STERLING CHEMICAL INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2001

OR

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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-10059

STERLING CHEMICALS HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE 76-0185186
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1200 SMITH STREET, SUITE 1900 713) 650-3700
HOUSTON, TEXAS 77002-4312 (Registrant's telephone number, including area
(Address of principal executive offices) code)

COMMISSION FILE NUMBER 333-04343-01

STERLING CHEMICALS, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE 76-0502785
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1200 SMITH STREET SUITE 1900 (713) 650-3700
HOUSTON, TEXAS 77002-4312 (Registrant's telephone number, including area
(Address of principal executive offices) code)

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Indicate by check mark whether each of the registrants (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of each of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. ____________

As of December 3, 2001, Sterling Chemicals Holdings, Inc. had 12,776,678
shares of common stock outstanding. As of such date, the aggregate market value
of such common stock held by nonaffiliates, based upon the last sales price of
these shares as reported on the OTC Electronic Bulletin Board maintained by the
National Association of Securities Dealers, Inc., was approximately $511,000. As
of December 3, 2001, all outstanding equity securities of Sterling Chemicals,
Inc. were owned by Sterling Chemicals Holdings, Inc.

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TABLE OF CONTENTS

1

IMPORTANT INFORMATION REGARDING THIS FORM 10-K

Readers should consider the following information as they review this Form
10-K.

PRESENTATION OF FINANCIAL STATEMENTS

This Form 10-K includes four separate sets of financial statements and
related notes:

- The first set of financial statements and related notes present both the
consolidated financial position, results of operations and cash flows of
Sterling Chemicals Holdings, Inc. ("Holdings") and its subsidiaries and
the consolidated financial position, results of operations and cash flows
of Sterling Chemicals, Inc. ("Chemicals") and its subsidiaries. Holdings
directly or indirectly owns all of the other subsidiaries whose financial
results are included in this Form 10-K and Chemicals is the primary
operating subsidiary of Holdings.

- The second set of financial statements and related notes present the
combined financial position, results of operations and cash flows of the
Guarantors and their subsidiaries (discussed below).

- The third and fourth sets of financial statements and related notes
present the consolidated financial position, results of operations and
cash flows of Sterling Canada, Inc. and its subsidiaries ("Sterling
Canada") and the financial position, results of operations and cash flows
of Sterling Pulp Chemicals, Ltd. ("Sterling Pulp"), our two significant
subsidiaries whose securities are pledged to secure a series of debt
securities issued by Chemicals.

Under SEC rules, specified financial information is required to be provided with
respect to subsidiaries of an issuer of debt securities that guarantee the
repayment of those debt securities. In July of 1999, Chemicals issued $295
million of its 12 3/8% Senior Secured Notes due 2006. The obligations of
Chemicals related to the 12 3/8% Notes were guaranteed by most of its
subsidiaries incorporated in the United States (the "Guarantors"). In addition,
all of the capital stock of each of the Guarantors was pledged to secure the
repayment of the 12 3/8% Notes. Finally, 65% of the capital stock of three of
Chemicals' subsidiaries incorporated outside of the United States was pledged to
secure the repayment of the 12 3/8% Notes, but these subsidiaries did not
guarantee the repayment of the 12 3/8% Notes. In order to comply with these SEC
rules, the financial statements of the Guarantors, each of which guaranteed the
repayment of the 12 3/8% Notes, and the financial statements of Sterling Canada
and Sterling Pulp, our significant subsidiaries whose securities are pledged to
secure the repayment of the 12 3/8% Notes, are included with this Form 10-K. The
financial statements of the Guarantors are included in this Form 10-K under Item
8 and the financial statements of Sterling Canada and Sterling Pulp are filed as
exhibits to this Form 10-K.

FORWARD-LOOKING STATEMENTS

This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. All statements other than statements of historical fact
included in this Form 10-K, including without limitation the statements under
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and "Qualitative and Quantitative Disclosure about
Market Risk" regarding the cyclicality of our industry, current and future
industry conditions, the potential effects of such matters on our business
strategy, results of operations or financial position, the adequacy of our
liquidity and our market sensitive financial instruments and other statements
identified by such words as "expects," "projects," "plans" and similar
expressions, are forward-looking statements. The forward-looking statements are
based upon current information and expectations. Estimates, forecasts and other
statements contained in or implied by the forward-looking statements speak only
as of the date on which they are made, are not guarantees of future performance
and involve certain risks, uncertainties and assumptions that are difficult to
evaluate and predict. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, no assurances can be given that such
expectations will prove to have been correct. Certain important factors that
could cause actual results to differ materially from our expectations or what is
expressed, implied or forecasted by or in the forward-looking statements include
developments in our Chapter 11 proceedings, the timing and extent of changes in

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commodity prices and global economic conditions, industry production capacity
and operating rates, the supply-demand balance for our products, competitive
products and pricing pressures, increases in raw material costs, our ability to
obtain raw materials and energy at acceptable prices, in a timely manner and on
acceptable terms, federal and state regulatory developments, our high financial
leverage, petitions or motions filed or actions taken in connection with our
bankruptcy proceedings, the availability of skilled personnel and our ability to
attract or retain high quality employees and operating hazards attendant to the
industry. Additional factors that could cause actual results to differ
materially from our expectations or what is expressed, implied or forecasted by
or in the forward-looking statements are stated herein in cautionary statements
made in conjunction with the forward-looking statements or are included
elsewhere in this Form 10-K. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Known Events, Trends,
Uncertainties and Risk Factors."

SUBSEQUENT EVENTS, ETC.

All statements contained in this Form 10-K, including the forward-looking
statements discussed above, are made as of December 20, 2001, unless those
statements are expressly made as of another date. We disclaim any responsibility
for the correctness of any information contained in this Form 10-K to the extent
such information is affected or impacted by events, circumstances or
developments occurring after December 20, 2001 or by the passage of time after
such date and, except as required by applicable securities laws, we do not
intend to update such information and disclaim any responsibility to do so.

DOCUMENT SUMMARIES

Statements contained in this Form 10-K describing documents and agreements
are provided in summary form only and such summaries are qualified in their
entirety by reference to the actual documents and agreements filed as exhibits
to this Form 10-K.

FISCAL YEAR

We keep our books of record and accounts based on annual accounting periods
ending on September 30 of each year. Accordingly, all references in this Form
10-K to a particular fiscal year refer to the 12 calendar month period ending on
September 30 of that year.

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PART I

This combined Form 10-K is separately filed by Holdings and Chemicals.
Information contained herein relating to Chemicals is filed by Holdings and
separately by Chemicals on its own behalf. Unless otherwise indicated, Holdings
and its subsidiaries, including Chemicals, are collectively referred to as the
"Company," "we," "our," "ours" and "us."

ITEM 1. BUSINESS

We were organized as a Delaware corporation in 1986 and have our principal
executive offices in Houston, Texas. As a result of our recapitalization and
reorganization on August 21, 1996, we are now organized under a holding company
structure and the only material asset of Holdings is the capital stock of
Chemicals, its wholly-owned operating subsidiary. Through Chemicals and its
subsidiaries, we own or operate facilities for the manufacture of eight
commodity petrochemicals at our Texas City, Texas plant. We also manufacture
chemicals for use primarily in the pulp and paper industry at five plants in
Canada and a plant in Valdosta, Georgia and acrylic fibers at our plant near
Pensacola, Florida. At our Texas City facility, we have production capacity for
styrene, acrylonitrile, acetic acid, plasticizers, methanol, tertiary butylamine
("TBA"), sodium cyanide and disodium iminodiacetic acid ("DSIDA"). We generally
sell our petrochemicals products to customers for use in the manufacture of
other chemicals and products, which in turn are used in the production of a wide
array of consumer goods and industrial products. We produce specialty textile
fibers and technical fibers at our acrylic fibers facility, as well as licensing
our acrylic fibers manufacturing technology to producers worldwide. Sodium
chlorate is produced at our five plants in Canada and our Valdosta facility.
Sodium chlorite is produced at one of our Canadian locations. In addition,
chlor-alkali and calcium hypochlorite are produced at one of our Canadian
locations. We also license, engineer and oversee construction of large-scale
chlorine dioxide generators for the pulp and paper industry as part of our pulp
chemicals business. These generators convert sodium chlorate into chlorine
dioxide at pulp mills.

RECENT DEVELOPMENTS

CHAPTER 11 PROCEEDINGS

On July 16, 2001 (the "Petition Date"), Holdings, Chemicals and most of
their U.S. subsidiaries (collectively, the "Debtors") filed voluntary petitions
for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Bankruptcy
Code") in the U.S. Bankruptcy Court for the Southern District of Texas (the
"Bankruptcy Court") and began operating their business as debtors-in-possession
pursuant to the Bankruptcy Code. None of our foreign subsidiaries, including our
Canadian subsidiaries, were included in the Chapter 11 filings.

The filing of the Chapter 11 petitions was driven by the Debtors' inability
to meet their funded debt obligations over the long-term, largely brought about
weak demand for petrochemical products caused by declines in general worldwide
economic conditions, the relative strength of the U.S. dollar, which has caused
their export sales to be at a competitive disadvantage and higher raw material
and energy costs. As a result of these conditions, the Debtors have incurred
significant operating losses. The reorganization contemplated by the Chapter 11
filings is designed to permit the Debtors to preserve cash and to give the
Debtors the opportunity to restructure their debt. During the pendency of the
Chapter 11 cases, with approval of the Bankruptcy Court, the Debtors may assume
favorable pre-petition contracts and leases, reject unfavorable pre-petition
contracts and leases and sell or otherwise dispose of assets. The confirmation
of a plan of reorganization is the primary objective of the Debtors. Unless
otherwise ordered by the Bankruptcy Court, the Debtors have the exclusive right
to propose a plan of reorganization until March 13, 2002, and the exclusive
right to seek acceptances of any plan proposed by them until May 12, 2002. A
plan of reorganization, when filed, will set forth the means for treating
claims, including liabilities subject to compromise and interests in the
Debtors. Such means may take a number of different forms. A plan of
reorganization may result in, among other things, significant dilution or
elimination of certain classes of existing equity interests as a result of the
issuance of equity securities to creditors or new investors. The Debtors are in
the early stages of formulating a

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plan of reorganization. The confirmation of any plan of reorganization will
require creditor acceptance as required under the Bankruptcy Code and approval
of the Bankruptcy Court.

At this time, it is not possible to predict the outcome of the bankruptcy
cases in general or the effect on the business of the Debtors, the claims of
creditors of the Debtors or the interests of stockholders of Holdings. As a
result of the bankruptcy filings, most of the Debtors' liabilities incurred
prior to the Petition Date, including certain secured debt, could be subject to
compromise. However, the ultimate resolution of these liabilities is not
presently determinable.

Effective July 19, 2001, the Debtors (excluding Holdings) entered into a
Revolving Credit Agreement with a group of lenders led by Tyco Capital (formerly
The CIT Group/Business Credit, Inc.) to provide up to $195 million in
Debtor-In-Possession financing (the "DIP Financing"). By interim order dated
July 18, 2001 and final order dated September 14, 2001, the Bankruptcy Court
approved up to $155 million in lending commitments under the DIP Financing (the
"Base Facility"), consisting of an $85 million "current assets revolver" and a
$70 million "fixed assets revolver." The initial draw under the DIP Financing
was used to repay all amounts outstanding under the Debtors' previous revolving
credit facilities. Additional borrowings under the DIP Financing may be used to
fund the Debtors' post-petition operating expenses and supplier and employee
obligations throughout the reorganization process. The final order dated
September 14, 2001 is on appeal to the U.S. District Court, but no stay of the
final order has been sought or imposed, and the order remains fully effective.
While no assurances can be given, we do not believe the final order will be
overturned on appeal.

Borrowings under the DIP Financing are subject to customary funding
conditions, including borrowing base restrictions under the current assets
revolver. The Base Facility is secured by substantially all of the assets of the
Debtors, but some of the liens have been granted super-priority administrative
expense claims for the amount of the DIP Financing which, subject to certain
carve outs, will entitle the DIP lenders to be paid before any other claims
against the Debtors are paid. The DIP Financing is designed to give the Debtors
the opportunity, during the reorganization process, to develop a new capital
structure that will support them over the long-term, including during recurring
cyclical downturns in the markets for the Debtors' petrochemicals products. At
September 30, 2001, the total credit available under the DIP Financing was
$112.8 million due to borrowing base restrictions under the current assets
revolver. At September 30, 2001, $42.3 million was drawn under the fixed assets
revolver and there were no borrowings outstanding under the current assets
revolver. In addition, approximately $4.4 million of letters of credit were
outstanding under the current assets revolver, leaving at September 30, 2001,
unused borrowing capacity under the secured revolving credit facilities of
approximately $66.1 million.

As a result of a priming order entered by the Bankruptcy Court on November
2, 2001 and reinstated on December 19, 2001, the lending commitments under the
current assets revolver were increased from $85 million to $125 million. The
priming order grants the lenders under the currents assets revolver a priming
lien on our fixed assets located in the United States and the capital stock of
most of our domestic subsidiaries, prior in right to the existing liens in favor
of the 12 3/8% Notes. Although the priming order was entered by the Bankruptcy
Court on November 2, 2001, it was appealed to the U.S. District Court by the
indenture trustee for the 12 3/8% Notes. By order dated December 17, 2001, the
U.S. District Court reversed the priming order and remanded the matter to the
Bankruptcy Court for a determination of a compensatory adjustment in favor of
the 12 3/8% Notes, which the U.S. District Court suggested would be satisfied by
a 4% increase of the interest rate payable on up to $40 million. On remand, the
Bankruptcy Court entered an order dated December 19, 2001, reinstating the
priming order subject to an appropriate compensatory adjustment in favor of the
12 3/8% Notes of four percentage points of additional interest on up to $40
million. In addition, the Bankruptcy Court scheduled a hearing for January 2,
2002 to determine certain technical details regarding implementation of this 4%
increase. The Debtors anticipate that the priming order will be further appealed
by the indenture trustee. The priming order will remain effective pending the
outcome of any appeal unless stayed by an appellate court. The Debtors will take
all reasonable actions necessary, either before the Bankruptcy Court or on
appeal, to maintain the effectiveness of the priming order and the additional
liquidity provided by the priming order. If the priming order is stayed or is
not ultimately upheld on appeal, the Debtors will need to seek additional
sources of financing or revise their business plan and operations consistent
with the level of
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available financing. However, we can give no assurances that the priming order
will not be stayed or will be upheld on appeal or, if stayed or not upheld on
appeal, that additional sources of financing will be available or adequate or
that our available financing will be adequate after implementing revisions to
the Debtors' business plan and operations.

As of July 11, 2001, our principal Canadian subsidiary, Sterling Pulp,
entered into a financing agreement with Tyco Capital Business Credit (Canada)
Inc. ("Tyco Canada") to provide up to the Canadian dollar equivalent of U.S. $30
million (the "Canadian Financing Agreement"). The initial advance under this
facility, approximately U.S. $20 million, was used by Sterling Pulp to discharge
a portion of an intercompany debt and was ultimately transferred to the Debtors
through an intercompany loan. The intercompany loan was approved by the
Bankruptcy Court's interim order entered on July 18, 2001 and final order
entered on September 14, 2001, which is a subject of the appeal of the final
order discussed above. At September 30, 2001, $20 million was drawn under the
Canadian Financing Agreement.

The Debtors are permitted to continue to operate their businesses and
manage their properties in the ordinary course without prior approval from the
Bankruptcy Court. Transactions outside of the ordinary course of business,
including certain types of capital expenditures, certain sales of assets and
certain requests for additional financings, will require approval by the
Bankruptcy Court. There is no assurance that the Bankruptcy Court will grant any
requests for such approvals.

On July 18, 2001, the Bankruptcy Court issued an order permitting the
Debtors to pay pre-petition salaries, wages and benefits to all of their
employees. The Bankruptcy Court also authorized the payment of certain other
pre-petition claims, in limited circumstances, as necessary to avoid undue
disruption to the Debtors' operations. Generally, actions to enforce or
otherwise effect repayment of pre-petition liabilities of, as well as all
pending litigation against, the Debtors are stayed while the Debtors continue to
operate their business as debtors-in-possession. The ultimate amount and
settlement terms for such liabilities will be subject to a plan of
reorganization and, accordingly, are not presently determinable. The Debtors'
trade creditors, including vendors, will be paid their post-petition claims in
the normal course of business.

As our foreign subsidiaries are not included in the Chapter 11 filings, all
of their creditors, including vendors, will be paid their claims in the ordinary
course of business, irrespective of whether the claims arose prior to or after
the Chapter 11 filings.

As a result of the bankruptcy filings and related events, there is no
assurance that the carrying amounts of assets will be realized or that
liabilities will be liquidated or settled for the amounts recorded. In addition,
confirmation of a plan of reorganization, or disapproval thereof, could change
the amounts reported in the financial statements. The ability of the Debtors to
continue as a going concern is dependent upon, among other things, (i) the
Debtors' ability to comply with the terms of the DIP Financing and related
orders entered by the Bankruptcy Court in connection with the Chapter 11 cases,
(ii) the ability of the Debtors to access the incremental $40 million in DIP
Financing that is dependent on an effective priming order (iii) the ability of
the Debtors to maintain adequate cash on hand, (iv) the ability of the Debtors
to generate sufficient cash from operations, (v) the ability of the Debtors'
subsidiaries that are not included in the Chapter 11 cases to obtain necessary
financing, (vi) confirmation of a plan or plans of reorganization under the
Bankruptcy Code and (vii) the Debtors' ability to achieve profitability
following such confirmation. As the Debtors can give no assurances that they
will accomplish any of the foregoing, there is substantial doubt about the
Debtors', and therefore the Company's, ability to continue as a going concern.

The accompanying financial statements do not include any adjustments that
may result from the resolution of these uncertainties.

MANAGEMENT CHANGES

On December 19, 2001 we announced that Frank P. Diassi had elected to
terminate his employment, effective immediately. Mr. Diassi joined Sterling in
1996 as executive Chairman of the Board and continued in that position until his
termination. Earlier this year he was elected Co-Chief Executive Officer along
with David G. Elkins, our President. Mr. Diassi has asserted that he had "good
reason" to terminate his

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employment and is claiming that he is entitled to receive payments under our
employee retention and severance plans. Our Compensation Committee is evaluating
the merits of Mr. Diassi's claim. Mr. Diassi will continue in his role as
director.

Succeeding Mr. Diassi as Co-Chief Executive Officer is Richard K. Crump.
Since joining us in 1986, Mr. Crump has served in a variety of management
positions, most recently as Executive Vice President-Operations. Mr. Crump has
also been elected to our Board of Directors, increasing the size of the Board of
Directors to seven.

In a separate action, Robert W. Roten was elected non-executive Chairman of
the Board of Directors, having served as a director since 1996 and as Vice
Chairman of the Board of Directors since 1998. Mr. Roten was employed by us for
25 years, eventually attaining the positions of President and CEO before he
retired in 1998.

FIBERS

On March 8, 2001, we announced our decision to withdraw from the
traditional commodity textile business and, thereafter, significantly reduced
our operations and staffing at our acrylic fibers plant in Santa Rosa, Florida.
The decision came after our rationalization and cost reduction programs failed
to return this business to profitable levels. We made this reduction due to
extremely difficult operating conditions now facing the domestic acrylic textile
industry, including conditions caused by the importation of finished goods by
offshore producers and higher domestic energy and raw materials costs. We
continue to produce our specialty and technical fibers products at this
facility, and are examining strategic alternatives with respect to this
business. We are also examining alternative uses of the portions of the plant
idled by this reduction.

SECURITY

Since the terrorists attacks of September 11, 2001, we have worked with
local, state and federal agencies as well as several security consultants to
enhance our Texas City facility's security. The plant has increased the number
of security personnel on duty and, on an as-needed basis, added armed patrols
along its perimeter.

In addition, the perimeter fencing and lighting at the plant have been
improved, permanent concrete barriers have been installed at all unmanned gates
and surveillance cameras along with observation towers have been added at
strategic locations. At the current time, we are working with the City of Texas
City to install road barricades adjacent to the plant to control access into the
plant. In addition to the physical changes at the Texas City plant, plant
employees have received additional security training, participated in security
and emergency response drills and all security procedures and protocols have
been updated to reflect recommendations from security consultants and
governmental procedural changes.

Additional security measures have also been instituted at our other plants
to restrict access into the plants and we have increased surveillance.

BUSINESS STRATEGY

Our objectives are to improve our capital structure, to be a premier
producer of chemicals, to maintain a strong market position, to achieve first
quartile cost performance in all of our major products and to provide superior
customer service. Our management team has adopted the following strategies in
pursuit of these objectives:

- continue to improve our cost structure;

- pursue improvements to our businesses and facilities through expansions,
upgrades and strategic alliances; and

- optimize capacity utilization rates through long-term supply
arrangements.

The cyclicality of the markets for our primary products, however, subjects us to
periods of overcapacity accompanied by lower prices and profit margins. In
addition, the instruments governing the DIP Financing

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and the Canadian Financing Agreement limit our ability to incur additional debt.
These and other factors, including our Chapter 11 filings, limit our ability to
successfully implement our business strategy.

INDUSTRY OVERVIEW

PETROCHEMICALS

Styrene. Current global styrene annual capacity is approximately 52
billion pounds. Current total North American annual styrene capacity is
approximately 15 billion pounds. As is the case with other petrochemicals,
styrene from time to time experiences periods of strong demand resulting in
tight supply and high prices and margins. This tight balance in supply and
demand often results in new capacity additions. In most cases, incremental
capacity comes in the form of large new plants or major expansions of existing
facilities. As this new capacity comes on line, it often exceeds current demand
growth and results in a decline in prices and margins.

Following a period of strong demand growth and high utilization rates from
1994 to 1996, several major petrochemical producers announced new capacity
increases in 1997 and 1998, particularly in the Far East. At the time of this
announced new capacity, there was a general slowdown in the economic growth rate
in the Far East, prompting petrochemical customers to begin utilizing their
available inventories and decrease purchases of additional product. As a result,
our average styrene prices declined from fiscal 1997 through fiscal 1999, as the
previously announced new capacity came on line at the same time that economic
events in various Asian countries significantly reduced demand growth for
styrene.

During fiscal 2000, styrene prices and margins increased significantly from
levels experienced in fiscal 1999. These improvements were driven by a
combination of stronger market demand, operating problems experienced at several
of our competitors and generally low inventory levels worldwide. Styrene prices
and margins peaked in April of 2000 at a published spot price of $0.48 per pound
and decreased over the second half of 2000.

During fiscal 2001, U.S. and world economies experienced a general slowdown
which has negatively impacted demand for most petrochemicals. Raw material and
energy costs spiked upward during the first half of fiscal 2001, increasing
significantly from the prior year, primarily due to the sharp increase in
natural gas prices. As a result, U.S. Gulf Coast petrochemicals producers
experienced significant margin erosion in most of their products. Due to these
conditions, many U.S. Gulf Coast petrochemicals producers, including us, reduced
production levels. During the second half of fiscal 2001, raw material and
energy costs began to moderate, although demand has remained weak due to the
continued economic slowdown. Reported styrene spot prices averaged from $0.17 to
$0.19 per pound during September 2001. We cannot predict future increases or
decreases in styrene prices and margins.

Acrylonitrile. Current global acrylonitrile capacity is approximately 13
billion pounds per year. The acrylonitrile market exhibits similar
characteristics to those of styrene regarding capacity utilization, selling
prices and profit margins. Moreover, as a high percentage of our acrylonitrile
sales are made in the export market, demand for our acrylonitrile is
significantly influenced by export customers, particularly those that supply
acrylic fibers to customers in China. During 1995, strong demand for acrylic
fibers and ABS resins, particularly in China, increased demand for
acrylonitrile, resulting in high prices and margins. High utilization rates and
prices prompted many major producers to announce new capacity increases and
approximately two billion pounds of capacity increases came on line between 1996
and 1998. As new acrylonitrile capacity in the United States and Asia came on
line, demand growth in Asian markets weakened, causing acrylonitrile prices and
margins to decrease significantly from 1996 through 1999. Beginning in early
fiscal 2000, acrylonitrile prices increased significantly due to improved market
demand, operating problems experienced at several of our competitors and
generally low inventory levels. Due to the general slowdown of U.S. and world
economies, along with higher raw material and energy costs, acrylonitrile prices
and margins weakened significantly in fiscal 2001. As a result, we rescheduled
maintenance turnaround work at our Texas City acrylonitrile facility, performing
this work during the second quarter of fiscal 2001 rather than later in the
year. The adverse economic conditions that made it commercially impracticable to
operate our acrylonitrile and other nitriles production units, and that served
as the basis for our decision to advance the timing of the turnaround,

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persisted beyond the completion of this maintenance turnaround work.
Consequently, we elected to postpone restarting our acrylonitrile facilities and
other nitriles production units until it is commercially practicable to operate
these facilities. Our other nitriles production units include the sodium
cyanide, TBA and DSIDA production units, all of which are dependent on the
acrylonitrile facilities for feedstocks. Our conversion agreement with Flexsys
America L.P. ("Flexsys") for the production of TBA terminates as of December 31,
2001. We are currently evaluating our options related to TBA production
following the termination of this contract.

Acetic Acid. Current North American acetic acid capacity is approximately
6 billion pounds per year. Several capacity additions occurred in 1998 and 1999,
including an expansion of our acetic acid unit in Texas City from 800 million
pounds of rated annual production capacity to one billion pounds. In addition,
in late 2000, BP Chemicals Inc. ("BP Chemicals") and Celanese AG began operating
880 million-pound and 1,100 million-pound acetic acid production units in
Malaysia and Singapore, respectively. The North American acetic acid market is
mature and well developed, with demand being linked to the demand for vinyl
acetate monomer, a key intermediate in the production of a wide array of
polymers. Vinyl acetate monomer is the largest derivative of acetic acid,
representing about 50% of total demand.

Plasticizers. Our rated plasticizers capacity is 280 million pounds per
year. We have an agreement with BASF Corporation ("BASF") pursuant to which we
sell all of our plasticizers production to BASF through 2007. Our plasticizers
are produced from linear alpha olefins (an ethylene-based technology), while
many of our competitors use propylene-based technology. Our plasticizers
typically receive a premium over certain propylene-based products due to their
performance enhancing properties. However, the financial performance of our
business can be affected by the cost of underlying raw materials, especially
when the cost of one olefin rises faster than the other, or by the introduction
of new products.

Acrylic Fibers. On March 8, 2001, we announced our decision to withdraw
from the traditional commodity textile business and, thereafter, significantly
reduced our operations and staffing at our acrylic fibers plant in Santa Rosa,
Florida. The decision came after our rationalization and cost reduction programs
failed to return this business to profitable levels. We made this reduction due
to extremely difficult operating conditions now facing the domestic acrylic
textile industry, including conditions caused by the importation of finished
goods by offshore producers and higher domestic energy and raw materials costs.
We continue to produce our specialty and technical fibers products at this
facility, and are examining strategic alternatives with respect to this
business. We are also examining alternative uses of the portions of the plant
idled by this reduction.

PULP CHEMICALS

Sodium Chlorate. Historically, sodium chlorate has also experienced cycles
in capacity utilization, selling prices and profit margins, although not to the
extremes seen in the petrochemicals markets. Since 1990, North American demand
for sodium chlorate has grown at an average annual rate of approximately 7% as
pulp mills have accelerated substitution of chlorine dioxide for elemental
chlorine in bleaching applications. Substitution of chlorine dioxide for
elemental chlorine is driven primarily by environmental concerns. Chlorine
dioxide is produced from sodium chlorate, which is one of our primary pulp
chemicals products. Under the United States Environmental Protection Agency's
"Cluster Rules," effective April 2001, elemental chlorine cannot be used in
bleaching applications, which has resulted in increased substitution of chlorine
dioxide for elemental chlorine by the North American pulp and paper industry.

In 1999, demand for sodium chlorate did not increase at historical rates
due to weak market conditions and lower operating rates in the pulp and paper
industry. In addition, new sodium chlorate production capacity was added while
implementation of the Cluster Rules was delayed. However, during fiscal 2000 and
2001, average sodium chlorate prices increased due to increased operating rates
at pulp mills and the continued conversion to elemental chlorine free bleaching
at pulp mills. The industry average market price (as reported by Chemical Week
Associates) increased by approximately 6% from fiscal 1999 to fiscal 2000 and
increased approximately 10% from fiscal 2000 to fiscal 2001. We and two other
companies collectively account for more than 65% of North American sodium
chlorate production capacity.

9

PRODUCT SUMMARY

The following table summarizes our principal products, including our
capacity, primary end uses, raw materials and major competitors for each
product. "Capacity" represents rated annual production capacity at September 30,
2001, which is calculated by estimating the number of days in a typical year a
production facility is capable of operating after allowing for downtime for
regular maintenance and multiplying that number by an amount equal to the
facility's optimal daily output based on the design feedstock mix. As the
capacity of a facility is an estimated amount, actual production may be more or
less than capacity, and the following table does not reflect whether the
facility is presently operating at capacity.

PRODUCTS

PETROCHEMICALS

Styrene. We have the fourth largest production capacity for styrene in
North America. Our styrene unit, located at our Texas City facility, is one of
the largest in the world and has a rated annual production capacity of
approximately 1.7 billion pounds, which represents approximately 11% of total
North American capacity. We sold approximately 26% of our styrene sales volumes
pursuant to conversion and other long-term agreements during fiscal 2001.
Approximately 44% of our styrene sales volumes were exported in fiscal 2001,
principally to Asia and Mexico.

Acrylonitrile. We have the third largest production capacity for
acrylonitrile in North America. Our acrylonitrile unit, located at our Texas
City facility, has a rated annual production capacity of approximately 740
million pounds, which represents approximately 19% of total North American
capacity. As stated previously, our acrylonitrile unit has not operated since
the second quarter of fiscal 2001 due to adverse economic conditions. We sold
approximately 83% of our acrylonitrile sales volumes pursuant to conversion and
other long-term agreements during fiscal 2001. Approximately 72% of our
acrylonitrile production in fiscal 2001 was exported. All of our acrylonitrile
sold in Asia and South America is sold through ANEXCO, LLC, our joint venture
with BP Chemicals. During fiscal 2001, we used a portion of our hydrogen
cyanide, a by-product of acrylonitrile manufacturing, as a raw material for the
production of TBA, DSIDA and sodium cyanide and burned the rest as fuel.

Acetic Acid. We have the second largest production capacity for acetic
acid in North America. Our acetic acid unit, located at our Texas City facility,
has a rated annual production capacity of approximately

11

one billion pounds, which represents approximately 17% of total North American
capacity. All of our acetic acid production is sold to BP Chemicals pursuant to
a long-term contract that expires in 2016.

Methanol. We own a methanol unit at our Texas City facility with a rated
annual production capacity of approximately 150 million gallons. On June 29,
2000, we, in conjunction with BP Chemicals, announced a multi-year contract with
Methanex Corporation ("Methanex") for the purchase of our respective methanol
requirements from Methanex. At that time, we granted Methanex exclusive rights
to acquire the output of our methanol plant, which we continue to own. Under
this agreement, Methanex chose to discontinue production at our methanol plant
on July 1, 2000, and provide our methanol requirements with methanol produced in
countries that have a significant advantage in the cost of natural gas, the
primary raw material in the production of methanol. However, Methanex may elect
to restart our methanol facility at any time, subject to notice requirements and
the payment of related expenses.

Plasticizers. We produce plasticizers at our Texas City facility for BASF
Corporation. Under our long-term agreement with BASF, which expires in 2007, we
sell all of our plasticizers production to BASF. Our rated annual production
capacity of plasticizers is approximately 280 million pounds.

TBA. Our rated annual production capacity for TBA is approximately 21
million pounds. In fiscal 2001, we used a portion of our hydrogen cyanide
by-product from our Texas City acrylonitrile facility to produce TBA, which we
sold to Flexsys pursuant to a conversion agreement. In December 1999, Flexsys
notified us of their intention to terminate the contract as of December 31,
2001. We are currently evaluating our options related to TBA production
following the termination of this contract. Since the second quarter of fiscal
2001, the TBA unit has not operated due to the continued shutdown of our
acrylonitrile unit.

Sodium Cyanide. Pursuant to a long-term arrangement, we operate a sodium
cyanide unit at our Texas City facility which is owned by E. I. du Pont de
Nemours and Company ("DuPont"). This sodium cyanide unit uses hydrogen cyanide
by-product from our Texas City acrylonitrile facility as a raw material. The
rated annual production capacity of this unit is approximately 85 million
pounds. Since the second quarter of fiscal 2001, the sodium cyanide unit has not
operated due to the continued shutdown of our acrylonitrile unit.

DSIDA. Near the end of the first quarter of fiscal 2001, we began
operating a DSIDA plant at our Texas City facility that is owned by Monsanto
Company ("Monsanto"). DSIDA is an essential intermediate in the production of
Monsanto's Roundup(R), a glyphosate based herbicide. Under long-term
arrangements with Monsanto, we operate the DSIDA plant on behalf of Monsanto and
supply hydrogen cyanide by-product from our Texas City acrylonitrile facility as
a raw material. The rated annual production capacity of the DSIDA plant is 80
million pounds. Since the second quarter of fiscal 2001, the DSIDA unit has not
operated due to the continued shutdown of our acrylonitrile unit.

Acrylic Fibers. On March 8, 2001, we announced our decision to withdraw
from the traditional commodity textile business and, thereafter, significantly
reduced our operations and staffing at our acrylics fiber plant in Santa Rosa,
Florida. We continue to produce specialty textile fibers and technical fibers at
this facility. Specialty textile fibers are targeted for specific applications
or end uses and typically have higher margins than regular textile fibers.
Technical fibers are specially engineered for industrial, non-textile uses such
as brake linings and typically have higher margins than textile fibers.

PULP CHEMICALS

Sodium Chlorate. We are the second largest producer of sodium chlorate in
North America. Our six sodium chlorate facilities have an aggregate rated annual
production capacity of approximately 500,000 tons, which represents
approximately 23% of total North American capacity.

Chlorine Dioxide Generators. Through our ERCO Systems Group ("ERCO"), we
are the largest worldwide supplier of patented technology for generators that
certain pulp mills use to convert sodium chlorate into chlorine dioxide. Each
mill that uses chlorine dioxide requires at least one generator. We receive
revenue when a generator is sold to a mill and also receive royalties from the
mill after start-up, generally over a ten-year period, based on the amount of
chlorine dioxide produced by the generator. We have supplied approximately
two-thirds of all existing modern pulp mill generators worldwide.
12

The research and development group of ERCO works to develop new and more
efficient generators. When pulp mills move to higher levels of substitution of
chlorine dioxide for elemental chlorine, they are usually required to upgrade
generator capacity or purchase new generator technology. Pulp mills may also
convert to a newer generator to take advantage of efficiency advances and
technological improvements. Each upgrade or conversion requires a licensing
agreement, which generally provides for payment of an additional ten-year
royalty.

Sodium Chlorite. We have a rated annual production capacity of sodium
chlorite of approximately 3,500 tons, with a second plant to be added to supply
the increased demand for chlorine dioxide as a primary disinfectant for
municipal drinking water.

For historical information presented on a segmented basis for our
petrochemicals business and pulp chemicals business, see Note 9 of the Notes to
Consolidated Financial Statements included in this Form 10-K.

SALES AND MARKETING

We sell our petrochemicals products pursuant to:

- multi-year contracts;

- conversion agreements; and

- spot transactions in both the domestic and export markets.

We have certain long-term agreements that provide for the dedication of
100% of our production of acetic acid, plasticizers, sodium cyanide, methanol
and DSIDA, each to one customer. We also have various sales and conversion
agreements that dedicate significant portions of our production of styrene and
acrylonitrile to certain customers. Some of these agreements provide for cost
recovery plus an agreed profit margin based upon market prices. These agreements
are intended to:

- optimize capacity utilization rates;

- lower our selling, general and administrative expenses;

- reduce our working capital requirements; and

- insulate our operations, to some extent, from the effects of declining
markets and changes in raw materials prices.

We compete on the basis of product price, quality and deliverability.

Prices for our petrochemicals products are determined by global market
factors that are largely beyond our control and, except with respect to a number
of our multi-year contracts, we generally sell these products at prevailing
market prices.

Some of our multi-year contracts for our petrochemicals products are
structured as conversion agreements, pursuant to which the customer furnishes
raw materials that we process into finished products. In exchange, we receive a
fee typically designed to cover our fixed and variable costs of production and
to generally provide an element of profit depending on the existing market
conditions for the product. These conversion agreements are intended to help us
maintain lower levels of working capital and, in some cases, gain access to
certain improvements in manufacturing process technology. Our conversion
agreements are designed to insulate us to some extent from the effects of
declining markets and changes in raw materials prices, while allowing us to
share in the benefits of favorable market conditions for most of the products
sold under these arrangements. The balance of our petrochemicals products are
sold by our direct sales force or through ANEXCO, LLC, our marketing joint
venture with BP Chemicals.

Our acrylic fibers facility currently markets products in North America
through our internal sales staff and to international customers through
non-affiliated agents. Acrylic fibers are priced based upon market

13

conditions, which include, but are not limited to, raw materials costs, prices
of competing and alternative products and type of end use.

We sell sodium chlorate primarily in Canada and the United States,
generally under one to five-year supply contracts, most of which provide for
minimum and maximum volumes or a percentage of requirements at market prices. In
addition, some of our sodium chlorate sales contracts contain certain "meet or
release" pricing clauses and restrictions on the amount and timing of future
price increases. However, the percentage of our sales subject to these clauses
is decreasing over time as these contracts expire or otherwise terminate.

We market chlorine dioxide generators worldwide to the pulp and paper
industry, providing licenses for technology and making sales of the requisite
equipment. In addition to being paid for the technology and equipment, we
receive royalties based on the amount of chlorine dioxide produced by the
generator, generally over a ten-year period.

For information regarding our export sales and domestic and foreign
operations, see Note 9 of the Notes to Consolidated Financial Statements
included in this Form 10-K.

CONTRACTS

Our key multi-year contracts, which collectively accounted for 18% of our
fiscal 2001 revenues, are described below. BP Chemicals accounted for
approximately 12%, 11% and 10% of our revenues in fiscal 2001, 2000 and 1999,
respectively. No other single customer accounted for more than 10% of our
revenues in the last three fiscal years.

All of the Debtors' contracts and agreements continue in effect in
accordance with their terms notwithstanding our Chapter 11 filings, unless
otherwise ordered by the Bankruptcy Court. The Bankruptcy Code provides the
Debtors with the opportunity at any time prior to emergence from bankruptcy to
reject any contracts or agreements that are burdensome or to assume any
contracts or agreements that are favorable or otherwise necessary to their
business operations. The Debtors are currently evaluating all of their contracts
to determine whether those contracts should be rejected or assumed.

ACRYLONITRILE-BP CHEMICALS

In 1988, we entered into a long-term production agreement with BP Chemicals
under which BP Chemicals contributed the majority of the capital expenditures
required for starting the third acrylonitrile reactor train at our Texas City
acrylonitrile facility. Under this agreement, BP Chemicals has the option to
take up to approximately one-sixth of our total acrylonitrile capacity. BP
Chemicals furnishes the necessary raw materials, pays us a conversion fee for
the amount of acrylonitrile it takes and reimburses us for a portion of the
fixed costs related to acrylonitrile production at our Texas City facility. To
protect BP Chemicals in the event we default under the production agreement, BP
Chemicals has a first priority security interest in the third reactor and
related equipment and in the first acrylonitrile produced in our three reactor
units to the extent BP Chemicals is entitled to purchase acrylonitrile under
this production agreement. This agreement was amended and restated during April
of 1998 to, among other things, encourage increased manufacturing and technical
cooperation. During fiscal 2001, we delivered approximately 15% of our
acrylonitrile production to BP Chemicals pursuant to this agreement.

We have incorporated certain BP Chemicals technological improvements into
two of our acrylonitrile reactors under a separate license agreement. We have
the right to incorporate these and any future improvements into our remaining
acrylonitrile reactor.

In order to enhance the marketing of our acrylonitrile, we and BP Chemicals
formed ANEXCO, LLC, an exclusive 50/50 joint venture to market acrylonitrile in
Asia and South America. During fiscal 2001, we sold approximately 60% of our
acrylonitrile production through ANEXCO, LLC.

14

ACETIC ACID-BP CHEMICALS

In 1986, we entered into a long-term production agreement with BP
Chemicals, which has since been amended, under which BP Chemicals has the
exclusive right to purchase all of our acetic acid production until August of
2016 and is obligated to make certain unconditional monthly payments to us until
August of 2006 and reimburse us for our operating costs. We are also entitled to
receive a portion of the profits earned by BP Chemicals from the sale of the
acetic acid we produce.

METHANOL-BP CHEMICALS-METHANEX

In August of 1996, we entered into a long-term production and sales
agreement with BP Chemicals, under which BP Chemicals contributed a significant
portion of the capital expenditures required for the construction of our
methanol production facility at our Texas City facility and obtained the right
to receive a substantial portion of our methanol production. The initial term of
this agreement expires July 31, 2016. Historically, a portion of the output of
the methanol facility was used in our acetic acid unit and the remainder was
marketed by BP Chemicals in the merchant market and in BP Chemicals' worldwide
acetic acid business.

On June 29, 2000, we, in conjunction with BP Chemicals, announced a
multi-year contract with Methanex for the purchase of our respective methanol
requirements from Methanex. At that time, we granted Methanex exclusive rights
to acquire the output of our methanol plant, which we continue to own. Under
this agreement, Methanex chose to discontinue production at our methanol plant
on July 1, 2000, and provide our methanol requirements with methanol produced in
countries that have a significant advantage in the cost of natural gas, the
primary raw material in the production of methanol. However, Methanex may elect
to restart our methanol facility at any time, subject to notice requirements and
the payment of related expenses. The initial term of these arrangements expires
December 31, 2003, with automatic annual renewals thereafter unless we or
Methanex elect to terminate these arrangements.

PLASTICIZERS-BASF

Since 1986, we have sold all of our plasticizers production to BASF
pursuant to a product sales agreement that has previously been amended and
expires at the end of 2007. BASF provides us with some of the required raw
materials and markets the plasticizers we produce. BASF is obligated to make
certain quarterly payments to us and to reimburse us monthly for actual
production costs. In addition, we share in the profits and losses realized by
BASF in connection with the plasticizers we produce.

RAW MATERIALS FOR PRODUCTS AND ENERGY RESOURCES

For most of our products, the cost of raw materials and energy resources,
including utilities in the case of pulp chemicals, is far greater than all other
production costs combined. Thus, an adequate supply of raw materials and
utilities at reasonable prices and on acceptable terms is critical to the
success of our business. Most of the raw materials we use are global commodities
which are made by a large number of producers. Prices for many of these raw
materials are subject to wide fluctuations for a variety of reasons beyond our
control. Although we believe that we will continue to be able to secure adequate
supplies of our raw materials and energy, there can be no assurance that we will
be able to do so at acceptable prices or payment terms. See "Certain Known
Events, Trends, Uncertainties and Risk Factors."

PETROCHEMICALS

Styrene. We manufacture styrene by converting ethylene and benzene into
ethylbenzene, which we then process into styrene. Ethylene and benzene are both
commodity petrochemicals. Prices for each can fluctuate widely due to
significant changes in the availability of these products. We have multi-year
arrangements with several major ethylene and benzene suppliers that provide a
significant percentage of our estimated requirements for purchased ethylene and
benzene at generally prevailing and competitive market prices. Our conversion
agreements require that the other parties to these agreements furnish us with
the ethylene or benzene necessary to fulfill our conversion obligations.
Approximately 17% of our fiscal 2001 benzene requirements and approximately 23%
of our fiscal 2001 ethylene requirements were furnished by customers
15

pursuant to conversion arrangements. If various customers for whom we now
manufacture styrene under conversion agreements were to cease furnishing their
own raw materials, our requirements for purchased benzene and ethylene could
significantly increase.

Acrylonitrile. We produce acrylonitrile by reacting propylene and ammonia.
Propylene and ammonia are both commodity chemicals and the price for each can
fluctuate widely due to significant changes in the availability of these
products. The propylene or ammonia needed for the acrylonitrile we produce under
conversion agreements is furnished to us by our customers. We purchase the rest
of the propylene and ammonia we need for acrylonitrile production. Approximately
23% of our fiscal 2001 propylene requirements and approximately 15% of our
fiscal 2001 ammonia requirements were furnished by customers pursuant to
conversion agreements. If various customers for whom we now manufacture
acrylonitrile under conversion agreements were to cease furnishing their own raw
materials and seek only to purchase acrylonitrile from us without supplying
their own raw materials, our requirements for purchased propylene and ammonia
could significantly increase.

Acetic Acid. Acetic acid is manufactured primarily from carbon monoxide
and methanol. In the past, we produced all of the methanol required by our
acetic acid unit. However, under the previously discussed multi-year agreements
with Methanex, we have purchased all of our methanol requirements from Methanex
since July 1, 2000. In 1996, Praxair Hydrogen Supply, Inc. constructed a partial
oxidation unit at our Texas City facility that supplies us with all of the
carbon monoxide we require for the production of acetic acid.

Plasticizers. The primary raw materials for plasticizers are alpha-olefins
and orthoxylene, which are supplied by BASF under our long-term conversion
agreement.

DSIDA. DSIDA is manufactured from hydrogen cyanide and caustic soda. We
use hydrogen cyanide provided as a by-product of our acrylonitrile manufacturing
process and we supply the caustic soda.

Sodium Cyanide. Sodium cyanide is manufactured from hydrogen cyanide and
caustic soda. We use hydrogen cyanide produced as a by-product of our
acrylonitrile manufacturing process and DuPont supplies the caustic soda under
our long-term conversion agreement.

Acrylic Fibers. Acrylonitrile is the most significant raw material used in
the production of acrylic fibers, representing approximately 50% of the total
cash cost of production. Pursuant to our supply agreement with Cytec Industries,
Inc. ("Cytec"), which we assumed in connection with our purchase of the acrylic
fibers facility from Cytec, our acrylic fibers facility was required to purchase
all of its acrylonitrile requirements from Cytec until February 28, 2002.
However, on May 3, 2001, Cytec discontinued supplying acrylonitrile to our
acrylic fibers facility and, since that time, we have either purchased the
acrylonitrile from outside sources, or supplied the acrylonitrile from existing
inventory at our Texas City facility.

PULP CHEMICALS

Sodium Chlorate. Sodium chlorate is manufactured by passing an electric
current through an undivided cell containing a solution of sodium chloride. The
primary raw materials for the production of sodium chlorate are electricity,
salt and water. Of these, electric power typically represents approximately 65%
of the variable cost of production. Consequently, the rates charged by local
electric utilities are an important competitive factor among sodium chlorate
producers. Electric power is purchased by each of our pulp chemicals facilities
pursuant to contracts with local electric utilities. On average, we believe that
our electrical power costs at our pulp chemical facilities are competitive with
other producers in the areas in which we operate. The current trend towards
deregulation of electric power makes our future cost for electric power
uncertain in the short term. We purchase most of the sodium chloride that we use
in the manufacture of sodium chlorate under requirements contracts with major
suppliers.

SODIUM CHLORITE

Sodium chlorite is manufactured from sodium chlorate, which is converted to
chlorine dioxide and then converted to sodium chlorite. Consequently, the same
factors which impact sodium chlorate costs, primarily power costs, impact sodium
chlorite.
16

TECHNOLOGY AND LICENSING

PETROCHEMICALS

In 1986, Monsanto granted us a non-exclusive, irrevocable and perpetual
right and license to use Monsanto's technology and other technology Monsanto
acquired through third-party licenses in effect at the time of the acquisition
of our Texas City facility from Monsanto. We use these licenses in the
production of styrene, acrylonitrile, methanol, TBA, acetic acid and
plasticizers. During 1991, BP Chemicals Ltd. ("BPCL") purchased the acetic acid
technology from Monsanto, subject to existing licenses.

Under an Acetic Acid Technology Agreement with BP Chemicals and BPCL, BPCL
granted us a non-exclusive, irrevocable and perpetual right and license to use
acetic acid technology owned by BPCL and some of its affiliates at our Texas
City facility, including any new acetic technology developed by BPCL at its
acetic acid facilities in England during the term of such agreement or pursuant
to the research and development program provided by BPCL under the terms of such
agreement.

BPCL has also granted us a non-exclusive, irrevocable and perpetual
royalty-free license to use its acrylonitrile technology at our Texas City
facility as part of the 1988 acrylonitrile expansion project. This license
automatically terminates upon the termination of our acrylonitrile production
agreement with BP Chemicals. We have agreed with BPCL to cross-license any
technology or improvements relating to the manufacture of acrylonitrile at our
Texas City facility.

We believe that the manufacturing processes we utilize at our Texas City
facility are cost effective and competitive. Although we do not engage in
alternative process research with respect to our Texas City facility, we do
monitor new technology developments and, when we believe it is necessary, we
typically seek to obtain licenses for process improvements.

We own substantially all of the technology used in our acrylic fibers
operations. We license certain of our acrylic fibers manufacturing technology to
producers worldwide. Approximately 15% of the world's total acrylic fibers
capacity is based on our technology.

PULP CHEMICALS

We produce sodium chlorate using state-of-the-art metal cell technology.
Our principal technology business is the design, sale and technical service of
custom-built patented chlorine dioxide generators. ERCO is involved in the
technical support of our sales and marketing group through joint calling efforts
which define the scope of a project, as well as producing technical schedules
and cost estimates.

We perform detailed design of chlorine dioxide generators, which are then
fabricated by contractors. Plant installation, instrumentation testing and
generator start-up are supervised by our joint engineering/technical service
team. Our pulp chemicals research and development activities are carried out at
our Toronto, Ontario laboratories. Activities include the development of new or
improved chlorine dioxide generation processes and research into new
technologies focusing on electrochemical and membrane technology related to
chlorine dioxide, including improvement of quality and reduction of quantity of
pulp mill effluents and treatment of municipal water supplies.

COMPETITION

The industries in which we operate are highly competitive. Many of our
competitors, particularly in the petrochemicals industry, are larger and have
substantially greater financial resources than we have. Among our competitors
are some of the world's largest chemical companies that, in contrast to us, have
their own raw materials resources. In addition, a significant portion of our
business is based upon widely available technology. The entrance of new
competitors into the industry and the addition by existing competitors of new
capacity could have a negative impact on our ability to maintain existing market
share or maintain or increase profit margins, even during periods of increased
demand for our products. You can find a list of our principal competitors in the
"Product Summary" table.

17

Historically, profitability of the petrochemicals industry has been
affected by vigorous price competition, which may intensify due to, among other
things, new domestic and foreign industry capacity. Our businesses are subject
to changes in the world economy, including changes in currency exchange rates.
In general, weak economic conditions, either in the United States or worldwide,
tend to reduce demand and put pressure on the margins for our products.

Operations outside the United States are subject to the economic and
political risks inherent in the countries in which they operate. Additionally,
export and domestic markets can be affected significantly by import laws and
regulations. During 2001, our export sales were approximately 24% of our total
revenues. It is not possible to predict accurately how changes in raw material
costs, market conditions, developments in our Chapter 11 proceedings or other
factors will affect future sales volumes, prices and margins for our products.

ENVIRONMENTAL MATTERS

GENERAL

Our operations involve the handling, production, transportation, treatment
and disposal of materials that are classified as hazardous or toxic waste and
that are extensively regulated by environmental and health and safety laws,
regulations and permit requirements. Environmental permits required for our
operations are subject to periodic renewal and can be revoked or modified for
cause or when new or revised environmental requirements are implemented.
Changing and increasingly strict environmental requirements can affect the
manufacture, handling, processing, distribution and use of our chemical products
and, if so affected, our business and operations may be materially and adversely
affected. In addition, changes in environmental requirements can cause us to
incur substantial costs in upgrading or redesigning our facilities and
processes, including our waste treatment, storage, disposal and other waste
handling practices and equipment.

We conduct environmental management programs designed to maintain
compliance with applicable environmental requirements at all of our facilities.
We routinely conduct inspection and surveillance programs designed to detect and
respond to leaks or spills of regulated hazardous substances and to correct
identified regulatory deficiencies. We believe that our procedures for waste
handling are consistent with industry standards and applicable requirements. In
addition, we believe that our operations are consistent with good industry
practice. We continue to participate in Responsible Care(R) initiatives as a
part of our membership in several trade groups which are partner associations in
the American Chemistry Council in the United States and the Canadian Chemical
Producers Association in Canada. Notwithstanding our efforts and beliefs, a
business risk inherent in chemical operations is the potential for personal
injury and property damage claims from employees, contractors and their
employees and nearby landowners and occupants. While we believe our business
operations and facilities generally are operated in compliance with all
applicable environmental and health and safety requirements in all material
respects, we cannot be sure that past practices or future operations will not
result in material claims or regulatory action, require material environmental
expenditures or result in exposure or injury claims by employees, contractors
and their employees and the public. Some risk of environmental costs and
liabilities is inherent in our operations and products, as it is with other
companies engaged in similar businesses.

Our operating expenditures for environmental matters, mostly waste
management and compliance, were approximately $34 million for fiscal 2001 and
$31 million for fiscal 2000. We also spent approximately $2 million for
environmentally related capital projects in fiscal 2001 and $1 million for these
types of capital projects in fiscal 2000. In fiscal 2002, we anticipate spending
approximately $1 million to $2 million for capital projects related to waste
management and environmental compliance. There are no capital expenditures
related to remediation of environmental conditions projected for fiscal 2002.

In light of our historical expenditures and expected future results of
operations and sources of liquidity, we believe we will have adequate resources
to conduct our operations in compliance with applicable environmental and health
and safety requirements. Nevertheless, we may be required to make significant
site and operational modifications that are not currently contemplated in order
to comply with changing facility permitting requirements and regulatory
standards. Additionally, we have incurred and may continue to incur liability
for investigation and cleanup of waste or contamination at our own facilities or
at facilities operated by

18

third parties where we have disposed of waste. We continually review all
estimates of potential environmental liabilities but can give no assurances that
all potential liabilities arising out of our past or present operations have
been identified or fully assessed or that the amount necessary to investigate
and remediate such conditions will not be significant to us. It is our policy to
make safety, environmental and replacement capital expenditures a priority in
order to ensure adequate safety and compliance at all times. In the event we
should not have available to us, at any time, liquidity sources sufficient to
fund any of these expenditures, prudent business practice might require that we
cease operations at the affected facility to avoid exposing our employees and
contract workers, the surrounding community and the environment to potential
harm.

We believe that we would be able to recover certain losses that may arise
out of claims related to environmental conditions at each of our facilities that
existed prior to their acquisition by us through contractual indemnities and/or
statutory law and common law principles, although there can be no assurance that
we would prevail against any prior owner of any of our facilities with respect
to any such claim.

Claims for environmental liabilities arising prior to our Chapter 11
filings will be addressed in the Chapter 11 cases. In general, monetary claims
relating to remedial actions at off-site locations used for disposal prior to
the Chapter 11 filings and penalties resulting from violations of environmental
requirements before that time will be treated as general unsecured claims.
Actions by governmental authorities to determine liability for and the amount of
such penalties will generally not be subject to the automatic stay. We will be
obliged to comply with environmental requirements in the conduct of our business
as a debtor-in-possession, including the potential obligation to conduct
remedial actions at facilities we own or operate, regardless of when the
contamination at those facilities occurred.

PETROCHEMICALS

Air emissions from our Texas City facility and our acrylic fibers facility
are subject to certain permit requirements and self-implementing emission
limitations and standards under state and federal laws. Our Texas City facility
is located in an area that the Environmental Protection Agency has classified as
not having attained the ambient air quality standards for ozone, which is
controlled by direct regulation of volatile organic compounds and nitrogen
oxide. The Texas Natural Resource Conservation Commission has imposed strict
requirements on regulated facilities, including our Texas City facility, to
ensure that the air quality control region will achieve the ambient air quality
standards for ozone. Our acrylic fibers facility is located in an area currently
designated as being in attainment for ozone under the Clean Air Act. Our Texas
City facility and our acrylic fibers facility are subject to the federal
government's June 1997 National Ambient Air Quality Standards which lower the
ozone and particulate matter threshold for attainment. Local authorities also
may impose new ozone and particulate matter standards. Compliance with these
stricter standards may substantially increase our future nitrogen oxide and
particulate matter control costs, the amount and full impact of which cannot be
determined at this time. In addition, in fiscal 2001, the Texas Natural Resource
Conservation Commission enacted new regulations requiring significant reductions
of nitrogen oxide which apply to our Texas City facility. The TNRCC is also
expected to propose similar regulations requiring the reduction of particulate
matter which will apply to our Texas City facility. The nitrogen oxide
regulations covering the Houston/Galveston Area State Implementation Plan were
approved by the United States Environmental Protection Agency on October 15,
2001. Under these regulations, we are required to reduce emissions of nitrogen
oxide at our Texas City facility by up to approximately 90%, which we estimate
would require Chemicals to make between $25 million and $30 million in capital
improvements at our Texas City facilities. The majority of these capital
expenditures would be expected in fiscal 2002 through 2005. Under our production
agreements with BP Chemicals, we would be able to recover a small portion of
these costs from BP Chemicals. We are currently evaluating several alternative
methods of reducing nitrogen oxide emissions at our Texas City facility that
would require less capital expenditures; however, we cannot give any assurances
that any alternative methods will be available to us or that, even if available,
these alternative methods would reduce the amount of capital expenditures
required to be made by a meaningful amount. In addition to reducing nitrogen
oxide emissions, some of these expenditures could result in a reduction in
operating costs, however, there can be no assurances that we will be able to
reduce our operating costs. We are also evaluating the potential impact of a
settlement agreement between TNRCC and an industry group, the Business

19

Coalition for Clean Air which could result in modification of the ozone
reduction requirements, including possible reductions in permissible levels of
emissions of volatile organic compounds (total or reactive), and a possible
reduction of the nitrogen oxide reduction target from 90% to 70%. Due to the
undefined nature and uncertainty of these potential changes, it is impossible to
predict the impact of these regulations and changes on our business or financial
condition.

To reduce the risk of offsite consequences from unanticipated events, we
acquired a greenbelt buffer zone adjacent to our Texas City facility in 1991
and, in connection with the acquisition of our acrylic fibers facility, acquired
a greenbelt area for our acrylic fibers facility. We also participate in a
regional air monitoring network to monitor ambient air quality in the Texas City
community.

On June 11, 2001, we received a notice from the U.S. Department of Justice,
Environment and Natural Resources Division, in which the Department alleged that
on April 1, 1998 an ethylbenzene release at our Texas City facility violated the
general duty clause of the Clean Air Act and invited us to engage in settlement
discussion with respect to the matter. Although we believe that the April 1,
1998 ethylbenzene release did not constitute a violation of the general duty
clause of the Clean Air Act, we have engaged in discussions with the Department
in an attempt to settle the matter on a consensual basis. However, any alleged
liability would constitute a pre-petition claim and any settlement would require
approval by the Bankruptcy Court. We do not believe that this matter will have a
material adverse effect on our business, financial position, results of
operations or cash flow, although we cannot give any assurances to that effect.

A settlement agreement entered into by the Environmental Protection Agency,
the Florida Department of Environmental Protection and an environmental group
potentially applies to our acrylic fibers facility. This settlement agreement
imposes a no-migration standard for injection wells in underground drinking
water zones without regard to actual risk considerations. We and several
similarly situated companies have been contesting this settlement. An April 1999
ruling by the United States Court of Appeals for the 11th Circuit may reduce the
likelihood that the no-migration rule is enforceable, although we can give you
no assurances in that regard. In the event that the no-migration rule becomes
enforceable, we may incur material costs in redesigning our wastewater handling
systems. However, in September 2000, the Florida Department of Environmental
Protection awarded us a five-year permit to operate the deepwell injection
facilities at our acrylic fibers facilities. Under this permit, we were granted
an "injection into an aquifer" exemption, subject to monitoring of groundwater.
As a result, during the life of this permit, we would not be subject to this
no-migration rule even if it became enforceable, assuming that this permit is
not revised in any material way.

PULP CHEMICALS

Our pulp chemicals business is sensitive to potential environmental
regulations. On November 14, 1997, the Environmental Protection Agency enacted
regulations that support substitution of chlorine dioxide for elemental chlorine
in paper pulp bleaching processes to reduce the amount of absorbable organic
halides and other chlorine derivatives in bleach plant effluent. Chlorine
dioxide is produced from sodium chlorate, which is one of our pulp chemicals
products. Therefore, regulations restricting, but not completely banning,
absorbable organic halides and other chlorine derivatives in bleach plant
effluent have a favorable effect on our business.

Conversely, a significant ban on all chlorine containing compounds could
have a materially adverse effect on us. British Columbia has a regulation in
place requiring elimination of the use of all chlorine products, including
chlorine dioxide, in the bleaching process by the year 2002. The pulp and paper
industry believes that a ban of chlorine dioxide in the bleaching process will
yield no measurable environmental or public health benefit and is working to
change this regulation. In April of 2001, a new government came into power in
British Columbia. This new administration is aware of the issues surrounding
this regulation and has agreed to negotiate amendments to the regulation. We are
working through the Alliance for Environmental Technology and the Canadian
Chemical Producers' Association to provide information to the British Columbia
Ministry of Environment to assist with these negotiations.

We acquired four of our Canadian pulp chemicals facilities from Tenneco
Canada, Inc. in 1992 and our Saskatoon facility from Weyerhauser Canada Ltd. in
1997. Groundwater data obtained during the acquisition of the Tenneco facilities
indicated elevated concentrations of certain chemicals in the soil and
groundwater.
20

Prior to completion of that acquisition, we conducted a focused baseline
sampling of groundwater conditions beneath the facilities and confirmed that
previous data. We have addressed or are addressing elevated soil or groundwater
concentrations of chemicals that we have encountered from time to time at the
facilities we acquired from Tenneco. We also reviewed air emissions sources
during the acquisition of these facilities and considered all available dustfall
and vegetation stress studies. This review indicated emission excursion episodes
at specific locations in the scrubber systems at the Thunder Bay, Buckingham and
Vancouver facilities. The conditions at these three sites have been addressed
and satisfactorily resolved. We believe that all of the facilities we acquired
from Tenneco are otherwise in compliance in all material respects with all
permit requirements under applicable provincial law. At our Saskatoon facility,
remediation plans regarding ground water contamination from prior operations are
under negotiation. Weyerhauser Canada Ltd. and Crown Investments Corporation,
who previously owned the facility, along with the Saskatchewan Environmental
Resource Ministry and ourselves, are participants in the negotiations.
Currently, our role is to coordinate the activities and the prior owners are
expected to fund the remediation costs.

EMPLOYEES

As of September 30, 2001, we had approximately 923 employees, including
approximately 539 assigned to our petrochemicals operations and approximately
384 assigned to our pulp chemicals operations. Approximately 42% of our
employees are covered by union agreements. The primary union agreement at our
Texas City facility is with the Texas City, Texas Metal Trades Council, AFL-CIO,
of Galveston County, Texas, which covers all hourly employees at our Texas City
facility. This agreement was renegotiated as of December 28, 1998 and will
expire on May 1, 2002. The agreement continues to be in effect notwithstanding
our Chapter 11 filing. Under the Bankruptcy Code, the agreement may be assumed
or rejected, but any rejection would require that we comply with the special
provisions of the Bankruptcy Code related to collective bargaining agreements.
We do not currently intend to reject the agreement prior to its expiration date
and expect to negotiate with the union concerning the terms of a new agreement
to take effect after the expiration date.

Approximately 76% of our employees at our Vancouver facility are
represented by the Pulp, Paper and Woodworkers Union. The Vancouver labor
agreement was renegotiated in November 2000 and is subject to further
renegotiations in November of 2003. Employees at our Buckingham facility are
represented by either the Communications, Energy and Paperworkers Union or an
office and professional workers union. Both Buckingham labor agreements were
renegotiated in November of 1999 and are subject to renegotiation in November
2002. Approximately 77% of the employees at our Saskatoon facility are
represented by the Communications, Energy and Paperworkers of Canada. Our
collective bargaining agreement with this union was renegotiated on June 25,
2001 and is subject to further renegotiation in September 2004. The union
agreements relating to our Vancouver, Buckingham and Saskatoon facilities, to
which certain of our non-debtor Canadian subsidiaries are parties, are not
affected by our Chapter 11 filings. Although we believe our relationship with
our employees is generally good, a strike by one or more of the unions
representing our employees could have a material adverse effect on our business.

INSURANCE

We maintain full replacement value insurance coverage for property damage
to all of our facilities and business interruption insurance. Nevertheless, a
significant interruption in the operation of one or more of our facilities could
have a material adverse effect on our business. We also maintain other insurance
coverages for various risks associated with our business. There can be no
assurance that we will not incur losses beyond the limits of, or outside the
coverage of, our insurance. From time to time various types of insurance for
companies in the chemical industry have been very expensive or, in some cases,
unavailable. As a result of the September 11, 2001 terrorist attacks, many
insurers have placed their respective insureds, including us, on notice that
acts of terrorism will be excluded from coverage after December 31, 2001. There
can be no assurance that in the future we will be able to maintain our existing
coverage or that premiums will not increase substantially.

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ITEM 2. PROPERTIES

Our petrochemicals facility is located in Texas City, Texas, approximately
45 miles south of Houston, on a 290-acre site on Galveston Bay near many other
chemical manufacturing complexes and refineries. We have facilities to load our
products in trucks, railcars, barges and ocean-going vessels for shipment to
customers. The site offers room for future expansion and includes a greenbelt
around the northern edge of the plant site. We own or lease all of the real
property which comprises our Texas City facility and all of the equipment and
facilities located there, other than the sodium cyanide unit which is owned by
DuPont, a cogeneration facility owned by a joint venture between us and Praxair
Energy Resources, Inc., the partial oxidation unit which is owned by Praxair
Hydrogen Supply, Inc. and the DSIDA plant which is owned by Monsanto. We also
own storage facilities, approximately 197 rail cars and an acetic acid barge in
connection with our petrochemicals business.

Our acrylic fibers facility is located on 1,100 acres near Pensacola in
Santa Rosa County, Florida. We own all of the real property on which our acrylic
fibers facility is situated and own or lease all of the facilities and equipment
located there. In July 1999, we entered into an agreement for the construction
of a cogeneration facility at our acrylic fibers facility that will be owned by
Santa Rosa Energy, U.S.

Our pulp chemicals business includes five manufacturing facilities in
Canada and our Valdosta, Georgia facility. We own the property on which our
Buckingham, Quebec and Vancouver, British Columbia manufacturing facilities are
located, with each site comprising approximately 20 acres. We also own the
property on which our Saskatoon manufacturing facility is located, which
consists of approximately 270 acres. We lease the property for our Thunder Bay,
Ontario and Grande Prairie, Alberta manufacturing facilities. Our Valdosta
facility was constructed in conjunction with and is leased from the
Valdosta-Lowndes County Industrial Authority. We also lease approximately 638
rail cars in connection with our pulp chemicals business. Headquarters for our
pulp chemicals operations are located in Toronto, Ontario in an office building
that we lease.

We lease our principal executive offices, located at 1200 Smith Street,
Suite 1900 in Houston, Texas.

We believe our properties and equipment are sufficient to conduct our
business.

ITEM 3. LEGAL PROCEEDINGS

As previously discussed, the Debtors filed voluntary petitions for
reorganization under Chapter 11 of the Bankruptcy Code on July 16, 2001. As a
result of the commencement of the Chapter 11 cases, an automatic stay has been
imposed against the commencement or continuation of legal proceedings against
the Debtors outside of the Bankruptcy Court. The automatic stay will not apply,
however, to governmental authorities exercising their police or regulatory
powers, including the application of environmental laws. Claimants against the
Debtors may assert their claims in the Chapter 11 cases by filing a timely proof
of claim, to which the Debtors may object and seek a determination from the
Bankruptcy Court as to the allowability of the claim. Claimants who desire to
liquidate their claims in legal proceedings outside of the Bankruptcy Court will
be required to obtain relief from the automatic stay by order of the Bankruptcy
Court. If such relief is granted, the automatic stay will remain in effect with
respect to the collection of liquidated claim amounts. As a general rule, all
claims against the Debtors that seek a recovery from assets of the Debtors'
estates will be addressed in the Chapter 11 cases and paid only pursuant to the
terms of a confirmed plan of reorganization.

ETHYLBENZENE RELEASE

On April 1, 1998, a chemical leak occurred when a line failed in the
ethylbenzene unit at our Texas City facility. The released chemicals included
ethylbenzene, benzene, polyethylbenzene and hydrochloric acid. We do not believe
any serious injuries were sustained, although a number of citizens sought
medical examinations at local hospitals after a precautionary alert was given to
neighboring communities.

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The following ethylbenzene lawsuits are outstanding:

1. Zabrina Alexander, et al. v. Sterling Chemicals Holdings, Inc., et
al.; Cause No. 00CV0217; In the 10th Judicial District Court of Galveston
County, Texas;

2. James Allen, et al. v. Sterling Chemicals, Inc., et al.; Cause No.
200015823; In the 152nd Judicial District Court of Harris County, Texas

3. Bobbie Adams, et al. v. Sterling Chemicals International, Inc., et
al.; Cause No. 00CV0311; In the 212th Judicial District Court of Galveston
County, Texas;

4. Nettie Allen, et al. v. Sterling Chemicals, Inc., et al.; Cause No.
00CV0304; In the 10th Judicial District Court of Galveston County, Texas.

5. Ida Goldman, et al. v. Sterling Chemicals, Inc., et al.; Cause No.
00CV0338; In the 56th Judicial District Court of Galveston County, Texas;

6. Joe L. Kimble, et al. v. Sterling Chemicals, Inc., et al.; Cause
No. 00CV0333; In the 56th Judicial District Court of Galveston, County,
Texas; and

7. Olivia Ellis v. Sterling Chemicals, Inc.; Cause No. JC7096; In
Justice Court No. 5 of Galveston County, Texas.

The 7 lawsuits, and an additional 3 interventions, involve approximately 821
plaintiffs/intervenors who seek an unspecified amount for damages. We believe
that all or substantially all of our future out-of-pocket costs and expenses
relating to these lawsuits, including settlement payments and judgments, will be
covered by our liability insurance policies or indemnification from third
parties. We do not believe that the claims and litigation arising out of this
incident will have a material adverse effect on our business, financial
position, results of operations or cash flows, although we cannot give any
assurances to that effect. Unless otherwise ordered by the Bankruptcy Court, all
of these claims and litigation are subject to the automatic stay and recoveries
(if any) sought thereon from assets of the Debtors will be addressed in the
Chapter 11 cases. To date, the Bankruptcy Court has lifted the automatic stay in
the cases of Bobbie Adams, et al., James C. Allen, et al. and Nettie Allen, et
al. for the sole purpose of allowing the plaintiffs to proceed against our
liability insurance policies. Small cash settlements, to be funded by our
liability insurance policies, have been negotiated with the plaintiffs in one of
the interventions and in the cases of Ida Goldman, et al. and Joe L. Kimble, et
al., have been approved by the Bankruptcy Court.

On June 11, 2001, we received a notice from the U.S. Department of Justice,
Environment and Natural Resources Division, in which the Department alleged that
on April 1, 1998 an ethylbenzene release at our Texas City facility violated the
general duty clause of the Clean Air Act and invited us to engage in settlement
discussion with respect to the matter. Although we believe that the April 1,
1998 release did not constitute a violation of the general duty clause of the
Clean Air Act, we have engaged in discussions with the Department in an attempt
to settle the matter on a consensual basis. However, any alleged liability would
constitute a pre-petition claim and any settlement would require approval by the
Bankruptcy Court. We do not believe that this matter will have a material
adverse effect on our business, financial position, results of operations or
cash flow, although we cannot give any assurances to that effect.

OTHER CLAIMS

We are subject to various other claims and legal actions that arise in the
ordinary course of our business. Claims and legal actions against the Debtors
that existed as of the Chapter 11 filing date are subject to the automatic stay,
and recoveries sought thereon from assets of the Debtors will be required to be
dealt with in the Chapter 11 cases.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

There is no established public trading market for Holdings' common stock,
par value $.01 per share, although our common stock is traded on the OTC
Electronic Bulletin Board maintained by the National Association of Securities
Dealers, Inc. under the symbol "STXX.OB" The following table sets forth the high
and low bid information of our common stock as reported on the OTC Electronic
Bulletin Board for the fiscal years ended September 30, 2001 and 2000.

As of December 3, 2001, there were approximately 560 record holders of
Holdings' common stock.

Holdings has not paid dividends on its common stock in any of the last
three fiscal years and does not anticipate paying dividends in the foreseeable
future. Any future payment of dividends will depend upon a variety of
conditions, including the outcome of the Chapter 11 cases. Due to the Chapter 11
filings, none of the Debtors may pay dividends on their shares of common stock
until after they emerge from bankruptcy. It is possible, however, that a plan of
reorganization will result in the significant dilution or elimination of all
equity interests in Holdings. The payment of dividends on Holdings' common stock
is also restricted by the terms of the indenture governing Holdings' 13 1/2%
Senior Secured Discount Notes due 2008 and the terms of both of Holdings'
outstanding series of preferred stock. In addition, our subsidiaries (including
Chemicals, Sterling Pulp and our Saskatoon subsidiary) are parties to various
debt agreements that limit their ability to provide funds to us by way of
dividends, distributions or advances.

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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data with respect to our
consolidated financial condition and consolidated results of operations and
should be read in conjunction with "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" and our Consolidated Financial
Statements and related notes in Item 8 of this Form 10-K.

- ---------------

(1) During fiscal 1997, we acquired our acrylic fibers facility and our
Saskatoon facility.

(2) During fiscal 2001, approximately $7.1 million in pre-tax charges were
recorded in connection with the withdrawal from the traditional commodity
textile business of our acrylic fibers operations, which related to $2
million in severance payments and a write-down of finished goods and stores
inventory to their net realizable value and $56.8 million of deferred tax
expense was recorded to reflect a full valuation allowance on our U.S.
deferred tax assets. During fiscal 2000, we recorded pre-tax charges of $2
million for costs associated with workforce reductions and a $60 million
non-cash charge related to the write down of our acrylic fibers production
assets. During fiscal 1999, we recorded pre-tax charges of $4 million for
costs associated with workforce reductions, $6.8 million non-cash charge
related to early retirement programs and benefit changes and a $26.4 million
non-cash charge related to the write down of our methanol production assets.
During fiscal 1998, we recorded a pre-tax charge of $6 million for costs
associated with workforce reductions.

(3) EBITDA (earnings before interest, taxes, depreciation, amortization, stock
appreciation rights ("SARs"), certain merger-related expenses, impairment of
assets and certain non-cash charges related to an early retirement program
and benefit changes) is presented because it is a widely accepted financial
indicator of a company's ability to incur and service debt. It is not
intended as an alternative measure of performance to net loss. Because
EBITDA excludes some, but not all, items that affect net loss and may vary
among companies, the EBITDA calculation presented above may not be
comparable to similarly

25

titled measures of other companies. Certain non-cash charges related to an early
retirement program and benefit changes were $6.8 million for the year ended
September 30, 1999. Non-cash charges related to the write-down of our production
assets were $60 million for acrylic fibers in the fiscal year ended
September 30, 2000 and $26.4 million for methanol in the fiscal year ended
September 30, 1999.

(4) Working capital at September 30, 2001 excludes pre-petition liabilities
subject to companies -- see Note 3 of the Notes to Holdings Consolidated
Financial Statements included in this Form 10-K.

(5) Excludes long-term debt of $603.8 million (net of related debt issue costs)
and $295.0 million, classified as pre-petition liabilities -- subject to
compromise and pre-petition liabilities -- not subject to compromise,
respectively, on the consolidated balance sheet at September 30, 2001.

SELECTED FINANCIAL DATA FOR CHEMICALS

The following table sets forth selected financial data with respect to
Chemicals' consolidated financial condition and consolidated results of
operations and should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Chemicals' Consolidated Financial Statements and related notes in Item 8 of this
Form 10-K. All issued and outstanding shares of Chemicals are held by Holdings
and, accordingly, per share data is not presented.

26

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

Holdings is a holding company whose only material asset is its investment
in Chemicals, our primary operating subsidiary. Chemicals and its subsidiaries
own substantially all of our consolidated operating assets. Other than
additional interest expense associated with our 13 1/2% Senior Secured Discount
Notes due 2008, our results of operations are essentially the same as Chemicals.

CHAPTER 11 PROCEEDINGS

On July 16, 2001 (the "Petition Date"), Holdings, Chemicals and most of
their U.S. subsidiaries (collectively, the "Debtors") filed voluntary petitions
for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Bankruptcy
Code") in the U.S. Bankruptcy Court for the Southern District of Texas (the
"Bankruptcy Court") and began operating their business as debtors-in-possession
pursuant to the Bankruptcy Code. None of our foreign subsidiaries, including our
Canadian subsidiaries, were included in the Chapter 11 filings.

The filing of the Chapter 11 petitions was driven by the Debtors' inability
to meet their funded debt obligations over the long-term, largely brought about
by weak demand for petrochemical products caused by declines in general
worldwide economic conditions, the relative strength of the U.S. dollar which
has caused their export sales to be at a competitive disadvantage and higher raw
material and energy costs. As a result of these conditions, the Debtors have
incurred significant operating losses. The reorganization contemplated by the
Chapter 11 filings is designed to permit the Debtors to preserve cash and to
give the Debtors the opportunity to restructure their debt. During the pendency
of the Chapter 11 cases, with approval of the Bankruptcy Court, the Debtors may
assume favorable pre-petition contracts and leases, reject unfavorable
pre-petition contracts and leases and sell or otherwise dispose of assets. The
confirmation of a plan of reorganization is the primary objective of the
Debtors. Unless otherwise ordered by the Bankruptcy Court, the Debtors have the
exclusive right to propose a plan of reorganization until March 13, 2002, and
the exclusive right to seek acceptances of any plan proposed by them until May
12, 2002. A plan of reorganization, when filed, will set forth the means for
treating claims, including liabilities subject to compromise and interests in
the Debtors. Such means may take a number of different forms. A plan of
reorganization may result in, among other things, significant dilution or
elimination of certain classes of existing interests as a result of the issuance
of equity securities to creditors or new investors. The Debtors are in the early
stages of formulating a plan of reorganization. The confirmation of any plan of
reorganization will require creditor acceptance as required under the Bankruptcy
Code and approval of the Bankruptcy Court.

At this time, it is not possible to predict the outcome of the bankruptcy
cases in general or the effect on the business of the Debtors, the claims of
creditors of the Debtors or the interest of stockholders of Holdings. As a
result of the bankruptcy filings, most of the Debtors' liabilities incurred
prior to the Petition Date, including certain secured debt, could be subject to
compromise. However, the ultimate resolution of these liabilities is not
presently determinable.

Effective July 19, 2001, the Debtors (excluding Holdings) entered into a
Revolving Credit Agreement with a group of lenders led by Tyco Capital (formerly
The CIT Group/Business Credit, Inc.) to provide up to $195 million in
Debtor-In-Possession financing (the "DIP Financing"). By interim order dated
July 18, 2001 and final order dated September 14, 2001, the Bankruptcy Court
approved up to $155 million in lending commitments under the DIP Financing (the
"Base Facility"), consisting of an $85 million "current assets revolver" and a
$70 million "fixed assets revolver." The initial draw under the DIP Financing
was used to repay all amounts outstanding under the Debtors' previous revolving
credit facilities. Additional borrowings under the DIP Financing may be used to
fund the Debtors' post-petition operating expenses and supplier and employee
obligations throughout the reorganization process. The final order dated
September 14, 2001 is on appeal to the U.S. District Court, but no stay of the
final order has been sought or imposed, and the order remains fully effective.
While no assurances can be given, we do not believe the final order will be
overturned on appeal.

27

Borrowings under the DIP Financing are subject to customary funding
conditions, including borrowing base restrictions under the current assets
revolver. The Base Facility is secured by substantially all of the assets of the
Debtors, but some of the liens have been granted super-priority administrative
expense claims for the amount of the DIP Financing which, subject to certain
carve outs, will entitle the DIP lenders to be paid before any other claims
against the Debtors are paid. The DIP Financing is designed to give the Debtors
the opportunity, during the reorganization process, to develop a new capital
structure that will support them over the long-term, including during recurring
cyclical downturns in the markets for the Debtors' petrochemicals products. At
September 30, 2001, the total credit available under the DIP Financing was
$112.8 million due to borrowing base restrictions under the current assets
revolver. At September 30, 2001, $42.3 million was drawn under the fixed assets
revolver and there were no borrowings outstanding under the current assets
revolver. In addition, approximately $4.4 million of letters of credit were
outstanding under the current assets revolver, leaving at September 30, 2001,
unused borrowing capacity under the secured revolving credit facilities of
approximately $66.1 million.

As a result of a priming order entered by the Bankruptcy Court on November
2, 2001 and reinstated on December 19, 2001, the lending commitments under the
current assets revolver were increased from $85 million to $125 million. The
priming order grants the lenders under the currents assets revolver a priming
lien on our fixed assets located in the United States and the capital stock of
most of our domestic subsidiaries, prior in right to the existing liens in favor
of the 12 3/8% Notes. Although the priming order was entered by the Bankruptcy
Court on November 2, 2001, it was appealed to the U.S. District Court by the
indenture trustee for the 12 3/8% Notes. By order dated December 17, 2001, the
U.S. District Court reversed the priming order and remanded the matter to the
Bankruptcy Court for a determination of a compensatory adjustment in favor of
the 12 3/8% Notes, which the U.S. District Court suggested would be satisfied by
a 4% increase of the interest rate payable on up to $40 million. On remand, the
Bankruptcy Court entered an order dated December 19, 2001, reinstating the
priming order subject to an appropriate compensatory adjustment in favor of the
12 3/8% Notes of four percentage points of additional interest on up to $40
million. In addition, the Bankruptcy Court scheduled a hearing for January 2,
2002 to determine certain technical details regarding implementation of this 4%
increase. The Debtors anticipate that the priming order will be further appealed
by the indenture trustee. The priming order will remain effective pending the
outcome of any appeal unless stayed by an appellate court. The Debtors will take
all reasonable actions necessary, either before the Bankruptcy Court or on
appeal, to maintain the effectiveness of the priming order and the additional
liquidity provided by the priming order. If the priming order is stayed or is
not ultimately upheld on appeal, the Debtors will need to seek additional
sources of financing or revise their business plan and operations consistent
with the level of available financing. However, we can give no assurances that
the priming order will not be stayed or will be upheld on appeal or, if stayed
or not upheld on appeal, that additional sources of financing will be available
or adequate or that our available financing will be adequate after implementing
revisions to the Debtors' business plan and operations.

In addition, as of July 11, 2001, our principal Canadian subsidiary,
Sterling Pulp Chemicals, Ltd. ("Sterling Pulp"), entered into a financing
agreement with Tyco Capital Business Credit (Canada) Inc. ("Tyco Canada") to
provide up to the Canadian dollar equivalent of U.S. $30 million (the "Canadian
Financing Agreement"). The initial advance under this facility, approximately
U.S. $20 million, was used by Sterling Pulp to discharge a portion of an
intercompany debt and was ultimately transferred to the Debtors through an
intercompany loan. The intercompany loan was approved by the Bankruptcy Court's
interim order entered on July 18, 2001 and final order entered on September 14,
2001 which is a subject of the appeal of the final order discussed above.

The Debtors are permitted to continue to operate their businesses and
manage their properties in the ordinary course without prior approval from the
Bankruptcy Court. Transactions outside of the ordinary course of business,
including certain types of capital expenditures, certain sales of assets and
certain requests for additional financings, will require approval by the
Bankruptcy Court. There is no assurance that the Bankruptcy Court will grant any
requests for such approvals.

On July 18, 2001, the Bankruptcy Court issued an order permitting the
Debtors to pay pre-petition salaries, wages and benefits to all of their
employees. The Bankruptcy Court also authorized the payment of
28

certain other pre-petition claims, in limited circumstances, as necessary to
avoid undue disruption to the Debtors' operations. Generally, actions to enforce
or otherwise effect repayment of pre-petition liabilities of, as well as all
pending litigation against, the Debtors are stayed while the Debtors continue to
operate their business as debtors-in-possession. The ultimate amount and
settlement terms for such liabilities will be subject to a plan of
reorganization and, accordingly, are not presently determinable. The Debtors'
trade creditors, including vendors, will be paid their post-petition claims in
the normal course of business.

As our foreign subsidiaries are not included in the Chapter 11 filings, all
of their creditors, including vendors, will be paid their claims in the ordinary
course of business, irrespective of whether the claims arose prior to or after
the Chapter 11 filings.

As a result of the bankruptcy filings and related events, there is no
assurance that the carrying amounts of assets will be realized or that
liabilities will be liquidated or settled for the amounts recorded. In addition,
confirmation of a plan of reorganization, or disapproval thereof, could change
the amounts reported in the financial statements. The ability of the Debtors to
continue as a going concern is dependent upon, among other things, (i) the
Debtors' ability to comply with the terms of the DIP Financing and any related
orders entered by the Bankruptcy Court in connection with the Chapter 11 cases,
(ii) the ability of the Debtors to access the incremental $40 million in DIP
Financing that is dependent on an effective priming order, (iii) the ability of
the Debtors to maintain adequate cash on hand, (iv) the ability of the Debtors
to generate sufficient cash from operations, (v) the ability of the Debtors'
subsidiaries that are not included in the Chapter 11 cases to obtain necessary
financing, (vi) confirmation of a plan or plans of reorganization under the
Bankruptcy Code and (vii) the Debtors' ability to achieve profitability
following such confirmation. As the Debtors can give no assurances that they
will achieve any of the forgoing, there is substantial doubt about the Debtors',
and therefore the Company's, ability to continue as a going concern.

The accompanying financial statements do not include any adjustments that
may result from the resolution of these uncertainties.

MANAGEMENT CHANGES

On December 19, 2001 we announced that Frank P. Diassi had elected to
terminate his employment, effective immediately. Mr. Diassi joined us in 1996 as
executive Chairman of the Board and continued in that position until his
termination. Earlier this year he was elected Co-Chief Executive Officer along
with David G. Elkins, our President. Mr. Diassi has asserted that he had "good
reason" to terminate his employment and is claiming that he is entitled to
receive payments under our employee retention and severance plans. Our
Compensation Committee is evaluating the merits of Mr. Diassi's claim. Mr.
Diassi will continue in his role as director.

Succeeding Mr. Diassi as Co-Chief Executive Officer will be Richard K.
Crump. Since joining us in 1986, Mr. Crump has served in a variety of management
positions, most recently as Executive Vice President-Operations. Mr. Crump has
also been elected to our Board of Directors, increasing the size of the Board of
Directors to seven.

In a separate action, Robert W. Roten was elected non-executive Chairman of
the Board of Directors, having served as a director since 1996 and as Vice
Chairman of the Board of Directors since 1998. Mr. Roten was employed by us
since our inception, eventually attaining the positions of President and Chief
Executive Officer before he retired in 1998.

MARKET CONDITIONS

The primary markets in which we compete, especially styrene and
acrylonitrile, are cyclical and are sensitive to factors such as:

- changes in the balance between supply and demand;

- the price of raw materials;

29

- currency exchange rates; and

- the level of general worldwide economic activity.

Styrene prices are cyclical and sensitive to overall supply relative to
demand and the level of general business activity. As is the case with other
petrochemicals, styrene from time to time experiences periods of strong demand
resulting in tight supply and high prices and margins. This tight balance in
supply and demand often results in new capacity additions. In most cases,
incremental capacity comes in the form of large new plants or major expansions
of existing facilities. As this new capacity comes on line, it often exceeds
current demand growth and results in a decline in prices and margins. Following
a period of strong demand growth and high utilization rates from 1994 to 1996,
several major producers announced new capacity increases in 1997 and 1998,
particularly in the Far East. At the time of this announced new capacity, there
was a general slowdown in the economic growth rate in the Far East, prompting
customers to begin utilizing their available inventories and decrease purchases
of additional product. As a result, our average styrene prices declined from
fiscal 1997 through fiscal 1999, as the previously announced new capacity came
on line at the same time that economic events in various Asian countries
significantly reduced demand growth for styrene.

During fiscal 2000, styrene prices and margins increased significantly from
levels experienced in fiscal 1999. These improvements were driven by a
combination of stronger market demand, operating problems experienced at several
of our competitors and generally low inventory levels worldwide. Styrene prices
and margins peaked in April of 2000 at a published spot price of $0.48 per pound
and decreased over the second half of 2000.

During fiscal 2001, U.S. and world economies experienced a general slowdown
which has negatively impacted demand for most petrochemicals. Raw material and
energy costs spiked upward during the first half of fiscal 2001, increasing
significantly from the prior year, primarily due to the sharp increase in
natural gas prices. As a result, U.S. Gulf Coast petrochemicals producers
experienced significant margin erosion in most of their products. Due to these
conditions, many U.S. Gulf Coast petrochemicals producers, including us, reduced
production levels. During the second half of fiscal 2001, raw material and
energy costs began to moderate, although demand has remained weak due to the
continued economic slowdown. Reported styrene spot prices averaged $0.17 to
$0.19 per pound in September 2001. We cannot predict future increases or
decreases in styrene prices and margins.

The acrylonitrile market exhibits similar characteristics to those of
styrene regarding capacity utilization, selling prices and profit margins.
Moreover, as a high percentage of our acrylonitrile sales are made in the export
market, demand for our acrylonitrile is significantly influenced by export
customers, particularly those that supply acrylic fibers to customers in China.
During 1995, strong demand for acrylic fibers and ABS resins, particularly in
China, increased demand for acrylonitrile, resulting in high prices and margins.
High utilization rates and prices prompted many major producers to announce new
capacity increases and approximately two billion pounds of capacity increases
came on line between 1996 and 1998. As new acrylonitrile capacity in the United
States and Asia came on line, demand growth in Asian markets weakened, causing
our acrylonitrile prices and margins to decrease significantly from 1996 through
1999. Beginning in early fiscal 2000, acrylonitrile prices increased
significantly due to improved market demand, operating problems experienced at
several of our competitors and generally low inventory levels. However, we were
not able to fully capitalize on this opportunity as a result of planned
shutdowns related to the construction by Monsanto of the DSIDA plant at our
Texas City facility and several plant operating problems. Due to the general
slowdown of U.S. and world economies, along with higher raw material and energy
costs described above, acrylonitrile prices and margins weakened significantly
in fiscal 2001. As a result, we rescheduled maintenance turnaround work at our
Texas City acrylonitrile facility, performing this work during the second
quarter of fiscal 2001 rather than later in the year. The adverse economic
conditions that made it commercially impracticable to operate our acrylonitrile
and other nitriles production units, and that served as the basis for our
decision to advance the timing of the turnaround, persisted beyond the
completion of this maintenance turn-around work. Consequently, we elected to
postpone restarting our acrylonitrile facilities and other nitriles production
units until it is commercially practicable to operate these facilities. Our
other nitriles production units include the sodium cyanide, TBA and DSIDA
production units, all of which are dependent on the acrylonitrile facilities for
feedstocks. Our

30

conversion agreement with Flexsys terminates as of December 31, 2001. We are
currently evaluating our options related to TBA production following the
termination of this contract.

The sodium chlorate market has also historically experienced cycles in
capacity utilization, selling prices and profit margins. Since 1990, North
American demand for sodium chlorate has grown at an average annual rate of
approximately 7% as pulp mills have accelerated substitution of chlorine dioxide
for elemental chlorine in bleaching applications. In 1999, demand for sodium
chlorate did not increase at historical rates as a result of weak market
conditions and lower operating rates in the pulp and paper industry. In
addition, new production capacity was added while implementation of the Cluster
Rules was delayed. During fiscal 2000 and 2001, average sodium chlorate prices
increased due to increased operating rates at pulp mills and the continued
conversion to elemental chlorine free bleaching at pulp mills. The industry
average market price (as reported by Chemical Week Associates) increased by
approximately 6% from fiscal 1999 to fiscal 2000 and increased approximately 10%
from fiscal 2000 to fiscal 2001. We cannot predict future increases or decreases
in sodium chlorate prices and margins.

We market a significant portion of our volumes of petrochemicals and
generate a significant portion of our revenues under our conversion and
long-term agreements. Under our conversion agreements, the customer furnishes
some or all of the raw materials, which we process into petrochemicals in
exchange for a fee designed to cover our fixed and variable costs of production.
These conversion agreements are intended to help us maintain lower levels of
working capital and, in some cases, gain access to certain improvements in
manufacturing process technology. Our petrochemicals conversion agreements are
intended to:

- optimize capacity utilization rates;

- lower our selling, general and administrative expenses;

- reduce our working capital requirements; and

- insulate our operations to some extent from the effects of declining
markets and changes in raw materials prices.

LIQUIDITY AND CAPITAL RESOURCES

DIP FINANCING AND CANADIAN FINANCING AGREEMENT

Effective July 19, 2001, the Debtors (excluding Holdings) entered into a
Revolving Credit Agreement with a group of lenders led by Tyco Capital (formerly
The CIT Group/Business Credit, Inc.) to provide up to $195 million in
Debtor-In-Possession financing (the "DIP Financing"). By interim order dated
July 18, 2001 and final order dated September 14, 2001, the Bankruptcy Court
approved up to $155 million in lending commitments under the DIP Financing (the
"Base Facility"), consisting of an $85 million "current assets revolver" and a
$70 million "fixed assets revolver." The initial draw under the DIP Financing
was used to repay all amounts outstanding under the Debtors' previous revolving
credit facilities. Additional borrowings under the DIP Financing may be used to
fund the Debtors' post-petition operating expenses and supplier and employee
obligations throughout the reorganization process. The final order dated
September 14, 2001 is on appeal to the U.S. District Court, but no stay of the
final order has been sought or imposed, and the order remains fully effective.
While no assurances can be given, the Company does not believe the final order
will be overturned on appeal.

Borrowings under the DIP Financing are subject to customary funding
conditions, including borrowing base restrictions under the current assets
revolver. The Base Facility is secured by substantially all of the assets of the
Debtors, but some of the liens have been granted super-priority administrative
expense claims for the amount of the DIP Financing which, subject to certain
carve outs, will entitle the DIP lenders to be paid before any other claims
against the Debtors are paid. The DIP Financing is designed to give the Debtors
the opportunity, during the reorganization process, to develop a new capital
structure that will support them over the long-term, including during recurring
cyclical downturns in the markets for the Debtors' petrochemicals products. At
September 30, 2001, the total credit available under the DIP Financing was
$112.8 million due to borrowing base restrictions under the current assets
revolver. At September 30, 2001, $42.3 million was drawn

31

under the fixed assets revolver and there were no borrowings outstanding under
the current assets revolver. In addition, approximately $4.4 million of letters
of credit were outstanding under the current assets revolver, leaving at
September 30, 2001, unused borrowing capacity under the secured revolving credit
facilities of approximately $66.1 million.

As a result of a priming order entered by the Bankruptcy Court on November
2, 2001 and reinstated on December 19, 2001, the lending commitments under the
current assets revolver were increased from $85 million to $125 million. The
priming order grants the lenders under the currents assets revolver a priming
lien on our fixed assets located in the United States and the capital stock of
most of our domestic subsidiaries, prior in right to the existing liens in favor
of the 12 3/8% Notes. Although the priming order was entered by the Bankruptcy
Court on November 2, 2001, it was appealed to the U.S. District Court by the
indenture trustee for the 12 3/8% Notes. By order dated December 17, 2001, the
U.S. District Court reversed the priming order and remanded the matter to the
Bankruptcy Court for a determination of a compensatory adjustment in favor of
the 12 3/8% Notes, which the U.S. District Court suggested would be satisfied by
a 4% increase of the interest rate payable on up to $40 million. On remand, the
Bankruptcy Court entered an order dated December 19, 2001, reinstating the
priming order subject to an appropriate compensatory adjustment in favor of the
12 3/8% Notes of four percentage points of additional interest on up to $40
million. In addition, the Bankruptcy Court scheduled a hearing for January 2,
2002 to determine certain technical details regarding implementation of this 4%
increase. The Debtors anticipate that the priming order will be further appealed
by the indenture trustee. The priming order will remain effective pending the
outcome of any appeal unless stayed by an appellate court. The Debtors will take
all reasonable actions necessary, either before the Bankruptcy Court or on
appeal, to maintain the effectiveness of the priming order and the additional
liquidity provided by the priming order. If the priming order is stayed or is
not ultimately upheld on appeal, the Debtors will need to seek additional
sources of financing or revise their business plan and operations consistent
with the level of available financing. However, we can give no assurances that
the priming order will not be stayed or will be upheld on appeal or, if stayed
or not upheld on appeal, that additional sources of financing will be available
or adequate or that our available financing will be adequate after implementing
revisions to the Debtors' business plan and operations.

As of July 11, 2001, our principal Canadian subsidiary, Sterling Pulp,
entered into a financing agreement with Tyco Capital Business Credit (Canada)
Inc., ("Tyco Canada") to provide up to the Canadian dollar equivalent of U.S.
$30 million (the "Canadian Financing Agreement"). The initial advance under this
facility, approximately U.S. $20 million, was used by Sterling Pulp to discharge
a portion of an intercompany debt and was ultimately transferred to the Debtors
through an intercompany loan. The intercompany loan was approved by the
Bankruptcy Court's interim order entered on July 18, 2001 and final order
entered on September 14, 2001, which is a subject of the appeal of the final
order discussed above. At September 30, 2001, $20 million was drawn under the
Canadian Financing Agreement.

Under the DIP Financing, the Debtors (excluding Holdings) are co-borrowers
and are jointly and severally liable for any indebtedness thereunder. The Base
Facility consists of:

- a $70 million fixed assets revolving credit facility secured by:

- first priority liens on all of the capital stock of Chemicals and the
other co-borrowers, all of our United States production facilities and
related assets and 35% of the capital stock of certain of our
subsidiaries incorporated outside the United States; and

- second priority liens on all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers and 65% of the
capital stock of certain of our subsidiaries incorporated outside the
United States; and

- an $85 million current assets revolving credit facility secured by:

- a first priority lien on all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers;

32

- a second priority lien on 35% of the capital stock of certain of our
subsidiaries incorporated outside the United States; and

- third priority liens on the remaining 65% of that stock, all of the
capital stock of Chemicals and the other co-borrowers and all of our
United States production facilities and related assets.

Available credit under the fixed assets revolving credit facility is not
subject to a borrowing base. At September 30, 2001, available credit under the
current assets revolving credit facility was subject to a monthly borrowing base
consisting of 85% of eligible accounts receivable and 65% of eligible inventory,
with an inventory cap of $42.5 million. In addition, the borrowing base for the
current assets revolver is required to exceed outstanding borrowings thereunder
by $12 million at all times, with a maximum of $85 million available under the
current asset revolving credit facility.

Assuming the priming order is not overturned on appeal, (i) maximum
availability under the current assets revolving credit facility is $125 million,
(ii) the monthly borrowing base consist of 85% of eligible accounts receivable,
the lesser of $10 million or 33% of specified estimated future royalty payments
related to the Debtors' chlorine dioxide technology and 65% of eligible
inventory, with an inventory cap of $62.5 million, and (iii) the borrowing base
for the current assets revolver is required to exceed outstanding borrowings by
only $6 million at all times.

If the priming order remains effective and the total commitments under the
current assets revolver are increased to $125 million, the incremental $40
million is secured by first priority liens on all of our United States
production facilities and related assets and all of the capital stock of the
co-borrowers (excluding Chemicals) to secure up to $40 million under the current
assets revolver, as well as all of the same collateral securing the initial $85
million current assets revolver. Consequently, after giving effect to the
priming order, the DIP Financing consists of:

- a $70 million fixed assets revolving credit facility secured by:

- a first priority lien on all of the capital stock of Chemicals;

- second priority liens on all of our United States production facilities
and related assets, all of the capital stock of the co-borrowers
(excluding Chemicals), all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers and 35% of the
capital stock of certain of our subsidiaries incorporated outside the
United States; and

- a third priority lien on the remaining 65% of that stock; and

- a $125 million current assets revolving credit facility:

- $40 million of which is secured by first priority liens on all of our
United States production facilities and related assets, all of the
capital stock of the co-borrowers (excluding Chemicals) and 35% of the
capital stock of certain of our subsidiaries incorporated outside the
United States and a second priority lien on the remaining 65% of that
stock; and

- all of which is secured by a first priority lien on all accounts
receivable, inventory and other specified assets of Chemicals and the
other co-borrowers, third priority liens on all of the capital stock of
Chemicals and 35% of the capital stock of certain of our subsidiaries
incorporated outside the United States and fourth priority liens on the
remaining 65% of that stock, all of the capital stock of the co-
borrowers (excluding Chemicals) and all of our United States production
facilities and related assets.

At September 30, 2001, the total credit available under the DIP Financing
was $112.8 million due to the current assets revolver borrowing base limitations
discussed above. At September 30, 2001, $42.3 million was drawn under the fixed
assets revolver and there were no borrowings outstanding under the current
assets revolver. In addition, approximately $4.4 million of letters of credit
were outstanding, leaving at September 30, 2001, unused borrowing capacity under
the secured revolving credit facilities of approximately $66.1 million. At
September 30, 2001, $20 million was drawn under the Canadian Financing
Agreement.

33

The DIP Financing and the Canadian Financing Agreement contain numerous
covenants, including, but not limited to, restrictions on the ability to incur
indebtedness, create liens and sell assets, as well as certain financial
maintenance covenants.

OTHER DOMESTIC BORROWINGS

As of September 30, 2001, other domestic borrowings consisted of:

- Chemicals' 11 1/4% Senior Subordinated Notes due 2007, 11 3/4% Senior
Subordinated Notes due 2006 and 12 3/8% Senior Secured Notes due 2006;
and

- Holdings' 13 1/2% Senior Secured Discount Notes due 2008.

The 12 3/8% Notes are senior secured obligations of Chemicals and rank
equally in right of payment with all other existing and future senior
indebtedness of Chemicals and senior in right of payment to all existing and
future subordinated indebtedness of Chemicals. The 12 3/8% Notes are fully and
unconditionally guaranteed by most of Chemicals' existing direct and indirect
United States subsidiaries on a joint and several basis. Each subsidiary's
guarantee ranks equally in right of payment with all of that subsidiary's
existing and future senior indebtedness and senior in right of payment to all
existing and future subordinated indebtedness of that subsidiary. The 12 3/8%
Notes and the subsidiary guarantees are secured by:

- a second priority lien on all of our United States production facilities
and related assets;

- a second priority pledge of all of the capital stock of each subsidiary
guarantor; and

- a first priority pledge of 65% of the stock of certain of our
subsidiaries incorporated outside of the United States.

As a result of the priming order, the second priority liens held by the
12 3/8% Notes on all of our United States production facilities and related
assets and the capital stock of each subsidiary guarantor became third priority
liens. The priming order does not affect the priority of the pledge held by the
12 3/8% Notes of 65% of the stock of certain of our subsidiaries incorporated
outside of the United States. As discussed above, we anticipate that the priming
order will be appealed by the indenture trustee for the 12 3/8% Notes.

The indentures governing the 13 1/2% Notes, the 12 3/8% Notes, the 11 3/4%
Notes and the 11 1/4% Notes contain numerous covenants, including, but not
limited to, restrictions on our ability to incur indebtedness, pay dividends,
create liens, sell assets, engage in mergers and acquisitions and refinance
existing indebtedness. Upon the filing of the Chapter 11 cases by the Debtors,
an Event of Default occurred under each of the indentures and all of the
indebtedness was accelerated and became immediately due and payable. The Debtors
may pay the indebtedness under the indentures only pursuant to a confirmed plan
of reorganization or order of the Bankruptcy Court. During the pendency of the
Chapter 11 cases, the Debtors will not, for the most part, be subject to the
restrictions contained in any of the indentures.

SASKATOON FACILITY

In July 1997, Sterling Pulp Chemicals (Sask) Ltd., our Canadian subsidiary
that operates our Saskatoon facility, entered into a credit agreement with JP
Morgan Chase of Canada, individually and as administrative agent, and certain
other financial institutions (the "Saskatoon Credit Agreement"). The
indebtedness under the Saskatoon Credit Agreement is secured by substantially
all of the assets of this subsidiary, including the Saskatoon facility. The
Saskatoon Credit Agreement requires that certain amounts of "Excess Cash Flow"
be used to prepay amounts outstanding under the term portion of the credit
facility.

The Saskatoon Credit Agreement provides a revolving credit facility of
Cdn. $8 million to be used by our Saskatoon subsidiary solely for its general
corporate purposes. No borrowings were outstanding under the Saskatoon revolving
credit facility as of September 30, 2001. We believe the credit available under
the Saskatoon revolving credit facility, when added to internally generated
funds and other sources of capital, will be sufficient to meet our Saskatoon
subsidiary's liquidity needs for the reasonably foreseeable future, although we
can give no assurances to that effect.

34

Because of restrictions in the Saskatoon Credit Agreement, we generally do
not have access to the cash flows of our Saskatoon subsidiary. In addition,
because of its designation as an "Unrestricted Subsidiary" under the DIP
Financing, our Prior Revolvers and the indentures for the 13 1/2% Notes, the
12 3/8% Notes, the 11 3/4% Notes and the 11 1/4% Notes, our Saskatoon
subsidiary's results are not considered in determining compliance with the
covenants contained therein.

The Saskatoon Credit Agreement contains provisions which restrict the
payment of advances, loans and dividends from our Saskatoon subsidiary to us or
Chemicals. The most restrictive of these covenants limits such payments during
fiscal 2001 to approximately $1 million, plus any amounts due to us from our
Saskatoon subsidiary under the intercompany tax sharing agreement.

An Event of Default occurred under the Saskatoon Credit Agreement as a
result of the Chapter 11 filings by the Debtors. However, the lenders under the
Saskatoon Credit Agreement executed a forbearance agreement under which they
have temporarily agreed to not exercise their remedies under that agreement. In
connection with obtaining the lenders' agreement to enter into the forbearance
arrangement, the Saskatoon Credit Agreement was amended in several respects,
including the elimination of the exceptions to the provisions restricting the
payment of advances, loans and dividends from our Saskatoon subsidiary to us or
Chemicals and the inclusion of a restriction on our ability to draw upon the
revolving credit facility during the remainder of calendar year 2001. The
Saskatoon subsidiary has not drawn on the revolver since its inception in 1997
and, as of September 30, 2001, has approximately $11.8 million in cash and cash
equivalents on hand. The forbearance agreement expires on December 31, 2001. We
are currently negotiating a waiver and amending agreement with the lenders and
expect to have that agreement executed in the near-term; however, no assurance
can be given that this waiver and amending agreement will be executed or that
the forbearance arrangement will be extended beyond December 31, 2001.

KEY EMPLOYEES

We believe that our success will depend to a significant extent upon the
efforts and abilities of our executive officers and senior management. In
addition, we will continue to depend upon the retention of our key sales and
purchasing personnel to maintain customer and supplier relationships. However,
due to uncertainty about our financial condition, it may be difficult to retain
our key employees or attract qualified replacements. On August 6, 2001, the
Debtors filed a motion with the Bankruptcy Court seeking authorization to
continue existing and implement additional retention and severance plans to
ameliorate the effects of the Chapter 11 filings on our key employees. This
motion was approved on October 31, 2001. Benefits totaling approximately $4.7
million are estimated to be paid during and at the conclusion of the
reorganization process.

STANDBY EQUITY COMMITMENTS

In December 1998, we entered into separate Standby Purchase Agreements with
each of Gordon A. Cain, William A. McMinn, James Crane, Frank P. Diassi, Frank
J. Hevrdejs and Koch Capital Services, Inc. Under each of the Standby Purchase
Agreements, we were able to require the purchasers to purchase shares if we are
able to satisfy certain conditions precedent relating to our financial
condition, and then only if we believed that the equity infusion was necessary
to maintain, reestablish or enhance Chemicals' borrowing rights under its
revolving credit facilities or to satisfy any requirement thereunder to raise
additional equity. As of September 30, 2001, we were not able to meet the
conditions to our ability to draw on the Standby Purchase Agreements and, on
December 15, 2001, they expired in accordance with their terms.

WORKING CAPITAL

Working capital at September 30, 2001 was $71.8 million, a decrease of
$11.7 million from September 30, 2000. Working capital at September 30, 2001
excludes pre-petition liabilities subject to compromise -- see Note 3 of the
Notes to Consolidated Financial Statements included in this Form 10-K.
Significant reductions in accounts receivable and inventory were offset by
reductions in accounts payable and accrued liabilities reflecting market
conditions and lower operating rates. Current portion of long-term debt
increased

35

by $30.7 million primarily due to the Event of Default under the Saskatoon
Credit Agreement discussed above.

CASH FLOW

Net cash provided by our operations was $8.3 million in fiscal 2001, a
decrease of $40 million compared to the net cash provided by our operations in
fiscal 2000. This decrease in net cash resulted primarily from an increase in
net losses between fiscal 2001 and fiscal 2000, primarily from our
petrochemicals business. Net cash flow used in our investing activities was
$16.9 million in fiscal 2001 compared to $28.8 million in fiscal 2000. Net cash
flow provided by our financing activities was $17. 3 million in fiscal 2001
compared to net cash flows used in our financing activities of $26.4 million in
fiscal 2000.

CAPITAL EXPENDITURES

Our capital expenditures were approximately $17 million in fiscal 2001, $29
million in fiscal 2000 and $30 million in fiscal 1999. Our capital expenditures
in fiscal 2001 were primarily related to routine safety, environmental and
replacement capital. Our capital expenditures in fiscal 2000 were primarily
related to the DSIDA project, a water disposal project and routine safety,
environmental and replacement capital. Our fiscal 1999 capital expenditures were
primarily related to the acetic acid expansion, our project to reduce the levels
of phenylacetylene, or "PA," in the styrene produced at our Texas City facility
and routine safety, environmental and replacement capital.

Capital expenditures are expected to be approximately $30 to $35 million in
fiscal 2002, with about $20 to $25 million dedicated to our petrochemicals
business and approximately $10 million dedicated to our pulp chemicals business.
These capital expenditures will primarily be for routine safety, environmental
and replacement capital.

Our capital expenditures for environmentally-related prevention,
containment and process improvements were $1 million for both fiscal 2001 and
fiscal 2000. We anticipate spending approximately $2 to 4 million on these types
of expenditures during fiscal 2002. During fiscal 2001 and fiscal 2000, we did
not incur any other infrequent or non-recurring material environmental
expenditures which were required under existing environmental regulations. See
"Certain Known Events, Trends, Uncertainties and Risk Factors."

NEW ACCOUNTING STANDARDS

Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,"
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. As of October 1, 2000, the transition adjustment related to
the adoption of these statements was not material.

We have an agreement relating to the supply of a portion of the electrical
energy at one of our Canadian sodium chlorate production facilities. This
agreement, which was previously designated as a normal purchase under SFAS No.
133, does not meet the criteria of a normal purchase based on guidance issued by
the Derivative Implementation Group (the "DIG") and cleared by the Financial
Accounting Standards Board in June 2001. All purchases under this agreement,
which expires on December 31, 2001, are used in the ordinary course of business;
however, effective July 1, 2001, this agreement is required to be
marked-to-market. At September 30, 2001, the value of this agreement was a loss
of approximately $1.2 million based on current market prices and quantities to
be delivered.

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires that all business combinations be accounted for
under the purchase method and requires separate identification and recognition
of intangible assets, other than goodwill. The statement applies to all business
combinations initiated after June 30, 2001.

36

SFAS No. 142 requires that an intangible asset that is acquired shall be
initially recognized and measured based on its fair value. The statement also
provides that goodwill should not be amortized, but shall be tested for
impairment annually, or more frequently if circumstances indicate potential
impairment, through a comparison of fair value to its carrying amount. SFAS No.
142 is effective for fiscal periods beginning after December 15, 2001.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, "Accounting for Asset Retirement Obligations." SFAS No. 143, which must be
applied to fiscal years beginning after June 15, 2002, addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. We are in
the process of evaluating the impact of SFAS No. 143 on our financial
statements.

In August 2001, the Financial Accounting Standards Board issued SFAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which
addresses financial accounting and reporting for the impairment of long-lived
assets and for long-lived assets to be disposed of. SFAS 144 is effective for
fiscal years beginning after December 15, 2001, with early adoption permitted.
We are currently evaluating the provisions of SFAS No. 144.

We do not believe that the adoption of SFAS No. 141, 142, 143 or 144 will
have a significant impact on our financial statements.

CERTAIN KNOWN EVENTS, TRENDS, UNCERTAINTIES AND RISK FACTORS

THERE ARE SIGNIFICANT UNCERTAINTIES RELATING TO OUR BANKRUPTCY PROCEEDINGS.

Our future results are dependent upon the successful confirmation and
implementation of a plan of reorganization. We have not yet submitted such a
plan to the Bankruptcy Court for approval and cannot make any assurances that we
will be able to obtain any such approval in a timely manner. Failure to obtain
this approval in a timely manner could adversely affect our operating results,
as our ability to obtain financing to fund our operations and our relations with
our customers and suppliers may be harmed by protracted bankruptcy proceedings.
Furthermore, we cannot predict the ultimate amount of all settlement terms for
our liabilities that will be subject to a plan of reorganization. The deadline
for filing proofs of claim against the Debtors was December 17, 2001 (or January
14, 2002 in the case of governmental units). We are currently reviewing the
proofs of claim filed against the Debtors and, in the event that the amount of
claims asserted in filed proofs of claim exceed the $1,070.5 million in accrued
liabilities recorded in the Consolidated Financial Statements as of September
30, 2001 as "Pre-petition liabilities subject to compromise" and "Pre-petition
liabilities not subject to compromise," we believe the excess will be
attributable to claims that are duplicative or without merit and will not have a
material effect on the Consolidated Financial Statements. Once a plan of
reorganization is approved and implemented, our operating results may be
adversely affected by the possible reluctance of prospective lenders, customers
and suppliers to do business with a company that recently emerged from
bankruptcy proceedings.

Other negative consequences that could arise as a result of the bankruptcy
proceedings include:

- making us more vulnerable to a continued downturn in our industry or a
downturn in the economy in general;

- limiting our flexibility in planning for, or reacting to, changes in our
businesses and the industries in which we operate;

- the incurrence of significant costs associated with the reorganization;

- impacts on the availability of raw materials and payment terms from our
suppliers;

- impacts on our relationship with suppliers and customers, including loss
of confidence in our ability to fulfill contractual obligations due to
financial uncertainty;

- placing us at a competitive disadvantage compared to our competitors;

37

- limiting our ability to borrow additional funds; and

- employee attrition.

WE ARE HIGHLY LEVERAGED AND HAVE SUBSTANTIAL DEBT OBLIGATIONS.

We are currently in default under many of our pre-petition debt
obligations. During the pendency of our bankruptcy proceedings, the Debtors may
obtain post-petition debt financing only with the approval of the Bankruptcy
Court and have already obtained approval for the DIP Financing discussed above.
As of December 14, 2001, there have been $48.8 million cash borrowings made
under the DIP Financing and letters of credit in the aggregate amount of $4.4
million have been issued under the DIP Financing, leaving unused borrowing
capacity under the DIP Financing, after giving affect to the priming order, of
approximately $57 million. Unless amended, the DIP Financing matures on the
earlier of July 19, 2003 or the effective date of a plan of reorganization.

Depending on the resolution of our bankruptcy proceedings, we could emerge
from bankruptcy highly leveraged with substantial debt service obligations. Thus
we would continue to be particularly susceptible to adverse changes in our
industry, the economy and the financial markets. In addition, our ability to
obtain additional debt financing after emergence may be limited by restrictive
covenants under the terms of credit agreements and any other debt instruments.
Those limits on financing may restrict our ability to service our debt
obligations through additional debt financing if cash flow from operations is
insufficient to service such obligations.

WE HAVE LIMITED LIQUIDITY, WHICH MAY PROVE INADEQUATE DURING OUR
REORGANIZATION PROCESS.

The Debtors are currently funding their liquidity needs out of operating
cash flow and from borrowings under the DIP Financing. The DIP Financing is
limited in amount and is also subject to numerous funding conditions which are
largely beyond the control of the Debtors, including borrowing base requirements
and compliance with the EBITDA covenant contained in the DIP Financing. The
ability of the Debtors to obtain additional financing during the reorganization
process is severely limited by a variety of factors, including the debt
incurrence restrictions imposed by the DIP Financing, numerous procedural
requirements and uncertainties relating to the bankruptcy proceedings, including
any continuing challenge to the priming order, and the Debtors' current
financial condition and prospects. Accordingly, no assurances can be given that
the Debtors' existing sources of liquidity will be adequate to fund their
liquidity needs throughout the reorganization process or, if additional sources
of liquidity become necessary during the reorganization process, that they would
be available to the Debtors or adequate. Any liquidity shortages during the
reorganization process would likely have a material adverse effect on the
Debtors' business and financial condition as well as their ability to
successfully restructure and emerge from bankruptcy.

THE INDUSTRIES IN WHICH WE PARTICIPATE ARE CYCLICAL AND DEPRESSED MARKET
CONDITIONS FOR OUR MAJOR PRODUCTS CAN NEGATIVELY AFFECT OUR BUSINESS AND MAKE
IT DIFFICULT FOR US TO RESTRUCTURE SUCCESSFULLY.

Demand for our petrochemicals and pulp products are cyclical and are
influenced by, among other things, the health of the global economy and changes
in overall supply relative to demand. An economic slowdown or a prolonged
downturn in our petrochemicals markets will impact both the sales volumes and
sales prices of our products and could have a material adverse effect on our
financial results. As prices decline, our profit margins generally decrease,
which adversely affects our business and our cash flows. Large global capacity
additions of styrene and acrylonitrile were completed between 1997 and 2001. For
styrene, approximately eight billion pounds of net new capacity was added and,
for acrylonitrile, approximately three billion pounds of net new capacity was
added. Further, reduced operating rates at North American pulp mills have
reduced the rate of demand growth in North America for our pulp chemicals
products and services. The resulting impact on prices and margins negatively
impacted our pulp chemicals' results in fiscal 1998, 1999 and 2001 and could
negatively impact our results in the future. If the markets for our primary
petrochemicals products worsen, it will be more difficult for us to successfully
restructure and emerge from bankruptcy.

38

THE PETROCHEMICALS, ACRYLIC FIBERS AND PULP CHEMICALS INDUSTRIES ARE HIGHLY
COMPETITIVE.

Many of our competitors, particularly in the petrochemicals industry, are
larger and have substantially greater financial resources than we have. We
compete with some of the world's largest chemical companies, many of whom, in
contrast to us, supply much of their own raw materials requirements. In
addition, a significant portion of our petrochemicals business is based upon
widely available technology. The entrance of new competitors into the industry
or the addition by existing competitors of new capacity may reduce our ability
to maintain profit margins or preserve our market share, even during periods of
increased demand for our petrochemical products.

OUR BUSINESS MAY BE ADVERSELY AFFECTED BY DEREGULATION OF ELECTRIC POWER OR IF
WE ARE UNABLE TO OBTAIN RAW MATERIALS AND ENERGY RESOURCES FROM THIRD-PARTY
SUPPLIERS AT REASONABLE PRICES OR ON ACCEPTABLE TERMS.

For most of our products, the combined cost of raw materials and energy
resources, including utilities in the case of pulp chemicals, is far greater
than all other costs of production combined. Therefore, an adequate supply of
raw materials at reasonable prices and on acceptable terms is critical to the
success of our business. If we are unable to obtain raw materials at reasonable
prices and on acceptable terms, our results of operations would be negatively
impacted. Most of the raw materials we use are supplied by others and many of
them are subject to wide price fluctuations for a variety of reasons beyond our
control. For example, changes in the availability of these products may result
from major capacity additions or significant facility operating problems. The
current trend towards deregulation of electric power makes our short-term future
cost for electric power uncertain. Electricity is the largest cost of
manufacturing sodium chlorate. In addition, natural gas is a significant cost of
production for some of our petrochemicals and pulp chemicals, as well as for our
suppliers of raw materials. Significant increases in natural gas prices may
increase our total costs of production and we may not be able to recover this
increase in costs through higher selling prices. We can give no assurances that
we will continue to be able to secure adequate supplies of electric power or any
of our raw materials or energy resources at reasonable prices or on acceptable
terms.

OUR INDUSTRY IS SUBJECT TO EXTENSIVE ENVIRONMENTAL REGULATION, WHICH CREATES
UNCERTAINTY REGARDING FUTURE ENVIRONMENTAL EXPENDITURES AND LIABILITIES.

Our operations involve the handling, production, transportation, treatment
and disposal of materials that are classified as hazardous or toxic waste and
that are extensively regulated by environmental and health and safety laws,
regulations and permit requirements. These regulations, and the potential for
further expanded regulations may increase our costs and thereby negatively
affect our business. Environmental permits required for our operations are
subject to periodic renewal and can be revoked or modified for cause or when new
or revised environmental requirements are implemented. Changing and increasingly
strict environmental requirements and the potential for further expanded
regulation may increase our costs and thereby negatively affect our business.
Changing and increasingly strict environmental requirements can affect the
manufacturing, handling, processing, distribution and use of our products and,
if so affected, our business and operations may be materially and adversely
affected. In addition, changes in these requirements may cause us to incur
substantial costs in upgrading or redesigning our facilities and processes,
including our waste treatment, storage, disposal and other waste handling
practices and equipment. For these reasons, we are uncertain as to the amount of
our future environmental expenditures and liabilities. In addition, the Texas
Natural Resource Conservation Commission has enacted new regulations requiring
significant reductions of nitrogen oxide which will apply to our Texas City
facility. The TNRCC is also expected to propose similar regulations requiring
the reduction of particulate matter which will apply to our Texas City facility.
The nitrogen oxide regulations covering the Houston/Galveston Area State
Implementation Plan were approved by the United States Environmental Protection
Agency on October 15, 2001. Under these regulations, we are required to reduce
emissions of nitrogen oxide at our Texas City facility by up to approximately
90%, which we estimate would require Chemicals to make between $25 million and
$30 million in capital improvements at our Texas City facilities. The majority
of these capital expenditures would be expected in fiscal 2002 through 2005.

39

THE REGULATORY OUTLOOK FOR OUR PULP CHEMICALS BUSINESS IS UNCERTAIN.

Our pulp chemicals business is sensitive to environmental regulations.
Regulations restricting, but not completely banning, absorbable organic halides
and other chlorine derivatives in bleach plant effluent have a favorable effect
on our pulp chemicals business. Conversely, any significant ban on all
chlorine-containing compounds in the pulp bleaching process could have a
material adverse effect on our financial condition and results of operations.
British Columbia has a regulation in place requiring elimination of the use of
all chlorine products, including chlorine dioxide, in the bleaching process by
the year 2002. The pulp and paper industry believes that a ban of chlorine
dioxide in the bleaching process will yield no measurable environmental or
public health benefit and is working to change this regulation. In April 2001, a
new government came into power in British Colombia. This new administration is
aware of the issues surrounding this regulation and has agreed to negotiate
amendments to the regulation. We are working through the Alliance for
Environmental Technology and the Canadian Chemical Producers' Association to
provide information to the British Columbia Ministry of Environment to assist
with these negotiations.

WE ARE SUBJECT TO MANY OPERATING RISKS, SOME OF WHICH MAY NOT BE COVERED BY
INSURANCE.

A business risk inherent in all chemical operations is the potential for
personal injury and property damage claims from employees, contractors and their
employees and nearby landowners and occupants. While we attempt to operate our
facilities responsibly and in compliance in all material respects with all
applicable environmental and health and safety requirements, we may face
expenses and liabilities as a result of our past or future operations. Some risk
of environmental costs and liabilities is inherent in our operations and
products, as it is with other companies engaged in similar businesses, and we
maintain insurance at levels that we believe are typical for our industry. A
major incident or other event at any of our facilities, however, could result in
liabilities in excess of our insurance coverages or uncovered liabilities or
claims beyond the financial ability of the insurance carrier to pay. All of our
facilities have strengthened their respective security programs since September
11, 2001, however the eventual exclusion of terrorism coverage from our policies
could result in an uninsured loss.

CURRENT AND FUTURE LEGAL PROCEEDINGS MAY HAVE UNFAVORABLE OUTCOMES.

We are currently a party to several legal proceedings and additional legal
proceedings could be filed against us in the future. We are not able to predict
the final outcome of the current proceedings and we cannot guarantee that the
ultimate resolution of current or future proceedings will not have a material
adverse effect on us. Legal proceedings in which claims against the Debtors that
existed prior to the filing of Chapter 11 cases are asserted are subject to the
automatic stay, and any such claims would be payable from assets of the Debtors
only pursuant to a confirmed plan of reorganization or order of the Bankruptcy
Court. For more information, see Note 8 of the Notes to Consolidated Financial
Statement included in this Form 10-K.

WE DEPEND UPON THE CONTINUED OPERATION OF OUR TEXAS CITY FACILITY.

All of the petrochemicals we manufacture, including all of our styrene,
acrylonitrile and acetic acid, are produced at our Texas City facility.
Significant unscheduled downtime at our Texas City facility could have a
material adverse effect on our results. Unanticipated downtime can occur for a
variety of reasons, including equipment breakdowns, interruptions in the supply
of raw materials, power failures, sabotage, natural forces or other normal
hazards associated with the production of petrochemicals. Although we maintain
business interruption insurance, we cannot guarantee that a significant
interruption in the operation of our Texas City facility would be covered by
this insurance or would not otherwise have a material adverse effect on us.

WE DEPEND UPON OUR LONG-TERM CONTRACTS AND SIGNIFICANT CUSTOMERS.

We sell significant portions of our acrylonitrile and styrene production
and all of our acetic acid and plasticizers production under long-term
contracts. These contracts are intended to provide stability in the event that
the demand for or prices of these products decline significantly, but also limit
our ability to take full advantage of attractive market conditions during
periods of higher prices for these products. The loss of one or

40

more of these contracts, or a material reduction in the amount of product
purchased under one or more of these contracts, could have a material adverse
effect on us.

WE FACE RISKS RELATED TO OUR FOREIGN OPERATIONS THAT MAY NEGATIVELY AFFECT OUR
BUSINESS.

Approximately 31% of our fiscal 2001 revenues were derived from our
Canadian-based pulp chemicals business and approximately 24% were derived from
export sales of our products. Our international operations and exports to
foreign markets make us subject to a number of special risks such as:

- currency exchange rate fluctuations;

- foreign economic conditions;

- trade barriers;

- exchange controls;

- national and regional labor strikes;

- political risks and risks of increases in duties;

- taxes;

- governmental royalties; and

- changes in laws and policies governing operations of foreign-based
companies.

The occurrence of any one or a combination of these factors may increase our
costs or have other negative effects on our business. In addition, earnings of
foreign subsidiaries and intercompany payments are subject to foreign income tax
rules that may reduce cash flow available to meet our required debt service and
other obligations.

As we derive most of our pulp chemicals revenues from production and sales
by our subsidiaries within Canada, we have organized our subsidiary structure
and our operations in part based on assumptions regarding various Canadian tax
laws, currency exchange laws, capital repatriation laws and other relevant laws.
While we believe that these assumptions are correct, we cannot guarantee that
Canadian taxing or other authorities will reach the same conclusion. If our
assumptions are incorrect, or if the Canadian government changes or modifies
such laws or the current interpretations thereof, we may suffer material adverse
tax and financial consequences.

A portion of our expenses and sales are denominated in Canadian dollars
and, accordingly, our revenues, cash flows and earnings may be affected by
fluctuations in the exchange rate between the United States dollar and the
Canadian dollar, which may also have material adverse tax consequences. These
currency fluctuations could have a material adverse impact on us as increases in
the value of the Canadian dollar relative to the United States dollar have the
effect of increasing the United States dollar equivalent of cost of goods sold
and other expenses with respect to our Canadian production facilities.

RESTRICTIONS ON ABILITY TO MOVE FUNDS BETWEEN DEBTORS AND OTHER SUBSIDIARIES
MAY NEGATIVELY AFFECT LIQUIDITY.

As a result of the provisions contained in the DIP Financing, the Canadian
Financing Agreement and the Saskatoon Credit Agreement, our ability to transfer
funds between the Debtors and our subsidiaries not in bankruptcy is severely
limited. These restrictions could negatively affect our liquidity and that of
our non-debtor subsidiaries.

FUTURE PROBLEMS WITH LABOR RELATIONS MAY NEGATIVELY AFFECT OUR BUSINESS.

Approximately 42% of our employees are covered under various union
contracts. Approximately 47% of our employees at our Texas City facility are
covered by one union contract which expires on May 1, 2002. This contract
continues to be in effect notwithstanding our Chapter 11 filings. Although we
have the right to reject

41

this contract under the Bankruptcy Code, any rejection would be subject to the
special provisions of the Bankruptcy Code governing collective bargaining
agreements.

Approximately 77% of our employees at our Saskatoon facility are covered by
one union contract which is subject to renegotiation in September 2004.
Approximately 76% of our employees at our Vancouver facility are covered by a
union contract which is subject to renegotiation in November 2003. Neither of
the Canadian union contracts are affected by the Chapter 11 case.

Although we believe our relationship with our employees is generally good,
a strike by one or more of the unions representing our employees could have a
material adverse effect on our financial condition, results of operations or
cash flows.

RESULTS OF OPERATIONS

The following table sets forth revenues, gross profit (loss) and operating
income (loss) for our segments for the years ended September 30, 2001, 2000 and
1999.

COMPARISON OF FISCAL 2001 TO FISCAL 2000

Our revenues were approximately $744 million in fiscal 2001, a decrease of
32% from the approximately $1,096 million in revenues we recorded in fiscal
2000. This decrease in revenues resulted primarily from lower styrene and
acrylonitrile sales volumes and sales prices. We recorded a net loss
attributable to common stockholders of approximately $224 million, or $17.27 per
share, for fiscal 2001, compared to the net loss attributable to common
stockholders of approximately $90 million, or $7.13 per share, that we recorded
for fiscal 2000. Chemicals' net loss was approximately $182 million for fiscal
2001, compared to a net loss of approximately $64 million for fiscal 2000. This
increase in net loss was primarily due to the level of net loss from our styrene
and acrylonitrile operations, along with the additional valuation allowance
taken for our deferred tax assets.

Revenues, Gross Profit (Loss) and Operating Income (Loss)

Petrochemicals. Revenues from our petrochemicals operations were
approximately $515 million in fiscal 2001, a decrease of approximately 41% from
the $870 million in revenues received in fiscal 2000. This decrease in revenues
was caused primarily by decreases in styrene and acrylonitrile sales volumes and
prices and decreased methanol sales volumes in fiscal 2001. Our petrochemicals
operations recorded an operating loss of approximately $89 million for fiscal
2001, whereas these operations recorded operating income of

42

approximately $5 million for fiscal 2000. This difference resulted primarily
from lower styrene and acrylonitrile sales volumes and prices, as well as higher
energy costs.

Revenues from our styrene operations were approximately $257 million in
fiscal 2001, a decrease of approximately 48% from the approximately $492 million
in revenues from these operations during fiscal 2000. Sales prices for styrene
during fiscal 2001 decreased approximately 24% from those realized during fiscal
2000. In addition, our total sales volumes for styrene in fiscal 2001 decreased
approximately 31% from those realized during fiscal 2000. These decreases in
sales prices and sales volumes resulted primarily from a continued slowdown in
demand attributable, to a large extent, to a slowdown in general worldwide
economic activity. During fiscal 2001, prices for benzene, one of the primary
raw materials for styrene, were approximately 9% lower than the prices we paid
for benzene in fiscal 2000 and prices for ethylene, the other primary raw
material for styrene, were approximately 8% lower than the prices we paid for
ethylene in fiscal 2000. Average costs for natural gas during fiscal 2001
increased 78% compared to average costs during fiscal 2000. Margins on our
styrene sales during fiscal 2001 decreased from those realized during fiscal
2000, primarily as a result of the decrease in sales prices and volumes and the
increase in energy costs, partially offset by the decreases in the costs of
benzene and ethylene.

Revenues from our acrylonitrile and derivatives operations were
approximately $87 million in fiscal 2001, a decrease of approximately 47% from
the approximately $164 million in revenues from those operations in fiscal 2000.
Total sales volumes of our acrylonitrile decreased approximately 61% in fiscal
2001 compared to fiscal 2000 due to our continued shutdown of our acrylonitrile
facility for most of fiscal 2001 due to unfavorable market conditions. Direct
sales prices for acrylonitrile in fiscal 2001 decreased approximately 10% from
those realized in fiscal 2000. During fiscal 2001, prices for propylene, one of
the primary raw materials for acrylonitrile, were approximately 4% higher than
the prices we paid for propylene during fiscal 2000 and prices for ammonia, the
other primary raw material for acrylonitrile, were approximately 28% higher than
the prices we paid for ammonia in fiscal 2000. Margins on our acrylonitrile
sales in fiscal 2001 decreased from those realized in fiscal 2000, primarily as
a result of higher raw materials costs and lower operating rates.

Revenues from our acrylic fibers operations were approximately $47 million
in fiscal 2001, a decrease of approximately 35% from the approximately $73
million in revenues from these operations during fiscal 2000. Sales volumes of
our acrylic fibers during fiscal 2001 decreased approximately 42% from those
experienced in fiscal 2000. Sales prices for our acrylic fibers in fiscal 2001
increased approximately 14% from those realized during fiscal 2000. These
decreases in revenues and sales volumes resulted primarily from our withdrawal
from the traditional commodity textile business in the third quarter of fiscal
2001 and corresponding significant reduction in our operations at our acrylic
fibers plant. We continue to produce our specialty and technical fibers products
at this facility.

Revenues from our other petrochemicals operations, including acetic acid,
plasticizers, and methanol, were $124 million in fiscal 2001, a decrease from
the $141 million in revenues from these operations during fiscal 2000. Our other
petrochemicals operations reported an increase in operating earnings for fiscal
2001 compared to that realized during fiscal 2000, primarily due to the positive
impact of our methanol plant shutdown and the benefit of our methanol
requirements contract. Also favorably impacting operating income during fiscal
2001 were net proceeds of $3 million recorded in connection with a dispute
related to the construction of our methanol facility, the proceeds of which were
received in April of 2001.

Pulp Chemicals. Revenues from our pulp chemicals operations were
approximately $229 million in fiscal 2001, an increase of approximately 1% from
the approximately $226 million in revenues from these operations during fiscal
2000. An increase in sodium chlorate revenue was partially offset by a reduction
in chlorine dioxide generator royalties. Sales prices of our sodium chlorate
increased approximately 6% during fiscal 2001 compared to fiscal 2000, while
sodium chlorate sales volumes increased approximately 2% during this period. Our
pulp chemicals operations recorded operating income of approximately $42 million
in fiscal 2001 compared to operating income of approximately $35 million during
fiscal 2000. These increases in revenues, sales prices, sales volumes and
operating income resulted primarily from the continued conversion to elemental
chlorine free bleaching at pulp mills.

43

Selling, General and Administrative ("SG&A") Expenses

Our SG&A expenses in fiscal 2001 were approximately $25 million, compared
to approximately $39 million in fiscal 2000. This decrease was primarily the
result of the accrual in fiscal 2000 of variable compensation related to our
fiscal 2000 financial performance with no corresponding accruals in fiscal 2001,
cost reductions in our acrylic fibers business and general cost containment
efforts.

Other Expense

We incurred other expense of approximately $3 million in fiscal 2001, which
was primarily for professional fees incurred in preparation of our filing for
reorganization under Chapter 11, compared to the $2 million incurred in fiscal
2000 related to the workforce reductions in our acrylic fibers operations.

Reorganization Items

Reorganization items incurred during fiscal 2001 were approximately $5.4
million, which was primarily for professional fees incurred after our filing for
reorganization under Chapter 11.

Interest and Debt Related Expenses

Interest and debt related expenses were approximately $113.4 million in
fiscal 2001 compared to $122.4 million in fiscal 2000. This reduction was due to
the fact that after the Chapter 11 filings, interest on liabilities subject to
compromise was not accrued. The contractual interest expense not accrued during
fiscal 2001 due to the Chapter 11 filings was $15.3 million.

Provision (Benefit) for Income Taxes

As of September 30, 2001, we had an available U.S. net operating loss
carryforward ("U.S. NOL") of approximately $318 million, which expires during
2018-21. In assessing the value of the deferred tax assets, management considers
whether it is more likely than not that all of the deferred tax assets will be
realized. Projected future income tax planning strategies and the expected
reversal of deferred tax liabilities are considered in making this assessment
and determining the valuation allowance. In fiscal 2001, based on the
uncertainty as to the effect of the Chapter 11 filings on the utilization of the
U.S. NOL and the future realization of other net deferred tax assets, we were
not able to conclude that it was more likely than not that we would be able to
realize the future benefit of our U.S. deferred tax assets. Certain reductions
to our U.S. NOL may result from confirmation of our plan of reorganization.
Further, at such time as we emerge from bankruptcy, we will likely undergo an
ownership change for tax purposes which may cause our utilization of the U.S.
NOL to become subject to limitations. Since numerous variables could affect the
bankruptcy proceedings (including the fact that a plan of reorganization has not
yet been submitted to the Bankruptcy Court for approval), it is not currently
possible to determine whether our U.S. NOL will produce tax benefits in the
future. Accordingly, an additional valuation allowance of $116.3 million was
recorded during fiscal 2001, of which Chemicals' was approximately $91.7
million, thus bringing the total valuation allowance as of September 30, 2001 to
$149.8 million. The ability to utilize part or all of our currently estimated
$318 million U.S. NOL will be an important consideration in developing our plan
of reorganization. However, the success of such strategies may depend on the
terms of the plan of reorganization as accepted by creditors and confirmed by
the Bankruptcy Court. Accordingly, there can be no assurances that such
strategies will be successful.

COMPARISON OF FISCAL 2000 TO FISCAL 1999

Our revenues were approximately $1,096 million in fiscal 2000, an increase
of approximately 48% from the approximately $740 million in revenues we received
in fiscal 1999. This increase in our revenues resulted primarily from increased
styrene sales prices and sales volumes and, to a lesser extent, increased
acrylonitrile, sodium chlorate and methanol sales prices and sales volumes. We
recorded a net loss attributable to common stockholders of approximately $90.0
million, or $7.13 per share, for fiscal 2000 compared to the net loss
attributable to common stockholders of approximately $112.7 million, or $8.94
per share, that we recorded for
44

fiscal 1999. Our improved performance was primarily due to increased styrene
margins and sales volumes and, to a lesser extent, increased acrylonitrile and
sodium chlorate margins and sales volumes. Our improved performance was
partially offset by increased interest expense and a $60 million non-cash charge
related to the write down of our acrylic fibers business production assets. Our
performance in fiscal 1999 was negatively impacted by a $26 million non-cash
charge related to the write down of our methanol production assets.

Revenues, Gross Profit and Operating Income (Loss)

Petrochemicals. Revenues from our petrochemicals operations were
approximately $870 million in fiscal 2000, an increase of approximately 63% from
the approximately $533 million in revenues we received from these operations in
fiscal 1999. This increase in revenues resulted primarily from increased styrene
sales prices and sales volumes and, to a lesser extent, increased acrylonitrile
and methanol sales prices and sales volumes. Our petrochemicals operations
recorded operating income of approximately $5 million for fiscal 2000, compared
to operating losses of approximately $64 million from our petrochemicals
operations for fiscal 1999. This increase in income resulted primarily from
increased styrene margins and sales volumes and, to a lesser extent, increased
acrylonitrile margins and sales volumes, partially offset by a larger impairment
expense recorded in fiscal 2000 than that recorded in fiscal 1999.

Revenues from our styrene operations were approximately $492 million in
fiscal 2000, an increase of approximately 100% from the approximately $246
million in revenues we received from these operations in fiscal 1999. Average
sales prices for our styrene increased approximately 78% in fiscal 2000 from
average sales prices for our styrene in fiscal 1999. In addition, sales volume
of our styrene increased approximately 17% for fiscal 2000 from sales volumes of
our styrene for fiscal 1999. These increases in revenues, sales prices and
volumes for our styrene resulted primarily from the combination of stronger
market demand, operating problems experienced at several of our competitors and
generally low inventory levels worldwide. However, styrene market conditions
peaked in April of 2000 with spot prices of $0.48 per pound and decreased to
$0.31 per pound as of September 30, 2000. During fiscal 2000, prices for
benzene, one of the primary raw materials for styrene, were approximately 56%
higher than the prices we paid for benzene in fiscal 1999 and prices for
ethylene, the other primary raw material for styrene, were approximately 47%
higher than the prices we paid for ethylene in fiscal 1999. Margins on our
styrene sales during fiscal 2000 increased from margins on our styrene sales
during fiscal 1999, primarily as a result of higher sales prices, which more
than offset our higher raw materials costs.

Revenues from our acrylonitrile and derivatives operations, including
sodium cyanide and TBA, were approximately $164 million in fiscal 2000, an
increase of approximately 76% from the approximately $93 million in revenues we
received from these operations in fiscal 1999. Average sales prices for our
acrylonitrile increased approximately 122% in fiscal 2000 from average sales
prices for our acrylonitrile in fiscal 1999. Sales volume of our acrylonitrile
increased approximately 19% in fiscal 2000 from sales volumes of our
acrylonitrile in fiscal 1999. These increases in revenues, sales prices and
volumes for our acrylonitrile resulted primarily from the combination of
stronger market demand, operating problems experienced at several of our
competitors and generally low inventory levels worldwide. During fiscal 2000,
prices for propylene, one of the primary raw materials for acrylonitrile, were
approximately 79% higher than the prices we paid for propylene in fiscal 1999
and prices for ammonia, the other primary raw material for acrylonitrile, were
approximately 27% higher than the prices we paid for ammonia in fiscal 1999.
Margins on our acrylonitrile sales during fiscal 2000 increased from the margins
we received in fiscal 1999, primarily as a result of higher sales prices, which
more than offset our higher raw materials costs.

Revenues from our other petrochemicals operations, including acetic acid,
plasticizers and methanol, were approximately $141 million in fiscal 2000, an
increase of approximately 12% from the approximately $126 million in revenues we
received from these operations in fiscal 1999. This increase in revenues was
primarily due to increased methanol volumes and sales prices during the first
nine months of fiscal 2000. Our other petrochemicals operations reported a
decrease in operating earnings in fiscal 2000 compared to fiscal 1999. This
decrease in operating earnings resulted primarily from a reduction in margins
for our plasticizers and acetic acid caused by higher raw material and energy
costs.

45

Revenues from our acrylic fibers operations were approximately $73 million
in fiscal 2000, an increase of approximately 6% from the approximately $69
million in revenues we received from these operations in fiscal 1999. Sales
volumes of our acrylic fibers in fiscal 2000 increased 6% from those realized
during fiscal 1999. Sales prices for our acrylic fibers in fiscal 2000 remained
approximately the same with those realized in fiscal 1999. The financial
performance of our acrylic fibers operations in fiscal 2000 was below the
performance of these operations in fiscal 1999 due to weak market conditions,
imports from foreign suppliers and higher acrylonitrile and energy costs.

Pulp Chemicals. Revenues from our pulp chemicals operations were
approximately $226 million for fiscal 2000, an increase of approximately 9% from
the approximately $207 million in revenues we received from these operations in
fiscal 1999. Sales volumes of our sodium chlorate, our primary pulp chemical
product, in fiscal 2000 increased approximately 7% from those realized in fiscal
1999. Sales prices of our sodium chlorate in fiscal 2000 increased approximately
4% from those realized in fiscal 1999. Our pulp chemicals operations recorded
operating earnings of approximately $35 million in fiscal 2000, compared to
operating earnings of approximately $27 million in fiscal 1999. These increases
in revenues, sales volumes, sales prices and operating earnings resulted
primarily from increased operating rates at pulp mills and the continued
conversion to elemental chlorine free bleaching at pulp mills.

Selling, General and Administrative Expenses

Our SG&A expenses in fiscal 2000 were approximately $39 million, whereas we
had SG&A expenses of approximately $38 million in fiscal 1999. Our SG&A expenses
were impacted favorably in fiscal 2000 by reduced costs for upgrades of certain
of our information technology systems, including year 2000 compliance
activities. However, these positive impacts were more than offset by increased
costs in fiscal 2000 primarily related to an increase in variable compensation
accrued as a result of improved business performance.

Other Expense

We had other expense of approximately $2 million in fiscal 2000 related to
workforce reductions in our acrylic fibers operations. We had other expense of
approximately $11 million in fiscal 1999 from one-time non-cash charges related
to early retirement programs, benefit changes and workforce reductions.

Interest and Debt Related Expenses

Our interest and debt related expense was approximately $122 million for
fiscal 2000 compared to approximately $104 million in fiscal 1999. This increase
resulted primarily from the higher interest rates we paid on some of our
indebtedness after we refinanced that indebtedness in July of 1999 and the
payment of interest on additional indebtedness we incurred at that time.

Provision (Benefit) for Income Taxes

Our provision for income taxes in fiscal 2000 was approximately $5 million,
reflecting the foreign tax provision on the income of our Canadian subsidiaries.
Due to the recurring losses of our United States subsidiaries, in fiscal 2000 we
recorded a valuation allowance in an amount equal to the benefit for income
taxes generated by the losses from our United States subsidiaries. Our benefit
for income taxes in fiscal 1999 was approximately $35 million.

Extraordinary Item

We had a $4 million after-tax ($6 million pre-tax) extraordinary item in
fiscal 1999 related to unamortized debt issue costs which were expensed in
fiscal 1999 as a result of the refinancing of some of our indebtedness in July
of 1999.

46

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

The table below provides information about our market sensitive financial
instruments and constitutes a "forward-looking statement." The table excludes
pre-petition debt of the Debtors due to the uncertainty related to the ultimate
resolution of these liabilities during the Chapter 11 proceedings. Our major
financial market risk exposure is changing interest rates, primarily in the
United States. Interest rate swaps may be used to adjust interest rate exposure,
when appropriate, based upon market conditions. A portion of our borrowings and
transactions are denominated in foreign currencies which exposes us to market
risk associated with exchange rate movements. All items described stated in
United States dollars.

- ---------------

(a) Borrowings under our fixed assets revolver bear interest, at our option, at
an annual rate of either the "LIBOR Rate" plus 3.75% or the "Alternate Base
Rate" plus 2.25%. Borrowings under our current assets revolver bear
interest, at our option, at an annual rate of either the LIBOR Rate plus
3.50% or the Alternate Base Rate plus 2.00%. The "Alternate Base Rate" is
equal to the greater of the "Base Rate" as announced from time to time by
The Chase Manhattan Bank in New York, New York or the "Federal Funds
Effective Rate" plus 1/2%. At September 30, 2001, the weighted average
interest rate in effect for our fixed assets revolver was 7.2% and there
were no amounts outstanding under our current assets revolver.

(b) Expected maturity amounts represent notional amounts. Fair value of
September 30, 2001 represents unrealized gain (loss). The interest rate
swap converts interest on $8.9 million of debt from a floating rate, based
on LIBOR, to a fixed rate of 6.7%.

(c) The Saskatoon tranche A term loan, which is denominated in Canadian
dollars, and the Saskatoon revolver borrowings bear interest, at
Saskatoon's option, at an annual rate of either the "Bankers Acceptance
Rate" or the "Base Rate" plus an "Applicable Margin" of 2.5% and 1.5%,
respectively, through September 30, 2001 and 3.0% and 2.0%, respectively,
thereafter. The Saskatoon tranche B term loan, which is denominated in
United States dollars, bears interest, at Saskatoon's option, at an annual
rate of either the "Eurodollar Rate" or the "Base Rate" plus an Applicable
Margin of 3.0% and 2.0% respectively, through September 30, 2001 and 3.5%
and 2.5%, respectively, thereafter. The "Base Rate" for the tranche A term
loan and the Saskatoon revolver is equal to the greater of the Prime Rate
for Canadian Dollar commercial loans made in Canada, as announced from time
to time by the agent bank or the rate for Canadian Dollar Bankers
Acceptances accepted by the agent with a term to maturity of 30 days plus
1%. The "Base Rate" for the tranche B term loan is equal to the greater of
the Prime Rate as announced from time to time by the agent bank, the
"Federal Funds Effective Rate" plus 1/2% or the "Base CD Rate" plus 1%. At
September 30, 2001, the interest rates in effect for the Saskatoon tranche
A and tranche B term loans were 5.6% and 6.1%, respectively.

47

(d) Borrowings under the revolving loan of the Canadian Financing Agreement
bear interest at the Canadian Imperial Bank of Commerce Rate (CIBC) "Bank
Rate" plus 2.00% per annum on Canadian Dollar loans and CIBC "Base Rate"
plus 2.00% per annum on American Dollar loans. At September 30, 2001, the
interest rates in effect were 7.25% and 8.50% on the Canadian and American
dollar loans. Borrowings under the Canadian dollar term loan of the
Canadian Facility bears interest at the "Bank Rate" plus 2.50% per annum.
At September 30, 2001, the interest rate in effect was 7.75%.

(e) Our Canadian subsidiaries periodically enter fixed price agreements for a
portion of their electrical energy requirements. We have an agreement
relating to the supply of a portion of the electrical energy at one of our
Canadian sodium chlorate production facilities This agreement, which was
previously designated as a normal purchase under SFAS No. 133, does not
meet the criteria of a normal purchase based on guidance issued by the DIG
and cleared by the Financial Accounting Standards Board in June 2001. All
purchases under this agreement, which expires on December 31, 2001, are
used in the ordinary course of business; however, effective July 1, 2001,
this agreement is required to be marked-to-market. At September 30, 2001,
the value of this agreement was a loss of approximately $1.2 million based
on current market prices and quantities to be delivered.

48

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

49

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS

- ---------------

(1) Contractual interest for the year ended September 30, 2001 totaled $128,671.

The accompanying notes are an integral part of the consolidated financial
statements.
50

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the consolidated financial
statements.
51

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY IN ASSETS)

The accompanying notes are an integral part of the consolidated financial
statements.
52

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the consolidated financial
statements.
53

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS

- ---------------

(1) Contractual interest for the year ended September 30, 2001 totaled $103,470.

The accompanying notes are an integral part of the consolidated financial
statements.
54

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the consolidated financial
statements.
55

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDER'S EQUITY (DEFICIENCY IN ASSETS)

The accompanying notes are an integral part of the consolidated financial
statements.
56

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the consolidated financial
statements.
57

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Sterling Chemicals Holdings, Inc. ("Holdings" and, together with its
subsidiaries, unless otherwise indicated, are collectively referred to as "we,"
"our," "ours," and "us") through its subsidiaries owns or operates facilities
for the manufacture of eight commodity petrochemicals at our Texas City, Texas
plant. Additionally, we manufacture chemicals for use primarily in the pulp and
paper industry at five plants in Canada and a plant in Valdosta, Georgia and
manufacture acrylic fibers at our plant in Santa Rosa County, Florida. At our
Texas City plant, we have production capacity for styrene, acrylonitrile, acetic
acid, plasticizers, methanol, disodium iminodiacetic acid ("DSIDA"), tertiary
butylamine ("TBA") and sodium cyanide. We generally sell our petrochemicals
products to customers for use in the manufacture of other chemicals and
products, which in turn are used in the production of a wide array of consumer
goods and industrial products. We produce specialty textiles and technical
fibers at our Santa Rosa plant, as well as licensing our acrylic fibers
manufacturing technology to producers worldwide. Sodium chlorate is produced at
our five plants in Canada and our Valdosta plant. Sodium chlorite is produced at
one of our Canadian locations. In addition, chlor-alkali and calcium
hypochlorite are produced at one of our Canadian locations. We also license,
engineer and oversee construction of large-scale chlorine dioxide generators for
the pulp and paper industry as part of the pulp chemicals business. These
generators convert sodium chlorate into chlorine dioxide at pulp mills.

Holdings is a holding company whose only material asset is its investment
in Sterling Chemicals, Inc. ("Chemicals"). Chemicals and its subsidiaries own
substantially all of our consolidated operating assets.

Our significant accounting policies are described below.

BASIS OF PRESENTATION

The accompanying consolidated financial statements have been prepared on
the going concern basis of accounting, which contemplates the continuity of
operations, the realization of assets and the satisfaction of liabilities in the
ordinary course of business. On July 16, 2001 (the "Petition Date"), Holdings,
Chemicals and most of their U.S. subsidiaries (collectively, the "Debtors")
filed voluntary petitions for reorganization under Chapter 11 of the U.S.
Bankruptcy Code ("Bankruptcy Code") in the U.S. Bankruptcy Court for the
Southern District of Texas (the "Bankruptcy Court") and began operating their
business as debtors-in-possession pursuant to the Bankruptcy Code. None of our
foreign subsidiaries, including our Canadian subsidiaries, were included in the
Chapter 11 filings. The accompanying consolidated financial statements have been
presented in conformity with the AICPA's Statement of Position 90-7, "Financial
Reporting By Entities in Reorganization Under the Bankruptcy Code," ("SOP
90-7"). The statement requires a segregation of liabilities subject to
compromise by the Bankruptcy Court as of the bankruptcy filing date, and
identification of all transactions and events that are directly associated with
the reorganization of the Debtors.

The Chapter 11 petitions were driven by the Debtors' inability to meet
their funded debt obligations over the long-term, largely brought about by weak
demand for petrochemical products caused by declines in general worldwide
economic conditions, the relative strength of the U.S. dollar which has caused
their export sales to be at a competitive disadvantage and higher raw material
and energy costs. As a result of these conditions, the Debtors have incurred
significant operating losses. The reorganization contemplated by the Chapter 11
filings is designed to permit the Debtors to preserve cash and to give the
Debtors the opportunity to restructure their debt. During the pendency of the
Chapter 11 cases, with approval of the Bankruptcy Court, the Debtors may assume
favorable pre-petition contracts and leases, reject unfavorable pre-petition
contracts and leases and sell or otherwise dispose of assets. The confirmation
of a plan of reorganization is the primary objective of the Debtors. Unless
otherwise ordered by the Bankruptcy Court, the Debtors have the exclusive right
to propose a plan of reorganization until March 13, 2002, and the exclusive
right to seek acceptances of any plan proposed by them until May 12, 2002. A
plan of reorganization, when filed, will set forth the means
58

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

for treating claims, including liabilities subject to compromise and interests
in the Debtors. Such means may take a number of different forms. A plan of
reorganization may result in, among other things, significant dilution or
elimination of certain classes of existing equity interests as a result of the
issuance of securities to creditors or new investors. The Debtors are in the
early stages of formulating a plan of reorganization. The confirmation of any
plan of reorganization will require creditor acceptance as required under the
Bankruptcy Code and approval of the Bankruptcy Court.

At this time, it is not possible to predict the outcome of the bankruptcy
cases, in general, or the effect on the business of the Debtors, the claims of
creditors of the Debtors or the interests of stockholders of Holdings. As a
result of the bankruptcy filings, most of the Debtors' liabilities incurred
prior to the Petition Date, including certain secured debt, could be subject to
compromise. However, the ultimate resolution of these liabilities is not
presently determinable.

Reorganization items reflected in the Statement of Operations for fiscal
2001 are composed primarily of professional fees directly related to the
bankruptcy cases.

As a result of the bankruptcy filings and related events, there is no
assurance that the carrying amounts of assets will be realized or that
liabilities will be liquidated or settled for the amounts recorded. In addition,
confirmation of a plan of reorganization, or disapproval thereof, could change
the amounts reported in the financial statements. The ability of the Debtors to
continue as a going concern is dependent upon, among other things, (i) the
Debtors' ability to comply with the terms of the DIP Financing and any related
orders entered by the Bankruptcy Court in connection with the Chapter 11 cases,
(ii) the ability of the Debtors to access the incremental $40 million in DIP
Financing that is dependent on an effective priming order, (iii) the ability of
the Debtors to maintain adequate cash on hand, (iv) the ability of the Debtors
to generate sufficient cash from operations, (v) the ability of the Debtors'
subsidiaries that are not included in the Chapter 11 cases to obtain necessary
financing, (vi) confirmation of a plan or plans of reorganization under the
Bankruptcy Code and (vii) the Debtors' ability to achieve profitability
following such confirmation. As the Debtors can give no assurances that they
will accomplish any of the foregoing, there is substantial doubt about the
Debtors', and therefore our ability to continue as a going concern.

We have limited liquidity, which may prove inadequate during our
reorganization process. The Debtors are currently funding their liquidity needs
out of operating cash flow and from borrowings under the DIP Financing. The DIP
Financing is limited in amount and is also subject to numerous funding
conditions which are largely beyond the control of the Debtors, including
borrowing base requirements and compliance with the EBITDA covenant contained in
the DIP Financing. The ability of the Debtors to obtain additional financing
during the reorganization process is severely limited by a variety of factors,
including the debt incurrence restrictions imposed by the DIP Financing,
numerous procedural requirements and uncertainties relating to the bankruptcy
proceedings, including any continuing challenge to the priming order, and the
Debtors' current financial condition and prospects. Accordingly, no assurances
can be given that the Debtors' existing sources of liquidity will be adequate to
fund their liquidity needs throughout the reorganization process or, if
additional sources of liquidity become necessary during the reorganization
process, that they would be available to the Debtors or adequate. Any liquidity
shortages during the reorganization process would likely have a material adverse
effect on the Debtors' business and financial condition as well as their ability
to successfully restructure and emerge from bankruptcy. See Note 4 for
additional information regarding the status of the challenge to the priming
order and the impact on our business.

The accompanying financial statements do not include any adjustments that
may result from the resolution of these uncertainties.

59

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of all of our
wholly owned and majority-owned subsidiaries, with all significant intercompany
accounts and transactions having been eliminated. Our 50% equity investments in
a cogeneration joint venture and an acrylonitrile marketing joint venture are
accounted for under the equity method, with our share of the operating results
of the joint ventures recorded in the Statement of Operations.

CASH EQUIVALENTS

We consider all investments having a remaining maturity of three months or
less to be cash equivalents.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost is primarily
determined on the first-in, first-out basis, except for stores and supplies,
which are valued at average cost.

We enter into agreements with other companies to exchange chemical
inventories in order to minimize working capital requirements and to facilitate
distribution logistics. Balances related to quantities due to or payable by us
are included in inventory.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost. Major renewals and
improvements which extend the useful lives of equipment are capitalized. Major
planned maintenance expenses are accrued for during the periods prior to the
maintenance, while routine repair and maintenance expenses are charged to
operations as incurred. Disposals are removed at carrying cost less accumulated
depreciation with any resulting gain or loss reflected in operations.
Depreciation is provided using the straight-line method over estimated useful
lives ranging from 5 to 25 years, with the predominant life of plant and
equipment being 15 years. We capitalize interest costs which are incurred as
part of the cost of constructing major facilities and equipment. The amount of
interest capitalized for fiscal 2001, 2000 and 1999 was $0.5 million, $2.2
million and $1.4 million, respectively.

IMPAIRMENT OF LONG-LIVED ASSETS

Impairment tests of long-lived assets are made when conditions indicate
their carrying cost may not be recoverable. Such impairment tests are based on a
comparison of undiscounted future cash flows or the market value of similar
assets to the carrying cost of the asset. If an impairment is indicated, the
asset value is written down to its estimated fair value. We incurred an
impairment loss of $26.4 million related to our methanol production assets in
fiscal 1999 and an impairment loss of $60 million related to our acrylic fibers
business in fiscal 2000.

PATENTS AND ROYALTIES

The costs of patents are amortized on a straight-line basis over their
estimated useful lives, which approximate ten years. We capitalized the value of
our chlorine dioxide generator technology acquired in fiscal 1992 based on the
net present value of all estimated remaining royalty payments associated with
this technology. The resulting intangible amount is included in other assets and
is amortized over the average life for these royalty payments of ten years.

60

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DEBT ISSUE COSTS

Debt issue costs relating to long-term debt are amortized over the term of
the related debt instrument using the straight line method, which is materially
consistent with the effective interest method, and are included in other assets.
Debt issue costs for debt subject to compromise are included as a valuation of
the related debt. When the debt subject to compromise becomes an allowed claim,
and if the allowed claim differs from the net carrying amount of the debt
subject to compromise, the recorded amount will be adjusted to the amount of the
allowed claim, with the difference reflected in reorganization items. As a
result of the DIP Financing, $2.0 million of debt issue costs were expensed as
interest and debt related expense in fiscal 2001.

INCOME TAXES

Deferred income taxes are recorded to reflect the tax effect of the
temporary differences between the financial reporting basis and the tax basis of
our assets and liabilities at enacted rates.

REVENUE RECOGNITION

We generate revenues through sales in the open market, raw material
conversion agreements and long-term supply contracts. In addition, we have
entered into profit sharing arrangements with respect to some of our
petrochemicals products. We recognize revenue from sales in the open market, raw
material conversion agreements and long-term supply contracts when the products
are shipped. Revenues from profit sharing arrangements are estimated and accrued
monthly. Deferred credits are amortized over the life of the contracts which
gave rise to them. We also generate revenues from the construction and sale of
chlorine dioxide generators, which are recognized using the percentage of
completion method. We also receive prepaid royalties, which are recognized over
a period, which is typically ten years. In addition, we generate revenues from
the sale of acrylic fibers manufacturing technology to producers worldwide,
which are recognized as earned. We classify shipping and handling costs
associated with product delivered to customers as cost of goods sold.

FOREIGN CURRENCY TRANSLATION

Our Canadian subsidiaries use the Canadian dollar as their functional
currency. For financial reporting purposes, assets and liabilities of these
subsidiaries denominated in Canadian dollars are translated into United States
dollars at year-end exchange rates and revenues and expenses are translated at
the average monthly exchange rates. Translation adjustments are included in
accumulated other comprehensive income, while transaction gains and losses are
included in operations when incurred.

EARNINGS (LOSS) PER SHARE

For purposes of computing net loss per common share, net loss has been
adjusted by an amount equal to the fair market value of "Released Shares," which
are shares held by Chemicals' employee stock ownership plan that have been
allocated to the ESOP accounts of our employees, minus amounts previously
recognized as compensation expense with respect to Released Shares, adjusted to
reflect the amount of depreciation/ appreciation in value of Released Shares in
prior periods. This adjustment to net loss is made because we are obligated,
under certain circumstances, to purchase from participants under the plan any
shares of Holdings' common stock distributed by the ESOP to these participants.
Accordingly, the weighted average number of

61

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

outstanding shares of the common stock of Holdings and the computation of the
net loss per common share are as follows (in thousands):

As losses were incurred in fiscal 2001, 2000 and 1999, basic and diluted
earnings per share are the same for these periods.

COMPREHENSIVE INCOME (LOSS) (IN THOUSANDS):

There is no tax expense or benefit associated with the cumulative translation
adjustment amounts above. The pension adjustment amounts are net of tax
provision (benefit) of zero, $24,000 and $(32,000), for the fiscal years ended
September 30, 2001, 2000 and 1999, respectively.

ENVIRONMENTAL COSTS

Environmental costs are expensed as incurred unless the expenditures extend
the economic useful life of the relevant assets. Costs that extend the economic
life of assets are capitalized and depreciated over the remaining life of those
assets. Liabilities are recorded when environmental assessments or remedial
efforts are probable and the cost can be reasonably estimated.

DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

In preparing disclosures about the fair value of financial instruments, we
have assumed that the carrying amount approximates fair value for cash and cash
equivalents, receivables, accounts payable and certain accrued expenses due to
the short maturities of these instruments. The fair values of long-term debt
instruments are estimated based upon quoted market values (if applicable) or on
the current interest rates available to us for debt with similar terms and
remaining maturities. The fair value of pre-petition liabilities subject to
compromise and pre-petition liabilities not subject to compromise is not
possible to determine given

62

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the uncertainty of the impact of the bankruptcy proceedings. Considerable
judgment is required in developing these estimates and, accordingly, no
assurance can be given that the estimated values presented herein are indicative
of the amounts that would be realized in a free market exchange.

ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported periods. Significant estimates include
environmental reserves, litigation contingencies, maintenance costs related to
shut downs, taxes and revenues. Actual results could differ from these
estimates.

RECLASSIFICATION

Certain amounts reported in the financial statements for the prior periods
have been reclassified to conform with the current financial statement
presentation with no effect on net loss or stockholders' equity (deficiency in
assets).

2. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS

63

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. PRE-PETITION LIABILITIES

LIABILITIES SUBJECT TO COMPROMISE

The principal categories of claims classified as liabilities subject to
compromise under reorganization proceedings are identified below. All amounts
below may be subject to future adjustment depending on Bankruptcy Court action,
further developments with respect to disputed claims or other events, including
the reconciliation of claims filed with the Bankruptcy Court to amounts recorded
in the accompanying consolidated financial statements. Additional pre-petition
claims may arise from rejection of additional executory contracts or unexpired
leases by the Debtors. Under a confirmed plan of reorganization, all pre-
petition claims subject to compromise may be paid and discharged at amounts
substantially less than their allowed amounts.

On a consolidated basis, recorded liabilities subject to compromise under
Chapter 11 proceedings as of September 30, 2001, consisted of the following:

- ---------------

(1) Debt liabilities are presented net of unamortized debt issue costs of $12.9
million.

64

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As a result of the bankruptcy filing, principal and interest payments may
not be made on pre-petition debt without Bankruptcy Court approval or until a
plan of reorganization defining the repayment terms has been confirmed. The
total interest on pre-petition debt that was not paid or charged to earnings for
the period from July 16, 2001 to September 30, 2001, was $15.3 million. Such
interest is not being accrued since management believes it is not probable that
it will be treated as an allowed claim. The Bankruptcy Code generally disallows
the payment of post-petition interest that accrues with respect to unsecured or
undersecured claims.

LIABILITIES NOT SUBJECT TO COMPROMISE

The principal categories of claims classified as liabilities not subject to
compromise under reorganization proceedings are identified below. Management
believes all amounts below are fully secured liabilities that are not expected
to be compromised.

On a consolidated basis, recorded liabilities not subject to compromise
under Chapter 11 proceedings as of September 30, 2001, consisted of the
following:

4. LONG-TERM DEBT

This note contains information regarding our debt as of September 30, 2001.
As a result of the filing of the Chapter 11 cases previously described, no
payments will be made by the Debtors on pre-petition debt except as approved by
the Bankruptcy Court.

65

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Borrowings consisted of the following:

Upon the filing of the Chapter 11 cases by the Debtors, an Event of Default
occurred under the Prior Credit Agreement (as defined below) and each of the
indentures governing our outstanding notes and all of this indebtedness was
accelerated and became immediately due and payable. The Prior Revolvers (as
defined below) were completely paid off with the proceeds of the initial draw
under the DIP Financing. However, the Debtors may pay the indebtedness under the
indentures only pursuant to a confirmed plan of reorganization or order of the
Bankruptcy Court. During the pendency of the Chapter 11 cases, the Debtors will
not, for the most part, be subject to the restrictions contained in the Prior
Credit Agreement (as defined below) or any of the indentures. However, the
Debtors will be subject to the restrictions contained in the DIP Financing,
Sterling Pulp Chemicals, Ltd. ("Sterling Pulp") will be subject to restrictions
contained in both the DIP Financing and the Canadian Financing Agreement (as
defined below) and our Saskatoon subsidiary will be subject to the restrictions
contained in its credit facility.

Effective July 19, 2001, the Debtors (excluding Holdings) entered into a
Revolving Credit Agreement with a group of lenders led by Tyco Capital (formerly
The CIT Group/Business Credit, Inc.) to provide up to $195 million in
Debtor-In-Possession financing (the "DIP Financing"). By interim order dated
July 18, 2001 and final order dated September 14, 2001, the Bankruptcy Court
approved up to $155 million in lending commitments under the DIP Financing (the
"Base Facility"), consisting of an $85 million "current assets revolver" and a
$70 million "fixed assets revolver." The initial draw under the DIP Financing
was used to repay all amounts outstanding under the Debtors' previous revolving
credit facilities. Additional borrowings under the DIP Financing may be used to
fund the Debtors' post-petition operating expenses and supplier and employee
obligations throughout the reorganization process. The final order dated
September 14, 2001 is on

66

STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

appeal to the U.S. District Court, but no stay of the final order has been
sought or imposed, and the order remains fully effective. While no assurances
can be given, we do not believe the final order will be overturned on appeal.

Borrowings under the DIP Financing are subject to customary funding
conditions, including borrowing base restrictions under the current assets
revolver. The Base Facility is secured by substantially all of the assets of the
Debtors, but some of the liens have been granted super-priority administrative
expense claims for the amount of the DIP Financing which, subject to certain
carve outs, will entitle the DIP lenders to be paid before any other claims
against the Debtors are paid. The DIP Financing is designed to give the Debtors
the opportunity, during the reorganization process, to develop a new capital
structure that will support them over the long-term, including during recurring
cyclical downturns in the markets for the Debtors' petrochemicals products. At
September 30, 2001, the total credit available under the DIP Financing was
$112.8 million due to borrowing base restrictions under the current assets
revolver. At September 30, 2001, $42.3 million was drawn under the fixed assets
revolver and there were no borrowings outstanding under the current assets
revolver. In addition, approximately $4.4 million of letters of credit were
outstanding under the current assets revolver, leaving at September 30, 2001,
unused borrowing capacity under the secured revolving credit facilities of
approximately $66.1 million.

As a result of a priming order entered by the Bankruptcy Court on November
2, 2001 and reinstated on December 19, 2001, the lending commitments under the
current assets revolver were increased from $85 million to $125 million. The
priming order grants the lenders under the currents assets revolver a priming
lien on our fixed assets located in the United States and the capital stock of
most of our domestic subsidiaries, prior in right to the existing liens in favor
of the 12 3/8% Notes. Although the priming order was entered by the Bankruptcy
Court on November 2, 2001, it was appealed to the U.S. District Court by the
indenture trustee for the 12 3/8% Notes. By order dated December 17, 2001, the
U.S. District Court reversed the priming order and remanded the matter to the
Bankruptcy Court for a determination of a compensatory adjustment in favor of
the 12 3/8% Notes, which the U.S. District Court suggested would be satisfied by
a 4% increase of the interest rate payable on up to $40 million. On remand, the
Bankruptcy Court entered an order dated December 19, 2001, reinstating the
priming order subject to an appropriate compensatory adjustment in favor of the
12 3/8% Notes of four percentage points of additional interest on up to $40
million. In addition, the Bankruptcy Court scheduled a hearing for January 2,
2002 to determine certain technical details regarding implementation of this 4%
increase. The Debtors anticipate that the priming order will be further appealed
by the indenture trustee. The priming order will remain effective pending the
outcome of any appeal unless stayed by an appellate court. The Debtors will take
all reasonable actions necessary, either before the Bankruptcy Court or on
appeal, to maintain the effectiveness of the priming order and the additional
liquidity provided by the priming order. If the priming order is stayed or is
not ultimately upheld on appeal, the Debtors will need to seek additional
sources of financing or revise their business plan and operations consistent
with the level of available financing. However, we can give no assurances that
the priming order will not be stayed or will be upheld on appeal or, if stayed
or not upheld on appeal, that additional sources of financing will be available
or adequate or that our available financing will be adequate after implementing
revisions to the Debtors' business plan and operations.

As of July 11, 2001, our principal Canadian subsidiary, Sterling Pulp,
entered into a financing agreement with Tyco Capital Business Credit (Canada)
Inc. ("Tyco Canada") to provide up to the Canadian dollar equivalent of U.S. $30
million (the "Canadian Financing Agreement"). The initial advance under this
facility, approximately U.S. $20 million, was used by Sterling Pulp to discharge
a portion of an intercompany debt and was ultimately transferred to the Debtors
through an intercompany loan. The intercompany loan was approved by the
Bankruptcy Court's interim order entered on July 18, 2001 and final order
entered on September 14, 2001, which is a subject of the appeal of the final
order discussed above. The initial term of the Canadian Financing Agreement
extends to July 2004. The Canadian Financing Agreement may be terminated by
either
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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Sterling Pulp or Tyco Canada thereafter only by giving 60 days written notice of
termination prior to each subsequent anniversary date. At September 30, 2001,
$20 million was drawn under the Canadian Financing Agreement.

Under the DIP Financing, the Debtors (excluding Holdings) are co-borrowers
and are jointly and severally liable for any indebtedness thereunder. The Base
Facility consists of:

- a $70 million fixed assets revolving credit facility secured by:

- first priority liens on all of the capital stock of Chemicals and the
other co-borrowers, all of our United States production facilities and
related assets and 35% of the capital stock of certain of our
subsidiaries incorporated outside the United States; and

- second priority liens on all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers and 65% of the
capital stock of certain of our subsidiaries incorporated outside the
United States; and

- an $85 million current assets revolving credit facility secured by:

- a first priority lien on all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers;

- a second priority lien on 35% of the capital stock of certain of our
subsidiaries incorporated outside the United States; and

- third priority liens on the remaining 65% of that stock, all of the
capital stock of Chemicals and the other co-borrowers and all of our
United States production facilities and related assets.

Available credit under the fixed assets revolving credit facility is not
subject to a borrowing base. At September 30, 2001, available credit under the
current assets revolving credit facility was subject to a monthly borrowing base
consisting of 85% of eligible accounts receivable and 65% of eligible inventory,
with an inventory cap of $42.5 million. In addition, the borrowing base for the
current assets revolver was required to exceed outstanding borrowings thereunder
by $12 million at all times with a maximum of $85 million available under the
current asset revolving credit facility.

Assuming the priming order is not overturned on appeal, (i) maximum
availability under the current assets revolving credit facility is $125 million,
(ii) the monthly borrowing base consists of 85% of eligible accounts receivable,
the lesser of $10 million or 33% of specified estimated future royalty payments
related to the Debtors' chlorine dioxide generator technology and 65% of
eligible inventory, with an inventory cap of $62.5 million and, (iii) the
borrowing base for the current assets revolver is required to exceed outstanding
borrowings by only $6 million at all times.

If the priming order remains effective and the total commitments under the
current assets revolver are increased to $125 million, the incremental $40
million is secured by first priority liens on all of our United States
production facilities and related assets and all of the capital stock of the
co-borrowers (excluding Chemicals) to secure up to $40 million under the current
assets revolver, as well as all of the same collateral securing the initial $85
million current assets revolver. Consequently, after giving effect to the
priming order, the DIP Financing consists of:

- a $70 million fixed assets revolving credit facility secured by:

- a first priority lien on all of the capital stock of Chemicals;

- second priority liens on all of our United States production facilities
and related assets, all of the capital stock of the co-borrowers
(excluding Chemicals), all accounts receivable, inventory and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

other specified assets of Chemicals and the other co-borrowers and 35%
of the capital stock of certain of our subsidiaries incorporated outside
the United States; and

- a third priority lien on the remaining 65% of that stock; and

- a $125 million current assets revolving credit facility:

- $40 million of which is secured by first priority liens on all of our
United States production facilities and related assets, all of the
capital stock of the co-borrowers (excluding Chemicals) and 35% of the
capital stock of certain of our subsidiaries incorporated outside the
United States and a second priority lien on the remaining 65% of that
stock; and

- all of which is secured by a first priority lien on all accounts
receivable, inventory and other specified assets of Chemicals and the
other co-borrowers, third priority liens on all of the capital stock of
Chemicals and 35% of the capital stock of certain of our subsidiaries
incorporated outside the United States and fourth priority liens on the
remaining 65% of that stock, all of the capital stock of the co-
borrowers (excluding Chemicals) and all of our United States production
facilities and related assets.

Borrowings under the fixed assets revolving credit facility bear interest,
at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined
in the DIP Financing) plus 3.75% or the "Alternate Base Rate" (as defined in the
DIP Financing) plus 2.25%. Borrowings under the current assets revolving credit
facility bear interest, at Chemicals' option, at an annual rate of either the
LIBOR Rate plus 3.50% or the Alternate Base Rate plus 2.00%. At September 30,
2001, the weighted average interest rate in effect was 7.2%. The DIP Financing
also requires Chemicals and the co-borrowers to pay an aggregate commitment fee
ranging from 0.75% to 1.25% on the unused portion of the commitment for the
fixed assets revolving credit facility, depending on the amount drawn, and an
aggregate commitment fee of 0.5% on the unused portion of the commitment for the
current assets revolving credit facility.

At September 30, 2001, the total credit available under the DIP Financing
was $112.8 million due to the current assets revolver borrowing base limitations
discussed above. At September 30, 2001, $42.3 million was drawn under the fixed
assets revolver and there were no borrowings outstanding under the current
assets revolver. In addition, approximately $4.4 million of letters of credit
were outstanding under the current assets revolver, leaving at September 30,
2001, unused borrowing capacity under the secured revolving credit facilities of
approximately $66.1 million.

At September 30, 2001, $20 million was drawn under the Canadian Financing
Agreement. Borrowings under the Canadian Financing Agreement bear interest at
the CIBC Bank Rate (as defined in the Canadian Financing Agreement) plus between
2.0% and 2.5%, or at the LIBOR Rate plus 3.5%.

The DIP Financing and the Canadian Financing Agreement contain numerous
covenants, including, but not limited to, restrictions on the ability to incur
indebtedness, create liens and sell assets, as well as maintenance of certain
financial covenants.

On July 23, 1999, Chemicals completed a private offering of $295,000,000 of
its 12 3/8% Senior Secured Notes due 2006. On November 5, 1999, Chemicals
completed a registered exchange offer pursuant to which all of these notes were
exchanged for publicly registered 12 3/8% Notes with substantially similar terms
(the "12 3/8% Notes"). The 12 3/8% Notes are senior secured obligations of
Chemicals and rank equally in right of payment with all other existing and
future senior indebtedness of Chemicals and senior in right of payment to all
existing and future subordinated indebtedness of Chemicals. The 12 3/8% Notes
are guaranteed by all of Chemicals' existing direct and indirect United States
subsidiaries (other than Sterling Chemicals Acquisitions, Inc.) on a joint and
several basis. Each subsidiary's guarantee ranks equally in right of payment
with all of that subsidiary's existing and future senior indebtedness and senior
in right of payment to all existing and
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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

future subordinated indebtedness of that subsidiary. The 12 3/8% Notes and the
subsidiary guarantees are secured by:

- a second priority lien on all of our United States production facilities
and related assets;

- a second priority pledge of all of the capital stock of each subsidiary
guarantor; and

- a first priority pledge of 65% of the stock of certain of the Company's
subsidiaries incorporated outside of the United States.

As a result of the priming order, the second priority liens held by the
12 3/8% Notes on all of our United States production facilities and related
assets and the capital stock of each subsidiary guarantor became third priority
liens. The priming order does not affect the priority of the pledge held by the
12 3/8% Notes of 65% of the stock of certain of our subsidiaries incorporated
outside of the United States.

The 12 3/8 Notes bear interest at the annual rate of 12 3/8%, payable
semi-annually on January 15 and July 15 of each year commencing January 15,
2000. During the pendency of the Chapter 11 cases, interest may accrue to the
extent permitted by the Bankruptcy Code but is not payable unless ordered by the
Bankruptcy Court. Without regard to the Chapter 11 filings, and except as
otherwise provided below, the 12 3/8% Notes may not be redeemed by Chemicals
prior to July 15, 2003. From that date until July 15, 2004, the 12 3/8% Notes
may be redeemed at a premium of the principal amount thereof at maturity of
106.188% and, from July 15, 2004 until July 15, 2005, the 12 3/8% Notes may be
redeemed at a premium of the principal amount thereof at maturity of 103.094%.
Thereafter, Chemicals may redeem the 12 3/8% Notes at their face value plus
accrued and unpaid interest. Prior to July 15, 2002, Chemicals may redeem in the
aggregate up to 35% of the original principal amount of the 12 3/8% Notes with
the proceeds of one or more specified Public Equity Offerings. Such redemptions
may be made at a redemption price of 112.375% of the face value of the 12 3/8%
Notes plus accrued and unpaid interest to the redemption date. After such
redemption, at least $191.75 million aggregate principal amount of the 12 3/8%
Notes must remain outstanding. No redemptions will be made during the pendency
of the Chapter 11 cases. The terms of a plan of reorganization will determine
any redemption rights thereafter.

On July 23, 1999, Chemicals also established two secured revolving credit
facilities providing up to $155,000,000 in revolving credit loans (the "Prior
Revolvers") under a single Revolving Credit Agreement (the "Prior Credit
Agreement"). Under the Prior Credit Agreement, Chemicals and each of its direct
and indirect United States subsidiaries (other than Sterling Chemicals
Acquisitions, Inc.) were co-borrowers and were jointly and severally liable for
any indebtedness thereunder. The Prior Revolvers consisted of (i) an $85,000,000
revolving credit facility secured by a first priority lien on all accounts
receivable, inventory and other specified assets of Chemicals and the other
co-borrowers and (ii) a $70,000,000 revolving credit facility secured by a first
priority lien on all of our United States production facilities and related
assets, all of the capital stock of Chemicals and all of the capital stock of
each co-borrower and a second priority lien on all accounts receivable,
inventory and other specified assets of Chemicals and the other co-borrowers. As
mentioned above, the initial draw under the DIP Financing was used to repay all
amounts under the Prior Revolvers.

As part of our recapitalization in August of 1996, Chemicals issued $275.0
million of its 11 3/4% Senior Subordinated Notes due 2006 (the "11 3/4% Notes")
and Holdings issued 191,751 Units, with each Unit consisting of one 13 1/2%
Senior Secured Discount Note due 2008 (collectively, the "13 1/2% Notes") and
one warrant to purchase three shares of the common stock, par value $0.01 per
share, of Holdings ("Holdings Common Stock") for $0.01 per share. Holdings
received $100 million in initial proceeds upon issuing $191.8 million of 13 1/2%
Notes under the Units offering. On April 7, 1997, Chemicals issued $150.0
million of its 11 1/2% Senior Subordinated Notes due 2007 (the "11 1/2% Notes").

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The 11 3/4% Notes are unsecured senior subordinated obligations of
Chemicals, ranking subordinate in right of payment to all existing and future
senior debt of Chemicals, but pari passu with the 11 1/4% Notes and all future
senior subordinated indebtedness. The 11 3/4% Notes bear interest at the annual
rate of 11 3/4%, payable semi-annually on February 15 and August 15 of each year
commencing February 15, 1997. However, no interest will be paid during the
pendency of the Chapter 11 cases. As management believes this liability is
subject to compromise, interest expense is not being recorded after the Petition
Date. The 11 3/4% Notes were not redeemable by Chemicals prior to August 15,
2001. Under the indenture for the 11 3/4% Notes, from that date through August
15, 2004, the 11 3/4% Notes may be redeemed at a premium of the principal amount
thereof at maturity varying between 105.875% and 101.958% and, after August 15,
2004, Chemicals may redeem the 11 3/4% Notes at their face value plus accrued
and unpaid interest. However, notwithstanding the foregoing, no redemptions may
be made during the pendency of the Chapter 11 cases and the terms of a plan of
reorganization will determine any redemption rights thereafter.

The 11 1/4% Notes are unsecured senior subordinated obligations of
Chemicals, ranking subordinate in right of payment to all existing and future
senior debt of Chemicals, but pari passu with the 11 3/4 % Notes and all future
senior subordinated indebtedness of Chemicals. The 11 1/4% Notes bear interest
at the annual rate of 11 1/4%, payable semi-annually on April 1 and October 1 of
each year commencing October 1, 1997. However, no interest will be paid during
the pendency of the Chapter 11 cases. As management believes this liability is
subject to compromise, interest expense is not being recorded after the Petition
Date. Under the indenture for the 11 1/4% Notes, the 11 1/4% Notes may not be
redeemed by Chemicals prior to April 1, 2002 and, from that date through April
1, 2005, the 11 1/4% Notes may be redeemed at a premium of the principal amount
thereof at maturity varying between 105.625% and 101.875%. After April 1, 2005,
Chemicals may redeem the 11 1/4% Notes at their face value plus accrued and
unpaid interest. However, notwithstanding the foregoing, no redemptions may be
made during the pendency of the Chapter 11 cases and the terms of a plan of
reorganization will determine any redemption rights thereafter.

The 13 1/2% Notes are senior secured obligations of Holdings and rank
equally in right of payment with all other senior indebtedness of Holdings and
senior in right of payment to all subordinated indebtedness of Holdings. The
13 1/2% Notes accreted interest until August 15, 2001, with no interest payable
in cash until February 15, 2002, at an annual rate of 13 1/2%, compounded
semi-annually. Commencing in 2002, interest becomes payable under the terms of
the 13 1/2% Notes semi-annually on February 15 and August 15 of each year until
maturity. However, no interest will be paid during the pendency of the Chapter
11 cases. As management believes this liability is subject to compromise,
interest expense is not being recorded after the Petition Date. Under the
indenture for the 13 1/2% Notes, the 13 1/2% Notes may be redeemed by Holdings
through August 15, 2006 at a premium of the principal amount thereof at maturity
varying between 106.75% and 101.35% and, after August 15, 2006, at their
principal amount plus accrued interest. However, notwithstanding the foregoing,
no redemptions may be made during the pendency of the Chapter 11 cases and the
terms of a plan of reorganization will determine any redemption rights
thereafter.

On July 10, 1997, Sterling Pulp Chemicals (Sask) Ltd. ("Sterling Sask"), an
indirect wholly owned subsidiary of Holdings and Chemicals, acquired
substantially all of the assets of Saskatoon Chemicals Ltd. ("Saskatoon
Chemicals"), a subsidiary of Weyerhaeuser Canada Ltd. (the "Saskatoon
Acquisition"). In connection with the Saskatoon Acquisition, Sterling Sask
entered into a credit agreement (the "Saskatoon Credit Agreement") with JP
Morgan of Canada, individually and as administrative agent. Funding under the
Saskatoon Credit Agreement occurred July 10, 1997, upon consummation of the
Saskatoon Acquisition. The Saskatoon Credit Agreement provides for a revolving
credit facility of Cdn. $8.0 million (the "Saskatoon Revolver") and a term loan
facility consisting of a Cdn. $25.0 million Tranche A term loan due June 30,
2003 and a $36.4 million Tranche B term loan due June 30, 2005 (the "Saskatoon
Term Loans"). Advances under the Saskatoon Revolver are subject to a borrowing
base consisting of 85% of eligible accounts receivable and 65% of eligible
inventory, with an inventory cap of 50% of the borrowing base. At September 30,
2001, the
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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

borrowing base did not limit available credit and there were no borrowings
outstanding under the Saskatoon Revolver. Sterling Sask's obligations under the
Saskatoon Credit Agreement are secured by substantially all of the assets of
Sterling Sask. The Saskatoon Credit Agreement requires Sterling Sask to satisfy
certain financial covenants and tests. In addition, the Saskatoon Credit
Agreement requires that certain amounts of "Excess Cash Flow" be used to prepay
amounts outstanding under the Saskatoon Term Loans.

The Sterling Sask Tranche A term loan and the Saskatoon Revolver borrowings
bear interest, at Sterling Sask's option, at an annual rate of either the
Bankers Acceptance Rate or the Base Rate plus an Applicable Margin (as such
terms are defined in the Saskatoon Credit Agreement) of 2.5% and 1.5%,
respectively, until September 30 2001, and 3.0% and 2.0% thereafter. The Tranche
B term loan bears interest, at Sterling Sask's option, at an annual rate of
either the Eurodollar Rate or the Base Rate plus an Applicable Margin of 3.0%
and 2.0%, respectively, through September 30, 2001, and 3.5% and 2.5%,
respectively, thereafter. The "Base Rate" for the Tranche A term loan and the
Saskatoon Revolver is equal to the greater of the Prime Rate for Canadian Dollar
commercial loans made in Canada, as announced from time to time by the agent
bank or the rate for Canadian Dollar Bankers Acceptances accepted by the agent
with a term to maturity of 30 days plus 1% (as such terms are defined in the
Saskatoon Credit Agreement). The "Base Rate" for the Tranche B term loan is
equal to the greater of the Prime Rate as announced from time to time by the
agent bank, the "Federal Funds Effective Rate" plus 1/2% or the "Base CD Rate"
plus 1% (as such terms are defined in the Saskatoon Credit Agreement). At
September 30, 2001, the interest rates in effect for the Tranche A and Tranche B
term loans were 6.3% and 6.1%, respectively. The Saskatoon Credit Agreement also
requires Sterling Sask to pay a commitment fee in the amount of 1/2% commitment
under the Saskatoon Revolver.

The Saskatoon Credit Agreement contains provisions which currently prohibit
the payment of advances, loans and dividends from Sterling Sask to Chemicals or
Holdings.

An Event of Default occurred under the Saskatoon Credit Agreement as a
result of the Chapter 11 filings by the Debtors. However, the lenders under the
Saskatoon Credit Agreement have executed a forbearance agreement under which
they have temporarily agreed to not exercise their remedies under that
agreement. In connection with obtaining the lenders' agreement to enter into the
forbearance arrangement, the Saskatoon Credit Agreement was amended in several
respects, including the elimination of the exceptions to the provisions
restricting the payment of advances, loans and dividends from our Saskatoon
subsidiary to us or Chemicals and the inclusion of a restriction on our ability
to draw upon the revolving credit facility during the remainder of calendar year
2001. The Saskatoon subsidiary has not drawn on the revolver since its inception
in 1997 and as of September 30, 2001, had approximately $11.8 million in cash
and cash equivalents on hand. The forbearance agreement expires on December 31,
2001. We are currently negotiating a waiver and amending agreement with the
lenders and expect to have this agreement executed in the near-term; however, no
assurance can be given that this waiver and amending agreement will be executed
or that the forbearance arrangement will be extended beyond December 31, 2001.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DEBT MATURITIES

The estimated remaining principal payments on the outstanding debt of our
subsidiaries that have not filed Chapter 11 are as follow:

5. CONDENSED COMBINED FINANCIAL STATEMENTS OF ENTITIES IN BANKRUPTCY

The following condensed combined financial statements are presented in
accordance with SOP 90-7:

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF OPERATIONS

73

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED BALANCE SHEETS

74

STERLING CHEMICALS HOLDINGS, INC.

(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF CASH FLOWS

75

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. INCOME TAXES

A reconciliation of federal statutory income taxes to our effective tax
provision (benefit) before extraordinary item follows:

The provision (benefit) for income taxes is composed of the following:

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The components of our deferred income tax assets and liabilities are
summarized below:

We have approximately $318 million in United States net operating losses
("U.S. NOL") which will expire during fiscal 2018-2021. In assessing the value
of the deferred tax assets, management considers whether it is more likely than
not that all of the deferred tax assets will be realized. Projected future
income tax planning strategies and the expected reversal of deferred tax
liabilities are considered in making this assessment and determining the
valuation allowance. In June 2001, based on the uncertainty as to the effect of
the Chapter 11 filings on the utilization of the U.S. NOL and the future
realization of other net deferred tax assets, we were not able to conclude that
it was more likely than not that we would be able to realize the future benefit
of our U.S. deferred tax assets and the valuation allowance was increased to
reduce U.S. deferred tax assets to zero. Certain reductions to our U.S. NOL may
result from confirmation of our plan of reorganization. Further, at such time as
we emerge from bankruptcy, we will likely undergo an ownership change for
federal income tax purposes which may cause our utilization of our U.S. NOL to
become subject to limitations. Since numerous variables could affect the
bankruptcy proceedings (including the fact that the a plan of reorganization has
not yet been submitted to the Bankruptcy Court for approval), it is not
currently possible to determine whether our U.S. NOL will produce tax benefits
in the future. Benefit was not provided for these loss carryforwards at
September 30, 2001.

7. EMPLOYEE BENEFITS

The Debtors have received approval from the Bankruptcy Court to pay or
otherwise honor certain of their pre-petition obligations, including payments
for employee wages and salaries, benefits and other employee obligations. The
Debtors' obligations under its employee benefit plans are liabilities that are
subject to compromise under the Chapter 11 reorganization proceedings. See Note
3 for further information on liabilities subject to compromise.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

We have established the following benefit plans:

RETIREMENT BENEFIT PLANS

We have non-contributory pension plans in the United States and employer
and employee contributory plans in Canada which cover all salaried and wage
employees. The benefits under these plans are based primarily on years of
service and employees' pay near retirement. For our employees who were employed
as of September 30, 1986 and who were previously employed by Monsanto Company,
we recognize their Monsanto pension years of service for purposes of determining
benefits under our plans. For our employees who were employed on August 21, 1992
and who were previously employed by Tenneco Inc., we recognize their Tenneco
Inc. pension years of service for purposes of determining benefits under our
plans. For our employees who were employed as of January 31, 1997 and who (i)
were previously employed by Cytec Industries Inc. and (ii) elected to retire on
or before January 31, 1999, we supplement the standard pension payable such that
the employee's total combined pension from us and from the Cytec Nonbargaining
Employees' Retirement Plan equals the amount the employee would have received
had he or she remained an employee of Cytec until retirement. The estimated
liability for such supplements as of September 30, 2001 and 2000 is immaterial.
Our funding policy is consistent with the funding requirements of federal law
and regulations. Plan assets consist principally of common stocks and government
and corporate securities.

Information concerning the pension obligation, plan assets, amounts
recognized in our financial statements and underlying actuarial assumptions is
stated below.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

All plans have projected benefit obligations in excess of plan assets at
September 30, 2001. For plans with accumulated benefit obligations in excess of
plan assets, the accumulated benefit obligation and fair value of plan assets
were $91.6 million and $77.1 million, respectively, at September 30, 2001.

Net periodic pension costs consist of the following components:

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

We provide certain health care benefits and life insurance benefits for
retired employees. Substantially all of our employees become eligible for these
benefits at early retirement age. We accrue the cost of these benefits during
the period in which the employee renders the necessary service.

Health care benefits are provided to employees who retire from us with ten
or more years of credited service except for Canadian employees covered by
collective bargaining agreements. Some of our employees are eligible for
postretirement life insurance. Postretirement health care benefits for United
States plans are contributory. Benefit provisions for most hourly and some
salaried employees are subject to collective bargaining. In general, retiree
health care benefits are paid as covered expenses are incurred. For United
States employees, postretirement medical plan deductibles are assumed to
increase at the same rate as long-term health care costs.

Information concerning the plan obligation, the funded status, amounts
recognized in our financial statements and underlying actuarial assumptions are
stated below.

Net periodic plan costs consist of the following components:

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The weighted average annual assumed health care trend rate is assumed to be
7.5% for 2001. The rate is assumed to decrease gradually to 5.8% in 2027 and
remain level thereafter. Assumed health care cost trend rates have a significant
effect on the amounts reported for the health care plans. A one percentage point
change in assumed health care trend rates would have the following effects:

During fiscal 2001, we recorded a curtailment gain of $2.0 million due to our
staffing reductions at our acrylic fibers plant associated with us significantly
reducing those operations. We recorded a $10.2 million charge, included in other
expense, increasing our pension liability and other postretirement benefits
liability in the second quarter of fiscal 1999 as a result of an early
retirement program for employees at our Texas City plant and certain benefit
changes for all of our U.S. employees. The early retirement program resulted in
curtailment expense for the pension plan and special termination benefits
expenses for both the pension and the other postretirement benefits plans,
partially offset by the curtailment gain from the reduction of postretirement
life insurance benefits for our currently active U.S. employees.

EMPLOYEE STOCK OWNERSHIP TRUST

In connection with our recapitalization in August of 1996, an Employee
Stock Ownership Trust (the "ESOT") was established which covers substantially
all United States employees. Allocations of shares of common stock were made
annually to participants. The ESOT primarily invests in shares of Holdings
Common Stock and, in fiscal 1996, borrowed $6.5 million from Chemicals (the
"ESOP Loan") to purchase approximately 542,000 shares of Holdings Common Stock.
In addition, during fiscal 1999 the ESOT purchased 14,000 shares of Holdings
Common Stock. In fiscal 2000 and 1999, 163,000 and 160,000 respectively, ESOT
shares were allocated to employees. We recorded $0.9 million and $0.7 million of
expense related to the ESOT in fiscal 2000 and 1999, respectively. There were no
shares allocated to employees and there was no expense recorded in fiscal 2001.
The shares of Holdings Common Stock purchased by the ESOT in August of 1996 were
pledged as security for the ESOP Loan. As of September 30, 2001, the ESOP Loan
had been repaid in full and all shares of Holdings Common Stock held by the ESOT
had been released and allocated to the ESOT participants' accounts. No
additional allocations are contemplated at this time. We are currently in the
process of terminating our ESOP and the ESOT and, upon any such termination, all
shares of our common stock held by the ESOT will be distributed to the
participants in this plan.

SAVINGS AND INVESTMENT PLAN

Our Sixth Amended and Restated Savings and Investment Plan covers
substantially all United States employees, including executive officers. This
Plan is qualified under Section 401(k) of the Internal Revenue Code. Each
participant has the option to defer taxation of a portion of his or her earnings
by directing us to contribute a percentage of such earnings to the Plan. A
participant may direct up to a maximum of 20% of eligible earnings to this Plan,
subject to certain limitations set forth in the Internal Revenue Code. A
participant's contributions become distributable upon the termination of his or
her employment. We did not make any contribution to this plan in fiscal 2000 or
1999. Beginning October 1, 2000, we began matching 50% of a participant's
contributions, to the extent such contributions do not exceed 7% of such
participant's base compensation (excluding bonuses, profit sharing and similar
types of compensation). Such contributions amounted to $1.1 million in fiscal
2001.

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EMPLOYEE SAVINGS PLAN

We introduced an employee savings plan for all eligible full-time Canadian
employees effective as of October 1, 2000. Each participant has the option to
contribute a percentage of his or her earnings to the Canadian savings plan,
with no limit on the maximum percentage contributed. Beginning October 1, 2000
we began matching 100% of a participant's contributions, to the extent such
contributions do not exceed 3.5% of such participant's base compensation
(excluding bonuses, profit sharing and similar types of compensation). Such
contributions amounted to $0.3 million in fiscal 2001.

PROFIT SHARING AND BONUS PLANS

In January 1997, our Board of Directors, upon recommendation of its
Compensation Committee, approved the establishment of a Profit Sharing Plan that
is designed to benefit all qualified employees and a Bonus Plan that is designed
to provide certain of our exempt salaried employees with the opportunity to earn
bonuses depending, among other things, on our annual financial performance. We
incurred $3.7 million and $7.4 million of expenses related to the Profit Sharing
Plan and Bonus Plan, respectively, in fiscal 2000. No expenses for profit
sharing or bonuses were incurred in fiscal 2001 or 1999.

OMNIBUS STOCK AWARDS AND INCENTIVE PLAN

In April 1997, our Board of Directors approved the establishment of our
Omnibus Stock Awards and Incentive Plan (as amended, the "Omnibus Plan"). Under
the Omnibus Plan, we may grant our key employees incentive and nonqualified
stock options, SARs, restricted stock awards, performance awards and phantom
stock awards. Our Board of Directors approved an amendment to the Omnibus Plan
which increased the total number of shares available for issuance under the
Omnibus Plan to 2,000,000, which was ratified and approved by our stockholders
at their annual meeting held on January 24, 2001. Of the 2,000,000 shares of
Holdings Common Stock available for issuance under the Omnibus Plan, 1,221,845
shares are the subject of outstanding grants. The terms and amounts of the
awards (including vesting schedule) are determined by the Compensation Committee
of our Board of Directors. Generally, outstanding stock options become
exercisable (vest) in equal annual installments beginning a year from date of
grant and ending five years from date of grant. In the event of a specified
change of control of Holdings or a qualified public offering of Holdings Common
Stock, all awards immediately vest and become exercisable. During fiscal 2001,
we granted options to purchase 515,000 shares of our common stock for prices
ranging between $0.50 and $6.00 per share (all of which were completely vested
upon their grant).

During fiscal 1999 we issued 1,500 restricted stock awards to one of our
employees. This restricted stock award vested 25% immediately, with an
additional 25% of this award vesting each year after the date of grant.

AMENDED AND RESTATED STOCK PLAN FOR NON-EMPLOYEE DIRECTORS

In April 1997, our Board of Directors approved the establishment of our
1997 Nonqualified Stock Option Plan for Non-Employee Directors. Under this plan,
each eligible director who was serving on our Board of Directors on each
subsequent October 1st was automatically granted an option to acquire 1,000
shares of Holdings Common Stock (2,000 shares for the Vice-Chairman). Effective
as of April 26, 2000, our 1997 Nonqualified Stock Option Plan was amended and
restated as our Amended and Restated Stock Plan for Non-Employee Directors.
Under our Amended and Restated Stock Plan, each of our non-employee directors
received $15,000 in shares of our common stock and options to purchase 2,000
shares of our common stock on October 1, 2000. This grant of shares was valued
at the average market price for a share of our common stock during the 90-day
period ending on the date of grant. Under both our 1997 Nonqualified Stock
Option Plan and our Amended and Restated Stock Plan, each of our non-employee
directors were eligible to participate and each had the ability to elect not to
participate. All options issued under these plans expire ten years from
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the date of grant, were granted with an exercise price at or above the fair
market value of a share of Holdings Common Stock on the date of grant (as
determined by our Board of Directors) and vested and became exercisable
immediately. On March 7, 2001, our Board of Directors elected to terminate this
plan with respect to future grants.

KEY EMPLOYEE PROTECTION PLAN

On January 26, 2000, our Board approved our Key Employee Protection Plan,
which has subsequently been amended several times. This plan was established by
our Board to help us retain certain of our employees and motivate them to
continue to exert their best efforts on our behalf during periods when we may be
susceptible to a change of control and to assure their continued dedication and
objectivity during those periods. This plan, as amended, was approved by the
Bankruptcy Court in our bankruptcy proceedings on October 31, 2001. A select
group of management or highly compensated employees has been designated as
participants under the plan and their respective applicable multipliers and
other variables for determining benefits have been established. Our Compensation
Committee is authorized to designate additional management or highly compensated
employees as participants under our Key Employee Protection Plan and set their
applicable multipliers. Our Compensation Committee may also terminate any
participant's participation under this plan on 60 days' notice if it determines
that the participant is no longer one of our key employees. Approximately $0.8
million was paid during fiscal 2001 pursuant to this plan.

RETENTION BONUS PLAN

On July 13, 2001, our Board approved our Retention Bonus Plan, which was
subsequently amended. This plan was established by our Board to help us retain
our employees whose resignations would cause significant disruption to our
operations and whose skills would be particularly difficult and costly to
replace, to improve their morale during the pendency of our bankruptcy
proceedings and help us incentivize these employees to work diligently toward
the resolution of our bankruptcy proceedings. The plan, as amended, was approved
by the Bankruptcy Court in our bankruptcy proceedings on October 31, 2001. A
select group of management or highly compensated employees has been designated
as participants under the plan and their respective benefits have been
established. Each participant in the plan is entitled to payments under the plan
on specified dates, unless the participant's employment with us terminates prior
to that payment date for any reason other than a termination by the participant
for "Good Reason" or a termination by us for any reason other than "Misconduct"
or "Disability." Payments under the plan are based on specified percentages of
the participant's annual compensation, including payments under our Supplemental
Pay Plan. Each participant who becomes entitled to payments under the plan will
be paid 25% of the total amount payable to that participant on the earlier of
April 15, 2002 and the date on which a plan of reorganization in our bankruptcy
proceedings is confirmed, an additional 25% on the earliest to occur of October
15, 2002, the date on which a plan of reorganization is confirmed in our
bankruptcy proceedings and the date on which all or substantially all of our
assets are sold or otherwise transferred, and the final 50% on the earlier to
occur of the date on which a plan of reorganization is confirmed in our
bankruptcy proceedings and the date on which all or substantially all of our
assets are sold or otherwise transferred. However, if payments are made solely
as a result of the sale of all or substantially all of our assets, a participant
is not entitled to any payments under the plan unless such sale or transfer
occurs after April 15, 2002 and, for any sale or transfer that occurs after that
date, the participant is only entitled to receive one-half of the final 50%
payment. Approximately $0.6 million was accrued during fiscal 2001 pursuant to
this Plan.

We may amend our Retention Bonus Plan at any time but any amendment that
adversely affects a participant's rights or benefits under the plan or reduces
our obligations under the plan will not be effective with respect to any person
who was a participant at the time of such amendment. In addition, we may

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terminate our Retention Bonus Plan at any time, but all benefits payable under
the plan must be paid in full notwithstanding any termination or amendment of
the plan.

SEVERANCE PLAN

On March 8, 2001, our Board approved our Severance Pay Plan, which has
subsequently been amended. This plan covers all of our non-unionized United
States employees and was established by our Board to help us retain these
employees by assuring them that they will receive some compensation in the event
that their employment is adversely affected in specified ways in connection with
a change of control. This plan as amended was approved by the Bankruptcy Court
in our bankruptcy proceedings on October 31, 2001. Under our Severance Pay Plan,
any participant that terminates his or her employment for "Good Reason" or is
terminated by us for any reason other than "Misconduct" or "Disability" during
the period commencing 180 days prior to the date on which a specified change of
control occurs and ending 180 days after such change of control is entitled to
benefits under the plan. If a participant becomes entitled to benefits under the
plan, we are required to provide the participant with a lump sum cash payment in
an amount equivalent to two weeks of such participant's base salary for each
credited year of service, with a minimum payment of six months' base salary and
a maximum payment of one year's base salary. The amount of this lump sum payment
is reduced, however, by the amount of any other separation, severance or
termination payments made by us to the participant under any other plan or
agreement, including our Key Employee Protection Plan, or pursuant to law. In
addition, a pro rata portion of any lump sum amount paid to a participant under
the plan must be repaid by the participant if the participant is rehired by us
or our successor within 90 days after the participant's termination date.

In addition to the lump sum payment, for a period of six months after the
participant's termination date, the COBRA premium required to be paid by such
participant for coverage under our medical and dental plans may not be increased
beyond that required to be paid by active employees for similar coverage under
those plans, as long as the participant makes a timely COBRA election and pays
the regular employee premiums required under those plans and otherwise continues
to be eligible for coverage under those plans.

We may terminate or amend our Severance Pay Plan at any time and for any
reason but no termination or amendment of the plan may be effective with respect
to any participant if the termination or amendment is related to, in
anticipation of or during the pendency of a change of control, is for the
purpose of encouraging or facilitating a change of control or is made within 180
days prior to any change of control. Finally, no termination or amendment of our
Severance Pay Plan can affect the rights or benefits of any participant that are
accrued under the plan at the time of termination or amendment or that accrue
thereafter on account of a change of control that occurred prior to the
termination or amendment or within 180 days after such termination or amendment.

SUPPLEMENTAL BONUS PLAN

On July 13, 2001, our Board approved our Supplemental Bonus Plan, which was
subsequently amended. The plan is designed to help us retain certain of our
employees during the pendency of our bankruptcy proceedings and provide us with
the ability to reward our employees who have made extraordinary contributions
and personal sacrifices in connection with our bankruptcy proceedings. Our
Supplemental Bonus Plan, as amended, was approved by the Bankruptcy Court in our
bankruptcy proceedings on October 31, 2001. Our Board has the ability to
designate employees as participants under the plan and determine the amount
payable to those participants, subject to an overall limit of $1.4 million in
payments under the plan. However, our Board may not designate any of our
employees as a participant under the plan if that employee is a participant
under our Retention Bonus Plan, and no participant under our Retention Bonus
Plan may receive any payment under our Supplemental Bonus Plan. Each participant
in the plan is entitled to receive the

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amount designated by our Board at the conclusion of our bankruptcy proceedings,
unless the participant's employment with us terminates prior to that time for
any reason other than a termination by the participant for "Good Reason" or a
termination by us for any reason other than "Misconduct" or "Disability." We may
amend our Supplemental Bonus Plan at any time but any amendment that adversely
affects a participant's rights or benefits under the plan or reduces our
obligations under the plan will not be effective with respect to any person who
was a participant at the time of such amendment. In addition, we may terminate
our Supplemental Bonus Plan at any time, but all benefits payable under the plan
must be paid in full notwithstanding any termination or amendment of the plan.

SUPPLEMENTAL PAY PLAN

On March 8, 2001, our Board approved our Supplemental Pay Plan, which was
approved by the Bankruptcy Court in our bankruptcy proceedings on October 31,
2001. Historically, we have paid our senior level employees below-market
salaries with the opportunity to earn above-market compensation through stock
based incentives and significant bonuses in years when we achieve targeted
levels of EBITDA. Due to our financial difficulties, the opportunity to earn
additional compensation through these programs was significantly reduced, if not
entirely eliminated. As a result, our Board established this plan to address
their concern that the overall compensation provided to our senior level
employees would always be below-market and, consequently, not adequate to retain
these employees or attract new highly-qualified employees. A select group of
management or highly compensated employees has been designated as participants
under the plan and their respective benefits have been established. Each payment
under the plan is a specified percentage of the participant's annual base salary
and payments are paid on or before the tenth day after the last day of each
calendar quarter. The participant must be employed by us on the relevant payment
date in order to be eligible to receive that payment under the plan. We may
amend or terminate our Supplemental Pay Plan at any time but any amendment or
termination of the plan can only become effective on a payment date and may not
affect the rights of participants under the plan that have accrued as of that
effective date, including the right to receive supplemental pay on that payment
date.

OUTSTANDING STOCK OPTIONS

A summary of the status of our outstanding stock options as of September
30, 2001, 2000 and 1999 and changes during the years then ended is presented
below:

- ---------------

(1) On December 14, 1998, we issued to all of our employees who held stock
options on that date new options with an exercise price of $6.00 per share.
The new options were issued in exchange for and in cancellation of stock
options previously issued to those employees for the same number of shares
and with the same vesting schedules.

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The range of exercise prices for options outstanding at September 30, 2001,
was $0.50 -- $12.00, with all exercisable options having an exercise price range
of $0.50-$12.00.

All stock options are granted with an exercise price at or above fair
market value of a share of Holdings Common Stock at the grant date. The weighted
average fair value of the stock options granted during fiscal 2000 and 1999 was
$0.6 million and $0.6 million, respectively. The fair value of each stock option
grant is estimated on the date of grant using the Black-Scholes option pricing
model with the following weighted average assumptions used for the grants in
fiscal 2000 and 1999; risk free interest rate of 5.8% and 5.9%, respectively;
expected dividend yield of 0.0% for all years; expected life of ten years for
all years; and expected volatility of 83% and 59%, respectively. Stock options
generally expire ten years from the date of grant and fully vest after five
years. The outstanding stock options at September 30, 2001 have a weighted
average contractual life of approximately four years. Depending on its terms, a
plan of reorganization for the Debtors may result in the elimination of all
stock options. Due to the Chapter 11 filings, it is unlikely that any of the
options granted will be exercised. As such, it is difficult to predict the
value, if any, of the options granted during fiscal 2001.

In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation,"
we utilize the intrinsic value method of accounting for stock-based compensation
and no compensation costs have been recognized for stock option awards described
above. Had compensation cost for all option issuances been determined consistent
with SFAS No. 123, it would not have had a material impact on our net loss and
loss per share for fiscal 2001, 2000 and 1999.

8. COMMITMENTS AND CONTINGENCIES

PRODUCT CONTRACTS

We have certain long-term agreements, which provide for the dedication of
100% of our production of acetic acid, methanol, plasticizers, sodium cyanide,
calcium hypochlorite and DSIDA, each to one customer. We also have various sales
and conversion agreements, which dedicate significant portions of our production
of styrene and acrylonitrile to various customers. Some of these agreements
generally provide for cost recovery plus an agreed margin or element of profit
based upon market price.

All of the Debtors' contracts and agreements continue in effect in
accordance with their terms notwithstanding our Chapter 11 filings, unless
otherwise ordered by the Bankruptcy Court. The Bankruptcy Code provides the
Debtors with the opportunity to reject any pre-petition contracts or agreements
that are burdensome or assume any pre-petition contracts or agreements that are
favorable or otherwise necessary to their business operations.

LEASE COMMITMENTS

We have entered into various long-term operating leases. Future minimum
lease commitments at September 30, 2001, are as follows: fiscal 2002 -- $6.9
million; fiscal 2003 -- $6.1 million; fiscal 2004 -- $5.6 million; fiscal
2005 -- $4.6 million; and thereafter -- $8.5 million.

All of the Debtors' operating leases continue in effect in accordance with
their terms notwithstanding our Chapter 11 filings, unless otherwise ordered by
the Bankruptcy Court. The Bankruptcy Code provides the Debtors with the
opportunity to reject any pre-petition leases that are burdensome or assume any
pre-petition leases that are favorable or otherwise necessary to their business
operations.

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ENVIRONMENTAL AND SAFETY MATTERS

Our operations involve the handling, production, transportation, treatment
and disposal of materials that are classified as hazardous or toxic waste and
that are extensively regulated by environmental, health and safety laws,
regulations and permit requirements. Environmental permits required for our
operations are subject to periodic renewal and can be revoked or modified for
cause or when new or revised environmental requirements are implemented.
Changing and increasingly strict environmental requirements can affect the
manufacturing, handling, processing, distribution and use of our chemical
products and the raw materials used to produce such products and, if so
affected, our business and operations may be materially and adversely affected.
In addition, changes in environmental requirements can cause us to incur
substantial costs in upgrading or redesigning our facilities and processes,
including waste treatment, storage, disposal and other waste handling practices
and equipment.

We conduct environmental management programs designed to maintain
compliance with applicable environmental requirements at all of our facilities.
We routinely conduct inspection and surveillance programs designed to detect and
respond to leaks or spills of regulated hazardous substances and to correct
identified regulatory deficiencies. We believe that our procedures for waste
handling are consistent with industry standards and applicable requirements. In
addition, we believe that our operations are consistent with good industry
practice. We continue to participate in Responsible Care(R)initiatives as a part
of our membership in several trade groups which are partner associations in the
American Chemistry Council in the United States and the Canadian Chemical
Producers Association in Canada. Notwithstanding our efforts and beliefs, a
business risk inherent in chemical operations is the potential for personal
injury and property damage claims from employees, contractors and their
employees and nearby landowners and occupants. While we believe our business
operations and facilities generally are operated in compliance with all
applicable environmental and health and safety requirements in all material
respects, we cannot be sure that past practices or future operations will not
result in material claims or regulatory action, require material environmental
expenditures or result in exposure or injury claims by employees, contractors
and their employees and the public. Some risk of environmental costs and
liabilities is inherent in our operations and products, as it is with other
companies engaged in similar businesses.

Our operating expenditures for environmental matters, mostly waste
management and compliance, were approximately $34 million for fiscal 2001 and
$31 million for fiscal 2000. We also spent approximately $1 million for
environmentally related capital projects in both fiscal 2001 and fiscal 2000. In
fiscal 2002, we anticipate spending approximately $2 million to $4 million for
capital projects related to waste management and environmental compliance. There
are no capital expenditures related to remediation of environmental conditions
projected for fiscal 2002.

The Texas Natural Resource Conservation Commission enacted new regulations
requiring significant reductions of nitrogen oxide which apply to our Texas City
facility. The TNRCC is also expected to propose similar regulations requiring
the reduction of particulate matter which will apply to our Texas City facility.
The nitrogen oxide regulations covering the Houston/Galveston Area State
Implementation Plan were approved by the United States Environmental Protection
Agency on October 15, 2001. Under these regulations, we are required to reduce
emissions of nitrogen oxide at our Texas City facility by up to approximately
90%, which we estimate would require Chemicals to make between $25 million and
$30 million in capital improvements at our Texas City facilities. The majority
of these capital expenditures would be expected in fiscal 2002 through 2005.

A significant ban on all chlorine containing compounds could have a
materially adverse effect on us. British Columbia has a regulation in place
requiring elimination of the use of all chlorine products, including chlorine
dioxide, in the bleaching process by the year 2002. The pulp and paper industry
believes that a ban of chlorine dioxide in the bleaching process will yield no
measurable environmental or public health benefit and
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is working to change this regulation. In April 2001, a new government came into
power in British Colombia. This new administration is aware of the issues
surrounding this regulation and has agreed to negotiate amendments to the
regulation. We are working through the Alliance for Environmental Technology and
the Canadian Chemical Producers' Association to provide information to the
British Columbia Ministry of Environment to assist with these negotiations.

Claims for environmental liabilities arising prior to our Chapter 11
filings will be addressed in the Chapter 11 cases. In general, monetary claims
relating to remedial actions at off-site locations used for disposal prior to
the Chapter 11 filings and penalties resulting from violations of environmental
requirements before that time will be treated as general unsecured claims.
Actions by governmental authorities to determine liability for and the amount of
such penalties will generally not be subject to the automatic stay. We will be
obliged to comply with environmental requirements in the conduct of our business
as a debtor-in-possession, including the potential obligation to conduct
remedial actions at facilities we own or operate, regardless of when the
contamination at those facilities occurred.

LEGAL PROCEEDINGS

As previously discussed, the Debtors filed petitions for reorganization
under Chapter 11 of the Bankruptcy Code on July 16, 2001. As a result of the
commencement of the Chapter 11 cases, an automatic stay has been imposed against
the commencement or continuation of legal proceedings against the Debtors
outside of the Bankruptcy Court. The automatic stay will not apply, however, to
governmental authorities exercising their police or regulatory powers, including
the application of environmental laws. Claimants against the Debtors may assert
their claims in the Chapter 11 cases by filing a timely proof of claim, to which
the Debtors may object and seek a determination from the Bankruptcy Court as to
the allowability of the claim. Claimants who desire to liquidate their claims in
legal proceedings outside of the Bankruptcy Court will be required to obtain
relief from the automatic stay by order of the Bankruptcy Court. If such relief
is granted, the automatic stay will remain in effect with respect to the
collection of liquidated claim amounts. As a general rule, all claims against
the Debtors that seek a recovery from assets of the Debtors' estates will be
addressed in the Chapter 11 cases and paid only pursuant to the terms of a
confirmed plan of reorganization.

Ethylbenzene Release

On April 1, 1998, a chemical leak occurred when a line failed in the
ethylbenzene unit at our Texas City facility. The released chemicals included
ethylbenzene, benzene, polyethylbenzene and hydrochloric acid. We do not believe
any serious injuries were sustained, although a number of citizens sought
medical examinations at local hospitals after a precautionary alert was given to
neighboring communities. The seven lawsuits, and an additional three
interventions, involve approximately 821 plaintiffs/intervenors who seek an
unspecified amount for damages. We believe that all or substantially all of our
future out-of-pocket costs and expenses relating to these lawsuits, including
settlement payments and judgments, will be covered by our liability insurance
policies or indemnification from third parties. We do not believe that the
claims and litigation arising out of this incident will have a material adverse
effect on our business, financial position, results of operations or cash flows,
although we cannot give any assurances to that effect. Unless otherwise ordered
by the Bankruptcy Court, all of these claims and litigation are subject to the
automatic stay and recoveries (if any) sought thereon from assets of the Debtors
will be addressed in the Chapter 11 cases. To date, the Bankruptcy Court has
lifted the automatic stay in the cases of Bobbie Adams, et al., James C. Allen,
et al. and Nettie Allen, et al. for the sole purpose of allowing the plaintiffs
to proceed against our liability insurance policies. Small cash settlements, to
be funded by our liability insurance policies, have been negotiated with the
plaintiffs in one of the interventions and in the cases of Ida Goldman, et al.
and Joe L. Kimble, et al., and have been approved by the Bankruptcy Court.

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On June 11, 2001, we received a notice from the U.S. Department of Justice,
Environment and Natural Resources Division, in which the Department alleged that
on April 1, 1998 an ethylbenzene release at our Texas City facility violated the
general duty clause of the Clean Air Act and invited us to engage in settlement
discussion with respect to the matter. Although we believe that the April 1,
1998 ethylbenzene release did not constitute a violation of the general duty
clause of the Clean Air Act, we have engaged in discussions with the Department
in an attempt to settle the matter on consensual basis. However, any alleged
liability would constitute a pre-petition claim, and any settlement would
require approval by the Bankruptcy Court. We do not believe that this matter
will have a material adverse effect on our business, financial position, results
of operations or cash flow, although we cannot given any assurances to that
effect.

Other Claims

We are subject to various other claims and legal actions that arise in the
ordinary course of its business. Claims and legal actions against the Debtors
that existed as of the Chapter 11 filing date are subject to the automatic stay,
and recoveries sought thereon from assets of the Debtors will be required to be
dealt with in the Chapter 11 cases.

LITIGATION CONTINGENCY

We have made estimates of the reasonably possible range of liability with
regard to our outstanding litigation for which we may incur any liability. These
estimates are based on our judgment using currently available information, as
well as consultation with our insurance carriers and outside legal counsel. A
number of the claims in these litigation matters are covered by our insurance
policies or by third party indemnification. Therefore, we have also made
estimates of our probable recoveries under insurance policies or from third-
party indemnitors based on our judgment, our understanding of our insurance
policies and indemnification arrangements, discussions with our insurers and
indemnitors and consultation with outside legal counsel. Based on the foregoing,
as of September 30, 2001, we had approximately $3.5 million accrued as our
estimate of our contingent liability for these matters and have also recorded
aggregate receivables from our insurers and third-party indemnitors of
approximately $2.5 million. At September 30, 2001, we estimate that the
aggregate reasonably possible range of loss for all litigation combined, in
addition to the amount accrued, is between zero and $21 million. The timing of
probable insurance and indemnity recoveries and payment of liabilities, if any,
are not expected to have a material adverse effect on our business, financial
position, results of operations or cash flows, although we cannot give any
assurances to that effect. While we have based our estimates on our evaluation
of available information and the other matters described above, much of the
litigation remains in the discovery stage and it is impossible to predict with
certainty the ultimate outcome. We will adjust our estimates as necessary as
additional information is developed and evaluated. However, we believe that the
final resolution of these contingencies will not have a material adverse effect
on our business, financial position, results of operations or cash flows,
although we cannot give any assurances to that effect. Moreover, such
contingencies represent pre-petition claims and, unless otherwise ordered by the
Bankruptcy Court, all of these claims are subject to the automatic stay and
recoveries (if any) sought thereon from the Debtors will be addressed in the
Chapter 11 cases.

9. SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION

Our operations are divided into two reportable segments: petrochemicals and
pulp chemicals. The petrochemicals segment is based in the U.S. and manufactures
commodity petrochemicals and acrylic fibers. The pulp chemicals segment is
primarily based in Canada and manufactures chemicals for use primarily in the

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

pulp and paper industry, and constructs chlorine dioxide generators for use by
pulp mills. Operating segment information for 2001, 2000 and 1999 is presented
below.

Sales to individual customers constituting 10% or more of total revenues
and export sales were as follows:

10. FINANCIAL INSTRUMENTS

FOREIGN EXCHANGES

We have previously entered into forward foreign exchange contracts to
reduce risk due to Canadian dollar exchange rate movements. The forward foreign
exchange contracts had varying maturities with none exceeding 18 months. We made
net settlements of United States dollars for Canadian dollars at rates agreed to
at inception of the contracts. We do not engage in currency speculation. The
last of our existing forward

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

exchange contracts expired in March 2000, and we do not intend to enter into any
additional forward exchange contracts.

GAS HEDGES

We hedged a portion of our natural gas to be used in the production of
styrene and methanol during fiscal 1999 and we had a net loss of $1.5 million in
fiscal 1999 due to such natural gas hedging contracts. During fiscal 2000,
fiscal 2001 and at September 30, 2001, there were no outstanding natural gas
hedges.

ELECTRICITY CONTRACTS

Our Canadian subsidiaries periodically enter fixed price agreements for a
portion of their electrical energy requirements. We have an agreement relating
to the supply of a portion of the electrical energy at one of our Canadian
sodium chlorate production facilities. This agreement, which was previously
designated as a normal purchase under SFAS No. 133, does not meet the criteria
of a normal purchase based on guidance issued by the Derivative Implementation
Group (the "DIG") and cleared by the Financial Accounting Standards Board in
June 2001. All purchases under this agreement, which expires on December 31,
2001, are used in the ordinary course of business; however, effective July 1,
2001, this agreement is required to be marked-to-market. At September 30, 2001,
the value of this agreement was a loss of approximately $1.2 million based on
current market prices and quantities to be delivered.

INTEREST RATE SWAP

We have entered into a declining balance interest rate swap that had, at
September 30, 2001, a notional amount of $8.9 million outstanding. Under the
swap, we pay a fixed rate of 6.66% and receive a floating rate based on LIBOR.
The swap is settled on a quarterly basis, with the interest rate differential
received or paid by us recognized as an adjustment to interest expense. This
swap was entered into to protect against interest rate volatility; however, it
does not meet hedge criteria under SFAS No. 133. Accordingly, the swap is
marked-to-market and reflected in the balance sheet as an asset or liability. At
September 30, 2001, the swap had an estimated fair value of ($0.2) million.

CONCENTRATIONS OF RISK

We sell our products primarily to companies involved in the petrochemicals,
acrylic fibers and pulp and paper manufacturing industries. We perform ongoing
credit evaluations of our customers and generally do not require collateral for
accounts receivable. However, letters of credit are required by us on many of
our export sales. Historically, our credit losses have been minimal.

We maintain cash deposits with major banks, which from time to time may
exceed federally insured limits. We periodically assess the financial condition
of these institutions and believe that the likelihood of any possible loss is
minimal.

Approximately 42% of our employees are covered by union agreements.
Approximately 23% of our employees are covered by union agreements which could
expire within one year. The primary union agreement at our Texas City facility
will expire on May 1, 2002. This agreement continues to be in effect
notwithstanding our Chapter 11 filing. Under the Bankruptcy Code, the agreement
may be assumed or rejected, but any rejection would require that we comply with
the special provisions of the Bankruptcy Code related to collective bargaining
agreements. We do not currently intend to reject this agreement prior to its
expiration date and expect to negotiate with the union concerning the terms of a
new agreement to take effect after the expiration date.

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

INVESTMENTS

It is our policy to invest our excess cash in investment instruments or
securities whose value is not subject to market fluctuations, such as
certificates of deposit, repurchase agreements or Eurodollar deposits with
domestic or foreign banks or other financial institutions. Other permitted
investments include commercial paper of major United States corporations with
ratings of A1 by Standard & Poor's Ratings Group or P1 by Moody's Investor
Services, Inc., loan participations of major United States corporations with a
short term credit rating of A1/P1 and direct obligations of the United States
Government or its agencies. In addition, we will not invest more than $5 million
with any single bank, financial institution or United States corporation. As a
result of the Chapter 11 filings, the Bankruptcy Court requires excess cash
presently held by Holdings to be invested in United States Treasury Bills or as
certificates of deposit with Chase Bank, N.A.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts reflected in the consolidated balance sheet for cash
and cash equivalents, receivables, payables and certain accrued expenses
approximate fair value due to the short maturities of these instruments. The
following table presents the carrying values and fair values of our long term
debt (including current maturities) at September 30, 2001:

Due to the uncertainty resulting from the Bankruptcy filings discussed in
Note 1, it is difficult to estimate the fair value of the Debtors' borrowings
and other pre-petition liabilities. Due to the DIP Financing, the Canadian
Financing Agreement and the Saskatoon Term Loans having variable interest rates,
the fair value approximates their carrying value.

At September 30, 2001, our interest rate swap had a fair market value of
($0.2) million, based on our estimate of what we would have to pay to terminate
the swap at September 30, 2001.

At September 30, 2001, our forward power contract had a fair market value
of ($1.2) million, based on our estimate of current energy prices and quantities
to be delivered under the contract.

11. RELATED PARTY TRANSACTIONS

In May of 1999, we engaged Credit Suisse First Boston Corporation ("CSFB")
and Donaldson Lufkin & Jenrette Securities Corporation ("DLJ") as Joint-Book
Running Managers in connection with the issuance by Chemicals of the 12 3/8%
Notes. CSFB and DLJ also underwrote the Prior Credit Agreement with Tyco
Capital, as Administrative Agent. We paid CSFB a total of $5,218,750 under these
arrangements in fiscal 1999. John L. Garcia, one of our former directors, was a
Managing Director and the Head of the Global Chemical Investment Banking Group
of CSFB from 1994 until April of 1999.

Since October 1, 1991, we have had ongoing commercial relationships in the
ordinary course of business with certain affiliates of Koch Industries, Inc.,
including agreements for the supply of raw materials, sales of petrochemicals
and transportation of natural gas. During our fiscal years ended September 30,
2001, 2000 and 1999:

- we made product sales to and purchased raw materials from Koch Chemical
and Koch Nitrogren Company, indirect wholly owned subsidiaries of Koch
Industries, Inc.;

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- we made payments to John Zink Company, an indirect wholly owned
subsidiary of Koch Industries, Inc., in consideration for certain
contracting and construction services performed at our Texas City
facility; and

- we made payments to Koch Gateway Pipeline Company for the transportation
of natural gas to our acrylic fibers plant through a pipeline in which it
is a partner.

Each of these relationships represented less than 5% of our revenues in
each of such fiscal years. In addition, in 1998 we filed a lawsuit against John
Zink Company seeking recovery for certain types of damages sustained in
connection with a release of nickel carbonyl from our methanol unit on July 30,
1997. This lawsuit has been voluntarily dismissed but, under a tolling agreement
between the parties, may be refiled at any time. In May of 2000, we entered into
a new 3 1/2 year ammonia supply agreement with Koch Nitrogen. The new ammonia
supply agreement replaced our prior ammonia supply agreement with Koch Nitrogen
which was not scheduled to expire until 2002. The new ammonia supply agreement
requires us to purchase the same annual quantity of ammonia from Koch Nitrogen
but at a revised pricing formula. In connection with the execution of the new
ammonia supply agreement, we made a payment to Koch Nitrogen of $1.2 million to
settle a dispute under the old ammonia supply agreement and we also made a
one-time payment to Koch Nitrogen of $1.8 million in exchange for the revised
pricing formula. Koch Capital Services, Inc., an affiliate of Koch Industries,
Inc., is one of our significant stockholders and, under the Voting Agreement
described below, has the right to designate a member of our Board of Directors.
Koch Capital has elected to waive its right to designate a member of our board.

The holders of 6,653,583 shares of Holdings Common Stock, representing
approximately 52% of our outstanding shares, are parties to a Third Amended and
Restated Voting Agreement dated as of February 1, 1999 (the "Voting Agreement").
Three of our directors, Frank P. Diassi, Frank J. Hevrdejs and T. Hunter Nelson,
and one of our former directors, William A. McMinn, are parties to the Voting
Agreement. Other parties to the Voting Agreement include Koch Capital Services,
Inc. (an affiliate of Koch Industries), affiliates of Clipper ("The Clipper
Group"), affiliates of Olympus, CSFB and Gordon A. Cain. The parties to the
Voting Agreement are required to vote any shares of Holdings Common Stock owned
by them in favor of three nominees to the Board of Directors of Holdings, one to
be designated by each of Koch Capital Services, Inc., The Clipper Group and Mr.
Cain. Rolf H. Towe is the current designee of The Clipper Group. Mr. Cain did
not designate a nominee to our Board following the resignation of his prior
nominee on October 26, 2000. Koch Capital has elected to waive its right to
designate a member of our Board. The rights of each of Koch Capital Services,
Inc. and The Clipper Group to designate nominees under the Voting Agreement
terminate on the earlier of August 21, 2006 or the time at which they beneficial
own less than 5% of the outstanding shares of our Common Stock, respectively.
The right of Mr. Cain to designate a nominee terminated on December 15, 2001.

As of December 15, 1998, we entered into separate Standby Purchase
Agreements with each of Gordon A. Cain, William A. McMinn, James Crane, Frank P.
Diassi, Frank J. Hevrdejs and Koch Capital Services, Inc. as described below in
Note 12.

12. CAPITAL STOCK

In connection with the issuance of the 13 1/2% Notes (see Note 4), Holdings
issued 191,751 warrants to purchase three shares of Holdings Common Stock for
$0.01, exercisable from August 1998 until August 2008. During fiscal 2000 and
1999, 1,515 and 32,460 shares, respectively, of Holdings Common Stock were
issued as a result of 505 and 10,820, respectively, of these warrants being
exercised. There were no warrants exercised during fiscal 2001. In connection
with the Saskatoon Acquisition, Holdings also issued to holders of the Series B
Preferred Stock warrants to purchase 201,048 shares of Holdings Common Stock for
$0.01,

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

exercisable from July 1997 until December 2007. A plan of reorganization for the
Debtors may result in the elimination of all stock interests, including
warrants.

In December 1998, we entered into separate Standby Purchase Agreements with
each of Gordon A. Cain, William A. McMinn, James Crane, Frank P. Diassi, Frank
J. Hevrdejs and Koch Capital Services, Inc. Under each of the Standby Purchase
Agreements, we had the right to require the purchasers to purchase shares only
if we were able to satisfy certain conditions precedent relating to our
financial condition, and then only if we believed that the equity infusion was
necessary to maintain, reestablish or enhance Chemicals' borrowing rights under
its revolving credit facilities or to satisfy any requirement thereunder to
raise additional equity. As of September 30, 2001, we were not able to meet the
conditions to our ability to draw on the Standby Purchase Agreements, and, on
December 15, 2001, they expired in accordance with their terms.

At September 30, 2001, warrants to purchase an aggregate of 697,203 shares
Holdings Common Stock were outstanding.

13. MANDATORY REDEEMABLE PREFERRED STOCK

In connection with the acquisition of our acrylic fibers facility, we
authorized 350,000 shares and issued 104,110 shares of non-voting Series A
Preferred Stock with a fair value and carrying value of $10.0 million. The
Series A Preferred Stock has a cumulative dividend rate of 10%, payable in kind
semi-annually on January 1 and July 1 of each year commencing July 1, 1997.
However, no dividends will be paid during the pendency of the Chapter 11 cases.
Under the terms of the Series A Preferred Stock, we may redeem all or any number
of shares of Series A Preferred Stock at any time with proper written notice at
a price of $100 per share plus accrued and unpaid dividends. The holders of
Series A Preferred Stock may elect to have us redeem shares on any dividend
payment date after June 30, 2009, with proper written notice, at a price of $100
per share plus accrued and unpaid dividends. However, no redemptions will occur
during the pendency of the Chapter 11 cases. The carrying value of the Series A
Preferred Stock at September 30, 2001 and 2000, was $15.8 million and $14.3
million, respectively (liquidation value of $100 per share). A plan of
reorganization for the Debtors may result in the elimination of the Series A
Preferred Stock for little or no consideration.

In connection with the Saskatoon Acquisition, we authorized 58,000 shares
and issued approximately 7,532 shares of non-voting Series B Preferred Stock
with a fair value of $4.9 million. The Series B Preferred Stock has a 14%
dividend rate through July 10, 2002 and thereafter a variable rate between 14%
and 18% depending on payment terms until redeemed. The dividend is payable in
kind on January 1, April 1, July 1 and October 1 of each year, commencing
October 1, 1997. However, no dividends will be paid during the pendency of the
Chapter 11 cases. Under the terms of the Series B Preferred Stock, we may redeem
all or any number of shares of Series B Preferred Stock at any time with proper
written notice at a price of $1,000 per share plus a premium ranging from 5% to
1% depending on the date of redemption plus accrued and unpaid dividends. The
holders of Series B Preferred Stock may elect to have us redeem shares on any
dividend payment date after June 30, 2009, with proper written notice, at a
price of $1,000 per share plus accrued and unpaid dividends. However, no
redemptions will occur during the pendency of the Chapter 11 cases. The carrying
value of the Series B Preferred Stock at September 30, 2001 and 2000, was $11.5
million and $9.6 million, respectively, based on liquidation value of $1,000 per
share, reflecting a reduction in the carrying value of the Series B Preferred
Stock in an amount equal to the fair market value of warrants issued to the
holders of the Series B Preferred Stock in connection with the financing. The
difference in the carrying value and the redemption amount is accreted as a
charge to equity over the holding period using the effective interest rate
method. A plan of reorganization for the Debtors may result in the elimination
of the Series B Preferred Stock for little or no consideration.

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. NEW ACCOUNTING STANDARDS

SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. As of
October 1, 2000 the transition adjustment relating to the adoption of these
statements was not material.

We have an agreement relating to the supply of a portion of the electrical
energy at one of our Canadian sodium chlorate production facilities. This
agreement, which was previously designated as a normal purchase under SFAS No.
133, does not meet the criteria of a normal purchase based on guidance issued by
the DIG and cleared by the Financial Accounting Standards Board in June 2001.
All purchases under this agreement, which expires on December 31, 2001, are used
in the ordinary course of business; however, effective July 1, 2001, this
agreement is required to be marked-to-market. At September 30, 2001, the value
of this agreement was a loss of approximately $1.2 million based on current
market prices and quantities to be delivered.

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations be accounted for
under the purchase method and requires separate identification and recognition
of intangible assets, other than goodwill. The statement applies to all business
combinations initiated after June 30, 2001.

SFAS No. 142 requires that an intangible asset that is acquired shall be
initially recognized and measured based on its fair value. The statement also
provides that goodwill should not be amortized, but shall be tested for
impairment annually, or more frequently if circumstances indicate potential
impairment, through a comparison of fair value to its carrying amount. SFAS No.
142 is effective for fiscal periods beginning after December 15, 2001. We do not
believe that the adoption of SFAS No. 141 or 142 will have a significant impact
on our financial statements.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, "Accounting for Asset Retirement Obligations." SFAS No. 143, which must be
applied to fiscal years beginning after June 15, 2002, addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. We are in
the process of evaluating the impact of SFAS No. 143 on our financial
statements.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
addresses financial accounting and reporting for the impairment of long-lived
assets and for long-lived assets to be disposed of. SFAS No. 144 is effective
for fiscal years beginning after December 15, 2001. We are currently evaluating
the provisions of SFAS No. 144.

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Except as modified below, the Notes to Holdings' Consolidated Financial
Statements are incorporated herein by reference insofar as they relate to
Chemicals.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

INCOME TAXES

Chemicals is included in the consolidated federal tax return filed by its
parent, Holdings. A tax sharing agreement between Holdings and Chemicals defines
the computation of Chemicals' obligations to Holdings. Chemicals' provision for
income taxes is computed as if Chemicals and its subsidiaries file their annual
tax return on a separate company basis. Deferred income taxes are recorded to
reflect the tax effect of the temporary differences between the financial
reporting basis and the tax basis of Chemicals' assets and liabilities at
enacted rates.

EARNINGS PER SHARE

All issued and outstanding shares of Chemicals are held by Holdings and
accordingly, earnings per share are not presented.

2. PRE-PETITION LIABILITIES

LIABILITIES SUBJECT TO COMPROMISE

The principal categories of claims classified as liabilities subject to
compromise under reorganization proceedings are identified below. All amounts
below may be subject to future adjustment depending on Bankruptcy Court action,
further developments with respect to disputed claims or other events, including
the reconciliation of claims filed with the Bankruptcy Court to amounts recorded
in the accompanying consolidated financial statements. Additional pre-petition
claims may arise from rejection of additional executory contracts or unexpired
leases by the Debtors. Under a confirmed plan of reorganization, all pre-
petition claims subject to compromise may be paid and discharged at amounts
substantially less than their allowed amounts.

On a combined basis, recorded liabilities subject to compromise under
Chapter 11 proceedings as of September 30, 2001, consisted of the following:

- ---------------

(1) Debt liabilities are presented net of unamortized debt issue costs of $6.6
million.

As a result of the bankruptcy filing, principal and interest payments may
not be made on pre-petition debt without Bankruptcy Court approval or until a
plan of reorganization defining the repayment terms has been

96

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

confirmed. The total interest on pre-petition debt that was not paid or charged
to earnings for the period from July 16, 2001 to September 30, 2001, was $10.2
million. Such interest is not being accrued since management believes it is not
probable that it will be treated as an allowed claim. The Bankruptcy Code
generally disallows the payment of post-petition interest that accrues with
respect to unsecured or undersecured claims.

LIABILITIES NOT SUBJECT TO COMPROMISE

The principal categories of claims classified as liabilities not subject to
compromise under reorganization proceedings are identified below. Management
believes all amounts below are fully secured liabilities that are not expected
to be compromised.

On a combined basis, recorded liabilities not subject to compromise under
Chapter 11 proceedings as of September 30, 2001, consisted of the following:

3. CONDENSED COMBINED FINANCIAL STATEMENTS OF ENTITIES IN BANKRUPTCY

The following condensed combined financial statements are presented in
accordance with SOP 90-7:

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF OPERATIONS

97

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED BALANCE SHEETS

98

STERLING CHEMICALS, INC.

(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF CASH FLOWS

99

STERLING CHEMICALS, INC. AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

4. INCOME TAXES

A reconciliation of federal statutory income taxes to Chemicals' effective
tax provision (benefit) before extraordinary item follows:

The provision (benefit) for income taxes is composed of the following:

100

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(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The components of Chemicals' deferred income tax assets and liabilities are
summarized below:

101

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of Sterling Chemicals Holdings, Inc.

We have audited the accompanying consolidated balance sheets of Sterling
Chemicals Holdings, Inc. and subsidiaries (Debtors-in-Possession) (the
"Company") as of September 30, 2001 and 2000 and the related consolidated
statements of operations, changes in stockholders' equity (deficiency in assets)
and cash flows for each of the three years in the period ended September 30,
2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. 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 the Company as of September 30,
2001 and 2000 and the results of its operations and its cash flows for each of
the three years in the period ended September 30, 2001 in conformity with
accounting principles generally accepted in the United States of America.

As discussed in Note 1, on July 16, 2001, the Debtors (as defined in Note
1) filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The
accompanying financial statements do not purport to reflect or provide for the
consequences of the bankruptcy proceedings. In particular, such financial
statements do no purport to show (a) as to assets, their realizable value on a
liquidation basis or their availability to satisfy liabilities; (b) as to
pre-petition liabilities, the amounts that may be allowed for claims or
contingencies or the status and priority thereof; (c) as to stockholder
accounts, the effect of any changes that may be made in the capitalization of
the Company; or (d) as to operations, the effect of any changes that may be made
in the Company's business.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1, the Company's
recurring losses from operations raise substantial doubt about its ability to
continue as a going concern. Management's plans concerning these matters are
also discussed in Note 1. The financial statements do not include adjustments
that might result from the outcome of this uncertainty.

DELOITTE & TOUCHE LLP

Houston, Texas
December 20, 2001

102

INDEPENDENT AUDITORS' REPORT

To the Stockholder of Sterling Chemicals, Inc.

We have audited the accompanying consolidated balance sheets of Sterling
Chemicals, Inc. and subsidiaries (Debtors-in-Possession) ("Chemicals") as of
September 30, 2001 and 2000 and the related consolidated statements of
operations, changes in stockholder's equity (deficiency in assets) and cash
flows for each of the three years in the period ended September 30, 2001. These
financial statements are the responsibility of Chemicals' management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. 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 Chemicals as of September 30,
2001 and 2000 and the results of its operations and its cash flows for each of
the years in the period ended September 30, 2001 in conformity with accounting
principles generally accepted in the United States of America.

As discussed in Note 1, on July 16, 2001, the Debtors (as defined in Note
1) filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The
accompanying financial statements do not purport to reflect or provide for the
consequences of the bankruptcy proceedings. In particular, such financial
statements do no purport to show (a) as to assets, their realizable value on a
liquidation basis or their availability to satisfy liabilities; (b) as to
pre-petition liabilities, the amounts that may be allowed for claims or
contingencies or the status and priority thereof; (c) as to stockholder
accounts, the effect of any changes that may be made in the capitalization of
Chemicals; or (d) as to operations, the effect of any changes that may be made
in Chemicals' business.

The accompanying financial statements have been prepared assuming that
Chemicals will continue as a going concern. As discussed in Note 1, Chemicals'
recurring losses from operations raise substantial doubt about its ability to
continue as a going concern. Management's plans concerning these matters are
also discussed in Note 1. The financial statements do not include adjustments
that might result from the outcome of this uncertainty.

DELOITTE & TOUCHE LLP

Houston, Texas
December 20, 2001

103

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
COMBINED STATEMENTS OF OPERATIONS

- ---------------

(1) Contractual interest for the year ended September 30, 2001 totaled $45,681.

The accompanying notes are an integral part of the combined financial
statements.
104

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
COMBINED BALANCE SHEETS

The accompanying notes are an integral part of the combined financial
statements.
105

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
COMBINED STATEMENTS OF
CHANGES IN STOCKHOLDER'S EQUITY (DEFICIENCY IN ASSETS)

The accompanying notes are an integral part of the combined financial
statements.
106

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
COMBINED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the combined financial
statements.
107

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

On July 23, 1999, Sterling Chemicals, Inc. ("Chemicals"), a wholly owned
subsidiary of Sterling Chemicals Holdings, Inc. ("Holdings"), completed a
private offering of $295,000,000 of its 12 3/8% Senior Secured Notes due 2006.
On November 5, 1999, Chemicals completed a registered exchange offer pursuant to
which all of these notes were exchanged for publicly registered 12 3/8% Notes
with substantially similar terms (the "12 3/8% Notes"). The 12 3/8% Notes are
guaranteed by all of Chemicals' existing direct and indirect United States
subsidiaries (other than Sterling Chemicals Acquisitions, Inc.) on a joint and
several basis and are secured by, among other things, a pledge of 100% of the
stock of these subsidiaries. These subsidiaries consist of Sterling Canada,
Inc., Sterling Pulp Chemicals US, Inc., Sterling Pulp Chemicals, Inc., Sterling
Chemicals Energy, Inc., Sterling Chemicals International, Inc. and Sterling
Fibers, Inc. and, together with two Canadian subsidiaries of Sterling Canada,
Inc., are collectively referred to as the "Guarantors." The consolidated
financial statements of each of these guarantor subsidiaries have been combined
to produce the accompanying financial statements.

The Guarantors manufacture chemicals for use primarily in the pulp and
paper industry at four plants in Canada and a plant in Valdosta, Georgia and
manufacture acrylic fibers at a plant in Santa Rosa County, Florida. Sodium
chlorate is produced at the four plants in Canada and the Valdosta plant. Sodium
chlorite is produced at one of the Canadian locations. The Guarantors also
license, engineer and oversee construction of large-scale chlorine dioxide
generators, which convert sodium chlorate into chlorine dioxide, for the pulp
and paper industry. The Guarantors produce regular textiles, specialty textiles
and technical fibers at the Santa Rosa plant, as well as licensing their acrylic
fibers manufacturing technology to producers worldwide. On March 8, 2001, the
Guarantors' announced their decision to withdraw from the traditional commodity
textile business and, thereafter, significantly reduced their operations and
staffing at their acrylic fibers plant in Santa Rosa, Florida. The Guarantors
continue to produce specialty textile fibers and technical fibers at this
facility.

CHAPTER 11 PROCEEDINGS

The accompanying combined financial statements have been prepared on the
going concern basis of accounting, which contemplates the continuity of
operations, the realization of assets and the satisfaction of liabilities in the
ordinary course of business. On July 16, 2001 (the "Petition Date"), Holdings,
Chemicals and all of the Guarantors except for the two Canadian subsidiaries of
Sterling Canada, Inc., (collectively the "Debtors") filed voluntary petitions
for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Bankruptcy
Code") in the U.S. Bankruptcy Court for the Southern District of Texas (the
"Bankruptcy Court") and began operating their business as debtors-in-possession
pursuant to the Bankruptcy Code. The accompanying combined financial statements
have been presented in conformity with the AICPA's Statement of Position 90-7
"Financial Reporting By Entities In Reorganization Under the Bankruptcy Code"
("SOP 90-7"). The statement requires a segregation of liabilities subject to
compromise by the Bankruptcy Court as of the Petition Date and identification of
all transactions and events that are directly associated with the reorganization
of the Debtors.

The Chapter 11 petitions were driven by the Debtors' inability to meet
their funded debt obligations over the long-term, largely brought about by weak
demand for petrochemical products caused by declines in general worldwide
economic conditions, the relative strength of the U.S. dollar which has caused
their export sales to be at a competitive disadvantage and higher raw material
and energy costs. As a result of these conditions, the Debtors have incurred
significant operating losses. The reorganization contemplated by the Chapter 11
filings is designed to permit the Debtors to preserve cash and to give the
Debtors the opportunity to restructure their debt. During the pendency of the
Chapter 11 cases, with approval of the Bankruptcy Court, the Debtors may assume
favorable pre-petition contracts and leases, reject unfavorable pre-petition
contracts

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

and leases and sell or otherwise dispose of assets. The confirmation of a plan
of reorganization is the primary objective of the Debtors. Unless otherwise
ordered by the Bankruptcy Court, the Debtors have the exclusive right to propose
a plan of reorganization until March 13, 2002, and the exclusive right to seek
acceptances of any plan proposed by them until May 12, 2002. A plan of
reorganization, when filed will set forth the means for treating claims,
including liabilities subject to compromise and interests in the Debtors. Such
means may take a number of different forms. A plan of reorganization may result
in, among other things, significant dilution or elimination of certain classes
of existing interests as a result of the issuance of equity securities to
creditors or new investors. The Debtors are in the early stages of formulating a
plan of reorganization. The confirmation of any plan of reorganization will
require creditor acceptance as required under the Bankruptcy Code and approval
of the Bankruptcy Court.

At this time, it is not possible to predict the outcome of the bankruptcy
cases in general, or the effect on the business of the Debtors or the claims of
creditors of the Debtors. As a result of the bankruptcy filings, most of the
Debtors' liabilities incurred prior to the Petition Date, including certain
secured debt, could be subject to compromise. However, the ultimate resolution
of these liabilities is not presently determinable.

Reorganization items reflected in the Statement of Operations for fiscal
2001 are composed primarily of professional fees directly related to the
bankruptcy cases.

As a result of the bankruptcy filings and related events, there is no
assurance that the carrying amounts of assets will be realized or that
liabilities will be liquidated or settled for the amounts recorded. In addition,
confirmation of a plan of reorganization, or disapproval thereof, could change
the amounts reported in the financial statements. The ability of the Debtors to
continue as a going concern is dependent upon, among other things, (i) the
Debtors' ability to comply with the terms of the DIP Financing described below
and any related orders entered by the Bankruptcy Court in connection with the
Chapter 11 cases, (ii) the ability of the Debtors to access the incremental $40
million in DIP Financing that is dependent on an effective priming order, (iii)
the ability of the Debtors to maintain adequate cash on hand, (iv) the ability
of the Debtors to generate sufficient cash from operations, (v) the ability of
the Debtors' subsidiaries that are not included in the Chapter 11 cases to
obtain necessary financing, (vi) confirmation of a plan or plans of
reorganization under the Bankruptcy Code and (vii) the Debtors' ability to
achieve profitability following such confirmation. As the Debtors can give no
assurances that they will accomplish any of the foregoing, there is substantial
doubt about the Debtors', and therefore the Guarantors', ability to continue as
a going concern.

The Guarantors have limited liquidity, which may prove inadequate during
their reorganization process. The Debtors are currently funding their liquidity
needs out of operating cash flow and from borrowings under the DIP Financing.
The DIP Financing is limited in amount and is also subject to numerous funding
conditions which are largely beyond the control of the Debtors, including
borrowing base requirements and compliance with the EBITDA covenant contained in
the DIP Financing. The ability of the Debtors to obtain additional financing
during the reorganization process is severely limited by a variety of factors,
including the debt incurrence restrictions imposed by the DIP Financing,
numerous procedural requirements and uncertainties relating to the bankruptcy
proceedings, including any continuing challenge to the priming order, and the
Debtors' current financial condition and prospects. Accordingly, no assurances
can be given that the Debtors' existing sources of liquidity will be adequate to
fund their liquidity needs throughout the reorganization process or, if
additional sources of liquidity become necessary during the reorganization
process, that they would be available to the Debtors or adequate. Any liquidity
shortages during the reorganization process would likely have a material adverse
effect on the Debtors' business and financial condition as well as their ability
to successfully restructure and emerge from bankruptcy. See Note 5 for
additional information regarding the status of the challenge to the priming
order and the impact on our business.

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The accompanying financial statements do not include any adjustments that
may result from the resolution of these uncertainties.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies of the Guarantors are described below.

PRINCIPLES OF COMBINATION

The combined financial statements include the accounts of all wholly owned
and majority-owned subsidiaries of the combined entities. All significant
intercompany accounts and transactions among entities included in the combined
financial statements have been eliminated. The Guarantors' investment in a
cogeneration joint venture in which the Guarantors have a fifty percent interest
is accounted for under the equity method.

CASH EQUIVALENTS

The Guarantors consider all investments with a remaining maturity of three
months or less to be cash equivalents.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost is primarily
determined on the first-in, first-out basis, except for stores and supplies
which are valued at average cost.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost. Major renewals and
improvements, which extend the useful lives of equipment, are capitalized. Major
planned maintenance expenses are accrued for during the periods prior to the
maintenance, while routine repair and maintenance expenses are charged to
operations as incurred. Disposals are removed at carrying cost less accumulated
depreciation with any resulting gain or loss reflected in operations.
Depreciation is provided using the straight-line method over estimated useful
lives ranging from 5 to 25 years, with the predominant life of the plant and
equipment being 15 years.

IMPAIRMENT OF LONG-LIVED ASSETS

Impairment tests of long-lived assets are made when conditions indicate
their carrying cost may not be recoverable. Such impairment tests are based on a
comparison of undiscounted future cash flows or the market value of similar
assets to the carrying cost of the asset. If an impairment is indicated, the
asset value is written down to its estimated fair value. During fiscal 2000, the
Guarantors incurred an impairment loss of $60.0 million related to their acrylic
fibers business.

PATENTS AND ROYALTIES

The costs of patents are amortized on a straight-line basis over their
estimated useful lives, which approximate ten years. The Guarantors capitalized
the value of their chlorine dioxide generator technology acquired in fiscal 1992
based on the net present value of all estimated remaining royalty payments
associated with this technology. The resulting intangible amount is included in
other assets and is amortized over an average life for these royalty payments of
ten years.

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

INCOME TAXES

The Guarantors are included in the consolidated United States federal
income tax returns filed by Holdings. The Guarantors' provision (benefit) for
United States income taxes has been allocated by Holdings as if the Guarantors
filed their annual tax returns on a separate return basis. The Guarantors'
Canadian subsidiaries file separate federal Canadian tax returns, as well as
returns in the provinces in which they operate. Deferred income taxes are
recorded to reflect the tax effect of the temporary differences between the
financial reporting basis and the tax basis of the Guarantors' assets and
liabilities.

REVENUE RECOGNITION

The Guarantors generate revenues through sales in the open market and
long-term supply contracts and recognize these revenues as the products are
shipped. Deferred credits are amortized over the life of the contracts which
gave rise to them. The Guarantors also generate revenues from the construction
and sale of chlorine dioxide generators, which are recognized using the
percentage of completion method. The Guarantors also receive prepaid royalties,
which are typically recognized over a period of ten years. In addition, the
Guarantors generate revenues from the sale of acrylic fibers manufacturing
technology to producers worldwide, which are recognized as earned. The
Guarantors classify shipping and handling costs associated with product
delivered to customers as costs of goods sold.

FOREIGN CURRENCY TRANSLATION AND FOREIGN EXCHANGE

The Canadian companies included in the combined financial statements of the
Guarantors use the Canadian dollar as the functional currency. For financial
reporting purposes, assets and liabilities of these companies denominated in
Canadian dollars are translated into United States dollars at year-end exchange
rates and revenues and expenses are translated at the average monthly exchange
rates. Translation adjustments are included in accumulated other comprehensive
income, while transaction gains and losses are included in operations when
incurred.

EARNINGS PER SHARE

All issued and outstanding shares of the entities included in Guarantors'
financial statements are held directly or indirectly by Chemicals and Holdings
and, accordingly, earnings per share information is not presented.

ENVIRONMENTAL COSTS

Environmental costs are expensed as incurred unless the expenditures extend
the economic useful life of the relevant assets. Costs that extend the economic
life of assets are capitalized and depreciated over the remaining life of those
assets. Liabilities are recorded when environmental assessments or remedial
efforts are probable and the cost can be reasonably estimated.

DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

In preparing disclosures about the fair value of financial instruments, the
Guarantors have assumed that the carrying amount approximates fair value for
cash and cash equivalents, receivables, accounts payable and certain accrued
expenses due to the short maturities of those instruments. The fair values of
long-term debt instruments allocated to the Guarantors by Chemicals are
estimated based upon quoted market values (if applicable) or on the current
interest rates available for debt with similar terms and remaining maturities.
The fair value of pre-petition liabilities subject to compromise and
pre-petition liabilities not subject to compromise is not possible to determine
given the uncertainty of the impact of the bankruptcy proceedings.

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Considerable judgment is required in developing these estimates and,
accordingly, no assurance can be given that the estimated values presented
herein are indicative of the amounts that would be realized in a free market
exchange.

ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported periods. Significant estimates include
environmental reserves, litigation contingencies and taxes. Actual results could
differ from these estimates.

ALLOCATIONS

The Guarantors are directly or indirectly wholly owned by Chemicals, which
incurs certain direct and indirect expenses for the benefit and support of the
Guarantors. These services include, among others, tax planning, treasury, legal,
risk management and the maintenance of insurance coverage for the Guarantors.
Chemicals allocated $2.9 million, $4.9 million and $3.5 million of such expenses
to the Guarantors in fiscal years 2001, 2000 and 1999, respectively, which are
included in selling, general and administrative expenses. Additionally,
Chemicals allocated $1.0 million of other expense and $1.8 million of
reorganization items during fiscal 2001. Allocations are based on the
Guarantors' proportionate share of the respective amounts and are determined
using various criteria including headcount, payroll, number of vehicles, amount
of pre-petition liabilities and revenue.

NEW ACCOUNTING STANDARDS

Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,"
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. The Guarantors adopted these statements as of October 1,
2000. The transition adjustment relating to the adoption of these statements was
not material.

The Guarantors have an agreement relating to the supply of a portion of the
electrical energy at one of their Canadian sodium chlorate production
facilities. This agreement, which was previously designated as a normal purchase
under SFAS No. 133, does not meet the criteria of a normal purchase based on
guidance issued by the Derivative Implementation Group (the "DIG") and cleared
by the Financial Accounting Standards Board in June 2001. All purchases under
this agreement, which expires on December 31, 2001, are used in the ordinary
course of business; however, effective July 1, 2001, this agreement is required
to be marked-to-market. At September 30, 2001, the value of this agreement was a
loss of approximately $1.2 million based on current market prices and quantities
to be delivered.

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations be accounted for
under the purchase method and further requires separate identification and
recognition of intangible assets, other than goodwill. The statement applies to
all business combinations initiated after June 30, 2001.

SFAS No. 142 requires that an intangible asset that is acquired shall be
initially recognized and measured based on its fair value. The statement also
provides that goodwill should not be amortized, but shall be tested

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

for impairment annually, or more frequently if circumstances indicate potential
impairment, through a comparison of fair value to its carrying amount. SFAS No.
142 is effective for fiscal periods beginning after December 15, 2001. The
Guarantors do not believe that the adoption of SFAS No. 141 or 142 will have a
significant impact on their financial statements.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, "Accounting for Asset Retirement Obligations." SFAS No. 143, which must be
applied to fiscal years beginning after June 15, 2002, addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
Guarantors are in the process of evaluating the impact of SFAS No. 143 on their
financial statements.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
addresses financial accounting and reporting for the impairment of long-lived
assets and for long-lived assets to be disposed of. SFAS No. 144 is effective
for fiscal years beginning after December 15, 2001. The Guarantors are currently
evaluating the provisions of SFAS No. 144.

RECLASSIFICATION

Certain amounts reported in the financial statements for prior periods have
been reclassified to conform with the current financial statement presentation
with no effect on net loss or stockholder's equity (deficiency in assets).

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS

4. PRE-PETITION LIABILITIES

LIABILITIES SUBJECT TO COMPROMISE

The principal categories of claims classified as liabilities subject to
compromise under reorganization proceedings are identified below. All amounts
below may be subject to future adjustment depending on Bankruptcy Court action,
further developments with respect to disputed claims or other events, including
the reconciliation of claims filed with the bankruptcy court to amounts recorded
in the accompanying consolidated financial statements. Additional pre-petition
claims may arise from rejection of additional executory contracts or unexpired
leases by the Debtors. Under a confirmed plan of reorganization, all
pre-petition claims subject to compromise may be paid and discharged at amounts
substantially less than their allowed amounts.

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Recorded liabilities subject to compromise under Chapter 11 proceedings as
of September 30, 2001, consisted of the following:

- ---------------

(1) Debt liabilities are presented net of allocated unamortized debt issue costs
of $4.0 million.

As a result of the bankruptcy filing, principal and interest payments may
not be made on pre-petition debt without Bankruptcy Court approval or until a
plan of reorganization defining the repayment terms has been confirmed. The
total interest on pre-petition debt that was not paid or charged to earnings for
the period from July 16, 2001 to September 30, 2001, was $7.0 million. Such
interest is not being accrued since management believes it is not probable that
it will be treated as an allowed claim. The Bankruptcy Code generally disallows
the payment of interest that accrues postpetition with respect to unsecured or
undersecured claims.

LIABILITIES NOT SUBJECT TO COMPROMISE

The principal categories of claims classified as liabilities not subject to
compromise under reorganization proceedings are identified below. The Guarantors
believe all amounts below are fully secured liabilities that are not expected to
be compromised.

Recorded liabilities not subject to compromise under Chapter 11 proceedings
as of September 30, 2001, consisted of the following:

5. LONG-TERM DEBT

This note contains information regarding debt of the Guarantors as of
September 30, 2001. As a result of the filing of the Chapter 11 cases previously
described, no payments will be made by the Debtors on pre-petition debt except
as approved by the Bankruptcy Court.

Upon the filing of the Chapter 11 cases by the Debtors, an Event of Default
occurred under the Prior Credit Agreement (as defined below) and each of the
indentures governing outstanding notes of Chemicals and Holdings and all of this
indebtedness was accelerated and became immediately due and payable. The Prior
Revolvers (as defined below) were completely paid off with the proceeds of the
initial draw under the DIP Financing. However, the Debtors may pay the
indebtedness under the indentures only pursuant to a confirmed plan of
reorganization or order of the Bankruptcy Court. During the pendency of the
Chapter 11

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

cases, the Debtors will not, for the most part, be subject to the restrictions
contained in the Prior Credit Agreement (as defined below) or any of the
indentures. However, the Debtors and the Guarantors will be subject to the
restrictions contained in the DIP Financing and Sterling Pulp Chemicals, Ltd.
("Sterling Pulp"), one of the Canadian companies included in the combined
financial statements of the Guarantors, will be subject to the restrictions
contained in the Canadian Financing Agreement (as defined below).

Effective July 19, 2001, the Debtors (excluding Holdings) entered into a
Revolving Credit Agreement with a group of lenders led by Tyco Capital (formerly
The CIT Group/Business Credit, Inc.) to provide up to $195 million in
Debtor-In-Possession financing (the "DIP Financing"). By interim order dated
July 18, 2001 and final order dated September 14, 2001, the Bankruptcy Court
approved up to $155 million in lending commitments under the DIP Financing (the
"Base Facility"), consisting of an $85 million "current assets revolver" and a
$70 million "fixed assets revolver." The initial draw under the DIP Financing
was used to repay all amounts outstanding under the Debtors' previous revolving
credit facilities. Additional borrowings under the DIP Financing may be used to
fund the Debtors' post-petition operating expenses and supplier and employee
obligations throughout the reorganization process. The final order dated
September 14, 2001 is on appeal to the U.S. District Court, but no stay of the
final order has been sought or imposed, and the order remains fully effective.
While no assurances can be given, we do not believe the final order will be
overturned on appeal.

Borrowings under the DIP Financing are subject to customary funding
conditions, including borrowing base restrictions under the current assets
revolver. The Base Facility is secured by substantially all of the assets of the
Debtors, but some of the liens have been granted super-priority administrative
expense claims for the amount of the DIP Financing which, subject to certain
carve outs, will entitle the DIP lenders to be paid before any other claims
against the Debtors are paid. The DIP Financing is designed to give the Debtors
the opportunity, during the reorganization process, to develop a new capital
structure that will support them over the long-term, including during recurring
cyclical downturns in the markets for the Debtors' petrochemicals products. At
September 30, 2001, the total credit available under the DIP Financing was
$112.8 million due to borrowing base restrictions under the current assets
revolver. At September 30, 2001, $42.3 million was drawn under the fixed assets
revolver and there were no borrowings outstanding under the current assets
revolver. In addition, approximately $4.4 million of letters of credit were
outstanding under the current assets revolver, leaving at September 30, 2001,
unused borrowing capacity under the secured revolving credit facilities of
approximately $66.1 million.

As a result of a priming order entered by the Bankruptcy Court on November
2, 2001 and reinstated on December 19, 2001, the lending commitments under the
current assets revolver were increased from $85 million to $125 million. The
priming order grants the lenders under the currents assets revolver a priming
lien on Chemicals' fixed assets located in the United States and the capital
stock of most of Chemicals' domestic subsidiaries, prior in right to the
existing liens in favor of the 12 3/8% Notes. Although the priming order was
entered by the Bankruptcy Court on November 2, 2001, it was appealed to the U.S.
District Court by the indenture trustee for the 12 3/8% Notes. By order dated
December 17, 2001, the U.S. District Court reversed the priming order and
remanded the matter to the Bankruptcy Court for a determination of a
compensatory adjustment in favor of the 12 3/8% Notes, which the U.S. District
Court suggested would be satisfied by a 4% increase of the interest rate payable
on up to $40 million. On remand, the Bankruptcy Court entered an order dated
December 19, 2001, reinstating the priming order subject to an appropriate
compensatory adjustment in favor of the 12 3/8% Notes of four percentage points
of additional interest on up to $40 million. In addition, the Bankruptcy Court
scheduled a hearing for January 2, 2002 to determine certain technical details
regarding implementation of this 4% increase. The Debtors anticipate that the
priming order will be further appealed by the indenture trustee. The priming
order will remain effective pending the outcome of any appeal unless stayed by
an appellate court. The Debtors will take all reasonable actions necessary,
either before the Bankruptcy Court or on appeal, to maintain the effectiveness
of the priming order and the
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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

additional liquidity provided by the priming order. If the priming order is
stayed or is not ultimately upheld on appeal, the Debtors will need to seek
additional sources of financing or revise their business plan and operations
consistent with the level of available financing. However, we can give no
assurances that the priming order will not be stayed or will be upheld on appeal
or, if stayed or not upheld on appeal, that additional sources of financing will
be available or adequate or that our available financing will be adequate after
implementing revisions to the Debtors' business plan and operations.

As of July 11, 2001, Sterling Pulp entered into a financing agreement with
Tyco Capital Business Credit (Canada) Inc. ("Tyco Canada") to provide up to the
Canadian dollar equivalent of U.S. $30 million (the "Canadian Financing
Agreement"). The initial advance under this facility, approximately U.S. $20
million, was used by Sterling Pulp to discharge a portion of an intercompany
debt and was ultimately transferred to the Debtors through an intercompany loan.
The intercompany loan was approved by the Bankruptcy Court's interim order
entered on July 18, 2001 and final order entered on September 14, 2001, which is
a subject of the appeal of the final order discussed above. The initial term of
the Canadian Financing Agreement extends to July 2004. The Canadian Financing
Agreement may be terminated by either Sterling Pulp or Tyco Canada thereafter
only by giving 60 days written notice of termination prior to each subsequent
anniversary date. At September 30, 2001, $20 million was drawn under the
Canadian Financing Agreement.

Under the DIP Financing, the Debtors (excluding Holdings) are co-borrowers
and are jointly and severally liable for any indebtedness thereunder. The Base
Facility consists of:

- a $70 million fixed assets revolving credit facility secured by:

- first priority liens on all of the capital stock of Chemicals and the
other co-borrowers, all of Chemicals' United States production
facilities and related assets and 35% of the capital stock of certain of
Chemicals' subsidiaries incorporated outside the United States; and

- second priority liens on all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers and 65% of the
capital stock of certain of Chemicals' subsidiaries incorporated outside
the United States; and

- an $85 million current assets revolving credit facility secured by:

- a first priority lien on all accounts receivable, inventory and other
specified assets of Chemicals and the other co-borrowers;

- a second priority lien on 35% of the capital stock of certain of
Chemicals' subsidiaries incorporated outside the United States; and

- third priority liens on the remaining 65% of that stock, all of the
capital stock of Chemicals and the other co-borrowers and all of
Chemicals' United States production facilities and related assets.

Available credit under the fixed assets revolving credit facility is not
subject to a borrowing base. At September 30, 2001, available credit under the
current assets revolving credit facility was subject to a monthly borrowing base
consisting of 85% of eligible accounts receivable and 65% of eligible inventory,
with an inventory cap of $42.5 million. In addition, the borrowing base for the
current assets revolver was required to exceed outstanding borrowings thereunder
by $12 million at all times with a maximum of $85 million available under the
current asset revolving credit facility.

Assuming the priming order is not overturned on appeal, (i) maximum
availability under the current assets revolving credit facility is $125 million,
(ii) the monthly borrowing base consists of 85% of eligible accounts receivable,
the lesser of $10 million or 33% of specified estimated future royalty payments
related to the Debtors' chlorine dioxide generator technology and 65% of
eligible inventory, with an inventory cap of

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NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

$62.5 million, and (iii) the borrowing base for the current assets revolver is
required to exceed outstanding borrowing by only $6 million at all times.

If the priming order remains effective and the total commitments under the
current assets revolver are increased to $125 million, the incremental $40
million is secured by first priority liens on all of our United States
production facilities and related assets and all of the capital stock of the
co-borrowers (excluding Chemicals) to secure up to $40 million under the current
assets revolver, as well as all of the same collateral securing the initial $85
million current assets revolver. Consequently, after giving effect to the
priming order, the DIP Financing consists of:

- a $70 million fixed assets revolving credit facility secured by:

- a first priority lien on all of the capital stock of Chemicals;

- second priority liens on all of Chemicals' United States production
facilities and related assets, all of the capital stock of the
co-borrowers (excluding Chemicals), all accounts receivable, inventory
and other specified assets of Chemicals and the other co-borrowers and
35% of the capital stock of certain of Chemicals' subsidiaries
incorporated outside the United States; and

- a third priority lien on the remaining 65% of that stock; and

- a $125 million current assets revolving credit facility:

- $40 million of which is secured by first priority liens on all of
Chemicals' United States production facilities and related assets, all
of the capital stock of the co-borrowers (excluding Chemicals) and 35%
of the capital stock of certain of Chemicals' subsidiaries incorporated
outside the United States and a second priority lien on the remaining
65% of that stock; and

- all of which is secured by a first priority lien on all accounts
receivable, inventory and other specified assets of Chemicals and the
other co-borrowers, third priority liens on all of the capital stock of
Chemicals and 35% of the capital stock of certain of Chemicals'
subsidiaries incorporated outside the United States and fourth priority
liens on the remaining 65% of that stock, all of the capital stock of
the co-borrowers (excluding Chemicals) and all of Chemicals' United
States production facilities and related assets.

Borrowings under the fixed assets revolving credit facility bear interest,
at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined
in the DIP Financing) plus 3.75% or the "Alternate Base Rate" (as defined in the
DIP Financing) plus 2.25%. Borrowings under the current assets revolving credit
facility bear interest, at Chemicals' option, at an annual rate of either the
LIBOR Rate plus 3.50% or the Alternate Base Rate plus 2.00%. At September 30,
2001, the weighted average interest rate in effect was 7.2%. The DIP Financing
also requires Chemicals and the co-borrowers to pay an aggregate commitment fee
ranging from 0.75% to 1.25% on the unused portion of the commitment for the
fixed assets revolving credit facility, depending on the amount drawn, and an
aggregate commitment fee of 0.5% on the unused portion of the commitment for the
current assets revolving credit facility.

At September 30, 2001, the total credit available under the DIP Financing
was $112.8 million due to current assets revolver borrowing base limitations
discussed above. At September 30, 2001, $42.3 million was drawn under the fixed
assets revolver and there were no borrowings outstanding under the current
assets revolver. In addition, approximately $4.4 million of letters of credit
were outstanding under the current assets revolver, leaving at September 30,
2001, unused borrowing capacity under the secured revolving credit facilities of
approximately $66.1 million. None of these borrowings were allocated to the
Guarantors.

118

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

At September 30, 2001, $20 million was drawn under the Canadian Financing
Agreement. Borrowings under the Canadian Financing Agreement bear interest at
the CIBC Bank Rate (as defined in the Canadian Financing Agreement) plus between
2.0% and 2.5%, or at the LIBOR Rate plus 3.5%.

The DIP Financing and the Canadian Financing Agreement contain numerous
covenants, including, but not limited to, restrictions on the Debtors' ability
to incur indebtedness, create liens and sell assets, as well as maintenance of
certain financial covenants.

In August of 1996, in connection with a recapitalization transaction,
Chemicals allocated $276.8 million of debt to the Guarantors. In addition, $81
million of debt incurred at the time Chemicals acquired its acrylic fibers
business was allocated to the Guarantors. Principal payments are allocated to
the Guarantors by Chemicals as scheduled principal payments are made on a basis
consistent with the original allocation. In addition, the Guarantors have made
payments to Chemicals, from time to time, out of available cash which were
applied by Chemicals as a reduction of the principal of the previously allocated
debt. Interest expense is allocated to the Guarantors based on the terms of
Chemicals' debt agreements. At September 30, 2001, interest rates on the
allocated debt ranged from 11.25% to 12.375%. Debt issue costs relating to
allocated long-term debt have been allocated to the Guarantors by Chemicals on a
basis consistent with long-term debt and are included as a valuation against
pre-petition liabilities -- subject to compromise.

On July 23, 1999, Chemicals completed a private offering of $295,000,000 of
its 12 3/8% Senior Secured Notes due 2006 which were subsequently exchanged for
the 12 3/8% Notes. The proceeds of the offering of the 12 3/8% Notes were used
to fully repay and terminate Chemicals' three outstanding term loans. Upon
consummation of the offering of the 12 3/8% Notes in 1999, the debt allocated to
the Guarantors by Chemicals increased to $351.3 million. The 12 3/8% Notes are
guaranteed by all of the Guarantors (other than the two Canadian subsidiaries of
Sterling Canada, Inc.) on a joint and several basis. Each guarantee ranks
equally in right of payment with all of the relevant Guarantor's existing and
future senior indebtedness and senior in right of payment to all of its existing
and future subordinated indebtedness. However, the 12 3/8% Notes and the
guarantees are subordinated to the extent of the collateral securing the DIP
Financing. Prior to the entry by the Bankruptcy Court of the priming order, the
12 3/8% Notes and the guarantees were secured by;

- a second priority lien on all of Chemicals' and the Guarantors' United
States production facilities and related assets;

- a second priority pledge of all of the capital stock of each Guarantor
incorporated in the United States; and

- a first priority pledge of 65% of the stock of the Guarantors'
subsidiaries incorporated outside of the United States.

As a result of the priming order, the second priority liens held by the
12 3/8% Notes on all of the Guarantors' United States production facilities and
related assets and the capital stock of each Guarantor became third priority
liens. The priming order did not affect the priority of the pledge held by the
12 3/8% notes of 65% of the stock of certain of the Guarantors' subsidiaries
incorporated outside of the United States.

On July 23, 1999, Chemicals also established two secured revolving credit
facilities providing for up to $155,000,000 in revolving credit loans (the
"Prior Revolvers") under a single Revolving Credit Agreement (the "Prior Credit
Agreement"). Under the Prior Credit Agreement, Chemicals and the Guarantors
(other than the two Canadian subsidiaries of Sterling Canada, Inc.) were
co-borrowers and were jointly and severally liable for any indebtedness
thereunder. The Prior Revolvers consisted of (i) an $85,000,000 revolving credit
facility secured by a first priority lien on all accounts receivable, inventory
and other specified assets of

119

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Chemicals and the Guarantors incorporated in the United States and (ii) a
$70,000,000 revolving credit facility secured by a first priority lien on all
United States production facilities and related assets of Chemicals and the
Guarantors incorporated in the United States, all of the capital stock of
Chemicals and the Guarantors incorporated in the United States and a second
priority lien on all accounts receivable, inventory and other specified assets
of Chemicals and the Guarantors incorporated in the United States. At September
30, 2000, approximately $37.2 million was drawn by Chemicals under the Prior
Revolvers, none of which was allocated to the Guarantors. As mentioned above,
the initial draw under the DIP Financing was used to repay all amounts under the
Prior Revolvers.

6. CONDENSED COMBINED FINANCIAL STATEMENTS OF ENTITIES IN BANKRUPTCY

The following condensed combined financial statements are presented in
accordance with SOP 90-7:

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF OPERATIONS

120

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
CONDENSED COMBINED BALANCE SHEETS

121

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS

122

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS

7. INCOME TAXES

The Guarantors are included in the consolidated federal United States tax
return filed by Holdings. The Guarantors' provision (benefit) for United States
income taxes has been allocated as if the Guarantors filed their annual federal
United States tax returns on a separate return basis. As of September 30, 2001
and 2000, zero and $14.6 million, respectively, of deferred income tax assets
were included in Due from Affiliates. For the years ended September 30, 2001,
2000 and 1999, the Guarantors recorded $14.6 million, zero, and ($4.0) million,
respectively, of United States income tax expense (benefit) in the provision
(benefit) for income taxes.

Canadian deferred income taxes are recorded to reflect the tax consequences
in future years of differences between the tax basis of assets and liabilities
and the financial reporting amounts at each year-end.

A reconciliation of the Canadian income taxes to the Canadian effective tax
provision follows:

The provision for Canadian income taxes is composed of the following:

123

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The components of the Guarantors' Canadian deferred income tax assets and
liabilities are summarized below:

8. EMPLOYEE BENEFITS

The Debtors have received approval from the Bankruptcy Court to pay or
otherwise honor certain of their pre-petition obligations, including payments
for employee wages and salaries, benefits and other employee obligations. The
Guarantors' allocation of obligations under the employee benefit plans, which
are reflected in due from Affiliates, are liabilities that are subject to
compromise under the Chapter 11 reorganization proceedings. See Note 4 for
further information on liabilities subject to compromise

The Guarantors' United States employees participate in various employee
benefit plans of Chemicals. Costs, assets and liabilities associated with United
States employees participating in these various plans are allocated to the
Guarantors by Chemicals based on the number of employees. In addition, the
Guarantors sponsor various employee benefit plans in Canada.

RETIREMENT BENEFIT PLANS

Chemicals has non-contributory pension plans in the United States which
cover all salaried and wage employees. The benefits under these plans are based
primarily on years of service and employees' pay near retirement. Chemicals'
funding policy is consistent with the funding requirements of federal law and
regulations. Plan assets consist principally of common stocks and government and
corporate securities. The liability relating to United States employees
allocated to the Guarantors by Chemicals for the retirement benefit plans and
included in Due from Affiliates was $4.0 million and $4.8 million at September
30, 2001 and 2000, respectively. The total pension expense relating to United
States employees allocated to the Guarantors was $0.6 million, $1.2 million, and
$1.1 million for the years ended September 30, 2001, 2000 and 1999,
respectively. During fiscal 2001, the Guarantors recorded a curtailment gain of
$2.0 million due to their staffing reductions at their acrylic fibers plant
associated with them significantly reducing those operations.

124

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

The Guarantors have employer and employee contributor plans in Canada which
cover all salaried and wage employees. Information for Canadian benefit plans
concerning the pension obligation, plan assets, amounts recognized in the
Guarantors' financial statements and underlying actuarial assumptions is stated
below.

125

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Net periodic pension costs for the Canadian pension plan consist of the
following components:

POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

Chemicals and the Guarantors provide certain health care benefits and life
insurance benefits for retired employees. Substantially all employees become
eligible for these benefits at normal retirement age. The cost of these benefits
are accrued during the period in which the employee renders the necessary
service.

Health care benefits are provided to employees who retire with ten or more
years of service except for Canadian employees covered by collective bargaining
agreements. All employees are eligible for postretirement life insurance.
Postretirement health care benefits for United States plans are
non-contributory. Benefit provisions for most hourly and some salaried employees
are subject to collective bargaining. In general, the plans stipulate that
retiree health care benefits are paid as covered expenses are incurred. The
liability relating to United States employees allocated to the Guarantors by
Chemicals for the postretirement benefits other than pensions and included in
Due from Affiliates was $7.7 and $7.6 million at September 30, 2001 and 2000,
respectively. The total postretirement benefits other than pensions expense for
United States employees allocated to the Guarantors was $0.7 million, $0.7
million and $0.8 million for the years ended September 30, 2001, 2000 and 1999,
respectively. In addition, a curtailment gain of $0.8 million was allocated to
the Guarantors during fiscal 1999 related to the reduction of postretirement
life insurance benefits for currently active U.S. employees of the Guarantors.

126

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

Information for Canadian benefit plans with respect to the plan obligation,
the funded status, amounts recognized in the Guarantors' financial statements
and underlying actuarial assumptions is stated below.

Net periodic plan costs for the Canadian postretirement benefit consist of
the following components:

The weighted average annual assumed health care trend rate is assumed to be
7.5% for 2001. The rate is assumed to decrease gradually to 5.8% in 2027 and
remain level thereafter. Assumed health care cost trend rates have a significant
effect on the amounts reported for the health care plans. A one-percentage point
change in assumed health care trend rates would have the following effects:

SAVINGS AND INVESTMENT PLAN

Chemicals' Sixth Amended and Restated Savings and Investment Plan covers
substantially all United States employees of the Guarantors, including executive
officers. This United States Plan is qualified under Section 401(k) of the
Internal Revenue Code. Each participant has the option to defer taxation of a
portion of

127

STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

his or her earnings by directing the Guarantors to contribute a percentage of
such earnings to this Plan. A participant may direct up to a maximum of 20% of
eligible earnings to this Plan, subject to certain limitations set forth in the
Internal Revenue Code. A participant's contributions become distributable upon
the termination of his or her employment. The Guarantors did not make any
contributions to this Plan in fiscal 2000 or fiscal 1999. Beginning October 1,
2000, the Guarantors began matching 50% of a participant's contributions, to the
extent such contributions do not exceed 7% of such participant's cash
compensation (excluding bonuses, profit sharing and similar types of
compensation). Such contributions amounted to $0.2 million in fiscal 2001.

EMPLOYEE SAVINGS PLAN

The Guarantors introduced an employee savings plan for all eligible
full-time Canadian employees with an effective date of October 1, 2000. Each
participant has the option to contribute a percentage of his or her earnings to
the Canadian savings plan, with no limit on the maximum percentage contributed.
The Guarantors will match 100% of a participant's contributions, to the extent
such contributions do not exceed 3.5% of such participant's cash compensation
(excluding bonuses, profit sharing and similar types of compensation). Such
contributions amounted to $0.3 in fiscal 2001.

PROFIT SHARING AND BONUS PLANS

In January of 1997, the Board of Directors of Holdings, upon recommendation
of its Compensation Committee, approved the establishment of a profit sharing
plan that is designed to benefit all qualified employees and a bonus plan that
is designed to provide certain exempt salaried employees of the Guarantors with
the opportunity to earn bonuses, depending, among other things, on the annual
financial performance of Holdings.

The Guarantors incurred no expenses for the profit sharing plan or bonus
plan in 2001 or 1999. The Guarantors incurred $2.0 million of expenses related
to each of the profit sharing plan and bonus plan in fiscal 2000.

PHANTOM STOCK PLAN

The Guarantors have a phantom stock plan for all eligible full-time
Canadian employees. The effective date of this plan was August 21, 1996 and the
expiration date was December 31, 2000. At the end of each plan year, the plan
administrator establishes a "determined percentage" for the preceding plan year.
This percentage is then multiplied by each participant's compensation for the
plan year to determine the award amount. The award amount is then divided by the
fair market value of one share of the common stock of Holdings as of December 31
of that plan year, to determine the number of rights to be credited to the
participant. Upon termination of employment, the benefit amount becomes payable
to the participant. The benefit amount is the number of vested rights in the
participant's account, multiplied by the fair market value of one share of
common stock of Holdings as of the most recent valuation date.

The Guarantors have recorded (income) and expense of $(0.4) million, $0.2
million and $0.2 million related to the phantom stock plan for fiscal 2001, 2000
and 1999, respectively.

9. COMMITMENTS AND CONTINGENCIES

LEASE COMMITMENTS

The Guarantors have entered into various long-term noncancelable operating
leases, some of which have been allocated to commonly controlled companies.
Future minimum lease commitments at September 30,

128

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

2001, are as follows: fiscal 2002 -- $5.6 million; fiscal 2003 -- $4.9 million;
fiscal 2004 -- $4.6 million; fiscal 2005 -- $3.8 million; fiscal 2006 -- $2.6
million; and thereafter -- $4.5 million.

All of the Debtors' operating leases are in effect in accordance with their
terms notwithstanding their Chapter 11 filings, unless otherwise ordered by the
Bankruptcy Court. The Bankruptcy Code provides the Debtors with the opportunity
to reject any pre-petition leases that are burdensome or assume any pre-petition
leases that are favorable or otherwise necessary to their business operations.

ENVIRONMENTAL AND SAFETY MATTERS

The Guarantors' operations involve the handling, production,
transportation, treatment and disposal of materials that are classified as
hazardous or toxic waste and that are extensively regulated by environmental,
health and safety laws, regulations and permit requirements. Environmental
permits required for the Guarantors' operations are subject to periodic renewal
and can be revoked or modified for cause or when new or revised environmental
requirements are implemented. Changing and increasingly strict environmental
requirements can affect the manufacturing, handling, processing, distribution
and use of the Guarantors' chemical products and the raw materials used to
produce such products and, if so affected, the Guarantors' business and
operations may be materially and adversely affected. In addition, changes in
environmental requirements can cause the Guarantors to incur substantial costs
in upgrading or redesigning their facilities and processes, including their
waste treatment, storage, disposal and other waste handling practices and
equipment.

The Guarantors conduct environmental management programs designed to
maintain compliance with applicable environmental requirements at all of their
facilities. The Guarantors routinely conduct inspection and surveillance
programs designed to detect and respond to leaks or spills of regulated
hazardous substances and to correct identified regulatory deficiencies. The
Guarantors believe that their procedures for waste handling are consistent with
industry standards and applicable requirements. In addition, the Guarantors
believe that their operations are consistent with good industry practice.
However, a business risk inherent with chemical operations is the potential for
personal injury and property damage claims from employees, contractors and their
employees and nearby landowners and occupants. While the Guarantors believe that
their business operations and facilities generally are operated in compliance
with all applicable environmental, health and safety requirements in all
material respects, they cannot be sure that past practices or future operations
will not result in material claims or regulatory action, require material
environmental expenditures or result in exposure or injury claims by employees,
contractors and their employees or the public. Some risk of environmental costs
and liabilities is inherent in the operations and products of the Guarantors, as
it is with other companies engaged in similar businesses. In addition, a
catastrophic event at any of the Guarantors' facilities could result in the
incurrence of liabilities substantially in excess of their insurance coverages.

A significant ban on all chlorine containing compounds could have a
materially adverse effect on the Guarantors' financial condition and results of
operations. British Columbia has a regulation in place requiring elimination of
the use of all chlorine products, including chlorine dioxide, in the bleaching
process by the year 2002. The pulp and paper industry believes that a ban of
chlorine dioxide in the bleaching process will yield no measurable environmental
or public health benefit and is working to change this regulation. In April of
2001, a new government came into power in British Columbia. This new
administration is aware of the issues surrounding this regulation and has agreed
to negotiate amendments to the regulation. The Guarantors are working through
the Alliance for Environmental Technology and the Canadian Chemical Producers'
Association to provide information to the British Columbia Ministry of
Environment to assist with these negotiations.

The Guarantors operating expenditures for environmental matters, mostly
waste management and compliance, were approximately $3.9 million for fiscal 2001
and $3.3 million for fiscal 2000. The Guarantors
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STERLING CHEMICALS GUARANTORS

(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

also spent approximately $0.6 million for environmentally related capital
projects in fiscal 2001 and $0.7 million for these types of capital projects in
fiscal 2000. In fiscal 2002, the Guarantors anticipate spending approximately
$2.6 million for capital projects related to waste management and environmental
compliance. There are no capital expenditures related to remediation of
environmental conditions projected for fiscal 2002.

Claims for environmental liabilities arising prior to the Debtors' Chapter
11 filings will be addressed in the Chapter 11 cases. In general, monetary
claims relating to remedial actions at off-site locations used for disposal
prior to the Chapter 11 filings and penalties resulting from violations of
environmental requirements before that time will be treated as general unsecured
claims. Actions by governmental authorities to determine liability for and the
amount of such penalties will generally not be subject to the automatic stay.
The Guarantors will be obliged to comply with environmental requirements in the
conduct of their business as a debtor-in-possession, including the potential
obligation to conduct remedial actions at facilities they own or operate,
regardless of when the contamination at those facilities occurred.

LEGAL PROCEEDINGS

As previously discussed, the Debtors filed petitions for reorganization
under Chapter 11 of the Bankruptcy Code on July 16, 2001. As a result of the
commencement of the Chapter 11 cases, an automatic stay has been imposed against
the commencement or continuation of legal proceedings against the Debtors,
including those Guarantors incorporated in the United States, outside of the
Bankruptcy Court. The automatic stay will not apply, however, to governmental
authorities exercising their police or regulatory powers, including the
application of environmental laws. Claimants against the Debtors may assert
their claims in the Chapter 11 cases by filing a timely proof of claim, to which
the Debtors may object and seek a determination from the Bankruptcy Court as to
the allowability of the claim. Claimants who desire to liquidate their claims in
legal proceedings outside of the Bankruptcy Court will be required to obtain
relief from the automatic stay by order of the Bankruptcy Court. If such relief
is granted, the automatic stay will remain in effect with respect to the
collection of liquidated claim amounts. As a general rule, all claims against
the Debtors that seek a recovery from assets of the Debtors' estates will be
addressed in the Chapter 11 cases and paid only pursuant to the terms of a
confirmed plan of reorganization.

Other Claims

The Guarantors are subject to various other claims and legal actions that
arise in the ordinary course of their business. The Guarantors believe that the
ultimate liability, if any, with respect to these claims and legal actions will
not have a material effect on their financial position, results of operations or
cash flows, although the Guarantors cannot give any assurances to that effect.
Claims and legal actions against the Debtors that existed as of the Chapter 11
filing date are subject to the automatic stay, and recoveries sought thereon
from assets of the Debtors will be required to be dealt with in the Chapter 11
cases.

PLEDGE OF COMMON STOCK

In order to secure the repayment of the DIP Financing, the following
pledges of stock were made by the holders of that stock:

- In order to secure the fixed assets revolving credit facility, a first
priority pledge of 100% of the common stock of the Guarantors
incorporated in the United States and 35% of the common stock of the
Guarantors incorporated outside the United States, and a second priority
pledge of the remaining 65% of that stock; and

- In order to secure the current assets revolving credit facility, a third
priority pledge of 100% of the common stock of the Guarantors
incorporated in the United States and 65% of the common stock of

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

the Guarantors incorporated outside the United States and a second
priority pledge of the remaining 35% of that stock; and

As a result of the priming order, in order to secure the additional $40
million of the current assets revolving credit facility, there is a first
priority pledge of 100% of the common stock of the Guarantors incorporated in
the United States and 35% of the common stock of the Guarantors incorporated
outside the United States, and a second priority pledge of the remaining 65% of
that stock, which will result in the lowering by one level of priority of each
of the pledges described above.

In order to secure the repayment of the 12 3/8% Notes, the holders of the
following stock initially made a second priority pledge of 100% of the common
stock of each of the Guarantors incorporated in the United States and a first
priority pledge of 65% of the common stock of each of the Guarantors
incorporated outside of the United States. If the priming order remains
effective, the priority of the pledge of the common stock of the Guarantors
incorporated in the United States will be a third priority pledge.

10. FINANCIAL INSTRUMENTS

FOREIGN EXCHANGE

The Guarantors have previously entered into forward foreign exchange
contracts to reduce risk due to Canadian dollar exchange rate movements. The
forward foreign exchange contracts had varying maturities with none exceeding 18
months. The Guarantors made net settlements of United States dollars for
Canadian dollars at rates agreed to at inception of the contracts. The
Guarantors do not engage in currency speculation. The last of the Guarantors'
existing forward exchange contracts expired in March 2000, and they do not
intend to enter into any additional forward exchange contracts.

ELECTRICITY CONTRACTS

The Guarantors' Canadian subsidiaries periodically enter fixed price
agreements for a portion of their electrical energy requirements. The Guarantors
have an agreement relating to the supply of a portion of the electrical energy
at one of their Canadian sodium chlorate production facilities. This agreement,
which was previously designated as a normal purchase under SFAS No. 133, does
not meet the criteria of a normal purchase based on guidance issued by the
Derivative Implementation Group (the "DIG") and cleared by the Financial
Accounting Standards Board in June 2001. All purchases under this agreement,
which expires on December 31, 2001, are used in the ordinary course of business;
however, effective July 1, 2001, this agreement is required to be
marked-to-market. At September 30, 2001, the value of this agreement was a loss
of approximately $1.2 million based on current market prices and quantities to
be delivered.

CONCENTRATIONS OF RISK

The Guarantors sell their products primarily to companies involved in the
acrylic fibers and pulp and paper manufacturing industries. The Guarantors
perform ongoing credit evaluations of their customers and generally do not
require collateral for accounts receivable. However, letters of credit are
required by the Guarantors on many of their export sales. Historically, the
Guarantors' credit losses have been minimal.

The Guarantors maintain cash deposits with major banks, which from time to
time may exceed federally insured limits. The Guarantors periodically assess the
financial condition of these institutions and believe that any possible loss is
minimal.

Approximately 31% of the Guarantors' employees are covered by union
agreements. None of these union agreements expire within the next year. These
agreements are not affected by the Chapter 11 cases.

131

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(DEBTORS-IN-POSSESSION)
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)

INVESTMENTS

It is the policy of the Guarantors to invest their excess cash in
investment instruments or securities whose value is not subject to market
fluctuations, such as certificates of deposit, repurchase agreements or
Eurodollar deposits with domestic or foreign banks or other financial
institutions. Other permitted investments include commercial paper of major
United States corporations with ratings of A1 by Standard & Poor's Ratings Group
or P1 by Moody's Investor Services, Inc., loan participations of major United
States corporations with a short term credit rating of A1/P1 and direct
obligations of the United States Government or its agencies. In addition, not
more than $5 million will be invested by the Guarantors with any single bank,
financial institution or United States corporation.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts reflected in the consolidated balance sheet for cash
and cash equivalents, receivables, payables and certain accrued expenses
approximate fair value due to the short maturities of these instruments. The
fair value of pre-petition liabilities subject to compromise and pre-petition
liabilities not subject to compromise is not possible to determine given the
uncertainty of the impact of the bankruptcy proceedings. Due to the Canadian
Financing Agreement having variable interest rates, the fair value approximates
its carrying value.

132

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholder of
Sterling Canada, Inc.
Sterling Fibers, Inc.
Sterling Chemicals International, Inc.
Sterling Chemicals Energy, Inc.
Sterling Pulp Chemicals, Inc.
Sterling Pulp Chemicals US, Inc.

We have audited the accompanying combined balance sheets of the Guarantors
(Debtors-in-Possession) (as defined in Note 1) as of September 30, 2001 and 2000
and the related combined statements of operations, changes in stockholder's
equity (deficiency in assets) and cash flows for each of the three years in the
period ended September 30, 2001. These financial statements are the
responsibility of the Guarantors' management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. 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 combined financial statements present fairly, in all
material respects, the financial position of the Guarantors as of September 30,
2001 and 2000 and the results of their operations and their cash flows for each
of the three years in the period ended September 30, 2001 in conformity with
accounting principles generally accepted in the United States of America.

As discussed in Note 1, on July 16, 2001, the Debtors (as defined in Note
1) filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The
accompanying financial statements do not purport to reflect or provide for the
consequences of the bankruptcy proceedings. In particular, such financial
statements do no purport to show (a) as to assets, their realizable value on a
liquidation basis or their availability to satisfy liabilities; (b) as to
pre-petition liabilities, the amounts that may be allowed for claims or
contingencies or the status and priority thereof; (c) as to stockholder
accounts, the effect of any changes that may be made in the capitalization of
the Guarantors; or (d) as to operations, the effect of any changes that may be
made in the Guarantors' business.

The accompanying financial statements for the year ended September 30, 2001
have been prepared assuming that the Guarantors will continue as a going
concern. As discussed in Note 1, the Debtors' recurring losses from operations
raise substantial doubt about the Debtors' and, therefore, about the Guarantors'
ability to continue as a going concern. Management's plans concerning these
matters are also discussed in Note 1. The financial statements do not include
adjustments that might result from the outcome of this uncertainty.

DELOITTE & TOUCHE LLP

Houston, Texas
December 20, 2001

133

REPORT OF MANAGEMENT

Management is responsible for the preparation and content of the financial
statements and other information included in this annual report and in the
exhibits to this annual report. The financial statements have been prepared in
conformity with generally accepted accounting principles appropriate under the
circumstances to reflect, in all material respects, the substance of events and
transactions that should be included. The financial statements reflect
management's judgments and estimates as to the effects of events and
transactions that are accounted for or disclosed.

Management maintains accounting systems which are supported by internal
accounting controls that provide reasonable assurance that assets are
safeguarded and that transactions are executed in accordance with management's
authorization and recorded properly to permit the preparation of financial
statements in accordance with generally accepted accounting principles. The
concept of reasonable assurance is based on the recognition that the cost of a
system of internal accounting controls should not exceed the benefits.

Deloitte & Touche LLP performed an independent audit of our financial
statements for fiscal years 2001, 2000 and 1999, for the purpose of determining
that the statements are presented fairly and in accordance with accounting
principles generally accepted in the United States. The independent auditors are
appointed by the Board of Directors and meet regularly with the Audit and
Compliance Committee of the Board of Directors. The Audit and Compliance
Committee meets periodically with our senior officers and independent
accountants to review the adequacy and reliability of our accounting, financial
reporting and internal controls.

DAVID G. ELKINS
President and Co-Chief Executive
Officer

JOHN R. BEAVER
Corporate Controller -- Principal
Accounting Officer

December 20, 2001

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STERLING CHEMICALS HOLDINGS, INC.

SUPPLEMENTAL FINANCIAL INFORMATION
QUARTERLY FINANCIAL DATA
(UNAUDITED)

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(1) During the third quarter of fiscal 2001, tax expense of $56.8 million was
recorded to provide a valuation allowance against all of our U.S. deferred
tax assets. During the second quarter fiscal 2001, approximately $7.1
million in pre-tax charges were recorded in connection with the withdrawal
from the traditional commodity textile business of our acrylic fibers
operations which related to $2.0 million in severance payments and a
write-down of finished goods and stores inventory to their net realizable
value. During the fourth quarter of fiscal 2000, $1.6 million of expense was
recorded related to workforce reductions at our acrylic fibers operations.
We also recorded non-cash expense related to the impairment of our acrylic
fibers production assets of $60.0 million in the fourth quarter of fiscal
2000.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

BOARD OF DIRECTORS

Our Board oversees our management, reviews our long-term strategic plans
and exercises direct decision making authority in key areas. Four of our six
directors are not our employees and only non-employee directors are eligible to
serve on our Audit and Compliance Committee or our Compensation Committee.

Personal information on each of our directors is provided below. With the
exception of David G. Elkins, who was appointed to our Board upon his promotion
to President on January 24, 2001 and Richard K. Crump, who was appointed to our
Board upon his promotion to Co-Chief Executive Officer on December 18, 2001,
each of our current directors was elected by our stockholders at our last annual
meeting.

Our Board held 21 meetings in fiscal 2001. On average, our directors
attended 90% of the meetings of our Board or any of our Board committees on
which they served. Our only director who attended less than 75% of the meetings
of our Board and all committees on which he served was Allan R. Dragone, who
attended three of five such meetings prior to his resignation in March of 2001.

Frank P. Diassi Mr. Diassi is Managing General Partner of The Unicorn Group,
Age 68 L.L.C., a private financial organization. He organized The
Director since August 1996 Unicorn Group in 1981 and has originated investments in over
40 entrepreneurial companies. Prior to the effective date of
his termination of employment on December 18, 2001, Mr.
Diassi served as our Chairman of our Board of Directors
since August of 1996 and our Co-Chief Executive Officer
since September 18, 2001. Prior to September 18, 2001, Mr.
Diassi exercised the duties of our Chief Executive Officer
due to the vacancy created by the retirement of our former
Chief Executive Officer on May 8, 2000. Mr. Diassi has been
Chairman of the Board of Hawkeye Chemical Company and was a
director of Arcadian Corporation, at the time the largest
nitrogen fertilizer company in the Western Hemisphere. Mr.
Diassi also currently serves as Chairman of the Board of
Software Plus, Inc., a human resource and payroll service
supplier, and Amerlux, Inc., a manufacturer of lighting
fixtures for commercial and retail markets, and a director
of Fibreglass Holdings, Inc., a truck accessory
manufacturer. In addition, he is a founding director and a
member of the Safety, Health and Environmental Committee of
Mail-Well, Inc., a NYSE company that manufacturers envelopes
and provides commercial printing services.

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Robert W. Roten Mr. Roten spent the first 25 years of his career with
Age 67 Monsanto Company and served as Vice President for sales and
Director Since August 1996 marketing for El Paso Products Company from 1981 to 1983.
Mr. Roten was President of Materials Exchange, Inc., a
Houston-based petrochemicals and plastics marketing firm,
from 1983 until 1986. He served as our Vice
President -- Commercial from August of 1986 until September
of 1991, when he became our Vice President -- Corporate
Development. Mr. Roten served as our Executive Vice
President and Chief Operating Officer from April of 1993
until August of 1996, and served as our President and Chief
Executive Officer from August 21, 1996 until April of 1998.
Mr. Roten served as the Vice Chairman of our Board of
Directors from April of 1998 until his appointment as our
non-executive Chairman of the Board on December 18, 2001.
Mr. Roten is currently a principal in Double R Companies,
Inc., a private investment company, and President of Hickory
Acquisition Group, a chemical asset acquisition company in
which he has been a principal and a director since April of
1999. Mr. Roten is also currently President of Xnet, Inc., a
Houston-based computer and systems consulting company, and
has served on its Board of Directors since June of 1995.
David G. Elkins Mr. Elkins has been our President since January 24, 2001 and
Age 59 our Co-Chief Executive Officer since September 18, 2001.
Director Since January 2001 Prior to his appointment as our President, Mr. Elkins served
as our General Counsel and Corporate Secretary since January
1, 1998 and our Executive Vice President -- Administration
and Law since May 1, 2000. Prior to May 1, 2000, Mr. Elkins
served as one of our Vice Presidents. Mr. Elkins previously
was a senior partner in the law firm of Andrews & Kurth
L.L.P., where he specialized in corporate and securities
matters.
Frank J. Hevrdejs Mr. Hevrdejs is a principal and President of The Sterling
Age 56 Group, L.P., which he co-founded in 1982. Mr. Hevrdejs has
Director Since August 1996 actively participated in acquisitions of over 40 businesses
in the past 20 years. He is Chairman of First Sterling
Ventures Corp., an investment company, and a director of
Enduro Holdings, Inc., a structural and electrical
manufacturing company, and Fibreglass Holdings, Inc., a
truck accessory manufacturer. He is also a founding director
and a member of the Compensation Committee of Mail-Well,
Inc., a NYSE company that manufactures envelopes and
provides commercial printing services, and a director and
member of the Compensation Committee and Audit Committee of
Eagle USA, an air-freight company. Mr. Hevrdejs previously
served as a director of Chase Bank of Texas, National
Association, a national banking association, and is
currently a member of the Advisory Board of Chase Manhattan
Bank, N.A.
Hunter Nelson Mr. Nelson is currently a principal of The Sterling Group,
Age 49 L.P. Prior to joining The Sterling Group in 1989, he served
Director Since August 1996 as vice president of administration and general counsel of
Fiber Industries, Inc., a producer of polyester fibers. Mr.
Nelson was previously a partner in the law firm of Andrews &
Kurth L.L.P., specializing in corporate and securities laws.
Mr. Nelson served on the Board of Directors of Sterling
Diagnostic Imaging, Inc. until it was sold in May of 1999.

137

Rolf H. Towe Mr. Towe has served as Senior Managing Director of The
Age 63 Clipper Group, L.P. since its formation in 1991 and is Vice
Director Since January 1998 President of Clipper Asset Management, Inc. He was the
Chairman of Executive Partner Limited, an executive
consulting firm, from 1989 to 1995. Earlier in his career,
Mr. Towe held various management positions over a period of
nearly 20 years in Union Carbide Corporation, a
multinational chemicals and plastics manufacturer. Mr. Towe
also serves as a director of several private companies. Mr.
Crump has served as our Co-Chief Executive Officer since
December 18, 2001.
Richard K. Crump Prior to that time, Mr. Crump served as our Executive Vice
Age 55 President -- Operations since May 1, 2000, our Vice
Director Since December 2001 President -- Strategic Planning from December 1, 1996 until
May 1, 2000, our Vice President -- Commercial from October
of 1991 until December 1, 1996 and our
Director -- Commercial from August of 1986 until October of
1991. Prior to joining us, Mr. Crump was Vice President of
Sales for Rammhorn Marketing from 1984 until August of 1986
and Vice President of Materials Management for El Paso
Products Company from 1976 through 1983.

The holders of 6,673,213 shares of our common stock, representing
approximately 52% of our outstanding shares, are parties to a Third Amended and
Restated Voting Agreement dated as of February 1, 1999. The parties to the
Voting Agreement and its most pertinent terms are described in detail in this
Form 10-K under Item 13. Certain Relationships and Related Transactions. The
parties to the Voting Agreement are required to vote all of their shares of our
common stock in favor of three nominees to our Board; one to be designated by
certain affiliates of Clipper Capital Partners, L.P. who are commonly referred
to collectively as "The Clipper Group," one to be designated by Gordon A. Cain
and one to be designated by Koch Capital Services, Inc. Mr. Towe is the current
designee of The Clipper Group. Mr. Cain's right to designate a member of our
Board under the Voting Agreement expired on December 15, 2001 and Koch Capital
has waived its right to designate a member of our Board.

DIRECTOR COMPENSATION

Our employees who serve as members of our Board do not receive additional
compensation for serving on our Board or any Board committees, although all of
our directors are reimbursed for their travel expenses related to their services
as a director. Each of our non-employee directors is currently paid a fee of
$5,000 per quarter for his service as a director. Prior to January 1, 2001, only
our Vice Chairman was paid a fee of $5,000 per quarter, as our other
non-employee directors were paid a fee of $2,500 per quarter. Our non-employee
directors also receive $1,000 for each Board meeting held in person that they
attend and $400 for each telephonic meeting in which they participate that lasts
at least 30 minutes. Each of our non-employee directors that serves as the
Chairman of one of our Board committees is paid $1,700 for each meeting of that
committee that he attends, and our other non-employee directors that serve on
our Board committees are paid $700 per meeting. In addition, each of our
non-employee directors that serves as the Chairman of one of our Board
Committees is paid an annual retainer of $1,000 for service as Chairman on that
committee.

Under our Amended and Restated Stock Plan for Non-Employee Directors, each
of our non-employee directors received $15,000 in shares of our common stock and
fully vested options to purchase 2,000 shares of our common stock on October 1,
2000. This grant of shares under our Stock Plan for Non-Employee Directors was
valued at the average market price for a share of our common stock during the
90-day period ending on the date of grant. On March 7, 2001, our Board elected
to terminate this plan with respect to future grants.

BOARD COMMITTEES

Our Board of Directors has created various standing committees to help
carry out its duties, including a Compensation Committee and an Audit and
Compliance Committee. Generally speaking, our Board committees work on key
issues in greater detail than would be possible at full Board meetings. We do
not have a standing nominating committee.

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COMPENSATION COMMITTEE

Our Compensation Committee is currently comprised of two of our
non-employee directors, Frank J. Hevrdejs (Chairman) and Rolf H. Towe, and met
four times in fiscal 2001. Our Compensation Committee is responsible for
discharging the compensation responsibilities of our Board, reviews general
compensation issues, determines the compensation of all of our senior executives
and other key employees and recommends and administers our employee benefit
plans that provide benefits to our senior executives. Our Compensation Committee
consults, from time to time, with outside experts concerning the performance of
its duties.

AUDIT AND COMPLIANCE COMMITTEE

Our Audit and Compliance Committee is currently comprised of two of our
non-employee directors, Hunter Nelson (Chairman) and Robert W. Roten, and met
seven times in fiscal 2001. This Committee operates under a written charter
adopted by our Board. Our Audit and Compliance Committee recommends the
appointment of our independent auditors to our Board, meets with these auditors
to review their report on the financial statements of our business and approves
the audit and other services to be provided by these auditors. In addition, our
Audit and Compliance Committee reviews our Form 10-K and Form 10-Q reports and
our practices in preparing published financial statements. Our Audit and
Compliance Committee also provides oversight with respect to the establishment
of and adherence to corporate compliance programs, codes of conduct and other
policies and procedures concerning our business and our compliance with all
relevant laws.

Mr. Nelson is considered "independent" under the listing standards of the
New York Stock Exchange, the American Stock Exchange and the National
Association of Securities' Dealers. Mr. Roten was a party to a Consulting
Agreement with Holdings dated as of February 16, 2001 pursuant to which Mr.
Roten was paid $10,000 per month and was reimbursed his expenses in exchange for
consulting and advisory services related to our sales, marketing and energy and
raw material procurement practices. This Consulting Agreement expired on August
31, 2001. Due to the existence of this Consulting Agreement, Mr. Roten is not
considered independent under any of these listing standards.

EXECUTIVE OFFICERS OF THE COMPANY

Personal information with respect to each of our executive officers is set
forth below.

David G. Elkins Mr. Elkins has been our President since January 24, 2001 and
Age 59 our Co- Chief Executive Officer since September 18, 2001.
Prior to his appointment as our President, Mr. Elkins served
as our General Counsel and Corporate Secretary since January
1, 1998 and our Executive Vice President -- Administration
and Law since May 1, 2000. Prior to May 1, 2000, Mr. Elkins
served as one of our Vice Presidents. Mr. Elkins previously
was a senior partner in the law firm of Andrews & Kurth
L.L.P., where he specialized in corporate and securities
matters. Mr. Crump has served as our Co-Chief Executive
Officer since December 18, 2001.
Richard K. Crump Prior to that time, Mr. Crump served as our Executive Vice
Age 55 President -- Operations since May 1, 2000, our Vice
Director Since December 2001 President -- Strategic Planning from December 1, 1996 until
May 1, 2000, our Vice President -- Commercial from October
of 1991 until December 1, 1996 and our
Director -- Commercial from August of 1986 until October of
1991. Prior to joining us, Mr. Crump was Vice President of
Sales for Rammhorn Marketing from 1984 until August of 1986
and Vice President of Materials Management for El Paso
Products Company from 1976 through 1983.

139

Paul G. Vanderhoven Mr. Vanderhoven has been our Chief Financial Officer since
Age 48 March 21, 2001 and our Vice President-Finance since October
of 2000. Prior to becoming our Chief Financial Officer, Mr.
Vanderhoven served as our Corporate Controller from October
of 1989 through March 21, 2001, and our Manager Finance from
August of 1986 through October of 1989. Before joining us,
Mr. Vanderhoven held various positions with Monsanto Company
from 1977 through August of 1986.

We have entered into an employment agreement with Mr. Elkins which is
described in detail in this Form 10-K under Executive Compensation.

ITEM 11. EXECUTIVE COMPENSATION

EXECUTIVE COMPENSATION

The following table shows the compensation we paid during the three fiscal
years ended September 30, 2001 to each individual who served as our Chief
Executive Officer or acted in a similar capacity during fiscal 2001 and our
other four most highly compensated officers during fiscal 2001.

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(1) Includes amounts paid under our Supplemental Pay Plan and amounts deferred
under our 401(k) Savings and Investment Plan.

140

(2) Includes amounts paid under our Bonus Plan and our Profit Sharing Plan and
other bonuses paid by us as follows:

(3) On December 14, 1998, we repriced all outstanding stock options to lower the
exercise price to $6 per share. With the exception of Mr. Vanderhoven, no
options were granted to any of our officers appearing in this table during
fiscal 1999. For all of our officers other than Mr. Vanderhoven, figures for
fiscal 1999 are included solely to reflect the repricing of options granted
during fiscal 1997 and fiscal 1998. For Mr. Vanderhoven, figures for fiscal
1999 include options to acquire 3,000 shares of our common stock that were
granted in fiscal 1999, as well as options granted during fiscal 1997 and
fiscal 1998 that were repriced on December 14, 1998.

(4) Includes premiums for group life insurance and premiums for executive life
insurance paid by us and matching contributions paid by us under our 401(k)
Savings and Investment Plan as follows:

(5) Mr. Elkins was promoted to President on January 24, 2001 and Co-Chief
Executive Officer on September 18, 2001, meaning that his annual
compensation for fiscal 2001 reflects compensation paid to

141

him in his prior capacity as Executive Vice President-Administration and
Law, General Counsel and Secretary for approximately 3 1/2 months and
compensation paid to him in his capacity as President (including
approximately two weeks as Co-Chief Executive Officer) for approximately
8 1/2 months.

(6) Includes premiums for liability insurance paid by us of $2,348.

(7) Mr. Spitz resigned from employment with us on March 21, 2001, meaning that
he was employed by us during fiscal 2001 for only approximately 5 1/2months.

(8) Includes compensation for unused vacation time of $16,608 paid upon Mr.
Spitz's resignation from employment with us.

(9) Mr. Vanderhoven was promoted to Chief Financial Officer on March 21, 2001,
meaning that his annual compensation for fiscal 2001 reflects compensation
paid to him in his prior capacity as Corporate Controller and Vice
President-Finance for approximately 5 1/2 months and compensation paid to
him in his capacity as Chief Financial Officer and Vice President-Finance
for approximately 6 1/2 months.

OPTION GRANTS IN LAST FISCAL YEAR

The following table sets forth certain information relating to options to
purchase shares of our common stock granted in fiscal 2001 to each of our
executive officers named in the Executive Compensation Table. All of these
options were granted under our Omnibus Stock Awards and Incentive Plan (the
"Omnibus Plan").

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(1) All options were completely vested upon their issuance.

(2) The dollar amounts set forth under these columns are the result of
calculations of assumed annual rates of stock price appreciation from the
date of grant of the options awarded to the date of expiration of such
options of 0%, 5% and 10%. Based on these assumed annual rates of stock
price appreciation of 0%, 5% and 10%, our stock price at January 24, 2011 is
projected to be $0.4688, $0.7636 and $1.2159, respectively. These
assumptions are not intended to forecast future appreciation of our stock
price. Our stock price may increase or decrease in value over the time
period set forth above. Mr. Elkins will not realize value under his option
grants without stock price appreciation, which will benefit all
stockholders. The potential realizable value computation does not take into
account federal or state income tax consequences of option exercises or
sales of appreciated stock.

AGGREGATE YEAR-END OPTION VALUES

The following table provides information on the value of unexercised stock
options, as of September 30, 2001, held by each of our executive officers named
in the Executive Compensation Table. There were no

142

exercises of options or stock appreciation rights during fiscal 2001 by any of
these officers, and none of these officers held any stock appreciation rights at
September 30, 2001.

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* The "value" of unexercised options is based on the amount, if any, by which
the market price of a share of our common stock on the relevant date exceeds
the exercise price of the option. The actual gain, if any, that one of our
officers realizes from the exercise of options will depend on the market price
of a share of our common stock at the time of exercise. An "In-The-Money"
option is an option for which the exercise price is lower than the market
price of a share of our common stock on the relevant date. None of our
officers held options with an exercise price below the market price of a share
of our common stock as of September 30, 2001.

PENSION PLANS

Salaried Employees' Pension
Plan.......................... Most of our salaried employees, including each
of our executive officers named in the
Executive Compensation Table, participate in
our defined benefit Salaried Employees' Pension
Plan. We determine the pension costs under this
Plan each year on an actuarial basis and make
all necessary contributions. The pension
benefits payable under this Plan are determined
by multiplying the employee's "vested
percentage" by the sum of (i) the number of
years the employee is given credit as having
worked for us times 1.2% of his or her "Average
Earnings" plus (ii) the number of years the
employee is given credit as having worked for
us (not to exceed 35) times 0.45% of the amount
which his or her "Average Earnings" exceeds the
average (without indexing) of his or her Social
Security taxable wage bases during the 35-year
period ending on December 31 of the year in
which he or she attains Social Security
retirement age. Generally, an employee's
"Average Earnings" will be either the average
compensation received by the employee during
the three years in which the employee was paid
the most in his or her final five years of
employment or the average compensation received
by the employee during the last 36 months of
his or her employment, whichever is larger,
excluding amounts received under our Profit
Sharing and Bonus Plans. However, due to
certain limitations imposed under the Internal
Revenue Code, benefits payable to an employee
under this Plan are effectively limited in
amount to those benefits that would be payable
to an employee having Average Earnings of
$170,000.

Pension Benefit Equalization
Plan.......................... Each of our salaried employees who is eligible
to participate in our Pension Plan is also
eligible to participate in our Pension Benefit
Equalization Plan. Our Equalization Plan pays
additional benefits to employees whose benefits
under our Pension Plan are limited as

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a result of specified limitations under the
Internal Revenue Code. The amount of benefits
payable under our Equalization Plan is designed
to eliminate the effect of these limitations on
the aggregate pension benefits payable to the
participants but not provide any additional
benefits beyond that amount. These benefits are
generally payable at the times we pay benefits
under our Pension Plan. We have paid benefits
under our Equalization Plan to former
employees.

Supplemental Employee
Retirement Plan............... Each of our employees who are a part of
management or who are considered "highly
compensated" and subject to limitations on the
amount of Pension Plan benefits they may
receive under the Internal Revenue Code is also
eligible to participate in our Supplemental
Employee Retirement Plan. Our Supplemental Plan
pays additional benefits to employees whose
benefits under our Pension Plan are limited as
a result of such employee's Average Earnings
exceeding $170,000 or due to the removal of
certain Social Security integration benefits
from the Pension Plan. The amount of benefits
payable under our Supplemental Plan is designed
to eliminate the effect of these limitations on
the aggregate pension benefits payable to the
participants but not provide any additional
benefits beyond that amount. These benefits are
generally payable at the same time as when we
pay benefits under our Pension Plan. We have
paid benefits under our Supplemental Plan to
former employees.

The following table sets forth the aggregate amount of annual normal
retirement benefits that would be payable under our Pension Plan, Equalization
Plan and Supplemental Plan if an employee retired during calendar 2001 at the
age of 65 with the years of service shown (assuming the continued existence of
our Pension Plan, Equalization Plan and Supplemental Plan without substantial
change and payment in the form of a single life annuity).

For our executive officers, the compensation covered by these Plans is
solely that compensation reported under the salary column in the executive
compensation table appearing in this Form 10-K and may, as to a particular
executive officer for a given year, differ by more than 10% from that executive
officer's total annual compensation reported in the executive compensation
table, depending on the amount of bonuses and other annual compensation paid to
that executive officer during the relevant year.

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As of September 30, 2001, the credited years of service under these Plans
of each of our executive officers named in the Executive Compensation Table
were:

Frank P. Diassi............................................. 5 years
David G. Elkins............................................. 4 years
Richard K. Crump............................................ 15 years
Gary M. Spitz............................................... 3 years
Paul G. Vanderhoven......................................... 25 years

Assuming retirement at age 65 (or after five years of service, if later)
and the continuation of their current levels of base salary until retirement,
the total retirement benefits payable to each of our executive officers named in
the Executive Compensation Table under the Equalization and Supplemental Plans
would be:

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(1) Mr. Diassi's pension benefits are calculated as of September 30, 2001.

(2) Excludes supplemental pension benefits payable to Mr. Elkins under his
Employment Agreement.

(3) Mr. Spitz resigned as of March 21, 2001 and is no longer eligible for
payments under these Plans.

All of the benefits appearing in the pension plan table are computed on a
single-life annuity basis and are not subject to any deduction for Social
Security or other offset amounts. However, our Supplemental Plan does contain an
alternative formula for determining benefits which includes a Social Security
offset. We have never used this alternative formula to determine the amount of
any benefits paid under our Supplemental Plan.

EMPLOYMENT AGREEMENT -- DAVID G. ELKINS

On November 12, 1997, we entered into an Employment Agreement with Mr.
Elkins under which we engaged Mr. Elkins to serve as our General Counsel and
Corporate Secretary and one of our Vice Presidents. Mr. Elkins' Employment
Agreement has been amended as of the date of his promotion to President to,
among other things, reflect his change in position. Under his Employment
Agreement, Mr. Elkins currently earns a base salary of $350,000 per year
(subject to increase at the discretion of our Board) and he participates in our
bonus and incentive plans. In addition, when Mr. Elkins signed his Employment
Agreement, we granted Mr. Elkins 5,000 shares of our common stock (none of which
remain subject to forfeiture) and options to purchase 60,000 shares of our
common stock for $12 per share (with 25% of such options vesting annually on
each January 1, commencing with January 1, 1999). On December 14, 1998, we
reduced the exercise price of these options to $6 per share. Mr. Elkins was also
granted the right to purchase up to 80,000 shares of our common stock but that
right expired on April 30, 1998 without having been exercised. Upon Mr. Elkins'
promotion to President, we granted Mr. Elkins options to purchase 250,000 shares
of our common stock for $1 per share and options to purchase 250,000 shares of
our common stock for $0.50 per share (all of which were completely vested upon
their grant), which grants are referred to in the amendment to his Employment
Agreement.

Either we or Mr. Elkins may terminate Mr. Elkins' Employment Agreement at
any time, for any reason or for no reason. However, if Mr. Elkins terminates his
employment for a Good Reason (as defined in his Employment Agreement) or we
terminate Mr. Elkins' employment for any reason other than Misconduct or

145

Disability (as those terms are defined in his Employment Agreement), Mr. Elkins
is entitled to continuing coverage under all of our life, healthcare, medical
and dental insurance plans and programs (excluding disability) for 36 months, so
long as Mr. Elkins pays any required employee premiums under these plans or
programs or COBRA. However, we are not required to make these payments or
provide these coverages if Mr. Elkins' obtains other employment where he is
provided with substantially similar benefits. Finally, if Mr. Elkins' Employment
Agreement is terminated under these circumstances, all vesting and similar
requirements and all conditions to entitlement to benefits are deemed satisfied
under these plans and programs, meaning that all unvested options held by Mr.
Elkins would immediately vest.

Under his Employment Agreement, Mr. Elkins is entitled to participate in,
and receive benefits under, most of our employee benefit plans as if his
employment with us commenced on January 1, 1993 or, in the case of our
post-retirement healthcare plan, January 1, 1988. In addition, Mr. Elkins is
entitled under his Employment Agreement to receive pension benefits which are
supplemental to the pension benefits payable to Mr. Elkins under our Pension
Plan, Equalization Plan and Supplemental Plan.

KEY EMPLOYEE PROTECTION PLAN

On January 26, 2000, our Board approved our Key Employee Protection Plan,
which has subsequently been amended several times. This Plan was established by
our Board to help us retain certain of our employees and motivate them to
continue to exert their best efforts on our behalf during periods when we may be
susceptible to a change of control, and to assure their continued dedication and
objectivity during those periods This Plan was approved by the Bankruptcy Court
in our bankruptcy proceedings on October 31, 2001. A select group of management
or highly compensated employees has been designated as participants under the
Plan and their respective applicable multipliers and other variables for
determining benefits have been established. Our Compensation Committee is
authorized to designate additional management or highly compensated employees as
participants under our Key Employee Protection Plan and set their applicable
multipliers. Our Compensation Committee may also terminate any participant's
participation under this Plan on 60 days' notice if it determines that the
participant is no longer one of our key employees.

Under our Key Employee Protection Plan, any participant under the Plan that
terminates his or her employment for "Good Reason" or is terminated by us for
any reason other than "Misconduct" or "Disability" within his or her "Protection
Period" is entitled to benefits under the Plan. A participant's Protection
Period commences 180 days prior to the date on which a specified change of
control occurs and ends either two years or 18 months after the date of that
change of control, depending on the size of the participant's applicable
multiplier. A participant may also be entitled to receive payments under the
Plan in the absence of a change of control but at a reduced level of payment. If
a participant becomes entitled to benefits under our Key Employee Protection
Plan, we are required to provide the participant with a lump sum cash payment
that is determined by multiplying the participant's applicable multiplier by the
sum of the participant's highest annual base compensation during the last three
years plus the participant's targeted bonus for the year of termination, and
then deducting the sum of any other separation, severance or termination
payments made by us to the participant under any other plan or agreement or
pursuant to law, plus 50% of the aggregate cash compensation paid to the
participant by us or our successor following the confirmation of a plan of
reorganization in our bankruptcy proceedings. In addition, if the participant is
entitled to a lump sum payment under the Plan in the absence of a change of
control, his or her applicable multiplier is reduced by 50%. Similarly, if a
participant becomes entitled to benefits under the Plan in connection with the
liquidation of all or substantially all of our assets for salvage or equivalent
value, the lump sum amount payable to him or her is reduced by 25%. If a
participant is not one of our senior executives, he or she is not entitled to
receive the lump sum payment if his or her termination date is after his or her
normal retirement date. Finally, a pro rata portion of any lump sum amount paid
to a participant under the Plan must be repaid by the participant if the
participant is rehired by us or our successor within one year after the
participant's termination date.

In addition to the lump sum payment, the participant is entitled to receive
any accrued but unpaid compensation, compensation for unused vacation time and
any unpaid vested benefits earned or accrued under any of our benefit plans
(other than qualified plans). Also, for a period of 24 months (including 18
months COBRA coverage), the participant will continue to be covered by all of
our life, health care, medical and
146

dental insurance plans and programs (other than disability), as long as the
participant makes a timely COBRA election and pays the regular employee premiums
required under our plans and programs and by COBRA. However, if the participant
is not one of our senior executives, the participant is not entitled to
continued coverage under our plans and programs if his or her termination date
is after his or her normal retirement date. In addition, our obligation to
continue to provide coverage under our plans and programs to any participant
ceases if and when the participant becomes employed on a full-time basis by a
third party which provides the participant with substantially similar benefits.

If any payment or distribution under our Key Employee Protection Plan to
any participant is subject to excise tax pursuant to Section 4999 of the
Internal Revenue Code, the participant is entitled to receive a gross-up payment
from us in an amount such that, after payment by the participant of all taxes on
the gross-up payment, the amount of the gross-up payment remaining is equal to
the excise tax imposed under Section 4999 of the Internal Revenue Code. However,
the maximum amount of any gross-up payment is 25% of the sum of the
participant's highest annual base compensation during the last three years plus
the participant's targeted bonus for the year of payment.

We may terminate our Key Employee Protection Plan at any time and for any
reason but any termination does not become effective as to any participant until
90 days after we give the participant notice of the termination of the Plan. In
addition, we may amend our Key Employee Protection Plan at any time and for any
reason but any amendment that reduces, alters, suspends, impairs or prejudices
the rights or benefits of any participant in any material respect does not
become effective as to that participant until 90 days after we give him or her
notice of the amendment of the Plan. In addition, no termination of our Key
Employee Protection Plan, or any of these types of amendments to the Plan, can
be effective with respect to any participant if the termination or amendment is
related to, in anticipation of or during the pendency of a change of control, is
for the purpose of encouraging or facilitating a change of control or is made
within 180 days prior to any change of control. Finally, no termination or
amendment of our Key Employee Protection Plan can affect the rights or benefits
of any participant that are accrued under the Plan at the time of termination or
amendment or that accrue thereafter on account of a change of control that
occurred prior to the termination or amendment or within 180 days after such
termination or amendment.

SUPPLEMENTAL PAY PLAN

On March 8, 2001, our Board approved our Supplemental Pay Plan, which was
approved by the Bankruptcy Court in our bankruptcy proceedings on October 31,
2001. Historically, we have paid our senior level employees below-market
salaries with the opportunity to earn above-market compensation through stock
based incentives and significant bonuses in years when we achieve targeted
levels of EBITDA. Due to our financial difficulties, the opportunity to earn
additional compensation through these programs was significantly reduced, if not
entirely eliminated. As a result, our Board established this Plan to address
their concern that the overall compensation provided to our senior level
employees would always be below-market and, consequently, not adequate to retain
these employees or attract new highly-qualified employees. A select group of
management or highly compensated employees has been designated as participants
under the Plan and their respective benefits have been established. Each payment
under the Plan is a specified percentage of the participant's annual base salary
and payments are paid on or before the tenth day after the last day of each
calendar quarter. The participant must be employed by us on the relevant payment
date in order to be eligible to receive that payment under the Plan. We may
amend or terminate our Supplemental Pay Plan at any time but any amendment or
termination of the Plan can only become effective on a payment date and may not
affect the rights of participants under the Plan that have accrued as of that
effective date, including the right to receive supplemental pay on that payment
date.

RETENTION BONUS PLAN

On July 13, 2001, our Board approved our Retention Bonus Plan, which was
subsequently amended. This Plan was established by our Board to help us retain
our employees whose resignations would cause significant disruption to our
operations and whose skills would be particularly difficult and costly to
replace, to improve their morale during the pendency of our bankruptcy
proceedings and help us incentivize these employees to
147

work diligently toward the resolution of our bankruptcy proceedings. The Plan
was approved by the Bankruptcy Court in our bankruptcy proceedings on October
31, 2001. A select group of management or highly compensated employees has been
designated as participants under the Plan and their respective benefits have
been established. Each participant in the Plan is entitled to payments under the
Plan on specified dates, unless the participant's employment with us terminates
prior to that payment date for any reason other than a termination by the
participant for "Good Reason" or a termination by us for any reason other than
"Misconduct" or "Disability." Payments under the Plan are based on specified
percentages of the participant's annual compensation, including payments under
our Supplemental Pay Plan. Each participant who becomes entitled to payments
under the Plan will be paid 25% of the total amount payable to that participant
on the earlier of April 15, 2002 and the date on which a plan of reorganization
in our bankruptcy proceedings is confirmed, an additional 25% on the earliest to
occur of October 15, 2002, the date on which a plan of reorganization is
confirmed in our bankruptcy proceedings and the date on which all or
substantially all of our assets are sold or otherwise transferred, and the final
50% on the earlier to occur of the date on which a plan of reorganization is
confirmed in our bankruptcy proceedings and the date on which all or
substantially all of our assets are sold or otherwise transferred. However, if
payments are made solely as a result of the sale of all or substantially all of
our assets, a participant is not entitled to any payments under the Plan unless
such sale or transfer occurs after April 15, 2002 and, for any sale or transfer
that occurs after that date, the participant is only entitled to receive
one-half of the final 50% payment.

We may amend our Retention Bonus Plan at any time but any amendment that
adversely affects a participant's rights or benefits under the Plan or reduces
our obligations under the Plan will not be effective with respect to any person
who was a participant at the time of such amendment. In addition, we may
terminate our Retention Bonus Plan at any time, but all benefits payable under
the Plan must be paid in full notwithstanding any termination or amendment of
the Plan.

148

PERFORMANCE GRAPH

The following Stock Performance Graph compares our cumulative total
stockholder return on shares of our common stock for a five-year period with the
cumulative total return of the Standard & Poor's Stock Index and the Standard &
Poor's Chemicals Index. The graph assumes $100 was invested on September 30,
1996 in shares of our common stock, the S&P 500 Index and the S&P Chemicals
Index and that dividends were reinvested.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
AMONG STERLING CHEMICALS HOLDINGS, INC., THE S&P 500 INDEX
AND THE S&P CHEMICALS INDEX

(GRAPH)

* $100 Invested on 9/30/1996 in stock or index-including reinvestment of
dividends. Fiscal year ending September 30.

In connection with our recapitalization in August of 1996, our common stock
was delisted from the New York Stock Exchange and is now included in the OTC
Electronic Bulletin Board maintained by the National Association of Securities
Dealers, Inc. We believe that this delisting, combined with the contemporaneous
significant reductions in the overall number of outstanding shares and record
holders of our common stock, have significantly reduced the liquidity of the
trading market for shares of our common stock.

We cannot give you any assurance as to future trends in the cumulative
total return on shares of our common stock or of the foregoing indices and we do
not make or endorse any predictions as to future stock performance.

149

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the ownership
of our common stock as of December 3, 2001 by (i) each of our directors, (ii)
each of our executive officers named in the Executive Compensation Table, (iii)
all those known by us to be the beneficial owner of more than 5% of our common
stock and (iv) all of our directors and executive officers as a group. Unless
otherwise noted, the mailing address of each such owner is 1200 Smith Street,
Suite 1900, Houston, Texas 77002-4312.

In addition, an aggregate of 566,726 shares of our common stock are held by
the Sterling Chemicals ESOP on behalf of our employees and former employees,
including certain of our executive officers, representing approximately 4.4% of
our outstanding shares of common stock, all of which have been allocated to
employees' accounts to date. These shares are held of record by Merrill Lynch &
Co. Incorporated, as trustee, who disclaims beneficial ownership of such shares.
Each person who has shares allocated to his or her ESOP account has the sole
power to vote the allocated shares.

- ---------------

* Less than 1%

(1) Includes shares of our common stock for which the named person:

- has sole voting and investment power or

- has shared voting and investment power with his or her spouse.

Includes shares of our common stock held by Merrill Lynch, as Trustee of
our Savings and Investment Plan or as Trustee of our ESOP, and allocated to the
named person's account as follows:

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Excludes shares of our common stock that:

- are restricted stock holdings or

- may be acquired through the exercise of stock options within 60 days

Excludes shares of our common stock and currently exercisable warrants to
acquire shares of our common stock held by persons other than the named
person who are parties to the Voting Agreement described in "Certain
Transactions." Each of Messrs. Diassi, Hevrdejs and Nelson, Clipper Capital
Associates, Inc., Koch Industries, Inc., Olympus Growth Fund II, L.P.,
Olympus Executive Fund, L.P. and Fayez Sarofim & Co. is a party to the
Voting Agreement. Other parties to the Voting Agreement include William A.
McMinn, one of our former directors, who beneficially owns 131,896 shares of
our common stock and currently exercisable warrants to acquire 40,000 shares
of our common stock, William C. Oehmig, who beneficially owns 361,772 shares
of our common stock, The Rheney Living Trust (Susan O. Rheney and Clarke
Rheney, Trustees), which beneficially owns 48,307 shares of our common
stock, CS First Boston Merchant Investments 1995/96, L.P., which
beneficially owns 75,900 shares of our common stock, and Von D. Oehmig, who
beneficially owns 2,083 shares of our common stock. In addition, Gordon A.
Cain, who beneficially owns currently exercisable warrants to acquire
160,000 shares of our common stock, and James Crane, who beneficially owns
currently exercisable warrants to acquire 30,000 shares of our common stock,
are parties to the Voting Agreement. All of the parties to the Voting
Agreement may be deemed to be members of a "group" within the meaning of
Rule 13d-5(b)(1) under the Securities Exchange Act and, as a result, may be
deemed to have beneficial ownership of all of the shares of our common stock
subject to the Voting Agreement. All shares of our common stock owned by the
parties to the Voting Agreement are subject to the Voting Agreement,
irrespective of whether such shares are currently owned or subsequently
acquired, through purchase, the exercise of warrants or otherwise. The
Voting Agreement expires at the time described in "Certain Transactions."
Currently, an aggregate of 6,673,213 shares of our common stock,
representing approximately 52% of our outstanding shares of common stock,
are subject to the Voting Agreement. Each of the named persons expressly
disclaims membership in such group and beneficial ownership of any shares of
our common stock or warrants to acquire shares of our common stock held by
the other parties to the Voting Agreement.

(2) Shares of our common stock that can be acquired through the exercise of
warrants or stock options within 60 days.

(3) Includes (i) 20,000 shares of our common stock held as Trustee of the
Gabrielle Diassi Trust, (ii) 40,000 shares of our common stock held as
Trustee of the Diassi Children's Trust, (iii) 10,000 shares of our common
stock held as Trustee of the Brianna Diassi Trust, (iv) 10,000 shares of our
common stock held as Trustee of the Nicholas Diassi Trust, (v) 10,000 shares
of our common stock held by Mr. Diassi's wife and (vi) 10,000 shares of our
common stock held by Amerlux, Inc., a manufacturer of lighting fixtures for
commercial and retail markets of which Mr. Diassi owns 50% of the
outstanding equity and serves as Chairman of the Board. Mr. Diassi disclaims
beneficial ownership of all of these shares.

(4) Includes 3,990 shares of our common stock owned by Mr. Hevrdejs' wife. Mr.
Hevrdejs disclaims beneficial ownership of such shares.

(5) Represents shares of our common stock and includes warrants to acquire
shares of our common stock held by The Clipper Group (see Note 6) with
respect to which Mr. Towe, as Senior Managing Director of The Clipper Group,
L.P. and Vice President of Clipper Asset Management, Inc., may be deemed to
have beneficial ownership. Mr. Towe disclaims beneficial ownership of such
shares and warrants.

(6) Clipper Capital Associates, Inc. ("Clipper") may be deemed to be the
beneficial owner of such shares of our common stock by virtue of its
relationship with entities that have beneficial ownership of such shares as
discussed herein. Clipper and its affiliated entities described herein are
collectively referred to as "The Clipper Group." Clipper is the sole general
partner of Clipper Associates, and is a Delaware corporation principally
engaged in holding investments, formed for the purpose of serving as general
partner of Clipper Associates. The mailing address of Clipper is 650 Madison
Ave., 9th Floor, New York, New York 10022. Clipper Associates is a Delaware
limited partnership principally engaged in making

151

investments, directly or indirectly through other entities, and is the sole
general partner of Clipper Equity Partners I, L.P. ("Clipper I") and
Clipper/Merchant Partners, L.P. ("Clipper II"), with sole voting and
dispositive power with respect to the securities held by such partnerships.
Each of Clipper I and Clipper II is a Delaware limited partnership,
principally engaged in making investments. Clipper Associates may be deemed
to directly beneficially own 11,831 shares of our common stock and, as of
December 3, 2001, indirectly beneficially own 15,940 shares of our common
stock by virtue of its status as nominee under certain nominee agreements,
pursuant to which it exercises sole voting and dispositive power with
respect to such shares. The nominee agreements, which originally covered
201,776 shares of our common stock, have been terminated but, as of December
3, 2001, the transfer of 15,940 shares of our common stock to the beneficial
owners had not been completed. Clipper I may be deemed to directly
beneficially own 444,537 shares of our common stock. Clipper II may be
deemed to directly beneficially own 516,031 shares of our common stock. Each
of Clipper/Merban, L.P. ("Clipper III") and Clipper/ European Re, L.P.
("Clipper IV") is a Delaware limited partnership, principally engaged in
making investments. Clipper Associates is the sole investment general
partner of Clipper III and Clipper IV, having sole voting and dispositive
power with respect to securities held by such partnerships. Clipper III may
be deemed to directly beneficially own 592,701 shares of our common stock.
Clipper IV may be deemed to directly beneficially own 296,328 shares of our
common stock. Clipper Curacao, Inc., a corporation organized under the laws
of the British Virgin Islands, is the sole administrative general partner of
Clipper III and Clipper IV, responsible for the administrative functions of
such partnerships. The share amounts set forth in this footnote include
warrants to acquire shares of our common stock in the amounts of 28 shares
with respect to Clipper Associates, 13,605 shares with respect to Clipper I,
18,149 shares with respect to Clipper II, 18,149 shares with respect to
Clipper III and 9,089 shares with respect to Clipper IV.

(7) Represents shares of our common stock held by Koch Capital Services, Inc., a
wholly owned subsidiary of Koch Industries, Inc. which may be deemed to be
the beneficial owner of such shares. The mailing address of Koch Capital
Services, Inc. and Koch Industries, Inc. is 4111 East 37th Street North,
Wichita, Kansas 67220.

(8) Represents shares of our common stock directly beneficially owned by FSI No.
2 Corporation, a wholly owned subsidiary of Fayez Sarofim & Co., which may
be deemed to be the beneficial owner of such shares. The majority owner of
Fayez Sarofim & Co. is Fayez Sarofim. The mailing address of FSI No. 2
Corporation, Fayez Sarofim & Co. and Fayez Sarofim is Two Houston Center,
Suite 2907, Houston, Texas 77010.

(9) Olympus Growth Fund II, L.P. and Olympus Executive Fund, L.P. are Delaware
limited partnerships principally engaged in making investments. OGP II,
L.P., a Delaware limited partnership, is the sole general partner of Olympus
Growth Fund II, L.P. and OEF, L.P., a Delaware limited partnership, is the
sole general partner of Olympus Executive Fund L.P. Each of OGP II, L.P. and
OEF, L.P. has the same three general partners, being LJM, L.L.C., RSM,
L.L.C. and Conroy, L.L.C., each of which is a Delaware limited liability
company. The majority owners of LJM, L.L.C., RSM, L.L.C. and Conroy, L.L.C.
are Louis J. Mischianti, Robert S. Morris and James A. Conroy, respectively.
The mailing address of each of these entities and individuals is Metro
Center, One Station Place, Stamford, Connecticut 06902.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires our officers,
directors and anyone who beneficially owns at least 10% of our common stock to
file reports regarding their ownership of our common stock and any changes in
that ownership with the SEC. We believe that, during fiscal 2001, our officers,
directors and 10% stockholders complied with all Section 16(a) filing
requirements, with the following exceptions. One of our directors, Robert W.
Roten, filed a Form 5 in November of 2001 to report the acquisition of 186
shares of our common stock that were allocated to his ESOP account in December
of 1998. In addition, one of our directors, Frank J. Hevrdejs, filed a Form 5 in
November of 2001 to report the acquisition by his wife of 2,000 shares of our
stock in April of 1997. Mr. Hevrdejs may be deemed to be the

152

beneficial owner of these shares, although he disclaims any such beneficial
interest. In making these statements we have relied on our review of copies of
these reports furnished to us and written representations from our officers and
directors.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The holders of 6,673,213 shares of our common stock, representing
approximately 52% of our outstanding shares, are parties to a Third Amended and
Restated Voting Agreement dated as of February 1, 1999. Three of our directors,
Messrs. Diassi, Hevrdejs and Nelson, are parties to the Voting Agreement. Other
parties to the Voting Agreement include William A. McMinn, one of our former
directors, William C. Oehmig, Susan O. Rheney (as Trustee of the Rheney Living
Trust), Koch Capital Services, Inc., affiliates of Clipper Capital Partners,
L.P. who are commonly referred to collectively as "The Clipper Group", FSI No. 2
Corporation, a wholly owned subsidiary of Fayez Sarofim & Co., Olympus Growth
Fund II, L.P., Olympus Executive Fund, L.P., Credit Suisse First Boston, Gordon
A. Cain and James Crane. The parties to the Voting Agreement are required to
vote any shares of our common stock owned by them in favor of three nominees to
our Board of Directors; one to be designated by The Clipper Group, one to be
designed by Gordon A. Cain and one to be designated by Koch Capital. Rolf H.
Towe is the current designee of The Clipper Group. Mr. Cain did not designate a
nominee to our Board following the resignation of his prior nominee on October
26, 2000. Koch Capital has waived its right to designate a member of our Board.
The rights of each of The Clipper Group and Koch Capital to designate nominees
under the Voting Agreement terminates on the earlier of August 21, 2006 or the
time at which they beneficial own less than 5% of our outstanding shares,
respectively. The right of Mr. Cain to designate a nominee to our Board under
the Voting Agreement terminated on December 15, 2001.

The holders of 8,763,302 shares of our common stock, representing
approximately 69% of our outstanding shares, were parties to a Stockholders
Agreement originally dated as of August 21, 1996 and a Tag-Along Agreement dated
as of August 21, 1996. The Stockholders Agreement restricted the transfer of
shares of our common stock held by the parties (with certain exceptions),
including any disposition of a control position, unless such shares were first
offered to be sold to our ESOP, then to us and then to the other parties to the
Stockholders Agreement. The Tag-Along Agreement provided that if any party to
the agreement, either by themselves or together with others, proposed to
transfer a total of 51% or more of our outstanding shares of common stock, that
party must have given notice of the proposed transfer to each person that
retained shares of our common stock in our recapitalization conducted in August
of 1996, and each of these stockholders would have the right to have any shares
they retained in that recapitalization included in the transfer on a pro rata
basis and on the same terms and conditions. The Stockholders Agreement was
terminated effective as of September 15, 2001 by the consent of the requisite
number of parties to that agreement, and the Tag-Along Agreement expired by its
terms on August 21, 2001.

Since October 1, 1991, we have had ongoing commercial relationships in the
ordinary course of business with certain affiliates of Koch Industries, Inc.,
including agreements for the supply of raw materials, sales of petrochemicals
and transportation of natural gas. During the fiscal year ended September 30,
2001:

- we made product sales to and purchased raw materials from Koch Chemical
and Koch Nitrogen Company, indirect wholly owned subsidiaries of Koch
Industries;

- we made payments to John Zink Company, an indirect wholly owned
subsidiary of Koch Industries, in consideration for certain contracting
and construction services performed at our facilities in Texas City,
Texas; and

- we made payments to Koch Gateway Pipeline Company for the transportation
of natural gas to our acrylic fiber plant through a pipeline in which it
is a partner.

Each of these relationships represented less than 1% of our revenues, with the
exception that our raw material purchases from Koch Nitrogen and Koch Chemical
totaled around 2% of our revenues. In addition, in 1998 we filed a lawsuit
against John Zink Company seeking recovery for certain types of damages we
sustained in

153

connection with a release of nickel carbonyl from our methanol unit on July 30,
1997. This lawsuit has been voluntarily dismissed but, under a tolling agreement
between the parties, may be refiled at any time.

PART IV

ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K.

(a) Financial Statements, Financial Statement Schedules and Exhibits

1. Consolidated Financial Statements

See "Item 8. Financial Statements and Supplementary Data -- Index to
Financial Statements." In addition, the consolidated financial statements of
Sterling Canada, Inc. and Sterling Pulp Chemicals, Ltd. for the years ended
September 30, 2001, 2000, and 1999 are filed as Exhibits 99.1 and 99.2 hereto.

2. All schedules for which provision is made in Regulation S-X of the
Securities and Exchange Commission are not required under the related
instruction or are inapplicable and, therefore, have been omitted.

3. Exhibits

The following exhibits are filed as part of this Form 10-K:

154

155

156

157

158

159

160

161

162

- ---------------

** Filed herewith.

+ Confidential treatment has been requested with respect to portions of this
Exhibit, and such request has been granted.

(b) Reports on Form 8-K.

i. On March 13, 2001, the Company filed a Current Report on Form 8-K
reporting Items 5 and 7 of such Form related to the resignation of the Company's
Chief Financial Officer and the appointment of his replacement.

ii. On July 17, 2001, the Company filed a Current Report on Form 8-K
reporting Items 3 and 7 of such Form related to the Debtors' Chapter 11 filings.

iii. On September 21, 2001, the Company filed a Current Report on Form 8-K
reporting Items 3 and 7 of such Form related to the filing of the Debtors'
Monthly Operating Reports with the Bankruptcy Court.

iv. On November 5, 2001, the Company filed a Current Report on Form 8-K
reporting Items 3 and 7 of such Form related to the filing of the Debtors'
Monthly Operating Reports with the Bankruptcy Court.

v. On December 10, 2001, the Company filed a Current Report on Form 8-K
reporting Items 3 and 7 of such Form related to the filing of the Debtors'
Monthly Operating Reports with the Bankruptcy Court.

163

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrants have duly caused this report to be signed
on their behalf by the undersigned, thereunto duly authorized.

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(Registrants)

By /s/ DAVID G. ELKINS
------------------------------------
David G. Elkins
President and Co-Chief Executive
Officer

Date: December 20, 2001

Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of each of the Registrants
and in the capacities and on the dates indicated.

164

EXHIBIT INDEX

- ---------------

** Filed herewith.

+ Confidential treatment has been requested with respect to portions of this
Exhibit, and such request has been granted.