伊士曼化學 (EMN) 2002 Q2 法說會逐字稿

Please stand by. We're about to begin. Good day everybody and welcome to the Eastman Chemical Company second quarter earnings conference call. This conference is being recorded. This morning's call is being broadcast live on the Eastman website at www.eastman.com. Hosting today's presentation will be Greg Riddle of Eastman Chemical Company Investor Relations, Brian Ferguson, Chairman and CEO, James Rogers, Senior Vice President and Chief Financial Officer, Al Wergo, Veridian Chief Financial Officer. At this time, for opening remarks, I would like to turn the call over to Brian Ferguson. Please go ahead, sir.

Thank you, Jamie. Good morning, everyone and welcome to our call. Let me first start by saying we have a very good quarter overall this second quarter of 2002. In general, our businesses performed very well on a number of dimensions and on top of that, the business climate improved over the first quarter a good bit, so we're pleased about that.

The best story we have is our volume story, which as you see grew about 9% versus the first quarter & has grown about 12% versus the second quarter of last year, and that's excluding Hercules. We've had, also, very good volume growth outside the United States, which is pleasing. We're especially pleased with the PET volume gains. We've had a 16% increase year-over-year and about 11% versus the first quarter. As we told you, we were going to go and get our share of the growth in the PET market, and that's exactly what we've done. All of that volume growth put together though, unfortunately led to a flat sales comparison to 2001, and this is caused entirely by price decline. And I think you've heard this story from more than myself. Many other people are talking about the same issues.

The prices, also, caused some margin squeezes there because the prices fell more than the raw materials year on year. If I look at last year's price, it has declined substantially from where we were 2001. The price decline resulted in the price of raw materials squeeze, compression resulted in about $144 million of margin compression -- or excuse me, the price decline caused $144 million of decline. We had $73 million of EFO compression as a result of that. So that was a significant thing to overcome. We have even sequentially seen raw materials rise a little bit, and the raw material costs rose about $31 million in the first quarter and increased prices that we enjoyed only recovered about $14 million of that. So even between the first and second quarter, we had a $17 million price raw material compression.

If I turn to the commitments that we made to you, you remember, we talked to you about overall commitments we'd make for the company relative to expanding our gross margins, holding overhead down, paying down debt, et cetera, spending below depreciation and amortization. Let me catch you up on how we're doin' there.

We paid a lot of attention to gross margin. You remember, we started this year at a gross margin of around 13%, and it rose to about 16 1/2% in the first quarter. It's still about 16 1/2% here in the second quarter, but that's in spite of the $17 million price raw material compression there, so we actually made some progress on our cost controls and other things and we're lucky to have held on because of that price compression. We will need to improve our pricing to expand our margins going forward and looking forward to the time we'll be able to do that some more.

On our overhead, can you see that our overhead is moving along at about 10 1/2% of sales. We told you we'd pull that below 11%. That's -- you should also remember that we're spending something on the order of about $4 million a month on new business development, which mostly shows up in that number. That new business development is, as a commitment we told you, would be somewhere in the neighborhood of 1% of sales, and that's about where we are.

Our earnings this quarter were a little higher than what we had indicated to you when we talked at the last conference call. Of course you can see we were benefited by some foreign exchange effects on the order of about $15 million. That was one of the reasons for that. We maintained our discipline in CAP-X and other kinds of directed investments and kept those down about the levels we told you we would. We've generated some pretty good free cash flows, as you see. So as a result, we paid off almost $150 million of debt.

Our restructuring in FASB continues as planned. We have a variety of things going on there and the benefits of that are phasing in over the next 12 months or so. So overall, we are very pleased with the job that's been done by our people. I'm looking forward to the performance for the balance of this year.

First of all, we have to recognize there are a lot of moving parts out there. On the upside, we have things like a weaker dollar helping our export profits. We have some price increases. I think in prior 10-Ks, we reported that we expected to lose some custom manufacturing business in our performance chemicals and intermediate business. We've been fortunate to retain and extend that contract for one more year into the middle of next year. That is something that's not going to go away as we expected.

On the downside, we have a very uncertain capital market out there and we worry that could affect personal and corporate spending, and therefore, the demand for our products. We worry about the unrest in the Middle East and actions that the U.S. might take, which could affect raw material pricing pretty dramatically. But, if we look through all of that noise, we see that our operating margins are changing up and down from business to business, but in the aggregate, we believe the total is fairly stable. So we expect the operating performance in our third quarter to be similar to what you've here just seen in the second quarter.

I use the term operating performance deliberately because every quarter we seem to have some ups and downs that adjust the operating earnings like, I guess, in the first quarter was Argentina peso devaluation that took something off of it. This time we had foreign exchange put something back onto it. And I'm not going to try to predict how those things will - totals will rise up or down in the third quarter.

Historically, the fourth quarter is our weakest quarter, and there's still some considerable uncertainty about the economy, so I'm not going to make any predictions today about the fourth quarter. If I take a slightly longer term view, I also feel very good about the way we're tackling the growth challenge in our company. I've spoken to many of you before about ways we wanted to expand our gross margin. A couple of those were fairly short term. There were things like a [path] utilization and cost control. We are making good progress on those things.

The key part of that margin expansion though, is the new products and services for the longer term. Those are, of course, the toughest things to do. It's always difficult for a mature industry to develop a rich set of ideas, and I'm very encouraged by the progress we've made in this area developing a much richer set of ideas that we can work toward in the future. It's made me even more encouraged about the possibilities of what we can do down the road.

So in summary, I feel we've made good progress and we feel good about our financial performance. We're making good progress on the things we promised we would do for you, and we see a pretty stable outlook for the third quarter. So let me pass the baton on here to Jim now.

Thanks, Brian. Good morning, everyone. I'm just going to echo Brian's comments that I think we had a good quarter, and in particular, it was good to see those volumes come back.

What you should know is overall, the plants handled those volumes very well in terms of our operating rates and efficiencies. We did have one lingering issue, lingering since about April, an operational problem in our PTA portion of the Voridian Rotterdam site. It doesn't have any customer impact, hasn't had, not expected to, but it is an internal cost issue. We felt some of that in the second quarter and we're going to feel more in the third quarter. We expect to have it wrapped up in the third quarter, but that's already built into the guidance Brian gave. I just thought I'd make you all aware of that in case you hear about it in some way. Again, no customer impact on that issue.

I'm also pleased to see the discipline continue on the cash and the cost. I feel like we're doing what we're supposed to do there. The debt paid down about $172 million bucks, so it's good to see this quarter. Our finished goods inventory was actually down in volume terms even though it was up slightly in dollars. Receivables were up because of the increased sales sequentially and our capital spending we held down again, as we did in the first quarter, to the kind of 103 number when it comes to capital spending plus the little acquisition we made of Ariel. So overall, a good working capital management. I would think that would continue.

As you look at the SGA line, that probably looks high to you at first. One of the things you need to know is we did take an additional $7 million of bad debt reserves in the quarter, and that's above and beyond the typical addition we would make to that reserve. So if you ask, looking forward over the next couple quarters, what would be a more typical SGA, I would back that out and run around 103 million or so. In any event, like Brian said, SGA and R&D about 10.6% of sales and that includes funding those new business developments. I'm glad we got this cash flow discipline.

This year we're paying down debt. Next year we're gonna have to divert some cash flow to our pensions. There will be pension funding required if things continue the way they are. You do your valuations at year end, so we'll see where the markets and interest rates and everything are at year end.

Right now, our anticipation is that we'll be doing some funding of the plan next year. No funding anticipated this year but next year we will be funding our pension plan. As we look at the continuing down the income statement, Brian hit on the other income line, and that's the one that really bounced around from quarter to quarter.

The last time we talked about Argentina. This time, we helped by staying unhedged on our cross currency exposures as the euro was strengthening. As we got up close to parody we did go ahead and start hedging that exposure to the point that I would not expect to see a lot of volatility or currencies on that line in the next quarter or two, because as I said, as we got near parody, we started locking up that exposure. we did go ahead and start hedging that exposure to the point that I would not expect to see a lot of volatility or currencies on that line in the next quarter or two, because, like I say, as we got near parody, we started locking up that exposure. Final thing I'll mention is that we did complete our R-3 implementation, substantially complete. There's a few sites in China that are not up, but we are now across the company, on R-3. And I'm hoping we continue to see some benefits out of that implementation.

Overall, gone fairly smooth I, little hiccups here and there but in general it looks like very good execution by our IT folks working with supply chain, finance, et cetera and we feel pretty good about bringing that R-3 system up around the world.

That's all I had to comment on. Now I'll turn it over to Greg.

Thank you very much. Late yesterday, the Eastman Chemical Company press release announcing second quarter earnings was distributed to the news services and posted to our web site at www.Eastman.com in the investor information section. If you are listening to this call by phone, we are also broadcasting live on our website.

Included with our press release are a series of financial tables. Table one is a statement of earnings for the second quarter 2002 and the same period 2001. The following results exclude interdivisional sales.

Sales revenue for second quarter 2002 was $1.4 billion essentially flat compared with second quarter 2001. Increased sales volumes were offset by lower selling prices. Sequentially, sales volume increased 13% mostly reflecting higher sales volumes attributed to customary seasonality, inventory restocking and improving market conditions. Costs of sales for second quarter 2002 was $1.166 billion compared to $1.144 billion excluding amortization of goodwill and indefinite lines intangibles for 2001. The increase is primarily attributable to costs associated with increased sales volume.

Selling and general administrative costs for the second quarter of 2002 were $110 million compared with $106 million for second quarter 2001. Sequentially, S&GA increased $20 million. The increase is attributable to $7 million of bad debt expense for credit exposures primarily related to one customer in Europe as well as a return to more normal levels after deferring some costs in the first quarter 2002.

Included in the reported corporate S&GA costs is approximately $8 million of S&GA for our subsidiary Sidia corporation. We expect to continue to recognize a similar level of quarterly costs related to Sidia as they add capacity while continuing to add new customers.

Research and development costs were $38 million in second quarter 2002 compared with $41 million second quarter 2001. We remain committed to keeping a combined cost of S&GA and R&D at approximately 11% of 2002 sales revenue. Year-to-date, these costs are 10.5% of sales revenues.

Operating earnings for second quarter 2002 were $81 million compared with $111 million excluding certain non-recurring charges and amortization of goodwill and indefinite live intangible assets for the same period a year ago. The declining operating earnings primarily reflects lower selling prices that were partially offset by lower raw material costs and lower unit costs resulting from increased past utilization. Sequentially, operating costs increased by $4 million reflecting increased sales volumes partially offset by increased raw material costs.

Net interest expense [excuse me] for $31 million in second quarter 2002, a $6 million decrease from the same period in 2001. The decrease primarily reflects a reduction in borrowings and increase in market interest rates year-over-year offset by a higher coupon on our recent 10 year bond issue versus commercial paper that was paid down with bond proceeds during the second quarter.

Other income net for the second quarter 2002 was $10 million reflecting the positive impact of foreign currency exchange rates due to the weakening of the U.S. dollar against the euro, partially offset by the continued devaluation of the Argentine peso and the write down of certain technology business venture investments. Earnings per diluted share for the second quarter 2002 were 58 cents compared with 61 cents excluding certain non-recurring charges and applying non-amortization provisions of FAS 142 for the same period in 2001. Excluding the effective of a change in accounting principle and a non-recurring charge, earnings per diluted share for the first quarter 2002 were 35 cents.

Table two is other sales and earnings information. Sales revenue increased in all regions except North America when compared to second quarter 2001. For Asia- Pacific increased sales revenue primarily reflects increased sales volume for the performance chemicals and fiber segments. Increased sales revenue in Europe, Middle East and Africa region primarily reflects increased sales volume for the coatings, adhesives, specialty polymers and heat segment mainly due to the Hercules acquisition and increased PET polymers sales volume. Increased sales volume in Latin America was mostly offset by lower selling prices and an unfavorable foreign currency exchange rate. For the north American region, lower sales revenue primary reflect lower selling prices mainly for PET, polymers and polyethylene.

At the beginning of 2002, Eastman implemented a divisional structure that grouped three segments into Eastman division and two segments into Voridian division. The divisional structure has allowed the company to align costs more directly with the activities and businesses that generate them. The divisional and segment financial results for the first two quarters of 2002, but not for prior periods, reflect this new cost structure and make earnings comparisons to the prior year difficult. Highlights of divisional and segment performance excluding interdivisional sales and certain items for the year ago period follow.

Eastman division. Eastman division sales volume increased 11% for second quarter 2002 versus the same period a year ago. Sales revenue for the division declined 1% at sales volume improvement was offset by lower selling prices. Operating earnings decreased year-over-year due to lower selling prices and lower gains on foreign currency hedging partially offset by lower raw material costs. Sales revenue increased over first quarter 2002 primarily due to higher sales volumes compared with the prior quarter, operating earnings for the division decreased due to higher raw material costs and lower selling prices that were partially offset by higher sales volumes.

CASPI segment operate earnings for second quarter 2002 decreased by $8 million when compared with the first quarter 2002 due to higher raw material costs, normal scheduled maintenance and selling and general administrative expenses increasing from first quarter 2002. The performance chemical and intermediate segment operating results improved by $1 million compared with the first quarter 2002. The increase is a result of higher sales volume offset by an unfavorable shift in product mix higher raw material costs.

Specialty plastics segment operating earnings for second quarter 2002 declined by $3 million when compare with the first quarter 2002 due to higher sales volumes being offset by lower selling prices, higher raw materials costs and selling and general administrative expenses increasing from first quarter 2002 levels.

Voridian division. Voridian division sales revenue was up slightly when compared to second quarter 2001 reflecting higher sales volumes offset by lower selling prices. The division sales volume, sales revenue and operating earnings improved when compared with both second quarter 2001 and first quarter 2002. The strong earnings are primarily the result of improved customer demand and operating efficiencies. Polymer segment operating earnings increased by $12 million sequentially reflecting a combination of a customary seasonal increase in sales volume, growth in underlying markets, selling price increases and operating efficiencies. In the third quarter, the business will experience the impact of the normal seasonal slowing of demand, planned maintenance shutdowns and operational problem in Europe.

Fiber segment operating earnings increased $9 million sequentially reflecting stronger customer demand especially in the Asia-Pacific region. The demand from Asia Pacific is not expected to be as strong in the second half of 2002.

Cash flow, table five. The company generated $335 million in cash flow from operations during the first six months of 2002 of which $103 million was used for net capital expenditures and directed investments and $147 million was used to reduce borrowings. The company continues this emphasis on cash flow and expects capital expenditures and directed investments for small acquisitions and other ventures for 2002 to be no more than depreciation and amortization.

Additional outlook for third quarter and remainder of 2002. We expect operating results for our underlying business in the third quarter to be similar to the second quarter. Historically, the fourth quarter has been our weakest, but with the current economic uncertainty it is difficult to estimate what to expect for this year's fourth quarter.

We maintain our commitment to generating positive free cash flow which will continue to benefit us through this uncertain economic period. We maintain our commitment to keeping capital spending and other directed investments for small acquisitions and other ventures to be no more than expected depreciation and amortization in 2002. We maintain our commitment to keeping S&GA and R&D costs at approximately 11% of our 2002 sales revenue.

The company expects to continue to pay a quarterly cash dividend and anticipates that excess available cash will be used to reduce outstanding borrowings, fund targeted growth initiatives such as small acquisitions and other ventures, and repurchase shares.

During this conference call we have made certain forward-looking statements concerning our plans and expectations for third quarter and second half of 2002. Actual results could differ materially from our plans and expectations. Certain factors related to future expectations are or will be detailed in the companys'second quarter 2002 sales and earnings press release and the supplemental information for second quarter 2002 on our website at www.eastman.com under the investor information section and in our filings with the Securities and Exchange Commission, including a form 10-k filed for 2001, form 10-q filed for first quarter 2002 and form 10-q to be filed for second quarter 2002.

This concludes our prepared remarks. Jamie, we are ready for questions. Please review the procedures for getting into queue.

Thank you, sir.

Today's question and answer will be conducted electronically. If you'd like to ask a question, please signal by firmly pressing the star key followed by digit one on your Touch-Tone telephone. If you find that your question has been answered and you would like to remove yourself from the queue, you may do so by pressing the pound sign. We'll take as many questions as time permits and we'll proceed in the order that you signal us. Please remember to state your affiliation prior to posing your question.

Let's begin with Sergei Vasmetsa with Lehman Brothers.

Yes, good morning. Pretty good results. I wanted to ask you, you give the overall guidance for the third quarter. Can you talk about the sequential improvements or declines in the regional trends?

In regional trends? I'm not sure I have an analysis that's as full as you'd like on that, Sergei, but regionally, we've been seeing our biggest quarter to quarter volume gains in Asia Pacific. I have an expectation that that would continue, I guess.

Europe has been going through a little more difficult time but we have had some volume gains in Europe that's going through a little more difficult time. It's hard to say whether they're gonna pick up steam in the second half or not. We've actually had pretty good gains in Latin America. So the leaders for volume growth for us have been Asia Pacific first, Latin America second and I think EMEA was third on that. If you have an estimate on how Europe and Middle East, Africa will come back, can you throw that -- you can use your own judgment on that.

Okay. Thanks.

We'll take our next question from Graham Coply with Sanford Bernstein.

Good morning, folks.

Good morning.

I'm obviously a little slow this morning because I'm not following something here. Your hedging adjustment in other income, obviously any day-to-day change in selling prices or costs associated with exchange rate change are reflected in the business. So is the gain we're seeing there an absence of hedging, physical hedging costs during the quarter or is it some sort of mark to market hedging gain and how should we expect the following two quarters to look in comparison with that?

Graham, you are right in terms of the typical exchange effect flows through your income statement and you see it up in your gross margin even. So, you can sell in a foreign currency, convert it back to dollars. You show a gain or loss to your income statement. The reason this is down on the other line where also, by the way, you have to show some positions that you would have if they did not get hedge treatment. That's not our case.

Our case is simply that we have different cross currency flows between, say, Switzerland and the U.K. or the U.K. and the euro, the Singapore dollar and the euro. Those we stayed open on. And in fact, we typically, you know, have not had as much exposure there but we have some changes in the quarter that increased our exposure there. By staying open on that, we had a positive result as we saw the euro strengthening.

It's a little complicated , I guess there's only so much can you go into on a phone call but the cross currency exposures, we'd gone up around parody against the euro, and dollar, we have gone ahead and hedged those up. That's separate from hedging, just our, basic business and what decisions we make about, you know, hedging foreign currency sales and coming back into the dollar. So I guess the way I'm thinking of it is, you know, you shouldn't annualize that or anything. It was a nice benefit to have in the quarter. As we saw the dollar weakening, it does come in on the other income line. Obviously there was a bit of currency effect up in our - up in the top of the income statement as well as those foreign currency sales got translated into dollars. That's probably the best explanation I can give to you.

Can I have a completely unrelated follow-up? Um, - You did a deal with Wellman on PET during the course of the quarter. Are you convinced that if you hadn't done that deal that plant would have been converted anyway, or have you actually kept the plant alive by doing the deal?

Let me ask Al Wargo to comment on that one for you, Graham.

Graham, the transaction with Wellman really is a case of capacity sitting there both in our case and in their case. In our case it's solid stating capacity. In their case, it's, you know, it's basic PET resin capacity. What that forces both of us to do is look at those assets. You know the game in PET. It's capacity utilization drives unit costs down. So the faster and higher you can run your plants, the better.

Both of us were looking at that capacity and saying, all right in our case, we've got solid state capacity. Should we put on some more basic PET resin capacity, meaning like build a plant or build some capacity to do that? And we said, this particular transaction provides a very low-cost, and by that I mean incremental costs. If you assume you've got the depreciation hitting you for those assets already, the incremental costs of this transaction is very small. So it's a low cost and low capital way to get additional capacity for both of us. Neither of us would have to build a plant. Neither of us would have to add any additional capacity. We just put the two pieces together, and we get higher capacity utilization, lower unit cost and additional product.

This is consistent with what we've said in the past. That we have ways of growing our PET business without having to plant expensive new plants in the ground for a while. This is a great example of that.

I guess if I could just chime in, Graham. To the point of your question - you know, Wellman is a public company so we're not going to comment on what their intentions would or wouldn't have been if we hadn't done this transaction.

Fair enough.

We'll go now next to P.J. Juvicar with Salomon Smith Barney.

Good morning, Brian and Jim.

Good morning, P.J..

Two questions on Eastman division. First on CASPI. I'm a little concerned about the stability of CASPI margin. Last year margins were 3%, in the first quarter they were 6% and down to 3% again despite a sequential revenue gain. Can you talk about what's driving that?

Yeah. There are a variety of cleanup things that have to do with restructuring that keep on chipping away at them.

This time, we had some one-time charges in Texas I think that were related to that. We continue to do some other kinds of restructuring, pulling a couple of business units together. Then there are some charges that go along with that. So what you're seeing is a little left over.

What I can't comment on is we don't give you full exposure to the gross margins of a business like CASPI but they are improving and getting better and we like what we see there but the bottom line numbers are still being chipped away by some of these other things. That won't go on forever, but that's what you are seeing.

So this is below the gross income line?

Basically, yeah.

The second question I have is on specialty plastics like Co-Polyester.

Yep.

You've seen a big decline there.

Yep.

Can you talk about issues there and also maybe focus on any long-term issues you might have like commoditization or substitution of the materials?

Again, a lot of moving parts in specialty plastics. Remember, it's made up of two or three pieces. Kind of think about it as 3 pieces. You have the cellulose triacetates, cellulosic polymers which are very mature, typically pretty high margins and you just care about whether your customers are using it or not. You are not moving prices and margins around much. In that case, we've had reductions in usage primarily what gos into the photographic industry for 35 millimeter film and things like that. We have kind of the mature co-polyesters. And those mature co-polyesters, those go into things like film and sheet. We are seeing competition from the Koreans and from others in Europe who are causing the prices to decline there. The third part of that or all of the new products that are being developed that are growing at 15% plus rates with pretty good margins. And those don't have a big enough base yet to overwhelm the other two things that are going on.

I guess what I see -- and the bigger picture here, too, are these mature co-polyesters are going head to head with things like polycarbonate and acrylic who have also gone through drastic price drops in the last couple of quarters and now they are starting to head in the other direction. So, yeah, you are right, it has headed south on us. We think we're about where the bottom ought to be. It ought to start stabilizing and going the other way. And some day when the new products start getting a big enough base, then it gonna start looking pretty good again. But that's a transitional situation we're facing right now in specialty plastics.

Right. Are you gaining any market share against polycarbonates?

Not that I'd be willing to report to you right now, P.J., to be honest with you.

Okay. Thank you, good quarter.

Thank you.

Our next question is Frank Mitch with Bear Stearns.

Good morning. A question for Brian and Jim. Brian, you seemed to draw distinction in terms of the third quarter operating results being equivalent to the second quarter operating results and you also highlighted the four x. Are you implying that your expectation for the third quarter would be below the 58 cents reported in the second quarter?

Let me jump in and then Brian may want to finish it off. What we're trying to do is show that you there is an underlying trend in the business. Brian hit on a couple of them in terms of the price, the negative being the price, raw materials squeeze that we continue to feel. And the positive, all of the stuff we're doing internally.

It's the things down on the other income line that we really try and avoid getting into predicting those because they are more one time in nature and we don't really think they are what you want to focus on as you look at our business and try and predict going forward. So there may be other pluses and minuses moving below the Op income line. What Brian was trying to do was give you the steady part at the top.

So if you are saying that looks similar -- and by the way, as I look at it just my perspective and listening to other people, you know, we're getting a mixed message out there. You got some guys saying the second half is going to be lower than the first half. We're more along the lines of just looking at the third quarter and thinking that should look a lot and feel a lot like the second quarter.

But, you know, we don't want to portray that the visibility has improved all that much quarter to quarter right now, so there's still a lot of fog out there you might say in terms of, "Is this volume inventory restocking? Is this really underlying growth?", and so we're trying to stick to the part that we feel the most comfortable with, which is up in the operating margins and things that might happen on the other income line. You know, we'll talk about those as they arrive.

But the answer to your question is no, I'm not trying to lead to you some conclusion on that, Frank. There are just as many likely outcomes that would drag it up as drag it down.

Ok. So I shouldn't - So that 58 cents is kind-of your bogey? We shouldn't take the $10 million and other income and subtract that out and say the company believes they can come in at 51 or something like that? 58 is the number that you are comfortable with right now for the third quarter?

Yeah. We didn't actually -- I guess we're trying to avoid giving you a hard EPS number 'cause we're trying to predict part of the income statement for you. There may be some pluses in the third quarter that look a lot like pluses in the second quarter. What we're trying to do is focus really on the operating earnings. If nothing happens below the Op income, well the, no, it won't be 58 cents because you can see we had a big positive in the other income line. That's the part we're not trying to predict for you. So we're really sticking with the Op income performance.

Crystal clear, Jim. [ laughter ] And with respect to your comment that if the markets stay the same, that you will be in the -- you will be contributing to the pension fund next year can you give an order of magnitude if everything were to stop today, roughly how much you may have to put into your pension plan?

I don't want to because it's just not fair. You do evaluation with your actuarys that you're in. That's the one that really counts. Obviously, it hasn't been pretty the past two or three months as the markets move. It's not just the equites going down as everyone knows. It's the low interest rates and what you will be using for discount rates.

You will see when our queue comes out, that part of our liability has moved into the 12-month time frame. Meaning, we won't be funding within 12 months of the date of the queue. You'll see that move up into current liabilitys. That number will be about $45 million.

That is not the whole year next year. That is just the piece we think in the next 12 months, the first funding early in 2003 would be in the range of about $45 million. But beyond that, we haven't and nor would we say any numbers until we actually have the actuarys do an evaluation.

Frank in all of the estimations that we do about this, maybe your underlying concern is; Will this somehow stress our opportunity to grow or will it stress, you know, the view of our bonds or anything? And the answer to that is no.

We are a sufficient cash generator that we're not worried about this commitment relative to the other ways we want to use cash to grow ourselves.

That's right.

This is not some kind of a hinderance to [INAUDIBLE] the plans we have for the company.

Terrific. Lastly, the 3 cent price increase on the PET, how does that stand?

The PET price increase is so far so good. We had one in April and we followed another one up in June. That kind of bumped its way along through June, but at this point, it's looking good.

All right, terrific. Thanks, Al.

We'll go next to John Roberts with Buckingham Research.

Good morning, guys.

Hey, John.

Take it off speaker. Jim, you may have noticed that your former employer is buying international specially products. It made me think about Genencor. Genencor hasn't turned out to be financially material to your results yet. The stock prices collapsed. Is there any thoughts of either buying that back in or discussing with your partner what change structure for Genencor.

First, I don't want anyone to think I accept your characterization at the price having collapsed. It's certainly down, I think, with the other biotech companies and it continues to, I think, track along with them. So I don't think there's been a market underperformance of their peers, but it's certainly been a disappointment, no doubt about it. We are very bullish on that company. Have been - you know, we own 42% of it. And it's a bit a puzzlement as to how something that has such strong EBITDA has a great based business with industrial enzymes and has all the upside of trying to make something happen on the health care arena why value is not recognized better than it is.

But in terms our game -- in terms of our game plan with that, we are not majority owner. There is another owner at 42% and we'd really have no comment other than we like the space they're in. We do not feel you have to be an owner in order to participate in that space. We could easily do projects with Genencor and other biotech companys without having an equity position, so we continue to think our main drive is to how do we create value for the shareholders with that asset and I think we're just going to have to show some patience given everything that's going on in the market.

Thank you.

We'll go next to Nancy Draff with Credit Swisse First Boston.

Good morning. I wonder if you could make a few more comments about PET, the operating rates so far this year, and if you're gaining share from your competitors and what the dollar impact will be on the maintenance shutdowns you're planning for the third quarter and that PTA operating problem.

I'll give that to Al again, Nancy.

Thanks, Nancy. We always chuckle every quarter about how long it will be before the first PET question comes in. It's a few down the road again this quarter, which is okay, but actually, this quarter we're glad to hear a PET question because as Brian said in his comments early on, we had a real good quarter for PET. Volume in particular was very good.

I think it was last quarter I talked about how in last year about the middle of last year we changed our strategy on PET. We particularly in the second quarter last year, we dug in our heels on price. We felt we would be the price leader and we'd raise the price and not budge.

And what it did, you heard in Greg's comments, talk about a relatively weak second quarter 2001. What it did was hurt us from a volume standpoint. And when you hurt from a volume standpoint, you're not running your plants full, your unit cost is goin up. Your capacity utilization going down, and so the folks in the PET business said this is not a very good outcome. We should be growing with the market, and not digging in our heels so hard on the price. And the reality is price in PET today really follows raw materials.

There's not an ability to drive price that would distinguish one company from another or, you know, unrealistically above or below where raw materials are going. So the game right now in PET is to distinguish yourself on a cost basis, to be the low-cost producer, to have high capacity utilization to be running your plants good, and to be having fairly big, large scale world class plants. And that's really, once we changed that strategy, that's really what benefited us in the second quarter this year. We ran the plants full. We're in the -- our capacity utilization is in the low 90s. Our unit cost is down. And we are, you know, we're doing very well from a volume standpoint. And prices, as I mentioned to Frank earlier, prices are keeping pace with raw materials so we're maintaining our spread as well.

What about the maintenance shutdown and the PTA problem?

Yeah, typically in the third quarter you catch your breath in PET anyway. You run hard in the first half of the year and then you catch your breath, do some plant maintenance shutdowns. So this is not unusual. So if you were to go back the last couple of years and look at what our revenues and earnings do in the third quarter, you'll find that breath catching going on just about every year. Nothing out of the ordinary this year. The PTA problem is not expected to have an impact on PET, as Jim mentioned. It's strictly a cost issue of fixing the operational problems there. So that's not going to be a big contributor in terms of revenue impact.

And cost, too, shouldn't be that large that we should have to worry about it?

That's right.

Okay, thank you.

We'll take our next question from Wes Rabbit with Morgan Stanley.

Good morning. A couple of questions that has more to do with some of the comments you made on CASPI in terms of the rationalization restructuring costs, also on PCI and the lack of profitability there. Could you somehow give us a sense of what those cost increases that were kind of rationalization restructuring to get the business fixed in CASPI were in the second quarter and whether or not that level of quarterly costs continues forward? Also, could you talk a little bit about how you plan to get PCI back into the black?

Yeah, let's start with PCI. PCI follows these kind of long waves that are driven primarily by supply and demand. And of late, you know, we've had a couple of competing ways there. We've had the [aciteals] heading down and the oxos staying down and the oxos are starting to head back up again with price increases across the industry. That goes to solvents, it goes to plasticizers, it goes to alcohols and it goes to a lot of other things. It's starting to flow back the other way. It's starting to improve. The custom synthesis part of PCI, also as we mentioned we retained a contract there so that is more stable and is not heading down the way that we'd expect. So PCI is in an improvement state but it goes a long way. It's not something that bumps up dramatically in a quarter. It goes in long - one or two year kind of cyclics. It's heading in the right direction.

On CASPI, you know, we don't have a lot more. This is not going to be something that lingers along for five more quarters. Would you have another quarter of activity like that in CASPI but it's not a huge thing. We've done most of the activity there.

And as I said, they're kind of underlying gross margin is improving the way we'd expect. We haven't been able to move it to the bottom line yet, until we get some of these things past us. So I guess I'm thinking another quarter or two basically is the answer to your question at last, but it's hard. The size of those things I can't tell you.

If I could put a little color on that. CASPI is one of the areas where you get the squeeze between price and raw materials. We have price increases starting in the third quarter. They're not sizable, but it's at least trying to make the trend go the right way. And so hopefully you can - not have to be overcoming that squeeze going forward such that some of the other improvements we make can start to show up.

I guess the point here - I think your underlying question is, are the fundamentals still right for CASPI is your question. The answer is yes. The fundamentals are still right. I'm feeling better about that. We've had extensive discussions about that of late. Asking that same question in a much more pointed way. And I still feel it's the fundamentals are right. We have some more work to do in cleaning that stuff up.

Just one more question. That is the $7 million bad debt reserve, was that charged against any specific division as well?

Yeah. Most of that went to the Voridian side because of a particular customer they have in Europe.

Okay, thank you.

We'll take our next question from Andy Cass from UBS Warburg.

Hi, Al Jim, Brian good morning.

Good morning, Andy.

Brian, I want to congratulate you. You proved to be quite the industry timer, knowing when to step into the Theo slot. [INAUDIBLE] Industry [INAUDIBLE]

Better to be lucky than good, right?

Well, take credit when you can, right? A couple of questions, maybe two or three. First, as it relates to the fibers business, I'm just trying to understand the way that these numbers are reported. You know, the volume change and the price change in the second quarter compared to the year-over-year change in the first quarter. You have that interdivisional effect, which I still don't quite understand. So if you could just explain to me --

what's going on?

Yeah, what the shipments were to your customers.

Yeah. First of all, the -- if you look across the fibers business over a total year it is a pretty stable business over a total year.

If you look at it month to month it gets pretty chunky because you have your regular customers that make up a pretty good percentage and the others buy big clumps of business and they don't always buy at the same time. You can end up having a first half that's loaded up with some of that export business and don't get it in the second half, et cetera.

What's overlying on top of that is we have some acidic acid and some high-dry kind of aciteal kind of chemicals business that's showing up there as interdivisional stuff in fibers. That's just kind of a cross division traffic that's kind of confusing you a little bit probably.

The basic story on fibers is that their businesses continues to be pretty darned stable. Across a year, they stayed pretty much the same. They perform pretty well every year. It is a chunky business so we my may have gotten a little bit more in the first half than the second half because of that chunkiness. I think what we've guided you toward here in the third quarter is that, we've take than into account. We've taken into the fact that, typically, as Al says, the third quarter is a little slower. You catch your breath on PET. The other parts of the business are, kind of, moving in the opposite direction and all of that nets out to a neutral third quarter for us. So there's nothing going on in the fibers business that you should -- that is worthy of, you know, trying to explore those numbers there. It's basically the same business you remember it to be and not dramatically moving up or down. It's just again, chunky.

I'd say they had a second quarter specifically with a strong second quarter for the fibers business. You're right, some of the comparability is lost. They pay for things now that they didn't pay for before. On the other hand, they are not getting allocated some of the new business development cost that they used to get allocated. So the comparability is tough but the business is performing extremely well this first half of the year and they had a very strong second quarter.

Ok. Could you actually give us the year over year maybe just in first half terms growth and filter tow? The reason I'm asking the question is, I'm trying to check out how you are doing against the, you know, the trends that you cited earlier. You know, the 10-k about polypropolyne tow and China being replaced with acetate. And also apparently Europeans are smoking longer cigarettes because of the bigger filters. I'm just wondering on a cycular growth basis, you know, is the first half sort of proving out this this -- that this business has returned to a growth profile for you guys?

Yeah, Andy, as Brian mentioned, we can talk about those numbers for the second quarter but they are going to mislead you because they are strong for the second quarter. Again, that has to do with the timing particular.

You heard Greg talk about the Asia Pacific demand. Demand from the Asia Pacific region was strong in the second quarter and the first half. We don't expect that to continue into the second half. So it is a timing issue -

For fibers.

For fibers. Just for fibers. Right. So if I talk to you about the, you know, the year-over-year numbers and so on, you'd say wow this business is really see something growth.

I'm just asking like for the first half or even your budget for the year. When you have good visibility on orders, what do you think -- will you have 2% growth this year?

As Brian told you it's the bit you always knew. There's not going to be profound large numbers of growth either way.

The number business was in decline so if you -- if that's the way I remember the business, I'll project continued decline.

I'd say that's probably not what we see. I think we see stability in where we are right now. Trying to call growth for growing or shrinking 2% is hard, Andy. This is a narrow slope with a big standard of deviation about it. What you hear Al and I saying is we're not willing to call that growth rate for you. It's either growing a couple of percent or shrinking a couple of percent. More likely, I think it will grow a little bit. I think we have a number in our 10-k that is something in that neighborhood.

All right. What about price? And filter?

Price as you see on the tables has declined for fibers year-over-year.

Okay. Well the first quarter and the second quarter are quite different, so it seems like something's going on in price from one quarter to the next?

Nope. That has to do with, as Prin said, the aciteal are gonna throw you off from quarter to quarter. They are relatively small impact for the basic tow and in that segment as you know, the prices are set kind of once a rear. You should not expect to see big swings in prices.

Thanks you for your question though, Andy.

Actually, I had one other question if I could. A few months back we estimated and illustrated your unfunded pension relative to peer group is quite high. An while that's not necessarily, you know, a bad thing because we view unfunded pensions as a source of financing, it's just being considered fully in evaluation of the company.

We took a stab at estimating what the earnings impact would be to various companies in a report we issued just the other day. Perhaps you've seen it. And for Eastman Chemical, we forecast that the earnings impact of the recent decline in estimated pension assets for your funded portion would only be about 10 cent a share. Could you put maybe confirm, deny or a little color around that sort of number? Because that's pretty immaterial. I don't think people should worry about it too much when it comes to EPS.

Yeah, I tend to agree with you. Again, I'm on a little thin ice because I haven't seen how the year's going to end and where the markets go from here. Our pension expense is not that sizable for us. You can pull it out of our footnotes.

Right.

I think in the past, maybe there was confusion with retiring medical liability which no one funds and pension, and maybe that's how the bigger numbers got out there.

I think of it more right now as a diversion of cash for the next couple of years. I agree with Brian's comment. I'm not concerned about that at all. We have good strong cash flow generators, so I do think of it more in terms of, you know, we'll have to put cash in the plan.

By the way, the way I think about that is when the market does eventually come back and rates do eventually go up, well then I'm not gonna be funding in the future because I'll have put the funds in under these assumptions. But I agree with you. I think it's worth looking at. I think there's players in the industry that probably spend a lot more time on it than we are here, if I can put it that way. But I guess that's the way we look at it.

Thank you.

We'll go next to Ozzy Nash with Goldman Sachs.

Good morning. I had a question on the income statement and the question on the cash flow. Does this other income/charge on a normalized basis, what do you think of that charge as being? Is it zero, is there a positive number, negative number?

You know, that's a good question. I've been at places where I could pretty much always count on a positive number there was because I had investment income, say.

The very fact that it's called other income expense tends to mean it's all of the one-time items. So, you know, I look at what's our Genencor interest comes through on that line. The charge for financing the receivables, you know, our sale of receivables comes through on that line. Those are fairly small and fend to net out. So what moves it is when you have any kind of larger items. And Ozzy I'm just not that good to call that. I'd like to think you could kind of zero that line out or maybe even a slight positive, but it gets moved by such big items that it's a tough one for not only us, but obviously are for you guys to call.

So I mean, you know, in any given quarter, one could just take that out and then, you know, sort of call that a nonrecurring item. Sometimes it will be positive, sometimes it would be negative. You wouldn't argue that, would you?

That's the way Brian, I think, tried to guide people. He said, "Hey, think about us at the Op income line and we'll do our best to try and make that a positive.", but I don't know that you're gonna give me any credit in my share price if one quarter I have an FX gain, next quarter I have a tax benefit, the next quarter I have something else.

Question on the cash flow statements. I'm trying to look at the swings from last year to this year. I understand there are large negative numbers last year so the swing dollars, you know, look very large. Still, I'm trying to understand some of these components, for example, there is $178 million dollar swing from last year for increase, decrease and liabilitys excluding borrowings and liabilitys for employee benefits and incentive pay.

So what exactly is that? It was a positive $105 million for this year and likewise the swing in the number of the other items, for example, provision and benefit would divert income taxes. A lot of these items contributed a lot, and I'm trying to understand where they come from and what one can expect going forward?

And Ozzy, it's going to sound like I'm ducking your question, but I want to rely on our disclosure in the 10-q for this one because, you know, other than just going through line by line on these items, and I don't necessarily have all of the notes with me to allow me to break down the $105 for you, I probably wouldn't give you a very good answer.

Jim, if you could just help me understand the three or four or maybe even the two big items that are contributing to this cash, and if you can just talk about the sustainability of these, that would be good enough.

Yeah. The biggest -- I mean, just set the statement aside for a second and think about what's going on in the business, what's really happening.

I mean, we had a little over $90 million in CAP-X for the first six months of the year and then we made a small acquisition. That's how you get to the little over $100 million number. That's a big absence of cash usage. In other words, there is a lot of discipline going on there.

The working capital stayed pretty much in control for six months. This is a period when quite often you will be building, et cetera. So you have both balance sheet management, I guess, is the main thing and then, you know, we've talked about how these assets are good cash flow generators.

You have a big, fixed plan, and you know, as we put the volume through it, cash falls out. And, you know, I'm trying to think if there was anything else incredibly unique. I mean, I always like to dig Brian a little bit. We gave up our bonuses early in the year. I mentioned it on the last call, I'll mention it again on this year. But, that wasn't big dollars. You know, some of at accruals we had for compensation in terms of some of our company-wide plans were, you know, lower.

But in general, it's just the business is a good cash flow generator. We're being very prudent and not spending money on acquisitions and not approving projects except things with really high returns and what we gotta do. The bottom line, that's how you generate the cash.

Jim, I don't want to belabor this. I fully understand your CAP-X line. That's below the cash provided by operating activities. I'm just trying to understand the cash provided by operating activities and in particular, I'm not focusing on the receivables and inventories I understand that part, I'm just trying to focus on some of the other items because they are large, and --

okay --

I don't understand what that is.

Yeah, Ozzy. Let us do this then. Let us - we will pay particular attention in that in the 10-q and try to give as much color to the top part. That's probably the best answer we can give you today.

Much appreciated. Thank you.

We'll go next to Chris Willis with J.P. Morgan Bowman.

Thanks. Actually, my questions were just answered.

Ok. Thanks, Chris.

Good to hear from you, Chris.

We'll move on to Andy Fineman with Meridian.

Thank you. Can you tell me what net debt is at the end of the quarter? I know on your last page of the press release, you gave short-term borrowing, long-term borrowing, but I don't know what the cash is, and I need to net that out to get net debt.

I think in one of our tables we had cash at the end of the period of $74 million. Is that correct?

Okay, then I missed it, sorry.

That's okay, you got it.

What's that?

It's on page 6 at the bottom.

Okay. And how about sold receivables. Are those on the balance sheet or off balance sheet?

No, that's what's disclosed. That's what so many of us do because you can tap a different market. That's off balance sheet. You sell the receivables. It looks like a sale of receivables because it is. It's the one special purpose vehicle we have. I think it's fairly common. Basically, you finance your receivables because you can get an attractive rate and you tap into a different market. Kind of a commercial backed -

I agree with you. I just wanted to know the amount at the end of the quarter.

I think we run at about $200 million.

About $200 million?

Yeah. If that wasn't there, you'd see $200 million more receivables and $200 million of debt.

Ok. And I was thinking about the issue with pension and I wanted to know, you know, you have this Genencor stock in the preferred and if you ever cash out, you've got to pay taxes, you know, 35% on that. So can you just contribute it to the pension fund, avoid paying the taxes and then if it goes up, you're in better shape next year?

Andy, you should have been an investment banker, but on this one, I don't think it works that way. So I guess the safest answer is I don't want to speculate on what we're going to do with our Genencor interest, but I -- and let me add this. I'd say we're very cognizant of the tax effects, so that's why you look at things of when's the best way to get that value into the shareholder's hand. One of the things you have to overcome is- Well if I just sell it, I pay tax on it.

So you couldn't use that to fund the pension fund or even part of it?

Andy, I'm not sure how wise that would be in terms of the fiduciary responsibility that we have to the pensioners, so, you know, I don't think you will see us considering that seriously.

Okay. I had a couple of detailed questions. Are you going to be around after the call?

You can go ahead and give me a call. Greg Riddle.

Give Greg a call. But we thank you for your questions on this call, Andy.

Thank you.

Can we make the next question the last question, please?

Yes, sir. We'll take our final question from John Naughton with Deutsche Banc.

Good afternoon, or good morning, rather. I don't know what time it is these days. A couple questions on the Asian volume increase. I was wondering, what is the mix of that in terms of the surge in fiber volumes versus the relative rest of the mix of the business.

The second question pertains to the raw materials. As you look over the next six months or so if gas prices rise. I'm wondering. How are you preparing for, you know, raw material preparations ahead of natural gas increases?

The comment on Asia Pacifics is we had a good quarter for the fiber sales. That was a piece of it for sure. There was performance. I just looked at that the other day. There's performance all across the board in Asia Pacific. It's gratifying to see a broad kind of participation of growth in Asia Pacific. I'll let Jim answer the other question.

Just on the raws. I mean, our look as we look forward for what it's worth is that we'll probably gonna be in a fairly steady state on raw materials. And that's, of course, when we talk raws, we're thinking of things like propane, paraxylene, natural gas, some of our bigger ones.

Having said that, we've had a policy for a couple of years now doing some raw material hedging. We vary the amount from time to time based on what we see and how much it costs to go forward. So you can expect we will have some insurance in place. We usually use options but we feel free to use forwards and just buying more inventory if we want to. But that's nothing as compared to the offset you get if you can just raise prices as the raws move. That is really like Brian focused on earlier, that's one of the key things going forward. It's getting those prices in line with the raw material costs. We're not looking for a lot of upside on the raws for the rest of the year but we'll see.

How much would you have, of your total raw material needs, how much would you say you would typically hedge?

We'll dance around this one a little bit, John, because we tend do it in ranges, so there's times of the year where it makes more sense to buy propane, for example. Propane hedges, propane options where you would see us at a higher number. Prices typically are off in the summertime.

The time you are really concerned about on the energy ones is in the winter so we're looking, say, at we would have some on already for this coming winter and would look at more. I'm not going to give you a hard percentage because frankly we consider that to be something of a competitive - I was gonna say a competitive advantage. If we do it well it's a competitive advantage, and we're doing that in terms of being able to be competitive for our customers.

Thanks, Brian and Jim.

Thank you.

That does conclude today's conference. I'll turn the conference over to you, Mr. Riddle for concluding remarks.

Thank you very much. If are any additional questions, please feel free to call me at 423-229-8692. A replay of the conference call script and Q&A will be available this afternoon and through the rest of this week. Can you hear the replay by calling 888-203-1112. Also an audio reply and transcript script of this session will be available on Eastman.com in the investor information section. Thank you very much for your interest in Eastman.