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Cytec Industries (NYSE:CYT)

Q1 2011 Earnings Call

April 25, 2011 11:00 am ET

Executives

David Drillock - Chief Financial Officer, Chief Accounting Officer and Vice President

Shane Fleming - Chairman, Chief Executive Officer and President

Jodi Allen - Investor Relations

Analysts

Michael Sison - KeyBanc Capital Markets Inc.

David Begleiter - Deutsche Bank AG

Robert Koort - Goldman Sachs Group Inc.

Laurence Alexander - Jefferies & Company, Inc.

P.J. Juvekar - Citigroup Inc

Operator

Good day, and welcome to the Cytec Industries Inc. First Quarter Earnings Announcement. Today's conference is being recorded. At this time, I will turn the conference over to Ms. Jodi Allen. Please go ahead, ma'am.

Jodi Allen

Thank you, Ruth, 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 2011. This call is being webcast in listen-only mode and it will be archived in audio format on our website for 3 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 #2 of our supporting material or at the end of our new release for the statements in our quarterly and annual SEC filings. In addition, our discussion includes certain non-GAAP financial measurement as define 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 the call over to Shane.

Shane Fleming

Thank you, Jodi, and good morning, everyone. Thanks for taking the time to join our first quarter earnings call. I'll begin on Slide 3.

Overall sales in the quarter for continuing operations were $766 million, an 18% increase over the prior year quarter. The year-on-year sales growth was driven by volume increases across all of our business segments, as well as our ability to secure necessary price increases in our Specialty Chemicals businesses to offset the significantly higher raw material costs. First quarter net earnings from continuing operations were $39.1 million or $0.78 per diluted share, excluding the special items that Dave will explain shortly. This represents a 34% increase versus $28.9 million or $0.58 per diluted share in the first quarter of 2010. The earnings improvement in the quarter was primarily a result of higher selling volumes in Engineered Materials and In Process Separation, as well as higher selling prices in Coating Resins.

Beginning on Slide 4, Coating Resins delivered sales of $404 million, an 18% increase versus the first quarter of 2010. Selling volumes increased 5%, mostly related to growth in waterborne and powder coating resins, reflecting strong demand in the automotive, packaging and general industrial market. From a regional perspective, the highest sales growth was seen in Europe and Asia Pacific regions.

Selling prices in Coating Resins increased by 12% versus the prior year quarter, as we've successfully implemented increases across each of our coatings products lines to stay ahead of rapidly rising raw material costs. Raw material costs were higher by $36 million in the quarter, so we faced a significant challenge. Exchange rate increased sales by only 1% in the quarter.

The chart on Slide 5 displays monthly sales revenue for the business, which shows a sequential sales improvement in the quarter, with March having the strongest performance. Coating Resins operating earnings for the quarter were $18.8 million, reflecting a 12% improvement versus the first quarter 2010, which is mostly a result of our higher selling prices combined with the overall increase in global demand.

Moving to Additives Technologies. Slide 6 shows sales in the segment of $67 million, an increase of 8% versus the first quarter 2010. Selling volumes are up 3% as we continue to gain market acceptance with our value-added technologies. The volume increase was driven primarily by improved demand in our specialty surfactants product line as our capacity constraints and polymer additives limited sales growth.

Selling prices for this segment increased by 4% and exchange rates increased sales by 1%. This business was able to offset about $3 million of raw material cost increases in the quarter with higher pricing. The overall result in the Additive segment was operating earnings of $8 million, a slight decrease from $8.4 million earned in the prior year period, with the earnings reduction partially due to higher maintenance costs in manufacturing to sustain operations at full capacity.

Slide 7 highlights results for the In Process Separation segment, which delivered sales of $78 million in the first quarter, an impressive 20% increase versus the first quarter 2010. Selling volumes increased by 16% versus the prior year quarter as a result of both higher demand, broadly for our mining chemical products, as well as our success in commercializing some of the new technologies that deliver high value to our customers. We also secured a long-term supply contract to supply mill extractants to 1 of the major global copper producers, and I'd like to recognize and to thank our sales team for this important win.

Selling prices in the quarter increased by 3%, while exchange rates increased sales by 1%. This resulted in operating earnings of $16.4 million in the first quarter versus $14.9 million in the prior year quarter, primarily due to the higher volumes in the mining markets we served. The segment was also able to cover most of the $2.4 million in raw material cost increases.

Slide 8 shows a summary of results in the Engineered Materials segment with sales of $217 million, an increase of 22% versus the first quarter 2010. Selling volumes were up by 21% versus the prior year quarter, due to increased demand in the large commercial transport sector driven by higher volumes from legacy programs, such as the Boeing 777 and 737, as well as newer commercial programs such as the Boeing 747-8, Airbus 380 and Bombardier CSeries. We also benefited from improved demand from our business jet customers, which showed higher sales in the quarter. In addition, the business delivered sales growth in the civil rotorcraft sector. Selling prices increased by 1% in the quarter, operating earnings were $26.7 million, up 27% from $21 million in the same quarter 2010. We did experience approximately $6 million in higher raw material costs in the quarter, primarily as a result of the tight carbon fiber market conditions. We were not able to secure sufficient price increases in the quarter to fully cover the impact of the higher cost. We also experienced an isolated production issue at 1 of our facilities that resulted in a charge of approximately $2 million in the quarter. Consequently, our margins in this business are under temporary pressure. We have plans in place to capture the necessary price increases over the course of the year to offset the projected raw material cost escalations.

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

David Drillock

Thank you, Shane, and good morning, everyone. Let's go right to Slide 9.

During the quarter, we have the following special item charges: Included in corporate and unallocated is a net special item credit of $0.7 million pretax related to adjustments to prior restructuring accruals, as the actual costs came in lower than forecasted. Next, included in other income expense is a special item charge of $3.2 million for an increase in environmental liabilities related to a meeting with the relevant state agency to discuss new design requirements concerning approaches to effective remediation at an inactive location. Finally, included in gain on sale of assets is a pretax gain of $3.3 million related to a sale of land at our former manufacturing site in Colombia, which we shut down in the second half of 2009. We were pleased to monetize this asset according to the shutdown plan for the site.

Let me say just a few words in our discontinued operations for the quarter. We announced in February that we completed a previously announced sale of the Building Block Chemicals business to an affiliate at H.I.G. Capital, LLC for approximately $176 million, which includes a 6-year $15 million note. We recorded an after-tax gain on the sale of this business of $36.8 million and an after tax earnings for operations for the 2 months of 2011 that Building Block was part of Cytec was $6.8 million.

Cash income taxes related to Building Block Chemicals for 2011 are approximately $31 million, and will be paid pro rata over the remainder of 2011. We wish the former employees and the new owners of Building Block Chemicals well. They remain an important supplier to Cytec for acrylonitrile and melamine.

Now let me review our operating results for the quarter. As Shane covered sales in operating earnings, let me add a bit more analysis for you. Our gross profit increased about 14% to $180 million, while our gross margin percentage after adjusting for the special items in both years is down just about 1% to approximately 23.5%. Overall selling price increases of approximately $51 million offset raw material cost increases of $48 million. This had the impact of reducing our gross profit percentage by about 1.5%. So excluding this effect, our gross percentage would be up about 0.5 point. The rest of the gross profit story is that the increased gross profit from the higher selling volumes more than offset the increase in manufacturing and freight and warehousing costs.

With the sale of Building Block Chemicals completed, we are no longer a large direct purchaser of propylene. However, many of our raw materials, particularly in Coating Resins, are derivatives of propylene. Propylene has increased significantly, with increases around 20% in North America, Europe and Asia just in the first quarter and they headed higher in April. When propylene moves, we generally see it 30 to 90 days later in the cost of many of our Coating Resins raw materials. So we must act quickly with selling price increases to recover the higher cost and protect margins. Our Coating Resins commercial team has done a good job so far in keeping up with the increasing raw material costs.

Shane also covered the operating segments performance, so let me add a few words on the corporate and unallocated segment for the first quarter. Those expenses, excluding the special items in both years are down $1.8 million year-on-year, mostly due to reduced consulting cost as we wound down our successful improvement projects of shared services and working capital. We had 2 months of continuing cost related to Building Block Chemicals and corporate and unallocated, which totaled about $1 million, whereas the prior year period reflects 3 months or about $1.5 million. Just 1 final note, our savings from the shared services initiative essentially cover the continuing costs from the sale of Building Block Chemicals.

Our operating expenses, excluding special items in both years, is up approximately $12 million but as a percent of sales is down 1%. The increase in dollars primarily reflects the investment in commercial and technical people we have made in our Engineered Materials and In Process Separation segments, plus higher payroll taxes and 401(k) matches related to the increased incentive compensation payments, and finally normal wage inflation. This is partly offset by the lower consultant cost that I just mentioned moments ago. Interest expense net is up about $1 million with the majority of this due to a reduction in a credit associated with amortizing mark-to-market gains from our 5-year cross currency swap, which expired October 1, 2010. The effective tax rate for the first quarter of 2011 was 31.25%, which excludes a $2.3 million in discrete tax benefit attributable to several international tax matters. This compares favorably to the 32.5% effective tax rate in the first quarter of 2010.

Operating cash flows from continuing operations were $21.5 million for the first quarter of 2011, and cash flow from discontinued operations was $5 million. We continue to do some good work concerning working capital. As you can see on Chart 11, during the first quarter, our average net working capital days decreased by 4 as compared to the fourth quarter of 2010. Trade accounts receivable increased about $60 million due to higher revenues, but the average days sales outstanding for the first quarter of 49 was flat with the fourth quarter of 2010 average. Inventory increased by approximately $49 million due to higher demand and production. While average days in the first quarter of 2011 of 69 was slightly up from the average for the fourth quarter of 2010 of 67 days. Accounts payable increased by about $115 million due to the higher demand levels, and our days payable outstanding in the quarter increased to 58 days versus the 51 days average for the fourth quarter of 2010.

The decrease in accrued expenses reflects payments of about $43 million related to incentive compensation payments. Other liabilities includes payments of $16 million to our pension plans, while the current period pension expense was slightly under $7 million.

Moving on Slide 12. Capital spending for the quarter was $26 million compared to $28 million in the same quarter of last year. Approximately 60% of the spending is related to our growth product lines. We continue to expect full year capital spending to be in the range of $170 million to $190 million as we ramp our projects in our Engineered Materials and In Process Separation segments.

Our cash balance increased to $522 million, up from year end's $383 million. This includes approximately $160 million in proceeds from the sale of Building Block Chemicals back in February. I'll remind you of our uses of cash and they are as follows: First, it's maintenance of business capital, then capital for expansion projects in our growth platforms and capital for fast payback cost reduction projects. This is followed by bolt-on acquisitions and debt repurchase when available at reasonable prices. And finally, the return of excess cash to shareholders through stock buybacks and dividends. Speaking of stock buybacks, during the quarter, we purchased 440,000 shares of our common stock for about $24 million and have approximately $170 million remaining on our current stock buyback authorization. Barring any cash used for bolt-on acquisitions, we expect this pace to continue in 2011.

In closing, we have a solid start to the year with good momentum as we tackle the challenges of 2011. Our balance sheet is in great shape along with our cash flow generation. Thank you. And now, I'll turn the call back over to Shane.

Shane Fleming

Thanks, Dave, and now I would like to review our outlook for 2011, which we have summarized on Slide 13.

We expect the improved demand environment to continue at a slow and steady pace through the rest of the year. As you are aware, many of our key raw materials are derivatives of propylene. The recent trends of rapidly increasing energy costs and supply challenges in the petrochemical industry continued to significantly impact propylene and its downstream products. We therefore expect raw material cost to remain a headwind.

Demand for propylene derivatives are expected to outpace new supply, and as a result, we believe supply will remain tight and raw material prices will continue the steep upward trends. We will continue to aggressively seek price increases to mitigate the impact of the higher cost across all of our impacted product lines.

We are reaffirming our guidance for 2011, continuing full year adjusted diluted earnings per share attributable to Cytec to be in the range of $3.15 to $3.50 versus 2010 full year earnings per share from continuing operations of $2.99. We're also reconfirming our 2011 full year operating earnings guidance for each of our individual segments.

In Coating Resins, we expect slow growth to continue in the global industrial markets, with potential near-term weakness in automotive OEM to the reduced global auto production forecast as a result of the disruptions in supply chains from the earthquake in Japan. We continue to be encouraged by the positive trends for conversion to our waterborne and RADCURE technologies, and we will remain focused on driving growth of these products in our target markets.

Given my earlier comments regarding raw material pressures, we will continue to take a market leader approach to mitigate the impact of the expected higher cost just as we have demonstrated this past quarter.

As part of our commitment to improve the profitability of this segment, we are making fundamental changes in the way we manage this business. After careful analysis of the segment product lines, approximately 70% of the portfolio now meets the criteria for our cash business model compared to 50%, 2 years ago. We will therefore begin to operate the majority of the segments portfolio with a focus on cash generation, with reduced SG&A and capital investment limited to quick payback projects.

The remaining 30% of the product lines, including waterborne resins, the specialty portion of our RADCURE product line and select additives and crosslinkers for coatings will remain classified as growth. The growth areas will warrant additional focused investment in areas such as business development, R&D and capital expansion. As a result of this change, we'll be making resource adjustments in this segment that include headcount reductions within the commercial, technical and administrative functions. We also shut down our RADCURE monomer manufacturing site in San Fernando, Spain in the first quarter and have signed an agreement to sell the site to the local municipality. We anticipate proceeds from this sale will be received in installments during 2011 and 2012. Additionally, we have signed an agreement to sell our Stanford research and development facilities and lease back space from the new owner, subject to buyer due diligence. Under the terms of the agreement, we estimate a non-cash charge in the range of $25 million to $35 million following completion of the sale. We continue to explore additional improvement initiatives including further product rationalization and manufacturing cost reduction to align the cash portion of the segment's manufacturing footprint and cost base to market demand, revenue and margin generation, following the successful model we employed in our Additives Technologies segment. Our commitment remains to strengthen the foundation of this segment and deliver year-over-year earnings and cash flow growth as we return the business to an acceptable level of profitability.

In Additives Technology, we are seeing increased demand due to both solid underlying market growth and the added value of our technologies gaining additional acceptance and penetrating knew applications. However, we face the challenge of meeting the increased global demand, when we're already operating our plants at full capacity. We are working to increase and broaden our supply base to allow further growth, but this will not be completed until late in the year or early 2012.

Demand for our In Process Separation technology is expected to remain strong, particularly in the emerging markets. We continue to penetrate the global mining industry with our innovative products that are bringing real value to copper alumina and our newly-targeted industrial minerals markets. Our innovation pipeline in this business remained strong and we expect to continue to grow organically as we investigate new business development opportunities to further expand our market presence.

In the Engineered Materials, demand for high-performing composite technology continues to expand in the Aerospace market. And we are seeing good sequential growth related to a ramp up in both legacy and new program build rates in the commercial Aerospace sector. We're also encouraged by the sales growth for some of our business jet customers, which was demonstrated in our first quarter volume increases, indicating this segment of the market may be finally turning the corner.

We recognize that we're now behind in securing the necessary price increases to offset the rise in raw material cost, particularly in carbon fiber. And we are committed to close this gap over the course of this year. We will balance our focus on meeting the increased demand of the rapidly expanding market, securing business, a new commercial Aerospace programs and delivering the required price increases to mitigate the increasing raw material cost in our legacy business. We remain confident in our ability to achieve these goals and reaffirm our operating earnings guidance in the range of $130 million to $140 million.

Long-term growth in materials will be driven by new programs requiring higher levels of composites and adhesives. The business continues to prepare for the upcoming build rate increases related to these new aircraft programs. We believe that airlines will become more focused on fuel-efficient aircraft to help offset the rising oil prices, and the order book for the newer planes should remain strong.

We're also very excited about a recent contract extension with Lockheed Martin, which now extends our contract period up to 2020 for supply of Cytec's special composites and adhesives used in the manufacture of the F-35 Lightning II program, also known as the Joint Strike Fighter. Cytec is very proud to play an important role in leading edge programs such as this 1, and we look forward to building upon our history of success in military programs. I would like to personally thank and congratulate all of the employees involved in the collaborative effort with Lockheed Martin.

Overall, I'm pleased with our first quarter results, given the tremendous pressure in the raw material environment. We strive to grow the top line with a more value-added and higher performing technologies, and we will continue to make progress, reshaping the portfolio to achieve a greater portion of our sales and earnings from our strategic growth platforms as we drive organic growth. I remain confident in our ability to deliver our long-term growth strategy, which will create value for our customers and for our shareholders.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of David Begleiter from Deutsche Bank.

David Begleiter - Deutsche Bank AG

Thank you. Shane, in Coating Resins in Q2, would you expect the propylene pressure to result in margins being below those in Q1 or flattish or even up?

Shane Fleming

I certainly believe we're going to see significant increase in raw material cost. And as we demonstrated this quarter, David, I think we're going to likely be able to cover those. I also think that as we normally see with this business, Q2 is a strong quarter from the demand standpoint. So I would not expect to see our operating margins diminish in this business in the quarter. In fact, I would expect them to go up.

David Begleiter - Deutsche Bank AG

And, Shane, in this segment, why not break out the cash portion of business in its own segment to highlight those margins versus those in the growth businesses?

Shane Fleming

It's something we're considering doing right now, David, for internal use as you would expect. The challenge for us in operating the business is that we've got common products within individual product lines, and if we have to extract those to categorize by cash and growth, it doesn't lead to operating the business in the right way. But it could lead to some enhancement in reporting. So I think I'll take your comment under advisement and we'll consider doing that. As I said, it's something we're looking at doing now internally, so perhaps we could do something externally with that as well.

David Begleiter - Deutsche Bank AG

And, Shane, last, Engineered Materials sales sequentially, will it be flattish over the next few quarters given the guidance?

Shane Fleming

I'd suspect it would be up slightly. We had a very strong first quarter. I believe that there is still some upside as we see some of the newer programs start to gain a little bit of momentum. On the other hand, it is a little bit concerning right now that we may see some stock building going on. So I'm not going to sit here right now and say we expect to see strong quarter-to-quarter increases, but I also wouldn't be surprised if we don't see sales staying at this level or maybe even up modestly.

David Begleiter - Deutsche Bank AG

Thank you.

Operator

Your next question comes from the line of Mike Sison from KeyBanc.

Michael Sison - KeyBanc Capital Markets Inc.

In terms of Coating Resins, what's changed this quarter and sort of your sentiments in the second quarter that gives you confidence you can raise prices? It was a little bit of an issue in the fourth, so anything that you've done differently or competitors, are they all sort of seeing the same pressures in raising prices?

Shane Fleming

Yes, I think it's probably a lot to do with the latter category. Our ability to raise price, hold price and keep our plants running at acceptable levels of occupancy is based on competitive response. And because there's so much headline news out there with energy prices being high, all the bad news going on around the world, I think there was more support by all the competition to raise price. So that was a big part of it. I think we're getting better from an execution standpoint as well, and probably we had some unfavorable FIFO accounting in the fourth quarter of last year that didn't carryover. So it was a few things, but I think the biggest was that we did get support from competition.

Michael Sison - KeyBanc Capital Markets Inc.

Right. And then going forward, you've talked about sort of another round of either, I don't know if you want to call it, cost savings, productivity for Coating Resins, you're making some changes here. What does this all mean in terms of sustainability of profitability? Are you feeling better about maybe keeping it at a certain margin level? Can you sort of help us understand what the benefits will be once you undergo this sort of next round for Coating Resins?

Shane Fleming

I'm probably going to stay away from trying to project operating profit or margin levels here. But what I will say is that, as I noted in my comments, we recognize that a higher percentage of the portfolio should be operated as cash versus what we had acknowledged a couple years ago. And we have a good model in place for operating cash businesses. We want to apply that to a fairly large, 70% of this total portfolio. So the cost savings will come from focused discipline, cash operations of that 70% of the segment. And that should translate itself ultimately into lower cost, better operating margins and better cash flow from the segment going forward. It was entailed in some of these restructuring changes, the things that we've announced already either in the press release or our 10, where the sale of the San Fernando site, the sale of the Stanford site, and there's also announced 85 headcount reduction in sales and technical and admin folks related to mostly cash portions of our coating support platform in Europe. Beyond that looking forward a little bit, we're looking very hard in our manufacturing assets, as I've said in the speech, and we're trying to make sure that we've got the right cost and the right footprint given the overall mix of volume demand and the profitability of that business.

Michael Sison - KeyBanc Capital Markets Inc.

Okay. And last 1 on Engineered Materials, sounds like given you kept guidance for the year, that you feel good about getting pricing. If you just walk us through how pricing raw materials works for that segment, contractual, is it just -- does not feel hard to raise price as a competitive reaction?

Shane Fleming

Yes, there's a mix of business and where we have long-term contracts in place, we have price escalators and there's some lags on those. So part of the reason we weren't able to keep up on price was just there's 90 days or -- that's an average number, but a certain number of days behind the actual increase when we can see it in our product pricing. But we also have quite a lot of noncontract business, and the noncontract business we can move more quickly to get price. I think we were caught a little bit by surprise at how quickly the carbon fiber prices went up in the quarter, so we've got some catch-up to do. But we're quite confident that by the end of the year, we will have covered all the raw material cost increase in the segment.

Michael Sison - KeyBanc Capital Markets Inc.

Got it. Thank you.

Operator

Your next question comes from the line of P.J. Juvekar from Citigroup.

P.J. Juvekar - Citigroup Inc

I have a question on Engineering Materials, about your South Carolina plant, when do you plan to start that? And post that start-up, how much carbon fiber will you buy versus make on your own?

Shane Fleming

We haven't announced the date for start-up yet. It's something we look at on probably a semi-annual basis. We'll be reviewing that again at midyear and making a determination then. And if we make a definitive decision, we'll probably announce that. But as of yet, we have not -- I'm still thinking that the start-up date is somewhere in the 12- to 18-month range. But don't quote me on that just yet. Right now, we purchase about somewhere between 60% and 70% of our carbon fiber demand and post start-up of this, when the 787 is running at full ramp up, we'll probably going to be around that 40% range. Most of the capacity that will come online with the new line, with the GP3 line will be to satisfy 787 increased demand. So it's not going to make a huge difference on the percentage of CapEx [ph].

P.J. Juvekar - Citigroup Inc

Okay, that's helpful. And then earlier you mentioned FIFO impact in Coatings, I was wondering if you could quantify that?

Shane Fleming

I'm sorry, I missed your question.

P.J. Juvekar - Citigroup Inc

The FIFO impact in Coatings?

Shane Fleming

Well, just in the fourth quarter of last year, I was telling Mike why there are differences between profitability in Q4 and Q1. We did have a fair bit of unfavorable FIFO in our fourth quarter of last year that depressed the fourth quarter margins. It was not just that, of course. There were many other factors, but we were short on covering price. We had FIFO impact, as well as weaker demand.

P.J. Juvekar - Citigroup Inc

All right. My question was did you get a positive FIFO impact in 1Q?

Shane Fleming

No. We did not have a positive impact in Q1. But at least, it's not hugely negative.

P.J. Juvekar - Citigroup Inc

And just lastly, can you shed some light on your raw material contract for a acrylonitrile, now that Building Blocks material is sold?

Shane Fleming

Yes, we have a long-term supply agreement with the purchaser of the Building Blocks business for both acrylonitrile and for melamine. It's a price that's between cost and market. If you want the specific details, why don't you contact Jodi and she can give you some additional information.

P.J. Juvekar - Citigroup Inc

Great. Thank you.

Operator

Your next question comes from the line of Robert Koort from Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc.

Shane, I'm intrigued by the slide on Coating Resins sales trends. I know you cautioned that there might be a little bit of auto weakness there, but it seemed like the trends through the quarter were pretty exciting. I wonder if you can give us some sense of why we would not expect that line to keep going up and to the right, especially as more price hikes come through and maybe what causes you to be somewhat cautious, as it would appear on your revenue guidance for that division this year?

Shane Fleming

Yes. I think I would expect that line to continue to move up through the second quarter. Again, a traditionally strong demand quarter for us. If you look at how this business plays, our strong months are February, March, all through Q2 and into early Q3. So I would expect to see that trend continue. And as you noted, it will be buoyed by pricing as well. If you were to strip out the price impact and just look at demand here, you wouldn't see nearly the increase, the apparent increase looks like on the slide. Probably the second point on caution for full year is what we have seen particularly in the last couple of years with downturns in the fourth quarter. So we had quite a weak demand quarter in the fourth quarter of 2010. And right now, it's too hard to say based on any advance order, notice from customers but just based on traditional cyclicality in this business, we're probably cautioning with a weaker fourth quarter.

Robert Koort - Goldman Sachs Group Inc.

And could you talk a little on the Engineering Materials business? What is the scope to seeing those margins go back to where they -- where historically, is there something that's been changed from a secular standpoint? Is it the pass-through of higher raw materials that makes the objects of margin as a percentage of sales different? How likely is it and what kind of time frame to get back up towards this 20% margin?

Shane Fleming

Yes, there's not much in the way of structural changes. There are 2 things that I would call more structural. The first is that we continue to invest at a higher level in product development, in R&D and in engineering in our plants to bring out some of these next-generation products for a bunch of new platforms that we're working on today. And that's in the 1% to 1.5% of sales. The only other thing that's gone on is, you may recall, when we revised our segment descriptions in early 2009, we actually pulled our Engineered Adhesives business from Specialty Chemicals and put those into Engineered Materials, so about $140 million, $150 million of business and it's a decent business, it's double-digit earning margins, but it's not as high as EM. So there's likely to be a little bit of dilution there and I don't think it's over 1%, but say in the 0.5% to 1% range. To your question on some dilution from higher raw material cost, that's possible. Although in this business, we don't look at just covering raw material cost. Our goal here is to maintain our marginal income or contribution margin percentages, so I don't think we're going to see too much of a dilution impact there. And then to the last part of your question about when will we or will we see our return to past peak cycle operating margins. Just with the exception of notwithstanding the 2 structural changes I referenced, we should get back there. Now it's going to -- our breakeven point is a little bit higher because we've added some additional manufacturing capabilities, but once we get our plants full, once we get back to near-peak cycle, I think you're going to see our operating margins here get close to past highs.

Robert Koort - Goldman Sachs Group Inc.

Great. Thanks very much.

Operator

[Operator Instructions] We'll go to our next question from Laurence Alexander from Jefferies.

Laurence Alexander - Jefferies & Company, Inc.

I guess, first off, on the Coatings business, could you revisit what kind of a structural shift you could do to improve the capacity utilization of your European facility? And any change in your thinking on that?

Shane Fleming

Yes, I think -- maybe structural for the asset redeployment there is a bit of a strong word because it's more of an incremental approach. But what we're trying to do is optimize our product mix to get the maximum amount of capacity for our growth products. And so for us, that means additional rationalization of the solvent-borne products. And that's the work that we're doing is going through a long list of solvent-borne products, determining which of those make sense to keep in the plants and which don't. If we can shut down lines, our production lines and just walk away from solvent-borne a little more, just solvent-borne business, we'll probably do that. The way we'll do that is raise price to find out which products really carry value and not. But it's kind of a little bit of a longer term, more than incremental approach to optimizing mix based on making sure we're running the right asset base based on the cycle times and the margin generated by on a product-by-product basis. And because this is quite a complex analytical process, we've actually contracted with a consultant to help us go through this because it's not simple. There's a lot of analysis that needs to be done to maximize that gross profit per reactor hour type approach.

Laurence Alexander - Jefferies & Company, Inc.

And then as you look at the water-based coatings technology platforms, do you feel strategically that you need to keep all 6 platforms?

Shane Fleming

I think there are elements of those 6 platforms that are really key for us, where there are good secular growth or these products have unique properties that we want to keep in the market. But you're asking exactly the questions that Dave and I are asking the management team as well. Do we really feel the that we've gotten to the right point here with the 70-30 split. Do we feel that everything in that 30% split is indeed in that growth category. And right now, that's a call we made. That's what we believe. But believe me, we'll be watching carefully to make sure that we are getting growth and maintaining margins in that 30% piece of the portfolio.

Laurence Alexander - Jefferies & Company, Inc.

And then lastly on the Engineered Materials business, do you expect this kind of raw material volatility and consequent lag in occasional period -- hits to your margins to be something that recurs every 6 to 8 quarters or is it something that is fixable in a structural way, so that is, that you would do a better job on the pass-throughs?

Shane Fleming

Yes, I think if you look over history, the frequency of run ups in carbon fiber pricing has been much less frequent than 6 to 8 quarters. It's a pretty long cycle. I think there are few things that contributed here. We have seen quite a bit of increased demand in the commercial Aerospace sector, which is a big user of Aerospace grade carbon fiber. I think the problems in Japan created a little bit of a scare. I don't think it's created any short-term supply issues, but it has created a little bit of a scare. So I think there are a few things that have driven this. But fundamentally, I think, because of the size of these investments and the time doing these investments online, cycles here are usually quite long. There is going to be some new capacity coming online, but we did get caught in a short-term crunch here.

Laurence Alexander - Jefferies & Company, Inc.

Thank you.

Operator

[Operator Instructions] There are no further questions in queue.

Jodi Allen

If there are no further questions, we thank everybody for your participation today. And if you would like to follow up with me directly, please do so by calling (973) 357-3283. Thank you very much, and have a great day.

Operator

This concludes today's conference call. Thank you for your participation.

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