Avient Corp (AVNT) 2005 Q2 法說會逐字稿

Good morning. My name is Jocelyn and I'll be the conference facilitator. At this time I'd like to welcome everyone to the PolyOne conference call.

[OPERATOR INSTRUCTIONS] After the speakers' remarks there will be a question and answer period.

Thank you, Mr. Cocco, you may begin your conference.

Thank you, Jocelyn. More importantly, thank everyone for joining us. As I know and you know, we had choices who's call you could be on this morning and we appreciate you joining us.

Joining us somewhat remotely on a phone line is Tom Waltermire who will be making some opening comments followed by Dave and then after that, we'll open the conference call for questions and we're going to end this call promptly at 10:00 so that those of you that want to move on to the 10:00 conference calls will be able to do that this morning. Earnings release is out, as you know.

As is our 10-Q and if some reason you did not receive a copy, please feel free to give my assistant Darlene a call and she'll be happy to make sure we send one forward to you. We're webcasting this call as we've done in the past and this call will be available for approximately two weeks after today, for post-view. On today's call, as I've cautioned in the past, we are likely to be talking about some forward-looking comments and we want those comments to be defined under the meaning of the Private Securities and Litigation Reform Act.

Forward statements give current expectations of forecasts of future events and are not guaranteed for future performance. I'd suggest and highly recommend you review those updated factors in the release and the 10-Q. They're constantly updated to reflect the current conditions. In addition today we'll probably, likely, talk about the non-GAAP terms in the release. We have an attachment that will be posted on the Web site.

All the non-GAAP terms in the reconciliation back to the proper GAAP terms. So what we talk about operating income before specials, or if we're talking about operating cash flow, those are non-GAAP terms and those are reconciled back in the release for you. Finally, we recognize you all would like an update on the status of discontinued businesses. However, as been the practice we'll not be commenting on the sales of those two remaining businesses today and so I'd suggest that you appreciate and take some understanding why we can't do that.

With that, I'm going to turn it all now over to Tom.

Dennis, thank you very much. And again welcome, everyone, this morning. I'd like to share with you my thoughts about the quarter and the things we're focusing on going-forward. Considering the environment of -- for downstream -- what I call downstream chemical companies and plastic processors such as ourselves, we're very happy to be able to continue the results -- or achieve the results we did in the second quarter, which added to the first quarter gave us the best-ever first half.

Also, the results that we announced last evening are in line with the outlook that we provided on June 9th. One of our strategic advantages compared to most of our competitors of course, is our backward integration and we designed the Company this way.

During the quarter just ended, this advantage is clearly demonstrated. There are few companies among our peers with up-earnings at this point.

Dave will talk more specifically about the second quarter financials, but I think you should pay particular attention to the significant cash flow turn around from the first quarter. We focused hard on keeping working capital in line with business levels, which were -- which were a challenge. Because we did not get -- the industry did not see the typical seasonal increase in business that we were, in fact, preparing for as we were going into the quarter. In the face of this, our people responded aggressively. We ended the quarter in line with our key targets.

Unfortunately, the slow plastic industry demand in North American as well as in Europe is impeding our growth goals. Adding to this, the continuing surge in raw material costs, that was up particularly in the first, I would say, four months of the year, and we admittedly did not achieve the recovery in margins in our manufacturing units. Only our Asian operations saw the demand growth we were expecting. But even here, margins have been hurt.

So the bottom line is that our diverse earnings base was a real asset in the quarter and first half. Our cash flow is generally tracking where we want it. We are focused on getting the very most we can for our manufacturing and distribution operations in a tough environment. Now, let's turn now to our comments on the 2005 priorities that we stated at the beginning of the year. In our comments, first of all, of course, was accelerating our organic business growth. The primary goal here is to grow faster than the markets in which we're participating. And the softness in Europe and North America -- in overall plastics demand clearly was down. Down from a year ago.

Yet, when we tear into our businesses, in most cases, we find share improvement, rather than share decrease. We'll continue this focus so we are growing in absolute terms, which is what we all, obviously, want, as well as in relative terms. Another component of our organic growth goal is to generate for the year in excess of $20 million of sales of very new technologies and our new technology portfolio and mid-year we're right on schedule to achieve this goal. This is very important for us because we need to build our new technology commercialization flywheel year after year.

Asia remains a top growth priority for us. In June, we opened our third plant in China, which is our fifth in Asia overall. Ultimately this new facility in Shenzhen will be able to double our business in China -- the new -- or already existing business. The new plant will include color and additive concentrates, engineer material compounds and a new participant for us in Asia, our polymer coating system business. All three of these business lines are being produced and shipped from Shenzhen right now.

We also introduced, in June, our new General Manager for Asia and we are delighted to have and his task is to map our growth and execute out growth throughout the region. Another step to add to our growth in a slow market was the Novatek vinyl compound acquisition. These products fit very nicely into our existing facilities and further strengthen our leadership in this business. Our second priority that we listed at the beginning of the year was the continued progress in building our North American Color in engineer materials units into strong contributors. There is no doubt that the conditions, you know, we all know they're there, I described earlier, in terms of lower demand and challenge margins is slowing our progress in getting the businesses where we want them. Our specialty color business, nevertheless, is clearly re-establishing its market position. This bellweather business has clearly gained share over the course of last year. Customer satisfaction and service metrics are all showing significant improvement. Our general purpose color business has definitely turned the corner with better operating costs and margins.

In engineer materials the key issue has been margin compressions just as it's been for all compounders. Our new leader that's been in place for the last nine months is getting us on the right track and we're already executing a rebuilding and expansion of our sales force and we are, today, commercializing more new technology in this business than we've seen in many years. In both North American Color and (Niem), our primarily focus remains to capture new customers and we also have goals to continue to work on margins, very importantly, and continue to make progress on service and quality.

The third priority we stated for the year was return to continue our return to full financial strength. That, of course, is all about cash flow and debt reduction. Every business unit has aggressive improvement goals on working capital management and we continue to work on divestments and as you recall we ended last year at right, just at, just under, four times debt-to-EBITDA as it is defined, you know, adjusted EBITDA defined in our loan agreements Our goal is to get that down to three. We expect to make a lot of progress toward that goal this year, although it is appropriate to say that the current environment may keep us from getting all of the way there, but you can expect to see some significant further progress on bringing that ratio in line to where we want it.

Our fourth business goal that we stated was to take steps to make permanent and ingrain our drive for continuous productivity gains and one of the headline measures of that, of course, is our overhead or S&A as a percent to sales. So far this year that's running at 8.1 and that is, some of you will remember, that that ratio, just a couple of years ago, was more like 12. We're, clearly, also working to make operating excellence a part of our culture and taking a number of internal steps to do that. Let me comment a bit on the second half as we begin it.

You know, we see some signs that inventory contraction throughout the chain is not as severe at this point so we're cautiously optimistic that we will see some sequential growth in volume in the third quarter. Such as you know will actually be countered to the usual, seasonal softening, compared to what is usually a strong second quarter volume-wise. The direction I'm giving our organization is clear and simple -- Two clear ideas we expect to drive very hard. That is -- Profitable sales growth, via closing target accounts and cash flow.

For the whole year, we are focused to apply our strategic advantages that we have, compared to our competitors to grow faster than our overall markets. And every business has clear, accountable goals to make that happen. Along with that, we must hit our cash flow goals by operating our business with excellence. We will be repaying $50 million of debt later in the year from our operations, and our goal, of course, remains far in excess of that. Sales in cash flow -- that's the focus and I will look forward to returning to this call and three months and showing you our progress. So, David, you want to take it from here?

I do. Thank you, Tom. Thank you, everyone, for listening in to our second quarter call.

As you have seen our sales slightly under $600 million for the quarter up 5% versus a year ago and 1% sequentially. That was due to pricing as we talked about the volume comparisons are the other way, with sales volumes from our continuing operations down 9% from a year ago and 2% sequentially. Our earnings EPS was $0.34 and split $0.25 from our continuing operations and $0.09 cents from our discontinued operations. This compares favorably to a year ago when we reported $0.24 overall, so we would be up a dime and the split there would be up $0.04 in our continuing operations and up $0.06 from discontinued.

As you look at the segment income I think that pretty well draws the picture in terms of where the earnings improvements have been. As Tom mentioned, our operating businesses have been under volume pressures this is year. We have not recovered the margins that we would have wanted by now in the year. Although I will point out that sequentially we have made some margin improvement.

But fundamentally the improvement we're seeing is the benefit, as was talked about earlier from having our backward integration, the strength of the PVC and chlor-alkali cycle. and oxy vinyls and Sun bet did very well this year-over-year to date and comparing the performance this quarter versus a year ago, that performance is up markedly. When we look at the other key metric in terms of cash flow we comment in the earnings release that our net cash use from operating activities was $7.2 million year-to-date. Which would be $6.1 million for the quarter. But our operating cash flow, which is the measure that we use, but it is a non-GAAP term, was a positive $26 million and that compared to consuming $66 million in the first quarter. So there's roughly a $90 million swing.

I would point out that our definition of "operating cash flow" and why we use it is the fact that it does reflect the cash that is available to us after funding our capital expenditures and other operating obligations for debt reductions or acquisition. It does exclude proceeds from divestments.

So the $26 million was a marked turnaround from the first quarter and was not unexpected, as we said at the end of the first quarter. We fully expected to generate positive operating cash flow and in the first quarter, the impact of building our working capital as our sales improved sequentially from year end is what drove, you know, the consumption that we had in the first quarter.

But looking at the improvements in the second quarter, we, in fact, reduced our net -- our -- the net of our receivables inventories and payables. Our receivable performance hit a historic low, if you will, for us. In terms of our day sales outstanding we hit 50.1 and by about .5 days. That is the best we've ever done. Days in inventories were 43.6 days, equal to the best that we have ever done.

I think it's worth noting that mid year our inventories, as you see on the balance sheet, are only up $6 million compared to year end. That is good reflection of the very good inventory management that we have put in place and are continuing to demonstrate. Our key contributors to the turn in cash flow is, in the second quarter we did get $19 million of distributions from our equity investments. That compares to getting nothing in the first quarter and also our cash from discontinued operations was up about $10 million quarter-to-quarter.

Here, it follows similar to what our continuing operations are doing in terms of the working capital liquidation and improved earnings. Key use of cash in the second quarter, as we've talked about was the cash that we used in our interest and here we paid out $33 million more in the second quarter than we did in the first and as we've said, our cash interest goes out principally in the second and fourth quarters. We think in the third quarter that was a large outflow that we will not see until the end of the year.

The other key aspect which was positive is we had lower outflows associated with accruals and that primarily reflects the fact that in the first quarter we pay out the year before (inaudible) payments. As you'll note in the cash flow statement, that we had sales of redundant assets of around $9 million. That benefit largely offset the outflow associated with environmental remediation. And this is the remediation of a specific plant that we talked about in the third quarter of last year. That remediation is complete and we would not expect, in subsequent quarters this year, to see anywhere near that level of cash outflow; in fact, one would anticipate it would be closer to a million or less per quarter going forward.

So all in all, you know we made the progress that we expected in the cash flow. Going forward. We continue -- we expect to continue to generate cash in the third and fourth quarters at levels that would enable us, as Tom alluded to, to be able to take out the $50 million of maturities that come due this year, plus more in terms of our debt. So we're on our path, as we had anticipated in terms of cash flow. I would also point out that key development that occurred toward the end of the second quarter and we concluded it earlier in the third, was the restructuring of our short-term borrowing facilities. We have amended our receivable facility. We've extended it five-years. It is still $175 million facility. But we are able to have lower interest costs going forward as well as less owners restrictions on us. The (covenant) test which formerly was interest coverage, has now been changed to a fixed charge coverage, which is defined as adjusted EBITDA less CapEx over cash, interest, tax, expenses, scheduled maturities and any dividends that we may pay out.

We noted that at the end of the second quarter, had we done that calculation, we would have had a fixed charge coverage of 1.22 compared to a covenant of one and that covenant only kicks in if we have available liquidity of less than $40 million. I would point out, that on that calculation, we had available liquidity at the end of the second quarter of $116 million. So, you know that's, as I look at it, I think this facility really minimizes any forward concerns that we would have in terms of liquidity positions.

I think we're very strong and comfortable with our liquidity position going forward and the focus that we need to have, therefore, is on the operations, generating the earnings and the cash flow. Make a couple of other quick points here so we can get to the questions. On the commodity cycle as I mentioned, we did get $19 million of distributions from our equity affiliates. We would anticipate that going forward, we will, in fact, continue to receive substantial distributions. We had talked earlier of expecting a year-over-year improvement in '05, similar to what we saw in 2004 and we would still hold to that. So, the expectation would be for stronger distributions in Q3 and Q4.

Even though in our outlook we talk about the fact that we see PVC resin margins coming under pressure, largely due to price adjustments that were made, by and large, in the second quarter, so that's what's driving the average quarter-to-quarter lower, primarily. You know, the earnings from the PVC end of the business are still going to remain well above normalized levels. And we also have not seen any break at this juncture on the ECU and so the continued strength that we've seen in Sunbelt as well as the chlor-alkali aspect of oxy vinyls is expected to continue through the balance of the year. Turning quickly to our outlook, there are four key components and here I'd refer you to our forward-looking statements.

As Tom mentioned in the operating businesses we do anticipate seeing a sequential improvement in our volumes. We believe that the second quarter was down primarily due to inventory adjustments. And so that even if finished good -- downstream finished good -- demand remains flat, our sales will improve as our customers start to buy more. We are anticipating a 1 to 3% improvement in our volume in the third quarter compared to the second. We had talked about PVC margins being off quarter-to-quarter and I'd also tell you we would anticipate higher conversion costs for producing PVC resin, vinyl chloride monomer and chlor-alkali products due to high energy costs.

As a result of that we have outlook that R&I segment would be down 5 to $7 million quarter to quarter and that is based upon our expectation that PVC resin prices do start to trend up again, in September. Ethylene trends, you know, is flat now and starts to trend up as we've seen in spot market for the balance of the quarter.

Total continuing operations, the benefit from our manufacturing businesses offset by the R&I decline, so we're looking at continuing operations being down 3 to $6 million quarter-to-quarter. In our discontinued operations we have outlook that net income would be down 1 to $3 million and this is more seasonal demand patterns as well as the fact that our discontinued operations are more heavily weighted towards automotive applications than our average continuing OPTs businesses and we also are anticipating some margin pressure in those businesses. So those would be down 1 to $3 million. And the final point that I would make is that, in our continuing operations, other income net line -- we did get the benefit of $2 million of foreign exchange and I think it would be somewhat speculative to expect that we would see a similar benefit in the third quarter.

So you put all of those together and you've got an adjustment, you know, to earnings in the, you know, 5 to $11 million range coming down, clearly, with the improvements that we're anticipating in demand we'll be working to improve our margins. But margin improvement has not been included as part of this outlook. With that, I will turn it back to Dennis and we'll take your questions.

Thanks, Dave and Tom. Why don't we open it up for questions?

[OPERATOR INSTRUCTIONS]

Your first question comes from Christopher Miller, JP Morgan.

Good morning. Just a company of questions on the overall portfolio.

I know you said you can't comment a whole lot on the discontinued operations when you look at the overall makeup are there any other assets that you have in mind that you might be selling over the next 12-18 months and conversely, are there any areas where you think you need to consider investing a little more at this point?

We couldn't comment on assets that we would intend to divest, but I could tell you that, you know, our investment plans have been for the last couple of years to continue to strengthen our position internationally, where we see a stronger growth profile for us.

And so, as reflected by the commencement of the third plant in China we'll continue to invest in production lines in our other facilities in Asia. As well as be looking for expansions in Europe, eastern Europe and selectively look for potentially smaller acquisitions that may fill out a technology gap or a geographical gap for us.

Our position in Western Europe is strong. But there are some markets where, frankly, we aren't -- you know, we don't have as much share as we may like and so there are opportunities in Western Europe. I guess that's all that says.

In North America, the investments are primarily focused at continued improvement and productivity as our capacity as a result of restructuring has by and large, you know, is by and large sufficient to enable us to meet forward-demand for the next couple of years. I would point out, as well, last year we made an acquisition for the distribution business, buying the resin direct, and that was very well integrated into the business and then in the second quarter we bought the business of Novatek to augment our PVC position.

So we are selectively going out making acquisitions and key investments. So I hope that -- hope that answers your question.

That's helpful. Two other quick ones. Thoughts on the PVC capacity coming online particularly in China. Any impact you think that is going to have on the market? Secondly, in terms of your leverage target, towards three times, have you said expressly, kind of, what the timeframe is and when you do hope to achieve that at this point?

Yes. Both. On the PVC, it is always dangerous to say we believe the market will consume additional capacity because it's predicated on the market continuing to grow.

But as we look at the supply-demand dynamics, yes, there's a fair amount of capacity coming on in China, but we also anticipate that the market, if, you know, barring the downturn, will by and large be able to absorb it. So I'm not concerned about the type of overbills in the industry that we saw. Probably the best and most significant recent example was the early '90s when about 15 or 16% global capacity was added as the market was turning down. So I'm not anticipating that that would be so much of an issue.

Your second question -- on the three, frankly, that was our target this year. And as Tom mentioned, we will make good progress toward it. I, you know, clearly we need to be there next year. As we've said, we -- part of our long term incentive plan is based upon us achieving and staying at three X and below. And so we need to get there. But as we model it, we will be there in 2006.

I'd also point out that we also have the target of getting to a three X leverage ratio with only our continuing operation manufacturing and distribution business. So that as we look out, you know, we take out the benefit of the R&I fly-up from the EBITDA and it is our expectation to be able, with our operating businesses, to be at three X by the end of 2007. That ties to a clear objective that we have in terms of improving the quality and sustainability of our earnings.

So that you know the fundamental earnings that underpin the Company are coming from our operating businesses, rather than our back integrated commodity assets.

Okay. Right, thanks so much. I appreciate it.

Okay, Chris.

Your next question comes from George Nissan with Merrill Lynch.

Tom, nice job. Tom you always seem to provide decent results in a very challenging economy. A couple questions for you, for the past year a lot of your competitors have recently been implementing some new strategic initiatives to reduce their raw material cost and it is a very high commodity cost driven economy by establishing a better line of communication with their supplier base. Could you provide some color to us on the call today when you guys are planning (inaudible) some new initiatives you have for the company to reduce your overall raw material cost by establishing a better line of communication with your suppliers?

Let me comment to that, this is Tom. We have had for the past -- we've had that as a priority for the past couple of years. We're clearly one of the largest purchasers of plastic additives in particular, and I would say in those areas, especially, we have very close relationships in dialogues with all of the major participant in that field. The -- we approach our raw material sourcing on a strategic basis. We have had innumerable examples of, what would you call it -- value-added or value-creating exercises where we work directly with suppliers to take cost out of the chain to make sure that we've got the most effective materials for our formulations to reduce logistics costs.

One of the things that we do as -- which we believe is unique, among our people in our part of the supply change, is that we actually run our own raw material, own internal raw material distribution operation. We call it integrated supply. One of the things that plagues companies like ours, because it is important for us to have a variety of facilities regionally, is that you can break up your raw material purchasing and a lot of little parts and add a lot of cost. and in -- and miss a lot of opportunity in the process.

Over the last four years, we have gone a long way into consolidating those purchases for our benefit as well as to reduce the cost of our suppliers who are now making far fewer shipments to us. We have just a couple of locations where we will keep our raw material safety stocks in effect.

And then supply the manufacturing locations on a rapid delivery, more or less just in time basis. So we have reduced costs in the chain by doing this and that has given us better economics which we share on a strategic basis with our suppliers. It is also worth noting, I don't know, this goes back probably, five years ago, anyway, where we've clearly been one of the leaders in direct electronic interfacing between our internal SAP-driven ERP systems along with our suppliers. We still order a lot of things just directly from system to system without people being involved in the middle. And so it is -- we've taken a -- I mean I think we've been out in front -- on doing exactly the kind of thing you're saying. It remains a critical part for us because obviously we're very raw material intensive.

You guys always seem to be way ahead of the curve. The last four-plus years I have been following your company. One thing I've noticed is quality is been always a top priority. How do you guys making sure all of your suppliers are meeting up to your quality standards? Are you scorecarding them on a regular basis? Are you meeting with them supplier forms and what are you doing to make sure your suppliers are meeting up to PolyOne's strict standards?

I would say scorecarding and, I would say, strategically selected audits. We've got a lot of suppliers and we also have to be a low-overhead operation so we don't have an army of people out there doing that. But we pick our shots. We have had well, innumerable sessions where we go through the statistical process control performance -- selected suppliers, so that we really have that kind of a strategic linkage.

Again it is something that we think -- that we know -- that we do far more of than the traditional small regional producer that does our kind of business. That is one of the reasons that national and international organizations prefer dealing with someone like us because we operate in the same level of quality.

And final question is -- what is the supplier feedback? Are they open to some of your initiatives? What's been the overall feedback? Are they kicking back at, no, maybe the way you handle their -- handle the discussions with them in terms of possibly telling them you have alternatives -- as in you can go other places? Are they open to partnerships with you guys? What's the overall feedback?

Well, I would say in a summary, probably because of our scale, we remain an important, you know, important customers for people who are supplying into this deal particularly more in -- particularly in the additives area.

But let's not kid each other. The environment we've been in the last couple of years particularly with respect to fighting over how the economics in the supply chain balance out, as we've -- as the whole chain from oil and natural gas down to the consumer level has been battling where the economics (inaudible) has been a real battle. And the -- as much as you try to keep it on a strategic level, when you get down to the crunch time, sometimes it is a matter of -- it comes under a matter of who's pocket the incremental dollar is going to be in. I mean that's unavoidable. So we work to try to keep this as strategic and long term as possible, but our business does not allow us to be anything other than very aggressive and I think that's what you expect us to be doing.

Great. Thank you very much. Good luck down the road.

Your next question comes from Bill Young, Credit Suisse First Boston.

Good morning?

Your next question comes from David Richards, Raymond James.

Okay. Good morning, David.

Good morning. Few things this morning. You know as you look at the third quarter I think you talked about the R&I segment you know the expectations there are that ethylene on the raw material cost side for that business is going to be rising as the quarter goes on.

You do expect the PVC on some level to strengthen a little bit as we go into September. You know, how -- how sensitive is that forecast to a rising PVC environment? Is it a couple million in there? More than that? Do you have any way of kind of giving us a sense for that?

Yes. We're expecting the quarter-to-quarter average for PVC resin down $0.015 to $0.02. We are anticipating that prices will move up at least $0.01 in September. And for our business, through the chain we'll make a half million dollars a month per penny increase in PVC. So, if we can see you know an average price PVC that does not decline as much as we projected, then we would be looking at about half a million dollars per month better -- a million, you know, a million and a half for the quarter -- per penny that would be better.

On the same -- in the same light, if PVC or if the market itself softens and PVC continue to go down and the September increase doesn't happen, which we don't think will be the case, but, you know, not yet September -- we would obviously have that same leverage on the down side. Ethylene, my belief is, looking at ethylene being generally flat quarter to quarter, we're reflecting expectations that the contract market will follow what we've seen already in the spot market and in July and start seeing that start to recover.

And so you know our expectation is that you know we'll see A $0.015 to $0.02 decline in the margin and that's really what's driving the quarterly decline. But you know clearly, we're very sensitive. PVC resin we're net -- net sellers of 600 million pounds of it through the course of the year. And because of our contracts and whatnot, and our equity position in oxy vinyls, and we are net buyers of 800 million pounds of ethylene, so we're -- it is very important for our profit structure right now to be seeing how those two commodities move.

Okay. If I could turn to cash flow for just a second? Both from the standpoint of the discontinued operations which I guess delivered at least on a GAAP basis, about $17 million in cash flow. You talked about working capital improvements in the core business.

Do you have any sense for what the working capital benefits might be in discontinued operations in the second half? Obviously, earnings sound like they are going to be weaker but that could be a source of cash flow.

Then, if I could follow-up with one other quick question? At one point, I think you guys had talked about maybe being 15 to maybe 20 million light of the ultimate earnings from R&I in the form of dividends. Is there anything that's different there from the standpoint of the difference between dividends and earnings?

No. That light is -- for everybody's benefit -- the difference between our expected dividends versus reported earnings is the fact that in oxy vinyls the first 25% of dividend-able cash goes to reducing oxy vinyl's debt, which is not at all -- it's not any part of our balance sheet but it is on the oxy vinyls'. Nothing has changed in that respect.

As we go forward, we would expect to see overall working capital liquidation from both continued and discontinued operations be about $35 million for the balance of the year. So we would expect that that would, you know, continue to be a, you know, a good -- a driver for a portion of the cash flow that we expect to generate in the second half of the year. But certainly not all. Another important driver would be the dividends from our equity affiliates plus the earnings from the business itself.

Okay. Great.

Thanks, Dave.

Your next question comes from the line of Rosemarie Morbelli, Ingalls & Snyder

Good morning Rosemarie. Good morning. By how much do you expect the inventories to come down in Q3 versus Q2 and then by year end if things pan out the way you are expecting them?

Oh, our inventories, you know, we expect them to be generally flat.

Q3 to Q2 we expect to maintain pretty solid controls. You know the inventory, in fact, holding them flat, Rosemarie, would be an improvement on our day sales and inventory since that's a forward-looking, we'd -- expectation would be October, per se, is going to be a stronger demand month than July will be for us.

So by holding our inventories flat, we'll improve on our metric. By the end of the year, you know, our -- I would hope that we could take, you know, another 10, plus, you know, 10 to $15 million out of our inventory level. Again, you know, following our metrics, we would expect to see our inventory bottom out in the middle of the fourth quarter and then start to come back a little bit in December, anticipating the January-february build.

But clearly flat in the third quarter and down 10 to 15 million in the fourth.

Okay. Thanks.

I know you are not going to talk about the progress on the discontinuing operations, but here is a question nevertheless, you may or may not answer it: Given the strong performance of those businesses as a whole, is there any chance that you would change your mind in terms of selling them? Or are you still following the initial plan?

We can't comment and you know, something changes, we will have to report that. So I can't comment on that, Rosemary.

Okay. I understand but I thought I would try.

Looking at your earnings, the majority of the earnings are really coming from the joint ventures. When we look at the earnings from operation exclusions from all sorts of special items, I mean, we are still substantially down versus last year. Now I understand there is is a raw material cost issue, but you are operating in an industry that is oversupplied and so on. Are there any major changes that you can, you know put into -- take into consideration in the future in order to eventually operate at a decent level regardless of the environment?

Well I think our business will always be subject to the environment per se. But you know, the one aspect of our second quarter performance and first half performance that has not been to target levels has been the volume growth. Even in a challenging market we would anticipate that we have got to demonstrate year-over-year growth -- sequential growth -- greater than we have so far this year and as Tom mentioned, we've got two key objectives -- cash flow and sales growth.

Getting new closes, improving our market position, and it's really through growth that we'll bring up our operating businesses and that is the primarily reason for the year-over-year decline -- that and the margins. The margins -- we will continue to work on the raw material side. Tom talked about that earlier. We will continue to work on quality so that we improve the level and the efficiency of our operations. But fundamentally what we've got to do and what the market has got to look for, is us to grow our top line and so that is clearly what our objective is.

Yeah. Let me comment on that. It really is -- growth comes from innovation and it comes from, you know, certainly from geographic expansion, is another kind of opportunity. It is one of the reasons we're pushing that so much. And I've stressed that in my opening remarks and in the priorities.

Geographically we have got a lot of opportunities. That's why I stress the sales from new technologies -- it's not nearly enough. But it is important for us to start and build that momentum and build that, that's why I call it a flywheel and you get success with it, you do more of it, you build on that.

The overall -- you know, it's no question, especially in North American Europe where most of our business is and on a global basis -- the growth rate and demand for plastic materials is not what it was 20 years ago, or 10 years ago. So it means that we've got to be even more creative in the opportunities that we identify, the niches that we pursue. So what we're doing in a variety of, probable -- you would have to call them small waves in that they're -- not any one of them is big enough to go out with a big press release -- is that we are making the Company more entrepreneurial. We are creating more smaller -- subdividing some of our business units into smaller entities. We are adding to our sales and technical services resources.

And you have got to build this base and that's why the top goal is organic business growth, because that's what -- we have got to be better at bringing a greater number of fresh ideas into the marketplace. And build that base. And the industry we're in is always going to have its ups and downs and we are regrettably but unavoidably, so the shore with the raw material. Tidal waves sometimes break and we fight to push those on. Those are just the facts of life of the business we're in. Where we got build [ inaudible ] through the tougher conditions.

As you are growing Asia, Tom, obviously seems to be the right thing to do, are you eliminating some capacity in Western Europe and North America where you see quite a few, I'm sure, of your customers moving into Asia , Europe?

We're not plastics consumption-wise it is at the moment down. We don't see the long term trend that we're on as down in Europe or the U.S., we just see it growing very slowly. So to the extent we'd say we're eliminating capacity, Rosemary, would be more eliminating something we'd might otherwise had done if the growth had been there.

We're just not going to be expanding capacity as much in those regions or would be doing it selectively on new products. While we're going aggressively after the parts of the world that are the need, the service, need the local service, which we are, you know, our businesses is all about.

Okay. Thanks, good luck.

Thank you, Rosemarie.

We'll take another question.

Your next question comes from Nancy Traubb, CSFB.

Good morning.

Good morning.

I don't want to beat a dead horse, but.

Wow! [ LAUGHTER ]

You had great results. You mentioned the inventory correction in the second quarter in North America and Europe and I was wondering if there was more to the downturn in volumes.

Is it a continuation of manufacturing moving to Asia or did you actually lose market share in these -- North America or Europe?

A very, very fundamental point and I can't think of anything that we've spent more more time trying to understand. I mean we're spending most of our time going out and doing something about it, but in terms of assessing where we are, we're asking those questions, you know, everyday.

The -- you get that kind -- you know, you try to gather a viewpoint of that by doing a lot of surveying of customers, raw material suppliers and so forth. You know? In terms of somebody having a preference for buying from somebody else, other than ourselves. We spend -- that's sort of the first thing you want to find out.

As we've done that, in detail, as I said, as disappointing as the volumes are and as we tear it apart by product line -- there's some places where we're probably down on a share basis, but there's far more where we're better on a share basis, even though the totals are lower. So [Indiscernible] I think we're -- add it altogether and think we made headway on that.

But the trends on offshore movement, I think, are longer term. They don't just show up all of a sudden. The conditions where they would show up, I think, are something that we saw in 2003 -- 2002, 2003, when world commodity markets were real sloppy. Regrettably it still seems to be the case and a lot of large producers still think that Asia is a kind of a place to move material.

And so one of the things that led to the sharp downturn in our industry, I think, or in U.S. in particular, and some in Europe, was that Asia not only had a labor advantage-- had a raw material advantage for a short -- for that period of time. That turned around in '04 and certainly a lot of commodities are still high in '05.

We've seen some softness in spot markets in materials here for part of '05. But I don't think the supply change can react so fast that you would say it's just material moving offshore, you know, sort of on a month to month basis. I think there's a long term trend that way. But when you say, well, why was business reasonably okay in the fourth quarter and first quarter and all of a sudden the second quarter, didn't have any kind of seasonal pickup? I don't think it is because everybody decided in February to pick up and move to Asia.

I mean, it just doesn't move that fast. So I think that's a long term trend, but not a short-term situation.

Okay. And you mentioned PVC prices being down, possibly one $0.015 to $0.02, third quarter versus second. How much have they come down so far to give us that kind of trend?

I think that what we saw was that increases that we thought were put in the market in March did not happen. We thought there was $0.02 in March -- it was only $0.01. As it turns out and I believe the market toward the end of the second quarter off $0.01 to $0.02. July is going to be a battle and, then, August flat; September up is how I would see the trend, Nancy.

Great. Do you have any price hikes announced for compounds? What was the trend in compound prices in the second quarter?

In the second quarter, the trend was up just a little bit. Primarily in the first part of the quarter where we were still on momentum from first quarter initiatives. And then flattened out, but quarter-to-quarter the average was up and I am unaware of any increases.

Thank you.

Other than, I think we ought to add, we're not out on -- you know sort of send out the letters broadcast kind of increases. We have places where -- we have a few laggards that we need to still pick up with and so it's more selective than it is widespread.

Great.

Your next question comes from Nina (Schiller) , Morgan Stanley.

Yeah, Nina, we'll take a short question because we're up against the hour here. Nina? Maybe not.

Your next question comes from Andrew O'Connor, World Capital.

How about that?

How about that, Andy?

Good morning, guys.

Good morning.

You know, are there some PolyOne products, the destocking of which by your customers has been more significant than others? I'm just trying to get a further sense for why you believe your customer inventories have bottomed? At this point? Any other evidence you can share to support that view would be appreciated. Thanks.

I think it is largely anecdotal -- [inaudible]

Unfortunately you're cutting out. At least on this end, I don't know about the caller.

Still here.

Go ahead Tom and try again.

Am I okay?

Yeah.

I think we're simply seeing a few signs of some improvement in some order rates but it is too early to call that widespread.

But personally I have been spending a lot of time out with customers in the last six weeks or so, and you know, you hear, you know, so many individual stories out there, but you if try to step back from the whole pattern, it seems that people are just expecting some kind of pickup.

You hear of even as good as some of the -- a lot of construction markets have been -- you hear stories of -- one of our big markets is the window industry, for example. The window industry and the siding industry was really not good at all in the first half of the year. They seem to be talking more optimistically in the stuff starting to move out of their warehouses.

It just, whatever people -- I think the other thing you would point to, is that spot prices for commodities have -- commodities resins have been moving and so the -- a lot of what you get in terms of inventory is not because they were super high, it is just that people are reacting to the future prospect of their prices being lower. And with what is going on with oil prices and, maybe, some consumption of some physical inventory, I don't think there's a lot of expectation of lower prices to come. And when that sort of speculation on the downside starts to dissipate I think you see a return to some other behavior.

It is too early to declare some kind of resurgence in demand. We're not seeing that, but we're seeing a few signs that, we are maybe at the very least, leveling off and maybe doing a little bit of pickup.

Okay. So it's just an overall general sense?

Yeah.

Okay. Thanks.

We wish there were data out there that everybody reported and you could track. This is really far more about behavior in expectations than it is that there was some kind -- that the warehouses were chock full and the tanks were full and nobody could take any more.

I wasn't that. It was a expectation change from, you know , you ought to be on the high -- little bit above average on inventories to wanting to be below and I think that's kind of rebalancing.

Got it, thanks,Tom.

Thank you, Andy. And Tom, thank you. And David, also. We're up against the hour and I do know there's other calls that we want to be respectful for.

We certainly are -- would be happy to take some calls through the balance of today and next week, so if you didn't get your question in, feel free to give myself a call later today. Thank you. And thanks, Tom, again, Dave, both of you for your help today.

Best wishes to everybody.

This concludes today's conference call.