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Cytec Industries Inc. (NYSE:CYT)

Q1 2010 Earnings Call Transcript

April 23, 2010 11:00 am ET

Executives

Jodi Allen – IR

Shane Fleming – Chairman, President & CEO

Dave Drillock –VP & CFO

Analysts

John McNulty – Credit Suisse

David Begleiter – Deutsche Bank

P.J. Juvekar – Citi

Mike Sison – KeyBanc

Laurence Alexander – Jefferies

Bob Koort – Goldman Sachs

Operator

Good day, and welcome to the Cytec Industries Incorporated first quarter earnings announcement. Today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Ms. Jodi Allen. Please go ahead.

Jodi Allen

Thank you, Jennifer and good morning everyone. We appreciate your participation in our conference call. For our call today, Shane Fleming, Chairman and 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 2010. This call is 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 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 response 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 discussions include 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, and good morning everyone. Thanks for joining our first quarter conference call. I will begin on slide number three. Our positive result in the quarter reflects stronger demand coming from improvements in the global economy as well as the benefits from executing our cost reduction initiatives over the last 18 months.

We continue to see sequential sales volume growth across the chemical business which has led to significantly improved earnings results in the first quarter. I'm pleased with the start to the year as sales on the first quarter were $787 million, a 29% increase versus the prior year and a 5% sequential increase over the fourth quarter 2009.

The sales increase was driven by demand improvement across each of the chemical business segments with only engine materials experiencing weaker volumes as compared to the strong first quarter of 2009. The overall results for the quarter with net earnings $32.7 million or $0.66 per diluted share excluding the special items that Dave will explain later in the presentation.

This compares with sales of $612 million and net earnings of $2.7 million in the first quarter last year. The significant improvement in first quarter earnings results versus the beginning of 2009 was due mainly to strengthening demand in chemicals and the improved on this leverage, resulted from our focused actions to take into execute cost savings initiatives.

We are also benefiting from lower raw material cost in the quarter as much as the recent significant raw material increase and especially chemical segments only begin to roll through our income statement in the second quarter. Now I would like to provide an overview of the business segment results.

Beginning on slide number four, Coating Resins delivered sales of $341 million, a 38% increase versus the first quarter of 2009. Selling volumes were up by 42% versus the first quarter of 2009 due to the strengthening global demand over the last several quarters, as compared to a period of significant destocking in the first half of the last year.

While all regions demonstrated good demand improvement versus the prior year period; growth in Asia has been particularly strong led by recovery in automotive and industrial markets. Selling prices decreased by 9% versus the same period last year in response to competitive pressures and lower material cost in the same product, in some product areas while the impact of exchange rates increased sales by 5%.

The chart on slide five displace revenue growth in the segment, which shows sequential growth in the quarter with March sales very strong, which could signal some pretty buying prior to announced price increases going to affect in the second quarter. The Coating Resin Segment also benefited from improved margins from a structural cost reduction efforts, which positively impacted earnings this quarter.

The business continues to focus on the positive trend towards environmentally friendly technologies and I'm pleased to report that we have secured major new contracts with one of our largest global coating's customers based on our ability to deliver a broad range of value added, environmentally friendly technology.

Operating earnings for the segment were $16.8 million in the quarter, a sharp improvement versus the loss of $20.3 million in the first quarter of last year. Moving to Additive Technologies, slide number six shows sales in the segment of $52 million, an increase of 22% versus the first quarter of 2009.

So move to coatings, the additive sales growth was seen across all regions and was particularly strong in Asia. Selling volumes were up 18%. Selling prices increased 1% and exchange rates increased sales by 3%.

As a reminder, we have divested our polyurethane product line in 2009. Excluding the impact from the divested business, sales were up 38% in the segment. The overall result in the additives segment was a very respectable operating earnings of $8.4 million versus $600,000 in the first quarter of 2009 due mainly to the higher selling volumes globally and the resulting leverage from our past cost initiatives.

Slide number seven highlights results from the In Process Separation segment, which delivered sales of $65 million in the first quarter, a 16% increase versus the first quarter of 2009. Sales volumes were up by 17% versus the prior year quarter driven primarily by the higher production rates by our base metal customers, as metal prices have strengthened due to the infrastructure investment in China in improving global economic conditions.

Sales were also strong in North America and in Europe with increased demand coming from the Fumigant Electronics markets. Selling prices decreased by 4% and the impact of exchange rates increased sales by 3%. Operating earnings in the segment were at $14.2 million versus $4.8 million in the prior year period with the significant improvement primarily due to the stronger sales volume across all the product line.

Slide number eight shows a summary of results in Engineered Materials segment with sales of $178 million, a decrease of 7% versus the first quarter of 2009. The lower sales were driven primarily by reduced selling volumes in the business jet sector and a temporary decline in the military segment as the F-22 rate reductions are not yet offset by Joint Strike Fighter increases.

Large commercial transport sales on the other hand showed improvement due to broadly stocking in the sector following destocking in the second half of the last year. Pricing and exchange rates each increased itself by 1% in the quarter. The net result is operating earnings of $21 million down versus earnings of $33.1 million in the first quarter of 2009.

Before leaving Engine Materials, I would like to say that I'm delighted with the Supplier of the Year Award presented to us last week by Boeing. Cytec was one of the 14 companies selected for exceptional commitment to excellence and working with Boeing. Quite an honor when you recognize Boeing has over 12,000 active fighters.

I want to recognize and to thank the entire business for achieving this honor and demonstrating the value we place on customer focus at Cytec. Building Block chemical results are shown in slide number nine. Sales in the first quarter increased 110% to $140 million driven by both higher volumes and pricing.

As a result (inaudible) propylene cost impacting the cost of petroleum nitro [ph] we passed through selling price increases of 75% versus the prior year period. Selling volumes increased by 35% due primarily to the improved demand for petroleum nitro [ph] and melanin in North America. Operating earnings in the segment were $4.1 million compared to $3.2 million in the first quarter of 2009.

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

Dave Drillock

Thanks, Shane, and good morning everyone. Let's go right to slide number 10. During the quarter, we made some additional progress on our improvement initiatives and we recorded the impact of the recent Healthcare Reform Legislation which we noted as special item charges. So let me start by reviewing those special items for you.

Back in the third quarter of 2009, we announced the shutdown of one our manufacturing sites in Spain. Production is ceased in the first quarter of 2010; we sold the property for its net book value, which was about $1 million. As a result of finding a buyer who actively used the property, we awarded certain contingent liabilities which were netted against some smaller restructuring charges resulted in the net pretax gain of about $400,000 in the first quarter.

While the proceeds received for this site were not material, reflects a great job by the restructuring trying to win for both Cytec and impact in employees of the site. We also recorded a non-cash charge of $8.3 million or $0.17 per diluted share due to the recent U.S. Healthcare Reform Legislation that eliminated a tax benefit on a subsidiary given to employers with respect to certain prescription drug benefits to retiree equivalent to those provided under U.S. Medicare Part D.

While non-cash in this quarter, there will be a use of cash that over future years as we no longer receive this tax benefit. This is the same charge who have undoubtedly noted other company's record that's associated with retiree medical benefits, so no need to dwell into this further.

As we always do, we are looking into what can be done to minimize this impact going forward. That covers the special items for the quarter. So, now we will move on to the operating results. Our gross margin percentage after adjusting for the special items in both years is up over 1.5% compared to the prior year period.

The key driver around the gross profit improvement is the favorable impact from overall higher selling volumes the changes discusses a few moments ago. It is more than offset the higher raw material cost that of selling price increases. It is a good example of what one can expect from our ability to leverage off our lower cost base.

Concerning the higher raw material cost in the first quarter, it was primarily Building Block Chemicals and mostly due to the high cost of propylene. Towards the end of the quarter, the high cost of propylene made its way to many of the raw materials we purchased and the rest of our chemical product lines.

We have also mended a number of selling price increase is to recover the entire cost and is to our practice we will report our progress to you at each quarter end. Operator expenses excluding special items in both years are flat year-on-year reflecting the impact from our restructuring initiatives and reduced consulting cost which cost at the $4 million unfavorable impact due to changes in exchange rates.

The consulting cost in 2009 were related to a working capital and other improvement initiatives and the returns in those initiatives were very good. Interest expense, net increased $2.5 million from the prior year primarily due to higher interest on the bond issue we completed in the third quarter of 2009.

We remember that proceeds from debts were used to pay down most of our debt due in 2010, and a portion of our 2013 debt is greatly improved our liquidity profile. Our estimated under, our estimated annual underlying income tax rate of approximately 32.5% decreased about 1.5 percentage points from the last year's first quarter rate.

The rate decrease versus last year is principally due to a favorable change in the earnings mix by jurisdiction. Also the research and development tax credit has not been reinstated-to-date. So, this increased our rate by a quarter to a half percentage point.

To close my discussion on the income statement, net changes and exchange rates were headwind of a few cents per share this quarter because of our broad global revenue cost base, we are pretty naturally hedged with changes and exchange rate generally limited a few cents per share although it has been unfavorable the last two quarters.

Our cash flow from operations for the quarter was a respectable $38 million. This is down from the last year's $62 million when we had a significant generation of cash from accounts receivable due to the precipitated drop in sale.

This year reflects increasing sales in much better scenario and this is reflecting in inventory and accounts payable cash activity as well. On in terms of working capital, we measure ourselves in days outstanding. Slide 11 will give you a good view of our performance to sustaining the gains we made in reducing networking capital base.

The encouraging start to the year in sustaining the gain and we think we can make some modest improvements as the year progresses. As I mentioned before, we have the process and incentives in place to both sustain and improve on a working capital gains to date.

And as you know that simply means greater cash generation going forward. Just a few other comments on cash flow from operations. Accrued expenses was the use of cash of $17 million and reflects cash payments of $11 million related to our restructuring initiatives and payments of $20 million relative to incentive compensation earned in 2009.

Other liabilities were the use of cash of $15 million and reflect contribution to our pension plans of approximately $16 million against accruals of $6 million. One should expect pension expense and cash contributions for the remaining quarter of 2010 tend to remain at similar levels.

As a reminder in 2009, we contributed approximately 1.2 million shares of Cytec stock, so our U.S. expansion plans in lieu of cash. The stock price at the time of the contribution was $21 per share. We continue to believe this was any as a good investment for our pension plan.

Moving on to slide 12, capital spending for the quarter was $29 million down from $64 million in the same quarter of 2009. In the first quarter of last year we had $24 million of expenditures related to the construction of our carbon fiber plan, which we put on hold until demand improves.

We also had $7 million related to our completed prepared prepreg plant in China and $6 million of capital related to maintenance turnaround to our Building Blocks Chemicals Manufacturing Facility. Our estimate for full year 2010 capital spending continues to be in the range of $140 to $160 million.

That's about 60% of just related to strategic or cost reduction projects in our growth product line and reminder maintenance of business capital. Also on slide 12, you will notice our cash balance is $262 million that was 2009 yearend despite the payment I just previously mentioned.

Our debt decreased by $40 million in the quarter bringing total gross debt down to $672 million. In closing, let's remind everyone on our expected uses of cash. First, it is the typical maintenance of business CapEx, pension contributions for mitigation projects just to name a few.

This is followed by expansion, cost reduction capital in our growth product lines and best payback margin improvement capital in our cash product line. In addition if available at a reasonable price, we would like to add both on and technology acquisitions to our growth product line.

We are lost a repurchase of our outstanding notes were available at a reasonable price. When the global economy shows the consistent recovery, we would revisit our dividend level and lastly we should not expect stock buyback in 2010.

In summary, we had another good quarter. We are gaining momentum and we are excited about our future. Thank you, and now we will turn the call back over to Shane.

Shane Fleming

Thanks, Dave. And now, I'd like to review our outlook for the remainder of 2010 which we have summarized on slide 13. The steadily improving global demand environment we've seen in each of the chemical business segments combined with restricted cost improvements provides us a good momentum as we move forward this year.

However, we also recognize there is still some uncertainty in the sustainability of this recovery. Additionally the reason that it could rise in energy and commodity prices will result in higher cost for many of our key raw materials beginning in the second quarter. Our sales and marketing teams have responded quickly with increasing cost and we are raising prices broadly to mitigate the impact across especially chemical product lines yet the environment remains competitive, so is too early to comment on the degree of success we will achieve in maintaining sales margins.

In addition to the rising cost, we are managing through supply shortages with several key raw materials. Due to increased demand and some specific production problems, a number of key suppliers are currently challenged to meet supplier requirement and this is creating additional volatility in raw material cost, while also in resulting the supply issues throughout the value chain.

Despite the current raw material challenges, we've taken a number of proactive steps and remained positive about the outlook for the year. With each of our operating segments performing well in the first quarter and providing positive momentum for the rest of the year, our current expectation is to achieve the upper end of our 2010full-year adjusted earnings per share guidance of $1.90 to $2.40 with the possibility of modestly exceeding the hind of the guidance. We anticipate providing a further update on the full-year earnings guidance when we release our second quarter guidance.

In the midst of the economic recovery remain focused on implementing the long-term growth strategy of delivering high performance technologies decreased value for our customers and for our shareholders, and comparability to build the present challenges and to deliver our growth strategy as the market continues to recover.

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

Question-and-Answer Session

Operator

(Operator Instructions) And we will now go with John McNulty with Credit Suisse.

John McNulty – Credit Suisse

Yes. Good morning.

Shane Fleming

Good morning, John.

John McNulty – Credit Suisse

Just a couple of quick questions with looking like the aerospace cycle seems to have bottomed down and we are starting to get some positive data points from a number of your end customers and with the Bombardier contract that you signed earlier this quarter, can you give some color is how to think about the growth rates in '011 and '012 relative to kind of the base year 2010?

Shane Fleming

Very good question, John and I kind of wish I could give you a more exact answer than I'm going to be will provide. We agree that it appears that we are at the bottom of the soccer right now, based on what we are having in first time discussions with our customers as well as what we are reading and I do believe that there is some modest upside particularly in the second half of this year versus what we had in our projections which is why we've taken our earnings guidance up a little bit. As you look into'011 and'012 if indeed Boeing and Airbus or able to run at the higher rates that they are now projecting for single [ph] yield and we see increases in build rates on programs like the 787s, 747-8.

I think there probably is some upside to the way we are looking at the market say six months ago and I'm sorry but I don't know that can give you a definitive view than that.

John McNulty – Credit Suisse

Okay. That's fine and in the Coating Resins business. I know at the beginning of the year, you were pretty at the onset about raw materials and clearly they've gone up and been going up, can you give us some colors to sequentially from 4Q to 1Q, what pressure you saw in with regard to raw materials in that segment and then how should we think about that going forward and what it might be doing to the margins?

Shane Fleming

Clearly, we are seeing certainly broad increase in raw materials anything based on propylene, given the run up in propylene over the last several months is going to be going up so for us acrylic derivatives, NPG, which are important raw materials for us also alcohol as well, but as you know with our FIFO accounting, much of that run up in raw material cost is yet to work its way through in our income statement. So, while we are seeing it now in terms of purchases, it didn't really show up in our income statement in fact our raw material cost were actually down versus Q1, 2009 within the coating segment.

That is going to change as we go forward now, we are seeing more and more those raw material cost come through and we are being quite aggressive as you would expect us to be in terms of going to the market and getting price increases, encourage you to take a look at our website just to get a sense for the number of price increases that we've announced so with the last several weeks.

The big question for me is can we get those price increases to stick given the competitive environment and the fact that demand today is still 15% to 20% down versus where was in 2008 without a lot of consolidation within the competitors of the supply resins to the coatings industry. If we are able to get the price increases to stick, I feel like we've been aggressive enough that we are going to be able to maintain margins.

I suspect that we are not going to be able to hold those increases at the announced levels in every case, so as I indicated at the end of the last year I do expect to see some margin erosion, but perhaps a little bit more positive now than I was three months ago in that regard.

John McNulty – Credit Suisse

Okay, great and then just one last question with regard to the Additive Technologies business, the margins were double what they were on a sequential basis or double what they were in the fourth quarter? How should we think about that business going forward, I believe you thought it could get to double digits, but you certainly got there may be faster than we expected, I'm kind of wondering how to think about that business going forward?

Shane Fleming

Yes. There are a few factors at play there. We did see demand step up quite a lot in our higher margin product lines, so there is clearly mix affect that got us up to that 13.5% margin. It surprise me as well as you -- I do see the business now that we've gone through the restructuring taken out a lot of cost, shared a lot of the little margin product lines, been a double digit owner, I wouldn't have been surprised to see that there is no 10% or 11%. I think 13.5% is the pretty high standard.

I would be surprised if we can maintain that level through the course of the year, but I would be disappointed if we can't deliver 10% operating margin in that business.

John McNulty – Credit Suisse

Great. Thanks very much for the time.

Shane Fleming

Thanks John.

Operator

Our next question comes from David Begleiter with Deutsche Bank.

David Begleiter – Deutsche Bank

Thank you. Good morning.

Shane Fleming

Hey, David.

David Begleiter - Deutsche Bank

Shane and David more on the raw materials, could you actually quantify the sequential increase you expect in your overall resins business from the higher propylene based in overall raws?

Shane Fleming

If I had a good crystal ball David to tell you what I thought propylene was going to be yes and so I guess the direct answer is if we know propylene cost, we can do a pretty good job of working that back to all the derivatives to our final products and we do that as you would guess on an ongoing basis. There is a little cheeky with my first comment is because propylene is bouncing around so much. It's up from mid-40s in the fourth quarter of last year into the mid-70s right now, but in North America just in the couple of days, we are hearing that propylene is going to plum it again.

There is reports that propylene could be down $0.15 to $0.20, so that actually makes it difficult for us in terms of price increases as well because we are just now using the higher propylene cost as the basis for pushing through materials and now our customers as I start to accept this price increases they're going to read about propylene falling again, so that probably creates more ergative through this process than anything just trying to understand what's really going on the raw material cost and been able to build a case for supporting your raw material base price increases, but I can't give you a number right now.

To tell you how much we think raw material impact is going to be because I just don't know what's going to happen with propylene given the volatility. I think what happened just give you some color on in the propylene market is prices got so high in the U.S. relative to Asia, North America that the big propylene users who are the polyurethane guys, the polypropylene producers could not compete.

They've shut down capacity, now there is a glut of propylene and you can buy it for $0.15 to $0.20 less today than what the spot market was just a couple of weeks ago, so that's what's really clouding this issue. Again I'm sorry I can't give you more definitive response.

David Begleiter - Deutsche Bank

I understand and just on the Coatings Resins business, you mentioned in the past that perhaps more than half of the business had limited ability to pass through high rose, is that still true?

Shane Fleming

Yes. I think that's a fair assessment. The businesses have the pricing power with the more proprietary products are right here business and one or more in products in liquid Coating resins and then the flip side of that is of course is the patterns business, and the Solvent-borne piece of liquid Coating Resins and is roughly 50-50.

David Begleiter Deutsche Bank

And it is lastly in for us the separation margins, which is also a peakish type number for the quarter?

Shane Fleming

A little bit, yes, I think the strength of our aluminum chemical sales and phosphine sales were abnormally high that the mix effect there was abnormally high relative to what we would normally see in the quarter and I think that is probably something that's going to be hard to repeat.

This business you know is a high quality business. We expect to see high teen sort of operating margins, but low 20s is probably the one usual.

David Begleiter Deutsche Bank

Thank you.

Operator

Our next question comes from P.J. Juvekar with Citi.

P.J. Juvekar – Citi

Hi. Good morning.

Shane Fleming

Hey P.J.

P.J. Juvekar – Citi

Shane, quickly on Coatings Resins, volumes were up 42%. Can you try to break us down for us what was inventory billed versus just easier comps? Then you also mentioned pre-buying by coatings customers.

Shane Fleming

I don't think I can quantify down the last piece, I will come back to your first question, but we as I have noted before. We put to a lot of price increases late in Q1, so normally when that happens customers will pre-buy a little bit, so that may have impacted our March sales which as you saw, from my comments were quite strong.

But when I look at our first quarter's volumes, if you look out that exceptional issue for maybe a little bit of pre-buying, I don't think we are in an environment too much anymore whether it is destocking and the restocking going on. I think we've seen now steady demand for the last couple of quarters in this business and any increase you see today is due to underlying demand versus possibly some restocking in the Q1, 2009 quarter. I don't think we are seeing much in the way of restocking right now.

P.J. Juvekar – Citi

Okay. So you think going into Q2 most of the restocking is done and you're going to see underlying demand?

Shane Fleming

Exactly, I mean if you go back and look at our last three quarter sales volumes in coatings, and they've been pretty flat. I really think the destocking ended and was replaced by restocking in the middle of the last year and since then we've been running pretty much at a steady demand rate albeit at a substantially lower level than what we saw in the peak in say mid-2008.

We were running at about 80% of those mid-year 2008 sales volumes.

P.J. Juvekar – Citi

Okay. Good and secondly on Engineering Materials, you've been getting some good news from Boeing with production increases with that in mind can you review the supply demand carbon fiber for us given that many of your competitors along with you added capacity, can you just review how does higher demand from Boeing play to that?

Shane Fleming

Yes. I would say just in a very summary fashion that carbon fiber is long and will stay long for some time. You are just now seeing I think the commercial aerospace business kind of bounce off bottom and this downturn wasn't projected when all that capacity was brought on to the market, so I think we've lost a couple of years minimum.

One with the downturn and two with the delays and the new programs both with Boeing and Airbus, so I think you're going to see carbon fiber stay long for sometime

P.J. Juvekar – Citi

And does that your margins will sort of stay around in this area?

Shane Fleming

No. I mean you really need to separate carbon fiber from the composite materials that we saw. First, carbon fibers are raw material cost, so in some way having carbon fiber long is not a bad thing for Cytec because we buy a lot of carbon fiber, so we are able to negotiate better long-term deals, and there is not a very direct correlation between carbon fiber cost and our pricing because they're especially products for the composite materials, but it does impact our investment where we had got well down the path of bringing a new plant online install a new capacity that's going to continue to be delayed and till the man picks up and we are able to run that plant at a very high fairly high loading levels from a margin standpoint not a major impact.

P.J. Juvekar – Citi

Okay and as your Epoxy being an issue in carbon fiber?

Shane Fleming

I am sorry?

P.J. Juvekar – Citi

Your boxes I mean with propylene going up the Epoxy….

Shane Fleming

Epoxy, yes Epoxy the whole trying to and this impacts our cuttings business as well which is the bigger Epoxy user. It's going up; it's more of an impact from a margin standpoint in coding where our sales margins are lower and we have less pricing power. We typically have contracts with CM we are able to pass on raw material cost increases to our customers.

P.J. Juvekar – Citi

Thank you.

Operator

Our next question comes from Mike Sison with KeyBanc.

Mike Sison – KeyBanc

Hey guys.

Shane Fleming

Hey, Mike.

Mike Sison – KeyBanc

Welcome back, Jodi. In terms of the just curious when you look back in January when you gave us guidance for the full year what were your expectations for propylene in terms of pricing heading in 2Q; they might give us a good feel for the magnitude of the raw material hit.

Shane Fleming

I think we gave exact guidance for propylene I think what we gave was oil pricing and if my memory serves me right we gave $75 for oil. So, oil is up and propylene is up disproportionably to oil; oil's only up $10; propylene is up 50%. So this is a bigger impact and we expected when we provided guidance three months ago.

Mike Sison – KeyBanc

Is it like double is that much of the order of magnitude or little bit?

Shane Fleming

The increase might be double but --

Mike Sison – KeyBanc

All right the increase might be double. Okay.

Shane Fleming

I mean if you I will help you out with the math a little bit I think we are talking about $0.45, $0.50 back in December, now we are talking about $0.75, so it's probably given when to how propylene and oil normally track we would expect propylene to be sort of half way to where it is today. But hold your breath to another couple weeks or maybe back down there again.

Mike Sison – KeyBanc

I got you, okay then heading into the second quarter it tends to be sequentially your strongest quarter in the especially chemical side putting (inaudible) out of technology. Historically out of your materials and I guess when you look at the guidance I know you don't give quarterly guidance you tend to have second quarter earnings better than the first. So can you give us a little bit of help in the puts and takes and I know obviously raw materials will be negative but on average it does come like volumes would be second quarter versus the first.

Shane Fleming

I think you have got it pretty well now. We typically see second quarter been our strongest quarter. I am not hearing anything today that makes me believe that from a volume standpoint that won't be true we would expect stronger results in Coatings and Resins. Aged materials is not as seasonally cyclic as the other businesses but Q2 typically has been an okay quarter. I would think that some of these ramp ups that the major commercial guys are talking about now would probably be more of a second half 2010 impact. So I wouldn't necessarily that the CM business would bounce in Q2 but you might see some I would expect to see some improvement in the second half of the year again that's part of the reason we have improved our guidance. The big bet for the industrial demand and our coding margins in the second half of the year is really going to depend on the duration links of the shutdowns, shutdowns in Europe in July and August and then what happens that into the year it's very hard to predict what's going to happen there depending on how much inventory customers build and how demand ultimately holds up.

So while we do expect Q2 to be up versus Q1 I would expect Q3 and Q4 to be down and that's really a question of how much they are down but I believe the bigger risk to earnings in 2010 for coding is more ability to maintain margin in a face of what we are seeing now in raw materials.

Mike Sison – KeyBanc

Got you and then real quick on additives technologies. Could you just give us a sort of a 1 minute, talk about the mix at higher margin products? Can you just sort of remind us the mix now of this business and what's good, what's maybe now, still not so good?

Shane Fleming

I mean there are kinds of two product lines within the addictives technologies. Specially additives which is predominantly surfactants and a little bit of specialty monomers and then the Polymer Additives business which is mostly like stabilizers, UV observers that go into multiple industry. So, the mix can be between the two product areas and Polymer Additives is more profitable from a sales margin standpoint. So, higher PA sales improves mix within specialty Additives we have special surfactants ago into pharmaceutical applications or other specific applications if that business is strong you will see an improved mix within specialty addictives and then going back to Polymer Additives we have got a lot of newer technologies that are going into automotive and that's been actually growing faster than some of the other business particularly in Asia where the Chinese producers are building a lot of car parts now with plastics that require a UV stabilizer so that business has been growing, so that's been driving improved mix but I see that been less cyclic or less order pattern related that's just a positive trend that's under way. So I do expect to see some mix improvement going forward in that business based on that trend I just think we had the planets and moons all aligned in this quarter.

Mike Sison – KeyBanc

Great. Thank you.

Operator

The next question comes from Laurence Alexander with Jefferies.

Laurence Alexander – Jefferies

Good morning Laurence. I guess you first mentioned that sausage were a bit of drag this quarter. What's your sense of how much of a drag either on a volume perspective or in an earnings perspective?

Shane Fleming

Not huge in Q1, I think we have done a pretty good question working with suppliers and in many cases in multiple suppliers to make sure that we can secure supply but if you are seeing problems in the Acrylic chain right now in North America there have been some plant shutdowns similar in Epoxy's we have seen some problems as well. So we did see some sales movement out in March into April but perhaps one way to look at it is the balance of sales that got pulled forward to avoid the price increases may have offset what we saw go the other way because of supply shortage. There were a fairly large number of -- so you can order that did move forward. So it's not insignificant, but it's not a massive impact either. The bigger concern for me going forward is that this doesn't continue because this continues is going to start the way on the business and it is trading a lot of volatility in pricing as well as in some of these raw materials.

Laurence Alexander – Jefferies

And then with respect to the sort of potential for an increase in production rates in the aerospace side, beating through to engine materials, do you have a sense for what inventory levels are downstream, not just at the prepaid level but the finished part level?

Shane Fleming

We're working very hard and that's something that we've spent a lot of time and energy on since we got caught a little bit off guard mid year last year. Yes, I think I we do have a pretty good sense of what the story is right now. I think the industry did a pretty good job of responding to Boeings announcement on the 777 cutback. So as that starts to ramp up I think we should see that pick up pretty quickly. I don't think there is a lot of inventory build there. The 787 supplier has got way ahead and that was an impact in the second half of last year where a lot of the 787 part producers just stopped marking parts.

My sense is right now that there is still a fair bit of inventory in the 787 chain and we're not going to see a huge favorable impact in the first half of the year, though we should start to see some 787 driven business pick up now in the second half. So I see that being pretty positive and I think that because the whole value chain has been, our supply chain has been emptied a little bit, if and when Boeing and Airbus ramp up their single hour rates, I think we'll start to see that flow through immediately as well. But I think the inventory situation is a lot better shaped than it was mid year last year. If there is any overhang, it's probably still in the 787 area. 747-8, as it ramps up will be positive as well because I don't there was a lot of inventory build there.

Laurence Alexander – Jefferies

And when you were thinking about your outlooks around Christmas, how much of the outlook for 2010 was assuming further de stocking rather than just a drop in volumes.

Shane Fleming

I think we've pretty well felt we were getting to the end of the de stocking by the end of last year. It was; you could clearly see it plateauing. And what we guided was that we expected -- basing our assumptions on rate reduction announcements, we didn't expect to see that impact ourselves until the second half of 2010 but the upside is really in the second half versus what we had in our guidance.

Laurence Alexander – Jefferies

And then lastly, just if I can flog on that horse or proverbial horse, given where interest rates are and the strength of their recovery or indications of recovery in different end markets, what's your appetite for large M&A?

Shane Fleming

Not that great. How is that? It's nothing but awfully a tasty morsel. Now I think we were pretty clear in terms of the strategy that we want to follow here and we're looking aggressively at the right sort of technology acquisitions or small bolt on acquisitions and we're not spending any time looking at any type of big deals. If you see us do anything I would think its going to be in the $25 million to $100 million. $200 million would be a very large deal for us anytime soon.

Laurence Alexander – Jefferies

Okay. Thank you.

Operator

And we'll go next to our question from Bob Koort with Goldman Sachs.

Bob Koort Goldman Sachs

Thank you. Good morning. Could you talk a little bit -- I think you mentioned you expect to maintain margins, given that the cost I guess will be a little bit of a spike into the second quarter that will mirror some of your price improvements but would you expect sequentially to see some margin compression and then expansion again in the third quarter. Is it feasible to actually have some steady margins through with the second and the third quarter?

Shane Fleming

If you're talking about operating margins I think I would be surprised if we see them fall off. There could be some noise between product lines like I mentioned before, especially additives, polymer additives are not likely to deliver 13.5% operating profit on an ongoing basis. But because we're going to get leverage from volumes and I don't expect to drop off there, I don't think you're going to see operating margins move too much from where we were in Q1. On a sales margin basis, contribution margin basis, there is some risk in coating resins if we see some of these spikes in our material cost move through the value chain and we're not able to recover pricing. So I think if there's any risk at all to contribution margin, it is probably that issue with in coatings.

Bob Koort Goldman Sachs

And Shane, you mentioned maybe some pre buying and your March month was much better. I guess the paint guys that have come out so far have talked pretty optimistically about April trends. So do you expect any fall back or do you think we're on a pretty good upward tilt in terms of sequential demand?

Shane Fleming

I tend to think we're on a pretty good run for the next quarter, just based on what we're seeing in April, the carry over we had in March because of some of the supply problems. I don't see anything short term really turning down from a demand stand point in coating. I feel pretty good about at least our next quarter.

Bob Koort Goldman Sachs

And if we want to maybe think about a three or five year horizon as you optimize that Coating Resin till we get back to a normal operating environment, where do you think margins could go?

Shane Fleming

Well we know the whole story about 10% operating margin in this business and I'm not going to fill that number out there and give you the timeline to get there. I've suffered enough pain from that but, there is two things that have got to happen. One we've got to see volumes continue to trend up a little bit to get margins up from where they're at. We've taken a lot of costs out. We certainly have operating leverage and we expect to see some improvement coming there. But also we recognize that we've got some work to do in the portfolio. We still have too much of our revenue coming from margin products and we're going to do that work as well. So in three to five years I would expect us to have brought in some higher quality business through acquisition and also potentially divested some of the lower margin stuff or even shut down some more of the lower margin business and that's going to drive margin improvement as well. My target of getting this business over 10% operating profit is still there. I'm just right now a little gun shot. I have given you a time to get there.

Bob Koort Goldman Sachs

Great, thanks so much.

Operator

And at this time, there are no further questions. I'll turn the call back to Ms. Allen.

Jodi Allen

Thank you for your participation in today's conference call and if you do have follow-up questions please contact me directly at 973-357-3283. Thank you and have a good weekend.

Operator

This does conclude today's conference call. We thank you for your participation.

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Source: Cytec Industries Inc. Q1 2010 Earnings Call Transcript
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