Avient Corp (AVNT) 2004 Q2 法說會逐字稿

Good morning. My name is Amanda and I will be your conference facilitator today. At this time, I would like to welcome everyone to the PolyOne Second Quarter Earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a Q&A period. If you would like to ask a question during the time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your questions, then press star, then the number 2 on your telephone keypad. Thank you. I would now like l turn it over to Dennis Cocco. Sir, you may begin.

Thank you, Amanda. And thank you all for joining us this morning. We have Tom Waltermire online. He is actually not physically here. Dave Wilson is here in the room with me and we'll be having some opening remarks from them and then take in some questions from you. We're going to conclude this call at 10:00. As you know, this is the earnings season so we're going to try to keep it short (ph).

Dave and I will be available for questions from you if you want to -- if you don't get them answered on this call after 11:00 this morning. If you, for some reason did not receive our earnings release, obviously it's available on our website, as is the Q that we issued. If you want to get a hard copy, feel free to contact Darlene (inaudible) my assistant at 440-930-1522. We are broadcasting this call as we have been even in the past and we'll (inaudible) this call available on the Website for at least 2 weeks, so you can review that, if you like.

First of all, I'd like to talk a little about the safe harbor. Today I'm sure we're going to be talking about information that we consider forward-looking. As you know forward-looking statements give certain expectation and forecast future events and obviously they don't guarantee anything about our future performance. But based on what we think are involve number of business risk. And anything that we talk about obviously could actually vary differently or materially from those that we actually talked about. I would specifically suggest that each of you read our forward-looking statement. We update that almost every press release when we review the risks of the business. If you want to access that it's obviously in our Website. It's in the 10-Q and the press release. It goes through the very specific factors that we've updated and reflected our current thinking and the risks that we may talk about from the forward-looking perspective.

We do use non-GAAP terminologies in the release and most likely here also in the conference call. Particularly we're going to talk about operating cash flow, operating income before special items and the shared effect of those special items. The most directly comparable GAAP financial measurements that relate to those measurements are net cash. By operating -- net cash provided by operating facilities, activities, operating income, and income loss per share. Why do we do that? We believe that use of non-GAAP financial measurements from our management perspective are important. It helps us review the consolidated and segmented results particularly on a special item basis to enhance our understanding of current profitability levels and how those current levels they may serve as a basis for future performance. They're also used for us to allocate resources.

In addition, the operating cash flow and operating income before special items are components of our annual operating incentive plan. In the press release, there is a reconciliation of the GAAP to non-GAAP terms. You could find those in the press release on our website. If you go to www.polyone.com, go to the Investor Relations section and click into the recent news, it's attachment number 5. And it will reconcile all the non-GAAP and GAAP terminologies that we (inaudible). For any questions on, that -- on that, feel free to give me a call. Now I'll turn the call over to Tom.

Dennis, thank you very much and welcome everybody. I have a few introductory comments here to summarize the quarter, how we're looking at the business and then I'll turn it over to Dave Wilson, who will go through the specifics and on to your Q&A. We are naturally quite pleased with our second quarter and our full first half. It's important to emphasize the progress we've made is not just a one quarter thing, it really is our whole first half. As one measure of that, our second quarter and our expected third quarter which we've outlined in the press release, those two quarters individually are both better than what many people thought we'd actually be able to achieve for the year as a whole when we began the year.

We're delighted that every one of our business units, both our continuing units as well as discontinued business did better than a year ago. So they contributed to the improvement. Now no doubt that the volume growth has been important and we've been -- we're undoubtedly being helped by the economy. But, I'm sure we can talk about this more, Dave certainly can. It's critical to remember that volume explains only about a third or fourth of the improvement from last year. And this is far more -- though our improvement -- our improved earnings is far more than a story of a stronger U.S. economy. The great majority of the earnings improvement comes from our own self created initiatives and we view the results that were reported last evening as just the beginning of the payoff from two to three years of tough decisions, hard work, all of them driven by a long-term vision of what PolyOne can be.

Two particularly noteworthy achievements I want to highlight. One is, the consecutive quarters of positive cash generation, even as working capital was being driven upward by higher sales. And number two, in the face of great raw material pressure, which you all know, we have been able to sustain for the most part our variable margins due to both effective purchasing as well as effective marketing. We have certainly been subjected to substantial raw material pressure and I don't want to minimize that at all. And we're not a 100% satisfied about how we dealt with it. But for the most part we've handled it well and our results show it. We remain tightly focused on our goals for the year. And you know what those 4 are. To get our debt down $200 million to $300 million through positive cash generation from our operations as well as the divestments that we've targeted, and we're on the way to doing that.

Finishing the job on getting our overhead structure as measured by selling and administrative expense relative to sales down to a run rate -- annual run rate of 10% of sales or less, and we're on track to doing that on a continuing basis. Getting -- keeping the turnaround going in our Color and Engineered Materials businesses in North America. And you saw a commentary in the press release on the progress we've made. We're very happy to report that compared to where we've wanted those businesses to be on earnings at mid-year, we are ahead of the schedule that we set for that. And so we have seen significant improvement already and we're expecting more. And fourth, to keep building our top line via marketplace, effectiveness, new technologies that we're commercializing and international expansion.

You've noted in the press release, we've made excellent progress in all four of these areas in the first half. And we intend to meet our goals in each of these areas and finish the goals in the second half. So that, as we enter 2005, we can say that we are focused on our best businesses with a solid financial position and with real top line momentum, and those are the goals that are foremost in our mind. Now, before turning the speaking role here over to Dave Wilson, I want to say a special thanks and give all the credit for this performance to the people throughout PolyOne. This group is truly operating as a team like never before. We've seen opportunities to do that and we are capitalizing on them and it's terrific to see. Our people are running the business everyday faster, smarter, and very importantly, more aggressively.

And early this year, we decided to help that along to give our people a chance to earn a tangible reward for a successful first half of the year so we could get off to a strong start. So a portion of our annual incentives was tied exclusively to how well we did in just the first half of the year. And the team came through and every business unit has qualified for a midyear payout on our incentive plan and tomorrow there will be extra paychecks distributed totaling several million dollars. And the best money you ever spend in any business is to reward your winners. And that's so we know that we have that how we want (ph). And on top of that, our people are eager to build on this success because they know and we all know that we have a lot more still to accomplish. So David, let's get into the specifics of the quarter and then on to the Q&A.

OK. Thank you Tom. And before I start, I want to echo your sentiments on the fine performance of the people of PolyOne. It's, as we know, it really is the hard work, diligent commitment of the people. And I join you in thanking them. It has been a terrific performance so far this year. Turning our financial performance, this morning I intend to cover 3 topics, Second quarter earnings, second quarter cash flow and liquidity and then the third quarter outlook. Each topic reflects a continuation of the strong performance and accomplishments that we saw in the first half and is enabling greater financial strength and flexibility.

In the quarter we earned $0.27 per share, generated nearly $30 million positive operating cash flow and reduced our debt as reflected largely by lower drawings on a receivable facility like $50 million. Each of these demonstrates our continued turnaround in performance from a year ago. The earnings progress continues to be encouraging. As provided in our earnings release we reported net income of $0.24 per share, which included $0.03 of special items for a total of $0.27 per share before special items. This $0.27 compares with $0.11 earnings before special items reported in the first quarter and it stands in marked contrast to the $0.04 loss before special items reported a year ago. For the quarter, both continuing and discontinued operations made money. Sales for continuing operations were $558 million, up 10% from a year ago and 4% from the 1st quarter. Operating income for continuing operations was $47 million, up $25 million sequentially, and $36 million from a year ago. Operating income before special charges for the total company was $60 million, up approximately $24 million from the first quarter and up 46 million from the 2nd quarter 2003.

As compared to a year ago, this earnings improvement was balanced and primarily reflects realization of cost restructuring and commercial improvement initiatives implemented broadly across our business units over the past several years. Of this improvement, only about 30% is due to increased sales volume, whereas 50% is directly attributable to cost reduction initiatives implemented by the company. The balance is due to improved R&I or Resins and Intermediate segment equity earnings. And to no longer depreciating our discontinued operation businesses.

In total, S&A to sales, sales and administrative costs to sales were again under 10%, consistent with our target for early 2004. YTD the S&A to sales ratio for our continuing operations was 10.3%, down 2.2% from a-year ago, but slightly higher than our year-end target which is to be under 10%. Now turning to cash flow and liquidity. This represents the second major accomplishment of the quarter and a continued progression from the first. We generated just under $30 million positive operating cash flow. I refer you, as Dennis did, to our earnings announcement attachment 5 where we reconcile this non-GAAP measure.

I also want to point out that operating cash flow as defined is before the effects of divestments of acquisitions. YTD, we have generated nearly $50 million operating cash flow which represents over $160 million improvement from a year ago, when we consumed approximately $120 million of cash. The positive cash flow that we've generated this year has enabled us to reduce our debt, largely as reflected in the lower drawings on our receivable facility as I mentioned before. Our cash flow performance benefited from our turnaround in earnings as well as further improvements in our working capital processes. For the year, working capital's percentage of sales is staying under 15% at 14.5%, an improvement of 1.8% point from a year ago. We continue to see progress in accounts receivable and inventory management. Day sales and receivables entered the quarter at 50.8 days down 3.2 days from a year ago's improving performance. And day sales and inventory finished the quarter at 45.7 days, down 8.2 days from the second quarter last year, when DSIs were traveling close to 55 days and were clearly unacceptable. Consistent with the solid cash performance, we ended the quarter in a strong liquidity position. As outlined in the 10-Q, we've had $180 million available drawing capacity in our short-term borrowing facilities. In the second quarter, we also saw a marked decline in our debt to EBITDA leverage ratio. At the end of June, our ratio was 6.05 times, which is less than half of where we were at the end of 2003.

Now, turning to our outlook for the third quarter, and as I do, I'd like to draw your attention to the outlook discussion in the earnings release as well as the 10-Q, as well as to our forward-looking statements. Since we provide a fairly comprehensive view of our expectations I'll only hit the high point. And let's start with continuing operations. It remains our position to base our outlook on a more cautious viewpoint of what we see coming in the third quarter. Our view is that sales will be down 1% to 2% in the quarter from the 2nd quarter. Still, this level of performance would represent an 8% to 10% gain over a year ago. As you know, industrial production gave a little ground in June and the growth rate associated with leading indicators has moderated fairly significantly over the past quarter. Our sales levels in July were spotty. Some businesses with continuing strength, but others seemed damp in demand for May/June levels due either to typical July holiday shutdowns or auto buildouts and model changeovers. We don't believe this trend will continue into August in North America, but we do anticipate slower August sales in Europe due to the holiday period. Our expectation is that North America, in North America is that August and September should see sales demand on par with fairly strong second quarter average daily demand rates.

Accordingly, as I said before, our outlook for the quarters for sales from our continued operations to decline 1% to 2%. With respect to margins and Tom commented on these a bit, we are expecting to see continued margin pressure on our operating businesses from higher raw material and additive costs. We're also not anticipating the chlorovinyl margin pressures that we've experienced all year, to moderate significantly in the third quarter. And the combined effect of lower sales and increased pressure on margins could result in lower operating earnings for our continuing operations of between 3 million and 5 million in the third quarter as compared to the second. I'd also draw your attention to the fact that the second quarter we received a benefit of roughly $3 million from what I view as largely nonrecurring costs. When we look at R&I segment and our earnings impact, as always there are puts and takes. We do however that the puts and takes will be net positive and we do anticipate earnings improvements from these businesses primarily as a result of expectations for PVC resins and caustic soda pricing to go up sequentially. We're also projecting ethylene to decline moderately, but frankly this projection could be offset by sustained high natural gas pricing. We project that natural gas will remain high, but generally in line with second quarter prices, which average to -- average is around $6 per million BTU.

Finally, we don't believe chlorine price movements will have a material effect on our earnings. All told with those puts and takes we think the R&I earnings could increase $2 million to $4 million, but as I pointed out in the release, these benefits could be fully offset if natural gas were to rise further. For our discontinued operations, the principal variable is the timing of the elastomer sales closing. Additionally we expect soft sales in July for engineered films, in margin pressure to continue for -- to be high for our specialty resins businesses. The engineered films business has seen automotive demand soft in July and for the specialty resins, we would expect VCM margin pressure to continue to outpace our ability to raise prices. All told, we could see a sequential decline in discontinued operation pretax earnings of between $8 million and $10 million. Again, the largest factor being the timing of the elastomer closing. In the release we also commented on interest expense, depreciation and taxes.

One other charge that we should bring up is we could face costs associated with prebuying our medium term or senior notes. If they trade at a premium, we will see a charge recorded and that would be reflected below the line in the category, other expense nets. We believe we're providing an appropriate yet somewhat cautious view of the third quarter. Even though we're projecting third quarter earnings to be down from the second quarter, performance is expected to be up substantially from the $0.4 loss before special items that we reported last year. Moreover, we're projecting to generate positive operating cash flow in the third quarter, which will contribute to the further strengthening of our financial position. Be assured as Tom said that as we go forward, we will continue to take the actions necessary to improve our earnings and cash flow results and to achieve our priorities in order to enhance our value to all our financial holders. With that, I thank you and we'll now turn the mike back to Dennis and open the conference call to questions.

Just one quick point, I want to make sure it's absolutely clear on Dave's reference to operating cash flow, on attachment 5. We determined that value through the use of GAAP measurements from the cash flow statement, so please reference that as actually new addition that we've added to the reconciliation tables in the past, the disclosures in the past, so please look at it. I think it will help explain our view of operating cash flow and how we measure ourselves. With that, Amanda, let's open it up to Q&A.

At this time I would like to remind everyone, if you would like to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first questions comes from Robert Ottenstein with Morgan Stanley.

Good morning, Robert.

Good morning. Nice job, guys.

Thank you

And I think it's great. Your troops have really gone through hell like we all have last couple of years. To give them a little kiss there is, I think that's great. In terms of that, is that in the SG&A line there in the 52 million or are we going to see that in the third quarter?

No, It's fully accrued.

It's fully in there?

Yes.

Great. So the actual run rate is actually even lower than the 52 than you reported in terms of the operations?

Well, expect that we hope to be paying out bonuses out at the end of the year. So we're going to keep that run rate going.

Right. Can you talk to us a little bit about that delta on the SG&A line, how you got that down from the first quarter and where you see that in terms of the rest of the year, absent the additional bonuses?

Yes. The S&A line in the 2nd quarter is down. Refer to the $3 million of what I referred to as largely nonrecurring cost benefits. Those hit it primarily in the S&A line so I don't think it's really appropriate for us to declare victory on getting below 10% for our continuing operations at this point. We do expect to hit that by the fourth quarter as we continue to put in some of the redesigned processes and make some other changes in the organization. But our second quarter S&A, as it's reported is reflecting that benefit of that $3 million or so.

Right. David, it's worth pointing out, that's why, Robert, we quoted an estimated sales number for the first six months because it's probably a little more indicative of kind of where we are. And rather than just looking at that second quarter number. We'd love to be able to declare victory right at that level.

No, but, of course, you had 3 million of the nonrecurring benefits, but you also have the special incentive comp in this. That will probably come close to (inaudible), right?

No. The incentive, Robert was really, what we did is we split the earnings pool into thirds, a third for the first half, a third for the first half, and a third for the full year, and what we paid -- or what we will be paying tomorrow is the third associated with the first half so it really was what we would anticipate for the incentive plan. It's just we cut the payment and paid a portion of it after the first half if we hit, you know, plan metrics.

OK.

That's sort of like an early payment ...

Right ...

On the full year (inaudible). However it's worth noting that as you can imagine with our results that we are running above our original target, that there is above planned incentive accruals. And secondly, it is significantly higher than (inaudible) a year ago. And I can guarantee you that.

Sure.

So, depending on how you calibrate it there is a little bit of extra in there, but not the full thing.

On an absolute dollar basis which you would be thinking about for the second half of the year on that line, closer to 50, closer to 60, somewhere in between?

I think by the end -- by the fourth quarter, you know, we're looking at close to -- I think about close to $53 million, 52, 53. We've got some work to get there. So I would expect that we're not going to, clearly we're not going to jump back to first quarter levels. But, you know, I would see us bringing it down sequentially, if you add back the $3 million this quarter, you're at 55. I would expect to see a million dollar or so per quarter reduction, sequentially.

Great. And can you -- can you just give us a sense, I mean, we've seen across the board almost higher input prices. Can you just kind of go through the businesses in terms of how you're dealing with those, whether we're going to get hurt in the second half of the year just in terms of how those are flowing through your inventories, how you're doing with pricing in terms of recovering that and whether you expect your margin to contract or expand or stay where it is in the second half of the year, your margin over costs?

Yes, I'm going to let Dennis respond to that question on amount of business by business basis and go through it. But let me out a little bit of backdrop in what we've been able to accomplish the first half. When we do our earnings reconciliations, if you (inaudible) well, when we look at volume and pricing and raw materials, as we look at first half to first half by comparing this first half to last year, our material margin would have a positive operating income impact of about $4 million. Not major, but positive. And second quarter, it was positive, less than that $4 million, so, you know, through the first half margins on a year over year basis, we've held our own and in fact have shown a little improvement that's fallen to the bottom line. But Dennis, why don't you provide some outlook on that.

That's very important. It really is. I think, as we look at it business by business, the first half our sourcing team has done a terrific job of holding back raw material increases. To what extent we're going to be able to do that in the second half will be, I think more challenging. The important thing to note though, is every particular business unit understands the raw material price increases that they're facing, particularly vinyl and some of the Color businesses and EM businesses. And each one of them has actually instituted offset programs to compensate for those price increases. So to the extent that we can mitigate them, our objective, we believe we're going to be able to mitigate a lot of them, maybe not the full extent. On the pricing side, as you know, we raised vinyl compound prices in the 2nd quarter. I don't know at this point in time and I wouldn't want to speculate where we're going to do any further price increases there. But I will tell you that in the other business units, particularly color, EM, and others, we are working hard to raise prices as we see those costs crossing our -- crossing our desk here. I think the most important thing to remember overall is one of the reasons that we were able to sustain our margins and actually especially in the 2nd quarter while everybody was trying to raise raw material prices to us, it's what we've been talking about for PolyOne for some time. We have the ability and the leverage in the marketplace to hold as much of the raw materials prices as we can. Now, we're always going to get increases, but it's one of the advantages from a purchasing perspective that we have and we'll continue to use that capability. So will we always get that? No. But I think for the most part we were able to hold back. In the second half it will be more challenging.

Is the pricing sticking, from what you can tell on the processing side -- the vinyl processing?

I think for the most part our vinyl compound increases are increases we've asked for, we have been able to obtain. And then the other business units, I think it's a little clearer and a little easier to raise prices as we get those cost increases coming to those businesses. We're doing a pretty good job I think in trying to retain those margins as we go forward here.

OK. Let me get back in queue. Thank you.

OK.

Your next question is from Saul Ludwig from Key McDonald.

Hey, good morning, guys.

Good morning, Saul.

Good morning, Saul

On the attachment 6, where you get down to other, which was a $2.3 million expense versus $6.8 million expense, that 2.3 was way out of whack with what that number has traditionally been. Is that where you booked the $3 million of credit?

Yes.

OK. And then on your consolidated 'statement, the other expense of $8.8 million, is that where you had the loss on the sale of Melos (ph)?

Yes.

OK. So when you make these adjustments, what sort of a tax rate that was used when you got to your -- your $0.18?

By $0.18.

$0.18. That was your earnings on continuing operations, right?

OK, right.

What was the pretax and what was the tax for it to be $0.18?

I knew you'd ask that question, Saul.

I'm sure you're well prepared?

Yes, as you see in our financial statements, we had roughly $20 million of pretax and we had $400,000 tax expense.

He did notice that?

Yeah . And I would also say that, in our queue we do go through what we have and really talk about how we came up with that. But what I would suggest is you think about it in certain earnings buckets. First we've got roughly -- well, we've got our earnings from our domestic operations and they were around I think, about $11 million and that is not tax affected. And then you've got -- because of our tax allowance, we're still under that and the NOLs, we then have our earnings from our international operations, which are taxed, and the effective tax rate for that is roughly 35% or so. Now, that would be the international operations from our continuing businesses. The loss on the Melos went a long way towards offsetting that on a net earnings basis. It was a taxable loss. We then had a fourth bucket and that was a nontaxable translation adjustment. And that was around $8 million. And so that's reflected in the earnings and it's not taxed. And so, if you look at the four buckets, you've got -- we'll do this roughly, $11 million of U.S. earnings, which are not taxed, you've got offsetting earnings, the net to close to zero between international continuing operations which are taxed at about 35% and then the loss that offset that and then you've got another bucket of earnings of $8 million, which being a cumulative translation adjustment is nontaxable. So in effect, what we have is $19 million of non-taxable earnings. And then on the other side, two buckets that offset each other that were taxable. And that's how you come up with almost no tax or $20 million of pretax earnings.

All right. That's perfectly clear.

Thank you.

I will refer you to the next person who asks the question on that.

If we looked at the 19.6 and add it back to that -- the 4.2 million pretax, which was the special item which would get you to 23.8 sort of pretax on continuing operations. And then to the $400,000 tax expense, you actually had a $7 million tax credit on the discontinued. So we come up with a $6.6 million tax relative to the 23.8. That gets you down to 17.2 after tax, which would be $0.18 a share. I mean, that's a sort of line of reasoning.

OK, OK.

Makes sense?

Generally, yes. But I think for us to really hammer it out, I need to be able to see some numbers and think it through. But I think, Saul, you're generally on the right track.

Of this 8 million nontaxable transaction, where did that show up in your consolidated statements? Is there $8 million gain buried someplace ? I'm looking at the consolidated statement. Where is that?

It's built in the Melos (ph) number. Saul?

Is it at this one of those buckets in your ...

Other expense net. It's built into that number. It's built into that number, Saul.

It's part of the Melos loss?

Right.

OK. And what tax rate should think about, going forward?

I think that, if you're looking at net income before special charges, you should be looking at roughly 35% for international and 38 or so for domestic earnings. For the financial statements in the third quarter, our U.S. operations will not be taxed. And you should anticipate foreign taxes to be roughly 35% or so. And so, if we make $10 million, say, in international you'd expect to see $3.5 million of tax on our financial statements.

OK. And finally you alluded to something about buying back some bonds at a premium. Is that something you have begun to do or you might do?

That is, as we've stated, our intention and our commitment this year is to reduce our debt by $200 million to $300 million. For us to do that, we've got to be looking at our medium term notes, our senior notes. And those would be market transactions and we have to pay what the market charges. So, what we're doing is just highlighting the fact that if we do, do that, because we have the excess liquidity and are able to do that, and provided that the elastomer transaction closes in the third quarter, we should have the liquidity to do that as the terms that we've disclosed for that transaction. We just want to point out the fact that it's -- there may be that charge associated with those actions.

OK. Great. Thank you.

You're welcome.

Your next question comes from Allan Cohen from First Analysis.

Good morning, Allan.

It's actually Dan Leonard. Hi, everyone.

I'm here, too. Hello.

Dennis, Dave, if I look at historical when it was running well and add back some accounting charges that you don't have to take anymore and I also look at one of your competitors, a bit of a high emerging competitor, subtract some legacy costs they don't have, et cetera, I come up with once your business is fully fixed, sort of a 7% to 8% operating margin on the -- your compounding operations. Is that (inaudible) distribution, is that in the ballpark or ...

I don't think it's probably for the total company. I would say that our -- you put the caveat when it's fixed and we still have work to do, but our compounding businesses should be 10% return on sales businesses, on average. Some a little higher, some a little lower. The distribution business, 3% to 4% -- we're in the 3% range. We should be able to leverage it as that business grows. So if you're looking at distribution being 25% at that 3% to 4% and the balance around 10, you come up with that number.

OK.

Eightish. And I think that's fair. And our challenge -- frankly our challenge is as we grow the top line, is to bring more than just $0.10 cent to the bottom line. We should be able to leverage gross margin line and material margin lines.

Right. OK, that's helpful. On the Color and the engineered material businesses, sequentially from the first quarter you saw very healthy volume gain, 11%, but the revenue line was flat. Was that more of a pricing issue, mixed issue about equal between those two factors. And can you talk to whether or not you're picking up market share in those areas?

It's primarily mixed and I would say that in our specialty color, it would be premature to say we're gaining share, I think it's clearly stabilized and it's moving in the right direction, but I think gaining share would be a connotation of performance that we're working towards, but I wouldn't say we're right there yet. In some of the general-purpose sectors, we probably are picking up share. Those are large contracts and we've been successful.

This is Allan. From an operational point of view, what are the major areas left yet to fix? I mean, they may not be showing up in the customers accepting it, they may not be showing up in the financials. But from an internal perspective, what if anything is left to fully rebuild?

Are you talking primarily color and EM?

Yes.

We still obviously have got to continue to grow the specialty sides of both of those businesses. As you know we have introduced, as Tom mentioned earlier, we've got some technologies that we're starting up, especially continue to put some emphasis on our nano clay technologies for our engineering materials businesses. And that is the real key for engineered materials is to continue to bring the technologies forward, continue to grow in profitable products that we have. In the color side it's continuing to grow top line. The business have both been restructured for the most part, maybe a little bit left to do, but for the most part, they've been restructured. Their cost structures are well in line. Their operating structures are well in line. It's really a matter of us continuing to go grow top line. As we can tell, we've said, I think that both businesses have done a nice job on the general-purpose side of their ledger. And obviously, it's more challenging to grow the specialty product lines. They're working hard at that, they've got good plans. And I think we're going to start to see the benefit of that as we go forward. That's really the key to getting to the levels we're talking about.

And I would say that we are seeing the benefit. Stabilized, not yet declaring victory. But that means, now, we've turned the corner and we're starting to move up the scale. And as Dennis said, that's the key to leveraging those businesses. As far as cost fixed, cost restructuring, there's always going to be continuous improvement. But the type of restructurings that you've heard coming from PolyOne over the past couple of years really aren't on the table presently .

OK. Finally just I want to make sure I have some of these numbers right. The $3 million in non-sustainable cost savings you had in the secnd quarter, is that something different than that $2.8 million that you showed in attachment 4?

I'm thinking yes, because I'm guessing attachment 4 is special items and this would be $3 million that's showing in the face of our incomes -- or not showing, as it is, in the face of our income statements. It has not been culled out as a special. These are some timing. They're also sales of assets that it's tough to -- you know, where you get a gain, it's tough to say you're able to do that again in the 3rd quarter. So that's why we've culled that out and brought it to your attention.

OK. And on the third quarter guidance, am I correct in my reading that the 3 million to 5 million sequential decline from your operating business is partially offset by the 2 million to 4 million sequential improvement is immediate?

Correct.

OK. Thank you very much.

You're welcome.

Dan Leornard: Take care, guys.

Your next question comes from Ed Mally with Murray Capital Management.

Hi. Thank you.

Good morning, Ed.

Good morning. Just one question with respect to cash flows. In your outlook for the third quarter really the second half of the year what are your expectations regarding working capital and whether or not it would be a use or a source of cash?

It should be a fairly significant source of cash for us. Third quarter, you know, I would tend to think that hopefully the demand will stay, so that you don't see much movement quarter to quarter. But at the end of the year we would expect to see our receivables come down and our inventories come down accordingly. And that's traditional. With our business like many, we build working capital in the first quarter, hold it in the second, third, and then see it decline in the -- see it decline in the fourth. So it should be a good source of cash. We are anticipating that for the balance of the year, we will generate levels of cash consistent with what you'd seen in the first half of the year

OK. So from a seasonal flow standpoint as you get into the second half of the year and work the working capital down, your expectation for the year is that it would be neutral to possibly a contributor of cash?

Yes.

Good. Thanks very much.

The next question comes from Rosemarie Morbelli with Ingalls & Snyder.

Good morning all, and congratulations on a very good quarter.

Thank you, Rosemarie.

Could you talk about the inventories at your customers site. You mentioned that in July, the demand had slowdown and even if it picks up in August, could they be using whatever they have been piling up? And then could you address your own inventory at the end -- I mean, after the end of the second quarter. As the demand slows down in July are you seeing that you're sitting on a little more than that you would like?

I don't want to overstate the July. We're talking about North American businesses, first of all. We're talking about business primarily around some construction and some automotive applications. Business is slower in July than it is in June. But that -- it would be misleading to imply that there's a slowing down in the overall demand perspective. Customers that are still buying, they're buying robustly. They're not buying for inventory or not building inventory as far as we can tell. So, it is just a very typical July for us. It is not an unusual thing for us. And I think one of the things that this may be a typical year from a seasonality perspective where the second quarter is the strongest quarter followed by the third quarter and then the first or fourth quarters will be the slowest quarter. I mean, this is a more typical year than the last. Last year, as you know, we had business building in the third quarter as we were coming out of the economy. And customers were starting to re-ramp-up their businesses. And so it's one of the reasons, we're seeing a little different perspective. So I don't see this as unusual. I don't see any unusual inventory built or anything like that.

And as far as our own inventories, we were careful to bring them down based upon expectations, but I would also say we were cautious not to bring them too far down to ensure that as expected business picks up in the back half of July, most of the July shutdowns around the fourth. And going into August that we're able to meet the demand.

OK. And then, if you could give us a little more color on Europe. It looks as though your international business is up, in terms of shipment, up 7% overall, but Asia is up 21%, so that must translate into a down quarter in Europe. Could you give us a feel for what is happening there and what you see going forward?

No, Europe is not down, Europe is 75% of the business. So, we continue to have quarters like we've had or half years like we've had in Asia and it will become more material for us as we want, but Europe continues to grow. Europe is spotty, frankly. The U.K. is a little softer. France has been a little softer, but other parts are growing. So, it's mixed. It is seeing improvement. Expectations coming out of the first half. Once we get through the holiday period in August, our continued growth trends, but Europe, not dissimilar to North America, that trend is low single digits.

OK. As in about 2% to 3%?

That's a fair trend line: Clearly the challenge to our management team is to beat the trend line.

Are you growing -- are you boosting your products essentially in Eastern Europe which could take the whole European business to a higher level of gross or are you putting your eastern European business with the Asian one?

No, it's with -- our Eastern Europe business is included in our European, and it is a focus for growth for us. We got the Color operation in Hungary. We have sales operation in Czechoslovakia and we're looking at other opportunities to expand. So we look at Eastern Europe as a way to beat the trend line in Europe. And also selective investments in the western European countries where we don't have a market presence.

As in where?

Italy as potential. We don't have engineered materials business there. Take you back a year, when we acquired TransColor, which provided us a general-purpose color operation in Spain that we could lever across Europe. So there are opportunities for us. And the team is aggressively pursuing them.

And you don't think increasing that capacity in Eastern Europe and shipping it to Italy would make sense?

If it makes sense that's how we'll do it. We will certainly assess it. I'm pretty tight on capital. So if we can do it -- but what we are finding is a local manufacturing presence, not just a local sales presence, helps your penetration plans.

Unidentified Speaker: Business is about being close to the customer.

Yes, business is about being close to the customer.

OK. That is helpful. On the debt repayment, my understanding was that you were looking at several considerations, either pay down the debt or have a pre-penalty -- I mean, prepayment penalty or you could also have paid down -- put some money into your pension, and the third solution would have been to take down the receivable facilities. So if you are willing I think to be understanding for the -- to prepay those notes and have a penalty, is that more efficient than doing one of the other two with (inaudible) higher rates, but no penalties linked to them?

We want to do all three and we will to the extent we have the cash to do it. The receivable facility is similar to a bank facility. If we have cash, we can take it down. Taking out the senior notes is going into the market. Somebody has to say yes, we have to say yes at a price. We do look at our near term maturities and it's important that we use our liquidity to try to clear the way of any material maturities over the next several years. As we look forward on the debt side, the $75 million '05 notes are the only material maturity that we have between now and 2010. And so you might guess that that would be an area where we would be looking. But also the pension, we're not -- that is part of it. It, too, is a good financial decision to offset that because pension obligations are just like short term debt maturities. We look at it, we get a hierarchy of priorities and frankly, we will go down the list that you gave to the extent that we have the liquidity to continue to reduce really in all three categories.

Could you remind me of the different rates on the three different pieces?

Yes, the '05s, they've got an interest rate of slightly below 7%. The receivable facility is around 4%. And the implied return on a pension prepayment is around 11%, a little over 11%.

That makes good financial sense.

That one makes a good financial sense, yes.

But you do want to slow your debt down because this is what the goal is, to take it down by 200 million to 300 million. And so you want to show thaty you're actually doing it while repaying the pension is going to be varied?

We want to do it all. It's a question of how much cash we generate. And how much cash we get from our divestments.

OK. Thanks a lot.

Thanks. We'll take one more question to try to keep us on time this morning.

Your next question comes from Bob Goldberg with Skippers Asset Management.

Good morning.

Hi, Bob.

OK. Given your assumption that working capital will be a source of cash in the second half of the year, are you just being conservative in guiding towards similar operating cash flow in the second half versus the first half?

I hope so. But, you know, there's other things, but -- the cash flow is without discussion of divestments. And as you would guess the working capital is the principal driver. We've got earnings. You know, we're going to have an interest payment in the fourth quarter of pushing $40 million, similar to what we had in the 2nd quarter.

I'm just talking about first half versus second half.

If we hit the same number in the second half, we will have generated close to $100 million from our operations this year. So I think what you're also seeing in the first half is the benefit of very rigorous working capital management and hopefully what we also see in the second half is continued good demand.

One thing I don't think you had much in the first half was a contribution or a cash dividend from OxyVinyls.

We would hope to get more in the second half, but we did get a $14 million distribution in the second quarter which as you know is generally atypical. Another component that probably is going to be a $8 plus million swing between first half, second half is capital expenditures, which from the first half of the year, I think we're tracking around $13 million or so. And we're still expecting to spend between 30 and 35. 35 is what we've said, but you know as well as I do that once you get behind on a track, it's tough to catch up. But still we would expect that Capex would be higher in the second half.

Thanks.

I know there's more people in the queue and I apologize, but I promised everyone that we'd keep this call to an hour. I want to thank everybody for joining us this morning. Certainly those who didn't get their questions answered, I will be and Dave will available later in the day. Thank you very much. I'm glad to hear -- sounds like everybody appreciated our net earnings in the last quarter. We did, too, and we -- our people have enjoyed it and we're going to continue to try to strive with these results going forward. Thank you very much and have a great day, everyone.