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Cytec Industries (NYSE:CYT)

Q2 2012 Earnings Call

July 20, 2012 11:00 am ET

Executives

Jodi Allen

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

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

Analysts

Robert Koort - Goldman Sachs Group Inc., Research Division

Laurence Alexander - Jefferies & Company, Inc., Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

P.J. Juvekar - Citigroup Inc, Research Division

John P. McNulty - Crédit Suisse AG, Research Division

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Operator

Good day and welcome to the Cytec Industries 2012 Second Quarter Earnings Conference Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Ms. Jodi Allen. Please go ahead.

Jodi Allen

Thank you, Ally, 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 continuing operations; and David Drillock, Vice President and Chief Financial Officer, will review the financial results, special items and discontinued operations. Shane will then finish with some commentary on our outlook for 2012.

This call is being webcast in listen-only mode and it will be archived in audio format on our website for 3 weeks. Throughout the call, we will be referencing the supporting materials, which can be downloaded from our Investor Relations website under Calendar of Events, or you may follow the slides accompanying today's webcast which are also available through our website.

During the course of this presentation, and in responses to your questions, you will hear certain forward-looking statements. Our actual results may differ materially. Please read our commentary on forward-looking statements in Slide #2 of our supporting materials or at the end of our news release or the statements in our quarterly and annual SEC filings.

In addition, our discussion includes certain non-GAAP financial measurements as defined under SEC rules. We have provided a reconciliation of those non-GAAP financial measures to the most directly comparable GAAP measure at the end of our press release. A copy of our press release is available on our Investor Relations website.

As a reminder, we are now reporting Coating Resins as discontinued operations so all financial information will be discussed accordingly.

Now, let me turn over the call over to Shane.

Shane D. Fleming

Thanks, Jodi, and good morning, everyone. I appreciate you taking the time to join our second quarter call.

I'll begin on Slide 3. Sales from continuing operations of the quarter were $404 million versus $347 million in the prior-year quarter. The year-on-year sales growth was driven by strong selling volumes in the In Process Separation and Engineered Materials segments. As a reminder, we are now reporting Coating Resins as discontinued operations so all financial information will be presented on that basis.

The second quarter net earnings for continuing operations were $34.3 million or $0.73 per diluted share excluding special items, which represents a substantial increase versus $0.30 per diluted share in the second quarter 2011. The significant earnings growth in the quarter reflects the progress we are making across the businesses as we leverage sales growth and improve product mix into stronger earnings for the company.

Slide 4 provides details on the Engineered Materials results. Sales in the segment increased substantially by 21% to $230 million. Selling volumes increased 70% versus the prior year quarter due to robust demand across each sector of the aerospace market. Higher bill rates and large commercial transports in both legacy and new programs contributed to the increase, along with our growth in military business primarily related to the Joint Strike Fighter and the V22 programs. Selling volumes of regional business jets were also up versus the prior-year period. Selling prices also increased by 4%.

Operating earnings in the quarter were $38.7 million, up 38% versus $28.1 million achieved in the prior-year period. During the quarter earnings were unfavorably impacted by several onetime events. We have scheduled maintenance costs associated with the planned turnaround of our Carbon Fiber facility amounting to $3.5 million. We incurred $1 million of expenses related to settlement of a union contract at a U.S. manufacturing site and we incurred $800,000 in bad debt expense related to a customer in Spain. Aside from these events, the business is operating according to plan and we anticipate solid performance to continue.

Moving on to Slide 5. The In Process Separation segment delivered record sales of $100 million, a 22% increase versus the second quarter 2011. This was driven by 16% higher selling volumes and a 7% increase in selling price. The selling volume increase was attributable to several factors, including strong demand for our Metal Extracting products, including plant sales at 2 new corporations in Africa, one in the DOC and the other in Zambia, accounting for over $6 million in sales. We also saw a strong demand for our mineral processing products in Latin America, Eastern Europe and the Middle East, including the first order for a new copper plant in Kazakhstan.

And finally, phosphine chemicals contributed record sales with strong phosphine gas volumes into the electronics and fumigation markets, as well as strong derivative sales into several applications.

The combined strength across the product lines resulted in earnings in the segment of $27.1 million versus $15.6 million in the prior-year period, driven by the higher sales of value-added technologies and the positive selling price impact.

Now on to Slide 6. Additive Technologies sales were $74.1 million in the quarter, down slightly from the prior-year period. The decline was driven by soft demand in the Specialty Additives product line which supplies surfactants and specialty stabilizers into industrial markets. This product line experienced significant weakness in the Europe and North American markets. However, this was largely offset by strong performance in Polymer Additives where volumes up approximately 11% versus last year due to increased demand for our higher value products in North America and Asia-Pacific, primarily for agricultural film, automotive and rotational molding applications.

Selling price increased by 2%. As a result of the increased pricing net of raw material cost and lower operating expense, the business delivered solid earnings in the quarter of $13.7 million, a 29% increase compared to the second quarter 2011.

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

David M. Drillock

Thank you, Shane, and good morning, everyone.

Let me start with a discussion of the special items in both continuing and discontinued operations which will give you a good deal of the activity going on to support our portfolio transformation.

Let's go to Slide 7. In continuing operations, we reported in Corporate and Unallocated pretax net restructuring charges of $11.6 million related to the future reduction of 146 positions to address the stranded costs associated with the sale of Coating Resins. I'll cover more in those stranded costs in a moment.

Next, same as last quarter is a pretax expense of $700,000 for accelerated depreciation related to the sale-leaseback transaction of our Stamford, Connecticut research facility that we completed last year. We also recorded a pretax charge of $2.9 million for costs incurred as part of that Umeco acquisition.

Lastly, included in income tax provision is a $14.5 million expense to establish a tax liability on a portion of the un-repatriated earnings of certain international subsidiaries associated with the Coating Resins business.

In earnings from discontinued operations, there are several special items as follows: We recorded a pretax charge of $8.9 million for costs associated with the sale of the Coating Resins business. We remain on track and are well-prepared for a targeted closing by this year-end. We recorded a pretax charge of $1.7 million related to an increase in the environmental liability at a certain site per new remedial design requirements.

We recorded a $3.7 million pretax benefit related to the restructuring of our Brazilian operations last year. We were able to find a buyer who will operate this site, relieving us of certain closer obligations. Good work for our Latin American team to find a great resolution for the site.

Finally, we recorded a charge of $7 million to establish a tax liability on a portion of the un-repatriated earnings of certain international subsidiaries associated with the Coating Resins business. The split between continuing and discontinued operations has to do with the various legal entity ownership structures. That's all for the special items.

And now let me move onto a discussion of our financial results. As Shane mentioned before, all the analysis I will provide except for the cash flows and working capital will exclude the Coating Resins segment as it is now reported as a discontinued operation. I'll discuss Coating Resins' excellent performance in my discussion on discontinued operations. I'd like to also remind everyone that prior-year discontinued operations results include our former Building Block Chemical business, which was sold in the first quarter of 2011.

Overall, our sales increased by 16% with selling volumes up about 13%, thanks to robust demand in our growth businesses. Selling prices were up 4% with each segment contributing. Exchange rate changes decreased sales by 1%.

Looking at our gross profit dollars, it increased 28% to $133 million, while our gross margin percentage of 32.8% is 3 percentage points higher compared with the prior-year period. Our improvement in both gross profit and margin is mostly attributable to double-digit volume growth and higher selling prices within our Engineered Materials and In Process Separation segments. We also had a favorable product mix in the In Process Separation segment. And we had good fixed cost leverage in the quarter in spite of the increased manufacturing costs within the Engineered Materials segment to support our higher manufacturing volumes. And finally, raw material costs increased almost $4 million, again, mostly related to the Engineered Materials segment.

Corporate and Unallocated expenses, excluding special items and continuing costs previously allocated to Coating Resins, were down $2 million year-on-year spread across a number of items.

Let me provide more insight on the continuing cost previously allocated to this Coating Resins, but now reclassified to Corporate Unallocated.

For this quarter, the continuing cost was approximately $17.5 million, and for year-to-date, it's about $35 million. Continuing cost consists of corporate functions such as IT, HR, Legal, as well as corporate related services in Europe and Asia. At this time, we expect to see continuing cost at close to the current run rate for the remainder of the year, although some cost reduction will occur as the year progresses.

Up to 2/3 of the annualized continuing cost should be removed within 60 to 90 days of the closing of the sale of Coating Resins, and subsequently, we expect additional cost reductions over the next 12 to 24 months. Overall, our goal is to eliminate 3/4 of the continuing costs within 2 years of the closing.

Operating expenses were slightly higher compared with the prior year in terms of dollars, but lower in terms of percent of sales owing to the leverage from the sales growth in both Engineered Materials and In Process Separation. Interest Expense net is down about $1.3 million, mostly due to higher capitalized interest, which is in line with our higher CapEx spending this year. Our effective tax rate for the quarter was 30.8% compared to the prior year's 31%, excluding the impact of special items in both years. The net result of all of the above, plus a lower share count resulted in unadjusted dilutings per share from continuing operations, 143% above the prior-year period.

Let me now cover the Coating Resins segment sales and earnings on the basis prior to classifying as a discontinued operation. This is shown on Slide 9.

During the quarter, sales were $394 million compared to the prior-year quarter sales of $451 million. Selling volumes are down 8%, some of this due to our decision to exit low profit products in 2011. The changes in exchange rates also reduced sales by 5%, and selling prices were essentially flat. Operating earnings of $39.2 million is well above the prior year quarter of $30 million, owing to the benefits of flat selling prices combined with lower raw material cost and reduced expenses resulting from prior-year improvement initiatives.

On a discontinued basis, operating earnings were $56.8 million pretax versus $47.5 million in the comparable period of 2011.

As noted in our press release, due to the complexity and time required to separate continuing and discontinued operations related to Coating Resins, our statement of cash flows is not available at this time. Therefore, the statement of cash flow split between continuing and discontinued operations will be available in our quarterly 10-Q filing which is expected to be filed on or about August 6.

However, to provide you with more color, I'll now discuss cash flows and working capital metrics on the basis prior to Coating Resins being classified as discontinued operations.

Moving on to Slide 10. Operating cash flows from operations are $48 million for the quarter, up from the $15.4 million from the prior-year period. At quarter end, our net working capital days were up 4 to 70 days compared with the first quarter of 2012. Average inventory days were up about 5 as a result of the higher demand in our growth businesses. Average accounts payables and receivable days were up 1 day versus first quarter 2012. Depreciation and amortization were $52 million and $22 million, respectively.

Our capital spending for the quarter was $39 million versus the prior-year period's $25 million, and we expect this to increase steadily over the rest of the year as we are ramping up spending on the previously announced expansion of capital in our Engineered Materials and In Process Separation segments.

Our outlook for 2012's full year capital spending remains at $200 million, with 80% of the spending related to investments in our growth platforms.

We had no stock buybacks in the quarter and continued to suspend purchases for the time being to maintain liquidity for the Umeco acquisition. We are funding this acquisition using some of our cash balances and $170 million drawdown from our $400 million credit facility. Our cash balance at the end of the second quarter is $591 million versus the prior year-end balance of $416 million, most of the increase due to the credit facility drawdown.

As we enter the second half of 2012, I am very pleased with each of our segments' performance and our efforts to change the portfolio of Cytec despite the challenging macroeconomic environment. Our balance sheet remains strong and we remain focused on generating the cash needed to support our growth. We believe we're on the right path to create significant value for our shareholders. And one final note, Shane and I agree that all of this could not happen without the great team of people we have here at Cytec. Thank you, and now I'll turn the call back over to Shane.

Shane D. Fleming

Thanks, Dave.

And I'd now like to update you on our increased outlook for 2012, which we have summarized on Slide 12.

I remain very excited about the growth opportunities across our portfolio. The past few quarters should provide good insight into our ability to deliver our growth strategy while executing our portfolio transformation. And speaking of portfolio transformation, I'm extremely pleased to announce that our acquisition of Umeco Plc was approved by the U.K. courts earlier today and the transaction has now closed. Umeco is an international supplier of advanced composite and processed materials into both aerospace and industrial markets. This acquisition will leverage our technology leadership position in advanced composite materials into adjacent markets while strengthening our position in Aerospace. I see tremendous potential for value creation in targeted industrial markets such as the high-volume automotive industry, and I look forward to strengthening Cytec's portfolio through the addition of this business.

Now back to our business outlook. In Engineered Materials, strong demand for advanced composite materials continues to be a primary driver for our growth in the aerospace market. In the large commercial transport sector, build rates on single body and new wide-body programs requiring higher levels of composites are ramping up and we're also seeing business regional jet rate increases. The only area where we may experience some short-term demand weakness throughout the rest of the year is related to the JSF program where there may be some excess inventory in the supply chain following conclusion of our customer's strike.

Taking a longer-term view, orders from the recent airshow combined with existing record order backlog points to excellent long-term growth prospects in the global aerospace market. The outlook at Cytec remains very positive for the short-term and long-term, and our guidance for full year 2012 sales is in the range of $880 million to $920 million compared to 2011 full year sales of $789 million.

Operating earnings are projected to be in the range of $170 million to $180 million, up from $125 million in 2011.

Sales in the In Process Separation segment are expected to remain strong, particularly in the copper market which supports Infrastructure growth and industrialization in emerging markets. We continued to be successful penetrating new geographies, which contributed to our strong performance in the second quarter.

Looking ahead, the aluminum market is under pressure at the moment as some customers have reduced manufacturing output and idle capacity, given the weak fundamentals. Demand for copper and other metals remains strong as does demand for a number of our processing chemical products and we expect this to continue throughout 2012. We are therefore increasing our full year sales estimate for In Process Separation to a range of $380 million to $390 million, and upping our operating earnings guidance to be between $85 million and $90 million, up from our prior guidance of $78 million to $83 million. This represents a minimum 20% increase over full year 2011 earnings.

In additive technologies, softness in the Specialty Additives product line is estimated to continue throughout the year, yet we expect a solid demand for Polymer Additives in the Americas to offset the shortfall. Europe is expected to remain weak this year while we are starting to see some recovery in Korea and Southeast Asia. Therefore, our estimate for full year sales is unchanged and in the range of $290 million to $300 million. Operating earnings are estimated to be between $40 million and $45 million.

The guidance for corporate and unallocated expenses is approximately $87 million for the year, which now includes approximately $68 million in costs previously allocated to Coating Resins. Other expense is forecast to be $2 million and Interest Expense net is expected to be $34 million. Our forecast for the underlying annual tax rate is expected to be in the range of 30.5% to 33.5%. This translates to full year 2012 adjusted diluted earnings per share for our continuing operations to be in the range of $2.45 to $2.70, an increase from the prior estimate.

With the Umeco acquisition adding an estimated $0.20 per share accretion through the rest of this year, this brings our full year 2012 adjusted earnings from continuing operations to $2.65 to $2.90 per share.

Overall, I am thrilled with our performance in the second quarter. Even as we were taking all the necessary actions to produce record quarterly as adjusted earnings, we also made enormous progress on the transformation of Cytec's portfolio during the quarter. We strengthened our 2 growth platforms through the acquisition of the Soil and metal extractant manufacturing ss [ph] in India for $37 million and the stock of Umeco for $439 million. We announced the sale of our Pressure Sensitive Adhesives product line for $105 million subject to adjustments, which we expect to close shortly, and we initiated the formal sales process for our Coating Resins business.

While a lot of work remains to be done to complete the integration of the acquired businesses and the divestiture of the SOIL businesses by the end of the year, Cytec will be repositioned as a higher growth, higher-margin, specialty materials and chemicals company poised to deliver long-term value creation for all of our stakeholders.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Bob Koort with Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc., Research Division

Shane, with Umeco closed, can you give us some sense of how their 2012 is shaping up? Will it be sort of on trend with those 15% revenue growth they've shown in that sort of 9%, 10% margin range?

Shane D. Fleming

Bob, I just don't think I can give you any kind of a look forward right now, I just -- they've recently released their first quarter results, so they're out there in the public domain. But at this point in time, I think it will be premature for me to give you any kind of an estimate for the full year.

Robert Koort - Goldman Sachs Group Inc., Research Division

Okay. If you take Coating Resins out and look at the go forward company, can you give us a sense of the raw materials stack and maybe the most important raw materials, how big that might be on the operation, how less sensitive you we might be or as sensitive as you might be going forward?

Shane D. Fleming

Yes. It's going to be a quite a different story than what we had with Coating Resins, where we had so many of our key raw materials in Coating Resins being propylene derivatives, so we could point to propylene and a couple of fairly large percentage of that by -- it's going to be quite a diverse number of products. I'm not sure I could point to any one large item. The materials that we purchase will continue to be propylene derivative. That would be the epoxies and some of the ox alcohols in the mining, but a much smaller percentage of the total take. There would also be some ethylene derivatives, some inorganics, Carbon Fiber in the case of the Engineered Materials segment, both the Cytec business, as well as Umeco. So it's pretty varied without much concentration in any single area, so it's going to be a little bit more complicated to explain that story going forward.

Robert Koort - Goldman Sachs Group Inc., Research Division

Yes, but maybe less complicated because you won't have to explain things so much.

Shane D. Fleming

I hope so, I mean we want to -- clearly, one thing that we would expect to see is less volatility in raw materials because of that tremendous volatility that we've seen from propylene over the last couple of years.

Robert Koort - Goldman Sachs Group Inc., Research Division

And Dave, if I might ask you a quick one. You mentioned there somewhere around the run rate of $70 million of stranded costs, of which 2/3 you can knock out pretty quickly after the Coating Resin separation.

David M. Drillock

Right.

Robert Koort - Goldman Sachs Group Inc., Research Division

Am I thinking about it right in that somewhere around $0.60 of cost reduction that can happen annualized pretty quickly?

David M. Drillock

Yes, that's correct. Yes, you got that right.

Operator

Your next question comes from Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company, Inc., Research Division

I guess, first, could you elaborate a little bit more on the Engineered Materials inventory swing in the back half, I mean, is that going to be mostly Q3 or is that going to be spread over Q3 and Q4?

Shane D. Fleming

Obviously not an exact science, but our expectation would be, it would probably be more near-term. We've specifically referenced the JSF issue with that strike now being over, we should start to see that flesh out over the next couple of months so that's where the most of the inventory build was, and as I said, that should flesh out over the next few months.

Laurence Alexander - Jefferies & Company, Inc., Research Division

And can you elaborate a little bit more on North American additives, what you're seeing in demand trends? Any concern about destocking in Q3?

Shane D. Fleming

I think we're pretty bullish on North America for the second half of the year. There's a pretty wide variety of applications. Things like -- even like solar cells in areas where there's been some recent growth. So I don't really expect there, one, to be much of a drop off as the result of any inventory build. And secondly, I think it's a pretty strong growth projection given the fact that it is across multiple markets, multiple applications.

Operator

Your next question comes from David Begleiter with Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Shane, now that you own Umeco, can you give us your next 6 months, the key issues you're going to work on and focus on for Umeco and the integration and growth, going forward?

Shane D. Fleming

Yes, let me try and do that. The short-term objectives for us are just to make sure that we can close the books properly, right, that we understand the financial situation and we got our, at least our initial IT systems connected. So that's going to be short-term. Longer-term, and so we're now talking probably into the next quarter and beyond, we want to go through the separation process where we'll move the operations, ownership and the business into different types of segmentation. So right now and through year end, we'll operate Umeco and the financials for Umeco will continue on a Umeco basis and the Cytec Engineered Materials basis. In the next year, we'll pull the Umeco Industrial business into the Cytec Industrial business and report a new segment, an Industrial Materials segment, and move the Aerospace business from Umeco into Cytec's Aerospace business and report a separate Aerospace business. So the short-term, so the medium-term focus will be to get that transfer complete, to get the financials setup to report the business in that manner and to operate the business in that manner. As we go through that process, we'll clearly look for ways to share best practice, to start to market, co-market where we can, to learn more about the Processed Materials business. And we think there's a nice growth opportunity associated with that Processed Material business and some synergies between that and our Aerospace business, so we'll be working through those.

Laurence Alexander - Jefferies & Company, Inc., Research Division

And Shane, just lastly, post the airshow, I'm sure you were talking to your customers, longer-term, where do you think Cytec stands, again, competitively and the ability to gain additional share at both the Airbus and Boeing where you've lagged from other players at those companies?

Shane D. Fleming

Yes. I think I'm as optimistic today, or maybe more so than I've ever been. We continue to do development work with those 2 major large commercial transport customers. We're also continuing to make headway with some of the other future large commercial transport suppliers like COMAC in China and UAC in Russia. You've seen our announcement recently of the contract we have to be a primary structure supplier for the 919, the COMAC plane, and we hope to be in a position to take a similar position on the Russian plane going forward. So not only are we making progress and continuing to do development work with the 2 majors in the market today, we -- we've positioned ourselves nicely for wins with some of up and comers.

Operator

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

P.J. Juvekar - Citigroup Inc, Research Division

Just quickly, what's the impact of the South Carolina plant now that you've given a green light to it? When does it start up? And can you talk about possible earnings contribution from it?

Shane D. Fleming

Yes. It's still a long way from the finish line. Dave, you'll have to correct me if I get these numbers wrong, but I think we're looking at roughly 18 months to finish the construction. And then, there's another 12 plus, maybe 12 to 18 months after the construction is complete before we have full qualification. So the plant won't be producing product for commercial sales until sometime like in late 2015, 2016 sort of timeframe. We're still a ways out there.

P.J. Juvekar - Citigroup Inc, Research Division

Okay. And then in, In Process Separation, your volumes were up 16%. We've seen some industrial slow down in western markets, as well as in emerging markets, so you think this business tends to lag and we could see some slowdown in growth in second half?

Shane D. Fleming

The only impact I would expect to see second half versus first half here would be some slow down on the alumina side where we've already seen some of our customers curtail some production because there's been a slowdown in metal demand, so hence, a slowdown in the demand of the precursor aluminum material that we help process. So yes, we do think there's potentially some shortfall there and that's reflected in our guidance. But the base metals business that comprises most of our segment, so copper and associated metals, we don't see that slowing down through 2012. That's given forecast from our customers, and the current metal inventory levels. And even longer term, we remain bullish on the copper business. Yes, you may see a drop from 3% or 4% annual growth down to 2% to 3%, but it's a very resilient market and our expectations are short, medium, long-term, you're going to continue to see strong demand for those types of metals because they're just so much a part, so integrated in any type of infrastructure build.

P.J. Juvekar - Citigroup Inc, Research Division

Great. And lastly, as you close Umeco, can you talk about the growth in the automotive segment from Umeco for Carbon Fiber and what you could expect next year?

Shane D. Fleming

Yes. I'm not going to be able to give you any specific projections for next year, and there's a lot of development work ongoing on in the automotive market right now. So what I can say is, we're extremely bullish on the position that Umeco gives us in the automotive market, coupled with some of our product technology and our own position there. I think the automotive market has potential to be a very large market and we are, I think, uniquely positioned to take advantage of that growth. But I don't think we're going to see a significant impact on our results of our operations in the next 12 to 18 months. I think that business is going to start to develop in the 2 to 3 to 5-year timeframe, and that's really the basis for us making this deal. To position ourselves for that growth when it comes.

Operator

Your next question comes from John McNulty with Credit Suisse.

John P. McNulty - Crédit Suisse AG, Research Division

Just a couple of questions. On the Coating Resins business, I don't know what you may be able to say or not, but can you speak to the interest level that you're seeing in that asset? Maybe reflect on the types of buyers that might be showing some interest and how you're thinking about the timing of that again.

Shane D. Fleming

Yes. John, I really can't say much there, unfortunately, we're just at that part in the process where it wouldn't be appropriate. But let me just say with regards to the process, it's going very well, very much as we expected it to, and everything that we said publicly about timing holds. So we remain very optimistic. We're going to get this done this year, and then we're going to be comfortable with the level of proceeds that come from this, so from our side, it's very positive, but I just can't share any more detail at this time.

John P. McNulty - Crédit Suisse AG, Research Division

It sounds fair enough. And the Engineered Materials business, it looks like your guidance for sales growth, at least taking kind of a middle, midpoint of the range is kind of calling for a low double-digit growth in the business, and yet the first 2 quarters, you're running close to a 20% run rate. So I guess, I'm wondering how to think about what you're looking for in terms of a slowdown? I understand there are some inventory issues, but it seems like that shouldn't been knocking your growth rate down by almost 10 percentage points. So what are -- what is incorporated into the guidance for your EM business in the second half?

Shane D. Fleming

That's really the only factor. We are not expecting to see build rate reductions or any significant demand changes in any of the markets that we supply to. But we -- as we said at the end of Q1, we thought there had been a little bit of inventory build, in some of the ramp ups for new programs, and we specifically called out some inventory build this quarter on the JSF. So that's really the bulk of it, John, it's just our view on customers got a little bit ahead of themselves, and we think there's some potential for a slow down there. If that doesn't happen, there some upside to the number that we have out there.

John P. McNulty - Crédit Suisse AG, Research Division

Okay, great. And then just -- with all the moving parts, if we can kind of take a look at just how to think about your base earnings. You've got the $2.65 to $2.90 on from continuing operations for this year, then assuming you can pull out all the stranded costs, it's another $0.60 to $0.70. Umeco, on an annualized basis, maybe adds another $0.20 to $0.30 for that. So if we're thinking about kind of a base to start 2013 off of, is kind of a $3.60 to $3.80, $3.90 kind of base, the right number, and then whatever growth your core businesses have or are there any other puts and takes that maybe we need to think about?

Shane D. Fleming

No, I think your math is pretty right on. I mean, those are the major issues that drive this. Of course, beyond that, post the Coatings transaction, and what we do with those proceeds could obviously have an impact as well.

Operator

[Operator Instructions] Your next question comes from Rosemarie Morbelli with Gabelli and Company.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Just a clarification on the balance sheet. The net debt of $227 million, does that include whatever debt is going to go away with the Coating Resins business? Or is there a certain adjustment that we will need to do?

David M. Drillock

No. There's no further adjustment. There is no debt going with the Coating Resins transaction. So that would be the -- the net debt that you see is what will be there after the Coating transaction, essentially.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And can you remind me how much budgeting for the Pressure Sensitive business?

David M. Drillock

Proceeds?

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Yes.

David M. Drillock

$105 million. It's a typical closing adjustments.

Operator

[Operator Instructions] Your next question comes from Mike Sison with KeyBanc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

In terms of the accretion for Umeco this year, is that going to be all in the fourth quarter? Or does it start to sort of stream in as the year unfolds?

Shane D. Fleming

No, I think it will be through the year. We should start -- we should see some impact in Q3 as well.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And then the Coating Resins outlook for the second half comes down quite a bit from the first half, any particular reason? Is it just some of the demand and raw materials situation?

Shane D. Fleming

Yes. Mike, it's just really normal seasonality. You're well aware of how this business goes with strong first and second quarters, and then you see demand fall off a little bit in Q3 with the holiday period in Europe, and then again, at the end of Q4 with the Christmas shutdown. So nothing out there beyond just a standard sort of seasonality we see in the business.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And then the Space and Defense business. A lot of concern, just generally speaking, for that end market. When you think about that going forward, can -- is it -- can it still grow in the environment that we're seeing?

Shane D. Fleming

Yes, I think so. I think for us it can grow. And that -- the base programs that run now, I think, are relatively solid, the rotorcraft program, the V22, at least for the next several years. And then with the growth for us, with it, of course come with the ramp up on the Joint Strike Fighter which still got a long ways to go to get to the targeted program build rate. So yes, I think the base business for us is relatively solid. You never know for sure when you're dealing with politics in the Pentagon, but relatively solid. And then some upside coming from the JSF as it ramps up.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And David, when you think about -- if everything goes through, you sell Coating Resins, will the tax rate change materially into '13 to any large degree?

David M. Drillock

Mike, for -- if you're modeling '13 for continuing operations, I'd say that the 31 to 32 range is appropriate.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

And then D&A?

David M. Drillock

Yes, we'll get back to you on that, I want to make sure. Because we got a lot of CapEx going through too, so I just don't want onto a number for you.

Operator

[Operator Instructions] And there are no further questions at this time. I would like to turn it back over to the presenters for today for closing remarks.

Jodi Allen

Thank you, everyone, for your participation in today's call. And if you have any follow-up questions, please contact me directly at (973) 357-3283. Thanks and have a great day.

Operator

Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.

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