The Lubrizol Corp. Q4 2007 Earnings Call Transcript

Feb. 8.08 | About: Berkshire Hathaway (BRK.A)

Lubrizol Corporation (LZ) Q4 FY07 Earnings Call February 8, 2008 ET

Executives

Mark Sutherland - Director, IR

James L. Hambrick - Chairman, President and CEO

Charlie Cooley - Sr. VP, Treasurer and CFO

Analysts

David Begleiter - Deutsche Bank

Jeff Zekauskas - J.P. Morgan

Laurence Alexander - Jefferies

Rosemarie Morbelli - Ingalls & Snyder

Saul Ludwig - Key Banc Capital Markets

Robert Felice - Gabelli

Richard O'Reilly - Standard & Poor's

Operator

Welcome to the fourth quarter earnings conference call. [Operator Instruction] As a remainder, this conference is being recorded. I would now like to turn the conference over to our host Mr. Mark Sutherland. Please go ahead.

Mark Sutherland - Director, Investor Relations

Thank you Stacy and thank you all who have dialed-in for joining us today, February 8, 2008 for discussion of our fourth quarter 2007 results, which we release this morning. This call is being webcast by ccbn.com and will be available for replay beginning about 6.00 PM Eastern Time today and continuing for the next 30 days. Our Internet site www.lubrizol.com has several supporting documents for this call at the Investor Relations earnings release page. You can access the presentation entitled earnings teleconference February 8, 2008 and you can follow along with today's teleconference. From this site, you can also access the replay and a written transcript of this call. Also on our site, you will find reconciliations to GAAP financials.

Our prepared remarks today include references to non-GAAP financials in our discussions of earnings, EBIT, and outlook. We want to remind everyone that this webcast contains time sensitive information that is accurate only as of today. Any redistribution, retransmission, or reproduction of this call without written company consent is prohibited. Participating on the call with me today are James L. Hambrick, Chairman, President and Chief Executive Officer; Charlie Cooley, Senior Vice President, Treasurer and Chief Financial Officer; Greg Taylor, Vice President for Planning, Development and Communications, and Scott Emerick, our Controller.

James will open today's call with some brief comments on the quarter and how we see performance going forward. Charlie Cooley will discuss the quarter's results and our outlook for 2008. We will then open the lines for questions and discussions. I need to remind you that some of the information to be furnished in today's session will constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are those focused on future plans, objectives, or performance as opposed to historical items. We remind you that actual results could differ materially from results projected or referenced in these forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements in this teleconference are contained in the risk factors section and the forward-looking statements section of Lubrizol's most recent filings with the Securities and Exchange Commission.

So with that preamble I'd like to now to turn things over to James Hambrick.

James L. Hambrick - Chairman, President and Chief Executive Officer

Thank you Mark. Good morning everyone. I really appreciate you joining us. I'm going to make my opening comments fairly brief, mostly letting the numbers and Charlie speak for the themselves. I would like to summarize 2007 performance specially as it relates to the positions of our product lines, I have a couple of points I'd like to make about the quarter and then offer a short description of how I see 2008 shaping up.

In terms of 2007, we opened and closed the year with really strong performance. We covered an awful lot of ground and faced our fair share of challenges in between. We continue to build a new company. We made good progress there. We established record financial results for the year, $4.5 billion in revenue, EPS of $1.05 …. $4.05 and $476 million in operating cash flow.

Lubrizol Additives, 2007 performance was near outstanding, really led by a strong growth in engine additives and industrial specialties. That success was largely based on delivering distinctive technologies and services that make our customers more successful and our customers were very successful last year. And it has made good progress in recovering lost material margin and made important progress in improving return on capital. We are not quite where we need to be there yet, but we will get there. Despite all of our prior work, today higher operating and raw material cost continue pressuring our profitability and our returns. Our fourth quarter 2007 price increased focused primarily on operating expenses since then raw materials increased again and both operating and capital cost continue to rise on labor equipment and material cost increases.

Our 2008 business plans just simply do not call for starting the year off by falling further behind. So there is more work to be done here. Advanced materials had a very challenging year and of course we're all disappointed by the poor overall financial performance of this segment. I'll make no excuses, but I will say that we definitely accomplished a lot more than the numbers suggest. And because of that, I am confident we'll do much better in 2008. We've been doing significant enterprise building work in this segment adding necessary manufacturing and ERP capacity and also the STAR expense necessary to use that capacity to drive organic growth in attractive sectors of these large performance chemistry markets.

Consumer specialties continued to perform very well using its strong product line positions to continue revenue and earnings growth through innovation, through geographic expansion, and operating efficiency improvements, really just textbook performance in consumer specialties. Engineered Materials lost some ground on margin but worked hard, and started turning that around in the third quarter. Unfortunately, TempRite residential plumbing volume weakened with North American housing in the second half of the year. We do have very good strategies in place and positions to grow these product lines. I expect about a 10% improvement in operating income in 2008 in the Engineered Materials.

Performance Coatings performed very poorly on significant margin and volume weakness in resins and polymers that was primarily driven by North American declines in textiles and housings. Housing will of course return but not industrial textiles. That’s moved offshore and that's the basis for our new textiles coating plant in Shanghai scheduled for start up late this year.

I’m confident our ongoing customer focus and product positioning work will significantly improve our results. We are taking the appropriate commercial and operational actions that are needed. Our plan is for approximately a 15% operating income improvement in 2008. We know exactly how to do this kind of work. We have done it before, just keep executing with customers and products and making significant operating efficiency improvements just like we did in engine additives.

Before I turn the mike over to Charlie I would like to say that I am really pleased with our overall progress in 2007. Of course I know that there is a lot more yet to be done really across all our businesses. We know we have to continue to execute to deliver our basic strategy of organic growth through innovation, geographic expansion, operating efficiency improvements, and targeted acquisitions. We concluded the year with good momentum. We are off to a good start in January and February on volume, but again I reference margin pressures and we will have to continue to manage that very well across all of our product lines. Not easy work, but it can be done.

Bottom line I project 2008 to be another year of solid growth out fifth consecutive year and in my opinion that fifth year is very important; it’s a milestone for us and demonstrating our ability to continue to grow and progress the enterprise and I am absolutely committed to make that happen so is the rest of the team. Charlie?

Charles P. Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Thank you, James. Good morning, everyone. I will start my comments on the quarter with a few headlines followed by more detailed discussion. Earnings this quarter reflected continued exceptionally strong performance in the Lubrizol Additives segment but disappointing performance, as James said, in the Lubrizol Advanced Material segment, especially in North America. Both segments saw continued strong topline growth in our international markets. The quarter also was marked by price increase activity in a number of our businesses, as well as some promising new product introductions. The net result was a fourth quarter with excellent overall operating performance concluding a record year for revenues, earnings, and operating cash flow.

In discussing results for the quarter remember that references to 2006 will be on a continuing operations basis and will exclude the impact of our 2006 divestures. As a reminder all references to earnings per share will be on a diluted basis. If you are following along with the PowerPoint presentation on our websites’ Investor earnings release page, I am now on page five where you can see the consolidated earnings for the fourth quarter of 2007 compared with the year-ago period.

This morning we announced that consolidated earnings for the fourth quarter of 2007 were $59.7 million or $0.86 per share including impairment charges of $0.01 per share related to an impairment of a coatings production line. Consolidated earnings from continuing operations for the fourth quarter of 2006 were $21.4 million or $0.31 per share and included restructuring and impairment charges of $0.41 per share which were primarily related to the impairment of the Noveon trade name announced on January 17, 2007.

When we exclude the restructuring and impairment charges in both years, adjusted earnings from continuing operations of $0.87 per share for the quarter were 21% higher than the fourth quarter of 2006. The primary drivers of consolidated earnings growth were an improvement in the combination of price and product mix, increased volume, reduced net interest expense, and a lower effective tax rate. These positive factors to earnings more than offset the impact of higher raw material and manufacturing costs and higher selling, testing, administrative and research or STAR expenses.

In addition, other income in 2006 benefited from favorable legal settlements of approximately $6 million and there was no significant similar benefit in 2007. Slide 6 compares the adjusted earnings from continuing operations for the fourth quarters of 2007 and 2006. We've noticed some of the special factors that influenced our results for the quarter.

First, currency favorably impacted the quarter by $0.06 per share based on our pro forma calculation that compares actual result to pro forma results translated at the prior periods exchange rates. Second, a lower effective tax rate and earnings from continuing operations as adjusted in the quarter contributed approximately $0.03 per share when compared with the effective tax rate in the fourth quarter of 2006. And I am going to spend a little more time on taxes a little bit later in my discussion.

Finally, as I noted a moment ago, we saw a benefit in the fourth quarter of 2006 from legal settlements of approximately $0.06 per share whereas in the fourth quarter of '07, we had similar settlements totaling only $0.01 per share.

Consolidated revenues increased 16% from the fourth quarter of 2006 to $1.15 billion. Volume increased 9% from the year ago period and improvement in the price… and combination of price and product mix increased revenues by 4% and currency was 3% favorable to revenues in the quarter. Gross profit rose 15% as the higher revenues more than offset higher raw material and manufacturing costs compared with the fourth quarter of '06.

Gross profit margin percentage declined 30 basis points from the year ago quarter and was down 90 basis points sequentially from the third quarter largely reflecting renewed raw material cost pressures and higher manufacturing costs. STAR expenses increased 11% from the fourth quarter of 2006. Research and testing expense of $57 million in the quarter increased 9% largely due in equal measure to unfavorable currency, and increased costs for salaries and benefits.

Selling and administrative expenses of $113 million were up 12%. Approximately one half of the increase relates to higher personnel costs, including growth resources in the Advanced Materials segment, while approximately one-third of the increase is related to unfavorable currency. The reminder of the increase relates to project costs associated with our implementation of SAP in the Advanced Materials segment.

Adjusted EBIT, which excludes restructuring and impairment charges rose 9% in the quarter to $93.4 million. Net interest expense was 19% lower than the year ago quarter, primarily reflecting our reduced debt balances due to the full repayment of our euro revolver and lower variable interest rates.

Turning to taxes, earnings from continuing operations as adjusted for restructuring and impairment charges were taxed at an effective rate of 23.6% in the quarter as compared with 26.6% in last year's fourth quarter. This lower rate accounts for the $0.03 per share impact that I mentioned earlier and was driven mainly by lower U.S. tax costs associated with our foreign subsidiaries earnings.

Our public reporting for the fourth quarter of 2006 showed a much lower rate, 3.6% because of the impact of restructuring and impairment charges, particularly the write-down of the Noveon trade name. The effective tax rate on continuing operations as adjusted for restructuring and impairment charges for the full-year of 2007 was 29% as compared with the 2006 rate of 32.3%. The reduced effective tax rate for '07 resulted primarily from the favorable resolution of tax matters from prior years, and improvement in our geographic earnings mix as a result of our strong international growth and an increase in non-taxable foreign currency translation gains.

And now, I'll turn to segment results and for all of you following the PowerPoint presentation I'm on slide 8. Revenues for the Lubrizol Additive segment in the quarter were up 21% year-over-year, including a 33% increase in Asia-Pacific, and a 27% increase in Latin America. Volume was very strong for a fourth quarter up 13%. The quarter also benefited from a favorable comparison with the fourth quarter of 2006, which was impacted negatively by some inventory de-stocking especially in Asia-Pacific.

The combination of price and product mix improved revenues 4% and currency contributed 4% as well. Volume growth in Lubrizol Additives was particularly strong with our major regional and national customers in Europe, Asia Pacific and Latin America due to strong market demand, share gains by our customers, as well as new business gains. We attribute the success to our customer service and technology, especially our recently introduced heavy-duty diesel engine oil additive packages, which are part of the solution for reducing diesel engine emissions.

Looking at segment volume growth by region. Volume in North America was up 6%, versus last year's fourth quarter primarily due to gains in engine oil additives and specialty industry additives. Volume in Europe was up 12% with strong demand in all of our product lines. The Asia-Pacific region saw significant volume growth of 23%, largely due to new business gains, as well as changes in order pattern. These gains also were broadly based across the product lines. The fourth quarter last year was weaker than normal due to customer inventory de-stocking. And volume in Latin America increased 22% as we experienced new business gains, principally in engine additives.

You may recall that Lubrizol Additives announced a round of global price increases effective December 1st. As anticipated, these increases did not impact fourth quarter results appreciably and will be implemented fully in the first quarter.

We continue to face cost pressures in the additives segment. In addition to continued upward pressure on raw materials, our operating expenses increased 16% in the fourth quarter of '07 compared with the year-ago quarter. Excluding the impacts of higher volume, currency, and acquisitions, operating expenses were up 9%. This increase largely was driven by higher manufacturing costs, notably for contract labor and maintenance in the U.S. Gulf Coast and in Europe. These factors were part of the justification for the December price increase.

Segment operating income in the quarter increased 24%. The earnings performance reflected strong volume growth and improved price mix despite the raw material and operating cost pressures. The two acquisitions made during 2007 were not a significant factor to segment earnings.

Turning now to the Lubrizol Advanced Materials segment on slide 9. Fourth quarter revenues were up 8% over last year. The increase reflected a 3% favorable impact from the combination of price and product mix, a 3% favorable currency impact, and a 2% increase in volume. Our Noveon Consumer Specialties and our Engineered Polymers product lines, both had increases in revenues of over 10%, while revenues in our Performance Coatings product line essentially were flat.

All product lines in the segment experienced double-digit revenue growth in Asia Pacific, strong North American and European revenues for Noveon Consumer Specialties and Engineered Polymers were offset by lower revenues for the Performance Coatings product line in North America.

I'll now go into the Advanced Materials product lines in a little more detail. The Noveon Consumer Specialties product line had revenues of $104 million, up 12% from the fourth quarter of 2006. Volume grew 18% in Asia Pacific, 12% in North America, 7% in Latin America, but declined 13% in Europe. The decline in Europe resulted from some supply issues in our specialty monomers business. Volume for Carbopol powdered thickeners for home and personal care product application increased 11% and our new Liquid Carbopol product volumes continued their excellent performance with an increase of 18%.

Revenues in the Performance Coatings product line were $129 million in the quarter, which was leveled with the fourth quarter of 2006. This product line continues to be impacted by the weakness in the North American textiles and coatings industries that we've discussed in previous teleconferences.

Volume in Europe also was down compared with the fourth quarter of 2006 due to weaker resins and polymers demand. We have been working to improve the profitability of this product line and hope to announce some actions around the end of the first quarter. The Engineered Polymers product line consisting of TempRite and Estane engineered polymers reported revenues of $146 million in the quarter, up 13% form the fourth quarter of 2006.

Estane products experienced double-digit revenue growth in all regions. We saw a rebound in North American film and sheet applications due to strong orders with our major customers, and we saw continued growth in our paint protection films, geophysical, and wire and cable applications. The quarter also benefited from pricing initiatives that we undertook at the end of the third quarter and beginning of the fourth.

Global volume for TempRite products increased 12% in the fourth quarter compared with the year ago period. International volumes grew 19%, thanks to strong demand in all international regions. North American volume grew 6% as increases in our commercial plumbing and fire sprinkler applications were only partially offset by the impact of weaker plumbing volumes that were attributable to slower residential construction. Performance in North America also was impacted by some competitive price pressures. We continue to be encouraged by the product demand in overseas markets, as well as for new applications such as North American commercial building water distribution. In these applications, current CPVC market penetration is low so there is greater upside potential. Despite the good topline growth, Advanced Materials segment operating income in the quarter decreased 31% from the fourth quarter of 2006.

Strong performance in consumer specialties and Estane products was more than offset by weaker performance in coatings and TempRite products. Segment STAR and manufacturing expenses have increased primarily due to the addition of growth resources, the impact of currency, increased compensation and benefits expense, and cost associated with the SAP implementation. We did see the impacts in the quarter of price increases in all of our product lines. Additional price increases are now being implemented and we'll look for opportunities for further price increases during the year as warranted.

I'll conclude my remarks on segment results with a quick comment on slide 10, regarding corporate expenses, which were $16 million in the fourth quarter. This 8% decrease in corporate expense is mainly was attributable to the reduced costs associated with the mark-to-market accounting of our international stock- based compensation program.

Turning to cash flow. We generated a record $476 million in cash flow from operations for the full-year of 2007 compared with $335 million in 2006. This improvement was attributable to record earnings and excellent working capital management. As a whole we managed our working capital very well throughout 2007. Days sales in receivables improved 1.5 days from the 2006 average and days sales in inventory improved more than 4 days.

Regarding our uses of cash. Capital expenditures for the full year were $183 million, which was slightly above our projected capital spending for 2007. We spend $140 million on acquisitions in 2007 with approximately $125 million for the purchase of Croda's refrigeration lubricants business, which closed in November.

Debt reduction for the year totaled $113 million and was largely comprised of the full repayment of our euro credit facility, which we competed in the third quarter. Last April we announced the expansion of our share repurchase program to buy back up to $300 million of common shares through 2009.

During the quarter, we repurchased 290,000 common shares for $18 million. So for the full-year of 2007, we purchased approximately 1.7 million common shares for $100 million. Also last April we announced a 15% increase in our dividend and we paid $80 million in dividends in 2007. As a result of these activities our cash balance at the end of the fourth quarter was $502 million, compared with $576 million at December 31, 2006. We currently expect to use some of this cash to retire the $200 million in notes outstanding, which mature in December of 2008. For the four quarters ending December 31, 2007, return on invested capital was 11.8%, compared with 9.3% for the fourth quarters ending December 31, 2006.

Now I'll turn to our outlook on slides 11 and 12. In 2008, we expect the continuation of essentially the same economic fundamentals that we saw in 2007 in the broad array of end-use markets that we serve. As James mentioned our volumes for the first two months so far bear this expectation out. On this basis our earnings guidance is $4.15 to $4.40 per share. For the Lubrizol Additives we forecast overall demand consistent with a 0 to 1% long-term growth rate of the industry. We expect Asia-Pacific and Latin America to be the primary markets for growth and we also will see the full year impact of the Refrigeration Lubricants acquisition.

We’re modeling steadily improving material margins on Lubrizol Additives during the year as our pricing actions recover increases in raw material costs. And finally we are modeling slightly higher EBIT margins than we saw in 2007. For Lubrizol Advanced Materials we project overall volume growth of approximately 5% right in line with our long-term growth target of 5% to 6% annual growth. Similar to the Additives segment our outlook is for continued growth in the Asia-Pacific and Latin America to more than offset slower market growth in the U.S. We are modeling solid earnings growth in all of the product lines but this will be dampened somewhat by higher systems related expenses. Even with the higher systems costs we project mid-to-high single digit operating earnings growth in the Advanced Materials segment in 2008.

For corporate expenses, we are modeling approximately 2% growth compared with 2007. On a consolidated basis the highlights of our guidance is revenue growth of approximately 9%, compared with 2007 and consolidated EBIT growth of almost 11%. We are modeling raw material cost to increase through mid-year and then stabilize in the second half. We are modeling STAR expenses to be slightly less than 14% of revenues, which is down from 14.2% in 2007. Depreciation is modeled at $144 million and amortization at $26 million.

On a consolidated basis we believe full year operating income, as a percent of revenues will improve year-over-year consistent with the strong EBIT growth rate that I noted earlier. We’re modeling net interest expense to be approximately $72 million. This assumption reflects lower cash balances due to our recent acquisition plus our projected uses of cash during the year together with lower interest rates, which are driving lower interest income. Our tax rate assumption for 2008 is 32.5% and we’re modeling the Euro to average $1.45 for the year.

Finally and this is important to note our outlook for earnings per share in 2008 is for a 51-49 pattern between the first and second halves of the year. Because we had unusually strong EPS performance in the first half of 2007 we expect a tough comparison in the first half but quite favorable second half comparison. I will note a few factors that would enable us to hit the upper end of our range; better margin recovery due to pricing actions, higher volume growth especially in Consumer Specialties and Engineered Polymers, lower operating expenses, and a lower effective tax rate. We don't have any acquisitions modeled in our guidance.

The main elements of our cash flow outlook are shown in slide 13 and are these capital spending is projected to be between $215 million and $225 million that’s higher level of spending compared with 2007 is driven by production capacity expansion for our Advanced Materials product lines in China, North America, and Europe and by spending on the SAP project. We plan to retire the $200 million of notes due in December. We are assuming a pretty meaningful build in Lubricant Additives and inventory due both to higher material costs as well as plans to maintain security of supply to our customers. We forecast making a $30 million contribution to our qualified pension plans. We’re modeling no change for dividend rate, and finally unless circumstances change we target repurchasing approximately $100 of our shares in 2008.

I would like to conclude by saying that we are obviously very pleased with our overall performance in 2007 and feel that we are well positioned for continued success as we enter what we project to be a fifth consecutive year of solid earnings growth in 2008.

Stacy?

Question and Answer

Operator

Thank you. [Operator Instructions] Our first question comes from the line of David Begleiter with Deutsche Bank. Please go ahead.

David Begleiter - Deutsche Bank

Good morning.

James L. Hambrick - Chairman, President and Chief Executive Officer

Hi David.

Charlie Cooley -

Senior Vice President, Treasurer and Chief Financial Officer

Hi David.

David Begleiter - Deutsche Bank

James, can you give us a little more detail on the profit declines in TempRite and in coatings, and how you see those profit improvements occurring through 2008?

James L. Hambrick - Chairman, President and Chief Executive Officer

Well, okay, if you want to disaggregate it we can certainly do that. I think, to really give you the clarity that you want, we probably have to go into some of the numbers disaggregated. Did, Charlie….

Charlie Cooley -

Senior Vice President, Treasurer and Chief Financial Officer

I can give a little bit of detail, David and then James, you can pick up from there. And this was actually a tailing off, David, in the November, December timeframe that we did not anticipate at the time of our October teleconference. So TempRite, the weakness was primarily North American plumbing consistent with the continued decline in housing starts and on that I simply note that for the year, our North American plumbing volumes were essentially flat compared to as you all know what housing did. In coatings, I would say it's more of just a North American story. It is not simply tied to textiles. Pretty much all of our coatings product areas had weakness in the fourth quarter particularly as the year came to an end in North America.

James L. Hambrick - Chairman, President and Chief Executive Officer

David TempRite margins were also under a bit of pressure. It's not easy to recover raw material cost increases in an environment where volume is dropping and demand is declining. So, that's a hurdle that, I think, we are over now and certainly in a better position in terms of '08. The Estane product line really is working hard at establishing a position in Asia and so it’s had to build out, it’s taken on some extra expenses, it’s tended to take a position there effectively secure a share spot. We have done that now. We’ve gotten line 1 fully utilized. We've got a second line coming on line. So, I feel pretty good about the Engineered Materials.

Coatings, here is the way I look at coatings. And I'm sorry, I know that it's only question David, but the work that we are doing, the work that I am leading is not all focused on '08. First of all, the Gold is a $1 billion to $2 billion Specialty Coatings segment to our business. It's a very large market. There is a lot of innovative performance sectors out there, good opportunities for film coating technology company like Lubrizol. We have good surface modifier technology, hyper dispersions, we have water insolvent capabilities, we understand films, we understand breathability. We have urethane and acrolite technology. We have all the basic building blocks there. I'm sorry to say, it was a business that has required more and longer than I anticipated but the fundamentals are there and I do expect that '08 is the year that it will begin to turn around.

David Begleiter - Deutsche Bank

And Jim how was the [inaudible] pipeline in coatings?

James L. Hambrick - Chairman, President and Chief Executive Officer

No, David, I don't normally talk about targeting… my public comments on acquisitions I don't normally talk about individual sectors and our activities there but here's what I will say. First of all, I've said that there is no sector of the company where we are not interested in making acquisitions. Having said that and we… of course there is a variety of sizes as well. Having said that, if there are good opportunities in coatings and there are a few from an acquisition point of view, we clearly will look at that but our primary objective is to stay focused on self-improvement.

David Begleiter - Deutsche Bank

Thank you very much.

James L. Hambrick - Chairman, President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Jeff Zekauskas with J.P. Morgan. Please go ahead.

Jeff Zekauskas - J.P. Morgan

Hi, good morning.

James L. Hambrick - Chairman, President and Chief Executive Officer

Hi Jeff.

Jeff Zekauskas - J.P. Morgan

Can you remind me as to what your volume growth was for Lubricant Additives for the year?

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Excluding the effects of acquisitions was up 4%.

Jeff Zekauskas - J.P. Morgan

So normally what you say is that the industry grows at 0% to 1% and your numbers are much higher than that. So, should we attribute that to market share gains or the market in '07 grew faster than you thought and why wouldn't we see some kind of volume retrenchment in the first or second quarters after you have had such strong volume growth?

James L. Hambrick - Chairman, President and Chief Executive Officer

First of all, I would say that, Jeff, when I think about the Lubricant Additives business it really doesn't follow the general economic cycle in terms of volumes. I mean there is some but largely it does… it is operating at a somewhat higher rate than it was at a higher level. But I don't see that falling back nor do I see it continuing to grow. It’s just kind of bumped up a little bit in '07. But if you were to look at it over, say a five, six, seven, eight projected time frame, it's really in that kind of 1%, 2% area. So, I don't really see a fundamental change in the business. We are growing internationally. Our customers are being very successful. I made comments about that in our... in my opening comments. We invest a lot of money in technology to build differentiation in value for our customers and they are being more successful and so all of that flows through.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

And I'd just add one more detail to that and that’s… it was a tale of two fourth quarters. The fourth quarter of '06, we saw a fairly significant inventory de-stocking whereas we had our strongest fourth quarter ever in 2007. In fact we actually had sequential growth in volume in Q4 '07 versus Q3 '07, which I don't know that in recent memory we've seen such a strong fourth quarter. So, there is some of that going on too just a comparison to the prior year period.

Jeff Zekauskas - J.P. Morgan

I guess just two other small issues. You seemed very confident about the operating profit growth that you'll achieve in your Advanced Materials division. And the economies are slowing and certainly you've had a difficult second half. So is the enhanced confidence that you have coming from a real change in the cost structure of that business that you can see right now?

James L. Hambrick - Chairman, President and Chief Executive Officer

Actually a part of the difficulty is that segment is carrying additional cost. It's carrying the investment cost for organic growth. Charlie made reference to that a couple of times in his comments.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Yes. I could... our topline growth assumption in the model for Advanced Materials is 9% and about 5% of that growth actually comes from about equal parts, from the pricing actions that are in place right now so we've got some confidence in that plus as I'd say about equal amount also coming from new product introductions in a number of our products lines. And then we go down the various product lines within Advanced Materials I think you can get some confidence that '08 has a good chance of being another growth year.

When you look at Consumer Specialties that is a product line that has... I had a track record of consistent profitable growth throughout the cycle just given the demand drivers in the Personal Care. Likewise, Estane has demonstrated over time, excellent track record of volume growth due to just a continued introduction of new products. The TempRite is looking for slightly down, volumes in North American volume plumbing, we've built that in. But we've got continued expectations of success in fire sprinkler and in industrial products and in our international markets.

Our Performance Coatings, clearly our model has a more mixed outlook. We do project in our model continued decline in North American textiles and will see that particularly showing up, we anticipate in the first-half. So and I failed to mentioned another aspect is that the new product introductions that we've got in place should be about 40 million bucks in our outlook.

James L. Hambrick - Chairman, President and Chief Executive Officer

I've got one more. I've got to put in here. Just I have to. There was just a recent co-change for non-halogenated flame-retardants in the industrial textile areas and in household furnishings excellent technology position for the company. Unfortunately our customer base has moved to Asia and we are in the process of making that move. We started it last year; we'll finish it off this year, and should be in great shape. I mean the fundamentals are basically there. It's just a matter of really how much headwind we get but I am pretty confident.

Jeff Zekauskas - J.P. Morgan

Thank you for that and then just last lastly I know your STAR expenses were up about 11%, and you said maybe half of that had to do with currency. Are you content with that rate of absolute expansion in that expense line or are you going to try to push that down next year?

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

We're not... the cost structure is something that we're actually paying quite a bit of attention to, we always do. It is a point well taken that those are large increases. But we have a lot of things going on it right now, where we are purposefully investing in STAR. The growth resources that we continually allude to for Advanced Materials, we think are important investments particularly for international growth in those product lines and then the SAP project also in Advanced Materials is a key component.

James L. Hambrick - Chairman, President and Chief Executive Officer

Jeff I've been watching STAR not only on an absolute basis and relative to the revenue line, but I've also been monitoring relative to margin lines, and operating income line so that we make sure that for the STAR expenses that we're adding that we clearly have plans that call for return... a proper return at the operating income line for those investments and they are prudent investments.

Jeffrey Zekauskas - J.P. Morgan

Thank you very much.

Operator

And our next question comes from the line of Prashant Juvekar with Citi Investment Research. Please go ahead.

Unidentified Analyst

Hi, this is Anthony Petternies [ph] standing in for P.J.

James L. Hambrick - Chairman, President and Chief Executive Officer

Hi, Anthony.

Unidentified Analyst

I had a couple of follow-up questions on Advanced Materials. First of all in December you indicated that you were looking at lowering prices for CPVC, has that gone through and looking forward to the first half are CPVC prices, are they down, are they flat?

James L. Hambrick - Chairman, President and Chief Executive Officer

Actually they went down and they're now coming back up.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

They went down in the second quarter.

Unidentified Analyst

Would that be low-single digits or roughly...?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

We haven't characterized that.

James L. Hambrick - Chairman, President and Chief Executive Officer

You mean percentage decline that you're asking.

Unidentified Analyst

Yes.

James L. Hambrick - Chairman, President and Chief Executive Officer

Yeah, it’s James, we haven't talked about it. I mean it's only... it had a meaningful impact, a part of it was anticipating, as we mentioned this is in the last call, anticipating the coming onstream of some North American production capacity by one of our competitors. So we're a just positioning ourselves appropriately for that additional capacity.

Unidentified Analyst

Okay. And second, you talked about increasing the non-US exposure of Performance Coatings as being a priority. Can you give us a rough indication of how much of sales from coatings is coming from outside the U.S. in '07 and after Shanghai comes online, what that could be in '09?

James L. Hambrick - Chairman, President and Chief Executive Officer

Sorry, I don't have that. But we have... trust me we have some spreadsheets here.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

I don't have...we have not talked about the revenue contributions from the Zhangjiang plant. The magnitude of the sales declines in North American textiles currently is much greater than the magnitude of textile gains that we are currently enjoying in China, and those gains will certainly increase once that plant comes onstream later on this year. But we've not yet quantified any specifics about Asian exposure.

Unidentified Analyst

Okay. Can you give us a sense of how much of the coatings business is exposed to U.S. textiles right now?

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Yes. We've talked about it.

James L. Hambrick - Chairman, President and Chief Executive Officer

We have broken it down for you.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Yes. It's about, I want to say it's about... it's less than 30% of coatings revenues as opposed textiles and that includes technical textiles, which is actually pretty good business.

Unidentified Analyst

Okay.

James L. Hambrick - Chairman, President and Chief Executive Officer

And again I mentioned the new spec change in non-halogenated flame retardant. So, it's encouraging.

Unidentified Analyst

Okay. Thank you.

Operator

And we have a question from the line of Laurence Alexander with Jefferies. Please go ahead.

Laurence Alexander - Jefferies

Good morning.

James L. Hambrick - Chairman, President and Chief Executive Officer

Hello, Laurence.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Hello, Laurence.

Laurence Alexander - Jefferies

I guess first on Advanced Materials, can you give a rough breakdown of the 2007 impact of both the growth investment and the SAP investment and how you expect the comp to be in 2008?

James L. Hambrick - Chairman, President and Chief Executive Officer

I’d just assume that started to taking you down into the details.

Laurence Alexander - Jefferies

Can you just very vaguely, sort of just give a broad-brush picture?

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Well, in terms of growth investments, I am sorry. Ask that question again Laurence that you were asking about.

Laurence Alexander - Jefferies

I want to get a sense of the year-over-year, I mean you had a drag this year from both the SAP implementation and the growth investments and both of those will continue next year but will they be changing in magnitude.

James L. Hambrick - Chairman, President and Chief Executive Officer

Yes they will, yes they will.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

There is about $20 million between the two in our 2008 outlook between SAP and the total amount of growth investments that we built over last couple years, it's about $20 million of spending.

Laurence Alexander - Jefferies

So that's a $20 million swing or just $20 million spending?

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

No, it's not a swing. Certainly there is some incremental growth about $4 million or $5 million of incremental growth resources in '08 versus '07. There is probably $3, $4 million more in the IS spending.

Laurence Alexander - Jefferies

Yeah, perfect. And then in Lubricant Additives, can you give us sense for the rough magnitude of the projected inventory built?

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Yeah. Our model has about $70, $75 million of cash flow used to build working capital in '08 and that's largely focused on inventories within Lubrizol Additives.

Laurence Alexander - Jefferies

And then when you look at Lubricant Additives over the next three to five years with respect to your return on capital targets, how important is that to shift the mix towards the industrial additives or the diesel, the new diesel product, I mean how important is the mix shift going to be in terms of affecting the return on capital on that business.

James L. Hambrick - Chairman, President and Chief Executive Officer

The strategy Laurence, is to sell to the marketplace, what our customers need to be successful at a return to us that is commensurate with really reinvestment economics. And so all of those things that are related to value add technology differentiations are important in across every product line in additives from engine additives all the way through driveline.

Laurence Alexander - Jefferies

Okay. Thank you.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Thanks Laurence.

Operator

Our next question comes from the line of Rosemarie Morbelli with Ingalls & Snyder. Please go ahead.

Rosemarie Morbelli - Ingalls & Snyder

Good morning all.

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Good morning.

Rosemarie Morbelli - Ingalls & Snyder

I’m glad that this time you are not competing with another conference call. I think it is James who made the comment about looking at the economy being the same in ‘08 versus '07 in terms of what you looked at in your earnings projection, in revenue projection. However what we hear out there is the potential of a recession. So, if we do, first of all, am I correct in understanding that this is what you talked about and if there is a recession, how much lower could your expectation be or if that built in already?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

First, it is Charlie Cooley who is now speaking and who made that comment about the outlook and I think it is important as we give investors our guidance for year. It is important particularly under the current economic uncertainties that we give investors the basis on which we're constructing that guidance and the basis on which we didn't construct that guidance is for essentially the same economic conditions that we've saw towards the end of '07 to continue into '08, which included some weakness in a number of our product lines and we have talked about them specifically in North America in our coatings business and in North American housing where we are exposed.

So, our outlook does take into account those types of conditions. It's anyone's guess as to what kind of outcomes we might see if there were a severe recession, I don't know whether it's really helpful to kind of quantify what kind of downside there would be. What we do talk to investors a lot about is the generally [ph] stable demand that we see in the really the majority of our product lines. If you look at our Lubricant Additives business, one of the key demand drivers particularly in the passenger car motor oil area is maintenance and people tend to maintain and change their oil with the same amount of frequency in good times and bad because it's a pretty small investment to maintain and expenses and assets.

Moving to Personal Care, the demand drivers for the kinds of products that our products go into tend to be fairly stable through the cycle just given the nature of what we are talking about. So, I guess, I will leave it there and as we go during the course of the year, obviously, we will update folks on how things are going. James noted and as did I that the year has gone off to a solid start January and we have had a look at February projections would give us sort of added support and basing our guidance on the economic outlook that we did.

Rosemarie Morbelli - Ingalls & Snyder

And that applies…. does last comment apply to both segments?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Yes. That's right. It does apply to both segments. Although, I would say that additives were it's a lot more off to a bullish start than some of our Advanced Material product lines, but again, but it's consistent with what we saw towards the end of the year where we saw soft…. softening in North America for some of our coatings businesses likewise with the businesses that we have that are exposed to North American housing.

Rosemarie Morbelli - Ingalls & Snyder

Would you have seen since you are expecting raw material cost to increase in the first half of the year and then stabilize or go down in the second half? Could you have seen in January and February some free buying in anticipation of those price increases that would follow raw material cost increases?

James L. Hambrick - Chairman, President and Chief Executive Officer

Nothing we can tell. No, ma'am.

Rosemarie Morbelli - Ingalls & Snyder

Okay. Thank you.

Operator

And our next question comes from the line of Saul Ludwig with Key Banc. Please go ahead.

Saul Ludwig - Key Banc Capital Markets

Hi, good morning everybody.

James L. Hambrick - Chairman, President and Chief Executive Officer

Hi, Saul.

Saul Ludwig - Key Banc Capital Markets

The 13% volume growth that you had in Lub Additives in the fourth quarter, now that must have included something from Croda and how much did it in your projection of 0% to 1% for '08, does that also... does that include I don't know a couple of percent from Croda or does it excluded?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

First off our percent growth in volume in the fourth quarter about 1% of the 13% if I recall and we're checking that right now was due to Croda. We had two months of Croda in our fourth quarter results. The outlook for '08 would be the underlying volume outlook excluding Croda to be in that 0% to 1% range and then Croda would probably be about 2% on the base of our volumes.

Saul Ludwig - Key Banc Capital Markets

All right. Great. And then looking... let's say at the beginning of the year, you had talked about things are off to a very, very good start. Your price increase has in effect for the first quarter and also Charlie, I note that last year in the first quarter you Lub Additive earnings were penalized by a $11 million, as you cut inventory last year. Now you say that you're going to run things pretty fallout you're going to actually grow inventories. Wouldn't that have the effect of having a very, very significant positive swing in your operating cost because you won't have the $11 million hit from a year ago in the first quarter alone?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

The first quarter we're still going to be... we're running flat out. So the inventory build Saul that we're talking about for '08 will likely be post Q1.

Saul Ludwig - Key Banc Capital Markets

It won't have the hit?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Correct.

Saul Ludwig - Key Banc Capital Markets

I mean that's a $0.11 a share right there?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

We're going to be... we could well be... I don't have any specifics Saul to give you any kind help on this inventory push pull for the first quarter.

Saul Ludwig - Key Banc Capital Markets

Okay. Then James you had mentioned in your comments that you were looking for operating income in Engineering Polymers in 2008, to be up 10% and that in Performance Coatings you were looking for operating profits to be up 15%. How much were they down in '07 or is it...'06 was sort of a 100 but coming down that the increase that you are looking for gets you back to where you where in '06 or you still behind the curve?

James L. Hambrick - Chairman, President and Chief Executive Officer

Saul I'm sorry I'm not going to answer the question but why I included those numbers. I felt like that if I came in this morning and I said well, we had a bad year in Engineered Materials and it was even worse in Performance Coatings but trust me, we're working hard and it's going to get better. I really didn't think that, that would be sufficient and so I really felt important to take our business plan and look at it and just to get to some nice round numbers, drive a stake in the ground and say that's what we intend to do based on all the work that we have been doing. I wanted it to have some meaning, not to give you the opportunity to start picking here and there to improve your model. So I give what I wanted to accomplish. Thank you, very much.

Saul Ludwig - Key Banc Capital Markets

Okay. And Charlie, if your stock moves to dollar, what impact does that have on the stock comp expense that goes through corporate expense, because you got some help there as you said in the fourth quarter, it’s probably not the fact to help you one, but how should we... as your stock moves how should we adjust our corporate expense number based on stock price change?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Saul that's a great question. I don't... of all the things I have in my fingertips to answer that's now one of them. I'll have to follow-up with you on that.

Saul Ludwig - Key Banc Capital Markets

Okay. And then finally James, what's going with Infineum and what do you think might happen there?

James L. Hambrick - Chairman, President and Chief Executive Officer

There is a lot of movement and really across the industry not just in additives but within additives, unfortunately I can't comment on any of those we are... that is just our normal position.

Saul Ludwig - Key Banc Capital Markets

And finally, you said that you had $40 million in new product sales built into your '08 outlook, was that in the Advanced Material sector or where did you include those?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Yes, that is all Advanced Materials, incremental revenues, about half of that is in Estane, which shouldn't come as a surprise because that is a product line that is been quite innovative over the years, we've got some very interesting things. I could note one semiconductor polishing pads is a product line out of our conductive polymers unit that has good growth and actually it’s already been exceeding our expectations. In Performance Coating, James talked about non-halogenated flame-retardants, and so we've got those kinds of materials for mattress coverings and draperies, those are adding revenues in 2008.

In TempRite, we've talked in the past about new products outside of traditional piping and we are looking at incremental revenues from CPVC siding products. So those would be some examples, but the list is quite long of things that we're introducing in '08.

Saul Ludwig - Key Banc Capital Markets

And how much did you have in '07 relative to the $40 million incremental that you're looking for in '08?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Less than that.

James L. Hambrick - Chairman, President and Chief Executive Officer

Yes.

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

I don't have that number.

Saul Ludwig - Key Banc Capital Markets

Okay, great. Okay, thank you very much. Keep the good news coming.

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Great thanks Saul.

Operator

And our next question comes from the line of Robert Felice with Gabelli. Please go ahead.

Robert Felice - Gabelli

Hi, guys. Most of my questions have been answered just a couple more. I guess first on Advanced Materials, you've done a nice job passing through the various parts there during the quarter but I guess some... I am still wondering what has changed over the last couple of weeks versus your expectations. I won’t say that business was probably tracking to expectation as of early December, and I know you have said that TempRite volumes were a bit weaker and coating volumes were a bit weaker and costs were higher. But I guess what took you by surprise, James?

James L. Hambrick - Chairman, President and Chief Executive Officer

We lost a North American textile customer that we didn't anticipate when last time we updated that was a pretty significant hit. And in fact not only did plumbing decline but as we neared the end of the year, there was an inventory situation, in fact it was a pretty precipitous drop. It is come all back in January but volume in TempRite plumbing was exceptionally weak in December. Those I couldn't necessarily say that was a surprise to me, we know housing... what the housing situation is, we still have a very good value proposition relative to steel and copper but… so that kind of a timing question, those would be the two big drivers I’d point to.

Robert Felice - Gabelli

Okay that is very helpful. And then I guess James you definitely put the stake in the ground relative to your expectations for Advanced Materials next year and I guess what I am trying to get my hands around is the sensitivity or variability around those expectations. What could occur as you look out to 2008 that would cause you to come in well above or well below those expectations?

James L. Hambrick - Chairman, President and Chief Executive Officer

Well, I would say that of course there is kind of going back to the prior question in Charlie’s response, I can always counter up a gloom and doom recession that would serve as a significant tripwire from a pure operating point of view, actually I like our plans, they’re pretty solid. The fact of the matter is it's not a big stretch. We've come down enough, we are almost to the point, said pretty crudely there is no way to go but up.

Robert Felice - Gabelli

And would you say relative to raw material costs and recent pricing that you are on track to close that gap?

James L. Hambrick - Chairman, President and Chief Executive Officer

We are working very hard we are working very hard.

Robert Felice - Gabelli

Okay. And then I guess lastly, your guidance calls for much higher interest expense versus year, which is quite a bit of headwind. And then I guess that was a little surprising to me given that your payouts and debt in the year and your average debt balance would be quite a bit lower. So, maybe you could just delve into that a little bit?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Yeah, I’ll take that one, it’s Charlie. We actually noted a number of the analyst models at much lower debt interest expense for us in '08 and we are guiding. I think the single largest factor is lower cash balances perhaps folks didn't fully take into account the fourth quarter expenditures for the Refrigeration Lubricant acquisition. And then as we progress through 2008, while we…. our models should take us to generate good cash flow from operations we are also taking into account the assumptions associated with debt reduction at the end of the year and share purchases during the course of it and substantially higher capital expenditures although should be working down our cash balances during the course of the year.

And expectation of lower interest rates on our remaining cash balances will reduce the offset against our interest expense. Our interest expense, our net interest exposure was set differently. When you take into account, our cash balances were over 100% fixed rate. And so, as interest rates come down that tends to be actually… it’s a net negative, right.

Robert Felice - Gabelli

Okay, thanks. That’s very helpful, I appreciate taking my question.

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Yeah, thanks.

Operator

And we have the question from the line of Richard O'Reilly with Standard & Poor's. Please go ahead.

Richard O'Reilly - Standard & Poor's

Okay, thank you. Good afternoon gentlemen. James did you give a profit forecast for the Consumer Specialties?

James L. Hambrick - Chairman, President and Chief Executive Officer

No, I did not because I don't need to. I needed to in the other area.

Richard O'Reilly - Standard & Poor's

Okay. Because if overall for the segment if you are looking for mid-to-high single digit, it might imply consumer is flattish?

James L. Hambrick - Chairman, President and Chief Executive Officer

No, that's wrong. I work in round numbers Richard.

Richard O'Reilly - Standard & Poor's

Okay, fine.

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Now, Richard, it’s Charlie, and I won't give you the numbers, but the kind of operating income growth that we are looking forward in 2008 is the same percentage growth that we saw in 2007.

Richard O'Reilly - Standard & Poor's

Okay, good, thanks. On the full year forecast on the earnings and EBIT margin, if you use that 11% number and I know you said almost 11% in the press release, if you use 11% you get well over your upper end and even the mid point of your range implies an EBIT margin not much higher than '07 if I do the math right?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Yeah.

Richard O'Reilly - Standard & Poor's

Am I right? Was this number we are missing trying to do that calculation?

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

If I understand your question correctly when we give a range and then we give specific assumptions for our guidance whether it’s revenue growth or in this case, you ask about EBIT growth, it's really as we think about the mid point of that range. So, the reason why, EBIT growth is so much higher than EPS growth is because we have the effects not only of the higher net interest expense, but also a higher tax rate. Did I answer your question?

Richard O'Reilly - Standard & Poor's

Yes. Maybe, I'll call Mark later, trying to backup into it, I... It doesn't come out but anyway, I'll give you've Mark a call later. Thanks a lot.

Charles P. Cooley - Chief Financial Officer, Senior Vice President, Treasurer

Thanks Richard.

Operator

Mr. Sutherland, we have no further questions.

Mark Sutherland - Director, Investor Relations

Okay, that's great Stacey. So if there are no further questions and I just want to thank everyone for dialing in this morning. We had a good session and I'd now like to provide two telephone numbers for follow-up. One is my direct line for clarification and the second will be the dial-in number for telephone replay. So my telephone number is 440-347-1206 and Stacey could you please provide the replay number? Hello Stacey?

Operator

Yes. I'm sorry okay, 1800...

Mark Sutherland - Investor Relations

Thank you.

Operator

You're welcome. 1800-475-6701 and then you enter access code 907670. So that's 1-800-475-6701 and you enter access code 907670.

Mark Sutherland - Director, Investor Relations

Very good, thank you.

Operator

Thank you.

Mark Sutherland - Director, Investor Relations

And with that, I'd like to thank everyone and conclude this call.

Operator

Thank you ladies and gentlemen, this concludes our conference for today. And thank you for using AT&T Executive Teleconference. You may now disconnect.

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