塞拉尼斯 (CE) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the second quarter 2006 Celanese Corporation earnings call. My name is Sheryl, and I will be your audio coordinator for today.

[OPERATOR INSTRUCTIONS]

I would now like to turn our presentation over to your host for today's call, Mr. Mark Oberle, Vice President of Investor Relations. Please proceed, sir.

Thank you, Sheryl. Thank you and welcome to the Celanese Corporation second quarter 2006 financial results conference call. My name is Mark Oberle, and on the call today are David Weidman, Chief Executive Officer, and John Gallagher, Chief Financial Officer.

The Celanese Corporation press release was distributed via Business Wire this morning and is posted on our website, Celanese.com. During this call, management may make forward-looking statements concerning, for example, Celanese Corporation's future objectives and results, which will be made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances.

Actual results may differ materially from these expectations due to changes in economic, business, competitive, market, political and regulatory factors. More details and information about these factors is contained in this morning's earnings release and the Celanese Corporation filings with the Securities and Exchange Commission. Celanese Corporation undertakes no obligation to update publicly or revise any forward-looking statements.

Our second quarter 2006 earnings release references the performance measures net debt, adjusted earnings per share and operating EBITDA as non-U.S. GAAP measures. For the most directly comparable financial measures presented in accordance with U.S. GAAP in our financial statements and for a reconciliation of our non-U.S. GAAP measures to U.S. GAAP figures, please see the accompanying schedules to our earnings release, which will also be posted on our website, Celanese.com.

This morning, Dave Weidman will review the performance of the company, and John Gallagher will provide an overview of the business results for each segment and the financials. We will have a question and answer period following the prepared remarks.

Now I would like to turn the call over to Dave Weidman. Dave?

Mark, thank you very much and welcome, everyone, to today's call. As always, we appreciate your continued interest in Celanese and we're both delighted and excited to discuss the quarter and to answer your questions. Celanese had another outstanding quarter, with adjusted earnings this year of $0.71, a 34% increase from 2005. Operating EBITDA increased in every single business, and as a company was 18% higher than last year. This quarter, strong performance in our Ticona, performance products and acetate businesses demonstrates the strengths of our hybrid business model.

The combined operating EBITDA of these three differentiated businesses increased to a total of 52% from last year. As a company, Celanese revenues increased 11% as we integrated the Acetex business that we successfully acquired last year. We are extremely proud of the contribution of our 9,300 associates around the world and their continued focus on executing the Celanese strategy.

Celanese is unique in the chemical industry. We're characterized by leading global positions in each business, our relentless pursuit of Celanese-specific opportunities and execution on our commitments. Now, today, I'd like to begin by highlighting the strength of our downstream or differentiated businesses.

Ticona's exceptionally strong performance was driven by two things - first, a resurgence in growth, which was fueled by innovation and market penetration and, second, benefits from last year's exit of an underperforming business. Acetate products performance was stellar and resulted from excellent execution of the revitalization strategy, designed to reshape the long-term outlook for this business. As part of the revitalization, we have created a sustainable step change improvement in our system-wide economics and have also completed the China ventures total capacity expansions.

Annual dividends from these ventures increased from a small single-digit number last year to around $20 million this year, and we expect it to grow to at least $30 million by 2008. Nutrinova also had an excellent quarter. Our strategy of capturing new launches by our customers in the low or no-calorie food and beverage industry is the real catalyst here.

Our expectations are increasingly more optimistic around this business, and over the next several quarters, we expect growth in volumes to offset pricing declines, with normal seasonality. Combined, these three differentiated businesses have grown to represent over 40% of our total business operating EBITDA. We're extremely pleased with their second quarter performance and expect these businesses to play an increasingly important role in our overall earnings performance. Now on to chemicals.

The heart of our chemical products segment is the acetyl change, which is benefiting from an extended period of sound industry dynamics and a favorable outlook that extends until at least 2008. While second quarter earnings were at the low end of our expectations due to the impact from recent capacity additions, we expect this business to improve from its current high level of performance going forward as demand outpaces new capacity additions.

Our relentless pursuit of Celanese-specific opportunities is synonymous with our internal objective to control the controllables. A year and a half ago, we identified over $400 million in improvement opportunity in multiple areas, including SG&A reduction, acquisition synergies, purchasing opportunities, restructuring efforts and several other items.

In December, at our analyst conference, we reported that we had delivered over 40% of these benefits last year and saw the remainder benefiting us in 2006 and 2007. Now, midyear 2006 we are delighted to report we are on track to realize at least 30% more of the original targeted improvements this year, and we will continue to deliver on these commitments as we invest the necessary resources to achieve these objectives.

In prior market communications, we have highlighted our strategic thrust to further focus our portfolio, increasing our sales from products where we're either number one or number two globally, from our current level of 85% to a target level of 95%.

We continue to evaluate alternatives to create value for our shareholders through both acquisitions and divestitures. Now, lastly, Celanese is a company that executes its strategy of both growth and productivity. Regarding growth, we continue to build on the platform of our extensive activities in China. Our new growth projects in China are centered on an integrated acetyls complex in [non-gene], and they are on track. Now, let me remind you that we have announced plans to construct five new units, with possibly a sixth unit in China, over the next three to five years.

China will be one of the cornerstones of our going-forward growth strategy. I'd like to finish on a couple of broader corporate items. Following the end of the second quarter, we paid down $100 million of term loan debt, consistent with our strategy to utilize our strong cash flow to deleverage the company. Also, Celanese continues to transform itself into a non-controlled company.

We recently announced a special meeting of shareholders to elect two new independent board members. When this action is completed, Celanese will have a board comprised of a majority independent members only three months after we became a non-controlled company.

I'd now like to turn the call over to John Gallagher, who will give us more details on our second quarter results and financial outlook.

John?

Okay, thanks, Dave. I'd like to take about 10 or 15 minutes to walk you through our second quarter results and our outlook for the second half of the year. As Dave said, the results for the quarter were outstanding, with all businesses fueling improved performance. The downstream or differentiated businesses, in particular, demonstrated the strengths of our hybrid model, with significantly improved performance, as they executed their business strategies. Increased performance from our affiliates, particularly from our cost investments, also helped to offset margin pressure in chemical products associated with capacity additions from late 2005 finally hitting stable run rates.

If you turn to page six on the presentation that's on our investor website, you'll see that net sales increased 11% to $1.7 billion, increased volume and the inclusion of sales from the Acetex acquisition drove top-line growth on a consolidated basis. Operating profit increased to $163 million, up 7% over last year, due to continued strong business performance, lower special charges and cost improvement.

Net earnings increased to $103 million from $67 million last year due to additional income from our equity and cost investments, which increased from $19 million last year to $57 million this year. Performance in these strategic affiliates has been excellent and they are vital to our overall strategy and success of Celanese. In fact, for the quarter and for the full year, the earnings impact from these ventures will account for approximately 25% of our total company net earnings. I will talk more about our affiliates in a few minutes.

Adjusted EPS was $0.71 per share for the quarter, a 34% improvement over last year. Operating EBITDA was also very strong for the quarter and increased to $308 million, an 18% improvement, over the same period last year. Overall, SG&A increased by $18 million -- $13 million of this is associated with squeeze-out related costs in Germany. For both adjusted EPS and operating EBITDA, the $13 million in expense and the $12 million of special charges were excluded.

Let's now review the performance of our businesses, beginning with chemical products, on page seven. Revenue was $1.2 billion, up 10% over last year, driven by the inclusion of sales resulting from the acquisition of Acetex, which accounted for 7% of this increase in revenue. Operating EBITDA was $206 million, an increase of 8% from last year's results of $191 million. Our basic chemical business of acetic acid and vinyl acetate continued to produce solid results. We saw some margin compression in our basic chemical products, primarily associated with an environment where additional capacity brought online in late 2005 and early 2006 has reached stable run rates.

But this was more than offset by increased underlying performance and the associated performance from IBN Sina, our Saudi methanol and MBTE cost investments.

Now I'll turn to page eight.

Ticona had a very strong quarter, as this business continued to increase its penetration of key customer segments and product applications. Ticona's net sales were up 3% to 230 million. Most importantly, however, volume improved 7%, with particularly strong results again in Europe. Volume gains were partially offset by the lost sales through the exit of the COC business and the price impact due to product mix. Operating EBITDA improved 22% to $67 million on the increased volume, solid performance from equity investments and reduced costs due to the exit of the COC business. Raw material and energy costs continued to be volatile and there was some headwind in this quarter. On page nine, acetate products had another outstanding quarter. Net sales were up 2% to $176 million.

Volume was lower, as we stopped shipping [tow] to our China ventures now that the expansions are online. But this was more than offset by increased pricing. Operating EBITDA more than doubled to $55 million from $21 million in 2005. Included in the 2006 results were $21 million of dividends from our China ventures. Keep in mind we expect to record dividend income only one time per year, typically in the second quarter.

Excluding the impact of the dividend, we still saw an increase of $13 million of operating EBITDA in the quarter. These results clearly demonstrate the success to date of our revitalization and will result in higher levels of sustained operating EBITDA earnings of between 130 and $160 million.

Performance products also had a great quarter. Net sales increased by 2% to $48 million, with 13% volume growth offset by 11% reduction in pricing, as planned. Operating EBITDA increased 17% to $21 million for the quarter. Now let's turn to page 10 and spend a minute talking about our equity and cost investments. As I said previously, these ventures are vital to the overall strategy and success of Celanese. The graph on the left shows the increasing impact on our income statement from both the equity and cost investments.

In the second quarter, income was 57 million, compared to 19 million in the second quarter of 2005. On the right, you can see the cash flow impact from the dividends from both types of investments. Cash dividends totaled 58 million for this quarter, versus 17 million last year.

The increase in dividends from our cost investments in this quarter is primarily attributed to the timing associated with IBN Sina dividends and the acetate China dividends mentioned earlier. For the year, we would expect continued growth in our equity investments, offset by our lower dividends from our cost investments due to the record performance of IBN Sina in 2005. The overall income impact in 2006 should be flat versus last year, with lower dividends from IBN Sina partially offset by the increased dividends from our China ventures.

As you look at page 11, I want to focus for a moment on our equity affiliates. You can see that only a portion of the value of our affiliates is being captured in operating EBITDA. We currently only report the net earnings from our equity affiliates in our operating EBITDA results, and this is shown in the lower blue section of the graph.

But if you would look at the proportional EBITDA in excess of the equity earnings, which is shown in yellow, you would see there is approximately 100 million in proportional EBITDA that is not captured in our numbers. We strongly believe that when valuing our company on an EBITDA basis, this entire proportional EBITDA from our equity affiliates should be used.

Now let's turn to page 12 and talk about capitalization. The company generated 144 million in cash from operating activities during the first six months of 2006. This result was lower than the 190 million generated in the same period last year, primarily due to an increase in working capital. During the second quarter, the company generated 165 million of cash from operating activities, versus 148 million in the same period last year, primarily due to increased dividends from our cost investments. Net debt at the end of the second quarter was 3.140 billion, an increase of 93 million from the end of 2005, but a decrease of 66 million from the end of the first quarter of 2006.

The increase in net debt from the end of 2005 is primarily due to a seasonal increases in working capital, cash set aside for financial obligations, particularly around the squeeze-out, and timing of payments. The decrease from the end of the first quarter is due to a strong operating cash flow generation with lower working capital during the quarter.

Cash and cash equivalents at the end of the period were 354 million, a decrease of 36 million from the year-end 2005 and an increase of 42 million from the end of the first quarter of 2006. The second half of the year is historically the strongest cash generation period for the company. Celanese expects increased cash generation for the remainder of 2006, and in July the company made a $100 million equivalent voluntary prepayment on our term loan facility.

Now let's turn to page 13 and discuss our business outlook. The company expects all of its businesses to continue to perform at seasonally adjusted high levels. While chemical products second quarter performance was strong, results were impacted by the timing of capacity additions to the industry made in late 2005 and early 2006 being absorbed into the market.

The company, however, views this as a short-term impact, as limited new capacity is expected to enter the market over the next several quarters. The company, therefore, has tightened its expected guidance range for adjusted earnings per share for 2006 to between $2.50 and $2.80, based on 172 million diluted shares outstanding. The guidance range assumes a 28% tax rate and the company continues to expect that its actual cash taxes will be significantly lower during 2006 due to utilization of net operating losses.

Now let me briefly highlight our outlook for our businesses. Chemical products performance should continue at sustained high levels, but as I said previously, and as the company has guided for the last two quarters, there has been an impact in the market while the industry absorbs new capacity.

We expect this impact to diminish throughout the year and we continue to expect an overall favorable supply-demand balance in our basic products through at least 2008. Downstream emulsions businesses are expected to continue improving margins. Ticona's growth through innovation and market penetration is expected to continue to be strong. During the first half of the year, Ticona's performance benefited from a number of actions that we have taken, and we expect this performance improvement to continue in the second half of the year.

Our equity investments are also expected to continue their strong performance and deliver solid growth in earnings. Acetate and Nutrinova should perform at their increased earnings levels, supported by revitalized operations and strong demand respectfully. Again, keep in mind that acetate will not have further dividends from China this year, and that Nutrinova volume growth is expected to turn to more sustainable high single-digit levels.

Our other activity segment will continue to be lumpy. Results for the first six months of 2006 were flat versus 2005, and overall for the year we expect this trend to continue. Finally, on page 14, you will find a list of other guidance measures to be used for your 2006 models. Aside from the adjusted EPS change mentioned previously and the number of diluted, outstanding shares, there are no other material changes at this time.

With that, let us open up to Q&A.

[OPERATOR INSTRUCTIONS].

Thanks, Sheryl. While we get ready for everyone to queue up their questions, I would ask that we keep the questions to one question, plus a follow up. If we have additional time, we'll be happy to continue taking some calls.

Any questions?

Sheryl?

Can you hear me? Oh, good. I'm sorry, our first question is from the line of Sergey Vasnetsov of Lehman Brothers. Please proceed, sir.

It's impossible for the sell side to ask just one question. I hope it doesn't count as my question, but my question is about your outlook for the new capacity additions. As I looked through my notes on both acetate and [inaudible], it seems like second half of the year in terms of new capacity additions should be very minimal. Really, as you mentioned, the trump up of certain plants, BP and some others.

Is your view that sequentially in the second part of the year you'll se more new capacity, as you've in the first part, and then I have one follow up.

Sergey, we support your view. There's not any significant new capacity. There's basically no capacity coming on in the second half of the year. The next new capacity of note would be our facility, which we'll bring on in the first half of 2007, and our expectation is that we will add that capacity as the market needs it or demands it, so it's in the first half somewhere.

The last thing that I'd point out is that our view of capacity, new capacity, in to the market, in acetic acid and VAM has not changed materially since our investor conference. We have, however, seen some reports in the press in China that BP's facility is now publicly saying that it will start up and sell product in 2008 late, or early 2009. Beyond that, though, there's not significant changes in our views.

And do you still expect some possible capacity shutdowns by yourself and by some other major players over the next couple of years?

Yes, it's public that BP is shutting [Hull] down a little earlier than I think had been projected or forecast, certainly a little earlier than we had anticipated. We continue to look at strategic options on our [pampha] facility, and though it's not decided or anything public, that is a high-cost facility in our system and if we can find different options for it, that would likely come out. In addition to that, Sergey, in market conditions like we have today, we have this price umbrella in the market where high-cost capacity is in and out of the market depending on marginal economics. Over the last several days, we've in fact seen some of that capacity come out of the market, pricings firm up, stabilize, tend to move within a $50 or $100 range as this goes on, so it seems to be working the way that we expected it.

Thank you. I'll get back in the queue.

Our next question will be from the line of Edlain Rodriguez. Please proceed, sir.

This is [Costas Cotsanos] for Ed, and I have a couple of questions, in the chemical products, I see sequentially methanol prices declining. I see ethylene prices declining. I see natural gas declining, and then I see your prices going up, your volumes are going up. However, your profit margins are significantly lower than the first quarter. And you mentioned it's due to the new capacity that's coming online, but can you please elaborate a little bit? I mean, what am I missing?

Yes, happy to talk a little bit about it. Let me talk first on a sequential - well, let me lay out our business at a very high level. As you're aware, we operate in a global environment where we have about 40% of our business in the NAFTA region, about 40% of our business in Europe and about 20% in Asia. And our Asia business is growing quite rapidly.

Those three regions have different dynamics. Pricing in North America tends to be more formula driven, raw material input formula driven. Pricing in Europe tends to be quarterly negotiations, and then in Asia we tend to see spot pricing. Raw material prices are different by region as well, and this may explain some of the confusion. In North America and Europe, on ethylene, we have contracts that are based on cost-plus to a large degree of our business, think in terms of 40, 50, 60%, depending on the region.

In Asia, we tend not to have those contracts. It tends to be more market driven, market-minus contracts. When you net all of that together and I'll get down to the details now, when you net all of that together, sequentially we did see a net increase in our raw material prices. Our pricing in the marketplace is relatively stable and it had the resultant effects on the business.

Okay, and on the Ticona, can you elaborate on the pricing pressure? I mean, are you guys pursuing some kind of volume pricing strategy? And what do you see in the auto markets?

Okay, I think you're on your third or fourth question. Let me cover those things briefly. The pricing, we're delighted that the growth in Ticona was restored again. Seven percent is probably a little higher than we would expect, but we would expect this business to be a two times GDP type growth business. Our business is largely North America and Europe, and so we would expect a 4 or 5% volume growth on an ongoing basis. Pricing, with the 2% decline that we had in pricing was more due to a mix effect rather than any pressures on products. Remember, we sell a whole host of products within this business space, hundreds of different SKUs within multiple market areas. And so what you're seeing is more market - excuse me, more market mix rather than pricing within a product space or a product area.

Automotive, we continue to see automotive being weaker in North America than in Europe. We benefit from our strong position in Europe. We also benefit from the fact that our largest global account in automotive is Toyota or Toyota-affiliated companies, and we also benefit in automotive, because, when you think about it, our focus, our strategic focus, is to put more pounds on every automobile out there, so penetration is the name of the game, and we continue to drive that, or the Ticona team continues to drive that very successfully.

Thanks, I'll get back in the queue.

Our next question is from the line of David Begleiter of Deutsche Bank. Please proceed, sir.

Thank you, good morning. It's actually [Jason Miner] sitting in for David this morning. Quick question, within the chemical products segment, if you could give us a little more sense of how the downstream products, such as emulsions, are trading off against the margins in your upstream acetic acid and how the integrated model is playing out there.

Thank you. Great question. I'll get started and John can elaborate a little more on it. Overall, we do have a hybrid business model and optionality within our business. Our downstream businesses do benefit as some of the pricing going into them goes down. So in the quarter we saw some improvements in the margin in our downstream businesses, such as emulsions. Prices are a little stickier there.

Yes, and I think the only thing I would add to that is if you would remember, we bought Vinamul last year, so we're still starting to realize some of the benefits of the synergies of moving that operation together also reflected in those downstream margins that are buried within the chemical product segment.

Okay, that's very helpful. Thank you. And then one other question, just to clarify, was the primary motivator to lowering the top end of range of your guidance the weaker outlook for acetic acid or near-term dynamics in acetic acid?

Yes, that's largely the effect. There's no new capacity that has come on, no surprises on that side. What is somewhat of a surprise to us is that everyone in the world seems to be operating their plants very, very well. Those that have followed this acetyl or acetic acid space know it's normal to have facilities run into unexpected disruptions or outages.

They tend to be tougher plants to run than some of the other plants out there. In the second quarter, and as we looked at the third quarter now, we're in an unusual period were everyone seems to be operating very well, and on that basis we had some pressure in our margin and we narrowed our guidance.

Very helpful. Thank you.

We have a follow-up from the line of Sergey Vasnetsov from Lehman Brothers. Please proceed, sir.

Sure, thank you. I wanted to ask you about the 14% increase in the SG&A line year over year in the second quarter.

Yes, I think a couple things we talked about. If you looked at the SG&A on an absolute basis, the 135 to 153 million, that includes some of the German restructuring costs are included in that SG&A. We also include this year 4 to $5 million of increased compensation cost because we're now expensing stock options. And then there's some investment, if you will, in some productivity improvements for Celanese-specific opportunities. So that's why even when you looked kind of last year, if you go back to, I think, the next table one, where you look at other activities, there's a number of investments, the timing of which is fairly lumpy that we think for the year we'd be flat, kind of looking at the other activities, and that these investments will generate productivity in the SG&A area that Dave talked about around Celanese-specific opportunities going into 2007.

And to add to that, to be a little more specific on the future, the activities that we're doing this year to benefit our SG&A costs next year focus on the German squeeze-out and on restructuring or efficiencies within the finance organization. Both of those projects are investments this year that will yield results, we expect, in 2007. And, as we look at, again, Celanese-specific opportunities, we judge that we can lower our SG&A spending beyond the current level through those two activities.

Okay, and a second question is you mentioned [inaudible] COC and some other segments where they've been dragging the performance of the company down, shutting down some units, et cetera. So when we think about the next year to year and a half, are there some other activities that you have not discussed yet and [preliminarily] what the impact might be?

Well, I think Dave alluded to in his remarks that we have said that 85% to 90% of our revenue, we're number one or number two. There's on margin 10 to 15% of our revenue that either fixed or divest strategies are being pursued. So it's too soon to say which way we could go there, and it would be too soon to predict the outcome, but you would imagine they're businesses that are earning less than their cost of capital, and if they came out of the portfolio, obviously that would have a more positive impact on overall margins.

Sure. And so what's the timeline for the fix or divest period?

Probably nine months, six to nine months.

Okay, all right, thank you.

Thanks, Sergey.

Our next question is from the line of Gregg Goodnight of UBS. Please proceed, sir.

Sure. Good morning, gentlemen.

Hi, Gregg.

Your Nanjing plant, you've mentioned that your plant is on schedule. I would wonder if you would comment on the comment that the [Singas] plant, which is needed to flange up with your startup, is that project on time for your startup?

Yes, I think, Gregg, as we looked at the market in China and the global market, as we indicated, we intend on bringing the unit up and supplying the market as demand develops. So, on that basis, we've got some optionality, some flexibility on our startup timing, and we would view that the startup of our unit would be sometime in the first half of next year, we would expect the market demand to require it at that point and we will be on schedule for that, as we understand it.

The Singas plant from Wesson will be on time for that?

Yes.

Okay, second question. With your recent lawsuit for BOC, what I've read is that you're claiming 250 million actual damages. Would you comment upon the nature of the damages, of the timing, cost, whatever?

Unfortunately, with pending litigation matters, Gregg, we can't comment at this time on anything related to that other than what can be gathered from reading the filing.

Okay, okay, thank you very much.

Thanks, Gregg.

Our next question is from the line of Roger Smith from Merrill Lynch. Please proceed, sir.

Thank you. Good morning. Do you see a Ticona gross margin squeeze in the second half of 2006 as natural gas prices are spiking back up to the $9 per BTU range?

That's a good question. Let me back it up a little bit. I think the impact on natural gas with Ticona is small. It's a modest number, so I guess in the absolute there would be some finite impact, but it's not material.

And just keep in mind on Ticona is seasonally the fourth quarter is the weakest quarter typically in Ticona on a margin basis.

Okay, and with the relative weakness in automotive OEM profitability, do you see that having any impact, either accelerating or decelerating the conversion to plastics, or would they consider converting to some perhaps lower-cost plastics, perhaps nylon and some of the other engineering plastics that you produce?

We've been involved in the automotive space for a long, long time, and our products are high-performance, high-price products. In most places where cheaper products could substitute, the substitution has already occurred, or if cheaper products could go into those applications, they're already in there. We tend to be in very corrosive environments or higher temperature environments or environments that require creating molding characteristics that only our products can deliver.

Consequently, we're not big pieces in an automobile. We tend to be the size of a fist or a finger or even smaller than that. Additionally, as new customer-friendly applications get in an automobile, such as GPS systems or wireless or a whole host of different applications - a hybrid automobile is an example. These open up brand-new opportunities that require our products, and we see growth along with that. Again, our penetration -we do focus on a short-term basis on the number of platforms that are manufactured, but ultimately our real key to success here is penetration and the number of pounds that go into an automobile.

And the second order metric we have is translation. How many applications can we take from Toyota into a Daimler, or how many applications can we take from an automobile into a consumer application? This last quarter is an example. We commercialized a brand-new application in the consumer application out of automobile that required high-temperature performance. I think it was in an oven/stove application for industrial use.

So there's an area where we benefited from our position and our technology and we translated it into our applications.

All right, well, thank you very much.

Thank you, Roger.

Our next question is from the line of Mike Judd of Greenwich Consultants. Please proceed, sir.

Good morning.

Hi, Mike.

A question about your acetate tow business. I think you indicated that you started up some new capacity in China. I'm just wondering if you could talk about the overall market for cigarette filter fiber in China. It seems like the volumes both for yourself and also for another player in the industry have been very, very strong in the first half of the year, and I'm just interested in what your thoughts are about what that could look like in the second half of the year, given the new capacity that's come up. What's the impact on you specifically and also what's the market look like - the Chinese have a habit of buying a lot of material then basically stop buying. So that's kind of the nature of my question.

Okay, thank you. Mike, as you know, our joint venture partner in China is the China National Tobacco Company. Essentially, we're joint venture partnered with our customer, so we have a good hand on inventory and dynamics of what's going on. To answer your question specifically, we don't see any - to answer your question specifically and then I'll broaden my answer a little bit, we don't see specific trends where the demand that we see is caused by inventory builds.

On a broader base, though, we do see improvement in our business based on steps we've taken to revitalize it. We went from five manufacturing facilities down to three. We exited from a nonperforming textile business and focused on our key strengths. We've taken big steps in reducing our SG&A and reducing our working capital. The benefits we're seeing in our performance are a sustainable step-change improvement because of the lower system operating costs. And that's' what's driving our performance within our business.

Okay, so if we look at it on a year over year basis, on the first half versus the first half last year, obviously, there was a pretty nice improvement. And would you expect the second half, for the full year, to look like the first half, or just sort of delta that off of the second half last year in terms of profits.

So here's how I'd look at it. You've got two things going on in the first half. One will recur and one will not recur. You've got a step-change improvement in the base business. That will be ongoing. There may be a little seasonality where these second half is a little weaker than the first half. But then you have $21 million dividend that's an annual dividend payout from the joint venture in the first half which will be nonrecurring in the second half. But it will go on in 2007, obviously, and we would expect that number to be larger in 2007.

And then I would point out, Mike that the fourth quarter - if you go back and look at the fourth quarter kind of run rate where we were with acetate, it gets to be tough comparables at that point. So it's tough to take the year over year from the end of second half of '06 versus second half of '05 and compare it to the first half, as you were trying to do, because we started seeing our benefits in the fourth quarter of last year.

Got it. Thank you.

Our next question is from the line of Edlaine Rodriguez of Goldman Sachs. Please proceed, sir.

Hi, this is Costas again, and I have two more questions if I may. The first one, one of your competitors had some nice things to say last weak about low-VOC acrylic paint. I would like to know what's your take with acetate in the low-VOC paint market and if you guys compete head to head with them.

The low-VOC market is increasingly important in interior coatings. Some in exterior, but more in interior. There is a regional dynamic. In North America, I would say that we're probably five to 10 years behind the push in VOCs here, low VOCs, here. In northern Europe, it's very mature, very advanced, and in southern Europe it's somewhere between where we are in North America and where northern Europe is.

The markets are finding different solutions. Certainly in northern Europe, our acetates or what we call vinyl systems are the predominant solution for that region of the world. We believe that the southern European, mid and southern European is going toward vinyl systems. Consequently, we see substantial growth based on that penetration.

North America at this point, strongly an acrylate market, and as it moves more and more to lower VOC, we're seeing increased attention from coatings, formulators, on low-VOC products based on vinyl systems. I'd say it's very much a jump ball right now in North America.

Okay, and then how big is the market? Did you have any idea, or any numbers?

Not off the top of my head, I'm sorry.

That's fine, that's fine. And then the second question is you reduced the top line from 290 to 280. So what are some of the pressures that you guys saw now versus three months ago, back in March?

Well, as I said before, it all centers in our acetic acid and acetyl business. The industry added some capacity in the second half of last year. Capacity utilization went from a year ago it was in the high 90% range. It moved down toward 90% capacity utilization. In the first half of the year, that new capacity is being absorbed into the market, and we saw a period of unusual good running of the industry's acetic acid plants. There's dozens of these plants globally, and usually you can expect to have some of them with unexpected disruptions or outages. That didn't occur in the second quarter to the degree that it has historically and it isn't occurring in the third quarter.

We think this is a temporary thing, but on the basis of that we saw pressures in our acid prices and subsequently adjusted our forecast or our outlook for the year. I would say that it's a mixed picture overall. That - the effect on pricing there doesn't translate through the system. Vinyl acetate, as an example, is incredibly tight. BP has force majeure in Europe, as you're aware. Very tight, pricing is very, very strong in Europe and North America, where it can be. Asia, pricing is pretty good on VAM, so it's a mixed picture across the system, but overall it's a pretty good picture, pretty good environment, and we view the effect that's going on with acid and the run ability of acid to be something that's just short term.

Thanks.

Our next question is from the line of Christopher Miller of JPMorgan. Please proceed, sir.

Good morning, just a couple quick follow-up questions. Working capital through the second half of the year, typically a source of cash for you. Any sort of range of expectations, and would you agree with that?

Well, let me just give you a sense on how to think about the first half, and then you can kind of work it from there on the second half, but absolutely it would be a source. I wouldn't want to give specifics. I can tell you, for the first half of the year, we used about $100 million cash in increased working capital. We did have about $50 million of cash on restructuring reserve spending. And then timing of our payments - there were some VAT taxes, some bonuses. So our first half is generally pretty much where we're at in terms of cash flow. So we still feel pretty good about a significant amount of cash flow, particularly coming in in the third quarter.

If you go back and check the records, I think in the third quarter of last year, operating cash flow less CapEx was approaching $300 million. So I wouldn't want to speculate specifically on where we would be in working capital, but clearly we would expect this to be a source of cash in the second half of the year for us to stay within the cash flow expectations we previously discussed.

Okay. And obviously you noted you've paid down an initial 100 million of term debt here in the third quarter. Any of guidance you can give us or thoughts you can give us on additional planned debt reduction over the course of this year and headed into next year?

I think we've said it is our priority, we want to march towards investment grade, so that's probably our first, if you will, use of cash is to think about paying down debt. However, we're constantly looking for acquisitions and ways to expand our portfolio and improve our portfolio.

I think the acquisition side, however, I think Dave has mentioned in the past, pricing seems a little high, a lot of money chasing few properties right now. Of course, we'll keep up with the dividend and continue at around $250 million of CapEx.

So I think we've said march towards investment grade, where can that get you over the next 24 months? We could maybe take 700 to $800 million out for net debt position over the next 18 to 24 months, potentially.

Okay, great. That's very helpful. Thank you so much.

Our next question will be from the line of William Matthews of Canyon Capital. Please proceed, sir.

Hi. You went into a little bit of detail about this, but I just want to try and get a better understanding. The capacity additions came on in the latter half of '05. Why was there not a bigger effect in Q1? Why was the effect more in Q2?

Well, great question. Acetic plants are notoriously difficult to start up. It normally takes six to nine months to ramp these units up. Consequently, in the first half there was some impact, but it was within our expectations. And then the second half, I guess we'd say that they ran better, so they ran to a point where they were just all running out there. But this is the industry. It tends to be a long period of time to get the units started up.

And can you give us your estimation of what percentage of global capacity was comprised in this addition and what the end markets are growing at? So, for example, was this 8% of global capacity and the end markets are growing 6%? Kind of could you give us...

Yes, we gave that last year, and let me see, [Mark], if I can pull this off the top of my head. Market is growing at GDP plus 100 to 150 basis points, so think in terms of a 4% market growth. And, last year, we had about 4 to 5% of the global market added in new capacity, about one year's growth, net growth added to the market.

Okay, and is there specific working capital uses that go along with this kind of industry dynamic where you have capacity just coming on, meaning - you mentioned some detail on the working capital on a previous question, but for this specific industry dynamic, could this cause a greater use of working capital, or not really?

No, no, I wouldn't link the two of them. I think what John was commenting on is that the first half tends to be a stronger revenue half for us than the second half, consequently, you absorb cash in working capital, which gets reversed in the second half of the year. These businesses are not unusual in their working capital profile.

I would say that as you put facilities in region rather than ship, you have a working capital effect there, but it's not a material effect.

Great. Thank you.

Our next question will be from the line of Melinda Newman of Post Advisory Group. Please proceed.

Hi, good morning. You had mentioned that you think everyone is running exceptionally well. Can you maybe on a more detailed basis tell us where you think - I think it's mostly Chinese plants that have come on in late '05, where you think they're running versus where your initial expectations were? And in the first quarter, I think the commentary was you thought everything had really been absorbed and so it's a bit of a - I understand that they're operating better than expected, but it is a bit of a surprise to now hear that you're seeing the effect of something that you thought effectively you had been absorbed.

Thanks for the question. I think the beauty of this is that we're within a percent or 1.5% of capacity utilization of having a very, very strong business with some nice margin expansion. We're operating at a very good level right now. We do see some of the facilities out there that are high-cost producers who are shutting down, so the price umbrella is working. But then we've go a point beyond that where demand continues to pick up, plants continue to operate and capacity utilization moves from a low 90% into the mid 90% range, let's say.

So if we were to look at Formosa or any of these other Chinese plants that have come on, you think they're operating where? In the 90s?

Well, right now, if they're the high-cost plants, they're not operating at all, as we understand it. We understand that the high-cost plants are shutting down. Even some of the new plants that were built last year were with high-cost technology. So low-cost plants, we'd say that they're pretty well operating at full rates right now, just as we are.

Okay, and you have seen no disruptions that give you - sometimes in the past you've commented that a plant went down and you felt the market tighten. You've seen nothing like that at all in the second quarter to try to gauge how close to balance it is?

No, and remember what I want to do is not - present an accurate picture of what we're looking at here is. We consume about two-thirds of our acetic acid internally for downstream applications. Those downstream products have totally different dynamics than the acetic acid, merchant acetic acid market does.

Sure.

And there are totally different dynamics in Europe and in North America than from Asia, so we're talking about at small part of the business in Asia, and the pricing volatility there is very high. Pricing, let's think in terms of a $500 or $600 a ton price, market price, can vary within a 14-day period of time by 100, $125 a ton. Subsequently, you do get almost an immediate reaction in that small market we're dealing with when a plant is out, when there is a disruption, and we don't see that. People are running, except for the high-cost people, and they've shut down.

Okay. Then, last question, did the virtual ethylene cracker economics, can you quantify or give us some sense - I assume that it might have had a negative impact, and can you tell us whether that's true, and if so just approximately how much that contributed to margin compression in chemical products in the quarter?

No, unfortunately, we're constrained on what we can share on that. But what I will say is that by virtual cracker I think you're probably referring to the cost-based contracts that we have in ethylene, and those cost-based contracts were advantageous versus buying at market.

Okay, thank you.

Thank you.

There are no further questions in queue, sir.

Great. Thank you very much. As always, thank you, everyone, for your participation. If there are any follow-ups, please feel free to give myself, or anyone on the IR team, a call. We look forward to talking with you soon. Thanks.

Ladies and gentlemen, this concludes the presentation. Thank you for your participation. You may now disconnect. Good day.