Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Solutia Inc. (NYSE:SOA)

Q2 2008 Earnings Call Transcript

July 29, 2008 10:00 am ET

Executives

Susannah Livingston – Director of IR

Jeff Quinn – Chairman, President and CEO

Jim Sullivan – SVP and CFO

Analysts

Daniel Caruzo [ph] – Hayden Capital [ph]

Randy Laufman – Imperial Capital

Navin Murthy – Stornoway Portfolio Management

Gentry Klein [ph] – Cedrus Capital [ph]

Bo Hunt – Banc of America Securities

Jim Stahl [ph] – Merrill Lynch

Laurence Jollon – Lehman Brothers

Jay Labunski [ph] – West Face Capital

Justin Boisseau – Gates Capital Management

Jerauld Dickerson [ph] – Technology and Issues Communications [ph]

Operator

Good day, ladies and gentlemen, and welcome to the quarter two 2008 Solutia Incorporated earnings conference call. My name is Michelle and I will be your coordinator for today. (Operator instructions).

And I would now like to turn the presentation over to your host for today's call, Ms. Susannah Livingston, Director of Investor Relations. Please proceed.

Susannah Livingston

Thank you, Michelle, and good morning.

We are pleased you have taken the time to join Solutia's second quarter conference call. My name is Susannah Livingston, Director of Investor Relations. On the call with us today are Jeff Quinn, Solutia's Chairman, President and Chief Executive Officer; Jim Sullivan, Senior Vice President and Chief Financial Officer; and Tim Spihlman, Vice President and Controller.

Jeff will open today's call with brief comments on the quarter and outlook, in addition to a strategic overview of Solutia. Jim will then discuss the quarter's results in detail, identifying factors that drove segment performance and non-reoccurring items. Jeff will then finish with some comments on the outlook for the remainder of 2008. We will then open the lines for questions and answers. This call is also being webcast in listen-only mode, and will be archived in audio format on our website for two weeks.

The Solutia's press release announcing second quarter earnings was distributed via PrimeNewswire last night and is posted on our website, solutia.com, along with slides for this webcast. 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 schedule in our earnings release and attached to the slides today. Also, just to be clear, we define EBITDA as earnings before interest, taxes, depreciation, amortization and reorganization items. Adjusted EBITDA is EBITDA excluding unusual gains or losses, including certain fresh start accounting impacts.

In addition, for the second quarter of 2007, we’ve made pro forma adjustments to incorporate Flexsys' results on a 100% basis, as that acquisition did not close until May 1st, 2007. Therefore, results will be reported on this call using pro forma adjusted numbers to include Flexsys’ results for the full quarter of the prior year.

I would like to begin by asking you to reference Slide Three. Our financial highlights for the quarter were strong in spite of continued macroeconomic headwinds. For the second quarter, we reported net sales of $1.095 billion, up 14% over last year's results. Adjusted EBITDA increased 27% to $118 million over the same period last year. And finally, we reported adjusted diluted earnings per share of $0.28 for the second quarter 2008.

Jim will talk in greater detail to these numbers shortly, but first let me turn the call over to Jeff.

Jeff Quinn

Thanks, Susannah, and thank you all for joining us this morning for our second quarter 2008 earnings conference call. It is a pleasure to have many of our investors that we have spoken to over the past few months on the call today, and also welcome to those of you that we have not spoken to in person.

I want to briefly speak to our strong results for the quarter to start on Slide Five. Despite the continued escalation of raw materials and the disappointing performance of our nylon business, we delivered significant year-over-year improvement in sales and earnings. This quarter highlighted the strength of our specialty chemical franchises. We were able to grow the top line and improve profitability in a challenging economic environment. Of special note was the strength of our specialty businesses outside the US, especially China, which allowed us to more than offset the softness in the domestic economy.

In the second quarter, 59% of our revenue came from outside the US. Ex the nylon business, 74% of our revenue was derived outside the US. Our strong top line growth was driven by a mix of both volume and price increases. Importantly, our volume growth was broad based. We experienced increasing volumes in all of our major businesses, with the exception of nylon intermediates and carpet. Technical Specialties' results were exceptional, yet another impressive quarter for that business, with year-to-date EBITDA results at the highest levels ever.

Much like the rest of the industry, rising raw material costs continued to be an issue across all of our businesses, especially in the nylon business. To date, our raw material spend is up over $182 million compared to last year, most of that in the nylon business. For the quarter, our consolidated selling prices covered 74% of raw material increases. Collectively in the three specialty chemical segments, Saflex, CPFilms and Technical Specialties, we fully recovered all raw material cost increases.

Due to the strong overall results in the second quarter and the outlook ahead for the rest of the year, we are increasing our guidance for the year to $400 million to $425 million of adjusted EBITDA. This increase is in spite of the high cost of raw materials and does not assume an abatement of the current historically unprecedented raw material cost environment. In addition, given the nylon strategic alternative process, which I will discuss in a moment, we believe it is appropriate to break out that segment in our guidance. Our guidance for the nylon business for the year is a range of $10 million to $35 million of adjusted EBITDA.

Moving to Slide Six, I would like to discuss a few key developments since last quarter, as we've had many announcements that have the potential to make a strong positive impact on the long-term profile of our portfolio. The first strategic announcement we made in June was our decision to retain HSBC to review strategic alternatives for our nylon business. First, I think it bears stating that we believe passionately in the strategic course we have chartered for our nylon business. Over the last three years, we have transformed what was a North American fiber-focused business into the world's second largest producer of nylon 66 plastics.

I believe the disappointing performance this year is due to the unprecedented raw material situation, and perhaps some commercial execution issues. It is not, in my opinion, an indication of any strategic flaw. I believe the business is capable of additional growth and improved financial performance. The assets are large-scale and world-class. The plastic lines, all 700 million pounds of it, are the latest technology.

Then why consider strategic alternatives at this time? Throughout the bankruptcy, I was confident we had the resources to pursue the transformation of the nylon business and the attractive growth opportunities in our specialty businesses. In recent months, however, more of our internal discussions sounded like an either/or type debate. Do we pursue one of the multitude of attractive projects in our specialty businesses or do we preserve liquidity, keep our powder dry, in case we need to fund more working capital investment in the nylon business? While we have been fully able to do so and will be able to going forward, the dialogue once again has brought into focus the fundamental difference in the nylon business and our other businesses.

I believe if we ever actually got into those either/or type decisions, we would sub-optimize both parts of the business. So simply stated, the review of strategic alternatives is simply to consider whether there is an alternative that will more fully enable the nylon business to reach its ultimate potential. If we identify such an alternative and execute on that in the same manner as we have done the last four years, it will be good for our shareholders, it will be good for our employees in that business, and it will be good for the business itself.

While we are still considering the full range of alternatives, it is intriguing to look at what a potential sale of the nylon business would mean for the rest of Solutia. It would, in our opinion, complete the transformation of SOA to a pure-play, high-margin, high-growth specialty chemical company. We think the new Solutia would have an abundance of value-creating opportunities for our shareholders. Certainly we would not be speaking with the intent of staying there. We think it would be a liberating event. We just have to make it happen, and we are fully focused on doing so.

Second, during the quarter, we announced our entree into the photovoltaic market on Slide Seven. As solar energy has begun to emerge as a cost-effective, sustainable solution for the world's energy needs, new opportunities for our Saflex segment began to emerge. With silicon prices rising due to the demand in the high-tech industry, thin film solar cell technology has come forward as a new solution for collecting the sun's energy. The photovoltaic thin film market is the most significant growth opportunity of any interlayer market segment today.

More importantly, the thin film photovoltaic subset, which incorporates PVB interlayer, has become one of the key technologies for high-volume commercialization opportunities for the Saflex business into the future. PVB has emerged as the preferred encapsulant material for use in thin film solar cells, due to the inherent qualities of – that PVB brings to traditional laminated glass, including edge stability, adhesion, moisture content and durability. In addition, PVB is one of the only encapsulant materials that can scale-up production to meet this high growth market.

Because of Solutia's previous investment over the past few years, we have the ability to enter this market without significant capital. If demand in the photovoltaics continue to grow at the expected rates, along with the continued growth in the architectural and automotive segments, new investment in PVB capacity may be considered. We are excited about the opportunities this new market will bring, and we expect it to grow into a third major market for Saflex segment within the next seven to ten years.

Moving on to Slide Eight, consistent with our asset reconfiguration plan which we have discussed with many of you previously, we announced the expansion of our PVB resins manufacturing at our Indian Orchard plant in Springfield, Massachusetts. This expansion is in addition to those announcements early in the year regarding the Antwerp, Belgium site, and the PVB sheet expansion ongoing at our Ghent, Belgium site. All of these signal our commitment to help our customers grow their businesses and meet the increasing demand of PVB globally.

In addition, in May we announced that we are seeking to expand our Crystex insoluble sulfur manufacturing capacity in the Asia-Pacific region. We are currently evaluating sites to best serve the rapidly growing China and Indian markets, and provide more local service to our customers in those regions.

Lastly, as it relates to noncore assets, in Technical Specialties, we announced the closure of our Ruabon, Wales facility. This facility represents about 25% of sales from the other rubber chemicals business or about 5% of the total Technical Specialties segment. As we noted last quarter, despite the outstanding efforts of our employees at the site, this business has underperformed, which prompted its rationalization. Going forward, we will continue to evaluate how best to leverage the remaining asset set within our other rubber chemicals business. We also announced in the quarter the sale-leaseback of our headquarters building here in St. Louis. This has allowed us to remain here in the building and pay down $42 million of debt.

Now I would like to shift gears and move on to Slide Nine and discuss our strategies for growth and operational excellence. On the growth front, we are capitalizing on the significant growth opportunities that exist for our businesses on a global basis, by implementing our multi-faceted growth strategy that I will review with you today. First, we are leveraging our market-leading positions to further grow our businesses. A great example of this effort is our recently announced initiative to enter the photovoltaic market, where we are leveraging Saflex's number one market share position to penetrate a high-growth adjacent market.

Second, we are taking advantage of strong growth within Asia and India driven by ongoing industrialization and improving socio-economical demographics in these emerging regions. To more fully participate in these important markets, we are prudently allocating our investments in business segments that provide the greatest opportunity for Solutia to grow profitably. For example, we have launched a new global market-facing organization concept for CPFilms that will provide greater emphasis on the significant growth occurring outside the US. This approach hinges upon a new focus on the major product categories that drive our business, and will be one of the keys to unlocking the potential of key growth markets like the architectural segment.

Third, we are developing innovation that has historically been a cornerstone of our market leadership, and will remain a major driver for our growth going forward. For example, the recent launch of our Saflex SilentGlass technology, which is an advanced acoustical interlayer system designed to dampen outdoor noises, is yet another example of our commitment to innovation.

Fourth, we are transforming certain businesses to unlock the value that exists in our asset base, much like what we have done in the nylon business over the past few years. Despite the recent slowdown in intermediate demand, we continue to capture virtually all of the growth in nylon 66 resins. And finally, our fifth leg of our growth strategy is strategic bolt-on acquisitions. While we don't have anything new to share with you today on this front, we are actively looking for businesses that would shore up our number one market positions, add complimentary technologies or solutions, or strengthen our geographic presence in key regions around the world. In addition to that five-part strategy, we will continue to look at the occasional shot down the field for larger-scale strategic transactions.

Operationally, our key initiatives are focused on strengthening our bottom line. As mentioned before, we have already seen our raw materials increase $182 million year-to-date, and this figure could potentially rise to in excess of $500 million for the entire year relative to 2007. We remain committed to recovering these cost increases, and will continue to analyze the appropriate timing and magnitude of implementing future pricing actions. Margin expansion will also be realized by focusing on manufacturing excellence. Asset performance is a key initiative for all of our businesses, and will remain at the forefront of our manufacturing excellence strategy going forward. A good example of this is in our Crystex business, which operated at very high levels during the quarter, supporting their strong market demand. In addition to 150 million pounds of new engineered resin capacity brought online in late March absorbed additional fixed costs of 10% compared to the first quarter of this year.

We are also constantly evaluating our logistics costs. This year our focus has been on cost containment, especially in light of record high fuel costs. A big portion of this strategy is more long term, and focused on better aligning our supply with market demand. Evidence of this initiative can be found in our recently announced Saflex facility expansion in Ghent, Belgium, that puts product in the right regions of the world where market demand is significant. The majority of this benefit will come in the fourth quarter and into 2009, after the expansion is completed.

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

Jim Sullivan

Thanks, Jeff, and good morning to everyone.

I will begin my discussion with Solutia's consolidated earnings and then break down our results by reporting segment. I will conclude with comments on cash flow, debt, and the bridge loan. As Susannah mentioned up front, to improve transparency with investors and highlight underlying sequential and year-over-year sales and earnings trends within the business, we have adjusted reported EBITDA in all periods for unusual items, both charges and gains, and we are also reporting against 2007 results with Flexsys included on a 100% basis. Page 11 of the slide presentation details the gains and charges we have excluded in our calculation of adjusted EBITDA for the second quarter 2008 and the second quarter 2007.

Briefly, as discussed on our first quarter earnings call, we implemented fresh start accounting at the end of February upon emergence. This required us to fair value our assets and liabilities, including inventory, which we stepped up in basis to $74 million. $25 million of this step up was charged to cost of goods sold in the first quarter, with the remaining $49 million taken in the second quarter. This noncash charge is excluded in our calculation of adjusted EBITDA.

In addition, during the quarter we announced our intention to exit the rubber chemicals manufacturing operations at our Ruabon, Wales facility in 2008. Consistent with Generally Accepted Accounting Principles, we recorded $6 million of charges in the quarter for severance and certain other decommissioning related activities. As we move forward in time, we would expect additional charges in line with what we detailed in our recent 8-K filing related to this portfolio improvement action.

Also in the second quarters of 2008 and 2007, we sold surplus real estate that generated gains of $3 million and $7 million respectively. Again, we have excluded these gains in both periods for purposes of calculating adjusted EBITDA. And finally, in the second quarter of 2007, we had a $21 million litigation gain and a $2 million Flexsys acquisition-related inventory charge. We have excluded these items in the calculation of our 2007 adjusted EBITDA. For reference, we have included tables in the appendix section of the slide presentation today that bridge reported EBITDA and EPS to adjusted EBITDA and adjusted EPS.

Turning to Slide 12, Solutia's consolidated and combined net sales for the quarter totaled $1.095 billion, up 14% year-over-year. Adjusted EBITDA was $118 million, up 27% over the second quarter of 2007, and adjusted EPS – or EPS was $0.28. Given that our pre-emergent share count in 2007 was different than today, the year-over-year comparison of EPS is not meaningful.

The $134 million or 14% increase in year-over-year sales is further broken down on Slide 13, with consolidated volumes accounting for 2% of the gain, selling prices 8% and currency exchange movements 4%. While on a consolidated basis, the volumes are only up 2%, this is a result of strong volume performance in each of our specialty chemicals segments, offset by weaker volumes in nylon. Slide 14 bridges the $25 million or 27% increase in year-over-year consolidated and combined adjusted EBITDA. Higher sales volumes and product mix, cost containment and solid manufacturing performance more than offset the $28 million EBITDA compression in the quarter, resulting from the negative spread between year-over-year higher raw materials and increased selling prices.

Speaking of raw materials, Slide 15 lays out the year-over-year quarterly movements we have seen with raw materials and selling prices, and the percentage recovery in the quarter. On a year-to-date basis, we have recovered 71% of the $182 million raw material cost push. Our recovery rate in the second quarter was 74%, up from 67% in the first quarter. It is important to note that while we continue to experience a lag in nylon, the remainder of the portfolio has been successful in more than fully recovering raw materials in both quarters.

Now let's turn to our segments. Saflex continues to deliver strong results, with net sales for the second quarter of 2008 at $220 million, up $31 million or 16% year-over-year. Volumes increased 5%, selling prices rose 3% and favorable currency exchange movements accounted for the remainder of the improvement. Strong international performance, where 75% of Saflex's revenue is derived, continues to offset some volume weakness in North America. In particular, we saw robust demand in the quarter in the European architectural and Asian architectural and automotive markets. In addition, Saflex continues to benefit from sales of auto replacement safety glass, which accounts for about 25% of this segment's consolidated sales.

Adjusted EBITDA for Saflex totaled $43 million, up $12 million or 39% compared to the prior-year period. Improved product mix and solid manufacturing performance contributed to a 300 basis point improvement in the adjusted EBITDA margin for the quarter. In addition, selling price increases kept pace with raw material cost increases in the quarter.

Slide 17, CPFilms net sales for the second quarter of 2008 totaled $71 million, up $5 million or 8% over the prior year. Volumes were up 6% and selling prices were up 2%. Here again, strong international volume growth in this segment continued to more than offset relatively weak US demand conditions, although the second quarter did show positive momentum in the US, following a difficult first quarter. And worldwide, we are seeing encouraging growth as dealers and distributors align with our branded market-facing growth strategy.

CPFilms' adjusted EBITDA totaled $22 million, up $2 million or 10% year-over-year. Higher gross profit from increased revenue in the quarter was reduced by approximately $1 million of year-over-year increased investment in the segment's global sales and marketing infrastructure. We believe these incremental investments which we have made in the first and second quarters of 2008 are prudent, and will continue to drive the strong future global market growth that we are seeking from this business. Notwithstanding the higher SG&A expense, second quarter results reflect a nice sequential uptick versus the first quarter, reflecting both an overall healthy rate of growth of the business and a rebalancing of the top and bottom line.

Technical Specialties continues to deliver outstanding results, with net sales for the second quarter of $275 million, up $68 million or 33% year-over-year. Volumes were up 15%, selling prices rose 11%, with the remaining year-over-year revenue growth coming from favorable currency exchange movements. Crystex, our premium insoluble sulfur product, continues to perform at outstanding levels along with our antidegradant rubber chemicals and Therminol heat transfer fluids product lines, due to the strong market position of each of these products.

The Technical Specialties segment also continues to benefit from sales into the global tire replacement market, which accounts for approximately 40% of the segment's revenue. Technical Specialties adjusted EBITDA totaled $58 million, up $23 million or 66% over the prior year. Strong top line growth more than offset increases in raw materials and unfavorable currency exchange movements, as many of our products in this segment are produced in euros and sold in US dollars. This segment also benefited from improved manufacturing performance due to higher asset utilization from increased volumes, all of which contributed to improved EBITDA margin from 17% last year to 21% this year, quite impressive, especially in light of the surge of raw materials that impacted this segment in the quarter.

Lastly, integrated nylon net sales for the second quarter 2008 were $518 million, up $29 million or 6% compared to 2007. Prices rose 10%, volumes declined by 5%, and currency exchange movements accounted for the difference. Sales volumes increased 28% in nylon, plastics and polymers. However, volumes in nylon intermediate chemicals, specifically merchant sales of adipic acid and acrylonitrile, and carpet fibers are not at the levels we experienced in 2007.

As the cost for raw materials continued to rise this past quarter, coupled with demand weakness in the US, some manufacturers who use our intermediate chemicals have temporarily idled their operations. Additionally, the depressed US housing market has adversely impacted carpet fiber volumes. However, with our continued low-cost convergence of fiber lines to plastic, this product line is becoming a smaller contributor to the nylon segment performance. The additional 150 million pounds of plastics capacity we brought online at the end of the first quarter is running very well, and we expect to sell 60% of this volume in 2008.

Nylon's adjusted EBITDA was $4 million in the second quarter 2008, down $27 million year-over-year, but up $11 million sequentially. The year-over-year decline in adjusted EBITDA was primarily due to unrecovered raw materials. In addition, logistics costs are adversely impacting this segment's results, due to the significant volume growth in plastics as well as fuel rate increases. Importantly, compared to the first quarter of 2008, asset utilization in nylon improved, mainly due to the new plastics capacity and fewer asset shutdowns in intermediate chemicals.

On Slide 20, we will talk about cash and debt. As we have mentioned in the past, cash generation and debt reduction are a priority for Solutia. You will note cash from operations before reorganization activities in the quarter was $52 million. Our cash profile improved significantly over the first quarter, primarily due to higher adjusted EBITDA, lower pension payments, no incentive payments, as we had in the first quarter of 2008, and lower seasonal working capital usage. Year-to-date cash from operations, excluding reorganization activities, was a use of $63 million. This included a $204 million increase in inventory and trade accounts receivable, of which approximately 60% is directly attributed to escalating raw material and energy cost, and the corresponding implementation of our selling price increases. Partially mitigating this substantial increase in working capital is an $85 million increase in accounts payable, related to higher input costs and improved supplier payment terms.

Effective management of working capital is a key focus for the company, and as we move forward in 2008, in particular in the fourth quarter, we will see net cash generation as the current relatively high working capital levels are monetized. Capital spending in the quarter totaled $40 million, up modestly from the first quarter. A big driver of this increase in quarterly spending was the Ghent Saflex expansion, which is on target to start up in the third quarter. With the completion of this project, the Ghent facility will be the largest, lowest-cost PVB plant in the world, and will position Solutia very well for the emerging photovoltaic opportunity.

Finally, the $42 million of proceeds from the sale of the Maryville headquarters building more than offset post-emergence reorganization payments made in the quarter, which were largely related to pre-emergence legal activity. Except for a modest tail in the third quarter, reorganization related spending is for the most part behind us.

With regard to debt, we ended the quarter with net debt of $1.756 billion versus $1.790 billion at the end of the first quarter. The second quarter's debt position was comprised of $181 million draw on our $450 million asset-based revolver, $1.194 billion on the term loan, $405 million on the bridge loan, and $35 million of short term debt netted against $47 million of cash. All this said, we have reduced net debt on a trailing 12-month adjusted EBITDA basis from 4.94 times at the end of the first quarter to 4.54 times at the end of the second quarter.

In addition, for the quarter ended June 30th, our total liquidity was a solid $242 million, up $37 million from the end of the first quarter. Lastly, I would now like to make a few comments on the status of our $400 million bridge loan. As mentioned during the first quarter conference call, we are evaluating all alternatives to replace this loan, given the high interest cost of 15.5% and the tax inefficiency of this debt in the context of our $1.2 billion US NOL.

We mentioned the securities demand holiday on this loan in our last earnings call, and as an update to that comment, you should be aware that we recently reached an agreement to effectively extend this holiday period through January 31st, 2009. Alternatives to replace the bridge could include lower cost debt, convertibles and/or equity for some portion or all of the loan. You will note we filed a universal mixed shelf registration on June 27th, which allows us to pursue a host of options. This shelf became effective on July 25th. At this point, we are continuing to closely monitor market conditions and are evaluating all financing alternatives.

Now I will turn it back to Jeff to talk about our 2008 outlook. Jeff?

Jeff Quinn

Thanks, Jim.

I will conclude with some brief comments on the outlook for the rest of the year. For our fiscal 2008, as previously stated, we are increasing our adjusted EBITDA guidance to a range of $400 million to $425 million, even assuming that the raw material cost environment remains at kind of the current record high levels. We expect capital expenditures to run in the $130 million to $140 million range for 2008. D&A will likely fall within the $135 million to $140 million range, and cash taxes will likely be around $20 million to $25 million for the year.

We take pride in the performance we have delivered during the second quarter in spite of the unprecedented raw material costs environment and the depressed US market. There's lots of noise due to the accounting around emergence, but when you look through the numbers, it was a very good quarter for us. We believe our leading positions and diversified portfolio, both geographically and by end market, provides us flexibility to allocate our resources to opportunities that present themselves and have the highest potential return for shareholders. We believe that the future for Solutia is bright, and we have a team that is focused on delivering that future.

Thanks for your time today. Now I would like to turn it over to Susannah to open it up for Q&A.

Susannah Livingston

Thank, Jeff. Michelle, if you could give some instructions, we will be ready to open it up for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Daniel Caruzo [ph] of Hayden Capital [ph]. Please proceed.

Daniel Caruzo – Hayden Capital

Hi, good morning. Great quarter.

Jeff Quinn

Thank you.

Daniel Caruzo – Hayden Capital

And good news on the delay in the security demand holiday, very happy to hear that. I guess these questions are for Jim. Your adjusted EBITDA was $118 million for the quarter and $206 million for the six months through June. On the last conference call you said that a good guide would be that 45% of adjusted EBITDA would hit in the first half of the year. So on that basis, we’d get to a single-point full-year adjusted EBITDA figure of $458 million for '08. Even if I only assume that third and fourth quarter EBITDA equals second quarter figures, even though you continue to book good sales growth, I could assume more aggressive than that, I still would get to $442 million of adjusted EBITDA. Is it possible that your newly increased range of adjusted EBITDA guidance of $400 million to $425 million is in fact a little bit on the conservative side?

Jim Sullivan

Daniel, the way I would answer that is we – our guidance is $400 million to $425 million. When we gave that split first half, second half, 45/55, a lot of that was driven by the raw material profile that we were experiencing and kind of what we expected. We have updated that. In addition, I would say that we had a really strong second quarter and we brought in a fair amount of the incremental earnings in the second quarter. You know, I think it is prudent for us to just stick to what we talked about in the presentation at $400 million to $425 million. But again, that is with very little expected from our nylon business.

Daniel Caruzo – Hayden Capital

Okay. Terrific. If I might follow up, what do you expect for the September quarter in terms of adjusted EBITDA relative to June's 118? I see you continue to put through significant price increases, and I am happy to see every one of those that comes through. They seem to be countering raw material and energy cost increases, and a lot of what you did in the second quarter, it really has a full quarter impact in the September quarter and only a partial impact in the June quarter. So I would assume that if you’d be able to book EBITDA, adjusted EBITDA in the September quarter that is about equal to June or maybe even better, is that a reasonable assumption?

Jim Sullivan

It is probably not unreasonable. We are not going to give out the third quarter guidance. But what I would tell you is the CPFilms and Saflex business, these businesses do have seasonality, with planned shutdowns in manufacturing units in August, for example, in Europe. So you will see some seasonality in those two segments. Technical Specialties will continue to be strong, with new prices going in effectively July 1, and we would expect a sequential uptick in nylon.

Daniel Caruzo – Hayden Capital

Okay. Final question, if I may. You recovered 67% and 74% of your raw materials cost increases via price increases in March and June. What would be a good range to assume for that kind of percentage recovery in the September quarter, based on what you know about the quarter to date? And I recognize you only know about one-third of the quarter today.

Jim Sullivan

We continue to push our prices as hard as we can taking into consideration the market conditions. So we will continue to work that to as high a level as possible. As I said, we do expect a better recovery in our nylon business, but I really don't want to speculate on how that will translate into overall recovery for the corporation. But we are very focused on that. It is important for us to get value in the market from the services and products that we deliver.

Daniel Caruzo – Hayden Capital

Okay. Thanks, Jim. Congratulations, everybody.

Jim Sullivan

Thanks.

Operator

Your next question comes from the line of Randy Laufman of Imperial Capital. Please proceed.

Randy Laufman – Imperial Capital

Hi, good morning, guys. Nice quarter.

Jeff Quinn

Thanks, Randy.

Randy Laufman – Imperial Capital

A couple of questions. Number one, just talking about the nylon segment it looks like on a net basis, raw material increases minus price increases was about a negative 90% impact on margins, if you just net it together, and I know 40% is contracted reset on a quarterly basis. How much of that was reflected in the second quarter and how much recovery should we expect going forward to dip into that net 90% decline?

Jim Sullivan

Randy, thanks for the question. I think as we think about nylon for the back half of the year and the reason why we do believe that there will be improvements there sequentially versus the first half, is a couple of factors. First, we have put in place new price increases that went into effect starting at the beginning of the third quarter. With raw materials appearing to plateau a bit, we will see improved recovery from those actions. In addition, recall that in the first quarter, we brought out this new tranche of capacity in plastics. We only had the benefit of that for one quarter, the first half of the year. We will have it available to us the full back half of the year. The caution –

Unidentified Company Participant

(inaudible) management incorporated.

Jeff Quinn

I'm sorry? The caution that we have in nylon really is around our volumes and pricing in our merchant intermediate chemical businesses, in particular adipic acid and acrylonitril. We talked about that in our prepared remarks.

Randy Laufman – Imperial Capital

Great. Thank you. And then touching on the Technical Specialties segment, it looks like the margins – your margin was a little lower this quarter and expectations with kind of divesting some of those other rubber chemicals is that margins should be increasing. I was wondering if you could talk about that, and whether that was really kind of the impact of some of the cost in foreign currencies or what your expectation for margins in that segment are going forward?

Jeff Quinn

Randy, I think you're right in that as we – as we exit the other rubber chemical segment, we expect over the mid to long-term that margins in that segment will improve.

Jim Sullivan

Yes. And as you know, we had a very, very strong quarter in the second quarter. We had a strong quarter in the first quarter. If you were to do – as you point out, if you do the margin analysis, while it is very good year-over-year, sequentially the margin went down a little bit. And I would say that that is primarily due to the run-up in raw materials in this business experienced in the second quarter. Sulfur, for example, is a key raw material for this business, and we saw dramatic increases sequentially in raw materials. Now, we have instituted price increases, and those price increases should start to come through in the third quarter.

Jeff Quinn

Yes. And the Ruabon closure has not yet impacted the numbers. In the second quarter, the numbers still basically include the Ruabon products throughout the quarter.

Randy Laufman – Imperial Capital

Okay. Great. Thanks a lot, guys. Nice quarter.

Jeff Quinn

Thank you.

Operator

Your next question comes from the line of Navin Murthy of Stornoway Portfolio Management. Please proceed.

Navin Murthy – Stornoway Portfolio Management

Hi. Just in terms of the fair valuation of your inventories, you mentioned that 60% of the increase is attributable to higher raw material and energy costs. Is that to say that the other 40% is attributable to an increase in units?

Jim Sullivan

Yeah. There is some parity impact but not significant. So there would be some volume increase versus our year-end position but that's normal at this time of year. I mean there is a seasonality to this business. I mentioned that there are some planned shutdowns in the back half of the year in certain of the businesses that will bring inventory down in kind of a planned manner. So as I commented when we were talking about cash flow and monetization of these working capital levels, we would expect to get the volume-related – most of the volume-related benefits later in the year. But you are right. I mean, a large portion of what we saw year-to-date is just due simply to the significant push we’ve seen on raw materials and our reaction in terms of raising prices.

Navin Murthy – Stornoway Portfolio Management

In terms of that monetization, when do you expect that when you say end of year? Are you saying Q3, Q4?

Jim Sullivan

Yeah, mostly in Q4.

Navin Murthy – Stornoway Portfolio Management

And what do you anticipate would be the magnitude of such a release of excess working capital?

Jim Sullivan

Yes, it's really hard to pinpoint because again it just absolutely depends on the exact timing of raw materials. You know, I would say that if things work out perfectly, the way we think right now that we are looking at order of magnitude $25 million to $50 million of cash generation from working capital in that kind of late fourth quarter timeframe.

Navin Murthy – Stornoway Portfolio Management

Okay. Thank you.

Jim Sullivan

Okay.

Operator

Your next question comes from the line of Gentry Klein [ph] of Cedrus Capital [ph]. Please proceed.

Gentry Klein – Cedrus Capital

Hey guys, great quarter.

Jeff Quinn

Thank, Gentry.

Gentry Klein – Cedrus Capital

On Technical Specialties, can you break out the volume growth by business? If that was really – was it Crystex related or Therminol, any sense you can give on that?

Jim Sullivan

We had very strong volumes in Crystex, Therminol and the antidegradant business, the Saflex business, Gentry. We really don't want to break that out by product line.

Gentry Klein – Cedrus Capital

Okay. With tire demand in North America declining, how should we think about the Crystex business going forward for the rest of the year?

Jeff Quinn

Gentry, I think the business is very strong and will continue to perform as it has so far this year. The ex-US demand still continues to be very, very strong.

Jim Sullivan

And Gentry, 80% of the sales in Flexsys, the former Flexsys, is really outside of the US.

Jeff Quinn

And we are finding – Gentry, I guess, finally on Crystex, we're finding that the current raw material environment has created opportunities for growth, because we are the strongest player in the space.

Gentry Klein – Cedrus Capital

And on integrated nylon, with regard to the 66 plastics, in terms of shipments outside the US, are you seeing any competition from any other competitors shipping to Asia?

Jeff Quinn

There's certainly significant competition in the Asian marketplace, Gentry. I think that is a significant growth opportunity in the nylon resin market, and that's where everybody is focused.

Jim Sullivan

And Gentry, I think what is contributing to that we have talked in the past about the very tight conditions with respect to the proprietary chemicals in nylon 66. That's true, if you will, over the last few years in the mid-term. But what is loosening that up a bit is the dramatic downturn that we have seen in – not only us, but our competitors have seen in the US carpet fiber areas. So these intermediates that were going into carpet fiber are finding their way into plastics that are competing in Asia right now.

Gentry Klein – Cedrus Capital

Okay. Thanks a lot. Great quarter.

Jim Sullivan

Thank you.

Operator

And your next question comes from the line of Bo Hunt of Banc of America. Please proceed.

Bo Hunt – Banc of America Securities

Hi, guys. As I look at your really nice year-over-year improvement in margins at your specialty businesses in the quarter, you mentioned that the manufacturing cost efficiencies were a big part of that improvement. I know you mentioned that asset utilization was a big part of that. I was hoping you could give a little more detail in terms of how we could measure it in terms of a operating metric, whether it is operating rate, something like that, to sort of quantify that manufacturing cost improvement?

Jim Sullivan

You know our focus in terms of manufacturing excellence is primarily on making sure when we want the unit to meet the demand, it is there and available to us. So we are very much focused on reliability. You know, with raw materials at record levels, yields are incredibly important. So that is a focus for us. And then just as a general practice, we are always watching our spending across the enterprise and where we can, we contain that cost. You know, it is just a focus we really have across the portfolio.

Bo Hunt – Banc of America Securities

Okay. So this is beyond just running your plants harder?

Jim Sullivan

Oh, absolutely.

Bo Hunt – Banc of America Securities

Okay. Got you. And then if current demand trends hold the way you have already talked about on the call, should we expect to see a similar sort of improvement in unit manufacturing costs in the third quarter on a year-over-year basis?

Jim Sullivan

Yes. Recall that we commented that in, for example, in the Technical Specialties segment and Saflex, there are planned shutdowns in the third and fourth quarters, which is typical.

Bo Hunt – Banc of America Securities

That's helpful. Thanks, guys.

Jim Sullivan

Okay.

Operator

Your next question comes from the line of Jim Stahl [ph] of Merrill Lynch. Please proceed.

Jim Stahl – Merrill Lynch

Hi, guys. Great quarter.

Jeff Quinn

Thank, Jim.

Jim Stahl – Merrill Lynch

Just had a kind of another question on the Technical Specialties and the Flexsys business, I think you talked about Crystex doing very well. I was hoping you could comment on the industry factors of the PPD and other more commodity rubber chemicals. I think there was some expectation that new capacity was coming online. Maybe you can just comment on the overall industry and competitive nature in those segments?

Jeff Quinn

Jim, unfortunately we weren't able to hear your question. You broke up.

Jim Stahl – Merrill Lynch

Sorry about that. I was just hoping you could comment on the basic rubber chemicals and PPD sub-segments within Flexsys? Are you experiencing a lot of competition there? Did you perform well on those sub-segments are you seeing capacity come on line from other competitors?

Jeff Quinn

Jim, I think that the answer to that is yes. I mean there is competition. We are seeing some – some capacity come on line. Some of the capacity announcements are just that, announcements. But we are seeing some capacity come online. But that being said, the – the demand trends in the PPD segment remain very strong, and that line remains a very profitable segment for us at this point. In terms of the other rubber chemical portion of – the Flexsys portfolio, sort of that other $200 million of revenue, we remain very focused on sort of rationalizing and managing that portion of the portfolio as we have talked about, with the Ruabon closure being the first step in that process.

Jim Stahl – Merrill Lynch

Okay, great. So you would I guess say that the competitive factors have lessened, or you guys are just remaining very competitive and prices are expected to hold in there, longer term?

Jim Sullivan

Yes. And PPD's pricing in this segment has remained very, very stable.

Jim Stahl – Merrill Lynch

Great. Thank you.

Operator

Your next question comes from the line of Laurence Jollon of Lehman Brothers. Please proceed.

Laurence Jollon – Lehman Brothers

Regarding the sale of your nylon business, does your credit agreement require that any asset sale proceeds be used to pay down the revolver or the term loan, or can you use proceeds for CapEx or acquisitions?

Jim Sullivan

Yes, the credit agreement would have to be modified to facilitate the sale of the nylon business, and so that would probably involve paying down debt.

Laurence Jollon – Lehman Brothers

Okay. And then I know your priorities are cash flow generation and debt reduction. I was just curious if you have a targeted leverage range? Specifically, I am just thinking through how potential bolt-on acquisitions may kind of hinder any –?

Jeff Quinn

Right. I think over the long term, we are comfortable running the business with sort of a 3X type of leverage. Obviously being 4.5 is a bit – a bit north of where we would like to be. But we believe that the type of strategic bolt-on acquisitions that we are working hard on in looking at are very consistent with that concept of getting our leverage down to 3X. I don't think it is an either/or type thing. I think we can do both.

Jim Sullivan

Okay. And as Jeff talked about earlier, within the other rubber chemicals, there are businesses that perform quite nicely in that segment that we would potentially look to divest to generate cash. So kind of like we did in the second quarter with the Maryville, we are scrutinizing really all of our noncore assets across the portfolio, and we will do what we can to provide cash generation to help us do these bolt-on, highly accretive strategic acquisitions.

Jeff Quinn

Yes, Laurence, I’ve used the analogy, we are doing now to the Flexsys portfolio kind of what we did to the overall portfolio in the course of the reorganization. And so I think there will be variety of actions there that will help – help fund sort of the ample opportunities that exist across the rest of the portfolio.

Laurence Jollon – Lehman Brothers

Okay. Thank you both.

Operator

Your next question comes from the line of Jay Labunski [ph] of West Face Capital. Please proceed.

Jay Labunski – West Face Capital

Hi, just a quick question. Of the $390 million ex-nylon EBITDA that you are forecasting for '08, how much of that is assumed to be unallocated corporate costs?

Jim Sullivan

We are really not going to get into breaking down the numbers between the segments within specialty or the core.

Jay Labunski – West Face Capital

Okay.

Operator

Your next question comes from the line of Justin Boisseau of Gates Capital Management. Please proceed.

Justin Boisseau – Gates Capital Management

Hi, thanks. Just wanted to make sure I understood correctly. You said first half of the year, the cash from operations for re-org was a use of 63, and you expected to have some recaps in back half of the year. What do you expect that number, the cash flow from ops before re-org, to be either for the second half or the full year? Thanks.

Jim Sullivan

Well, I think we have given kind of guidance on the key drivers within the cash flow in terms of EBITDA, interest, CapEx and working capital. I mentioned that in working capital, we would expect $25 million to $50 million of cash generation from the levels that we had at the end of the second quarter. But again, we are not going to get into forecasting or predicting for – you know, specifically around cash from operations excluding re-org items. I mean, again, we are very focused on that but timing of raw materials in the month of December can dramatically impact, for example, what the cash flow is for the year. So, we think it is prudent just to give you guys the key drivers of cash flow and let you put your models together on the basis that you think is appropriate.

Justin Boisseau – Gates Capital Management

Very good. Thanks.

Operator

And your next question comes from the line of Jerauld Dickerson [ph] of Technology and Issues Communications [ph]. Please proceed.

Jerauld Dickerson – Technology and Issues Communications

Yes. Jeff, I'd like to echo my comments on your numbers this quarter, and you did this while you are expanding and also cutting costs and containing them. My question has to do with the nylon business. Do you have a prospectus or put a package together yet and any potential suitors?

Jeff Quinn

That process and the whole review of strategic alternatives is progressing, and we have made good progress towards looking at that in a prudent timeframe, and are moving forward, but we are not going to conclusively [ph] going to provide an exact timeframe for any part of that process.

Jerauld Dickerson – Technology and Issues Communications

Thank you.

Operator

And that does conclude the question-and-answer session. Oh actually, we have one more that popped in from the line of Navin Murthy. Please proceed.

Navin Murthy – Stornoway Portfolio Management

Hi, can you provide some more color on the normalization of trade credit?

Jeff Quinn

Well, it's of course coming out of Chapter 11, it has been a big focus of ours to work with our suppliers to improve our trade credit. You know, I believe as the company continues to progress, gets several quarters underneath its belt in terms of performance as we work in improving our leverage, et cetera, that we would continue to see some benefits that are kind of one-time in nature related to that. I think we saw some of that in the second quarter. A fair amount of that $85 million increase, however, was due simply to just the rise in materials. But it is something we are very focused on, and we will continue to look as a source of incremental liquidity moving forward over the next several quarters.

Navin Murthy – Stornoway Portfolio Management

And that $20 million to $50 million potential release of excess working capital, does that factor in a normalization of trade credit or is that just simply reducing inventories and receivables?

Jim Sullivan

No, when I made that comment I was thinking about inventory, trade receivables and accounts payable.

Navin Murthy – Stornoway Portfolio Management

Okay. Great. Thank you.

Jim Sullivan

Thank you very much.

Operator

That does conclude the question-and-answer session. I will now turn it back to Susanne for close regular marks.

Susannah Livingston

Just thank you for your time today and your interest in Solutia. And if you have any additional questions, feel free to call me at the number on the press release.

Jeff Quinn

Thanks very much, everyone.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Solutia Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts