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Executives

D. Michael Donnelly - Chief Operating Officer and Executive Vice President

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

David L. Begleiter - Deutsche Bank AG, Research Division

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

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

Christopher W. Butler - Sidoti & Company, LLC

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

Solutia (SOA) Q3 2011 Earnings Call October 27, 2011 11:00 AM ET

Operator

Welcome to the Q3 2011 Solutia Inc. Earnings Release and Conference Call. My name is Kim, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Susannah Livingston. Ms. Livingston, you may begin.

Susannah Livingston

Thank you, Kim, and good morning. We are pleased you have taken the time to join Solutia's Third Quarter Conference Call. Jeff Quinn, Solutia's Chairman, President and Chief Executive Officer; Mike Donnelly, Executive Vice President and Chief Operating 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 third quarter 2011 results. Finally, Solutia's 10-K will be filed within the next few days.

If you'd 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 reconciliation 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

Thanks, Susannah, and thanks to all of you for joining us this morning for our third quarter earnings conference call. I want to apologize at the start because my voice is a little bit raspy today, a little bit under the weather, so please, I beg your forgiveness there.

I will begin by discussing some highlights in the quarter and some of the geographic trends we're seeing in our markets. Mike Donnelly, our Chief Operating Officer, will then review the current state of our end markets and the progress we are making with regard to our working capital initiative. Jim Sullivan, our Chief Financial Officer, will then walk you through a detailed review of the numbers for the quarter, and then I'll conclude by talking about our current focus areas and our expectations for the remainder of 2011. And then we will open up the call for your questions.

Starting with Slide 4. In the third quarter, we continued to see improvements to revenue reflective of selling price increases implemented this year in the growth and premium products. The demand for our premium products remains strong in Advanced Interlayers, especially in our acoustic products, which were up 22% over a year ago for both architectural and automotive; and in our Saflex premium color options, which is up 14% year-over-year. In addition, we continued to see our Performance Films super premium vehicle automotive film exceed expectations. As we expected, overall volumes for the company were down modestly in the quarter, driven predominantly by continued inventory corrections in the Chinese tire market, lower solar sales, lower heat transfer business due to the timing of certain fills and the destocking in the electronic business in addition to loss volumes from the divestment of our Other Rubber Chemicals businesses. We find most of these events to be unique in nature, and at this time, we do not believe we are headed into a global recession based upon what we see but no doubt, we have seen some slowing in certain markets and certain geographic regions.

However, as we stated before, the destocking we saw in the Crystex business has returned to a more normal order pattern starting in September. Due to the macroeconomic worries in the markets, we did not have plans -- we do have plans in place that will allow us to act quickly in event that our markets turned down as they did back in 2009. In total, our adjusted EPS was up 7% year-over-year resulting from strong commercial practices, lower interest expenses and improved manufacturing, but still impacted by increased raw material prices.

During the third quarter, we generated free cash flow of $17 million and ended the quarter with liquidity of $449 million. We continued to improve our capital structure and year-to-date, we have reduced debt by $127 million, inclusive of $25 million in repurchases of our 2017 and 2020 notes in the third quarter, moving us closer to our 2x gross debt-to-EBITDA goal.

Consistent with our strategy in Performance Films, during the third quarter, we announced the agreement to acquire Southwall Technologies and additional capacity acquired from Aimcore Technologies in Taiwan. These acquisitions further reinforce our leading global positions in advanced films solutions.

Southwall Technologies is a leading innovator of energy savings film and glass products for automotive and architectural markets, which Mike Donnelly will discuss later in the call. Making acquisitions in an uncertain economic environment requires much confidence in the value creation proposition for the transaction, and I have exactly that with regard to Southwall. This is a significant strategic acquisition of technology that will drive the performance of our Performance Films business in the near term and position us for success in the long term. We would expect this acquisition to close by the first quarter of 2012 and anticipate it will be modestly accretive to Solutia's earnings per share in the first year.

Also, the additional Aimcore assets purchased will add capacity needed by Flexvue in conductive films in the high-growth markets in Asia. We look forward to welcoming Southwall to our global organization and further building out our Asian team.

Before I discuss details around the quarter, I want to say a few words about the management changes that have taken place during the quarter. I hope that one of the hallmarks of my tenure here at Solutia has been not to be complacent. Our performance has been and will continue to be strong, but I identified areas where we were not doing as well as we should. So I made a difficult decision and made changes to our management structure, naming Mike Donnelly as our Chief Operating Officer back in August. Mike and I have a shared vision in regard to the leadership and strategy of the company to drive and sustain excellent operational performance while positioning Solutia to achieve its growth potential.

During his nearly 40 years of experience, Mike has a proven record of excellence in manufacturing operations and technology, as well as strong general management experience. Since becoming part of Solutia, Mike has contributed to superb business results within the Technical Specialties business and most recently as President and General Manager of Performance Films. He has been instrumental in setting that division on a solid path to realize its full global potential. I look forward to you all hearing from Mike today on the call and meeting him in person at our Investor Day, which has been scheduled for December 15 in New York.

I also made a change with respect to our EVA business and named Nadim Qureshi as head of that business, and I've asked Nadim to move to Shanghai to run that business out of Asia to ensure the appropriate focus on building the business in the Chinese marketplace. Nadim previously built the Nylon Plastics and Polymers business in China when we owned the old Nylon business and most recently in our strategy group. He is a polymer chemist in the MBA and before joining us 5-plus years ago, he was with AD Little and CRA. Underscoring the importance I see in making an immediate improvement in the direction of that business, Nadim is reporting directly to me at his new position. Nadim has already made moves to strengthen our organization and improve our relationships with key customers in the area. I'm optimistic that under Nadim's leadership and with our renewed focus, we will be able to reach the full potential of this business given the very difficult current market environment.

Turning to Slide 5, during the third quarter, net sales were $519 million, a 2% improvement over 2010 and 4% down from the second quarter. Adjusted EBITDA was $121 million, down 7% over 2010 and 14% over the second quarter with adjusted EBITDA margins at 23%. We recorded $0.45 adjusted EPS, a 7% improvement over the third quarter of 2010.

The raw material environment has remained challenging throughout the year. The third quarter was impacted by higher raw material pricing as we expected of $29 million compared to the third quarter of last year. In the fourth quarter, we expect to see some limited relief on raw material pricing on a sequential basis, but to still be up significantly over 2010. As such, our view is full year 2011 raw material costs will amount to approximately a 12% to 14% increase over 2010 on a constant volume basis.

Strong commercial efforts have slightly improved prices from the second quarter of this year. Jim Sullivan will cover the specific of price increases versus raw materials in each of these segments in a moment. Manufacturing utilization rates for the company as a whole were in the low to mid-80% in the third quarter as we continue to see steady demand in our end markets and in the regions in which we operate.

Speaking of regions, on Slide 6 is our revenue by geography, as well as the growth we have experienced year-over-year. In total, our net sales by world area have changed only slightly from last quarter with Europe representing slightly lower net sales on a percentage basis with increases in the U.S. and in the rest of the world, mainly Brazil. The numbers in that table reflect the quarterly year-over-year growth in each segment by world area. As noted previously, sales growth from the third quarter cooled overall -- and most world areas were up a few percentage points from last year, consistent with our total growth.

In the Asia-Pacific region, Advanced Interlayers had a strong quarter related to both automotive and architectural sales. Performance Films experienced another strong quarter in their premium products, principally in Asia, while Technical Specialties was down in the Asian region due to inventory corrections in the Chinese tire market as production slowed. In Europe, Advanced Interlayers continues to experience growth though at a slower rate than last quarter as the premium acoustic products are resilient in the face of the challenged construction market, and we had gained some new customers in 2011.

In the U.S., Advanced Interlayers sales into the architectural markets have improved as some of our key customers gained share in their markets, along with some increased intermediate sales. As a reminder, Technical Specialties, of course, is impacted by the reduction in revenue from the Other Rubber Chemicals businesses that we have exited. So overall, we are seeing a steady demand environment where pockets of growth in various markets reflective of the balanced geographic exposure of our portfolio as well as the diversity of our -- of the end markets we serve.

I recognize the state of the geographic end market is a topic of much discussion these days, especially for Europe and how any potential downturn may affect Solutia. We are closely monitoring our markets and stay close to our customers for any demand signals. And currently, we do not see significant movements in our demand beyond what we have already discussed today.

Now I would like to turn the call over to Mike Donnelly, our Chief Operating Officer. Mike?

D. Michael Donnelly

Thanks, Jeff, and good morning to everyone. I'm delighted to be here today and look forward to meeting many of you in the coming months. If you turn your attention to Slide 8, I would like to make some comments about our end markets. Most of our end markets continued to show growth though at a slower pace. Our electronics market has improved 1% year-to-date over last year, driven mainly by the electronic display market. In the third quarter, we experienced some additional softness because the e-reader market was still working off excess inventory. Overall, the new lower-priced Kindle should drive increased demand in 2012.

In addition, we did experience displacement of our silicon-released films, which were primarily sold into the tablet markets. As we have stated in the past, we are working diligently to upgrade our production process and quality control systems at our Martinsville, Virginia site, and those upgrades are nearly complete. We believe these upgrades will enable us to requalify our material in early 2012.

The architectural market represents 12% of our revenue. Sales of architectural products continue to show steady growth around the world with volumes up 8% for the quarter over last year, in part due to our architectural Saflex acoustic product continuing to display strong growth. Sales of these products are up 12% year-to-date. In addition, after 4 straight months of decline, the Architectural Billings Index turned positive.

Revenue from energy solutions is down 5% year-to-date. This group includes our solar industry products PVB and EVA, which are used as encapsulants in solar modules; and Therminol, which is used in concentrating solar power applications.

Additionally, in our Performance Films division, we have our solar window films for both architectural and automotive applications. Our aftermarket solar window films continue to grow North of 25% year-to-date driven by strong performance in our premium V-KOOL brands in Asia. Therminol in the solar market continues to achieve new solar plant fills but saw a decrease year-over-year due to timing of fills. We expect a strong fourth quarter in this business.

Now let's discuss our encapsulants for solar modules, which represent 4% to 5% of total sales, less than half of our energy solutions revenue. We believe in this end market and are focused intently on the execution of our strategy to win at the growing and long-term winning OEMs. No doubt the market remains challenged, but as noted by Solarbuzz, the module installations are expected to be around 21 gigawatts in 2011. This equates to approximately 10% growth, which is not too bad once the market works through its excess inventories and production is more in line with installations.

Solutia's plan to build out our capacity in China remains unwavering. Our Suzhou facility is up and producing high-quality material. And our progress in China, Asia continues as we are in certification for advanced testing with Tier 1 and Tier 2 customers, and we expect sales off this line in early 2012. In addition for the quarter, we saw EVA volumes sequentially improving, up 28% compared to the second quarter of 2011.

Moving on. Automotive OEM represents 19% of Solutia's revenue. Third quarter experienced slower growth as the European sovereign debt situation, potential austerity measures and financial market volatility remain impediments to vehicle production and sales. Year-to-date, this market has grown by 4% for Solutia. J.D. Power's forecast of global annual builds is now at 76.9 million units in 2011 or 3.6% increase over '10, inclusive of fourth quarter improvements to the Asia region and a seasonally better fourth quarter in Europe. Our replacement market, inclusive of automotive glass, architectural glass, aftermarket film applications and the tire and rubber market, make up 35% of our revenues.

Despite a decrease in U.S. miles driven for July and year-to-date of this year, our sales in replacement and aftermarket glass remain strong, up 8% year-to-date, reflective of improved automotive and architectural revenues and Performance Films and Advanced Interlayers.

Relating to commercial tires, truck tonnage in August was near flat compared to July, but is up 5% year-over-year. Lastly, in our replacement tire and rubber market, exclusive of the divested Other Rubber Chemical sales over the past year, this end market would be up around 7%, impacted this quarter by the sluggish demand from the China tire producers.

On Slide 9 is our view of our working capital. Our quarter-end DSO or days sales outstanding came down to 40 days compared to 44 days at the end of last quarter. Securing timely payments from our customers and improving payment terms where possible continues to be our focus and has produced very good results this year. DPO has remained flat for the quarter. Our inventory days on hand or DOH increased by 5 days and drove the working capital increase for the quarter. These builds were purposeful as our businesses prepared for scheduled plant downtime related to technology work and the startup of new lines in the coming months, combined with higher demand for certain products and higher raw material cost.

Overall, our working capital as a percentage of sales stayed flat compared to the second quarter at 19%. This is one area that's been a focus for Solutia this past 1.5 years and has become part of our culture, engrained not only in our corporate finance groups but in the daily activity of the businesses as well. It is a process in our organization that will continue to be an area of focus and discipline.

Finally, one last slide before I hand it over to Jim, if you'll turn to Slide 10. As Jeff mentioned previously, we look forward to welcoming the addition of Southwall and the additional capacity of the Aimcore assets in Taiwan. Performance Films strategy this year has been in line with our goal with 19% growth year-to-date. We believe the Southwell acquisition will help elevate our global leadership in the films business by improving our growth in existing markets, accelerating the step change in our technology efforts and further expanding our geographic footprint.

The Southwall acquisition joined Solutia's commercial and market expertise with Southwall's technology and manufacturing capabilities. It secures Solutia's access to Southwall's proprietary XIR technology, a key base material for our premium V-KOOL window film. In addition, it will add "state of the art" manufacturing capacity and capabilities, allowing us to optimize asset utilization across the globe in support of a fast-growing demand for high-tech films for the electronics and energy markets.

Further, this acquisition will give Solutia the ability to expand its product offering to our current Saflex customers by offering Southwall's patented XIR transparent film encapsulated between layers of Saflex PVB. Lastly, Southwall's leadership and technology for more than 25 years, combined with the expertise with Solutia, will create what we believe to be the greatest talent pool of sputtering expertise in the world. With the addition of the high-tech conductive film assets in Taiwan, Performance Films manufacturing assets will expand 3 continents: Europe, North America and Asia; and support the future growth of this business.

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

James M. Sullivan

Thanks, Mike, and good morning to everyone. Let's take a closer look at the financials for the quarter, starting on Slide 12. This slide details the items excluded in our calculation of adjusted EBITDA in the third quarter of 2011 and the third quarter of 2010.

In the third quarter of 2011, we have excluded a net gain of $23 million, which is comprised of a $29 million gain on the sale of our 2% retained interest in the former integrated nylon business, partially offset by a severance charge associated with the senior management change that Jeff referenced earlier in the discussion, as well as expenses related to the Aimcore and Southwall acquisitions.

Turning to Slide 13. In the third quarter, we continued to see top line growth with net sales up $8 million or 2% versus the year-ago period. Adjusting for the impact of divested businesses, net sales were up $24 million or about 5%. Average selling price increases and the positive impact of foreign currency translation each contributed 4% while sales volumes were down 3%. Compared to the second quarter of 2011, sales were down $24 million or 4%, and this was mainly attributed to seasonally lower volumes, partly offset by a modest sequential improvement in selling prices.

Moving to Slide 14. Adjusted EBITDA for the third quarter of 2011 totaled $121 million, down $9 million or 7% versus 2010 and down $20 million or 14% versus the second quarter. Excluding 2010 earnings from the divested businesses, adjusted EBITDA in the quarter was only down $6 million or 5% versus last year. For both the year-over-year and sequential comparisons, higher average selling prices and improved manufacturing costs were more than offset by the earnings impact from lower volumes and higher raw material costs.

Slide 15 bridges the company's year-over-year and sequential quarterly movements in earnings per share. Adjusted EPS in the third quarter of 2011 totaled $0.45, an improvement of $0.03, or 7% compared to 2010. Lower interest expense and a modestly lower tax rate more than offset the decline in adjusted EBITDA and the loss of earnings from the divested businesses. Compared to the second quarter, adjusted EPS was down $0.12 with the impact from lower EBITDA partially offset by an improved tax rate.

The year-to-date effective tax rate of about 13% is reflective of the company's advantage tax attributes with the U.S. NOL position, as well as the benefits from tax holidays in both Malaysia and China, and we do expect the rate to remain in the low to mid-teens for some time.

Now let's turn to our reporting segments, starting on Slide 16, with Advanced Interlayers. Third quarter sales for this business totaled $227 million, up 7% year-over-year primarily due to favorable currency translation effects from a stronger euro versus U.S. dollar. Higher revenues from average selling price increases of 2% were offset by an equivalent decline in sales volumes. In the quarter, Saflex architectural revenues improved by 21% versus 2010 with volumes up 8% and the combination of higher selling prices and favorable product mix adding 13%.

Saflex automotive OEM and replacement revenue was up 10%, driven mostly by higher selling prices and improved product mix as volumes overall were about flat with the prior year. Saflex premium product volumes, including acoustic and Vanceva colors, were up a very strong 17% in the quarter compared to 2010. VistaSolar encapsulant volumes were down approximately 40% in the third quarter versus the year-ago period.

Advanced Interlayers' adjusted EBITDA for the second quarter totaled $47 million, and that's down $1 million or 2% year-over-year. The earnings decline was driven by higher raw material costs in the quarter, which were only partially offset by increased average selling prices, product mix enhancement and lower expense associated with our annual incentive plan.

Sequentially, sales for Advanced Interlayers were down $5 million or 2%. Seasonally lower volumes in Saflex were partially offset by an increase of VistaSolar sales in Europe, as solar industry conditions in the third quarter improved slightly compared to the second quarter.

Adjusted EBITDA was down $5 million sequentially with lower Saflex volumes and higher raw material costs more than offsetting the earnings improvement from higher VistaSolar volumes. Year-to-date growth in our architectural markets and better product mix, together with selling price increases implemented across the year and lower manufacturing costs driven by production yield improvements, have more than offset raw material cost increases. This has resulted in an improvement of $8 million in adjusted EBITDA year-to-date over the same period in 2010.

Looking ahead for Advanced Interlayers, we expect sales in the fourth quarter to be modestly lower than the third quarter as the forecasted negative impact from translation due to a strengthening U.S. dollar is expected to more than offset modestly higher Saflex automotive volumes mainly in Asia. Saflex architectural volumes are projected to hold steady at the improved level achieved in the third quarter for the remainder of the year while VistaSolar volumes are not premised to show meaningful recovery until 2012.

We expect the adjusted EBITDA margin for the segment to be relatively flat to the third quarter in the low-20% range as the benefits expected from higher selling prices are mostly offset by lower fixed cost absorption from inventory control actions and some modest increases in manufacturing costs. In addition, we are still on track to bring up the second Saflex line at our Suzhou, China plant in the first quarter of 2012.

Performance Films results are summarized on Slide 17. Net sales for the third quarter totaled $74 million, up $1 million or 1% compared to the third quarter of 2010. Selling prices and currency translation were both up 1%, partially offset by a modest decline of 1% in sales volumes. Aftermarket automotive window film sales in the quarter were up 15% versus 2010 with the majority of this growth coming from Asia driven by strong demand for our premium Novomatrix V-KOOL and Huper Optik brands and the continued development of the predelivery installation market in the region.

Aftermarket architectural window film sales were up about 4% in the quarter versus 2010. This growth was, again, mainly in Asia. Flexvue sales were down about 22% in the quarter due to the e-reader industry working off excess inventory in the temporary displacement of release liner sales that Mike referenced earlier.

Performance Films' third quarter adjusted EBITDA totaled $12 million, down $1 million versus the third quarter of 2010. The decrease was mainly driven by increased spending on sputtering technology and upgrades to our production processes and quality control systems to meet the more stringent requirements of the Electronics market. The combination of increased selling prices and lower manufacturing costs offset higher raw material cost in the quarter. Sequentially, Performance Films' sales and adjusted EBITDA in the third quarter were down $12 million and $7 million, respectively, mostly due to seasonally slower aftermarket window film volumes. Year-to-date, Performance Films' adjusted EBITDA was up 19%, driven by strong new car sales, new EnerLogic film products and new channels, like the predelivery installation for our premium V-KOOL product This was partially offset by increased costs as we build out our Asia business and implement quality improvements in our manufacturing facilities.

Looking ahead for Performance Films, we expect sales and adjusted EBITDA in the fourth quarter to trend down from the third quarter due to normal seasonality. However, in addition, as the products in this segment are the most discretionary purchase in our portfolio, with a bit slower consumer demand profile, we do expect weaker year-over-year sales in the fourth quarter in both window films and electronics.

Turning to Slide 18. Technical Specialties' net sales for the third quarter totaled $218 million, down $6 million or 3% compared to the third quarter of 2010. Adjusting 2010 actual results for the impact of the divested Other Rubber Chemicals businesses, sales in this segment were up $8 million or 3%. Average selling prices were up 5%, currency translation added 3%, and volumes overall were down 5%.

Santoflex volumes increased in the third quarter about 5% with strong sales into Asia. Crystex volumes overall were down about 7%, with a more pronounced decline in the Chinese truck and bus market from a combination of lower end-market demand and inventory destocking at the tire companies, more than offsetting low single-digit percent gains in other world areas.

As expected, Specialty Fluids volumes declined about 15% year-over-year in the third quarter, but as Mike said earlier, this is mostly just timing as 2 large solar fills are scheduled for delivery in the fourth quarter. Year-over-year selling price increases were realized across all product lines.

Technical Specialties adjusted EBITDA for the third quarter of 2011 totaled $75 million, down $7 million versus the prior year. Adjusting for the divested businesses, EBITDA was down $4 million or about 5%. Manufacturing cost improvements offset the earnings impact from lower volumes with the main driver of the year-over-year decline being uncovered raw material costs in the Santoflex product line. While selling prices were up in this product line, the increases were not sufficient to offset raw material cost inflation as the anti-degradant market is currently in an oversupplied condition.

Sequentially, Technical Specialties sales were down about 3% and adjusted EBITDA was down 8%. This was mainly driven by inventory destocking in Crystex, timing of large Therminol fills and uncovered raw materials in Santoflex. Year-to-date, adjusted EBITDA was down $11 million, and this was predominantly driven by the divested Other Rubber Chemicals businesses. Increased selling prices across this segment in combination with an improved cost profile and strong fluid volumes more than offset the higher raw material costs.

Looking ahead, volumes in Technical Specialties overall are expected to increase in the fourth quarter, mainly with Crystex as demand in China returns to a more normal pattern and also with Therminol due to the scheduled large solar fills. The adjusted EBITDA margin for this segment is also expected to move up a bit in the fourth quarter with the increase in volumes and lower raw material prices more than offsetting seasonally lower production levels and an increase in project-related costs associated with the Crystex technology program and the Kuantan Crystex expansion.

Moving on to Slide 19, here we highlight results for our unallocated and other reporting segment. Total net expense in the quarter was $13 million, flat versus third quarter of 2010. Corporate spending was down $2 million, mainly due to reduced expense related to the company's annual incentive compensation program. This savings was offset by a reduction of dividend income received in the prior year from the retained interest in the Integrated Nylon business that was sold in the third quarter.

Slide 20 details the company's operating cash flows and capital spending. Cash from operations in the third quarter totaled $47 million, bringing the year-to-date 2011 total to $144 million, $67 million lower than the same period in 2010. The year-over-year gains in adjusted EBITDA were more than offset by the targeted inventory increases that Mike referenced earlier, as well as higher incentive payments to date in 2011. Recall in 2010, incentive payments were made in the fourth quarter and in 2011, payments were made in the first quarter.

Capital spending in the third quarter totaled $30 million, up $16 million versus the year-ago period. The increases in the third quarter and year-to-date versus 2010 were predominantly associated with key strategic projects that will structurally improve our global cost position and expand capacity and premium product capabilities at our facilities in China, Belgium and Malaysia.

Cash from operations less capital expenditures in the fourth quarter of 2011 is expected to be the highest quarter of the year as a result of planned working capital reductions. Our full year free cash flow is now projected to be in the range of $120 million to $130 million.

Moving on to Slide 21. Here, we summarize our debt liquidity profile. We ended the quarter with gross debt of $1,337,000,000, down $25 million from the second quarter. As Jeff mentioned during the third quarter, the company repurchased on the open market $25 million of the 2017 and 2020 notes, bringing total debt reduction year-to-date to $127 million. The company's gross debt to trailing 12-month adjusted EBITDA as of the end of the third quarter was 2.6x. In terms of liquidity, the company ended the quarter with a very strong position of $449 million, including $279 million of availability on our cash flow revolver and $170 million of cash on hand.

With that, I'll turn it back to Jeff for some closing remarks. Jeff?

Jeffry N. Quinn

Thanks, Jim. A few final comments to make before we open it up for your questions. First, let me address the company's expectations for the remainder of the year. Improved product mix through premium products, the continued focus on maintaining our low-cost structure combined with a steady demand environment gives us the confidence in setting our full year adjusted EPS guidance at approximately $2 a share.

On the specific topic of raw materials, we recognized that on a consolidated basis, raw materials have been a headwind for us. We have been making good progress in our goal to fully recover these costs through increased selling prices, but in particular we have fallen short of this objective in the Advanced Interlayers business over the past few years. As we have mentioned in a recent press release, we plan to change the dynamic in our future contracting and will continue to implement price increases in the 2012, inclusive of models to decrease the exposure to raw material fluctuations. The expectation from our 2 other segments remain resolute. Through various price increases we have implemented to date, we expect to cover the impact of higher raw material costs by year end.

As for the quarter, though the economic uncertainties of the world continue to impact our end markets and regions in which we operate, our commitments to outstanding performance, our strategic focus on value creation and our track record for meeting and exceeding those commitments have not changed as was noted by the year-over-year increases to earnings in the quarter. We will continue with our strategy to diversify our exposure, both geographically and with regard to our end markets and we will continue to invest in innovation-driven premium products supported by strong cash generation and a strong balance sheet. No doubt we will do so while staying close to our customers and end-markets' reaction to the world events unfolding before us. It's our commitment to these principles that have created the resiliency, that positions Solutia for solid growth over the past few years, and it's this kind of resiliency that will continue to position the company for future success.

Thank you for your continued interest in Solutia and your continued support. And now, we would like to turn it back over to the operator to open it up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And at this time, we have a question from Frank Mitsch from Wells Fargo.

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

Jeff, you did a good job outlining the price raw materials situation and you also reminded us of the actions you're taking in AI to change your contract terms. Is the way we should think about this is that you're probably not going to get back to parity in the fourth quarter, but the expectation is that we should expect to see that in the first quarter? Is that how we should be thinking about that?

Jeffry N. Quinn

I think that's a pretty good approximation, Frank, yes.

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

All right, great. And one of the things that I was struck, I guess, in the release you were talking about volumes being higher sequentially in Q4. Can you offer some comments in terms of what you're seeing the -- you're seeing the destocking end in the -- the end to destocking in the electronics as well as the Chinese truck and bus market?

D. Michael Donnelly

Frank, this is Mike. We clearly see the tire market in China changing so there was a big overbuild in Q1 and Q2 and a destocking in Q3. That clearly is returning to normal. And our September volumes were good, and indicative of how the fourth quarter is looking. In the electronics side, on the e-reader market, and what we're talking about on e-reader is we're supplying them to the front-playing laminates, and that business had overstocking and actually some efficiency improvements in their yields. So that combination took volumes down in the third quarter also -- or there were very little volumes in the third quarter to be frank. But again, we saw September picking up, and we're optimistic that, that market is also returning to normal.

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

All right, great. And then lastly, I think you mentioned that you -- the replacement glass market in the U.S. was up 8%, which to me -- struck me as a rather large number. How comfortable are you that you'll -- you can continue to grow that business at that level?

Jeffry N. Quinn

Well, that's really a function of market growth, number one. And second, it's our premium architectural products, which are really doing well. The Q series or acoustic products are catching on, on the industry and provide that sound barrier that people are liking. So we're very optimistic about that product line and that continuing performance.

Operator

Our next question comes from Laurence Alexander from Jefferies.

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

This is Lucy, on for Laurence today. I guess starting with -- there's a comment in your press release regarding some lower discretionary spending in Q3. I was just wondering how much of a benefit that was in the quarter? And if, I guess, if that's ongoing how much of a benefit it should be in the fourth quarter?

James M. Sullivan

This is Jim Sullivan. Certainly, we're always watching our spending levels very closely, but as the global economic environment kind of changed a little bit in the third quarter, we redoubled our efforts in that area. And I would say that it probably contributed a couple of million dollars of benefit into the third quarter, and we would expect that kind of level to continue into the fourth quarter.

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

Okay. And regarding the, I guess, adjusted pricing mechanisms in Saflex that you've announced, have you begun discussions with customers? And if so, how is your initiative being received so far?

Jeffry N. Quinn

Lucy, I mean, we have begun that dialogue and that will be an ongoing dialogue for months, several months, to come. And I think that it's like any change in an industry practice, you have to be able to demonstrate that there is benefit to that on both sides of the equation. And so that dialogue will continue. I mean, we pride ourselves in the Saflex business over the last number of years being the strong leader in the marketplace not only in technology and cost position, and in customer service, but in favorably and appropriately valuing the products we supply, but making sure that there's a real value delivered to our customers. So that will continue to be an ongoing dialogue and no change has changed and sometimes, there's a certain barriers to change. But we are very confident that in the fullness of time, we can demonstrate that change and that mechanism is fair to both parties and appropriate given the value of the products offer.

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

Okay. And one last quick one. You mentioned in your prepared remarks strength in Brazil. I was just wondering how large a market this is for Solutia overall now? And which parts of the business are showing the most strength there?

Jeffry N. Quinn

I mean, I think overall, it's in the slide, it's in the deck in terms of our the rest of the world area, which a big part of that is sort of the South America regions about 12%. Brazil's among the highest growth markets there.

D. Michael Donnelly

It's off a pretty small base.

Jeffry N. Quinn

Yes. I mean, but -- it's a strong growing economy and we will be participating there across the portfolio, but it's a pretty small base to start with.

D. Michael Donnelly

And Lucy, as you know, we do have manufacturing operations in Brazil for our rubber products, as well as Saflex.

Operator

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

Christopher W. Butler - Sidoti & Company, LLC

Not to beat the change in contracts subject to death here, but I'd have to imagine that your customers look on these lengthier price contracts as a benefit with inflation being the norm for resin costs. Do you anticipate that you're going to have to give something back to customers in order to facilitate this change?

Jeffry N. Quinn

Chris, I think it's -- anytime you try to affect a change in commercial practices, it's a give-and-take and you have to be able to demonstrate that it creates value for your customers. We deliver value to our customers in so many ways other than just pricing. I don't anticipate that the discussion becomes solely one about price. There's all kinds of issues in terms of mix and volumes relating to premium products. But certainly, it's not illogical to say that there is some relationship between pricing and derisking volatility and pricing. So it's a very complicated negotiation, and frankly, it varies customer by customer. So we fully expect that it will be an interesting dialogue with each and every customer. But again, we have to remain focused on the value our products deliver and the value that the technical sales and service that we offer as a clear differentiator in the marketplace.

Christopher W. Butler - Sidoti & Company, LLC

And shifting gears, you'd said that you had built up some inventory for some downtime that you expect here in the fourth quarter. Is there -- are there added expenses that you're expecting here in the fourth quarter that you have already in your full year EPS guidance as a result of these turnarounds?

James M. Sullivan

Chris, Jim Sullivan again. We did talk when I was kind of giving you an outlook by segment of some of the give-and-take we expect in the fourth quarter. And certainly, as we bring down our inventory levels, we'll have some fixed costs that are uncovered. And also, I commented that we expected a little bit of a cost increase in Advanced Interlayers, that's in Saflex. When you run your facilities at a little lower rate, your yield performance is not always as good, and we tried to take that into account. Hopefully, some of the discretionary spending focus that we talked about earlier will kick in, but those are the key items from a cost perspective.

Christopher W. Butler - Sidoti & Company, LLC

Any EPS impact that you can give us?

James M. Sullivan

Not specifically on each of those. Just I would say that it is reflected in the overall guidance that we laid out by segment, though. There will be a hit because of bringing down our inventories a little bit. Our production will be a little bit lower in the fourth quarter. Some of that is just seasonal with the holidays. We are expecting working capital monetization in the fourth quarter, which is going to help drive our cash flow, as I mentioned, in the quarter to the highest level of the year. So there is certainly going to be some, if you will, short-term penalty for that.

Christopher W. Butler - Sidoti & Company, LLC

And just finally on the acquisition, could you talk to the synergies that you're expecting and how you're going to achieve those?

D. Michael Donnelly

This is Mike Donnelly. There'll be synergies really across the board. We see synergies in our SGA as you consolidate 2 companies, that's very normal. We see synergies in the manufacturing technology in exchange of that technology, optimization of those assets across the world. And we have a team in place that is addressing those value drivers and putting plans in place today to address those head on and make sure that we get them as planned and scheduled.

Christopher W. Butler - Sidoti & Company, LLC

Are you planning on keeping your management intact when the deal is done?

D. Michael Donnelly

Of course, not all management will be intact. There'll be some changes as we're integrating.

Operator

Our next question comes from Mike Sison from KeyBanc.

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

Jim, in terms of the $2 guidance for EPS for '11, does that -- the EBITDA assumption of that, is that, if I did my math right, somewhere around $520 and $400 on EBIT?

James M. Sullivan

It's in that area on EBITDA.

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

Okay, great. And then, Jeff, you talked pretty enthusiastically about Southwall. Any color on what type of growth you expect to see in that business next year, and maybe give us a little bit of the longer-term growth potential of that business?

Jeffry N. Quinn

Mike, we'll definitely talk about those subjects at Investor Day here in just a few weeks. I think that not only is there the very positive impact on current business, there's also the developing technologies that show promise. So we'll address that here in just a few weeks as we lay out our view for 2012.

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

Okay, no problem. And then you might touch base on this at the Analyst Day, too, but when you -- you rolled out pretty aggressive goals next -- for 2015 last year, and when you think about where the business is going to end up this year, what do you need to see to get '12, '13 sort of back on that track?

Jeffry N. Quinn

I think that if you look at -- and one of the things that we've committed to do at our Investor Day in December is we're going to try to actually hold ourselves accountable to kind of bridging any change in views. And I think the real -- the issue -- the biggest issue really is the EVA business in terms of the photovoltaic business being a very choppy and difficult marketplace this year. And so we'll talk about that a bit. But clearly, that's been an area that we've taken -- we'll take a hard look at and talk about what our long-term view is there as impacted by the disappointing short-term outlook and performance. So -- and then, we'll talk a little bit about the other businesses and where they are. But I feel really good about -- in each of the 3 businesses that being on track to really deliver the type of growth that we talked about last year.

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

Okay, great. And Mike, you did have some commentary on solar. Any view on inventories and -- we know things are being installed, but how do you gauge whether inventories are -- or when they will get to the point where installs will match production?

D. Michael Donnelly

Our data for that mostly comes from Solarbuzz. So as they've -- looking at the market, they're really the what we think is the best view of the market. The inventories appear to be coming down. We expect sometime in '12 to start reaching equilibrium if production is rational.

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

Okay, great. And last question on Crystex. The competitive environment that's -- it's unusual to see that business see the destocking that it did to some degree, but on a competitive basis, has all the players remained pretty rational, I guess?

D. Michael Donnelly

The answer is yes. And as we have said before, when there are big downturns, and there was in China in Q3, there is some share shifting that goes on. And there's also some substitution with lower quality softwares that can happen and do happen because in those environments, the companies are looking to save some money. But as soon as it turns back up, we return to our normal position and high growth because our products, frankly, give them the best productivity, the best bang for their buck, and that will come back.

Operator

Our final question comes from Bill Hoffmann from RBC Capital.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

I just -- I wondered if you could explain a little bit on the new facility in China encapsulants business and just want to get a sense on sort of how that market looks right now just given some of the disruptions we've seen.

D. Michael Donnelly

As you probably know, a lot of the module production has shifted dramatically to China in the last year. And we saw that coming, and that's why we're building assets in China very proactively. So we're very optimistic about -- we're doing the right thing. We're in the right market. Our products are in qualification now with the Tier 1 and Tier 2. And so we're looking to have sales in early 2012.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

And does that look like it -- I mean, hasn't there been some meaningful softness, though, in that market? Does that look like it just sort of, it's a slower sort of ramp-up time frame for that kind of facility?

Jeffry N. Quinn

Yes, Bill, this is Jeff. I think one of the things that's probably happened there is that the whole qualification process has taken just a little bit longer because there's -- the market is just not clamoring for product quite as much as it was a year ago. But we see the strength and logic of the move there being the same as it was. But we're really increasing our focus on that marketplace and frankly, that's why that business is going to be run out of China. And the new head of the business, as I mentioned, it will be based in Shanghai and is on the ground and very actively working to develop that marketplace. And we will build out a really enhanced team in photovoltaics, and that team will be based there in China. So I mean, the ramp-up may be a bit slower than it would be in a real robust market environment, but frankly, we still believe that in the midterm and the long term, the strategy of a strong Western quality, German quality product produced in China at competitive prices, with the technical sales and service that has been a hallmark of Solutia's global businesses for years will create a very strong total value offering for our Chinese customers. And we look forward to competing aggressively in that marketplace against the Chinese competition and the other Western competitors trying to create their toehold in the region, and that strategy is still very much on track.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Great, that's very helpful in that. And just one other question. This is sort of more generic. When you look at the European markets and your position there, obviously, there's some architectural and some auto, et cetera. Could you just talk a little bit about what you're seeing dynamics of the end markets there? Or are people pulling back more in the last month or so? Or are things roughly steady still at this point?

D. Michael Donnelly

Given the economic uncertainty in Europe, our markets have been surprisingly resistant or resilient in Europe. So tire's doing decent, our automotive -- our glass products, architectural, in particular, is doing well. Where we're seeing the most impact in Europe is in the window film side, where it's more discretionary spending and those products happen to go into the hotter countries, so -- Spain, Italy, Portugal, the ones with the most financial problems.

Jeffry N. Quinn

Just I guess, in -- let's have one more? Okay. One more question, I'm sorry. I thought we were -- we need to wrap up.

Operator

We have time for time for one more question. David Begleiter from Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jeff, couple of things. First, in Q2, your selling prices were up $22 million versus $4 million above raw's [ph]. But in Q3, your price has lagged raw's by, I think, $11 million Why was that?

James M. Sullivan

David, this is Jim Sullivan. Let's break it down by segment. First off, as we've talked about on our release kind of mid-September, we had seen a little bit of a runoff on the raw materials in the Saflex business that wasn't anticipated. The good news there is that we are in new contracting negotiations on price, so we see that dynamic turning a little bit in the fourth quarter. On Technical Specialties, really, price increases continue to cover raw materials in our Crystex business, in our fluids business. Where we're challenged, as we talked about on the call, is in the Santoflex business. While we did get some pricing there in the quarter, it wasn't sufficient to offset the raw materials, and you know that, that particular market segment is a little bit oversupplied at the moment.

David L. Begleiter - Deutsche Bank AG, Research Division

Okay. Jeff, just on M&A versus debt reduction, how is the M&A pipeline going forward? Do you foresee additional Southwall-type transactions over the next 12 months?

Jeffry N. Quinn

David, we will continue to prudently and thoughtfully look at the small strategic bolt-on type of acquisitions, something like Southwall that we had been interested in and pursuing frankly for years. You cannot always control when those things come to fruition. But certainly, as we move forward, it's a very balanced approach, and we will continue to delever and we will continue to really balance the priorities of the use of our cash flow. So we'll look at those things opportunistically. But we will -- I mean, that's a priority, but it's just one of many priorities and it's definitely not at the top of the list. I think keeping the balance sheet strong, delevering and then eventually considering ways of returning excess cash flow to shareholders are at least equal to that if not higher priority at this point than that.

David L. Begleiter - Deutsche Bank AG, Research Division

Okay. Just lastly on Saflex and the pricing structure, are you -- will these structures be in place for this year or given the timing of negotiation later on? And on this year's annual price negotiation, I believe last year, the issue was operating rates were just not high enough to support higher levels of price increases. Is that the same level situation right now where we're just not seeing high enough operating rates to push the maximum price increases required?

D. Michael Donnelly

I think that we hope to make significant progress in terms of having new pricing structure in place for -- as we move forward into the year. It's not certain that in all cases that will be the case. I think overall, in terms of the market environment and the environment, we would view it being slightly probably more positive than it was a year ago in terms of the market dynamics as we go into pricing. But certainly, a more robust economic environment would even improve that. But net-net, I think the situation is better than it was last year.

Jeffry N. Quinn

Well, with that, we'll wrap up. Again, thanks very much for your continued interest in Solutia. We remain very focused on executing and delivering performance regardless of what the economic environment might be. I know there's certainly a lot of uncertainties in that economic environment now, and we're not insulated from some of those concerns and changes. But we remain focused on playing the hand that we're dealt to the maximum extent we can. And I think that will continue to be a hallmark of the performance of this company is doing a good job, playing the cards as they're dealt. So thanks very much for your interest today, and appreciate your interest in our company.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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