Ciba announces half year results and strategic moves to reshape portfolio

Brendan Cummins, Chief Executive Officer comments:

“We are taking significant action to reshape the portfolio and focus on areas of technological core strength in plastics, coatings and water. A number of options are being evaluated for the paper and publication inks businesses, which are not performing in line with our expectations and require additional strategic action to improve their market positions. Decisions will be taken on an appropriate course of action for both businesses in the next few months. In accordance with accounting requirements, we have also adjusted goodwill levels for the Water & Paper Treatment segment, which brings us into a loss for the second quarter.”

“In Plastic Additives we are in the process of agreeing a joint venture to expand our plastics capability in the fast growing region of the Middle East and we are planning to make acquisitions in the next few weeks that will strengthen our Coating Effects business. These moves will enhance already strong market positions in these segments.”

“The half year results were unquestionably disappointing. We experienced intense margin pressure from the escalation of raw material and energy costs, which went up 10 percent in the second quarter alone, with the heaviest impact in April and May. However, by mid June, we were able to offset these higher costs with sales prices increases and we are seeing further significant sales price increases coming through in July.”

“Business conditions going into the second half clearly remain a challenge. We are experiencing a deterioration in some markets, particularly in Europe, however, we are also seeing continued robust growth in other regions, notably in Asia, where we have a strong market position. Overall, based on our current market forecasts, raw material costs and foreign exchange rates; we believe the outlook we communicated at the first quarter, is achievable with the margin improvements that are coming through from the increased sales prices in the second half. However, should business conditions worsen further, the results may be lower than we are currently anticipating.”

Sales in local currencies up in Asia, Americas - slower in Europe

Sales of CHF 3,088 million (2007: CHF 3,308 million) were flat in local currencies and 7 percent lower in Swiss francs. Growth was strong in Asia, with good sales across the business, in particular double digit growth in lubricant additives and electronic materials. China itself was up 10 percent in local currencies.

Sales in the Americas were 1 percent higher over the same period in 2007 in local currencies, and 10 percent lower in Swiss francs, as a result of the much weakened US dollar. Growth in the Americas came through strongly in the water treatment business in NAFTA, as well as South America.

European sales were weaker than the previous year, 5 percent lower in local currencies and 7 percent lower in Swiss francs. There was growth in some areas of the plastics businesses, as well as in lubricant additives and water treatment, however, there were declines in paper as a result of weaker demand in the industry.

Gross profit margin of 26.8 percent (2007: 29.0 percent) was impacted by the high levels of raw material costs. Production costs were flat over the first half of 2007, despite a 10 percent increase in energy costs, reflecting the success of the lean manufacturing initiative, which is delivering considerable savings in the production network.

Raw material prices increased 8 percent (CHF 119 million) over the first half of 2007, with the strongest impact felt largely in April and May, where there were double digit increases in a number of areas of the business. Sales contracts with some of the largest customers were concluded before the impact of heavy escalations in raw material costs took place and this added to the normal implementation lag between higher costs coming through and sales prices fully compensating. By mid June, however, increased sales prices had started to offset the higher costs and the margin erosion was stemmed. Significant increases in sales prices are now very visible in the first part of the third quarter, with a substantial increase from June to July.

Operational profitability significantly impacted by raw material costs and strength of Swiss franc relative to the US dollar

Operating income (EBIT) before restructuring was CHF 161 million (2007: CHF 273 million), resulting in a margin of 5.2 percent (2007: 8.2 percent). The result was severely impacted by the escalation in raw material costs, as well as the strength of the Swiss franc relative to the US dollar. The margin erosion from the higher costs has now been stemmed, with significant sales price increases coming through in mid June and into the third quarter.

Restructuring costs related to the Operational Agenda program to improve the cost structure and facilitate growth, which was launched in 2006, were CHF 44 million. Savings of around CHF 60 million were achieved in the first half, although the impact was less visible as the cost structure was significantly affected by the high raw material and energy costs. By the end of next year the Company expects to have around 2,500 fewer positions; a leaner manufacturing network; a consolidated corporate structure; and a new global IT platform. In addition, the innovation process has been overhauled and marketing and sales function is running effectively. The program is well on track to achieve a reduction in cost structure of approximately CHF 100 million in 2008.

Goodwill impairment In the first half, the Company conducted a strategic review of the paper business and concluded that further strategic options needed to be evaluated for this business, as market dynamics had changed considerably over the last few years and previously forecast profitability levels would not be met. In addition, the Company experienced higher interest rates and equity risk premiums; and therefore an increase in discount rates. Together, these factors triggered an impairment test and a resultant CHF 595 million non‑cash goodwill impairment for the segment. Around two thirds of this relates to the acquisition of Allied Colloids in 1998.

The Company has therefore reported a net loss for the first half of 2008 of CHF 569 million (2007 net income: CHF 103 million).

Balance sheet and cash flow

Working capital of CHF 1,657 million was lower than the previous year (2007: CHF 1,788 million), although not yet in line with Company expectation. However, with SAP now rolled out across the organization and sales and operating processes fully aligned, the Company expects a further structural improvement going forward.

Free cash flow before restructuring at a negative CHF 126 million, was lower than the same period in 2007 (CHF 39 million), which had included CHF 101 million from the sale of some buildings in Switzerland. This follows a normal pattern of cash‑outs, particularly interest payments, which results in much lower first half year free cash flow levels than second half. The Company still expects to deliver free cash flow levels comparable to 2007.

Debt Maturity Profile. The Company has assessed a number of refinancing options to address maturities coming up. This has enabled the Company to further optimize the maturity profile of the debt structure and it is expected that borrowing costs, despite difficult business conditions, will be similar to current levels.

Overview of second quarter Sales for the second quarter were CHF 1,531 million, 1 percent higher in local currencies, and with the mainly weaker US dollar, 7 percent lower in Swiss francs. In Europe, sales were impacted by slowing demand in the paper, inks and converting industries and in local currencies, were 7 percent lower than the second quarter of 2007. The Americas, however, were 3 percent higher in local currencies, with strong growth in lubricant additives and water. Asia was 13 percent higher than the second quarter of 2007 in local currencies, with double digit growth in coatings, plastics, paper and lubricant additives. Japan and China both showed double digit growth.

Gross profit margin was 25.5 percent (2007: 29.3 percent), indicative of the dramatic raw material and energy cost escalation.

Operating income (EBIT) before restructuring of CHF 54 million or a margin of 3.5 percent (2007: CHF 139 million, 8.4 percent margin), was significantly impacted by the raw material cost escalation and the relative strength of the Swiss franc. Sales price increases did not start to compensate for the increased costs until mid June, however, the increases have now taken hold and will have considerably more traction in the third and fourth quarters.

Restructuring costs for the Operational Agenda program were on track as expected at CHF 26 million.

The adjustment of goodwill levels in the Water & Paper Treatment segment has resulted in a non-cash impairment of CHF 595 million, around two thirds of which relates to the acquisition of Allied Colloids in 1998. The Company has therefore reported a net loss for the second quarter of 2008 of CHF 606 million (2007 net income: CHF 27 million).

Portfolio being reshaped to deliver value

The Company is planning to make changes to the portfolio over the coming months.

In summary:

Evaluation of strategic options for paper business The market dynamics of the paper industry have changed considerably in the last three years, and the structural shift of growth to Asia, along with dramatically increased raw material costs have further compounded an already difficult business environment. Although a new business model was successfully implemented in 2007, it was not sufficient to counter balance the difficult market conditions and it has not been possible to achieve satisfactory profitability levels. The Board of Directors of Ciba has decided to evaluate a number of strategic options to ensure a sustainable future for the business.

Strategic options under consideration for publication inks business Despite actions to turn around the publication inks business over recent years, the unit has not been able to perform in line with the Company’s expectations. A number of strategic options are now under consideration for the business. Ciba is committed to finding an optimal solution in the next few months.

Acquisitions and JV to strengthen Plastic Additives and Coating Effects The Company is planning a joint venture in Plastic Additives, as well as acquisitions for Coating Effects, to strengthen market positions and develop new areas of technological application potential. In plastics, this joint venture will expand operational capacity in the Middle East, where rapid growth in this region will build on the Company’s global leadership position in plastic additives. In the next few weeks, announcements will be made concerning these initiatives.

New industry-focused operating model With SAP now live across the organization, the Company is now in a position to implement its new operating model. Industry focused platforms are being created to better leverage the Company’s six technological core competencies and develop higher margin market potential. The new model will be fully effective by January 1, 2009 and will bring a number of benefits across the Company, such as a greater degree of transparency and a deeper level of business accountability. In essence each business will manage and report its own operations, with profit and loss responsibility and a lean support structure.

All the plastics businesses for example, (which currently comprise Base Polymers and Polymer Products in the Plastic Additives segment, along with pigments for Plastics in Coating Effects) will become one unit.

There will also be a new growth platform, where a number of small, high potential businesses will be brought together with embryonic projects and technologies. In this platform, specialist R&D and marketing expertise will work together to exploit markets for new products, as well as actively pursue technological partnerships with research institutes, entrepreneurs and universities.

The financial results will be reported in the new operating model from January 1, 2009.

Brendan Cummins, Chief Executive Officer, comments:

“These strategic moves mark an important crossroads for Ciba. By making these changes, we can unlock the value in the business and I am convinced that by further optimizing our portfolio we can better leverage our leading market positions and build on our unique innovation capabilities for the longer term. ”

“I believe that after some turbulent times, we are approaching the end of our transformation. The Operational Agenda program is half way through and we are on course to complete in 2009. Cost savings are materializing as we expected and our operations are significantly leaner.”

Outlook Assuming that current market conditions continue throughout the year, in 2008 the Company expects sales in local currencies to increase over 2007 levels. On the profitability level, the Company believes the outlook provided at the first quarter, is achievable with margin improvements that are coming through from increased sales prices in the second half. This would result in an operating income before restructuring around 15 percent lower than 2007 and free cash flow to be around the levels reported in 2007. This reflects changes in assumptions for raw material costs and exchange rates. However, should business conditions worsen further, the results may be lower than currently anticipated.

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