伊士曼化學 (EMN) 2005 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's website at www.eastman.com. We will turn the call over to Mr. Greg Riddle of Eastman Chemical Company's investor relations. Mr. Riddle, please go ahead, sir.

Okay, thank you, Rufus, and good morning, everyone, thanks for joining us. On the call with me this morning is 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 you will hear certain forward-looking statements concerning our plans and expectations for the third quarter and full year 2005. 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 2005 financial results news release, on our website and in our filings with the Securities and Exchange Commission, including the Form 10-K filed for the year 2004 and Form 10-Q to be filed for the second quarter 2005. With that, I'll turn the call over to Brian.

Hey, good morning, everybody, and thanks for joining us. As usual, I'd like to make some comments on the corporate level highlights for the second quarter and then comment specifically on the segments in the regions, and finally wrap up with an outlook going forward. Last night, we recorded the fourth best quarterly earnings per share in our history, and if we combine that with our results in the first quarter, we've reported the best half year of EPS in our Company's history. So we continue to establish new high water marks and our hit parade of corporate earnings history and we're very excited about this great performance across our company.

So we continue to establish new high water marks at our hit parade of corporate earnings history; and as you can guess, we're very excited about this great performance across our Company. Our gross margin increased by over 500 basis point in the second quarter compared with the year ago quarter; and excluding items, our operating earnings improved by over 75%. This earnings improvement was despite an increase in the costs of raw materials and energy of more than $100 million versus last year, particularly for propane, paraxylene, and ethylene glycol. These increased costs were more than offset by a combination of higher selling prices, improved volumes and cost-reduction efforts that we have been implementing for several years now. The strong earnings performance was very broad based also, and I will talk more about that in a minute. Our revenues continue to be very strong, basically flat compared with the first quarter, which was a company record is you remember.

And we continue to see improved volumes, with our second quarter sales volume increasing by 5% year over year, excluding sales from the CASPI businesses and product lines that we divested last July. Our strong base of earnings is continuing to deliver great steady results, while our more cyclical segments continue to take advantage of the upcycle in their specific product lines. Now, looking at the segments individually, over the last several quarterly calls and investor conferences I've attended, I spoke to you about a strong base of earnings for the Company. This base includes our fibers, CASPI, and special plastic segments, which are characterized by consistent double-digit operating margins.

During the second quarter, they continued to deliver great results. The second quarter combined operating margin for these three base businesses was 18%, and for the first half of the year their combined operating margin was 19%. Looking at the results by individual segment, the fiber segment operating earnings were $43 million, which is a $10 million increase compared with the second quarter of '04. That increase was driven by higher volumes and prices that were partially offset by higher raw materials and energies. The second half of '05 should be stronger for fibers due to the positive changes in the industry structure that we've talked to you about before.

CASPI segment operating earnings were $65 million, excluding a $1 million restructuring charge. This is a $14 million improvement compared with the results from the continuing product line for the second quarter of '04. It's basically flat compared with the first quarter. Their second quarter operating margin was 20% and their first half operating margin is also 20%. Their results are due to strength in both their specialty products and their more cyclical commodity products. Our specialty plastics operating earnings were $21 million, down $2 million from the year-ago period excluding items. Our volumes in treated 6%; frankly, we think we can make this a better number in the future. The overall increase in volume happened despite reduced acetate volumes for use in photo films. So that's still a pretty good result. In addition, we are making a conscious choices and investments in growth opportunities in this segment.

We'll talk to you more about this at our Investor Day in September. So those investments pulled the earnings down a bit for specialty plastics. Turning to results for PCI and polymers, the PCI operating earnings were $52 million, which is about three times what they made in the second quarter of '04 on an apples to apples basis. Prices increased due to high industry utilization rates or key derivatives such as our [oxo and acetyl] product lines. Higher sales volume was due to strong demand, particularly for intermediate products, and the implementation of some long-term supply arrangements. Polymer segment operating earnings were $48 million, which is more than double the year-ago period. The improvement was due to higher earnings of for PET in North America and polyethylene.

Sequentially, operating earnings declined for a couple of reasons. Although North American PET improved sequentially, earnings and Latin-American declined as they head toward their winter season, and earnings in Europe declined due to lower industry utilization levels and the general nature of competition in that region. And of course, our polyethylene margins declined sequentially for reasons that you all understand in line with the rest of what's been happening in that industry. Some comments on the regions now, North America revenue increased by 6% year over year, as higher prices were partially offset by lower sales volume. That decline in sales volume was primarily due to the divestiture last year of businesses in the CASPI segment.

Second quarter operating earnings in North America more than doubled, as higher prices and cost-reduction efforts more than offset higher raw materials and energy costs. In Europe, our revenue declined by 11% year over year as higher prices and favorable foreign currency exchange rates were more than offset by lower sales volumes. As in North America, those lower volumes in Europe were mainly due to the divestiture last year of businesses from the CASPI segment. A good story in the Asia-Pacific region, our revenue increased 24% due to higher prices and higher volumes. Increased volumes were particularly in the [viridian] division. Our operating earnings in Asia -- we don't as you know report operating earnings specifically by region -- but just to let you know, our operating earnings in Asia were up over 50% year over year, due primarily to continued improvement in the fibers segment.

And in the Latin American region, our revenue was up 12%, with higher selling prices more than offsetting lower sales volume. Now some comments on the view looking forward. In the past, we have told you that in a typical year, we have about 60% of our earnings in the first half of the year and approximately 40% of our earnings in the second half of the year. We believe that sounds about right this for this year as well. Now as usual, there are a lot of moving parts and external variables in that model, including the volatility of raw materials and energy costs and our ability to keep up with all those moving parts with our prices and our volumes. As we look at the second half of the year, we expect propane, paraxylene, and ethylene glycol to continue to be volatile, so we're planning for that; and we also anticipate that volumes will continue to be strong, although there are always subject to the normal seasonal declines in some of our business areas.

So in summary, folks, we've had a great first half. It's an all-time best, and we expect this to be a really great year overall. We're expecting another great year in 2006; and when we look beyond 2006, I hope you ill join us at our Investor Day on September 7th, in just about a month, where we will talk with you about how we can build a great future for our Company that goes beyond this industry cycle. So with that, let me turn it over to Rich.

All right, thanks very much, Brian. Good morning, everyone. I'm going to change up my format just a bit this quarter and talk first about sources and uses of cash, and then I will conclude my comments with some information about our current position and our priorities for cash going forward. First of all, on sources of cash, we had cash flow from operations of about $210 million in the first half of this year. This was driven primarily by the strong net earnings of $370 million. In that, we also had a working capitol build, primarily inventories. We have some prebuying of certain key raw materials.

We've got -- what I would say the normal preparations for maintenance shutdowns coming in the second half; and in addition, we made a pension contribution of $62 million in the second quarter. I'll talk a little bit more about the pension contribution in a minute. You may recall that we -- when we sold the CASPI businesses, we -- in July of last year, we held seller paper of $50 million with a 7-year tenor. I am really pleased to let you know that we received payment for this note during the second quarter and that you can see that in the proceeds for the sale of assets lying on the cash flow statement. That was the last remaining item from that transaction, and it ties a ribbon on it, and we are pleased to have it behind us.

As for Genencor, I mentioned in the last call -- and the timing of that was very nice -- but we have now fully completed that divestiture of that interest engine in core for $417 million in net cash proceeds after tax, and we can -- we now see this results in the second quarter reports. One additional source of cash in the first half of the year has been the exercise of stock options, and that contributed about $90 million to our cash. As a result of that, our diluted shares outstanding have increased to about $82 million at the end of the second quarter, up from about $79 million at the end of 2004. Combined, these items total over $750 million for the second quarter.

Now, let's turn to uses of cash. Immediately after concluding the Genencor transaction, we launched a tender offer to repurchase $500 million of our long-term debt, and we completed that transaction in June. The costs associated with that were $46 million. This included the premium paid against par to purchase the selected bonds as well as the customary transaction fees. In addition to that, during the second quarter, we brought down our commercial paper and credit facility borrowings by about $120 million. With these actions, we hit our goal, we solidified our credit profile as we had committed to, and we now have solid investment-grade ratings from all three rating agencies.

Getting back to the pension, I mentioned earlier in the cash from operations discussion that we did make a $62 million contribution to the U.S. defined benefit pension plan during the quarter. In addition to that, we plan to make an additional contribution to the plan of about $100 million during the third quarter. With that $100 million contribution, that will get us up to about a 90% funded rate, and it will have the effect in future years of making the contributions slightly smaller than we had anticipated. Also, since those pension obligations are part of the overall debt profile, this contribution again further strengthens our balance sheet on a long-term basis and reduces future obligations.

Finally, on the earnings side, as a result of that, there is a minor but positive impact on EPS. Terms of other uses of cash, during the second quarter, we paid our dividend -- and that's the 46th straight quarter as public company that we've paid our dividend. In addition, our capital expenditures were $124 million. As usual, I will repeats the same message that we usually give earlier in the year, and caution you not to annualize this number, as our normal pattern is for higher Cap Ex in the second half of the year. As this year goes on, our spending for the new IntegRex facility going up in Carolina and other items will increase in the second half. We continue to expect our capital expenditures to be in that same range we guided in the last call, somewhere between 340 and $360 million.

Finally, summarizing, with the debt repayment in the second quarter, our net debt is now just over $1.2 billion. That's net of cash of about $240 million that we have on hand at the end of the quarter. Our stockholders equity has increased to just above $1.5 billion at the end of the quarter, and that's $325 million better than the end of 2004. Looking forward into the second half of the year, we anticipate strong cash generation, as the earnings will remain solid, and we'll have some seasonal reduction in that working capitol. And priorities for cash continue to be the dividend, that $100 million funding of the U.S. defined benefit pension plan, and we will be continuing to fund some targeted growth initiatives. With that, back to you, Greg.

Okay, thanks, Rich; and that concludes our prepared remarks. Rufus, we are ready for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] And we will pause for a moment to assemble a question was to. Again, that is star one to ask a question. And for our first question, we go to Frank Mitsch with Fulcrum.

Good morning.

Hi, Frank.

Brian, if I look at Eastman's earning patterns, second quarter is almost always better than the first quarter, which makes some sense given that you see some seasonal strength in the beverage market, you see some strength in the coatings market. And obviously you had a very strong first quarter this year, so you know, the comp would be that much more difficult. You'd indicated I guess three months ago, you looked for something in line with what you reported in the first quarter. What happened?

Well, if I -- well, we said we were going to be similar to in the second quarter. If you look at five segments of our Company, four out of the five were so close to being similar to, they're almost identical. The only segment that varied from that similar to was the polymer segment. As we went through the quarter, there were a number of some -- you know, some pretty well recognized and publicized things happening in both the PET and polyethylene markets that gets us back to -- when we say there's a penny of -- a penny of margin loses $0.25 a share in the quarter, those kinds of things started happening in there. The first, second of the quarters -- first, second -- first quarter to second quarter kind of trajectory, the first quarter just started off awfully strong. We were running pretty much flat out the first quarter, we continue to be running pretty much flat out. And so we didn't have the seasonal increase in things like CASPI. But again, going back,.

Was that a surprise that you didn't have the seasonal --

That was, again, just pretty much running flat out in the first quarter, not totally a surprise; that's why we gave you similar to kind of guidance. And again, four out of five segments were similar to -- well, polymers off a bit -- and there's a, you know,lot of well understood reasons for polyethylene drifting off. PET, the emphasis I want to make is, sequentially we improved in North America, where we're making investments on PET. North America continues to be very strong. Europe has a very tough supply-demand and competitive situation -- Latin America's seasonally off.

The disposal some of the underperforming CASPI businesses occurred last year. How much of delta improvement did you see due to that disposal in the second quarter here?

I'm going to let Greg give you some estimation on that. But it's a -- pretty much all of the change that you see would be attributed to that. But Greg, do you have any other comments?

Yes, last year in the second quarter, the businesses that we divested had a loss of $6 million, Frank.

And I'd say that, you know, the majority of that improvement is due to the restructuring. There are some cyclical upcycle things that happen in CASPI relative to solvents, Frank. The rest of them are pretty steady, so the ones that were steady were steady last year. The difference is in the continuing business, they probably more on the solvents area, they would tend to be a little cyclical. And so once we net out the cyclicality of solvents, the rest of the improvement is the restructuring, and I'd say that is the lion's share of what you saw in the improvement there.

And then lastly, can we look at 65/66 per quarter run rate in CASPI as kind of peak earnings for that business? Given that you're running flat out?

Until we get more juice, that's probably a fair way to look at it. And I caution you until we get more juice we continue to work on our mix, the way we use assets, and over time we expect to have a great story for CASPI; but for the time being, we are doing about everything we can do.

Thank you.

And for our next question we go to Jeff Zekauskas with JP Morgan.

Hi, good morning.

Good morning, Jeff.

Good morning.

A few questions. First, can you talk about why the PCI business is so much better this cycle than in previous cycles, and sort of the sustainability of this tremendous level of income?

The better this cycle versus pervious cycles is one reason, it's just bigger. Since the last cycle, we've added more stuff. So we have more leverage to an upcycle. We have been very explicit about trying also trying to upgrade our product mix. This is the time when you try to make choices about markets and customers and product segments; we have been doing that. We've made some reference to some longer-term operating agreements that we have made that have put some extra volume into our system to keep our utilization rates, and we continue down that road. The folks running that business have done a great job. They have more thoughts for continuing to improve it. I -- it's a combination of bigger and better and product mix, would be the three short answers there, Jeff.

Yes. Second question is, there was a dock announcement for a PET expansion in South Carolina where they talked about, you know, how their technology would eliminate the solid stating step, and it sounded very much like IntegRex. Is the technology similar or different, or are there advantages to yours or advantages to theirs? How does that stack up?

We are very aware of that announcement. That announcement -- we have some idea of what is meant by that announcement and we do not see a lot of similarity between their technology and ours. We continue to have a high confidence that our technology is going to generate some significant advantage for us. And the two were not similar as to the degree that we understand things.

Okay. And is yours -- do you think yours is a material improvement over theirs or is it similar, or do they just do the same thing in a different way?

I continue to believe that we're going to have a very strong cost position relative to our competitors, and the articulation of that in some detail is something we'll do in the September meeting giving you our best understanding of that. But this is truly -- the technology we have undertaken truly is very different process; it is not evolutionary, it is revolutionary. And I judge -- I personally judge many of the other changes to be more evolutionary in nature.

Okay. And last question is, why is fibers going to be stronger in the second half?

There are some industry structure changes, as we've mentioned, relative to some consolidations by one of our competitors. And the business in Asia continues to be pretty strong, so that's -- you know, I have alluded to that business is having a more positive future than we thought some years ago, and this is just a step along that path.

Okay, thank you very much.

We go next to Nancy [Trough] with Credit Suisse First Boston.

Good morning.

Hi, Nancy.

Hi. I wondered if you could give us a bit of an outlook for PET in the third quarter. How do things look, say in July versus, you know, the -- and what was the trend during the second quarter?

Well, as I -- you know, again, characterizing, we had our volumes improve sequentially first to second quarter. That's a seasonal thing that you'd should expect to happen in a normal year. We also improved our margins in North America. The competitive battle in Europe continues to rage on, and Latin America typically falls off during the winter period. As we go into the latter part of the year, that's the dynamic you start with. We believe that raw materials have probably bottomed out and that would indicate that the raw material drawdown is done. So as a result, we have a $0.04 price increase the out there for August that we are very supportive of that is out there, and we would anticipate following that with a price increase in September probably. And so I guess I'm explaining to you that we judge the supply and demand situation to be in pretty good shape going into the second half of the year. Latin America will firm up that -- as they approach their summer in South America.

Okay, and one other thing. What do you judge to be the biggest risks to your outlook in general for the company?

It's always this -- these sine waves that are generated by raw materials and pricing that don't always completely coincide with each other. If you remember, we had a difficult call with you at the end of -- the end of '04 call, where we were -- we pushed some of the business activity from the fourth quarter into the first quarter. So one of the reasons the first quarter was so outstanding is some of the stuff we expected to happen in the fourth kind of moved off into the first. So everybody was just all in a flap on the fourth quarter call, and the first quarter call, we were all exhilarated. And now here, you know, we have the same kind of sine wave activity kind of happening. It a -- it's a misalignment of those.

When I think about the trajectory of the businesses and what's out there that could upset the apple cart for us, we feel pretty darn confident about the basic business dynamics being in good shape. But on a very short-term basis -- I've used the word "chunky" before -- there are these big movements in raw materials and pricing that don't always completely coincide at any moment in time. Over time, they integrate and catch up with each other, and that's the biggest risk I see, frankly. We will see the economic recession or anything like that, as we don't have that cooked into any of our maps.

Thank you.

We go next to [INAUDIBLE] with Lehman Brothers.

Good morning.

Good morning.

Brian, I want to take a -- I have a PET question on this quarter. Some people might argue we have seen at least an interim peak in the PET cycle in the first quarter of this year. What's the real view for the first quarter of 2006 with your seasonally strong season?

The -- I mean, I've -- I think I've said before that in the world of PET, because of the nature of competition, because of the easy entry of entrance -- in this case the ability to convert fibers to PET -- the fact that everybody has pretty similar technologies, this is a business that we should kind of view as kind of continually on the verge of being oversupplied. It's one of those businesses where it you have one pound too many in the marketplace the prices drop like a rock, and if there's one pound too few in the marketplace the prices rise rapidly. Our -- and I would view that to be true today. It's true in the first quarter of next year, so if we get some more capacity in, it will start to affect things. Our whole approach to this is to put ourselves into a very different position relative to our performance, relative to our technology, and then we won't be nearly as sensitive to that down the road. That starts happening around the end of 2006. But when we talk about peaks and valleys, the peaks and valleys in this business are not like the ethylene business where it goes in 7-year runs. Increments and capacity come in quickly. Remember that the market in North America, for instance, gross some, what? 250,000 tons a year or something like that -- it's a big number. And so you have growth covering up some of that and they -- there are always little bumps -- it's like the stock market. It generally goes up, but it has lots of soft tooth in it.

Okay. And so as a follow-up, when you're speaking about improvements in [INAUDIBLE] technology, you're probably talking about integrators, and obviously that's great technology [INAUDIBLE]. Is it big enough -- in delta, big enough to make a difference for the Eastman total global competitive position?

Yes, actually -- yes. And we have more conversation coming up on that in about five weeks when we get to New York. We're going to be much more explicit about that. But this, it starts to make a difference immediately when we get the plan in, and then future thoughts have an even bigger impact on us. So we very much look forward to laying that out to you in more detail in about five weeks.

Okay. And sorry, lastly, on fibers, you talked about unfavorable product mix and how it will impact on earnings. I wasn't sure what products are out there besides aligning and [INAUDIBLE]. Can you sort of [INAUDIBLE] on what's coming forth?

Did I say unfavorable product mix? I didn't mean to say that. The fibers business is -- is being helped by restructuring of some of our competitors. We are -- we always have a mix of filter tow, acetate, acetyl chemicals and acetate yarn. The acetate yarn business is improving -- the acetyl chemicals are going strong very strong, as are the filter tow. So they're -- we occasionally have mixed shift between those, but it's -- rhe whole business is doing very well.

Okay, thank you.

For our next question, we go to Kevin McCarthy with Banc of America Securities.

Good morning.

Hey, Kevin.

Made a lot of progress on the balance sheet following the sale of Genencor. As you look ahead a year or two, where do you think your financial ratios would need to be to more seriously consider returning capital to shareholders, either via some share repurchases or a possible dividend increase?

At the end of this, I'm going to throw it over to Rich; but first of all, we feel very good about our dividend position. I would prefer at this point to grow the Company around the dividend. On the question of share repurchases, we always use that as a benchmark when we have capitol. When we're holding -- when we're holding cash, we use that as a benchmark against which you judge all other choices. If we want to invest in growth, we have to judge that against the benchmark, the bright line of what do you -- create -- have value to creative for shareholders by buying back stock. So far, we judge that we have opportunities to grow the Company more successfully than buying back the stock. But in terms of any comments about where our ratios are going to be, Rich, have you got any comments?

No, Brian, I wouldn't add much to what you said. Dividend, we think we are in good shape and returning a very fair percentage of our cash to the owners; and as you said, share repurchase, yes, we always have that as a hurdle rate when we look at future investments and we continue to see growth opportunities. We'll -- you know, we look forward to improving -- continually improving balance sheet and the ability to fund those growth initiatives.

Brian, if I look at table seven of your release, you have some sales volume trends by geography. I think they are quite muddy by the divestitures that you have made. If you have numbers excluding the divestitures, or if not, perhaps you can discuss qualitatively what you are seeing around the world?

I'm going to let Greg give you some of that color, but generally Asia-Pacific, Latin America doing quite well. Everybody has got their issues in Europe right now, because of the general economic situation. North America has been a pretty good story for us in growth. Greg, you want to give -- I've got to give you a second to get your numbers together with that comment. What you say?

Yes, I don't have numbers X the divestitures for the regions, the comments that you just made are correct. I mean, we've identified that in North America and in Europe, they specifically were impacted by that divestiture; but if you were going to look at the two, certainly North America is, from a volume standpoint, stronger than Europe.

Up in North America, up in Latin America -- up in -- Latin America double digits -- up in Asia Pacific a good -- you know, what is it, some 20% or something? It's a pretty good number. I think we had a middle single digit number like 5% or 6%, something like that in North America. Or maybe a little less. I can tell you -- I'm looking through the numbers here. And then Europe was just not so hot.

Okay. Then finally, in CASPI, since that was down sequentially in the second quarter, can you comment on the sequential trend looking ahead to the third quarter?

Talking about down in terms of volume?

Well, just operating income -- I'm sorry -- you know, to follow up on Frank's question, normally we'd see a seasonal uptick in Q2. Didn't get that this time around. How should we be thinking about the third quarter there?

Yes, again, they're -- they've got very good business, steady business, we are running about flat out. We're running about flat out, and I'd go back to kind of my 60/40 comments for the Company. You get that 60/40 because of this segment's kind of behaving that way. And that's about as far as I think I can go there, Kevin.

Okay, thanks very much.

We go next to Frank Dunau with Adage Capitol.

Yes, just got a couple questions. First, I think directed -- I mean, following on Kevin, I mean, you've had some significant share creeps over the last year. And I know on future -- prior calls you've said that you -- that your shares are undervalued, so I know you've got other calls for cash, but do we continue to see this share creep or do you have any plans to at least stop that?

When you share creep, are you talking about going from 79 to 82 million share?

Uh-huh.

What you see there is a company that has issued a whole lot of options over a decade, and a lot of those coming due with some pretty good performance. There is a limit to how far that goes. And when you run out of that, that's when the share creep starts to -- stops happening, frankly. I think -- I would hope the shareholders wouldn't mind too much that the good performance has allowed people to exercise their options. But I think the biggest wave of that's probably behind us already, Frank.

Yes, I mean, but a lot of -- you know, there are a lot of companies that when that starts to happen they just buy -- they at least go in and repurchase shares to keep the number equal to the original number as opposed to having a $3 million increase.

Yes.

And --

That's a topic we can discuss. I'll -- again, the whole availability use of the cash conversation is one I want to in a broader context than just let's talk about buying back shares.

Okay.

But I got your point, Frank.

I mean, just to [INAUDIBLE] this, I've got to [INAUDIBLE] one more time, if you had $90 million in from the exercise options, maybe you could do it -- maybe turn it around and buy back some shares with it.

I got you, Frank. I take the -- we'll take that into consideration.

And then the other question was -- and [DOW] has the same pattern in their specialty area -- sequentially, your margins contracted in -- in the three eastern divisions, first quarter to second quarter, and I guess -- and it was my understanding, I thought raw materials were down. But that may be wrong given what you buy. So why was there a margin contraction?

Well, again, these sine waves of pricing and raw materials don't always completely coincide. A couple things -- you lose the prices of polyethylene. There was an example of that where people quit buying in Asia, polyethylene prices fell. There was some looseness in activity in polyester in Asia, prices fell. They don't always completely coincide. If you look at them in short bursts like that, you can't do the math, you can't -- you would infer too much to infer industry structure or supply-demand affects looking over a two or in three month period. It just takes longer for those cycles to kind of coincide with each other.

And that's true in the three Eastman divisions, to0?

Well, yes, it is. I mean, that's just -- the -- for example, in the specially plastics area, we talked about margins contracting there, PX was down, AG was down, volume was up, so why didn't earnings go up? Because we chose to spend some money there for growth. That would be one of the answers there.

Just to -- if I could add onto that. You know, CASPI was basically the same. It was $66 million in the first quarter and $65 million in the second next to items, and then PCI went from 54 to 52. So there's not a lot of margin contraction that we're talking about here from the first quarter to the second quarter. And the first quarter was a very strong quarter -- both of them were strong quarters.

Okay, thanks.

We go next to Jeff Cianci with UBS.

Yes, hey Brian, just to follow up on that raw material question affirmative. If I look sequentially first quarter to second quarter on CASPI, are you suggesting that raw materials went -- that the pricing of CASPI actually went down sequentially? I guess I'm not following that.

No, I would say the pricing effect happened probably more in the PCI and polymers area. I am not aware of downward pricing -- there might be a few little products in the CASPI area.

Let me just -- let me just add to that, though. If you look at propane, which is a key raw material for the CASPI segment, it was basically flat if you take the average of the first quarter versus the average of the second quarter. Maybe a penny down, but not that much difference.

Okay. And you [INAUDIBLE] pricing then for CASPI, flat overall sequentially?

Yes, pretty much. I mean, some up, some down, but pretty flat.

Okay. So it was -- the [INAUDIBLE] was the average there. Thank you. And the other question was on the strong volume growth, on fibers, you'd said there was an opportunistic situation with competitors. Is that more of a permanent thing or do we have to give some of that back when competitors get their act together? What's the underlying -- would you say it's half underlying and half opportunistic?

No, there was a structural change there with some consolidations by -- with [INAUDIBLE]. But they consolidated some of their manufacturing operations in Canada and in acetate yarn. So those capacities are gone. And that has something to do with our business level.

Can we wrap this four quarters from now? Or is it -- four quarters from now?

Again, this is something that is a permanent effect. And you add to that there's interesting growth going on in Asia Pacific, it allows us to think about somewhat different positive trajectory for the fibers business going forward.

So when we look ahead after the opportunistic share gain, is this a 5% grower that used to be a 2% grower?

I wouldn't -- 5% may be a little bit more than you want to say right now. Again, I'm going to get into more detail in about four or five weeks. But we used to tell you flat to down, then we started telling you flat to up, and now we're just telling you up. And how much up, is your question. How much -- how much I'd rather get into with a more comprehensive discussion.

Okay, great. Thank you so much.

We go next to Chuck Peterson with Barklays Capital.

Yes, good morning. One easy one for you guys. The AR facility, how much was drawn on that at the end of the quarter?

That would be Rich's comment.

That's $200 million.

So flat with the --?

Yes, it's flat.

Okay, perfect. Thank you.

And for our next question, we go to Greg Goodnight with UBS.

Good morning, Brian.

Good morning.

Bridging off of Jeff's question with respect to this [inventor fissure] advance announcement, my understanding is that that was a development proposal for a continuous [pulverization] process. And my question to you is, has a [pulverization] process, a continuous one, ever developed, or is it suitable for producing PET resin quality materials limited to fiber type products?

You're asking about our process, you're asking about our?

No, the inventor fissure process in terms of continuous [pulverization] and in the past has continuous [pulverization] ever shown that promise of developing quality PET resins?

Yes, I'm going to get in over my head trying to answer your question. I really don't want to comment on somebody else's technology. I'd rather have our technology guys comment on that, but Greg would have to hook you up with somebody to talk about that. What I can tell you about our process is that we have taken a dramatically different approach to the whole process from the front to back. And that it results in a dramatic difference in capital efficiency and conversion costs both. The -- and we -- of course, we make PET resin. Whatever -- there are processes that will make fibers, that can also be converted to PET in a continuous fashion. But I'm going to get over -- I'm going to say more than I know if I try to answer your question. Greg could hook you up with somebody that could give you a better answer.

Okay, great. I will talk to you about that in September.

Okay.

Second question, I was a little bit surprised of your characterization of North American PET in the second quarter. One of your competitors was indicating that at least in their opinion that they thought volumes were down due to inventory correction at the customer level.

Yes.

Did you see any of that? And what do you believe growth is going to be this year in PET resins in NAFTA?

Remember, the demand growth is pretty darn steady. The demand growth is, you know, about a plant a year or something greater than a plant a year. And that is something we kind of see happening year in and year out. The supply growth causes that to vary. The inventory swings that happened with Asia coming in or Asia coming out, or people doing things to change the apparent demand -- people will buy early or they will hold on to products -- but we did improve our volumes sequentially from first quarter to second quarter. Our margins did expand in North America from first quarter to second quarter. We continue to feel very good about our position in North America and that's why we are investing in North America. So just to be clear, we still see growth in this region. We see it as being pretty steady growth in North America and our variability happens to us more in Europe and Latin America than it does in North America.

Okay, thanks for the comments.

For our next question, we go to Chris Willis with Impala.

Good morning. Could you provide a little more clarity on pricing in the chemical intermediates segment? Maybe you can talk a bit about broad groupings, but just give us some order of magnitude of how much pricing was up or down in some of the bigger areas?

The oxos and the acetyls -- these are the products that come out of Texas, and acetyl chemistry is kind of the chemical that come out of Tennessee -- continues to be strong because both supply and demand remains tight. Remember, when we talk about the intermediates, there's two kinds of steps in the value chain you have to do the math on to figure out how margins works out. There is the basic margin you get because you make olefins, and when olefins are tight you get a margin because of that. There's also the margin for supply and demand on the derivatives. Our derivatives are fairly tight, and so we've had had our pricing power either to hold or to raise in the oxos and the acetyls, and there's a whole bunch of them, so I can't make one blanket statement. And of course, then you add onto that whatever's happening in the olefin cycle, which should be at this point bottoming out and things starting to pick back up again.

Okay. And my other question, can you give us any sort of a sense of how much of your inventory build was raw material versus finished product for sale?

It was both. I'm not going to break it out for you, but it was both. And you know, remember, we have an interim year cycle where we build working capitol in the first half of the year because we're selling stuff in the middle of the year and the end. Same pattern this year, so we had both. In the case of raw materials, some of that was a financial decision. We wanted some physical hedges to put some stuff in the ground when we thought we could get a better price on it. In some cases, it was preparing for fast selling seasons. And so it was a mix of both.

Mm-hmm. Great, thanks. Appreciate it.

We go next to [Kudal Benergi] with Morgan Morgan Stanley

Good morning, Kudal.

Yes, good morning, Brian. Just want question regarding your Latin American strategy. Someone had told me you were thinking of investing a little bit down in Argentina in PET. I'm just wondering whether that's a market, and the [INAUDIBLE] market that you are better off serving from up here. Because it looks to me like [INAUDIBLE] has made a pretty active move there with its base plant and is showing more commitment now, with the PTA investment as well. What is the -- the question would be, is that an IntegRex investment as well? Or if not, why just go with a plain vanilla investment in Argentina?

Well, first of all, we haven't announced or even hinted at any kind of an investment strategy in Latin America. So that's the first comment. We consider the full range of choices for all the regions all the time. And we explored the math of doing those things. That exploration is always far from making decisions, so you would infer too much if you say that we are planning some kind of an investment down there. It is true that we explore all kinds of options. We will be talking more about the kinds of choices that we are making in the upcoming Investor Day, but the -- what you've heard us say more often than not is that our strength is in the North American region. We've chosen to invest there. And that's as much as we've said so far.

Okay, that's comforting to hear. So it is North America and you would think very hard about Europe and Latin America then?

The strongest region structurally and our access to markets, our access to customers, is North America. We continue to look at options all around the world. We'll continue to explore those -- we would be dumb if we didn't do that. We have to understand the competitive dynamics everywhere. We'll talk about the range of choices that we're thinking about in about four or five weeks. Again, I don't want to get ahead of myself because if I tell that story without all the data behind then it's just -- it's a half story. So I'd rather just tell whole story in New York on September 7th.

All right, thanks, Brian.

And we go next to Michael Judd with Greenwich Consultants.

Yes, thanks for taking my question, Brian.

Sure.

Couple of questions on raw materials for PET. What other transfer raw material prices for paraxylene and ethylene glycol in the third quarter, and if you had some -- and I apologize if you already mentioned this before, but what are the trends also in the third quarter for PET please?

The -- whenever you try to call these trends, you are right about -- as usual -- about at half the time. But what we was experienced recently is a reduced activity in Asia, therefore reduced the demand for paraxylene and EG in Asia. That washed around the world as an impact on raw materials. And raw materials fell as a result. That was paraxylene primarily. The -- we think that the EEG has been strong and it's on the verge of being less strong. But I would -- I would anticipate that paraxylene is going to be in increased demand again by the Asians as their economic activity for fibers picks up. That's going to have an effect on the raw materials in the latter half of the year. Let me pause to see what Rich and Greg would like to add to that.

Well, I'd echo the same sentiments. We see paraxylene increasing in the second part of the year. And that's part of the impetus for our price increase announcement for August.

Terrific. And secondly, CASPI, and I may have gotten this wrong again, but did you mention that pricing was fairly flat in CASPI?

Yes, CASPI is a collection of dozens and dozens of products, so in the aggregate, pricing, I think, was pretty flat, as were the raw materials.

That's a sequential comment. Year-over-year prices, CASPI prices were up pretty nicely.

Okay, I guess my question is, you know, are -- have you reached a point where with price increases, you know, at least from a sequential perspective as you move forward, are you willing to walk away from some business in order sort of a little bit more aggressively push through higher prices in that business?

All across the Company -- that's a good question -- all across the Company, when you are in the situation we are in, we are making choices about future mix, future customers, future products. And we have been -- very explicitly have been adjusting mix and customers and products, to not only think about the cycle but to think about years beyond this cycle. So yes, that is absolutely going on. To characterize these segments, remember, I put a base out there that was fibrous CASPI and specialty plastic. We have said to you that the fibers business is a 20% to 25% operating margin kind of business, and it continues to be in that range today. We have described CASPI as a 15% to 20% kind of an operating margin. You see that it's at the upper end of that right now. And we've have describe, especially plastics, as sort of a 10% to 15%. You put the three of those together, you weight them out and you end up with something in the neighborhood of -- what, Greg, 15% to 20% kind of an operating margin for that group of three. And we expect them to pretty much stay in that area pretty much -- you know, most of the time.

Okay, Great. And lastly, just another volume question. We've been hearing from a number of chemical companies over the last week or so, you know, mentioning that, you know, volumes look like they will be up in the third quarter, but there's quite a bit of concern about higher raw material costs. So there's a big impetus to push through further price increases. Is that generally your view also?

Yes. I mean, again, you're at least protecting margins. I've described a situation where supply and demand is fairly tight in a lot of our derivative. When raws go up, we've not only got to capture that for sure, but if there's also extra tightness, we've got to work on expanding the margins as well.

Thank you very much.

And just a general comment, we are feeling optimistic about the business outlook. We think it's going to be okay.

And we go next to P.J. Juvekar with Smith Barney.

Yes, hi. Good morning, Brian.

Good morning.

You know, you mentioned that PCI profits went up as your financial profitability went up. Can you just try to split exactly the profitability for us? How much of that goes into PCI versus polymers?

I'm going to try to do this, but you know, again, I don't want to get behind our reporting protocols.

Okay.

The vast majority of our raw -- of our interdivisional raw material transfers are done more at the cost basis than on a market basis. So that's another way of saying that the PCI guys to make the olefins don't get a margin on most of the stuff that they transfer to their brethren in the other four segments. So most of the margin associated with making olefins either shows up in the polymers area where you make polyethylene, or it shows up in CASPI where they make the derivatives, or it shows up in the products that PCI sells directly. So, you know, to get the map that you're really looking for, I'd have to give you how much of the olefins are sold directly by PCI as their derivatives, and I can't easily go there in a conference call. We might be able to help you with Greg doing some work, but I think what you're trying to get to is how much leverage is there against an olefin cycle, and it will be easier to give that to you in the aggregate with the map that we're going to give in about five weeks because we give some -- the mountain charts kind of show how we think the whole cycle affects the company.

That's fine. And then secondly, the other question I had was on PET. You know, if you look at [EMEI], they're looking at double digits for [INAUDIBLE] in 2005, and 2006. But I'm wondering in Asia with oil and [PTA] prices up, has any of the capacity been pushed out?

Any of the new capacity in North America?

[INAUDIBLE] in Asia --

Asia. It may have been pushed out in Asia. Asia is really -- is just going gangbusters on fiber. But they're having a little pause right now, but fiber is a big deal for them. And they always make these trade-offs between fiber and PET. One of the things to keep in mind when we start trying to do global math on these commodities is that logistics now, are sometimes two or three times the conversion costs. Logistics have become a big deal in the global math of moving low-priced commodities with narrow margins. And so it tends to create more regional dynamics -- the competitive dynamic tend to be more regional in nature, and it takes a pretty big arbitrage of some kind to start getting that big cross-border traffic. And I'm really talking about us versus Asia. I think that the hurdles for getting from Asia to Europe are different in the lower, but Asia to here, logistics is a big deal. So even if they push it out or don't push it out, it's really more about how much of an arbitrage in pricing is there between Asia and the U.S. And that's really what drives whether it comes in or doesn't come in.

Right. And then a few years ago, there was the whole issue of bags versus railcars, where the Asians were shipping in bags, and then, how is that issue playing out? I mean, is it still an issue or you can overcome that? Or the Asians could overcome that.

Well, they're clever folks, they'll overcome as much as they can. But the point is, you've got to go, you know, 6,000 miles, get it into a different conveyance and then move it to St. Louis. And that continues to be a big deal for a commodity, where you might make a few cents here and a few cents there. The physical logistics of whether it's a bag or a container I think are the sort of things people can invest capital and then they get have to get returns on that, they can change that. But I really -- again, the one good thing about the PET business is that the raw materials tend to level around the world. EG and paraxylene do not usually have big regional arbitrages is between them. There was a time when that happened and it caused some grief, but they tend to level out. That means that you're fighting it out on conversion costs and logistics, and since everybody has similar technologies except for the one we are going to have, the conversion costs are pretty similar. So the logistics all of a sudden become a big deal in that equation. It means that we end up with regional dynamics in North America that tend to be more isolated -- same in Europe, same in Asia.

That's a good point. Thank you.

We'll make the next question the last question, please.

And for that question, we will go to Jeff Zekauskas with J.P. Morgan.

Very quickly, on the fibers business, is the second half -- is the second half strength coming from volume or price? And then, in terms of IntegRex and the monies that you're spending and your returns on capitol, you know, you basically have a very difficult industry structure in PET. So, I mean, isn't it better to license that technology, or are you just throwing good money after bad?

The first question on fibers, the strength is coming through mix and volume. And prices are not changing so much. Prices are changing in a wide acetate yarn. But for the aggregate of that, it's not changing that much, I don't think. It's more about mix and volume.

Okay.

Regarding hour first IntegRex investment, we are through that investments increasing utilization of existing PTA assets to the high level.

Yes.

You get capital leverage. You get a much higher capital efficiency, much lower conversion cost. That is an absolutely great investment. Now in July -- excuse me, in September -- we're going to to talk about the combined array of technologies we've developed that start at the front of the horse and go all the way to the back, and how much of an advantage we can create. And then I'll let you judge when you hear that story whether the you think it's throwing good money after bad. We'll let you judge.

Okay, I look forward to that sustained PET profitability.

Okay.

Okay, thank you.

And with that, Mr. Riddle, I'll turn the conference back over to you for any closing remarks.

Okay, thanks again everyone for joining us this morning. An audio replay of this conference call will be available this afternoon through Friday, August 5th. And as always, I'm available to answer any questions you might have through the day. Thanks again.

And ladies and gentlemen, this does concludes today's Eastman Chemical Company second quarter earnings conference call. We do appreciate your participation and you may disconnect at this time.