伊士曼化學 (EMN) 2003 Q2 法說會逐字稿

Good day, everyone and welcome to the Eastman Chemical Company second quarter earnings conference call. Today's conference is being recorded. This call is being broadcast live on the Eastman website at www.Eastman.com. We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company, Investor Relations. Mr. Riddle, please go ahead, sir.

Thank you, Rufus. Good morning, everyone. With me today are Brian Ferguson, Chairman and Chief Executive Officer and Jim Rogers, Senior Vice President and Chief Financial Officer.

Before we begin, let me remind you that during this call you will hear certain forward-looking statements concerning our plans and expectations for the third quarter and second half of 2003. 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 2003 sales and earnings press release and the supplemental information for second quarter 2003 on our website at Eastman.com under the Investor section, and our filings with the Securities and Exchange Commission, including the Form10-K filed for 2002 and the Form 10-Q to be filed for the second quarter, 2003.

Now let me turn the call over to Brian.

Well, good morning, everyone and thanks for joining us today.

Let me give you some brief comments about the quarter, let me turn then to some strategic discussions, strategic issues, then finally wrap it up with the outlook and hand it off to Jim after that.

Overall our performance for this quarter, we feel, was pretty good in a difficult environment. Our net earnings without the asset impairment and restructuring charges were a little higher than a year ago, and we feel good about that.

There are two parts to that story. One relates to pricing, the other relates to volumes. We were able to raise prices for a number of businesses, especially for polymers and in the PCI business to recover much of the raw material energy costs from the first quarter and early in the second quarter.

Should say we're still behind the eight ball on that but we got some of it back in the second quarter. We all know the raw material costs are still high on a year-over-year basis that's pretty much across the board. We see it in things like propane, where we see it in all the oil-based products, as well.

Switching over to volumes, the most significant declines were in polymers and CASPI. Not entirely unexpected. The polymers affect the declines there were more outside the U.S. than inside and two different stories there.

In Europe, the Asian exports from Asia coming to Europe are back again. There's also a new recycling law in Germany that's affecting things for a short period of time here.

We had some cooler weather in North America. Of course that always affects our North American consumption.

In CASPI, the volume decline was mostly in the inks and coatings resins area and these are areas where we are normally the least profitable. In the areas where we are most profitable are coating specialties, they're actually doing quite well.

Turning to the strategic issues. I'm expecting I'll hear from you on three things today, CASPI, Genencorp, and developing businesses.

Let me say something about each of those three. I've talked previously about CASPI in three tiers, the first being very profitable, the second being kind of in the middle, and the third being very, very earnings negative.

We have defined a range of options that we are bringing to our board here just very shortly. And we're going to be discussing getting some insights from the board that would guide our management decisions going forward.

I promised that I'd give you some more insight on the details of that coming up in the latter part of August, and I still am on track to do that. At that time, I'll be giving you more information about what are these things that we are working on, what businesses have we gathered up in this category of the bottom tier, what might CASPI look like before and after the changes that we anticipate, et cetera and the timing ranges of these options.

And really today is just not a day for doing that because I owe it to my board to have those discussions and get some agreement with them before I have those discussions with you.

Secondly, Genencorp, again, another area where we are in active consideration on our options. I need to remind everybody, this is a public traded company, has its own stock out there. And so we're always mindful of making comments on a conference call about somebody else's stock that's going to affect that.

So mostly I'm going to, you know, respond to your Genencorp questions about the fact that we are actively considering our choices and in a few months down the road, we will maybe make those transparent to you.

Developing businesses, we're on track to spend this year still at about a 1% of sales rate, even though we were at a higher spending rate in the first half. That means the second half is going to improve remarkably, we already see that starting to happen.

In the case of Cendian, their operating results are improving versus previous quarter and year-over-year, they are going to continue to improve the remainder of the year and we're closely, closely monitoring their progress.

There has been some activity in the coal gasification area. Some of you may have observed that we have done some testifying at Congressional hearings. That is by invitation. The Congress has recognized that they have an issue relative to natural gas and they are looking for solutions, potentially coal gasification of the solution.

We've had a number of interested customers knocking on our doorstep and so we see good developments there.

We continue to be very, very focused on a strategy to improve the profitability of the company. And looking at that business by business. The plans that we have for improvement are discreet plans in each business, one at a time.

We also remain very committed to taking all the appropriate cost reduction actions to improve our profitability. You've seen a few of these, you'll see more.

And we continue as we said before to look at selected businesses, primarily in the Eastman Division, where we might divest to make things look better. You've seen that in Speciality Plastics and you'll probably will see more down the road.

Now let me turn to the outlook. We said in the outlook that we gave you some history. We told you in a typical year, we generate about 60% of our earnings in the first half, and about 40% in the second.

And, you know, if we're going to change that this year, that means we're going to have to be very aggressive on pricing in a difficult market in the second half. Now in the second half we do expect volumes to increase.

You know in the first half here, we had raw materials rise and peak and start to fall. And as those raw materials started to fall a little bit, the customers held their breath, destocked a little bit and that's part of the volume story that you saw there.

The volumes are coming back because they can only hold their breath so long. And now we're going to be engaged in a very aggressive discussion on pricing that will determine our profitability.

Now let me take, preempt, maybe not preempt, but at least start the dialogue on one question that I'm sure to get. And that question is, do we make this outlook deliberately indecipherable or was that accidentally so?

And I'd say, you know, there was kind of a deliberate intent here. The downside on our forecast is that kind of 60/40 thing. The upside is better than that on the expectation that we would be able to hold pricing better than that historical norm.

And the truth is, this is a very, very dynamic situation out there, where we are slugging it out in very aggressive discussions and it's just hard for us to call that. So I have to kind of lean toward the deliberately indecipherable side of the forecast just to be very, very direct with everyone.

Let me now turn it over to Jim for some comments.

Okay. Thanks, Brian. And it was a good quarter. And it's one of those quarters there we needed you know, it feels good to have a good quarter like that.

Let me hit a few of the cash flow and balance sheet type items, a couple other things, then we'll get to Greg.

First on cash flow, you know, we dug a hole in the first quarter for a number of reasons. Receivables up, et cetera, funding of pensions. This quarter, we started back out of that hole little bit at least on the cash flow from operations, we generated $73 million in net cash there so we're still a net user of cash on that line at $95 million. Receivables went up by about $36 million, so we're up $146 million for the year which is a big number for us.

Of course, our sales are up so that probably explains part of why that is. Inventory is also up a little bit.

You know, that little question everyone likes to, ask all right, now you guys said you were going to try and get your net debt levels back down to where they were when you started the year. We're -- that's still our ambition, that's still our goal.

I mean, the second half of the year, we're going to be working to get cash out of inventory. That will probably be a major initiative in the third quarter. And then Receivables, you usually always look to grind on those in the fourth quarter so we're going to be wanting the cash to come out of working capital.

May also get a little help from some other things you might not normally think of, some smaller divestitures or things like tax refunds, et cetera, that could help us get to that goal, as well. So treasury is still tasked with trying to hit that target of coming close to the same net debt level that we started the year with.

Speaking of debt, during the quarter, we had a bond issue. Felt pretty good about that. We did a five-year 3.25.

Timing was pretty good but in particular, we liked the reception we've got in the capital markets. As you might expect, our name's still very well received in the capital markets. Several times oversubscribed to my strong pricing on the issue. Pricing the same day we announced.

And that was of course setting up the funding of the $500 million that's due in January. So we used those proceeds to pay down commercial paper.

And I would think we'll be generating cash the second half we've got that liquidity. We could do another issue of similar size before year end. Or we'll see how cash flow comes in from other corporate actions we might take before we make that decision.

On the pension side, we funded another 50 so we're up to 140 funded. You see now, we kind of alluded to it before but you see we've kid of upped our target to 238 for the year, that's not what's required.

But if we hit that 238, it looks like we will have zero funding requirement for next year if any funding, maybe a little funding the 2004 year. But more than likely, close to zero funding if we put in the 238.

And so again, I know everyone likes to talk about pension, et cetera but if you think about our company longer term and cash flow, we paid down a good amount of debt last year. Probably close to $300 million if you think about what was off balance sheet that we brought back on.

This year was a pension funding year we said that. Then next year, we can go to a debt pay down year again if that's what we choose strategy-wise. So the fundamentals of the cash flow generation really haven't changed.

On CAPEX, CAPEX we only spent about $100 million the first year. It was the first half of the year, it was about $96 million first half of last year.

On that, when you see us holding down CAPEX, we're still funding what we call business support which you would call what it takes to keep the plants running and well maintained. We're still spending what we want there.

Usually it means we're holding back things like capacity expansions or other projects like that. But the plants are still being well maintained. You can see that in our safety records et cetera.

Now, when you look at the second half of the year, you wouldn't expect us to stay at that level. We traditionally spend more in the second half of the year, I think last year we came in around 260 overall.

That might not be a bad target for this year maybe a little more than that even, you know, but probably under 300. So I'm starting to bracket it for you between 260 and 300.

Of course, we have flexibility to move that number as we go through the year. But overall, when you think of cash, fairly good discipline being exhibited. Another indicator as to SGA and R&D, still only 10% of sales.

Let me mention one business thing because on the last call I indicated we'd extended a contract for a year with a key customer in the Custom Synthesis area. And now we've signed a multi-year contract with that good customer. I'm sitting here trying to find who I'm looking at, Brian, trying to find a way to do a verbal high five with Brian here.

Well, let me just give you some color on this.

The -- this is a business where a competitor, a very capable competitor targeted us, attacked us, decided to take this business away. And we responded over a period of time. We let the customer know this business was important to us, we've won it back and it's still a profitable business.

And I think it's a testament to our ability to respond both technically and business-wise. There -- these were high stakes. This was a high-stakes thing for both of us.

And the stakes for winning are high for us, the stakes for losing for the competitor are not so good. And that's just giving us, some indicating that we're out there again slugging it out every day.

That was the CEO's polite way of saying this is not your daddy's Eastman anymore. So that's a message as much to competitors as to customers and shareholders.

Say, on asbestos, there's not much new, which is a good thing usually. We do have a few more cases, we have claims, we're up to 11,000 from 8,000 because of an additional case filed in Mississippi, but still no settlements.

Nothing really major or new to report there. And no change in our opinion, in terms of the significance of this to Eastman.

I guess the final thing I to mention is a bit of a reminder.

On goodwill, we said the third quarter is a quarter at which we'll do our FAS 142 each year. And that's where we look at goodwill and the indefinite live intangibles and test them for impairment.

So I don't want to preclude the actual study that we have to do because there's a lot of work involved in that. We'll be announcing that at the end of the third quarter.

But just as a reminder, on most of this goodwill intangibles is tied to the acquisitions we made in CASPI. And to draw the connection when Brian talks about the third that looks fairly weak, and is not performing the way you'd like, it's really quite a bit of the acquired businesses.

So I'm just trying to give you a heads up that we're going to be looking at the value of that goodwill and intangible assets in the third quarter. Obviously anything you do there is a non-cash item but still just wanted you to be aware of it.

I think that's all I have, Greg.

Thanks, Jim. Yesterday afternoon, the Eastman Chemical Company news release announcing second quarter 2003 results was furnished to the SEC on Form 8-K, distributed to the news services and posted to our website in the Investor section and the News Center section.

Included with our news release are a series of financial tables. Table one includes a statement of variance for second quarter 2003 and second quarter 2002.

Sales revenue for second quarter 2003 was $1.48 billion, an increase of 6% compared with second quarter 2002. The higher sales revenue was due primarily to an 8% increase in selling prices and the favorable impact of foreign currency exchange rates that more than offset lower sales volumes.

Cost of sales for second quarter 2003 was $1.24 billion, an increase of 6% compared with second quarter 2002. The increase is attributed primarily to higher raw material and energy costs, especially for propane, paraxylene, and ethylene glycol and natural gas.

Selling and general administrative costs for second quarter 2003 were $108 million compared with $110 million for second quarter 2002. The decline is primarily due to cost reduction efforts.

Research and development costs were $42 million in second quarter 2003, compared with $38 million in second quarter 2002. We expect 2003 R&D costs to increase over 2002 due to the company's efforts to develop operational efficiencies and as a result of the company's increased technology efforts associated with new business initiatives.

We remain committed to keeping the combined costs of SG&A and R&D at or below 11% of sales revenue. Second quarter 2003 these costs were approximately 10% of sales revenues.

For second quarter 2003, the company reported operating earnings of $75 million, compared with operating earnings of $81 million in second quarter 2002. Operating earnings declined as higher raw material and energy costs and lower sales volumes were partially offset by higher selling prices and cost reduction efforts.

Operating earnings for second quarter 2003 also reflect the impact of asset impairment and restructuring charges totaling $16 million before tax primarily related to the impairment of certain assets in Eastman's performance chemicals and intermediate segments, fine chemicals product lines.

Other income net for second quarter 2003 was $5 million, reflecting a gain of approximately $6 million due to favorable foreign currency exchange rates, primarily due to the strengthening of the euro. Other income net for second quarter 2002 was $10 million, primarily reflecting a gain resulting from the remeasurement of foreign currency denominated amounts.

The provision for income taxes in second quarter 2003 was $14 million, reflecting an effective tax rate of 28%. Year-to-date the effective tax rate is 32%. We expect the effective tax rate for full year 2003 to be between 30% and 33%.

Net earnings were 46 cents per diluted share for second quarter 2003 compared with net earnings of 58 cents per diluted share for second quarter 2002. Second quarter 2003 net earnings reflected the impact of the previously mentioned asset impairment restructuring charges, which were $12 million after tax.

Table Two, other sales information.

Second quarter 2003, external sales revenue increased compared with second quarter 2002 in the North America and Europe, Middle East, and Africa regions, while slightly declining in both Asia Pacific and Latin America. Sales revenue in the Europe, Middle East, and Africa region increased by 13%, primarily due to the positive impact of foreign currency exchange rates which more than offset lower sales volumes, particularly for PET polymers and for inks.

North American sales revenues increased 7% as higher selling prices, particularly in the polymer segment, more than offset lower sales volumes. Sales revenue in Asia Pacific declined slightly as lower sales volumes, particularly for acetate tow were mostly offset by higher selling prices particularly for the performance chemicals in intermediate segment.

In Latin America, sales revenues declined by 4% as lower sales volumes especially in the polymer segment were largely offset by higher selling prices.

Eastman Division.

Second quarter 2003, compared with second quarter 2002, Eastman Division's external sales revenue increased 5% as higher selling prices and favorable foreign currency exchange rates more than offset lower sales volumes. Sequentially, external sales revenue increased 2%, as higher selling prices more than offset lower sales volumes.

For second quarter 2003 versus second quarter 2002, Eastman Division's operating earnings without the $16 million in asset impairment and restructuring charges increased as higher selling prices and cost reduction efforts were partially offset by lower sales volumes. Sequentially, operating earnings improved with the asset impairment restructuring charges, primarily due to higher selling prices.

Coatings, Adhesives, Specialty Polymers, and Inks operating earnings in second quarter 2003 were slightly below the year-ago period as lower sales volumes and a one million restructuring charge were mostly offset by higher selling prices. Sequentially, operating earnings improved primarily due to higher selling prices and improved product mix.

The Performance Chemicals and Intermediate segments operating earnings improved in second quarter 2003 compared with second quarter 2002 due to higher selling prices, more than offsetting $15 million of asset impairment restructuring charges and unfavorable shift in product mix. Sequentially operatings improved without the asset impairment restructuring charges as higher selling prices more than offset lower sales volumes.

Specialty Plastics segment operating earnings improved second quarter 2003 compared with second quarter 2002 as higher selling prices more than offset higher raw material and energy costs. Sequentially, operating earnings declined by $23 million as first quarter 2003 operating earnings included a gain of approximately $20 million for the sale of the company's high-performance crystal and plastics assets.

The Voridian Division.

Second quarter 2003 compared with second quarter 2002 external sales revenue increased 5% due primarily to higher selling prices that more than offset lower sales volumes. Compared with first quarter 2003, external sales revenue increased by 4% as once again higher selling prices more than offset lower sales volumes.

Voridian Division's earnings from operations for second quarter 2003 declined by $11 million compared with second quarter 2002, as higher raw material and energy costs and lower sales volumes were partially offset by higher selling prices and cost reduction efforts. Sequentially, operating earnings improved by $9 million as higher selling prices more than offset lower sales volumes.

Polymer segment operating earnings declined year-over-year by $6 million as higher raw material and energy costs and lower sales volumes were partially offset by higher selling prices and cost improvement efforts. Sequentially, polymer segment operating earnings declined slightly, as lower sales volumes were mostly offset by higher selling prices.

Fiber segment operating earnings declined by $5 million, second quarter 2003, compared with second quarter 2002, due primarily to lower sales volumes of acetate tow shipments to China. Acetate tow sales to China were particularly strong in the first half of 2002, due to the timing of customer buying patterns.

Sequentially, Fiber segments operating earnings increased approximately $11 million, due primarily to higher sales volumes of acetate tow to China.

Developing Businesses Division.

Second quarter 2003 compared with second quarter 2002 external sales revenue increased by $14 million, primarily due to implementation of customer contracts by Cendian Corporation. Compared with first quarter 2003, external sales revenue increased by $3 million.

Operating results for second quarter 2003 improved by $2 million compared with second quarter 2002 as increased revenues more than offset increased costs associated with efforts to increase external sales revenues. Sequentially, operating results improved by $7 million.

Table Six, cash flow.

The company generated $73 million in cash from operating activities in second quarter 2003. This includes the company's second quarter contribution of $50 million to the U.S. defined benefit pension plan.

Additional outlook for 2003.

We expect 2003 funding of the U.S.defined pension benefit plan to be $238 million versus the previously announced $220 million. The additional $18 million in funding will allow the company to significantly reduce or eliminate night its required funding in 2004.

The company continues to expect that it will invest between 1% and 1.5% of sales revenue in new growth opportunities in the Developing Businesses segment.

Although we expect sales of acetate tow to China will increase in the second half of 2003 due to a few unsuccessful spot tender bids and a trend toward lower cigarette production in North America for both the domestic market and for export, we expect that operating earnings in 2003 for the Fiber segment will be about 5% lower than in 2002.

We expect that changes in pay and vacation policy implemented during the first quarter of 2003 will favorably impact results for the next two quarters. We expect cash flow from operations to improve in the second half of 2003. This concludes our prepared remarks. Rufus, we are ready for questions.

Thank you, sir. Our question and answer session will be conducted electronically. If you would like to ask a question, please firmly press the star key followed by the digit one on your touch-tone telephone. We will come to you in the order that you signal. And if you find that your question has been asked and answered before you can ask it and you would like to remove yourself from the question roster, please firmly press the pound key. Also if you're on a speaker phone, please make sure that your mute button is disengaged so that your signal can reach our equipment. Again, if you would like to ask a question, press the star key, followed by the digit one. And for our first question, we go to Kevin McCarthy with Banc of America Securities.

Good morning, everyone.

Good morning.

A couple of questions for you on CASPI. Brian, you've talked about the 1/3 of the business that's challenged there. Can you talk to specifically how did those businesses do year-over-year, and sequentially have they stabilized?

We try not to report little pieces of CASPI otherwise we get into a different segmentation. I can say that there's been an awful lot of management time and effort invested in improving those businesses and some of them have.

There are some secular issues in places like inks and resins where Eastman coatings resins where you've got some pretty strong head winds there. And even though you've made a lot of improvement in the cost area, the market area just keeps on slapping you in the face. So, the answer is yes and no there, Kevin.

I think the main thing is we see when we get done with this and neutralizing the negative effect of that 1/3 that the CASPI segment is a very attractive double-digit earner. And that's the main thing we're focused on there.

How much of the 10% volume decline there do you feel is attributable to unfavorable weather?

It's hard for me to guess on that. I'd say it was not an insignificant piece. I think if I'd look around, I'd gauge myself by listening to the other coatings guys talk. And the other coatings guys have mentioned this more than once, that's it's a bigger deal. So I guess I'd say it's got to be some, you know, probably on the order of half. But we had some other, you know, low-margin business that wasn't appropriate for us to take. And that was probably another piece of that.

Finally, Jim, it sounds like you have a charge coming down the pike here on FAS 142. I know you haven't sharpened your pencil completely. But do you care to bracket in rough terms how much that could be?

I sure don't. You get in trouble if you're supposed to have a process that the SEC wants you to follow and then you already know the answer before you get to the end of the process. But I was just trying to make everyone alert to the fact that when Brian talked about the segment, that, you know, had those losses and still a drag on us today in our current earnings.

The drag is still there in that part of CASPI. That, you know, that is the same part that we'll be look at for intangibles. I'm not going to be able to give you a number. You can see how much goodwill we have on our balance sheet and that's what we're looking at.

Okay. Fair enough. Thank you.

We go next to Graham Copley with Bernstein.

Good morning, guys.

Good morning.

I'm looking at your guidance on the sort of deliberate sort of sketchiness of it. But going back to CASPI again. The titanium dioxide guys are talking about an inventory problem because of slower sales in the coatings area. Is it something we have to worry about here? Do you think some of your customers are holding inventory that's going to affect their purchasing patterns, sort of July, August, September? I'd like to ask the same sort of question on PET, as well.

I'd say that, well, maybe, Jim, do you have a brief from the guys on [INAUDIBLE].

I would think there is some of that but it's hard to quantify, you know, how much that is. I mean, some of that is related not just to weather but because you're drifting to PET.

Some of it's related into pricing and customers being able to watch what raw materials are doing versus the price increases they see in the marketplace. And I think you maybe heard from some other players there that there's a belief that the customers are probably trying to use out of inventory versus buy trying to wait for prices to come down again.

You probably saw a little of that in CASPI, probably more so in PET. But the weather would have been part of it. But it's hard to quantify something like that, Graham.

When you talk about the risks around your guidance, though, I mean, do you think the bigger risk is to Q3 or to Q4?

You know, Q4 is always a harder quarter to figure out and anticipate. So Q4 is always a more curious quarter for us I'd say that's probably the bigger risk.

But just a clarification on the PET business. We expect better volumes in the second half on PET. So this isn't about the people continuing to hold their breaths. Even though there's more product out there looking for more customers, we expect higher volumes in the second half.

This is a situation where raw materials are rising a little bit in PET. There's a little more volume out there because of the new plans. And so you have two conflicting things. Normally in a rising raw material environment, you'd expect price increases. Normally in a rising supply environment, you'd expect flat to downward pricing and those two are fighting each other. And that has not sorted out yet.

And that's part of the uncertainty in the outlook we're giving you. That's not a weather comment, it's kind of those two conflicting things between raws and supply.

Is it unusual to see a second half stronger volume in PET?

We do see a stronger second half in PET.

I think he asked is it usual.

No, it's not usual. I'm sorry, I didn't hear your question. It is not a usual thing. When we expect some higher volumes, at least in the third quarter anyway.

Okay. Thanks.

We go next to Frank Mitsch with Bear Stearns.

Good morning. Brian, I'm thinking that part of the indecipherableness of the outlook is because of all the time that you've spent in D.C.

You're right. I learn quickly, Frank.

Now, you've been there a couple of times. Could you lay out a time line on what's going on in coal gasification. It seems like there's a lot more interest building here. When might we actually see some licenses, et cetera?

Yeah, interesting things happening there. I guess the background on this, just to, you know, the way that the people in D.C. are looking at this.

They see that we have maybe reached a crossroads with natural gas that we reached in the early 1970's with oil where we became net importers and importers forever. And that's the concern that the price of natural gas domestically will now be determined at the border by the LNG offloading just the same way oil was determined with oil imports.

That creates the diversions between coal and natural gas that could potentially shift the attractiveness of technologies for power generation.

I think more urgently, the politicians know that there has been 10 years of policy drivers that have stimulated natural gas consumption. And now they're going to have widows and orphans maybe going cold this winter with expensive natural gas and they're looking for solutions.

So this technology has surfaced as a potential solution because it is affordable, and it is also clean. And you -- it's harder to get those combinations with coal.

The time line question you're asking, we're getting a lot of interest. And I say a lot, I'm talking about multiple inquiries with people that are interested in projects. They have a high interest in our know-how, in helping them with those projects. Some are domestic, some are international. And frankly, I got to tell you there's probably about as much interest internationally as there is domestically so this is not just a phenomenon that's isolated to North American natural gas situation.

We are working with these people. And we're working through their project schedules and talking to them and as soon as we have something to announce, we'll do that. I got to -- we're working with one or two clients now on a consulting basis. And that is, we were having some remarkably good results in those relationships. And those results are actually funding the efforts that we're doing in coal gas.

So the good news on this is this not a cash burner. This is something that's actually paying its way as we work our way through it. So altogether, I think a lot of tailwind here pushing us along. Public policy, economics, environmental, friendliness, et cetera. So we're -- but a lot of good things have to happen over the next six months for us to continue our enthusiasm there. So we're just working through it, Frank.

Would you anticipate the contribution to EPS, positive contribution in EPS in '04? And then you also mentioned that it's affordable technology. At what price of natural gas does this become very competitive -- Hello?

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Am I back?

Please go ahead, sir.

Okay. I don't know where I got broken off there. I was trying to answer Frank's question. Did any of that come through?

Probably not, Brian --

Hello?

Yes, sir. Please start again from the beginning.

Okay. Frank, the answer to your question is there is a lot of interest in this technology because it's economical, it's clean coal. There are public policy drivers pushing this direction. We're hopeful that we can do something well with this. And we'll let you know as soon as we start to sign some things. On the Q4, excuse me, the '04 earnings, it's too early for us to quantify that. We'll, as we give the guidance for next year, we'll start to talk about that.

Our next question comes from P.J. Juvekar with Smith Barney.

Good morning. You feel good about the intermediate segment. That did quite well in the quarter. If you look at the delta from last year, where is it coming from? Can you talk about the pieces oxyls aceteles?

Yeah. As you know, the -- I guess primarily this was a price move in PCI BO. There was a lot of pricing activity, a lot of aggressive pricing, we've been emphasizing that all year long so that was probably biggest thing across the board. The cost position of a coal-based acetele is something you like to have during this environment of high natural gas prices so you can bet that that's one that's doing pretty well.

The expensive propane relative to propylene is a troubling thing. And that divergence continues to happen going on for the rest of the year where we expect propane to diverge, continue to diverge from propylene, meaning that propane's more expensive than propylene. So that's something that's going to be weighing on the shoulders of the PCI folks going forward for the rest of the year here. So, it's really a tale two of cities there.

Plus, we have the Performance Chemicals part of PCI, where they've been making progress for some of the other customers, things that we've talked about. And that was part of that success.

Right. So the propane, propylene issue will weigh on oxyls more than aceteles?

That's a good way to phrase it.

Right. And then if you look at your revenue breakdown, there is price, there is volume, and there is mix shift. That mix shift was negative 11% for acetate tow. Can you expand on that? I mean, is it due to the shift to, you know, genetic brands?

No, it has to do with the fact that that segment has a combination of chemicals and filter tow in it and we sold more in high dry to our JV with Rodea here in Kingsport. And so, what that means is that JV in Kingsport is running like a scalded dog, making lost of filter tow. And when we do that, will send a lot of high dry and that just kind of weights up the mix with more of that which is lower priced than filter tow.

Okay. Got you. And finally, quickly, with all of the cost cutting you're doing, do you have a goal in mind for 2003, like what you did in 2002?

Yeah, you know, we do. And I'm straight away from giving you the cost savings goals. Because when everybody gives cost savings goals, it may or may not show up in the gross margin numbers so I've always tried to stick with the gross margin calls for you guys on those things. Yeah, we're, I've made two comments here in the opening statement about us being committed to cost reductions. That's -- you're going to hear more about that. And we will be more explicit about that.

But I really would rather not give you a numerical goal here. Because with all the moving parts, sometimes you -- it either shows up as a larger number in the gross margin or a smaller number in the gross margin. But yeah, we have some specific plans in mind and we're working on them right now, P.J.

Great. Thank you.

We go next to Chris Willis with JP Morgan.

Good morning, how are you?

Hey, Chris.

I had a couple of questions. Genencorp is a great fit for at least one very well-heeled multi-national company. If you were to sell your stake, can you sell that in a tax-advantaged way, or should we be thinking about it as just a plain vanilla, you know, sale, which we'd have the tax effect because it's currently including the prefers is worth close to $7 a share and probably would be worth more than that on a gross dump basis. Can you just talk a little bit about tax strategy, if you were to go ahead and do something there? Then I have one other question.

I've got a very capable CFO to answer that question for you.

Chris -- I love --

He's also a board member of Genencorp.

Which means I've got to be careful, but I love the way you ask the question about this if and then try and take us down the road we were trying to shy away from since it is a public company.

I didn't want to put you on the spot.

Yeah, I understand. Well, one, you're right. We own 25 million shares of Genencorp. So when someone owns a per share of Eastman, they own about 1/3 of a share of Genencorp. Plus there's a preferred stock piece there that the value of is somewhere around 85 to $90 million. So that's that probably tacks on a little more than another dollar a share. And you can make your own assumptions about a transaction price. And again, it's your supposition, not ours because we haven't gone down that road.

In terms of the tax basis, you know, I don't want to spell out the exact tax basis. It's not -- I tell you it's not zero, though. It's not like one of these things you got where there's just a few pennies per share. But there would be, let's put it this way. There would be significant tax planning that would have to go on. Whether or not that tax planning would take place within the transaction itself, if such a transaction occurred, or it would be offset by other transactions we might do in terms of things that have a higher basis that you might show a capital loss on. You know, we would be doing our best to minimize that impact to shareholders but I don't want to spell out the exact basis.

Okay. It sounds like there's a fair chance that if you were to do something you could offset a good portion of the potential gains, I guess.

That would be a great outcome, Chris.

Then secondly, could you just talk to us quickly about the composition of your board. Should we be expecting any changes there in the near future?

Yeah. We have many of you may know that we have as historically since we started as a public company term limits. Those term limits are three consecutive three-year terms for directors. Quick math on that means, one out in 1994, it's now 2003 so we're coming up on the classified board rotating out directors. Eventually, rotating out the entire board.

We have recruited a couple of very excellent directors here this year. I was actually on a trip visiting some more prospective directors this past week. Would expect to be making some more announcements about that regularly. And I think in our bylaws, it says we'll be rotating out I think, five more directors over the next two or three years.

So yeah, there's going to be a significant change. And that will definitely affect the culture of the board. And I'm expecting that in very positive ways.

Great. Thank you.

We go next to Sergey Vasnetsov with Lehman Brothers.

Good morning. Brian, you said you would refrain from talking about the goals from cost savings. But can you talk about the actual results achieved so far to date? Where the cost savings came from, what the total amounts, the rough split between the divisions?

The -- there are a multitude of cost saving programs. At Meridian they have a thing called the Winners Circle which has annual targets that they need to achieve. And they're trying to get hundreds of millions of dollars saved. They are following along the amount. I don't think we publicly reported where they are and where they're supposed to be. And tell them to stay away from that.

We had labor savings relative to the actions that we took earlier where we affected vacation accruals and lowered salaries and those are still in effect. So we got some of the savings that way. You can see that our SG&A and R&D is not rising. We're down now to 10% of sales on the overhead. And that is some combination of being frugal and headcount things and labor things. Jim, am I missing something here?

No, I think those are the big buckets. I mean, we started the year saying that raw materials and price were not moving in the direction we wanted and we had to make that up. We wanted to close a lot of that gap with our pricing efforts. And you see some of the results of that in the second quarter.

But we realized that we probably weren't going to get there all the way with pricing although we continue to try. And so the remainder of the bucket had to be filled with cost saving initiatives. And as you saw us take some of the actions like the pay reduction, change in the vacation plan, et cetera. And that's, you know, I like to think in terms of this large bucket.

I understand the mechanics. I'm sorry, I missed the total number that you saved in first half of the year.

And I guess we didn't. You know, you didn't miss it, Sergey, because we didn't put it out there. What Brian was trying to say is, you know, we don't just focus on a particular cost saving number because in a way we think it's misleading. What really counts to you is what shows up in the EFO lines. So you may save some costs, but you end up, you know, if you end up passing that along to customers, et cetera, you know, we've just been down the road too many times where people announce victory on a major cost saving program and oh, by the way, the EFO hasn't moved.

And my second question is just to clarify then the informal guidance that Brian had mentioned earlier. If we apply the 60/40 rule to this year, number so far, you said 58 cents for the first half and the math shows 38 cents for the second half as a base case and the upside from that? Is that the right way to think about that?

I do consider that a downside case. And we are working very hard to create an upside case, Sergey. And I just want to -- I am trying to bracket a range of uncertainty. I'm not giving you the size of the upside. You guys have your own estimates out there. But I just wanted to give you some bracketing on that. But you're thinking about it right. The 60/40 thing is my downside case.

I understand. Thank you very much.

We go next to Andrew Cash with UBS.

Good morning. Hi. Do you have a year-over-year shipments of acetate tow in North America for the second quarter or for the first half?

Andy, we -- because it's the fiber segment, we only report on the segment basis. So we don't give you the specific numbers on acetate tow as a product.

Just to comment though, when Greg was giving us stuff there, what you should pick up from the comments being made in the Fiber, the second half is going to be better than the first. We get the chunkiness of China ends up in the second half this year as it was in the first half of next year, of last year, I mean. And you know, we didn't get some of the tenders we wanted in the first half. We're going to go after some of those tenders in the second half. Second half should be better than the first. What he said is the net for the year will be about 5% lower than 2002.

Okay. Another area I wanted to ask about was you mentioned Asian imports to Europe on PET. Do you have any idea what the amount of imports to Europe have been?

You know, I bet somebody knows that one. I don't have that with me here, Andy, we can probably pass that question on to the PET guys. I think Europe, a quick -- I'm using my memory here, maybe using your time badly. But I think they're 2/3 self-supplied. And 1/3 has to come from someplace else.

And the someplace else has, you know, before the Asians showed up, it was folks like us in Latin America. Then the Asians took bigger and bigger chunks of that. So you have about 1/3 of the Asian PET that has to come from somebody. And that balance shifts back and forth depending on how aggressive the Asian cash cost positions are. And that's kind of the share shifting that goes on between the Asians and the rest of us on that 1/3 of Europe.

So I guess really what I'm concerned about is what's to keep the Asian material, you know, out of the United States? Historically it's been the container argument. But do you think that there's greater probability that we're going to see more Asian material in the United States?

That hadn't showed up on the radar screen and me talking with the businesses there. So far, they feel like we're very strong in North America, Latin America, continue to be strong. We have reason to believe that our cost position will continue to improve.

There was an arbitrage on raw materials between North America and Asia when PX and PTA were cheaper in Asia for some odd reasons. I think Asia's net short on PX PTA because the China fiber producers are back in business. And that means PX and PTA are heading from our region to theirs. So that means there's freight and duty going their direction for raw material, then they've got to come back to the states.

And that puts enough of a hitch in the system to where we don't feel so threatened in North America and Latin America. I think it's -- you have a new Middle Eastern plant making PET down the road. You have a Russian plant, you have the Asians. And I think they're all kind of focused on Europe.

Okay. Actually, I had one other question. You mentioned the -- that you passed on some low margin business in CASPI?

Yep.

Was that business losing money?

It was just not acceptable. We have a lot of business that's negative earnings number. You know sometimes you're doing cash economics, and finally get down to the level of cash economics where you say, you know, I'm not going to go there. And that's what happened in some of those.

Okay. Thanks a lot.

Yeah.

And we return to Graham Copley with Bernstein.

I think he just answered my question actually. So, carry on.

Okay.

We go next to Nancy Traub with Credit Suisse First Boston.

Nancy Traub, CFA: Good morning. I wonder if you could you give us an idea as to the impact the higher raw material costs had on your cost of goods sold.

Greg, I think we have some numbers, what is -- I --

Nancy, I don't have a number in front of me that quantifies the amount that raw materials increased year-over-year.

We gave you some of those numbers in the first quarter conference call. We were talking about just tens and tens of millions. Some of that continued in the second quarter. I don't have that number in front of me. We could probably pass that back to you.

Nancy Traub, CFA: Great.

I can give you some color, Nancy. I don't have the exact number. But I know that, you know, through the first half of the year, raw materials are up significantly. And pricing only made up a portion of that. In the second quarter, we actually gained some ground so we actually got a little more price in the increase in raw materials in the second quarter. But still, for the first half of the year, still behind. But I don't have the exact numbers on how much. I'd hate to do it from memory.

Nancy Traub, CFA: Okay. And also you gained quite a bit on the top line from foreign exchange. I think it was about --

On revenue, it's 4%, Nancy.

Nancy Traub, CFA: Yeah. $68 million or so. How about on the bottom line?

You know, by the time you get down to the bottom line, Nancy, you only get a fraction of that because we do have costs in those currencies, as well. You know, we produce around the world, including Europe, a lot of sites. So it wasn't the big impact, say, if we were just a domestic producer shipping it would have been. Really just a -- I would characterize it frankly as somewhat of a small fraction of that 4%.

Nancy Traub, CFA: Like 10%, 25%? Kind of --

Yeah, in that kind -- yeah. Why don't I not narrow it down more because it can move from quarter to quarter. But it's in that kind of ballpark it's not more than half or something like that.

Nancy Traub, CFA: Okay. All right. Thank you. Oh and hedging, how did that impact this quarter?

Again, the way I'll say it is we do hedge both currency, interest rates, and raw materials. So not to get too specific, we intentionally had lightened up on currency hedges some time ago when the dollar started going our way. It doesn't mean we don't hedge at all, but we do feel we've got the flexibility to move how much exposure we hedged. We were hedging less than normal as the dollar was going our way.

On raw materials, we typically hedge in the fashion that just protects us against a down size case, so that usually means options. And right now, frankly, as we look out on raw materials, you look at, you know, a lot of people what they're thinking natural gas is going to do in the wintertime, you know, you've got a forward curve that's not all that attractive and yet we will probably still continue hedging. But we do feel like we got the right to vary how much we hedged.

On interest rates, we're just trying to maintain a certain floating fixed mix and so you'll see us swap out different fixed pieces of paper to take advantage of the floating rates. But I'm not going to give you a dollar amount of the impact of hedging, it's just part of the whole gestalt of how we do business here.

Got to say it's getting harder, though. I mean, the---

Well, it's hard, that's right. You can't do any better than the forward curve on any of these.

Right. And you know, we had a time in the past, you had a policy situation where natural gas was a wintertime fuel, not a summertime fuel. It got cheap in the summer so you could either buy inventory by forwards or caps or collars. Now it's summertime fuel generating [COFLEXIT] power and it's getting harder because it's expensive in the summer and it's expensive in the winter. So it's getting to be a tougher thing.

Nancy Traub, CFA: Thank you.

We go next to Bill Young with Credit Suisse First Boston.

Good morning. I was wondering if you could update us on your ethylene polyethylene business, given the fiscal situation of the plant, given the raw materials slate. What is your strategy for that business going forward, please?

Good question, Bill. Something we're talking about. The -- I guess the basic situation is that if -- the polyethylene has been actually in fairly good shape the first half of this year. And where it was a concern in the past, that it was some kind of a very negative drag, I think we look about the entire year for this year, polyethylene is not a big effect either plus or minus as we look at kind of the integrated effect for the year.

But what you're pointing to is, what is our, how do we feel about the whole feed stock orientation exposure that we have in Texas to volatility, et cetera. That's a big issue. And it's something that we are working on, and we have a number of ideas. It fits into a bigger corporate strategy, and so it's probably inappropriate for me to speak about it in an isolated way.

We do feel like we have a little time on this, too, Bill, because there's an up cycle that we see coming relative to general olofins in general, oxo specifically. And it gives us a little bit of time to think through this. But you're right in focusing on that, it's something we're focusing on, as well.

And I'm kind of deliberately giving you a nonanswer on what our strategy is there except that we recognize the same thing that you do that this an exposure that we somehow have to work on.

If I could add I think you mentioned operationally, too. Operationally, the guys are doing a great job. Assets is running very well. You know, great utilization, great up time, and so they did put in a good quarter this quarter. But Brian's overall comments are probably really the more important comments.

Do your customers have an alternative source of supply of the same types of grade in case you do have a mechanical hiccup which could always happen?

All of the products that we make down there are competitively supplied by major competitors like Dow and like Celanese and many others. We had some unique products in the oxo stream but we also make those in Singapore. So I think our customers should never worry about supplies in the company.

Okay. Okay. Thanks.

Can we make this the last question, please?

And our final question comes from Bill Cort with Goldman Sachs.

Good morning. Actually it's Duffy. The question, second quarter was a little I guess out of whack because of two factors, weather and SARS. You know, so everybody else we're talking to, things accelerated throughout the quarter. Can you kind of talk month by month, you know, about general business conditions for you guys. And then what you have seen in July so far.

We try to not get too much detail on that. I think the volume story has affected by the things you talk about, there's no question. And we said we expect better volume in the second half. I guess you could infer from that that people were -- as I said earlier -- were holding their breath for a variety of reasons. Some of it was weather, some of it was they hoped for declining raw materials prices, some of it could have been SARS related, but we don't see that very much.

So second half, if it's free of those things, gets a little bit better. But the profitability story for us, Bill, is all around the margin above ROS. Most ROS are, you know, either moving sideways or up a little bit. A lot of pricing activity out there and that's really the battleground, the battlefront that we see, more than it is weather or SARS or anything like that.

Okay. And I was little confused on inventories for you guys. I think at one point you talked about inventories were being worked off in the first half and in the second quarter in particular. Then in response to one of the questions, you know, you said that maybe some inventories were building. Can you just again, you know, through your different business segments talk about where you feel inventories are, you know, with you but more so with your customers?

Jim may have to help me with some of this here. I think --

Let me start by saying inventories were up in dollar sense in the quarter, I'd have to go back and check on the volumes, but it wasn't a major change in our inventories. I don't know if Brian you have some color on customer inventory but those are tougher to call.

Yeah, the customer inventories we know are always pretty low. I think in the case of coatings, the paint was not flying off the shelves of Lowes and Home Depot and Wal-Mart. And that affected a little bit of a bulge in that system, the cost and volume issues. The cooler weather caused a little bit of a ball to be produced in anticipation of a normal volume second quarter. And we had a little bit of a bulge in PET volumes because of the lower demand. I think all that is going to work itself off because it's going into the third quarter.

But downstream, we still don't see, nobody's had any inventory for sometime. We have seen few people even go the further destocking when they think the prices are going to fall and they just hold their breath for a while But there's still not a lot of inventory downstream.

Okay. Thank you.

Okay. If there are any additional questions, please feel free to call me at 423-229-8692. An audio replay of this conference call will be available this afternoon through August 1. You can hear the replay by calling 888-203-1112, or on Eastman.com in the Investor Information section. Also, a transcript of the prepared remarks will be available on Eastman.com in the Investor Section, supplemental information later today. Thank you for your interest in Eastman.

Ladies and gentlemen, this does conclude the Eastman Chemical Company second quarter earnings conference call. We do appreciate your participation. You may disconnect at this time.