Huntsman Corp (HUN) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2005 Huntsman Corporation earnings conference call. My name is Colby and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. John Heskett, Vice President of Corporate Development and Investor Relations. Please proceed, sir.

Thank you, operator, and good morning to everyone. As the operator mentioned, my name is John Heskett and I am the Vice President of Corporate Development and Investor Relations for Huntsman Corporation and its principal operating subsidiaries -- Huntsman International, Huntsman LLC and Huntsman Advanced Materials. Welcome to Huntsman's investor conference call for the second quarter of 2005. Joining us on the call today are Peter Huntsman, our President and CEO, Kimo Esplin, our Executive Vice President and CFO, and Sean Douglas, Vice President and Treasurer.

As a reminder, a recorded playback of this call will be available until midnight, August 11. The recorded playback may be accessed from the U.S. by dialing 1-888-286-8010 and from outside the U.S. by dialing 1-617-801-6888. The access code for both dialing numbers is 44253985. A recording of this call may also be accessed through our Web site.

Before we began a discussion of our earnings, I would like to say a few words about forward-looking statements. Statements made during this conference call that are not historical facts are forward-looking statements. Such statements are predictions or expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially based on a number of factors, including but not limited to, future global economic conditions, changes in the prices of our raw materials and the energy we consume in our production processes, access to capital markets, industry production capacity and operating rates, the supply/demand balance for our products and that of competing products, pricing pressures, technological developments, changes in government regulations, geopolitical events and other risk factors. With respect to Huntsman Corporation, Huntsman LLC, Huntsman International and Huntsman Advanced Materials, please refer to our most recently filed Forms 10-K and Forms S1 and S4 for a more complete discussion of the risk factors applicable to our business and operations.

Turning to earnings, I would like to point out that as I summarize the earnings, I will be referring to adjusted EBITDA, which is EBITDA as adjusted to exclude the impact of discontinued operations, restructuring, reorganization and plant closing costs, loss on the sale of accounts receivable, net gains and losses arising from the early extinguishment of debt and non-reoccurring legal and contract settlements. In the second quarter of 2005, we recorded a net total of 63.6 million of such costs and expenses, and in the second quarter of 2004, we recorded 172 million of such costs and expenses. We focus on adjusted EBITDA from a management standpoint as we believe it is the best measure of the underlying performance of our Company and our operations. We have received feedback from any of you in the investment community that this is how you prefer to look at our business. A reconciliation of both EBITDA and adjusted EBITDA to net income can be found in our second-quarter earnings release, which has been posted to our Web site.

Today, Huntsman Corporation and its subsidiaries announced second-quarter earnings as follows -- Huntsman recorded adjusted EBITDA from continuing operations of 429.9 million as compared to adjusted EBITDA from continuing operations of 288.5 million in the second quarter of 2004. This represents a 49% increase in adjusted EBITDA over the results achieved last year.

Net income available to common stockholders for the second quarter of 2005 was 112.7 million or $0.48 per diluted share. This compares to a net loss to common stockholders for the second quarter of 2004 of 207.3 million or a loss of $0.94 per share. Excluding the after-tax impact of 40.4 million related to discontinued operations and 16.4 million in charges related to restructuring, plant closing costs and the early retirement of debt, net income was 169.5 million or $0.73 per diluted share. This compares to 64.4 million adjusted net loss from continuing operations or a loss of $0.29 per share for the comparable period in 2004. Stronger year-over-year results were driven by improvement in five of our six divisions while in Base Chemicals, results were essentially flat with the 2004 period. On a sequential basis, adjusted EBITDA was down approximately 12% as compared to the strong results we experienced in the first quarter.

I'd like to now briefly outline the performance of each of our six segments. Polyurethanes recorded adjusted EBITDA of 198.2 million for the second quarter of 2005. Adjusted EBITDA increased by 8 million as compared to the first quarter and was 79.2 million higher than in the second quarter of 2004. We continue to experience very solid market conditions for MDI globally. In addition, our PO business benefited from higher pricing for propylene oxide and stronger coproduct MTBE margins.

Advanced Materials recorded adjusted EBITDA of 44.6 million for the second quarter of 2005. This was down from 49 million in the first quarter, but up from 39.6 million in the second quarter of 2004. In Advanced Materials, we continue to realize the benefits from our well-balanced, market-driven portfolio and our ongoing business restructuring activities. In addition, margin improvement has been aided by our concerted efforts to raise prices for our products. I'd also note that results for the second quarter did not include any unallocated foreign exchange gains or losses, as beginning this quarter, we have elected to consolidate all of the foreign exchange gains and losses on inter-company loans at the corporate level.

Performance Products recorded adjusted EBITDA of 65.9 million in the second quarter as compared to adjusted EBITDA of 36.9 million in the second quarter of 2004, and adjusted EBITDA of 67.9 million in the first quarter of this year. We experienced improved pricing in nearly all of our major product lines as compared to the first quarter, which resulted in stronger margins. The obvious exception was ethylene glycol, where we saw prices fall throughout the quarter. We also had our largest ethylene oxide and corresponding glycol unit down for the month of June for planned maintenance.

Pigments recorded adjusted EBITDA of 39 million in the second quarter, which was down from 42.2 million in the first quarter of 2005, but an increase of 9% as compared to the second quarter of 2004. Although sales volumes in the second quarter were 3% higher than in the first quarter, average selling price in dollar terms softened a bit due to the stronger U.S. dollar and direct costs were also higher due to $8.7 million non-cash charge related to a change in the treatment for purchase contracts. Excluding this charge, sequential results were higher by approximately 13%.

Polymers recorded adjusted EBITDA of 33.5 million in the second quarter of 2005, an increase of 28.2 million as compared to the second quarter of 2004. Adjusted EBITDA decreased by 13.3 million as compared to the first quarter, as improved results in polypropylene and EPS were more than offset by weak profitability in polyethylene, where we saw prices fall during the quarter.

Results were also weak in our Australian styrenics business, which generated an EBITDA loss of 5.2 million in the quarter, due to very soft styrene monomer conditions.

Base Chemicals recorded adjusted EBITDA of 83 million in the second quarter of 2005, a decrease of 81.3 million as compared to the first quarter and essentially flat as compared to a year ago. Results declined in both our European and U.S. businesses.

Finally, before turning the call over to Kimo, I'd like to briefly review our outstanding common shares that were used as the basis for calculating our EPS and adjusted EPS in the second quarter. Following the IPO and the conversion of the HMP warrants, total issued and outstanding shares were approximately 220.5 million. This does not include approximately 745,000 restricted shares that have been issued to management pursuant to long-term incentive compensation plans, which have not vested.

On a diluted basis, our mandatory convertible preferred stock is convertible into approximately 12.5 million additional common shares. This results in 233 million diluted shares outstanding for the second quarter.

With that, I'd like to turn things over to Kimo Esplin, our CFO, for his comments on financial highlights.

Thank you, John. We continue to be very pleased with the financial performance of our business in 2005. Although our adjusted EBITDA declined somewhat from the record results that we posted in the first quarter, profitability was still almost 50% higher than the level that we achieved in the same period of last year. Although the profitability of the commodity business was somewhat down in the second quarter relative to our expectations, we continue to be very pleased by the adjusted EBITDA generated by our differentiated businesses, which includes our polyurethanes, Advanced Materials, and Performance Products segments.

Adjusted EBITDA at these differentiated segments continues to grow and there's over $300 million of EBITDA during the quarter, comprising approximately two-thirds of the total. As we have said in the past, this collection of businesses formed the core of our portfolio and will be the focus of our strategy going forward. It is where we see the growth and where we will look to invest most of our discretionary capital going forward.

Also, the impact of our deleveraging program was clearly evident on our bottom line this quarter, as interest expense was approximately 101 million as compared to the pre-IPO levels of 153 million in the fourth quarter of 2004. This represents a 35% reduction. This was achieved despite higher LIBOR rates, which impact approximately 50% of our funded debt.

As it relates to our capital structure, we continue to make very good progress towards our goal of reducing our debt levels by 2 billion by the end of 2007. Since the end of 2004, we have paid off approximately $400 million of bank and bond debt from free cash flow. We have nearly $3 billion of prepayable and callable bank and bond debt, which we will continue to reduce rapidly as our levels of free cash flow allow. To this end, we would expect to redeem the remaining 59 million of Huntsman Corp. 9.5% fixed and floating-rate notes immediately following the completion of the proposed Huntsman International, Huntsman LLC merger expected to close sometime this month.

As I indicated on our last quarterly conference call, we've been exploring a range of options that would allow us to simplify and streamline our legal and financial reporting structure and consolidate certain of our credit facilities. Consistent with this goal, we intend to merge Huntsman International and Huntsman LLC operating subsidiaries. In early July, we received certain consents from holders of our Huntsman LLC Senior Secured and Senior Unsecured Notes, and just this week, we've completed the syndication of approximately $2.5 billion in new credit facilities for the combined entity. These new credit facilities will consist of approximately $600 million in revolving commitments due 2010 and approximately 1.9 billion term loans due 2012. This new debt will be priced at LIBOR plus 175. Although this merger and refinancing won't directly lead to additional deleveraging, it will allow us to further reduce our interest expense by approximately $20 million per year.

We expect to complete the merger and refinancing in the third quarter and anticipate that this transaction will result in approximately $38 million in expenses related to the early retirement of debt in the third quarter, primarily representing the non-cash expense of capitalized loan fees.

Another significant event which took place in this quarter was the sale of our TDI business to BASF. As you know, we are a small player in TDI with the capacity of our Geismar plant at only about 90 million pounds. Market conditions have been poor in TDI and this has been a very disappointing business for us over the past few years. In fact, TDI lost about $10 million on an EBITDA basis in 2004 and 7.4 million in the first half of 2005. The sale of this business will allow us to focus on MDI, which is clearly the growth driver for us.

In the second quarter, we have reflected a $40.4 million charge related to the disposal of the business as a discontinued operation. 26.5 million of the loss was non-cash and relates to the write-down of asset values. 9.9 million relates to a provision for a certain take or pay raw material purchasing contract and is net of the amounts we will receive from BASF. While the balance, $4 million, relates to operating losses incurred by the TDI business in the second quarter.

Finally, we have also restated prior periods to reflect the losses associated with TDI as discontinued operations. We would expect to incur approximately 2 million over the next 12 months to decommission the plant site. These amounts will be expensed as incurred.

Now, I'd like to take a minute to discuss our restructuring charges. Total charges in the quarter were 18.8 million, substantially all of which will be payable in cash. These charges were primarily related to previously announced restructuring activities. Also during the quarter, we made cash restructuring payments of 39.5 million and the restructuring of accrual now stands at 97.9 million. We believe that additional cash charges related to previously announced restructuring activities will be approximately 15 to 20 million in the third quarter.

Capital expenditures for the first half of 2005 were approximately 128.7 million as compared to 94.2 million for the comparable period in 2004. We expect to spend approximately 400 million in 2005. This is expected to include approximately 50 million for the construction of our UK low density polyethylene plant. You will notice that the 2005 spending on the polyethylene plant has come down by $30 million for 2005. This does not reflect any delays in the project, rather an adjustment to the phasing of the capital spend as amounts for 2005 are being pushed into 2006. This will also include amounts spent via our consolidated Chinese polyurethane joint venture on CapEx of $62 million, of which we have funded approximately 8 million in cash contributions, with our J.V. partners and local borrowings making up the difference. In addition, we would expect to invest approximately $8 million in the unconsolidated portion of our Chinese MDI joint venture, all of which have been spent to-date. So as you look at our cash flow statement, full-year CapEx should be around 400 million, while approximately 8 million will show up as an investment in the unconsolidated subsidiary.

Let me remind everyone of the tax guidance we gave on our previous call. We have over $1 billion in U.S. NOL's and other valuation allowances, which will likely mean that our effective tax rate should be in the range of 15 to 20% for 2005 on an adjusted basis. Adjusting out the impact of the 18.8 million in restructuring and 2 million charges on the early retirement of debt, our effective rate in the second quarter was just a bit under 16% for the quarter.

Finally, a few thoughts on the third-quarter directional earnings guidance. As we sit today in early August, it appears that the market conditions for Base Chemicals and Polymers businesses have stabilized and appear to be poised for recovery. Demand appears to have recovered. Inventory levels have fallen and operating rates are higher. Spot prices in the U.S. and Europe have risen dramatically over the last several weeks and contract price increases have been nominated for July and August in the United States. How quickly these businesses can recover will be dependent on macroeconomic demand and the level of discipline that we and other producers exhibit in implementing these price increases. With crude oil over $60 a barrel and natural gas pushing $8 per MMBtu, our current view is that margins and Base Chemicals in the third quarter are likely to be down relative to the second quarter, particularly in Europe.

In Pigments, we are through the critical paint season and in Europe and Asia Pacific, demand fell relative to the strong 2004 season. Prices appear to have hit a plateau. Our ability to maintain current pricing will be a function of demand in the back half of the year, which remains uncertain.

In our differentiated businesses, this is our polyurethanes, Advanced Materials and Performance Product segments, we continue to see solid demand and pricing for most of our major products. Although we have seen raw material price increases recently for some of our main raw materials.

Finally, before we turn things over to Peter, our President and CEO for his remarks regarding our operations in the second quarter, I'd like to respond to a topic that generated quite a few questions from our investor base recently.

As I am sure most of you are aware, the lockup agreements that were entered into at the time of the IPO will expire on the 20th of this month. Also as you recall, the Company entered into a registration rights agreement with HMP Equity Trust, which is the vehicle through which Matlin, Patterson and the Huntsman family own their remaining shares.

The decision to exercise these registration rights and pursue the sale of all or a portion of their shares is a decision that will be made by Matlin Patterson and the Huntsman family in their sole discretion. Management doesn't control the timing of this decision. However, we have committed to support our major shareholders in an orderly process should they elect to reduce their holdings of some point in the future. Our sense is that if any transaction comes to market in the near-term, it would be a registered, underwritten, broadly syndicated transaction. With that, I'll turn it over to Peter.

Thank you, Kimo. We're obviously very pleased with our second-quarter results. The level of profitability that we achieved in the first quarter represented a record for Huntsman. And this quarter is a close second. Keep in mind that these results were achieved in an environment where we again saw record high feedstocks and energy costs. We continue to see very strong results in our differentiated segments as demand remains stable and price increases have been successfully implemented, which has resulted in margin expansion, particularly in Performance Products. In Base Chemicals and Polymers, our performance in the second quarter was softer and reflects the margin compression that we experienced in our ethylene and polyethylene and polyolefins businesses. We think this softness is temporary and we are very encouraged by the rapid improvement we have seen in market conditions over the past several weeks. In Pigments, although our volumes were higher than in the first quarter, the prices were essentially flat. Our costs were higher primarily due to a non-cash accounting charge related to a purchase contract.

We also completed planned maintenance during the quarter on several of our facilities. One of the lines at our butadiene plant was down for 20 days in April and our largest ethylene oxide, ethylene glycol plant was down for 30 days in June for a recatilization. Also, we had both of our MDI lines in Rosenberg down late in April and May and took two of our three lines in Geismar down for a couple of weeks in June for scheduled maintenance work.

As an industry, we continue to suffer through some of the most volatile and highest raw material prices we have ever experienced. During the second quarter, crude oil averaged $53 a barrel but peaked at over $60 a barrel. Natural gas averaged $6.57 per MMBtu, but spiked at close to $8 MMBtu and benzene, a raw material for our petrochemicals, polymers, LAB and polyurethanes, averaged $3.06 a gallon, but ended the quarter at $3.80 per gallon.

These prices represent increases of up to 15 to 50% or more compared with levels in the second quarter of 2004. Since the end of the quarter, we've seen material increases even more -- crude jumping to over $62 a barrel and natural gas to over $8 per MMBtu and benzene to about 3.50 per gallon.

Our results across the board have also improved as we successfully followed through on our commitment to reduce our costs. This cost reduction effort, which we refer to as project Coronado, has a goal of lowering our fixed costs as measured against 2002 costs on a fixed currency basis by $200 million. These savings are in addition to the ongoing annual cost inflation that we have experienced since 2002, which we estimate to be in excess of $100 million. The $200 million target represents roughly a 10% reduction in our fixed costs of approximately $2 billion in 2002. We continue to make very good progress on this program and as we sit today, we are confident that we will meet or exceed our $200 million target by the end of this year.

In addition to project Coronado, which specifically addresses fixed manufacturing costs in SG&A, we are also aggressively attacking our variable cost structure through a number of targeted programs, including ongoing Six Sigma efforts. The variable savings from these programs have been significant.

Moving on to operations, I'd like to take a few minutes and go through each of the six operating business groups that make up our Company. These include our Base Chemicals, our Polymers, titanium dioxide or TiO2, Performance Products, Advanced Materials and Polyurethanes.

Our Base Chemicals segment, which includes our ethylene, propylene, benzene, paraxylene, butadiene, MTBE and cyclohexane, we saw our profitability fall dramatically from the record levels achieved in the first quarter. Let me remind you that about half of our operations are located on the Texas Gulf Coast while the other half are located in Europe, specifically in the northeast of New England. I would like to spend a few minutes discussing the general market conditions of each of these regions.

In Europe, which has contributed the majority of our Base Chemicals profitability over the last several quarters and in fact contributed approximately 75% of our Base Chemicals EBITDA in the second quarter, prices settled roughly flat or even slightly up for the second quarter as compared to the first quarter. Remember our olefin prices in Europe are settled on a quarterly basis, while aromatic prices are now settled monthly, similar to the mechanism in place in the United States. However, raw material costs on average were higher in the second quarter, resulting in margin squeezes, which were impacted further by stock devaluation associated with lower raw material costs at the end of the quarter and lower inventory levels. Also we were adversely impacted by the strengthening of the dollar relative to the euro and the pound sterling as the quarter progressed. The combination of these three factors resulted in approximately $40 million in margin compression relative to the first quarter.

As we look into the third quarter, prices for ethylene and propylene have settled lower by EUR110 per ton and EUR65 per ton, respectively, while feedstocks, namely Naphtha, have increased relative to average second-quarter prices. So absent any dramatic change in feedstock costs, margins are likely to be softer in the third quarter as compared to the second. The good news is that downstream derivative demand has stabilized and spot prices have increased which should position the business for improvement in the fourth quarter of this year.

In the U.S. markets, I think the dramatic drop in prices for both ethylene and propylene have been well-publicized as we saw spot ethylene price drop from a high of $0.43 in the first quarter to a low of $0.25 per pound in the second quarter, while contract prices dropped from an average of $0.415 per pound in the first quarter to $0.383 per pound in the second quarter. The drop in propylene was even more dramatic. At the same time, we saw the weighted average cost to produce ethylene increase by about 10% in the second-quarter as compared to the first quarter. This obviously resulted in margin compression in our olefins business as some of our selling prices tend to be blended average spot price and contract price. The good news is that derivative demand is now stabilized, which together with the number of unplanned outages in the industry, has brought supply and demand more into balance. Spot ethylene prices have moved back up close to contract prices and producers are set to announce a $0.01 price increase in July, the first for this year. How quickly this portion of the business can recover on the back half of the year remains to be seen and will be largely dependent on economic growth and feedstock prices.

Our Polymers business, which includes our polypropylene, ACAO, polyethylene and expandable polystyrene, have an adjusted EBITDA for the second quarter of $33.5 million, which was down a bit from the first quarter but well ahead of the second-quarter of last year, when adjusted EBITDA was only $5 million.

Volumes were actually a bit stronger in the quarter with polyethylene and polypropylene both up 2% while EPS was up 7%. This, along with cutbacks in production, have allowed us to reduce our inventory levels by 10 million pounds during the quarter. Polyethylene is a product which has certainly been the center of quite a bit of discussion in the investment community lately. Let me again remind everyone about the scope of our business.

We have capacity to produce approximately 430 million pounds of high pressure, low density, and 270 million pounds of linear low-density product at our Odessa, Texas facility. This represents less than one-third of our total polymer production capacity. In the first quarter, EBITDA from polyethylene comprised approximately 25% of the Polymer segment adjusted EBITDA and approximately 2% of total Huntsman-adjusted EBITDA. It's just not a significant part of our business.

The larger part of our Polymer portfolio comprised of polypropylene, where we have approximately 1 billion pounds of capacity spread across three plants in North America. The profitability of polypropylene continues to be reasonably strong. In fact, our EBITDA from this product actually increased by about 9% as falling propylene prices more than offset the reduction in selling prices that we experienced. We may see a bit of margin compression in the third quarter as propylene prices have risen dramatically, but we think this is temporary and we have announced price increases to offset this.

Also contained within our Polymers segment is our Australia styrenics business, where we produce styrene and certain derivatives. This is a small business and is focused exclusively on the Australian, New Zealand markets and has increasingly come under pressure as the global styrene markets have been soft and Asian imports remain a threat to this region. Needless to say, the performance of this business has been very disappointing recently and we are currently reviewing all of our strategic options as we evaluate these assets.

Our Pigments business, including our TiO2 and related byproducts, this segment had adjusted EBITDA that increased to $39 million or 9% higher than the results achieved in the 2004 period, but about 8% lower than the first quarter. The sequential decline was almost entirely related to a non-cash charge due to the change in the treatment for a purchasing contract. This charge resulted in a marked to market expense of approximately $8.7 million in the quarter. Excluding this non-reoccurring item, adjusted EBITDA would have been approximately 47.7 million or a 13% improvement over the first quarter.

Sales volumes improved by 3%, primarily North America. Volume growth in Europe was very sluggish as we didn't experience much in the way of the paint season in this region. Prices in dollar terms were about 1% lower than the first quarter but up approximately 1% in local currencies, primarily in the U.S. as we continue to implement announced price increases.

In Europe, prices in local currencies were essentially flat due to the sluggish demand that I just mentioned. As you know, 2004 was very much a transition year for TiO2 profitability. Demand growth was strong, estimated to be about 7% for the year, which resulted in higher capacity utilization rates and lower stock levels and allowed all major producers to successfully implement a series of price increases in the second half of 2004 and into 2005. As we look at prices in the second quarter, they were 13% or approximately $240 a ton higher than the year ago.

As we sit today, our ability to further increase selling prices will largely be a function of demand. Demand in 2005 is tracking about 5% below last year. In Europe, the critical paint season never materialized to the extent that we had hoped. Pricing has been relatively stable, but with soft demand in this region, we have obviously been limited in our ability to further increase prices and we will be challenged to keep prices at current levels unless demand improves.

With about 50% of our business in Europe, we believe that the outlook for the second half of this year will be highly dependent on the overall economic picture in Europe. On the positive side, industry inventory levels appear to be in fairly good shape and appear to be running at 45 to 50 days, which should provide some stability in the market. We would expect to selectively reduce our production in Europe in the third quarter to keep inventories at reasonable levels. In North America, demand feels descent, and we are optimistic about our ability to push new price increases.

Our Performance Products segment, which includes our surfactants, LAB, amines, maleic anhydride product and licensing, and our glycols business groups, recorded an adjusted EBITDA increase of $65.9 million, similar to the first quarter and approximately 78% higher than a year ago. With the exception of ethylene glycol, we were able to increase prices across all of our major product groupings in the second quarter as compared to the first quarter, and this was achieved in a period of falling raw materials. This allowed us to offset much of the decline experienced in our glycol product lines.

In the first quarter, glycol contributed $17 million in EBITDA; in the second quarter, this dropped to less than $1 million, which means that the profit contribution from our core portfolio of amine surfactants and maleic improved by almost 50% in the quarter. Demand from these products has been stable with sales volumes fairly consistent with the first quarter. This segment continues to be a very key component of our growth strategy. We have recently announced our intention to expand our capacity in a couple of these product lines, ethylene amines and ethylene carbonates. We are a global leader in both of these niche products and both of these projects represent attractive returns and will allow us to expand our capacity by 30 to 35% over the next several years to meet customer demands.

We announced two other expansions in ethanolamines and maleic anhydride in the first quarter, and we are seriously evaluating several other similar type projects in this segment as we remain committed to growing our core product lines in this business.

Our surfactants and LAB businesses continue to face the challenging business environment, particularly in Europe. We continue to exit low-margin business and have had recent success in pushing through price increases in both of these lines.

As we have indicated in previous calls, one of the features of our Performance Products business is that as ethylene markets soften, the cost of raw materials for certain of the products in this segment decrease. This certainly accounts for a portion of the margin expansion that we have experienced in the second quarter. To a certain extent, the reverse is also true and should we see Base Chemicals prices strengthen in the second half of the year, it will result in a headwind in parts of our Performance Products business.

We are continuing to aggressively take costs out of this business with the reduction of close to 400 positions in Europe and North America. On June 30th, we essentially closed our White Haven, UK facility; during the third quarter, our Guelph, Ontario, and Austin, Texas sites will be closed.

Our Advanced Materials segments, which includes our coatings, construction and adhesive applications, composites and power and electrical groups, had an adjusted EBITDA for the second quarter of $44.6 million, which was up 13% from 39.6 million in 2004 and up from $33 million reported in the first quarter. However, we need to keep in mind that foreign exchange gains and losses have impacted these numbers in prior periods. Foreign exchange losses were 12.9 million in the first quarter. If you normalize the adjusted EBITDA to exclude this foreign exchange impact, adjusted EBITDA was down slightly from the first quarter. Benefiting from our well-balanced market-driven portfolio, overall volumes were stable as compared to the first quarter softness in construction and coating systems in Europe and certain electrolaminating resins were more than offset by continued high growth in our attractive high-end market segments within our portfolio.

Having successfully completed the majority of the business restructuring program, the process of reshaping our portfolio continues. We have exited certain commodity lines in favor of growing our downstream formulated businesses. Our focus is building on our strong presence in high-value growth markets such as aerospace, power transmission and wind power generation. We're also developing new applications into new markets.

During the first six months of 2005, we have seen continued higher feedstocks and energy costs, primarily in bisphenol-A and epichlorohydin. In this segment alone, we had to absorb approximately $38 million in higher raw materials year-to-date as compared to last year but have been able to maintain margins by increasing selling prices. We are also encouraged by lower prices for some of our raw materials, particularly in North America in the third quarter, giving confidence that we will continue to maintain our operating margins in this business.

Our polyurethanes segment, which includes our MDI, propylene oxide, polyols, TPU and our PO byproduct MTBE, as well as aniline and nitrobenzene had an adjusted EBITDA for the second quarter of $198.2 million, which represents a 67% increase relative to the second quarter of 2004 and a 4% increase over the first quarter of this year. MDI volumes were sequentially flat, as we had both of our units at our Rosenberg, Netherlands plant down for scheduled maintenance work in April and May, and two of our three lines in Geismar down for a couple of weeks near the end of June. Altogether, these planned maintenance activities probably resulted in approximately 15 million pounds of lost production and impacted the P&L by $8 million in the quarter. The good news is this maintenance activity is behind us and the increased capacity improvement has allowed us to implement the first phase of our announced expansion at these plants. And we now have an additional 40 million pounds of production capacity that will be used to meet market growth beginning in the second half of this year.

We continue to see solid demand for MDI in all regions of the world, particularly in insulation composite with products, and adhesives and to markets, where substitutions of traditional material and an increasingly energy-conscious economy is driving consumption. We also continue to see very strong demand in Asia and Pacific region. In fact, year-to-date EBITDA in this region is running almost three times the level achieved last year. The global MDI industry continues to operate at very high capacity utilization levels. Although with our planned maintenance work behind us now, and together with some of our competitors having worked through their operating issues, the supply/demand environment has settled down a bit.

MDI average selling prices were up approximately 42% versus the second quarter of last year and up 1% relative to the first quarter of this year. We estimated that global demand for MDI grew by approximately 11% last year, well above the long-term trend line of 7 to 8% per annum.

Our current estimate for 2005 would indicate industry growth of about 4 to 5%, which really reflects the supply-constrained state of the industry. As we mentioned in our last call, we announced the expansion of both our Geismar, Louisiana and Rosenberg, Netherlands plants. These expansions will add 130 million pounds of capacity at Geismar and 220 million pounds in the Netherlands over the next two years, as demand dictates.

The maintenance work and expansions I mentioned earlier has allowed us to achieve the first 40 million pounds of this expansion with the balance being completed in 2006 and 7. Together with our Caojing, China plant due online in late 2006, we believe we are well positioned to grow what we believe to be our most attractive business.

As Kimo mentioned, in early July, we sold our TDI business to BASF. As I'm sure most of you are aware, this is a very small part of our urethanes portfolio and is a business we have been disappointed with for quite some time. In 2004, this business generated $60 million in revenues and approximately $10 million in EBITDA losses. In the first half of 2005, revenues were $23 million and EBITDA was a loss of approximately $7 million. This transaction represents a very attractive and efficient manner in which to cut our losses and exit this business, as BASF, which has a far more significant investment in the global TDI sector, now owns the customer list and related assets, while we will retain and will decommission the plant site. Although cash proceeds year-end are not significant, they will help offset some of the closure costs. We believe this transaction will benefit our shareholders.

I also want to briefly touch on our propylene oxide business, which is the other major product line in our polyurethanes segment. Clearly less significant than MDI, but still a major contributor to the profitability of this segment. In fact, of $198 million of adjusted EBITDA, $43 million was related to propylene oxide, propylene glycol and coproduct MTBE. The second quarter was much stronger than both first quarter and a year ago. Propylene oxide margins have improved and MTBE C (ph) factors reached record levels. The strength we have seen in MTBE has continued into the third quarter as the average July C factor was $1.25 per gallon as compared to an average of $0.53 per gallon in the second quarter.

In summary, we are pleased with the result of the second quarter. Profitability was much stronger than in the comparable period last year. We continue to be concerned about the impact that high oil and energy costs may have to the overall economy and potentially our ability to expand margins. In the third quarter, we will see a typical seasonal slowdown as customers take vacation. We did experience some softness in certain of our commodity olefins and polyolefins businesses, but conditions appear to have stabilized and are hopefully poised for recovery in the second half of this year as we see rising spot prices and low customer inventory. We are satisfied that over 50% of our revenues and two-thirds of our profitability is coming from our differentiated segments. We will continue to push through price increases and product lines where market conditions will allow and continue to focus on things we can control.

Our priority remains to operate all of our facilities in a safe manner. Our current operating safety rates are a third of the industry average. We also give high priority to our continued improvements in our environmental stewardship and performance. Regardless of energy price volatility, we continue to reduce energy consumption and consolidate our purchasing power across the Company. Today, we are better focused than ever before on reducing our operating costs by eliminating sites and positions that can be handled out of common locations or more efficient sites. With fewer sites and less overhead costs, we are able to bear resources and attention on creating stronger value in our downstream businesses, providing better customer service. We are successfully lowering our costs while at the same time improving our portfolio of products and services to the market.

I think 2005 will be a great year for our Company and many of our peers, and I think that this industry is well positioned to benefit from further improvements in profitability over the next several years as new industry capacity is expected to be limited and the global economies appear to be poised to achieve moderate to sustainable growth in demand. This leaves us even more confident in our ability to meet our primary financial objective of reducing our debt by $2 billion, which I believe will maximize the return to our shareholders.

With that, I would like to turn the discussion back over to John Heskett, our Vice President of Corporate Development and Investor Relations.

Thank you, Peter. Operator, I think we're now ready to open the conference call up for questions.

(OPERATOR INSTRUCTIONS). Don Carson, Merrill Lynch.

Thank you. Kimo, first a housekeeping question. You mentioned that you had changed the way that you account for FX costs or at least moved it from the segments to corporate. Can you just tell us what the total amount of FX expense was arising from these inter-company loans?

Yes, for the quarter it was zero.

Okay. And is that because of the -- is that just the way the exchange rate went, or was that due in part to your reclassification of some of these loans? Just wondering what we can expect going forward -- what the exposure is going forward.

As you know, the euro softened significantly against the dollar through the period and so there was a lot of FX movement. We said on the last call we were doing a lot in terms of restructuring these inter-company loans and also we've done some things in terms of swaps and derivatives. So I think you should expect that the volatility on the FX line should be significantly decreased. And hopefully it's similar to this quarter where it's negligible.

Okay. And Peter, a follow-up on the outages. You quantified the MDI outage and what that might have cost you. Can you talk about -- you also had your EO plant down and butadiene plant down. Just quantify those outages. And then final question, you made the comment that supply/demand for MDI has settled down a bit. Can you be more specific on your MDI outlook?

Yes, let me get the MDI, Don, outlook out of the way first. I think that during the -- certainly during the first quarter, MDI shortages were very severe. I think that it hurt some of the growth of the industry on a short-term basis. And I think that the industry probably may have been just a bit hurt because of the tightness in the lack of capacity in the market. I think where we are today and where we are poised today, we're in a much better position to meet the demands of our customers and I think that we have much better opportunity to continue to encroach on displacing of the products and developing new products and new applications.

I mean obviously, you do want to see operating rates in the high 90 to be able to put through pricing and so forth. But when operating rates in the industry are 108%, you get to the point where you've got some dissatisfied customers and you also get to a point where you really are inhibited from taking advantage of new product development and so forth. And so we continue to see the MDI market very strong and demand continues to be robust in the areas where we are focusing our marketing on our developmental efforts. And we think that the industry today is in better balance. I think if you look back on the first quarter, the industry -- I think it was operating at about 108% of its nameplate capacity.

So I think where we are today is certainly close to probably in the high 90's, 100%. Some areas of the world being perhaps in the mid to high 90's, other areas of the world still being very tight. As you look at -- I did outline the costs that we think that the MDI maintenance work cost us. I think that when we look at the amount that the turnaround cost us and the maintenance recatilization cost us and ethylene oxide, ethylene glycol, you're probably looking in both the cases of EOEG and C4's, our butadiene lines, probably in the low singular millions of dollars per line. EG margins, ethylene glycol margins in the second half, were not anything to write home about. And I'm not sure that we were affected more than 2 or 3 million bucks.

Mike Judd, Greenwich Consultants.

Good morning. Thanks for taking my question. Kimo, question on interest expense in the third quarter. Obviously there are some moving pieces here. Could you give us a sense of that? And then Peter, secondly, with MDI, given the strong demand here, even though it looks like -- it sounds like you've added some, incrementally, a little bit more capacity, are prices holding here in the third quarter? Is there any erosion in pricing?

Michael, let me take your first one in terms of interest expense. We will close our new bank facility towards the end of the quarter, obviously, so we won't benefit from the reduced LIBOR spreads in that bank facility. LIBOR rates have come up a bit and we paid off some bank debt and some bonds. So all in all, I would expect it would be pretty darn close to what we experienced here in the second quarter -- right around 100 million or a little more. And I think you heard me say that this new bank facility should save us about $20 million.

I think when we look at MDI pricing, Mike, we see very stable prices at this time. Benzene prices, while they are high right now, around that 3.50, my gut would tell me that probably over the third quarter, they are poised probably to drift down a bit. I think that where MDI prices are today, they are good, solid margins and there's not a great deal. We are increasing prices in certain areas of polyurethane customer segment, but I do not see any declines on a global basis.

Okay, just a follow-up to the MDI volume question. If you were able to run the 41 million pounds of additional capacity at full rates in the third quarter, what impact would that have on the EBITDA?

Was your question on volume or margins? Are you talking about the 40 million pounds of material, you're looking at about 12 million pounds more sales in the third quarter and what impact did that 12 million pounds of added material have on the bottom line?

Right, it's probably not a lot, but any idea?

I don't know what the contribution was (multiple speakers). I don't have those contribution margins handy for that business address, so I think it would be hard to give you contribution margins in MDI.

1 or 2 million, the singular millions of dollars.

Okay, so if you delta (ph) off the higher maintenance costs in the second quarter, then you're looking around a $10 million difference. Is that about right?

That's probably a good estimate.

I would think so.

Lawrence Alexander, Jefferies.

Good morning. First on Advanced Materials, could you outline what you're seeing in the coatings and construction demand in Q3?

Excuse me, can you repeat the --?

Related to the Advanced Materials business, are you seeing any signs of an improvement in demand in coatings and construction?

We are seeing demand in coating construction continue to grow at the rate of GDP in North America and in Asia. Europe, I would say, continues to be flat.

And second, can you go into a bit more detail on how much of the Advanced Materials is exposed to aerospace and how significant that is for you?

It's about 15% of our market segment, but it bear in mind that this is kind of a tough one because we deal with a lot of OEMs that go into aerospace and roundabout components and so forth. And so it's kind of a hard one to get your hands around if there's one specific product or application that goes into aerospace. And I think that as we look at the aerospace segment, for us, you're dealing with everything from military planes to drones to the commercial aviation, civilian aviation -- I think that we're probably looking at around 15% --

Of the Advanced Materials --

Of the total Advanced Materials sales.

Thank you.

(OPERATOR INSTRUCTIONS). David Begleiter, Deutsche Bank.

Good morning, gentlemen. Peter, can you address the U.S.-based chemicals business, under some pressure right now? Any units there that you might want to look at for possibly shutting down given the results in Q2?

Any units that we would be closing?

Temporarily shutting down or looking at competitiveness of U.S.-based chemicals assets.

No, no, I think that as we look at all of our units across the board, they all have positive contribution margins. And I think that when we see -- when you look at the spot prices of products here, I think that we would be quite concerned had we seen contract pricing follow spot down to $0.25 per pound, but you've seen spot prices go from $0.25 a pound a few -- month and a half ago, upwards to about $0.35, $0.36 per pound today in ethylene.

I think that propylene, the prices are very volatile. Propylene remains a very high-in-demand product. I think butadiene remains strong. MTBE obviously remains strong. Cyclohexane has room for improvement, but remains strong. I think across the board, Dave, it's a good portfolio and I think that directionally, where we were three months ago talking about the first quarter, we ended the first quarter with many of these prices going down. We ended the second quarter with many of these prices going up. The big question I think in the third quarter will really be focused around raw material volatility in this particular area. But no, these facilities -- all of them on a product by product, plant by plant basis remain competitive and remain profitable.

In fact, if we did have any swing capacity, this is probably the time to bring it out. Because people are going to make a bunch of money in this segment we think over the next two years.

Fair enough. And just on your European TiO2 business potential for profit improvements, if not in Q3 about heading into Q4 and next year?

We continue to think that with titanium dioxide, we had a very good year last year in demand. This year, typically paint season in Europe starts around Easter weekend, particularly in the UK -- Northern Europe. This past Easter weekend, it was a variable blizzard across Northern Europe. The paint season, as you'll see in the results of many of the coatings customers in Europe and so forth just really never took off this year. I think when you look at the fundamentals of titanium dioxide, particularly in Europe, we are very encouraged with the fact that inventory levels are low. There seems to be proper constraint and discipline on the side of producers to not build the necessary inventory. Our costs continue to get more competitive in our European businesses. We've shut down our higher cost facilities in Groomsee (ph), and I think that the prospects of those businesses would certainly positive.

Kuanl Banerjee, Morgan Stanley.

Thank you and good morning. Just on this Base Chemicals piece, half of your business you mentioned is in Europe, the other half in Texas, and if you look at the margins, the sequential margin declines, the declines in Texas or in the U.S. was significantly higher than that in Europe just because of that quarterly mechanism that you talked about. Yet you mentioned in your commentary that there was 40 million of margin compression in the European business, which is roughly half of the total sequential decline. So I'm just wondering, does the stock evaluation that you referred to a pretty significant part of that 40 million in margin compression? And just related to that, are we in for some sort of an asymmetric payoff here because we're now getting into the third quarter where the European prices have settled significantly lower, U.S. has started to move up, and we also have the raws moving up. So if you could just comment on that, any part of that stock evaluation that doesn't stay with us in the third quarter, and then I had another question.

I'll let Kimo comment on the stock revaluation, but that does vary quarter to quarter. It's not a fixed plus or minus that we get quarter to quarter. I'll let Kimo comment on that.

But if you look at the market conditions, and I think we've said for the last couple of quarters now that Europe has been very strong on the Base Chemicals basis. There continues to be virtually no new capacity coming on in Europe. I continue to believe that European margins on the longer-term -- if you look out over the next two, three years -- will continue to be fairly strong. I think that the area for improvement is in the U.S. and I think that there's quite a bit of room for improvement in the U.S. So given the fact that we're seeing falling prices in Q3 in ethylene and propylene, I personally believe that if we were negotiating for fourth quarter prices today, you would see higher prices because you're seeing spot prices increase quite rapidly in Europe, but I don't see Europe -- this downward trend in this quarter in Europe, I wouldn't read that as a long-term trend. I think Europe will remain strong as it has in the last couple of quarters. The area for improvement really is the U.S. and so I do believe that there will be opportunities for the U.S. to improve faster than Europe. But bear in mind, it's got a lot of runway there for improvement.

Yes, I was just looking at CMAI numbers for the second quarter. I think they had effective utilization rates in the U.S. in ethylene of 94% and Europe was 96%. So Europe still continues to be sort of over that magical 95% threshold, which means we have some pretty good price leverage. Kunal, of the $40 million that we saw in terms of the second quarter EBITDA decline in Europe, $20 million was that sort of inventory reduction revaluation. And 10 million was raw materials, roughly 10 million was foreign exchange.

Is that 20 million then -- is it a fair assumption that that 20 million doesn't stay with you going into the third quarter or is it something that you would expect?

I think that's fair. That was just bringing our inventories down and lower raw materials at the end of the quarter.

Okay. And then just on MTBE, Valero recently made the announcement regarding discontinuing MTBE use. What is your plan there. And obviously you've got both the European and U.S. base, I'm assuming, so you're still going to be active in Europe. What is the -- the thing that I find more disconcerting is that the oxygenate requirement is being phased out of the Energy Bill. So now, the refiners don't even have a reason to be using the 2% -- meeting the 2% requirement. What is your strategy for MTBE in the U.S. in light of that?

Our strategy for MTBE is that we believe it continues to be a very good product. It has -- refineries continue to put a very high value on it. I still am just amazed at the stupidity of this Energy Bill. As you look at the amount of MTBE that is produced in North America, should it be shut down completely, it would be equivalent to the U.S. losing about 250,000 barrels a day of refining capacity, which is about the equivalence of a 400,000 barrel a day refinery, which is as large a refinery as we have in North America.

But as we have met with our MTBE customers here recently, the value in MTBE is the ability to get a high octane component out of this product. I have not heard any other companies other than Valero taking the drastic steps that Valero has. We continue to hear from our customers that they are reviewing the situation, to customers that say they're going to continue to use it. That what has been done has been done in groundwater contamination and it's not going to get any worse. Tanks have been replaced. Suits have fallen off and so I think you've really got a mixed bag. We continue to see aggressive growth in MTBE consumption in South America, Europe and Asia.

If we were in a position where we could not market a single barrel of MTBE in North America, we do have the capability to export 100% of MTBE to international markets. And depending on those markets, where those markets would be, it would cost us between 20 and $25 million a year. We continue to believe, as we look at the margins on alternative products, such as isooctane and so forth that we could produce from MTBE or ETBE -- we continue to believe that even exporting MTBE at the present margins that we're seeing around the world is a better alternative than investing money and producing another product. But we do have multiple options open to us from exporting the product to producing ETBE to isooctane, and we will continue to evaluate those options as we move forward.

Just to add, to give you a sense, we have two facilities, to remind you. We have the coproduct at Port Neches, Texas with our PO unit and we have a C4 extraction unit in Port Neches. If you think about it on an '04 basis, it's about 4% of revenues -- MTBE is, and in '04 it was about 2% of EBITDA. So it's not a significant part of our business.

My question was really more with relation to how your PO production would be impacted if let's say you had a drop dead date and you didn't have the conversion to either DIB or isooctane up and running by then. But you're saying that that's not really an issue because you would just export --

I think in a worst-case scenario, we just export MTBE whilst we are looking to take that tertiary butyl alcohol stream off the PO plant and doing something different with it. I do not see a scenario right now where all of a sudden, we couldn't export MTBE, we couldn't sell it anywhere in the world and all of a sudden we're having to shut down the entire PO and PBE (ph) unit.

Gregg Goodnight, UBS.

Following up on Kunal's question a little bit, I was having problems understanding the sequential change in Base Chemicals also, and that helped. I was going to ask if there was any additional margin reduction, for instance for cyclohexane on a sequential basis or other products that contributed to the second-quarter performance.

I think most of that -- the vast majority of it -- over 3/4, would have been based on ethylene propylene. As you look at products like cyclohexane and butadiene for us, the vast majority of this product we sell on a polled basis. And so we might get some increase in margins on cyclohexane if we've locked into a price for the next month in benzene, the major raw material were to plummet for some reason, for inventories from the last month where we may have bought more benzene and we saw the prices going up, we might be able to benefit from pre-buying some benzene for the next month. But for the most part, our volatility in margins on butadiene, cyclohexane, even on about a-third to 40% of our MTBE that we produce in our Base Chemicals group, these are all done on a polling basis and have been for several years. And the volatility there in margins is just not all that severe. They don't make money hand over fist, but you rarely ever see them losing money.

Okay, thanks, that helps. A couple questions on MDI one near-term, one longer-term. In the conference call yesterday, VASF mentioned that their Antwerp expansion is now up and they characterize the marketplaces "more balanced" now. Do you see the market more balanced in terms of not being able to get in additional price increases through the second half of the year?

No, I -- well, I think when we see more balanced, as I said earlier, it really is coming around, operating at a higher than 100% capacity utilization rate and maybe moving that down to the high 90, 98, 99, 100% capacity utilization rate. The industry has been limited in its ability to grow because we just don't have the capacity out there. And frankly, if we are to take in all of the capacity that we'll be bringing on in China and so forth, we need to be continuously -- have 1, 2% of excess capacity free for new product development. The reason MDI is such a great product is it continues to displace a lot of other products, applications, new products, installation construction, adhesion, aerospace -- there's just so much new opportunity out there we certainly want to be part of.

And so I think personally, longer term, our ideal market conditions are for the industry to be operating at 98, 99% capacity rather than 108% capacity, where you are actually discouraging some of the customers using your product for new applications because they can't get it. So I can't interpret what VASF said. I don't know the context in which they said it, but when we say kind of the same thing, that we see the market in better balance today, I see that just better balance in being able to meet our customer needs. I don't see the market in any way today so long now all of a sudden that you couldn't put through price increases.

Okay. Second question, in MDI, longer term, if you look at balances out through '07, how long do you see this market staying tight, and is there a scenario, for instance in '07, where announced and planned expansions could bring down operating rates in the industry?

I think that, again, a lot of that is going to be a function of macroeconomic conditions. If we continue to see 7, 8, 9% growth as we have over the last 40 quarters in this industry, I think that you may see capacity utilization rates dropping into the mid-90s. And so I still think that that allows you to have very strong pricing power, and I think that having the ability to have 1 or 2% extra percent capacity for new product development is going to be very key to being able to capitalize on those new applications in the future. But I continue to be very bullish on the longer term -- not just the supply and demand of MDI, but also the new market developments and the opportunity for MDI to continue to encroach on other products and find new products of its own.

Okay, thanks for the response.

There are no further questions in the queue, so I will now turn the call back over to Mr. John Heskett. Please proceed, sir.

Thank you, operator. I think that concludes the second quarter conference call and thanks, everyone, for participating.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.