Cytec Industries' CEO Discusses Q2 2011 Results - Earnings Call Transcript

Jul.22.11 | About: Cytec Industries (CYT)

Cytec Industries (NYSE:CYT)

Q2 2011 Earnings Call

July 22, 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

Peter Grondin - OSS Capital

Robert Koort - Goldman Sachs Group Inc.

John McNulty - Crédit Suisse AG

Laurence Alexander - Jefferies & Company, Inc.

P.J. Juvekar - Citigroup Inc

Operator

Good day, and welcome to the Cytec Industries Second Quarter 2011 Earnings Conference Call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the call over to Ms. Jodi Allen. Please go ahead.

Jodi Allen

Thank you, Tequila, 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 updated 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 also available through our website.

During the course of this presentation and in responses 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 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 measures at the end of our press release. A copy of our press release is available on our Investor Relations website.

Now let me turn over the call to Shane.

Shane Fleming

Thanks, Jodi. Good morning, everyone. I appreciate you taking the time to join our earnings call. Let me begin on Slide 3. Overall sales in the quarter for continuing operations were $798 million, a 14% increase over the prior quarter. The year-on-year sales growth was driven by 10% selling price increases across our all of our business segments with additional support from foreign exchange. Volumes versus the prior year quarter were down by 1%. And if you recall, Cytec had very strong earnings performance in the second quarter 2010, particularly in Coating Resins and Engineered Materials.

Net earnings from continuing operations in the second quarter this year were $45.9 million or $0.92 per diluted share, excluding the special items that Dave will explain shortly. Although this is a decrease versus the prior year quarter record earnings performance, it does reflect an 18% increase versus $39 million earned in the first quarter of this year.

Beginning on Slide 4, Coating Resins delivered sales of $421 million, a 14% increase versus second quarter of 2010. The increase was driven by 15% higher selling prices and favorable exchange impact of 8%. This was partially offset by volume being down 9% due to weaker demand, particularly, later in the quarter as customers reduced inventory levels, anticipating lower raw material costs in the third quarter. Volume in the quarter was also negatively impacted by the shutdown of our San Fernando, Spain, Radcure monomers plant in March next of this year and bottom slicing actions we have taken with certain solvent-borne commodity products as we move to improve mix and reduce manufacturing cost in this segment.

From a global perspective, volume was down in all regions of the world with the largest decline in Asia Pacific, where the most opportunistic buying practices typically take place. I'm pleased to point out that we were able to grow volume in our waterborne product line despite the softening demand environment.

Our team did a great job executing required pricing actions and were able to secure $54 million in price in the segment, more than offsetting the roughly $47 million in raw material cost escalations.

The chart on Slide 5 displays monthly sales revenue for this business. This shows the strong sales performance in the first 2 months of the quarter with increased revenue from price increases more than offsetting reduced demand and the drop-off in June sales as customers reduced inventories.

Coating Resins' operating earnings for the quarter were $28.2 million, a slight improvement over the very strong prior year quarter. I'm particularly pleased with our disciplined pricing actions in the first half of this year as we accumulatively achieved $98 million in price increases in this segment over the past 6-month period.

Moving to Additive Technologies. Slide 6 shows sales in the segment of $73 million, an increase of over 10% versus the second quarter 2010. Once again, increased selling price was the primary driver of growth, achieving 8% versus the prior year period with an additional 5% benefit from exchange rates.

Selling volumes are down by 3% although this is primarily due to capacity limitations constraining product availability in Polymer Additives rather than reduced demand. That said, we did see a slower pace in the North American market but our results were due much more to volume shortages and the economic slowdown. Also in Specialty Additives, we continued to experience a sold-out situation with some products. The order book in our additives product line remains strong, and we are actively working on capacity expansions to meet increasing market demand.

The overall results in additive segment was operating earnings of $10.1 million, a slight decrease from the $10.7 million earned in the prior year period but a 25% earnings increase from the first quarter this year.

Slide 7 highlights results for the In Process Separation segment, which delivered sales of $82 million in the second quarter, a 16% increase versus the second quarter 2010. Selling volumes increased by 10% versus the prior year quarter as a result of both higher demand in our aluminum markets as well as good demand for our phosphine products.

We continue to demonstrate success, commercializing our new mining technologies that deliver high value to our customers. Selling prices in the quarter increased by 4% while exchange rates increased sales by 2%. This resulted in operating earnings of $15.6 million in the second quarter, a 9% increase versus operating earnings of $14.3 million in the prior year quarter.

Slide 8 shows a summary of results in the Engineered Materials segment with sales of $222 million, an increase of 13% versus the second quarter 2010. Selling volumes were up by 9% versus the prior year quarter due to increased demand in the large commercial transport sector, driven by higher build rates from new programs, including the Boeing 747-8 and 787 as well as the Airbus 380. Higher revenues also included increased supply for legacy programs including the Boeing 777 and 737 and the Airbus 320 in preparation for the announced upcoming rate increases.

We also benefited from the improved demand from the civil rotorcraft sector. The favorable volume was partially offset by declines in military, specifically related to the ramp-down of the F-22 program.

Selling prices increased by 3% in the quarter as we are making necessary price increases in response to the rise in raw material cost, particularly carbon fiber that began earlier this year.

Exchange rates had a 1% favorable impact on sales. Operating earnings were $30.4 million, down from $38.6 million in the second quarter 2010 as a result of higher period and operating cost. Period costs were increased through the hiring of additional operations staff to meet the stronger demand for our products coming from the announced bill rate increases for legacy commercial jet programs as well as the ramp-up for the new programs. In addition, delays in completing qualifications for our recently constructed plant in China and a new line at our plant in Germany have led to higher-than-anticipated cost at our qualified sites to supply these materials.

We had expected these site qualifications to be completed and fully operational earlier this year and had therefore staffed the new facilities to take on this demand.

Now that the qualifications are complete, we are beginning to transfer production to the new lines, and we should see increased production rates and improved volume leverage in the second half of this year. Operating costs were up to due increased product development cost related to supply and qualification materials to new aerospace programs. I will come back to these 2 topics again when I discuss the full year outlook.

Now let me turn the call over to Dave, who will provide additional details on the financial results in the quarter.

David Drillock

Thank you, Shane. Good morning, everyone. Well, let's go right to Slide 9. During the quarter we had the following special item charges. The first is a pretax net charge of $12.5 million or $9 million after-tax for restructuring activities principally related to the elimination of approximately 85 positions in the commercial, technical and administrative functions in the Coating Resins segment. The split by P&L line item is $800,000 in manufacturing cost of sales, $4.7 million in selling and tech services, $6.8 million in research and process development and $200,000 administrative and general.

The second special item is a pre-tax charge of $1.2 million or $700,000 after-tax related to an increase in the environmental liability at an inactive site for new remedial design requirements. This was recorded in other expense. In regards to discontinued operations for the quarter, the net after-tax loss of $1.1 million relates to the final working capital adjustment, offset by some favorable tax benefits related to U.S. manufacturing deductions allocable to Building Block Chemicals. That closes out the final accounting for the sale of our Building Block Chemical business.

Now let me review our operating results for the quarter. Just a reminder that all amounts and percentages I discuss will exclude any special items unless specifically mentioned otherwise. I'll start with gross profit.

Our gross profit dollars increased almost 4% to $202 million, while our gross margin percentage is down just about 2.5% to approximately 25.3. So the selling price increases of approximately $67 million more than offset our raw material increases of about $60 million. This had the impact of reducing our gross profit percentage by a little over 1%. The rest of the gross profit story is that the increase in manufacturing cost that Shane just explained, mostly in the Engineered Materials segment, reduced our gross profit by a little over 1%. And as a Shane has said moments ago, we expect the situation to improve over the second half of 2011.

Looking at raw materials for a few moments. Propylene has declined from the high mounts we had at the end of the first quarter. Even with those declines, propylene remains at very high levels, and further declines look to be smaller. There is still some tightness in supply for certain alcohols, acrylic acid and a few other raw material, so that is keeping declines related to propylene moderated. As a reminder, when propylene moves, we generally see it 60 to 90 days later in the cost of many of our Coating Resins raw materials.

And let me add that our Coating Resins commercial team continues to do a very good job in covering the higher raw material costs. Looking at corporate unallocated for the second quarter. Those expenses are down about $3 million, partially due to reduced consulting fees. Also in 2010, we had about $600,000 of higher start-up costs related to our Shared Services Center and $1.7 million of previously allocated cost to our more former Building Block Chemical Segment.

Operating expenses are about $11 million year-on-year, but as a percent of sales down 0.5%. Half of that increase in dollars is due to changes in the exchange rates. The rest is primarily due to investments in additional commercial and technical people for our Engineering Materials and In Process Separation segments, partially offset by the lower consulting costs I mentioned moments ago.

Interest expense net is up $1.7 million with the majority of this due to a credit in the prior year associated with amortizing mark-to-market gains for our 5-year cross currency swap, which expired October 1, 2010. The effective tax rate for the second quarter of 2011 was 32.3%, which includes the $700,000 in discrete tax expenses mostly attributable to the remeasurement of our deferred tax position related to changes in U.S. state tax rates.

Excluding the discrete tax expense, the effective tax rate is 31.25%, which compares favorably to the 31.75 effective tax rate percent in the second quarter of 2010.

If you move to Slide 11 and 12, operating cash flows from continuing operations are $28.7 million for the second quarter of 2011. During the quarter, our average net working capital days were flat compared to the first quarter of this year. While trade accounts receivable increased $14 million due to higher revenues, the average day sales outstanding are approximately 48 or slightly down compared to the first quarter's average of 49 days.

Inventory increased by $51 million in the second quarter of 2011 due to weak demand and preparation for seasonal production shutdowns. Average inventory days on hand of approximately 74 was up from the prior average in the first quarter of 69.

Accounts payable decreased by 3 million due to the lower demand levels. While accounts payable days were up 4 to 62 versus the average for the first quarter of 58 days. In addition, during the quarter, we made a partial tax payment related to the gain on the sale of Building Block Chemicals of $15 million. We also made cash payments to our pensionary retiree medical of $20 million in the quarter versus an expense accrual of $7 million. Debt net $13 million is included in other liabilities. The good news is that our pension plans are well-funded, and one should not expect this level of contributions in 2012 and beyond.

Similar to last quarter, our capital spending was $25 million with approximately 60% of the spending attributable to Specialty Chemicals segments and 40% to Engineered Materials. We had expected higher capital spending in 2011 in the Engineered Materials segment. But in light of the higher production pressure levels there, we have focused those engineering resources to critical capital projects and rescheduling others since 2012.

As a result of this, we are revising our total outlook for a full year capital spending to a range of $120 million to $130 million, down from our previous guidance of $170 million to $190 million. Also during the quarter, we purchased 415,000 shares of our common stock for $23 million. The remaining amount on our current share repurchase authorization is approximately $147 million. Barring any bolt-on acquisition activity, one should expect us to continue at this rate for the second half of 2011.

Lastly, during the quarter, we renewed our senior unsecured $400 million revolving credit facility, which now expires in 2016. Our prior facility was to expire in June of next year.

We improved our spread over LIBOR from a 350 basis points to 137.5. Our leverage ratio is 3.5 debt to EBITDA, which has improved from the 3.25. And our interest coverage ratio is unchanged at 3.5x. For your information, at the end of June, our debt-to-EBITDA ratio is 1.4 and interest coverage is 11.4. All in all, we’re pleased with this transaction.

In closing, this has been a good first half but not without its challenges. But we enter the second half of the year with good momentum and what looks to be a challenging environment also.

Thank you. And now, I'll turn the call back over to Shane.

Shane Fleming

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

While I'm encouraged by the year-to-date results, as I mentioned earlier, we started to see a weakening demand picture later in the second quarter, especially related to global industrial markets, which impacts our Coating Resins and Additives Technologies businesses. Two notable exceptions to the softening demand trend being the European automotive market driven by German exports and the Japanese market, which is showing signs of early recovery from the earthquake.

With the uncertain pace of the recovery continuing to be a headwind, coupled with the standard seasonality in the next 2 quarters, we remain cautious in our view of the second half Coating Resins performance. On top of this, the key raw materials for the Coating Resins business are derivatives of propylene, which reached an all-time high of $0.96 in the second quarter. The forecast for chemical grade propylene remains relatively high for the second half of the year, despite the expected short-term decline in the summer months.

According to the latest CMAI forecast, chemical grade propylene prices for North America are estimated to average $0.80 per pound in 2011 in comparison to the 2010 average of $0.60. We have remained disciplined in our pricing actions to offset these raw material increases and plan to continue to cover increases where necessary throughout the remainder of the year.

Given the significant increase in pricing already implemented in the Coating Resins segment to recover first half raw material cost, we are revising our full year sales projection to be in the range of $1.55 billion to $1.65 billion, up from $1.5 billion to $1.52 billion. The outlook for full year operating earnings for the segment remains in a range of $78 million to $80 million.

In Additive Technologies, we'll be faced with some supply constraint challenges for the second half of 2011 as we do not expect the manufacturing improvements and capacity expansions to be fully operational until year end. Therefore, our full year guidance for sales continues in a range of $260 million to $280 million, and operating earnings outlook also remains unchanged in a range of $37 million to $40 million.

The In Process Separation business has had strong performance in the first half of the year, and we expect steady demand to continue through the second half. We see good progress advancing our high-performing mining technologies in Latin America, Europe and Australia over the next several months.

Due to a rapid ramp-up in demand for phosphine-based products used in our mining and phosphine product lines, we are beginning to face capacity constraints in some key products important for our growth. We completed de-bottlenecking work in June that has added incremental capacity, and we've initiated scoping work on a major capital project, which would lead to a significant expansion of phosphine capacity. We expect the scoping work to be completed by year end and anticipate taking a decision at that time to be in construction in 2012.

We are confident in the production outlook for the global mining market. And therefore, our full year projection for sales continues in a range of $320 million to $330 million, and operating guidance continues to be in the range of $60 million to $70 million.

In Engineered Materials, we expect the solid demand trends to continue as our customers ramp up for the upcoming build rate increases in key commercial transport and military programs. As I mentioned earlier, we are making good progress with the price increase actions and secured $5 million of increases in the second quarter. The majority of the impact on these increases will come in the second half of this year.

We intend to fully offset the rise in raw material cost, which has put pressure on our margins in the first half of this year. It's also important to understand that we've just completed some important manufacturing qualifications, which will allow us to move certain production volumes from our existing qualified sites to our newly expanded sites in China and Germany. This will allow us to expand overall output and leverage this new fixed cost while reducing overtime cost at the legacy sites in the second half of the year.

We also remain focused on securing awards for several next-generation programs. We continue to make investments to develop and qualify our materials in these new programs, which has led to higher than anticipated R&D cost in the first half of the year.

Securing business on these new programs is important for the long-term growth of the business, and we anticipate continued periodic investments as we move through the development and qualifications. Given the continued strong demand in the short, medium and long term for this segment and factoring in the shorter-term higher cost I have just described in manufacturing and research, we are revising our outlook for Engineered Materials.

Full year sales are now estimated to be in the range of $880 million to $900 million, up versus the prior year guidance -- sorry, the prior guidance range of $825 million to $845 million. Full year operating earnings are now projected to be in the range of $125 million to $135 million, down versus the prior range of $130 million to $140 million.

On a consolidated level, the guidance for corporate and unallocated is unchanged at an expense of $16 million to $18 million for the year. Guidance for other expense and net interest expense also remains unchanged at $4 million and $37 million to $39 million, respectively.

The forecast for underlying annual tax for ongoing operations continues to be in the range of 30.5% to 32.5%. Finally, our revised 2011 continuing full year adjusted diluted earnings per share is now in a range of $3.25 to $3.50 on sales of $3 billion to $3.2 billion versus the prior projection of $3.15 to $3.50 on sales of $2.9 billion to $3 billion.

Overall, we made good progress in the second quarter. We demonstrated excellent pricing discipline across the portfolio, advanced our product rationalization and cost reduction programs in coatings and were successful growing our value-added technologies across each business segment.

We remain focused on reshaping the portfolio to achieve a greater portion of our sales and earnings from our strategic growth platforms as we drive organic growth. We have positioned ourselves to be able to support higher volumes in our Engineered Materials segment, and we're excited about the secular trends and composites for the aerospace market and our ability to leverage this growth into improved operating margins.

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, Tequila, 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

Just on the industrial demand, you referenced 2 things: one, some destocking by customers as well as then some end market weakness. Which was a bigger impact in terms of the lower volumes in Coating Resins?

Shane Fleming

David, as you would expect, it's little bit hard to understand what part of that demand decline came from those 2 factors, so I'm just going to be able to give you an approximate. But what we saw in the early part of the quarter said that we weren't seeing a structural reduction in demand. So I think my view is that the biggest impact probably did come more from destocking. I guess a little bit of that as well is if you look at our order book, we had a relatively strong order book going through the end of May into early June, and then it dried up pretty quickly. So that tends to make you believe that there was some inventory adjustments going on as well.

David Begleiter - Deutsche Bank AG

And on your raws, given the normal lag, will you still be seeing obviously higher raws in Coating Resins in Q3?

Shane Fleming

Yes. I think first of all, we've got higher cost inventory right now, materials that were produced based on those higher cost raw materials. So we've got roughly 60 days of new inventory in coatings we've got to work through. So I think the earliest we would see declines would be at the end of the third quarter and probably more likely early in the fourth quarter.

David Begleiter - Deutsche Bank AG

And just lastly, on the CapEx, big reduction. Does this relate to the carbon fiber plant or is there something else driving the reduction in CapEx?

Shane Fleming

No, it's not really related to the GP3 expansion. We didn't have a lot of capital in the plan for that. I think what we had in the plan is probably what we'll spend. It's more related to ancillary projects. As Dave mentioned in his comments, we're really focusing our efforts right now on some key projects that we're going to need for capacity expansion. And we’ve just taken engineering away from some of the other projects that were going to be spent and push those projects back into 2012.

Operator

Your next question comes from the line of John McNulty with Crédit Suisse.

John McNulty - Crédit Suisse AG

A few questions. First one, with regard to the capacity expansions that you're building out toward the end of the year in the Additives business, in terms of overall capacity, how much should we be thinking about that increasing your volume potential for next year versus this year?

Shane Fleming

John, I'm going to be guessing a little bit. I'll try to give you a number. We got a few different projects that are ongoing here, some of which will be completed end of this year, and some of them will actually roll into end of next year. If we look at the stuff that will impact us, say, at the beginning of the year, that's a new line in a China facility as well as some incremental capacity in our plant in the U.S. I'm thinking it's probably in the 5% to 10% potential range. Now whether we can fill all that capacity up next year is a different question. But I think that's the level of increase we're talking about. And we've got another expansion ongoing for Specialty Additives business that's not going to hit until later in the year, and that's probably going to add another sort of 5% on the Specialty Additives side.

John McNulty - Crédit Suisse AG

Okay, fair enough. And then with regard to the Coating Resins business, I guess, 2 questions on that. Your guidance in terms of the margin outlook, it looks like you're calling for something in the neighborhood of 3% margins despite the fact that raws, whether they fall or not, they seem to be leveling off. So I guess it seems like it's tied to concerns about volumes dropping off. But are these -- again, maybe back to the -- is it your customers destocking or is there real demand destruction going on? And can you give us a little bit more color there? And if it is destocking, how close or I guess what kind of color do you have in terms of how close we are to seeing an end to that?

Shane Fleming

Yes, I think, Dave, that is destocking. Well, let me rephrase that. To the extent that it is de-stocking, that's just going to be beginning of the quarter impact. I think more likely, what you're seeing is one, our normal seasonality. So we typically got a 52-48 or 53-47 split, and that's due, as you all know, to the slowdowns in our large European customers midyear with the holidays and then year-end slowdown. So it's a little destocking possibly, normal seasonality and then probably a little bit of a more pessimistic view on total demand, but that's not maybe the biggest driver.

John McNulty - Crédit Suisse AG

Okay, fair enough. And then just one last follow-up on the Coating Resins business. I know you're in the middle of a kind of reviewing all the different product lines and trying to figure out what necessarily makes sense to maybe bottom slice out and/or sell and what to keep. I guess I'm wondering how far along are you in that process. And when can we get an update as to maybe how to think about that business going forward?

Shane Fleming

Yes, let me try and give you some color there. We have started some of the bottom slicing. I referenced a little bit that impacted our volumes in Q2, and that will continue. But as I believe you understand, we've engaged some outside support, consulting help to look at our large complex, particularly liquid coating resins plant and try and put together a good plan to reduce the volumes, bottom slice away the right products that will allow us to then take out fixed cost to offset that loss margin. And we started at our largest, most complex site in Austria. That work is going to be coming to an end in the next month or 2 and then we'll take our learnings there and start to transfer that to other sites. So we'll see some impact, probably in the fourth quarter from some of the work that got started. But we're not going to really start to see a significant impact from that until probably the first part of next year.

Operator

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

Michael Sison - KeyBanc Capital Markets Inc.

In terms of your outlook for Coating Resins, would you expect volumes to turn positive as soon as the third quarter? Or do you think it's something that you have to wait until the fourth for everything to flush through?

Shane Fleming

I think it's going to be up and down a little bit. I think as we, again, noted in our press release, we think there was some opportunistic buying practices, meaning, particularly in Asia, customers backed off because they thought they were going to see raw materials turn. So if that indeed happens, I think you'll see inventories build again. You'll see some restocking. But until that happens, as I said in John's earlier question, I think there's probably going to be some destocking that may continue into the early part of the third quarter waiting for that turn to actually take place and those raw material prices to come down. So you’ve got some probably some destocking that's going to come early and then some restocking earlier on. And then you layer on top of that what we normally see with seasonality and the holiday shutdowns in Europe. And then on top of that, a little bit more of a pessimistic view in terms of just overall demand. So it's going to be patchy, I think, is kind of the way we look at it.

Michael Sison - KeyBanc Capital Markets Inc.

Right. And you talked about product rationalization as part of the weakness. And does that -- I mean you've obviously identified areas that maybe don't make sense for you to participate in. Does that accelerate as you head into the third and fourth quarter as well?

Shane Fleming

We might see a little bit more of it just within liquid coating resins. There was one fairly significant event as I referenced in my speech. We did shut down our Radcure monomers plant in Spain at the end of Q1. So that kind of led to a step change in reduction in monomer volumes. That was by far the largest reduction we saw in any of the product lines in coatings. Now as, again I reflected in my comments to John, we're starting this work looking at optimizing product mix in some of these larger complex, liquid coating resins plants, and that's going to be an ongoing process. So that will pick up some momentum. As I said, we're working through the largest plant right now, and we'll start to probably see some of that impact later in the year. But as we move that globally into some of our other sites, you're not going to see some of that action really result in significant movements in volume until early next year.

Michael Sison - KeyBanc Capital Markets Inc.

Okay, and then any updates on maybe strategic moves you can make in Coating Resins? Any businesses that you think are sellable or maybe areas that you need to reduce costs more? You're obviously working through the product rationalization. Any sort of update on what else you can do to continue to improve this business?

Shane Fleming

Yes, I think I can touch on a few items [ph]. I probably won't speculate so much on the M&A side. But on the Radcure monomer side, we've recognized we've got an opportunity to reduce our footprint. We've done that. We also have some tolled volume that we'll probably back away from as we decide that they're just pieces of this business that we don't want to participate in. So that's on the Radcure monomer side. On the liquid coating resins side, particularly on solvent-borne and some of our amino acids, this is what we're focusing, a real in-depth understanding of contribution margin versus fixed cost and doing some fairly aggressive product rationalization. So that's a major initiative for the business. That's something that we're tracking here carefully, and we expect to see some benefits there. At the same time, we hope and expect to see growth within some of the more specialty areas in that coatings platform, namely our waterborne liquid coating resins and our Radcure oligomers. Again, as I noted in my comments, we did see waterborne volumes actually grow in the quarter, which was a positive sign given the overall economic environment. So I think you're going to see -- hopefully, see some mix improvement as we reduce volumes of these more commodity materials and continue to see some growth on the specialty side. Also, I just want to add one other thing. It's something that I think has already been out there, but just to remind you, we did some restructuring in the second quarter. We had some layoffs in our manufacturing tech service research group primarily in Austria. And we'll start to see the benefit from that restructuring in the second half of the year, and that, again, is related to liquid coatings primarily. Again, you'll see more of that in 2012, more of the impact. But that's just another indication of the types of decision we're taking to improve the portfolio. And then I think I'll just wrap up by saying our perspective here is that our expectation for the business is that we continue to show quarter-to-quarter, year-to-year improvement in earnings. And if we don't see that, we will ratchet up the types of decisions we take about restructuring, shutting down, potentially divesting assets.

Michael Sison - KeyBanc Capital Markets Inc.

Okay, and last question on Engineered Materials. You -- looks like you reduced your outlook by about $5 million for 2011. So is that $5 million indicative of the additional cost that you had to take to spend in R&D and ramp up SG&A? And does that reoccur in '12 as well?

Shane Fleming

Well, I think there's several cost buckets. So the biggest one being operating cost, not so much SG&A or R&D. And that's just investment in operators and training of new operators to help us meet increased demand. Also, part of that increase was staffing up these 2 new expansions. So there's a bucket of cost in the operating area that will continue as we meet the increased demand we're facing going forward. There were some overtime costs that we incurred in Q2 that, hopefully, will go away a little bit, but some of that’s going to be replaced as we continue to add operating staff. So that's kind of one category. The second category is SG&A. There has been some increase there, but that's relatively modest. That is more in the product development area but not a major driver. The bigger cost increase coming from R&D was one-time cost that we incur to provide materials to our customers to do qualification work. So we're moving along in these programs now, developing products for these new programs. And rather than supply small-scale samples for lab-type work, now we're starting to supply large volume materials, hundreds and thousands of dollars worth of materials to advance these programs. Those are hard to predict. They tend to be more one-off cost, and there was a number of those that did occur in Q2. And that led to some higher cost there. But let me just kind of sum it all up by saying we have seen increased costs in Q2. We're disappointed that some of it caught us a little bit by surprise, and we were also disappointed by the fact that we weren't able to get these new expansions qualified and running. At the same time, a lot of those costs are going to give us a lot more production capacity, and we expect to be able to leverage that increased cost with increased volume and continue to drive margin improvement. So like you, I'm sure we are disappointed with the margin in Q2 and in the first half of the year. As you can tell from our guidance, we are expecting margin to improve over the second half of this year and continue to move in a very positive way as we move into 2012 and beyond.

Operator

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

Laurence Alexander - Jefferies & Company, Inc.

I guess first question just you continue on the theme for the Engineered Materials. So it looks as if your outlook is looking to get to about maybe 100 basis points or so of margin improvements in Q3 and Q4 as you get back to normalized levels in the first half of 2012. I mean, this is assuming no swings in qualification costs. Is that roughly the way you're thinking about the trajectory? Or is there some seasonality?

Shane Fleming

I think it's -- well, CEM you’re talking about now?

Laurence Alexander - Jefferies & Company, Inc.

Yes.

Shane Fleming

I think our expectations for the second half are a couple 100 basis points of margin improvement versus the first half.

Laurence Alexander - Jefferies & Company, Inc.

Okay. And then on the coating side, have you quantified roughly how much savings all of these restructuring should give you when they're fully completed next year?

Shane Fleming

Yes. Between the restructuring actions that we've already taken, and then I would have to also look at savings coming from the manufacturing work that we've referenced a couple times this morning. I think we're talking about something in the $20 million neighborhood.

Laurence Alexander - Jefferies & Company, Inc.

Okay. And then with the -- as you think about sort of the pricing that you're doing, can you give a little bit more color on -- are you raising prices equally across your product lines? Or are you raising price more in the lower quality line that you're trying to shift customers away from to sort of -- I mean, like how are you handling...

Shane Fleming

That's a good question. I would I think put it in kind of 3 buckets. For our specialty products, and that would include a lot of -- most of our IPS portfolio, most of CEM, certainly, the specialty portions of our coatings portfolio, our expectations are we increase price to the point that we maintain our contribution margin ratio. So we're looking to more than just cover the raw material cost increase. We don't want to see margin dilution because we've added price to cover cost. For a majority of the more commoditized products within, say, the coatings portfolio, while we're not trying to bottom slice, we’ll at minimum try and match run to cost increase, so we don't lose any contribution margin on a unit basis. And then the third category, our products where we are looking to rationalize and we typically use price as the tool to drive that rationalization rather than just walking away from business. We'll price it to a point that our customers will switch. And if we hold onto it at a price that's acceptable, that's fine. If we lose it, then we lose it. And I think as you may have noted in your write-up this morning, somebody picked it up. There was probably an element of that in our volume reduction in the second quarter as well, where we pushed price pretty hard on some of the commodity areas and saw a little bit of share loss.

Laurence Alexander - Jefferies & Company, Inc.

And then lastly just very quickly. When you look out at your OEM customers, have they said anything yet about some European shutdowns, how they're going to compare with last year?

Shane Fleming

Yes, we haven't, and that's a question I've been asking our team. At this point in time, we're planning for, and our guidance reflects, sort of typical shutdowns. I suspect that we may see a little bit more favorable terms, if you will, on the shutdowns in Germany with this strong export they're seeing. But that's a relatively small piece of the total market when you look at the number of BMWs and Mercedes that get produced. I think the bigger producers are probably well -- anyway, we're planning right now for the bigger producers to run at the sort of typical seasonality levels.

Operator

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

P.J. Juvekar - Citigroup Inc

So quickly in carbon fiber. How long do these investments in qualification processes are likely to go on? Do you think they'll be done by end of the year?

Shane Fleming

They're for the most part done now. We had anticipated that -- the plant investments have been done for some time. The actual mechanical construction has been complete for some time. Our China plant mechanical construction was actually finished, I think, late 2010, early 2011. But once you get the work done, you then have to produce large quantities of material. Our customers have to take those materials, they have to make sure that we're providing the level of consistency. We have the quality systems in place. The performance is okay, et cetera. So we work with customers on programs to actually get the plants qualified so we can move that volume over. That's actually the delay. It wasn't the mechanical completion of the projects. It was getting the qualification work done. And I don't think we have 100% of the qualifications at this point. But we've got the majority of the qualifications that have really all come in the last several weeks. So we feel like we're in a pretty good shape now for the second half of the year. That's specific to the new line at our plant in Germany and the new plant we have in China.

P.J. Juvekar - Citigroup Inc

Okay. And then you talked in your press release, you talked about inventories going up due to weak demand. And you talked about destocking on the call. Not too many companies that are seeing industrial market slowdown, at least so far. So I'm wondering if this issue that you're having, is that in the 70% of the coatings portfolio that is more commodity oriented?

Shane Fleming

Well, it's definitely more pronounced in the commodity area. As I said, on the waterborne side, we actually grew volume. So we didn't see as much destocking there. So the 2 areas where we saw the largest volume drop were our solvent-borne materials and our Radcure monomers. How much of that was demand destruction? How much of that was inventory reduction? It's always a little bit of a difficult question to answer. But as I mentioned earlier, just based on the buying patterns and the slowdown we saw in the second half of June, I suspect a fair bit of it was inventory reduction. And I think a lot of the inventory reduction was really related more to opportunistic buying. Again, we saw the biggest slowdown in Asia and that's where you typically see the most opportunistic buying. We're looking at all-time high propylene cost, all-time high acrylic and acrylic derivative cost. I think our customers, where they can, are trying to wait and purchase once the corner has been turned. And we see that now with propylene but it hasn't made its way back through the rest of the value chain. So I think that's driving the destocking activity as much as anything else, less just the overall reduction in industrial demand.

P.J. Juvekar - Citigroup Inc

And lastly, with acrylonitrile prices going up with propylene, how much pricing power do you think you have in carbon fiber business?

Shane Fleming

Yes, we really don't price our carbon fiber based on raw material inputs, and most of our pricing is long-term contract rather than spot pricing. So and probably another important point is acrylonitrile, while an important raw material, is not a key cost component in the production of carbon fiber. So we really price carbon fiber based on the value that we can get from the products that we produce from carbon fiber, which are the composite materials. We don't sell a lot of carbon fiber as a standalone material, unlike some of our competitors.

Operator

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

Robert Koort - Goldman Sachs Group Inc.

Shane, could you help us a little bit on the Coating Resins business? I think you mentioned maybe you could try and optimize some of the product slate there. So that $1.5 billion, $1.6 billion of revenue, can you give us some idea of the variation in margin throughout that product line? Or are 1/2 the products north of 5%, north of 6%? Is it -- do you have one big heavy tail that you have to chop off? Or how do you sort of see the variation in variability in margin there?

Shane Fleming

All right. Well, I guess the first part of the answer is it's quite significant between product lines. And the 2 specialty pieces, the waterborne resins, which is part of our liquid coating resins, and the oligomers portion of our Radcure are typically low double-digit operating profit segments. The other pieces are quite dependent and highly volatile based on what's going on with raw materials and our ability to cover, but they’re going to be low single-digit type earners. And it's going to change a little bit depending on whether you’re talking about aminos or solvent-borne or Radcure monomers, et cetera. But they're all going to be probably less than 6%, and some get closer to 0, depending on where we're at with raw material costs and our ability to hold price. Now just to give you an idea on split, the specialty portion of that portfolio was about 30%, and the commodity piece is about 70%.

Robert Koort - Goldman Sachs Group Inc.

And are the -- does the integration of operations across those product lines make it difficult to more plant closures or separate some plants and optimize? It seems like you've gone through that process. So is there anything left to do there? Is there too much integration for what's left?

Shane Fleming

It's a good question, and that's exactly what we're tackling now in this project I referenced earlier looking at optimizing mix. So where we've had isolated standalone plants that produce commodity materials, whether that be monomers for our RADCURE business or solvent-borne products, we have for the most part, shut those sites down. As you know, we've gone through a number of site shutdowns over the last several years. And kind of where possible have taken out plants that were dedicated to particularly low margin commodity type products. The hardest piece for us to tackle and the piece we are tackling right now is liquid coating resins, and that's because our waterborne and our solvent-borne products share the same reactors and the same raw materials. So if we were just to shut down or walk away from a lot of that solvent-borne business, we're not able to jettison enough fixed cost to offset the loss in margin, contribution margin. So what we're trying to do, and while this is a complex process, I'm confident we're going to make progress here, is look at the product lines, look at things like cycle time in our plants; make good, informed decisions about where we can exit. And then use the spare capacity either to make other higher margin products or simply exit that and walk away from cost. And that's a process that we’re going through. As I sort of indicated in my response to somebody's question, may have been Laurence's question, about our expected cost savings from this type of activity, I said $20 million. About $10 million of that was from headcount reduction that we've announced in the second quarter. Another $10 million of that is coming from that activity that I just described.

Robert Koort - Goldman Sachs Group Inc.

Shane, it would strike me that this is a pickle that you're not alone in dealing with. So are there not some opportunities to consolidate with somebody else that's got the same sort of miseries and then maybe you can optimize from a combined asset base?

Shane Fleming

I mean, there are some companies out there with similar portfolios. The folks that have had pure plays with solvent-borne as an example have done to a large degree what we have and that's exited capacity. So I think that's limited a little bit kind of the degree of the freedom that we have. Bob, where there are opportunities to look at tolling, either for somebody or having somebody toll for us and taking out assets, we're absolutely open-minded to do that. We just haven't uncovered anything recently that looks all that exciting.

Robert Koort - Goldman Sachs Group Inc.

All right. And can you give us any more granular flavor on what you’re sold out of in additives? [indiscernible]

Shane Fleming

Yes, a couple of product lines. Particularly for Polymer Additives, it's our HALS-based materials so UV absorbers. There are a couple of different product families that are based on that HALS chemistry, but hindered amine light stabilizers is a general class of products, and that's an important product class for us. And then, again, we do make other products from those HALS. One of our more important product lines, it's what we call THT, a patented material and that relies on HALS. And then on the Specialty Additives side, we make an acrylic monomer stabilizer that's used in the production of acrylic acid, phenothiazine, PTZ, and that product line has been full for some time. And we've had a capacity project now recently get approved, and we're starting the work to add that capacity as well. So those are probably the 2 areas where you'll see the most relief as we go into 2012.

Operator

Your next question comes from the line of Peter Grondin with Surveyor Capital.

Peter Grondin - OSS Capital

Shane, I just want to go through a second, the guidance for the Engineered Materials and specifically try to focus on the margin potential here. If I look at your sort of implied guidance midpoint, you're saying roughly you guys are going to do $890 million for the year in Engineered Materials and do $130 million in operating income. I'm just taking the midpoint of the 2 ranges.

Shane Fleming

Yes, you got it.

Peter Grondin - OSS Capital

Okay, so if I back out what you did the first 6 months and throw that away, you're basically implying, call it, roughly $450 million to $452 million for the second half in top line and Engineered Materials and about $70 million -- $73 million, $75 million, operating income. You just kind of back that out? So presumably, and you said in prior calls, I think you said, look guys, after the first quarter call, where you sort of stumbled, you said, look, our expectation is margins are going to increase sequentially throughout the year in this segment. So I'm throwing a lot of numbers here at you, but if I take margin on kind of the $452 million on the $73-plus million, you're like 16.2% for the second half of the year. And if I assume that what you said before is correct, where you kind of can see the sequential growth in margins, is it unfair for me to think that your fourth quarter exit rate margin in this segment could be 16.5%, 16.7% or something like that?

Shane Fleming

Yes, I don't -- I haven't -- I did exactly the analysis you've done. Obviously, looking at first half, second half and your numbers are right in line with mine. So our expectation second half margins are just over 16%. I'm not sure how it would break up Q3 versus Q4. I suspect that Q4, the way it played out, will be a little bit stronger. But we should see a fairly significant impact moving from Q2 to Q3 because we had these one-time costs in Q2 that won't reoccur. And we also have -- and this is maybe more to your point, whenever you put in pricing increases, it takes some time to get those ramped up and get full year effect. So we're continuing to push price. We'll see price impact stronger in Q4 than in Q3. So that's going to lead to expanded Q4 margins. But maybe to take advantage of your question, just to add one other thing, we're expecting that sequential margin improvement to continue into 2012 as well.

Peter Grondin - OSS Capital

[indiscernible]

Shane Fleming

Yes, okay, I thought that might be where you are going, but I mean we're looking at least for another 1% over that second half run rate in 2012.

Peter Grondin - OSS Capital

Which is -- I mean so, I could -- let's say I'm right. I mean, I could paint a picture of your second quarter next year. I mean it could be very significant, the margins.

Shane Fleming

I mean, again, I think next year you did the same math I did, just over 16% of the second half of this year. I would expect us to get close to 17% in 2012. We haven't developed a business plan yet, but everything that I see in looking at the business says that we should be able to get there. We're certainly not going to have any issues with demand given our order book today.

Operator

You have a follow-up question from the line of John McNulty with Crédit Suisse.

John McNulty - Crédit Suisse AG

Just one quick follow-up on the $20 million of potential savings that you see in the resin coatings business that, I think you had indicated it was next year versus this year. Is that right? And are there any puts or takes against that? Or should we -- all else being equal, volumes basically flat and raw materials kind of flat year-over-year, we should be seeing a $90 million to $100 million number out of the Coating Resins business next year?

Shane Fleming

The only caveat, John, is that half of that $10 million, we're going to get a quite a large chunk of that in 2011. The restructuring piece is for the most complete. So we're going to get say $5 million of that $10 million impact in the second half of this year. So from an additive standpoint, you're only getting an additional $5 million there. The $10 million that I talked about from the plant optimization, product rationalization, that's really going to be more weighted into 2012.

John McNulty - Crédit Suisse AG

So year-over-year, $15 million is kind of a more reasonable number.

Shane Fleming

Yes, I think you're probably looking at more like $15 million year-over-year exactly.

Operator

There are no further questions at this time. Speakers, would you like to make any closing remarks?

Jodi Allen

Yes. Thank you, everyone, for your participation in the call today. And if you have further follow-up questions, you can contact me directly at (973) 357-3283. Thank you, and have a nice day.

Operator

Thank you. This does conclude today's conference call. You may now disconnect.

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