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OPERATOR: Good afternoon. My name is Tamara, and I'll be your
conference operator today. At this time, I would like to welcome
everyone to the Wellman, Inc. third quarter 2007 earnings call. All
lines have been placed on mute to prevent background noise. After the
speakers' remarks, there will be a question and answer session.
(OPERATOR INSTRUCTIONS) Mr. Bermish, you may begin your conference.
MICHAEL BERMISH, IR, OFFICER, WELLMAN: Thank you. Good afternoon,
ladies and gentlemen. I would like to welcome you to Wellman, Inc.'s
third quarter 2007 investor conference call. This call is being
webcast live on the Wellman, Inc. website, www.WellmanInc.com. A
replay of this call will be available on our website beginning later
today through midnight Tuesday, November 6, 2007. During this
presentation, certain non-GAAP terms may be used. An explanation of
these terms can be found on the Wellman, Inc. website, which once
again, is www.WellmanInc..com, in the financial glossary section of
the Investor Relations page. Presenting to you today will be two
Wellman executives, Tom Duff, Chairman and Chief Executive Officer;
and Keith Phillips, Chief Financial Officer. After the formal
presentation, the lines will be open for questions and answers. At
that time, the operator will explain the procedures for the Q&A.
Before we begin with our prepared formal remarks, I would like to
direct your attention to slide number two of the presentation, the
forward-looking statement and copyright which will be in effect for
this call. I will now pass the program to Keith Phillips for the
financial update.
KEITH PHILLIPS, CFO, WELLMAN: Thank you, Michael. As Michael stated,
Tom and I would like to review the results of the third quarter 2007
and describe the current state of our business.
I would like to start by going to slide four, which summarizes the
quarterly sales revenues of our two segments. The results on this
slide, as well as the results of our continuing operations exclude
the results of our European fibers and European PET resins businesses
which were sold earlier this year. As you can see, our chemical base
segment contributed about 95% of our sales in the third quarter. The
decrease in sales in the third quarter is primarily attributable to
decreased PET resin sales volumes associated with the chemical base
segment.
The next slide, slide five, presents quarterly financial information
for the five quarters ending with the third quarter of 2007. As you
can see, we had disappointing third quarter results. This was due to
increased raw material costs and competitive pressures in the North
American PET resins market, resulting in lower PET resin margins and
volumes. The lower volumes increased our per unit cost of production,
which adversely effected our profitability. This resulted in an
increase of our operating loss before other items of about $10
million.
As we mentioned in previous calls, we are no longer able to provide a
tax benefit for losses from continuing operations. Therefore, in
general, when we incur losses, we expect to have a small tax expense
as a result of state taxes, which may be adjusted for any changes in
our tax exposures. In the third quarter of 2007, we entered into a
settlement agreement with the IRS related to uncertain tax positions
and recorded a tax benefit of $3.6 million, which is primarily
related to this settlement. We received a cash refund associated with
this settlement in October.
As shown on side six, we recognized $1.4 million of income associated
with other items in the third quarter of 2007. The other items were
primarily attributable to the gains on the sale of small assets,
which increased both our income and generated cash, but which are not
going to be recurring. We continue to work with our insurance
companies to settle our claim related to Hurricane Katrina, and we're
working toward the substantial payment in the fourth quarter of 2007.
Since we are actively discussing this with the insurance companies,
we can't make any further comment with respect to this matter at this
time.
Slide seven provides the components in the calculation of EBITDA as
defined. We have provided the non-GAAP measure EBITDA as defined
because our major debt agreements use this measurement to determine
our ability to incur additional indebtedness, to make investments,
and make certain restricted payments, such as dividends. It's also an
important measurement tool for financial institutions that provide us
with capital for investors and for our Board and management. In each
instance, we use EBITDA as defined because it excludes items that are
not expected to impact the long-term cash flow of the business and
are not an indication of our ongoing operating performance. We
provide EBITDA as defined as an additional measure frequently used to
value an enterprise and to enable investors to analyze the efficiency
of our operations and to compare or rank us -- with other comparable
companies with different capital structures. Despite the importance
of EBITDA as defined, we recognize that this nonfinancial measure
does not replace the presentation of GAAP financial results. It is
not intended to represent cash flows or an alternative to net income.
EBITDA as defined is simply to provide us supplemental information.
EBITDA is defined as calculated by adding the earnings or loss from
continuing operations, income tax expense or benefit, interest
expense, depreciation and amortization, and permitted adjustments.
Said differently, our EBITDA is defined as EBITDA plus permitted
adjustments. Permitted adjustments are included in the calculation of
EBITDA as defined in our bank agreements. We'll provide the details
of these in the next slide. For the third quarter 2007, we had EBITDA
as defined of about 2 million.
Slide eight provides the details of permitted adjustments. As we
stated previously, permitted adjustments are items which are included
in the calculation of EBITDA as defined pursuant to our major debt
agreements. In the third quarter of 2007, other items were also
permitted adjustments.
Slide nine provides information on our debt and liquidity at
September 2007. Despite disappointing third quarter results, we were
able to reduce our total debt by approximately $21 million, primarily
as the result of the sale of our European fibers business. At
September 30, we had approximately $129 million borrowed under our
U.S. revolving credit facility and had availability of approximately
$69 million. This is lower than either of our previous two quarters.
We were successful in reducing our inventory in the third quarter,
but since the bulk of this reduction was the result of lower raw
material purchases in September, we will not see the cash benefit of
the reduction until October. In October, we expect a reduction
September 1, to have a $20 million positive effect on our cash flow.
As we have mentioned previously, since our fixed charge coverage
ratio as defined in our U.S. revolving credit agreement was below 1
to 1 in the third quarter of 2007, our U.S. bank revolver doesn't
permit us to reduce our availability below $45 million for more than
eight consecutive days in the fourth quarter of 2007. Our
availability has never fallen below $45 million.
We also have approximately $450 million in other long-term debt,
which is comprised of a first lien term loan and a second lien term
loan. The second lien loan, as reflected in our balance sheet is that
of unamortized, original issued discount. Both loans were funded as
part of our February 2004 financings. All of our debt is covenant
light and does not have any rating terms. With that, let me turn it
over to Tom who will update you on the business.
TOM DUFF, CHAIRMAN, CEO, WELLMAN: Thank you, Keith. Turning to our
business discussion, I would first like to discuss the recent
developments in our ever-volatile raw materials and then discuss
specific business issues.
Slide number 12 shows the basic polyester chain from oil and natural
gas to polyester. Oil has recently reached another all-time high,
pushing the MXPX chain toward higher price levels. Fourth quarter
normally is a period of declining costs for MXPX, as the peak summer
driving season has ended and gasoline alternative values for MX drop.
We are now seeing a fourth quarter rise in PX, simply fueled by the
underlying value of oil. I will discuss the MEG side of the molecule
in a moment.
First, let's turn to slide 13, which shows the worldwide capacity for
the feedstocks for polyester shown in polyester equivalent pounds.
The orange vertical line shows polyester demand. As you can note,
there continues to be a huge worldwide overcapacity in the ability to
make polyester. Most of it built in China over the last several
years, this is now almost matched by overcapacity to make PTA more
recently built in China. However, the other raw materials, PX and
MEG, are both in tight supply for this year, as well as for 2008. New
capacity is scheduled to be available in these chemicals for 2009,
but these new projects are generally in the Mideast and China and
typically run behind schedule.
Turning to slide 14, one of the immediate issues for the polyester
industry is availability and price of MEG. This has been a tight
market for several years. Recently, inventory has been limited and
many facilities have been running full out. There have been several
unplanned outages, the most significant being at [Savex] facility, a
significant explosion has taken out approximately 20 to 30% of their
MEG capacity and it is now reported this line will not be operational
until sometime in the second quarter. Most of this production went to
supply the China market, leading to a very tight supply situation,
with polyester capacity closed due to supply or cost issues.
[NE] Global has also declared force majeure in the Americas with a
70% allocation expected through November of this year. This shortage
may limit some NAFTA capacity. These various outages have led to a
very tight global MEG supply, with significant price increases. Spot
prices for MEG are approaching $1500 per ton in China from the $1050
per ton level earlier. The high Asian costs and lack of supply for
MEG could limit their production and should reduce PET exports from
the Far East to the NAFTA market, leading to more balanced supply
demand structure at least for the next two to three quarters.
Slide number 15 shows the relationship between the U.S. and Far East
in raw material costs. The GAAP with China has lessened and all three
regions are moving up based on the MEG prices. Obviously a smaller
differential is to the U.S. advantage, but generally a higher price
also limits Far East production for exports, as the last incremental
purchase sets the spot price market going forward.
Slide number 16 shows the recent trade data for the PET market. The
third quarter projects as its trade surplus for NAFTA for the first
time since the 2005 hurricanes. The additional capacity that came
online during 2007 has led to increased exports each quarter and the
very competitive prices available domestically have reduced imports.
All of this data is before any effect from the MEG shortage. Those
effects will not be seen until late this year or into 2008.
Turning to the specifics of our business, slide 18 addresses the
factors that effected third quarter. In PET, margins decreased as a
very competitive price environment prevailed. Overall demand was down
in what is traditionally a seasonally weaker quarter. The new
capacity additions that have been slowed early in the year by the
various raw material issues, PIA, acetic acid, et cetera finally
impacted the market, leading to aggressive marketing tactics in a
weak demand environment. In staple fiber, selling price increases
offset the increased raw material costs in the quarter. Volumes for
the industry were flat.
Slide number 19 shows our polyester staple fiber sales. The blue
section is our chemical-based volumes up sequentially year on year.
This increase is based on moving products from the recycled fiber
assets closed last year to our Palmetto chemical-based plant.
Overall, industry shipments for Staple, as shown on slide 20, are
down in 2007. Capacity utilization improved marginally, based on
lower capacity, fiber imports have continued at about the same rate
as 2006 with overall fiber industry demand continuing to shrink due
to imports of finished textiles and apparel. We will continue to
follow our strategy of selling into less import-sensitive end
markets.
Side number 21 shows our sales volume story in PET. Year to date, we
continue to be significantly up on 2006 levels, but third quarter was
our lowest shipping level for this year. Again, this is a seasonally
slow period for PET, and this was exacerbated by aggressive marketing
of some of the new capacity available this year.
Slide number 22 looks at the overall NAFTA PET market. The growth
projections continued to be in the 6% range for the next several
years. The water and new age segments continued to lead this growth.
Looking at the supply side of the market, I would like to address the
2007 additions first and then look at the more recent financings.
Slide number 23 shows the various 2006 through 2007 capacity changes.
The total production capacity for both 2007 and '08 is approximately
600 million pounds per year higher, or slightly above the market
growth. Fortunately, almost all of these pans have been introduced to
the market in 2007. This has resulted in difficult market conditions
in 2007, but should allow for improvement in 2008, especially in
light of the trade and raw material situations.
Slide number 24 addresses the next round of announcements for 2009
additions. These announcements by StarPET and M&G comprise total
new capacity of over 3 billion pounds. At this point, we don't
believe there is sufficient PTA available in NAFTA to support these
expansions. If PTA were to be built, we believe additional PX would
also have to be built.
Slide number 25 looks first at the PX availability. If these
expansions were in place and polyester ran full, NAFTA is short by
2.6 billion pounds of PX. Even at 90% capacity, polyester utilization
rates, PX is over 700 million pounds short and that includes running
all PX capacity, even less efficient, older facilities that are not
running today.
Slide number 26 shows the same look at PTA. Again, with full
polyester capacity utilization, PTA is 3.6 billion pounds short and
at 90% utilization, is 2.1 billion pounds short. We do believe the
StarPET facility will be built since they have a PTA commitment and
will start up in mid-2009. They will represent the 2009, 2010 market
growth for PET. Any other new capacity needs new PTA construction and
new PX construction, or imports of these raw materials.
In summary, I do believe we'll be seeing improving results in 2008.
Internally, we have initiated a cost reduction program that we expect
will reduce our operating costs by 20 million to $25 million in 2008.
We also believe the overall market for PET should be improving. As
previously noted, the worst of the market effect from the
introduction of the 1.2 billion new pounds is behind us and no
significant new capacity is expected before mid-2009. The improving
trade picture, especially in light of the MEG situation, should also
greatly improve the supply/demand picture, especially through the
peak demand months of 2008.
Now, before going to questions, I would like to review our strategic
alternatives initiative. As announced, our Board has engaged Lazard,
Freres, and Company to explore strategic alternatives for the
Company. At this point, we are facing two significant events for
Wellman. We need to refinance our debt in 2008 at an expected 20
million to $30 million in costs. In addition, Warberg Pincus, who
invested in a convertible preferred stock in June of 2003 set its
conversion price as of June this year and is now interested in
monetizing its investment.
Beginning this process ahead of incurring the significant cost of
refinancing should lead to the best outcome for all of our
stakeholders. From an overall industry viewpoint, the PET industry is
certainly in need of consolidation and/or restructuring. Wellman will
be proactive in exploring these opportunities in this process. Our
position as a public company with a significant U.S. market share and
two world class manufacturing facilities leave us well positioned to
lead this change. We expect to move through this process
expeditiously. We will postpone any action on our engineering resins
business until this initiative is resolved. With that, if you can
take us to questions, I would appreciate it.
OPERATOR: (OPERATOR INSTRUCTIONS) Your first question comes from Mike
Judd with Greenwich Consultants.
MIKE JUDD, ANALYST, GREENWICH CONSULTANTS: Good afternoon.
TOM DUFF: Hey, Michael.
MIKE JUDD: A question about the 20 million to $25 million of savings
for next year, is that an absolute number for the entire year, or is
that basically a run rate that you hope to achieve by the end of the
year? Trying to get a sense of in terms of modeling out quarterly
earnings for next year, how we should allocate that? In other words,
should we take half of that basically and apply it to the year?
Should it be, you know, back end loaded, that kind of a thing? And
then if you could provide some details -- that's a pretty big number.
If you could give us an indication of where we're going to see that?
Is that going to be in SG&A? Where is it going to be?
TOM DUFF: First, let me start with the fact we expect, we've already
started on some of these initiatives. Some of these changes are
happening now. We would expect that is the range of number we should
get in total for 2008. If you want to load it 40/60, 45/55, yes, that
might be appropriate, Mike, but it is the total number we expect to
get for '08. I would take you back to 2003, which is the last time we
really tried something significant. We said we were going to go find
$50 million of savings. We did basically that. Matter of fact, I
think we did slightly better than that. This is across the Company.
There are various things we were changing, both in terms of -- some
of this is coming off of some of the changes we made earlier in the
year and how we're structured, there are logistics changes, there are
cost changes, and from our freight, how we're moving stuff around.
There are plant changes, there's some SG&A, R&D. It's across
the organization, and we feel fairly comfortable, as I said, that for
'08, that's a number that will be accomplished during the year.
MIKE JUDD: Thanks for the help.
TOM DUFF: Okay.
OPERATOR: (OPERATOR INSTRUCTIONS) Your next question comes from the
line of Rosemarie Morbelli with Ingalls and Snyder.
ROSEMARIE MORBELLI, ANALYST, INGALLS & SNYDER: Good afternoon, all.
TOM DUFF: Hi, Rosemarie.
ROSEMARIE MORBELLI: Well, this is quite an interesting time for
Wellman, isn't it?
TOM DUFF: Yes, it certainly is. I believe it is a Chinese curse that
we should live in interesting times.
ROSEMARIE MORBELLI: Yes, I would agree with that. Regarding the
growth rate for the industry, which you expect to be at 6% for the
year and needing 500 million pounds annually, that does not concur
with Eastmans estimate that the industry now needs no more than 250
million pounds a year.
TOM DUFF: No, I, I think their--. I believe their number was 200,000
tons a year, which is about 400 and some million pounds, but I don't
have their quotes right in front of me, but I believe it was a higher
number that that, Rosemarie. In any case, the point simply is we
don't try to do this ourselves, to be quite honest. We use a
consulting company. Those are their estimates. Frankly, there are
times, as I mentioned, this has been a slightly slower third quarter
than frankly people expected I think from a demand perspective. There
have been some significant light weighting initiatives that were
started during the year, especially in some of the water areas that
have, I think, depressed demand during this year. However, you can
only do it once, so there's been a significant amount of light
weighting that's already taken place. I believe there's more to come,
but you can't just keep light weighting, light weighting, or pretty
soon your hands get wet when you touch the package.
So we may have fallen below 6% for this year, but frankly, that's a
6% over, several years average. So whether it's four or five in one
year, six or seven of the year, I don't know. Keith found the quote
for me. That number was 200,000 tons, which is about 450 million
pounds a year. So we're not very far off. And when we're looking at a
market that is somewhere between 9 billion and 10 billion pounds,
obviously, 5 to 6% of that 500 million to 600 million per year, so
that isn't much different than what they are expecting. As I said, I
think we had some situations this year where we did have some
significant correction of light weighting that took a reasonable
amount of pounds out of demand, that, as I said, once you've taken it
out, you can't take it out again.
ROSEMARIE MORBELLI: Yes, and actually my apologies. I was thinking of
their numbers in pounds, as opposed to tons. It is still a little
down, but not as much. There have been announcements, if my memory
serves me right, from some of the bottlers regarding recycling,
getting back bottles and reusing them. Could that effect -- I mean is
that, first of all, feasible, reasonable expectation? And what kind
of an impact would it have on the PET demand in North America?
TOM DUFF: Again, I -- from the public announcements that are out
there, at one point both of the major carbonated soft drink makers
said they were going to try to get to 10% recycle content. I believe
they may have at some point reached it. I don't believe that's still
the case for most packaging today, however. I believe Coca-Cola had
recently announced an investment of about $40 million to build a 100
million-pound recycling facility. Obviously that's a very expensive
capital rate for 100 million pounds, and frankly, as I said, in a 10
billion-pound market, 100 million pounds doesn't really have that
much effect.
The biggest issue for recycling continues to be not the use of the
packaging materials coming back. Today, the polyester carpet market
and other applications will take back most of the bottles that are
available in the U.S. They are paying reasonably high prices. Further
demand simply makes that recycling more expensive and more difficult
to do. The bigger issue for recycling has been and continues to be
supply, getting bottles back. The percentage of bottles being
recycled has gone down for many years. It was close to half at one
point for PET and I think it's in the low 20s today, but the ability
to get the packages back has gotten more difficult. A lot of the
newer packaging that was introduced doesn't carry the deposits in
deposit states.
So that has hurt, as far as the amount of material coming back from
those, and frankly, one of the things that has been very, very
positive for the PET industry, which has been the development of
single-serve, being a bigger and bigger piece of what -- where these
packages are sold, I've again seen recently someone talking about one
of the fast food chains looking at substituting the cups and
dispensers with single-serve again, which obviously that kind of move
would be a significant plus for PET. But that use outside the home
also significantly lowers recycle rates, because people don't tend to
recycle at their office, or when they are walking around, or outside.
All those things are actually reducing the amount of material that's
available, certainly on a percentage basis, although the total pounds
I think are up slightly over the last several years, but only
slightly.
So the big issue is not their, their appetite to do some of this.
It's where the supply would come from and just how much of it can
they actually get back. As I say, they are talking about $40 million
investment to get 100 million pounds, while that's a significant
investment on their part and is a, I think showing their commitment
to get there, I think it just shows in terms of the increments at
which you do it, it's very difficult to take a whole bunch of this
material back into food packaging.
ROSEMARIE MORBELLI: Okay, and the rationale behind waiting before
restructuring the debt, is that because you think that an acquirer
could do it at a much better rate, or do you have any other reasons
for waiting?
TOM DUFF: Number one, spending the money before -- and then possibly
being acquired just means you've sort of wasted the money because
whoever does it is going to have to restructure it again, anyway. A
takeover of Wellman in any form requires the debt be redone. So you
would simply be spending the same money twice, and frankly looking at
what these opportunities are now ahead of doing the restructuring
seem to make a heck of a lot more sense for everybody, plus, just
putting the debt back in place without resolving the Warberg
situation really left us with the same problem. How do we structure a
-- a way for Warberg to be able to monetize their investment.
ROSEMARIE MORBELLI: And what are the options for Warberg under the
agreement, or is the agreement being nullified and changed?
KEITH PHILLIPS: No, the agreement isn't being modified and changed,
Rosemarie. What they have is a perpetual convertible preferred stock.
They -- for better, for worse, though, when private equity firms
invest they do it with a goal of selling, and the easiest way for
them to monetize their investment at this point is a sale of the
whole Company. If our stock goes above $8.44 for more than 30 days,
we can force conversion, but, you know--.
ROSEMARIE MORBELLI: So we can all dream.
KEITH PHILLIPS: I know, we can all dream, yes. Especially with the
level it's at right now. So that's sort of really where it is.
ROSEMARIE MORBELLI: So--.
TOM DUFF: At this point, Rosemarie, there -- the, they can -- they
could convert the stock and then just try and sell the stock.
Obviously that represents a 40, low 40% of our total outstanding.
Obviously that would be a very difficult and slow process. They can
simply continue to accrete their 8.5% dividend that is an accretion
of stock each year, changes to 10% next year.
KEITH PHILLIPS: 10% in June of 2008.
TOM DUFF: June of 2008, so they can just stay with that position and
they are now in this investment just a little over four years.
Obviously as Pete said, private equity generally has an idea of how
long they want to stay in something when they invest. If we redo our
debt, et cetera, we would certainly hope to put something in the
three to five-year change, which then leaves us beyond where they
would like to see their exit. So take this look today. See what can
be done. Frankly looking at where this industry is today, and as I
truly do believe it's an industry that needs to have something change
in terms of how we're structured. It has been a, as you know, over
the last several years, very difficult operating environment and just
continues to be so. And we felt at this point this is an opportunity
before we make the next step, refinance, and sort of leave Warberg,
I'll say, in there, in their position going forward. This is the
right time to look at this.
ROSEMARIE MORBELLI: And if I may ask one last question, on the patent
infringement, of course, Eastman says that they are not infringing
anything. How comfortable are you that you actually have a patent
infringement there?
TOM DUFF: Well, look, we have a patent. We have two patents, one in
which -- we have a lot of patents, but these two that are
specifically involved here. One of which involves making PET resin
using titanium as a catalyst rather than anemone as a catalyst. We
went public with this several years ago. We actually in analyst
presentations, we've had slides about this where we thought it was a
benefit, where we thought it would be a better-performing product, et
cetera. And mentioned the fact that it was patented technology.
We have tested the ParaSTAR technology. We believe it infringes our
patent using titanium as a catalyst. We also have a patent for the
manufacturer of preforms from PET containing titanium as a catalyst.
And we believe by selling this product that infringes, they are
inducing our customers and other customers to infringe that patent.
We obviously didn't file a suit because we don't believe they are
infringement. We believe they are. Obviously this is something that
eventually a court decides, not us. So I'll leave it at that. I don't
know everything about patents, but I do believe we filed a patent
complaint here that's legitimate.
ROSEMARIE MORBELLI: All right. Good luck.
TOM DUFF: Thank you.
OPERATOR: Your next question comes from the line of [Ray Tisobe] with
AIG.
RAY TISOBE, ANALYST, AIG: Hi, thanks. Just had a couple questions
beginning with liquidity. Can you share your current availability on
the revolver?
KEITH PHILLIPS: Sure. In, in October, our average availability was a
little over $75 million and we expect to end today with somewhere
between 85 million and $90 million in availability, depending on what
collections actually are today.
RAY TISOBE: All right. So we should expect the schedule of interest
payments to be made later this week?
KEITH PHILLIPS: Yes. In fact, tomorrow. I think tomorrow. I'm sorry.
Thursday -- it's the first, but yes, definitely.
RAY TISOBE: And then just on [Saiveg], I haven't seen anything in the
press. Just wondering if you've heard when they may be up and running
with respect to their MEG.
TOM DUFF: As far as we know, the -- what happened in Saiveg was they
had the cold room, which is where oxygen is removed and made
available for their process. There was an explosion. As we understand
it, there is a new MEG facility that's actually being built, adjacent
to the site, and the idea was they would originally cannibalize that
to repair this tower that was involved in the explosion. As we
understand it, that has now been changed and their idea is they will
simply continue to build out the new facility, use that to supply the
old facility and that that will be accomplished sometime during
second quarter and therefore our expectation is that if they stay to
that schedule and can do that, with what's happening in terms of
inventory, et cetera, it would probably be somewhere in the third
quarter before I'll say normal market conditions would come back for
EG.
RAY TISOBE: Great, thank you.
TOM DUFF: Sure.
OPERATOR: Your next question comes from the line of John Roberts with
Buckingham Research.
JOHN ROBERTS, ANALYST, BUCKINGHAM RESEARCH: Good afternoon, guys.
TOM DUFF: Hey, John.
JOHN ROBERTS: Tom, what do you think's the right model for a
rationalized PET industry? What could it look like?
TOM DUFF: John, that's a difficult question. If you ask me to take
all the various PET assets that are out there and find the right way
is that they should all restructure and come back together to make a
nice rational industry, I would probably get put in jail for
antitrust or something. I don't know what the right model is. I
certainly know what we're doing today doesn't seem to be working very
well. Certainly scale, in terms of ability to have a more -- a market
leader needs to develop for this industry. Today we don't seem to
have a market leader. I think certainly integration in terms of how
people operate is important. However, it can be accomplished simply
through alliances, through partnering with raw materials suppliers,
et cetera. It's basically been Wellman's attempt in this industry
over the years, which I don't think has served us badly, in terms of
how we've been able to work with our raw material partners. But
certainly some idea there.
Possibly whether, whether partnering upstream toward bottle
manufacturing, whether partnering downstream toward raw material
manufacturing -- I don't know which is, which is the better model,
but I do know that there's certainly a lot of different ways to look
at what's out there. There are obviously various sets of assets in
private and public hands that if we're better structured I think
would work better, number one, in terms of reducing costs for the
overall industry, producing better products, hopefully keeping some
of the volatility, getting some of the volatility out, which I think
would serve everyone better over time. I mean those are the kind of
things I think that we all need to look at, address and see if there
is some way, and certainly Wellman is saying through this that we
would like to be one of the people to help look at that.
JOHN ROBERTS: You didn't mention globalization among all -- you
talked about scale and integration, but if you look at the polyester
fiber business, North America's been pretty rationalized, and that
hasn't really produced a healthy industry.
TOM DUFF: Yes, but for a different reason. The problem is that the
customer base, the reason the fiber industry has been rationalized in
the U.S. is the customer base has gone away. The -- there is no --
boy, I wish I would say never. Never say never, but there is no way I
can see in the foreseeable future that bottles will easily be shipped
around. So I don't believe the same type of issue. I think it's a
regional customer market. Whether it has to be regionally supplied by
PET is the question, but it's certainly with the freight and at least
face the existing duties, when you look at the value-added in
converting these raw materials to PET versus the transportation
costs, if you, especially if you are taking it across the water,
transportation in some cases is more than the cost to make the stuff,
or significantly more.
So it's hard to see this as being a, anything other than a good
regional market play eventually, simply because the customer isn't
going to be regional. That wasn't the case in fiber, as the customers
all moved to Asia. And that became the issue of why the U.S. fiber
industry rationalized and didn't succeed necessarily in doing so. So
I think it's two totally different models, and I don't know that
globalization at one point, we did feel -- obviously we invested in
Europe and had plans to expand in Europe because we felt that the big
users of PET would want to buy from the same suppliers, would want to
buy the same products, would be looking to globalize their supply
chain. That didn't turn out to be the case. We could never really
find any good basis. That's one of the reasons we left Europe. We
could never find any good basis to be able to deal with customers
that said, gee, we'll be your supplier here and somewhere else. So
that hasn't helped.
Now, it does -- the economics, does the trading of raw material, does
it make sense for someone in the Mideast who wants to build PX or PTA
to invest into these regional markets as a way to bring raw material
here or an EG supplier? I mean these are the kind of things I think
that as industries we all need to explore. Does it make more sense to
actually make the products in those kind of places, versus make the
raw materials? These are the answers -- these are the questions that
we hope to answer in what we're trying to do in this process and get
out there and see what is out there that makes sense.
JOHN ROBERTS: Thank you.
OPERATOR: Your next question comes from the line of Omar Jama with
Owl Creek.
OMAR JAMA, ANALYST, OWL CREEK: Good afternoon.
TOM DUFF: Hi, Omar.
OMAR JAMA: See, one -- on the liquidity side, can you just break out
the debt and the cash, how much cash do you have, if any?
KEITH PHILLIPS: Well, at the end of the third quarter, and it's a
little bit unusual, we had $2 million in cash. We typically operate
with pretty close to a 0 cash balance, but some receipts came in late
in the day and sort of got trapped in the system. Normally when stuff
comes in, we use it to pay down debt under our revolving credit
facility in the same day.
OMAR JAMA: Okay, and then the revolving credit facility balance?
KEITH PHILLIPS: The revolving credit facility balance at the end of
the quarter, we had that on slide nine and it was $129.4 million.
OMAR JAMA: Okay, and then just a more general question, other
industry participants have been continuing to build new capacity,
both in the U.S., Eastman and then overseas, and it looks like, at
least if you take it at face value, the cost per pound to construct
capacity has been -- even with higher steel costs and everything,
it's still been coming down, and some of the costs per pound numbers
I've seen are as low as $0.07 to $0.08 per pound in South America,
and in Asia, I imagine it's even lower for the Chinese. What is --
why would somebody want to acquire Wellman at a premium, given that
you can still transport polyester to those kinds of replacement cost
values? Like what other source of value is there for Wellman's stake
holders before considering some strategic benefit, which probably
should accrue to the acquirer primarily?
TOM DUFF: All right. From the perspective, first, of what's been
happening, you mentioned Eastman. Eastman has been building new
capacity to replace old. I mean they have basically said for the most
part they are taking down some of their older high cost assets and
replacing with this. So I think that has been sort of their strategy.
We have two other people who have announced capacity, as we mentioned
earlier. StarPET, who is building additional, they're coming off a
very small base here. That will bring them up basically around the 1
billion -- well, billion, 2 billion, 3 level, I believe. M&G, who
has announced the plant, but as we said, we don't believe there's raw
material to support that right now. Someone needs to build some more
raw material if that's actually going to happen.
As far as the lower costs, I agree. You can build lower capital costs
than certainly in Asia. I'm not sure. I think you may be referring to
the M&G plant in Brazil. I don't think it was quite that kind of
number, but it was certainly lower than what it would probably cost
to build the same facility here in the U.S. Obviously labor costs are
significantly lower in some of these places. The rest of it, I don't
think is any different. I believe the technology, steel, whatever --
I don't know if there were that big a difference between here or
there.
The issue is, that I said earlier, if you want to transport material
today from China to the U.S., the cost is somewhere north of $0.10 a
pound, which is significantly more than it costs, full cost to make
it here in the U.S. and certainly well above cash costs multiples of
cash costs to make it. So not too many people are actually building
there with the idea that their market is to bring it here. They build
there, they fill out their domestic facilities by shipping here
and/or until their own demand grows into it. I don't think anybody is
really trying to build there with the idea that their business plan
is to sell it here at less their their cash costs for a long time and
that's what a lot of the stuff comes here at. We're certainly at just
their variable cash cost. So I don't think that's, that's really the
issue.
I think the issue is you've got -- in the case of both our Pearl
River facility and our Palmetto facility, when you put those plants
on a cost per pound scale across the industry, they are certainly on
the left-hand side of the scale in terms of cost per pound for
production, so they are considered still world class assets,
certainly in this market, they are very good assets on a cost basis.
The market position we have today, we are somewhere over 20% of the
U.S. market, so obviously, coming here and finding a market versus
being able to be in a market that's already here, we do have some of
the world-leading products in terms of quality and performance. So I
think those are all the sort of things that people look at and look
at and value and trying to decide, gee, does it make sense to either
acquire a partner or whatever with another Company. So I believe we
do bring in this regional market, we bring a lot of value to the
table.
OMAR JAMA: Okay. I'll get back in line. Thank you.
TOM DUFF: Thank you.
OPERATOR: Your next question comes from the line of Gregg Goodnight
with UBS.
GREGG GOODNIGHT, ANALYST, UBS: Good afternoon, gentlemen.
TOM DUFF: Hi, Gregg.
GREGG GOODNIGHT: Did I understand you correctly that in your
estimation there are not enough raw materials to support the MEG
plant that's scheduled for the U.S.? I still see that plant in your
handout as late '09.
TOM DUFF: No, well, the two facilities that were announced, one is
the StarPET facility. The other is the M&G facility. The -- if
you build the two of those, there is not enough PTA capacity in the
United States today. It's somewhere north of 3 billion pounds short
if all the polyesters running, over 2 billion short at 90% rates. So
it doesn't seem that people would be building, PET if they didn't
know they had supply. StarPET plant does have supply. They have, I
believe, contracted with a PTA supplier. They have themselves set up
and we believe that plant, as we said earlier, is coming on about
mid-2009. For the M&G plant to be built, which is about twice the
size of that, someone has to either significantly debottleneck. I
don't know if you can debottleneck quite that much, and/or build new
PTA capacity.
However, when you step back from PTA, obviously one of the other
considerations is how you make PTA. PX in the U.S., again, looking at
capacity that's out there, what's running, et cetera, we also believe
if all this was built and was running at 100% or 90% of capacity, is
also short. And I also believe that it is much more difficult to get
commitments for that PX simply because it means MX availability has
to be there, and obviously as we've seen in the past, MX sometimes
gets pulled back to the gasoline pull, especially seasonally during
the summer. So while there might be PX available at certain points,
there won't be PX available at peak times when MX is going back into
gasoline to enhance octane and lower revapor pressure during the
summer driving season.
So in both cases, there is some investment that's needed on the raw
materials side, or you have to count on being able to import those
products at some number that gives you at least a competitive
situation, with U.S. or regional supply.
GREGG GOODNIGHT: Okay, thanks for that. The second question I had was
the negotiations for 2008 contracts that typically occur in the
fourth quarter, have they started yet, and it seems that it's going
to be a very competitive round of negotiations and you're announcing
your strategic alternatives. Is that going to put you at a
disadvantage in negotiating those contracts?
TOM DUFF: Well, obviously I believe people would try to push you
there, but, no, I don't believe that's the case. The -- frankly, the
negotiations that normally would have been taking place by now have
barely begun. We have had a couple of customers we've sort of
scheduled conversations with, but nothing really has begun. I think
the issue is, and it's a, it's a very different fourth quarter market
than anyone has seen for several years. The raw materials situation
has sort of changed, I think, some of the buyers' strategies.
Previous to this, during fourth quarter, prices were generally coming
down in any case, because generally it's a weakening time for our raw
materials. MX and PX are dropping because summer gasoline season is
done. MEG is sometimes coming down, as ethane, natural gas prices
drop again, off of some peaks and/or simply from change in demand
because PET world demand is generally now slackening off seasonally.
This year we're having just the opposite. We're having raw material
run-ups. We're having increased prices. We've had a $0.03 price
increase that was implemented for October 1. There's a $0.05 price
increase I believe in the market I know we've announced for November
1. Again, just trying to keep up with what has been this run-up in
raw material costs. So I believe the customers have sort of been
holding back starting negotiations because rather than in a time of
falling prices and excess supply, we're sort of in a situation where
the import-direct is tough to bring to the table, as importers are
beginning to pull back and raise their prices.
We, as an industry here in the U.S. are under a significant force
majeure in MEG, so we have a less than full raw material chain
available to the U.S. producers, Americas producers. So prices are
going the wrong direction for them to be negotiating of how much they
would like to buy better for 2008. So I believe it's going to be a
significantly different approach in terms of how people are going to
be looking to buy. I don't know if people are going to try to put a
shorter term package together with the idea that they are hoping then
prices fall after that, or exactly how this is going to work out.
I know one of the bigger issues we continue to hear from customers,
is there any way to get more stability in our pricing, less
volatility? Frankly, we feel the same way. We don't -- the volatility
certainly hasn't helped us, sort of tired of reciting how much FIFO
costs quarter to quarter and how much prices moving up and not being
able to capture all of it on the way down et cetera, has cost us over
the years. So we would also like to find ways to take some of the
volatility out, but as I said starting my remark, it seems like our
raw materials are just getting more volatile rather than less
volatile.
So, Greg, I don't at this point -- people are really ready to sit
down and try and right next year simply because of what's happening
with pricing and with supply, however, I don't believe that's going
to change certainly over the first couple of quarters of the year.
So, again, I'm just not quite sure whether we're going to develop the
normal pattern of how we bought or whether we'll see people trying to
do a shorter term and then renegotiate, et cetera.
GREGG GOODNIGHT: Well, bottom line, you don't see yourself losing
market share in '08?
TOM DUFF: No, I would expect not. Frankly, we have at times passed on
some business during third quarter based on where our prices were. I
believe some of those is what's happening in the raw material market
and the, as I said, the tightening of the supply and imports is
happening. I think some of that business will probably move back
towards us.
GREGG GOODNIGHT: Okay. Hey, thanks, for all of that.
TOM DUFF: Sure.
OPERATOR: You have a follow he's up question from John Roberts with
Buckingham Research.
JOHN ROBERTS: Hey, Tom, it seems to me the water bottles downgauged
more than I would have guessed and got there faster. I don't know
whether you share that opinion, but they seem very flimsy to me and
there's still a lot of rigid bottles out there, so whether it's in
iced tea or other new age drinks, is there a fair amount of
downgauging left to go beyond water? You seem to indicate that it was
sort of all done, but seems to me there still are a fair amount of
firm bottles out of there rather than the ones that squish easily
when you grab them.
TOM DUFF: No, John, I don't want to say by any means it's all done
because basically this has been happening since day one. The bottle
gets introduced at a much higher weight to make sure it's, it works
well, to make sure it stacks, to make sure the consumer likes it, to
make sure the beverage doesn't go flat or change in some other way.
And then over time it gets lighter. I mean if you go back to the old
2-liter bottles that were almost as firm as a glass bottle when they
first came out, today when you go to pour from them, they tend to
squeeze very easily in the middle and they are very thin.
You're right. Water has moved dramatically down, one of the -- the
largest water company I think has been sort of the leader there and
has taken a lot of the weight out. Water doesn't have the concern of
carbonation, so I think maybe it's easier in a less of a product risk
to take weight down in terms of water.
The products that are out there which shape, with design, et cetera,
those are tougher I think in some ways to take weight out simply
because part of the weight is there to let them get shape and design.
Obviously I think over time all these products will continue to take
weight out, but that's been a fairly consistent move, as I said, just
on a gradual basis, as any new product is introduced later it gets to
weigh less. I'm not saying we're over, by any means, in water. What
I'm saying is that one of the big market leaders has done an awful
lot already this year. Once that's out, it doesn't come out again.
You're right. Others will continue to come out and that's been
happening right along and you still have the kind of growth rates
that you've had. So that's, that's not a new phenomenon. It's not one
that we're, that we think is accelerating any. We think it was simply
just a very concentrated year of -- all these small single-serve
packages came on over a relatively short time and I think the
concentration of taking weight on them, got very big this year and I
think we'll probably continue to see it.
But as I said, what's gone once is gone. They can't relightweight the
same bottle, or at least for the same extent. So we don't think
lightweighting is starting -- stopping by any means. All I'm saying
is that I think we had an especially aggressive year of it this year.
We'll continue to have it, but even with that happening this year,
the market still grew, and it will continue to grow. It's one of the
reasons I think we have, in those forecasts -- if you notice you have
CSD actually getting smaller than what it's been previously. I think
some of that is the anticipation that these 20-ounce and half-liter
and 12-ounce bottles over time will get lighter. I think that's part
of where that loss gets. I don't believe it's necessarily just a
lessening of sales. Could be a little bit of that, but I think it's
much more a correction of the weight that's in there. And that is
still leaving you with these approximately 6% growth rates.
JOHN ROBERTS: Thank you.
OPERATOR: We have time for one last question. Your last question
comes from Omar Jama with Owl Creek.
OMAR JAMA: Keith, I just had a follow-up question. What was your
accounts payable balance? Has that changed quarter to quarter?
KEITH PHILLIPS: Omar, the accounts payable balance at September 30,
was about $61 million.
OMAR JAMA: Okay, so is that down?
KEITH PHILLIPS: That's down $81 million from where it was. It was --
yes, it was $81 million at June 30. That's about a $20 million down.
That's sort of the result of the raw -- of reduced raw material
purchasing that I was talking about that was churning additional cash
in the fourth quarter.
OMAR JAMA: Got it, okay. Thank you. And then just following on that,
I remember when you did the debt refinancing two years ago, part of
the use of proceeds was to make a payment. Was it to BT, your
terrathalic acid supplier? Was that right?
KEITH PHILLIPS: There was a whole -- we had a whole bunch of -- there
were a few off balance sheet transactions that we had at that point,
one was a synthetic lease we had receivable securitization, but--.
OMAR JAMA: I'm talking about the raw material. You had to prepay
something like 80 million or $90 million to have access to PTA, and
looking at your slide on page 15 showing kind of the consistent
higher raw material costs in the U.S., I think at least part of that
is because PTA costs more in the U.S. because BP and the other
producer basically have a strangle hold on the market. When does your
supply contract come up for renewal? Because I'm wondering if you
might not have to make another large payment to ensure access to PTA
supply?
KEITH PHILLIPS: I mean, Omar, we're not really concerned about access
to PTA supply. But I'll tell you what, why don't I give you a call
back off line and we can talk about it.
OMAR JAMA: Okay.
TOM DUFF: Omar, look, you're asking about a lot of things that
frankly are not generally talked about publicly, and I'm sorry this
is not appropriate for the call. You can -- as a debt holder, you're
more than entitled to certain information, but--.
OMAR JAMA: But it is disclosed in all your public documents.
TOM DUFF: --under contract, it's under contract through 2008 for --
and has an evergreen contract that frankly, renews every year after
that for overall may. As far as the other stuff is -- if you would
like to talk to Keith specific on some of the other stuff, why don't
you give him a direct call?
OMAR JAMA: I apologize. I thought this was all -- I thought I read
this in the 10-K, which I think is in there somewhere.
TOM DUFF: Okay. All right. Thank you very much. I appreciate
everybody's participation. Hopefully we'll come back to you with some
better news for fourth quarter. Thank you.
OPERATOR: This concludes today's Wellman, Inc. third quarter 2007
earnings call. You may now disconnect.
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