Cytec Industries, Inc. Q2 2009 Earnings Call Transcript

| About: Cytec Industries (CYT)

Cytec Industries Inc. (NYSE:CYT)

Q2 2009 Earnings Call

July 17, 2009 11:00 am ET

Executives

Shane Fleming - Chairman, President & Chief Executive Officer

Dave Drillock - Vice President & Chief Financial Officer

Jodi Allen - Director of Investor Relations

Analysts

David Begleiter - Deutsche Bank

Laurence Alexander - Jefferies

Mike Judd - Greenwich Consultants

Anthony Pettinari - Citi

Amy Zhang - Goldman Sachs

John McNulty - Credit Suisse

Operator

Good day and welcome to the Cytec Industries Incorporated second quarter earnings announcement. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the conference over to your host, Ms. Jodi Allen.

Jodi Allen

Thank you and good morning everyone. We appreciate your participation in our conference call. For our call today, Shane Fleming, Chairman, President, and Chief Executive 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 our website for three weeks.

Throughout the call, we will be referencing the supporting materials, which can be downloaded from our Investor Relations website, under Calendar of Events or you may follow the slides accompanying today’s webcast, which are also available through our website.

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 in slide number two of our supporting materials or 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 measures as defined under SEC rules. We have provided a reconciliation of those non-GAAP financial measures to the most directly comparable GAAP measure at the end of our press release. A copy of our press release is available on our Investor Relations website.

Now, let me turn over the call to Shane.

Shane Fleming

Thanks for taking the time to join our second quarter earning conference call. The challenges that began late last year related to weak demand and customer destocking in the specialty chemicals industry continued into the second quarter, and we’re now also faced with softening in the engineering material segment which further impacted our second quarter earnings results.

As you can see from slide 3, total company sales in the quarter were $685 million, down 32% versus the second quarter of 2008. While the specialty chemicals segment remained pressured by the global economic slowdown, we are seeing positive signs of improvement in this sector. We’ve experienced sequential volume improvements over the last several months that we’re hopeful signal the end of the destocking in these segments.

On a regional basis, we’re seeing some early signs of demand recovery in Asia. In the Americas and Europe, while there has been substantial improvement since the first quarter, we don’t expect year over year improvement in demand until the fourth quarter when the comparisons become easier. The overall result for the quarter was a net loss of $0.01 per diluted share excluding the special items that Dave will explain, compared with a net earnings of $1.20 per share in the second quarter of last year.

I would like to provide an overview of the results for each business segment, but first I want to remind you that last month we announced a change in our business segment reporting structure. Our new reportable segments are better aligned with the company’s growth strategy as we focus on strengthening our position in high growth markets and operate in cash businesses to maximize cash flow. We also believe the new operating model will provide you with better clarity as we continue to implement the new strategy.

Beginning on slide 4, the coating and resin segment remained challenged by the difficult demand environment, and as a result delivered sales of $295 million which represents a 30% decrease in volume versus the same period last year. Selling prices decreased by 3% which is primarily due to the powder coating product line as competition became more aggressive pursuing share gain in a weak demand environment. The impact of exchange rates decreased sales by 5% as the majority of this business resides in Europe and is therefore significantly impacted by euro-dollar fluctuations.

There were some bright spots in the quarter which keep us encouraged about he second half of the year. For example, selling volumes were up over 25% versus the prior quarter, likely signaling the end to the customer destocking we saw late last year through early 2009. The graph on slide 5 indicates a nice trend upward in the segment with 4 successive months of sales growth, and this was seen across the liquid coating resins, radcure, and powder product lines.

Sales in Asia continue to recover more quickly than elsewhere in the world, driven largely by improved automotive sales in northern Asia and infrastructure build in China. Finally, we continue to see positive trends with our ecofriendly coating products including strong year over year sales growth with our new waterborne alkyd products for trim paint and deck stain. The results for the coating resin segment were an operating loss of $19.2 million versus operating earnings of $21.9 million in the same period last year.

I’m pleased with the good progress we’re making in the restructuring actions related to this segment, and we’re on target to deliver our structural cost savings goal with the larger impact coming in the second half of this year. I will talk more about full year segment projections later in this call.

Slide #6 shows an overview of additive technologies, which had sales of $63 million in the quarter, a 30% decline versus the same period last year. This segment is faced with similar economic pressures as coating resins with lower demand in industrial markets significantly impacting sales. However, approximately one-third of the decline is related to our exit of certain low-margin product lines in the second half of last year as we focused our efforts on marketing more value added technologies.

The increased focus on the higher value products has also increased our pricing power, as the segment delivered a 1% increase in price in the quarter, offset by exchange decreasing sales by 4%. As a result of reduced volumes, the segment delivered $3.1 million in earnings in the second quarter versus $6.9 in the prior year quarter.

Moving on to slide 7, the in-process separation segment also experienced soft demand due to customer destocking in both the mining and the phosphine product lines. Sales in this segment were $58 million, a 23% reduction versus second quarter 2008. As you can see in slide #8, the production of copper and alumina was down in the first half of this year, and this coupled with the destocking activities led to lower volumes. Our pricing increased by 3% as a result of our ability to leverage the performance of our differentiated product technologies. The impact of exchange rates decreased sales by 2%. We do have a positive view for the second half of this year in this segment, and I will share that detail with you later in the call.

Slide #9 shows a summary of the results in the engineered materials segment where sales decreased 21% to $178 million. Selling volumes decreased by 22%, and about 40% of this decrease was related to destocking at customers who supply the large commercial transport sector. Another 35% is due to the dramatic decline in billed rates for business jets, and the remaining 25% is due mainly to demand decline in our high performance automotive market. Selling prices increased by 3%, but this was partially offset by a 2% sales reduction related to exchange rates. The result is that operating earnings of $22.1 million were approximately half of the earnings in the same period last year, related primarily to the lower selling volumes and to the decreased production rates. I will discuss our restructuring plans to address this when I review our outlook for the remainder of the year.

Slide #10 shows the results for building block chemicals. Sales decreased by 34% to $91 million which was mainly driven by the steep price decline of acrylonitrile in the quarter as a result of lower propylene cost. Selling volumes did increase by 30% due to last year’s acrylonitrile maintenance outage. As a result, segment operating earnings were $1.9 million, down from $6.5 million one year ago.

Now let me turn you over to Dave.

Dave Drillock

Shane covered the revenues for the quarter, so I’ll go right to a review of our gross margin followed by an overview of the special items recorded in the quarter and our operating expenses. I’ll cover some balance sheet and cash flow analysis and close with a summary of the actions taken in the quarter to improve our liquidity.

Our gross margin after adjusting for the special items in both years decreased about 5.5% from the prior year period. This decrease resulted principally from the low manufacturing production rates in the quarter which increased our fixed cost per unit and has impacted all our segments except for building block chemicals. We reduced our production levels significantly in light of the lower demand, and our internal efforts to bring our inventories down to a more appropriate go-forward level.

As our production levels were reduced, we also challenged ourselves to further decrease our period cost spending, and our efforts resulted in an overall manufacturing period cost reduction of almost 15%, and as Shane mentioned earlier, our structural cost takeout initiatives have a greater impact on the second half of the year, as the benefits from our previously announced site restructurings start in the third quarter.

In summary, in spite of some significant cost control efforts this quarter, our fixed cost per unit went up which negatively impacted our gross margin. The upside to this is that we have made great progress in reducing work days as part of our working capital initiative. I’ll talk more about this later.

For the quarter, our special item restructuring charges were $34 million, with $24 million included in manufacturing cost of sales and the remainder in operating expenses. The charges were mostly related to a number of cost reduction initiatives in specialty chemicals as we right-sized the business to the difficult demand environment we’re in. Also included in the restructuring charge is approximately $2 million related to a restructuring in our engineered materials business that Shane will discuss further in a few minutes.

For the first half of 2009, our total restructuring charges were $37 million, and we expect the full year restructuring charges to now total about $115 million with about $35 million of that to be noncash. The split of the restructuring charges by quarter as you know depends on the timing of certain actions, but we expect most of this to be complete by year end.

Our cost reduction actions in manufacturing and operating expenses are expected to achieve run rate savings of approximately $120 million in 2009 and 2010. About $70 million of the 2009 savings is related to our short term temporary cost saving initiatives such as furloughs, merit increase cancellations, and incentive compensation payout reductions to name a few. These short-term initiatives will be replaced by our structural or permanent cost takeout actions in 2010, but if demand remains weak, we could continue certain of these initiatives over to 2010.

I’ll close this topic by reminding everyone that all of our actions are implemented or in progress, so we remain confident about achieving the benefits from these important initiatives.

Moving on to operating expenses, they are down about $20 million year over year after excluding special items. Our cost reduction efforts account for about two thirds of the reduced expenses and changes in exchange rates the remainder. Other expense for the quarter was essentially break even compared to $3.7 million net income in the prior year period. The prior year period included transaction exchange gains and the benefit of an insurance settlement which together account for the difference.

Our annual underlying income tax rate increased about 3.5 percentage points versus last year, principally due to an earnings mix towards higher tax jurisdictions mostly to US and limitations on certain US manufacturing deductions.

Moving on to cash flow for the quarter, we had a great quarter, and our cash flow from operations was $168 million, significantly up from the prior year’s $44 million. The increase was related to the improvement in our net working capital partially offset by the lower earnings. Slide 12 will give you a good view of our performance in reducing net working capital days outstanding which is how we’re monitoring our progress. Accounts receivables used about $4 million of cash, but days outstanding continuing the trend from the first quarter decreased by five.

Our inventory decreased $105 million in the second quarter, and our days on hand decreased by 33. Taking up on my discussion from last quarter in March, we adjusted our production schedules further, and we began to see a drop in inventory days. Our manufacturing and supply chain teams took additional actions including several process improvements to reduce our days on hand, and we expected to see progress this goal by the end of the second quarter. The results? They exceeded our expectations, and this is a good example of what a focused Cytec team can do.

Accounts payable increased $33 million. As we begin to increase our raw material purchases again, we are starting to see the impact resulting from our efforts to improve work days outstanding by working in partnership with our suppliers. Our engagement level on our working capital initiative remains high throughout the company, and we expect continued improvement as we go forward, particularly in our engineered materials segment. Let me close out this topic by saying this is simply great work by the commercial, supply chain, manufacturing, and finance teams.

Capital spending for the quarter was $53 million, up from $43 million in the same quarter of 2008. Two thirds of the spending in the quarter was related to the carbon fiber expansion project in the US and the composite prepreg manufacturing plants in China. As I mentioned last quarter, we have delayed the completion of the carbon fiber plant for at least 12 months which takes into account the combination of delays in new aircraft programs, plus legacy aircraft production slowing down.

So the expenditures for the rest of this year are related to purchase commitments made for equipment which will be stored until we restart this project. The prepreg plant in China has been successfully completed and is in start-up mode, so this will not be a factor for capital spending going forward. Our full year outlook for 2009 capital spending is a range of $180 to $190 million.

Looking at the balance sheet, we’re pleased to say our overall debt decreased $95 million in the quarter, a big benefit related to our working capital initiatives. The balance of our main credit facility was $23 million at the end of the quarter, down from $113 million at the end of the first quarter. Concerning the credit facility, during the quarter, we completed an amendment which effectively increases the maximum permitted consolidated debt to consolidated EBITDA ratios through March 31, 2010, and also excludes up to $100 million of cash restructuring costs from EBITDA through March 31, 2010.

Our debt to EBITDA ratio at the end of the second quarter was 2.8 versus the maximum covenant of 3.75. Taking into account our recently revised earnings guidance, our estimated ratios still provide us well over $100 million of borrowing capacity in the third quarter and over $200 million for the fourth quarter of this year under the new covenant. Following up on some additional actions identified at the last quarter conference call, we completed the action to contribute $1.2 million shares of Cytec stock to our US pension master trust, conserving cash and pre-funding the trust for 2009.

In another action taken to improve our liquidity and remove risk, we completed a $250 million bond offering which has an 8-year tenor and an 8.95% coupon and simultaneously began a tender for up to $250 million of our outstanding debt. Yesterday, we purchased $235 million of our October 2010 notes leaving us only $15 million of these notes still outstanding. We anticipate that we will purchase $15 million of our 2013 notes at the end of the month. We are pleased with these transactions as they improve our debt maturity profile, which you can see on slide 14, and this should help reduce liquidity concerns.

Lastly, Moody’s reaffirmed our investment grade rating with a BAA3 stable outlook. Standard and Poor’s rating was investment grade at BBB- stable outlook, change from BBB negative outlook.

In closing, we had a busy quarter and first half of the year. The many steps we have taken should greatly improve our company and reduce overall risk. While we still have to remain cautious in these uncertain times, we remain focused on executing our growth and improvement initiatives. With the committed team of great people here at Cytec, we are confident of a bright path for our future.

Thank you, and now I’ll turn the call back over to Shane.

Shane Fleming

Thank you Dave, and now I’d like to review our outlook for the remainder of 2009, which we have summarized on slide 15. In coating resins as I explained earlier, we believe our customers are ending their destocking activity based on incremental demand improvements we saw in the prior months. We’re also starting to see the benefits from the various cost savings initiatives underway including both the short term and the structural improvements. The realized cost savings combined with sequential volume improvements will bring this segment above breakeven performance later this year. However, as a result of the difficult first half, we are still estimating a full year operating loss in a range of $42 to $50 million.

The additive technology segment will also show modest improvements in the second half as these product lines from selling more high value products and modest demand improvement. We will continue our focus to maximize cash generation by running our operations more efficiently. We estimate this segment’s full year operating earnings to be in a range of $8 to $12 million.

We have positive news related to the in process separation segment for the second half of this year. Our commercial and technology teams have successfully captured several new pieces of business as a result of the superior performance of our new products for the alumina, metal extract, and mineral processing areas. The resulting new business will begin over the coming months including several extract and fills that are scheduled for delivery in the second half of the year.

This segment was also impacted by destocking in the first half of the year; however, as you can see from the graph on slide 16, the forecast for global copper production is expected to improve in the latter part of this year, while alumina production rates are expected to be effectively flat with the second quarter levels. Due to these positive trends, we are estimating full year operating earnings to be in the range of $32 to $40 million.

The engineered materials segment stays with softening demand for commercial aircraft as I detailed earlier in the call. We’re therefore taking aggressive actions to better align our cost structure with the current customer demand. These actions are designed to bring our manufacturing, commercial, and support function costs in line with the expected new level of demand including a difficult but necessary decision to reduce the work force in this segment by 8%. These measures are expected to deliver a total of $20 million in additional cost savings on an annualized basis. Approximately half of this amount or $10 million will be realized in the second half of this year. These new actions are additive to the previously announced cost restructuring initiatives, which were related primarily to specialty chemicals.

While we are focused on managing costs through the current down cycle, we are sustaining investments and key strategic projects driven by the secular conversion of metals to composites. This includes opportunities such as the Bombardier aircraft platforms, Russian regional jets, and the China regional and large ship programs, in addition to our early successes commercializing new product technologies such as our out of autoclave prepreg which significantly reduces our customers processing costs.

Additionally, while early in the expiration phase, we’re receiving very positive interest in our technology from several customers in the high performance industrial materials segment. Given the reduced commercial build rates and ongoing destocking activity that would likely continue throughout the year, we’re estimating this segment to deliver operating earnings in a range of $100 to $105 million.

In building block chemicals, we see demand improvement in acrylic fiber markets in Asia and in Europe, but we also believe that margins for acrylonitrile will continue to be under pressure as the cost of propylene rises in North America. The global melamine market has seen only modest improvements and is expected to remain weak for the remainder of the year. Therefore, we estimate operating earnings to be approximately $5 million for the full year.

Our guidance for corporate and unallocated for the year is an expense of approximately $20 million, and net interest expense is estimated to be $33 million. Our forecast for underlying annual tax rate for ongoing operations is in the range between 34-35%. Taking into account these estimates, the expected business segment performance and our ongoing cost reduction initiatives, we are affirming our recent guidance for full year adjusted diluted earnings to be in the range of $0.60 to $0.90 per share.

Although 2009 has been a challenging year for us, given the soft demand across many of our markets, we have developed and are successfully executing a number of restructuring initiatives and expense control measures to deliver significant cost savings. The company’s progress on working capital management is evident in the considerable improvements in cash flow that Dave highlighted earlier. Now, as we move into the second half of this year, with the cost reduction and liquidity improvement initiatives well underway, we will turn more of our attention to driving topline growth in our global markets by delivering high performance product and applications technologies that create value for our customers. Cytec has leading market and technology positions in a number of attractive markets. Our strategies are sound, and we have the financial strength and the organizational talent to execute these strategies. In my earlier remarks, I provided several examples of the progress we have made in 2007 that will benefit the near and the long term. Our commitment to investing in growth remains unwavering as does my confidence in our ability to delivering increasing shareholder value.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Begleiter - Deutsche Bank.

David Begleiter - Deutsche Bank

Shane, in engineered materials, how long do you think it will take you to get back to the earnings and margins you enjoyed back in 2008? Is it a 2- to 3-year process, or is it longer than that?

Shane Fleming

It’s obviously difficult to predict exactly, but I think our thinking right now based on triangulating with many customers is that the trough is probably going to be sometime in the second half of 2010 to early 2011, and if you look at previous cycles, it’s easily 1 to 2 years up from that trough period, so you’re probably talking about 2012 to 2013 before you’re back up on top of the cycle.

David Begleiter - Deutsche Bank

Does that mean that the new carbon fiber plant will not be built until perhaps 2013-14 timeframe?

Shane Fleming

I think we’ll continue to evaluate that. One of the big drivers for that carbon fiber expansion is the volume related to the 787. Despite the fact that we may see some demand reduction on carbon fiber in our legacy business, if the 787 build rate forward aggressively, I think we potentially could be restarting our investment in that plant and completing that plant more quickly than what you suggested.

David Begleiter - Deutsche Bank

On coating resins, what’s your longer term margin forecast in this business?

Shane Fleming

I am not going to give you a number right now, Dave. I don’t think I can. I think we still have to do some structural things to improve that business. There are pieces of business we really like. There are pieces that clearly are more in the catch category. As you would have heard in past communications, it’s our intent to look at restructuring that portfolio. Longer term, my expectations are to have double digit operating earnings, but in the environment we are in right now, with difficult ability to predict future volume, I think it would be premature to try and give you a target.

Operator

Your next question comes from the line of Laurence Alexander – Jefferies.

Laurence Alexander - Jefferies

What is your current thinking for target for leverage ratios and your priorities for uses of cash after that?

Dave Drillock

On the leverage ratios, in terms of debt to book cap and those types of ratios, we’re going to be in a 30-40% range, or we keep driving towards that, but our uses of cash will be the maintenance of business, the safety investments that we know we’re going to do. It’s investing in the growth opportunities and any expansions we see available in those areas once demand returns, cost reduction projections, and then it’s continued debt pay-down, and we’ll go from there.

Laurence Alexander - Jefferies

As you look at the working capital turnover ratios that you posted this quarter, do you feel those levels are sustainable, or what level would they ratchet back to in a more normalized environment?

Dave Drillock

Laurence, our goal was to make these numbers, and I think I said in my prepared remarks that we made process improvement so that we think these are sustainable, and that’s our goal—to make these sustainable, so I don’t want to give you an exact number, but we do not expect them to ratchet back up to the high you see in that chart.

Laurence Alexander - Jefferies

On building blocks, how much of recovery in end-market demand is needed to offset the raw material pressure that you’re seeing, or what are you baking into your assumptions?

Shane Fleming

I don’t think we’re baking much in the way of recovery on the melamine front. I think our view is that it’s going to stay soft through the rest of the year, maybe at the levels we’re at right now. We have seen some modest improvement in demand for acrylonitrile, and I think we do have a more positive view about acrylo demand right now than, say, we would have a few months ago, but the problem offsetting that is the fact that propylene prices are rising faster in North America than they are in Europe and Asia, and that’s creating margin problems for us.

So we have a pretty I think conservative view about any improvement in that business in the second half versus first half. There are some offsetting factors out there, but I don’t see strong volume growth turning that business around in the second half right now.

Operator

Your next question comes from the line of Mike Judd - Greenwich Consultants.

Mike Judd - Greenwich Consultants

One of the things which is a little confusing, not so much just for your company but also across the entire chemical industry at this point is really on the demand side. You essentially have a business where there is a seasonal pick up in the second quarter, and what I’m trying to understand a little bit better because I know obviously Europe they are on vacation for the whole month of August or whatever, maybe this year for longer, is the information that you provided to us in terms of revenues or volumes picking up sequentially each month in the second quarter. Is that something that you anticipate continuing into the third quarter despite basically vacations Europe, and then obviously there are seasonal factors in the fourth quarter where there are typically lower operating rates? Can you flush that out, and I guess in particular in coatings, resins, additive technologies, etc., in those areas in particular?

Shane Fleming

First of all, we’re not really to see our sequential volume improvements to continue across the second half of the year. I think our view is that the destocking is mostly behind us now, and the run rates that we’re seeing later in the second quarter are more reflecting of the existing base business, and as we put our full year earnings projection together, we would certainly look at the normal seasonal effect we see in late Q3 with vacations in Europe as well as the December slowdown, so what we’ve projected effectively has base business at the end of Q2 run rates and then some softening in demand later in Q3 and late in Q4 due to vacations. In fact, just to drill it down a little bit on Europe, if you look across the globe, we’ve seen pretty positive news coming out of Asia, and we’re not just seeing sequential improvement, but in certain product lines, we’re actually seeing year to year improvement there. North America seems to be a little stronger than Europe, and in Europe, which is a big area for us, that’s the market that we’ve not really seen the volume pick up yet, and again that’s reflected in our full-year forecast.

Mike Judd - Greenwich Consultants

This is really helpful, this forecast that you provided for copper and alumina. Again, I guess it’s a little unclear for those of us who don’t have offices in China, but there seems to be two thought processes. One is that they have been buying copper inexpensively and filling up their inventories, and you guys come out in terms of in terms of your view of what’s going on in China. Do you think that they have adequate inventories of copper or do you think they need more?

Shane Fleming

Well, I think there’s probably been some buying, and that’s led to decreases in copper inventory levels which have led to pricing increasing now, and that again turns up production rate, so that’s the underlying drive behind the higher metal prices and the higher production rates that we’re seeing. I think the basic question is is this sustainable at the levels that we’re seeing right now. I think our view is pretty positive.

The infrastructure build in China is consuming a lot of metals, so this is not all just going into inventory, and auto build rates which also is a big copper consumer are picking across Northern Asia, China, Korea, and Japan. So the experts who predict these metal production levels, inventory levels, and pricing seem to be pretty comfortable with that they have projected.

The upturn is modest. It’s not huge, but it’s getting us back to into the 2008 run rates for copper production. I’m pretty comfortable that those are reasonable forecasts, and we actually provided our own view of alumina production. We didn’t have a look forward on alumina, but what we do is we work in pretty much every large alumina plant around the world including China, and we know what the run rates were.

We have the historical run rates for Q1 and Q2, and then laid on top of that what we’re seeing with plant startups, our increasing volumes, and that’s reflected in our second half view for alumina. Alumina is not in our view going to bounce back quite as much as copper has because there was a lot of excess alumina and aluminum metal inventory when this downturn started, so I think again we look at both those metals which are big drivers for our business, and I think we have taken a relatively conservative view of demand for the second half, and I will just say that a bigger part of our improvement in our earnings and revenue growth in the second half is related to new commercializations rather than improved demand, because the demand improvement as I said is relatively modest.

Operator

Your next question comes from the line of Anthony Pettinari – Citigroup.

Anthony Pettinari - Citi

Shane, in coating resins you saw selling prices decline, and you indicated that waterborne you kept prices, and that in powder coatings you saw pricing pressure. Just to get a little more granularity there, is the positive sequential trend that you’re seeing in monthly coating sales, are you seeing that at all in powder coatings?

Shane Fleming

Yes, we are. It was across the board. Sequentially, we have seen improvement across all the segments. If you look at the markets that we serve, the markets that have turned up the least tend to be more on the construction on the side, and that’s where a lot of the powder product goes. So if you look at graphics, automotive, some of our other big non-industrial markets, that’s where we’re seeing more improvement. Powders are quite linked to construction, and that’s where we’re seeing less improvement, but we’re seeing sequential improvement.

Anthony Pettinari - Citi

So would you expect some of this pricing pressure to abate in the powder business?

Shane Fleming

I don’t think so. I think the problem is that the market is down so far. Of all of our segment from a product line standpoint, powder is down the most, and there is a lot of global capacity, so I think people are going to continue to try and hold or grow share, and that is putting a lot of pricing pressure in that market.

Anthony Pettinari - Citi

I have another question on pension. In May, you contributed the 1.2 million shares. Looking at your funded status after the contribution, are you comfortable with that? Is there any possibility you’d need to contribute more equity to the plan?

Dave Drillock

No. We’ve met or just about met all the requirements on our US plans this year, so I wouldn’t anticipate that.

Operator

Your next question comes from the line of Amy Zhang - Goldman Sachs.

Amy Zhang - Goldman Sachs

I have a question on engineered materials. I want to take a little bit of a longer term view, over the next one or two years, and obviously the aerospace industry is heading to a downturn, and the large aircraft sector will probably be hit pretty significantly. Military application ramp up quite slowly. At the same time, if you talk with the carbon fiber producers in Asia, they have been under significant pressure for both volumes and pricing and inventories are rising, but on the other hand, I understand you guys have the restructuring actions, a lot of self-help efforts. I just want to get a little bit more color about the volume trends in 2010-11, and also the margin versus the last downturn—it will be better, worse, or about the same? How should we think about the whole dynamics for that business?

Shane Fleming

Let me tackle the volume side first and then how we look at the business over the next couple of years. We share your view that there is a great likelihood you’re going to see a slowdown in large commercial transport, and that’s factored into our thinking going forward. How much is a big question, but typical cycles are down 20-30%, and that’s what we would expect from this cycle.

The other major hit in our aerospace business has been the significant downturn in business jets which are down depending on the producer 50-75%, so that’s a negative news. On the positive side, we have nice positions on some military airframes that will be growing going forward—the Joint Strike Fighter being probably the one that will have the most impact, and that is going to provide some offset as that build rate picks up.

We’re also seeing the impact of the 787, which is an important airframe for us. The delays there certainly don’t help, but we still remain bullish that we will see significant 787 build as we get out into the latter parts of this cycle, 2011-12, that should offset some of the downturn in LCT build rates. Beyond that, as you know, we started a new venture within our composites business, our high performance industrial material segment, and we’re bullish there. We think that there are opportunities for us to take some of our higher performing products into certain segments of that market that require high performance, and that’s going to help offset some of the LCT downturn.

I think finally the other area that we’re positive about is we’ve been quite successful over the last couple of years bringing new technology to market and we feel like there are opportunities for us to take share or grow our business with new programs, and some of that will be at the expense of our competitors. So yes, there’s clearly a negative view in terms of the impact of LCT build rates, but we think we’ve got a number of things ongoing that will help offset that in terms of growth in other sectors.

On the second part of your question around operating margins going forward, we will very carefully watch demand in this sector and rightsize as appropriate our costs to make sure that we are able to maintain margins. Our expectations are that we will maintain our margins at the bottom of the cycle at the similar levels as the last cycle. That’s going to require us to be prudent and on guard in terms of being able to take out cost, but we’ve got a lot of experience doing this. We’ve been through multiple cycles in the past, and our expectations are that we’ll do so again.

Amy Zhang - Goldman Sachs

The carbon fiber producers in Asia, the industry in that region is not as disciplined maybe as in North America and Europe, as we see from the major producers. Do you worry about the pricing pressures in that region or anything like new capacity additions to steel that they have been talking about that will have any structural impact on the global carbon fiber industry that may exert additional pressure on this downturn?

Shane Fleming

On the aerospace segment itself, I don’t really think there is too much concern there. I think the excess capacity is going to find its way into the industrial markets, and there is going to be pressure there. That’s something that might make some of those opportunities less attractive on the non-aerospace side of things, but as you know in the aerospace area, the barriers to entry are very high. Time to qualify for new airframes or to replace products on existing airframes is years. There is a small number of companies that have the qualifications, that have the confidence and the capabilities to supply to the major airframers, and I just don’t see the excess capacity now that was really brought on in advance of expectations of extra growth both in industrial and in the aerospace to have big impact on the pricing in the aerospace market.

Operator

Your next question comes from the line of John McNulty - Credit Suisse.

John McNulty - Credit Suisse

In the coatings and resins segment, you had indicated in the press release and in your comments that some of the weakness that you felt in terms of margins and costs was because you were working through your inventories, and so you were running your plants at lower utilization rates. Can you give us some color as to how much that artificial hit was to you overall costs?

Dave Drillock

Overall for the company, it’s about $30 million.

John McNulty - Credit Suisse

$30 million is the hit in the second quarter that realistically when you’re done drawing down inventories won’t be there?

Dave Drillock

Yes.

John McNulty - Credit Suisse

Can you give us some color by division as to where the biggest hits were?

Dave Drillock

The biggest hits would have been on the chemicals side, but I don’t have that detail with me or in front of me.

Shane Fleming

Just to add one little bit to that, we’re not done with inventory reduction, so you’re going to still see some of that impact into Q3 and maybe even some into Q4.

John McNulty - Credit Suisse

Should we think of it being as extreme or similar or half or can you give us some color?

Dave Drillock

I don’t have an exact amount, John. It won’t be as extreme. If you’re modeling, maybe you guys can pick half for want of a better number.

John McNulty - Credit Suisse

In terms of the engineered materials business, you just commented that you think you can get back to the past trough margins, which if our numbers are right is somewhere around 16%, give or take a little bit, at least at the last trough. Is that a number that you think you can get to by the end of the year, or is the cost cutting and the work that you have to get done there, does it take a bit longer than that?

Shane Fleming

I would hope so, but we do have some work to do, John. I think we’re really now moving pretty quickly to try to understand all of that we have do to take out cost, and it’s a moving environment here. The challenges of course is as business slows down, you’re not able to immediately furlough or shut down lines which is where the real cost savings come from. We’ve got to be able to still supply the existing customers, so you’ve got to work through this process a little bit and understand demand and understand how you’re going to supply the customer base going forward. I think some of the immediate steps that we can take, we’ve already taken.

Some of the structural stuff has also been taken, with the 8% headcount reduction you’ve seen, but if we see demand continue to fall off, we’re going to have to look at potentially some other structural changes as well, so I’m a little bit concerned about trying to tell you by some point in time we’ll get there, but what I do want to set is the expectation in terms of how we want to operate this business through the cycle, out that downturn, and there is certainly no reason that I believe we shouldn’t be able to maintain margins at past cycle levels.

Operator

This concludes today’s question and answer session. At this time, I’d like to turn the conference back over to your host, Ms. Jodi Allen, for any additional comments.

Jodi Allen

Thank you for joining our conference call today, and if anyone has any followup questions, feel free to give me a call directly at 973-357-3283. Thank you.

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