伊士曼化學 (EMN) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to the Eastman Chemical Company third 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 now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Mr. Riddle, please go ahead, sir.

Thank you, Rufus, and good morning, everyone. Thank you for joining us. With me on the call 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 fourth quarter 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 third quarter 2005 financial results news release on our website and in our filings with the Securities & Exchange Commission, including the form 10-K filed for 2004 and the form 10-Q to be filed for third quarter 2005. With that, I'll turn the call over to Brian.

Good morning, everybody, and thank you for joining us. As usual, my prepared comments will go over some corporate highlights, some comments about the segments and the regions and I'll try to give you a little more color about the fourth quarter at the end of my comments. Last night, we reported all time record sales revenue and strong third quarter earnings despite a very tough business climate toward the end of this quarter that were marked by raw materials and logistics disruptions and sharply higher costs, as you all know. When you break these earnings down by segment, you will notice that we, once again, benefited from our very strong base of earnings, which consists of our fibers, CASPI and specialty plastic segments. Taken together, these segments had an operating margin of 19%, both in the third quarter and for the first nine months of 2005. So very steady in those segments. We've also had good earnings from our more cyclical polymers and PCI segments. As a result, we reported third quarter earnings per share excluding certain items of $1.53, which is 90% higher than the quarter a year ago.

This earnings improvement was despite an increase of more than $100 million per year, year-over-year in our costs for raw materials and energy. And that was particularly true in propane, paraxylene and natural gas. Year-to-date our costs for raw materials and energy have increased by roughly $400 million. We are continuing to work on offsetting these higher costs and the resulting margin compression through a combination of cost reductions and improving the mix of the entire Company portfolio, through risk management activities and, of course, higher selling prices. I'd also like to point out that we had a great organizational response throughout the Company to the impact of the hurricanes. I never cease to be amazed at the dedication and the capability of our Eastman employees. They did truly remarkable things and we're proud of everyone of them for what they did there.

As a result, we remain on track for one of the best years in our Company's history. Now, turning to the segment results. The Fibers segment had their best quarter in more than eight years with operating earnings of $58 million. This improvement was driven primarily by the structural changes in the acetate tow and acetate yarn markets that we spoke about with you in our investor day in September. Their sales revenue increased by 24% year-over-year, driven by higher volumes and prices both. Turning to the CASPI segment, our operating earnings were $65 million, essentially flat compared with the first and second quarter. Year-over-year their operating earnings improved by about 50%. Third quarter operating margin was just under 20% and their operating margin through the first nine months has been 20%. So they're again fairly steady. They are also benefiting from continued cost reductions and they have strength in both their specialty products and their more cyclical commodity products at this time.

Specialty Plastics operating earnings were about $17 million, which is down $4 million from a year ago, excluding some items. Volumes declined by 3% as a result of some difficult price and volume tradeoffs we're having to make in their various markets in this time of rising costs. In addition, as we told you in investor day, we are investing in some growth programs for this segment and this has added some additional costs to the Specialty Plastics segment but we're still very encouraged by all of the future that they have in front of them. Turning to the PCI and Polymers results, PCI operating earnings were $47 million, which is a significant increase over third quarter 2004. Their year-to-date earnings are over 100 million more than a year ago. A few points about the volumes in the third quarter for PCI. In the third quarter of last year, we implemented some long term supply arrangements with some key customers, and this is the first time that you are really seeing a before and after comparison of those volumes.

In addition, I would add that PCI is a basic engine for our Company and as a result, their streams are often diverted to other parts of the Company when times are tight, as they are now. Also, PCI continues to make very deliberate choices to improve the quality of their mix, and that is positively impacting their results. PCI third quarter operating earnings also include $10 million from an as acetyl technology licensing agreement. The Polymer segment operating earnings were $27 million, which is substantially higher than the third quarter of 2004. The year-over-year improvement was primarily due to higher earnings in both the PET and polyethylene parts of that segment. Sequentially operating earnings declined due to higher propane prices, which compressed margins for polyethylene. We had a typically light winter season in Latin America.

There are low industry utilization levels in Europe for a variety of reasons and in North American PET we were confronted by some very adverse market conditions due to the hurricanes in the Gulf coast. Some statistics there, the paraxylene prices increased about 50% from August to September. There was and continues to be limited availability of both paraxylene and ethylene glycol due to declared force majeures of key suppliers. And we faced much higher energy costs, primarily due to a greater than 40% increase in natural gas from August to September which, by the way, have increased another 30% from September to October. So some very dramatic increases in energy costs. Despite these challenges, we were able to pass along much, but not all, of the hurricane related variable cost increases in the form of temporary surcharges. However, we did absorb all of the cost increases related to reduced capacity utilization. Some comments about the regions, which we don't always do. North America revenue has increased 9% year-over-year, primarily due to pricing.

The third quarter operating earnings in North America increased 75% year-over-year as a result of pricing and cost reduction efforts, which have more than offset some of the higher costs. In Europe, revenue was flat year-over-year. We had higher prices and better mix, but we also had lower sales volumes. Lower volumes were mainly due to the divestiture last year of businesses in the CASPI segment. A real bright spot is Asia Pacific. In that region, revenue has increased about 22% year-over-year due to strong overall growth in that region. Our operating earnings in Asia are up over 60% year-over-year, primarily due to continued improvement in the Company's mix of products there. And that's that story we've been telling you about for some time. In the Latin American region, revenue is up 27% due to very strong growth in several of our businesses there.

Now I'm going to make some comments on the fourth quarter outlook. You will note in the release that we did not give any guidance for the fourth quarter. Typically, Eastman fourth quarters are lower than Eastman third quarters due to the normal seasonality of our Polymers and our CASPI segments. The current first call range of estimates for the fourth quarter is today it's $0.78 to $1.48, which is a really large range, as we all know. I think the reason that range is so wide is because it reflects everyone's understanding of the high degree of volatility that exists in the market today and the wide range of economic scenarios that could play out in this quarter. We have a lot of moving parts in the quarter. The cost of our key raw materials in the after math of the Gulf coast hurricanes continue to fluctuate daily. We have significant capacity for key raw materials that continues to be down as a result of the damage from the hurricanes and we still don't know exactly when that will be up.

There are also varying estimates to how much the higher raw materials and energy costs will affect overall economic growth and, of course as I said, we have normal seasonality. So those are the headwinds. The things we're doing to take actions to offset this are working with our customers to pass along higher raw material and energy costs in the value chain, reducing costs across the Company, and are continuing to benefit from all the actions we've taken in the past. But because of the significant volatility, that's as much as we have been willing to say. We think that that range is -- reflects the kind of scenarios that could play out. We're not willing to give much more pinpointed guidance than that. With that, I'll turn it over to Rich.

Thanks, Brian. Good morning, everybody. First I'd just like to add my thanks and recognition for the tremendous response of our employees to the impact to the hurricanes in the gulf. It was fantastic. As Brian outlined, we reported third quarter earnings of $1.53, excluding items. I would like to mention again that these results were bolstered somewhat by the licensing income in the PCI segment for the acetyl technology and that was about $0.08 a share. Moving on to cash flow, we generated $165 million in cash from operations in the quarter and 374 million year-to-date. Included in that, we finalized our pension contribution for this year by making 103 million contribution to the defined benefit pension plan here in the U.S. during the quarter. And on a year-to-date basis, that brings that up to 165 million. And that sets us at about a 90% funded level. And as we've discussed in the past, we feel comfortable with that.

Net working capital remained about flat in the quarter. And that's despite the increase in the cost of raw materials and how that hit inventory and the increases in pricing, which, of course, pushes up our accounts receivable. So we felt pretty good about remaining flat for the quarter. Capital expenditures are 224 million year-to-date with 100 million coming in the third quarter. And this, of course, includes the spending for our new IntegRex PET facility in South Carolina, which continues to be on time and on budget. Looking forward, we continue to expect our capital expenditures to fall in the range of about 340 million to 360 million for this year. Just mentioned the dividend during the quarter. We paid a dividend for the 47th straight quarter as a public company. That leaves me to summarize our current financial position. Our net debt is now under 1.2 billion, which is our long-term borrowings of 1.436 billion netted by the cash we have on hand at the end of the quarter of $286 million. Our stockholders equity has increased to just under 1.6 billion this year, and that's an increase of over $400 million so far or about 35%.

Our priorities for cash right now continue to be, obviously, fund the dividend and funding the targeted growth initiatives that we've discussed. A few other items to cover. We're evaluating repatriating accumulated foreign earnings under the American Jobs Creation Act. If we decide to go forward with that, we'll repatriate somewhere between 325 million and 375 million. Assuming we do that, we would recognize a related tax charge of somewhere between $15 and $20 million. However, we do have some other offsetting tax items and we do expect our overall effective tax rate for the year to stay at approximately 30%. One other minor item I want to mention is that the $4 million of asset impairments and restructuring charges in the quarter, of that $3 million is related to the final shutdown cost of Cendian, which really closes the book on that. With that, I'll turn it back to you, Greg.

Okay, thanks, Rich. That concludes our prepared remarks this morning. Rufus, we are indeed ready for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] For our first question we go to Mike Judd with Greenwich Consultants.

Good morning and congratulations on a good quarter.

Thanks, Mike.

The energy surcharge that you put through on PET, does that run out at some point? What's the timing? Are there any timing issues there and do you have a further energy surcharge that you expect to push through there?

The nature of a surcharge, Mike, is that you're trying to just deal with the dynamic nature of the raws and not anything else. So the answer to your question is it's going to follow the timing of the raws movement. If they ease off, we'll be responding in that direction. If they stay high, we'll be responding in that direction. So that surcharge is all around what's going on with the velocity of the raws. And it just depends on what they do. It's doesn't have the same characteristic as a price increase which sticks around for longer periods of time.

And secondly, congratulations in the fiber segment. You did a great job there. And I'm just interested could you comment on the seasonality of that business?

This is a business that typically is chunky. We use the word chunky a lot with this business. But it's not about seasonality. The chunkiness comes in ordering patterns, global ordering patterns. This is a very global business, a lot of business in Asia. We see surges high and low in the demands in the global customers that we have. And they're not necessarily tied to seasonal issues. It's about their inventory management practices. We've had a pretty good growth spurt here, as you can see, in the fibers and we don't anticipate this kind of growth spurt to continue. We have characterized this as a 3% annual grower with operating margins in the 20% to 25% kind of neighborhood and that's how we continue to characterize this. We got a little bit ahead of that curve here recently but it's still very steady, very strong business.

Should we use the 58 as a base or is that really too high because it just kind of -- it includes some sort of catch up or something?

I think I would look at the year and kind of think about that year as being kind of a typical year. But it may be -- the growth rate would be a -- I wouldn't want you to extrapolate the growth rate that you have seen here year-over-year. But this year might be kind of typical of what you would see next year.

Thank you.

We go next to Frank Mitsch with Fulcrum Global Partners.

Good morning and nice quarter. Brian, in some of the previous recent quarters where you've posted strong results, you've also commented on your -- the low level of your share price. Obviously, we're back at those levels here today. Rich was mentioning no need to further fund the pension plan. And it appears that you're going to be repatriating some cash that certainly can be used for some of your growth initiatives that you've outlined. Any steps on the horizon in terms of addressing the share price or share repurchase?

Well, Frank, you beat Frank Dunau on asking that question. Congratulations, I now Frank's biting his lip right now. This is a question, I think, is a top-of-mind for a number of our investors and we are sensitive to it. As you remember at our investor day, we didn't rule it out. I think what we said is we have spent our money this year on good things. We fixed our balance sheet, we fixed our pension, and we are going to have a little bit of money left over this year. We said also that we wanted to have some time to sort out our thoughts on these organic growth -- targeted growth opportunities that we worked on. All of those -- we're setting up the priorities, we're making great progress on getting started on all of those and we're very encouraged by all of those.

Frank, I am probably a year away from making a more substantive comment because I judge that it's about a year before I have the kind of decision point that you're talking about. Today I don't have a lot of money to spend on some kind of a stock buyback. And we have a number of things ahead of us to sort out and decide over the next year. We are probably a year away from making some kind of a substantive statement on the question that you're asking. I just will say again that our priorities are to fund our growth initiatives and then we are always focused on using the money wisely to provide a good return to our shareholders. And that is very much in the front of our minds.

One of the things that struck me at your investor day was talking about your growth initiatives, it didn't strike me as utilizing large sums of capital. And it looked like you're going to free up another 300 plus million with the American Jobs Creation Act. Am I missing that? Was I wrong in terms of the expectation of massive amounts of capital needed for your growth initiatives?

Frank, this is Rich. Let me say, at least on the repatriation cash, that's more or less moving our existing assets around as opposed to generating fresh money. So I wouldn't say that that's going to be additive to our overall cash flow.

But your general sense of your question is still right. We have not given you any kind of an outlook that says that we have truly massive capital expenditures. But again, Frank, I just want to reserve the right. I'm very cautious about -- you remember in the dialogue we had over the other questions you've had in the past about whether -- how you fix CASPI or how you fix Genencor. We were always cautious about making statements when it was time to make statements. This is another one of those cases where we keep our powder dry and make a statement when it is time to make it. And it's just not time.

Terrific. By the way, there was a great article in the Journal this week regarding companies repatriating cash and announcing share repurchase programs, although that was not the intent of the American Jobs Creation Act. And then lastly, given your comments, and thank you for the puts and takes on the fourth quarter, is there a likely scenario out there where you fall below the $0.78 low end of the range?

We don't see a scenario where we have a turn down like we had last year. You know, last year was a pretty significant turndown in the fourth quarter. We are not foreseeing that kind of a turndown. It's just that there are so many moving parts there, Frank, I got a bigger chance of being wrong than being right in trying to give you a more pinpointed outlook. So, we're just going to try to be quiet on that. But, no, I don't see the kind of turndown we saw last year.

Terrific. Thank you.

And we go next to P.J. Juvekar with Citigroup.

Good morning, Brian.

Good morning.

(indiscernible) on cigarette filter tow, you had mentioned that in places like China that the filters are lengthening by 30%. Now, is that -- was that a step change in one year because of some regulations or is that something that could slowly go on for several years?

Yes. Your question is a good one, P.J. We were a little surprised, I have to say we were a little surprised at the rate of increased demand in Asia, ourselves. And we always have to make judgments about how much of that is about their anticipation of the thing that you said, the buyer's anticipation of the raising of the lengthening filters or is it the reality of the lengthening filters. I don't have true visibility on that. Again, all of the best information we have says that as we look over time, this should be about a 3% grower. We got ahead of that curve. Now, again, we were surprised this year. I don't have any reason to say that I'm going to be surprised next year, but we're still looking at that kind of a 3% normal growth rate.

Yes, but if the cigarette filters are really lengthening, this could be more than 3% growth.

Yes. And again, I don't want my statements to get ahead of what I know. I don't have any hard data that tells me what's going to happen there. So, until I have that, I'm going to rely on what I know.

Okay. And then on the specialty plastic side, you made a comment that there is some demand restriction because of higher prices and not many companies have said that. So maybe you may want to elaborate on that.

I'll be happy to. They face some of the same problems our polymers guys do in PET. There has been some disproportionate impact on the availability of PX and EG that has affected anybody that makes polyesters. That has not been the same kind of proportionality that has happened in some of the other competing polymers, like polycarbonate, acrylics and others. So we've had to make some very careful price and volume tradeoffs with our customers. Our objective here is to retain a long-term business relationship with our customers and to do what's necessary to maintain that continuity. And it caused some difficult tradeoffs.

We judge that this is a bump in the road, just so you know, this is a bump in the road situation for them. And also, again, I want to reinforce that we have some really exciting growth initiatives going on in specialty plastics area, and they are making great progress on those. But the cost of investigating those and pursuing those are being borne inside that segment. So again, another little bump in the road.

Okay. Thank you

We go next to Jeff Zekauskas with JP Morgan.

Hi, good morning.

Good morning.

You spoke of the difficulty of having visibility in the fourth quarter. But surely, October must be relatively transparent.

Yes.

So, you know, when you look in the polymers area, you know, how does the month of October compare to the averages in the third quarter.

October is -- it is very visible to us. Our problem with fourth quarter numbers is typically what happens in December. People come back after Thanksgiving and they just quit buying. In October, we have a strong demand scenario, which as you might well understand. Supply is short, demand is high. The equations we're trying to wrestle with are all about cost equations. Many of the effects of the hurricane season will show up more in the fourth quarter than in the third quarter, because we just had a September effect, really, in the third quarter. So we have that in front of us. We have the Asians taking advantage of a temporary arbitrage in paraxylene, where it's a little bit lower in Asia than it is here in the States. So they have a bunch of stuff on the water coming this way.

They're shipping into a tight market and that arbitrage opportunity won't last terribly long. It will be gone before the end of the year. But that's an unknown for us, as to how much that gets in the way of the quarter. Our procurement situation, we have -- it's been a challenging September and October, I have to tell you, but we have been able to serve all of our customers by pulling down inventories all through the supply chain. EG will continue to be challenging in November but we'll have the supply to meet our needs. PX will be challenging but there shouldn't be any market shortages. Operating rates in North America are probably 70% to 80% range, I'm guessing right now, and that will increase as the plants come back online. Of course, while you're spending time at that 70% to 80% rate, you're incurring some higher costs because of the lower utilization. So if there's -- there's probably a few more headwinds than there are tailwinds on polyesters in this quarter. We're working hard to overcome those headwinds.

So if I understand what you're saying to me, Brian, you're saying, well, you know the margins in October are pretty good, but we really don't know whether they're sustainable over the next two months.

Yes. And then -- that's probably the best way to say it. And the impact of the Asians and the order patterns that happen at the end of the year are the two biggest variables there.

If I can ask a question on fibers. So pricing and fibers, I think, in the quarter was up 13%.

Yes, overall.

Now, how did you do that?

Remember that the fibers division is a combination of filter tow, it's acetate yarn and it's acetyl chemicals. And most of that pricing activity was in the latter two, the yarn and the chemicals. Fibers prices are negotiated over longer periods of time with our large customers.

Right. And in terms of the volume growth, was a lot of that in China or what was the volume growth in the quarter in China for you in fibers?

We have -- we don't break it out for you, as you know, but we did have volume growth because of higher filter tow demand in Asia. We had higher volume because of acetate yarn sales because of the rationalization that occurred with one of our competitors. And we had higher volume and sales and price for the acetyl chemicals because we're a low cost producer of some of these basic building blocks, like cellulose acetate flake, and people come to see us to buy as much of that as they can. So, all of those were -- it was several factors. It was hitting on all cylinders, one of those hitting on all cylinders stories there, Jeff.

And then lastly, you talked about using this year's operating profit as a base and then you said that next year would resemble this year or we would grow 3%. Are you trying to say that next year would be flattish or you would grow 3%?

We're getting a little ahead of our next year projections because we usually do that a quarter from now. We're still sorting out the annual business planning process. I don't want to get pinned down too tight. I guess the point is that this is a business that doesn't swing a lot. You're seeing a very good year. We expect them to have a another very good year next year and I'm not good enough right now to say up or down or sideways 3% on next year until we get through our planning cycle here.

Is the tax rate 30% for the year including the Jobs Creation effect or excluding it.

That's including the jobs creation effect, Jeff.

Okay. Thank you very much.

We go next to John Roberts with Buckingham.

Brian, is there any update on the joint project with the utility on a coal-based facility that would be power and you would have a chemicals facility there.

No update I can talk about, but a lot of discussion and thinking and working going on there. This concept of relying more heavily on coal as a raw material is very alive and very active inside our Company. What a great time to be thinking and talking about this when you look around and see what's happening in the business environment. And so that just accelerates our activity and our thoughts on that. Again, we just got cranking pretty hard on this. We gave you some insight into that on the investor day so that you wouldn't be surprised if we do announce something, but today's not the day and when it's right, we'll say something. We're working very hard and we are very encouraged by the progress we're making.

Back to Frank's first question, would that be materially capital intensive for your share. It can be. It depends on how we do it, but I think when we gave you an outlook on investor day, we were contemplating the likely scenarios for how we would spend money on that. It was contemplated in what we gave you on investor day. Thank you

Our next question comes from Sergey Vasnetsov with Lehman Brothers.

Good morning, Brian.

Good morning.

I understand the future is always uncertain. The best way to make it certain is to look in the past. But when you thinking about your decision to postpone share buyback for another year, I'm just curious what are the factors that are influencing that? Is it that you decide to drive to lower debt to capital ratio, in which case maybe you can share your progress there. Is it the more confidence in your recently strong results continuing rolling forward? Is it frankly, lower share price that makes it more attractive? What could it be?

I start with trying not to spend money I don't have, Sergey. I think we're not in a position -- we're not DuPont. We didn't have a bunch of money sitting in a sack someplace ready to use. We don't have that situation. We want to take a measured approach. We have just now had three really great quarters in a row and we are still sorting out our options and way of going forward. And we don't want to say things that are premature that we can't execute on. So, we're going to wait until it's time and we'll assess the situation.

Okay. And my second question is about raw materials. It's an extension of Jeff Zekauskas' question earlier. You pretty much know your raw materials in the month of October by now. How do they compare with your average fourth quarter and maybe September?

Yes. They're still very high. I have to say, they're high and steady is what we're seeing. You can look at the forward curves from natural gas. That's one of the big effects. Natural gas forward curves are around $14 per million BTU. They're just very high and steady.

Okay, thank you.

We go next to Kevin McCarthy with Banc of America.

Good morning, guys, and congratulations. I think every quarter when I see your fibers number my eyebrows raise, Brian, in a good way. If I look at the profitability year-to-date in that business, is there a way where we can carve it up as to improvement as a function of the change in the higher growth profile versus, perhaps, a change in the industry structure given rationalizations at your primary competitor there.

Yes. And I'll try to do my best there without going overboard. You've seen a big growth spurt here and I think most of what you're seeing there is structural because of what some of our competitors did, like the turn around on the acetate yarn, high demand for our acetyl chemicals because of our good coal cost position. If we look at the fibers business, again, if we took that part of it, it should be a 3% grower year in, year out. But, as was pointed out, there are some uncertainties in Asia that could kick that up for a while. So there are a couple of step [tant] change effects. You've seen most of the structural impact. There could be something that goes on in Asia, we don't know. But year in, year out that 3% for the fibers pace -- and the fibers is, you know, I don't know if you’d characterize fibers as a percentage of that total segment, but it's a healthy percentage of it, more than half. So, that's as much characterization as I feel comfortable giving, I guess, Kevin.

Okay. Then a clarification on your PET surcharges and as different people were out with some different numbers, can you talk about how successful that was. And also, perhaps, Rich, accounting-wise, do you account for the surcharges in the exact same way as you would a price increase or are there some subtle differences or accruals involved there.

Let's get Rich to answer that part first.

Yes. We record the surcharge just as we do anything else. There's no -- we don't discount it. We've had our customers agree to the surcharge and we bill it.

How much was accepted, the entire amount?

The success of the surcharge was that -- I think the way I would characterize it, we experienced margin compression from Q2 to Q3. If I think about price over raws, we experienced some margin compression. The surcharge recovered much of what would have happened but not all. We also absorbed sort of the fixed cost effect of running things at lower rates. We didn't try to recover that in the surcharge. So the surcharge was about what was happening in price over raws. We put that out there to try to recover that. We got most but not all. So we had some margin compression. And then the lower operating rates are just something we had to deal with ourselves.

Did you expect to maintain a surcharge every month as a matter of practice or is it more temporary in nature.

I'd rather have the business guys talk that over with their customers than make a comment to you on the conference call. I think there's a realization in the marketplace that, with these dramatic moves in raws, we have to work with our customers, closely with our customers, to move this through the value chain appropriately. We are working very hard with them. And the way that we do that is a discussion I'd rather see happen between our customers and our pricing folks.

Okay, thanks, Brian.

And we go next to Jeffrey Cianci with UBS.

Hi, Brian. Just curious on PET. It appears this sharp move up, you are covering your raw materials. Can you make a comment if you're actually beating them now in terms of the run up of PET versus raw materials. Too hard to say?

I'd rather not comment. The -- again, the purpose of the surcharge is to directly reflect what's going on in the raw material and energy environment and not to have some other agenda. And so we are working with our customers for an appropriate response in that area. With regard to price increases, that's kind of a separate activity. And how we balance price increases with surcharges is the whole strategic pricing effort of our business. And I don't want to get ahead of them with some kind of a comment here about what they're doing there.

Fair enough. This is a plastic that tends to depend on new uses for its very high growth and you're at unprecedented pricing levels. At what point do you see a little slowdown in the volume growth?

That's a great question. The other -- the competing materials are typically aluminum and glass. You might imagine that they're a little challenged as well because energy for them is a very high percentage of their total content. We see this continuing to be the preferred packaging material for many, many applications, continuing to grow at that kind of a 6 to 8 domestically, 8 to 10 globally kind of a rate, needing something in the neighborhood of 250 to 275,000 tons a year of new demand in North America, for an example. We don't see any interruption in that growth rate. Water continues to grow very aggressively. New applications, if you go to the store and see cooking oils or teas or a number of other things, you start to see it crop up even more, cosmetics, other places. So the demand continues strong and new applications continue strong.

Thanks. And finally, is there a barrier for a customer to switch? Cost-wise would it be expensive for a packager to reformulate and how much money and or time would it take them to do that?

Reformulating from what to what?

From PET to a substitute material.

Oh, to a substitute material. The machines -- I'm not an expert on this but my sense is that it's not trivial. If you're talking about a different material, it's definitely not trivial. If you're talking about another plastic, I'm not an expert to know how much of a switch there is, but I think all the plastics are having a similar kind of an impact. So, I'm not sure the motives are there.

Thanks, Brian.

And we go next to Kunal Banerjee with Morgan Stanley.

Good morning.

Good morning.

Just a couple of questions. I just wanted to revisit the volume issue for the fourth quarter. You mentioned that you had enough EG and PX to meet your needs. Does that imply, then, that you're back to running your facilities at pretty much full capacity in the fourth quarter? And this is with regard to PET. Also, on your ethylene side is the cracker back up and the polyethylene facilities, are they running?

Okay. First of all, our crackers and polyethylene facilities have always been running flat out. We were not interrupted. More an issue of price then anything else, for what you had to bite or feed them. We didn't have any disruptions in supply or availability for our crackers. We always had access to the East Texas oil and gas fields for our raws and we ran flat out.

Okay.

On your question about availability of polyester raws, we have procured what we want to sell in the fourth quarter. Whether or not we're running at full rates, we have some maintenance work that we're doing in some cases. We have our business plan that we want to execute in the fourth quarter. We have what we need for the fourth quarter. Procurement, availability is not the dominant issue. That procurement did not come cheaply. There was a price in getting all of those raws and we're working through the issues that are around that.

And you mentioned you didn't quite cover the movement in raws with your surcharge in the third quarter. In the fourth quarter looks like PX is either rolling over or it doesn't look like it's going to go higher. And EG is the one that's starting to move. So your surcharges in the fourth quarter, would you care to comment on whether you'd be covering the movement in raws in the fourth quarter?

The whole intention of the surcharge process is to try to cover the dramatic moves that happen in raws. And so we're working with our customers to do that. And that's as much as I really need to say. Again, this is -- you don't need the CEO on a conference call to be guiding the pricing practices of one of your businesses. So.

Right.

We're going to let them work with the customers on the right way to address these dramatic effects that we're all feeling.

I just think logically here in terms of the volumes, you don't seem to be raw material constrained and you've got your August and September prices, even if you don't get any more pricing. And with your surcharge more or less covering your raws, difficult for me to see how polymers doesn't have a better quarter because the August and September prices, I would assume, would be with you for the duration of the fourth quarter.

Yes. The natural gas and energy prices are a big factor for us. So what you're looking at is the demand in pricing situation, thinking other things are kind of constant or thinking about just recovering raw materials. The $14 natural gas is a big, big hit for making -- for all of our sites, frankly. That's one factor. The other factor is that we don't know for sure how much Asian material is popping up here in November and December and that can create a temporary supply demand kind of a dynamic as well. So, that's why we're trying to be a little cautious in how we characterize the fourth quarter, Kunal. There are scenarios where it could be good, scenarios where it could be not so good. I guess I said that I saw, on balance, more headwinds than tailwinds. I know you have other views from other people that might sound somewhat different than that, but we just are concerned that we might have more headwinds than tailwinds. So we're being a little cautious in our guidance there.

That makes sense. And then on fibers, just going back to the economics here. Obviously well above reinvestment and we've had recently rationalization. Does the industry now turn around and so the Asians start thinking about extra capacity? I know you have one but that's way out in the future. Are the Asians in a position to add much more much quicker? Do you have any intelligence on that?

I think you may remember that we indicated that we had aspirations for adding some capacity in Asia and Europe both to serve our customers. So, yes. The answer to that would be yes. Remember our situation may be somehow different from some others. Because we are vertically integrated to coal, you're seeing some of the benefits of what it's like to be vertically integrated to coal. I'm not sure everybody has the same kind of a picture. So that may be a factor in how many people see the kind of picture that you see.

Okay. All okay, thank you

And we go next to Chris Willis with Impala Fund.

Good morning. Just had a couple quickies. Can you remind us how much natural gas you purchase on an annual basis? And then secondly, I remember your raw material guys did a really good job back in the sort of late spring early summer procuring a little bit of low cost raw materials. Can you give us a rough idea of how much that might have helped you in the quarter? .

Chris, I don't think we've ever told anybody how much natural gas. Remember natural gas is a fuel for us, it's not a raw material. So it kind of goes into that kind of a -- you know, as a factor of cost. Energy are typically kind of in the high single-digit as a total COGS kind of a component. It gets to be a bigger deal when they double or triple the price of energy. So that kind of gives you some sense of how it plays into the whole COGS picture. You're kind of talking about risk management procurement practices. We have a combination of physical risk management things where we put stuff on the ground. We have financial instruments, financial derivatives that we use. We've worked all those very aggressively. We've used a bunch of those, especially the physical ones. When it's time to drag cheaper stuff out of the ground, what better time to do it than now. We've done a lot of that and that has helped our third quarter and, obviously, some of that is getting harder. Right, Rich?

Right now is not a great time to put anything in the ground. So I'll just reinforce what Brian said. We've had an active program for a rainy day and it was pouring out. So we've activated it.

Okay, thank you.

We go next to Frank Dunau with Adage Capital.

I was not going to beat the share repurchase dead horse on this call.

Sure, Frank.

I was? I do have a question. It strikes me this may be the one time in 10 or 20 years where operating an ethylene cracker in Longview, Texas. May not a bad idea.

That was not lost on us, as well. Yes.

My question is it feeds a lot of your other business and to the extent Longview can feed a lot of your businesses, and some of your competitors may be having trouble getting raw materials for their business, for their competing businesses, are you seeing any competitive advantage in there in the marketplace because of that right now?

Yes. We've been busy. That's fair to say we've been busy down in Texas and for all the reasons that you're citing. And that's been okay. That's been a good thing. You're instincts are right there, Frank. It's been helpful. There haven't been a lot of years where we declared it was a really good thing to be 150, 200 miles away from the Gulf coast, but this was one of them.

All right. Thanks.

And for our next question, we go to Rosemarie Morbelli with Ingalls & Snyder?

Good morning, all. Regarding the imports from Asia on PET, they are obviously taking advantage of the shortage and their lower cost. Are you hearing anything in terms of the price they are selling it at compared to the U.S. prices, the quality of the material, and is there a likelihood that they will stay around even when the U.S. goes back to normal, if there is such a thing?

Obviously, we don't have any insight into pricing. We have insight into the arbitrage between North American and Asian PX. And that would indicate something about the margin. That arbitrage is on something that costs typically around $1000 a ton right now. They might have $150, $200 kind of an arbitrage in their favor. That's temporary. We think that that's going to dry up. When that dries up it makes it harder for them to enter North America. So I guess I would -- on the last part of your question, we view the Asian exports as being enabled by that arbitrage and disadvantaged if the arbitrage goes away. So we don't anticipate this to be anything more than a temporary effect. If there was some reason for them to be in the market more aggressively, they would have already been there before and they weren't. Regarding the quality, there I'm sure the quality meets the customer's needs. There are many high quality producers there, so I don't have any insight into that beyond that.

So you haven't heard anything about poor quality shipment and customers actually having trouble producing what they needed?

Actually, I haven't heard anything but if you have anything you'd like to share with me, it might be helpful. I'd love to hear it.

Well, [INAUDIBLE] that it may not always be up to snap.

Well, I'd love for you to say that as loudly as you'd like to. So --?

Okay. Thanks.

Okay, thank you.

And with a follow-up question we return to Jeff Zekauskas with JP Morgan.

I guess just two last questions. In the quarter, did you make more money in PET or in PE.

This was a good quarter for both, is what it boils down to. Compared to year-over-year, it was a good quarter for both. Obviously, the short-term dynamics that are out there right now are probably more favorable for the polyethylene guy short-term. But we really try not to break this apart into pieces.

I wasn't trying to -- I wasn't trying to really pin you down. I just wanted some very rough ballpark sense of what's going on.

But year on year both of them made more money than last year. Let's characterize it that way. And as far as which one made more money, I'm not -- I just probably not going to go there.

Just secondly, if you listen to the conference calls of the beverage companies or the bottlers, you know there's a lot of talk about them being able to get Asian material. And you know what they do is they talk about how they think PET prices will come down relatively quickly. Do you have an opinion about that or what do you make of it when you hear that?

We do have an opinion of that. We are very cognizant of what the world pricing is for raw materials. We are very knowledgeable of what the conversion costs are for all of the various players. We're also very cognizant and knowledgeable about what the freight rates look like, what it costs to get it out of a container and into a rail car and get it to the middle of the country. We do the math on that. And so it allows us to have an informed opinion about the question that you're asking. I'd rather not go farther on that opinion other than to say that our forecast and our outlooks that we give you about the business reflect that understanding. We are not guessing there. We have a pretty good idea of how all that shakes up. So when we hear those comments, we can do the math to understand how to interpret those comments.

Maybe another way of asking this is forget the volatility of raw materials in the fourth quarter. Sort of what's your basic outlook, at least, for the first half of 2006?

Okay. I think we're going to have a more stable situation. I think we expect the arbitrage between North America and Asia and PX to disappear, raw materials in general to disappear and we'll return to a lower profile of Asian imports. The demand environment should be positive in the first half of next year. And so we feel like it's going to be a much more stable and maybe optimistic outlook in that time frame. But we're going through a period of uncertainty here in the fourth quarter.

Okay. Thank you very much.

And also with a follow-up question, we return to P.J. Juvekar with Citigroup.

Yes, hi, Brian. I want to go back to Frank Dunau's question about Longview cracker. Clearly you are making a lot of money there right now. But as these any crackers begin to come back on line, maybe by end of the year, what do you expect the contribution of the cracker may be in the first half of next year?

Yes. During this ethylene cycle we're doing okay in Longview with our entire integrated facility there, including the crackers. We've told you that longer term, we are looking at the best way to think about managing those assets and we said we're probably about the middle of next year going to make some comments about what we -- how we thought about sorting that out. We have time to consider that still, PJ, because we're doing okay for now and we are very mindful of the fact that it's a changing world. And we'll be commenting on how we respond to a changing world. But it's probably about the middle of next year sometime.

Okay. And then secondly, on the filter tow business, again. As you ship more volumes to China, what is the sort of incremental margin on that extra product? Is it much higher than 20%? I would imagine that would be the case.

You know, now I'm -- I'd really rather not comment on margins in one part of the world for one part of a business. The fibers -- the filter tow business is a solid business for us around the world. We negotiate prices with customers who are global customers. They have choices of whether they want to negotiate those for global situations or for regional situations and we try to work with them on their choices there. And it would be hard for me to comment there. I'm just not going to.

Fair enough. What are the operating rate on that line in Kingsport?

We operate at pretty high rates in our fibers area. We're making a lot. We're operating pretty high. In fact, we're -- we typically make about everything we can make.

So you're running full out?

Full out. But this is one of those things that if you needed more, you certainly have the resources to get more. We're not going to be constrained. Ultimately, you shouldn't think of this business as a business where we're constrained by the ability to produce the fibers. We can, in a very efficient way, find a way to make more.

Okay. Thank you.

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Riddle, I will turn the conference back over to you for any closing remarks.

Okay. Thanks again, Rufus. And thank you all for joining us this morning. An audio replay of this conference call will be available this afternoon through Friday, November 4th and, as always, I'll be available through the day today to take any additional questions. Thanks again for joining us.

And ladies and gentlemen, this does conclude the Eastman Chemical Company third quarter earnings conference call. We do appreciate your participation and you may disconnect at this time.