伊士曼化學 (EMN) 2008 Q4 法說會逐字稿

Good day, everyone. Welcome to the Eastman Chemical Company fourth 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. Please go ahead, sir.

Okay, thank you, good morning everyone. Thank you for joining us. On the call with me today are Brian Ferguson, Chairman and CEO; Jim Rogers, President and Chemicals and Fibers Business Group Head; Curt Espeland, Senior Vice President and CFO; and Marie Wilson, Manager, Investor Relations.

Before we begin, I'll 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 2009. 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 2008 financial results news release on our website and in our filings with the Securities and Exchange Commission including the Form 10-Q filed for third quarter 2008 and the Form 10K to be filed for full year 2008.

Second, except when otherwise indicated all financial measures referenced in the call and in the slides accompanying the call will be non-GAAP financial measures such as sales revenue, operating earnings and earnings per share that exclude restructuring related and other items. A reconciliation to the most directly comparable GAAP financial measure and other associated disclosures including a description of the restructuring related and other items are available in our fourth quarter and full year 2008 financial results news release and the tables accompanying the news release. With that I'll turn the call over to Brian.

Hi, good morning everyone. Thanks for joining us. I think we all know these are very unusual circumstances. We're reporting on different kinds of data than we normally do.

So for the first time in my memory, we're going to use some slides to improve our communications and make sure that we get the data to you. And the slides will turn automatically as we go through the session here. Or you have the choice of using the PDF file and flipping through them yourself.

I'll start by walking through fourth quarter and full year 2008 results and then Curt will discuss our strong financial position and I'll conclude with some comments on corporate strategy.

Now, starting with our fourth quarter. Everyone knows the world changed pretty dramatically beginning in November when demand dropped as rapidly as I've ever seen it. As a result, our sales volume declined by 17% year-over-year and this was throughout the Company.

The lower sales volume led to lower capacity utilization which averaged 66% in the fourth quarter and was down as low as 50% in December. December was the lowest capacity utilization month in my 31 year memory with this Company; certainly not something that was expected.

With capacity utilization at these levels, our cost per unit increased and the lower price raw materials did not flow through our system because we were not buying enough of them due to the very low demand and the end of year inventory reductions.

One other item in the quarter were losses in the settlement of commodity hedges that were over $60 million. The combination of all these factors led to the decline in EPS that we reported.

Looking at full year results, prior to demand dropping significantly in Q4, we were on track for another strong year. Through nine months, our revenue, operating earnings and EPS were all higher compared to the first nine months of 2007. So the decline in full year operating earnings and EPS is entirely due to the fourth quarter results that I've just discussed.

Turning next to the segments beginning with Fibers. Fibers fourth quarter revenue declined slightly as lower sales volume was partially offset by higher selling prices. The lower volume was in acetate yarn and acetyl chemicals both due to the global recession. The higher selling prices were primarily in acetate tow to offset higher raw material costs.

Operating earnings declined mainly due to the lower acetate yarn and acetyl chemical volumes. And looking at the full year, our operating earnings were flat even with the decline in the fourth quarter, demonstrating once again the strength and resiliency of this business.

Looking at 2009, we each expect another solid year as our acetate tow facility should continue to run full and perform well financially.

Next, on our coatings, adhesives, specialty polymers and inks referred to as CASPI, you'll recall that through three quarters they were partially offsetting volume weakness in North America with solid growth outside the US. In the fourth quarter, weak demand spread to all regions and therefore volumes decline was greater.

Operating earnings declined both in the fourth quarter and for the full year due to lower volumes and higher raw material costs, which more than offset higher selling prices. Looking at 2009 we expect demand weakness to continue. We also expect raw material costs to continue to be volatile, but our specialty business continues to hold up reasonably well. And we see CASPI holding up reasonably well at the segment for this year.

Moving to PCI. Revenue declined primarily due to lower volume, mostly in olefin derivatives. During the quarter our olefin stream ran at just below 60% capacity utilization rates and was below 40% in December.

Operating results declined in the fourth quarter for three reasons. First, the lower utilization rates caused cost per unit to increase. Second, prices declined due to lower raw material prices. For example, propane declined by about 60% during the quarter, which drug derivative prices with it. But the lower raw material costs were not pulled through our system due to the low capacity utilization rates. And third, we had losses from the settlement of hedges. These were for propane and natural gas, which both dropped at unprecedented rates during the quarter.

Looking at 2008 through nine months, revenue and operating earnings were up versus 2007. So the full year operating earnings decline was due to the fourth quarter results. Looking at 2009 I would first point out that PCI had full year operating earnings of just $13 million in 2001 and $7 million in 2002, which was our last recession.

In every scenario we see today, the Performance Chemicals and Intermediates group should meaningfully surpass that despite the fact that the current economic environment is much worse than in early 2001 and 2002.

Specialty Plastics is next and their fourth quarter story is also about a decline in demand. Packaging, durables and consumable volumes were all down due to the recession impacting copolyesters. For cellulose esters, the LCD demand dropped off considerably in the fourth quarter as customers stopped ordering all together late in the quarter.

Operating results in the quarter declined due to lower volumes and the impact of lower capacity utilization. The polyester stream had an operating rate in the mid 60's during the quarter and was below 50% in December. Looking at the full year, operating earnings declined due to fourth quarter results and the volatility of raw material prices throughout the year, particularly paraxylene; negatively impacting margins in this specialty business. Looking at 2009, the key to the Specialty Plastics improvement is increased demand. Now but through January demand has not changed much from fourth quarter levels.

Last up is Performance Polymers and before I talk about what was a tough fourth quarter for them, I want to remind you that through nine months they had improved their operating earnings by almost $50 million, so we were on track to improve this business. However, in the fourth quarter things changed externally which negatively impacted our results.

Operating results declined for three primary reasons. First, volumes decline both for PET and for our entire polyester stream. In the second half of 2008 the industry PET demand actually had a negative growth of 2 to 3%. And for a business that traditionally grows above 5% annually, this is a very big change.

Second, the decline in volume led to lower capacity utilization which led to higher unit costs and this was on top of the planned debottleneck of the IntegRex facility. And third the dramatic decline of paraxylene hurt margins in August. Paraxylene was at an all-time high and then in the fourth quarter alone it dropped by over 30% dragging prices with it. In addition because of the low utilization, we are not seeing the flow through of the lower paraxylene costs.

Naturally we're disappointed with the results and we likely will see continued weak PET demand in the first quarter along with high cost paraxylene continuing to flow through our system but I'm convinced when demand returns to a more steady state level above where it is today, the actions we've taken in this business will position us to improve significantly.

Now on to our outlook for the first quarter of 2009. First, there is very little visibility into demand at this time. And this is all the way through our value chain. We can only see a few weeks ahead and we are not seeing the normal order patterns people are just ordering month to month on what they need. What we do see is that volume remains weak, although it has been improving month to month.

In December, our capacity utilization bottomed at approximately 50% which, as I said earlier is a historic low for us. In January, it looks like our utilization will be in the low 60's and it should improve as the quarter goes on. As a result we expect our first quarter utilization will average above 70%, slightly better than the fourth quarter average of 66%. We therefore expect our first quarter earnings per share to be slightly above first quarter or fourth quarter earnings.

At this time, there isn't enough visibility into what demand will be for the year to give you a full year outlook, but we will revisit this when the pass of the recovery is more apparent to us.

One other point, this lack of visibility and the general market volatility is the reason we postponed our Investor Day scheduled for February 10. We thought it did not make sense for us to talk about our long term strategy and how we are implementing it with the current lack of visibility.

The significant drop in demand started just a few months ago in November so we need some time to see where this mess all goes and as a result we have postponed until the Fall and we look forward to hosting you then. With that, I'll turn it over to Curt who will speak about our solid financial position.

Good morning, everyone and thank you, Brian. We all agree that these are unprecedented economic conditions and that fourth quarter was extremely challenging. As events unfolded during the quarter, we made an operating decision to manage our cash flow and reduce operating costs. I am pleased with how the men and women of Eastman responded immediately to the challenge. These actions improved an already solid financial foundation that will sustain us even through an extended period of weak demand.

So in addition to discussing our fourth quarter results and our full year financial position, I'm going to spend a few minutes talking about our financial discipline over the last several years and how that has situated with us a healthy capital structure, a strong balance sheet, and fundamentals that are indicative of a strong BBB credit rating. An attractive debt profile and liquidity position and a flexible cost structure and cost actions that are aligned with business conditions.

Eastman is well funded and has the advantage of being able to continue to invest in a few very attractive growth options.

Just to wrap up the discussion of fourth quarter results. As I mentioned, we shifted our operating principles to cash generation during the quarter. Even with the sharp decline in demand, we significantly drew down inventory levels as well as reduced receivables. As a result we reduced working capital by $190 million.

This combined with our other operating activities enabled us to generate strong cash from operations of $360 million in the quarter. We generated $124 million of positive free cash flow in the fourth quarter and at the end of the year our net debt was less than $1.1 billion underscoring our solid financial position.

I want to hit one other item, which is our tax rate. Our effective tax rate for the year on a continuing operations basis and excluding items was 27%. Looking just at the fourth quarter our tax rate was impacted by a research and development tax credit that we were able to take based on legislation enacted in October, lower overall pre-tax earnings, and a favorable mix of earnings in the different tax jurisdictions. Looking at 2009 we expect our full year rate on a continuing basis to be between 30 and 33%.

Our focus on financial discipline throughout the Company has put Eastman in a great position to weather an economic downturn. Our cash from operating activities has been steady. Over the past four years we've generated on average about $700 million of cash from operations. In 2008, we generated $653 million of cash from operations which given the economic environment is a solid year.

For the year, working capital increased slightly as reductions in payables and increases in inventories were largely offset by a decline in receivables. Net debt to total cap remains in a good place at 41%. We finished 2008 with net debt under $1.1 billion. It is up slightly versus 2007 due primarily to share repurchase of approximately $500 million during the year. And our stockholders equity declined slightly at year-end but remains in a solid place. The decline was due to the share repurchases and the impact of a decline in our pension assets.

So we start 2009 with a great balance sheet. In addition, Eastman has an attractive debt profile and liquidity position. There is no significant debt coming due until 2012. We have attractive interest rates on our borrowings. Our net interest expense was $70 million in 2008, slightly higher than 2009 due to lower interest income on lower invested cash balances.

For 2009 we expect net interest expense to increase slightly compared with 2008 for the same reasons. We have a committed and undrawn $700 million revolver with substantially all of it available well into 2013 and our cash and cash equivalents at year-end 2008 were $387 million. We are in a very strong position from a liquidity standpoint.

Since the last recession we have taken many actions to restore our financial condition and shore up our underlying business strategies. We have either divested or shut down a total of 30 manufacturing sites representing over $2.5 billion in revenue. These actions reduced our exposure to the ethylene cycle and strengthened our CASPI and PCI segments. Our current portfolio of businesses provides a healthy platform to generate sustainable cash flows.

During the same time period we reduced our employee headcount by more than a third from 16,500 to less than 10,500 going into 2009. We have implemented productivity improvements, process improvements and cost reduction actions and continued to seek opportunities. This is an important part of our culture and a job commitment of everyone at Eastman.

And as we've announced in December, we have initiated additional actions to reduce labor related dollars including elimination of overtime, wherever possible, a significant reduction in contractors and part time labor, and a reduction of our management staff. When combined with the other actions that we have taken or have completed the total reduction in costs in 2009 will be $100 million.

The immediate effect of these actions realized in the fourth quarter was in a reduction in our labor related cost of 7% in the fourth quarter when compared to the third. What enables this timely response is a flexible labor structure that was implemented over the last several years to enable us to act quickly and with immediate results in response to any downturn in business conditions.

We have been disciplined in our financial approach and that extends to our priorities for cash. I mentioned earlier that free cash flow was a focus for us and we are committed to delivering positive free cash flow in 2009. First, we will continue to pay our dividends as we have for every quarter we have been a public Company and our current yield is about 6.5%.

Coming into 2008, our US pension plans were fully funded as well as a majority of our defined benefit plans outside of the US. In 2009, we expect our contributions to our pension plans to be at a very manageable $25 million to $50 million.

And we have prioritized our capital spending for 2009. Our baseline capital is $200 million to $250 million and we will be managing to the low end of that range in the current environment.

On top of that we are selectively funding our growth initiatives such as completing the construction of our Tritan copolyester facilities, finalizing feed efforts associated with our industrial gasification project, and completing projects to enable shut down of our crackers at Texas.

For 2009, we expect capital expenditures to be in the range of $350 million to $400 million. And while we have other growth projects available to us, we recognize we need to balance the expected benefits of such initiatives relative to the timing of the underlying market opportunity. So for example, our cellulose esther expansion for the electronic LCD display market is on hold until market demand improves. With all these factors in mind, again, we are committed to generating positive free cash flow in 2009.

Eastman has a strong balance sheet, sufficient liquidity, and a history of financial discipline. Plus the actions we have taken provide us with a portfolio of businesses that are well positioned to recover with improved economic conditions.

We are actively evaluating all options to create shareholder value from our strong balance sheet both looking into and beyond a recession. This includes continuing work on our industrial gasification initiative, developing additional organic growth opportunities, and exploring merger and acquisition opportunities.

Our approach to growth initiatives and creating shareholder value will remain disciplined. For example, a boundary condition to all our strategic endeavors is to maintain our BBB credit rating. We are committed to this rating as it is a good place for Eastman.

It is with the position of financial strength that Eastman is not only able to consider opportunities that might present themselves in the marketplace but also allows Eastman to continue to advance on attractive organic growth projects. Now I'll turn it back to Brian to give you an update on some of these.

Thanks, Curt. Your review of our financial position is a great lead into the discussion of our growth initiatives. These are growth initiatives that we are continuing in 2009. As Curt has told you we are scaling back our capital expenditures due to the economy.

However, we are moving forward in a few areas. The expansion of acetate tow, constructing the Tritan copolyesters, and pursuing the Beaumont Industrial gasification project; as they continue to be attractive despite the economy.

Starting with acetate tow. During the fourth quarter, we completed the expansion of our working to an acetate tow facility. The acetyl chemicals for the facility will come from Kingsport, meaning we will be integrated back to coal as a raw material and this expansion will serve the growing market in Eastern Europe.

About a month ago we announced another acetate tow capacity expansion, this time through the acquisition of an 80% ownership interest in a joint venture with SK Chemicals in Korea. With this joint venture, we will expand what is currently a 12,000 met ton facility to 20,000 met tons.

As with our Workington expansion, the acetyl chemicals will be supplied from our Kingsport facility. And we expect to see benefits of this expansion in our fibers results beginning in the second half of 2010. With these two expansions Eastman will increase our global acetate tow capacity but more than 20% and we will be well positioned to grow with our customers.

Moving next to Tritan copolyester, as I've talked about before, Tritan has a number of unique product attributes including high temperature and chemical resistance and the fact that it's BPA free. As a result, demand continues to be very strong in areas such as housewares and infant care.

Today in our [semi works] facility we are selling all we can make and we are actually making more than we thought we would. And so that strong demand and continued market pull for new applications has encouraged us to increase capacity as quickly as possible. However, given the current economic environment, we have slowed down the pace of the project somewhat just to optimize the costs of construction. We expect the new capacity will be up and running in 2010, benefiting results in our specialty plastics [segment].

Turning next to our industrial gasification project in Beaumont. One of the fundamental beliefs we continue to hold is that there will be a significant spread between liquid and solid hydrocarbons for many years in the future and that we can exploit that through industrial gasification.

Because of the global recession and the consequent decline in demand for natural gas and oil, the spread has compressed in the near term. Although it is still wide relative to historical norms. Looking out beyond this recession, we remain confident that all the economic and political trends support the continued expansion of this spread.

We expect natural gas prices to rise from where they are today, driven by the demands of new power generation, recovering industrial use and the implementation of global climate change policies in the US and abroad. At the same time, we see PET coke prices declining from where they are today as PET Coke supply increases and declining coal prices pressure PET Coke.

And so we continue working diligently to complete the milestones you see listed on this slide. The first is the front end engineering and design or feed process which we still expect to complete this Summer after working to lower the cost as much as possible. Enhanced oil recovery which has been practiced successfully for over 30 years in Texas continues to be our CO2 solution for the project. We continue to work on completing input and output contracts for the project and we continue to work on financing.

Now some of you may not be familiar with the Department of Energy federal loan guarantee that we are pursuing for this project. That program was established in 2005 by the Energy Policy Act. We were chosen as one of the 16 finalists out of 143 applicants in 2007. Our full application was successfully submitted about two months ago and a decision is expected in the second half of 2009.

The due diligence requirements for this program are consistent with commercial project financing and if successful this would eliminate dependence on the commercial bank market. 2009 is a very important year for this project and we will update you as we make progress on these milestones.

So to summarize, certainly the global recession is presenting near term challenges and we are focused on them. We entered 2009 as well positioned financially as we have ever been and we will continue to pursue attractive growth options in a very disciplined manner. With that I'll turn it back over to Greg.

Okay, thanks. We are ready for questions.

Thank you, sir. (Operator Instructions) For our first question, we go to Jason Miner with Deutsche Bank.

Thank you, good morning.

Good morning, Jason.

Firstly, I think when Curt last talked about raw materials headwinds, he described like a 60 to 180 day lag to see some of the benefits flow through. But given volumes it sounds like that may be extending. I just wonder if you could discuss where we are in that thinking now. And maybe particularly in fibers where would you expect or when would you expect pressures on raw material side to ease?

Let me jump on the fibers one first and then let Curt do the Company as a whole if I could. Because something unusual happened last year where the raws moved so much on us with wood, pulp and coal that the industry actually had a price increase during the year. It happened during the fourth quarter.

So you had the impact of having the raw materials for the full quarter but the pricing only kicked in for a portion of the quarter. So you would expect that to even up here during the first quarter.

And fibers overall guys is still such a strong business and I think we reacted well to what we saw in the raw materials there. And I'll let Curt --

Right. And Jason what you're seeing and some of the impact of the inventory turns is really what we're referring to there was really fourth quarter, which is where we saw demand coming off. As well as we were running our plants to focus on our cash flows.

If you look at how we're starting the year, right now, basically our production is there to match demand. So you should see the inventory turns that you'd normally expect in our businesses as with matching a demand in production.

All that said we're probably going to run-off most of this high cost inventory this quarter. There will be a little bit of a lag in some of the plastics but most of it runs off this quarter.

That's very helpful. Okay, thank you and then just on raw materials and energy again. In the quarter, you mentioned about $25 million of headwind. How does that overlap perhaps with the $60 million plus of hedging loss and maybe just to drill down a second. In PCI, roughly how much were those impacts in PCI in the quarter?

Sure. To answer that question, I think the $25 million excludes the hedging. So the headwind of the $25 million is on top of the hedging headwinds. If you look at the impact of the hedges in the fourth quarter, those were predominantly natural gas and propane. And I'd say two-thirds of the $60 million you saw in PCI and the rest of it to a greater extent you saw in CASPI spread with the rest of the businesses.

That's very helpful. And then the last question on IntegRex, what kind of conditions in the PET market would you expect would create additional demand for licensing? Sounds like there's a lot of pressure and I know you're low cost.

Yes, this is an industry that has got an unstable industry structure. As we look around, we see bankruptcies. We see significant restructurings; lots of rumblings of people that are either operating at or below cash margins. And the technology provides an opportunity to go to a lower cost position.

There are some people that are actually in a drop dead position where it's actually advantageous to move to the new technology as opposed to where they are. Especially in things like PTA. So yes, we continue some discussions there on the licensing.

And I think a little bit of an improvement in the business demand. People are a little paralyzed just generally right now. So a little pick up in the business level would also be helpful from that standpoint.

Fair enough. Thank you very much.

For our next question we go to PJ Juvekar with Citigroup.

Yes, hi, good morning.

Good morning, PJ.

If I look at your portfolio, fibers are steady. CASPI is a decent business. We all know PCI is cyclical. And then in performance polymers, which is basically PET. They're holding out for hope for double digit margins with IntegRex and all that. But PET is PET. Can you really achieve those kind of margins?

Well, we believe we can achieve above cost of capital or we wouldn't have invested. When I look back -- just to give you some reference points here. We had about two quarters last year; the second and third quarters on IntegRex. The first quarter was a start up. Fourth quarter was messed up. So second and third quarters, when I look at those quarters, those were money making quarters to IntegRex. And that's before we get a significant expansion and we also improve the quality.

So do I worry about whether I'm going to get above cost of capital on the IntegRex investment? No, I don't. It's not going to be an investment we have to apologize for.

The other PET obviously is dragging everything down. Those are assets we have held for conversion to specialty plastics over time. But PJ, the flip side of your coin is supposing I decided to unload or shut down PET assets? I'd still have an intermediates engine that has to run. I'd have to move the PTA.

So the question is, are you going to like moving PTA any better than you like moving PET? If you decide you don't want to make the PTA, now you have an entire acetyl stream that starts to drag down. It's integrated and kind of entwined into the engines of our streams. And that's the dilemma when people think about the question, why don't you just sell PET or get rid if it? Wouldn't that be better? It's a more complicated question than that.

Okay, I got it. So it's got the mass balance and energy balance.

Yes. And you got to keep the engine running in the center otherwise you start dragging down the coal gas and everything else because you aren't making PTA.

One question for Curt. You mentioned I think $25 million to $50 million pension funding next year or I should say this year. Can you talk about what your P&L expense was for pension in '08 and what it would be in '09?

The pension expense I don't have right at my fingertips but you'll see that. I think it's $39 million through nine months so you can analyze that. As it relates to pension expense increases in 2009 over 2008 it will be $5 million to $10 million higher.

Okay and just one more quick question. I think Brian you mentioned M&A possibility. Over the last five years, you basically sold businesses. So with a strong balance sheet and cheaper valuation, what kind of assets might you look at? Thank you.

Well, first before I turn this question over to the guy that's going to be making those decisions, let me point out that we're doing one right now. The SK acquisition is an ideal situation. Going to create a lot of value. Got a great bargain on that one because it's a brownfield in Asia. Meaning that it's cheaper than a greenfield in Asia. So we've got a great cost position on that.

So it's not like we haven't done it. But when we consider future M&A I think I'll turn it over to Jim and let him comment on that.

Thanks for the question, PJ. First before I even talk about M&A, let me assure everybody on the call our number one priority right now is running the businesses, okay? And churning out the cash as best we can.

I like the position I'm inheriting in that it is a strong balance sheet. The management team has been very disciplined. We haven't been chasing acquisitions during the big boom years. So we aren't sitting here trying to explain why we are trying to pay for something that looked so good a year ago but now we're suffering under.

So you're hearing the voice of experience here when it comes to acquisitions. And you have to be very prudent. But I understand the jist of your question. You're looking for what is the opportunity. How do we take advantage of the fact that we have been so disciplined and we've got the cash on our books and we have the debt capacity.

I would say that as we look in the future and the different uses for cash, everything is going to be on the table. But I don't feel compelled that we have to run out and do an acquisition just to show that we've got a strong balance sheet. It has to be something that really makes a lot of sense.

I like what we're doing in the fibers business with SK. That's the kind of thing that just very, very high probability that you're going to like the return on that.

And so I would think you'll see us be conservative but we're aware that shareholders want us to give them a reason to ride with us when we come out of this recession. And we're going to be looking for every way we can to create value with our balance sheet.

Any further questions, sir?

No, thank you very much.

And for our next question we go to Mike Judd with Greenwich Consultants.

Yes, good morning.

Good morning.

Is there any off balance sheet debt that's not included in those net debt numbers?

We do have an accounts receivable securitization program [in] $200 million. That's still available to us and is fully drawn at the end of the year.

Okay, fair enough. And going back to this issue of the lag in the push through of lower raw material cost. Given the lower operating rates that you're anticipating in the March quarter. When would you expect -- I realize the visibility is low here -- but when would you expect to begin to realize some benefits from that. Because it's difficult from our perspective to know what your exact US LIFO inventories look like from a raw material perspective.

Yes, I'd say we're going to run-off the high cost raw materials this quarter in the vast majority of them are going to run-off this quarter. The slowest turns we have are in the Specialty Plastics area and that may lag a little while longer but even -- many of them are running off in the middle of February. Some of them are waiting until the end of March. Mostly the raw material effect that we talked about is running off this quarter.

Okay, and then lastly in fibers. Again given it looks like a lot of that goes into China, what are some of the dynamics at least in January that you've seen there? Is it just a continuation of what you saw in December? Or is there -- what do you anticipate there at least in the near term?

The fibers business is going to run flat out on making tow in 2009. This is a business that will not do better than 2008 this year but it's not going to be meaningfully worse than 2008 this year either. My point is you should not be trying to annualize the fourth quarter to look at fibers.

We've always used the word chunky on fibers. The fourth quarter would fit the definition of chunky by any measure. The demand for tow remains strong globally and continues to grow faster elsewhere in the world as it declines in North America. So we're not worried about filter tow demand at all.

The Chinese New Year just passed and I realize that that was really just a very recent occurrence; literally a week ago or whatever. But what are you looking to in that business as an indication of a potential pick up or inventory restocking or whatever?

Everyone has been anticipating that there would be a resurgence of demand from Asia following the Chinese New Year and it has just concluded as you said. And yes, there are some early indications that demand is starting to pick up.

I think I said in the comments, we don't have great visibility. We believe February is going to have a higher operating factor than January. We believe that based on looking at one or two weeks worth of data that could change at the end of February. We don't know. And I've never seen a March that was worse than a January. I've got to tell you, March is usually better.

So I would expect some improving demand through this quarter and that's why we said we think this quarter has a low 70's kind of an operating factor as opposed to the 66 in the fourth. So we were counting on some of the Asian demand in that math. There is -- early indications are it's starting to happen but it's just too early to call.

Fair enough. Thanks for the help.

We go next to Jeff Zekauskas with JPMorgan.

Hi, good morning.

Good morning, Jeff.

Did you say earlier in the call that the settlement of your hedges cost you about $60 million in the quarter?

That's correct.

So if that's the case, why shouldn't the first quarter earnings be, I don't know, $0.60 a share higher than the fourth quarter earnings because you don't have the hedge losses?

Yes, good question. Really what you're seeing the dynamic occur is a couple things. One is during the fourth quarter raw materials did come off and come down lower so you actually generated as a North America producer you generated a LIFO benefit of that. And in essence, that hedge to a greater extent offset that LIFO impact.

Another way to think about this, Jeff, we had the -- ex the hedges, if the hedges hadn't been in place in the fourth quarter. We would have been able to take advantage of the discontinuity of falling raws with prices still high. Unfortunately, the prices have had a chance to equilibrate to the new raw material positions. So we lost our shot.

Okay, that's helpful. Second, if I understood your commentary, you'd be increasing your tow capacity by about 20% over the next couple of years. The tow market probably grows at 1% or 2%. Why have so much capacity relative to that rate of global growth?

Well, about 20,000 tons of that is a share shifting from somebody else to us. It's not all new tow. We're talking about our capacity growing much but not necessarily the world capacity growing that much.

I was going to say SK had some capacity and all we're doing is taking those existing assets and moving them to another part of the country and now we own 80% of that. So that 20% is a combination of the European expansion which is for Eastern Europe, which is growing. As well as us taking a bigger presence in Asia, which of course is the big growth market. And just like Brian said, it's not an additional; all those tons aren't new to the market.

Okay. And then lastly, on the Beaumont project. I guess, I look at some of the industrial gas companies that are always involved in very capital intensive projects. What they have are take or pay features to them or they have various ways that they normalize the returns or generate a steady return on capital with the potential for upside. And those are relatively large companies compared to Eastman.

And so when, and we look at sort of what's happened in the volatility of energy prices over the past couple of years, the volatility has been much greater than people might have imagined. And so when you think of investing a very large amount of money relative to the size of Eastman in the midst of all of this volatility, are there ways that you feel that you can regularize your returns? Or do you just have to get your ideas about these spreads right over a longer period of time and they're essentially unhedged?

No, it's a great question. What you see us trying to do is to replicate the business model that is used by the big air companies. We're daisy chaining the take or pay aspects of this a couple of ways. And then on top of that we lay in hedges as part of the financial structure to lock in some of the inputs. So this would look more like a utility company play where they lock in natural gas and electricity on both ends.

I serve on a utility Board and I'm always amazed that they can lock in gross margins a year or two in advance because they do forwards and options on both the inputs and the outputs that they are involved with. And it's the same kind of methodology that we're pursuing here. If you think about what's required for project financing, you have to have guaranteed margin to pull that off. And so we would not be able to qualify for project financing, if we did not lock in those margins, Jeff.

Okay, thank you very much.

Our next question we go to Kevin McCarthy with Banc of America/Merrill Lynch.

Yes, good morning.

Good morning.

Just to clarify on the commodity hedges, if propane and natural gas stayed where they are today, what would be the impact if any of the hedges in the first quarter of '09?

We still have an active hedging program but to start the year, we have no forwards outstanding on any commodity hedges. So if anything, we might have a few options to try to help protect the floor but it all comes down to how our pricing responds to the impact of the new raw materials.

Great. And then as prices decline in 4Q and you liquidated inventory at lower prices, as the quarter progressed. Is it possible to quantify the effect of that across the Company in the quarter?

That's hard for me to differentiate that factor versus all of the factors that you had. There was just tremendous margin pressure when you put all of the factors together.

The look back, we could do it but I'm not sure it would be instructive. I think may what you're getting at is where do you start to breakeven and make money? You don't make money at 50%. Obviously, we operate at around 65% in the fourth quarter and we just about broke even, so the math tells you that when you start heading North of that we start to make money.

I've indicated that we're going to start to head North of that this quarter but we don't know how much North of that. So that's the kind of math you're probably trying to get to.

Clear enough. And then a question on the Workington and Korea expansions. You mentioned, you'd be exporting coal based chemicals from Kingsport presumably in hydride. Gas looks like it's near $4.50 at the moment. Is there a price at which you may in the future decide to discontinue export and shift sourcing to local vendors?

It's not actually in hydride, it's acetate flake that we ship and it's from here in Kingsport where we're starting from coal. So it's very advantaged for us to serve all these sites; serve both these sites from Kingsport. So I think it's highly unlikely we would do something else.

Great. Final quick one if I may. What is your outlook for PET demand in 2009, recognizing that visibility is low. And end use markets in food and beverage, you would think might hang in reasonably well but I know there's been light weighting of other factors going on.

So you're asking for the PET demand?

Yes, do you think it goes back to a positive number?

Yes, I do. I mean, yes, I do. I think more importantly, since we have maybe two-thirds of our capacity at the lowest point in the cost curve, we're going to be running flat out on that. So our problem ultimately, it has been an issue of volume demand but ultimately it's not going to be volume demand for us, it's going to be about spread. And we've got the best cost position that anybody could hope to have right now. So the PET question for the year probably won't be volume driven. It will be what is the industry structure looking like, how desperately is it wheezing and is there enough spread to get where we need to be.

Thank you very much.

We go next to Chris Willis with Impala.

Good morning. Just had a follow-up question on Fibers. How much of the delta in terms of the decline in the fourth quarter is related to the acetate tow versus the other products in there? And was it a mix issue, a cost issue? Can you just flush out a little detail there, please?

Yes, think about it in two buckets, Chris. Apart from tow, we have acetate yarn as well, which is something we like to run that helps absorb costs and typically, honestly, like a breakeven business; sometimes a little positive, sometimes a little negative.

This fourth quarter just given what's happened to apparel, that's another portion of the stream that ran less than 40% utilization; our yarn business. So that that was a chunk of -- when we talk chunky -- that's one of the chunks that brought it down from its normal run rate. The other was this lag between wood pulp and coal going up and us getting the price increases only for a portion of the quarter.

Great, thank you.

We go next to Frank Mitsch with BB&T Capital.

Good morning, gentlemen. Just to follow-up on that, so from your perspective, when you look at fibers; chunky good, chunky bad. This was one of the chunky bad ones and you don't have any causes for concern that volumes down 10% is going to play itself out in '09?

Frank, absolutely not. In fact, in a way I'm a little surprised all of the attention for fibers. I thought I was just going to get to sit in on this call and let all of the other guys answer this stuff. I mean if you look across Eastman, fibers is a business you should least be concerned about. If you look across the industry, I could probably say pretty much the same thing. Fibers remains a great business.

You heard that the main driver of the tow is going to run flat out as it's been doing and we're expanding and that's just a good story overall. So we'll see what happens in the apparel world, see how well we can manage our costs around yarn. We caught up when it comes to price versus the raws. I mean, we'll see where they go from here. But -- so that one looks good.

And as Brian was trying to ballpark it for you, it's just a little less. Expectations are just a little less than what it did this year but it certainly has a two in front of it. And it's probably close to, between that 220ish to 230ish, I guess, if you really want to hone in on it.

Well, I know that on the acetate yarn line that casket linings is a dying business. So that's another thing that's a part of the issue that we have there.

Yes.

I think you talked earlier about some cost cutting initiatives in 2009, $100 million. Can you talk a little bit more about the timing of that and how you anticipate that impacting your income statement?

The effect of that cost cutting was almost immediate. You notice you don't see any restructuring charges here. We dialed the labor knob back, almost instantaneously. I think Curt told you that the fourth quarter labor was down 7% compared to the third quarter. That's how quickly we dialed it down.

We can do more if we need to. Curt said a couple of times we're managing for cash. We want to be self-funding. We don't want to necessarily rely on the banks to be there for us because they aren't acting like they are always going to be everywhere for everybody.

So we look at their cash that it takes to sustain us and sustain our CapEx, sustain our dividend, sustain our interest and pension issues. And if we need to do more on that, we can. But the effects are already immediate and we don't have to wait for them to kick in.

All right, terrific. And I think you mentioned earlier that you do see Asia getting better at this point here in the first quarter and you obviously are calling for higher operating rates due to seasonal pick up. Can you talk a little bit about what you're seeing in North America and Europe?

It's picking up slowly across-the-board. It's interesting when we looked at the declines, we thought we would see some differences in the declines between North America, Europe, Asia, et cetera. And they all declined between 18 and 20%. They all kind of declined together at a similar way and the pick ups are kind of coming across-the-board. It's really -- the data is so limited right now, it's hard for me to give you good, really good grounded estimates on that, Frank. But so far it looks like it's across-the-board.

Thanks Brian. Thanks guys.

Our next question we go to Sergey Vasnetsov with Barclays Capital.

Good morning. It's encouraging that you're looking to get government financing and [instead] could become available. And I'm certainly glad to see your government still has some money left after they spent a fortune on automotive, housing and banking.

Yes, we hope.

So the question is Brian if you're successful in getting the government money as a grant or a loan, can you talk in general terms what are the conditions? The amounts, the interest rates, duration, recourse and other course and other important conditions?

We will be talking more about that as it develops but these are obviously advantaged interest rates. They come in the form of federal loan guarantees, so you have kind of a three party arrangement on that. This is long term financing. This is not bridge financing. So it goes for a long period of time.

And it's not like -- this is not like being a government contractor where you have all of these reporting requirements that go along with it. This is just more or less a financial deal. It just has some guarantees that come with it. Curt have you got -- ?

Yes, the way to think of it is, especially compared to the current credit market, obviously as we mentioned it still has to have the same cash flows to support a financial project. And we continue to expect that to be on a non-recourse basis.

The advantages the Federal Loan Guarantee program would have is against current conditions. One is you could borrow with the Federal Funds Bank which would have much more advantaged interest rate and potentially you could do it at better leverage and better terms than you might commercially. So it's a very attractive program.

Okay, good to hear. When do you expect to have some important meaningful updates on this loan and from the project?

Middle of next year. And closing would be later but middle of this year, excuse me. It is this year. Middle of 2009 and then closing probably about a year from now.

Okay, thank you and good luck.

For our next question we go to Andrew Feinman with Iridian.

Thank you. First of all, I just wanted to tell Curt that I'm thrilled with the networking capital job he did in the fourth quarter and how much you turned into cash. And then I also just wanted to commend you guys at making the tough decision and finally telling us the answer to what capital spending would be for this year and dropping it down to 350 to 400 from 644 is not something I know you were happy about. But I think it's a reason to still own the stock. So you're going to generate a lot of cash this year and I'm thrilled about that.

The question I had was if you could just tell me the depreciation and amortization that I should use for 2009?

Andy, I'd expect depreciation and amortization to be at or slightly higher than what we saw in 2008. We had a little bit of accelerated depreciation in 2008. That's now behind us. So if you'd normalize that out but it will be slightly higher just because of the higher capital spend.

Well, if I normalize that out it would be around $260 million?

That's within the ballpark.

$250 million, $260 million, yes.

Thank you.

And ladies and gentlemen, this does conclude our question and answer session. Therefore Mr. Riddle, I'll turn the conference back to you for any closing remarks.

Thanks, Rufus. And again thank you everyone for joining us this morning. An audio replay of this conference call will be available this afternoon through Friday, February 6. Have a great day.

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