Avient Corp (AVNT) 2010 Q2 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the PolyOne Corporation's second quarter 2010 conference call. My name is Michael, and I will be your operator for today. At this time all participants are in listen-only mode. We will have a question and answer session at the end of the conference. As a reminder, this conference is being recorded for replay purposes.

At this time I would like to turn the call over to Joe Kelley, Vice President of Planning and Investor Relations. Please proceed.

Thank you, Mike. Good morning, and welcome to everyone joining us on the call today.

Before beginning, we would like to remind you that statements made during this conference call which are not historical facts may be considered forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995. Forward-looking statements will give current expectations or forecasts of future events and are not guarantees of future performance. They are based on management's expectations, involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements.

Some of these risks and uncertainties can be found in the company's filings with the Securities and Exchange Commission, as well as in today's press release.

During the discussion today the company will use both GAAP and non-GAAP financial measures. Please refer to the earnings release posted on the PolyOne website, where the company describes its non-GAAP measures and provides a reconciliation of them to the most comparable GAAP financial measures.

Operating results referenced during today's call will be comparing the second quarter of 2010 and the second quarter of 2009, unless otherwise stated. All prior-year financial references will be based on restated financial statements for the change in inventory valuation accounting to the FIFO method adopted by the company effective January 1, 2010.

Joining me today on the call is our Chairman, President and Chief Executive Officer, Steve Newlin and Senior Vice President and Chief Financial Officer, Bob Patterson. Now I will turn the call over to Bob, who will review the quarterly results.

Thank you Joe, and thanks again to everyone who is joining us on the call this morning. As always we welcome the opportunity to speak to our investors and analysts about the recent performance of PolyOne.

For the second quarter of 2010 we reported sales of $693 million and net income of $45.7 million or $0.47 per share. This compares favorably with the second quarter of 2009, when we reported sales of $497 million and a net loss of $1.9 million or $0.02 per share.

Consolidated revenues grew 40% year-over-year, driven by a 27% increase in volume. Each platform recorded double-digit sales increases due to new business gains and improving demand conditions.

Fluctuations in foreign currency exchange rates, primarily a weaker euro, negatively impacted consolidated revenues by 1%.

As a result of the increase in sales volume and improved operating margins, operating income before special items and nonrecurring items increased to $47.1 million or 6.8% of sales for the second quarter of 2010, from $18.5 million or 3.7% of sales in the second quarter of 2009, a 310 basis point improvement in profitability.

Excluding special items and one-time tax adjustments in both periods, and nonrecurring gains in the second quarter of 2010, EPS increased to $0.25 per diluted share for the second quarter of 2010, compared to $0.09 per diluted share recorded in the second quarter of 2009. The $0.16 year over year increase in earnings per share was driven by the earnings growth of our three strategic platforms, which combined for record-setting operating profit of $52.9 million.

Our specialty platform continues to drive our transformation strategy, recording $23.7 million in operating income, a new record for PolyOne, and nearly half of the combined strategic platform operating income.

Versus prior-year, specialty revenues grew 23% to $265 million for the second quarter of 2010, driven by an 18% pick-up in volume. Price mix added 8%, while a weaker euro reduced sales 2%.

Specialty platform growth was led by gains in transportation, healthcare, and electrical end markets. Regionally, North America sales grew 29%, followed by Asia at 28%, with Europe at 17%, respectively, over the prior year.

From a profitability standpoint, specialty platform operating income as a percentage of sales increased to 9.3% from 5.5% in the prior year. This increase was driven by 150 basis points of gross margin expansion coupled with the previously described top line growth.

Now let's look at PP&S. Driven by a 28% increase in volume, our Performance Products and Solutions segment grew sales 28% over prior year to $219 million for the second quarter of 2010.

Price and mix was flat as auto sales contributed the most to PP&S growth, followed by industrial and [appliance].

Building and construction related revenues for the platform grew 17% over the prior year -- respectable, but still behind the other previously mentioned markets.

PP&S platform operating income expanded to $17.6 million or 8.1% of sales, from the $12.4 million or 7.3% of sales reported in the second quarter of last year.

At 8.1%, PP&S achieved a new record in profitability, as the expansion from the prior year was driven by improved mix, volume gains and the continued realization of Lean Six Sigma benefits.

Our distribution platform achieved the largest year-over-year revenue expansion of any of our businesses. Sales increased 79% on 34% higher volume.

The remainder of the increase in revenue was driven principally by price increases associated with higher raw material costs, which are largely passed through in this business. Over one-third of the platform sales growth was attributable to new business gains through new supplier agreements with DuPont, Bayer and INEOS ABS. The 79% sales growth resulted in operating income of $11.6 million or 4.8% of sales, almost triple that of the prior year amount and a new record for PolyOne. The increased profit level of this platform is a direct result of scale, as we leverage our invested capital base and SG&A. Recall that PolyOne distribution has no fixed assets, and its only investment is working capital, which declined from 18% in 2008 to 11% in 2010.

POD achieved a 32% return on invested capital on a trailing 12 month basis. From an end market perspective, POD's revenue growth was driven by consumer, automotive and health care, in that order. POD continues to lead PolyOne's healthcare expansion, and so far this year we have announced two significant supplier wins, as BASF and Dow Corning selected us to distribute their healthcare products. This is further evidence that suppliers are seeking us out now, not only because of our customer relationships and service levels, but also because of our strong image and expertise in healthcare applications.

Dow Corning's healthcare product line a silicone elastomer, is used in a variety of medical applications and represents the first non-thermal plastic in PolyOne distribution's product portfolio.

Overall we are very pleased with our second quarter performance from our three strategic platforms. We were also encouraged to see improved sequential profitability from our SunBelt joint venture due to chlor-alkali pricing gains and a pickup in volume. Our 50% share of SunBelt second quarter earnings increased $6.4 million from the first quarter but was still 25% below the prior year.

Other P&L items to report include corporate and other costs before special items, which declined $9.7 million from last year, principally due to lower pension and post-retirement expense and one-time insurance and legal recovery gains of $4 million -- the $4 million, which we specifically excluded from our earnings per share of $0.25.

During the quarter, special items included a $14.4 million favorable insurance recovery related to previously incurred environmental remediation costs, offset partially by environmental charges and previously announced restructuring expenses.

And finally, our effective tax rate for the quarter excluding special items and a tax valuation allowance adjustment was 36%, bringing our year-to-date effective rate to 34%, which we continue to believe is a good rate to use for modeling.

Cash taxes paid in the quarter were well below this 34% due to NOLs in the US and a $5 million state tax refund received in the quarter.

From a balance sheet perspective, we ended the quarter with $241 million of cash. This is up $41 million from the first quarter and principally due to cash from operations, including approximately $18 million from insurance recoveries and legal settlements.

Continued improvement in working capital efficiency has minimized the investment required to support the 38% sales growth achieved during the first half of 2010. In fact, working capital as a percentage of sales is now 9%, or a net 30 days, which we consider best in class performance.

Net debt including the SunBelt guarantee was reduced to $199 million, resulting in a net debt to EBITDA ratio of 1.1 times. This improvement has not gone unnoticed by the rating agencies, as both S&P and Moody's upgraded us during the quarter. The June 30th Moody's upgrade cited continuing, sustainable and significant improvement in operating income generated from our strategic platforms. Both firms are pleased to see that we are no longer dependent on equity earnings from our joint ventures.

Following the quarter close on July 7th of 2010, we repaid $40 million of borrowings and terminated our Citibank credit facility, ahead of its regularly scheduled maturity in 2011. Even after the early retirement of debt, we still have the best balance sheet in company history and ample liquidity to fund future growth initiatives.

I will now turn the call over to our Chairman, President and CEO, Steve Newlin.

Thanks Bob, and good morning. I'm very pleased with our second quarter results, and as Bob highlighted, we achieved a number of performance records, despite housing starts and auto sales continuing to be well below historic levels. This is important, because our performance does not simply reflect a rebound from the unsustainably low levels of demand in these end markets, but rather it illustrates the diversity of our end markets and the earnings power of the new PolyOne.

To better calibrate our performance and demonstrate the significance of these record-setting results, it might be helpful to look at the first half of 2010 results and compare them to pre-recession performance levels.

During the first half of 2010, the combined three strategic platforms generated $94.6 million in operating income, 53% greater than the $61.7 million recorded during the pre-recession first half of 2008.

During the same comparative period, EPS grew over 75% to $0.42, from $0.24, and this was despite sales declining from $1.5 billion to $1.3 billion and equity earnings declining $8.8 million.

For PolyOne it's not about getting back to pre-recession profit levels. We are past that. In fact, earnings per share for the first half of 2010 have already exceeded earnings per share for all of 2008.

Our product portfolio, culture, strategy, business mix, financial profile, and management team have all radically changed, and we are demonstrating consistent performance gains across key value drivers as never before. We significantly strengthened our leadership team and instilled a performance-based culture of accountability and urgency, as evidenced by our consistent record-breaking performance.

Over the last 3 years we have diversified our portfolio by growing our business in highly attractive and less cyclical end markets such as health care, consumer products, and packaging. Subsequently, we have reduced our direct exposure to housing and automotive end markets to 13% and 14% of our total sales, respectively.

Our current housing and auto exposure should be viewed as a positive. Consensus estimates for US housing starts is 650,000 in 2010, well below the 50-year statistical average of 1.5 million units per year.

Similarly, at 11.5 million vehicles, the consensus estimates for US auto and light vehicle sales this year does not equal the estimated annual scrap rate of 12 million and would have to increase by 30% to reach the long-term average of 15 million vehicles sold per year in the US.

Demographic projections support returning to historical average levels of housing starts and auto sales at some point in the future. We view an eventual recovery in these end markets as additional upside to our current record-setting performance. But we continue to prudently operate under the premise that the recovery could be slow to develop.

Today the PP&S platform maintains the majority of our exposure to the US housing market, and despite the current market conditions, this business recorded $29.7 million of operating income, or 7.4% of sales in the first half of 2010. Profit levels of this magnitude exceed the 6% of sales this platform recorded in the pre-recession and peak housing fiscal years.

Profitability enhancement of this magnitude, combined with our recent performance in specialty and POD, confirms that we are on or ahead of our schedule to achieve all of our 2012 stated financial performance targets.

Despite the significant profit improvement highlighted in Bob's comments, additional margin expansion is targeted for all 3 of our strategic platforms.

We have publicly stated five goals to be achieved by 2012, and just as a reminder, they are --

First of all, to expand operating margins, and we've outlined these by platform. The 2012 targeted operating income margin for the PP&S segment of 8% to 10% represents further margin expansion of 100 to 300 basis points from the 7.4% achieved year-to-date. And at 4.4% of sales, our distribution business is already at the low end of our 2012 expectations of 4% to 5%. So we now have our sights set on the high end of this range, and we are confident, with growth in demand, continued new business gains, and improving mix, we will reach or exceed the upper end.

The specialty platform's 2012 targeted operating income margins of 10% to 12% represent further margin expansion of 100 to 300 basis points to the 8.6% achieved during the first half of 2010. So again, our trajectory has us ahead of plan here.

In terms of how we get there from here, I would highlight the key drivers being Lean Six Sigma, new business gains, and innovation and improved mix.

First, our award-winning LSS process is deployed throughout the entire organization. As this happens, we will continue to add 100 basis points of gross margin expansion to our manufacturing business each year, at least through 2011.

Next, we will benefit from increasing volumes, driven by new business gains, as we leverage our fixed cost structure.

Last, but perhaps most important, we believe the key to ongoing margin improvement is to continuously invent and create innovative and differentiated value-added solutions for our customers. Only through innovation can we achieve long-term, sustainable margin expansion.

And this leads me to our second objective for 2012, which is to achieve a specialty vitality index of 35% to 40%. We measure our success in selling new, innovative products through our vitality index, which measures the percentage of specialty sales generated from products developed in the last 5 years. We achieved 40% in the first quarter and have maintained this best in class performance in the second quarter as well.

One recent example of a new product innovation is WithStand, which we recently introduced at the medical device manufacturers' show in New York City. WithStand is a great example of listening to the voice of the customer and leveraging our formulating and compounding expertise to deliver a solution.

WithStand is an antimicrobial technology designed for the healthcare market. This new additive platform helps fight hospital acquired infections by adding antimicrobial characteristics to medical devices, medical packaging, and our other healthcare and wellness related applications. The new technology has broad reach for potential applications in the marketplace, and we are excited about this latest product launch for this target market segment.

Let me move to our third objective, to derive more than 50% of operating -- platform operating income from our specialty business.

Operating profit for the specialty platform has expanded rapidly every year since 2005, when it represented only 2% of our income, and now accounts for 45% of the company's operating income for the first half of 2010. Our 2012 goal is to deliver more than half of our operating income from specialty, and our current trajectory has us ahead of that goal.

For our next objective, we targeted a pretax return on invested capital of greater than 15% by 2012. In the first half of this year with our expanding profit margins and improved working capital efficiency, we exceeded this target, reaching 16% ROIC for the last 12 month period. Since 2008 we've reduced our working capital as a percent of sales from 15.4% to 9.0%.

Lastly, our globalization target is to derive at least 40% of revenues from outside the US. Year-to-date 2010 revenues outside the US totaled 34% of sales. The nearly 80% growth in sales of our largely domestic distribution business has challenged our progress toward this target, but in a way, that's a good problem to have.

The reorganization of our specialty businesses, announced at the beginning of this year, will enhance our ability to grow our international revenues as we leverage innovative products, customer relationships, and best practices across geographic borders. Additionally we plan to complement our organic growth initiatives with acquisitions and have publicly stated our objective to gain a presence in South America and the Middle East, as well as expand our operations in Asia and Eastern Europe.

As you can see, we are well ahead of our plan to achieve targeted performance goals established a few years ago. Our successes to date give us great confidence in our ability to meet or exceed all of these established goals. But perhaps more importantly, our successes should give investors and stakeholders confidence in our management team's ability to deliver on established objectives.

As we look to the balance of 2010, it is difficult to project quarterly sales and earnings with clarity. We have historically experienced some seasonality in our business, with Q2 clearly being the strongest, followed by Q3. While that was not the case in 2009, we may return to such a pattern in the near term.

August, for example, is an extremely slow month in Europe, and construction related sales in the US begin to pull back at the end of the summer. Additionally, POD year-over-year revenue growth rates will begin to soften as the marquee new business gains of 2009 begin to lap themselves.

That being said, current demand levels with our existing customers presently provide no evidence which would suggest a double-dip recession.

We are focused on winning new business, providing customers with new and innovative products and solutions, and improving profitability and cash flow with the continued successful deployment of Lean Six Sigma.

To continue driving growth and strategic execution, we intend to prudently invest in approximately 50 incremental commercial and technology resources over the next few quarters. But we will remain mindful of economic conditions as we do so.

In addition, over the next 6 to 9 months we expect to invest $4 million to $6 million in new sourcing, supply chain, and sales force efficiency tools. These tools will allow us to more effectively consolidate global sourcing activities and improve our customer relationship management capabilities.

I am extremely confident that we have the right management team and strategy in place to drive these initiatives. And as a result, we expect to continue to outperform in terms of revenue and earnings growth.

We have made substantial progress over the past several years, but we still have plenty to do and a world of opportunity. It is truly an exciting time to work at PolyOne and to be part of a winning culture.

That concludes our prepared remarks, and now I would like to turn the call back over to Mike [Drennen], who will open up the line for your questions.

(Operator Instructions). [Mike] Mitsch, BB&T Capital Markets.

Did you change your name, Frank?

Interestingly, that is the name of my brother and my father. So they are -- they've been hearing me talk about PolyOne, so they are [certainly] (technical difficulty) enthused about the results this morning.

Steve, if you could talk a little bit about the -- you were mentioning you expect to see some slowdown in the August time frame, particularly in Europe. But can you talk about the pace of business that you have seen in July? Obviously we are seeing some more signs that perhaps the automotive market domestically is not taking the level of summer shutdowns that they have in the past. Can you compare and contrast how July has started out relative to the pace of business in the second quarter?

Well, I -- obviously whenever you conduct your quarterly calls, you have usually got a month under your belt, and you have obviously figured that out. So we are feeling good about how the quarter has started. Can't say too much more about this specific quarter.

I would say -- to the earlier part of your question and comment about Europe -- August -- I lived there for 4 years. August is just always a slow month in nearly every business, unless you are in the resort business in Europe, because it is a holiday period, and factories take turnarounds and shut down. So that is just a common thing, and we don't expect this year to be any different. We expect Europe will be seasonally soft in August.

But the automotive sector that we are seeing here in the US, it looks like 11.5 million units will be built. That's up from last year, without the stimulus that we had for cash for clunkers last year. And again, we really looked into, how many cars do you need to build in the US to understand just sort of a steady-state? The data suggests that's about 12 million units. So we're not even running quite at that pace right now. So we're feeling pretty good about the automotive sector and the economy in general right now.

I would just offer a comment that perhaps with the World Cup, June was not as robust as it otherwise might have been, so the comp might not be as difficult with the August shutdown.

I've noticed, obviously your net debt is down and your leverage ratios are really on the under-levered side. How do you look at the fact that your shares are creeping up here, I guess with stock options being granted, in terms of at least offsetting that? And how -- in general how do you look at -- how would you prioritize the use of cash going forward?

I will start with that. I would say our primary use of cash in the near term is going to be for acquisitions. We've specifically said that we want to grow our specialty platform, not only with bolt-on acquisitions but geographically in areas like South America, Middle East, and our presence in Asia. So number one, I would say, continues to be to support our acquisition growth.

We certainly have more than enough liquidity to handle bolt-on acquisitions of let's say $75 million to $100 million. Anything beyond that, we would probably be looking to do something incrementally with debt.

So as we just think about the cash on the balance sheet, where it is right now, we would say that is probably a good way to think about our acquisition capabilities. And beyond that, I would say we're just happy to have the level of cash that we do. I mean, if you are thinking about an observation relative to stock buybacks or anything of that nature, we just have not made a decision to do anything further at this point.

It looks like you're trading at under 6 times EBITDA, looking out a year, although as -- Steve, as you mentioned, you're hitting your targets on margins well ahead of the 2012 schedule. It just seems on the surface that there probably are not that many M&A opportunities that are as intriguing as buying your stock, but I do understand your thought about the geographic diversification.

Yes. I mean, look, we are looking for opportunities that are not only geographic of course, but as we find some unique technologies that I think are un-leveraged or underutilized, maybe they are in a region that we could, through our infrastructure and with our brand, leverage across the globe, that is what we would be doing. So it is technology and new products, new platforms, innovation. It is, again, geography, and then finally it would be sort of synergy plays where we see and have a lot of comfort that a deal makes great sense because it could be bolted on or combined with our organization. That is kind of how we look at our acquisition strategy.

All right. Perfect. Thanks. And nice quarter again.

Saul Ludwig, Northcoast Research.

Steve, I wonder if you could just elaborate a little more on those acquisitions. You and every other company in America is flush with cash, and everybody's looking for deals -- particularly your endeavor to get into the Middle East and South America. You have been pushing this for a long time. Are you at the point where you think there is maybe some live potential here? That would you think that before the end of the year you might be able to consummate a deal? How do you see the environment?

Well, it is a great question, and of course as you well know, there are limits to what we can talk about because it could disrupt our process and the strategy that we have deployed to go after the business there. And I don't want to risk that or jeopardize it in any way.

But I would just say this, we are in discussions in South America. We are talking with people in the Middle East. And I would say South America is likely to happen ahead of our Middle East -- the culmination of any deals we might come up with. I think we're seeing a lot of interest, people who are taking PolyOne very seriously and know that we're going to be there, one way or another, and we will.

This is -- a lot of this is -- there is a build/buy element of this too that we analyze. You can move in without a lot of capital and do greenfield sites in these areas, so you're really trading off -- sometimes you are compromising a bit, location or establishment versus -- so starting from scratch, and you trade that off for time and immediate presence.

So those are the kind of evaluations that we make all the time. And then of course we have established over the last few years a track record of not overpaying for any acquisitions. We don't want to burden businesses and then have to reduce costs to the point that they can't grow.

I think a great example is GLS, where after acquiring that in January of '07, they are going to be pushing $29 million, $30 million of OI this year, which is about 2 1/2 times the takeover amount. So we did not constrain them. We did not take people out of the organization. We left them alone to run their business and then encouraged them to do a few things on the efficiency side that PolyOne is pretty good at.

So that would be the kind of approach we would take with acquisitions, is don't overpay. If it is a small, high-tech issue, we might -- you might come up with a higher multiple. If it is a synergy play, we are going to be very, very careful about it.

So we are in discussions on both fronts, and that is probably as far as I could carry that conversation.

Okay. Bob, you mentioned the corporate expense of $8 million. That was inclusive of the $4 million recovery, and why would it be there and not in the special? Why wouldn't you have broken it out?

Yes, in the same way that we reported the first quarter, if you will recall, we had $3 million of gains included in corporate costs that were not designated as special items. The primary reason is that those costs and recoveries were actually against recently incurred expenses, and we would describe those is operational in nature, specifically for how we design our incentive plans. And so there is a special definition for special items. Those costs don't meet the definition of that, and that is why they are included in corporate costs.

However -- and this is certainly after receiving feedback from the first quarter -- we did go ahead and call those out this quarter and specifically excluded the $4 million from our EPS of $0.25 this quarter.

Got you. Thank you for the clarification. And from a seasonal standpoint, do you think that your revenues would typically decline 4% or 5% from the second to the third quarter? If you go back in history, not necessarily last year, which was unusual, but what would be the more traditional seasonal decline on the revenue front from second to third quarter?

It is very -- I have thought about this on a number of occasions. I think that that is probably a pretty reasonable estimate historically. You have to go back 3 or 4 years to actually get a lot of traction on what seasonality looks like, because of acquisitions that we have done, as well is just changing dynamics in the housing market in '08 and '09. So I hate to say that that is a great number, but directionally probably reasonable.

And then just finally, we've been reading about a lot of decreases in the prices for basic plastics, PVC, polypropylene, polyethylene, etc. Are you in a position to maybe capture some of that savings and have higher variable margins in the third quarter than you had in the second quarter? Or will you have to give back some price as these raw material costs have receded?

Well, it sounds like there might have been 2 questions in there. But I would generally say that coming into this -- or about halfway through the second quarter we did see some easing in raw material costs vis-a-vis the first quarter of this year. All things being held equal, that would be a tailwind. However, there have been some recent developments in the ethylene markets suggesting -- and from a spot perspective, August deliveries of ethylene have spiked upwards. And so we might see some additional pressure on prices that we did not see in the second quarter coming through in the third.

So I think it is actually a bit of a mixed bag. If it were not for the recent activity in spot prices, I would tell you that it seemed like in the second quarter we would see that as a tailwind going into the third.

And of course, as you know, this is going to affect our distribution business more than any other. And they are pretty -- quite immediate in terms of the adjustments and reactions that they have to make. So you get a little bit of benefit from what inventory you may have on hand, but we are really tight on the amount of inventory that we're holding. We are getting a lot of turns in that business. So if you do get a little margin expansion opportunity there, it is quite short-lived.

Mike Sison, KeyBanc.

Nice quarter. First question, in terms of your operating rates, I guess it would probably be different between each of the segments, the major segments. How does that compare now relative to where they were in '08?

Relative to '08 they are all better than '08 on each one of the platforms, if you are referencing operating margin.

No, operating -- I'm trying to get a gauge of your operating rate, so --

Oh, yes. I'm sorry. I thought you meant operating margins. Yes, if you -- for example from a volume standpoint -- and we don't typically disclose our operating rates, but I will kind of give you a little bit of historic context here if I can. Volumes for example in the second quarter of this year are about 11% below where they were in the second quarter of 2008. And if you recall, in the second half of 2008 we took out about 9 plants. Overall, combining those restructuring actions with what we did in the first quarter of 2009, we estimate we reduced our fixed capacity by probably 18% to 20%.

So hopefully that gives you a little bit better barometric reading on how we are from a capacity standpoint now versus then.

We did make some comparisons in the call about our performance relative to 2008. Certainly earnings and operating margins have improved, and all that despite the 11% decline in volume I just mentioned.

Right. And then, Steve, to get to the top end of your '12 range for operating profitability, is it just to recoup the rest of this volume?

No. Really it is not as much about volume as it is innovation and driving uniqueness and differentiation and the right -- going after the right kinds of customers, getting the right kind of mix in the organization. As you know, we have been slowly pruning our way out of some business arrangements that were not very attractive, and some business applications where we did not have a lot of distinction. So that process continues, and we will continue to go through that long-term proposition and upgrade our accounts and bring in new accounts that's more attractive than some of our base business.

So the more we innovate and drive products, we -- we are pricing properly now for our innovations I believe. We are pricing them for the value that they deliver to our customers, which is something -- we really priced based on cost before. So we got to keep cranking out new innovations and new products and continue to upgrade our mix and upgrade our client list, and that is what is going to really get us to that 12% and beyond.

Okay. Then in terms of seasonality, for the fourth quarter has historically been the weakest. Is that trend going to continue?

We think so. There is nothing out there that suggests it is going to be any different. We don't see -- what could change that? A major surge in housing, in auto. But I don't expect something to happen abruptly enough to impact that. I think we will follow generally our seasonal patterns, and so the fourth quarter will be -- will probably be off.

In terms of the economic outlook, I was encouraged to hear that you suggested customers felt fairly optimistic that we would not be going back into a recession. Is there any particular end markets or -- that just their visibility looks better? Can you give us a little bit more color on what customers are saying?

Well, I think you just see this. And again, these are mostly -- this is anecdotal, okay? But you see them having concerns about having enough inventory, where in the past their concern was of a different flavor. It was, gee, I don't want to take anything because I don't know if I'm going to get any orders to fill. So I think that would be one comment -- their business, the better customers are having more demand on their business. And they are just -- there's beginning to be a little bit of cautious hiring that is going on. So those would be the comments we would have that would say, things look right now pretty good, if we don't talk ourselves into trouble here.

So it's a little bit of contradiction to what you may be hearing in other areas. But we are not seeing anything that suggests a double dip right now. That is just based on order patterns and the comments from our customers.

Christopher Butler, Sidoti & Company.

I wanted to come at the raw material question another way. We have hit it from future looking and the pricing side, but your gross margin held up very well in this quarter, considering that the headwinds up through April must have been fairly substantial. Could you talk about what you are doing differently now than the historical PolyOne that would have really gotten caught in this?

Well, I think there are several things. First of all I would say, one of the things that influenced our gross margin in the quarter to the downside was the mix, with our distribution business being up so strong, and distribution actually came in at 35% of our sales in the quarter, which a year ago, it was 27% of our sales. So that's a lower-margin business, and that has a mitigating effect of the expansion that we have.

But what is going on differently -- to your question specifically -- is we just have much better discipline and rigor around our pricing process. We also have Lean that's constantly working on improving gross margins on the manufacturing side.

But we really have to get this on pricing, and how do you get this on pricing? We take excellent care of your customers, and you try to drive the growth of products where you have some distinction and some distinguishing characteristics. And then you keep quality high, and you keep your delivery rates up. Those are the best ways I think we can manage our margins.

Innovate new products, treat customers very, very well, come out with quality products and solutions, and then drive cost efficiency through the organization and get the pricing right. And those are the disciplines that we have built into our organization.

I hope that answers --

It does. Just to follow up with a slightly trickier question, I guess -- looking at the segment results, it seems that your performance products business was able to handle material costs a little better than your specialty products. Could you give us some color on that?

Is that a question -- I mean, I would say relative to the second quarter of last year, that is not the case, but if your reference is to the first quarter --

Right, sequentially.

Yes, sequentially that is true. The primary observation we would make on that is really a mix driven phenomenon where our North America engineered materials business has grown the most, I would say, Q1 to Q2, which is principally auto and wire and cable, two of our toughest markets from a margin standpoint. And that's -- this is really within -- yes, again, the specialty platform. I would say that weighed on second quarter versus the first quarter more than anything else.

Shifting gears over to the balance sheet a little bit, you had mentioned the improvements to working capital. Is this a baseline that we should look at for the remainder of the year, now that sales seems to have stabilized a little bit?

For modeling purposes I think that is fair. I would say that as you model growth and changes in the top line, if you used a 9% number to understand working capital investment, I think that would go fine.

And finally, looking forward a little bit, 2012, you have some debt due. Does it make sense to refinance that now? Is that something that you would like to do ahead of possible acquisitions? Or is that just whenever the best opportunity comes?

Well, we have not prioritized the refinancing ahead of acquisitions. Of course it is dependent on the size of an acquisition. Whereas I said previously that we would handle bolt-ons of say $75 million to $100 million with cash on the balance sheet. If something were larger than that, we would probably look for debt financing to do such a deal. And if we did find one that was that large, in all likelihood we would probably do a refinancing at the same time, because it makes sense to just do one transaction.

Certainly looking at where rates are today, the single B index is down around 8% or even slightly below that. Market conditions are good historically. So all things held equal, I think that if we could find an opportunistic time to do something between now and 2012, we might take advantage of it.

Dmitry Silversteyn, Longbow Research.

Congratulations on a good quarter. A couple of questions. First of all, on the acquisition front you talked about obviously going after the specialty business as a platform that you are trying to build but that you -- you have also mentioned that leading the charge into the healthcare applications and into some of the high -- higher-growth, more specialty application had to be in your distribution business. Would you be -- in other words, how broad is the universe of targets that you are looking at? Are you just looking at the specialty compounding and color type of business? Or are you looking to perhaps get into the market, if it is possible, to do either cheaper from the infrastructure point of view with a distribution type of business?

When you ask about how broad the opportunities are, I would tell you that if that is a question about how many things are we looking at at any one point in time, I would tell you that there's probably 10 to 12 opportunities that are in front of us at various stages of discussion, inquiry and research. Some are further along than the others.

I will tell you that all of those are in our specialty platform and really would say that some of those are specific to health care. What we have seen is that the health care acquisitions have a tendency to be smaller, more niche focused, and I think NEU is a very good example of that, the deal we did was last December, where we found existing technologies that allowed us to expand our own portfolio of products. And that relationship really holds true with what we're looking at today.

Steve, I don't know if you'd (multiple speakers)

Yes, I would add that while it is clear, it should be very obvious to all who have watched us that our primary focus in terms of acquisition is specialty. There are some opportunities that cut across businesses that are in very attractive markets, and health care would be an example. Health care sales were up 49% over 2Q of '09, and that was balanced across all the segments. Specialty and PP&S, were up 51%. POD was up 48%.

So it is conceivable that we could find an opportunity that in a market that's very attractive to us that could have elements in one or more than one of the different platforms, and it may not necessarily be limited to specialty. But certainly in terms of masterbatch, engineered materials, that is our clear focus, but we're not going to walk away from interesting and compelling opportunities that would exist to expand our presence in these markets that we really are enjoying and learning a lot more about.

That is helpful. My second question is on raw material pricing relationship. We kind of see where raw material is going. You mentioned the spot ethylene pricing starting to move up as well. Obviously hurricanes will have a lot to do with what pricing does over this late summer and fall. But with respect to things that you can control as far as pricing beyond the pass-through on the distribution side, are your utilization rates high enough, is the demand strong enough, or is the competitive environment disciplined enough to where if you need to get pricing in your specialty business or your PP&S business, that you can do it if raw material inflation dictates the need for that?

You know, pricing is always a very sensitive issue with customers. And this time of improved performance is no different than it has been my entire career. I have never had a customer thank me for taking a price increase, and I don't expect that to happen through at least my retirement period, whenever that may be. It is always tough.

But you know, they are reasonable, and they understand. If you are providing something that is differentiated, that is unique, they understand it. They understand that costs go up, and they have to participate with you.

And it is also is a -- if done properly, it is a vehicle for them to improve their business opportunity with their customers as well, if it is done properly.

So is it tough? Of course. It is always tough out there. But it has been tough for a very long time, and our skill set has improved, our tools have improved. When you can walk into a customer and demonstrate that you are worth it and you're worth more than what you're charging them and that you have opportunities to demonstrate what you can do for that customer in real value terms, like our EVE tool allows us to do, then they get it.

Now, you have to be talking to the right people, because the procurement people will not really give you a lot of credit for it. That is why we have to call high, wide and deep in the organization. We have to get our proposition in front of people who have bottom-line P&L responsibility, versus just -- how much are your pellets per pound or per kilo?

Right. That is helpful. But I was actually looking at more of an incremental change if there is one. I understand that pricing is difficult to get, but is it becoming more difficult? Or is it becoming easier to get? And what is your view on that going forward?

Tough question. I can't tell you. I can tell you this, our people are more skilled at handling these kinds of opportunities than they ever have been in the past. And I call it an opportunity. It is a challenge and an opportunity when you have to get pricing, or you have the opportunity to get pricing. Our skill set is better. They have been trained. They have tools. They can go in and demonstrate things to the customer that we could not in the past. I think our goodwill with customers is improving, our brand is improving, our product quality is very, very high. Our delivered performance stands out across the competition. And those are the things that help you get it.

But I would just say, I cannot really judge whether it is easier or more difficult. Let me say this though, we are facing a period -- our industry is facing a period of raw material shortages. There are some products where capacity was taken down to levels, and working capital was taken down to levels that put a lot of constraints on the supply side of the business, suppliers coming to us. And that limits what we can do for our customers.

Customers understand this. And in situations like that, clearly they have to be more responsive. If they want to get supplied, we try to be very fair with our customers. We try to get the most we can of our suppliers. But in the end, when you have a crisis of availability of raw materials, it does give you an opportunity to make sure that you get fair pricing.

Okay. Thank you much. That was helpful.

Rosemarie Morbelli, Ingalls & Snyder.

Congratulations on the quarter. Could you give us a feel regarding the distribution as to how much came from your new supply agreements and when they will anniversary and you will go back to a more normalized volume level versus the economic recovery?

Yes, I can do that. We said -- I made an observation earlier today as well that a little bit better than a third of our volume increase in distribution -- or excuse me, our sales increase in distribution came from those new supplier agreements. Those three begin to lap themselves really crossing both the third and the fourth quarter. If you recall last year, we said we started to see pickup in DuPont in that August/September time frame. So it will really be by the end of this year that you will see that happening.

Did they help the margin? Or was the margin extension solely due to the volume that went through that (multiple speakers) [through the area]?

Clearly the most significant influence on margins in that business, as we said, was scale. This really is a scalable business, and leveraging the incremental volume to deliver improving operating margins.

We have added over 500 new accounts since one year ago, August of 2009, in POD. And we've got about 1200 active customers who are buying DuPont products from us at this time -- if that gives you any --

Yes, no, that is very helpful. Thanks. Steve, you talked about several investments you were going to focus on. Could you give us a little more details in what you expect will come out of that, as well as what it will do to your CapEx expectations in 2010 and 2011?

Yes. Okay. Let me try to start by saying, first of all, with regard to -- I mentioned supply chain and tools, customer relationship management system and supply chain. We're looking at about a $4 million to $6 million price tag. I can't tell you exactly the breakout between capital and expense, but there will be an expense [combined] (multiple speakers)

About half.

-- [with] that. About half?

And then we talked about around 50 sellers in technology research and development and even marketing investments. Probably the average tab on that is about $150,000 all-in on average across those three different elements.

So we are going to be very careful about this. We are not going to go do all this at once, but we need to get started. We think that we have a lot of -- we have ample opportunities on the supply chain side to consolidate our spending, to be a little more thoughtful, to be more global in how we procure goods and services.

And this is not just about cost take-out. It also has an element of delivery, on-time performance. It has a quality element, and it also has a "who's going to bring us technology so we can differentiate?" component.

So we are really excited about this opportunity. We have waited for the right time. We have waited very patiently, until we felt we had discipline to capture the savings and felt -- until we felt we had enough infrastructure to support the expanded R&D opportunities by working more closely with suppliers. So we think it is going to have a terrific return on I.

We have not gone public with what we believe the return on investment to be. I guess you have to have enough faith in us to recognize that if we did not think it was worthwhile, we would not make the investment, because there are lots of other things we could do with the money.

On the people front, those 50 -- roughly 50 people that we will add over the next say three quarters, we need that to continue to bring in new business. Our new business rate has been very strong. But you know, there are limits to how much time people have, and we need more feet on the street, we need more people working in our laboratories to invent and develop differentiated products.

So this is just about prudency on a couple of fronts -- looking out for the long term, balanced with managing the quarterly earnings that we expect to deliver, and that is really what it is about.

We had to shrink a year ago. We are being very selective. It is not staffing up in terms of staff. It is very selective investment of people who can have an impact to the top line or the bottom line in the organization, and some tools to help them succeed.

Okay. Now, that is very helpful. Now, on another topic, if you come across a decent sized acquisition, would you consider a combination of debt and stock?

Yes, I think that in order for us to consider a combination, it would really probably be leverage driven more than anything else. So as we focus on growing through acquisition, we are going to remain mindful of our credit metrics and want to continue to improve upon those as well. So I would tell you the largest -- or the driving force behind our decision to use equity would most likely be around maintaining or improving our leverage.

Okay. And if I may ask one last question, regarding the fourth quarter, which seasonally is the weakest, last year fourth quarter was reasonably strong. Do you think that you can beat those numbers? Or is it more reasonable -- considering what you see in the marketplace and the strong results of last year, is it more reasonable to expect a down fourth quarter year over year?

Yes. Well, we have not specifically said what the fourth quarter is. We did say that in the second half of this year we expect to achieve sales and earnings growth. I would expect that to happen across both quarters. But at this point I do think that seasonality is going to return and we will see that in both the third and the fourth quarters.

All right. Thanks.

We have time for just one more call, operator.

Steve Schwartz, First Analysis.

If you could help, Bob, just with your outlook on SG&A. Steve, you mentioned adding 50 resources, and I think your prepared remarks, you commented that you're hitting your financial targets for the year. So what do you think the second half looks like?

I do think that we could see an uptick in the second half versus the first half as a result of these incremental costs. Specifically on the $4 million to $6 million that we referenced earlier, I said about half of that is SG&A, and I expect that could come in the second half of the year, just depending on how well we can execute.

And then I would say that the incremental resources will really come over the course of the next three quarters, and we have not specifically stated how that will play out over the balance of this year. But that -- look, we are trying to set some targets here for our own investment and growth, and we'll just give some perspective on when we think that would happen but have not specifically said what the dollar effect would be in the next two quarters.

Okay. So if before you were talking maybe $70 million to $75 million per quarter average, maybe now it is $75 million to $80 million?

Well, the one thing I would also remind you is that historically we do see some of our incentive accruals or expenses come down towards the second half of the year, really in the fourth quarter. So I think there would be some balancing effect there that won't make it go as high as $80 million, but I think $75 million is a reasonable approximation for where it could land.

Okay. And then I realize we are at the hour, but if you could just -- my last question being on SunBelt. Can you give us an outlook there, what you're seeing in terms of the chlor-alkali environment?

Well certainly pricing is improving. And I would tell you that for our own quarter we also saw a little bit better volume in the second quarter. Historically for us we have a fixed take-or-pay contract with OxyVinyls that sort of keeps the volume flat. And I would say that we might see that return to more normal levels in the third and fourth quarter, and then probably the same level of profitability, although slightly down, just depending on what that volume might end up being.

Okay. Great. Thank you.

Well, thanks everyone for joining us on the call today. This does conclude our second quarter 2010 conference call and remarks. We look forward to updating you on our 2010 progress during our third quarter conference call, scheduled for early November. Again, thanks for joining us today, and have a great day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.