Chemtura Corporation Q3 2008 Earnings Call Transcript

Chemtura Corporation (CEM)

Q3 2008 Earnings Call

October 31, 2008 09:00 am ET

Executives

Stephen Forsyth - EVP, CFO and Treasurer

Bob Wood - Chairman and CEO

Analysts

David Begleiter - Deutsche Bank Securities

Bob Koort - Goldman Sachs

Mike Judd - Greenwich Consultants

Steve Schwartz - First Analysis Securities Corp.

Dmitry Silversteyn - Longbow Research, LLC

Edward Yang - Oppenheimer & Co.

Bill Hoffman

Ivan Marques

Tariq Ahmed

Presentation

Operator

Ladies and gentlemen, thank you for holding. My name is David and I will be your conference operator today. At this time I'd like to welcome everyone to the Chemtura third quarter 2008 earnings release conference call. (Operator Instructions).

Thank you. Mr. Forsyth, you may begin your conference.

Stephen Forsyth

Thank you. Well, welcome, everybody, to Chemtura's third quarter 2008 investor conference call. With me today is Bob Wood, Chemtura's Chairman and CEO. To complement our press release issued last night, as usual, we have provided additional quarterly information that can be found in the Investor Relations section of Chemtura's website.

Now let me revisit our usually cautionary reminders. Today's conference call and webcast commentary may include certain forward-looking statements, which by their nature, involve risks and uncertainties. Further information about such risk and uncertainties can be found in Chemtura's filings with the Securities and Exchange Commission.

Such statements reflect Chemtura's best estimates and assumptions based on currently available information and actual results may differ significantly from any prospective results discussed today. Forward-looking information is intended to reflect the opinions as of the date of this call, and such information will not necessarily be updated by the company.

Well, having covered the formalities, I will now turn the call over to Bob Wood.

Bob Wood

Thank you, Stephen. Good morning everyone and thank you for joining us today. As usual on today's call, Stephen will cover the financial details and I will discuss the trends in our business.

I want to cover three topics with you today: first, our performance in the third quarter; second, our assessment of what the specific effects on our company would be in 2009 of the changes in the macroeconomic outlook for the global economy; and three, our liquidity profile.

Let's start with third quarter performance. Chemtura continues to improve our operating performance and generate better financial results. The third quarter results represent the fourth consecutive quarter of year-over-year earnings improvement.

We achieved improvement in this quarter despite some adverse conditions, including severe raw material cost inflation, as well as the Gulf Coast hurricanes, which reduced revenues in our Polymeric Additives, and a soft end to what has been a weaker pool season for the consumer businesses.

Overall, however, it was a quarter of continued progress despite the challenges. Earnings per share from continuing operations on a managed basis for the quarter were $0.11 versus $0.07 for the year-ago quarter, exceeding First Call consensus.

Gross profit margins were 21% for the quarter versus 22% for the year-ago quarter. Gross margin was negatively affected by the impact of relentless cost increases over the last four quarters.

Our total raw material and energy costs were $67 million higher in this quarter than they were in the third quarter of 2007, but in the quarter we were able to increase selling prices by $59 million.

Our initiatives to increase the speed with which we pass on changes in raw material costs are delivering results, reducing the gap between changes in raw material costs and selling prices to only $8 million in the third quarter, the best performance this year.

Even so, the $8 million gap somewhat obscured the benefits of our cost reduction efforts, manufacturing rationalization and productivity improvements in many of our plans. But these actions kept us from experiencing a significant reduction in earnings for the quarter.

Having chased raw material inflation for the last seven or eight quarters, there is now a change in trend. In recent weeks, we have seen the spot prices of key commodities start to fall. While it can take time for such changes to work their way down the supply chain, we should start to see some relief in raw material costs later in the fourth quarter.

With manufacturing cycle times and inventory affects, it will likely be the first quarter of 2009 before we see sequential improvement in our cost of goods sold. Improvements in a year-on-year comparison may take longer, as raw material costs must fall significantly before they are below the costs seen in the first and second quarters of 2008.

Turning to business performance, our Crop Protection business had another great quarter. Revenue was up 24% and operating income improved by 64% to $18 million compared to $11 million a year ago.

We've continued to benefit from strong agricultural demand globally, and we have created positive advantage by leveraging our product portfolio in our worldwide distribution channels.

Performance Specialties continued its strong performance as well. Revenue increased 14% and operating income increased 11%, despite raw material, energy and freight costs increases.

Consumer Products had one of their weaker pool seasons. In the third quarter, revenues declined 13% or $18 million compared with the third quarter of 2007, mainly due to lower volumes.

After a cold and wet start in North America and inventory overhangs in Europe from the 2007 floods, we saw a slow end to the 2008 season. We believe partially due to the uncertainty about the economy that is constraining consumer spending. As a result, operating profit declined 20% or $4 million.

We continue to have confidence in our consumer business, even though operating income declined in the quarter compared to last year. We were able to maintain strong relationships with the key customers in our most important channels, as well as increase selling prices.

However, this was not enough to overcome higher input costs, freight fuel surcharges and what proved to be again one of the weakest pool seasons in recent years. Nonetheless, the business is sound and we expect the 2009 season to benefit from the full year of increases in selling prices.

Polymer Additives revenues were $414 million, $33 million lower than the second quarter of 2007. The biggest factor was a $45 million reduction, due to the divestures of OleoChemicals in the first quarter of 2008 and the divestiture of Organic Peroxides in the third quarter of 2007.

Volume also declined by $21 million, primarily related to plastics antioxidants. These reductions were partially offset by higher selling prices of $25 million, improved mix, and favorable foreign currency translation of $8 million.

Year-on-year increases in energy and raw material costs were $37 million in the quarter. Selling prices increases offset all but $12 million of this inflationary effect. This represents an outstanding job by our commercial team in achieving selling price improvement in the face of difficult supply demand dynamics.

The hurricanes that hit the Gulf Coast in early September resulted in our Taft, Louisiana facility being closed for four days. However, it took longer to overcome the disruption of raw material supplies and customer demand, as all who had been impacted restored their operations. The negative impact on operating income for the quarter due to the hurricanes was approximately $3 million.

With the benefit of product mix, cost reductions, volume gains, and foreign exchange translation; we were able to contain the decrease in the operating income to only $2 million or 13% in the quarter versus last year for Polymer Additives.

Although there was positive demand for clear brine fluids used in drilling applications, the combination of lower sales in plastics antioxidants, disruptions from the Gulf Coast hurricanes, slowing demand for flame retardant products, particularly in electronics applications and the relentless rise in raw material and energy costs; was more than the business could overcome in the quarter versus last year. This remains our most challenged business, we're making progress but there's more work to do.

We continue to benefit from the restructuring actions taken in 2007. On a managed basis SGA&R expenses were down 13% or $13 million from the third quarter of 2007. Year-to-date, SGA&R is now $41 million lower than 2007.

These reductions have helped the company overcome the impacts of raw material cost inflation and report higher overall operating profit. Managing our cost in light of the external conditions remains a critical focus.

Looking back at the quarter, despite an uphill climb we achieved improved operating income from 5.6% of revenue in the third quarter 2007 to 6.1% in the third quarter of this year. While still far from where we expect to be, it represents progress under some very challenging industry conditions.

As we look toward 2009, we are now tightly focused on managing our performance in the fourth quarter of 2008 and understanding the implications and outlook of 2009. Like most companies, we're assessing what the specific effects of the credit environment will be on our company in 2009, as well as the macroeconomic outlook for the global economy. Many of our customers are beginning to anticipate reduced demand in 2009, and some are already reducing their requirements.

Chemtura's four businesses serve the needs of a diverse set of industries, each with different exposures to macroeconomic changes. Some may be impacted by recession and some may not. Some may see impacts sooner and others later.

For example, the electronics market has seen demands soften as the year has progressed, and now in the fourth quarter we're seeing customers in the Asian region take actions to reduce production and destock inventories. Needless to say, we're taking comparable actions to manage our own operations.

Meanwhile, our Petroleum Additives business has continued to grow despite higher oil prices and lower new automobile production. They have and are developing alternative markets for their products that can substitute for declines in demand.

In building and construction applications, we've seen end market demand soften for at least four quarters. Nonetheless, we've been able to offset much of the impact through co-producer deals in the diversity of the applications we serve. It's too soon to have a definitive view of the demand in 2009, but it will be challenging.

In these applications, the evolution of raw material costs and selling prices will be as important as any changes in unit volume as supply and demand balances find equilibrium. Our crop business is sustained by the global demand for food and continued growth in emerging markets.

Our consumer business has just completed a difficult season due to weather, increased input costs and fuel surcharges, as well as consumer uncertainty. It's unlikely that all of these factors will reoccur in 2009 and we will have the benefits of the actions taken to improve prices and reduce costs this year.

We will all learn more as the fourth quarter progresses, but our focus is clear; we'll take actions to sustain cash flow and profitability in anticipation of demand from certain industries declining.

Let's turn to our liquidity profile. The first critical fact is that today, we have significant and sufficient liquidity. As of September 30, 2008, we had $107 million in cash on hand, revolver availability of approximately $580 million, and additional capacity under our accounts receivable securitization lines, and we are comfortably in compliance with our financial maintenance covenants.

That being said, with the uncertainties about the global economy in the financial markets, it is prudent management to seek ways to expand that liquidity and reduce debt levels. We have several options to address our July 2009 debt maturity. If financial markets are attractive, we will consider refinancing that debt.

However, if financial market conditions remain difficult, we have other sources of liquidity; including our revolver, our cash balances, and the additional cash we can generate in the coming months. Finally, any proceeds from any asset sale would be used to reduce debt first.

To achieve our objectives, create additional liquidity and continue to delever, we have implemented a five-point plan. First, we're reducing inventories to free up meaningful cash reserves, though this may cause some cost absorption effects in some of our plants and result in manufacturing variances in the fourth quarter of 2008. We will continue these initiatives in 2009.

We've decreased our planned 2008 capital spending by $25 million and are reevaluating our spending plans for 2009. We will maintain tight cost control on discretionary spending and take appropriate steps to rationalize capacity as demand dictates.

In line with our announcement on June 26, 2008, we continue to actively evaluate strategic options including among other options, select business divestitures, value-creating acquisitions and changes in the company's capital structure. Today's market conditions may extend the conclusion of these deliberations slightly longer than we had originally expected. We, nonetheless, continue making progress.

Finally, we've decided to suspend the payment of our dividend with immediate effect to conserve liquidity and increase our financial flexibility and options. By taking these steps to expand our liquidity further, we remain confident that we will continue to have sufficient liquidity to continue to build our enterprise.

In summary, we continue to meet the challenges of difficult industry and macroeconomic conditions. Our core businesses are performing well. We have a focused and specific program to continue improving an already solid liquidity program, and finally we have an intense focus on controlling what we can control, despite the conditions that we face. We are on solid ground and improving as we move toward 2009.

Now I will turn the call over to our CFO, Stephen Forsyth, who will discuss the third quarter financial results. Stephen?

Stephen Forsyth

Thank you, Bob. Well, in my comments this morning, I'm going to review our cash flow in the quarter as well as dig a little deeper into our liquidity as of September 30, 2008. So, first, let me start by reviewing our cash flow for the third quarter.

As many investors are aware, in the first half of each year, the company traditionally uses cash as working capital builds and as we move into the seasonally strong period for our consumer and crop businesses. The company's annual cash cycle then sees a cash inflow in the second half of the year, as that seasonal working capital declines.

This year is no different, although raw material inflation has increased the amplitude of the cycle. Net cash provided by operations in the third quarter was $68 million compared to $124 million provided by operations in the third quarter of 2007. Now, these inflows are net of the change in our accounts receivable securitization programs.

Accounts receivable securitization as of September 30 was $313 million, a reduction in the quarter of $37 million. If you exclude that reduction in the utilization of those facilities, the net cash provided by operations this quarter, in the third quarter of 2008, was $105 million compared to $127 million provided by operations in the third quarter of 2007.

We dig more into more detail around those net cash inflows. Net working capital; that's accounts receivable, inventory, less accounts payable reduced in constant currency terms by $70 million in the third quarter, reflecting the benefit of a reduction of over $100 million in our accounts receivable outstanding between September 30 and June 30.

Inventory, however, in constant currency, grew by $24 million in the quarter with raw material inflation continuing to be the most significant component. As you would expect, as the unit cost of items in inventory increases because of the raw material content value has increased, so our inventories grow.

As we've reported in our financial statements, this has been the highest quarter yet of raw material inflation, and that's reflected in the growth in inventory levels. If we look at the year-to-date, total inventories in constant currency have grown by about $96 million, and of that approximately $50 million of that growth comes from that raw material inflation effect.

Now, while we have that influence of raw material inflation, our businesses are redoubling their efforts to reduce inventories in the fourth quarter. It's both a prudent source of cash, it's also a way of managing if we now are to see raw material costs fall, the impacts of that declining value in raw materials upon the cost of our products. We will continue those efforts in 2009.

Now, as Bob has noted, inventory reductions will probably reduce the absorption of cost within our plants and we anticipate that we will see some increased negative manufacturing variances in the fourth quarter of 2008 and the first quarter of 2009. Nevertheless, the net cash flow benefit will outweigh this cost.

From a cash used in investing perspective, we used $46 million this quarter compared to $2 million in the third quarter of 2007, when we had divestiture proceeds to offset the cost of capital spending. Capital spending in the quarter was $35 million compared to $27 million in 2007.

In light of the demand outlook, the company has reduced its anticipated capital expenditure plans for the calendar year of 2008. We'd originally advised you an intent to spend $165 million this year and we've now reduced that to $140 million.

The spending in the fourth quarter will now just be those projects that had been previously committed and commenced. Those expenditures include for the year as a whole, the costs associated with the consolidation of our legacy ERP systems onto a single instance of SAP. As we look forward to 2009, we are reevaluating capital expenditure plans to reduce expenditures in light of the slowing economy.

With the benefit of the inflows during the quarter, total debt as of September 30 was $1.96 billion, a modest reduction of $19 million from June 30, 2008. You will see we also utilized cash to reduce our drawings under our accounts receivable securitization lines by $37 million. Cash and cash equivalents were $107 million as of September 30, compared to $110 million as of June 2008.

So, in summary, the company has generated significant free cash flow in the third quarter and has modestly reduced debt. The company's initiatives to reduce working capital and capital expenditures are focused on maintaining positive free cash flow that can be applied to debt reduction. The more the company can generate cash and deliver, the greater its liquidity and its financial flexibility will be.

So, just to look in a little more depth at our liquidity, as you have seen from our balance sheet, we have 107 million of cash and cash equivalents on hand. We also have significant undrawn borrowing capacity under our bank revolver agreement. That revolver agreement, that has a maturity in July of 2010, is in the face amount of $750 million.

Today, we use approximately 100 million as non-cash credit support for things such as letters of credit, and as of September 30, had cash drawings of approximately 70 million. Deducting for these items, you're left with the undrawn borrowing capacity of 580 million that we noted. In addition, we also have capacity under our US and European accounts receivable securitization facilities.

As of September 30, we were comfortably in compliance with the financial maintenance covenants under our revolver agreements. And I know many of you ask about these, so let me just briefly review those. First, we have an interest coverage test, whereby EBITDA should be at least 4.5 times interest expense. Today, we're well north of five times coverage. We also have a leverage test that measures total debt to EBITDA.

Now, total debt for the purpose of this covenant is defined as balance sheet debt plus certain specific contingent liabilities specified in the agreements, which are things such as guarantees and joint venture debts and they usually sum to an amount of $50 million or less. As of the end of September, we were at 2.7 times versus the requirement to be less than three times, so comfortably in compliance.

So we're now focusing on generating additional liquidity through working capital reduction, capital expenditure reductions, suspension of the dividend. We are focusing on reducing total debt, so that we have increased financial flexibility in this uncertain economic period.

As Bob has noted, by taking these proactive steps to expand our liquidity, we remain confident that we will satisfy our debt maturity obligations in 2009, while still continuing to build our enterprise.

Well, that completes our prepared comments. I will now turn the call back to the Operator, so that we may start the question-and-answer section of this call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Begleiter. Your line is open sir.

David Begleiter - Deutsche Bank Securities

Good morning.

Bob Wood

Good morning.

David Begleiter - Deutsche Bank Securities

Bob and Steve, can you comment or quantify the manufacturing variance that will be caused by the reduction in inventories in Q4 and Q1?

Stephen Forsyth

I can't give a specific number because it will depend on the timing and mix of inventories affected. But you could look spread over a couple of quarters at $10 million or $15 million cumulatively of variances if you were to reduce inventory by say, $50 million or $60 million.

David Begleiter - Deutsche Bank Securities

That's very helpful, thank you. And just in crop, can you quantify the currency headwinds that you might face in Q4 from Brazil in crop?

Stephen Forsyth

Yes, well, the irony is that, there really is less of a currency headwind for us because the Brazilian currency has devalued against the US dollar. The folks that handle the distribution of the products and the sales of the products to the growers and to the distributors, are based in Brazil and so, that SG&A component, which is sizable in a crop business, is denominated in the Brazilian currency.

We obviously manufacture some of our goods in Brazil, but we manufacture others in North America and import them to Brazil. Now, those costs will increase. However, a lot of them are related to crops that the Brazilian growers will export. And so their export prices will increase and offset the fact that there will be an increased cost component in what they get from us in Brazilian currency terms.

So, we're not so concerned about that change in the value of the Brazilian currency, but we do monitor how those emerging economies are performing to make sure that we're comfortable, that the growers from a financial capability will have the ability to pay for the products that they purchase.

David Begleiter - Deutsche Bank Securities

And last, just how is demand in October trending in the US and Western Europe?

Bob Wood

It varies by business, David. In the polymer business, it's relatively soft. That's driven in part by electronics in Asia. If you look at North America and Western Europe, I'd say we've seen some decline but less so than we've seen that associated with the businesses in the Asian region. Petroleum additives has declined a little bit, but it's still a pretty solid business.

David Begleiter - Deutsche Bank Securities

Thank you very much.

Operator

Your next question comes from Bob Koort. Your line is open.

Bob Koort - Goldman Sachs

Thanks good morning guys.

Stephen Forsyth

Good morning, Bob.

Bob Wood

Good morning.

Bob Koort - Goldman Sachs

Even if your debt levels held at current levels, how much EBITDA wiggle room do you have before you get down to that 4.5 times threshold? In other words, if we looked forward a year and somehow you retain your debt level, how much could EBITDA compress before you would hit that threshold?

Stephen Forsyth

Well, in terms of the interest coverage threshold, it's 4.5 times interest expense, so interest expense is $80 million. So EBITDA would have to decline below $360 million before you had a problem.

Now, what you see us doing in terms of our actions is we want to reduce total debt and interest expense, so you'll expand further your wiggle room, as you move through this period of economic uncertainty. So hence the religious focus on generating cash and being able to apply that to manage our debt levels.

Bob Koort - Goldman Sachs

And if you were to trip that covenant, what are the repercussions?

Stephen Forsyth

Well, for any company that trips a financial maintenance covenant, you then have to go talk to your bank group and see what relief they will give you with respect to that covenants. Our plan is not to be in that circumstance.

Bob Koort - Goldman Sachs

Sure. And Bob, you mentioned the pool season is a little disappointing. And it seems like it has been a pretty volatile business since you've owned it. Has that business fundamentally changed or what's sort of gone differently from historically when Great Lakes ran it? An occasional manufacturing blip was in there, but it seemed to have a little more stability. So has the market become a little bit more challenging?

Bob Wood

I'd say, Bob, fundamentally we're a bit more sound than we have been in that business, given the costs that we've taken out and given the focus that we have on specific channels that are more profitable. We've decided not to participate in a couple of low margin segments; in particular, the distribution segment. But we have been very solid in the mass channel as well as in the pro channel. Those are the two areas where we have greatest strength.

I'd say that the stability of the business going forward should improve. And again, naturally, weather in that business does have some effect. But when you look at where we are from a cost perspective and from a market share perspective in the channels that we've chosen to participate in, the business has improved and we would expect it to continue to improve. The volatility having been around getting the channels correct and fighting through some of the weather conditions we've had the last couple of years. But we feel pretty good about the solidity of that business and what the prospects are going forward.

Bob Koort - Goldman Sachs

Thanks. And a last one, if I might. The reality of next year is that a much weaker economy, you think you'll be required to take any additional restructuring measures to right-size the assets or headcount base?

Stephen Forsyth

I think there certainly is that prospect. What we've said in the earnings release, that we will act to manage our capacity and our cost base to reflect the available demand. Too soon to know quite what that might require, but we're not going to sit by and just let idle assets and facilities eat into our operating profitability.

Bob Wood

Bob, I'd just add to that, that one of the biggest issues we have in our Polymer Additives business is the footprint associated with the accumulation of plants over time that has put us in a position where we're not low cost or not close to low cost in that business. And it may require us to take some actions around restructuring that we have put off for a little bit of time, as we've looked at other options in that portfolio.

Bob Koort - Goldman Sachs

Thanks, very much.

Operator

The next question comes from Mike Judd. Your line is open.

Mike Judd - Greenwich Consultants

Yes, good morning.

Stephen Forsyth

Good morning.

Mike Judd - Greenwich Consultants

Couple of questions on balance sheet related items here. I thought you indicated that your accounts receivable securitization had declined by about 37 million sequentially? So, it would be around 313, is that about right?

Stephen Forsyth

That's correct. As of September 30, 313 compared to 350 as of June 30.

Mike Judd - Greenwich Consultants

Okay. And then secondly, looking again at the balance sheet the pension and post-retirement healthcare liabilities, that's been trending down. Can you just talk a little bit about how the funding is related to that? Do you expect to have to make any additional payments? And is some of that due to some of the acquisitions, but also sales of businesses that you guys have had?

Stephen Forsyth

Well, there is some significant pension and post retiree medical liabilities that have sat in our balance sheet for years, the cumulative effect from all the different acquisitions over the years. I think for all companies, and Chemtura is no different, the fact that the equity markets in particular have declined has reduced some of the values of assets in the various plants.

Because of the way the accounting works, you don't sort of see that on a real time basis in the financial statements, but companies will have lower assets just like every individual has lower assets in their 401(k)'s. And that will, over time, if that were to remain, increase the level of cash contributions required by companies to their plants. But over multiple years, it doesn't sort of suddenly frontload things. And then the same is true for expense.

So there's no sort of 2008 consequence to those changes, but for all companies 2009 and beyond, we're going to have to look at probably increasing progressively over time -- we're talking about multi-year processes here, contribution rates and expenses. And if the markets bounce back that gap will narrow quite quickly. So, it's a future rather than a current concern and we, like everybody else, will monitor it as we go forward.

Mike Judd - Greenwich Consultants

Okay. And then just lastly on working capital, I thought that you indicated that there was at least a $50 million potential improvement. I wasn't sure whether that was in the December quarter and the first quarter of next year. Can we add that onto something else, which would be, let's say, a typical end of the year improvement in working capital, to get some sort of sense of how much cash might be available to go back onto the balance sheet from improvements in working capital, let's say, by the end of December or so?

Stephen Forsyth

Well, we haven't given the specific targets on inventory reduction. The $50 million is actually referring to the inflationary effect that sits in inventory today. And I gave David an example of if we were to reduce by $50 million or $60 million, what the P&L impact would be.

We will drive down inventory as much as we can in this quarter, because we think that's the prudent sensible thing to do, both from a cash flow perspective but also to manage you know the now what may be a deflationary environment. The cost of our products that we don't have higher cost products to sell when raw material costs have fallen.

We would normally generate cash from working capital in the fourth quarter. I think we will do so this year. If we're successful, we'll do better than usual. And that normally contributes to the fourth quarter being a cash positive quarter. And that's our intent, to keep it a cash positive quarter in the fourth quarter of 2008.

Mike Judd - Greenwich Consultants

That's terrific. Is there any way just to size that at all or not really at this point?

Stephen Forsyth

We obviously have various internal estimates and targets. There's so many moving pieces, I'd rather not give a specific guidance other than clearly, we are very much on a path where we want to generate cash and we want to reduce debt, not increase debt at a time of economic uncertainty, just prudent management.

Mike Judd - Greenwich Consultants

Thanks for the help.

Operator

Your next question comes from Bill Hoffmann. Your line is open.

Stephen Forsyth

Good morning.

The next question comes from [Bill Hoffmann]. Your Line is open.

Bill Hoffman

Hi, Good morning. Stephen, I wonder if you could just explain a little bit more. You're talking about using a benchmark of $50 million inventory reduction. I just want to understand whether that is basically the deflation on the cost side as well as the volume differential, because probably I would assume you're doing both.

Stephen Forsyth

Well, the 50 million was given as an illustrative example of what the P&L impact would be. I'd certainly like to get 50 million, but I've not given the specific target, but that is a constant price, constant currency sort of type of example. If raw material costs fall significantly, you'll squeeze out that inflationary effect, and that's a freebie. We can't manage on the basis that that's going to happen; we obviously would like it to happen. But in terms of looking to generate cash, we actually have to change the unit volumes of inventory on hand, not just wait for financial measures of inventory to change.

Now, I think that inflationary effect will likely decline. It will take longer than you would first think, simply because the supply chain in the Specialty Chemical industry is such that while you may see spot prices of commodities like oil change, it will take some time to work it through to the products that we buy.

So Bob, commented that that's more likely to be evident in terms of purchases towards the end of the quarter, but that would only have a limited effect on the inventory. Then in terms of the P&L, it's probably going to be the first quarter before you really start to see cost of goods sold benefiting from lower input costs.

Bill Hoffmann

Okay, thanks. That helps. And then also with regards to the P&L effect in the range of $50 million does that include cost absorption and changes in all that as well?

Stephen Forsyth

Yes, that's exactly it. If you choose to reduce inventory in a time of slack demand, you are going to get absorption effects. But from a cash flow perspective, clearly as long as those P&L effects are about a third of what the inventory reduction is, you're still building capacity under your covenants and improving your overall liquidity.

Bob Wood

I'd just add to what Stephen said. That this environment that we're in causes us to take a real hard look at both the income statement and the balance sheet, as we're trying to take these actions that will both improve liquidity and get us positioned to go into '09 in the strongest position that we can.

Bill Hoffmann

Oh, great. Thanks. Then a question for Stephen regarding the revolver. And using that to (inaudible) if you had to. Have you guys thought about throwing down on that revolver now? Just given that we've seen a number of companies do that ex some liquidity at this point in time. And the other question is if you do that, it seems to me like you're going to start bumping into the covenant. So, I just wondered if you've actually gone to the banks and started talking about that additional flexibility, because your covenant seems to be pretty tight versus most of those companies.

Stephen Forsyth

I would imagine there's not a Treasury Department in the country that hasn't gone through the , should we or shouldn't we draw on the revolver debate. In recent weeks, you've seen some people do it and some people haven't. We haven't done anything at this time but we'll continue to monitor that situation. We have a great bank group, from some of the biggest surviving banks in the system.

So we have no concerns as to them being there for us. But we will just continue to monitor that and see what is prudent and sensible as the world evolves. I think we've all seen events in the last six weeks that we never thought we'd see in our lifetime. So, you sort of, you maintain a very open mind.

Bill Hoffmann

Have you gone proactively to talk to banks about the covenants too, because they seem awfully tight for this environment?

Stephen Forsyth

We have not, and we don't view them as particularly tight. We just view them as something that's sort of causes you to manage your affairs appropriately. So, we will continue to do that. So when you see us having this relentless focus on cash flow and liquidity, we're making sure that we can live within the terms of the agreements we've entered into.

Bill Hoffmann

Great, thank you.

Operator

Your next question comes from [Ivan Marques]. Your line is open.

Ivan Marques

Hi guys.

Bob Wood

Hi Ivan

Ivan Marques

What was the raw material gap that wasn't offset by pricing? And do you expect to close that by the end of the year?

Bob Wood

$8 million in the third quarter, we were up $67 million in raw materials and $59 million in price increases. We're on a positive trend. I would say that we're not going to get the benefit of some of the cost decreases for raw materials until later in the quarter. So with the momentum of price and the momentum of raw materials, we should be very close to closing that gap and going into '09 on a positive note.

Ivan Marques

Do you think overall you'll be able to hold pricing with raw materials falling or do you think you're going to have give back some?

Bob Wood

Well, that, of course, is the $64,000 question. That's where the entire focus of our commercial organization is. And what gets missed sometimes is that when raw material prices go down, there's an inherent lag effect of when those prices get implemented and when you're able to get Europe to cover what wasn't covered with price.

So, our intent is clearly to maintain price and clearly to continue covering the raw material increases. In an environment where supply demand may not be fully in balance, it becomes a tougher challenge and we have more leverage in some areas than others. But that's our full intent, is to maintain price to cover the raw materials that we haven't covered to this point.

Ivan Marques

Great, thanks. And then a quick question in the bromine flame retardants. I know in '01 and '02, you said that volumes are down double digits and there tends to be pricing also fell with it. Is there a difference between the industry now than it was eight years ago or do you expect to see the same thing if volumes continue to fall as they do?

Bob Wood

Well, back in that period, in the '01 period, you had a double whammy of the dot.com impact as well as demand from an overall economic point of view. At this stage of the game, we do not expect to see that severe decline. Although when you look back at history and you look at what's happened in those businesses, there's a pretty wide swing from peak to trough. Based on where we are today, we expect to see some decline, but we don't think at this stage it will be that severe.

Ivan Marques

But do you think you're near the trough? Or how much farther do you think there is to go?

Bob Wood

I'd be reluctant to predict whether we're at the trough or not. We've begun to see some customers take down factories and take down inventories. You have two schools of thought; one is that it's going to last about six months and come back and other that says it may be this soft for the balance of the year. We'll know more in the fourth quarter, so when we have the fourth quarter call, we'll be in a much better position to be able to answer that question.

Ivan Marques

Great and then real quick question on pool chemicals. Did you see some softness towards the end? Was that all in North America or did you see the same effect in Europe? And on top of that, in the stores that weren't distributors, did you see people maybe taking the product off the shelf sooner than which was typically expected or what do you think drove that softness?

Bob Wood

No, I think it was purely demand. I think there was some inventory in the system because the pull through was not as strong as it was anticipated to be. I'd say that the mass channel was a bit stronger than the pro channel and because of our pulling away from some of the distribution business, our business was probably a bit softer than were some other people. But from a mass point of view and a pro perspective, it was soft, we think based on demand.

Ivan Marques

Great. And then also in Europe, typically in a recession, I know North America tends to be pretty stable. Do you see the same thing in Europe or does demand typically fall off if there's a recessionary period?

Bob Wood

We see them as being pretty similar. The biggest problem we had in Europe was there was a lot of inventory left from '07 when floods occurred in Europe and a lot of product didn't move off the shelf. That improved somewhat through the pool season. At the end of this season, there was less inventory but still more than you would consider as average. We think North America and Western Europe are pretty much the same in terms of demand through different economic cycles.

Ivan Marques

Great, that's all I got. I'll jump back in the queue. Thanks.

Operator

Your next question comes from Steve Schwartz. Your line is open.

Steve Schwartz - First Analysis Securities Corp.

Good morning everyone.

Stephen Forsyth

Good morning.

Bob Wood

Good morning Steve.

Steve Schwartz - First Analysis Securities Corp.

Just a question. Tax rate and other income, those two things. What could we expect going forward, because you had a good swing on other income?

Stephen Forsyth

Other income by its nature tends to swing up and down. I usually tell folks to think of that as an expense rather than an income over the longer haul. This year, you've seen it net positively for the year because we had that large foreign exchange gain at the start of the year. But if you're sort of doing projections for 2009, if you look back at 2007 for instance, it would look at it as sort of an $11 million or $12 million expense. And it's more likely to be expense than income. And if we do better well that's good, but it's not something I would predict as the regular occurrence.

In terms of the tax rate, as everyone is aware, our GAAP tax rate is somewhat volatile just because of the complex nature of our operations and what parts of the world are we recognizing income. We have, therefore, used what we call this managed basis tax rate of 35%, which we still believe is the best long-term indicator of a tax rate for the company.

Our GAAP rate has tended most of this year to be less than that amount. So, I think it's a reasonably conservative measure when we suggest that people use 35%. Now, I'd also note and you can sort of do the math by looking at the cash flow statements. Our cash tax rate is lower still. So we're really talking about book rates rather than cash rates when we talk about these percentages.

Steve Schwartz - First Analysis Securities Corp.

Okay. And then beyond the obvious issues in the credit markets, are there any other governors that are kind of slowing down you guys getting some of these strategic deals done that you've alluded to over the past couple quarters?

Stephen Forsyth

Well, I think you're in this period of sort of unprecedented almost volatility in the financial markets and I think that has two impacts. One is that all companies are more cautious in their investment decisions at this moment in time. The practical reality is that you're talking in the M&A market about strategics and not financial buyers. But even for the strategics, for those that would need to raise capital to do a deal, it's obviously more complicated and more costly to do that today than it would have been.

So all of those factors, as we indicated in the press release, move one to believe that this process may be a little bit slower in reaching our conclusion than when we would have thought back in June when we made the announcement. But it does not inhibit our ability to move forward.

Bob Wood

Steve, what I will add to that is, I think it's important to say that from where we are today and our analysis looking forward, an asset sale is not required for us to manage our debt situation. So we've been purposely very careful to analyze what makes the most sense for us from a company going forward. And if a transaction is beneficial to us, then we would complete one, although again importantly it's not required for us to satisfy our obligations.

Steve Schwartz - First Analysis Securities Corp.

Okay. And then just one last one on the crop business. I've seen some things regarding Brazil, where banks are tightening lending, no surprise there. But that it's specifically impacting the ag sector. So I'm just wondering if you foresee any issues as we go into the growing season there?

Stephen Forsyth

Let me respond. In terms of demand from our customer base, we're not seeing that as a significant factor. I think what it does make us do, though, is just be that little bit more cautious on the credit we extend to folks ourselves. We had some bad experiences two or three years ago and we don't want to repeat them. So it just puts us all on notice to be a little cautious. But at the moment, we see the Brazilian agricultural economy as remaining robust.

Steve Schwartz - First Analysis Securities Corp.

Okay, great. Thanks. Have a good day.

Operator

Your next question comes from Dmitry Silversteyn. Your line is open.

Dmitry Silversteyn - Longbow Research, LLC

Good morning. A couple of questions, you're talking about the consumer business, undergone some issues manufacturing wise with the Conyers plant fire a few years ago and I guess some changes in the process flow to the plant. You've walked away from a low margin business in the distribution channel. Are we now at the point, heading into 2009 season, where this business is basically in a shape that you want it to be in terms of both manufacturing costs as well as distribution costs and selling channels?

Bob Wood

Yes, Dmitry, we think it is. We've had some pretty significant focus on getting our manufacturing sites aligned. There's still some work to do in Conyers from a take-out -- from a cost perspective. But we think we're aligned from a marketplace point of view and from a customer point of view, to build the business now, take out some of the volatility from the mix changes. We remain very solid from a mass point of view. We feel very good about our pro channel relationships and we feel very good about what we've been able to gather from the distribution business going direct.

Dmitry Silversteyn - Longbow Research, LLC

So, if I look at this business a couple of years out, the fluctuations and the performance of the business should be related to weather and raw materials more than walking away from businesses or mix shift changes?

Bob Wood

Yes, I'd say that's correct.

Dmitry Silversteyn - Longbow Research, LLC

Okay, very good. And also give us a little bit more detail on which of your divisions will be undergoing the inventory correction over the next couple of quarters? You were referring to, I understand Polymer Additives is one of them. Is there anything that will be done in specialties or other businesses?

Bob Wood

Yes. All of the businesses are getting the same treatment in terms of what we think they can deliver. Frankly, the crop business is probably the least of the businesses to deliver a significant amount of money to the bottom line in that exercise. But the other three have very rigorous program to participate in generating cash from inventory.

Dmitry Silversteyn - Longbow Research, LLC

Okay. You talked about the restructuring and the plant consolidation you've undertaken in Polymer Additives to lower your high cost base and make the business a little bit more competitive. Can you remind us what your asset footprint looks right now in Polymer Additives vis-à-vis plants in the US and Europe and Asia? Kind of where the distribution of manufacturing is versus sales distribution?

Bob Wood

We're about half and half in Europe and in the US. The issues from a cost point of view are largely around our European plants. We announced last year that we were taking some portions of capacity down in Pedreng and Catenoy. In the US, we feel pretty good about where we're positioned. In this business, there are six different sub segments, all of which have different dynamics in them. The plastics antioxidants plants, which were largely in Europe, are the ones that have been the most rationalized, but we'll continue to look at opportunities to further consolidate those plants and improve our overall cost position.

Dmitry Silversteyn - Longbow Research, LLC

Okay. All right. So of the two regions, which one would you say needs more rationalization?

Bob Wood

Well, I would say that we're at a bigger cost disadvantage in Europe than we are in the US. So looking at ways to consolidate, to get co-producer programs in place that will allow us to rationalize, but improved cost is the focus that we have today.

Dmitry Silversteyn - Longbow Research, LLC

I got you. And the distribution of customers is about the same between Europe and the US? Or do you have a sizable chunk of customers in Asia?

Bob Wood

Well, it's about the same in the US and in Europe. And we do have a sizable chunk of customers in Asia. That's largely driven by our flame retardant business, but we do have other business over there as well.

Dmitry Silversteyn - Longbow Research, LLC

Okay. And my final question, you talked about it and we've seen it in other sources that certainly, the spot prices for commodities are beginning to roll over. And it may take some time, but eventually, hopefully, your contract prices will as well. What's the stickiness of your selling price in that environment? I remember -- I think it was back in 2005, when this inflation started, that yourself and some other companies on the specialties side went to shorter contracts to try to reset your own pricing a little bit faster and catch up with the raw material inflation. How does that work on the way down?

Bob Wood

It varies from business to business based on what's happening from a supply demand point of view. I'd say it's more sticky in the petroleum additives, urethanes business. Less sticky in some parts of Polymer Additives, although those areas have pieces of them that allow for, using your word stickiness again. I'd say the most vulnerable because of supply and demand is Polymer Additives. We continue to work on getting ourselves in position where we have businesses with competitive advantage that allow us to maintain those pricing increases that we've achieved thus far.

Dmitry Silversteyn - Longbow Research, LLC

Okay. Speaking of Polymer Additives, you do control a lot of the raw materials in bromine, and is that market still in fairly good tight condition and prices are still stable to going up?

Bob Wood

It appears to be in pretty good condition and prices at this moment are stable.

Dmitry Silversteyn - Longbow Research, LLC

Okay. Thank you very much.

Operator

Your next question comes from Edward Yang. Your line is open.

Edward Yang - Oppenheimer & Co.

Hi, good morning.

Stephen Forsyth

Good morning.

Edward Yang - Oppenheimer & Co.

First question on your debt. How much of that is foreign currency denominated? And what percentage of the balance, if any, would fluctuate with currency exchange rates?

Stephen Forsyth

In terms of our debt, virtually all of it is US dollar denominated. The way we spread debt to Europe is more sort of intercompany debt agreements and third party borrowings.

Edward Yang - Oppenheimer & Co.

Okay, thank you. And with regards to your covenants and the calculations, does the EBITDA used in those covenants, do they include or exclude restructuring charges?

Stephen Forsyth

The covenants provide that cash restructuring charges get deducted from LTM EBITDA, but when you take an accrual, that gets excluded. So you only take it when you spend cash.

Edward Yang - Oppenheimer & Co.

Okay. And lastly, on Polymer Additives, given all the puts and takes, your own restructuring activities and some potential for slower demand, what's your level of confidence that Polymer Additives margins next year will be up or down from where they are currently?

Stephen Forsyth

Well, I think where the margin will be is a tougher proposition to answer at this moment. But clearly, Polymer Additives is exposed to markets where common sense would suggest that demand will be less in 2009 or at least a portion of 2009 than it's been for 2008. And so we're adopting an operating methodology where we can respond and react to that to try to manage any impacts there may be to margins from that occurrence.

Edward Yang - Oppenheimer & Co.

And Stephen, would there be any sort of reasonable scenario where you think Polymer Additives margins could actually dip negative in 2009?

Stephen Forsyth

Well, one couldn't absolutely hypothesize that. The job is to try to avoid that from happening.

Edward Yang - Oppenheimer & Co.

Okay, thank you very much.

Operator

Your next question comes from [Tariq Ahmed]. Your line is open.

Tariq Ahmed

Good morning.

Stephen Forsyth

Good morning.

Tariq Ahmed

Two quick questions. You talked about lowering CapEx for 2008. Can you give us what sort of a, just a true maintenance CapEx level would be for the business?

Stephen Forsyth

I always found this a difficult question to answer because everybody has a different way of thinking about maintenance. So let me define it. Maintenance CapEx, in my mind is investment that you make to sustain the current revenue and activity base of the company as opposed to cost that you invest to grow the business. If we look at our, you know, spending over the last two or three years, you're probably looking at somewhere between 80 million and 100 million as being the sort of normalized maintenance spending on that sort of a definition. Clearly, in a period of economic downturn, you can reduce that spending below that rate. So all companies have some levers they can pull in these circumstances.

Tariq Ahmed

Okay, that's helpful. And then have you disclosed when the securitization matures?

Stephen Forsyth

Yes. The US securitization matures at the end of August, 2010.

Tariq Ahmed

Okay. That's all I had. Thank you very much.

Operator

Due to the time, that will end today's Q&A session. I will now turn the call over back to the speakers for closing remarks.

Bob Wood

Thank you, David. Thank you, everyone, for joining us. Know that we remain focused on leveraging our core businesses, reducing costs in line with market conditions, and continuing to solidify our liquidity. That all done, to continue to build our enterprise and become the kind of company that we aspire to be and that you expect us to be. Thanks very much for joining us.

Operator

This concludes today's conference. You may now disconnect.

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