Avient Corp (AVNT) 2003 Q2 法說會逐字稿

Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to the PolyOne 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 star, 1 on your telephone keypad. If you would like to withdraw your question, press star, 2 on your telephone keypad.

And now I would like to turn the call over to your host, Mr. Dennis Cocco, Investor Relations, and Mr. David Wilson, CFO. You may begin.

Thank you. Good morning, everyone, and thank you very much for joining us this morning. First of all, I recognize that some of you -- folks here at Cleveland and us have created some conflict on the conference call. Apologize for that. We do try to make sure we don't cross each other throughout the chemical industry, continue to do that unfortunately -- had a lot of choice on. As you know, we are web casting this, and broadcasting this live on our web (inaudible) next two weeks.

As we go into the Q and A session, I'd ask only the analysts to ask questions. The media are more than welcome on this call but I'd ask you to hold your questions. One thing I'd ask you to do also is to - the forward-looking statement that is in our press release.

We have tried to detail all the particular issues that might affect some of the forward-looking comments that are both in the press release -- talk about today. There are things that could materially change throughout the quarter. Make sure you keep that in mind one of the things that we did not put out in our press release this past month is a small divestiture of a joint venture that we had in Australia called Welvich (ph). We do discuss it in our supplement. We did not do that because we didn't consider -- I just wanted to note that to you that occurred long ago. That concludes that, and that shows up in our resident and intermediate -- by reporting segment.

A couple things that I wanted to point out in the press release and a couple comments -- number one, I don't think there's anybody here that is obviously satisfied with our performance the past quarter. The way we're going -- possible, look at the things - very positive steps we've made in the last quarter, and while the economic conditions are -- Dave is going to talk a little about -- certainly affected our entire industry -- continue -- forward on the things we can control and are doing -- we think is better -- by the end of this year -- next year.

Some of you who attended the MPE show in Chicago, I'm sure you heard from our competitors and other folks there and our customers that are - second quarter. -- challenging for me to understand how the second quarter --, on the other hand though we continue to take some -- steps. We continue to work on our SG&A costs -- now starting to pay dividends not only in SG&A but also a little bit of market activity.-- really important. Continuing to price our products, we're looking at the markets that we're involved in, we're continue to market to key customers.

We need to look at products that are non-profitable in our product line and take actions on those --. The levers that we have internally, we have a very precise and detailed program that we'll move forward on. So with those few remarks, we'll be happy to take some questions in a few minutes, and I'm going to ask Dave

Thanks, Dennis, and thank you, everyone, for listening in this morning to our conference call. As Dennis said, second quarter was certainly a disappointment coming out of the first quarter and the momentum we thought we were seeing and then going into April and having to largely confirm and then having the door shut in May and June was a significant disappointment. Some of the anecdotes and I'm sure you all read the trade information and have heard other companies talk about it, but for our OxyVinyls business, the second quarter was the second worst quarter in its history.

The fact that its volume was off 20% first quarter absolutely astounding and the fact that --actually took a week off is astounding for a second quarter, and it probably speaks to the fact that there was a feeling of momentum in the first quarter coupled with -- hydrocarbon or energy-based price increases that were coming down the way, and I would guess that it's probably -- clear that there was some stocking going on in our customer base in the first quarter that was in anticipation of price increases that were announced, as well as clear expectation of typical season recovery second quarter versus first quarter.

Then as that did not materialize, de-stocking began, and there was one comment that I read that made it sound like from the PVC side that, the month of May seemed like the month where everybody tried to buy as little as possible -- year-over-year comparison down about 20% as well.

Be that as it may, our challenge is to bring this company back to profitability, and as you saw in our press release, we're not seeing the economy improve, not seeing a market condition favorable on a net basis to our margins, and so for us to -- our earnings level that we have, you have to take aggressive decisive steps. In the release, we talk about some pricing initiatives that we've done, talk about five different actions on our manufacturing side. We don't talk about that we're realigning some of our SG&A as you would expect further efforts from the January activities that we had, and we point out that those activities should, on an annual basis, on the manufacturing side, improve earnings by some $15 million, and we know that we've still got work to do.

We've stated publicly many times that our SG&A sales has gotten to be under 10% to be competitive. We can all calculate that we're not there yet, expect that there's more to do in that arena as we thought. And so our challenge as a management team over the second half of the year is what we can bring the business back to profitability certainly much stronger earnings base for 2004, but not give up on the second half either, although as I say, there's not a lot in the marketplace that points you to that direction.

The other thing we need to do is demonstrate an ability to generate cash. Second quarter, our cash flows were slightly worse than I would have wanted them to be. The principal area was inventory, getting caught short because demand doesn't -- it's getting to be fairly hollow in everyone's ears, and we've just got to lever the information -- how better to get ahead of that curve.

On the other hand, our receivable performance continues to be very good, down a day and a half from the end of March to June.

Overall, you know, our challenge really -- it is our expectation to generate cash in the third quarter some improvement in working capital. Second quarter is, in fact, from a cash interest expense or a cash interest payment perspective unusual as the fourth quarter half of our interest that we pay seemingly comes out second and fourth quarters. Third quarter, we'll get a benefit there, and too, some anticipation of cash coming out of our equity affiliate.

But that is clearly a challenge for us. It's unacceptable not to be generating cash financing and bond yield and restructuring of our short-term facilities to give us a very strong position on liquidity, we've got to ensure that we maintain that strength, even in a tough operating environment. those two ends our cash management as well as pulling other levers internally that we our costs down sales profitable even in an operating environment like we have, our mission of the management and employees of PolyOne going forward.

With that, I'll turn it back to Dennis.

Let's take some questions.

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

Your first question comes from Mike Franson of MacDonald Investment.

Good morning, Mike.

Good morning, guys. Can you hear me?

Yes. Can you hear us?

Yeah, it's actually a little fuzzy, to be honest with you. I don't know if it's my phone or -

We have a little problem with the system this morning.

Regarding your comments in the release that PolyOne is maintaining market share at target areas, that sounds encouraging. Can you give us a little more specific via product line and why you think you're able to sort of hold share?

Yeah. Well, looking into vinyl, which has been one of the areas where there's been some question, our volume went up in the second quarter and arguably the industry would appear to have gone the other way. Now, some of that is put and take, so the fact that we held volumes and showed sequential improvement would indicate to us that we're holding share plus, you know, we know where we battle.

On the Elastomer side, we may not have held share overall to the industry as a couple long-term accounts. Some of our major customers, in fact, took pieces of their business back inside. We didn't lose it to competition, they just -- you know, they're challenged as we are, and so they're finding ways to cut their cost.

So in the Elastomer side, we may have given up some, but on the color side, you know, I think there's some pretty good news out there that there's a story in Plastics News relative to Folgers going to a plastic coffee and we will be the for that project.

And so that is a very, very important win, and I think a reflection of improved capabilities that we now have. We've talked about the fact that we've needed to improve our turnaround, our color match capabilities, being able to land this large and this important of a job is an indication of the improvements we've made. More to do, the more we can do, the more we will do, but it is a reflection that we're starting to see the benefits in the marketplace. So that's generally, Mike, where we would get and draw those conclusions.

Great. And in terms of your go-to-market strategy, what logistically have you done thus far since April, and what is left to do for the rest of the year to sort of complete the transition, if you will?

What we've done so far is we have done a rather broad and full segmentation of our customer base in order to determine what services we provide that they value so that we can tailor our offer to them, and then align internal resources to support the customers according to what they value.

People who don't want tech service, whatever, know, they basically want a low-cost product on time, we'll put a low touch, low cost service delivery system in place for them. We've also re-priced low-end customers. We've done a lot of product customer profitability analysis.

We make mention of the fact that we believe that there's about a $2.5 million benefit to actions that we've taken there. Now this is outside of broad price increases like you'd normally -- surgical, looking at populations where the margins aren't where they need to be in going after it.

Yet to do is to continue to work on sales close, target key account management, put sales plans in place more specific than what we've had in terms of leveraging -- as an outgrowth of the segmentation, determining those customers that do look for the value solution package, and then making sure that we've got a broad company-wide coordinated response to that. And then on the target closes, that's a continuing process.

What the initiative does, frankly, is puts more discipline into the process. The Folgers success that I just mentioned is clearly the work of over a year of effort, but it's a Goodwin on the target closes, and our challenge in this environment is to be able to go into the market and make customers say, yes, new customers as well as old customers for broader areas of their offer.

OK. Last two questions. Number one, do you think the inventory de stocking phenomenon that happened in the second quarter sort of flushed through the system? And secondly, when you think about the important variables that are required to sort of improve your operating results to what they were in the past, let's say improve utilization, maybe lower raw material cost or get this go-to had-market strategy, you know, up and running, which ones in the near term are most important?

Well, I think the actions that we've taken on the plans, those are fairly rapid. What I would do is I'd go back to January and just the whole -- we call it the aligning for profitable growth. What we did in January is took a large chunk out of our SG&A, went after it hard and fast and got that success.

We then initiated the go-to-market and sourcing initiatives, and really on the manufacturing side, put it on the back burner because we knew we had capacity that exceeded our existing business or our existing sales base, but we also believe that we were aggressive in an up economy, we could get some of that business back and still -- plans.

As we came out or got into the middle of the second quarter, it became apparent that that was not going to happen. Now it's not as if we had a lot of costs associated with that. It doesn't take a lot to bring shifts in or out or lines up or down, relatively speaking, in a compound business as compared to a revisitation business.

But at that point, it became clear that we needed to take a hard look at our capacity utilization and just bring our capacity down to the current level of business. Five actions that we took -- that we've taken that are highlighted in the release talk to that.

Also, really the go-to-market intensified that. It really has been on a fairly accelerated base from the beginning because we've known that what we've got to demonstrate, what we've got to start doing, building our top line. And that whole initiative is to do that and to align the resources and the company supports that as best as possible.

And the sourcing initiatives, we've continued to do the challenge that we've got on sourcing, and it's sourcing as you've all said to us over the last two years, is extremely elusive to be able to keep those savings once you make them.

And so one of the actions, initiatives that we have going that really blends between go-to-market and sourcing is assuring that we have the price disciplines and we have the ways to track price decisions that ensure that we're able to see that we keep the sourcing benefits that we capture. Near term, obviously cost is the quickest lever, and so the manufacturing actions were taken.

Next round, you know, going after the next bit of SG&A is more over early into 2004 target because we've got to do it carefully. It's just not pockets of cost that you can take out without jeopardizing parts of the business, and so we've got to do that very carefully, make sure we make the changes structurally as well as organizationally to be able to capture those benefits.

Going forward after -- going forward into 2004, it's clearly got to be the market initiatives, because that, as I say, is where the top-line growth has got to come from. You should be able to take out costs to be profitable in this environment, but not at a satisfactory level. For us to get into satisfactory earnings levels, we've got to start improving our delivery of variable margin dollars to the bottom line.

Great. And just your quick thoughts on the inventory situation, and I'll get back in queue.

The inventory situation, we just have got to hit it hard. We have plans, we'll get it down some and the forecast has it coming down some in the third quarter back to where it ought to be by the end of the fourth quarter, but inventories -- you've got to look at inventories as day-to-day management. You've got to get in, lever the information systems and just get on top of that harder than we have, and I believe the business teams have got that square in their sights, and I will be disappointed if I don't start seeing improvements in the months between quarters end.

Mike, I think you're referring to customer inventories.

Yeah, customer inventories.

You see where my mind is at.

Which is OK. Mike, I guess the only answer to that is obviously we don't see any further deterioration from where business fell in the April/May time frame. We have a sense that certainly it looks like it's bottomed out. The only question, is when they'll regain confidence to start building inventory. You know, they're obviously looking at -- you know, as prices have peaked out and they're looking for prices to decline, they're going to wait and see where prices decline to.

A lot of the industry sees prices moving down, but there's -- you know, August will be a good month to see that. You can't see it in July because of all the shutdowns, and we'll have a better sense of that in about another 30 or 40 days.

OK. Thanks, guys.

OK.

Your next question comes from Nancy Traub of Credit Suisse First Boston.

Can you hear us? Alright?

No, it was very light.

I'm sorry. I think we're having some technical problems, and I apologize to everybody. We'll try to speak as loudly as we can and hopefully you'll be able to hear us.

I want you to comment on raw material cost in your business outlook, you mention about them being troublesome, and PVC being one of them, I would think that would be beneficial to you, so can you give us a little more color?

Sure. PVC unfortunately is projected to come down, and I say "unfortunately" because, as you know, we're net sellers of it, although our operating businesses clearly are buyers. I think -- and we're also would b e expecting that chlorine will be down a piece and ethylene will be down a piece. But there's going to be continued -- pressure for the non-resins, non-more commodity-like materials as those suppliers continue to try to get price increases into the market place.

I think the other part and it's really (inaudible) more on the margin side than just price, is that to the extent that raw materials continue to soften would be a reflection of the market itself, and quite honestly, the softness at the end of the second quarter took all the wind out of the sales as the vinyl and the Elastomer price increases that we had, and so pricing in the third quarter is going to be very much of a challenge, I believe, and price erosion may take the benefits that you normally expect from softening raw materials away from us. I think we and the rest of the industry are going to have to work hard to maintain pricing in the third quarter unless demand starts to improve dramatically. And as we've said, we don't see that occurring yet.

So real raw material cost you can specify that are going up?

No. I'll pass that to Dennis. We are trying as hard as we can to make them do the opposite, and I'm not aware -- you know, we're not necessarily successful in getting them down, but we have for the most part, I think, stopped them from coming up.

Right.

And if there's a couple that are going up, Nancy, it should not be material. I think our challenge is to hold our margins, increase our margins and to do that, it's got to be more on holding our pricing.

I don't really have much more to add because as you know, most of the polymer-based products, you know, have started to rescind, although slowly, and of course some of them have actually gone back out and asked for additional price increases as they've suffered some margin compression too in the third quarter. But you know, I know, we've had a pretty good run-up in the second quarter on some of these products. We saw that very dramatically in our distribution business, and while there's going to be some slow erosion of those prices, we don't think it's going to be enough to impact margins.

And, you know, it's also clear that we did not get price increases up enough in the second quarter to offset the raw material inflation that we saw at the end of the first quarter going into the second quarter.

Right. Were you successful in getting some of your compound prices up?

Yeah. We got over 3 cents in the second quarter as compared to the first. If we look at quarter two versus quarter one on an income variance basis, if you will, final was worth about $8 million to us.

her thing is that in your forecast, I can't find it again, but it sounded like you don't expect to be any better than you were in the second quarter.

We swallow hard at that because where we were in the second quarter is unsatisfactory. But what we're saying is, there's nothing in the external environment that would give us reason to believe we would do better. If we do better -- internally. Be assured as you see in the press release, we are taking aggressive actions across many fronts to get our costs down so that we don't repeat the second quarter. But there's nothing out there that would tell you looking out, you know, any of the macro factors, pricing, margins, what have you, that would indicate that the third quarter is going to be better than the second.

So it sounds like it would be worse, what you said previously about the resin spreads coming down and also your -- business, margins being squeezed probably. Do you think you have cost-cutting that can offset that?

We're doing all that we can, Nancy. We're not satisfied with where we are, so we've got to raise our profitability and we can't make ourselves think the market is going to do it for us.

One other question. In distribution, you mentioned sales down 3%, volume down 15, and U.S. and Canada, sales were down one, volume down eight. Where is the rest of the decline?

Mexico. And we're in the process of phasing -- we're in the process of transitioning that business. We're moving to -- basically move out of most of the distribution business in Mexico. We're retaining some U.S.-based customers. The Mexican operation had a color plant. That is being integrated with our color business, but as far as Mexican distribution, we're by and large exiting that business.

And is it safe to say you're out of it already or what should we expect in future quarters?

Third quarter will be drips and drabs, and fourth quarter, we'll be out.

Thank you.

Your next question comes from Bob Goldberg of New Vernon Associates.

Good morning. One question on OxyVinyls and one on the cash flow. On OxyVinyls, I guess I was maybe expecting to hear a little more positive commentary about the volume outlet for maybe August and September. Is it too soon to see the order books for August? We're almost there. Or is it not just materializing?

I think their outlook is certainly an expectation that the third quarter will be better than the second quarter. The question is, is it going to be as good as the first quarter. And from a PVC resin perspective, but their business is picking up, but it's -- you know, as I said earlier in my call, August is a critical month not only for our operating business, but for OxyVinyls too. It's looking better. It certainly could be even better than it's looking, but, you know, it's not getting any worse.

I just wanted to understand that, a little more color on that. It sounds like you're characterizing it in your statements and the press release as a pretty modest improvement versus the second quarter.

From a volume perspective.

You mean second to the third in

Yeah, second to the third.

The volumes in May tanked, they came back a little bit in June. They're encouraged by July, although July is July. That's usually a softer month. And so expectation would be improvement in August, but not to robust levels. So improvement, yes. Robust, no.

I think there's a reasonable chance that oxy vinyl shipments overall will be up 10% from the second quarter or so, but the real challenge -- it's going to come -- you're going to see it in August and September, and it's a little difficult for us to predict. We didn't do a very good job at the beginning of May looking at May and June, so -

The other challenge on OxyVinyls, as you'd guess, is whether or not the October -- or the August price increase that's on the table is successful. If it's not, resin spreads will decline in the second quarter as compared to -- I'm sorry, decline in the third quarter as compared to the second.

If July was -- doesn't seem to be reflecting a lot of pre-buy, July's volumes.

I would be surprised if the processors think that that will happen, but we're one step removed from that.

On the cash flow, Dave, I wanted to go through some of the items for the second half that you mentioned in the supplement. When you have interest expense of I think $39 million, you mentioned in the second half CAPEX of 24, restructuring, cash outlays of 17, that gets you to, I believe, $80 million in outflows for the second half, which is more than the EBITDA you have in the first half by about 20 or, I guess, 18 or 19 ex-special items. What else -- talk about some of the ins and outs and the terms of the second half cash flow. My concern is not so much that you're losing a little bit of money, but the cash drain was pretty significant in the first half. In the second quarter, I think you -- something like 50 or $60 million.

The working capital in the second half of the year, we would project to be coming down at least $50 million. We're also anticipating that the type of earnings that we have in the OxyVinyls and to a lesser extent SunBelt will turn to cash, which, per se, they haven't yet. And those, I would guess, would be the two majors in terms of improvements to our cash flow that would tend to offset what was coming out. You know, you've got to make your own assumptions on the earnings. We haven't anticipated -- we have an anticipated $15 million or so pension payment in the third quarter. Outside of that, those are -- you know, those would be the majors. Working capital coming back down and cash from our equity affiliates.

Why haven't OxyVinyls and SunBelt distributed cash in the first half?

OxyVinyls typically doesn't. It waits to see its cash position for the rest of the year before they distribute, and it's -- OxyVinyls is on a dividend basis, it takes an action to do it because Oxy does the treasury. SunBelt is more of a cash-as-you-go basis, and there were expenditures, capital expenditures in the first part of the year that were larger than normal, associated with an expansion. But we would anticipate that OxyVinyls will distribute cash in the third and fourth quarters, and SunBelt will be net positive even after a payment of the $6 million off the guarantee at the end of the year.

All right. Dave, did you say SunBelt is expanding capacity? What was the capital outlay?

The capital was more than it normally was. You know, SunBelt has done a little bit of de bottlenecking. I mean, you know, that's -- it's one of those things that clearly you want to be able to do, but it's not -- you know, SunBelt's capital expenditures typically are about a third of its depreciation, and so that's usually a pretty good -- of cash, and there was a little bit more capital expenditure done in the first part of the year, so we didn't see that.

Can you just tell me how much capacity they added to the market?

I can't right now. Can I come back to you on that?

Sure. Any thought on how much -- I mean, should the distribution for OxyVinyls be forced into the equity income?

Yes. That's our expectation.

Thanks. I'll get back in.

OK.

Your next question comes from Kunal Banerjee of Goldman Sachs.

Good morning. Just a couple of questions and then one just to follow up on the previous question. First off, where is your capacity utilization today post all the facility closures that you've implemented first half?

Low 70's.

Low 70's? So you've still got a fair bit of realignment to do, is it fair to say?

When you take a look at what we put into the press release in terms of taking many of the vinyl plants down to five days, the engineering materials restructuring taking a couple lines down, you know, those actions are intended to take our capacity utilization up to, you know, the low 80's where we would want them to be, and in some cases on the vinyl side, it's in the 90's, and for an effective capacity rate, that's pretty much where you'd -- that's pretty much where you'd want to be balanced. So I do not believe that there are other major realignments required.

We've taken actions that we believe get our capacity in line now and are going to be starting to capture the cost savings a little bit in the third quarter, more of a full measure in the fourth, but, you know, we will continue to take a look at that.

So at this point, are you past the permanent closures and you're just basically looking at flexible adjustments through workweek adjustments, et cetera? Is that --

I it's my hope that that's the case, but, you know, we will continue to look at where the demand is, the product lines, so I wouldn't say that there won't be further plant closures. I don't think we could ever say that. But I would say that we are looking more now at, as you call them, the flexible realignments.

The thing I would add, Kunal, is that each of the operating plants obviously are working very hard to improve their operating efficiencies, and, you know, as we also do some product rationalization and some other things to improve our operating efficiencies, we're going to free up additional capacity.

As we do that, we're going to continue to assess whether we need to shut down additional lines or other plants, but that's something we're going to continue to look at. That's an ongoing thing as we go through the go-to-market process.

Right, and related to that, when you make those decisions about, you know, walking away from the unprofitable business, I'm just wondering, how do you balance that decision with the need to load your facilities, given that you're still in the 70% range on utilization? I mean, in other words, is the business that you're walking away from business that wasn't even yielding incremental positive margins, i.e., uncovering variable costs on that business? Can you talk a little bit about that?

First of all, we're not walking away from business. What we're doing is re-pricing product, and, where necessary, we'll re-price products to the point where we return at least the variable margin component of our investment. In general, we're talking about relatively small volumes overall here.

As you recall, if you remember seeing our presentation back in February where we looked at where most of the gross margin is generated relative to customers and customer size, there's a very large component of a number of products that deliver very little gross margin, and that's the component that we're assessing, but at the same time, we believe a lot of those products can easily be re-priced or the service offering can be adjusted to those products to make them more profitable.

So we don't expect overall that some of the re-pricing and product rationalization have a huge effect, but it's something we're going to continue to look at as we go through this over the next few months.

Do you have a guesstimate what's the hit going to be like 3% on volume?

I don't think we're ready to -

Not even that?

One thing I want to correct, you know, the 70% is where we were, say, in the second quarter with the actions that we're taking, you know, we're going into the 80%, which is pretty much for the product mixes, you know, where you want to be, because you can't be at 100%, so we're balanced -- you know, we believe we've balanced our capacity now to available demand to be able to service it the way we think we need to.

OK. Fair enough. And then just on PC & C and engineered materials. I notice that you had a negative mix shift in compounds and colors but a positive mix shift in engineered materials. What was going on there?

In the engineered materials, there would have been a higher percentage of proprietary, which frankly reflected -- what it reflects better is a less amount of producer-type volumes.

Right.

On the color side, it's a shift to general purpose, but here too, it was more a relative decline on the specialty side, much of which is rectified by the project that we talked about earlier.

And were you able to feel any addition - seal any additional deals on the proprietary side and engineered materials -

That would be on the producer side. And I'm not aware that we've announced any, but, you know, we continue to get some business, yes. But not that we talk about specifically.

OK. Thank you.

Your next question comes from Bill Hoffman of UBS Warburg.

Yeah. Good morning. Just a question going forward. You mentioned $24 million in CAPEX in the second half of this year. Just wondering what you're thinking for next year and whether there's any flexibility on this year's number as well.

This year's number started out at 50 and we've ratcheted it back to 40 because of conditions. If conditions don't improve, I think 40 will be the high number next year. What we will be doing is expanding our international operations. I think international capital represents about half of this year's number. It's a little less than half. And we'll continue investing in our international businesses as we can, as opportunities arise. As long as North America continues to be soft, we will not be spending more than we are this year. We may even ratchet it back some. So, you know, if things don't improve, 40 is the top number, I think.

OK. And then just with regards to the JV, any sense of just sort of if we stay status quo how much cash might come out of that JV in the second half?

Well, it's what you think our earnings would be would probably be the best answer. And we don't forecast or project OxyVinyls earnings, although we don't expect them to fall off the table, but we don't expect them to rebound strongly from where they are right now, and fourth quarter is usually softer than the third. So if I looked at it, you know, probably a little less than we got last year, but, you know, we would say that we would be seeing a balance of cash and equity earnings.

OK. And then just final question, as you looked at -- capital, you mentioned $50 million of cash -- second half. Assuming that going into 2004, we'll have the same working capital swing that you normally see seasonally in the first half of that year, is 50 enough to buffer that cash -- those cash needs early in the year next year, assuming we have a similar year to what we're looking at now?

I don't know. I hope so. Part of the challenge we had in the first half of this year is coming off such a horrendously low December. There's nothing to say that December won't be 2003 won't be as tough as it was in 2002. If that's the case, that 50 number goes up because we're certainly not projecting that bad of a December/November period. And as I look at the cash out and I looked at our days in inventory, you know, I think we're $20 to $30 million high on our inventories, frankly, and so we get that in line, make some continued improvements in working capital, I would guess you would see a use of cash from working capital in the first half of the year. I don't think that dynamic will change, but I don't think it will be as dramatic as we've seen this year.

Bill Hoffman And then if you wanted to target to get that $30 million of inventory reduction in the second half of the year, are you currently set up operationally, or is it going to take more downtime and rationalization to get there?

We're set up operationally to be able to do it. It's one of the challenges, we set goals to get people accountable, measure it gets done.

Thank you.

Your next question comes from Robert Ottenstein of Morgan Stanley.

Hey, guys. A couple of questions. Just to follow up on the working capital, is it right to say, OK, so you've got $50 million, you're going to take out 20 to 30. Is inventories in the second half -- is that right? And then where would the other -- where is the rest going to come from?

Largely seasonal.

The rest is a seasonal -

Right. Right. I mean, fourth quarter will be lower sales undoubtedly than what we're seeing right now. Although I'd like to be wrong on that.

Right. Another question, sequentially, Q1 to Q2, can you tell us what happened to color volumes and distribution volumes?

Yeah. Yeah. Color volumes Q1 to Q2, color volumes were down about 6%. Distribution overall was down 8%, but I think a lot of that is driven by the Mexico situation, and so in the U.S. and Canada, 6%, so it was impacted by two percentage points. and frankly, as we've looked around and listened, you know, we believe that those types of numbers sequentially are reflective of where the market was. You know, the vinyl business was up couple percentage points sequentially.

Our formulator business was up 4% sequentially, which is good to see. It had last half of this year and first quarter this year, it had been in a hard patch in terms of its volumes and our international volume sequentially went up 6%, which is extremely encouraging as we're seeing demand rebound in China after a dip May associated with SARS.

Robert, I'd add in the distribution business, there's really two stories there. The engineered materials products that we distributed actually did reasonably well in the quarter. Where the big fall-off is in our commodity resin sales. They were obviously because of our relationship with the people that supply us those products, we were working hard to try to raise prices in the second quarter on commodity resins, and there was a lot of pushback by customers on those products.

Engineered materials (inaudible) I don't have the breakdown between those two.

So maybe the engineered materials was down 2 and resins was down like 15?

It may have been something on that order of magnitude.

Initially, the 8 looked pretty good initially.

Yeah. It was almost all in commodity.

Looking at into 2004 based on the plans that you have, where do you see depreciation going to? What was it, you know, in the first half in this year and what does it go to in 2004?

I don't think we've projected it's going to materially change, Robert. It's going to be roughly -- D & A in total is about $74 million for the year, and we would expect it to be within a million or two of that.

So even with the plants coming down, that's not going to reduce depreciation?

It will reduce it a little, but these aren't highly capitalized plants. The fact that we're spending less in depreciation probably in time will have a downward drag on depreciation, but, you know, within a couple million of where we currently are, I think is probably a pretty good projection.

OK. Great. Thanks a lot, guys.

Thank you, Robert.

Your next question comes from Omar Jama (ph) of Merrill Lynch.

Good morning.

Morning.

You guys answered the OxyVinyls question I had, with but another question, the JVs have debt, and a I'm wondering what kind of financing have you in place at the JVs, and there are any debt maturities coming up that might have to be - and if there are, would they be funded by the JVs or would you guys direct your balance sheet cash to help them?

The SunBelt debt is being amortized over the next 16 years, I think $6 million a year, our portion of it, and we would anticipate that SunBelt would fund that. In terms of OxyVinyls, the guarantee that we had in place went away in May, and debt that OxyVinyls has will be paid by OxyVinyls cash flows. So there's really no - I would see no call on our balance sheet to fund any equity affiliate debt.

OK. And could you just repeat your annualized interest expense?

Well, I think on a run rate basis, it's going to be around $18 million a month. Now -- I'm sorry, a quarter. Good gracious! A quarter. What you've got --

Couple people are on the floor right now.

And third quarter is, you know, continuing to pay interest on about $56 million of the September maturities, and then obviously in the fourth quarter, that goes away. So we will see interest expense, I would project in the third quarter about $2 million higher than what we saw in the second quarter, but then it should come down by a million, million and a half in the third quarter -- I'm sorry in the fourth quarter as compared to the third. And that, depending on your projections for our cash flows, would go down by what you'd think our short-term funding would be required versus where it is today.

In your outlook, it seems to be kind of a -- outlook. If people are de stocking, wouldn't you have the expectation that they would be restocking at some point or do you think people are comfortable with the inventory levels they have?

I wouldn't call it dower. I'm trying to be realistic about what we know and what we see and be as truthful as we can be. It's realistic more than it is dower. It's hard for us to expect business to pick up after what we just went through in the second quarter. Certainly we're doing everything we can internally to generate more sales and hopefully encouraging customers to buy more but there's just nothing on the horizon. There's nothing that we're hearing in the industry that would indicate anything is going to change from a demand perspective of any substantial - I think customers, if I had to be a customer right to today, I want to see where prices and costs are going to be and where my demand is going to be, and I'm watching cash just like everybody else, and I suspect that's what they did in the second quarter.

Thank you.

We'll take one more question.

Your final question comes from Bob Goldberg of New Vernon Associates.

Wanted to ask you guys about the impact of all the cost savings measures. Any thoughts on the change in the cost base from year-end 2002 to where you think you'll be at the end of this year and what the savings during the year might turn out to be?

Well, let's see. We know on an SG&A basis, we are capturing the 40-plus percent run rate from what we did in January. We've started the year with a $15 million offset associated with pensions and benefits and those sorts of things.

Our plant costs in North America, second quarter to second quarter, were down $20 million on a direct cost basis, but compared to where we are for the end of the year, you know, our expectation was to pick up about $24 million associated with triple crown, $15 or so million dollars associated with the actions that we've just taken.

We know we've got another round of SG&A to get us to 10%, so I'm not sure what all those add up to, but it ought to be a dramatically lower number, Bob. What we're doing is we're looking at where the business is today, and, you know, I think margins are about as compressed as they're going to get. I think volume is about as down as it probably is going to get, I hope, so that on a variable margin basis, we should be able to sustain that kind of delivery.

And so what we need to do is then take a look at our cost structure from where we are now going forward to be able to get our self to profitability. And that's going to require taking some significant actions. We've taken some in the plants, we'll take more in SG&A. So we're looking to get ourselves profitable and the cost base aligned with our current volume activity.

Just last detail question, I think you mentioned in the release that natural gas expects to be flat 2Q to 3Q for OxyVinyls?

That's an operating assumption.

Is there some hedging involved there? Because the cost in the market is coming down.

No, there isn't hedging, but, you know, we're seeing it come down. We're glad it's come down. But I still get concerned about changes in weather and changes in dynamics. I'm not sure why it's -

If the price were to stay where it is through the rest of the quarter, would you have some cost savings there?

Yeah, we'd have two months of about a dollar per million MBTU, which would be worth about, what, $2 million to PolyOne.

Thanks.

Thanks, everyone, for joining us this morning. Again, I apologize for the quality of the call this morning. We didn't recognize till later that we had a problem. But Dave and at least I will be here for the next day and a half. Dave will be here for parts of today, and we'll be happen to circle back if any of you have any follow-up questions. Have a great day, guys. Take care.

Thank you for participating in today's PolyOne earnings conference call. You may now all disconnect.