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Cytec Industries Inc. (NYSE:CYT)

Q4 2008 Earnings Call

January 30, 2009 11:00 am ET

Executives

Jodi Allen - Director of IR

Shane Fleming - Chairman, President and CEO

Dave Drillock - VP and CFO

Analysts

Mike Judd - Greenwich Consultants

Steve Schuman - Lafayette Research

Bob Koort - Goldman Sachs

Mike Sison - KeyBanc

P.J. Juvekar - Citibank

Laurence Alexander - Jefferies

David Begleiter - Deutsche Bank

Chris Shaw - UBS

John McNulty - Credit Suisse

Operator

Good day and welcome to the Cytec Industries Incorporated Fourth Quarter Earnings Announcement. Today's call is being recorded. For opening remarks and introductions, I'd like to turn the conference over to Ms. Jodi Allen. Please go ahead.

Jodi Allen

Thank you, Darren, and good morning everyone. We appreciate your participation in our conference call. For our call today, Shane Fleming, Chairman, President and Chief Operating Officer, will provide an overview of operations; and Dave Drillock, Vice President and Chief Financial Officer will review the financial results and the special items noted in our press release. Shane will then finish with some commentary on our outlook for 2009.

This call is also being webcast in listen-only mode and it will be archived in audio format on website for three weeks.

During the course of this presentation and in responses to your questions you will hear certain forward-looking statements. Our actual results may differ materially. Please read our commentary on forward-looking statements at the end of our news release or the statements in our quarterly and annual SEC filings.

In addition, our discussion includes certain non-GAAP financial measurements as defined under SEC rules. We have provided a reconciliation of those non-GAAP financial measures to the most directly comparable GAAP measures at the end of our press release. The copy of our press release is available on our Investor Relations website.

With that I would like to turn the call over to Shane.

Shane Fleming

Thank you, Jodi, and good morning everyone. Thank you for taking the time to join our fourth quarter Earnings Call. We are all acutely aware of the extraordinary economic conditions that exist today and the impact this is having on industrial markets across the globe. Market conditions continue to deteriorate in the fourth quarter resulting in sharp demand declines across most of our chemical product lines.

The end result in the quarter was earnings per share of $0.10, excluding the special items that Dave will cover shortly, compared with $0.96 earnings per share in the same period in 2007. Although these results are disappointing, we are pleased that the diversity of our portfolio helps soften the blow as some of our product lines particularly Engineered Materials and Mining Chemicals continue to perform well.

Sales volumes in the Surface Specialties businesses were most severely impacted as approximately half of our volume in this portfolio is sold into industrial markets including automotive and construction. These markets who are already under pressure going into the quarter and when combined with inventory destocking activities by our customers, demand essentially collapsed in the month of December.

The net result was segment sales of $281 million, which represents a 32% decline in selling volume, a 4% increase in selling prices and a 2% decrease in currency exchange, compared with the prior year quarter.

This impact was felt across Surface Specialties product lines including our eco-friendly technologies in Radcure and waterborne. And while we had a modest increase in selling prices in the quarter, the benefits from the recent reduction in energy and propylene cost was now realized as most of this favorable impact has just now started to show up in final product cost.

Excluding the goodwill impairment charge of $385 million and a charge of $1.4 million for accelerated depreciation related to the exit of our Pampa, Texas site; this segment had an operating loss of $18.4 million for the fourth quarter, compared to operating earnings of $20 million in the same period last year.

The Performance Chemicals business was also impacted by the sharp demand declines, with overall sales of $159 million down 17% versus the same period last year. Selling volumes declined by 23%, selling prices increased by 9% and exchange rates contributed to a 3% decline.

Although demand weakness was seen across each of the product lines, polymer additives, urethane specialties and pressure-sensitive adhesives, volumes were the most impacted by the market turmoil. The segment delivered significant favorable pricing in the quarter with the Mining Chemicals and Phosphine product lines benefiting from price increases above raw material cost increases and improved product mix driven by strong new product sales.

This resulted in a strong earnings performance of these two product lines and helped offset some of the weaker performing lines. Overall the segments operating earnings were $15 million in the quarter, down about 7% from earnings of $16.2 million in the same period last year.

Sales in Building Block Chemicals are also significantly impacted by the slowing global economy, down 27% to $94 million in the fourth quarter. Selling volumes declined 34% partially offset by price increases of 7%. Our exports of acrylonitrile during the quarter were again impacted by the low production levels in acrylic fibers market in both Asia and Europe.

In addition, AVS demand in the US and in Europe declined further as a result of weakness in the automotive sector. Melamine volumes are also significantly down, as the markets for this product line including housing and construction.

Another contributing factor was the high cost of inventory in the quarter, which has not completely recovered. The net result was an operating loss of $6.4 million compared to operating income of $7.2 million in the fourth quarter 2007.

The Engineered Material segment demonstrated good performance in a difficult quarter. Sales were $164 million, an 8% decline versus the prior year. Volume in this segment decreased by 9% principally due to the IAM strike at Boeing, excluding the strike impact volume grew across most of the aerospace segments led by rotorcraft.

Selling prices increased sales by 3% and exchange rates decreased sales by 2%. The net result was operating earnings of $30.5 million versus $36.1 million in the fourth quarter of last year.

While there are some concerns about reduced commercial transport build rates in the medium term, we continue to see multiple growth opportunities in this segment that will soften this impact and we continue to invest in this business to deliver the growth.

Now, let me turn you over to Dave, to go through the financial details.

David Drillock

Thank you, Shane, and good morning everyone. I'll begin with a review of our gross margin followed by an overview of our operating expenses, the special items recorded in the quarter and close with some balance sheet and cash flow highlights.

Gross margin decreased about 4.3% from the prior year period. This decrease resulted primarily from two items. First, being that our chemical plants ran at a reduced rate in a quarter, about 60% of capacity overall. In spite of our cost control actions, this increased our fixed cost per unit and lowered overall gross margin by about 3.5%.

The second item is the impact of our FIFO inventory accounting, where the higher raw material costs in inventory at the end of the third quarter, flowed into the fourth quarter. This hit the Surface Specialties and Building Block Chemical segments particularly hard and they were not able to recover these high costs through higher selling prices.

Also included in the manufacturing cost, the sales of two special items, with the first being a net restructuring charge of $600,000 and a second related to accelerated depreciation of $1.4 million for our planned exit of Radcure manufacturing on lease, Pampa, Texas facility. We have stopped production at this site and are in a process of moving Radcure production to our site in North Augusta, South Carolina.

Operating expenses are down about $12 million year-over-year. Costs were lower by $9 million in the quarter, which is evidence of our cost and prior restructuring efforts of working, and changes in exchange rates reduced costs by another $6.5 million.

Offsetting these benefits was a net restructuring special item charge of $3.5 million, primarily from employee severance as part of our broader initiatives to reduce costs in light of the weak demand environment, Shane mentioned just a few moments ago.

As we discussed in a separate release earlier this month, we have a number of improvement initiatives that we will be implementing throughout 2009. So we'll see more restructuring charges, as we move forward in the year.

We had net other income for the quarter of $2.5 million, compared to $0.5 million in net expense in the prior year period. Including in the quarter was a special item gain of $6 million related to a legal settlement. We also recorded a gain of almost $2 million, due to repurchase of some of our public debt at a discount. We are pleased that we were able to seize this opportunity, on favorable terms.

We recorded a non-cash special item charge of $385 million to reduce the carrying value of goodwill, related to the Surface Specialty segment. The continued deterioration of the macroeconomic environment and it's impact in our view of the long-term outlook for Surface Specialties led us to conclude, an impairment has occurred related to the segment's goodwill.

To summarize this point without the accounting jargon, the long-term outlook for environmentally friendly coating is still very positive. However, the growth rates are now starting from a lower base, as sales volumes declined in 2008, and are expected to decline further in 2009. Hence, future growth will start from a smaller base which impacted our discounted future cash flows and fair value of the goodwill recorded on our books.

Included in the income tax benefit for the quarter is a $26.7 million benefit, related to the goodwill impairment charge and a special item credit of $2.6 million for favorable ruling in an international jurisdiction, related to the sale of our water treatment business in 2007.

Our annual underlying income tax rate of 32% increased about 1.5%, versus last year. This increase is principally due to an earnings mix towards higher tax jurisdictions, primarily the U.S. as our Engineered Materials segment became a larger portion of our overall earnings. Going forward, one should expect our rate to increase one to two points from this year's underlying rate, almost all due to earnings mix.

Moving on to cash flow for the quarter. Our cash flow from operations was $58 million down from the prior year of $75 million. The decrease is principally related to the lower earnings offset by an increase in cash, due to improvement in our net working capital.

Trade accounts receivable generated about a $153 million of cash, due to the lower sales, partially offset by days outstanding increasing by five versus the third quarter of 2008.

Our inventory decreased $27 million, as the higher raw material costs went through cost of sales, but our days increased to 96 up from 80 at the end of the third quarter. This increase in days was the result of the sever drop off in demand and even with our plants running at about 60% of capacity was not enough to match declining demand.

Accounts payable decreased to $115 million due to lower production levels and cost controls, which led to a reduction of spending from the third quarter. I don't have to tell you the cash is king in this environment, and we have begun our initiative to improve our cash flow, by improving our networking capital turns by one, which equates to approximately $200 million by the end of 2009.

Capital spending for the quarter was $80 million, up from $49 million in the fourth quarter of 2007 with almost all of the increase, due to investments in our Engineered Material segment, as we continue to investment in this growth business. For the full year 2008, capital spending was $196 million. And our revised expectation for 2009 is for capital spending to remain about flat with 2008.

We are continuing our work on the carbon fiber plants in South Carolina and our composite prepreg plant in China. However, in light of the current economic environment, in our view of no recovery in 2009, we have further scaled back our capital spending and with the exception of the two projects mentioned, we've limited it to mostly safety, maintenance of business and fast payback projects.

We did not repurchase any of our shares in the fourth quarter and going forward given a continued economic challenges one should not expect us to be actively repurchasing our stock.

Let me take a moment to add a few comments on our pensions. And the theme you're probably hearing from many companies, pension expense will be higher in 2009 versus 2008, due to amortization of the investment losses on our pension equity assets and a lower discount rate. This will reduce our earnings per share by about $0.05 for 2009.

Our pension funding is now estimated to be about $45 million in 2009, up from 2008's $30 million, but they are up from our previous estimate of $70 million, due to some clarity and relief on pension funding rules.

Finally, as a result of the investment losses in 2008, and a lower discount rate, we have increased our pension liability by approximately $140 million with the resulting charge reported in other comprehensive income. Our overall debt decreased $15 million in the quarter, before anyone asked let me remind everyone that our next scheduled debt maturity is October 1st, 2010, for $250 million of 5.5% notes, and the maturity date for our revolver is June 2012.

In closing, let me discuss our priorities for cash. Typically you would hear maintenance of business followed by capital for cost reduction in growth projects, paid down debt, both on acquisitions that need a stock buyback test and dividends. In this environment however, let me simplify and summarize changes in my priorities for use of cash. Maintain our liquidity, while keeping all the improvement initiatives we just discussed on track.

We have a great team of people at Cytec making it all happen. That just are my prepared remarks, and with that I'll turn over the call to Shane.

Shane Fleming

Thank you Dave and now let me spend a few minutes addressing our plans for 2009. As indicated in our press release, we do not foresee any material improvement in the global economy in 2009. And the extended downturn will continue to negatively impact our volumes across the three chemical segments.

We have taken aggressive action in light of the decrease in demand and earlier this month, we announced restructuring plans to align our cost structure, to the challenging demand environment. Part of the restructuring initiative involved the consolidation of certain specialty chemical manufacturing facilities in Europe.

Subject to consultation and negotiation with the works councils in the region, our intention is to reduce capacity of the lower margin cash product lines within our specialty chemical operations. This will now realign our asset base with a new demand situation, but will also position us to leverage the growth of our more value-added product lines when the demand levels return.

As a result, we anticipate that the La Llagosta, Spain operations will be closed and production of certain product lines in Drogenbos, Belgium and Hamburg, Germany will be significantly reduced and the remaining product lines at these sites consolidated. Among additional restructuring initiatives, we plan to consolidate certain service groups into regional shared service centers in Europe and United States.

In total, we expect the announced actions will result in a $90 million benefit on an annualized basis by the end of this year. These initiatives will require restructuring charges of up to $140 million over the next several quarters, including a non-cash charge of $50 million for the write-up of assets.

Additional restructuring and cost reductions plans are under development and will be implemented as required to further reduce our cost structure in line with market demand. As Dave previously mentioned, we have launched a project to improve our working capital management with an objective of delivering an addition $200 million in cash flow by the end of this year.

We will manage our cash carefully and we are prepared to take all necessary actions to preserve our financial strength during the challenging year ahead. We plan to maintain our capital spending in 2009 at 2008 levels, a significant reduction from our preliminary 2009 plans. With much of this investment going to the two large Engineered Materials projects, Dave described.

These projects remain essential to maintain the high growth rates of this business into the future, by supporting the high utilization of composites on future aerospace platforms.

Clearly, 2009 will be a challenging year. We'll work through this difficult period by remaining focused on our customers, leveraging our differentiated products to improve margins and increase our market share while reducing cost and maintaining liquidity through focused restructuring, cost reduction and cash improvement programs.

With so much uncertainty in the demand environment, we will not be providing 2009 earnings guidance at this time. We expect to have better visibility as the year progresses and will provide additional insight as conditions allow.

The actions we are taking this year will position Cytec to weather these challenging times and emerge as stronger company with an enhanced portfolio, poised to deliver strong earnings growth as market stabilize and demands return.

Now, let me turn the call over to our moderator Darren so he can respond to your questions.

Question and Answer Session

Operator

(Operator Instructions). We'll take our first question from Mike Judd, Greenwich Consultants.

Mike Judd - Greenwich Consultants

Yes, thanks for taking my question. I’m just wondering if you could give us a sense in Engineered Materials. What do you think the demand profile will look like in the first half of the year please?

Shane Fleming

We don’t see the demand profile changing dramatically in the first half of 2009 to the profile that we would have seen through the last half of 2008. We do expect to see some softening in commercial build rates towards the latter part of 2009, but I think if you looked at our view right now for the first half of the year, its going to be balanced across all of our segments with reasonably strong demand.

Mike Judd - Greenwich Consultants

Okay and then just secondly in the building blocks area, now that the Chinese New Year has passed us, and realizing that was just recently over. Has there been any pick up in the demand in the export market for any of the Building Block Chemicals?

Shane Fleming

Mike, I think it's too early to say right now. We haven't seen any real strong indications in January that markets are turning around, and that would go across all of our chemical segments.

Mike Judd - Greenwich Consultants

Okay. Should we anticipate any voluntary pension contributions, cash contributions in '09?

Shane Fleming

I wouldn't rule it out. I think we're looking at all opportunities here and it's going to depend on the demand environment. And I just -- I'd say, we'll keep our pattern dry. I don't know Dave, if you want to comment beyond that?

Dave Drillock

Yeah. Pension money, Mike I said, we estimated to be about $45 million.

Mike Judd - Greenwich Consultants

Maybe, on top of what you run through the income statement, is that?

Dave Drillock

I think that depends on how the year progresses.

Mike Judd - Greenwich Consultants

At about 45, is that what you're saying?

Dave Drillock

Yeah.

Mike Judd - Greenwich Consultants

Okay. And then lastly, is there any off balance sheet, debt item or accounts receivables, securitizations or any like that I just forget, I don't remember they were or not?

Mike Judd - Greenwich Consultants

No, we don't have anything like that.

Mike Judd - Greenwich Consultants

Okay. Thanks a lot.

Shane Fleming

Okay, Mike. Thank you.

Operator

We'll go next to Steve Schuman, Lafayette Research.

Steve Schuman - Lafayette Research

Good morning, guys.

Shane Fleming

Good morning

Steve Schuman - Lafayette Research

I've asked this in the past in the Engineered Materials if you are interested in looking into some of the wind energy areas, particularly now that aerospace has slowed somewhat. I know one the large European company is actually building with carbon fiber. Is that something that you may look at with some slowing in aerospace now?

Shane Fleming

Yeah, I think we'd announced sometime in the second half of 2008 that we were starting to do some preliminary investigations, really driven by some higher performance applications. A lot of the wind energy materials today they've really been more glass and carbon fiber.

Steve Schuman - Lafayette Research

It's correct.

Shane Fleming

And the carbon fiber contents been relatively low, but as these turbines get larger and blades get larger in diameter, the amount of carbon content and the performance requirement has gone up pretty dramatically. So I wouldn't rule it out.

Our priority is still obviously, in the aerospace area, where we have a very strong position. But we are starting to look a little bit more seriously at wind and some other industrial applications. But again we would focus on more the high performance side.

Steve Schuman - Lafayette Research

Would you expect any material impact in '09?

Shane Fleming

No. I would be very surprised that, they would move the needle at all for us in '09.

Steve Schuman - Lafayette Research

All right. Thank you.

Operator

We'll go next to Bob Koort, Goldman Sachs.

Bob Koort - Goldman Sachs

Thanks very much. Good morning.

Dave Drillock

Hey, Bob.

Shane Fleming

Good morning, Bob.

Bob Koort - Goldman Sachs

So can you talk a little bit about what you would expect in terms of the price cost dynamic as you go forward here in a choppy demand environment?

Shane Fleming

Obviously, it's all a bit difficult to predict, I mean we have seen, as everyone is aware, the falling raw material cost, energy cost, propylene cost, which ultimately are going to roll their way through into lower cost for our building block materials, acrylic acid and (inaudible) 1.55-11 glycol, those kinds of things. Today, we've been pretty successful holding on to price in light of these falling materials, because they haven't worked their way through the value chain and we're not really seen the benefit in terms of lower finished product cost.

Now, as we get into a choppy demand environment, when people are potentially trying to take share, there's a possibility that you could see some undisciplined action in the markets. And it's hard to predict how much of that's going to take place. So far, I think are holding the line pretty well. I think generally my view is that we are going to see margin improvement.

There will be certain more commodity related areas, where it's going to be more difficult for our enterprise and they are areas like mining and some of our other businesses, where our mix is good, where we've got a lot of proprietary or highly differentiated products. And our expectations in those areas that we'll be able to hold on to all of the price.

So, it's a mix bag. I think in general, I see this has been a positive trend. I think in some of the commodity areas though, it could be difficult if people trying to grab a share.

Bob Koort - Goldman Sachs

And then on the mining side, obviously you guys have done a terrific job there. But when we watch that end market those company's aren't exactly doing so well right now. Can you sustain the trends you've seen there, or is there some reason that you might have had, a little bit unusual demand or product development? What's going on there in mining?

Dave Drillock

I think it's a kind of mix and complex story. We are clearly seeing some demand loss. Base metals are down 5 to 10%, over where they would have been sort of mid year last year. I think aluminum is down more like 15 to 20%. So we will be selling the impact of lower demand. Working in our favor though is, we've had a number of new product launches over the last 18 months, two years that are really gaining quite a bit of momentum and we're taking share or increasing the size of the market, by replacing ours or our competitors materials with these higher value products.

And we still got pretty good legs on a couple of those areas, both in copper and aluminum. So I think we've got some offset there. I think our financial viability or strength in the market is also working to our advantage. On a regional basis you've get a lot of smaller players, people that are reselling, sometimes importing Chinese products and we're seeing some competition and struggle managing cash. And I think that provides some opportunity as well. So I'd stay pretty bullish on the market, despite the fact that we are going to see some pressure with the decline in demand.

Bob Koort - Goldman Sachs

Great. Thanks.

Operator

And we'll take our next question from Mike Sison with KeyBanc.

Mike Sison - KeyBanc

Hey, guys. Good morning.

Dave Drillock

Hey, Mike.

Shane Fleming

Hey, Mike.

Mike Sison - KeyBanc

Just for specialties, can you just sort of give us sort of qualitative view of how we get back to breakeven sort of the dynamics there? Obviously, volumes plays an important point, but there are certain sales level that we should sort of think of in 2009 to see a breakeven point?

Shane Fleming

I mean, you can probably back into our number a little bit just by looking at what we’ve announced in terms of cost takeout and what the volume impact has been on revenue. So I’m not going to be able to give you an exact number, but nor am I going to be happy standing here watching this business start to list significant amounts of money.

So if there is such a dynamic environment, we're going to continue to take our cost as volume drops. So I’m not looking at the snap shot and time and saying okay, this is a targeted breakeven, because that targeted breakeven may change as the volume environment changes.

We as you've seen in the press release and heard in Dave and my comments, we have been pretty aggressive in terms of shutting down assets and consolidating product lines to try and match our breakeven with the new demand environment. I’m committed to take additional actions if required, if we see demands softening further.

So, I'm sorry Mike, I can't give any more of the definitive answer than that. I think the message I want to leave you with is that we’re committed to take out the cost to keep this business as close to breakeven as possible given this difficult period and clearly we expect to see a turnaround in the future. And we want to be poised to be able to deliver growth of the high value products when that happens.

Mike Sison - KeyBanc

Did all the sub segments and Surface Specialties being Radcure, powder, waterborne and solvents, did they all lose money in the quarter and is there any difference in the magnitude between the four?

Shane Fleming

I think we did see all three businesses, all three segments operating at a loss, I’m not sure there was a huge difference of magnitude. The real hit we took besides the demand falloff that we all sort of saw in October, November was in some areas, we had almost no orders in December, we had customer shutdown.

I think the automotive sector in Europe is probably a good example, where the automakers just quit making cars in December; they took their normal holiday shutdowns, and decided to not start back up again. So, I believe that December was a little bit of an anomaly, although that's representing ongoing demand rate, but that certainly had a major impact on our fourth quarter.

Mike Sison - KeyBanc

Okay then at the end of the day when you run through your cost saving initiatives, for 2009, it sounds like a lot of it will be in Surface Specialties. How much capacity will you be taking out like 20%, 30% or so, when we think about a recovery mode, you start to think about what the potentials for this business is 2010 and beyond?

Shane Fleming

I don’t think I can give you an exact number. What we try to do is focus on the capacity take out in the really low margin areas and in some cases that’s going to be removed through temporary shutdowns, in other cases permanent shutdown. So and I think the number is north of 10%, but some of that could be ramped back up if necessary. Some of that's going to be permanent shutdown.

Mike Sison - KeyBanc

Okay. Thank you.

Shane Fleming

Thanks Mike.

Operator

And we go next to P.J. Juvekar with Citibank.

P.J. Juvekar - Citibank

Yes, hi, Good morning.

Shane Fleming

Good morning.

P.J. Juvekar - Citibank

Shane, Boeing did not give guidance on their playing fields for ’09 and ‘010. I was wondering if you have any expect -- what are your expectations, and given what's happening with airlines, do you expect any significant order cancellations?

Shane Fleming

Well, we don't have a pipeline in to Boeing that give us absolute transparency or clarity in terms of what their plans are, so I’m not going to try any, so I can guess them or outguess them. We try and build our production and our revenue projections based on what we know and we triangulate talking to other suppliers, getting as much information as we can in the public sector and build our plans on that basis.

Given what's going on right now with some cancellations with backlogs decreasing. As I said earlier, we felt pretty good about LCT holding up through the first half both Boeing and Airbus, but I think there is some potential weakness with commercial build rate in the second half of the year. And PJ I'm sorry, but I probably can't give you much more color than that.

P.J. Juvekar - Citibank

Okay. And then on the military side, what do you expect with the new administration?

Shane Fleming

It’s a tough question. I really don’t have a crystal ball. I think if you look at how much depletion has gone on in the number of the programs that we serve over the last couple of years, we still think there is good legs there that there is opportunity for our base business continues strong, rotorcraft and some of the more conventional stuff.

And we also see the ramp up coming in the JSS. Don't hear anything to-date that gives us concern that that's going to change. So I would say, in general, our view on military remains positive even with the new administration.

P.J. Juvekar - Citibank

So, if look at all these comments, your expectations are what, low to mid single-digit volume growth?

Shane Fleming

I'm sorry, PJ I didn't hear you.

P.J. Juvekar - Citibank

Based on all your comments, what do you expect your volume growth would be sort of mid single-digit type volume growth?

Shane Fleming

In CM, I'm not sure we're necessarily going to see volume growth in terms of the number of craft build. I think we expect to see some improvement coming from the higher content and improved mix, but modest because we do see some offset with lower commercial build rate in the second half of the year. So, I think our view and we're not giving guidance right now, I would say, relatively flat CM in volume.

P.J. Juvekar - Citibank

Okay. And one quick clarification question for Dave. Dave, did you give the FIFO impact for the quarter?

Dave Drillock

I didn't give it in my prepared remarks, but it's approximately $20 million.

P.J. Juvekar - Citibank

Thank you very much.

Operator

And we'll go next to Laurence Alexander with Jefferies

Laurence Alexander - Jefferies

Good morning.

Shane Fleming

Good morning Laurence.

Laurence Alexander - Jefferies

I guess first on Surface Specialty, it is a two part question. Could you discuss competitor behavior in this environment and whether you are seeing any -- or whether you expect to get a benefit from falling raw materials? And then secondly, how are you thinking about -- do you have any kind of normalized margin target for the business as you restructure it?

Shane Fleming

Yeah, let me go to that first question. In terms of competitive behavior, it's been reasonably disciplined at this point in time. The pressure right now is on margin is less coming from our competitors that are going out there and trying to capture share, although you're seeing some of that. It's more commitment to the fact that our customers are under a lot of pressure and because the customers are under pressure, they see our raw material cost dropping, they are pushing real hard.

So, that dynamic will probably change in time. But at this point I feel pretty good as I said earlier, about our ability to even improve margin as raw material cost, worked away through our supply chain. So far, so good, all bets maybe off in some of the lower margin areas in the next couple of months as volume stay down, what 25, 30, 40% levels that could change the dynamic. But so far margin pressure is not my biggest concern. It's really more on the volume side.

Normalized margins with the change in mix, this is how we will ultimately drive the CFS business to the level of profitability that we want is to improve mix. I think the process has been accelerated for us a little bit as we've gone through these restructuring initiatives and taking out some of the lower margin materials. So we should see when we are back at capacity, several points of margin improvement. The challenge of course, is trying to define when that period of time is going to be.

Laurence Alexander - Jefferies

And then on the performance businesses, are you happy with the portfolio given new more depressed outlook or are there parts of the business that you might try and find a strategic alternative for?

Shane Fleming

We've got some business under pressure there, the business we've talked about in the prepared remarks and in the press release and businesses are basically some of the same markets that we serve in Surface Specialties. So if you look at our polymer additives business and our specially additive business, particularly those two rely to a large degree on automotive, construction and you have seen the same types of decline, the same percentage decline rates there, that we've seen in some of the other Surface Specialty areas, so.

In some cases, we've got some differentiated technology that's helping us a little there, with share take. But I'm not thrilled that we're seeing that same volume fall off in the performance chemicals portfolio as well, there is obviously, some work we can do to improve that portfolio.

Laurence Alexander - Jefferies

And lastly, the new Engineered Materials capacity is expected to come on stream on the same schedule. You're not delaying when it actually comes on.

Shane Fleming

At this point in time the two major projects, we talked about the carbon fibers plan, which I think would start up towards the end of 2010 and the plant in China, which starts up in the second half of this year, are still on schedule.

Laurence Alexander - Jefferies

Thank you.

Operator

And we'll go next to David Begleiter, Deutsche Bank.

David Begleiter - Deutsche Bank

Good morning.

Shane Fleming

Good morning, David.

David Begleiter - Deutsche Bank

Shane, just to be clear, do you expect, Surface to loose money in Q1?

Shane Fleming

I don't think I can answer that question directly. I think we're doing everything we can to make sure that the business doesn't loose money in 2009. And I think I'm going to have to leave at that.

David Begleiter - Deutsche Bank

I have the next question, so '09 is still in your mind, could be a loss year for the segment for the entire year?

Shane Fleming

We're hoping not. We're planning not. But it does obviously depend on volume.

David Begleiter - Deutsche Bank

And Engineered Materials, if Boeing cost you $50 million in Q4, should we just add that to the Q1 to get the Q1 number?

Shane Fleming

Well, I mean the mix changed a little bit quarter-to-quarter. And we actually saw, I think we've referenced the fact that we had a couple of areas outperform expectations a little bit. So, I wish that would be the case. But I think that would be a little bit bullish.

David Begleiter - Deutsche Bank

And for the full year, should this segment be up year-over-year do you think?

Dave Drillock

I think, David, I've kind of addressed that in my earlier comments. We expect some falloff in the second half of the year in LCT regional, and business jets. And to stay flat even year-to-year that means, we're going to have to have some penetration with some other programs, as well as, the improved mix that I've talked about. So, I'm certainly not expecting -- we're not expecting strong growth, but in balance that the year shouldn't be that different than 2008.

David Begleiter - Deutsche Bank

Okay. And lastly, just on the normalized margin question in surface. Was that 200 basis points improvement of the low 6% base over last couple of years?

Shane Fleming

Yeah, we're not satisfied with that 6% base. And our intent is to get that up. You've talked to us before, linked about 10% target and I recognized that's a long ways from where we are at today. But we will have significantly improved the mix of products by the time we work through these restructuring actions. And once the volume comes back, I think we're going to be in a position to move up that 6% base and move towards that 10% number.

David Begleiter - Deutsche Bank

Thank you.

Operator

We'll take our next question from Chris Shaw, UBS.

Chris Shaw - UBS

Hi, good morning. How are you doing?

Dave Drillock

Hi, Chris.

Shane Fleming

How is it going, Chris?

Chris Shaw - UBS

Good. Could you guys have a number for what your sort of, raw material cost inflation was for all of 2008?

Shane Fleming

Across all the segments?

Chris Shaw - UBS

Yes.

Chris Shaw - UBS

Have to dig it out.

Dave Drillock

Yes, obviously, we'll get that for you.

Chris Shaw - UBS

Okay.

Shane Fleming

We'll get back to you about (inaudible). I think it will take a little addition.

Chris Shaw - UBS

Okay. And on the pension you mentioned, the discount rate was following, right. I thought that would be up year-over-year?

Dave Drillock

No, no, actually rates came down towards the end of the year and its usually based on 10-year, treasuries are AA bonds and they actually came down towards the end versus what we had in '08.

Chris Shaw - UBS

Okay. They – it must have dropped it later in the year. When I was looking at back, I think earlier, fourth quarter, third quarter.

Dave Drillock

It was actually more favorable.

Chris Shaw - UBS

Okay. And then just how do you think the cost savings, the restructurings, is it mostly going to be, you’re going to get much of that in the first half or is it going to be pretty much second half in fourth quarter.

Dave Drillock

Its spread, I think the impact from the major plant shutdown initiatives and line restructuring, that will be second half but we are already seeing the benefit from some of the headcount reduction and the SG&A reduction, you saw some of that in the fourth quarter with that $9 million reduction there. So I would say if you weight it, I don't know 25%, 75% first half, second half something like that.

Chris Shaw - UBS

Okay. And I just want to confirm you said CapEx was probably flat year-over-year?

Dave Drillock

Yes.

Chris Shaw - UBS

2009?

Dave Drillock

Yes. About $200 million.

Chris Shaw - UBS

Great, thanks.

Operator

And we’ll take our next question from John McNulty, Credit Suisse.

John McNulty - Credit Suisse

Yes, good morning, just a few questions. On the Performance Specialty business, the margins actually held up pretty solidly despite the fact that you saw significant volume decline. Should we be thinking about this is kind of the right margin level or at least the decline year-over-year from '07 or improvement actually year-over-year from '07 to '08. Is that a sustainable level when we should be thinking about 2009?

Shane Fleming

Well I think the business did quite a good job as you saw in the release getting priced in the quarter, over raw material. So we were very aggressive in that business over the last half of the year. I'm not sure that in all cases across that portfolio we are going to able hold on to that price. In fact, some of it is actually indexed. So, some of the index almost, catch up with us. I think there is going to have to be a little bit of margin give back in couple of areas.

But we've also been working to improve the product lines in CPC. We discontinued some lower margin materials. You are aware of polymer additives restructuring, so that's helping the overall margin as well. But again given low volumes, it's going to be a battle if we don’t see either some share gain or success, commercializing some new products in some of the areas outside of mining, because right now mining is really carrying a lot of weight in that sector.

John McNulty - Credit Suisse

Okay, great. And then, on the Engineered Material side, do you have a rough idea of how the Boeing strike cost you in terms of margins in the fourth quarter?

Shane Fleming

I don’t have a margin number. I think that $15 million earnings number we talked about is probably the right way to think about it.

John McNulty - Credit Suisse

Okay, maybe looking at it from a different perspective. When we look to 2009, is there any reason why you shouldn’t see margins roughly the same as what you saw in 2008, whether it's the ramp up of some more carbon fiber capacity or what are the potential takes that might potentially hit that margin year-over-year?

Shane Fleming

I am just trying to think right now, the biggest impact I think would be the threat of some softening in LCT and I think I anticipated softening in the region and commercial area. We are continuing to invest, add commercial expense, R&D expense, we talked about that in the fourth quarter as well.

So, the recent year-to-year carry over there is on an annualized basis you're going to see expenses increase. Again, I don't see it's been a significant change year-to-year. Dave, did you have something?

Dave Drillock

Yes, John I don’t think you're going to see a significant decline in the margin. But we've always said this thing is going to range from that -- at any one quarter from that 17% to 20%-21%. I think these stocks expect to be in that range.

John McNulty - Credit Suisse

Okay, fair enough. And then just a last question with regard to the building block materials business, it's running at probably one of the biggest losses its run at since the last recession. What can you do to improve the profitability of that business or is it really just a function of, you need the demand to come back?

Shane Fleming

Well demand certainly helps solve all problems there. We are looking at different ways to manage expense within the business options around for allowing shutting down units and campaigning -- some of that you are limited in some areas as to what you can do there. Trying to make sure that we are accessing all the available markets for our products, but at the end of the day if we don't see relatively strong volume it's tough to make money in that business.

John McNulty - Credit Suisse

Okay, great. Thanks a lot.

Operator

We’ll go next to (inaudible) with 40|86 Advisors.

Unidentified Analyst

Hi, sorry if you covered this already in your prepared remarks. But did you mention the revolver drawings and just any details around the potential covenants on that revolver would be helpful info.

Shane Fleming

Yes, at year end, we drew down the revolver about $110 million and then in terms of covenants I think the best thing for me is to say is at year end we’re fine with all the covenants and then just going forward as we said in our prepared remarks, our job this year is to maintain good liquidity for the company, so we continue all this good work regarding the initiatives we got going on.

Unidentified Analyst

Okay. Thank you.

Operator

(Operator Instructions). We'll take our next question from Laurence Alexander, Jefferies.

Laurence Alexander - Jefferies

I have just one follow-up on engineered materials. As the new projects come on stream will there be a drag on margins in 2010 due to sort of or you will still be rampaging up the capacity.

Shane Fleming

Yeah. I think that's consistent with our view, Laurence I think we've have said that in the past. When you bring one of these new projects online, you run them for a while, making that product to do your qualification and there was period of time where, you're incurring the higher cost, but you don't have the benefit of the revenue that comes from operating those plans. So anytime, I bring a new plan online in the CM area, there is a drag following a startup.

Laurence Alexander - Jefferies

And so with two of them coming on stream, should you still be within that 17 to 21 range?

Shane Fleming

Yeah. I think the first one will have worked through by the time we get into mid 2010. So and it's not a massive investment. The bigger pressure is going to come in, probably more in 2011, as we bring the new carbon fiber capacity online.

Laurence Alexander - Jefferies

Okay, great. Thanks.

Operator

We'll take a follow up question from Mike Sison with KeyBanc.

Mike Sison - KeyBanc

Hey guys. The CapEx budget fallen by a $100 million. What was sort of taken up the table that seems to be a pretty big $100 million, with your certain areas that you're going to sort of not invest in?

Shane Fleming

Well, I think it's a pretty broad spread, Mike. We looked very hard at our maintenance capital and we've done a fair bit of hair cutting there really across all of the segments. We've had some growth projects in Chemicals and MCM, but due to reduced demand, we've been able to slowdown a little bit or push out, maybe into 2010 or 2011.

So, as you might guess, given the fact it's a $100 million, that was pretty widespread, not just one or two areas. And we recognize that, we do have some investments that we need to make in the future to support growth and we'll continue to do that. And we'll just manage capital elsewhere, to make sure that we don't slow ourselves down in areas where we can get growth.

Mike Sison - KeyBanc

Right. Then Dave, D&A for next year?

Dave Drillock

Mike, it will be a bit higher than the D&A that we have and the cash flow for this year won't change a whole lot.

Mike Sison - KeyBanc

Okay. Then I guess when you think about operating rates have been where they are at for Surface Specialties in demand trend. Why wouldn't you be more aggressive on taking down your capacity, it's probably a decent time to do that. You sort of mentioned that maybe capacity might -- the reductions would decrease by 10%. I mean is there any reason you wouldn't be more aggressive there?

Shane Fleming

Well, I think that 10% was really looking more as structural change, where we're taken capacity out that is not likely to come back. I think once we start going beyond that, you will see us do things more like let's say [BSF] announced, where we do temporary shutdowns, freeloads. There is a fair bit of flexibility right now particularly in Europe the government is working with employers to retain jobs.

So we're investigating all possible ways of taking capacity out for the short-term, not losing that asset base, yet like shutting those cost and that's really the focus for us right now.

Mike Sison - KeyBanc

Okay. And then, I guess in the follow-up to Building Blocks, is there the kind of breakeven in this type of environment or do you – is it basically you're going to need a pretty decent amount, because you've basically have gone back and restructured that business, pretty well I thought. And when sort of the demand returns, we sort of think that things will be below breakeven for a while?

Shane Fleming

We need some level of demand, certainly above the level of demand, we saw in the fourth quarter. Our expectations are not that Drogenbos we're going to make a lot of money in 2009. But we actually know that we've done a lot of restructuring, where we're trying to manage the site, the business, in a very cost effective manner. But if we don't see some pick up in demand, its going to be tough to make any money there.

Mike Sison - KeyBanc

Okay, great. Thank you.

Operator

It appears there are no more questions at this time. Ms. Allen, I'd like to turn the conference back over to you for any additional or closing remarks.

Jodi Allen

Thank you for your participation in our call today. And if you have any further follow-up questions, please contact me directly at 973-357-3283. Thank you very much.

Operator

This concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.

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Source: Cytec Industries Inc. Q4 2008 Earnings Call Transcript
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