Cytec Industries Inc. Q3 2009 Earnings Call Transcript

Cytec Industries Inc. (CYT)

Q3 2009 Earnings Call

October 16, 2009 11:00 am ET

Executives

Shane D. Fleming - Chairman, President, and Chief Executive Officer

Dave M. Drillock - Vice President & Chief Financial Officer

Jodi Allen - Director of Investor Relations

Analysts

David Begleiter - Deutsche Bank Securities

PJ Juvekar - Citigroup

Michael Judd - Greenwich Consultants

Michael Sison - Keybanc

Steve Schuman - Lafayette Research

Amy Zhang - Goldman Sachs

Laurence Alexander - Jefferies

Lavon Von Redden - Hockey Capital

John McNulty - Credit Suisse

Presentation

Operator

Good morning ladies and gentlemen my name is Yvonne and I will be your conference operator today. At this time I would like to welcome everyone to the Cytec Industries Incorporated Third Quarter Earnings Conference Call. (Operator Instructions). For opening remarks and introductions I would like to turn the conference over to Miss Jodi Allen. Please go ahead.

Jodi Allen

Thank you Yvonne 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 No. 2 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 measurements 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

Thank you Jodi, good morning everyone and thanks for joining our third quarter conference call.

After a challenging start to 2009 I am extremely pleased with the progress that we have made with our restructuring actions, cost control measures and working capital improvement. These actions coupled with sequential sales volume growth in our Chemicals businesses has led to much improved earnings and cash flow results in the third quarter.

As you can see in Slide No. 3 versus the third quarter 2008 overall sales in the quarter were down 23% to $740 million. In the Chemicals businesses we have begun to see modest improvements in selling volumes signaling customer-restocking activity across most of our Specialty Chemical markets, while in Engineered Materials we saw the second successive quarter of softening demand.

The overall result for the quarter was net earnings of $27.6 million or $0.57 per diluted share, excluding the special items that Dave will explain later. This compares with net earnings of $51.2 million or $1.06 per share in the third quarter last year. Importantly our third quarter earnings results were a vast improvement versus the first half of the year, in part due to the demand improvement in Chemicals, but coming as well from the focused actions taken by our organization to improve margins and execute cost saving initiatives.

Now I would like to provide an overview of the Business segment results. Beginning with Slide No. 4 coating resins delivered sales of $336 million, a 23% decline versus the third quarter of 2008. Selling volumes were down 16% and selling prices decreased by 5% versus the same period last year in response to competitive pressures brought about by lower raw material costs and the lower demand environment. The price erosion was mainly seen in our powdered resins product line as we recaptured volumes in Europe and in Asia. Exchange rates also had an unfavorable impact decreasing sales by 2% related to euro/dollar fluctuations.

When comparing the third quarter results to the second quarter this year selling volumes increased by 12% in coating resins reflecting restocking actions by our customers and strong demand for seasonal products; in particular, we enjoyed sales growth in liquid coating resins in North America and in Europe related to the respective automotive incentive programs.

The chart on Slide 5 displays revenue growth in the segment which shows stronger sales in July and September and a dip in August which is typically our holiday slow down period in Europe. Overall we continue to see positive signs of recovery in greater China and Japan led by recovering automotive, electronics, and tires.

The Coating Resins segment also benefited from improved margins as raw material costs fell more sharply than price, as well as our structural cost reduction efforts which positively impacted earnings this quarter. The result for this segment was operating earnings of $18.5 million in the quarter, down versus earnings of $22.7 million in the third quarter last year, but I am pleased to say a substantial improvement versus the first half of this year and clear evidence that our efforts to significantly reduce a break even sales for this business have been successful.

Moving to Additives Technologies, Slide 6 shows sales in the segment of $65 million, a decrease of 20% versus third quarter 2008. Selling volumes were down 18% with the majority of this decline related to the exit of commodity polymer additives products last year. This segment also delivered modest sequential demand improvement in both the Polymer and Specialty Additives product lines as a result of customer restocking activity and strong sales of polymer additives to the automotive market in Asia.

Selling prices and exchange rates each decreased sales by 1%. The overall result in the Additive segment was operating earnings of $3.1 million, down versus $6.1 million in the third quarter 2008 and relatively flat with earnings in the second quarter 2009.

Slide No. highlights results for the In Process separation segment which achieved sales of $71 million in the third quarter. Although this is a 14% decrease in sales versus the prior year period, it represents a 60% increase in selling volumes versus the second quarter, a considerable improvement and additional evidence of increased production in the copper and aluminum sectors of the mining industry.

Our new product innovations such as MAX HT and OPT extractants continue to penetrate the market and as a result new products sales are increasing across all regions. Operating earnings in the segment were $12.5 million, down from $19 million in the prior year period primarily due to the lower volumes, but up substantially versus the first half of this year.

Slide No. 8 shows as summary of results in the Engineered Materials segment with sales decreasing by 24% versus the third quarter 2008 driven by reduced selling volumes. The demand for business and regional jets remains weak and inventory destocking continues up to Tier 1 parts manufacturers within the commercial transport sector. We are also experiencing a decline in the high performance industrial markets related primarily to Formula I and high-end automotive sports cars: Pricing in this segment increased by 1%, which was offset by a 1% decline in exchange rates versus the prior year period.

We made good progress in the quarter with our inventory reduction actions; however this negatively impacted earnings by approximately $4 million. The net result is operating earnings of $18.3 million down from $40.6 million in the third quarter 2008.

Building Block Chemical results are shown in Slide No. 9. Sales in the third quarter decreased by 29% versus 2008 to $99 million driven primarily by the large selling price decline of 51% as a result of lower propylene costs impacting the price of acrylonitrile versus the prior year period. Selling volumes did increase by 22% due to demand improvement related to the acrylic fibers markets in Europe and in Asia. Operating earnings in this segment were $4.8 million, a sizable increase versus the operating loss of $1.3 million in the third quarter 2008. This is largely due to the negative impact of Hurricane Gustav in the Gulf Coast which led to additional costs in the third quarter last year.

Now let me turn the call over to Dave who will review the financial results for the quarter.

Dave Drillock

Thank you, Shane, and good morning everyone. It has again been a busy quarter for Cytec and there are many improvement actions taken to discuss with you this morning.

We began the quarter by completing an offering of $250 million principle amount of 8.95% senior unsecured notes due 2017. We used $235 million of the proceeds to purchase most of our 5.5 % notes maturing October 1, 2010 at a premium to par. We used the remainder of the proceeds to purchase $15 million of our 4.6% notes maturing July 1, 2013 at a slight discount to par. The result of these transactions was a charge of $8.6 million in the quarter, but more importantly a vast improvement in our debt maturity profile.

In response to the uncertain economic times we are in we took some additional difficult, but necessary, actions to better match our costs with current and future demand. As shown on Slide 10, Specialty Chemicals recorded a pre-tax charge of approximately $20.6 million principally related to the shut down of manufacturing sites in Spain and Columbia. We are exiting certain low margin products and transferring the remaining production to existing sites and we expect production at both sites to cease by year-end. Approximately $5.7 million of the charge is non-cash related for accelerated depreciation on the assets and a write-down of all construction and progress amounts. There will be another non-cash charge of approximately $19 million in the fourth quarter for the remaining accelerated depreciation associated with these sites.

In Engine and Materials we recorded a pre-tax charge of $1.6 million related to additional structural employer reductions as we further adjust our costs in light of current demand. Since the second quarter we have reduced the head count in this business by slightly over 15%. In addition, we have taken additional temporary measures such as increased furloughing at our manufacturing plants to respond to the drop in demand. Our view for this business remains positive and that is why we have chosen additional furloughing and other temporary cost control measures over further permanent reductions.

We also recorded a non-cash pre-tax gain of $8.9 million related to the sale of land for which the purchase price was paid to us in 2004.

That covers the special items for the quarter, so now I will move onto the operating results.

Our gross margin, after adjusting for the special items in both years, is essentially flat with the prior year period. The favorable impact from net lower raw material costs, mostly in Coating Resins and our cost improvement initiatives, was offset by lower selling volumes and continued low production rates.

In regards to the low production rates, we did adjust our production rates lower than the demand picture to bring our inventory levels down as part of a working capital initiative and this had adversely impacted earnings in the quarter by approximately $11 million. This impacted all of our segments except for Building Block Chemicals. As noted last quarter, our structural costs take out initiatives have a greater impact on the second half of this year and into 2010 that the benefits from our announced site restructuring started in the third quarter.

To sum up the gross margin discussion, our sales people have done a good job in limiting the selling price decreased in light of the lower raw material costs; our cost take out actions are on track, and our volumes and Specialty Chemicals continue to recover, although from a very low starting point. Engine and materials selling volumes continue to be impacted by customer destocking, but as I mentioned earlier we have taken difficult but aggressive actions to better align costs with current demand yet still be prepared for what we believe are positive growth trends.

Operating expenses excluding special items in both years are down about $9 million year on year with our cost reduction efforts accounting for about 2/3 of this amount and changes in exchange rates the remainder.

Let me now point out that our overall structural cost reduction actions in manufacturing and operating expenses are expected to achieve run rate savings of $125 million beginning in 2010 with approximately $50 million included in our 2009 full year guidance.

As a reminder, in addition to these restructuring efforts we have also initiated several shorter temporary cost saving initiatives such as furloughs, merit increase cancellations and incentive compensation pay out reductions, to name a few. We expect these initiatives to reduce expenses by about $70 million in 2009 and if demand reverts to earlier levels we could continue certain of these initiatives over into 2010.

Our annual underlying income tax rate of 34% increased about 2.5% points versus last year, but down from the 35% noted in the second quarter. Both of these changes are principally due to changes in the earnings mix.

Moving onto cash flow, we had another great quarter and our cash flow from operations was $165 million, significantly up from the prior year’s $89 million. Through the first nine months our cash flow from operations was $395 million, a significant improvement over the prior year and the increase is mostly related to the improvement in our net working capital. Slide 11 will give you a good view of our performance in reducing net working capital days outstanding, which is how we are monitoring our progress.

Trade accounts receivable used about $3 million of cash, but days outstanding remained flat with the second quarter at 50 which is no small feat in this economic environment.

Our inventory decreased $44 million in the third quarter and our days on hand decreased by 4 to 68 days.

Accounts payable increased $40 million with our days payable outstanding decreasing 6 to 43 days since the end of the second quarter.

Our engagement level on a working capital initiative remains high throughout the Company and we are focused on sustainability.

Before I move on, let me repeat what I said last quarter, this is simply great work by the commercial supply chain, manufacturing, and finance teams across Cytec.

Moving on to Slide 12, capital spending for the quarter was $43 million, down from $46 million in the same quarter of 2008. About 2/3 of the spending in the quarter is related to the previously delayed carbon fiber expansion project in the US and the completed composite prepreg manufacturing plants in China. The expenditures for the carbon fiber plant 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 in start up mode, so these are final payments for equipment and related costs. Our full year outlook for 2009 capital spending remains in the range of $180 to $190 million

Looking at the balance sheet, we are pleased to say our overall debt decreased $43 million in the quarter and year-to-date we have reduced our debt by $153 million. The balance of our main credit facility is zero and I have already discussed the completed bond offering and debt tender. The impact of all of this is shown on Slide 13 highlighting our new debt maturity profile.

In closing, we had a busy quarter, while in fact we had a busy first nine months of the year. We have taken many steps to improve our company and reduce overall risk while keeping our growth initiatives intact.

Thank you and now I will turn the call back over to Shane.

Shane Fleming

Thanks, Dave. Now I would like to review our outlook for the remainder of 2009, which we have summarized on Slide 14.

In Coating Resins we have seen gradual improvement in business conditions through customer restocking activity and this, combined with our cost reduction initiatives, has resulted in a significantly improved earnings performance. We must keep in mind, however, that the short-term automotive incentive programs are reaching an end and we have historically experienced seasonal effects near year-end due to the holiday period. We will continue to realize cost savings as our restructuring efforts near completion and therefore we are estimating the full year operating loss in this segment in the range of $10 to $15 million which is an improvement versus our prior guidance.

The Additive Technologies segment also benefited from modest demand growth in the third quarter and we anticipate this to continue at a slow pace through the remainder of the year. We continue to see positive trends in the Polymer Additives markets in Asia Pacific and within Specialty Additives we expect surfactant sales to continue to grow as the economy improves. We estimate this segments full year operating earnings to be in a range of $8 to $10 million.

Our In Process Separation business is making good progress as metal prices improve and the global copper and aluminum industries strengthen. We anticipate good performance in the fourth quarter as we bring our new product technologies to market, several new mines start up, and production of copper and aluminum are expected to improve. We are however exercising caution on the timing of certain orders in December as some shipments may fall into the early part of 2010; therefore, we are estimating full year operating earnings for this segment in a range of $30 to $35 million.

The Engineered Materials business continues to be faced with customer destocking related to the commercial transport market and as we have stated in the past we expect this to continue through year-end. In addition, we do not foresee any improvement in the business and regional debt markets in the short term. As Dave explained, we have a number of cost reduction measures underway to address the lower demand environment. Given this outlook we are now estimating full year operating earnings in the segment to be in a range of $85 to $90 million.

We remain focused on our research and customer collaboration efforts to develop new and advanced materials for future aircraft platforms. We are happy to report that we recently completed renewals on key aircraft programs, for example we have renewed a long-standing contract with Boeing Commercial Aircraft and Boeing Integrated Defense Systems for supply of advanced materials for Legacy production programs and also in support of new aircraft programs including the 787 and the 747-8. This contract is a five-year term and up to ten years on certain products and covers potential sales of $300 million. Applications include secondary structures, aircraft interiors, rotorcraft structures.

Last month we also announced our strategic business collaboration with Mitsubishi Rayon to advance carbon fiber reinforced composite materials technology. The companies will collaborate to share their superior technologies and engineering capabilities to meet the advancing requirements of customers in the aerospace industry. We expect to be speaking with you about additional customer agreements and new business developments in the coming months.

So, despite the current demand challenges we are facing in this segment, we remain excited about the growth opportunities ahead based on the large number of ongoing development projects with our key customers and the positive secular trends in the industry.

In Building Block Chemicals we have seen demand improvement for acrylonitrile in both the Europe and Asia acrylic fiber markets. Although this positive demand trend should continue we have some planned maintenance outages scheduled in the fourth quarter along with uncertainty around US Gulf Coast propylene pricing, which will put pressure on margin. As a result our estimate for full year operating earnings in this segment is now $12 million given the better than expected results in the third quarter.

We have also updated our guidance to corporate and unallocated to be and expense of approximately $25 million annually, and interest expense net is estimated to be in the $28 to $29 million range. Our forecast for the underlying annual tax rate for ongoing operations is estimated to be 34%. The net impact of these changes is positive relative to our outlook following the second quarter and as a result we are revising our full year earnings guidance up to a range of $0.80 to $1.00 per share versus our prior guidance range of $0.60 to $0.90 per share.

Let me finish by saying that I am extremely pleased with the progress that we have made in reducing costs, improving liquidity, and increasing cash flow over the last several months. The difficult decisions that we have taken, and the excellent execution by our employees, have made Cytec a stronger company for both the near and the long term. As we move forward we will increasingly turn our attention to implementing Cytec’s long-term growth strategy by delivering high performance technologies that create value for our customers and for our shareholders. I will report on our progress to you over the coming quarters.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from David Begleiter with Deutsche Bank Securities

David Begleiter - Deutsche Bank Securities

Shane, given the work you have done in comporting resins, what do you think the normalized margins could be in 2010 and 2011? Do we get to a double-digit rate in this business ever?

Shane Fleming

I suspected that double-digit question was coming. That is one I have been dealing with over the last several years. David it is, as you would guess, very, very demand dependent. We got our operating margins up about halfway to that target in the third quarter at lower than historical demand levels, clearly demonstrating an amount of costs that we have taken out of the business. I expect that we will get this business to double-digit margins at some point in time, but not being able to predict future volume I just can’t tell you when.

I think we have a lot of good programs still ongoing, new technologies coming to market that are going to improve our mix, but I think it would be premature for me to try and give you a target right now.

David Begleiter - Deutsche Bank Securities

Shane just on the Composites business, as destocking continues through year end what are you hearing from your customers about next year on a volume pick up for Boeing Airbus?

Shane Fleming

It is a very mixed story. Boeing and Airbus neither one have made any announcements of their intent to decrease their build rates. In fact, if you look at build rates for 2009 they are expected to be higher than 2008; 2010 right now should be similar to 2009 based on the material that is available publicly, but if you look at the activity with the Tier 1 suppliers they are pulling back build rate of parts in the anticipation of future reductions.

So, there are no clear signals out there. We have the Tier 1 guys pulling inventories down with the expectation of rate reductions, but neither Boeing nor Airbus actually announcing that they are planning to do so, so it is very difficult to get any clear signals from the market.

We are trying to obviously stay as close to the market as possible to understand the situation, be conservative in terms of how we are running the operations, make sure that we are ready to take the necessary steps to keep our costs down; but also at the same time we have to keep the powder dry in the event that we do see some restocking take place.

Right now I would say there is no change given publicly available information, but some of the activities of our customers suggest that there is some expectation that we will see LCT build rates reduce.

David Begleiter - Deutsche Bank Securities

Given the work that you have done in composites could margins long term be back to 20% in your view?

Shane Fleming

I clearly expect that to happen. We are very positive about some of the newer products we are bringing to market; about some of the programs we have got ongoing right now with major customers. We really have a nice backlog of developmental work that will yield significant benefits, high margin opportunities going forward. Clearly we are suffering from the low volume right now, but there is nothing that is structurally changed in this business that doesn’t make me think that as we start to get back towards typical volume or higher cycle volume levels this business won’t be a 20% plus earner.

Operator

Your next question comes from PJ Juvekar with Citigroup.

PJ Juvekar - Citigroup

Shane quickly about coatings you made some comment about restocking, something that we haven’t heard yet from anybody. Can you tell us what kind of customers are restocking, and why do you think they are restocking? Do you think demand is improving or are some of these customers worried about raw materials going up?

Shane Fleming

I think it is less the later, PJ. I think what has happened is there was so much destocking that took place in the first half of the year that customers are at inventory levels that were just too low to be able to operate. So, some of this is just getting inventory back to levels that reflect the current demand environment. The current demand environment is clearly down versus where we were last year, but I do think there is a possibility that we may have seen some additional sales in the third quarter related to the fact that customers had overshot in terms of taking their inventory levels down too far.

PJ Juvekar – Citigroup

So are these like paint companies or what kind of companies?

Shane Fleming

In the coatings area for us it would be the major paint companies, the big 5 the big 7 global coatings companies which are our biggest customers. Some of this is related to the industries in which they operate as well. For example, in the US I think the entire supply chain that supports that automotive industry had been stripped and when the Cash For Clunkers program really kicked in and started to gain some traction I have never seen such a flurry of activity over such a short period of time where clearly our customers did not have inventory of our raw materials and we were air freighting product around the world just getting our customer’s inventory back so they could supply the industry.

We have seen that tale off a little bit at the end of the third quarter; I think some of the auto incentive programs going back, but I also think that there was an inventory correction and maybe some of our customers inventory levels are today back at more sustainable levels.

PJ Juvekar – Citigroup

Okay, thanks for that explanation. One quick question on the engineering materials, you always said that aerospace cycle lags the economy, so when do you see the bottom and when do you see the positive impact of the Dreamliner and Airbus 380?

Shane Fleming

The bottom is a good question. I mean I have access to the same public information that you and others do, as well as some insight from our customers. It is very difficult to predict. I would say it is going to be sometime in 2010 or 2011. I hope more like 2010, but I can’t say that unequivocally.

What was the second part of your question PJ?

PJ Juvekar – Citigroup

I was just wondering when you see the actual positive impact from the Dreamliner and A380?

Shane Fleming

Well if Boeing does indeed fly the 787 later this year and start to ramp up I don’t think the year-to-year impact will be noticeable in 2010, because we did have some business in 2009, but as the ramp rate starts to pick up we will start to see our business impacted in 2011 and beyond.

The 380, I don’t think there is going to be much of a change. I think the 380 is running at the same rate today that it is expected to over the next couple of years.

PJ Juvekar – Citigroup

Okay, thank you very much.

Operator

Your next question comes from Michael Judd with Greenwich Consultants.

Michael Judd - Greenwich Consultants

I have a question about China. Everyone likes to talk about how things are going so well over in China and that is fine. I just want to get a sense though of what you guys are actually seeing on the ground there. There has been a big stimulus program there by their government and it is kind of unclear at this point whether they are slowly but surely removing some of that stimulus. Are you guys beginning to see any impact from that, or if that is too direct of a question and you are not really sure what the answer is, maybe just talk more about what your expectations are in terms of demand going forward?

Shane Fleming

Okay I think I can answer that fairly directly. I think even going back into Q2 when the stimulus packages were announced in Asia, and in China particularly, we started to see an impact fairly quickly. Specifically we have seen demand for metals pick up, copper, alumina, and I think as you have seen metal prices improve and production rates increase to a large degree those global changes are coming from the stimulus package in China.

Other areas where we have seen volume pick up is automotive. The Chinese auto build this year is going to be greater than the US and projected to continue to grow into the future with our without a stimulus package and we are enjoying that both in our polymer additives and our coatings area. We have seen some improvement in electronics as well, which we serve somewhat indirectly, but clearly the infrastructure investment in China is having a positive impact on our business and several of our product lines are actually running at the same rates in 2009 as they were in 2008 in Asia, and that is probably the only part of the world where we can say that.

Michael Judd - Greenwich Consultants

Okay so just as a follow up to that though, I mean the Chinese have a long history of basically buying a lot of materials and then they just stop buying suddenly and then they come back at a later date and they buy a lot more. Are there any signs that they are letting up or they have adequate inventory at this point, because the return on capital concept is not necessarily at the forefront of their minds.

Shane Fleming

I think that is probably a little bit more typical in the commodity markets and there is some concern that the reason that copper and alumina volumes picked up was China was trying to horde a little bit when costs were low, but if you look at our product lines and the materials that we sell directly to our end users, especially the materials, are typically not the type of products that you try and buy cheap and hold onto, the prices don’t move that much. So, I don’t see that having a direct impact on our business. Maybe a little bit of in indirect impact, but I think that is less of an issue today than it was probably five or ten years ago as well.

Michael Judd - Greenwich Consultants

Thanks for the help.

Operator

Your next question comes from Michael Sison with Keybanc.

Michael Sison – Keybanc

In terms of coating resins if I sort of think about going back to the fourth quarter of ’08 to possibly through 2009 it looks like volumes will be down somewhere in the neighborhood of $600 million roughly. How much of that volume do you think is recoverable over time? Maybe there is some of that business you don’t want back, if you will.

Given that you are back in profitability, what sort of incremental margins are on that volume, again over time, as you sort of recoup it?

Shane Fleming

Let me answer that first question. I am not sure I am going to be able to give you a direct response on the second, but on the first question, we have exited some production and some product lines as a result of the restructuring actions that we have taken. We are significantly smaller in the solvent borne product area now at a couple of our sites in Europe and that has probably destroyed $100 to $200 million of potential revenue, so the rest of the downturns is across our other product lines LCR Radcure powders. I don’t see any reason why we can’t get all of that back.

There is a question obviously on time and my sense is that we are not going to see a V recovery here. It is going to be more like a long, slow incline. So, you can read what people think about automotive build rates, which is a major market for us, construction markets as well, and a lot of pundits don’t think we are going to see levels back to 2007 production rates until maybe ’13 or ’14. So, I think we are looking at a slow climb back in terms of industrial demand. We think we can take some share.

We think we can bring some new product technology to market that will increase our revenue, increase our margin as well. So, as mix improves with the exit from the solvent borne business and we bring new products to market, I think we are in a really good position to leverage that additional volume, both higher margin products as well as lower fixed costs, but I am not going to be able to give you a percentage by say $100 million increment at this point.

Michael Sison - Keybanc

Right. Historically, it looked like incremental margins were sort of in the mid-teens to 20%. Given you new cost structure do you think it should be better?

Shane Fleming

Obviously if we were to run at the same revenue levels as we were pre-restructuring we would see better earnings. I also, as I said, think we are going to see mixed improvement going forward, but I am going to have a hard time getting any more specific than that Mike.

Michael Sison - Keybanc

Right, but you don’t see anything, with the exception of volume, to sort of get back to that $100 million type of level that you were sort of steady at for a couple of years? I mean you think you have the business restructured that when volumes do return to that, sort of getting back to that number and maybe even better is possible?

Shane Fleming

Yes, I think our plants have the capability to produce revenue well in excess of what is required to generate that level of earnings. We did take down some assets, but we have also used lean to get additional capacity in our plants, and as I said the mix is going to be a lot better going forward because we expect growth to come back in some of the areas where we get higher margin and higher unit selling prices. So, yes I don’t think getting to $100 million of revenue in our Coatings business is that big of an obstacle at all. We are going to need some help from the demand site, but I also think, as I said, we are also going to be able to take some share and bring some new products to market and that is going to help as well.

Michael Sison – Keybanc

Great and then my last question is in terms of your outlook for 2009 you have somewhat of a wide range; I understand being in this environment for the fourth quarter. Can you give us a little bit of help on what sort of gets you to the high end, what gets you to the low end? Is it more Aerospace driven, is it more the other businesses driven? I just want to get a feel for that.

Shane Fleming

Yes, I think it is really across all of the businesses and I would characterize it as demand uncertainty. Right now as we look forward we feel good about the beginning part of the fourth quarter from a volume standpoint, but as you look into late November and December there is a big question, particularly in Europe, around the holiday period shut downs. Are they going to be more typical two week type shut downs or are they going to be more like what we saw in 2008 with some of our customers, or our customers customers, actually taking four to six week shut downs. If I had more visibility on that I think we could tighten that earnings range a little bit, but that is really the biggest driver for us. I think the fundamentals that we control are in pretty good shape, it is just really this question around demand, I would say in the coatings area, and maybe within aerospace to a lesser degree.

Michael Sison - Keybanc

Great, thank you.

Operator

Your next question comes from Steve Schuman - Lafayette Research.

Steve Schuman - Lafayette Research

On engineering materials a lot of those are highly customized and have a fairly low shelf life, so how much impact do you think inventory destocking really had? Going forward is that a big part of the demand picture, or demand swing, going back and forth?

Shane Fleming

The issue is not so much destocking of our product, because you are right, our materials tend to be very temperature sensitive and they need to be stored in freezers whether it be an adhesive or a composite product. But, where the destocking has taken place is in the parts manufacturing segment where our customers buy our material and then convert that to either a primary or a secondary structure for an airplane, the tell, a rudder, whatever. The parts guys build inventory thinking that the build rate for Legacy programs, as well as for the new programs, were going to accelerate. When they didn’t see that happen, or they even saw some programs slow down a little bit, they are the ones that went through the massive restocking.

Steve Schuman - Lafayette Research

Okay, I got you. That is great clarification. My second question is on coatings. When you look at some of the end markets for those products you have US residential down 24% this year, construction down, and that is down 25% from last year. I mean it is going to take a long time to get back to those demand levels. I know you have done some restructuring, but is there a point where you need to acquire or sell to really boost the sort of scale of those businesses where you can spread some of the operating costs over a higher volume? You or someone you may sell to?

Shane Fleming

Let me just get to the first piece. I agree with you, I think some of the markets that we supply are big markets in construction and automotive: that together represents about 40% of our business, so there is still a lot of volume outside of those two areas, but those two markets in particular in Europe and in North America, I think, they are going to be pretty slow to recover as I said earlier in my response to Mike. At the same time we are seeing good growth in automotive in Asia and particularly in China and we are moving to take advantage of that, so I think we are going to see a geographical shift in our business going forward. I think the industry is going to see a geographical shift going forward following this downturn. But, I think we can get growth in other markets as well.

I am not suggesting that we are not looking at potential acquisitions in our growth platforms where we think we have got a nice market position or technology position, we would look to something on to gain share, but that is not a fundamental driver of our growth going forward. We feel good about our ability to grow the markets based on the technologies that we have, our geographical presence and where we have got capacity. We do have to overcome that challenge though of having potentially slow growth in a couple of large markets in Europe and the US.

Steve Schuman - Lafayette Research

Okay, thank you.

Operator

Your next question comes from Amy Zhang with Goldman Sachs.

Amy Zhang - Goldman Sachs

My first question is related to your business in Europe and then coating resins, the volume growth on a sequential basis are very strong. Given your big exposure there that 12% I am just wondering how much is from Europe and then how much is from North America.

Shane Fleming

I don’t know, maybe Dave can grab the number: I don’t have it in front of me, but I think it is pretty reflective of our market positions in those two areas. I don’t think one grew substantially faster than the other. Both benefited from the auto incentive programs, but my sense is that we saw pretty good sequential growth both in Europe and in North America. If you go back to earlier in the year Europe was not growing as strong as the US. I think the US recovered a little bit more quickly, but my sense now is that Europe and the US recovered about the same rate. I think Dave has a number.

Dave Drillock

Amy, I don’t have the exact number, but I think Shane characterized it correctly.

Amy Zhang - Goldman Sachs

Okay and then a follow up question to that is one of your global coating customers reported earnings yesterday and then they noted a very modest sequential rebound in their European businesses. Then also, they do expect the raw materials environment to be pretty benign heading into 2010, but obviously the sequential volume rebound reported by your Coating Resins business is more impressive than the numbers that they reported. So, I just want to know how we should reconcile the difference here.

Dave Drillock

I think it is probably the markets that we serve. I saw the report you are referencing and if you look at the markets that company serves in Europe and then the markets we serve in Europe, I think they are somewhat different. We have quite a big presence in packaging, industrial, automotive in Europe and that is probably a little bit different than this company’s share that you are referencing. I think that is probably the biggest driver.

Amy Zhang - Goldman Sachs

Thank you and then my next question is the full year guidance for 2009 implies continued profit margin erosion probably into Q4 for the engineered materials business. So, if we look back in trough at the past and the several recessions and then margins around like 11%, 12%, but the Q3 margins already came roughly in line with the low end of this range and heading into 2010 what is there to deceive the aerospace industry heading into the downturn and how should we think about the margin progress for the engineered materials business?

Shane Fleming

Just one point on the third quarter and then I will talk about it going forward. As you probably would have noted, we did take a fairly significant earnings hit, about $4 million in the quarter as a result of our inventory reduction actions. So, if you add that back on I think you are looking at margins more like 14% to 15% for the business or roughly 13%.

Our expectations going forward are that we are going to see trough margins in the low teens. I am not sure that what we are seeing now in terms of demand is that much worse than what we may see at the bottom. The reason I say that is we have seen a lot of destocking going on that doesn’t necessarily reflect underlying demand and we have a lot of good growth programs in the pipeline as well. As those growth programs start to deliver revenue I think we can offset some of the downturn. So, I don’t see this as being a lot different than past trough margins. I think we will be in the low teens, maybe not 15 to 17 like we’ve been in some of the more shallow cycles, but I do feel like we are also making some investments around long-term technology development that may pull margins down a little bit relative to some of the historical levels. We feel we have to do this though, so that we are in a position to take advantage of the growth opportunities going forward.

Amy Zhang - Goldman Sachs

I’ve got it and my last question is in the third quarter the operating profits in the Coating Resins the first time surpassed whatever you achieved in Engineered Materials. I am wondering if going forward we should expect the recovery in the Coating Resins business will be able to fully offset whatever the profit erosion is from the Engineered Materials in 2010?

Shane Fleming

It is hard to say. I mean I hope so, I actually believe so, but it is really going to depend on what we see with recovery in some of these larger industrial markets and some of our big markets. I guess right now my expectations are that I would think that would be the case.

Amy Zhang - Goldman Sachs

Okay, thank you.

Operator

Your next question comes from Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies

Could you update your thinking about targets for your balance sheet ratios, for example in terms of your debt to EBITDA and how that plays into your priorities for both divestitures and acquisitions?

Dave Drillock

Let me just talk about how we think about cash going forward to answer that question a little better. Because we are in a good position now, granted we are going to be cautious over the next couple of quarters still, but where we are at a position with our balance sheet, which is much stronger today, and the cash on hand is that we can invest in our plants and their efficiency which is good for our costs. We can look at bolted acquisitions. We can look at our growth platforms and make the capacity expansions when they are needed, and as Shane mentioned we can look at small bolted acquisitions and even look at our dividend level going forward. So in terms of a target, I don’t want to give you a specific target, but other than that, that is how we are thinking about our cash use going forward and using our balance sheet.

Laurence Alexander - Jefferies

And if you did see a larger acquisition opportunity, I mean do you have any sense of what your upper pain threshold would be on the leverage ratios?

Dave Drillock

That is hard to say, because it all depends on the acquisition and how accretive it is and things like that, so I would just say that in terms of opportunities we are looking at bolt ons, clearly bolt ons.

Shane Fleming

Just to build on what Dave said, I would think that maybe in other words in cash resins we are not at this point in time looking to point ourselves in an extremely leveraged position.

Laurence Alexander - Jefferies

Also, could you flesh out a little bit on the in process separation segment? Sort of the factors that led to the slight reduction in the outlook and what you are seeing in terms of the new product ramp into the first half of next year?

Shane Fleming

It is really just a handful of large orders which may actually stay in 2009, in which case we will be closer to our previous guidance. But, there are a number of start ups, or restarts, in the metals extractants area in Africa, South America, even in the US where timing is in late November or December and it seems that you get a firm delivery time and then more likely than not you see some slippage a couple of weeks, sometimes a month or two, because of mechanical start up problems etc… So, we are just trying to be a little bit cautious. We have been burned before where we have had a couple of these large orders just shift a few weeks and go from on year to the next and that is really the basis for our guidance.

Laurence Alexander - Jefferies

Okay thank you.

Operator

Your next question comes from Lavon Von Redden - Hockey Capital

Lavon Von Redden - Hockey Capital

In terms of the engineered materials I wanted to kind of flesh out what kind of changed between your previous guidance and the current guidance. I know you have mentioned business shifts being weaker and more inventory destocking, but I kind of thought a lot of that was already in your thinking. Could you flesh that out a little bit more for me please?

Shane Fleming

I think that is really the issue. I don’t think we have seen cost or margin erosion in raw materials or anything like that. It is really a demand driven situation where business in regional jets has probably decreased a little further than what we expected, and the destocking has continued. We are supplying material at a lower rate today then say the build rates would suggest. So, when you look at the amount of our material that is going on the planes that are being constructed and the amount of material we are selling, that tells you that there is destocking going on in the market. We know we have not lost share, so it is just a matter of somewhere in the value chain people are pulling inventories down and it is happening maybe a little bit longer than we expected.

Lavon Von Redden - Hockey Capital

In terms of the cost cuts and restructurings that you are taking, could you kind of quantify what those would be in the material segment for this year, maybe, and how that flows into next year?

Dave Drillock

In terms of both the short-term actions and the long-term actions, for engine materials we are looking at about $25 million for the year. Going into next year that rate would be at a $38 million rate.

Lavon Von Redden - Hockey Capital

Okay and Shane, if I am reading you properly you kind of don’t expect a whole lot of 787 or much change from Airbus next year in 2010 from some of the programs. Are there any other newer programs that we might look at for engineered materials that might be helpful for us in terms of [interposing].

Shane Fleming

Yes, I think there are. We have actually got ourselves in a very nice position with the Joint Strike Fighters, so as the Joint Strike Fighter ramps up then we should see some impact next year; we will see a benefit coming there. We have been able to gain share on other military programs. We have ourselves in a good supply position now on some of the new regional planes; some of that may be more later ’10 early ’11, but we are going to see some favorable impact there as well. But, I think you characterized our view on the 787 properly. I don’t expect to see a big impact in 2010.

As far as Airbus goes the 350 is still too far down the road to see any impact in 2010, 380 is pretty much running at a flat rate. I think there is probably some chance that we may see some build rate reduction there based on what Airbus is seeing, but they have not committed to that; so I kind of look at Airbus as being effectively flat in 2010 versus 2009.

Lavon Von Redden - Hockey Capital

My final question is I didn’t catch what your expectations were for the corporate expense for the full year this year?

Shane Fleming

They are $25 million.

Lavon Von Redden - Hockey Capital

Thank you.

Operator

Your last question comes from John McNulty with Credit Suisse.

John McNulty - Credit Suisse

In the resin business if we don’t see a noticeable pull back in volumes is there any reason why you shouldn’t be able to put up 5.5% margins next year, or are there any puts and takes that we should be taking into account for 2010 in that business?

Dave Drillock

No, I think your math is not dissimilar to mine. If we see volumes that run at the rates we saw in Q3, which is not a huge stretch that is quite possible. Now are we going to see a double dip, how much of an impact are we going to see from the discontinuation of these auto incentive programs, those are the questions that are going to drive our margin next year more than anything else.

John McNulty - Credit Suisse

Okay and then in terms of the cost cuts and some of the restructuring that was done in the resin coating segment, is it all done at this point: have you shut down all the lines, have you closed the plants? Is all of that kind of reflected in the third quarter numbers; is there a little bit more in terms of efficiency or cost cuts that may trickle in either in the fourth quarter of next year?

Shane Fleming

No, we are still not running at the full rate. Our plan in Spain is still operating and we will be through I guess the end of the year or sometime in late December, so we haven’t seen the benefit from that yet. I think we are seeing the Belgium reduction pretty much run at full rate in the third quarter: that shut down took place in the second quarter. I think our German plant there is still some savings to come from that as well; I don’t have the exact number. I would say that roughly 60% of the structural savings in Coatings have been realized, so there is still a big chunk to come in the fourth quarter.

John McNulty - Credit Suisse

In terms of your cash and in particular your CapEx for 2010, I know you have cut back on a couple of the carbon fiber projects that you were working on. Can you give us some color as to what 2010 might look like?

Dave Drillock

On that one we are still going through the review with the businesses, but I would suspect that it will be somewhat, a bit lower than what we saw in 2009.

Shane Fleming

Probably not too far off the mark though, because we do have a few growth projects that we are funding in the chemicals area.

John McNulty - Credit Suisse

Okay great. Thanks a lot.

Operator

At this time I would like to turn the conference back over to Miss Allen for any additional or closing remarks.

Jodi Allen

Thank you everyone for your participation in today’s call. If you have any follow-up questions please contact me directly at 973-357-3283. Thanks and have a nice weekend.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation.

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