SOLUTIA INC.
575 Maryville Centre Drive
P.O. Box 66760
St. Louis, Missouri 63166-6760
[Solutia logo] Tel 314-674-1000
October 10, 2006
Securities and Exchange Commission
Division of Corporate Finance
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Mr. John Cash
Ms. Tricia Armelin
Ms. Anne McConnell
RE: SOLUTIA INC.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005, FILED
MARCH 15, 2006
FILE NO. 1-13255
Dear Ladies and Gentlemen:
Solutia Inc. (Solutia or the Company) acknowledges receipt of the staff's
comment letter dated September 18, 2006 concerning the Company's Annual Report
on Form 10-K for the year ended December 31, 2005 as filed with the Securities
and Exchange Commission (the "Commission") on March 15, 2006 (The "2005 Form
10-K"). The Company's responses to your comments are set forth below. For your
convenience, we repeat each comment in caps immediately before the response.
This letter is being filed via EDGAR in accordance with the rules and
regulations of the Commission.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
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NOTE 2. SIGNIFICANT ACCOUNTING POLICIES, PAGE 68
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INVENTORY VALUATION, PAGE 69
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COMMENT NO. 1
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WE HAVE THE FOLLOWING COMMENTS REGARDING YOUR INVENTORY ACCOUNTING POLICY AND
RELATED DISCLOSURES:
o PLEASE EXPLAIN TO US WHY YOU VALUE YOUR INVENTORY USING BOTH THE
FIFO AND LIFO METHODS.
o PLEASE TELL US IF SIMILAR MATERIALS AND PRODUCTS ARE VALUED USING
BOTH THE FIFO AND LIFO METHODS.
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
o PLEASE EXPLAIN TO US HOW YOU HAVE CONSIDERED CHAPTER 4 OF ARB 43 IN
ELECTING TO VALUE YOUR INVENTORY USING BOTH THE FIFO AND LIFO
METHODS. IN YOUR EXPLANATION, PLEASE TELL US HOW AND WHY EACH METHOD
MOST CLEARLY REFLECTS PERIODIC INCOME.
o PLEASE EXPLAIN TO US HOW STANDARD COSTS ARE INCORPORATED INTO THE
COST BASIS OF YOUR INVENTORY.
o WITH A VIEW TOWARDS FUTURE DISCLOSURE, PLEASE HELP US UNDERSTAND HOW
YOUR USE OF DIFFERENT ACCOUNTING POLICIES IMPACTS YOUR OPERATING
RESULTS.
RESPONSE NO. 1
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Please find the Company's response in similar bullet format for ease of tying
to the original comments.
o The Company was formed on September 1, 1997, when the former
Monsanto Company (now known as Pharmacia Corporation, which we refer
to in this letter as "Pharmacia") distributed all of the shares of
common stock as a dividend to Pharmacia stockholders (the
"spinoff"). At inception, the Company applied the previous
accounting policies adopted by Pharmacia as it relates to inventory
valuation and has continued the consistent application of these
policies to date. Such policies valued inventory under both LIFO and
FIFO methodologies. All inventory not manufactured in the United
States is costed on a FIFO inventory valuation methodology, whereas,
nearly all inventory manufactured in the United States is costed on
a LIFO inventory valuation. Both the FIFO and LIFO inventory
valuation methodologies are necessary because of the tax benefits
recognized within the United States as a result of the application
of LIFO. More specifically, the Company determined that due to the
statutory financial reporting requirements for foreign subsidiaries
and the nonrecognition for tax purposes of LIFO in certain foreign
countries, the appropriate methodology was to utilize both FIFO and
LIFO in valuing inventory. As discussed in paragraph 6 of ARB 43 and
Section Three of the AICPA's 1984 Issues Paper, "Identification and
Discussion of Certain Financial Accounting and Reporting Issues
Concerning LIFO Inventories," the application of one acceptable
method to a portion of the inventory and application of another of
the acceptable methods to other portions of the inventory is
acceptable.
o There are instances where the Company values similar end products
using LIFO and FIFO, depending on whether the products are
manufactured in the United States or abroad, as discussed above.
Laminated Glazing Interlayer (LGI) product, for example, is
produced at the major manufacturing facilities in Trenton, MI and
Springfield, MA, as well as the Ghent facility in Belgium.
o The Company considered Chapter 4 paragraph 4 of ARB 43 and Section
Three of the AICPA's 1984 Issues Paper, "Identification and
Discussion of Certain Financial
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
Accounting and Reporting Issues Concerning LIFO Inventories," when
it selected the cost flow assumption for valuing its inventory. As
indicated above, the primary reason the Company uses two different
cost flow assumptions is that the differing methodologies are
necessary to reflect the tax benefits recognized within the United
States as a result of the application of LIFO. Section 3-5 of the
AICPA Issue paper recognizes that not adopting LIFO for all
inventories is acceptable when valid business reasons exist. The
Company determined that valid business reasons for having multiple
costing methodologies exist due to the tax benefits recognized in
the U.S. as a result of adoption of LIFO, as well as the statutory
financial reporting requirements for foreign subsidiaries and the
nonrecognition for tax purposes of LIFO in certain foreign
countries.
o Standard costs are the basis for valuation of the Company's FIFO
inventory, with all variances between standard and actual costs
expensed within the Statement of Consolidated Operations on a
monthly basis. On a quarterly basis, the Company performs an
analysis to ensure the standards reflect the actual costs, within
a prescribed threshold. The Company's quarterly LIFO analysis
utilizes FIFO inventories to calculate the appropriate reserves as
of each reporting date.
o For both internal and external purposes, the LIFO reserve is treated
as a corporate item. Accordingly, in Management's Discussion and
Analysis, the Company reports and discusses the operating results of
its segments based on the FIFO cost flow assumption. Then, any
change in the LIFO reserve is disclosed in the corporate results.
Additionally, in footnote number eleven within the 2005 Form 10-K,
the Company discloses the impact of any LIFO liquidation and
separately discloses the dollar amount of total balance sheet
inventories priced at FIFO and the valuation of the LIFO reserve. In
addition, in footnote number two, we provide the percentage of total
inventory valued on a LIFO and FIFO basis. We believe enabling the
reader to analyze results as if all inventory were valued at FIFO
allows for an understanding of consolidated results and ability to
analyze the underlying operating business on a consistent and
comparable basis. These disclosures are included in both our annual
and quarterly periodic filings. We will update the following
disclosure in future filings to our Significant Accounting Policies
footnote to read as follows (revisions and additions are
underlined):
...The cost of inventories in the United States, excluding supplies,
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(73 percent as of December 31, 2005 and 67 percent as of December
31, 2004) is determined by the last-in, first-out ("LIFO") method,
which generally reflects the effects of inflation or deflation on
costs of goods sold sooner than other inventory cost methods. The
cost of inventories outside of the United States, as well as
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supplies inventories in the United States, is determined by the
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first-in, first-out ("FIFO") method.
Securities and Exchange Commission
October 10, 2006
Page 4
Solutia Inc.
INTANGIBLE ASSETS
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COMMENT NO. 2
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CONFIRM, AND REVISE FUTURE FILINGS TO CLARIFY, THAT GOODWILL AND
INDEFINITE-LIVED INTANGIBLE ASSETS ARE ALSO ASSESSED FOR IMPAIRMENT MORE
FREQUENTLY IF CHANGES IN CIRCUMSTANCES INDICATE THEY MAY NOT BE RECOVERABLE.
RESPONSE NO. 2
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We confirm that the Company reviews its goodwill and indefinite-lived
intangible assets more frequently than on an annual basis if changes in
circumstances indicate they may not be recoverable. In our future filings,
we will update the following disclosure to read as follows (additions are
underlined):
Goodwill and indefinite-lived intangible assets are assessed annually for
impairment in the fourth quarter, or more frequently if changes in
--------------------------------
circumstances indicate they may not be recoverable.
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NOTE 3. LIABILITIES SUBJECT TO COMPROMISE AND REORGANIZATION ITEMS, NET, PAGE 73
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COMMENT NO. 3
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IT APPEARS TO US THAT YOU HAVE PRESENTED YOUR DEBT SUBJECT TO COMPROMISE NET
OF UNAMORTIZED DISCOUNT AND ISSUANCE COSTS INSTEAD OF ADJUSTING THE RECORDED
AMOUNT TO THE AMOUNT OF THE ALLOWED CLAIM. PLEASE EXPLAIN. REFER TO PARAGRAPH
25 OF SOP 90-7.
RESPONSE NO. 3
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In our 2005 Form 10-K, we evaluated all of our debt to determine appropriate
classification. For debt that met the requirements of SOP 90-7, the debt and
associated unamortized discount and issuance costs were presented in the
2005 Form 10-K as Liabilities Subject to Compromise. To the extent the
non-subject to compromise debt, specifically the debtor-in-possession
facility and the Euronotes, have associated unamortized discount and
issuance costs, those items are not reported as Liabilities Subject to
Compromise, in like manner with the associated debt. We believe that we have
appropriately accounted for these items and that our presentation is in
accordance with paragraph 25 of SOP 90-7.
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
For your convenience, the disclosure is set forth below:
The amounts subject to compromise consisted of the following items:
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(Dollars in millions) DECEMBER 31,
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2005 2004
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Postretirement benefits (a)............................... $1,098 $1,090
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Litigation reserves (b)................................... 136 141
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Accounts payable (c)...................................... 118 130
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Environmental reserves (d)................................ 82 82
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Other miscellaneous liabilities........................... 74 76
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6.72% debentures due 2037(e).............................. 150 150
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7.375% debentures due 2027(e)............................. 300 300
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11.25% notes due 2009 (f)................................. 223 223
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Other (g)................................................. 43 43
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716 716
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Unamortized debt discount and debt issuance costs......... (48) (48)
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TOTAL DEBT SUBJECT TO COMPROMISE.................... 668 668
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TOTAL LIABILITIES SUBJECT TO COMPROMISE................... $2,176 $2,187
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<FN>
Applicable footnotes:
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(e)While operating during the Chapter 11 bankruptcy proceedings,
Solutia has ceased recording interest on its 6.72% debentures due 2037
and its 7.375% debentures due 2027. The amount of contractual interest
expense not recorded was approximately $32 in both 2005 and 2004.
(f)Pursuant to a bankruptcy court order, Solutia is required to
continue payments of the contractual interest for the 11.25% notes due
2009 as a form of adequate protection under the U.S. Bankruptcy Code;
provided, however, that Solutia's official committee of unsecured
creditors (the "Creditors' Committee") has the right at any time, and
Solutia has the right at any time after the payment of the contractual
interest due in July 2005, to seek to terminate Solutia's obligation to
continue making the interest payments. Solutia or the Creditors'
Committee could successfully terminate all or part of Solutia's
interest payment obligations only after showing that the noteholders
are not entitled to adequate protection, which would depend, among
other things, on the value of the collateral securing the notes as of
December 17, 2003, and whether that value is decreasing during the
course of Solutia's bankruptcy case. The amount of contractual interest
paid with respect to these notes was approximately $25 in both years
ended December 31, 2005 and 2004, and the accrued interest related to
these notes was included in Accrued Liabilities classified as not
subject to compromise as of December 31, 2005 and 2004.
(g)Represents the debt obligation included with the consolidation of
the assets and liabilities of a synthetic lease structure consolidated
as part of the adoption of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities. The obligation, representing the synthetic
lease arrangement with respect to Solutia's headquarters building, was
reclassified to liabilities subject to compromise in 2004 as Solutia
believes it is unable to continue to perform on this debt obligation.
Securities and Exchange Commission
October 10, 2006
Page 6
Solutia Inc.
Paragraph 25 of SOP 90-7 states, "Debt discounts or premiums as well as debt
issuance costs should be viewed as valuations of the related debt. When the
debt has become an allowed claim and the allowed claim differs from the net
carrying amount of the debt, the recorded amount should be adjusted to the
amount of the allowed claim (thereby adjusting the existing discounts or
premiums)."
The trustees for each of the three debt issuances (e.g. 6.72% debentures due
2037; 7.375% debentures due 2027; and 11.25% notes due 2009), as well as the
trustees for the noteholders of the headquarters building lease arrangement,
have filed claims in our Chapter 11 case. As of December 31, 2005 and through
the date of this letter, these claims have not been approved by the bankruptcy
court for the Southern District of New York (the "Bankruptcy Court"). In fact,
the amount asserted in each of the claims is the subject of ongoing
negotiation between the Company and the claimants. These claims will not
become allowed claims until these disputes are resolved either consensually by
the parties or upon a ruling by the Bankruptcy Court. As an allowed claim
amount had not been determined as of December 31, 2005, no adjustment to the
net carrying amount was recorded in accordance with paragraph 25 of SOP 90-7.
COMMENT NO. 4
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IT IS UNCLEAR TO US IF YOU HAVE PRESENTED YOUR LIABILITIES AT THE EXPECTED
AMOUNT OF THE ALLOWED CLAIMS. PLEASE ADVISE. REFER TO PARAGRAPHS 23 AND 24 OF
SOP 90-7.
RESPONSE NO. 4
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With respect to the liabilities classified as Liabilities Subject to
Compromise, we have considered the provisions of paragraphs 23 and 24 of SOP
90-7 and SFAS 5, and believe we have appropriately accounted for these
liabilities and presented them at our best estimate of the expected amount of
the allowed claims. The Company's belief in this regard is discussed in
footnote number one in the 2005 Form 10-K as well as below. The background which
follows is important in considering the Company's approach.
On December 17, 2003, the Company filed voluntary petitions under Chapter 11
of the Bankruptcy Code ("petition date"). On June 7, 2005, the Company
announced that it had reached an agreement-in-principle with Monsanto
Company ("Monsanto") and the Official Committee of Unsecured Creditors in
Solutia's Chapter 11 case (the "Unsecured Creditors' Committee") that we
believed would serve as a framework for Solutia's plan of reorganization.
The agreement, among other provisions, achieved a reallocation between
Monsanto and Solutia of the OPEB, environmental and litigation liabilities
("legacy liabilities") currently classified as Liabilities Subject to
Compromise.
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
The agreement-in-principle immediately was not supported by the Official
Committee of Equity Holders in Solutia's Chapter 11 case, and later, by the
holders of the 6.72% and 7.375% debentures. Both parties asserted through
various legal theories that they were entitled to additional consideration
in the reorganized Solutia than was provided for in the
agreement-in-principle, and that the additional consideration should come as
a detriment to the consideration provided to Monsanto.
If Monsanto, in exchange for accepting lower consideration, is not willing to
assume or fund a substantial portion of the legacy liabilities, and the
Company is unable to eliminate these liabilities through alternative legal
action in the Bankruptcy Court, the Company may be required to fund the legacy
liabilities that existed as of the petition date. This would dramatically
limit the Company's ability to fund other liabilities or service debt levels
comparable to peers. In addition, in the event the Company was to ultimately
retain a significant portion of the legacy liabilities, it would have a
significant negative impact on the overall valuation of the Company, impacting
consideration levels for all constituents. The Bankruptcy Court has not
actively ruled on many of these legal actions, in anticipation of the parties
being able to reach a negotiated settlement. These differing views, and lack
of clarity from the Bankruptcy Court existed as of the date of the filing of
the 2005 Form 10-K, and still exist through the date of this letter.
As of the petition date, Solutia made a determination of its pre-petition
liabilities, as well as liabilities in which uncertainty exists about whether
a claim is undersecured, or may be impaired under the plan, and classified
these as Liabilities Subject to Compromise, in accordance with paragraph 23 of
SOP 90-7. At that time and through the date of this letter, the carrying
amount of these liabilities was the best estimate of the allowed claim amount,
except for certain claims which have been resolved. For resolved claims, at
the time a better estimate of the allowed claim amount other than the carrying
value was known, the Company adjusted the amounts reported as subject to
compromise to reflect the expected amount of the allowed claim, or
reclassified the item out of liabilities subject to compromise, as
appropriate. Items that have been adjusted to date are few in quantity, as
indicated by the small dollar amounts reported in the Reorganization Items,
Net table within footnote number three in the 2005 Form 10-K.
Such complications related to Monsanto and other parties in the Bankruptcy
Court, as of December 31, 2005, have given rise to significant uncertainty
as to the ultimate resolution of the legacy liabilities. Moreover, approved
claim amounts for other claims, including the claims of our debenture
holders and trade creditors, will not be resolved until the legacy
liabilities are adequately addressed. These dynamics create significant
overall uncertainties with respect to items classified within Liabilities
Subject to Compromise, and the accounting treatment as of December 31, 2005.
Accordingly, for items that have not been adjusted since the petition date,
Solutia does not believe a better estimate exists than the existing carrying
values, as of December 31, 2005.
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
NOTE 21. COMMITMENTS AND CONTINGENCIES, PAGE 94
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COMMENT NO. 5
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IT IS UNCLEAR TO US WHY YOU HAVE CEASED UPDATING YOUR DISCLOSURE REGARDING THE
STATUS OF CERTAIN LEGAL PROCEEDINGS. WITH A VIEW TOWARDS FUTURE DISCLOSURE,
PLEASE TELL US WHETHER IT IS REASONABLY POSSIBLE THAT THESE MATTERS COULD HAVE
A MATERIAL IMPACT ON YOUR FINANCIAL STATEMENTS.
RESPONSE NO. 5
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As disclosed in the 2005 Form 10-K, at the time of the Solutia spinoff in
1997, the Company assumed the defense of specified legal proceedings and
agreed to indemnify Pharmacia in connection with those proceedings. These
defense and indemnification obligations to Pharmacia are pre-petition
obligations under the U.S. Bankruptcy Code that Solutia is prohibited from
performing, except pursuant to a confirmed plan of reorganization. As a
result, Solutia ceased performance of these obligations as of the petition
date. In many of these proceedings, Pharmacia was named as a defendant, and
Monsanto, due to its indemnification agreement with Pharmacia, assumed
day-to-day management of these legal matters.
As an initial matter, Solutia is unable to provide disclosure regarding these
legal proceedings simply because it is no longer managing them and therefore
does not have access to complete information regarding the current status of
the cases. We believe that providing only the information available to the
Company through court filings by the parties to the various cases may provide
an incomplete picture of the current status of the litigation and in fact be
more detrimental to an understanding of the litigation.
Furthermore, given the designation of these matters as pre-petition
liabilities, any further developments in these legal proceedings may give rise
to a potential change in the ultimate claim amount that may be asserted by
Monsanto or Pharmacia, a claim that would be addressed through the
confirmation of a plan of reorganization.
In our future filings, we will add the following underlined disclosure:
...The legal proceedings which are in this category are (i) Owens v.
Monsanto; (ii) Payton v. Monsanto; (iii) other Anniston cases; (iv) the
PENNDOT case; and (v) premises based asbestos litigation. Legal proceeding
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activities are currently being funded by Monsanto for these matters.
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Monsanto's funding of these legal activities may give rise to a claim against
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Solutia which Monsanto may assert in Solutia's bankruptcy case.
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Securities and Exchange Commission
October 10, 2006
Page 9
Solutia Inc.
NOTE 23. SEGMENT AND GEOGRAPHIC DATA, PAGE 103
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COMMENT NO. 6
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WE NOTE THAT YOU HAVE TWO REPORTING SEGMENTS: PERFORMANCE PRODUCTS AND
SERVICES AND INTEGRATED NYLON. PLEASE EXPLAIN TO US HOW YOU HAVE IDENTIFIED
YOUR OPERATING SEGMENTS AND IF/HOW YOU HAVE COMBINED THESE OPERATING SEGMENTS
INTO YOUR TWO REPORTABLE SEGMENTS. IN THIS REGARD, PLEASE PROVIDE US A
COMPREHENSIVE ANALYSIS OF HOW YOU CONSIDERED THE AGGREGATION CRITERIA IN
PARAGRAPH 17 OF SFAS 131, INCLUDING SIMILAR ECONOMIC CHARACTERISTICS. PLEASE
ALSO PROVIDE US WITH COPIES OF THE INTERNAL REPORTS USED BY YOUR CODM.
RESPONSE NO. 6
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Solutia is a global manufacturer and marketer of a variety of
high-performance chemical-based materials, which are used in a broad range
of consumer and industrial applications, including performance films for
laminated safety glass and after-market applications and an integrated
family of nylon products including high-performance polymers and fibers. The
Company has determined its operating segments through evaluation of its
management structure and consideration of operating results and related
information that the Company uses to allocate resources and assess
performance.
The Company's management structure is lead by an Executive Leadership Team
("ELT"), comprised of Jeff Quinn, Chairman, President and Chief Executive
Officer; Luc de Temmerman, Senior Vice President and President of Performance
Products; Jonathan Wright, Senior Vice President and President of Integrated
Nylon; Jim Voss, Senior Vice President, Business Operations; Rosemary Klein;
Senior Vice President, Secretary and General Counsel; Jim Sullivan, Senior
Vice President, Chief Financial Officer and Treasurer; Bob Debolt, Vice
President, Strategy; Tim Spihlman, Vice President, Corporate Controller, and
Max McCombs, Vice President, Environmental, Safety and Health. The Company has
added Kent Davies, Senior Vice President and President of CP Films, in 2006,
as further described below. The Company has identified Mr. Quinn as the
Company's chief operating decision maker ("CODM") due to his overriding
authority as the Chief Executive Officer of the Company.
In consideration of operating results and related information used to allocate
resources and assess performance, the ELT and the CODM use two separate and
distinct reports: the Solutia Inc. Operating Highlights ("Operating
Highlights"), and the Executive Leadership Report, provided monthly to the ELT
and the CODM. These reports are being provided to the staff of the Commission
separately in accordance with Rule 83 of the Freedom of Information Act and
Rule 12b-4 of the Exchange Act.
The Operating Highlights report is the first report generated after the
initial close and forecast updates provided by the business units, generally
on the seventh work day after close. At the time of
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
issuance, the Company has not finalized its accounting for the month and the
associated analysis of results has not yet been completed. This report is
designed to inform the ELT and CODM of the results and full year forecast as
soon as practically known. Given the underlying analysis to fully understand
the results is not yet complete, the Company compiles a page two for this
report, which breaks down the results and projections into significant detail
to allow for some understanding of the factors shaping the results and
forecast. This report is not distributed beyond the ELT. The Executive
Leadership Report is the final report generated, after the accounting
activities are complete, analyzing the month's performance, and the full year
forecasted results and is the primary report utilized by the CODM in assessing
performance. In contrast with the Operating Highlights report, this report
includes the appropriate analysis, both numerically and in commentary to
assess the performance of the Company. This report is distributed to Solutia's
ELT as well as to financial advisors of the various authorized committees of
the Bankruptcy Court, who are bound by confidentiality agreements with the
Company regarding the usage of this information.
In accordance with paragraph 10 of SFAS 131, "Disclosure about Segments of an
Enterprise and Related Information," the Company has evaluated its operating
segments based upon the criteria of a component of an enterprise:
o That engages in business activities from which it may earn
revenues
o Whose operating results of the component are regularly reviewed by
the enterprise's chief operating decision maker to make decisions
about resources to be allocated to the segment and assess its
performance, and
o For which discrete financial information is available.
As previously mentioned, these are the reports used in the ELT and CODM's
analysis of Company performance, and clearly identify three distinct operating
segments: Integrated Nylon, Performance Products ("PP") and Pharmaceutical
Services ("Pharma").
Additionally, per paragraph 13 of SFAS 131, "an enterprise may produce reports
in which its business activities are presented in a variety of different ways.
If the chief operating decision maker uses more than one set of segment
information, other factors may identify a single set of components as
constituting an enterprise's operating segments, including the nature of the
business activities of each component, the existence of managers responsible
for them, and information presented to the board of directors." The Company
notes that the CODM regularly reviews financial information related to the
Company's CP Films business ("CP Films"), separate from the remainder of
Performance Products ("OPP"). With regards to reporting structure, it is
important to note that Mr. Luc De Temmerman had previously held responsibility
for all components of PP, including CP Films. While there were managers over
each of the respective components, only Mr. De Temmerman was directly
accountable for all components, and he maintained regular contact with the
CODM to discuss operating activities, financial results, forecasts and other
plans for the segment. His managers did not have regular communications with
the CODM. In 2005, the CODM determined that a direct reporting relationship
with CP Films was desired, and the Company created a new position, Senior Vice
President and President of CP Films (which was filled by
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
Mr. Kent Davies in early 2006, as disclosed within the Summary of Significant
2005 Events in the Management's Discussion and Analysis of Financial Condition
and Results of Operations section of the 2005 Form 10-K). As a result, Mr.
Davies reports the results of CP Films directly to the Company's CODM in 2006.
Based on these factors, the Company believes Performance Products contains two
operating segments; specifically, CP Films is deemed to be an operating
segment, separate from OPP, which is also an operating segment. We have
evaluated if there are other components of OPP that could be considered
operating segments and, due to the reporting structure and lack of evaluation
by the CODM of the components of the operating segment, we do not believe that
other individual operating segments exist.
In accordance with paragraph 17 of SFAS 131, we have aggregated the operating
segments of CP Films, OPP, and Pharma services into one reporting segment. The
following is our review of the aggregation criteria utilized by the Company to
arrive at this conclusion. Note the discussion of the Pharma aggregation
criteria is discussed separately below.
o The CP Films and OPP operating segments have similar economic
characteristics:
For the three years ended December 31, 2005, 2004 and 2003, both CP
Films and OPP carry EBIT margins between 10 - 18%, primarily due to
significant S,G&A investment due to the branded nature of many of
the products in both operating segments. CP Films has carried a
higher EBIT margin than OPP for the periods noted above; however,
the outlook is for EBIT margins of these operating segments to
converge due to the strategic direction of both segments. These
strategies include an aggressive revenue expansion in CP Films,
which we expect will deteriorate EBIT margins on a percentage basis.
For OPP, the Company has initiated a more disciplined pricing
approach, as well as new product introductions which is expected to
enhance the EBIT margins of this segment. Further, the long term
outlook for CP Films and nearly all of OPP is for demand growth
above GDP, projected to be in the 5% range in the near future.
Finally, the Company expects the capital requirements in upcoming
years for both of these segments to be significant, more than one
times their respective annual Depreciation and Amortization rates,
to expand capacity to adequately serve the growth in these markets.
o The CP Films and OPP segments have the following similar
characteristics in each of the following areas:
Nature of the product and services
----------------------------------
The majority of products within this segment carry a branded product
concept coupled with a strong support service aspect offered by
the Company. Given the technical nature of these products, a
strong service offering to assist the end users of the product is
necessary. These products generally bring the functionalities of
safety, security, and process and energy efficiency to their
customers. The vast majority of these products are sold into the
transportation and architecture markets. Further, certain of the
product lines within both OPP and CP Films sell intermediate
products to competitors within the industry.
Nature of the production process
--------------------------------
These products are produced through chemical reactive manufacturing
environments, which generally run on a continuous basis. These
reactions occur in
Securities and Exchange Commission
October 10, 2006
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Solutia Inc.
controlled environments, where factors such as temperature and air
pressure are regulated to achieve the desired outcome. These
processes utilize natural gas as the primary energy source to
facilitate production, and nearly all the raw materials are
crude oil-based derivatives. This controlled environment also leads
to rigorous quality control reviews within the manufacturing process
for these products. Labor is not a significant cost component in
these products, rather the raw materials and fixed manufacturing
costs are the significant costs of the production process.
Type or class of customer for their products and services
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As identified above, the end user of the majority of these
products is in the transportation and architecture segments, and
certain products are sold in an intermediate state to competitors
in both the CP Films and OPP segments. Customers in both segments
are not the end-users, utilizing our product as a component of a
final product. The markets that these segments sell into are
characterized as having relatively few, large customers.
The method used to distribute the product
-----------------------------------------
Both segments have product that is sold to both other manufacturers,
who perform additional processing utilizing our products, and as
finished product through distributors to provide the product to the
ultimate end user. Both segments spend considerable resources
working directly with the end users to ensure appropriate
application of the product, as well as to enhance the Company's
understanding of the market needs. However, the revenue recognized
by the Company is when the product is sold to an intermediary, who
provides traditional distribution functions, and/or utilization of
our product into a larger offering for the end user.
The nature of the regulatory environment
----------------------------------------
Certain products within the OPP as well as CP Films are dependent
on the existence of safety codes, particularly within the
transportation and architectural markets. These products provide
regulatory solutions for the end user.
Additionally, it is important to note that the Company's financial advisors of
the various authorized committees of the Bankruptcy Courts receive financial
information for the Company's two reportable segments, demonstrating the fact
that the primary external users of the financial statements review and make
decisions based upon the Company's financial information provided at the
reportable segment level. Further, note that the Company's Board of Directors
has consistently received the financial information and related analysis at
the consolidated PP level. Based on these factors, the Company believes the
aggregation of the CP Films operating segment and OPP is appropriate and in
accordance with paragraph 17 of SFAS 131.
The Operating Highlights and the Executive Leadership reports refer to Pharma
in its reporting information to the CODM. It should be noted that the Pharma
business is not a material component of the overall enterprise. Specifically,
for the years ended December 31, 2005, 2004 and 2003, Pharma comprised
Securities and Exchange Commission
October 10, 2006
Page 13
Solutia Inc.
approximately $66M, $64M and $56M, respectively, in net sales, representing
approximately 2% of consolidated net sales for each of the years then ended.
In terms of EBIT, Pharma comprised approximately $5M, ($38)M and ($115)M,
respectively, which represented 4%, 18% and 23% of consolidated EBIT for the
years then ended. The 2004 and 2003 results comprise a higher percentage due
to the asset impairment charges taken in each of those two years. These
charges are fully disclosed in the respective 10-K filings, on the face of the
financial statements, as well as in the Management's Discussion and Analysis
of Financial Condition and Results of Operations. The charge is disclosed both
in terms of the amount, as well as to which operating segment the charge
relates to. Excluding this charge to assess the results of the operations of
this component, the EBIT of Pharma comprised approximately 1% and 4% of
consolidated EBIT, respectively, for the years ended December 31, 2004 and
2003. Finally, Pharma comprised approximately $69M and $81M of total assets,
respectively, which represented 4% of total assets as of both December 31,
2005, and 2004.
Per paragraph 18 of SFAS 131, such immaterial operating segments would not be
required to be reported separately. Further, note that the organizational
structure of the Company is such that the segment managers for the operating
segments of PPD, CP Films and Integrated Nylon report directly to the CODM, as
well as the additional ELT members as noted above. The Senior Vice President
of Business Operations has oversight responsibility for the Pharma business.
Mr. Luc De Temmerman also has oversight responsibilities for this business due
to the legal structure that contains the Pharma business, and Mr. De
Temmerman's role as a Managing Director of that legal entity.
Given the immateriality of the Pharma business, coupled with the reporting
structure as noted above, the Company has aggregated this operating segment
with the CP Films and OPP operating segments, as the Performance Products
and Services reporting segment.
COMMENT NO. 7
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WE NOTE THAT COUNTRIES OUTSIDE OF THE U.S. ACCOUNT FOR A SIGNIFICANT
PERCENTAGE OF YOUR TOTAL NET SALES. PLEASE REVISE FUTURE FILINGS TO SEPARATELY
DISCLOSE THE MOST MATERIAL INDIVIDUAL FOREIGN COUNTRIES. REFER TO PARAGRAPH 38
OF SFAS 131.
RESPONSE NO. 7
- --------------
The Company has considered paragraph 38 of SFAS 131, and believe our
reporting is appropriate. For 2005, countries outside of the U.S. accounted
for approximately 40% of the Company's total net sales. The most material
individual foreign country in terms of sales is Japan, which represented
approximately 4% of total 2005 Company net sales. The second most significant
is China, at approximately 3%, and no other foreign country represented
greater than 2% of total Company net sales in 2005. We do not believe that
disclosures of individual countries, given these small percentages, are
material, and therefore, not required per paragraph 38 of SFAS 131. To the
extent individual countries become material in future reporting periods, we
will disclose them in accordance with paragraph 38 of SFAS 131.
NOTE 26. CONSOLIDATING CONDENSED FINANCIAL STATEMENTS, PAGE 106
- ---------------------------------------------------------------
COMMENT NO. 8
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Securities and Exchange Commission
October 10, 2006
Page 14
Solutia Inc.
PLEASE CONFIRM TO US AND REVISE FUTURE FILINGS TO CLARIFY, IF TRUE, THAT YOUR
SUBSIDIARY GUARANTORS ARE 100% OWNED RATHER THAN WHOLLY-OWNED BY THE PARENT
COMPANY. REFER TO RULE 3-10(h)(1) OF REGULATION S-X.
RESPONSE NO. 8
- --------------
The Company's subsidiary guarantors are 100% owned, as defined by Rule
3-10(h)(1) of Regulation S-X. We will update our disclosure in future
filings to reflect this clarification.
ITEM 9A. CONTROLS AND PROCEDURES, PAGE 115
- ------------------------------------------
COMMENT NO. 9
- -------------
WE NOTE THE DISCLOSURE THAT YOUR CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL
OFFICER CONCLUDED THAT YOUR DISCLOSURE CONTROLS AND PROCEDURES WERE EFFECTIVE
IN TIMELY ALERTING THEM TO MATERIAL INFORMATION REQUIRED TO BE INCLUDED IN
PERIODIC FILINGS. PLEASE CONFIRM TO US, AND REVISE FUTURE FILINGS TO CLARIFY,
IF TRUE, THAT YOUR OFFICERS CONCLUDED THAT YOUR DISCLOSURE CONTROLS AND
PROCEDURES ARE ALSO EFFECTIVE TO PROVIDE REASONABLE ASSURANCE THAT YOU RECORD,
PROCESS, SUMMARIZE AND REPORT THE INFORMATION REQUIRED TO BE DISCLOSED IN
REPORTS FILED UNDER THE EXCHANGE ACT WITHIN THE SPECIFIED TIME PERIODS.
ALTERNATIVELY, IN FUTURE FILINGS YOU MAY SIMPLY CONCLUDE THAT YOUR DISCLOSURE
CONTROLS AND PROCEDURES ARE EFFECTIVE OR INEFFECTIVE, WHICHEVER THE CASE MAY
BE, WITHOUT DEFINING THEM. SEE EXCHANGE ACT RULE 13a-15(e).
RESPONSE NO. 9
- --------------
The Company's officers have concluded that our disclosure controls and
procedures are also effective to provide reasonable assurance that we
record, process, summarize and report the required disclosure information
within the specified time periods. We will update our disclosure in future
filings to reflect this clarification.
** ** **
In connection with Company's response to the comments of the Staff, the
Company acknowledges that:
o the Company is responsible for the adequacy and accuracy of the
disclosure in its filings with the Commission;
Securities and Exchange Commission
October 10, 2006
Page 15
Solutia Inc.
o the Staff comments or the Company's changes to its disclosure in
response to the Staff comments do not foreclose the Commission
from taking any action with the respect to the filings; and
o the Company may not assert the Staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Very truly yours,
/s/ James M. Sullivan
James M. Sullivan
Senior Vice President, Chief Financial
Officer And Treasurer
cc: Jeffry N. Quinn, Chairman, President and Chief Executive Officer
Rosemary L. Klein, Senior Vice President, Secretary and General Counsel
Timothy J. Spihlman, Vice President, Corporate Controller
Nathan M. Suddeth, Deloitte & Touche LLP