伊士曼化學 (EMN) 2006 Q4 法說會逐字稿

Good day, everyone, and welcome to the Eastman Chemical Company fourth quarter earnings conference call. Today's conference is being recorded. This call is also being broadcast live on Eastman's Web site at www.eastman.com.

We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Please go ahead, sir.

Okay. Thank you, Danielle, and good morning, everyone, and thank you for joining us.

On the call with me today are Brian Ferguson, Chairman and CEO, and Rich Lorraine, Senior Vice President and Chief Financial Officer, and Jennifer Bogni, our Manager of Investor Relations.

Before we begin let me cover two items. First, during this call you will hear certain forward-looking statements concerning our plans and expectations for first quarter and full-year 2007. 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 fourth quarter and full-year 2006 financial results news release on our Web site and in our filings with the Securities and Exchange Commission, including the Form 10-Q filed for third quarter 2006 and the Form 10-K to be filed for full-year 2006.

Second, some of our comments today will reference non-GAAP financial measures, such as earnings per share and operating earnings that exclude restructuring-related items. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures, including a description of the restructuring-related items, are available in our fourth quarter and full-year financial results news release and the conference call tables accompanying the news release.

With that, I'll turn the call over to Brian.

Hi. Good morning, everyone. Glad you have joined us.

I'm going to follow the agenda that we have used before. I'll start with some corporate highlights for the quarter and the year and then we'll talk about the segments, the regions, the outlook for the first quarter and a little bit about '07 and then finally wrap up with corporate strategy.

Last night we announced full-year 2006 earnings per share of $5. Looking at the fourth quarter, our earnings were $1 per share, which is higher than a year ago, and I remind you that last year's fourth quarter was the best in ten years. These excellent results were driven by solid earnings from most of the Company.

CASPI set a fourth quarter and a full-year record for operating earnings. Our PCI and Fibers segments had operating earnings that were their best in about ten years. We also set an annual record for sales revenue at $7.5 billion.

As I've said on just about every conference call for the last three years or so, raw material and energy costs were up. For the full-year 2006 they increased approximately $400 million, and since 2004 they have increased an astounding $1.5 billion.

We've worked very hard as a company to implement needed price increases to mostly offset these higher raw material and energy costs. As a result, our gross profit in 2006 was about $1.3 billion, which translates into a gross margin of 17%.

Our operating margin for the year was 9% and although this is pretty good, it is still a bit below where we would like to be as a company. We'd like to be in the 10 to 15% range over time. And that leads me to a point I'm going to make a few times this morning.

Our earnings reflect very strong results from four of our five segments. One way to highlight that for you is to exclude Performance Polymers, which of course are the PET and polyethylene results, from our 2006 earnings.

When you do this, you'll see that our operating margin would have been over 14% and our EPS would have been, frankly, about the same excluding the Performance Polymer's results. In other words, Performance Polymers contributed almost no EPS for the year.

Now obviously, we have sold the polyethylene business and we're certainly not happy about the results in our PET business. I'm going to talk more about the actions we're taking to improve there in just a few minutes.

The main point I want to highlight for you that outside of PET, we are doing quite well. And there is a lot of upside when we finish transforming our PET business.

Now talking about segments, let me make a comment about our strong and steady base of earnings, namely the combination of Fibers, CASPI, and Specialty Plastics businesses.

Combined, they increased their operating earnings by over $20 million in 2006 compared with a very strong 2005. They accounted for almost 80% of the Company's operating earnings with an operating margin of 17%, and they increased revenue by 9% year-over-year.

Looking at them by segment, starting with Fibers. Fibers operating earnings were $228 million in 2006, over a $10 million improvement compared to 2005.

They maintained their operating margin at 25% for the year and they increased revenue by 5% as higher prices and sales volume was partially offset by unfavorable shifts in mix. The mix affect was due to selling less acetate tow in Asia, particularly China, due to the capacity additions in 2005, and some increased sales of acetyl chemicals.

Looking at the fourth quarter, earnings were lower year-over-year primarily due to lower sales volume. This is the traditional chunkiness that we have described for you in the past in customer buying patterns.

We also had a minor operating issue which impacted them in the second half of the year, but that's behind them now. Looking at full-year 2007, we expect the Fibers earnings to be at least as good and more likely better than 2006.

Next is CASPI, where I've mentioned earlier, 2006 operating earnings were their best ever. This is a little bit nostalgic for me, because you might remember that in 2004, prior to the divestitures of the underperforming businesses, operating earnings for CASPI were almost $100 million lower than they were in 2006.

The improvements can be contributed to a number of things. We had higher volumes beginning in 2004 and sustained in '05 and '06, but we also had a number of actions to reduce costs and to upgrade the product mix, and we had an ability to implement needed price increases to offset higher raw material and energy costs.

We continue to see the CASPI business as having a 15 to 20% operating margin and growing at about GDP rates.

Going to the Specialty Plastics segment. During the fourth quarter and full-year 2006, we began to see results from the market development investments we have made over the last several years, with volumes increasing 20% and11%, respectively.

The increases were broad-based in markets as diverse as shrink films and medical applications, and they were across geographies, with double digit full-year growth in Asia, North America, and Europe all three. And although raw material and energy costs continued to be a challenge during the year, particularly paraxylene, the gross profit in this segment increased in 2006 compared with 2005.

Now we continued to reinvest the increase in gross profit in our growth initiatives, but we believe we have hit the peak of the run rate on that spend in 2006 and forward it will be flat to down. And I should mention that we are on track for commercializing our new high-temperature copolyester product in the second half of this year, which is very exciting for us.

Now turning to our more cyclical segments, starting with Performance Chemicals and Intermediates. They had another great year in 2006 with operating earnings of $161 million and an operating margin of 10%.

This was their best year since 1997. They continue to benefit from strong global capacity utilization rates for many of their derivative products.

The segment has also benefited from their ability to implement needed price increases to offset the higher raws in energy, and they continue to benefit from long-term supply arrangements with some of our key customers. While we see 2006 was the likely peak year for PCI profitability, we expect 2007 will still be a very strong year for earnings in this segment.

Now turning to Performance Polymers. The fourth quarter was tough, to say the least, for our global PET business, concluding what was overall a difficult year. There are three major factors that have been driving the underperformance in that segment.

One, declining volumes and prices the North America. The volume declined due to continued high levels of Asian imports, coupled with weak demand at the end of the year as customers destocked inventory in expectation of seeing lower prices in the future.

Prices declined due to capacity being added to the market in the second half of '06 and the first half of '07, and we also started up our IntegRex facility, which means that we had some of the customary preproduction costs that entered into the fourth quarter figures.

The second factor driving PET performance is underperforming assets outside the U.S., especially in our nonintegrated sites. In Europe we have seen volume declines due to regional overcapacity, and we continue to be impacted by a trade issue in Latin America.

The third major driver is, of course, volatility in paraxylene costs. From September to November market prices of paraxylene declined about 30%, and this led to a customer reaction of destocking inventory and dramatically reduced overall demand.

Now a frame of reference here. As you know, we have dealt with underperforming businesses before, we'll do it again here with PET. The first necessary step for us to get started on this, of course though, is the start-up of our 350,000 metric ton low-cost IntegRex facility in November.

The facility is operating great now, is making excellent product. We expect it to be fully operational by the end of March. And with this lower cost PET, our results in the U.S. will improve.

Shortly after the plant is fully operational, we will debottleneck it to add another 100,000 metric tons, bringing the total to 450, and expect this will be completed by the middle of 2008. Now to complement that we are also implementing a project to rationalize 350,000 tons -- that's 350,000 metric tons of capacity at our South Carolina facility, and we expect the bulk of this to be completed by the end of 2007, and it will be all done by the middle of 2008.

Regarding our nonintegrated PET assets outside the U.S., we've previously said that our options are to fix, sell, or shut down the assets. We have, for the most part, exhausted the fix options, so we're aggressively pursuing the others.

First, we are taking actions to permanently shut down our site in San Rogue, Spain. This was not our preferred option, but it is the only option given a very untenable labor situation there.

We want to take additional steps on other parts of the assets by the middle of the year. As you know, we don't always control the timing on some of these things.

At our Investor Day last November, we committed to you that we would transform our PET business to yield approximately 10% operating margins by the middle of 2008.

With our fourth quarter results and the industry outlook for the quarter, you may be wondering whether we still think we can do this, and I want to reaffirm to you that the answer is yes. We are confident that we're taking the actions necessary that will get us to that goal.

Now some comments on the regions beginning with North America. Full-year North American revenues increased by 3% as higher selling prices more than offset a 1% decline in volumes.

The percent of our revenue in North America stayed constant at just under 60%. The profitability in North America declined as earnings increases in CASPI and Fibers were more than offset by a decline in Performance Polymers.

In Europe, our revenue increased by 7%, driven by higher selling prices and increased sales volume. The higher sales volume was mostly in the Fibers and Specialty Plastics segments. Profitability in Europe declined primarily due to the Performance Polymer segment.

Asia Pacific revenue increased by 1% in 2006 compared with '05 as higher prices were partially offset by lower volumes. The lower volumes were primarily due to lower acetate tow sales in the region in response to the capacity additions in China that came online during the fourth quarter of '05.

But despite the decline in acetate tow sales in the region, our operating earnings were up slightly during the year due to increases in Specialty Plastics and other Fibers products and PCI.

Lastly, Latin America, revenue grew by 24% for the year driven by higher sales volume, mostly in the Performance Polymer segment.

Now to the outlook. Like the Fibers business, our company earnings outlook for '07 has a bit of chunkiness to it as well, but overall, it should be another very good year.

During the first quarter, we expect continued solid results in all of our segments with the expectation of the Performance Polymer segment. PET will be continue to face very challenging conditions globally.

As a result, we expect our first quarter 2007 earnings per share to be above $0.90, excluding gains and charges related to ongoing strategic decisions. That's a good bit lower than the estimate that has been out there up until today.

Before anyone panics on that thought, let me say that we expect very solid results from our four businesses that delivered all of the earnings in 2006. PET will improve throughout the year as we get our new plant fully operational and we take more actions related to the troubled assets.

It's not our normal practice to give full-year guidance, as you know, but with all the moving parts we have in this transitional year, we feel we should give you some more insight.

We expect full-year 2007 earnings per share to be a bit lower than the current consensus estimate of $4.53 per share, but we would only discount that estimate by something less than 10%. As always, that's excluding gains and charges related to ongoing strategic decisions.

Our 2007 expectations also include a 20 to $0.30 per share dilutive impact on earnings for the polyethylene divestiture that we completed in the fourth quarter. That may or may not have been reflected in the consensus estimate entirely.

Now for the corporate strategy comments, let me conclude with some thoughts there. In November of last year, we hosted an Investor Day in New York where we outlined a strategy for dramatically improving the profitability of our company.

The strategy had different time horizons for results, it had some actions impacting near-term results and some actions were impacting longer-term results. In 2007 you will see progress and milestone achievements to execute this strategy. On PET we will continue to drive all the actions I just described to you earlier.

Regarding chemicals from coal, we will say more about the projects and the partners and we expect to get started on one and maybe more than one of the projects this year. As I mentioned earlier, we are on track to produce commercial quantities of our new high temperature copolyester in the second half of 2007, and we will better define the growth opportunities for acetate tow in Asia during the year, but that's likely somewhere in the second half.

So in conclusion, we have a strong base of earnings. Our PCI segment continues to deliver strong results, and there is a significant upside through our transformation of the PET business.

So we're very excited about the possibilities of our company. I'm looking forward to the call a year from now when we have a lot of this behind us, and I hope that you can see the possibilities as well.

With that, I'll turn it over to Rich.

Okay. Thanks, Brian. Good morning, everybody.

I'm going to add some color around some of the restructuring-related items we incurred in the quarter, talk a bit about cash flow, net debt, touch on our tax rate and wrap it up with our overall financial metrics.

First, to restructuring items. As Brian said in his remarks, we're taking a number of actions to improve the profitability of the Company. Obviously, these are difficult but necessary actions to take and result in the kind of charges that you're seeing in our numbers for the fourth quarter and the full-year '06.

The majority of the actions we've taken in the fourth quarter impacted the results for our PET polymers business. The total charges for PET in the quarter were $46 million, and in addition, PET incurred accelerated depreciation of $7 million.

These actions, to be a bit more specific, were around severance in our South Carolina facility, as well as some actions to reduce the cost of corporate functions that support the PET business.

In Spain, the CHDM intermediates facility's been shut down in order to optimize our global capacity, and that also included some severance. Back here in the U.S., dismantlement of our IntegRex R&D facility was undertaken as we transfer the research and development to the commercial scale facility.

The accelerated depreciation costs of $7 million, that I mentioned, was due to the planned shutdown of some PET assets in South Carolina.

These are not recorded as specific asset impairments because these assets don't have, as accountants call it, separately identifiable cash flows, and therefore we can't make an impairment calculation. And these accounting rules require then, that we accelerate depreciation on those assets, which we've done.

In addition to the charges for PET, we incurred other restructuring charges of $32 million for the quarter, primarily related to a corporate voluntary retirement program. In addition, the previously mentioned CHDM shutdown also impacted the Specialty Plastics segment.

We also had other accelerated depreciation costs for non-PET assets of $3 million in the quarter. These costs are in the PCI segment and that's related to the planned shutdown of a cracking facility in Longview, Texas. Again, these are recorded as accelerated depreciation costs.

Another item I want to highlight is in other income. Other income for the fourth quarter 2006 included a $12 million gain related to an agreement reached with the U.S. Department of the Army after some years of negotiations to obtain funding for post employment benefits being provided to retirees of what was Holston Defense Corporation.

Holston Defense Corporation is a wholly owned sub of ours that prior to January 1999 operated a government-owned ammunition plant. These retirement benefits were not fully funded prior to the termination of Holston Defense Corporation's manufacturing contract with the Army, and that took place back in 1998.

The Company has continued to accrue and pay for these costs while pursuing reimbursement and funding for future liabilities. There's a $12 million gain in there and that reflects the recapture of these previously recorded costs that were included in prior period earnings.

We'll also have a recurring gain going forward as portions of the remaining amounts will be amortized back into earnings in the future as the OPEB liability is now fully funded.

Moving on to cash flow. Our cash from operations for the full-year 2006 was $609 million and during the fourth quarter we generated $376 million of that. That was driven by continued strong earnings from our solid base of businesses and PCI, which combined contributed almost all of our net earnings for the year.

Our depreciation and amortization increased slightly to $308 million in 2006, about in line with our expectations. We do expect depreciation and amortization to be up to about $350 million in 2007, with the increase from 2006 primarily reflecting accelerated depreciation related to the restructuring actions we've discussed in South Carolina and Texas.

Looking at working capital. In the fourth quarter our receivables declined by over $100 million due to sales volume impacts, primarily in North America. However, looking at the full-year our receivables increased by about $80 million.

The primary drivers of that, we had a shift in the geographic mix of revenue, primarily seeing increased sales in Latin America and Europe, where the credit terms with our customers there are somewhat longer than with our customers in North America.

Inventories came down in the fourth quarter. That's our normal seasonal pattern, but you can see they're up about $100 million for the year.

That's two primary drivers here. We needed to rebuild inventory levels in our adhesives product line following the depletion -- after the hurricanes last year, and that's within our CASPI segment.

One other major factor was a slowdown and softness in sales in the latter part of the year in PET that caused some inventory to remain in our books.

I'll turn to pension funding. In 2006 we contributed $75 million to the U.S. defined benefit pension plan. That's compared to a contribution of $165 million in 2005 and these impacts are included in the liabilities for employee benefits line.

In 2007 we've contributed $100 million to the U.S. defined benefit pension plan in January, and this puts us at about 100% of the funding requirements for our pension plan at this point. We expect this to -- in addition to the funding result, we expect it will have a favorable impact to earnings of about $5 million.

We also had some other items that helped us during the fourth quarter. We received proceeds of $310 million related to the divestiture of the polyethylene business and the Arkansas manufacturing facility. In addition, we had some proceeds from stock option exercises for the year of approximately $100 million.

Turning to uses of cash. Our Cap Ex totaled $389 million in 2006. As you're aware, we started up the new IntegRex facility last November and as Brian said, the plant is mechanically complete and we expect to be fully operational shortly.

We also had capital expenditures related to the pilot plant for the high temperature copolyester products in the Specialty Plastics segment and we expanded our CHDM intermediates capacity here locally in Kingsport.

Looking forward into 2007, we've got a number of projects and initiatives that we're funding. First, the final spending related to the completion of our IntegRex facility and the subsequent start on the debottleneck of the facility.

We expect some expenditures related to our first steps in coal gasification. We'll also have expenditures related to the move from pilot plant operation to commercial manufacturing for our high temperature copolyester products and we expect that to be coming on and available in commercial quantities the second half of this year.

We're also beginning to work on our acetate tow expansion in Workington, England during the year.

Last year on this call I told you that our 2006 capital expenditures could be approaching $450 million. We ended up spending less than that mainly due to choices and timing of strategic projects and for now, that $450 million level sounds about right for 2007. But we'll be keeping our eye on it, we'll keep you informed as we go forward, again, primarily around choices and timing of strategic investments.

Looking at our net debt, obviously that's our total borrowings less cash. We made great progress in '06.

We ended the year with net debt of about $650 million. That's a decline of almost $450 million from the beginning of the year. Looking back through the end of 2003, we've reduced our net debt by over $1 billion.

Our interest expense declined in 2006 by about $20 million, and we expect net interest expense to continue to decline in 2007 and our estimate right now is about $70 million.

Looking at our tax rate. The tax rate excluding items for the full-year 2006 was 33%, a little bit below our previous guidance and part of that was our ability to record some R&D tax credits in the quarter.

This compares with 30% for the full-year '05, and the driver in the change there is the unfavorable foreign rate variance related to the fact that more of our earnings are coming from the U.S. during the year. We expect in 2007 our tax rate to be about 35%, as the impact of the unfavorable rate variance continues in the full-year.

Finally, leading to financial metrics, let me make a few comments. During our Investor Day in November, I showed a number of charts that detailed our expectations for return on invested capital.

Looking at 2006 we're very pleased with our ROIC, which was 14%, excluding restructuring-related items. This was pretty great performance and puts our ROIC well above our cost of capital for 2006.

As we look at the actions we've taken over the last few years, we're on very solid financial footing. As I mentioned previously, we've reduced our net debt by almost $450 million in 2006, and by $1 billion since the end of '03.

We've made great progress on improving stockholder's equity during the year, which increased by $450 million and by $1 billion since '04, and it now stands at about $2 billion. When you add this up, we continue to be rated a strong BBB, BAA2 by our ratings agencies and our outlook for generating cash over the next several years continues to be solid.

Thanks. And with that, I'll turn it back over to Greg.

Okay. This concludes our prepared remarks and Danielle, we are ready for questions.

Certainly. [OPERATOR INSTRUCTIONS] Our first question comes from Mike Judd with Greenwich Consultants.

Good morning.

Good morning.

I have a question about, you know, when you had your Investor Day, you provided some capacity for 2007 with the new IntegRex capacity, it was roughly 1175 in terms of thousands of metric tons, PET capacity. If I go through and do a material balance on your PTA capacity, it appears to me that you don't have enough PTA capacity to actually support that level of capacity.

I can understand that the capacity is actually physically there, but it doesn't appear that you have enough internally-produced PTA in order to run those assets at full capacity. First of all, is that a correct analysis?

And then secondly, there's been a number of fairly modest delays in terms of the new capacity. It was supposed to come up from various competitors in the first quarter, including DAK and StarPET, M&G and others.

Evidently some of this new capacity is being delayed into the second quarter. And so I was just wondering if you can comment on how volumes are in the business right now? So those are my two questions. Thank you.

Okay. Very good.

Now Mike, just so I'm clear, the 1175, you're trying to get a kind of a company view of PTA or are you more interested in the regional view?

Well, I'm really interested in Eastman's particular material balance because what it implies is that your actual effective capacity is actually lower than that.

Yes, we have two places where we make the PTA. We have a big facility in South Carolina, another one in Rotterdam. We self-supply pretty much everything in the United States.

In Mexico, we buy some PTA to fill that plant out, we're right next door to the supplier. In Argentina, we've gone back and forth between self-supplying and buying.

In Spain, we're next door a person that supplies us. In Rotterdam and Workington, we self-supply.

We have a couple of plants -- your math is about correct. We have a couple of plants where we have to be net purchasers, we've had long-term agreements with some suppliers there, but by and large, we're largely self-supplied in the current configuration.

As we rationalize -- you can do the quick math, we're putting on 450 and rationalizing 350, so the net is only an increase of 100 with what we've just implemented, so it doesn't create any big shortfall because of what we have done there.

So Brian, what you're saying is that you purchased PTA on the market in order to make up for the delta that you have from the new IntegRex capacity?

It's not from new IntegRex, we've always been configured in Mexico and in Argentina and Spain the way that I described. Those have been since the beginning [been] configured that way.

Okay.

And then in terms of the new industry supply, do you have any thoughts there? Because my understanding is that volumes have been fairly decent here in the first quarter.

Yes, the volumes fell off a cliff in the fourth quarter and there was a great debate in the industry about what was driving that. I heard some of my favorite theories that I heard were a thing called garage inventory, people put inventories in the garage waiting for the hurricanes, the hurricanes didn't happen, they used up the inventory.

The scanner numbers going over the Wal-Mart belts and other big grocery chains showed lower volumes in the fourth quarter. So it wouldn't be surprising that you'd be picking up volumes in the first quarter.

People, our customers, certainly, saw declining raw material prices and so they were destocking in the hopes that they could wait a while and buy at a lower price, which is exactly what's happening. So now it's a judgment game by the customers, when have I got the rock bottom price that's going to happen in the marketplace, and I think we're there right now so I expect the volumes are going to start picking up again and this is a behavior you'd expect in a commodity product.

Okay.

And then just lastly, I understand, and I don't know if this is a reliable source or not, but I understand that the IntegRex capacity does actually have some issues that you guys are working out. Could you just elaborate on that?

Yes, the answer is no. I mean it's making first-quality product, it's making the products we wanted to make.

It's got great performance characteristics, it's got to half the capital and half the conversion costs we said it has. This is been one of the best start-ups we've ever had in our history. So that may be wishful thinking by somebody, but we're feeling pretty darn good about it.

All right. Well, I stand corrected. Thank you.

And next we'll hear from P.J. Juvekar with Citigroup.

Good morning, Brian.

Good morning.

Now that your IntegRex plant is running for a couple of months, let's say if you had that running fully for the fourth quarter, under those conditions, what do you think would be the profitability? I'm just trying to understand what sort of difference would the new technology make in profitability?

P.J., the closest I can come to helping you on that is that we are pretty much operating at the Asian cash cost level in the pricing right now.

We've always made a reference to you that the cap of pricing in North America is eventually driven by Asian cash costs plus freight and duty to get into the marketplace. That's pretty much where we are right now.

We have said, we continue to reaffirm that we can get reinvestment economics on the IntegRex facility in that environment and we see nothing to change our view on that. It'd be hard for me to do the math for you because I'd have to sit down with a piece of paper and do the weighted average of IntegRex versus everything else.

But the big deal here is not just about adding it, it's also about taking out the high cost stuff. That's the trade-off that really adds value, and that's the math that you need to do ultimately.

We have more expensive DMT plants, for instance, in South Carolina, that are at the higher end of the cost curve and they're part of the 350 that's going down. So the trade-out is a pretty dramatic trade-out between IntegRex and those higher cost plants and that's the trade-out that starts to drives that extra margin we keep referring to.

Right. I'll follow-up with you on that.

Sure.

Just quickly a second question on PCI. Can you just discuss the supply demand outlook for oxo's and acetyls? [Inaudible] '06 was probably the peak there. What makes you say that?

I think that's more an olefin comment than it is acetyl-driven, by, you know, the world is swimming in acid these days. We don't rely so much on acid. We have a lot of other acetyl derivatives that are our big drivers.

We have some commodity-like acetyls that will, they'll feel some softness, but I think it's more in the olefin derivatives area that we expect some softness. I don't want to overemphasize that, this is not some dramatic change, it's just that we think '06 was the peak in PCI.

I would characterize my comment as an olefin comment, P.J., and you guys know more about that I do, frankly. We're less in the olefin business these days.

Okay. And then lastly, just quick one for Rich.

The gain of $12 million in fourth quarter from Holston, it's sort of a gain that is similar to like a prior-year tax gain, so why did you decide to keep it rather than calling it out?

It's going to be recurring, not the specifics behind the calculation in 2006, but the Holston defense retiring medical funding will generate income for us going forward for many years. So it is a recurring-type of a item. But I did wanted to explain it on this call just so that you'd understand what caused that jump in other income.

Okay.

But you'll see other income in 2007 and 8 and beyond driven by this agreement.

Is that at the same rate, $12 million a quarter?

No, I think that's, the $12 million was a catch-up for the year and we'll see somewhat lower amounts going forward as we go through this. But they will be other income related to that Holston [inaudible].

When you're getting money from the government, you try to get as much up front as you can as fast as you can, as you know.

Thank you.

And the next question comes from Jeff Zekauskas with JPMorgan.

Hi. Good morning.

Good morning.

Good morning.

A couple of questions on Performance Polymers. There's a phrase that you used, the plant will be fully operational by the end of March.

What does fully operational mean? Or in what way will it be operational then that it's not operational now?

Getting up to full rates is all that means, Jeff. We're at reduced rates right now because we're still finishing some pieces and parts that weren't done, frankly.

So we are running at somewhat reduced rates, making great quality product. We'll get up to full rates but we're running at a fairly healthy rate right now.

So like can you give us some orders of magnitude, like you're running at 70% utilization and you'll get to 100, or 50 and you'll get to 100, what's the right order of magnitude?

We're probably in the neighborhood of half rates and we're going to be getting up to full rates over the next, oh, gosh, a month or so.

So what we've heard is that there's a lot of off spec PET product in the market and--

Yes, we generated a bunch of it. That's what preproduction's all about. That's what you do when you start up and start working through all this.

A lot of that was pretty good stuff, we just didn't feel right about the specs until we were just dead sure. We didn't want to take any risk with our customers but we put a bunch of that in the market.

Okay. It seems that you've also signed a memorandum of understanding for a joint oxo project.

Yes.

Can you talk about why that's of -- how that fits into Eastman's longer-term strategy? Why the oxo project in India is important to you?

Especially since I didn't talk about it in any of the comments that I made up until now.

Sorry about that.

No, that's fine. I'm glad somebody asked it. Good for you.

This was something that came to us, Jeff. As you know, we have not characterized oxo as some kind of a central strategic thrust for the Company, and it's had a spotty history in terms of what we like and what we don't like about oxo.

This was a unique circumstance. SR came to us. They have a refinery in the northwestern corner of India. It's making some quantities of propane there.

The propane market in India is artificially subdued by the government to keep fuel inexpensive for the number of Indian people that use it as a household fuel.

Their alternative uses, then, would be to use the FCC's to turn it into propylene. They didn't have enough to drive a propylene plant, they did have enough to drive an oxo plant.

In the conversations with us they really presented us, what I would call, a compelling value proposition for why they could help us derisk our investment in that. And I really, I'm really not at liberty to go into the details, but the margin was very attractive and it is at a much lower risk equation than I would normally see in a similar kind of investment because of the nature of the agreement.

So the situation was compelling enough that we just had to think about it, and it's a relatively small investment. We're going in for half of a plant, it's going to be less than $100 million, well less than $100 million. So it is not a big number relative to the portfolio.

I guess lastly, if I can ask a naive question.

When you talk about ramping up your Cap Ex in the area of coal gasification, are the larger amounts that you would spend monies in order to convert carbon monoxide plus some other ingredient to get to methanol, to get to propylene? That is, is that where the spending comes in?

That is, you get low cost CO and then you go from there? That is, what exactly are the large projects that you plan that are expensive that will require higher spending levels?

That's an excellent question, Jeff, and I'd be happy, this is hard to do on a phone. I'd be happy to sit down and kind of walk through that with you at your leisure.

To answer your questions as quickly as I can, there's a pretty, just like a cracking plant, there's a pretty big investment in the first piece, which is turning coal into syngas and syngas is CO and H2. So it's not, well, it is almost a cracking plant sized investment just to start that step.

The step that takes the syngas to methanol is sort of a polyethylene plant or polypropylene plant sized kind of investment to make -- so you can think about it in an olefin stream kind of a context. And so you have that kind of an investment to make the methanol. And then to make the derivatives thereafter, they can vary in size from pretty big to pretty small.

But I would say, gosh, you know, I'm pulling numbers out of the air here, but it's probably at least a third, maybe more than a third of the Cap Ex to just turn the coal, or the PET coke into syngas and the rest of it's distributed on the next two derivatives.

The thing, excuse me, the value proposition is that you have to convince yourself you've got methanol that is advantage compared to the lowest cost strand of gas you can get anywhere in the world and that's how you make some of the decisions. Once you have that, making chemicals out of methanol is the chemistry that we practice.

Jeff, we've got to move on to the next question so everybody has a chance.

And next we'll hear from Frank Mitsch with BB&T Capital Markets.

I thought I'd never get on.

We're having too much fun, Frank, [inaudible].

I could tell, I could tell. Unfortunately, I've got to come on and throw a wet blanket on it.

Hey Brian, you talked about raw material costs in '06 being $400 million negative to you. What was it in the fourth quarter? What do you think it's going to be in the first quarter? What do you think it's going to be for '07?

We're thinking more flat and I wish it was more down. I mean we're all watching what's happened with oil so, you know, it seems like when oil's going up, the [inaudible] explanation from our suppliers is that oh, it's driven by oil, and then when oil goes down, it's oh, it's driven by supply demand. So I guess the short answer is basically flattish.

All right. So, you saw a deceleration, then, in the fourth quarter but you're going to, and carrying it to the first quarter?

Actually, the fourth quarter was flat year-over-year. Paraxylene prices were still higher even though they came down fourth quarter to fourth quarter.

All right. Terrific.

And the PET plant shutdown in Spain, when are you going to do that? How much capacity is that?

It's already down. It's, gosh, I'm going to say it wrong if I try to do it from memory here but I think it's about 175, Greg will get back to you on that.

The plant's already down right now, so it's now, it's a matter of making all of the permanent -- taking all the permanent actions dealing with employees, dealing with assets, et cetera.

All right. Terrific.

And you talked about your business in Asia Pacific. Can you give us some ideas by, what are the major divisions there, and what are the trends there? What should we see out of Eastman in 2007 in terms of your Asia business?

Great question. As a company, we're about out of juice until we build some more stuff and that's why we're investing right now.

But what we have seen and what we continue to do is more CASPI, more Specialty Plastics, more Fibers, less PCI, and less anything else that we have going out there. So that's the kind of trade-out that happens so it kind of obscures the profitability story for Asia and we've always had that problem.

The profitability of what's growing is typical of what you'd see in that strong CASPI, Specialty Plastics, Fibers base. So it's the strong base growing and sacrificing some pounds to make the material balance work out for the Company by taking out a PCI and if we had any Performance Polymers.

So from a volume standpoint, you really need more capacity to come online before you can increase your sales in Asia?

And thus the opportunistic and profitable investment in India, thus the filter tow plant in Asia, that would be two examples. The fact that we finished the Qilu texanol plant a couple of years ago, those kinds of things.

All right. Then lastly, in the second half of the year, you're going to start up, I think it was a high temperature copolyester?

Yes.

In your Specialty Plastics. Can you size that opportunity for us?

I will someday, but it's a little -- it's big, it's meaningful. This year, Specialty Plastics is over $800 million.

This is the kind of product that over time can potentially lead to a significant improvement in that $800 million, I'm imagining a business that's well over $1 billion in [SPBO] and driven in large part by the opportunities in plastics like this Mustang and then some others that we have going so it is.

That's the code name, excuse me, like this high temperature polymer. It's big. It's not trivial.

All right. So $200 million run rate by the end of '08 is what we should build in?

That's a little light -- I don't know. I have to think about that.

We're not sizing it today, Frank.

We're not sizing it today

I'll wait for the November analyst meeting.

Yes, we'll see.

Thank you.

And the next question comes from Sergey Vasnetsov with Lehman Brothers.

Good morning.

Hey, good morning.

Good morning.

You're undertaking the pretty ambitious program of restructuring your PET business and given that you're one of the global leaders it's a massive scale. I'm just curious, what do you estimate the cash cost for this overall upgrade conversion shutdown program to be over the next couple of years?

I'm going to have to turn to my CFO on this question. When you say cash costs --.

Yes, let me, first of all with Spain, as Brian said, we've decided to execute a permanent shutdown. We will, of course, be looking at liquidating working capital, writing down the physical assets and paying some severance. On balance, that should be cash positive.

When I consider the other outside U.S. facilities exiting that part of the business should be cash positive so that I don't, Sergey, I don't look for this to be a drain, but rather a recapture of the investment that we've had outside the United States.

Well, arguably liquidating inventories is not the brand new way of cash flow generation. I understand your point. At least it's not a cash drain, that's clear.

We're not looking for that to be our savior, Sergey. It's simply looking at our global business and deciding where we can compete effectively and --

I understand.

And leaving the other.

I understand. And far as conversions of some other plants into the new IntegRex technology or building a replacement of the shutdown plants with new IntegRex technology, what do you figure the cost might be?

Well, we said that the one in South Carolina was a bit over $100 million for what will be 450,000 tons. And that gives you kind of a scaling on that. 450,000 is a lot of PET for a little over $100 million.

And you say it right, this is basically a replacement. We're bringing in the new and taking out the old to maintain a better industry balance and also it's a great product.

Okay.

I would just add to that, Sergei, that, you know, obviously the facility in South Carolina was the PET part. If we were to go forward with a full IntegRex facility would have the PTA part as well.

Which is more expensive. But we've kind of characterized, rather than me giving a number, we've characterized this as [inaudible] a .5 compared to what the best anybody else can do in a North American situation, or really any place. If you put them side by side, it's about .5X.

Okay. And second question relates to that spend.

By now, it seems like you [inaudible] with cleaning up CASPI and some other divisions over the past several years of restructuring program. A lot of hard work and a lot of unusual charges. Do you think you're pretty much done? XPT with restructuring in Eastman?

Yes. I go back to saying the four out of five are humming. I think we're, yes, we're done.

The last shoe to drop was what you saw in PCI with the polyethylene and the cracking plant story there. So those are all ramped up. We got one more and this is same song, third verse. We'll get it done.

The only wrinkle to that, Sergey is, of course, the crackers will be, the smaller crackers in Texas will be phased out over time.

Yes. That we already know. Thank you very much.

And next we'll hear from Kevin McCarthy with Banc of America.

Yes, good morning.

Good morning.

A couple weeks ago I saw that TX Energy was awarded a investment tax credit of $130 million, Brian, in connection with a coal gasification project. What can you tell us about TX and are there any details you can share about that project such as timing, location, product slate, and associated capacity?

Yes, this is one of the projects we alluded to in the Investor Day. It's the Texas project where we manufacture, we use PET coke as the feed, we go to methanol and then go to propylene and that will replace the lost propylene from the shutdown of the old crackers. It gives us a tier 1 global position on propylene when we're all done.

There are other derivatives that will come out of that that are still being worked on but they're basically chemical derivatives. It will be online about, we expect to get started on it this year, online about 2011.

The tax credits were -- we gave some more detail than what I just described to the government as part of the, to file for the tax credits and that was the award that we got which was a substantial award. We're very glad to have that.

Okay. Have you lined out your equity interest in that project and the associated Cap Ex figures?

Yes.

Wait for November?

No, no, no. Not November. This is, we'll be talking about this sooner rather than later, but you're dealing with partners and partners have their own sensibilities about what and when they want to say stuff.

So we'll -- as soon as I can, Kevin. But feeling very good about not only that project, there may be even one more that we can get going on this year, too. So encouraged that we're going to have some progress on the front there.

Okay. Fair enough.

And then shifting over to the PET business. What is the operating loss associated with your San Rogue, Spain PET resin plant in 2006?

You know we don't do that, Kevin. But it was, frankly, one of the more troubled assets, to say it that way, I guess.

But if you were trying to work your way into, was it somehow the bulk of the numbers that you're seeing in the 2006, it's a piece of the story, but it's a piece among four or five. So it wouldn't be somehow dominating the entire landscape of the PET story.

Okay. I was just trying to get a sense for how much your profit --

Yes, I know.

Would improve all else held constant. In a similar vein, what kind of bracket would you put around your IntegRex start-up costs in the fourth quarter? How much did that nick the profitability in the Polymer segment?

I think for the quarter, I'm thinking 5 or $6 million.

Okay. And then, Rich, a question for you on pension, if I may.

From the figures that you threw out, it sounds like you've injected an average of about $113 million a year into the pension over the last three years. What do you think that figure might be over the next three years?

We took a look at the numbers and it will be very small. We're about 100 -- we're as close to 100% funded now as we could calculate and that includes the impact at a new legislation.

So the changes will be any changes in our mix of employees and the demographics. So it's, we're there and I think it's something we're real pleased with and I think all of our employees will be pleased with.

Okay. Thank you, guys. I'll get back in the queue.

And the next question is from Bob Goldberg with Scopist Asset Management.

Good morning.

Good morning, Bob.

I wanted to ask about the depreciation. Rich, you said the depreciation is going to be about $350 million in '07?

That's correct.

And that's up from about 308 in '06?

That's right.

Is that difference of $42 million flowing through the earnings or are you going to be calling out?

We're going to call out the accelerated depreciation for the decisions we made around the crackers in Texas and the decisions we made about the transformation in South Carolina. And that's, my estimate sitting here right now is that's about $50 million.

Okay. So in terms of your guidance, there's no real change in depreciation flowing through, just the increase in the tax rate?

That's right.

Okay.

And in terms of the PET, the strategic direction, any real, I'm just trying to understand is there a change in your strategy since the Investor Day? It seems like there may be some change in emphasis of the pace and the strategy you're putting in place with regard to the nonintegrated assets.

Yes, you hear us saying more emphatically what was already on our minds. But you have, this is entirely consistent with everything that we've said. For those of us that have followed us a long time, when we start using words like fix, sell or shutdown, you know that there's stuff already churning or we wouldn't use those words.

This is entirely consistent with Investor Day. The pace is dictated by the successful start up of IntegRex.

We had to be a little bit cautious on Investor Day, because everything starts with the successful start up of IntegRex and you don't want to call that our before it's done. Now that you've got it done, we can hustle and that's what we're doing.

Were all geographies in the red in the fourth quarter in PET?

In the red on EBIT, yes.

Okay. Okay. And in terms.

And Bob, I'd just remind you that North America had the $6 million of preproduction costs that we talked about.

Right. But that was, I mean that was such a huge swing from Q3 to Q4.

Absolutely.

And I think Q3 had a similar level of start up costs.

Yes.

So it kind of focuses the mind about what you need to go through.

Well, absolutely. Are there any sales in this? Are you beyond the potential to sell some of these assets?

Not at all.

Not at all. These assets have great sale value and that is certainly part of the thinking.

Spain was a bit of a unique situation because of what's going on with the labor there.

Unfortunately, the Spanish employees chose to follow the wrong leaders and it may lead to the loss of all the jobs instead of a better outcome that we had offered. So that's a unique situation.

Okay. And just last question.

I know this is, since Frank [Denauw] is not around anymore since he retired, I have to ask the question. [Inaudible] I'm going to be in the mantle here.

Okay. We'll answer that, clearly.

We've been very quiet about that and I'd just say that nothing is off the table. We're considering all alternatives and that's where we stand right now. So you'll hear more about it at the right time.

Okay. Let's make the next question the last one, please.

And that question comes from Andrew Feinman with Iridian.

How do you like that? Under the wire.

Hi, Andy.

Hi, guys.

So if you spend $450 million on Cap Ex this year, what do you think your net debt will be at the end of the year, like ballpark? Or magnitude, anything?

I think it will go down.

It'll go down.

Yes, I know that. But it's 653 million, so --

It could do go down as much as it went down this year. We're trying to ramp up the spend.

Okay.

Andy, I'd say, and you also have the wild card, we're being pretty blunt about our decisions around the PET plants outside the U.S. That takes its own life. It's very difficult to project timing on what might happen or values, et cetera.

We're working on it. We do believe that we will generate free cash flow beyond the Cap Ex and dividend, et cetera, so I don't want to be too precise at this point, but our projections internally are is that it will go down.

Could you tell me how much the off balance sheet receivable debt was at the end of the year? Maybe if you want, you could give the year-over-year?

It's $200 million.

Okay. So that hasn't changed?

No, that hasn't changed. That's consistent.

And the pension, if you put $100 million into the pension plan next year, that's the cash, but what about the non-cash expense part that goes in the sources side of the cash flow statement?

Yes --

That corresponds with the hundred.

The hundred is already contributed.

I understand. So you're putting a hundred in 2007, how much will you expense in 2007 -- I don't want to penalize you for the whole hundred because you're going to get some of it back, because you're going to expense some number, what's the number?

I'm looking across the table, I'm coming up short.

Okay. Well I can get back to Greg on that.

Yes, please do.

I expect that your number of shares is going -- I'm trying to hurry 'cause I know you're out of time. 84.7 million is what I have for the number of shares for 2007 if you take where you were at the end of this year and you add the dilution. So is that about right?

Yes.

Okay.

So let me just say that in relation to this last guy's question about the buyback, if you don't mind my, you know, the number of shares, I think if that number's right, is up 8.2% since the full-year 2004. And I understand you're using the money for a lot of good things and that's why I own the stock, but I also, you know, that's 8.2%, so I wouldn't mind getting a little bit of that money in addition to the 2.8% dividend if you guys do decide to buy back any of those shares.

And I'm going to carry your comments to the board discussions, Andy. This is, I mean this kind of -- we've been seeking this kind of feedback from our big investors and you are in that category.

This is an active dialogue that's going on with our board. Your comments are important, and now I've got that comment to take with me as well.

Well, thank you for the privilege of letting me give my opinion. I appreciate it.

Andy, it's good to hear from you.

Okay.

This concludes our prepared remarks, or our questions and answers, excuse me. An audio replay of this conference call will be available this afternoon through Friday, February 2nd and thank you very much and have a great day.

And that concludes today's teleconference. We thank you for your participation. Hope you have a wonderful weekend.