SOLUTIA INC.
575 Maryville Centre Drive
[SOLUTIA Logo] P.O. Box 66760
St. Louis, Missouri 63166-6760
Tel 314-674-1000
January 8, 2007
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 December 6, 2006 regarding 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 response to your comment is set forth below. For your
convenience, we repeat your comment in bold immediately preceding our
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 23. SEGMENT AND GEOGRAPHIC DATA, PAGE 103
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COMMENT NO. 1
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WE HAVE REVIEWED YOUR RESPONSE TO OUR PRIOR COMMENT SIX. PLEASE PROVIDE US
WITH A MORE COMPREHENSIVE DISCUSSION OF HOW YOU HAVE CONSIDERED THE ECONOMIC
CHARACTERISTICS OF CP FILMS AND OPP IN DETERMINING THAT THESE OPERATING
SEGMENTS COULD BE AGGREGATED INTO THE SAME REPORTING SEGMENT. IN THIS REGARD,
PLEASE PROVIDE US WITH A SPECIFIC ANALYSIS OF THE HISTORICAL MARGINS OF EACH
OF THESE OPERATING SEGMENTS. IN ADDITION, PLEASE PROVIDE US WITH A MORE
CURRENT VERSION OF THE INTERNAL REPORTS USED BY YOUR CODM WHICH INCLUDES THE
BREAKOUT OF CP FILMS.
Securities and Exchange Commission
January 8, 2007
Page 2
Solutia Inc.
RESPONSE NO. 1
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Pursuant to the request of the Commission, the Company is providing two
separate and distinct internal reports: the Solutia Inc. Operating Highlights
("Operating Highlights") and the Executive Leadership Report. In addition, the
Company is providing an analysis of the historical and projected margins of
the operating segments. These internal reports and analysis 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.
With respect to Operating Highlights and Executive Leadership Report, please
note that the Company's CODM first began receiving these reports with CP Films
separately identified in 2006. As discussed in our response dated October 10,
2006 to the Staff's Comment letter dated September 18, 2006 regarding the
Company's 2005 Form 10-K ("October 10 Letter"), the CODM initiated a business
planning process in 2005 that led to the determination that a direct reporting
relationship with CP Films was desired and, as a result, the Company created a
new position: Senior Vice President/President CP Films. This position was
filled in early 2006. These changes resulted in the 2006 reporting format with
CP Films separately analyzed.
As stated in the Company's October 10 Letter, in accordance with paragraph 17
of Statement of Financial Accounting Standards No. 131, Disclosures About
Segments of an Enterprise and Related Information ("SFAS 131"), historically,
we have aggregated CP Films, Other Performance Products ("OPP"), and Pharma
Services into one reporting segment: Performance Products and Services.
Subsequent to the divestiture of Pharma Services in May 2006, we continued to
aggregate CP Films and OPP into one reporting segment: Performance Products.
Based on our analysis of the long-term historic and prospective economic
characteristics of CP Films and OPP, the Company believes that these operating
segments should be aggregated into the same reporting segment. The Company's
internal reports, 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, focus significant attention on the EBIT measures of the
operating segments, as this is the financial metric utilized by the CDOM to
assess performance and allocate resources. In addition, EBIT, and EBITDAR on a
consolidated basis, are key economic measures discussed with and deemed
relevant by the constituents in the Company's Chapter 11 proceedings.
Accordingly, the historical and projected analysis utilizes EBIT to assess
comparability and to discuss the economic characteristics of the segments.
Securities and Exchange Commission
January 8, 2007
Page 3
Solutia Inc.
The Company considered the following specific factors in evaluating the
segments for like economic characteristics:
o The operating segments of CP Films and OPP are both deemed to be
specialty chemical businesses. This view is shared internally by
management, as well as confirmed through discussions with financial
institutions who have advised the Company as to how the investing
community views Solutia. Whereas the investing community generally
views Solutia's Integrated Nylon segment as a commodity chemical
business, it generally views Solutia's remaining businesses (i.e.,
CP Films and OPP), particularly after the Pharma Services
divestiture, as specialty chemical businesses.
o The historic EBIT margins for CP Films and OPP exhibit similar
long-term economic characteristics. Specifically, EBIT margins for
the two operating segments are: a) within a reasonable range of each
other; and b) the deviation between these segments' margins has
compressed in recent years. This compression, which is primarily due
to improvement in the OPP margin profile, is due to new management
within both Solutia and certain components of OPP. This new
management team has brought new strategies to the business, which
can generally be characterized as more effectively leveraging the
strengths these businesses have within their markets and investing
in the growth prospects of these businesses, to generate financial
performance more in-line with that of a specialty chemical operating
segment. These new strategies and resulting improved performance are
still evolving and will be over several years.
o One of the factors the Company considers when evaluating EBIT
margins of these two segments is the infrastructure utilized by both
segments in selling its products outside of the United States. The
OPP segment has been with the Company since inception, and has sold
into the international market for several decades. Consequently,
this segment has had a support infrastructure in place globally to
facilitate its commercial activity for some time. The CP Films
segment, which was acquired in 1999, had minimal non-domestic
infrastructure at that time. Since acquisition, this segment has
utilized the OPP infrastructure for services such as logistics,
customer service, accounting, information technology, human
resources and other relevant support functions. The costs of this
infrastructure are primarily included in the OPP operating results.
While certain costs have been allocated to CP Films, the Company has
not done an analysis to determine an equitable allocation of
infrastructure costs. The Company also believes that an analysis to
determine the equitable allocation of infrastructure costs is not
cost beneficial at this time. The Company incurs, at a minimum, $30
million of costs associated with non-domestic functional support,
principally for specialty chemical related commercial activity. CP
Films receives an allocation of less than $1 million of these costs;
an amount the Company believes is materially
Securities and Exchange Commission
January 8, 2007
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Solutia Inc.
different than the cost of services being provided to this segment.
As a result, it is the Company's view that the EBIT margins of the
businesses, on a fully costed basis, are more similar than what the
underlying data, 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, suggests and that reporting
CP Films separately from OPP would cause financial statement users
to draw inappropriate conclusions regarding the segments operating
results.
o Current manufacturing cost profiles are similar for both of these
segments. In 2006, approximately 55-60% of the cost of goods sold
expense category is attributed to raw material and utility costs,
whereas the remaining 40-45% is attributed to other manufacturing
related costs. As a result, both segments have similar economic
characteristics in that a significant portion of the cost profile is
beyond the Company's immediate control. Raw material and energy
price volatility, coupled with the fact that these segments do not
have the ability to immediately pass through these cost changes to
customers, creates earnings volatility for these segments. Both
segments have been successful in executing price increases to
mitigate this volatility, which in recent years has been due to the
raw material and energy cost increases. However, implementation of
these pricing actions can be delayed as much as a year due to
current contractual relationships with customers.
Based on raw material and energy price volatility and the Company's
inability to implement price increases immediately, short-term
results for these segments may not be reflective of their underlying
economic characteristics. Therefore, in accordance with paragraph 17
of SFAS 131, the Company believes examining the economic
characteristics of these segments on a long-term basis, inclusive of
future performance, is the most appropriate manner to assess
comparability.
o The Company believes that examining future earnings trends is
necessary in determining the long-term economic characteristics of
these businesses. The future operating projections demonstrate a
continuation of the trend experienced in recent years, and indicate
that the EBIT margins will converge. Specifically, projected EBIT
margins for CP Films and OPP are expected to be within five
percentage points of one another in 2007, narrowing to within two
percentage points by 2011 (without adjusting for infrastructure cost
allocations). The current projection assumes a return of raw
material and energy costs to historical levels during this time
period. In addition, the compounded average growth rate ("CAGR") of
adjusted EBIT margins for CP Films and OPP over the 2007 to 2011
time period are nearly identical.
Securities and Exchange Commission
January 8, 2007
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Solutia Inc.
o Further, other economic characteristics of both operating segments
include significant, globally recognized branding of the key
products. The branded nature of these products allows the Company to
secure pricing premiums versus alternative products in respective
markets. This brand strategy requires a significantly higher S, G &
A investment in the businesses.
o In addition, the long-term outlook for CP Films and nearly all of
OPP is for demand growth in the markets in which we operate to be
above GDP, projected to be in the 5% range in the near future. Both
segments premise that international expansion, particularly within
the China market, will continue to be a key driver of growth in
future years. This growth is expected to be primarily volume driven,
and given the high utilization rates currently in both segments,
this volume increase will require significant capital investments
within both CP Films and OPP. To adequately serve the growth in
these markets for both segments, the Company expects the capital
requirements in upcoming years to be significant, at more than one
times their respective annual depreciation and amortization rates.
Additionally, please note that the Company provides financial information for
the Company's two reportable segments to the financial advisors of the various
authorized committees in the Company's Chapter 11 case, 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. Based on these factors, the Company believes the
aggregation of CP Films and OPP into the same reporting segment, Performance
Products, is appropriate and in accordance with paragraph 17 of SFAS 131.
** ** **
Securities and Exchange Commission
January 8, 2007
Page 6
Solutia Inc.
In connection with the 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;
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 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