance of one share of the company's common stock for every five shares of Monsanto common stock held of record as of August 20, 1997. As a result of the Spinoff on September 1, 1997, the company became an independent publicly-held company listed on the New York Stock Exchange and its operations ceased to be owned by Monsanto. Monsanto and Solutia have entered into a number of agreements with respect to the separation of the companies and to provide mechanisms for an orderly transition following the Spinoff. Pre-SpinofF Financial Information Financial data included in the accompanying consolidated financial statements, for periods prior to the Spinoff, were prepared on a combined basis. They reflect an estimate of what the historical assets, liabilities and operations would have been if Solutia had been organized as a separate legal entity, owning certain net assets of Monsanto. Generally, only those assets and liabilities of the ongo ing chemicals businesses that were expected to be transferred to Solutia prior to the Spinoff wrere included in the Statement of Consolidated Financial Position. The Spinoff was accomplished through a distribution agreement which defined the assets that were contributed to Solutia and the lia bilities that were assumed by Solutia. Certain of those assets and lia bilities were not included in the accompanying Statement of Consolidated Financial Position as of December 31, 1996, Those omitted assets and liabilities were principally comprised of a joint venture interest in Monsanto's elemental phosphorus business and a defined amount of cash and debt. Monsanto and Solutia also entered into an employee benefits and compensation allocation agreement that set forth the manner in which assets and liabilities under employee benefit plans and other employment-related liabilities were divided between them. Certain assets and liabilities related to the plans have not been included in the accompanying Statement of Consolidated Financial Position as of December 31, 1996. Items excluded were comprised principally of assets and liabilities for U.S. and ex-U.S. defined benefit pension plans as well as workers' compensation and additional obligations for health care and other postretirement benefits that Solutia retained for substantially all retired U.S. employees. The following unaudited pro forma amounts were estimated to give effect to the previously described assets and liabilities that were excluded from Solutia's December 31, 1996 Statement of Consolidated Financial Position, as well as certain other items. For the unaudited pro forma condensed Statement of Consolidated Financial Position, the amounts were estimated as if the Spinoff had occurred on December 31,1996. The comparable audited amounts as of December 31, 1997 are included for informational purposes. For the unaudited pro forma condensed Statements of Consolidated Income, the amounts were estimated as if the Spinoff had occurred as of the beginning of the years presented. Condensed Statements of Consolidated Financial Position as of December 31: 1997 Unaudited Pro Forma 19% Total Assets......................................................... $ 2,768 S 2,660 Long-Term Debt................................................ 597 1,029 Postretirement Liabilities................................. 958 876 Stockholders' Deficit............. ........................ (131) (439) Total Liabilities and Stockholders' Deficit...... $2,768 $2,660 Unaudited Pro Forma Condensed Statements of Consolidated Income for the years ended December 31,1997 and 1996: 1997 1996 Income Before Income Taxes........................... $ 235 S 9 Net Income........................................................ 157 17 Earnings per Share............................................ $1.33 $0.15 Earnings per Share, assuming dilution............. $1.27 $0.14 The pro forma information is presented for illustrative purposes only and may not be indicative of the results that would have been obtained had the transactions actually occurred on the dates assumed, nor is it necessarily indicative of the future consolidated results of operations. The final determination of the assets contributed to Solutia and the liabilities assumed by Solutia was made pursuant to the agree ments entered into between Monsanto and Solutia in connection with the Spinoff. As of the date of the Spinoff, a net liability transfer to Solutia was affected directly through the "Monsanto Company Equity" account in the Statement of Consolidated Financial Position. Monsanto provided certain general and administrative services to Solutia, including finance, legal, treasury, information systems, and human resources. The cost allocated to Solutia for these services was based upon the percentage relationship between the net assets utilized in Solutia's operations and Monsanto's total net assets, as well as other methods which management believes to be reasonable. These allocations were $12 million, $85 million and $72 million in 1997, 1996 and 1995, respectively. In preparation for the Spinoff, SAR 0034 M/W07Q774 Monsanto began a transition plan for the separation. As part of this plan, Monsanto discontinued its allocation of corporate expenses for these general and administrative services on April 1, 1997, as these expenses were specifically identified and segregated as part of Solutia's ongoing cost infrastructure. As a result of the Spinoff, Solutia is now required to perform these general and administrative functions using its own resources or purchased services and is responsible for the costs and expenses associated with the manage ment of a public company. If Solutia had operated as a stand-alone entity in 1996 and 1997, management estimates that general and administrative services would have been lower by approximately $39 million in 1996 and higher by $ 13 million in 1997 in order to reflect the cost of replacing the services represented by these allocations. As described in Notes 10, 11 and 12, Solutia employees and retirees participated in various Monsanto pension, health care, sav ings and other benefit plans. The costs and certain obligations relat ed to these plans were included in Solutia's consolidated financial statements generally based on the percentage of Solutia payroll costs to total Monsanto payroll costs. Certain assets and liabilities related to Solutia's operation had been managed and controlled by Monsanto on a centralized basis. Such assets and liabilities have been allocated to Solutia in the man ner described in the preceding paragraphs for allocated general and administrative expenses and benefit plans. A portion of the follow ing pre-Spinoff assets and liabilities have been determined in this manner: other assets, accounts payable, postretirement liabilities, miscellaneous accruals and other liabilities. Monsanto used a centralized approach to cash management and the financing of its operations. As a result, cash and cash equivalents and debt were not allocated to Solutia in the pre-Spinoff historical financial statements. Solutia generally has not had borrowings except amounts due to Monsanto. Interest expense was allocated to Solutia in the consolidated financial statements to reflect Solutia's pro rata share of the financing structure of Monsanto. This allocation in the consolidated financial statements is based on the percentage relation ship between the net assets utilized in Solutia's operations and Monsanto's net assets. , The allocation methodology followed in preparing the consoli dated financial statements may not necessarily reflect the results of operations, cash flows, or financial position of Solutia in the future, or what the results of operations, cash flows, or financial position would have been had Solutia been a separate stand-alone entity. Post-SpinofT Financial Information Financial data included in the accompanying consolidated financial statements, for periods subsequent to the Spinoff, have been pre pared on a basis that reflects the historical value of the assets, liabil ities, and operations of the businesses that were contributed to Solutia by Monsanto in accordance with the distribution and employee benefits and compensation allocation agreements described in the preceding paragraphs. Effective with the Spinoff on September 1, 1997, the assets con tributed to Solutia and the liabilities assumed by Solutia included a joint venture interest in Monsanto's elemental phosphorus business, cash of $75.million, debt of SI.029 billion, accrued net pension liability for the U.S. and ex-U.S. defined benefit pension plans, and additional obligations for healthcare and other postretirement benefits. At the date of the Spinoff, the amount of postretirement liabilities assumed by Solutia totaled approximately $ 1.018 billion. 2. Significant Accounting Policies Basis of Consolidation Subsequent to the Spinoff, the consolidated financial statements include the accounts ofSolutia and its majority owned subsidiaries. Other com panies in which Solutia has a significant interest (20 to 50 percent) are included in "Investments in Affiliates" in the Statement of Consolidated Financial Position. Solutia's share of these companies' net earnings or losses is reflected in "Equity earnings from affiliates" in the Statement of Consolidated Income. Prior to the Spinoff, the consolidated finan cial statements included the accounts of Solutia as described in Note 1. Cash and Cash Equivalents Cash and cash equivalents consist ofcash and temporary investments with maturities of three months or less when purchased. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the finan cial statements and that affect revenues and expenses during the period reported. Estimates are adjusted when necessary to reflect actual expe rience. Significant estimates are used to account for the allocation between Monsanto and Solutia of financial statement amounts, restruc turing reserves, environmental reserves, self-insurance reserves, employee benefit plans, asset impairments, and contingencies. CurrencyTranslation The financial statements for most of Solutia's ex-U.S. operations are translated into U.S. dollars at current exchange rates. Unrealized currency adjustments in the Statement of Consolidated Financial Position are accumulated in equity. The financial statements of exU.S. entities that operate in hyperinflationary economies are trans lated at either current or historical exchange rates, as appropriate. These currency adjustments are included in net income. Property, Plant and Equipment Property, plant and equipment is recorded at cost. The cost of plant and equipment is depreciated over weighted average periods of 18 LAM018775 SAR 0035 years for buildings and 10 years for machinery and equipment, by the straight-line method. Impairment of Long-lived Assets Impairment tests of long-lived assets are made when conditions indicate a possible loss. Such impairment tests are based on a comparison of undiscounted cash flows to the recorded value ofthe asset. If an impair ment is indicated, the asset value is written down to its fair value based upon discounted cash value, using an appropriate discount rate. Inventory Valuation Inventories are stated at cost or market, whichever is less. Actual cost is used to value raw materials and supplies. Standard cost, which approximates actual cost, is used to value finished goods and goods in process. Standard cost includes direct labor and raw materials, and manufacturing overhead based on practical capacity. The cost of certain inventories (77 percent as of December 31, 1997) is 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. The cost of other inventories generally is determined by the first-in, firstout ("FIFO") method. Income Taxes Subsequent to the Spinoff, Solutia became responsible for its income taxes and will file its own income tax returns. Prior to the Spinoff, the company did not file separate tax returns because its results were includ ed in the income tax returns filed by Monsanto and its subsidiaries in var ious U. S. and ex-U. S. jurisdictions. The tax provisions reflected in the Statement of Consolidated Income, for periods prior to the Spinoff, have been computed as if Solutia was a separate company. The company accounts for income taxes using the asset and lia bility method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of temporary dif ferences between the carrying amounts and tax bases of assets and liabilities using enacted rates. Earnings per Share Effective December 31, 1997, Solutia adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Under this new standard, the presentation of primary and fully diluted earnings per share required by current standards is replaced by basic and diluted earnings per share. Basic earnings per share measures operating performance assuming no dilution from securities or contracts to issue common stock. Diluted earnings per share measures operating performance giving effect to the dilution that would occur when securities or contracts to issue common stock are exercised or converted. This change and the amounts associated with it are more fully described in Note 14. For periods ended prior to the Spinoff, the number of weighted average shares outstanding and common share equivalents used in the earnings per share calculation was based upon the weighted average number of Monsanto shares outstanding and Monsanto common share equivalents for the applicable period, adjusted for the distribution ratio in the Spinoff of one share of the company's common stock for every five shares of Monsanto common stock. Environmental Remediation Costs for remediation of waste disposal sites are accrued in the accounting period in which the obligation is probable and when the cost is reasonably estimable. Postclosure costs for hazardous and other waste facilities at operating locations are accrued over the esti mated life of the facility as part of its anticipated closure cost. Environmental liabilities are not discounted, and they have not been reduced for any claims for recoveries from insurance or third parties. In those cases where insurance carriers of third-party indemnitors have agreed to pay any amounts and management believes that col lectibility of such amounts is probable, the amounts are reflected as receivables in the consolidated financial statements. Effective January 1, 1997, Solutia adopted the American Institute of Certified Public Accountants' Statement of Position ("SOP") 96-1, "Environmental Remediation Liabilities." SOP 96-1 establishes authoritative guidance regarding the recognition, mea surement and disclosure of environmental remediation liabilities. The primary change in Solutia's accounting principles associated with the adoption of this SOP was an acceleration of the recogni tion of certain environmental remediation liabilities at operating facilities. This change and the amounts associated with it are more fully described in Note 16. Derivative Financial Instruments Currency forward contracts are used to manage currency expo sures for financial instruments denominated in currencies other than the entity's functional currency. Gains and losses on contracts that are designated and effective as hedges are included in net income and offset the exchange gain or loss of the transaction being hedged. Major currencies effecting the company's business are the U.S. dollar, the British pound sterling, the Belgian franc, and the German deutsche mark. Currency restrictions are not expected to have a sig nificant effect on Solutia's cash flow, liquidity, or capital resources. 3. Intercompany Transactions Transactions with Monsanto prior to the Spinoff, included in the Statement of Consolidated Income, are summarized as follows: Year Ended December 31, 1997 1996 1995 Intercompany sales....................................... $42 $63 $75 General and administrative services........... 12 85 72 Interest expense ........................................... 26 36 36 SAR 0036 LAM018776 S u i u t i a I r; i: Intercompany sales were made at Monsanto's established transfer In December 1994, Monsanto and Akzo Nobel N.V. agreed to prices, in addition, the costs for certain general and administrative form a 50-50 joint venture by combining their respective rubber services were allocated to Solutia. As further discussed in Note 1, chemicals businesses.The venture partners agreed to bear the one Monsanto discontinued its allocation of the cost of general and time costs required to integrate their respective rubber chemicals administrative expenses to Solutia, effective April 1, 1997, as part businesses into the joint venture. For Solutia, these integration of its transition plan of separation. Such expenses were specifically costs, which totaled $40 million pretax ($25 million aftertax), identified and segregated as part of Solutia's ongoing cost infra were primarily for the cost of reducing the work force by approx structure. Interest expense charged to Solutia represents an alloca imately 120 people and for special termination benefits for tion from Monsanto of its total interest expense. approximately 300 people transferring from Solutia to the joint venture.The charge for these action was recorded in the first quar 4. Restructuring and Other Actions Items that affected Solutia's results of operations in 1997 included a first quarter charge of $ 10 million ($6 million aftertax) associat ed with the adoption of the SOP 96-1 which is further discussed in Note 16.The second quarter of 1997 included a charge of $10 million ($6 million aftertax) for environmental-related litigation. This charge resulted from a settlement that Monsanto reached with 811 plaintiffs in six lawsuits related to the Brio Superfund site near Houston,Texas.The suits were among eleven suits brought in Harris County District Court or the United States District Court for the Southern District ofTexas on behalf of 960 plaintiffs who claimed injuries resulting from alleged exposure to substances present at or emanating from the Brio site. In addition, the second quarter included $8 million ($5 million aftertax) of reversals of excess restructuring reserves from prior years. The excess was primarily the result oflower exit costs associated with the sale and closure of nonstrategic facilities included in 1995 restructuring actions. The fourth quarter of 1997 included charges of $72 mil lion ($46 million aftertax) associated with changes in estimates for environmental remediation liabilities. These charges are discussed further in Note 16. In December 1996, Solutia recorded pretax restructuring charges totaling $256 million (S164 million aftertax) to cover the costs asso ciated with the closure or sale ofcertain facilities, asset write-offs, and workforce reductions. Included in these charges were pretax amounts for asset impairments totaling $ 56 million.These write-offs were nec essary primarily because of excess production capacity, coupled with ter of 1995. On May 1, 1995, the joint venture, known as Flexsys, L.P. (" Flexsys"), began operation and is accounted for as an equi ty affiliate. Accordingly, Solutia's share of the earnings of Flexsys after that date has been reflected in "Equity earnings from affili ates" in the Statement of Consolidated Income. Solutia's results of operations for 1995 included net sales of $140 million from the rubber chemicals business. Operating income for this business during these periods was not significant. Other items that affected Solutia's results of operations in 1995 included the receipt in the first and third quarters of settlement payments from various insurers related to environmental and other insurance litigation. The combined effect of these settle ments totaled $88 million pretax ($55 million aftertax). In addi tion, Monsanto settled a lawsuit related to a Comprehensive Environmental Response, Compensation and Liability site, com monly known as a "Superfund" site, in La Marque, Texas. The suit was brought by IT Corporation ("IT"), a subsidiary of International Technology Corp., and claimed, among other things, breach of a contract calling for IT to perform incineration and remediation work at the site. Monsanto settled the suit by paying $41 million pretax ($25 million aftertax), and Solutia recorded the payment in the third quarter of 1995. The components of the pretax expense (income) related to the restructuring programs and the other actions included in the accompanying Statement of Consolidated Income were: 1997 1996 1995 Changes in estimates for environmental reserves and application of SOP 96-1 ........ $ 82 i insufficient demand for certain products. Asset values were written Cost of employee reductions...................... $ 157 S 22 down to their discounted cash values, using appropriate discount Shutdown and consolidation of rates. Significant progress was made on this plan in 1997, with various facilities and departments.............. (8) 33 44 employment being reduced by approximately 600 people. Asset impairments ...................................... 56 In December 1995, Monsanto's board of directors approved a Insurance-related settlement (income).................................... i restructuring plan.The pretax charge associated with these actions Litigation settlement ................................... 10 (88) 41 was $66 million ($57 million aftertax) and covered the costs of Joint venture integration costs ................... 40 work force reductions, business consolidations, facility closures, Other costs................................................. 10 and the exit from nonstrategic businesses and facilities. This plan was substantially completed by the end of 1996 and reduced Total ............................................................ $84 $256 S59 employment by approximately 100 people. SAR 0037 k. LAM018777 [35] fj u 1 c s To Consolidated Financial State in outs Restructuring expenses are recorded based on estimates pre pared at the time the restructuring actions are approved by the board of directors. The balance in restructuring reserves as of December 31, 1997, was $104 million. It is earmarked primari ly for work force reduction costs and the costs associated with the consolidation of various facilities, and departments. Management believes that the balance of these reserves as of December 31, 1997, is adequate for completion of those activities. Restructuring actions during the last three years have reduced these liabilities by approximately $ 350 million. Approximately 60 percent of these reductions were recorded for write-offs and expenditures related to the shutdown and consolidation of vari ous facilities and departments. The remaining reductions were related primarily to the cost of work force reduction programs. As of December 31, 1997, substantially all of the restructuring reserves established in 1995 had been utilized. The pretax expenses (income) related to the restructuring programs and the other unusual items were recorded in the Statement of Consolidated Income in the following categories: 1997 1996 1995 Cost of goods sold.............................. ...... $84 $ S6 H7) Restructuring expenses -- net ........... 192 53 Decrease in operating income........... Other expensed ................................. Total decrease in income before income taxes........................ ...... 84 248 8 $84 $256 46 13 $59 0) In 1996 and 1995, other expense includes Solutia s share of restructuring actions undertaken for the Flexsys joint venture. Net income was decreased by $53 million, $164 million, and $52 million in 1997,1996, and 1995, respectively, because of these restructurings and other actions. 5. Investments in Affiliates At December 31,1997, Solutia's investments in affiliates consisted principally of its 50 percent interests in the Flexsys rubber chemi cals joint venture and the Advanced Elastomers Systems, L.P. ("AES") joint venture for which Solutia uses the equity method of accounting. Summarized combined financial information for the Flexsys and AES joint ventures follows: Results of operations: Net sales ................ Net income........... Financial position: Total assets ... Total liabilities . ............. $865 ............. 78 $779 64 $628 3 ............. $899 ............. 254 $853 237 $854 290 6. Inventory Valuation The components of inventories were: Finished goods ....................................... Goods in process ................................... Raw materials and supplies .................. Inventories, at FIFO cost....................... Excess of FIFO over LIFO cost ........... Total ....................................................... 1997 1996 $259 $258 60 47 148 126 467 431 (142) (140) $325 $291 Inventories at FIFO approximate current cost.The effect of LIFO inventory liquidations was not material in 1997, increased pretax income by $5 million in 1996 and was not material in 1995. 7. Income Taxes The components of income before income taxes were: United States........................................... . Outside United States........................... 1997 $187 103 1996 $11 22 Total........................................................ . $290 $33 1995 $221 10 $231 The components of income tax expense charged to operations were: Current: U.S. federal.......................................... . U.S. state.............................................. Outside United States.......................... 1997 $36 7 23 1996 1995 $13 $39 27 31 13 66 46 59 Deferred: U.S. federal.......................................... 19 (21) 23 U.S. state............................................... Outside United States ........................ 2 0) 3 11 (23) (1) 32 (45) 25 Total......................................................... $98 $ 1 $84 Factors causing Solutia's effective tax rate to differ from the U.S. federal statutory rate were: 1997 U.S. federal statutory rate...................... ... 35% 1996 35% 1995 35% U.S. state income taxes........................... ... 2 1 3 Tax benefit of foreign sales corporation...................................... Taxes related to foreign income, net of credits............................................ (2) (23) _3 (4) 4 Income from equity affiliates recorded net of tax................................... Other......................................................... ... (3) 2 (13) - (1) (1) Effective income tax rate ................... ... 34% 3% 36% SAR 0038 t-AM018778 Deferred income tax balances were related to: Property.......................................... ............. Postretirement benefits .................... ............. 1997 $(177) 394 Restructuring reserves...................... .................. Environmental liabilities ................... ............. SI 80 Inventory............................................. Other .................................................. ............. (2) 41 Net asset............................................. ............. $ 387 1996 $(176) 248 92 57 4 77 $ 302 Income taxes and remittance taxes have not been recorded on $33 million in undistributed earnings of subsidiaries, either because any taxes on dividends would be offset substantially by foreign tax credits or because Solutia intends to reinvest those earnings indefi nitely. It is not practicable to estimate the tax effect of remitting these earnings to the U.S. 8. Debt Obligations Debt Maturing in One Year Debt maturing in one year consisted principally of commercial paper balances, which totaled 5190 million as of December 31, 1997. The weighted average interest rate on this debt was 6.99 percent as of December 31,1997. Interest expense on commer cial paper balances, charged to income subsequent to the Spinoff was at a weighted average rate of S.78 percent. As of December 31,1997, Solutia had a five-year revolving credit facility of $800 million with a syndicate of banks to support its commercial paper. The credit facility is also available for work ing capital and other general corporate purposes. Interest on amounts borrowed under this credit facility is expected to approximate money market rates. The credit agreement contains various covenants that, among other things, restrict the ability of Solutia to merge with another entity and that require Solutia to meet certain leverage and inter est coverage ratios. The company does not anticipate that future borrowings will be limited by the terms of this agreement. No borrowings were outstanding under this credit facility as of December 31, 1997. Long-Term Debt Long-term debt consisted of the following: 1997 1996 6.5% notes due 2002 ........................................... $150 $ - 7.375% debentures due 2027 ............................. 300 - 6.72% debentures due 2037 .............................. 150 - Unamortized debt discount ................................ (3) - Total ....'............................................................... $597 S - The notes and debentures are unsecured obligations. Interest is payable semiannually, on April 15 and October 15 of each year, commencing April 15, 1998.The 2037 debentures may be repaid on October 15, 2004 at the option of the holder. The notes and debentures contain provisions that, among other things, restrict Solutia's ability to create liens against assets and its ability to enter into sale and leaseback transactions. 9. Fair Values of Financial Instruments The estimated fair value of Solutia's long-term debt as of December 31, 1997, was $605 million. This estimate compares with the recorded amount of $597 million. The recorded amounts of cash, trade receivables, thirdparty guarantees, accounts payable and short-term debt approximate their fair values. The estimated fair value of the company's foreign currency forward contracts approximates their notional amounts. Fair values are estimated by the use of quoted market prices, estimates obtained from brokers, and other appropriate valuation techniques based upon information available as of December 31, 1997.The fair-value estimates do not necessarily reflect the val ues Solutia could realize in the current market. 10. Postretirement Benefits - Pensions Prior to the Spinoff, Solutia's employees participated in Monsanto's noncontributory pension plans. In conjunction with the Spinoff, Solutia assumed pension liabilities and received related assets from those plans for its active employ ees and for certain former employees who left Monsanto in earlier years. Solutia's plans are substantially identical to Monsanto's plans. Pension benefits are based on the employ ee's years of service and/or compensation level. The pension plans are funded in accordance with Solutia's long-range pro jections of the plans' financial conditions. These projections take into account benefits earned and expected to be earned, anticipated returns on pension plan assets, and income tax and other regulations. The company's net pension cost was $28 million in 1997. It consisted of $9 million of net pension costs incurred subsequent to the Spinoff and $19 million of cost allocations from Monsanto. Solutia's net pension cost allocations from Monsanto were $18 million and $1 million in 1996 and 1995, respectively. Separate calculations of the components of Solutia's net pension cost and the funded status of the plans prior to the Spinoff are not available. Subsequent to the S^R 0039 LAM018779 [37] Notes To Consolidated Financial Statements Spinoff, ihe company's net pension cost was $9 million and its components were as Follows: 1997 Service costs for benefits earned.......................................... $ 11 Interest cost on benefit obligation........................................ 52 Assumed return on plan assets").............. Amortization of unrecognized net gain .............................. () (1) Total........................................................................................ S 9 0) Actual return on plan assets was 544 million for the four months ended December 31,1997. The funded status of Solutia's pension plans at year-end was: 1997 Plan assets at fair value ................................................. $ 1,834 Actuarial present value of plan benefits: Vested................................................................................ $ 1,538 Nonvested ........................................................................ 107 Accumulated benefit obligation........................................ 1,645 Effect of projected future salary increases ..................... 179 Projected benefit obligation*'1 ..................................... $ 1,824 Excess of plan assets over projected benefit obligation .............................................. $ 10 Less: Unrecognized initial net gain.......................................... 33 Unrecognized prior service costs ................................. Additional liability........................................................... (178) 14 Unrecognized subsequent net gain ................................ 269 Accrued net pension liability*-'..................................... $ 128 (') Included $27 million in 1997 for unfunded plans. (2)Included $22 million in 1997 for unfunded plans. The accrued net pension liability was included in: Postretirement liabilities ...................................................... Less: Other assets................................................................... Accrued net pension liability........................................... 1997 $136 8 $ 128 Included in the preceding table are plan assets and projected ben efit obligations for the principal U.S. plan of approximately $ 1.762 billion and $1,732 billion, respectively, as of December 31, 1997. Plan assets consist principally of common stocks and U.S. govern ment and corporate obligations. Contributions to these plans were neither required nor made in 1997 because Solutia's principal pen sion plan is adequately funded, using assumed returns. The significant actuarial assumptions used to estimate the projected benefit obligation for the company's princ pension plan were as follows: 1997 Assumed long-term rate of return on plan assets Annual rates ol salary increase (for plans 7.25% 9.50% that base benefits on final compensation level) . . 4.00% 11. Postretirement Benefits - Health Care and Other In connection with the Spinoff, Solutia assumed retiree medical liabilities for its active employees and for approximately two- thirds of the retired U.S. employees of Monsanto. Solutia's employees participate in benefit programs that provide certain health care and life insurance benefits for retired employees. Substantially all regular, full-time U.S. employees and certain employees in other countries may become eligible for these ben efits if they reach retirement age while employed by Solutia. These postretirement benefits are unfunded and are generally- based on the employee's years of service and/or compensation level. The costs of postretirement benefits are accrued by the date the employees become eligible for the benefits. Solutia's postretirement benefit costs in 1997 were $54 mil lion, which consisted of $23 million of postretirement benefit costs incurred subsequent to the Spinoff and $31 million of cost allocations from Monsanto. Solutia's postretirement benefit cost allocations from Monsanto were $50 million in 1996 and $54 mil lion in 1995. Because of the significant increase in postretirement liabilities assumed in the Spinoff, future postretirement benefit costs are likely to increase when compared to historical amounts. Separate calculations of the components of Solutia's total cost for postretirement benefits and the status of the plans prior to the Spinoff are not available. Subsequent to the Spinoff, the company's postretirement benefit cost was S23 million, and its components were as follows: 1997 Service costs for benefits earned ......................................... $ 4 Interest cost on benefit obligation ....................................... 20 Amortization of unrecognized net gain............................... (1) Total...................................................................................... $23 As of December 31, the status of Solutia's postretirement health care and life insurance benefit plans, and employee disability bene fit plans was: Accumulated benefit obligation: 1997 Retirees .............................................................................. $ 762 Eligible active employees .................................................. 32 Other active employees..................................................... 124 Total $918 Unrecognized benefits from prior service........................ 27 Unrecognized subsequent net loss.................................... (32) Accrued liability.............. $913 The accrued liability was included in : Miscellaneous accruals....... Postretirement liabilities Accrued liability......... LAM018780 1997 .. $ 91 822 .. $913 SAR 0040 Postretirement benefit costs were determined using the follow ing rate assumptions: 1997 Discount rate.......................................................................... 7.25% Initial trend rate for health care costs ................................... 5.00% Ultimate trend rate for health care costs................................. 5.00% A l percent increase in the assumed trend rate for health care costs would have increased the accumulated benefit obligation by $ 38 million as of December 31, 1997. 13. Stock Option Plans The Solutia Inc. 1997 Stock-Based Incentive Plan (the "1997 Plan") provides to officers and employees of the company and its subsidiaries incentives directly linked to the price of Solutia's stock.The 1997 Plan is the company's current stock-based incen tive plan for management. The 1997 Plan authorizes up to 7,800,000 shares of compa ny common stock for grants of non-qualified and incentive 12. Employee Savings Plans stock options, stock appreciation rights, restricted stock awards, and bonus stock awards. Shares used may be either For some employee savings plans, employee contributions are matched in part by Solutia. The value of these contributions for Solutia was $ 10 million in 1997 and S11 million in 1996 and 1995. In connection with the Spinoff, Monsanto common stock held by the Monsanto Employee Stock Ownership Plan ("ESOP") and related Monsanto ESOP borrowings were allocated between Solutia and Monsanto. As a result of this allocation, Solutia received 2.4 million shares of Monsanto common stock and assumed $29 million of ESOP debt to third parties. Simultaneously, Solutia created its own ESOP, established a trust to hold the Monsanto shares and issued a $29 million loan to the trust. Proceeds of the loan were used by the trust to repay the assumed third-party debt. Subsequent to the Spinoff, the ESOP trust was required by government regulations to divest its hold ings of Monsanto common shares and use the proceeds to acquire Solutia common shares. As of December 31,1997, Solutia's ESOP trust held approximately 9.9 million shares of Solutia common stock and approximately $21 million of cash. A portion of the ESOP shares is allocated each year to employ ee savings accounts as matching contributions. In 1997, 232,674 shares were allocated to participants' accounts under the plan, leav ing 3,700,792 unallocated shares as of December 31, 1997. Unallocated shares held by the ESOP are considered outstanding for earnings per share calculations. Compensation expense is equal to the cost of the shares allocated to participants, less dividends paid on the shares held by the ESOP. Information regarding the ESOP follows: 1997 1996 1995 Total ESOP expense..................................... $ 5 $3 S 5 Interest portion of total ESOP expense ...... 32 3 Cash contributions....................................... -- - Dividends paid on ESOP shares held........... ---- -- For periods prior to the Spinoff, the total Monsanto ESOP expense and the related interest were allocated to Solutia from Monsanto. Cash contributions and dividends paid on ESOP shares for periods prior to the Spinoff were not applicable to newly issued shares or treasury shares or both. Under the 1997 Plan, the exercise price of a stock option must be no less than the fair market value of the company common stock on the grant date. Additionally, the 1997 Plan provides that the term of any stock option granted under the plan may not exceed ten years. As of December 31, 1997, approximately 3,232,275 shares of company common stock remained available for grants under the 1997 Plan. During 1997, non-qualified stock options granted under the 1997 Plan were 1,046,000 to all current executive officers and other senior executives as a group and 3,519,500 shares to all other employees at an exercise price of $19.25 per share. The options granted in September 1997 to the company's executive officers and other senior executives are accelerated performance options. The options granted to the other management employ ees are time-based.They become exercisable in thirds, one-third on each of the first three anniversaries of the option grant date. Certain options granted under Monsanto's stock option plans ("Monsanto Options") to company employees in 1997 prior to the Spinoff were converted into Solutia options with adjustments to preserve their value. In addition, unexercised Monsanto Options granted to Solutia and Monsanto employees prior to 1997 were converted into two awards, one based on Monsanto common stock and one based on Solutia common stock, with the same overall value at the time of the Spinoff as the old award. Effective January 1, 1996, Solutia adopted Statement of Financial Accounting Standard ("SFAS") No. 12 3, "Accounting for Stock-Based Compensation." As permitted by the standard, Solutia has elected to continue following the guidance of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," for measurement and recognition of stock-based transactions with employees. Accordingly, no compensation cost has been recognized for Solutia's option plans. Had the determination of compensation cost for these plans been based on the fair value at the grant dates for awards under these plans, consistent with the method of SFAS the Solutia ESOP. SAR 0041 LAM018781 Notes To Consolidated incial Statements No. 12 3, Solutia's net income would have been reduced to the pro forma amounts indicated below: 1997 1996 1995 Net Income: As reported .................................................. $ 192 S 32 S 147 Pro forma..................................................... 159 18 144 Earnings per share, assuming dilution: As reported .................................................. $1.55 S0.27 $1.27 Proforma..................................................... 1.29 0.15 1.24 The resulting compensation expense may not be representative of compensation expense to be incurred on a pro forma basis in future years. The fair value of each option grant is estimated on the date of grant by using the Black-Scholes option-pricing model. The following weighted-average assumptions were used to cal culate the expense attributable to the company for Monsanto 1997, 1996 and 1995: 1997 1996 1995 Expected dividend yield 0.3% 1.5% 3.0% 27.0% 25.0% 20.0% 6.3% 6.0% 7.1% 4.0 4.0 4.5 The following weighted-average assumptions were used for grants of Solutia options in 1997: 1997 Expected dividend yield ...................................................... 0.2% Expected volatility ................................................................. 25.0% Risk-free interest rates......................................................... 5.9% Expected option lives (years).............................................. 4.0 The weighted-average fair values of options granted during 1997 and 1996 were $4.83 and $6.43, respectively. A summary of the status of the company's stock option plans for the period subsequent to the SpinofT through December 31, 1997 follows: Exercisable Shares Outstanding Weighted-Average Shares Exercise Price September 1, 1997 .. 10,269,960 24,122,741 SI 3.48 Granted.................. 4,565,500 19.25 Exercised............... (752,102) 9.29 Expired.................. (118,411) 16.36 December 31,1997. 9,517,858 27,817,728 $ 14.53 The following tables summarize information about stock options outstanding as of December 31, 1997: Options Outstanding: Range of Exercise Prices Shares $ 3 to 7... 5,627,732 8 to 11... 55,479 12 to 15 . .. 1,722,939 16 to 18.. 15,660,834 19 to 23... 4,750,744 S 3 to 23 . .. 27,817,728 Weighted-Average Remaining Contractual Life 3.6 years 6.9 7.5 7.9 9.0 7.2 Weighted - Average Exercise Price S 5.73 10.07 12.63 16.47 19.30 $ 14.53 Options Exercisable: Range of Exercise Prices S 3 to 7..................... .............. 8 to 11..................... .............. 12 to 15..................... .............. 16 to 18..................... .............. 19 to 23..................... .............. S 3 to 23..................... .............. Shares 5,623,032 44,729 1,098,815 2,705,082 46,200 9,517,858 Wc ighted - Average Exercise Price $ 5.73 10.18 12.16 16.82 19.11 $ 9.71 14. Earning per Share Effective December 31, 1997, Solutia adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Under this new standard, the presentation of primary and fully diluted earnings per share required by current standards is replaced by basic and diluted earnings per share. Basic earnings per share measures operating performance assuming no dilution from securities or contracts to issue common stock. Diluted earnings per share measures operating performance giving effect to the dilution that would occur when securities or contracts to issue common stock are exercised or converted. For periods ended prior to the Spinoff, the number of weight ed average shares outstanding and common share equivalents used in the earnings per share calculation was based upon the weighted average number of Monsanto shares outstanding and Monsanto common share equivalents for the applicable period, adjusted for the distribution ratio in the Spinoff of one share of the company's common stock for every five shares of Monsanto common stock. SAR 0042 0 LAM018782 S o l u tia Inc. The computation of basic earnings per share is reconciled with diluted earnings per share as follows: 1997 Basic Earnings per Share: Net income ......................................... Per-share Income Shares Amount $192 117.7 $1.63 Effect of Dilutive Securities: Common share equivalents common stock issuable upon exercise of outstanding stock options............... 6.0 Diluted Earnings per Share ............ $192 123.7 $1.55 19% Basic Earnings per Share: Net income ......................................... Income Shares $ 32 116.2 Per-share Amount $0.28 Effect of Dilutive Securities: Common share equivalents common stock issuable upon exercise of outstanding stock options............... 3.6 Diluted Earnings per Share ............ $ 32 119.8 $0.27 1995 Basic Earnings per Share: Net income ......................................... Income Per-share Shares Amount $147 113.5 $1.30 Effect of Dilutive Securities: Common share equivalents common stock issuable upon exercise of outstanding stock options............... 2.6 Diluted Earnings per Share............ $147 116.1 $1.27 15. Capital Stock The company's board of directors declared a dividend of one pre ferred stock purchase right on each share of the company's com mon stock issued in the distribution of shares by Monsanto to its stockholders on the effective date of the Spinoff. If a person or group acquires beneficial ownership of 20 percent or more, or announces a tender offer that would result in beneficial ownership of 20 percent or more, of the company's outstanding common stock, the rights become exercisable and for every right held, the owner will be entitled to purchase one one-hundredth of a share of a series of preferred stock for S125. If Solutia is acquired in a busi ness combination transaction while the rights are outstanding, for every right held, the holder will be entitled to purchase, for S125, common shares of the acquiring company having a market value of $250. In addition, if a person or group acquires beneficial owner ship of 20 percent or more of the company's outstanding common stock, for every right held, the holder (other than such person or members of such group) will be entitled to purchase, for $125, a number of shares of the company's common stock having a market value of $250. Furthermore, at any time after a person or group acquires beneficial ownership of 20 percent or more (but less than 50 percent) of the company's outstanding common stock, the board of directors may, at its option, exchange part or all of the rights (other than rights held by the acquiring person or group) for shares of the company's common stock on a one share-for-everyone-right basis. At any time prior to the acquisition of such a 20 percent position, the company can redeem each right for $0.01. The board of directors is also authorized to reduce the aforemen tioned 20 percent thresholds to not less than 10 percent. The rights expire in the year 2007. The company has 10 million shares of preferred stock, par value $0.01 per share, authorized. As of December 31, 1997, there were no preferred shares issued or outstanding. 16. Commitments and Contingencies Commitments, principally in connection with uncompleted additions to property, were approximately S21 million as of December 31, 1997. Solutia was contingently liable as a guaran tor for bank loans totaling approximately $12 million as of December 31,1997. Monsanto was contingently liable as a guar antor for bank loans and discounted customers' receivables relating to Solutia totaling approximately $16 million as of December 31, 1996. Solutia's future minimum payments under noncancelable operating leases and unconditional purchase obligations are $23 million for 1998, S17 million for 1999, SI2 million for 2000, $8 million for 2001, S41 million for 2002, and S15 million thereafter. Solutia has entered into agreements with customers to supply a guaranteed quantity of certain products annually at prices specified in the agreements. In return, the customers have advanced funds to Solutia to cover the costs of expanding capacity to provide the guar anteed supply. Solutia has recorded the advances as deferred credits and amortizes the amounts to income as the customers purchase the products. At December 31, 1997, the unamortized deferred credits were approximately $59 million. The more significant concentrations in Solutia's trade receivables at year-end were: U.S. chemical industry........................................... U.S. carpet industry .............................................. European chemical industry .................................. 1997 $130 73 41 1996 $129 79 36 Management does not anticipate losses on its trade receivables in excess of established allowances. LAM018783 SAR 0043 he;--*' C o r> s o I i il n l c (I Financial State m c n \ s Solutia's Statement of Consolidated Financial Position included accrued liabilities of S217 million and S1 SO million as of December 31,1997 and 1996, respectively, for the remediation ofiden tified waste disposal sites. Expenditures related to remediation activities were $39 million in 1997, S59 million in 1996, and $68 million in 199S. Solutia recorded charges of approximately $34 million ($22 mil lion aftertax) in the fourth quarter of 1997 to increase its environmental reserves.This action was required in order to reflect reused estimates for changed circumstances relating to the ultimate outcome of previously known emironmental matters. These revised estimates were based upon further discussions with emironmental authorities and the availability of new information from recently completed emironmen tal studies.These events and activities help to define better and to quantify the company's ultimate liability for these matters. Effective January 1, 1997, Solutia adopted the American Institute of Certified Public Accountants' Statement of Position ("SOP") 96-1, "Environmental Remediation Liabilities." SOP 96-1 establishes authoritative guidance regarding the recognition, measurement and disclosure of emironmental remediation liabilities. A charge of approximately $10 million ($6 million aftertax) was recorded in the first quarter of 1997 associated with the adoption of SOP 96-1 .The timing of this charge was predicated upon an application of SOP 961 in which liabilities arising under the Resource Conservation and Recovery Act ("RCRA") should be recorded when a RCRA correc tive measures study ("CMS") is completed. Subsequently, the compa ny reassessed its application of SOP 96-1 and concluded that these liabilities would be recorded over a continuum of events leading up to and including a CMS. As a result, the company recorded in the fourth quarter of 1997 additional charges of approximately $ 38 million ($24 million aftertax) associated with these RCRA environmental liabili ties. Uncertainties related to all of the company's environmental liabil ities are evolving government regulations, the method and extent of remediation and future changes in technology. Because of these uncertainties, the company estimates that potential future expenses associated with these liabilities could be an additional $20 million to S 30 million. Although the ultimate costs and results of remediation of contaminated sites cannot be predicted with certaintv, they are not expected to result in a material adverse effect on Solutia's consoli dated financial position, liquidity, or profitability in any one year. Monsanto is a part)' to a number of lawsuits and claims relating to Solutia, for which Solutia has assumed responsibility in the Spinoff and which Solutia intends to defend vigorously. Such matters arise out of the normal course of business and relate to product liability, government regulation, including environmental issues, and other issues. Certain of the lawsuits and claims seek damages in very large amounts. Although the results of litigation cannot be predicted with certainty, management's belief, based upon the advice of Solutia's njri SAR 0044 counsel, is that the final outcome of such litigation will not have a material adverse effect on Solutia's consolidated financial position, profitability or liquidity in any one year, as applicable. 17. Supplemental Data Supplemental income statement data were: 1997 1996 1995 Raw' material and energy costs............ $1,102 $1,059 $929 Employee compensation and benefits . . 746 715 794 Current income and other taxes ........ 149 134 152 Rent expense......................................... 28 29 31 Technological expenses: Research and development............... 60 81 77 Engineering, commercial development and patent .................. 27 7 18 Total technological expenses ............... 87 88 95 Interest expense: Total interest cost ............................. 49 41 42 Less capitalized interest .................... 8 5 6 Net interest expense............................. 41 36 36 Currency losses including equity in affiliates' currency gains and losses....... 6 2 3 18. Segment and Geographic Data Effective December 31, 1997, Solutia adopted Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments ofan Enterprise and Related Information," which redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a company's oper ating segments. The required disclosures follow. As permitted by the standard, information for years prior to 1997 was not restated to conform to the new disclosure requirements because it was imprac ticable to do so. Solutia reported one segment prior to the adoption of SFAS No. 131. Solutia has three reportable segments: Chemicals, Fibers, and Polymers & Resins. The Chemicals segment produces intermediate chemicals used in other finished products, phosphorus-based products used in food and beverages and personal care products, and specialty fluids and lubricants. The Fibers segment produces Acrilan acrylic fibers used in apparel, cloth and brake fibers; nylon carpet fibers for residential and contract markets; and industrial-strength nylon fibers used in tire and other industrial applications. The Polymers 8t Resins segment produces Saflex plastic interlayer used in automotive and architectural applications, specialty resins used in paints and adhesives, polymer modifiers and plasticizers used in flooring products, sealants, caulks, and adhesives, and Vydyne for engineering thermoplastics and nylon 6,6 polymers for fiber applications. LAM018784 Solutia's reportable segments are groupings ofthe company's ten business units, which are managed to focus on key technological strengths of polymer chemistry, phosphorus chemistry, fiber tech nology, and process engineering expertise. Business units sharing similar economic characteristics and similarities in the areas of products, production processes, types ofcustomers, and methods of distribution were aggregated. Accounting policies of the segments are the same as those described in the summary ofsignificant accounting policies in Note 2. However, segment profit only reflects the operating expenses that are directly attributable to the segment. Unallocated service costs Solutia's 1997 segment information follows: Segment: Chemicals .............................................................................................. Fibers...................................................................................................... Polymers & Resins ................................................................................ Segment Totals..................................................................................... Reconciliation to consolidated totals: Elimination of intersegment sales ...................................................... Other revenues...................................................................................... Unallocated depreciation and amortization........................................ Consolidated Totals............................................................................. Segment: Chemicals .............................................................................................. Fibers...................................................................................................... Polymers & Resins................................................................................ Segment Totals.................................................................................... Reconciliation to consolidated totals: Less unallocated service costs included in: Cost of goods sold................................................................................ Marketing, administrative and technological expenses.................... Equity earnings from affiliates.............................................................. Interest expense .................................................................................... Other income (expense) -- net............................................................ Income Before IncomeTaxcs........................................................... Unallocated assets and capital expenditures ...................................... Consolidated Totals............................................................................ Solutia's geographic information for 1997 follows: Segment: U.S............................................................................................................ Other countries...................................................................................... Consolidated Totals.......................................................................... are managed centrally and primarily include costs of technology, engineering and manufacturing services that are provided to the segments. These amounts also include corporate administration costs. The company accounts for intersegment sales at agreed upon transfer prices. Intersegment sales are eliminated in consolidation. Segment assets consist primarily of customer receivables, finished goods inventories, and fixed assets directly associated with the pro duction processes of the segment ("direct fixed assets"). Segment depreciation and amortization is based upon direct fixed assets. Unallocated assets consist primarily of deferred taxes, certain investments in equity affiliates, and indirect fixed assets. Net Sales $ 965 979 1,041 2,985 Intersegment Depreciation Sales and Amortization $18 $ 37 - 26 5 41 23 104 (23) 7 $2,969 Profit $ 231 161 272 664 (23) $- Assets $ 601 400 571 1,572 38 $142 Capital Expenditures $ SO 33 55 138 (148) (226) 31 (41) 10 $ 290 1,196 $2,768 27 $165 Net Sales $2,030 939 $2,969 Long-Lived Assets $803 120 $923 SAR 0045 LAM018785 19. Quarterly Data - Unaudited Net Sales ....................................................................... ..... 1997 1996 Gross Profit ......................................................................... 1997 1996 Operating Income (Loss) ........................................... ...... 1997 1996 Net Income (Loss) ...................................................... ...... 1997 1996 Earnings (Loss) per Share........................................... ...... Earnings (Loss) per Share, assuming dilution........... ...... 1997 1996 1997 1996 First Quarter $719 70S 176 160 95 56 65 36 0.56 0.31 0.54 0.30 Second Quarter $770 749 189 175 97 62 62 47 0.52 0.41 0.51 0.39 Third Quarter $749 753 173 200 88 96 56 61 0.47 0.52 0.44 0.51 Fourth Quarter $731 770 115 117 10 (181) 9 (112) 0.08 (0.96) 0.06 (0.93) Total Year $2,969 2,977 653 652 290 33 192 32 1.63 0.28 1.55 0.27 In the first quarter of 1997, net income included an aftertax charge of $6 million associated with the adoption of SOP 96-1 for environmental reserves at operating locations. Net income in the second quarter of 1997 included an aftertax charge of $6 million for environmental-related litigation at the Brio Superfund site and $5 million of aftertax reversals of excess restructuring reserves from prior years. In the fourth quarter of 1997, net income included aftertax charges totaling $46 million related to changes in estimates for environmental remediation liabilities. Net income for the fourth quarter of 1996 included an after tax charge of $ 164 million for restructuring and other actions. SAR 0046 LAM018786 Financial Summary (Dollars in millions, except per share) Unaudited Pro Forma t1) Operating Results: 1997 1996 Net Sales*2).................................................................... Gross Profit.................................................................. As percent of net sales........................................... $2,960 $2,962 647 649 22% 22% Marketing, Administrative and Technological Expenses........................................... As percent of net sales............................................. Operating Income*')................................................. As percent of net sales............................................ Income Before Income Taxes.................................. Net Income**).............................................................. As percent of net sales............................................. 393 13% 254 9% 235 157 5% 420 14% 37 1% 9 17 <1% Share Data: Earnings per Share*'*................................................ . Earnings per Share, assuming dilution*')........... Dividends per Share................................................ Common Stock Price:............................................. High....................................................................... Low......................................................................... Close....................................................................... Price/Earnings Ratio on Year-End Stock Price .. Number of Registered Stockholders.................. Year-end Shares Outstanding (in thousands)... Shares Repurchased (in thousands)..................... Average Daily Trading Volume (in thousands) .. $ 1.33 1.27 " $ 0.15 0.14 - Other Data: Interest Expense*6)..................................................... S 60 IncomeTaxes............................................................... 78 Depreciation and Amortization........................... 142 Total Assets.................................................................. - Capital Expenditures................................................ - Intercompany Charges*7).......................................... - Long-Term Debt*6)..................................................... - Employees (year-end).............................................. - S 64 (3) 166 2,660 - 1997 1996 $2,969 $2,977 653 652 22% 22% Historical 1995 $2,964 721 24% 1994 1995 $3,097 729 24% $3,028 699 23% 363 12% 290 10% 290 192 6% 427 14% 33 1% 33 32 1% 410 14% 258 9% 231 147 5% 439 14% 256 8% 228 149 5% 438 14% 300 10% 290 192 6% $ 1.63 1.55 0.01 S 0.28 0.27 $ 1.30 1.27 $ 1.30 1.27 $ 1.61 1.59 27 V4 - - -- 18'Vi6 - - -- 26 "/i6 - - -_ 17 - - - - 57,894 - - -- 117,408 - - -- 1,570 - - -- 1,053 - - -- $ 41 98 142 2,768 165 12 597 8,800 $ 36 1 166 2,483 192 85 0 - S 36 84 162 2,462 179 72 0 - $ 29 79 219 2,435 187 69 0 - S 19 98 224 2,491 179 61 0 - <|)Thc unaudited pro forma financial information is presented for illustrative purposes only. It may not be indicative of the results that would have been obtained had the Spinoff and the company's 1997 debt offering actually occurred on the dates assumed, nor is it indicative of the future consolidated results of operations. <2>Nct sales for the company included $140 million in 1995, $400 million in 1994 and $407 million in 1993 for its rubber chemicals business. In May 1995, this busi ness was contributed by Monsanto to the Flcxsys L.P. joint venture. < ^Operating income includes (charges) credits for restructuring and other actions of $(84) million in 1997, $(248) million in 1996, $(46) million in 1995, $(34) mil lion in 1994 and $43 million in 1993. In addition, operating income in 1993 includes $25 million for the company's rubber chemicals business. Operating income for this business was not significant in 1994 and 1995. (tiNct income includes (charges) credits for restructuring and other actions of $(53) million, or 5(0.43) per share in 1997, $(164) million, or $(1.37) per share in 1996, $(52) million, or $(0.45) per share in 1995, $(21) million, or $(0.18) per share in 1994, and $26 million, or $0.22 in 1993. SAR 0047 <5>For periods ended prior to the Spinoff, the number of Monsanto weighted average shares outstanding and common share equivalents were adjusted for the distribution ratio in the Spinoff of one share of Solutia's common stock for every five shares of Monsanto common stock. <6>Monsanto used a centralized approach to cash management and the financing of its operations. As a result, cash and cash equivalents and debt were not allocated to the company in the historical financial statements. Interest expense was allo cated to the company in the company's consolidated financial statements to reflect the company's pro rata share of the financing structure of Monsanto. <tiPrior to the Spinoff, Monsanto provided certain general and administrative ser vices to the company, including finance, legal, treasury, information systems and human resources. The cost of these services was allocated to the company based upon the percentage relationship between the net assets utilized in the company's operations and Monsanto's total net assets, as well as other methods which man agement believes to be reasonable. LAM018787 Quarterly Data (Dollars in millions, except per share) Unaudited Pro Forma 1997 1996 Net Sales ......... Total......................................................................................... ......... $ 71S 765 749 731 $ 2,960 S 701 745 749 767 S 2,962 Gross Profit IQ............................................................................................ ......... 2Q............................................................................................ 3Q............................................................................................ 4Q............................................................................................ Total......................................................................................... ........ S 173 186 173 115 $ 647 S 159 174 198 118 S 649 Operating Income (Loss) IQ............................................................................................ ......... 2Q............................................................................................ 3Q............................................................................................ 4Q............................................................................................ Total......................................................................................... ......... $ 82 84 78 10 $ 254 S 56 62 97 (178) S 37 Income (Loss) Before IncomeTaxes IQ............................................................................................ ......... 2Q............................................................................................ 3Q............................................................................................ 4Q............................................................................................ Total........................................................................................ ......... $ 78 76 74 7 $ 235 S 46 62 84 (183) S9 Net Income (Loss) IQ........................................................................................... ......... 2Q........................................................................................... 3Q........................................................................................... 4Q........................................................................................... Total........................................................................................ ......... s 52 SO 46 9 $ 157 S 32 43 57 (115) S 17 Earnings (Loss) per Share IQ........................................................................................... ......... 2Q........................................................................................... 3Q........................................................................................... 4Q............................................................................................ Total........................................................................................ ......... s 0.44 0.43 0.38 0.08 $ 1.33 S 0.28 0.37 0.49 (0.99) S 0.15 Earnings (Loss) per Share, assuming dilution IQ........................................................................................... ........ 20.................... ........................ 3Q.................... ....................... 4Q........................................................................................... Total.................................. ........................... ......... s 0.43 0.41 0.37 0.06 $ 1.27 S 0.27 0.36 0.48 (0.97) S 0.14 SAR 0048 Historical 1997 1996 $ 719 770 749 731 $ 2,969 $ 70S 749 753 770 $ 2,977 1995 S 802 756 70S 701 $2,964 $ 176 189 173 115 $ 653 S 160 175 200 117 S 652 S 189 183 165 184 $ 721 $ 95 97 88 10 $ 290 $ 56 62 96 (181) $ 33 S 85 71 73 29 S 258 $ 99 94 90 7 $ 290 3 S3 69 90 (179) $ 33 $ 83 65 64 19 S 231 $ 65 62 56 9 $ 192 S 36 47 61 (112) $ 32 $ S3 41 41 12 S 147 $ 0.56 0.52 0.47 0.08 $ 1.63 S 0.31 0.41 0.52 (0.96) S 0.28 S 0.47 0.37 0.36 0.10 S 1.30 $ 0.54 0.51 0.44 0.06 $ 1.55 5 0.30 0.39 0.51 (0.93) S 0.27 S 0.47 0.35 0.35 0.10 S 1.27 LAM018788 INC . Quarterly Data (Continued) (Dollars in millions) Quarterly operating income and net income, both on a pro forma and historical basis, were affected by restructuring and unusual items as follows [expense/(income)]: Operating Income Cost of employee reductions.................... Shutdown and consolidation of various facilities and departments......... Asset impairments...................................... Environmental-related charges................. .... Other costs................................................. Total............................................................ .... IQ97 $10 $10 2Q97 S(8) 10 $2 3Q97 4Q97 $72 $72 1997 $(8) 92 $84 1Q96 2Q96 3Q96 4Q96 SI 57 1996 SI 57 33 33 56 56 2 S248 2 S24S Net Income Cost of employee reductions.................... Shutdown and consolidation of various facilities and departments......... Asset impairments...................................... Environmental-related charges................. ... Other costs................................................. Total............................................................ ... 1Q97 $6 $6 2Q97 $(5) 6 $1 3Q97 4Q97 $46 $46 1997 $(S) 58 $53 IQ96 2Q96 3Q96 4Q96 S100 1996 S100 21 21 35 35 8 S164 8 S164 0049 LAM018789 S o i u tia Inc. Effects of Restructuring and Unusual Items (DoHjn in mtlhcns) Operating income, pretax income and net income were affected by restructuring and unusual items as follows [expense/(income)]: Operating Income Cost of employee reductions....................................... Shutdown and consolidation of various facilities and departments............................... Asset impairments......................................................... Insurance-related settlement....................................... Litigation settlement...................................................... Environmental-related charges.................................... ...................... Joint venture integration costs.................................... Other costs.................................................................... Total......................................................................... ...................... Unaudited Pro Forma 1997 1996 5(8) S 157 33 56 92 2 $84 $ 248 1997 5(8) Historical 1996 $157 33 56 92 $84 2 $248 199S $ 17 36 (88) 41 40 $46 Pretax Income Cost of employee reductions....................................... Shutdown and consolidation of various facilities and departments............................... ...................... Asset impairments......................................................... Insurance-related settlement....................................... Litigation settlement...................................................... Environmental-related charges.................................... ........................ Joint venture integration costs.................................... Other costs.................................................................... Total............................................................................... ........................ 5(8) 92 $84 S157 33 56 10 $256 5(8) $157 33 56 92 $84 10 $256 $22 44 (88) 41 40 $59 Net Income Cost of employee reductions....................................... Shutdown and consolidation of various facilities and departments............................... .................... Asset impairments......................................................... Insurance-related settlement....................................... Litigation settlement..................................................... Environmental-related charges.................................... ....................... Joint venture integration costs.................................... Other costs.................................................................. Total......................................................................... ....................... 5(5) 58 $53 $100 21 35 8 $164 5(5) $100 21 35 58 $53 8 $164 $17 40 (55) 25 25 $52 SAR 0050 LAM018790 SGtuTIA INC. Key Financial Statistics (Dollars in millions, except per share) Working Capital (Current assets less current liabilities)......... Current Ratio (Current assets divided by current liabilities) ................................... Trade Receivables Days Sales Outstanding (Average receivables divided by net sales times 365 days)........................ InventoryTurnover Ratio (Cost of goods sold divided by inventory)................................................. Interest Coverage Ratio (Income before interest expense and income taxes divided bytotal interest cost)....................................... Cash Provided by Operations/Total Debt ........................... Total Debt/Total Capitalization (Total capitalization equals the sum of short-term debt, long-term debt and stockholders' equity)................... 1997 1996 $106 S121 1.1 1.2 51 48 7.1 8.0 6.8 1.7 20% N/A 120% N/A N/A Share Data Earnings per Share, assuming dilution................... 1997 $1.55 Pro Forma Earnings per Share (Unaudited), assuming dilution ................................ $ 1.27 Common Stock Price: High.................................................................................. Low.................................................................................. Close................................................................................. 27 % 18 M/u> 261 l/ft Price/Earnings Ratio on Year-End Stock Price 17 Dividends per Share'1'................................................. S 0.01 Other Share Data: Number of registered stockholders................................ Year-end shares outstanding (in thousands)................. Shares repurchased (in thousands)................................. Average daily share trading volume (in thousands).................................................... 57,894 117,408 1,570 1,053 1996 S 0.27 S 0.14 N/A N/A N/A N/A N/A N/A N/A N/A N/A ' ~cl997Shareowner Composition I 52.7% U.S. Institutions 10.7% Employee Plans 0 3.7% Ex-U.S. Institutions 1 0.3% Directors & Officers H 12.1% Record Holders 15.5% Brokers B 5.0% Banks * Based upon estimated information provided bv Gcorgeson & Company Inc. SAR 0051 Because Solutia was not formed as an independent public company until September 1, 1997, only one quarterly dividend was paid in 1997. . _ uAN1018791 [Ml S o i uiia Inc. Businesses and Products Solutia manages its businesses as a single enterprise, to keep costs low and opportunities for synergy, high. All of the following units share a single staff for administrative functions (e.g., legal, human resources, controllership) and technical product support. Fibers Segment Acrilan Acrylic Fibers. We are North America's largest producer of acrvlic fiber, which is used to make finished products such as apparel, craft yarns, upholstery fabrics and brake fibers. Our Acrilan trademark is widely recognized in the industry, as are the brand names used to identify products made with Acrilan, such as Wear-Dated upholstery and Wintuk, Sajelle and Bounce-Back fibers for craft yarns. Carpet Fibers. Solutia is the world's largest producer of nylon staple fiber and major nylon BCF supplier to the carpet industry in North America. Our products are used by carpet mills to make car peting and rugs for homes, offices, hotels and other buildings. Our carpet fibers are marketed under two ofthe industry's most respect ed brand names: Wear-Dated carpets for the residential market; and Ultron VIP nylon for the contract or commercial market. Nylon Industrial Fibers. We produce a complete line of industri al-strength nylon fibers, which our customers use to make a wide variety of finished products - from dental floss to cargo slings. Some of our heaviest yarns are used to make bias tires for earth movers, NASA space shuttles and aircraft. Late in 1997, we opened a new production unit for high-tenacity nylon fiber for auto airbags. Major End-Use Markets Major Products Major End-Use Products & Applications Major Competitors Major Raw Materials Major Plants Construction and Home Furnishings Nylon carpet staple; nylon bulk continuous filament; Acrilan acrylic fiber Broadloom and commercial carpet; area rugs; bath mats; upholstery fabrics; drapes; blankets DuPont; Allied Signal; BASF Acrylonitrile; ammonia; cvclohexane; propylene Pensacola, FL; Greenwood, SC; Decatur and Foley, AL Personal Products Acrilan acrylic fiber; nylon polymer Sweaters; knit apparel; half-hose; active wear; craft yarns; hand-knit yarns; apparel; dental floss Sterling Chemicals; MonteFibrc; Courtaulds pic; Mitsubishi; DuPont Acrylonitrile; ammonia; cyclohexane; propylene Pensacola, FL; Decatur, AL Vehicles and Industrial Applications Nylon filament; ACRl-PULP-, acrylic friction fiber Tires; air bags; brakes; convertible tops; sewing thread; conveyer belts; tents DuPont; Allied Signal; Sterling Acrylonitrile; ammonia; cyclohexane; propylene Pensacola, FL; Decatur, AL; Greenwood, SC SAR 0052 Acrilan, ACRl-PULP, Bounce-Back, Butvar, Clear Pass, Dequest, Gelva, KeepSafe, Leverage, Levn-Lite, Modajlow; No-Shock, N'utrijos, Pan-O-Lite, PhosChek, Resimene, Sajlex, Santicizcr, Santosol, Sayellc, Scripset, Skydrol, Therminol, Ultron, Vydync, Wear-Dated anti Wintuk are registered marks uf Solutia Inc. Agrado; Applied Chemistry, Creative Solutions; Dyenamix, Glacier Metahvorking Fluids, Katch, Pet-Agree, Sajlex IIIG, SkyKleen and Solutia arc trademarks of Solutia Inc. LAM018792 S oiu i ia Inc. Chemicals Segment Industrial Products. Solutia is a leading manufacturer of specialty industrial fluids and lubricants, known for their high performance characteristics. Our products include Skydrol hydraulic fluids for avi ation, Therminol heat transfer fluids, SkyKJeen environmentally friendly solvent, Dequest water treatment chemicals, and Glacier Metalworking Fluids. Glacier fluids are the industry's first environmentally-friendly lubricants for metalworking operations such as drilling and grinding that generate no oil mist and are biodegradable. Intermediates. Solutia manufactures more than three dozen "building block" chemicals which are used to make a number of finished products, such as pigments, herbicides, solvents, resins, fertilizers, detergents and animal feed supplements. Our intermediates business is built around proprietary process technology, exceptional product quality and world-class manu facturing scale. Phosphorus Derivatives. Solutia is a world leader in develop ing and marketing applications for phosphorus chemistry. Our proprietary products are used in a wide range of industries, including food and beverage ingredients; personal care products such as toothpaste; industrial cleaners; specialty chemicals; and fire retardants such as Phos-Chek which is dropped from aircraft to extinguish forest and brush fires. Major End-Use Markets Major Products Major End-Use Products & Applications Major Competitors Major Raw Materials Major Plants Capital Equipment Therminol heat transfer fluids; Dequest water treatment chemicals; Glacier Metalworking Fluids Heat transfer fluids; scale inhibitors; oil field chemicals; lubricant for machin ing operations such as grinding, drilling and threading Dow Chemical Co.; Nippon Steel Chemical Co.; Albright & Wilson; Bay er Corp. Benzene; phenol; phosphorus trichloride Alvin,TX; Anniston, AL; Newport, Wales (UK); St. Louis, MO; Bridgeport, NJ Vehicles/ Transportation Skydrol aviation hydraulic fluids; SkyKleen aviation solvents Hydraulic fluids for commercial aircraft; cleaning fluids for avi ation maintenance Exxon; DuPont Phosphorus oxychloride; methanol St. Louis, MO Chemicals Industrial phosphates; phosphoric acid; phosphorus pentasulfide; phosphorus trichloride; acry loni trile; Phos-Chek fire-fighting agents Oil additives; pesticides; mining chemicals; chemical intermediates; fire retardants Albright & Wilson; FMC; Rhodia* Elemental phosphorus Augusta, GA; St. Louis, MO; Sauget, IL; Trenton, Ml Personal Products Oral care phosphates; industrial phosphates Dentifrices; water conditioners; dishwasher detergents Albright & Wilson; FMC; Rhodia* Elemental phosphorus Augusta, GA; Newport, Wales (UK); St. Louis, MO; Sao Jose dos Campos, Brazil; Soda Springs, ID;Trenton, MI Food and Beverage Levn-Lite, Pan-O-Lite, and Leverage phosphate; Nutrifos STP; Katch Fish phosphate; phosphoric acid Leavening agents for bakery goods; agents used in curing and processing meats and poultry; agents for extending shelf life of meats, poultry and fish; soft drink additives FMC; Rhodia* Elemental phosphorus St. Louis, MO; Sao Jose dos Campos, BraziljTrenton, Ml Intermediate Chemicals Nylon salt; adipic acid; hexamethylenediamine; adiponitrile; acrylonitrile; ammo nia; chlorobenzenes Nylon and acrylic fiber; nylon plastics; herbicides; feed supplements DuPont; Rhodia*; BASF; Asahi `The chemicals subsidiary of Rhone-Poulenc S.A. SAR 0053 Natural gas; propylene; benzene; chlorine; cyclohexane Anniston and Decatur, AL; Alvin, TX; Greenwood, SC; Bridgeport, NJ; Sauget, IL; Pensacola, FL m] LAM018793 Polymers & Resins Segment Nylon Plastics & Polymers. Solutia makes and sells merchant poly mer and a line of Vydyne nylon molding resins and extrusion polymers. Our products give plastics molders the ability to add certain perfor mance characteristics to their products, such as heat and chemical resis tance and toughness - so they can be used in demanding applications such as electrical connectors and auto parts. Polymer Modifiers. We use our knowledge of polymer chemistry to manufacture and market a line ofpolymer modifiers and specialty plas ticizers. These products are used by our customers to improve the flex ibility, resiliency, and other performance of flooring products, sealants, caulks, adhesives and other finished goods. Resins. Solutia makes a line of specialty resins which are used in the manufacture of products such as crosslinkers, flow modifiers, pressure sensitive adhesives, paper surface size and plastic products, among oth ers. Our products are marketed under a number of respected brand names, such as Santosol solvents, Gelva adhesives, Butvar specialtybinders, and Modaflow flow and leveling agents. Saflex Plastic Interlayer. Solutia is the world's largest producer of polyvinyl butyral, a plastic interlayer used to make laminated glass for automotive and architectural applications. Our Saflex brand name is one of the automotive industry's most widely recognized trademarks. In addition, we recently launched a new trademark - KeepSafe glass for residential security windows. Major End-Use Markets Major Products Major End-Use Products & Applications Major Competitors Major Raw Materials Major Plants Construction, Home Furnishings, and Industrial Saflex plastic interlay er; Modaflow flow and leveling agents; Resimene crosslinkers; Gelva pressure sensitive adhesives; Santicizer plasticizers; Nylon polymer; AstroTurf* doormats; Santosol DME Architectural glass; coatings and adhesives; resiliant sheet and tile flooring; caulks and sealants; paints; wall coverings; coated fabric; wire and cable; carpet; door mats; environmentallvfriendlv solvents DuPont; Cytec Industries; National Starch and Chemical Co.; Ashland Inc.; Rohm & Haas Co.; Air Products and Chemicals Inc.; Akzo-Nobel Butyraldehyde; ethanol; polwinvl alcohol; vinyl acetate monomer; acrvlate esters; butanol; methanol; formalde hyde; melamine; polyethylene Antwerp and Ghent, Belgium; Bridgeport, NJ; LaSalle, Canada; Springfield, MA; Sao Jose dos Campos, Brazil; Trenton, MI; Pensacola, FL; Addyston, OH; Westport, MO Vehicles Stfllex plastic interlayer; Resimene crosslinkers; Modcflow flow and leveling agents; Gelva pressure sensitive adhesives; Vydyne nylon molding resins; Nylon polymer; Clear Pass spray suppressors Windshields; automotive coatings and sealants; automotive interior and exterior and under-the-hood molded parts; tire cord;carpet; spray suppressors DuPont; Cytec Industries; National Starch and Chemical Co.; Ashland Inc.; Rohm & Haas Co.; Air Products and Chemicals Inc.; Rhodia** Butvraldehvde; ethanol; polyvinyl alcohol; vinyl acetate monomer; acrvlate esters; butanol; formaldehyde; melamine; acryloni trile; ammonia; cyclo hexane; propylene; polyethylene Antwerp and Ghent, Belgium; Bridgeport, NJ; Foley, AL; LaSalle, Canada; Springfield, MA; Pensacola, FL; Sao Jose dos Campos, Brazil;Trenton, Ml; Addyston, OH Personal Products Sancicizer plasticizers; Gelva adhesives; Vydyne nylon molding resins; Scripsct resins; Nylon polymer Packaging; medical devices; paper; hosiery and apparel Ashland Chemical; Cytec Industries; DuPont; Hoechst Celanese; Rhodia**; National Starch and Chemical Co. Acrylate esters; styrene butvraldehvde; ethanol; formaldehyde; maleic anhydride; melamine; methanol; acrylonitrile; ammo nia; cvclohcxane; propylene Springfield, MA; LaSalle, Canada; Greenwood, SC; Addyston, OH *AstroTurt is a registered trademark of Southwest Recreational Industries, Inc. licensed to Solutia Inc. ** The chemicals subsidiary ofRhone-Poulenc S.A. SAR 0054 LAM018794 Solutia Growth Opportunities This table summarizes a number of products and technol ogies which Solutia has recently launched or is preparing to launch. Through our New Product and Process Development (NPPD) program, we are actively managing several hundred promising growth projects. Post-Launch Phase KeepSafe Max Product Category Sajlex plastic interlayer for architectural safety glass Sajlex for Automotive Side Windows SkyKleen Skydrol 5 Sajlex plastic interlayer for auto glass Aircraft equipment cleaning fluids Aircraft hvdraulic fluids Early Launch Phase KeepSafe Pet-Agree Product Category Sajex plastic interlayer for residential security windows Carpeting underlayer Next Generation Sajlex Gelva for Postage Stamps Agrado Antioxidant Sajlex plastic interlay er for laminated safety glass Gelva aervlic pressuresensitive adhesives Animal feed ingredient Pre-Launch Phase One-Step Phenol Manufacturing Process Product Category Chemical intermediate manufacturing Dyenamix Commercial carpet color system Resimine and Gelva Geographic Market Expansion Wear-Dated and Ultron Carpet Alliances in China Fire Safety Products Automotive and industrial paints and pressure-sensitive adhesives Commercial and residential carpeting Phosphorus derivatives Next-Generation Paint Crosslinkers Technology Licensing Thermoset paints for automotive, industrial applications Acrylonitrile, acrvlic fiber and other manufacturing technologies Primary Uses and Benefits Used to laminate window glass for homes and buildings in hurricane-prone regions; prevents flying debris from penetrating window; eliminates need for storm shutters Used to laminate auto side windows; prevents break-ins, car thefts; reduces potential for passenger ejection during accidents A biodegradable, non-combustible aircraft engine and equipment cleaning fluid; replaces traditional solvents; doesn't affect performance of aircraft hydraulics .An advanced aircraft hydraulic fluid; offers higher temperature stability, improved fuel and maintenance efficiency and reduced environmental impact compared to previous generation products Primary' Uses and Benefits Used to laminate residential window glass; enhances personal safety by preventing home break-ins Carpet enhancement system, prevents odors, spills from penetrating carpet backing Reformulated Sajlex product; reduces glass manufacturer's costs by simplifying the lamination process; offers superior performance through improved adhesion New adhesive formulation; pressure-sensitive, for added convenience; recyclable .Animal feed supplement; improves cattle feed conversion; enhances meat quality Primary Uses and Benefits Revolutionary one-step manufacturing process for a widelv-used chemical intermediate; creates licensing opportunities for Solutia; improves yields, reduces costs for Solutia, other chemical manufacturers Improved carpet dyeing technology; offers superior color clarity, richness and stabilityJ New paint, adhesive formulations; products tailored to market demands of European, Asian customers Established North American carpet fiber brands, manufacturing technology preparing for launch in China; products, marketing strategy tailored to needs ofan emerging market Ingredients for fibers, plastics, fluids; using flame-retardant properties of phosphorus to control and prevent fires in a wide range of products/applications Advanced crosslinker technology; simplifies paint application; reduces environmental impact Advanced manufacturing processes; offering a low-cost supply of intermediate chemicals, or access to world-class technologies through licensing agreements SAR 0055 LAM018795 HU Soiutia Inc. Locations Technical Centers Belgium: Louvain-la-Neuve United States: Decatur, Ala. Springfield, Mass. (Indian Orchard) Pensacola, Fla. St. Louis, Mo. U.S. Sales Offices Atlanta, Ga. Chicago, 111. Detroit, Mich. Houston, Texas Springfield, Mass. (Indian Orchard) Laguna Hills, Calif. New York, N.Y. Regional Centers Belgium: Louvain-la-Neuve Brazil: Sao Paulo Singapore: Singapore United States: St. Louis, Mo. Satellite Centers in key countries worldwide Plant Sites Belgium: Ghent Canada: LaSalle, Quebec Singapore: (1998 startup) United Kingdom: Newport, Wales United States: Alvin, Texas (Chocolate Bavou) Anniston, Ala. Augusta, Ga. Bridgeport, N.J. (Delaware River) Columbia, Tenn. Decatur, Ala. Folev, Ala. Greenwood, S.C. Ontario, Calif. Pensacola, Fla. Sauget, 111. (W.G. Krummrich) Springfield, Mass. (Indian Orchard) St. Louis, Mo. (Carondolet, J.F. Queenv, Westport) Trenton, Mich. Business General Managers (Itlfl m ry/u in pholo^rjfhj Ann McCorvey, N ice President anil General Manager, Nvlon Plastics & Polvmers Graham Wildsmith, N ice President and General Manager, Intermediates Vicki Holt, N ice President and General Manager, Acrilan John Ferguson, Vice President and General Manager, Sallex Russ Belle, Vice President and General Manager, Resins Gary Weihs, Vice President and General Manager, Industrial Products Jeff Wolff, Vice President and General Manager, Carpet Fibers Norma Curby, Vice President and General Manager, Phosphorus Derivatives Bob Toth, Vice President and General Manager, Polvmer Modifiers Hameed Bhombal, Vice President and General Manager, Nvlon Industrial Fibers LAM018796 SAR 0056 Guest Operations at: Belgium: Antwerp Brazil: Sao Jose dos Campos United States: Addyston, Ohio (Port Plastics) Luling, La. Nitro, VV.Va. Employees 8,800 Selected Joint Ventures Advanced Elastomer Systems (Elastomers JV with Exxon Corporation) Flexsvs (Rubber chemicals JV with Akzo Nobel N.V. kev plants located at Monongahela, Pa.; Nitro, WVa.; Ruabon, Wales) Fosbrasil S.A. (Phosphoric acid JV in Brazil) Monsanto Chemical Co. Ltd. (Therminol Heat Transfer Fluid JV in China) P4 Joint Venture (with Monsanto Company in Soda Springs, Idaho) Quimica M (Sapcx JV in Mexico) Montor Performance Plastics Co. (Nylon plastics JV withToray in Detroit, Mich.) Thailon Six Six Limited (Nvlon JV in Thailand) Staff Team Leaders t/c/i lo rylu in photogrophl Johnnie Foster, Vice President and Chief Information Ollicer Sheila Feldman,* Vice President, Human Resources Dennis Cavner,* N ice President, Operations Excellence Gary Dewel, Vice President, Supply Chain John Saucier, Vice President, Strategic Planning, Mergers and Acquisitions Christy Beckmann, Vice President, Public Aflairs Roger Hoard* Vice President and Controller Rod Bishop,* Vice President and Treasurer Bruce Greer* Vice President, Commercial Development LAM018797 Jerry Mullis,* Vice President, Technology Mike Pierle, Vice President, Environment, Safety and Health Glenn Ruskin, N ice President, Government Aflai * Ewcutivo olf'iecrs Board of Directors Bob Blakely. 56, Executive Vice President and Chief Financial Officer, Tenneco Inc. He also serves as a director of the New York City Ballet, Manhattan and Bronx Council of the Bov Scouts of America. Joan Bok, 6S, Chairman of the Board, New England Electric Svsteni. She also serves as a director of Averv Dennison Corporation, the New EnCg1land Electric Svstem, and John Hancock Mutual Life Insurance Company. Paul Hatfield, 62, Principal, Hatfield Capital Group. He also serves as a director of DEKALB Genetics Corporation and Penford Corporation. John Hunter,* 51, President and Chief Operating Officer, Solutia. He also serves as a director of Missouri Baptist Hospital. Bob Jenkins, 55, Chairman of the Board, CEO, and director of Sundstrand Corporation. He is also a director of AK Steel Holdings Corporation. Pete Love, 67, retired Chief Executive Officer, National Intergroup, Inc. He serves as a director ofAEA Investors. Frank Metz, 64, retired Senior Vice President, Finance and Planning, and Chief Financial Officer, International Business Machines Corporation. He serves as a director of Allegheny Energy, Inc. and Norrell Corporation. Bob Potter,* 58, Chairman of the Board and Chief Executive Officer, Solutia. He also serves as a director of Southdown Inc. and Stepan Company. Bill Ruckelshaus, 65, Chairman, BrowningFerris Industries, Inc., and Principal, Madrona Investment Group L.L.C. He also serves as a director of Browning-Ferris Industries Inc., Coinstar, Inc., Cummins Engine Co., Inc., Gargoyles, Inc., Monsanto Company, Nordstrom, Inc., and Weyerhaeuser Company. John Slaughter, 63, President of Occidental College. He also serves as a director of Atlantic Richfield Company, Averv Dennison Corporation, International Business Machines Corporation, and Northrop Grumman Corp. Secretary: Karl Barnickol,* 56, Senior Vice President, General Counsel, and Secretary-, Solutia. Advisory Directors: Bob Clausen* S3, Senior Vice President and Chief Financial Officer, Solutia. Mike Miller* 56, Senior Vice President and Chief Administrative Officer, Solutia. He is a director of Watlow Electric Co. * Executive officers LAM078798 (Seated, left to right) Bill Ruckelshaus, Bob Potter, John Hunter, Bob Blakely; (standing, left to right) Joan Bok, Pete Love, Frank Metz, Bob Clausen, Karl Barnickol, Bob Jenkins, Paul Hatfield, Mike Miller, John Slaughter SAR 0058 Shareholder Information Stock Listing: Solutia's stock is traded principally on the NewYork Stock Exchange. Our stock symbol is SOI. Dividend Policy: The declaration and payment of quarterly dividends is made at the discretion of Solutia's Board of Directors. The Board anticipates that its current dividend policy, 4c/year paid quarterly, will remain unchanged for the foreseeable future. Solutia also uses its share repurchase program as an additional means of returning net income to shareholders. Shareholder Services: Please contact Solutia's Transfer Agent and Registrar, First ChicagoTrust Company of New York (First Chicago) with questions concerning stock certificates, dividend checks, transfer of owner ship, or other matters per taining to your stock account. First Chicago can be reached by writing to: First ChicagoTrust Company of New York P.O. Box 2500 Jersey City, N.J. 07303-2500 By telephone at its toll free number: (888) 987-6588 (if you are calling from within the U.S.) By E-mail at: fctc@em. fenbd .com SAR 0059 Dividend Reinvestment Plan: Solutia shareholders who wish to have their dividends automatically reinvested in Solutia common stock may choose to enroll in the Dividend Reinvestment Plan (DRIP).To receive a DRIP brochure that explains the details of the plan, please contact First Chicago as noted above. Duplicate Mailings: If you receive duplicate mailings of Solutia's annual report and would like to help us eliminate redundant mailings, please send your written permis sion to First Chicago at the above address. (Duplicate mailings can occur if shares are held in multiple accounts, are registered under different names, or are registered with slight differences in names and addresses.) Please include the labels from the duplicate copies, or the names of the accounts and the account numbers. Additional Information: Shareholder, financial and other information about Solutia is available to vou free of charge from several sources. On the Internet:You can access financial and other information, such as significant news releases, Forms 10-K and 10-Q, and the text of this annual report on the internet at http://vvwvv.solutia.com By telephone: You can obtain financial information such as Forms 10-K and 10-Q by calling (314)674-4520. By writing: You can also re quest these materials by writ ing: Solutia Inc. Investor Rela tions - G4NJ P.O. Box 66760 St. Louis, Mo. 63166-6760 Annual Meeting: The first annual meeting ol the Solutia shareholders will be held at 1:45 p.m., Wednesday, April 22, 1998, at Westport Plavhouse, 600 West Port Plaza, St. Louis, Mo. 63146. A formal notice of the meeting, together with a proxy statement, is being mailed to each shareholder. Photo Credits: We are grateful to the follow ing individuals for permitting their photos to appear in this annual report (listed from left to right): Page 9: Wendy Gray, princi pal; Christi Johaningmeyer, project manager, Gray Design Group, Inc.; Page 11 : Wes Harris, instru mentation and electrical tech nician; Jayne Morris, special ist, Intermediates Technical Center R&D Group, Pensacola, Fla. pilot plant; Page 13: Gladys Smith, SDI operator; Dale Borths, SDI team leader; Greenwood, S.C. plant; Page 15: Dan Reilly, plant trainer; Mary Morgan,Total Quality team leader; Eric Smith, materials handler operator, Elisabeth Neff, STP area operator; Carondelet (St. Louis) plant; Page 17: Herb Brewton, senior safety coordinator, Barbara Jones, Xo-Shock oper ator, Pensacola, Fla. plant. We are also grateful for the assistance of Charles H. Pawley Architect PA (Coral Gables, Fla.), designer of the home which appears on page 7. Cautionary Statement LAM018799 This Annual Report contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ materially from those anticipated in these forward-looking statements. Readers are referred to the Company's Annual Report on Form 10-K for the year ended December 31, 1997, as filed with the Securities and Exchange Commission, which identifies important risk factors that could cause actual results to differ from those contained in the forward-looking statements, including gen eral economic and business and market conditions, customer acceptance of new products, efficacy of new technology and facilities, changes in U.S. and ex-U.S. laws and regulations, costs or difficulties relating to the establishment of the Company as an independent entity, shortages of raw materials and fuels, and increased competitive and/or customer pressure. SOLUTI A Applied Chemistry, Creative Solutions ~ Solutia Inc. 10300 Olive Boulevard P.O. Box 66760 St. Louis, Missouri 63166-6760 SAf* 0060 Printed on recycled pjper with 10 percent post-consumer fiber LAM018800