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Solutia, (NYSE:SOA)

Q2 2011 Earnings Call, Jul 26, 2011

July 26, 2011 10:00 am ET

Executives

James M. Sullivan - Chief Financial Officer, Executive Vice President and Treasurer

Jeffry N. Quinn - Chairman, Chief Executive Officer and President

Susannah Livingston - Director of IR

Analysts

Bill Hoffman - RBC Capital Markets, LLC, Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Frank Mitsch - BB&T Capital Markets

Christopher W. Butler - Sidoti & Company, LLC

Lucy Watson - Jefferies & Company, Inc., Research Division

Duffy Fischer - ClearBridge Advisors

Operator

Welcome to the Second Quarter 2011 Solutia Inc. Earnings Conference Call. My name is Christine, and I will be your operator for today's conference. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Susannah Livingston, Vice President, Investor Relations and Communications. Please go ahead.

Susannah Livingston

Hey, Christine, and good morning. We are pleased you have taken the time to join Solutia's Second Quarter Conference Call. Jeff Quinn, Solutia's Chairman, President and Chief Executive Officer; and Jim Sullivan, Executive Vice President and Chief Financial Officer, are with me this morning.

First, I'd like to remind you that we are webcasting this call, which you can access through our website, solutia.com. Also, we will be using presentation materials today that are posted on the website along with the earnings release announcing second quarter 2011 results and a video highlighting our performance. Finally, Solutia's Form 10-Q will be filed within the next few days.

If you please turn to Slide 2. During this call, management may make certain forward-looking statements. These statements are based on management's current expectations and are subject to change. Our actual results may differ materially. Please read our commentary on forward-looking statements at the end of our press release or the statements in our quarterly and annual SEC filings.

Our prepared remarks today include reference to non-GAAP financials in our discussions of earnings. For reconciliations of our non-GAAP measures to GAAP figures, please see the schedules in our earnings release and contained in the slides today.

Now let me turn the call over to Jeff.

Jeffry N. Quinn

Good morning. Thank you, Susannah, and thanks to all of you for joining us this morning for the second quarter call. I'm pleased to share with you another strong quarter for Solutia. I'll begin by discussing some of the highlights of the quarter. I'll talk about the current state of our -- the geographies in which we compete and the state of our end markets. Then, I'll turn the call over to Jim Sullivan, our Chief Financial Officer, who will walk you through a more detailed review of the numbers for the quarter. And then finally, I'll conclude by talking about some of our current focus areas and our expectations for the remainder of 2011. And then, of course, we'll open it up for your questions.

Starting on Slide 4. This quarter was a record quarter for Solutia in terms of earnings and was the highest revenue quarter since the third quarter of 2008. It also happened to be the best quarter in terms of safety performance since our emergence from bankruptcy back in 2008.

The second quarter was reflective of the strength of our portfolio of market-leading businesses and the resiliency of those businesses. The balanced geographic exposure of our portfolio, as well as the diversity of the end markets we serve clearly paid off this quarter as we delivered strong results even with uncertain markets and geographic regions in a state of flux. We experienced positive trends for both revenue and adjusted EBITDA, both up from the first quarter and year over year that resulted from different drivers than was seen during the first quarter. It was a record quarter.

We got everything going our way. Second quarter results were driven by the price increases implemented across all the segments this year, as well as strength in some of our European markets, which helped offset the softness in the Asian tire market, automotive and general due to the impact of the Japanese earthquake and solar. In addition, the strong performance of our premium products, whether it be our acoustic PVB products in Advanced Interlayers or super premium V-Kool automotive window film in Performance Films, improved our overall product mix and therefore earnings in their respective segments. This is a testament to how innovation continues to help fuel the growth of this company.

Overall, our adjusted EBITDA margins remained outstanding at 26%. This is the ninth quarter in a row that our adjusted EBITDA margins have exceeded 24%. It was the 10th quarter in a row that our Technical Specialties segment had margins over 30% and the ninth quarter in a row that our Advanced Interlayers business had margins over 21%.

You've heard me talk about this many times before, about how the cost structure we created with the changes we made back in 2009 have created a sustained margin profile. The facts speak for themselves. Despite the bucking-ness of the economic recovery around the world, we are growing this company and we are maintaining our industry-leading margin profile.

During the second quarter, we generated free cash flow of $25 million and ended the quarter with global liquidity of $447 million. This strong cash generation will allow us to continue to invest in our businesses and improve our capital structure. Year to date, we have reduced debt $102 million, inclusive of a voluntary pay down of $25 million of debt in the second quarter, moving us closer to that 2x gross debt to EBITDA goal that we've talked about many times. And we invested $40 million of capital in the businesses during the quarter.

Finally, to update you on the impacts to Solutia from some of the natural disasters that happened in the first quarter. I'm very pleased to report that the Kashima, Japan site has been fully operational since late May. The dedication of our colleagues in Japan has been incredible, and I just want to publicly recognize Takasu-san, the plant manager at Kashima, and his team for some gallant efforts in terms of managing that crisis.

In addition, the Anniston, Alabama site, and our plant management there, Alan Rutherford, and his team, was impacted by the severe storms in the Southeast back in May. That plant is also back up and running. And again, outstanding effort. Results like this don't just happen, it's driven by people like Takasu-san and Alan Rutherford. And Solutia's full of those type of people.

In part due to the great work by the business teams in minimizing costs and mitigating losses, we expect in all of the 2, the natural disasters, to have a very minimal impact on our business results during 2011.

Now turning to Slide 5. During the second quarter, net sales were $543 million, an 8% improvement over 2010 and 7% up over the first quarter. Adjusted EBITDA was $141 million, a 5% improvement over 2010 and up 4% over the first quarter, with our adjusted EBITDA margins at 26%, as I mentioned earlier.

We recorded $0.57 in adjusted EPS, a 30% improvement over the second quarter of 2010. Again, it was the best quarter for Solutia since our emergence.

Without a doubt, the raw material environment remained challenging in the quarter. During the quarter, we were impacted by higher raw material prices of $18 million compared to the second quarter of last year, as we had expected. With raw material prices beginning to level off, we still believe our previous stated view of a 10% to 12% cost increase year over year on a constant volume basis is an appropriate view. What was very significant to the second quarter was the success of our commercial efforts and the reconfirmation of the value that our products deliver to our customers, as we have been able to offset the entire push in raw materials with the benefit of price increases that we implemented over the past 2 quarters.

The selling price actions we discussed last quarter had been implemented and have taken hold. As a reminder, in Technical Specialties, we implemented pricing actions in the first quarter. Further increases took effect on April 1 across many products in that segment. We have also been successful in implementing third quarter price increases in our Saflex business -- I'm sorry, in our Santoflex business. In Saflex, the annual price increases are fully reflected in the second quarter results. In addition, we have implemented further price increases starting July 1 where contracts have allowed us to do so, which could impact between 15% and 20% of our Saflex volume. Jim will cover the specifics of price increases versus raw materials in each of these segments in a few moments.

No moving on to Slide 6. You'll see that where we set forth our revenues by geography, and as well as the growth we have experienced year over year in each of those regions. In total, our net sales by world area remained fairly constant from last quarter on a percentage basis. However, a few points of interest specific to this quarter's growth are clear from the table at the bottom of the page. The numbers in the table reflect the quarterly year-over-year growth in each segment by world area.

The Asia Pacific did cool off a bit this quarter, with sales over on the region being flat to last year, mainly due to the slowing in the Chinese tire market, as many producers slowed production to reduce inventories and as a general economic reaction to the government's efforts to curb inflation.

We did also have a slight decline in the region in the Advanced Interlayers business. However, this decline was totally due to the presence of a onetime intermediate sale in Asia last year. Otherwise, Advanced Interlayers would have been up about 4% year over year.

Performance Films experienced strong growth again in the Asia Pacific region, especially in their premium products. Automotive demand in this segment was in fact strong across all regions, and there was also good demand for the architectural products.

Offsetting the overall slowness in Asia was strong growth of our recovery in Europe, with Advanced Interlayers architectural markets showing strength as well as the strong demand from the tire industry, as Crystex sales were up 14% on a volume basis and for heat transfer fluids in addition.

In Advanced Interlayers, sales were up 26%, and overall sales were up 20% for Solutia year over year in Europe. As a reminder, the Technical Specialties business was impacted by the reduction of revenues from the other rubber chemical businesses that were exited last year.

So overall, solid 8% growth led by strong growth in Europe. And, boy, it's been a while since I've had that to say, that Europe led our growth. It was obviously a very positive development for us.

Now moving to Slide 7 to take a closer look at the end markets. Most all end markets continued to show growth this quarter, though at a somewhat slower pace. Our electronics market has improved 13% year-to-date over last year, driven mainly by electronic displays. The softer second quarter is mainly due to the e-reader market working off excess inventory.

The architectural market represents 12% of our revenue. The construction market in Europe began to show some signs of life during the quarter with volumes up 10% for the quarter over last year, in part due to our architectural Saflex acoustic product continued to display strong growth.

Energy solutions was down 2%. Again, this group includes our solar industry products, both PVB and EVA encapsulants, which are used in solar modules and Therminol used in concentrated solar power applications. Additionally, in our Performance Films division, we have our solar window film for both architectural and automotive applications grouped into this energy solutions group.

Our aftermarket products in Performance Films continued to grow north of 30% year to date, in part driven by the strong performance in our premium V-Kool brand in Asia. Therminol and the solar market continued to show strong growth with our recent announcement of 2 additional solar plants builds in Spain that we have been awarded.

As it relates to our encapsulant business for solar modules, which happens to be about 5% of this 12% of our revenue, the first half of this year was slow as government incentive changes had been implemented country by country. This result comes off of a much stronger than expected second half of 2010 which produced great results for the business.

According to solar buzz, the module sales in the back half of 2011 are expected to be stronger, almost double the first half, driven by lower module pricing, but with some of the expected demand to be supplied from the excess inventory currently in the system. Overall, solar buzz is projecting the solar market over the long run to grow at a 15% to 20% CAGR.

Certainly, when we acquired the VistaSolar business, we recognized that we were moving into a developing, more volatile market. We never believed, and still don't believe, that the success of that acquisition will be determined by any one short-term period. The acquisition was premised on entering with relevant scale a business that has strong growth potential, entering a business in which we have the competencies to be successful, expanding the business to Asia and enhancing the quality of the product offering, calling upon over 80 years of experience in PVB.

We believe in this end market over the mid to long term, and we are focused intently on the execution of our strategy to win at grid parity and to win in China. We now have a high quality production in the right world area at a competitive price, and we look forward to supplying the Chinese solar market as the demand for encapsulants continues to follow module production to the East.

Last week, we made the first commercial sales from our new plant in China. The product coming off the plant is the best quality product ever produced by VistaSolar. So while the encapsulant portion of our energy solutions product offering is a bit soft right now, the area is still one a strong growth for us and one of strategic importance.

Moving on. Automotive OEM, which represents 19% of our revenue, experienced slower growth, mainly impacted by parts supply issues from the events in Japan. Year to date, this end market has grown by 3% for Solutia. J.D. Power's forecast of global builds is now 77.7 million units in 2011, or a 5% increase. As the economic impacts from the Japan natural disasters continue to mitigate, the automotive OEM market is expecting near-normal production from July going forward, with a strong fourth quarter.

Our replacement market, inclusive of replacement automotive glass, architectural glass, aftermarket film applications and the tire and rubber market, comprised 35% of our revenue. Despite U.S. miles driven decreasing from March and April of this year, our sales and replacement and aftermarket glass are up 8% to date, reflective of strong automotive and architectural revenues in Performance Films and Advanced Interlayers.

Specifically related to tires, truck tonnage in May was down 2% compared to April, but up almost 3% year over year. Growth in our replacement tire and rubber markets may seem to have been a bit slow, but you have realize that while this was in part of due to the sluggish demand from Chinese tire producers, it was also due to the impact of the sales of the other rubber chemical businesses over the past years. Exclusive of the other rubber chemical sales, the replacement market would have been up around 10%.

Finally, on Slide 8, to talk briefly about working capital. We continue to focus on this area. Our quarter-end DSO, or days sales outstanding, have remained relatively flat compared to last quarter as we continued to focus on securing timely payments from our customers and improving payment terms where possible. This demonstrates a very good result with past due receivables at an all-time low.

DPO also remained flat for the quarter. Our inventory days on hand increased by 5 days as we drove most of the working capital increase during the quarter. This was mainly attributed to higher raw material prices and our business deliberately building inventory in preparation for scheduled plant downtime relating to technology work and the startup of new lines over the coming months.

Overall, our working capital as a percentage of sales ended the quarter at 19%. Going forward, the processes we have put in place and the commitment of our organization will ensure continue focus in discipline in this area.

Now I'd like to turn the call over to Jim Sullivan, our Chief Financial Officer. Jim?

James M. Sullivan

Thanks, Jeff, and good morning to everyone. Let's take a closer look at the financials for the quarter, starting on Slide 10.

This slide details the items excluded in our calculation of adjusted EBITDA in the second quarter of '11 and the second quarter of '10. Overall, both quarters included a net charge to EBITDA of $1 million. The second quarter of 2011 was fairly quiet, with only one special item, a $1 million follow-on charge related to the first quarter relocation of the company's European regional office to Zaventem, Belgium.

Turning to Slide 11. In the second quarter, we continued to see solid top line growth with net sales up $41 million or 8% versus the year-ago period. Volumes were up 1%, average selling prices were up 4% and foreign currency translation boosted sales by 4%. The VistaSolar and Novomatrix acquisitions added 3% as these businesses began to fold into our regular bridge during the quarter, with VistaSolar closing in the end of May 2010 and Novomatrix the end of April 2010.

Lastly, the rubber chemical and plastic products divestitures over the past year decreased revenue in the quarter by 4% versus 2010. Compared to the first quarter of 2011, sales in the second quarter were up $34 million or 7%. The combination of improved volumes, higher average selling prices and currency more than offset the sequential decline in revenue from the divested businesses.

Moving to Slide 12. Adjusted EBITDA for the second quarter of 2011 totaled $141 million, up $7 million or 5% versus 2010 and up $6 million or 4% versus the first quarter. For both the year-over-year and sequential comparisons, increased sales volumes, improved product mix and higher average selling prices more than offset the increase in raw materials, the loss of earnings from the divestitures and modestly higher manufacturing and SG&A costs. Importantly, selling prices increased -- the increases that have been implemented over the past 2 quarters more than offset raw material cost push on both a year-over-year and sequential basis.

Slide 13 bridges the company's year-over-year and sequential quarterly movements in earnings per share. Adjusted EPS in the second quarter of 2011 totaled $0.57, an improvement of $0.13 or 30% compared to 2010, driven by higher EBITDA, lower interest expense and a modestly lower tax rate, partially offset by increased depreciation and amortization expense from the acquisitions and the impact from the divestitures. The lower interest expense in 2011 was driven by the elimination of mark-to-market changes on the interest rate hedges, lower average interest rates and a lower average debt balance.

Compared to the first quarter, adjusted EPS was up $0.07, primarily due to higher EBITDA with lower interest expense offsetting a higher tax rate. The effective tax rate in the second quarter was approximately 15%, and this is the rate that we expect for the full year.

Now let's turn to our reporting segments, starting on Slide 14 with Advanced Interlayers. Second quarter sales for this business totaled $232 million, up 12% year over year. Higher revenues from average selling prices added 3%, currency translation added 6%, and an additional 2 months of VistaSolar sales in 2011 versus 2010 contributed 4%. These gains were partially offset by an overall volume decline, 1%.

In the quarter, architectural revenues improved by 18% versus 2010. This was driven by higher selling prices and favorable mix, with volumes up 6%. Automotive OEM and replacement revenue was up 5%, with higher selling prices and improved mix more than offsetting lower volumes, which were down 5% in the quarter. Revenue from premium products was up 18% in the second quarter compared to 2010. Solar encapsulant volumes were up in the second quarter versus the year-ago period with the addition of the VistaSolar EVA product line and higher Saflex solar sales. Finally, our proprietary resin and intermediate chemical sales in this segment were down this quarter due to timing of shipments this year versus last year in the quarter.

Advanced Interlayers' adjusted EBITDA for the second quarter totaled $52 million, up $8 million or 18% year over year. The earnings improvement from increased average selling prices, product mix enhancement and higher fixed cost absorption more than offset the raw material cost push in the quarter. Sequentially, sales for Advanced Interlayers were up $19 million or 9%. This was primarily due to higher volumes and selling prices in Saflex products, partially offset by lower solar encapsulants demand in Europe.

Adjusted EBITDA was up $3 million sequentially with higher Saflex volumes, improved selling prices and product mix, more than offsetting higher raw material cost and lower EVA volumes.

Looking ahead for Advanced Interlayers, we expect automotive sales in the second half of 2011 to be modestly higher than the first half, with the third quarter experiencing a normal seasonal slowdown in Europe followed by a broad-based pickup in the fourth quarter as the global automotive parts supply chain fully recovers from the Japan outage.

Architectural volumes in the second half of the year are expected to hold steady with the solid level achieved in the second quarter, and solar volumes are expected to increase in the back half of 2011 as demand in this sector improves and inventory levels across this system come down.

We expect the adjusted EBITDA margin for the segment to be down modestly in the third quarter on seasonally lower Saflex volumes, higher project-related expense and lower fixed cost absorption from inventory control actions, with a rebound in the fourth quarter as the volume profile across the segment steps up.

Performance Films results are summarized on Slide 15. Net sales for the second quarter totaled $86 million, up $13 million or 18% compared to the second quarter of 2010. Volumes were up 10%, and the addition of one month of sales from the Novomatrix acquisition in 2011 versus 2010 accounted for 7% of the year-over-year increase.

Aftermarket automotive window film sales in the quarter were up 23% versus 2010, with the majority of this growth coming from Asia due to the introduction of new distributors in the region and continued success in penetrating the predelivery and installation market segment.

Aftermarket architectural window film sales were up about 17% in the quarter versus 2010. This growth was across all regions, in part due to strong demand for our new EnerLogic product and a few large architectural building wins.

Flexvue products were down in the quarter in most world areas due to the e-reader industry working off inventory. The exception of Europe, where we saw growth from key design wins in the medical device market.

Performance Films' second quarter adjusted EBITDA totaled $19 million, in line with the second quarter of 2010, as improved volumes were offset by increased manufacturing and selling costs. We continued to upgrade our production processes and quality control systems in this segment to accommodate the more demanding Flexvue applications, we'll also meet an increasing in demand in window films. Some of these additional manufacturing improvement costs were seen in the segment results this quarter.

Sequentially, Performance Films sales in the second quarter were up $10 million or 13%, with adjusted EBITDA flat. Here again, that's due to higher sales and the profit from that offsetting increased manufacturing costs.

Looking ahead for Performance Films, we expect sales in the second half of the year to approximate the level achieved in the first half, with adjusted EBITDA margins trending down slightly due to increased sales and marketing spending, additional manufacturing expenses to further improve our clean room capabilities in support of the Flexvue business and the normal seasonal production slowdown in the fourth quarter. Overall for 2011, we expect EBITDA margin for this segment improve to the low-20% range.

Turning to Slide 16. Technical Specialties' net sales for the second quarter totaled $225 million, up $8 million or 4% compared to the second quarter of 2010. Volumes were up 1%. Average selling prices were up 7%. Currency translation added 3%, with the divested other rubber chemical businesses reducing sales by 7%. Therminol heat transfer fluid volumes were up 13% year-over-year in the second quarter mainly due to strong demand out of Europe. Crystex and Santoflex volumes declined modestly, with slower demand from Chinese tire producers and lower overall auto production impacting the second quarter. However, price increases positively impacted all product lines. And if you exclude the divestitures, the segment revenue improved by 11% year over year.

Technical Specialties' adjusted EBITDA for the second quarter of 2010 (sic) totaled $82 million, down $2 million versus the prior year. This decrease was driven by the reduction in adjusted EBITDA coming from the divested businesses. Selling price increases more than offset rising raw material cost and also partially offset higher manufacturing cost due to increased project-related expense and maintenance costs incurred during scheduled shutdowns at a few plants. The impact of the Japanese earthquake and tsunami increased logistics and maintenance cost in the quarter for this segment by approximately $1 million.

Sequentially, Technical Specialties sales were up about 2%, and adjusted EBITDA was up 1%. This improvement was driven by higher selling prices across all key product lines more than offsetting raw material cost inflation.

Looking ahead, rubber chemical volumes in this segment are expected to increase in the back half of the year, in particular in the fourth quarter, consistent with the growth in the global tire market, while fluids volumes are projected down slightly due to the timing of Therminol fill activity across the year. We expect the additional revenue from the selling price increases implemented across the portfolio to date to continue to offset raw material cost inflation and keep adjusted EBITDA margins for the segment approximately on par with the levels achieved in the first half of the year. We do expect a slight negative impact to margins as project-related costs associated with the Kuantan Crystex expansion start to kick in, in the back half of the year.

Moving on to Slide 17. Here, we highlight results for our unallocated and other reporting segment. Total net expense in the quarter was $12 million, down $1 million versus the second quarter of 2010. This decrease was mainly due to reduced expense associated with the company's annual incentive compensation program.

Slide 18 details the company's operating cash flows and capital spending. Cash from operations in the second quarter totaled $48 million. Cash generated from higher adjusted EBITDA and lower interest expense was offset by higher contributions to our frozen U.S. pension plan and increased working capital requirements versus the year-ago period.

Capital spending in the second quarter totaled $23 million, up $14 million versus the year-ago period. This increase was predominantly associated with growth expenditures that will expand capacity and extend premium product capabilities at our facilities in Suzhou, China and Ghent, Belgium.

In addition, as we just announced this morning, we will begin spending on our PVB resin plant to be built at our Kuantan, Malaysia plant, which will allow us to cost effectively meet the increasing demand for Saflex sheet produced at our manufacturing facility in Suzhou, China.

Cash from operations in the back half of 2011 is expected to be higher than the first half as our working capital position will be maintained or modestly reduced versus current levels. The absence of working capital related cash usage, coupled with the after-tax earning profile expected in the second half of the year, will allow us to fund increased spending on our strategic growth capital projects and generate free cash flow for the year in $150 million to $200 million range.

Turning to discontinued operations. Cash usage for the second quarter was $7 million as we continued to dismantle the former primary's rubber chemical manufacturing facility, and that project is progressing in line with our original cost estimates. The company is currently exercising its put option related to the retained ownership stake in the former nylon business, and expect that the approximate $30 million of cash proceeds in the third quarter from this transaction will more than offset future spending on the primary shutdown project.

Moving on to Slide 19. Here, we summarize our debt and liquidity profile. We ended the quarter with gross debt of $1,362,000,000, down $25 million versus the first quarter and $102 million from the end of 2010. The company's gross debt to trailing 12 months adjusted EBITDA as of the end of the second quarter was 2.6x, down 0.1x from the first quarter, and is tracking as expected against our target of approximately 2x. In terms of liquidity, the company ended the quarter with a very strong position of $447 million, including $278 million of availability on our cash flow revolver and $169 million of cash on hand.

With that, I'll turn it back to Jeff for closing comments.

Jeffry N. Quinn

hanks, Jim. A few final comments to make before we open it up for your questions regarding our near-term focus.

First, let me address our overall perspective for the year. As stated earlier, we are effectively managing raw material headwinds on a consolidated basis with the various price increases we have implemented to date, improved product mix and the continued strong operational execution in maintaining our low-cost operating structure. These actions, in combination with our expected second half rebound in our automotive market, steady demand environment and architectural volumes similar to those in the second quarter and our modest recovery in the solar market, will deliver revenue in the range of $2.125 billion to $2.2 billion for the year, with EBITDA margins remaining on par with the first half, which gives us confidence in maintaining our adjusted EPS range of $2.10 to $3.25 per share.

To sum up the quarter, Solutia didn't just deliver solid earnings. We delivered record earnings and the strongest revenue quarter in almost 3 years. The end markets and geographic markets in which we compete will change. They will continue to do so, throwing us curve balls from time to time that we must react to. What's not changing however, is our commitment to outstanding execution and delivering outstanding performance, our focus on a compelling value-creating strategy and our track record for meeting and exceeding those commitments.

We're here today with record earnings in a strong quarter and a strong record of consistent high performance because of our strategy to diversify our exposure both geographically and end market-wise and invest in innovation-driven premium products.

We know some markets are recovering more quickly than others. We know we'll see changes in cost of raw materials from time to time, and which are somewhat out of our control. But we also know what works in any climate or any market environment, targeting premium products, improving those products with innovation, process improvements, tight operating costs and smart growth supported by strong cash flow. It's our commitment to these guiding principles that created the resiliency that positions Solutia for solid growth in the quarter. And it's this kind of resiliency that will continue to position the company for future success.

Thank you very much for your time today. I'm now about to turn it back over to our operator, Christine, who will open it up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Edlain Rodriguez from Gleacher.

Edlain S. Rodriguez

Just quick question on the solar business, the encapsulants. You've talked about the potential end to the inventory destocking that we're seeing now. Are you seeing any pickup in activity at all, or it's just something that you hope to be seeing going forward?

Jeffry N. Quinn

We think that we're seeing indications of the market that moves forward this year. We think the back half of the year would look very similar to the back half of last year, which will obviously be a significant pickup from the first half. What's really the positive development for us is, as I mentioned in my comments, we produced our first commercial rows out of for our Suzhou plant. We now have a quality product in the right world area, and we are receiving a significant market receptiveness to that. And so in the months and quarters moving forward, we really look forward to being a supplier of our premium product to the Chinese marketplace.

Edlain S. Rodriguez

Okay, it makes sense. Another question on Advanced Interlayers. You've talked about the growth in the premium products, which get better pricing. Can you remind us again, like how much of the portfolio that is in terms of segment sales, and where do you see that in 1 year or 2?

James M. Sullivan

Yes. So we're talking specifically here, Edlain, about the acoustic material for both architectural and auto, as well as heads-up display. On the auto side, acoustic is penetrated on an OEM basis by about -- to the level about 15% of our sales, and we expect that to grow close to 25% -- to 25% over the next several years. And on the same level of penetration, we see, in particular in Europe on the architectural side. So it will be a meaningful contributor, and has been a meaningful contributor, to the evolution of our margins over the past year or so.

Operator

The next question comes from David Begleiter from Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jeff, just on VistaSolar, what were the sales down year-over-year and quarter-over-quarter?

James M. Sullivan

So David, your question is on a pro-forma basis?

David L. Begleiter - Deutsche Bank AG, Research Division

Yes.

James M. Sullivan

So sales are down in the first quarter roughly 40% year-over-year -- I'm sorry, in the first half of the year, 40%. And then sequentially down just about, let's see here, about 20%.

David L. Begleiter - Deutsche Bank AG, Research Division

And where do your margins stand now versus when you acquired the business?

James M. Sullivan

So when we acquired the business, the margins were in the kind of high 40s area. As we said, when we bought the business, we expected the margins to decline over time. We ended the year 2010 with margins around 40%, and we're seeing those margins move down into the 30s in 2011.

David L. Begleiter - Deutsche Bank AG, Research Division

And just lastly on available Advanced Interlayers price versus raws, it was, I guess, negative $5 million in Q2. What would you expect that delta to be, less than positive in Q3 and Q4.

James M. Sullivan

Generally, across the back half of the year, we would expect maybe a little bit of compression between the selling prices and the raw materials. But not very meaningful, David, just a few million.

Jeffry N. Quinn

And David, as I mentioned, we had the price increases that kicked in for that portion of the business, that we could do that. And that was kicked in end of July.

David L. Begleiter - Deutsche Bank AG, Research Division

So just to be clear, Advanced Interlayers Q3 price versus raw should be positive or negative in Q3?

James M. Sullivan

Probably just modestly negative.

Operator

The next question comes from Laurence Alexander from Jefferies & Company.

Lucy Watson - Jefferies & Company, Inc., Research Division

This is Lucy Watson on for Laurence today. A quick call to clarify on your comment regarding the regular seasonal slowdown in Europe in Q3. How severe are you expecting August shutdowns in auto to be this year compared to last year?

James M. Sullivan

Lucy, I don't think we see really a big change in how the production facilities in Europe in particular are being handled in the third quarter. So it's going to be a normal seasonality in the Saflex business that we see.

Lucy Watson - Jefferies & Company, Inc., Research Division

Okay. And could you remind us on the timeline in order of magnitude for the announcement you made yesterday for the PVB resin expansion in Kuantan?

Jeffry N. Quinn

So we have done pilot test work on the new technology, which we're excited about. And we're going to be moving to scale up feasibility and engineering testing here in the back half of the year. That facility will not be online until 2013.

Lucy Watson - Jefferies & Company, Inc., Research Division

Okay. And just one more. Have the supply chain kinks that you mentioned in Technical Specialties that were related to Japan worked themselves out? Or do you expect to see continued delays or difficult -- I guess, logistical difficulties in Q3?

Jeffry N. Quinn

So we said we had incurred about $1 million of additional expense associated with logistics in the second quarter. That will come down a little bit, but there will be a little bit of disruption in the third quarter, and we see the fourth quarter getting back to normal levels of activity.

Operator

The next question comes from Christopher Butler from Sidoti & Company.

Christopher W. Butler - Sidoti & Company, LLC

You'd given us some of the year-over-year numbers as far as on Technical Specialty due to the tire softness coming out of China, but could you give us a sense of where normal might have been? What you would've expected, if not for that weakness? And as you look to the third quarter, does the -- has the inventory work-down come to an end of this point? Is that going to continue substantially into the third quarter?

Jeffry N. Quinn

I think, Chris, I think as the third quarter started, we've continued to see a bit of that inventory kind of reduction. As we said, we do expect some recovery in the back half of the year in total, but I think that those inventory kind of adjustments are continuing a bit as we've been into the third quarter here.

Christopher W. Butler - Sidoti & Company, LLC

And similarly, the manufacturing costs in Technical Specialty, it's a bit high. You had mentioned $1 million in there. Also you said you had some excess product cost. Could you give us some color on what the manufacturing cost component was? And what kind of impact that Crystex expansion might have on that as well?

James M. Sullivan

So we had a little bit higher level of project-related expense, Chris, and this is associated with our capital expenditure program. And so typically, for every $1 of capital, we'll pull in about $0.15 of project expense. So there was a little bit higher level of capital spending in the quarter versus the year-ago period.

Christopher W. Butler - Sidoti & Company, LLC

And on the Crystex expansion plan, the benefits, when you would expect to start seeing some of the benefits there?

James M. Sullivan

That facility, we wouldn't expect it contribute to earnings until 2013.

Christopher W. Butler - Sidoti & Company, LLC

And just finally, the contribution to the pension plan, is that just part of the normal contribution, or has that changed the amount that you hope to contribute this year?

James M. Sullivan

Well, that's in line with what we had expected, Chris. It's the contribution that's required under the law.

Operator

The next question comes from Mike Sison from KeyBanc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

In terms of your outlook for EBITDA for 2011, I guess, the way the math works is your first half EBITDA margin's roughly in the low 26% range, and you gave a sales guidance. So does that imply EBITDA somewhere like 550 to 575? Is that sort of a ballpark where you're looking at this year?

James M. Sullivan

Yes. I think, Mike, that's the math that works, and we feel pretty good about the kind of the dull green [ph] in those revenue numbers. And then we'll work hard to maintain that margin profile. And if those numbers worked out that way, that's kind of where the math leads. And we'll continue as we always do as to better that, but that's where the math leads us, yes.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And then when you think about the raw material squeeze in Technical Specialties and Performance Films, well, those will go away by the end of the year? And wouldn't they sort of turn positive by the fourth if you sort of catch up?

James M. Sullivan

Yes. In Technical Specialties, we feel very good with the price increases that we've implemented and raw materials stabilizing, that, that equation should be positive for the company in the back half of the year. Now Performance Films, we really don't generally see a lot of increase in raw materials in that segment. Typically, our selling prices move pretty consistent with how raw materials are moving in that segment. It's mostly volumes that we're focused on.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And the manufacturing cost in Performance Films that you got hit with in the second, that goes away in the third and the fourth?

James M. Sullivan

Yes. We'd like to think that we're going to completely eliminate that in the next quarter. I think realistically, Mike, this will be a continuous effort on the part of the company to bring the manufacturing practices in Performance Films up a notch to meet the higher kind of clean room type of needs of the Flexvue business. So that will continue to be a challenge for the organization, but I would say every day, we make progress.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And then I just wanted to understand the volume growth potential in Interlayers and Technical Specialties. I understand why it was a little bit quick this quarter, but is that ramping up in the third and the fourth to, I don't know, low- to mid-single digits or sort of that range as we move into the second half of the year?

James M. Sullivan

Yes. I think where we see the sales increase second half versus the first half is primarily in Advanced Interlayers and Technical Specialties. And in Advanced Interlayers, the stronger revenue in the back half of the year is going to be driven by, call it, the recovery or the rebound from the Japanese outage and improving solar volumes. And then in Technical Specialties, I think we see the entire market's improving. Some rebounded in Q3, but mostly in Q4. And then as I said earlier in my comments, a little bit of an offset to the rubber chemicals improving in the back of the year versus the first half would be Therminol fills are projected to be down modestly. And that's just timing of projects and when we deliver the volumes on those projects. So nothing fundamental to the business. That business continues to grow very strongly year over year.

Operator

The next question comes from Frank Mitsch from Wells Fargo.

Frank Mitsch - BB&T Capital Markets

Jeff, you said a couple of things that I think we're a little bit noteworthy or surprising, in that Europe was the leading region for growth. And architectural volume's up nicely, which I hadn't heard in a while. I believe you said that the second half, you were expecting architectural volumes to hold steady with the second quarter. And I guess my expedition would've been that perhaps that would've been the case for the third quarter, but you'd see a decline in the fourth quarter. Can you elaborate on what you're seeing over on the architectural side?

Jeffry N. Quinn

Well, I think, Frank, we're just seeing real solid penetration of our acoustic product. We were starting to see some, evidenced by the sales, just see some -- a bit of life in the market. And we've fundamentally changed our position in that marketplace over the last couple of years as we brought on the expansions again. So I think you're just seeing -- we're seeing the natural progression of having the capacity, having the quality product and starting to see a demand, a little bit of a demand pick up. Our growth there will always be a little bit stronger than the market growth anyway because of that increased presence of increased penetration of our product there. If you recall that a few years ago, that was a product we were real short in the market because of not having the capacity at Ghent, and we've corrected that with the expansions.

Frank Mitsch - BB&T Capital Markets

Do you envision the underlying European market to be on a recovery path here?

Jeffry N. Quinn

Well, I'm certainly not going to get out there at the edge of the diving board and go forecasting a recovery in Europe behind what all of the economists and prognosticators are. But certainly, from our results and our specific sales into the region, we are encouraged.

Frank Mitsch - BB&T Capital Markets

All right, great. And on the video, you were talking about some large growth that you've been seeing in the acoustic interlayer, as well as the heads-up display. Can you talk a little bit about the penetration rates for those products and where could that got to over the next couple of years?

Jeffry N. Quinn

I think -- and I don't have specific numbers for you right now, but I think what we're seeing in the marketplace is just a strong receptivity to those product offerings. And obviously, those are strong pricing in terms of that. But I mean, I would not be surprised to see growth in those areas of 25% or more.

Operator

The next question comes from Bill Hoffmann from RBC Capital Markets.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

I just wonder if you'd talk a little bit about some of the cash items, specifically the capital spending. I was just wondering whether you still expect to get, to have a number over $100 million, which is sort of where you expected earlier in the year. Second is the pension. I guess, typically, you make another contribution in the fourth quarter would be expectation there. And then finally, if you could address some of the working capital potential release here by the time you get into the fourth quarter.

James M. Sullivan

Yes, Bill. Jim Sullivan. Good morning. In terms of cash flow, we do project a very strong back half of the year. Free cash flow, we're saying we see in the $150 million to $200 million for the year. In the first half of the year, we generated $57 million. So very strong cash generation in the back half of the year. And that's even with our capital spending stepping up from what we did in the first half of the year. We spent roughly $40 million on CapEx in the first of the year, and we'll be increasing that in the back half of the year. But notwithstanding that, expect strong free cash flow generation. In terms of pension, we did make that $13 million contribution in the second quarter. For the full year, we would expect the contribution to be in the area of $35 million to $40 million. So a little bit higher contribution in the back of the year. This will be offset by lower cash expenditures that we're projecting. So kind of net-net for retiree programs, first half versus second half, it's pretty much consistent. And then working capital, as we talked, we did have usage of about $60 million in the first half of the year. Most of that increase is associated with the inventory levels and in terms of payables and receivables. We continued to hold those metrics in line with the increase in sales. So for the back half of the year, we would expect to not have any cash usage from working capital, which would certainly help drive the strong free cash generation in the back half.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Great, that's helpful. And then just a second question just with regards to the whole solar business. I mean, obviously, things have been for shaking out here in the first half of the year. And you talked a little bit about seeing some improvement in the back half. As you guys look at that business going forward, what kind of sort of growth rates do you expect to be reestablished as a go forward? I mean, it doesn't feel like we're going to do to the kind of growth rates we saw in the last couple of years, maybe in the next year or so. But I just wondered if you could talk about that a little bit.

Jeffry N. Quinn

I think sort of a 15% to 20% type of growth. We feel pretty comfortable with. Some people out there might have higher numbers, but 15% to 20% is something that's very comfortable for us, and it's something that we believe fuels a development of a very successful business, especially as we really enter the Chinese market in a major way.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

And what -- just within the context of that between 2011 in 2012, where does that get you on some of the capacity utilizations over there after the expansion that you're working on, in China, especially?

Jeffry N. Quinn

I think that as we entered the 12, then what we'll do is that we'll sort of tapering in capacity as we move forward to meet the market demand. I think at those rates, the existing capacity we're putting in will become very effectively utilized with that growth rate.

Operator

Today's final question comes from Duffy Fischer from Barclays Capital.

Duffy Fischer - ClearBridge Advisors

The Suzhou plant, what's the revenue contributions to the plant? And roughly how long will it take to get up to that -- mostly filled out?

James M. Sullivan

We don't really released specific revenue by facility, Duffy, but it's going to be a very important plant for Solutia. We're taking the capacity of that facility from about 10 million to 15 million square meters and moving it to about 30 million. And importantly, that additional capacity will be very flexible capacity that can be moved between all 3 of our markets: architectural, solar and automotive. So a very important plant for the company.

Duffy Fischer - ClearBridge Advisors

Fair enough. And then on the rubber side for tires, with the increase coming from the butadiene, people are trying to shift around a little bit of the mix in tires, whether it's fillers or natural rubber. What do you guys see on that front, your customers doing there, and how will that affect your rubber business?

Jeffry N. Quinn

That really will not have an impact on Crystex. Crystex will remain a very key component of any quality regular tire manufacturer anywhere in the world. And really not a significant impact on the antidegredant business either. So we don't believe that has a significant implication for us at all.

Operator

That's the last question for today. Please go ahead with any final comments.

Jeffry N. Quinn

Thank you, Christine. Just in closing, I want to thank you for your continued interest and support of Solutia. We're very pleased with the solid results of the quarter. We're especially pleased with many of the delivered record performance in terms of the financial metrics, also with the best quarter we've had in safety since our emergence, which continues to be, in our belief, a significant benchmark in terms of showing manufacturing efficiency in a well-run operational environment. We continue to work in that regard towards 0 incident culture. We believe that is potentially achievable, and our organization's really focused on delivering that type of performance that capped the outstanding financial performance.

So again, thank you for your continuing support, and we'll continue to focus intently on meeting and exceeding your expectation. Have a good day.

Operator

Thank you for participating in today's conference. This concludes the conference for today. You may all disconnect at this time.

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Source: Solutia,'s CEO Discusses Q2 2011 Results - Earnings Call, Jul 26, 2011 Transcript

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