Avient Corp (AVNT) 2011 Q2 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the PolyOne Corporation second quarter 2011 conference call. My name is Katie, and I will be your operator for today. At this time, all participants are in a 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, Katie. 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 meaning 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, and 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 the 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 the 2011 to the second quarter of 2010 unless otherwise stated. All prior year financial references will be based on restated financial statements for the change in pension accounting to the mark to market method adopted by the Company effective January 1, 2011.

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

Thanks Joe, and also to everyone joining us today. We always welcome the opportunity to speak to our investors and analysts about the recent performance of PolyOne.

For the second quarter of 2011, we reported sales of $769 million, net income of $28.5 million, or $0.30 per share. This compares with the second quarter of 2010 when we reported sales of $693 million, net income of $48.1 million, or $0.50 per share, and recall that earnings in 2010 included equity income from our now divested SunBelt joint venture, and both periods include special items and tax adjustments.

Consolidated revenues for the quarter grew 11% year-over-year, with each platform recording double-digit revenue growth and operating income gains. The revenue growth was driven by improved mix, higher selling prices associated with raw material cost increases, and favorable foreign exchange, as volume was effectively flat. Adjusted earnings per share for the second quarter of 2011 increased 41% to $0.31 per share, compared with $0.22 per share recorded in the second quarter of 2010, representing an all-time record high level of adjusted quarterly earnings.

And for those of you picking up headlines this morning, I would just like to point out there was a clarification by Reuters that just came out a few minutes ago. Again we were up 41% year-over-year. Special items recorded in the second quarter of 2011 include environmental remediation costs of $2 million, while prior years special items included a benefit of $16 million attributable to reimbursement of previously incurred environmental remediation costs. In addition, tax adjustments of $13 million in the prior year, principally related to deferred tax asset valuation allowance reductions.

Now let's take a look at the quarterly performance for our three platforms, Specialty revenues increased 11% over the prior year to $294 million, driven primarily by a 13% improvement in mix, and higher selling prices associated with raw material inflation. Our two acquisitions in Brazil and favorable foreign exchange added 4% and 6% respectively, but this was offset by a 12% decline in volume as pruning actions increased.

Note that if we excluded these pruning actions, same-store sales combined with new customer gains volume increased 2%. The net effect of improving the sales mix towards higher value, less commoditized products is evidenced by our expanding year-over-year gross margins, in both percentage and dollar terms. We think it is important to focus on margins as a percentage of sales, because it speaks to the overall health and vitality of our product offerings, whereas simply looking at gross margins dollars per pound has commodity connotations that are inconsistent with the Specialty business.

From a profitability standpoint Specialty operating income expanded over the prior year to $25.3 million. This marks the eighth consecutive quarter where our Specialty platform has expanded year-over-year in quarterly profits. And what makes this streak particularly notable is that we have expanded profits while simultaneously and significantly investing in sales, marketing and technical resources. Recall that in the second half of 2010 we began making aggressive but thoughtful resource additions to drive long-term growth. Within the Specialty platform alone these investments added approximately $5 million of costs that were incremental to our quarter a year ago. We recognize that in making these investments, we moderate our earnings growth in the short term to capture longer growth opportunities.

Our Distribution platform is another business where we have made investments in commercial resources to expand our market-leading position. During the second quarter POD revenues grew 10% to $266 million, driving a 32% increase in operating income to a new record of $15.3 million. Double-digit revenue expansion was primarily driven by increased pricing associated with raw material costs inflation and improved mix, which were partially offset by a 5% decline in volume. The year-over-year volume decline in Distribution is principally due to pruning. But we also believe to a lesser extent, the lower volume reflects the temporary slowdown in North America automotive production. This is at least partially associated with supply disruptions stemming from the tragic earthquake in Japan during the first quarter. We anticipate this auto market specific pullback to be temporary.

As a perfect illustration of the power of pruning and mix improvement, nearly 50% of PODs year-over-year growth was in healthcare. The benefits of this shift can be clearly seen in the profit margins which reached 5.8% of sales for the quarter, a full 100 basis points better than the prior year. Our performance, products and solutions platform also benefited in the second quarter from a favorable product mix shift. PPS revenues grew 10% versus prior year to $241 million. This growth was driven by a 6% improvement in mix and price, combined with a 4% uptick in volume.

The 10% pick up in sales led to a 21% increase in operating income to $21.3 million, or 8.8% of sales. This demonstrates the leverage of maintaining gross margins combined with sales growth, as operating profits increased 70 basis points. The expansion and profitability over the prior year reflects the diversification of our product offering within this platform, towards more differentiated niche applications and solutions. These results highlight that we are not waiting for a housing recovery to achieve sales growth and operating income gains.

Other P&L items to report, include corporate and other costs before special items of $8.6 million, which decreased about $1 million from last year, principally due to lower pension and set up costs, offset partially by increased investment in commercial and sourcing resources. During the quarter we generated $19 million in free cash flow, and ended with $417 million in cash on the balance sheet. We did this all while accelerating CapEx to $13 million for the quarter, making our first dividend payment since 2002, and repurchasing an additional 1 million shares of PolyOne stock. We continue to believe dividends and shares repurchases provide a balanced means for rewarding our shareholders, and we have ample cash to continue to do both.

We also plan to accelerate CapEx this year, and expect we will spend between $55 million and $60 million. There are three primary reasons why we are increasing CapEx. First, US taxpayers are permitted to fully deduct qualifying capital expenditures in 2011 as accelerated depreciation, and we are thoughtfully accelerating domestic expenditures where it makes sense to do so, and believe this will save us about $2 million on a net present value basis.

Second we are increasing our investments in Information Technologies to drive our commercial and sourcing agendas, and accelerate the implementation of SAP around the world. In some cases we are electing to buy hardware and software versus leasing, because of the current low cost of capital. Third, we see strategic opportunities to expand our product offerings in Brazil, and need specific machinery and equipment to provide our customers with incremental Specialty solutions there. To be clear we are not expanding capacity in the traditional sense, and as always we have no intention of chasing volume.

Beyond funding our operating needs and the additional CapEx just mentioned, our primary expected future use of cash remains funding acquisitions. Our M&A focus remains primarily on Specialty platform acquisitions that expand our geographic presence, our Specialty product offering, and our presence in attractive end markets. During the quarter we hired Joel Rathbun as Vice President of Mergers and Acquisitions. Joel brings extensive investment banking and M&A experience to lead our efforts in this regard, and the pipeline of targets is more robust today than at any point in recent history. That said, we remain disciplined in confirming strategic fit, and prudent regarding valuations and financial return assumptions, careful to not overpay.

That concludes my prepared remarks. I will now hand the call to Steve Newlin, our Chairman, President, and CEO.

Thanks Bob, good morning everyone. Let me begin by saying that I am very pleased with our second quarter results. We are reporting the highest level of quarterly sales in Company history, and the same is true for adjusted EPS.

Those of you familiar with our history, know that as part of our transformation we sold our minority interest in two joint ventures. Both were commodity chemical companies that historically comprise the majority of PolyOne profits. Earnings we are reporting today for the second quarter of 2011 were 100% generated by our three strategic platforms of Specialty, PP&S, and Distribution, and reflect the seventh consecutive quarter of expanding year-over-year profits. Each of our three platforms grew revenues double-digits, and expanded operating income, despite an economic recovery that may be taking a bit of a breather.

For instance, US new vehicle production growth moderated in April and May, and turned negative year-over-year in June. Global automobile production declined 3.8% from prior year second quarter levels. As Bob mentioned, we believe this is at least partially attributed to supply chain disruptions stemming from the Japan earthquake in March. We also observed a pullback in solar and alternative energy demand. We do not believe these are long-term impacts, and it is likely we will continue to observe fits and starts as the economy advances its recovery.

On the other hand US residential new home construction is showing no signs of recovery. Consensus estimates for US new housing starts has steadily decreased all year, it is now estimating only 590,000 new starts for 2011. That is 14% below the Consensus estimate at the beginning of the year, and it is flat with 2010 levels. Current estimates suggest that this will be the third consecutive year with housing starts below 600,000, which is only 40% of the 50-year historical year average for new housing starts. Despite these end market challenges, we continue to evolve our business towards becoming a true specialty Company, and expanding adjusted EPS each quarter.

As you know, over the last several years we have made significant progress in overhauling the culture and earnings mix of PolyOne. We believe we are in the middle innings of our evolution, and we have moved into the investment phase that is required to consistently deliver profitable growth over the long term. Since the second quarter of 2010 we have added 152 commercial resources, at an approximate annualized cost of $25 million. This is a sizable investment, but it is focused and strategic. While we know it impacts our earnings growth in the short term, these are the types of decisions that drive sustainable growth performance over the long haul.

I have to tell you that I am very energized by our recent new hires. We have hired some of the best and brightest sales, marketing and technical resources around the world. And while they are already having an impact, it is fair to say that it will take 12 to 24 months before we see the sustained effect of their efforts. I have no doubt these investments will prove to be a competitive differentiator for us. Let me be very clear though, our investments are not administrative positions, or just limited to incremental head count. These are thoughtful and strategic.

We have developed interactive technical design centers, acquired or will acquire software to measure and drive customer satisfaction, sales force effectiveness, accelerate innovation, and maximize visibility to our global supplier spend, to achieve sourcing gains, just to name a few. We are also investing in assets such as machinery and equipment, but I want to emphasize this is not about traditional capacity expansion to chase volume. These additions are needed to either expand our Specialty product offering, or localize production in areas like Brazil.

While I am pleased we get an accelerated tax deduction for our domestic spending we are not letting the tax tail wag the investment dog, with an addressable market of $30 billion, we have substantial growth opportunities in front of us, and we aim to make the most of those. For example, during the quarter we announced a very important global expansion initiative for our Distribution business. On July 1st we opened a distribution facility in Shanghai. In just one year we have added distribution capabilities in Brazil, with our Uniplen acquisition, and now we have a distribution presence in Asia. We are taking this business to Asia to serve our customers who are asking us to do so.

In North America, our Distribution business has established a powerful reputation and market leading position, particularly in healthcare. This has attracted the attention of many multi national suppliers and customers alike, who have come to rely on PolyOne for the service, consistency and expertise that our Distribution business provides. While healthcare customers and suppliers will serve as the basis for our initial expansion into Asia, we do plan to expand our offerings to other markets over time.

As you know, healthcare is a critical end market for us, not just in China, and not just in Distribution. Globally we have dedicated 52 resources focused on penetrating this attractive growth market, and second quarter healthcare revenues grew 22% over the prior year. Our healthcare team is focused on existing and future customers. During the quarter we broadened our portfolio of precertified biocompatible products, to include Versaflex Soft Touch TPEs, giving us one of the largest offerings in the industry.

Why are free certifications so important? Simply put, it helps customers speed up their regulatory compliance process required to introduce their new medical devices to market. And in the medical industry, improving speed to market can mean everything. The fact that PolyOne solutions address our customers needs and can expedite their process is just one more reason they choose us now, and others will choose us in the future.

Developing innovative solutions is not just part of our Specialty platform. At Asia's largest plastic show, Chinaplas, held mid-May in Guangzhou China, we introduced our Geon SF superior flow molding solutions. These materials utilize patent-pending technology to expand rigid vinyls processing window, delivering superior flow and improved thermal stability, compared to current vinyl compounds used in molding applications. Now I know investors are not necessarily thermoplastic engineers, so what this means is that we have been able to increase the flow characteristics 25%, and the thermal stability 75%, compared to current vinyl offerings.

With these improved technical characteristics, product designers can incorporate the chemical resistance, flame retardancy, and weatherability of vinyl, into applications which historically were too big to use vinyl. These enhancements open up new markets and applications, where the performance advantages of vinyl can be leveraged to replace applications historically using materials such as ABS. The competitive advantage of vinyl-based compounds compared to other polymers with a much higher content of hydrocarbon feedstock is improving with the sustained high price of oil. These inflationary pressures on oil combined with our core competency in thermoplastic design formulation and material science is helping PP&S' innovative new products gain traction in the market.

Our success in providing innovative new solutions and penetrating less cyclical end markets, are direct results of our four-pillar strategy, which has been guiding the transformation of this Company since its introduction five years ago. I would like to talk about that strategy for just a moment. We recently assembled our executive management team for a two-day meeting. The team spent focused time discussing the future of our Company. We challenged ourselves on what it takes to continue on and accelerate our journey to becoming a specialty company. I can tell that you discussion around strategy was invigorating and thought-provoking. And just as we challenge our customers and stakeholders to think, what if, we too challenged ourselves.

Looking back at PolyOne's recent successes, our steadfast commitment to our four-pillar strategy of specialization, globalization, commercial and operational excellence, has been the basis of our turnaround story. The execution of this strategy has led to record-setting results, and the best mix of earnings in PolyOne's history. The question we ask ourselves is this, is this the right strategy going forward? The answer from our management team was a resounding and unanimous yes. There was also unanimous recognition that our people deserve the credit for our successes, and ultimately, people are the foundation of all four pillars.

During the early stages of our transformation, we replaced a number of people with outside new hires. Today our renewed strategy will place a greater emphasis on talent development, rather than restructuring and replacement. Increasingly we are becoming an employer of choice. We have successfully launched leadership training programs in most functional areas of the Company, with some departments starting their third class of participants this summer.

Developing bench strength in each discipline is critical, as we transition to the profitable growth phase of our evolution. We have invested in the training and development of key employees with our Lean Six Sigma program perhaps being the best example. Our 2011 class of black belts, comprises 21 of our best people, and I am told that this year's certification test scores were the highest ever of any class so far. Today we have 35% of our employee-base trained in LSS principles and practices. There are currently 177 LSS projects in flight, each one focused on responding to the voice of the customer.

Our Lean Six Sigma program has steadily become part of the culture here at PolyOne, and is continuing to deliver benefits on many different levels. After falling below our 95% on-time delivery target the past few quarters, I am proud to say we again reached 95% during the second quarter. This is a difficult metric, because it is based on customer request date, not date promised. We believe this is Best-in-Class performance, and has been a focused area of differentiation for PolyOne the past few years, and Lean Six Sigma certainly helped enable this.

We obviously have plenty of activity around making our Company great, for our investors, customers, and employees, and we are very enthusiastic about our future. Speaking of our future, in looking ahead to the second half of the year, as you have no doubt been hearing, the headlines suggest a potential slowdown in the near term. We certainly believe we observed some of this in the latter part of the second quarter, but at this point it is too early to predict how that will impact our business over the next couple of quarters. We do expect seasonality to return in the second half, driven by European holidays and a slowdown in construction-related business.

Historically our second quarter is the strongest of the year. That being said, and unless we encounter further economic headwinds, we expect to deliver year-over-year adjusted EPS growth of 10% to 15% in the second half of 2011, and we are already setting our sites on 2012 and beyond. During the two-day off site meeting I referred to earlier, we also began to outline our key performance initiatives for 2015, which we plan to announce early next year. I mention this because while we believe our 2011 performance will indeed be record-breaking, we want you to know that we have aspirations and a commitment to success well beyond this year, and you won't be disappointed with the new goals we have set for ourselves for 2015.

Our future is grounded with a proven strategy and propelled by our past and future strategic investments. While strategy is important, in my book execution matters even more, and I think we have consistently demonstrated that our leadership team and employees, know how to execute and deliver superior results.

So this concludes our prepared remarks, and now I would like to turn the call back to Katie, who will open up the lines for your questions.

Thank you. (Operator Instructions). Please limit your question to one question with one follow-up. Your first question comes from the line of Saul Ludwig from Northcoast Research. Please proceed.

Good morning everybody.

Saul, this is Bob. Before you ask your question if I can, let me make a clarifying observation relative to one of my first statements early on the call, respect to the Reuters announcement. Reuters was specifically referring to our GAAP EPS number, and it just so happened that the 41% was the same as we were reporting on an adjusted basis. Sorry for any confusion I may have caused they were initially referring to GAAP, whereas I was reporting on an adjusted basis. Thanks to Reuters for the additional announcement that they made, which I think references both measures of performance. My apologies for any confusion I caused. Go ahead Saul.

Thank you. Could you clarify two things, one, what was the specific volume growth not acquired, but core volume growth in the two specialty segments in the first quarter? And maybe make any comments about the nature of that volume change? And secondly, unrelated to that, you mentioned that there was a little slowdown in solar activity in the second quarter, which is true. Could you remind us again where in PolyOne your solar-related activity is, and exactly what functionality does it perform?

I will take the first part of that, Saul. Specifically for color in the second quarter, volume was down roughly 14%. And I would point out that excluding the specific pruning actions, volume was actually up 16% over the prior year. And then going on to EM, going on to EM, sorry, volume or the sales increase was up 16% over the prior year. Price and mix added 14%, favorable FX added 5%, acquisitions contributed 7%, and volumes were down 10%.

Let me answer the solar question, Saul. Most of that, it is all in specialty, and most of that is in EM with some color, some Smartbatch color in that space. Our revenues to the solar industry versus the prior quarter, were down about 18%, and we don't believe we lost any share. We may have gained a little bit of share, but it is just a very difficult marketplace right now, and we don't know how long, a lot of this has to do with government incentives, and the expiration of those, and so on and so forth, and maybe a little bit of inventory drawdown. We still like the market, the alternative energy market long term, but you will see probably a little bit longer before we recover in the solar marketplace. That will be reflected primarily in EM, but secondarily in our color specialty platform.

Steve, just remind us on what exactly you do in the solar world?

We provide a lot of various compounds. Our eco products are low smoke, and fume, and zero halogen compounds. And of course as you know Saul, this is a green space, and it only makes sense for them to have wire, and cable, and connectors, et cetera that are also a green derivative of products. We have a very nice position in that space, whether it is photovoltaic wire and cable, or in some cases colors for solar reds or blues with the UV additive concentrates that are inside. Those are primarily. There are some concentrates that we sell for cross linking, our OnCap solar product is used in that application.

Thank you very much, guys.

Thank you, Saul.

Your next question comes from the line of Mike Sison from KeyBanc. Please proceed.

Nice quarter.

Thanks, Mike.

In terms of the second half of the year for your outlook underpinning the 10% to 15%. What type of growth or volume growth are you expecting in each of the segments?

We are not specifically giving guidance for volume by segments. I would just point out that typically we do see revenues decline in the third and fourth quarter, relative to the second, driven by the reasons Steve cited, principally seasonality. Last year, for example, it was about a 1% to 2% decline in the third quarter. But historically it has been a little bit higher than that on seasonality. So I think at this point we are comfortable with the information we have provided, and we are not intending to give any more on volumes.

Let me add a little color to that for you Mike, I think as we have often talked about on these calls, we are very careful internally and externally, and probably even more so internally to not get deep into the volume discussions. Because as long as we continue to go through this mix-up process, we don't want to measure the wrong things, and reward the wrong kinds of behavior.

Let me give you a couple of examples to illustrate. We are trying to be far more selective about the amount of black and white color compounds that we sell. As you know these are very commoditized. It is very difficult to differentiate when you are selling general-purpose blacks and whites. They don't add as much value for the customers. Oftentimes we will work on penetrating an account much further on a high-end color, a very sophisticated color application, or perhaps even a liquid color.

It wouldn't be uncommon for us to lose 1 million-pound of blacks and whites, and replace it with 200,000-pounds of a higher grade color. If you looked at it that way you would say gee your volume in this account went down 80%, yet in fact our profitability could very easily and should improve through that process. So I think that is an illustration and example of the kinds of things that we do every day to upgrade the profitability, the differentiation, the uniqueness of our organization, that really don't show up, and are very misleading to be viewed on a volume basis. So hopefully that helps answer your question to the best degree we can, Mike.

Got it. When you take a look at each of the segments, the only one that seems to be maybe a little bit lagging the 2012 goals is global color additives and inks. what do you think needs to happen to get the margins closer to that 10% to 12% goal you are looking at for next year?

I think we need to perform better in certain applications, and Asia is one example, and that is a case by the way where we were very heavy with a company we acquired many years ago, probably six or seven years ago, where the company was primarily in black and whites, and we are pruning that business, and moving on to specialty color additives and effects. They have to sell more business, capture more share, and it has to be the right kind of business. We like the trajectory. We like where they are going with the business. We have stood by our commitment to make it to get to that 10%, and I believe they -- at least to the 10% -- and we believe they will by the end of next year as we have steadfastly been behind.

It is really a matter of continuing to upgrade. And in order to do this, we insist that they capture some new business to replace some of this pruned business that is going, that we end up walking away from. So I think that is the biggest thing they have to do. Secondarily to continue on the path of innovation and driving new product introductions, and new launches that are more value creating for our customers, that are characterized by higher margins.

I would make one other statement and that is that if it weren't for the incremental resources that we have added to that business in the second quarter, they would have actually been higher than 10%. I think that illustrates as Steve has discussed, that we have to make these trade-offs between the short-term and the long-term, and believe we have done the right things really to sustain our improvement over the long haul.

Got it. Great, thank you.

Your next question comes from the line of Dmitry Silversteyn from Longbow Research. Please proceed.

Good morning guys, and let me add my congratulations to a good second quarter. A couple of questions, first of all, you mentioned the automotive industry struggling globally and in the US in the first half, and the second quarter particularly because of the earthquakes. We have heard that may be made up in the second half of the year as some of the typical shutdowns will not be taken because demand is still there, and it was really a function of being able to get the parts to get the cars out. Do you share this view? Do you see business coming back? As we [exit] July you talked about June actually comping down, but do you also expect second half automotive business to be a little bit stronger versus typical seasonality?

It is a great question, and I am not sure that we have any greater insights in some of the variety of resources that are out there today. The Journal had an article about the annual rate, and I think most people up until very recently have had the view you suggested, that things would get better in the second half in automotive. I am not sure that we could share that at this point. We don't have any evidence that suggest that we are going to see an uptick in automotive.

We have certainly seen some disruptions associated with Japan, but the truth is, we can't actually link the downturn in production with shortages of supplies from Japan. I think the latest view is the annual rate is looking at about 12.2 million to 12.3 million vehicles. The first quarter's pace was 13 million. I am not sure that we could share the view that we are going to see a big upturn or even a modest upturn in the second half of automotive. We are certainly hopeful about that, but we are preparing our organization to respond to a more conservative outlook.

Got it. Thanks, that is helpful. My second question actually basically a follow-up to Saul's question. The pruning that is going on in Specialties, which looks like it is reducing your volumes by about low to mid-teens or so on a year-over-year basis. I understand the pruning is going to be an ongoing part of the Company philosophy and strategy as it should be, as you constantly strive to innovate and get new products, but is the magnitude of pruning or the level or how deep you guys are going, should we expect you to maintain the double-digit weeding out of businesses for the balance of this year and into next year, or are you just going through a particularly high patch, and then longer term we should be looking at maybe more like mid-single digit pruning efforts?

Well, first of all I would say, this is Bob, pruning is not a new thing for PolyOne, and it has always been a hard question to answer. Our continued efforts to reposition our portfolio towards higher value more differentiated products drives these decisions that we made. I think you have seen and we have seen an increase in this recently, some of this being around inflation, and this really started in the fourth quarter of last year. The pick-up was a little bit more in the second quarter versus the first quarter, because of some actions taken in that first quarter. And I think that it will moderate as we get towards the end of this year, and not continue to be in that high -- the range that you have seen so far. I think that moderates towards the end of this year as we lap some of the actions we took in the fourth quarter.

I would also tell you that we try to balance this, I mean these are decisions. They're usually pretty thoughtful. I think when we have extremely strong performances like we have been having the last several quarters, it gives us cover to do things that are much better for us on a long-term basis.

It is little easier for us to redirect the customer to some other company in the space that offers a more transactional setting for them. And I think the better our performance gets, frankly, the more of this you are going to see until we get through the preponderance of it. I would also say, it is even difficult for us to know exactly the degree of pruning, because sometimes pruning may show up as a conversion from a less dense product to a more dense product, something that does more for a customer than we perhaps did in the past, that might be a 3-to-1 reduction in utilization of pounds from us, but may well be and should be accretive to our overall profitability. Not just as a percentage, but the overall gross profits and subsequent profitability of that account.

There are lots of examples. Going, converting from a master batch pellet to a liquid is yet another example of pruning, where profitability improves, and yet at the same time, due to the concentration rates and letdown ratios, the volume will decline. That is why I think we have been very consistent with this message, at least for the last four years or so, on this kind of pruning that we are going to be doing, and the mixing up that is going on in our Company. It is not something that we spend a lot of time worrying about here.

In fact, in many cases we encourage it. I think the throttle, the governor is really what is the overall economic climate, how well are we penetrating other business, that can give us good cover in order to leave some of these accounts that we know long term, sooner or later, are probably going to fall prey to some other circumstances, whether it is a bad debt because it is a financial challenge to account, or it is a competitor who will sell an undifferentiated or modestly differentiated product at a lower price. Hopefully that helps answer your question.

It absolutely does, and thanks for adding that color. My only follow-up would be, I understand the strategy behind it, and I certainly agree with the validity of it, and we are seeing in the profitability numbers that you are going the right way, but at the end of the day, your production needs are going to be down 10% to 15% versus what they were at the beginning of the year. Is there an opportunity to go back, maybe, and resize the business once the majority of the pruning is done, to where you can improve utilization rates even further, particularly in Europe and North America, obviously you still need to grow in Latin America and Asia?

Yes, I think what is happening there Dmitry, is basically some of these new specialty products run off of different types of equipment. This is a more -- smaller batch applications, different types of extruders, et cetera. Hence some of the changes that we are making in terms of capital, that modest amounts of capital we are investing in equipment is really for the Specialty platform, and we just can't necessarily convert one of these large, long-run line long volume extruders to something that works efficiently in Specialty.

We always look and lean out our manufacturing process, and Tom Kedrowski does a great job for us on this, and we will keep our eye toward this, but I am not sure that we are seeing the kind of changes that would cause us to eliminate a bunch of net capacity. We might take out a big machine for example and replace it with a smaller machine; it may or may not have a little bit less of a labor component. Sometimes these specialty products are more labor intensive. So on a per-pound or per-kilo basis, you don't really gain all that much.

Thank you very much for that -- the great clarity.

You are welcome.

Thanks, Dmitry.

Your next question comes from the line of Daniel Garofalo from Piper Jaffray. Please proceed.

Good morning everyone.

Good morning.

I was just wondering any color you could provide in what you are seeing with the raws. You've referenced Butadiene and Titanium dioxide, in the past as being particularly tight I think in the last few quarters. Any change in what you are experiencing there, and your outlook?

Do you want to take that, Bob?

Sure.

What we are seeing and what we continue to see Butadiene and TiO2 as tight, as well as Nylon 66 in carbon black, and we continue to see substantial inflation in the raws. While we think it is probably at a point where it is going to start subsiding, we can't say that for sure. Market prices, if you look at our basket of raw materials, they increased about 11% sequentially Q2-versus-Q1, and about 25% over prior year levels. There is still substantial raw material inflation.

That is another reason I am really pleased with our performance, because we have been able to effectively continue to develop our margin story in the face of this kind of inflation, which is really unprecedented. But those are the four key raw materials that we see tightness. I will tell you that many suppliers are having trouble making deliveries to us, and we have managed this very well, but I have to tell you that it is a concern that we have continuing to get, we work hard on our delivery rates to our customers, but if we can't get raws from our suppliers, it effects our delivery rates. While we captured back to 95%, our suppliers are delivering to us about 70% on time right now. That is not good enough. It says, and they know how important this is to us, it says that there is still some tightness in elements of the market. Bob, do you want to add color?

No, I think that was a pretty good summary.

Great, thanks. You had touched on Uniplen contributing to growth in Specialty, I was wondering if you could just give us a little more general color on how that acquisition has progressed since the purchase, and in terms of, maybe, the organic growth and contribution to the enterprise?

Yes, well, I think when we talked about the year-over-year deltas in revenues for Specialty, our Brazil acquisitions added about 6%. That just gives you a little bit of clarity around their contribution. I would tell you that I think we have done a lot of really good things integrating that business this year, particularly around being part of our transformation strategy, being part of our culture, and I think really changing the inside of the organization, in terms of how it functions, and relates to their customers. The best information I can really give you from a dollars and cent standpoint, is what I said on the -- excuse me I said 6%; it is 4% for the second quarter. But we really couldn't be happier in terms of the team that is part of us now, and what we are excited about is candidly increasing some of our capital expenditures to add specialty lines, where we previously did not have the capability to offer TPEs or eco for example, and want to do that going forward.

I can tell you that we will definitely be pruning some of the business, and we will be upgrading and mixing up a lot of the business in Brazil. It was a conscious decision. We got very much what we thought we were acquiring. We got into the market more quickly. We didn't have to go through the process of building. We bought instead. But in fact, we are going to continue to upgrade and pursue the Specialty path in Brazil just as we have done in the US here. So we are happy with what we have. We see great opportunities in those markets, but we will be moving farther up the value chain into Specialties.

Very good. Just one final follow-up with regard to the repurchases, Bob, obviously the weighted average has come down significantly the last couple of quarters. I think you shared that you -- a balanced approach between repurchases and dividends. I wonder if you could give us a sense for where you stand with your existing authorization and potentially some color on how you are approaching potential additional repurchases?

First of all I would say we are committed to maintaining, and hopefully over time improving the level of our dividend payout. So that is something that we see hopefully going up over time. We are not specifically committing to a certain level of repurchases in the short or long term. We have 6.75 million shares still outstanding, under which we can buy back against, but plan to do so opportunistically. I don't think we should expect that that is going to be an exact level one quarter to the next. It really will depend on future market conditions.

Sure, thank you very much.

Your next question comes from the line of Steve Schwartz from First Analysis, please proceed.

Good morning, guys.

Steve.

I guess if we could start off, can you just clarify for me your 2H 2010 EPS that you are using as a basis for the guidance. It is $0.31?

The 2H 2010 is $0.22. When you back out equity earnings from SunBelt, what did you say second half or Q2?

2H for the second half of 2010.

Right. So that is $0.24 for the third quarter, and $0.15 for the fourth.

Okay, so $0.39.

Yes.

Okay, great. And I guess just as a follow-up, can you give us an idea of the staff adds? It sounds like you added maybe 25 to 30 additional resources in the second quarter. Bob, if I just understand it correctly with the pruning, usually when you see that sort of thing you see gross margin go up. You mentioned $5 million in additional SG&A. Can you layer on what your outlook is for adding people and the additional SG&A costs, on top of the discussion we have already had about the pruning, and where we might expect to see additional margin improvement from that?

There are a couple of different things there. First, let me just say you have the numbers right with respect to how many people we have added thus far. We believe the rate of hiring should moderate substantially as we head into the second half of this year, as training and deployment of these new resources become the primary focus. We are not giving specific head count numbers, but you certainly, I think, can expect that the increases won't be to the extent that you have seen in the last year.

And really what I would assign as the most important aspect of these resources in terms of their effect on gross margin expansion is ultimately driving innovation. That is really what we see as a long-term benefit from these resources, and not necessarily something that you will see in an immediate quarter. As Steve mentioned, obviously we are very happy with the people we have hired. We are already seeing the positive contributions they are providing to the Company, but the sustained result of their efforts is something we will see in 12 to 24 months.

Great. Thanks, Bob.

Your next question comes from the line of Rosemarie Morbelli from Gabelli & Company. Please proceed.

Congratulations. Steve, since you have no distribution business currently in Asia, am I correct?

Well, we just opened, you are correct, except as of July 1st we just opened our first distribution business in healthcare in China. Very focused. Very specific. But you are correct in that prior to July 1st we had none.

My question is since you are following your customers there, you must have a pretty good feel as to how large it can be between now and the end of the year, for example. Could you share some of that with us? Some of your expectations?

We haven't, that is a great question. I can't answer it for you, because we haven't really gone public with those expectations. We are being very cautious because just the uncertainty, the unknown. We don't know what degree of penetration we are going to receive. We have some goals. We have some targets, but they are internal at this point. I will just say, again, we are starting in healthcare. We are just putting our toe in the water here. Obviously when your customers take you somewhere, it really helps you get established. But we don't know yet, we know that we can do a great job, and succeed with our multinationals, global customers. We don't know how we will do with the local and regional customers just yet, so we are just reluctant to make any kind of forecasts about Distribution in Asia, or anywhere outside North America at this point in the process.

Do you have a feel for what the local competition is about?

I mean, we understand who they are. We understand some of the differences between distribution in the US and North America versus in Asia. We understand there are differences in terms, there are differences in terms of logistics. But I think what we have to offer that will be unique to China and Asia, is this incredible array of supplier relationships that we have worked very hard to establish. We have absolutely the best brands, the most renowned brands in the business. We have a formula that has been extremely successful throughout North America that we think is transferable to Asia, because we think customers do want help, they want more than a product, they want some assistance in how to apply it, and how to determine which one to use, and we also have a knack for being extremely efficient with our distribution business. I mean there is a reason that our distribution business stands out from the rest of the pack in terms of profitability and growth in North America. It isn't just serendipitous, we work hard at this, and we are pretty darn good at it, so we are confident that we will have success in Asia in distribution, but we are going to proceed slowly, because it is new territory for us.

So the fact that you are doing well, efficient, your customers like you, need your products, you are offering service. All of that translated in that 5.8% margin in the second quarter. Is that a new level? Is that sustainable? Is there something in that number that should lead us to expect that you can stay there?

Yes, I think overall we believe we are going stay above 5%. I don't see any reason why that doesn't come down outside of candidly just volume and leverage, which typically in the second half of the year happens as a result of seasonality. We are certainly seeing a sustained improvement in margins this year versus last year.

You might also be referring to, Rosemarie, because you have followed us for some time, when we established our 2012 goals for distribution, the upper end of our range was 5%, at that time based on where we were and based on what was going on in the industry, we thought that is where we could stretch to.

Obviously we have beaten that, and we believe we will beat that with consistency. When we come out with our 2015 goals you will see a new set of expectations built into the return on sales numbers for distribution. It is scalable. We are doing very, very well, and we expect that to continue. So we don't think there was any sort of one-time effects in here, that would inflate that number.

Okay. And then if you don't mind, my last question, what are your assumptions regarding the economy in the second half, when you look at the numbers you have given us? Are you expecting a slowdown, are you expecting the consumer to retrench, could you help us understand what is behind your numbers?

I think what happens is basically the leading indicators point to slower growth, and they don't show the kind of pronounced declines that would indicate another recession, but they are consistent with what is probably going to be a soft patch for the next two or three quarters. And that is the basis that we have, we also don't see any evidence of any improvement in the housing and construction starts, of course, you know that is a big indicator for us as well. So we see very modest GDP growth, certainly in North America, and Europe is a little bit soft as well, but at the same time again remember amount of potential we have, and our philosophy is, look there is plenty of business we don't have, and our job is to go capture that business, and get enough new gains to continue to grow. And that is why we continue to forecast a double-digit EPS growth, even in the context of a slowing second half economy.

And while you see no pick-up in housing, do you see anything going on on the commercial side of construction?

We really don't spend much time analyzing that, because we are 95% housing and maybe 5% commercial, and it is just not a metric that we worry with all that much, because it has an immaterial effect on our total outcomes.

Okay. Thanks.

Unfortunately, we have bumped up against the end of the hour here, and this will conclude our second quarter 2011 conference call. I would like to say thanks for everyone joining us today, and we look forward to updating you on our 2011 progress during our third quarter call to be held in late October. Thank you.

Thank you.

Ladies and gentlemen, thank you very much for your participation in today's conference call, you may now disconnect. Have a wonderful day.