伊士曼化學 (EMN) 2004 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 conference is being broadcast live on the Eastman Web site at www.Eastman.com. Again, that's www.Eastman.com. I would now like to turn the call over to Mr. Greg Riddle, Investor Relations.

Thank you, Tina, and good morning, everyone, and thanks for joining us.

With me today are Brian Ferguson, Chairman and CEO, and Rich Lorraine, Senior Vice President and Chief Financial Officer.

Before we begin, let me remind you that during this call will you hear certain forward-looking statements concerning our plans and expectations for the third quarter and full year 2004. Actual results could differ materially from our plans and expectations. Certain factors related to future expectations are or will be detailed in the company's second quarter 2004 financial results news release and our filings with the Securities and Exchange Commission including the Form 10-K filed for 2003, and the Form 10-Q to be filed for second quarter 2004.

Now let me turn the call over to Brian.

Good morning everybody. It's always a pleasure to speak with you on the morning after we reported a pretty good quarter.

I'm going to give you some highlights from this quarter. I'm going to tell you a little bit about the third quarter outlook and then I want to put in a plug for our Eastman investor day that's coming up in September, early September.

As I said, it was a very good quarter. It also follows behind a good first quarter. And these results have been driven by the many, many plans and actions that we've been discussing with you routinely over the past two years to improve our company's profitability.

Our second quarter 2004 earnings per share of 82 cents, excluding all the restructuring and separation items, is our best quarterly EPS since the year 2000. And our sales revenue in the second quarter was the highest in our company's history, topping the all-time record that we just set in the first quarter of this year.

The strong sales revenue was primarily driven by higher volume which was up 10% year-over-year and which, again, was also the highest in the company's history with gains coming in really all of our segments. As we achieve these records, we continue to remain very disciplined in managing our costs.

Our combined SG&A R&D spend as a percentage of sales revenue was approximately 9%, and you know that that's below our commitment of 10% to you, so we're in good shape there. Our sales volume per employee was is at an all-time high and that number has nearly doubled since 1996.

We're also on track to manage our headcount to approximately 12,000 employees at the end of 2004, compared to approximately 15,000 at the beginning of the year, and this is due to the successful activities to divest some of the CASPI businesses which Rich we'll be talking about.

With all that said, we still have a lot more progress to make. You all know that our entire industry is challenged by high raw material and energy costs. Those have increased beyond everyone's expectations.

For us propane, paraxylene, ethylene glycol, and other raw materials are up 20 to 25% in this quarter compared to last year's quarter. Another example is coal. Coal prices for us are up about 60% year-over-year and they're probably going to go higher.

So with in this mind, we continue to focus on our pricing initiatives throughput the company. We need to raise prices and preserve our margins in the face of these historically high raw material and energy costs and we're very aggressive in that effort.

Turning to the results of the divisions, let me point out the Eastman Division has seen very significant improvement. If we look through all the noise of restructuring and separation costs and go to the core earnings numbers for the Eastman Division, the three businesses in there, individually and collectively, have so far this year exceeded the earnings for all of 2003, and that's a heck of a turn around story, and of that turn around story has been a focal point for you, it's certainly been a focal point for us.

In this report we provided some tables to you. Table Four is worth looking at, especially the second page. We've given you visibility to the CASPI pieces, with and without the parts that are being divested, and Rich is going to give you some more details on the divestiture process in a minute.

What you'll see there is that the coatings and adhesives businesses remaining in CASPI have very strong operating earnings as we have mentioned to you before. You'll also see that they're growing, and the operating earnings increased about 20% and sales revenue increased 12% in the first six months of '04 versus last year.

Moving on to Specialty Plastics, this is also a very good story with earnings moving up nicely. Sales revenue for this segment increased by 10% in the six months of '04 compared to '03, and this reflects very strong global volume growth especially in Asia Pacific and Latin America for them.

Continuing the theme, Performance Chemicals and Intermediate's earnings, operating earnings, excluding items, are also better in the first six months of '04 than the full-year 2003 results. They are seeing a combination of higher selling prices and some volume growth with particular strength in the second quarter.

Now, turning to the Voridian division, we've also seen strong volume growth during the first six months of this year. In the Polymers segment, we experienced a similar pattern this year as to what we saw last year, but with stronger volumes this year.

Raw material prices such as paraxylene have increased substantially, as I mentioned earlier, and our prices had trouble keeping up with that in the first quarter. In the second quarter, prices were increased and margins improved and the volumes have remained strong, up 13% in the first six months.

Looking at the Fibers segment as always, we see a steady business there with very strong operating margins, and they are benefiting this year from very strong acetate tow volumes in Asia and from strong acetyl chemicals volumes generally do a high capacity utilization here in this facility.

Finally in the Developing Businesses, there are a number of interesting things going on in the Developing Businesses. We are narrowing our focus and working on some interesting business developments there.

The one that has not met our expectations, as I've mentioned to you in the past, is Cendian. Cendian has not demonstrated that they can generate the acceptable margins that we need with their external customers.

The new CEO at Cendian has taken a clean sheet approach to their business processes and their business model, and while they are doing that, they will not pursue new customers or renew contracts with existing customers. As part of that, we're reviewing how Cendian provides logistics services to us.

But one point I do want to make is that we've had very stable logistics costs in total for our company due to their work and other work that's gone inside, so we are in very good shape on logistics costs generally.

We don't give you much visibility to the Developing Business segment in general. We're coming to a time when we'll talk about more what's going on in that segment, and that would be on investor day which is coming up in early September.

Let me move to third quarter outlook.

As we look at the third quarter, we expect our volumes will increase on a year-over-year basis. They'll decline some sequentially, and that's a normal pattern for us every year. It's a seasonal pattern that we always see.

We also anticipate continued pressure from high raw material and energy costs, which are not showing any signs of declining from their current, very high levels. So our ability to obtain pricing to offset these high raw material and energy costs continues to be a very key driver of our profitability.

Overall, looking at all the various forces working for and against us, we expect third quarter net earnings to be somewhat higher than the current First Call mean estimate of 63 cents per share, but somewhat lower than the pro forma 82 cents per share we had this quarter.

Now a plug for our corporate strategy and 2004 Eastman investor day in New York on September 2nd. I mentioned to you during last quarter's conference call, we are reach a point where we want to engage with you more about our corporate strategy going forward.

We are nearing completion, or we have completed a number of the tactical actions that we needed to take to restore a basic level of financial performance in our company, and just starting to see the results of those actions now and we're giving you insight that those will continue. But at the same time, we have also been thinking very deeply about how we can create a better future for our customers, for our employees, and a better future that meets your investment objectives as well. We want to begin this dialogue with you at our investor day meetings in New York City on September 2nd and we hope that you will be able to join us.

So with that, let me turn the conversation over to Rich Lorraine.

Thanks, Brian. Good morning everybody.

I'm going to cover four items this morning. Quick update on what's going on with the CASPI restructuring.

I'll provide a little additional color on the asset impairments and restructuring charges and the net deferred tax asset we've reported. I'll give some highlights from the cash flow statement and finally talk about the impact of some actions we've taken related to our other post employment benefits, or OPEB.

First, CASPI. As you know we recently announced an agreement to sell certain portions of the CASPI segment to Apollo Management. This deal represented all of the remaining businesses and product lines that we had been seeking to divest.

The current event, the news is that we have the signing, the final signing and closing for that transaction scheduled for this afternoon, and we have a team in New York ready to do that.

We feel like we accomplished what we were set out to accomplish, namely, number one, divesting the assets as a total group rather than a piecemeal restructuring and sale process. We completed the process on the aggressive time line we had set out for ourselves, which was mid-year 2004. We obtained what we feel is a fair value for the asset.

Importantly, too, Apollo is recognized as a strong firm, and we feel it's well positioned to succeed with the businesses and in this segment, and that's a good thing for the employees that are going to be joining Apollo from Eastman and we feel good about that. Proceeds, as we've indicated, they're earmarked directly for debt reduction.

Moving on to asset impairment and restructuring charges and the net deferred tax asset. From an accounting perspective, we made what I'll call the final adjustment to the estimated impairment we recorded last year, and related to this transaction we've taken a $62 million impairment during the quarter. It relates, of course, to adjusting the book value to the final expected purchase price.

In addition, during the quarter, we recorded a net deferred tax asset of $82 million, which is included in the income tax line. Also, we recorded additional restructuring charges of $17 million. 13 of the 17 million is severance charges primarily related to the voluntary separation package that we offered during the quarter.

You recall in the last call we couldn't record that in the last quarter because we didn't have a solid way of estimating what the full impact of that would be.

Looking forward, we will see some additional charges for this voluntary separation in that there are some people that will be leaving the company in the third quarter and even a few on into the fourth quarter as we, you know, saw what kind of work load we were going to have.

Finally, included in that was $4 million of ongoing restructuring costs associated with the recently closed manufacturing sites. That's primarily Hartlepool in Waterford.

Cash flow is a very positive story. We generated 182 million in cash flow from operating activities during the first half, 216 million was generated during the second quarter. This compares with a use of 95 million during the first half of 2003.

Of course, you recall we did have defined benefit pension contribution in the first half of last year of about 140 million, so this helped us.

During the first half of '04, our working capital increased by about $90 million, while looking back at the first half of '03, working capital creased by $175 million. I think we've done a pretty strong job managing working capital, particularly inventories, in a period when revenue and volume is growing pretty well.

The payables increased in the first half of '04. That's primarily driven by the higher raw material costs that Brian described, and, of course, we've got a nice increase in overall volume.

As a net result of this cash generation we've been able to reduce net debt during the first six months by $28 million, to just over 2 billion. In addition, through the first half we've continued as we've committed to remain disciplined in capital expenditures.

Lastly, wanted to touch on other post-employment benefits. After a review during the second quarter, we amended certain of our plans for other post employment benefits, or OPEB.

As a result of amending the plan during the quarter, the future obligation is remeasured and taking into account all the things that are impacting that, such as the CASPI restructuring, employee separations, and the amendments, our OPEB obligation going forward is declining by about 240 million. You won't see this directly in the balance sheet liability, that change, but you'll be able to see that clearly in the second quarter 10-Q footnotes.

On an overall basis, what this does for our 2004 pension and OPEB expense is to stop the rate of increase, and we'll see about the same level of expense in '04 as we have in '03.

With that, turn it over to Greg.

Thanks, Rich.

Last night the Eastman Chemical Company news release announcing second quarter '04 financial results was distributed to the news services and posted to our Web site. Included with the news release are a series of financial tables.

Table One includes a statement of earnings for the second quarter '04 and the second quarter 2003. Sales revenue for second quarter 2004 was 1.7 billion, an increase of 13% compared with second quarter 2003, primarily due to higher sales volume.

Cost of sales for second quarter 2004 was 1.4 billion, basically flat as a percentage of sales revenue compared with second quarter 2003. An increased focus on more profitable businesses and product lines and cost reduction measures were offset by higher raw material and energy costs.

Selling and general administrative costs for second quarter 2004 were 112 million, compared with 108 million for second quarter 2003, due primarily to higher employee related costs and increased costs associated with actions being taken to improve the company's profitability.

Research and development costs were 38 million in second quarter 2004, compared with 42 million in second quarter 2003. We remain committed to keeping the combined costs of SG&A and R&D at or below 10% of sales revenue.

For second quarter 2004 these costs were about 9% of sales revenue compared with a little over 10% in second quarter 2003.

The company reported operating earnings of 41 million in second quarter 2004, compared with operating earnings of 75 million in second quarter 2003. Second quarter 2004 operating earnings included asset impairment and restructuring charges of 79 million, while second quarter 2003 included 16 million of asset impairment restructuring charges.

Excluding these items for both periods, operating earnings improved year-over-year as higher sales volume, an increased focus on profitable businesses and product lines, and cost reduction efforts were partially offset by higher raw material and energy costs.

Interest expense net was slightly lower in second quarter 2004, compared with the year-ago period, as a lower average interest rate offset slightly higher average borrowings.

Second quarter 2004 had an "Other" charge net of 1 million compared with other income net of 5 million in second quarter 2003. The income in second quarter 2003 was primarily due to favorable foreign currency exchange rates.

The company's effective tax rate, based on normal earnings for second quarter 2004, was approximately 28%. The tax rate reflects a combination of the treatment of the asset impairments and restructuring charges, the impact of favorable foreign rate variances, and extra territorial income exclusion benefits on normal taxable earnings.

For second quarter 2004, the company reported earnings of $1.07 per diluted share, compared with earnings of 46 cents per diluted share for second quarter 2003. Excluding asset impairments and restructuring charges for both periods, and a net deferred tax benefit for second quarter 2004, earnings per diluted share for second quarter 2004 were 82 cents compared with 61 cents in second quarter 2003.

Table Two, Other Sales Information.

Second quarter 2004 sales revenue increased in all regions when compared with second quarter 2003. Sales revenue in the Latin America region increased 29%, due primarily to higher sales volume, particularly in the CASPI segments coatings, additives, solvents and adhesives raw materials businesses and product lines. Volumes also increased in the polymer segment in Latin America.

Asia Pacific sales revenue increased 14% compared with year-over-year period, due to higher sales volume, particularly in the CASPI segments, coatings, additives, solvents and adhesives raw materials and business line, businesses and product lines and for the Specialty Plastics segment. Asia Pacific sales revenues also benefited from improved product mix particularly for the Fiber segment.

North American regional sales revenue increased 12% year-over-year, primarily reflecting increased sales volume throughout most segments.

In the Europe, Middle East and Africa region, sales revenue increased 11%, mainly due to favorable foreign currency exchange rates and higher sales volumes, particularly in the Polymer segment.

Table Three, Operating Results, Eastman Division.

Excluding asset impairments and restructuring charges in both periods, operating earnings for Eastman Division improved year-over-year, due to higher sales volume, an increased focus on more profitable businesses and product lines, and continued cost reduction efforts that were partially offset by higher raw material and energy costs.

Sequentially, the division's operating earnings increased excluding items in both periods, due to higher sales volume, an increased focus on more profitable businesses and product lines, and continued cost reduction efforts. Excluding items in both periods, operating earnings in the CASPI segment improved year-over-year, due to higher sales volume, particularly in the coatings, additives, solvents and adhesives raw materials businesses and product lines.

Operating earnings also improved year-over-year, due to an increased focus on more profitable businesses and product lines, and continued cost reduction efforts that were partially offset by higher raw material and energy costs. Sequentially, operating earnings improved, excluding items, due primarily to higher sales volume, which was up by 7%, an increased focus on more profitable businesses and product lines, and cost reduction efforts.

The Performance Chemicals and Intermediate segments operating earnings declined slightly in second quarter 2004, compared with the year-ago period, excluding items in both periods, due primarily to an increase, due primarily to increased sales volume, higher selling prices, and cost reduction efforts which were more than offset by higher raw material and energy costs. Sequentially, operating earnings improved, excluding items, due to an increased, due to increased sales volume, higher selling prices, and cost reduction efforts that were partially offset by higher raw material and energy costs.

Operating earnings for the Specialty Plastics segment improved year-over-year, due to higher sales volume, an increased focus on more profitable businesses and product lines, and cost reduction efforts which more than offset higher raw material and energy costs. In addition, second quarter 2004 segment operating earnings include asset impairment and structuring costs of 4 million. Sequentially, excluding items, operating earnings for the Specialty Plastics segment were flat.

Voridian division operating results.

Voridian division operating results declined year-over-year, as higher sales volume was more than offset by higher raw material and energy costs. Sequentially, division operating results improved, as higher selling prices and cost reduction efforts, more than offset higher raw material and energy costs and lower sales volume.

Polymer segment operating earnings declined year-over-year, as increased sales volume and cost reduction efforts were more than offset by higher raw material and energy costs. Sequentially, operating results improved, as higher selling prices and cost reduction efforts, more than offset higher raw material and energy costs and lower sales volume.

Fiber segment operating earnings declined slightly in second quarter 2004, compared with the year-ago period, as higher sales volume and improved product mix were more than offset by higher raw materials and energy costs. Sequentially, operating earnings were flat, as improved product mix was offset by lower sales volume.

Developing Businesses division.

Developing Businesses operating results were lower in second quarter 2004, compared with second quarter 2003, due primarily to a larger operating loss than anticipated at Cendian. Sequentially, operating earnings improved slightly.

This concludes our prepared remarks. Tina, we are ready for questions.

Thank you, gentlemen. Today's question-and-answer session will be conducted electronically. If you would you like to ask a question, you may do so by pressing the star key followed by digit one on your touch-tone telephone. That is star one if you have a question. If you find that your question has been answered and would like to remove yourself from the queue, you may do so by pressing the pound sign. If you are using a speaker-phone today, please be sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star one now if you do have a question. And we'll first hear from Frank Mitsch at Fulcrum Global Partners.

Nice result, guys. Brian, you mentioned this was the best volume improvement that Eastman has had and yet Asia was only up 4%, I guess, on a volume basis. Now I know a lot of that is refocusing the portfolio away from products to more profitable products. At what point do we start to anniversary the change in business strategy and allow the underlying growth within the Asian region to really show through in the results?

Yeah, Frank, what's not visible to you, you're asking a good question. Because what's not visible to you is that the upgrading of the product mix in Asia Pacific, especially in the Eastman division, has resulted in some very nice earnings gains for them. We just don't report that to you.

And that has been a trade-out of things like bulk liftings. And why is that? Because now there's more demand across the world and there's better places to put those commodity solvents and things that we were sending there, acid, acetic acid, better places to put those here and in closer places. And then we have beefed up the size of some of our specialties there.

I'm going to get more explicit about that in about a month, Frank, is the answer to your question. And we'll give you some insight but we expect to have a very healthy growth profile in Asia. It's going to be focused on some of our more specialty products and that's the growth that we're seeing right now. So this is not something we imagine we can do, we're actually doing it right now. And it's going to be a good, solid, big double-digit number that you'll like when we get done.

Okay. Can you comment on the profitability improvement in your polymers business? You talked about playing catch-up from the first quarter, high raw material costs, and, you know, are we, have we fully caught up? Will we start to get a little bit of a cushion here in the third quarter? And if you give your answer in context of where your operating rates, or where is the industry's operating rates, so we can have a better idea as to what we can expect from that segment.

Good question, Frank. The, comparing last year and this year, you remember last year, we got to some pretty darn good prices in PET early in the year last year and through second quarter, and then we had new capacity come in, kind of took the air out of the system and we reported for two or three quarters it's going to be okay, just wait for it, and sure enough the volume growth that you see now, allowed us to get pricing in the second quarter which improved our margins.

The growth has occurred the way we expected it would in this industry. The industry has returned to some more tight operating factors and a lot of people are running at some pretty high rates.

The sustained, high raw material environment that we're in, sets up the situation where we can continue to drive for price increases there. So I would expect that we would be driving for more price increases to recover, continue to support our margins and maybe even recover some margins as we go forward here in PET.

So there's reason for optimism then in the third quarter with this segment?

I think stability, more stability than we have seen, certainly than last year. We don't expect that same kind of a big industrywide deflation that we saw last year for sure.

Thank you.

We'll next here from P. J. Juvekar at Smith Barney.

Good morning.

Hi, P. J.

I'm looking at your CASPI segment and you got $25 million improvement in CASPI earnings year-over-year. But correct me if I'm wrong, but if 21 out of the $25 million of increase is coming from assets held for sale, so can you talk about the base business and what's going on there in terms of profitability?

P J, I'd make a few comments on that. First of all, I mean, what you're seeing is that the businesses that are remaining are profitable, and you haven't had visibility to that before. So when you talk about the year-over-year increase, really what you're seeing is the businesses that are remaining with us are going to continue and have been profitable.

P. J., you're seeing the businesses the way you would have seen them if we had not had the acquisitions. That's the way we carve those out. So you see steady revenue growth, you see a steady earnings growth. That is, we're giving you a backward picture as if we didn't have those businesses and what you see there is just some pretty darn good growth.

I mean if you look at it on a six-month basis, you also see that the businesses that are remaining had some pretty good growth on the operating earnings line.

I alluded to the fact that we got something that looks like, I think I said this a year ago, when we get done, we're going to have something that looks like it's about a billion dollars of sales, and it's going to be making around 15% kinds of operating margins, and that's what you see there.

Okay. Well, I appreciate breaking out the results. Second question I have is on PET. Can you talk about your operating rates or industry operating rates? And secondly, with raw materials going up in Asia, have you seen less imports coming from Asia?

Good questions both. The operating rates are pretty high, P. J., and we don't report the actual numbers, but we're making a lot of stuff, everybody else is making a lot of stuff. The buyers recognize this is a tight market. They recognize that the raw materials are high. So that sets up the dynamics for us to preserve margins. It also sets up the dynamics for them to preserve their margin and push forward into the value chain as they need to.

The Asia Pacific situation is a different situation than it was a couple of years ago. There was a reverse arbitrage where raw materials were cheaper in Asia, for reasons that I never fully understood, and that has clearly reversed, so the Asian volumes coming into North America have been lower. There were some anti-dumping effects in Europe that shifted some of the impact of the Asians in Europe, so the Asians have generally been less of a competitive issue for us than they were in years past.

Right. With that happening are you surprised that the industry is struggling with price increases?

You know, this is the question I always have to wrestle with myself. The way I reconcile myself to this is if you draw a cost curve, you know how those S curves look, the cost curves, you have on the left side of a cost curve, you have the low cost guys, and then you have kind of a curve that flattens out, and then it rises at the back end where the high cost people. This cost curve is a very flat curve and remember the X axis on that curve is capacity.

So you have a very flat curve, and the way an over-supplied industry works, it's the cash costs are the most expensive guide that sets the pricing, Right? So, with a very flat curve, you can slide along a lot of capacity lines and the pricing doesn't move as much as it should.

This is sort of a perennially over-supplied industry, and it's all about cost position at the end of the day, and that's something we're very much focused on and will be talking to you about in the future.

Good. Thank you.

We'll now hear from Jeff Secaucus at J.P. Morgan.

Hi. Good morning.

Hey, Jeff.

When Dow Chemical reports its results, what does is it says, raw material cost inflation was a certain amount for the quarter and for the first half. Can you do in that rough terms?

I'm looking at my financial guys here.

What we've done for you, Jeff, and what Brian mentioned in his opening remarks is to talk about some of our key raw materials and to tell you on market basis you've seen 20 to 25% increase.

No, no, I understand what you've told me. I was looking for average numbers.

We don't break them out like that Jeff.

All right. Secondly, when I look at the CASPI business, and sort of Eastman in general, what strikes me is that your volumes are sort of better than many of your peers, and your prices are a little worse than many of your peers. Is that in part a strategic decision on your part to gain share because you're really leveraging your SG&A structure?

Not really, Jeff. I mean it looks like that but I would say no to that question. I know the statistic you're looking at and that one frankly confused me a little bit when I looked at it, too. And I had to quiz myself and quiz our folks a little bit about that statistic. Because what I know has been happening since the fourth quarter is that we've been driving prices like crazy and we've had a lot of success in driving prices. When I look back at second quarter, and I think you're looking at the year-on-year number.

Yeah.

When I look back at the second quarter of last year, we had been successful in driving a lot of prices up including PET prices and a number of others. The extra supply in PET didn't allow that to stay and there were a number of other factors and competitive factors that drove the others down so there was a big kind of air coming out of the balloon second half of last year. That's one factor.

The other factor is, we have three or four businesses, you compared us to Dow, we have Fibers, we have the Specialty Plastics Business, we have what you now see as the adhesives and coatings business, and those are fairly stable in their pricing. They don't get yanked around as hard, up or down, as some of those more commodity-like things that a Dow would have that get yanked around pretty darn hard.

And I guess third, there has been some [inaudible] impression that we still have to fight against, and that, again, the environment coming into the second half of the year is more favorable for us to deal with that. But those are the things I would point to on that. No, it's not a strategy, and we do need to drive our pricing and we're driving that as hard as we can.

How long can you keep your SG&A flat on absolute terms? That is, is this sort of an unusual year for you, or can you do it in '05?

The operating software, if you'll let me use that term, that we have been using in our company for the last couple of years, has been turn around operating software. We're about managing costs, managing margins, keeping our heads down, fix the systems we have. As we turn our attention to building a better future, it will be hard to hold those numbers in absolute terms.

Right.

But in the aggregate, we'll commit to you about how we manage our growth and how we expect our earnings to grow, and that will include the component of SG&A and R&D and again, that's a conversation I want to start you with in early September. But as a percentage of sales, I wouldn't see it going crazy on us, but if your sales rise dramatically, you're going to have some additional SG&A and R&D to go with it.

And just lastly. Do you still view Genencor as non-strategic?

Absolutely.

Okay. Thank you.

Moving on we'll here from Andrew Cash at UBS.

Hi, Brian. You've pretty much delivered on everything I've wished for, except for Genencor, and I trust that that's going to be monitized before too long. One thing that resonated really well with me is, I think your last conference call you talked about the company had to earn the right to grow. But now what you're saying, you're coming to New York on your sort of cloud of glory and you're going to start talking about the future, making changes for the future. Maybe I'm reading into this, but it sounds like maybe you're going to prematurely jump into some M&A activity and, you know, you won't really demonstrate to the market that you can grow the existing asset base. I'm wondering is that the reason we're coming to New York, to talk about an M&A strategy?

Oh, no, no. That would be a big misread, Andy. No, you're going to hear a strategy that's continuing some themes about responsible investment and connecting up what we know how to do with markets that we need to know some more about. But this is not going to be anything that would cause the kind of heartburn you're talking about, Andy. Absolutely not.

So this earning the right to grow, I mean, do you think --

Still on our minds.

Pardon?

Still on our minds. I mean, this is a journey, this is not a destination. We haven't achieved some destination about earning the right to grow. We've still got baggage out there for things we spent money on in the past. We recognize, as we go forward and invest in the future, that we've got to continue to earn confidence in the things that we choose to grow in and you will see our reflections on those thoughts as we talk to you. But no, you should not buckle up for some kind of a big M&A ride. That's not going to happen.

Okay. Very good. See you in September.

Okay.

Up next is Kevin McCarthy, Banc of America Securities.

Yes, good morning.

Hey.

Brian, I was somewhat surprised to hear you say that coal was up 60%. I thought you had some long-term contracts there that would insulate from you that kind of volatility. How can we think about that exposure quantitatively? Perhaps you can comment on how much you consume and what the drag was on income.

Okay. I probably, I was using a couple of phrases interchangeably. I said coal for us. Coal in the market went up about 60%. We do have some long-term contracts and we do have some insulation from that volatility. You don't have insulation long-term, but you have some short-term insulations.

Coal is, as you remember, both a raw material and a fuel source. As a fuel source, it makes up a high percentage of the fuel used certainly here in Tennessee. It's a high percentage, it's become a less of a percentage, actually, in places like Texas and Arkansas.

The raw material aspect is also important. I guess if I had to, I'm going to do this roughly, and I may get this wrong. This may be one of those things where Greg has to say later what the CEO meant to say was, but I think that coal makes up roughly 25% of our raw material stream, you know, rough numbers.

That's on BTU base.

And that's on kind of a BTU base, as Greg reminds me. And then you have the olefin stream, kind of the all the ethylene, propylene derivatives kind of pulling in another 20, 25%, and then we have all kind of miscellaneous cats and dogs in cellulose and organics things and things that we buy and that makes up all the bulk of the rest of the stuff we buy.

So that's the level of exposure we have on our raw material side and it's probably more than 50(ph)% of our energy.

Okay. And the update on your coal gasification efforts?

Yeah, a lot of interesting dynamics happening there. Again, this is a conversation that's better taken up, this is probably not the right place or time to go into the details.

Suffice it to say that the financial realities of what people see is creating a much higher level of interest in these technologies both for utilities and now for chemical companies. And their thought processes are turning toward not only how do I generate clean power, electric power, but how can I think about my raw material streams.

And there's just an awful lot of interesting things going on in both industries right now around this. It's picking up momentum. And that's, that is encouraging to us, frankly. We'll give you some more details in about a month or so.

Question on PET resin. We're seeing a very significant cost push in styrenics right now as a result of benzene. Wondering what your folks think in terms of any potential benefit or favorable substitution effect into PET resin from styrene as the summer progresses here? Are you seeing any increased interest along those lines?

Well, if I had to use a phrase in PET, substitution is us. I mean that's, pretty much we made our living substituting for glass and aluminum. We have made a more modest, up until now, living in places in our specialty plastics substituting for other plastics, not only in packaging, but in other applications for durables.

You can bet that our guys and ladies are looking at these dynamics all the time, and the story that, to make good on the thing that you're suggesting requires some applications development, some rapid applications development capabilities, and that is a topic that is very much on our mind right now. But, yeah, the short answer to your question after all that is, yeah, there are opportunities.

Thanks very much.

Now we'll hear from Nancy Traub at Credit Suisse First Boston.

Morning. I wondered if could you just review what your tax rate is going forward and, because there were so many special items this quarter, and where you would expect your debt to be at the end of the year?

Nancy, this is Rich. Our effective tax rate on operating earnings run about 28%. And we, that's our view going forward.

In terms of where we expect net debt to be, I don't have a specific target to give you sitting here, but I will tell you that it's, we see it coming down by a nice number in the second half.

Using a lot of your free cash flow?

That's the primary use of cash in the short run, is debt reduction.

Okay. And one other thing. PET, you mentioned how the operating rates are pretty high and the, you've been trying to get price through here. Can you give us a little color on how it is, say in Europe, compared to the U.S.?

Europe has been a pretty good market for us so far this year. Some of that is currency related, of course.

There's a different, an entirely different supply demand dynamic there, and when Europe gets a little bit loose, it gets ugly, and when it gets a little bit tight it starts to look the way you'd expect. But the dynamic in Europe is, I'm trying to remember, fairly tight, I think, right now, and doing pretty well. A lot better than it was about a year and a half or two years ago.

The only reason I ask is, year-over-year it looks like that business was down. I mean, overall.

You mean on an operating earnings basis, Nancy?

Yes.

Yeah, it was down a little bit but what you're seeing is continued high raw material costs of paraxylene, ethyl glycol particularly, and we're out there trying to offset it as much as we can.

Nancy, I understand the sense of your question. Actually, our issues this year are more in Latin America than they are in Europe and Latin America's been a bit of a drag causing some of that.

Okay. Thanks.

Please remember, if you do have any questions please press star one now. We'll now hear from John Roberts at Buckingham Research.

Good morning, guys.

Hi, John.

Related to Kevin's question, is there any way to quantify the economic benefit of coal versus natural gas on your acetyls chain? And I ask the question because gas has gone up first and so you've had a benefit there that I suspect you're coming up on anniversaring at least the maximum benefit of coal versus gas and now as coal starts to move up, do we need to worry a little bit about that differential narrowing now?

It narrows a little bit but you should always expect this to be preferred position for us.

I understand that. Both were stable. Relatively stable advantage, but now we've had dynamic.

Yeah. It will have some effect. It will absolutely have some effect but again, we don't break those out separately for you, John. We kind of give you the corporate earnings outlook, gave you a corporate earnings outlook that has a lot of stability in it going into the third quarter and so we're not predicting any kind of a major shortfall or big issue coming there as a result of what you're suggesting there.

That's helpful. It's a minor effect.

It is a relatively minor effect.

Thank you.

And we'll hear from Hans Gregerson at Enskilda Securities.

Good afternoon. A couple of other participants asked questions regarding Genencor. Could you provide any sort of insight to the timing or potential exit? Would it potentially be before year-end 2004, or whatever can you say on it?

We've been very careful because Genencor is a publicly held company, to not comment on whatever things that they are doing relative to their future. You should really get any statements from them. As a 40 something percent owner of Genencor stock, we have said that this is a strategic asset for us, that we don't feel that's it's reflected, the ownership is reflected in their stock price and that disappoints us and we're looking for paths to have that reflected, and we want to do in that a timely manner. But I won't go any farther than that, I'm sorry.

But you did confirm earlier that it is a non-core asset?

It is a non-strategic, non-core asset for us. It is a financial asset, is the way I think the way we describe it, so we're looking for a way for that financial value to be reflected in our stock price.

Thank you.

And gentlemen it appears we have no further questions. I'd like to turn the conference back to Mr. Riddle for any additional and closing comments.

Thank you. If there are any additional questions, please feel free to call me directly at 423-229-8692. An audio replay of this conference call will be available this afternoon through Friday, August 6th. You can hear the replay by calling 888-203-1112 and entering the passcode 272303, or on our Web site in the Investor Information section.

Lastly, as Brian mentioned earlier, we are having our 2004 Eastman investor day at the New York Helmsley Hotel, on Thursday, September 2nd. The event will begin with a continental breakfast at 8:00 a.m., presentations will begin at 9:00 and we plan to conclude by 1:00. If you're unable to attend in person, both the slides and audio from the event will be available via Web cast on Eastman.com. Thank you again for your interest in Eastman.

That will conclude today's conference. Thank you for joining us. You may now disconnect.