Avient Corp (AVNT) 2002 Q3 法說會逐字稿

Good morning. My name is Teri, and I will be your conference facilitator today. At this time I would like to welcome everyone to the PolyOne third quarter 2002 earnings conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press *, then the number 1 on your telephone keypad. If you would like to withdraw your question, press *, then the number 2 on your telephone keypad.

I would like to introduce Mr. Dennis Cocco, chief investment officer, and also Mr. Dave Wilson, chief financial officer, Mr. Cocco; you may begin your conference.

Thank you very much, Teri. Good morning, everybody, and thank you for joining us this morning. It's always interesting to have the third quarter conference call on Halloween. I'm not too sure if that's a good day or a bad day, but it seems like it's fallen that way the last few years.

Let me tell everyone that we are...let me give you a few updates here. Number one, we are web casting this conference call, so you will be broadcast to the world as you ask your questions. I'm not going to repeat the Safe Harbor language, but as you know, I would undoubtedly expect you to ask us questions that will force us to talk about some forward-looking items, and I would ask you to look at that document which is in the release.

If you are from the news media, while we are perfectly all right with you being on this conference call, we would ask you to refrain from questions. We're trying to [inaudible] questions that will be answered later for the analysts, and we're happy to take your calls later. If, for some reason, the information that we sent out last night did not...if you did not receive it or, for whatever reason, it didn't come across correctly, please feel free to give my assistant, Darlene Henson, a call at 216-589-4376 and she'll be glad to help you.

Dave Wilson, while here in spirit, is not physically here. He's on the call with us from Europe. He's in Europe doing some reviews of plans and strategies for our European operations this week with Tom. So this is going to be a little awkward not having Dave physically with us this morning, but we're going to do our best. So we're going to try to keep our comments brief and apologize if we kind of have some dead time as we try to figure out who's going to answer which question, since it's hard to do sign language over the phone.

Let me give you a couple of things. I'm going to make a few comments and then I'll pass it back over to Dave. Number one, I want to alert everybody that in the next few weeks Dave and me will be involved in a number of analyst meetings. And some of you who would be interested, we'll certainly welcome you to join us. I'll give you the dates and the places.

On November 7, First Analysis is having a meeting in New York City, and we certainly invite those of you who would like to join us then. On the 12th here in Cleveland, Merrill Lynch is having a small regional chemical conference in which we're going to participate on the 12th. On the 19th, Ingoll Snyder is having a conference back in New York, and Dave and I will be there for that. In fact, on the 18th there's a small dinner. If you'd like to join us, let us know about that.

On the 20th of November, Lehman Brothers is having a trip in the Houston area, and we're going to have a visit to our Seabrook compounding plant. And if anybody would like to join us, feel free to contact Lehman and let them know. Then, of course, on the 3rd of December, the Salomon Smith Barney conference will be taking place, and we'll be at that on the 3rd. I wanted to give you an update on that.

One special item that we had this quarter, I think we tried to let everybody know about that earlier this month, because we were just informed later in the quarter that that was going to take place. Just to make sure it's very clear, this is a unit with OxyVinyl's Deer Park facility. This is one unit, not the entire facility that is being shut down permanently. The rest of the unit in that facility is still idle. And hopefully, when market conditions warrant, the rest of that unit will be restarted.

Relative to OxyVinyls and really the whole PVC chlor-alkali business, as we talked about in our earnings release, it was an important contributor to earnings here in the third quarter. It actually did better than I think we had given you indications of at the end of July. You know, we saw strength in PVC prices; obviously saw strength in caustic and chlorine pricing in the quarter. And PVC demand, for the most part, was okay. We saw a slippage in PVC demand as we got into late August, early September. But as we've indicated also in our write-up, as we go into the fourth quarter, we're going to lose a little of that momentum.

The good news is, on some of the fundamentals...and Dave will talk more about the high-leveraged variables, but ethylene and natural gas were pretty steady for us. And those are two of the big cost items that affect OxyVinyl.

We're still very optimistic as we look toward next year. I think most of you are quite aware of the fundamentals in the whole chlor-vinyl chain. The fundamentals as we look to 2003 look good. PVC demand and capacity utilization basis looks like it will be in the mid to high 90s for next year, assuming reasonable economic customer demand. And obviously we're moving into the fourth quarter with attempts to move chlorine and caustic sodium a little bit higher. The ECU value for chlor-alkali is at least north of 250 and approaching 300, and hopefully will eventually get above that. So we're looking for continued strength, but we're going to see some weakness here in the fourth quarter in OxyVinyls because demand has slowed down and because, as is normal in that industry, as demand slows down, PVC pricing will continue to probably have a difficult time staying where it was at the end of the third quarter.

I want to update everybody a little on Triple Crown. We had a number of projects which have, as you may know, our North American performance plastics, colors and compounds business. It is the business that we're doing all the asset nationalization in.

We're quickly wrapping up that project as we move toward the end of the year. We only actually had one plant closure in the third quarter, which is our Houston facility. Two other facilities, Gastonia, North Carolina and Somerset, New Jersey, both color facilities, closed in early October. We thought they might close in September.

The good news is about two-thirds of the product transfers have taken place already in that whole Triple Crown project. So we've got quite a bit done. We've still got a little bit more to go. As we said, when we're done, we will have closed 14 out of the facilities and we will have a few that will probably close now. They're going to partially close this year, but finally close in '03. So by early '03 or mid '03, we should have all the facilities closed that we had intended and have the project well under our belts. With that comment, I will pass it back to David.

Thank you, Dennis. And thank everyone for joining us this morning, your time, I guess; afternoon, mine. I say greetings from Belgium. It's an opportunity for Tom and me to be with our international business team going through the '03 and really '04-'05 type plans. I would tell you that our international operations continue to be a source of earning strength for us and real market opportunities. And we've had two or three days of being able to hear that.

Earlier this quarter we put out a release where we talked about the various expansions for our international operations that we've done this year; the Spanish-engineered materials facility, the French and Belgian color, expansions at each of the four Asian operations, and then we also mentioned in the supplement our intention to conclude the acquisition of the Spanish color operation in December called Trans Color. So our international operations continue to be a focus for us and as I say, from what I've heard the past couple of days, with good earning strength and market opportunities.

Now, when we look at the third quarter, it would be nice to take heart in the fact that we doubled our second quarter earnings, but I would tell you it was a tale of two halves in terms of looking at the quarters. July was really a very good month for us and August started out that way, but midway through the month we started to see softness across the board, really, in our North American operations. And September was fairly weak. And as a consequence, we only came in at $0.14, which was somewhat below where we hoped we would be.

As you'd see, to earn that $0.14 was really paced by the resin and intermediates business, it was doing what it should do in terms of providing good earnings when downstream businesses start to see margin compression. But we did see a $10 million improvement versus second quarter this year, third quarter last year. So I would say our resin and intermediates operated at about mid-cycle type earnings.

Vinyl demand was disappointing in the month, or in the quarter, rather. It started out pretty good, as I mentioned, but by the end of quarter it had tailed off; and also the pricing, where we got about $0.03 on average in the quarter, with mixed results. Rigid extrusion, we got the target, $0.04 to $0.06, depending upon segments. Flexibles, we got quite a bit less than that in our injection molding business. Mixed changes, frankly, overshadowed any of the price increases.

As we look to the fourth quarter, it's an odd one. You read our outlook, and I believe that that's a fair view, although I would tell you that as we look at our demand patterns, they are mixed. As the earlier release in early September indicated, or early October, I guess it was...yeah, it was early October...indicated our distribution business demand held through October. Our formulator business had probably its strongest month in two years.

The elastomer business was pretty good, and international business held pretty well. Where we saw softening was in our films business; the vinyl compound business, the specialty color business. But overall, there is concern, regardless of how the month of October went, that with the industrial economy pretty clearly slowing down and also being exacerbated by the fact that the fourth quarter is seasonally slow anyway on a relative basis, there is concern for November and December, also the fact the gains that we saw in resin and intermediates in the third quarter are likely to be given back in the fourth, as we would anticipate with the slowdown in demand. Not only PVC volumes will come down, but also, as supply and demand come out of balance, we would expect to see pressure on prices.

And with the coming of the winter months, natural gas will trend up, and that will put cost pressure on ethylene. And so we are anticipating that we could lose most of what we saw gained in the third quarter in the fourth.

In terms of demand, our overall viewpoint is that we should exceed fourth quarter 2001, but we would expect to see a percentage...5, 6, 7, 8, whatever percent decline versus the third quarter in our top line. And that's largely seasonal, although, as I say, there are some pockets where we're seeing the impact of seemingly a stalled recovery.

Value-capture initiatives up maybe $2 million versus the third quarter, no single initiative stands out from a liquidity perspective, though I would tell you that our leverage test is well-cushioned and secure. And following on that in terms of cash flow, in the third quarter, as we indicated a quarter ago, we did generate cash.

Our working capital management overall was good. Our receivables continued to improve as our DSOs went down a day and a half. We made some progress on our inventories, but I'll be the first to tell you that I'm not satisfied with the level of them. Even if the day sales and inventory came off modestly from where they were at the end of the second quarter, they're still not where they need to be.

We would anticipate, however, with some pretty active programs, that inventories will, in fact, come back into line by the end of the year. Obviously cash drives on that, but also the deflation in some of the raw materials mandates that we not be holding too much inventory.

In terms of working capital, by year-end we would expect to see working capital off 60, maybe a little more than that, million dollars from where we were at the end of September. And that will drive a fairly strong cash flow in the fourth quarter. And I don't believe this is any different story than what we've been talking about really since we went out with the bond issuance in April.

Looking at governance, I would tell you that we have expanded the scope of our rep letters with our operation and financial management. We continue to formalize our internal processes, but we really haven't changed them. But we will continue to make improvements to ensure that we maintain excellence in our financial reporting.

I'd also draw your attention to the supplement, where we provided, I think, some additional disclosure in terms of the pension status, in terms of our liquidity. And you would have seen at the end a view on stock-option accounting, which you may or may not want to discuss.

As we turn to 2003...and I think that's really one of the real questions for us...the question that we have is when will the economy turn for real? Our projections...and these certainly don't differ from what you'd read...is that, on an industrial production index basis, '03 will not get back to 2000 levels. Automotive builds will likely be flat. Maybe there's some downward pressure on them. New-home builds are supposed to come down a little, but still off pretty good rates. We would expect Europe to soften a bit but pick up after the first quarter, and we would expect Asia to continue at pretty strong growth rates through the year.

In terms of the value capture, we hold firm to the $200 million versus 2000 that we've committed to. In August, a full board process was put in place to have our general managers and functional heads go through each of the programs to ensure that we were on track to hit the targets that we have set, and that when you look at that, what we're looking at is an '03 to '02 improvement in value capture in the neighborhood of $90 million. And if you break that down, about half comes from Triple Crown, our North American asset realignment. We would also expect to see growth initiatives kick in another $15 million. Ten million of that comes from international programs and half of that $10 million would come from the Trans Color acquisition.

Direct materials, we're looking at another $10 million; Smart Source, which is indirect procurement and logistics, kicking in about $10 million in aggregate as those programs ramp up for really '04 benefits, and then manufacturing initiatives around the other businesses, non-North American PCC, looking at the $10 million to $15 million range. And this is a combination of improvements in quality, improvements in lean manufacturing practices, and some restructuring that we've done at plants like Burlington, as we referenced.

The resin and intermediates business we would expect next year to be close to mid-cycle levels. We anticipate that if you look at the high-leverage variables...these would be PVC resin, caustic chlorine, ethylene and natural gas...they should contribute favorably to our resin and intermediates business, about $30 million. On the other hand, I would tell you that the increases in PVC resin, chlorine and ethylene will impact our downstream operating businesses by about the same amount of money.

And so then the question comes in, what level of improved compound pricing can we anticipate for next year? And if we assume that we're able to hold fourth quarter averages really where we ended the third quarter versus the average for 2002, we would be somewhere in the $15 million to $20 million benefit range.

So things we know, I think it's likely that net high-leverage variables to the company will be favorable by $15 million to $20 million. That includes compound pricing, value-capture initiatives up $90 million. We referenced the fact that our pension expense is going to be up $8 million. That would be an offset. But I would also tell you, as you read the release, it's our intention to take actions, and we really haven't defined them in detail yet, to offset a lot of the inflationary pressures through internal actions.

And so, looking at 2003, we know it's a big year for PolyOne. We have to hit that $200 million commitment level. We certainly intend to and have the plans in place. And so really, with that pacing, our earnings, we would expect to see a fair improvement in our earnings from 2002, regardless of what the economy does. As we've said before, we've had a lot of opportunity to improve our earnings through our own actions. And as we go into 2003, frankly, with a lot less top-line momentum than I think any of us believed we would have, certainly towards the end of the second quarter, beginning the third quarter, it just tends to underscore the importance of bringing home the controllable earnings improvements that we've identified. And that's certainly what our intention is. And, with that opening, I'll pass it back to you, Dennis, to open us up for questions.

Thanks, David. And as I said to all of you, since we're not physically here, if you want to direct it at one or the other of us, it'd be easier to do that from your end. But we'll try to be flexible and try to answer your questions. Teri, let's open it up.

Thank you. At this time I would like to remind everyone, if you would like to ask a question, press *, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Fred Seimer-ph of Seimer-ph Company.

Yes, good morning, just a couple of quickies. One, I wondered about foreign exchange, if that helped you in sales or income in the quarter.

Yes.

And any comments on the rubber pricing inquiry and any news there? Just those two questions.

Okay. In the third quarter, our sales were helped about $9 million through foreign exchange. And this is primarily the strength of the Euro versus the dollar that really started at the end of the second quarter. On a year-to-date basis, that number is 10. And on earnings, we got about $700,000 benefit. And these numbers would be versus third quarter of last year. And on a year-to-date basis, it was about $900,000 benefit in earnings versus the second quarter, sales benefit was $6 million and earnings benefit was half-million.

And on your question, Fred, relative to the rubber chemicals inquiry that's going on, we are not in that. And so it would be really imprudent for us to make any comment, but we're not in that investigation.

Thanks.

Your next question comes from Andrew O'Connor of Strong Capital.

Good morning, Dennis. Good morning, David.

Good morning.

Good morning.

I wanted to know, what improvements in working capital do you think the company can achieve during the fourth quarter? And I was looking at your inventories and accounts receivable in particular. Thanks.

In terms of the accounts receivable, our current days outstanding is 56 and a half. And this is within a day of the best rate that we've...best single month that we ever had. That was in July, in fact.

Okay.

So I'm guessing that you'll see receivables hold pretty close to that level as we go through the end of the year. Obviously in December there's going to be some pressure on that number, as there is pressure really probably at every quarter's end for opposite reasons we look at payables.

In terms of inventories, our days in inventories now are about 49 and half days at the end of September. And we would expect to bring that down by four to five days by the end of the year. But I would tell you that that 44-and-a-half, 45-day range, it really is our target. And so when we're talking about being disappointed, even though we're making some improvements, you know, bringing it back down to that mid 40s level really is where we ought to be operating.

But, you know, having said that, as a result of expected declines in sales as well as improvement in our terms on an inventory that really is what drives that $60 million improvement that I alluded to in terms of point-to-point working capital balances between the end of the third quarter and the end of the fourth.

Okay, that's helpful. And then on pricing, with customers reducing the quantities of material that they're buying from the company, can you speak more explicitly to pricing for your product line in the fourth quarter and the first quarter? How sticky do you think prices are?

I'll talk for the resin business. Certainly I think prices will come down. How much is speculation. History might say a penny a month until you hit February.

In terms of the compound, vinyl compound price, the pockets of that that are less differentiated, as demand softens, pricing activity will increase, despite the fact that we spent the third quarter trying to get our prices up.

Other parts of the business aren't as price-sensitive as really the vinyl chain businesses that we have. So I'm not expecting that we'll see too much pressure on those prices. Dennis?

Yeah, I concur, David. If you look over the last year and a half at some of our other compounding businesses, including vinyl formulators and so forth, those pricings have actually helped very extensively. And actually, when we do get some cost increases, we've been able to fairly quickly incorporate those cost increases into the selling price.

But one that we just don't know about is vinyl compound. This is...as we've talked about this is a very seasonal, slow period. There is a couple of markets that, you know, are still being challenged in that segment, and that's certainly the wire and cable business, where we did not see a lot of price increase in the third quarter. And hopefully we'll be able to hold at least what we have going into the fourth quarter next year.

So it's really hard to say, but I think you can see that while we were...the fact that we were disappointed in what prices we got in vinyl compounds in the third quarter. We're not giving up trying to continue to move those prices, but we'll probably have to wait till demand starts to pick up early next year.

Sure. Thanks, Dennis. Thanks, Dave. Good luck, guys.

Thank you.

Your next question comes from Timothy Gerdeman of Lehman Brothers.

Hi guys, just a couple of brief questions. One, I'm curious, given your commentary about running around break-even in 4-Q, whether you've already had that discussion with your credit agencies as well as your banks?

We keep our banks informed of where we are. You know we talk to them regularly. So we don't...it would be part of a standard update, Tim, not anything sinister, as I mentioned in my opening remarks. The leverage test is secure with that. We have built up a buffer. And as you know, the target comes down. But even with it coming down, we've got room, and also into the first quarter, which has got to be in our eyes as well, in light of where demand seems to go.

Maybe naïve on my part. I was just trying to ensure that we had a good read on whether or not you thought that there'd be additional downgrades, and how does it impact borrowing costs and interest expense on P&L and things like that?

Downgrades...well, one, we don't think that'll happen. Two as we look at...and I think we went through this in the supplement in terms of what the impact of the split rating is in terms of having to put higher levels of our receivables in a reserve. And that's the only impact; that the split level had no impact on our public debt or our revolver financing costs, nor access to those facilities; really the short-term facility. The longer-term debts obviously pulled out.

And if we look at total sales volumes back a few months ago when it appeared, at least in the manufacturing sector, that we might be eking out health, finally, do you sense that some of your customers were not only ordering materials that they needed but also building some surplus inventory that they've now worked back down? Or how do you think through those dynamics? Was it primarily just-in-time and the slowdown we're seeing now is just a direct correlation to their business?

I'll take a shot and then I'll pass it to Dennis. I think clearly there was some pre-buy in the second quarter with all the announced pricing increases. You would have seen that in the resin side of the business, and also the vinyl compound side. I don't think in other parts of our business we would have seen that. I don't believe there was much of that in the distribution business from our discussions with our distribution management. And so third quarter, some tailing down due to the inventory that may have been built in front of a price increase.

But now I think the demand patterns are fairly reflective, and I think in September they were as well, of just what's going on in the general economy. The supply chain, I think, has clearly shortened, as we've all really picked up our game in terms of being able to get from order to delivery from our suppliers as well as to our customers. Dennis?

Yeah, Dave, I concur. I think it's not a pattern that you wouldn't expect when you're trying to raise compound prices in the $0.07 to $0.08 range that people would not hedge a little on that. And certainly that's what was taking place early in the third quarter. And they really did not have business to justify it. But, you know, I think we now know that.

No matter what we try to do, we try not to let that happen. We try not to let customers try to hedge buy. But that's almost inevitable. So I think Dave is correct that the level of business probably was being reflected in the late second quarter, early third quarter to that. But as we move forward, I don't get a sense there's a lot of inventory out there. We've been...I think, if you look back the last two years, I think we've looked at this industry a little differently. I think our customers have been much better at managing their inventories than ever before. And so that's why you see these swings from quarter to quarter.

And jog my memory on what percent of total sales ultimately gets tied into auto OEM. And how are you thinking about the cycle in your own budgets when you give us guidance?

A little less than 20 percent goes to the automotive. And as we look at next year, the numbers that we're using would have automotive being essentially flat overall; the big three down maybe a little bit, but not materially, so '02-'03, fairly flat.

Great, thanks. And have a pint of stout and [inaudible] tonight.

All right, thank you.

Your next question comes from Robert Ottenstein of Morgan Stanley.

Good morning, guys. It's Justin.

Hi, Justin.

Hi, Justin.

I was wondering if I try and analyze the income statement...I know this is tough, because things don't happen in a vacuum...but I'm looking at the performance businesses' EBITDA, which are roughly flattish year-over-year. And you guys are talking about what I think looks like $12 million of incremental third quarter '01 versus third quarter '02 cost savings associated with your run toward the $200 million. And so if I look at the P&L, I'm just trying to figure out where I could identify some of those savings. And maybe you could help me, you know, put that in the framework of flattish EBITDA for the performance businesses.

Okay. There are...well, I'm not sure you're going to see it, because cost of sales doesn't break between variable and fixed. But if you look at S&GA, there's going to be some savings there. There are savings in our manufacturing plants, reflective of plants that were closed primarily in '01, since there haven't been all that many closed in '02. There’s also a benefit in raw materials. But I would also say that when we look at the raw materials, they are what we judge to be true benefits versus competition. And we try, as best as we can, to keep any economic influences out of it.

Having said that economic increases in certain raw materials have offset some of the benefits, but also price pressure, particularly on the vinyl side, has caused margins to compress. And so I think the long answer to where the value-capture initiative it's primarily in the margin compression that we've seen. Some of which is offset naturally by the improvement in the resin and intermediates, which is...you know, with that investment, it does provide some stabilizing factors to downstream margins on a fully-integrated basis. But when you split it out between operating businesses and R&I, you know, the operating businesses, and, as I say, primarily vinyl compound, has seen margin pressure.

Can you remind us what the split of your cost of goods sold is between fixed and variable costs, an approximation.

Yeah. I'm thinking that our average...and Dennis may be someone who is there who can help you better than I can...but I'm thinking that our incremental margin. Which would be sales less raw materials less energy, less packaging, is in the 25 to 30 percent of sales range? And I would hope somebody back in Cleveland can confirm that.

We're looking, David.

But will you guys look maybe at...help me with just another quick one. As you look out to the $90 million of incremental savings you expect to realize in 2003, how much of that...maybe discuss your confidence level in achieving that without losing any volume. I understand that you transferred two-thirds of your product in your manufacturing already. But maybe just discuss your confidence being able to keep volumes flat, because that's a pretty significant chunk of cost to take out, I guess, from my perspective.

I think, in terms of the potential to lose volume you're looking at Triple Crown because that's where customer service would be affected as we make the transition. And as you point out, we're well over halfway through that transition. But we've got to keep our eye on it. The driving factor in terms of our ability to move forward with plant closures is customer acceptance of products that have been transitioned to another line. So we're working very closely with customers.

I would say, though, that there have been certain service issues, and that always puts your customers at risk...a percentage, a relatively small percentage, frankly, of your customers at risk as they may look to doing some second sourcing. But here, too, I would say that one of the legs of what we call Triple Crown. . .in fact, two of the legs, frankly. . . were to enhance the reliability and quality consistency of the products that we offered.

And so, where we continue to have issues servicing customers because the businesses were fundamental broken and we're putting the foundation in to fix them, and to the extent that that has continued through '02, we would expect to see that turnaround in '03. And this is primarily on the color business.

And we would expect that once Triple Crown is behind us, once we demonstrate the type of lead-time capabilities that we believe we're putting in place that we will demonstrate and earn back the confidence of the customers. And so, at net, we shouldn't lose any customers we don't want to lose. And at this juncture, obviously, we don't want to lose any. But there could be some rough patches early as we prove our capabilities. Dennis?

Yeah, I'd just add to Dave's point. I mean, it's very hard for us, when you look at the changes that are going on in our North American PC&C business, to look at it on a baseline basis. There is so much moving going on, products costs, raw materials, plant costs, plant shutdowns, investments going on.

You know; as I've cautioned everybody, judge us starting in the second quarter of next year on North American PC&C and how we're performing, now on how we're performing this year. We have been extremely internally focused and trying to take care of those customers we do have. And it's at times, quite frankly, barely being able to do that.

Our customers have had to put up with a lot. I mean, they've had...we said we had some broken businesses where we had quality and service issues, especially in our color and engineering materials business. And so we've worked hard to try to retain those customers while we're going through this transition. But we could not...you can't do it just by wishing it. You've got to put some assets in the ground that'll help you do that.

And now we've got people trained. We're in the midst of training people. We're in the midst of manufacturing being behind us. And once that is completed, we'll be in better shape. As I said, you know, we've already transitioned about two-thirds of our products, but we're talking about literally tens of thousands of products. And so it's been a tough year for the North American PC&C business, not only from the economic perspective but also from the transformation they're going through. So the real judge of our business will be early next year as we finally get that behind us.

Thanks a lot, guys.

Your next question comes from Nancy Traub of CSFB.

Good morning. I had a question that was similar to the last one, and it related to your comment that you had lost some sales in, I guess it was elastomers, because of the change.

Right. That's --

And, you know, whether that would happen, because you're closing, like, five plants in the next quarter in PCC.

Right. We would not expect a similar situation. The issue is more, in the elastomer side, Canadian customers who want to buy from a Canadian supplier. And when we shut down our Tilsenberg plant, we took our capability of doing that, because that was our principal belief.

In terms of the plants that we're shutting down in the fourth quarter, we've been able to work with the customer base that those plants currently cover. And they're aware of what we're doing. And, as I said earlier, before we actually do proceed with a closure, the customers are signing off on the transition and signing off on the product coming out of the new facility.

Yeah, let me add a point to that, David. Tilsenberg, which is an elastomer plant...as you may or may not know, there is an issue relative to the kind of products you produce in our rubber business. They do have a very short shelf life. And Canadian customers were quite concerned that the product coming out of the U.S., that the product they would be getting in Canada wouldn't be as well as what they were getting on a local supply basis. It does have a shelf life. They were concerned about that.

We thought we had addressed that by really targeting two of our other plants here in the U.S., in Wisconsin and Ohio. But, you know, Canadian customers were just concerned about delays, product quality coming across the border. And that's not unusual when it comes to the rubber business. That would be unusual, but that is not the case in most of the thermal plastic businesses. So they're really talking about two different things.

Okay, thanks, and another question. You mentioned the erosion in the vinyl compound business. What percent of your sales in PCC are vinyl compound? Ball park.

I think we had it in the supplement.

You may.

It's vinyl plus engineered materials plus...oh, no, we...yeah, PCC is in the supplement.

No, but just the vinyl compound is what I'm worried about.

Oh, what percentage is vinyl?

We'll have that number for you in a minute here, Nancy. We're not smart enough to have it on top of our head.

Okay, thank you.

We'll come back to you in a second.

I think the answer is going to be 60.

I think you're probably right. Sixty to 65 percent is the answer, next question.

Your next question comes from Abby Nash of Goldman Sachs.

Good morning, guys.

Good morning, Abby.

I had a couple of questions. First of all...this is a tiny little question. Where, on your cash-flow statement, do you show the cash payment for the pension fund?

Other. It would be in the accrued expenses and other.

Got it. Second question: I'm still trying to understand the receivables in the inventories. I heard, Dave, what you said about what your goals are in terms of days outstanding for each. And yet, I mean, this year it has chewed up huge amounts of cash. It has also led to the $150-odd million of extra borrowing that you required. Could you just go through, again, what has happened right now? It's not as if business, in terms of volume and revenue, is all that hot. So --

Yeah, it's not all...yeah; I get asked this about every board meeting. When you look our sales and you look at, say, August and September sales, and you compare that to November and December, you'll come up with $90-odd million of improvements. So we may not be pleased with where our sales are right now, and we may have even seen a slowdown, but relative to where sales were at the end of the year, we're still up just about each quarter so far, versus the end of the year, around $100 million. And so that's really what's driving the receivables and the inventories.

Also, depending upon what...if you're looking at the gross receivable, which would account for it, the other, if you're looking at the net, is that our receivable facility drawings are down not quite $30 million, I think, from the end of last year.

I'm just looking at the first nine months cash-flow statements for this year and for last year. And I understand that, you know, there are some swings because of differences in securitizations and this and that. But first nine months last year, huge cash generation, so to speak, from working capital, and this year a huge amount needed. And the differences are large enough that I'm not able to explain that in my mind.

Okay. If we look at...let's see. What are we looking at? One, in terms of inventories, as we entered '01, we were closer to 60 days. I mean, we talked about this last year...you may not recall...that we finished the year with our inventories fairly bloated in the year 2000, and so part of the draw-down that we did was just getting better inventory management practices in place.

And so, as we came through this portion of last year, our day sales and receivables were in the 47-48 range, as I look at the three months, July, August, and September of '01. And so part of what we're seeing is this year, in the end of September, we're looking at something around 49 and a half. So our DSI has climbed a bit off of a slight higher sales level.

Receivables, on the other hand, are up on a DSI basis, or a DSO basis. We've, in fact, improved them. But versus where sales were at the end of 2000 versus where sales were at the end of 2001, you're going to see in 2000, on a similar level of sales...third quarter sales were slightly higher this year, but not that much --

David, I don't mean to be a pest, but I'm still not getting it. I can understand why last year there was a, quote/unquote, "positive" generation of cash, because you were bloated at the end of 2000. Terrific, that's fine. Now, this year it's not that sales are very hot. I heard what you said about sales going up a little bit. But --

I wouldn't say $100 million in the relevant two-month picture is a little bit, though. Because if sales are up $90 million to $100 million in the August-September versus November-December time frame and our receivables are at about 56 and a half days, I mean, most of that $100 million is going to be seen in the receivable billed.

But, Dave, you just pointed out that August and September, if anything, was a touch disappointing. And if sales go up, and then payables also go up. I mean, all I'm saying is that just, you know, in a year that has not been terribly great, in an economy which is not terribly great, with the momentum the last two months being weak, you know, there's, I don't know, $125 million or so of cash requirement for receivables and inventories. It just seems like a lot. At some point, if you have to bring inventories down, you'd have to turn the operating rate from the plants down. And so I guess the question becomes, when do you see that happening? This year or do you see some of that happening next year?

Well, I think, when you're looking at what we've had to increase and you're comparing it to the fourth quarter last year, what we're saying is that receivables and inventory by the end of this year, which would be the comparable end points with this year's expectations for November and December to be stronger than last year, we're going to pull $60-plus million out of receivables and inventories by the end of the year. So, I mean, the type of slide that you're alluding to is in our plans.

In terms of receivables, as I say, that's just continued management from a DSO metric, comparable to where we are, just following the sales down. But also, on an inventory basis we've said we're over-target on where we want our inventories to be. And we expect them to be back to that mid-40s level by the end of the year. And, you know, that results in an inventory reduction from where they are at the end of the third quarter of some $30-odd million. And that's a combination of a lower sales level, looking at January versus, say, October, but also improving the metric.

And part of why the metric is over where we want it, as we point out, is there is this temporary bubble in our investment because of Triple Crown as we've had to put more material into inventory to ensure our service levels. There's also a couple of pockets where inventory has aged over the last four months that, you know, the relevant business team is committed to getting that out of the system.

I see. Okay, Dave thanks.

The next question comes from Gene Fullum of Salomon Brothers.

Yes, Gene. Hello?

Go ahead, Mr. Fullum.

Well, let's move on.

Your next question comes from Michael Sisson-ph of McDonald Investments.

Good morning, guys.

Good morning, Michael.

One quick question on your guidance for the fourth quarter, in terms of the sales decrease, sequentially fourth versus third, does that include any pricing assumptions?

No, not really. It's largely volume. Dennis?

Yeah, I agree. There's...you know, we did not build a lot of...I don't think we built very little compound price change into that, Michael.

Now, if you go back to the resin and intermediates, it does have a price assumption built in it. But, I mean, that's not our top line. That just shows up in our equity income, as you know.

Right. I understand. So you think you can keep pricing flat sequentially fourth versus third, at this point?

Yeah. Like I said, the only area where pricing is an issue, Michael, is in our vinyl compound area. Most of the other businesses are not going to be...they're not going to be under price pressure. And as we've talked about, we didn't get the entire price that we thought we were going to in the third quarter. And, quite frankly, we're still trying to get price increases in the fourth quarter.

So hopefully we'll retain it. I don't see a lot of erosion out. As we get closer to the start of next year, when we look at business conditions next year, you know, it'll be interesting to see where prices go. But for the balance of this year, we don't expect a lot of price change.

And as I recall from last year December has been depicted somewhat as an abnormally slow month. People shut down their factories earlier than most expected. When you look to this year relative to your guidance does December look more normal or are you somewhat expecting early shutdown for the year?

I think the way the industry has been reacting, our industry has been reacting over the last year, and the last month of the year is a month of inventory slowdown from our customers' perspectives. They obviously are looking at their balance sheets and cash flows as well. And so we expect that December will be quite slow.

But not --

Okay. And when you kind of gauge your customers' inventories at this point, are they somewhat in line, a little high, a little low?

You know, Michael, we have only...we don't have quantitative data. We only have qualitative data. And the only way we can look at that is order patterns beginning of the month and the end of the month. And, you know, we expect orders will be stronger in early November and very weak in late November, and likewise in December as people just watch their inventories and only build [inaudible]. We don't have any quantitative information. The only thing we can look at is order patterns.

Okay. And final question, could you just comment on market share in North America? Have you held your share this year? Are you losing a little bit here and there?

I think in...boy, that's a question we ask ourselves all the time. And the general managers of the various business units...obviously there are a couple of areas we've been very good at. I mean, our distribution business, it'd be hard not to say we haven't gained market share there. And, in fact, we did gain market share. In our elastomers business, we've...you know, if you exclude the people taking business back in house, I don't think we've lost any significant business at all.

In our North American PC&C business, and the biggest one being vinyl compounds, we honestly do not think we've lost any market share. We've lost customers, but we've also gained customers. And net, we don't think we've lost any market share there. And the only area that I think we would probably agree that has been tough for us, and we may have lost some market position...and it's probably more a two-year issue than it is a 2002 issue...is in our color business. And that's a business that, you know, as we've said, we're in the midst of trying to fix. And it's been really challenging for us to hold on to that business as we go through this fix.

And last question with the economic environment not improving as we all had hoped earlier in the year, have you seen the competitive environment become more intense lately?

Who likes competitors? They're always intense. I mean, you know, I don't think it's...it would be nice if we had such a differentiated business that customers [inaudible]. I don't think it's changed. You know, in the vinyl compound business, our competitors have been just as aggressive this year as they were last year. It hasn't changed. I think where we're doing better is because of our relationships with some of our key suppliers in some of our areas where we've been able to leverage our business and grow, especially in some of our engineered materials area and also in distribution.

Have you seen some of these smaller mom-and-pops have more trouble? And do you think your strategy of becoming bigger has given some of your customers more comfort in this environment that you, you know, obviously will survive and maybe some of the smaller ones are potentially going out of business?

I haven't seen any competitors going out of business yet that I can read. And, I mean, I'm sure there's a few that are struggling right now, and I know there's a few of them that obviously, you can tell by their actions, are having some cash-flow issues.

But we do really well, obviously, with the folks that look to us to be a global supplier. We've talked about this a number of times. The customers that look to us to have...you know a great example is Procter & Gamble. We use that all the time. We can sell their Tide color anywhere in the world, and that's the kind of suppliers they're looking for. And we've got developed and continue to develop a strong relationship with those types of customers.

Great. Thanks a lot.

Thanks, Michael. We'll take one more question.

Thank you. Your next question comes from Rose Marie Morbelli of Ingoll & Snyder.

Good morning, all.

Boy, I'm glad I didn't stop the call before I got your question, Rose Marie.

I hoped you would have been devastated. I actually have several questions. If your exposure to automotive is about 20 percent of total revenues, what is your exposure on the housing side?

Well, we don't talk about housing per se. We talk about building materials, because I don't think we have a metric to look at our exposure to housing starts per se, because we're a little broader than that. But we have about 18 to 20 percent of our business goes into building materials.

And is this mostly new construction, or is it maintenance and resale of, I mean, more maintenance?

It is both. We obviously have products that go into new homes. We also have products that go into rehab. I mean, the Home Depots and Lowes are important eventual customers of ours.

And do you have a feel for the streets between the two?

Honestly, Rose Marie, no.

Okay. So then on the covenant side, what was the requirement of debt to EBITDA for the third quarter? And where are you and what is the requirement for Q-4?

It was five and a half for the third quarter and five and a quarter for Q-4. And at the end of the third quarter, we were, I think, a shade under 475; a shade over 475...476.

We're getting lots of affirmative nods, David.

Okay, so you still have a little room.

Oh, yeah, yeah.

You talked about the elastomer side, and most of the business you have lost there, besides Canada, is in captive business, which went back in house. Is there more that you are going to lose, or have you lost everything that you had on the captive side?

I don't think we lost everything.

Okay. Well, then, details, please.

I don't think I can give you details as to who and how much, but we --

Well, a feel for how much could go away still.

I don't think so. I think the business that we have lost has already, you know, gone back in house. In fact, we're still capturing some business...doing some more capturing business. So we're offsetting some of that. Some of those that did take it back in were under discussions to recapture it. So I think we're...you're asking us if we're at the trough on that scenario. I think we are.

Well, even with automotive slowing, could that trigger a next wave of business moving away?

You know, honestly, my sense, from talking to folks in John Quinn's business, I don't think so. I think they've got some very aggressive plans. I think we understand captive conversion better than maybe we did two years ago. So I'm pretty optimistic that, you know, we're not going to lose any more business. In fact, if you look at it, their business has been strengthened a little here in the third quarter.

All right. On the distribution side, what do you attribute the strength in the third quarter, and what do you anticipate in Q-4 and '03?

Well, I think its two things. Obviously, as we pointed out, the vinyl business has been a terrific add-on to our distribution business. The customers that we gained as a result of that, they want to do business with one distributor. They don't want to deal with multiple distributors.

And so we gain some add-on business to the vinyl compound business, because in many cases, those were customers our distribution business had not been working with before. And they just did a terrific job. I mean, they have captured, from what we can tell, almost every single customer [inaudible] that was being serviced by Ashland, and they have picked up additional business. So, you know, I think our distribution business has done as well as we could have hoped for this year.

And what about this current quarter and '03? Do you see any change in trends?

Well, so far in October...and David, you can correct me...I think their business has been tracking quite well here in October. They've captured...it looks like they're going to have a very good month from a vinyl compound perspective. And overall, I think they're going to be pretty much on track the way they were performing in September.

Any sense for '03?

They're positioned obviously to do more. They're looking to pick up additional supply lines to distribute. I think, you know, as you may have read, there's some question about Ashland's retention of their distribution business. And so we're looking to see if there's an opportunity for us.

Okay. And lastly, you talked about pricing in the compounding area and some areas were more sensitive than others. Could you give us a feel as to the percentage of each of those? Where are you more likely to get pricing?

In the vinyl compounds going forward? Is that what you're talking about Rose Marie?

In the overall compound, not...yes, I guess your overall compound business.

Yeah, in the overall compound business, we tend to move it...as we get cost increases; we tend to move pretty rapidly. Most of the engineered materials and color businesses are not set prices. The one that floats with the market in competition more than anything else is vinyl compounds. Relative to that, I mean, as we said, the most challenging area we have is our wire and cable to raise prices here in the fourth quarter. And I don't know if we're going to be able to do that.

So we'll just have to see. We're going to continue to try that. But as I've pointed out, our exposure there is heavily in telecom, and telecom has been a segment of that wire-and-cable business that has been down now for almost two years, and we don't expect it to turn around. Though there's a lot of cost and price pressure in that industry and it's very difficult for us to raise prices there.

Okay, thanks a lot.

You're welcome. David, anything you want to add?

No, no. I want to thank everybody for listening in, and hopefully...I know you'll give Dennis a call. I will be back in the country as of Monday if there are questions that anybody has for me. Don't hesitate to give Dennis or me a call and we'll do our best to get the answers out to you.

Yes. Thank you, David. And thank you for joining us this morning. And, again, if you have additional questions as the day proceeds and beyond, feel free to give us a call. Thank you.

Thank you, gentlemen. This concludes today's PolyOne third quarter 2002 earnings conference call. You may now disconnect.