STERLING CHEMICAL INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

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 a (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 (IRS 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)

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 [ ]

As of July 31, 2002, Sterling Chemicals Holdings, Inc. had 12,776,678
shares of common stock outstanding. As of July 31, 2002, all outstanding equity
securities of Sterling Chemicals, Inc. were owned by Sterling Chemicals
Holdings, Inc.

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IMPORTANT INFORMATION REGARDING THIS FORM 10-Q

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

PRESENTATION OF FINANCIAL STATEMENTS

This Form 10-Q includes two separate sets of financial statements and
related notes:

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

- The second set of financial statements and related notes present the
combined financial position of the Guarantors (Debtors-in-Possession) and
their subsidiaries (discussed below).

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 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"). Each of the Guarantors is
a wholly-owned direct or indirect subsidiary of Chemicals and the Guarantors
have fully and unconditionally guaranteed the 12 3/8% Notes on a joint and
several basis. In order to comply with these SEC rules, the combined financial
statements and related notes of the Guarantors and their subsidiaries are
included with this Form 10-Q. Separate financial statements of, and other
disclosures concerning, each Guarantor are not presented in this Form 10-Q
because management has determined that such separate financial statements and
disclosures are not material to investors.

FORWARD-LOOKING STATEMENTS

This Form 10-Q 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-Q are forward-looking statements, including without
limitation the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" 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.
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
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 filed or actions taken in connection with our bankruptcy
proceedings, the availability of skilled personnel, 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-Q or Holdings' and Chemicals' combined Annual Report on Form 10-K
for the fiscal year ended September 30, 2001 (the "Annual Report"). See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Known Events, Trends, Uncertainties and Risk Factors"
1

contained in the Annual Report. All subsequent written and oral forward-looking
statements attributable to us or persons acting on our behalf are expressly
qualified in their entirety by these cautionary statements.

SUBSEQUENT EVENTS

All statements contained in this Form 10-Q, including the forward-looking
statements discussed above, are made as of August 12, 2002, 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-Q to the extent
such information is affected or impacted by events, circumstances or
developments occurring after August 12, 2002 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.

DOCUMENT SUMMARIES

Statements contained in this Form 10-Q 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 the Annual Report or this 10-Q.

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-Q to a particular fiscal year refer to the twelve-calendar-month period
ending on September 30 of that year.

This combined Form 10-Q 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 "we,"
"our," "ours" and "us."

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STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

INDEX

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STERLING CHEMICALS HOLDINGS, INC.
(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

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(1) Contractual interest for the three and nine-month periods ended June 30,
2002 totaled $30,095 and $91,836, respectively.

The accompanying notes are an integral part of the consolidated financial
statements.
4

STERLING CHEMICALS HOLDINGS, INC.
(DEBTOR-IN-POSSESSION)

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

The accompanying notes are an integral part of the consolidated financial
statements.
5

STERLING CHEMICALS HOLDINGS, INC.
(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

The accompanying notes are an integral part of the consolidated financial
statements.
6

STERLING CHEMICALS, INC.
(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

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(1) Contractual interest for the three and nine-month periods ended June 30,
2002 totaled $23,624 and $72,299, respectively.

The accompanying notes are an integral part of the consolidated financial
statements.
7

STERLING CHEMICALS, INC.
(DEBTOR-IN-POSSESSION)

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

The accompanying notes are an integral part of the consolidated financial
statements.
8

STERLING CHEMICALS, INC.
(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

The accompanying notes are an integral part of the consolidated financial
statements.
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STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

INTERIM FINANCIAL INFORMATION

In our opinion, the accompanying unaudited consolidated financial
statements reflect all adjustments necessary to present fairly:

- the consolidated financial position of Sterling Chemicals Holdings, Inc.
(Debtor-in-Possession) ("Holdings") and its subsidiaries and the
consolidated financial position of Sterling Chemicals, Inc.
(Debtor-in-Possession) ("Chemicals") and its subsidiaries as of June 30,
2002, and

- the respective consolidated results of operations and cash flows of
Holdings and its subsidiaries and Chemicals and its subsidiaries for the
applicable three and nine-month periods ended June 30, 2002 and June 30,
2001, respectively.

All such adjustments are of a normal and recurring nature. The results of
operations for the periods presented are not necessarily indicative of the
results to be expected for the full year. The accompanying unaudited
consolidated financial statements should be, and are assumed to have been, read
in conjunction with the consolidated financial statements and notes included in
Holdings' and Chemicals' combined Annual Report on Form 10-K for the fiscal year
ended September 30, 2001 (the "Annual Report"). The accompanying consolidated
balance sheets as of September 30, 2001 have been derived from the audited
consolidated balance sheets as of September 30, 2001 included in the Annual
Report. The accompanying consolidated financial statements as of and for the
nine-month period ended June 30, 2002 have been reviewed by Deloitte & Touche
LLP, our independent public accountants, whose reports are included herein.
Unless otherwise indicated, Holdings and its subsidiaries, including Chemicals,
are collectively referred to as "we," "our," "ours" and "us."

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' deficit.

The accompanying consolidated financial statements have been prepared on
the going concern basis of accounting, which contemplates the continuation 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 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 as of
the Petition Date and identification of all transactions and events that are
directly associated with the reorganization of the Debtors.

INDUSTRY CONDITIONS AND LIQUIDITY

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 petrochemicals products caused by declines in general
worldwide economic conditions, the relative strength of the U.S. dollar (which
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

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STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

A confirmation of a plan of reorganization is the primary objective of the
Debtors. The Debtors filed a plan of reorganization (the "Plan") on May 14, 2002
with the Bankruptcy Court, along with an accompanying Disclosure Statement. The
Disclosure Statement must be approved by the Bankruptcy Court before the Debtors
are authorized to solicit acceptances of the Plan from voting creditors. The
Plan may be modified prior to the time that the Disclosure Statement is
approved. The Plan, as filed, is premised upon an asset separation structure,
with our pulp chemicals business being separated from our core petrochemicals
business. Equity ownership of the pulp chemicals business would be transferred
to the holders of Chemicals' 123/8% Senior Secured Notes, while equity ownership
of the petrochemicals business would be shared, in percentages to be determined,
by one or more new equity investors and the holders of unsecured claims. The
Debtors are currently negotiating with a potential equity investor. The Plan
calls for the infusion of up to $80 million by the new equity investors, $50
million of which would be invested at the time the Debtors' emerge from Chapter
11. Since the filing of the Plan, the Debtors have been engaged in negotiations
with their major creditor groups in an effort to reach a consensus as to the
ultimate terms of the Plan. Those negotiations have resulted in a decision by
the Debtors to begin marketing their pulp chemicals business. It is currently
contemplated that any resulting sale would close contemporaneously with the
Debtors' emergence from bankruptcy. The Debtors reserve the right, however,
based upon marketing results, to defer the sale of their pulp chemicals business
and to continue forward with the Plan in its current structure, with other
modifications that may be agreed to with the major creditor groups. No
assurances can be given that the Plan will be confirmed or that any plan that is
confirmed will contain the terms in the current Plan. However, when confirmed,
the Plan is expected to result in the elimination of Holdings' classes of equity
interests and the significant dilution or elimination of some or all of the
Debtors' classes of existing public debt.

At this time, it is not possible to predict the outcome of the bankruptcy
proceedings or the effect on the business of the Debtors or the claims of
creditors of the Debtors or the 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, are likely to be subject to
compromise. However, the ultimate resolution of these liabilities is not
presently determinable.

Reorganization items reflected in the Statement of Operations for the three
and nine-month periods ended June 30, 2002 are composed primarily of
professional fees directly related to the bankruptcy cases.

Effective July 19, 2001, the Debtors (excluding Holdings) entered into a
Revolving Credit Agreement with a group of lenders led by The CIT Group/Business
Credit, Inc. to provide up to $195 million in Debtor-In-Possession financing
(the "DIP Financing"). The DIP Financing was 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. 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." Commitments under
the current assets revolver were increased to $125 million upon entry of the
priming order discussed below. The initial draw under the DIP Financing was used
to repay all amounts outstanding under the Debtors' pre-petition 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 was appealed to the U.S. District Court by the indenture
trustee for Chemicals' 12 3/8% Senior Secured Notes, but no stay of the final
order was sought or

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STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

imposed, and the order remains fully effective. By order dated February 7, 2002,
the U.S. District Court denied the appeal. The indenture trustee appealed this
denial to the 5th Circuit Court of Appeals on March 1, 2002. While no assurances
can be given, we do not believe the final order will be overturned by the 5th
Circuit. 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, and has been granted super-priority administrative expense claim status
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.

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 current 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. That appeal gave rise to a series of
hearings before, and orders by, both the U.S. District Court and the Bankruptcy
Court, from which further appeals were taken by both the Indenture Trustee and
the Official Committee of Unsecured Creditors. The result of the hearings held,
and rulings issued to date, is that the Company is required to pay an additional
4% interest as a compensatory adjustment in favor of the 12 3/8% Notes on up to
$40 million of funds borrowed pursuant to the priming order. Through further
appeals pending before the U.S. Court of Appeals for the 5th Circuit, the
Indenture Trustee seeks to reverse the priming order entirely or, in the
alternative, to increase the rate and tighten the payment terms of the
compensatory adjustment. Through cross appeals pending before the 5th Circuit,
the Official Committee of Unsecured Creditors seeks to preserve the priming
order in force as originally implemented by removing the requirement for the
Company to pay any compensatory adjustment. By orders dated May 15, 2002 and
July 1, 2002, the 5th Circuit consolidated all pending appeals related to the
Company's post-petition financing. The priming order will remain effective
pending the outcome of any appeal unless stayed by an appellate court. While no
assurances can be given, we do not believe the priming order will be overturned
by the 5th Circuit. 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 overturned on appeal, the Debtors may need to seek
additional sources of financing or revise their business plan and operations
consistent with the level of available financing. We can give no assurances that
the priming order will be upheld on appeal or, if 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.

At June 30, 2002, the total credit available under the DIP Financing was
limited to $144.7 million due to borrowing base restrictions under the current
assets revolver. At June 30, 2002, $70 million was drawn under the fixed assets
revolver and $6.5 million was drawn under the current assets revolver. In
addition, approximately $5.6 million of letters of credit were outstanding under
the current assets revolver leaving, at June 30, 2002, unused borrowing capacity
under the DIP Financing of approximately $62.6 million.

As of July 11, 2001, our principal Canadian subsidiary, Sterling Pulp
Chemicals, Ltd. ("Sterling Pulp"), entered into a financing agreement with CIT
Business Credit Canada, Inc. ("CIT 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
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STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

initial term of the Canadian Financing Agreement extends to July 2004. The
Canadian Financing Agreement may be terminated by CIT Canada thereafter only by
giving 60 days' written notice of termination prior to each subsequent
anniversary date. Sterling Pulp may terminate the Canadian Financing Agreement
at any time but is required to give 60 days' notice and pay an early termination
fee. At June 30, 2002, $6.2 million was drawn under the Canadian Financing
Agreement.

CERTAIN BANKRUPTCY IMPLICATIONS

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 can be 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. As required by
the Bankruptcy Court, 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 can be 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:

- 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,

- the ability of the Debtors to maintain access to the incremental $40
million in DIP Financing that is dependent on an effective priming order,

- the ability of the Debtors to maintain adequate cash on hand,

- the ability of the Debtors to generate sufficient cash from operations,

- the ability of the Debtors' subsidiaries that are not included in the
Chapter 11 cases to obtain necessary financing,

- confirmation of a plan or plans of reorganization under the Bankruptcy
Code and

- 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
Holdings' and Chemicals', ability to continue as a going concern.

13

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Debtors 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. In
addition, the Debtors may have additional liquidity from borrowings under the
Saskatoon Refinancing Agreement discussed below. 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 under
the current assets revolver and compliance with an EBITDA covenant. The EBITDA
covenant is reset at the beginning of each fiscal year and currently increases
in amount in October 2002. Based on current business forecasts, the Debtors
would not be in compliance with the EBITDA covenant beginning in October 2002.
The Debtors and lenders are currently discussing amendments to the EBITDA
covenant, however there can be no assurance that a satisfactory amendment will
be reached. If an event of default occurs, the DIP lenders may terminate their
commitments and/or declare any or all portion of the proceeds outstanding under
the DIP Financing to be due and payable.

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

RECENT DEVELOPMENTS

On December 19, 2001, we announced that Frank P. Diassi had elected to
terminate his employment as Co-Chief Executive Officer and executive Chairman of
the Board. On January 25, 2002, Mr. Diassi resigned from our Board of Directors.
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 Key Employee
Protection Plan and our Retention Bonus Plan. On June 3, 2002, we denied Mr.
Diassi's claim under our Key Employee Protection Plan and, on July 24, 2002, we
denied Mr. Diassi's claim under our Retention Bonus Plan. We do not know whether
Mr. Diassi will continue to pursue either of these claims.

On May 1, 2002, the collective bargaining agreement covering most of the
hourly employees at our Texas City facility expired. On June 7, 2002, we locked
out the union employees, numbering about 215, after several weeks of
unsuccessful negotiations with the union leadership and after a majority of the
union members voted not to accept our final proposal. Since the lockout began,
the Texas City facility has been operated, without interruption or loss of
production, by our salaried personnel and contract workers. To date, the lockout
has had no material adverse effect on our business, financial position, results
of operations or cash flows and, although no assurances can be given, we do not
believe the lockout will have such an effect in the future.

On July 24, 2002, Sterling Pulp Chemicals (Sask) Ltd. ("Sterling Sask"),
our Canadian subsidiary that operates our Saskatoon facility, entered into a new
credit agreement with a group of lenders led by Bank of Montreal to provide up
to Cdn. $8 million in revolving advances ("Facility A"), and Cdn. $60 million in
term loans ("Facility B") (collectively, the "Saskatoon Refinancing Agreement").
An initial borrowing of approximately Cdn. $25 million from Facility B was used
to repay all outstanding amounts under the
14

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Saskatoon Credit Agreement described below. The remaining Cdn. $35 million of
availability under Facility B can be borrowed at any time prior to September
2003, subject to certain funding conditions, and up to Cdn. $30 million may be
used to supplement the Debtors' liquidity.

Borrowings under Facility B are required to be repaid on or before July 24,
2006. Borrowings under the revolving Facility A are required to be repaid on or
before July 24, 2003.

Available credit under Facility A is generally subject to a borrowing limit
equal to the lesser of Cdn. $8 million and the amount determined as follows: 75%
of eligible Canadian accounts receivable plus 60% of eligible United States
accounts receivable, plus the lesser of $2 million and 50% of the value of
eligible inventory.

Borrowings under Facility A generally bear interest at an annual rate of
LIBOR plus .5 to 2.0%, depending on the option selected by Sterling Sask.
Borrowings under Facility B generally bear interest at an annual rate of LIBOR
plus 1.0 to 2.5%.

The Saskatoon Refinancing Agreement contains numerous covenants, including,
but not limited to, restrictions on the ability of Sterling Sask to incur
indebtedness, create liens and sell assets, as well as maintenance of certain
financial covenant ratios. As of August 12, 2002, none of these covenants
restrict our ability to borrow or restrict the use of proceeds under the
Saskatoon Refinancing Agreement, although there can be no assurances that they
will be not be restrictive in the future.

SEGMENT INFORMATION

Our operations are divided into two reportable segments: petrochemicals and
pulp chemicals. Our petrochemicals segment manufactures commodity petrochemicals
and acrylic fibers. Our pulp chemicals segment manufactures chemicals for use
primarily in the pulp and paper industry and licenses large scale chlorine
dioxide generators to the pulp and paper industry. Operating segment information
is presented below (in thousands).

COMPREHENSIVE LOSS

Our total comprehensive net income (loss) for the three-month periods ended
June 30, 2002 and June 30, 2001 was $11,357,000 and $(96,276,000), respectively.
Our total comprehensive net loss for the nine-month periods ended June 30, 2002
and June 30, 2001 was $(19,730,000) and $(183,598,000), respectively. The total
comprehensive net income (loss) of Chemicals and its subsidiaries for the
three-month periods

15

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ended June 30, 2002 and June 30, 2001 was $11,420,000 and $(71,867,000),
respectively. The total comprehensive net loss of Chemicals and its subsidiaries
for the nine-month periods ended June 30, 2002 and June 30, 2001 was
$(19,434,000) and $(145,948,000), respectively.

2. INVENTORIES

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.

Pursuant to an order of the Bankruptcy Court, the Debtors mailed notices to
all known creditors that the deadline for filing proofs of claim with the
Bankruptcy Court was December 17, 2001. Differences between amounts recorded by
the Debtors and claims filed by creditors are continuing to be investigated and
resolved. Accordingly, the ultimate number and amount of allowed claims is not
presently known and, because the settlement terms of each such allowed claim is
subject to a confirmed plan of reorganization, the ultimate distribution with
respect to allowed claims is not presently ascertainable.

16

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On a consolidated basis, recorded liabilities subject to compromise under
Chapter 11 proceedings as of June 30, 2002 and September 30, 2001, consisted of
the following:

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

(1) Debt liabilities are presented net of unamortized debt issue costs of $12.9
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 the pre-petition debt described above that was not paid or
charged to earnings for the period from July 16, 2001 to September 30, 2001 was
$15.3 million and for the three and nine-month periods ended June 30, 2002 was
$18.7 million and $56.3 million, respectively. 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. The Debtors
believe all amounts below are fully secured liabilities or have been approved by
the Bankruptcy Court and are not expected to be compromised.

On a consolidated basis, recorded liabilities not subject to compromise
under Chapter 11 proceedings as of June 30, 2002 and September 30, 2001,
consisted of the following:

17

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

4. LONG-TERM DEBT

This note contains information regarding our short-term borrowings and
long-term debt as of June 30, 2002 and September 30, 2001. As a result of the
Debtors' bankruptcy filing, principal and interest payments may not be made 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 Debtors' pre-petition revolving credit facilities (the "Prior
Credit Agreement") and each of the indentures governing our outstanding notes,
and all of this indebtedness was accelerated and became immediately due and
payable. The indebtedness under the Prior Credit Agreement was completely paid
off with the proceeds of the initial draw under the DIP Financing. The Debtors
may not, however, pay the indebtedness under the indentures other than pursuant
to a confirmed plan of reorganization or an order of the Bankruptcy Court.
During the pendency of the Chapter 11 cases, the Debtors are not, for the most
part, subject to the restrictions contained in the Prior Credit Agreement or any
of the indentures. However, the Debtors are subject to the restrictions
contained in the DIP Financing, Sterling Pulp is subject to restrictions
contained in both the DIP Financing and the Canadian Financing Agreement and our
Saskatoon subsidiary is subject to the restrictions contained in its credit
facility.

In July 1997, Sterling Sask entered into a credit agreement with The Chase
Manhattan Bank of Canada, individually and as administrative agent, and certain
other financial institutions (the "Saskatoon Credit Agreement"). The
indebtedness under the Saskatoon Credit Agreement was secured by substantially
all of the assets of Sterling Sask, including the Saskatoon facility. The
Saskatoon Credit Agreement required that certain amounts of "Excess Cash Flow"
be used to prepay amounts outstanding under the term portion of the credit
facility. In addition, the Saskatoon Credit Agreement contained provisions which
prohibited the payment of advances, loans and dividends from Sterling Sask to
Chemicals or Holdings. The Saskatoon Credit Agreement originally included a
revolving credit facility of Cdn. $8 million to be used by Sterling Sask solely
for its general corporate purposes.

The Saskatoon Credit Agreement contained provisions which restrict the
payment of advances, loans and dividends from Sterling Sask to us or Chemicals.
The most restrictive of these covenants limited such payments during fiscal 2001
to approximately $1 million, plus any amounts due to us from Sterling Sask under
our intercompany tax sharing agreement. In addition, because of its designation
as an "Unrestricted Subsidiary" under the DIP Financing 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,
Sterling Sask's results are not considered in determining compliance with the
covenants contained therein.

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
agreed to not exercise their remedies prior to December 31, 2001, in exchange
for the elimination of the exceptions to the provisions restricting the payment
of advances, loans and dividends from Sterling Sask to us or to Chemicals and
the inclusion of a prohibition on draws under the revolving credit portion of
the facility during the remainder of calendar year 2001. On January 2, 2002,
Sterling Sask entered into a waiver and amending agreement (the "Waiver
Agreement"), effective December 18, 2001, with its lenders. The Waiver Agreement
waived the existing defaults, rescinded the acceleration of the amounts
outstanding under the Saskatoon Credit Agreement and reinstated the commitments
thereunder. The Waiver Agreement provided for a reduction of the revolving
credit facility commitment to Cdn $4.0 million and changed the expiration date
on the Tranche A term loan from June 30, 2003 to December 31, 2002 and on the
Tranche B term loan from June 30, 2005 to June 30, 2003. During the first nine
months of fiscal 2002, payments of approximately $14.2 million were made
pursuant to this obligation. The Waiver Agreement also set a minimum discount
rate and Eurodollar rate margin of 2.50% over the Base Rate or LIBOR,
respectively,
18

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

for the remaining term of the facility. Sterling Sask never drew on the
revolving credit facility and, as of June 30, 2002, had approximately $8.4
million in cash and cash equivalents on hand.

On July 24, 2002, Sterling Sask entered into a new credit agreement with a
group of lenders led by Bank of Montreal to provide up to Cdn. $8 million in
revolving advances ("Facility A"), and Cdn. $60 million in term loans ("Facility
B") (collectively, the "Saskatoon Refinancing Agreement"). An initial borrowing
of approximately Cdn. $25 million from Facility B was used to repay all
outstanding amounts under the Saskatoon Credit Agreement. The remaining Cdn. $35
million of availability under Facility B can be borrowed at any time prior to
September 2003, subject to certain funding conditions and up to Cdn $30 million
may be used to supplement the Debtors' liquidity. Borrowings under Facility B
are required to be repaid on or before July 24, 2006. Borrowings under the
revolving Facility A are required to be repaid on or before July 24, 2003.

Available credit under Facility A is generally subject to a borrowing limit
equal to the lesser of Cdn. $8 million and the amount determined as follows: 75%
of eligible Canadian accounts receivable plus 60% of eligible United States
accounts receivable, plus the lesser of $2 million and 50% of the value of
eligible inventory.

Borrowings under Facility A generally bear interest at an annual rate of
LIBOR plus .5 to 2.0%, depending on the option selected by Sterling Sask.
Borrowings under Facility B generally bear interest at an annual rate of LIBOR
plus 1.0 to 2.5%.

The Saskatoon Refinancing Agreement contains numerous covenants, including,
but not limited to, restrictions on the ability of Sterling Sask to incur
indebtedness, create liens and sell assets, as well as maintenance of certain
financial covenant ratios. As of August 12, 2002, none of these covenants
restrict our ability to borrow or restrict the use of proceeds under the
Saskatoon Refinancing Agreement, although there can be no assurances that they
will be not be restrictive in the future.

19

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Borrowings consisted of the following:

5. COMMITMENTS AND CONTINGENCIES

PRODUCT CONTRACTS

We have certain long-term agreements that provide for the dedication of
100% of our production of acetic acid, plasticizers, sodium cyanide, DSIDA and
methanol, 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.

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 continue to evaluate their contracts to
determine whether those contracts should be rejected or assumed.

ENVIRONMENTAL REGULATIONS

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

20

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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
products and the raw materials used to produce our products and, if so affected,
our business, financial position, results of operations and cash flows 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 emission producing practices and
equipment and 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. 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 we
believe that our business operations and facilities generally are operated in
compliance with all applicable environmental, 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 or 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. In addition, a
catastrophic event at any of our facilities could result in the incurrence of
liabilities substantially in excess of our insurance coverages.

A significant ban on all chlorine containing compounds could have a
materially adverse effect on our financial condition and results of operations.
British Columbia had a regulation in place requiring elimination of the use of
all chlorine products, including chlorine dioxide, in the bleaching process by
December 31, 2002. However, in April 2001, a new government came into power in
British Columbia. This new administration was aware of the issues surrounding
this regulation and commissioned a study by the British Columbia AOX Scientific
Advisory Panel. The panel concluded that there was no evidence available to it
at this time to indicate that further reductions of effluent AOX beyond that
already achieved would result in any demonstrable environmental benefit. On July
5, 2002, British Columbia amended the previous regulation which now permits a
monthly average discharge of 0.6 kg of AOX per air dry metric ton, which is
similar to the U.S. EPA regulations governing bleach pulp mills.

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 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
21

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 or
punitive damages 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 required 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.

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
the April 1, 1998 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.

We are presently investigating allegations by the Florida Department of
Environmental Protection ("FDEP") that past or present waste handling practices
at our acrylic fibers facility in Santa Rosa, Florida have adversely affected
the water quality of streams on the property. The results of analysis performed
by our independent contractors have been submitted to the FDEP for review. At
this time we do not know the nature of remedial actions, if any, that may
ultimately be required.

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 must have asserted 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. A description of this release is found under "Legal
Proceedings" in Note 8 of the "Notes to Consolidated Financial Statements" of
the Annual Report and is incorporated herein by reference.

22

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The six lawsuits listed below and three interventions, involving a total of
approximately 675 plaintiffs, have been filed based on this release alleging
personal injury, property damage and nuisance claims:

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

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

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

- James C. Allen, et al. v. Sterling Chemicals, Inc., et al.; Case No.
2000-15823; In the 152nd Judicial District Court of Harris County, Texas

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

- Olivia Ellis v. Sterling Chemicals, Inc.; Case No. JC5000305; In Justice
Court No. 5 of Galveston County, Texas

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. 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, with our support, lifted the automatic
stay in the cases of Bobbie Adams, et al., James C. Allen, et al. and Nettie
Allen, et al., allowing the plaintiffs to proceed against our liability
insurance policies. As a condition to the lifting of the automatic stay, these
plaintiffs waived their right to seek any recoveries against us directly and
look solely to insurance proceeds to satisfy their claims. Motions to lift the
stay on behalf of additional plaintiffs are currently pending before the
Bankruptcy Court. We have entered into a settlement related to the James Allen,
et al. lawsuit which is pending Bankruptcy Court approval. All amounts payable
to the plaintiffs in this case under the proposed settlement agreement would be
paid by our insurance carriers. 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 Ida Goldman, et al. case, and have been approved by
the Bankruptcy Court.

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

On December 19, 2001, we announced that Frank P. Diassi had elected to
terminate his employment as Co-Chief Executive Officer and executive Chairman of
the Board. On January 25, 2002, Mr. Diassi resigned from our Board of Directors.
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 Key Employee
Protection Plan and our Retention Bonus Plan. On June 3, 2002, we denied Mr.
Diassi's claim under our Key Employee Protection Plan and, on July 24, 2002, we
denied Mr. Diassi's claim under our Retention Bonus Plan. We do not know whether
Mr. Diassi will continue to pursue either of these claims.

23

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 June 30, 2002, 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 June 30, 2002, 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.

24

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 HOLDINGS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF OPERATIONS
(UNAUDITED)

25

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STERLING CHEMICALS HOLDINGS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED BALANCE SHEETS
(UNAUDITED)

26

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STERLING CHEMICALS HOLDINGS, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED COMBINED STATEMENTS OF CASH FLOWS
(UNAUDITED)

27

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. INCOME TAXES

As of September 30, 2001, we had approximately $318 million in United
States net operating losses ("NOLs") which will expire over the period from
fiscal 2018 to 2021. In assessing the value of our 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. Based on the uncertainty as
to the effect of the Chapter 11 filings on the utilization of the NOLs and the
future realization of other net deferred tax assets, we are not able to conclude
that it is more likely than not that we will be able to realize the future
benefit of our U.S. deferred tax assets and, consequently, our valuation
allowance reflects U.S. deferred tax assets as zero. We expect our NOLs to be
eliminated or substantially reduced as a result of the consummation of a 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 will
likely cause our utilization of our remaining NOLs, if any, to become subject to
certain limitations. Since numerous variables could affect the bankruptcy
proceedings, it is not currently possible to determine whether our NOLs will
produce tax benefits in the future. Benefit was not provided for these loss
carryforwards at June 30, 2002.

8. NEW ACCOUNTING STANDARDS

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 years beginning
after December 15, 2001. We do not believe that the adoption of SFAS No. 141 or
SFAS No. 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.

In April 2002, the Financial Accounting Standards Board issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." SFAS No. 145 eliminates Statement
No. 4 and as a result, gains and losses from extinguishment of debt should be
classified as extraordinary items only if they meet the criteria in APB Opinion
No. 30. SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," to eliminate
an inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. SFAS No. 145 also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings or describe their applicability under changed
conditions. The provisions of this Statement related to the rescission of SFAS
No. 4 apply to fiscal
28

STERLING CHEMICALS HOLDINGS, INC.
STERLING CHEMICALS, INC.
(DEBTORS-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

years beginning after May 15, 2002. The provisions of this Statement related to
SFAS No. 13 apply to transactions occurring after May 15, 2002. All other
provisions of this Statement are effective for financial statements issued on or
after May 15, 2002. The adoption of SFAS No. 145 did not, nor is it expected to,
have a significant impact on our financial statements.

In July 2002, the FASB issued SFAS No. 146, "Accounting For Costs
Associated with Exit or Disposal Activities." SFAS No. 146 is effective for exit
or disposal activities initiated after December 31, 2002. We have not yet
adopted SFAS No. 146 nor determined the effect of the adoption of SFAS No. 146
on our financial position or results of operations.

29

REPORT OF INDEPENDENT ACCOUNTANTS

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

We have reviewed the accompanying consolidated balance sheet of Sterling
Chemicals Holdings, Inc. and subsidiaries (Debtors-in-Possession) (the
"Company") as of June 30, 2002, and the related consolidated statements of
operations and cash flows for the three and nine-month periods ended June 30,
2002 and 2001. These financial statements are the responsibility of the
Company's management.

We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.

Based on our review, we are not aware of any material modifications that
should be made to such consolidated financial statements for them to be 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 not 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 to the
accompanying financial statements, 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 to the financial statements. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of September 30, 2001, and the related consolidated statements of
operations, stockholders' equity (deficiency in assets), and cash flows for the
year then ended (not presented herein); and in our report dated December 20,
2001, we expressed an unqualified opinion on those consolidated financial
statements and included an explanatory paragraph concerning matters that raise
substantial doubt about the Company's ability to continue as a going concern. In
our opinion, the information set forth in the accompanying consolidated balance
sheet as of September 30, 2001 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.

DELOITTE & TOUC