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PolyOne Corporation (NYSE:POL)

Q4 2008 Earnings Call

February 5, 2009 09:00 a.m.ET

Executives

Stephen Newlin – Chairman, President and CEO

Robert Patterson – Senior Vice President and CFO

Analysts

Michael Judd – Greenwich Consultants

Dmitry Silversteyn – Longbow Research

Steven Schwartz – First Analysis

Rosemarie Morbelli – Ingalls & Snyder

Christopher Butler – Sidoti and Company

Operator

Good morning and welcome to the PolyOne fourth quarter 2008 earnings conference call. Before we begin, the company would like to remind you that statements made during this conference call which are not historical facts may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements will give current expectations or forecasts to future events and are not guarantees of future performance. They’re based on management's expectations and involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed and/or implied by forward-looking statements.

Some of these risks and uncertainties can be found in the company’s filings with Securities and Exchange Commission as well as in today’s press release. During the discussion today, the company will use both GAAP and non-GAAP financial measures. Please refer to the earnings release posted on the PolyOne website where the company describes the non-GAAP measures and provides a reconciliation of them to most comparable GAAP financial measures. Now, I would turn the call over to Mr. Steve Newlin, Chairman, President, and CEO. Please proceed sir.

Stephen Newlin

Well thanks Chantalle (ph) and thank you to everyone and good morning to all of you joining us on this call this morning. As always I welcome the opportunity to speak to our shareholders and analysts about the recent performance of PolyOne. And joining me today is our Chief Financial Officer, Bob Patterson.

I’m pleased to report that the fourth quarter earnings per share of $0.08 before special items exceeded our expectations and was equal to the prior year despite an unprecedented decline in sales volume. For the year, we reported earnings per share of $0.41 before special items again equal to our performance in 2007.

We talk a little bit about the year, you know when we began the year and started off 2008, we thought we deliver EPS before special items slightly better than 2007. And while we didn’t quite get there, we believed this is a solid performance given the significant decline in year-over-year demand that we experienced. 2008 proved to be extremely volatile. The fourth quarter was certainly not an exception to that. The year began with a sense that the US housing market would reach a bottom in 2009. With the US entering perhaps a mild recession and Europe and Asian, we thought might escape the economic slowdown. But we saw very early on, however that exports from Asia were slowing. And we mentioned this in our first quarter earnings call and it was a sign that tougher times lay ahead, although it wasn’t clear then, just how bad the economic environment is going to get.

During the first half of the year, raw material and energy cost rapidly escalated and you recall that in late Summer, oil approached to high of nearly a $150 per barrel. Around at the same time, we saw the first signs of weakness in Europe and mentioned this in our second quarter earnings announcement.

During the third quarter we saw the financial crisis creep the world and credit markets essentially come to a virtual standstill. And shortly thereafter the US announced that it was officially in a recession. The market reacted unfavorably to all of this news and sent equity markets as you well know to low not seen since 2003.

Customers immediately reduced order intake in anticipation of a global deceleration in production. As it appeared that Europe was entering recession, lower raw material cost offered some relief in the fourth quarter, that were not enough to offset the significant declines in year-over-year demand, which was exacerbated by customer de-stocking and extended holiday shutdowns that went well beyond what we normally observe at the end of the year.

As we looked back, we clearly made the right decision in July to reduce capacity and head count. But as the economy deteriorated further we were really left with no choice but to remove additional costs. And on January 15th of this year, we announced actions to further reduce capacity and head count. We expect these actions will deliver $25 to $30 million of free tax savings in 2009 and we also anticipated a run rate savings of approximately $40 million achieved in 2010.

We believed these measured position PolyOne very well for enduring what appears to be a challenging year. And when the economy recovers, we’re poised for significant earnings expansion due to our continued and unwavering focus on commercial and operational excellence as well as specialization.

So with that as a backdrop, I’ll now go to turn the call over to Bob Patterson, who is going to review the results of the operations for the quarter as well as outline certain expectations for 2009. Bob?

Robert Patterson

Thanks Steve. Before I begin, let me preface my comments by saying that unless our time frames are specifically stated or referenced during today’s call, we’ll be comparing the operating results for the fourth quarter of 2008 to the fourth quarter of 2007.

The fourth quarter is a traditionally strong cash flow quarter for PolyOne and was again this year. During the quarter, we generated $54 million of free cash flow and used the funds principally to reduce debt by $50 million and increase cash. As of December 31st we had cash on hand of $44 million and availability under our accounts receivable facility of a $121 million for total liquidity of $165 million.

For the fourth quarter of 2008, consolidated sales fell nearly $90 million or 14% to $542 million including a benefit of acquisition growth. We observed unprecedented demand to client as volume fell 24% below the prior year and by 26% below the preceding quarter. We attribute this to a number of factors some of which may prove to be short term.

First given the proximity to the end of the year, many customers announced extended holiday shutdowns. Second, we believed customers were working through on hand inventory quantities prior to making additional purchases, partially to conserve cash, but also because there was an expectation that raw material prices would continue to fall into the beginning of 2009. Third and most concerning is that global production is decelerating and demand trends observed during the fourth quarter, may continue into the first half of 2009 and possibly beyond. This last point reflects the comments Steve made about the continued erosion of the economy and the overall perspective that 2009 would be more challenging than 2008.

As a result of special items, primarily related to a non-cash, goodwill impairment charge of $170 million, a non-cash tax valuation allowance of $105 million and restructuring cost. We are reporting a net loss of $3.07 per share for the fourth quarter of 2008. This compares with net income of $7.1 million or $0.08 per diluted share for the same period a year ago. Excluding special items in both periods, we reported $0.08 per share in both the fourth quarter of 2008 and 2007.

Earnings per share before special items were modestly better than we had expected back in November, principally due to improved gross margins, resulting from lower raw material cost and LIFO reserve adjustments. Many of PolyOne’s domestic non-distribution businesses are on LIFO accounting and as a result, current cost of raw materials are reflected in the income statement versus historical cost if we were reporting on FIFO.

Before I begin to review the results of operations, I will comment on our special items. First, during the fourth quarter we recorded a preliminary estimate of good will impairment related to our Geon compounds and specialty coating reporting units within the Performance Products and Solution segment.

The total charge of $170 million is comprised of all of the goodwill related to Geon and about two-thirds of that related to specialty coatings. This non-cash charge is due mainly to the significant deterioration in the capital markets in the fourth quarter and the corresponding increase in our cost of capital. As you know cost of capital is used to discount future cash flows and therefore is a key assumption used in estimating the fair value of a business.

In addition, the impairment charge will reflect the reduction in our near term earnings outlook for Geon compounds and specialty coatings. While the outlook for this reporting has declined in the fourth quarter, they’re still profitable and we continue to believe that they will both generate significant earnings improvement when the economy recovers.

As I’m sure many of you are aware, we are not alone in recording a good will impairment charge this quarter. Many companies including some in our industry have also announced the impairment charges and they have cited similar reasons for doing so. Whether or not cost of capital should be adjusted for short term market fluctuations is a subject to great debate, and I’m sure it’s been a hot topic in board rooms across the country.

Our understanding of the relevant accounting rules supported by recent SEC interpretation is that our cost of capital should be revised upward to reflect not only a higher risk premium for equity, but also a higher cost of debt for an average market participant. The fact that we are recording an impairment charge does not change our long term strategy and does not in any way diminish our assessment of PolyOne’s value proposition.

Next during the quarter we recorded a special item for a tax valuation allowance of a $104.5 million against US deferred tax assets. The charge to the income statement is larger than anticipated due primarily to finalizing our accounting for the charge and determining that about $35 million of the allowance that we have previously planned as a direct reduction of equity now must be charged as expense. This does not change the company’s previous statements that this is a non-cash charge that has no impact on PolyOne’s cash flow, liquidity or product facilities.

Further, the company expects that it will have sufficient US profitability during the tax loss carryforward period to realize substantially all the deferred tax benefits. In total we have $98 million of net operating losses in the US that do not begin to expire until 2024.

Finally special items also included $26.6 million of pre-tax charges related to the restructuring and actions announced on July 28 of last year and on January 15th of this year. Both of these programs are proceeding according to plan and I’ll have more to say about them in a moment.

I’ll now comment on the results of operations. For the first time this year, the Performance Products and Solution segment reported year-over-year quarterly operating income improvement despite volume declines of 31%. While revenues fell from $246 million to a $194 million, gross margins improved due to lower raw material cost and LIFO reserve adjustments.

Our specialty platform was significantly impacted by the slowdown in Europe and Asia, where collectively volume fell 36%. As a result the specialty platform is reporting a decline in operating income for the first time this year. In total, specialty platform sales declined from $229 million to $200 million including the benefit of the acquisition of GLS.

Foreign exchange is unfavorable and reduced sales by approximately 4%. On an organic basis and excluding FX, specialty platform fourth quarter sales were down $50 million year-over-year and operating income fell $5 million on the same basis. This lower organic operating income is due to the unprecedented volume declines in Europe and Asia.

Unfortunately the international slowdown overshadows a great example of our specialization progress in the specialty color additives and mix business where return-on-sales more than doubled from 2.5% to 5.1%. This clearly illustrates our focus on innovation, calling on profitable customers, improving sales mix, and accelerating new business gains and higher margins sustainable businesses.

Our Distribution business delivered another solid quarter and operating income exceeded the prior year. While revenues fell from a $184 million in the fourth quarter of 2007 to $173 million in the fourth quarter of 2008. Distribution profitability improved primarily as a result of aggressive spending containment. This is a business that makes a modest return on sales and every penny counts. From a four year perspective, the Distribution business has had a record year, achieving record on time delivery performance which we believe is a critical driver of customer satisfaction.

Our Resin and Intermediate segment, which is our SunBelt joint venture delivered substantially lower operating income in the fourth quarter of ’08 versus’07. This was primarily a result of force majeure claims asserted by SunBelt sole customer OxyVinyls as a result of the plant closure in December. Otherwise and given higher cost to (inaudible) prices, we would have expected better earnings performance from the joint venture.

Finally when comparing the fourth quarter of 2008 to 2007, interest expense increased primarily as a result of the addition of the $40 million credit facility in January and $80 million of senior notes in April, both undertaken upon the acquisition of GLS.

I now want to make some comments about our 2009 expectations. As Steve mentioned in his opening remarks, it appears that 2009 will be a challenging year for us and we expect sales will fall below 2008 levels. Accordingly, we have taken actions to reduce capacity and cut cost. Recall that in July of last year, we announced our manufacturing realignment to reduce capacity. As the economy has worsened since that time, we realized that those actions were not sufficient. As such on January 15th of this year, we announced another phase of cost reductions to improve PolyOne’s financial strength and competitiveness.

These included eliminating approximately 370 additional jobs worldwide or 8% of the global workforce. Implementing reduced work schedules for another 100 to 300 employees based on demand, closing our Niagara, Ontario facility and idling certain other capacity. Additionally and among other actions, we have announced that we have frozen executives salaries throughout 2009 and deferred other salary adjustments.

We expect to incur one time pre-tax charges of approximately $45 million related to these actions, of which $18 million was recorded during the fourth quarter of 2008. In total this one time charges will include cash cost of approximately $35 million related to severance and site closure cost, with the remaining $10 million of non-cash cost related to asset write-downs and accelerated depreciation. The company expects these actions will deliver pre-tax savings of approximately $25 to $30 million in 2009 and approximately $40 million on an annualized run-rate basis.

We focused our cost reduction efforts on actions that have a short payback of about a year or less ensuring that they will not significantly impact our liquidity. Fortunately, PolyOne has a very limited amount of immediate or near-term debt payment allocations. In fact, our only immediate payment requirements are the medium term notes of which $20 million are due in 2009 and 2010 respectively.

In 2009, we expect pension and post retirement plan expense to increase approximately $27 million over the prior year due primarily to a 33% decline in pension asset values during 2008. The incremental expense may be higher than compared to other companies who used a historical five-year average of plan assets in determining expense for the next year. Several years ago PolyOne elected to use the actual reported year-end asset values and comparatively this drives the higher expense assumption for 2009. Nevertheless our strategy is bend to invest pension assets among a diversified mixed of equities and fixed income securities and this is unchanged. While pension expenses increased the minimum fund in requirements for 2009 approximate $11 million. We always have the option of funding more and may choose to do so of casual support incremental contributions.

In short, and from an overall capital structure perspective, we’ll be focusing and preserving an increasing cash and liquidity in 2009 due to what we see as a challenging economic environment. This is consistent with what we set at the end of the third quarter and this will not change in the near term.

I’ll now end the call over to Steve who will review full year performance and make some closing remarks.

Stephen Newlin

Okay, thanks Bob. I want to take just a moment to thank the PolyOne employees around the world for their tireless resolve, their commitment and their efforts over the past year. With all the doom and gloom that surrounds us today, it’s easy to overlook that our team delivered EPS before special items of $0.41. It’s a solid performance and noteworthy when considered in the context of the challenges that we faced this past year.

In this regard, let me provide some annual highlights, since Bob focused primarily on the results of the fourth quarter. For the full year of 2008, our specialty platform revenue grew from $945 million to just under $1.1 billion. And it is now our largest plat (inaudible). Specialty operating income increased from $29.9 million to $46.8 million or 57% excluding corporate charges, specialty operating income now makes up one-third of our total business operating income. And that’s up from 2% just three years ago.

The acquisition and successful integration of GLS was the most notable specially improvement in 2008 and really a key highlight for us for the year. GLS has been our very important acquisition because this truly is a specialty business. And I for one, I’m extremely pleased by the progress we’ve made. In 2008 GLS’ US operating income improved 28% versus the prior year and overall the acquisition was accretive to earnings in 2008. GLS serves attractive in-markets that have helped us grow our specialty platform with higher margin, sustainable business. And we just couldn’t be happier to have GLS as a part of our team.

Excluding GLS and foreign exchange, specialty platform revenues declined $55 million last year; however, operating income increased $2.2 million as a result of pruning on profitable customers and controlling cost.

The sharing star (ph) has no doubt been the specialty color additives in this business, which would lower volume and relatively flat revenues was able to improve operating income from $7 million to $13.5 million. A return-on-sales improve from 3% to 5.9%. This is a business that until last year had lost money and as Bob mentioned is a great example of specialty transformation and action. And I’d like to thank the team for their hard work and determination this year to achieve this level of performance.

Another 2008 standout is our distribution business, which increased full year revenue from $744 million in 2007 to $797 million in 2008. PolyOne Distribution has distinguished itself from the competition consistently by listening to customers and operating unbiased solutions with a quick delivery response.

Distribution achieved record on time delivery of 95% this year. We believed this is a critical measure of performance for our customers.

Operating income increased from $22.1 million to $28.1 million and return-on-sales improved to 3.5%. This is a business that has not only embraced operational excellence and raised penny pinching to an artform (ph), but they’ve also demonstrated tremendous leadership by expanding our healthcare sales. After growing 26% in 2008, healthcare revenues for distribution now represent 19% of the total revenue for this business. And for PolyOne and total healthcare sales have increased from $145 million to a $187 million in 2008, that’s a 29% increase.

Our after sales projects in healthcare have increased over a $150 million just the end of 2007 and new healthcare business generated in 2008 more than double. PolyOne’s global focus in the healthcare segment and our extensive sales marketing and manufacturing capability is attractive to suppliers who are interested in addressing the healthcare market. As I’ve said repeatedly, we are redirecting sales and R&D activity to drive growth in the less cyclical in more attractive markets like healthcare, where we believe customers appreciate and pay for value.

I’m particularly pleased with advances we’ve made in developing environmentally friendly products and solutions. In September, we received the Frost and Sullivan Green Excellence Award for 2008. Frost and Sullivan has long been known for recognizing best practices in the industry and we were honored to receive to first award ever given in this category.

Another example of our leadership in creating sustainable and environmentally friendly products is our recently announced collaboration with Archer Daniels Midland Company, to jointly developed bio-based plasticizers for using in polymer formulations.

In August of 2008, we announced our license of Battelle Technology for bio-based plasticizers. And this is the next step toward developing and commercializing viable candidates for the polymer industry. And for those who may be unfamiliar, plasticizers are used primarily to make plastic softer and more flexible. The goal of this alliance is to develop and commercialize bio-based plasticizers from corns and oil seeds.

We recently announced our portfolio of value added solutions that helped customers made safety standards for toys and products marketed for use by children. PolyOne has a number of alternatives to help our customers comply with Consumer Product Safety Improvement Act, known as CPSIA that goes into effect on February 10th. Additionally, we develop new test methods and services to support our customers and serve key global OEMs who may have specifications more stringent than those required by legislation.

And during the fourth quarter of 2008, PolyOne introduced the sustainability promise with a number of sustainable solution products. The sustainability promise outlines are commitment to environmental and social dimensions of sustainable development. PolyOne sustainable solutions are products which meet the fine criteria for regulatory compliance and eco-conscious composition. This example showed that while many companies preach about being green, PolyOne is actually doing something about it. This is driven by our customer needs and our desire to do the right thing and it pays.

I’m also very pleased to report that we continued to make advancements for new products introductions. And in 2008 our vitality index increased to nearly 18% of sales from 13% in 2007. This was a direct result of advancements in research and development as well as improved sales force training. Exiting the year, the gross margins of our vitality offering exceeded the current PolyOne reported gross margin by 600 basis points, continuing to emphasize the importance and value of differentiated specialty new products to PolyOne and their customers. We’re teaching our sales force to understand our customers’ needs and go beyond our current product portfolio in addressing them.

For our toughest story of the year is certainly been the performance products and solutions segments. This has heavily focused in US housing, auto, and related in-markets, which have all declined precipitously this year. Volumes were down 31% and we were unable to fully offset raw material cost increases with selling price increases. Year-over-year operating income fell from $57.5 million to $34.9 million.

Finally, our Resins and Intermediate segment, which is our SunBelt joint venture with Olin reported a year-over-year earnings decline. Our 50% share of earnings fell $6.2 million primarily as a result of force majeure claims asserted by its sole customer OxyVinyls. This was a significant disappointment for us as high caustic soda prices certainly lead us to believe the JV would have had higher earnings this year.

In 2008, the prevailing market conditions such as those impacting our performance products and solutions segment prompted us to take aggressive actions to reduce cost, control spending, limit capital expenditures and focus on improving our working capital. And for the year we were able to reduce our capital expenditures to $43 million without limiting our investment in India or slowing our previously announced manufacturing re-alignment actions.

Unfortunately, the deteriorating demand and pricing dynamics in the US combined with the abrupt and steep downturns in Europe and Asia lead us to the conclusion that the a couple of cut-backs and the manufacturing re-alignment actions announced in July were inadequate to offset further declines in demand and as a result we announced further cost reduction initiatives as Bob has already outlined.

I can tell you without question, decisions like these are never easy. They’re agonizing and we absolutely do not take them lightly, but they were necessary to improve our near term operating efficiency while advancing our longer term strategic position. We remain very cautious about the future and these actions ensure that PolyOne remains competitive through an economic downturn of uncertain duration and magnitude.

The current economic crisis, the cyclical nature of our traditional end markets and the price sensitive nature of our commodity business, only serves to reinforce the need for our transformational strategy. For those of you who have followed PolyOne, our long term investors, you know that we are transforming PolyOne into a specialty company. Given the economic environment we are experiencing today, it will take longer than we previously expected. But we’re absolutely convinced that the actions we have taken are working without a doubt and our results demonstrate our success.

We’ll continue to make intelligent capital allocation decisions and be prudent with cash as the economic crisis may continue for some time. And we have to be adaptable and cautious. We’re adhering to our strategy as we continue to focus on the four pillars of specialization, globalization, commercial and operational excellence. However, we have slowed the pace of investment and increased our focus on improving working capital and free cash flow. We understand the importance of maintaining our liquidity under these conditions. I’m confident to PolyOne’s leadership team and employees. We’ve never had a better and more capable management team to lead us through the near term economic downturn, while also guiding our long term transformation process. Even with the prevailing headwinds, we are winning new business every day by providing our customers with new and innovative products and services and solutions. We believe that PolyOne is well-positioned not only to survive this downturn, but to emerge from it as one of the strongest players. While times are tough, so are we. We are seizing the current situation as an opportunity to make internal and external improvements that cut costs, improve efficiency, increase productivity and land new business. In addition to making structural changes that reduce costs, we are also embarking on a lean six-sigma initiative

While times are tough, so are we. We are seizing the current situation as an opportunity to make internal and external improvements that cut costs, improve efficiency, increase productivity and land new business. In addition to making structural changes that reduce costs, we are also embarking on a lean six-sigma initiative. We have selected 26 of our best employees to be formally trained as black-belts. This is not an inconsequential investment and it’s a great example of investing selectively in the business today for profitability growth tomorrow.

Externally we continue our expansion into Asia with construction underway of our facility in India and the addition of a commercial development office in Japan. During a recent trip a couple of weeks ago I was encouraged that the potential new Japanese customers I met showed keen interest in the services and technology we offer. We continue to focus on gaining new business with customers who are looking for innovative ways to increase their productivity and lower their operating costs.

Our management team, global footprint, and growing differentiated and environmentally friendly product portfolio provide one of the strongest positions in the polymer industry. If the stock market is truly forward-looking, investors should recognize these personnel and product assets as best in class as they position their portfolios for an economic recovery.

I’ll now turn the call back to the operator to open the line for questions. Thank you.

Question and Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Mike Judd of Greenwich Consultants. Please proceed.

Michael Judd – Greenwich Consultants

Yes, good morning.

Stephen Newlin

Hi, Mike.

Michael Judd – Greenwich Consultants

A couple of balance sheet items. I didn’t see the queue-out (ph) this morning so your portion of the Sunbelt debt, is it still $61 million?

Robert Patterson

It’s 55 at the end of the year.

Michael Judd – Greenwich Consultants

Okay. And the accounts receivable securitization, it was 26 last quarter, what was it at the end of the year please?

Robert Patterson

14.

Michael Judd – Greenwich Consultants

Okay. And then, just you guys have made some investments – I forget the exact timeframe – but you had been expanding into areas where you thought that there would be better opportunities for growth in manufacturing. For instance, in China and I believe that there was an investment that was made in Eastern Europe also. Can you talk a little bit about – I realize these are tough times globally – but in particular those investments that you’d made, how are they performing in this difficult environment?

Stephen Newlin

Well, Mike, let me start with Eastern Europe first, which is what our Poland plant was positioned for, I mean we got off to a terrific start with that plant and we’re still very optimistic. We think we put it in the right location, we made the right level of investment, we have opportunities for future expansion. But I would also tell you that the slowdown in Europe is affected Eastern Europe, not to the same degree, but it certainly is having an impact. And so right now we’re temporarily going through a period in Eastern Europe that is clearly influenced by the effects of the Western European economy.

We don’t have any different view on that decision today than we had in the past. If anything I mean we’ve had new customer applications. Just that when customers don’t produce as much, even though we have their business, they’re not going to buy as much compound from us. So we’re very happy with that investment.

Our penetration in China, again we have an extremely nice position in China. I just came back from a trip to Asia and I’ll tell you truthfully I’ve never seen this region of the world – and I used to run this region many, many years ago in a different role, I’m fairly familiar with it – I’ve never seen this region go through the kind of pain and downturn that they’re dealing with right now. It is across the board. And it’s the first time I’ve ever sort of felt the downturn in this environment. I’m not just talking about from PolyOne’s perspective.

So that doesn’t change or alter our positioning of the plants that we have throughout China, and we actually have six plants throughout China. But it does both force us to be more and more efficient with those plants that we have. And we do have to deal with the people and deal with reducing capacity when we’re not getting the kind of order flow that we really designed those plants for. So I would just say to you I don’t regret in any way the positioning of the plants. I think it’s one of the strongest positions in our industry. But we are – there is not a place that I really see in the world right now that’s immune from this economic environment that we see every day right here in the U.S.

I hope that answers your question.

Michael Judd – Greenwich Consultants

Alright, it does. And just one last question about the balance sheet. If I look at the stockholder’s equity line, obviously it’s been impacted by the goodwill impairments and also potentially the higher pension expense. In terms of the – I mean it was a pretty big write-down in the fourth quarter – should we anticipate kind of given where things are that there’s a potentiality for a negative shareholder equity number in the future?

Robert Patterson

I’ll answer that question. Of course we have performed this kind of cash flow projections, Mike, to arrive at our conclusion for the goodwill impairment and we have taken the charges that we believe were prudent and appropriate to do so. You know our discounted cash flow analysis suggests a higher valuation than where the shares are trading today. We can’t share that valuation with you, but nevertheless we certainly believe that the share price should be trading higher than it is.

If you look at book capital going from the end of last year to this year, the significant decreases are due to $170 million from goodwill impairment, $105 million from the valuation allowance against deferred tax assets. And as I mentioned in the call $98 million of those don’t begin to expire until 2024. Our pension assets have declined and our under-funded position is down about $145 million year-over-year. Currency translation is another $25 million and then we had some smaller other adjustments to go through that. So to answer your question, we don’t expect it to go negative and largely supported by what we believe the fair value of the shares should be.

Michael Judd – Greenwich Consultants

Okay, I just want to make sure I understand that we’re talking – my question is really about the book equity on the balance sheet. But you don’t anticipate that going negative?

Robert Patterson

Right. It’s $175 million right now and that’s where we think it should be. Again, not reflective of the fair value that our projections would tell us it should be, but where it is from a book accounting standpoint.

Michael Judd – Greenwich Consultants

Thank you.

Operator

Your next question comes from the line of Dmitry Silversteyn of Longbow Research. Please proceed.

Dmitry Silversteyn – Longbow Research

Good morning. A couple of questions if I may. First of all you’re one of the few companies talking about raw material prices coming down and being a positive for you in the fourth quarter. Can you give us an idea of what’s going on in the first quarter with raw material prices and also how are your selling prices responding to declines in the raw material costs?

Stephen Newlin

Yes, Dmitry, first of all let me say that we did indeed see pull backs in raws in the fourth quarter. And in the first quarter we’re seeing a lot of attempts at increases, a lot of announcements at increases. A few are sticking, but nowhere near the magnitude whatsoever that we saw during the first half of last year, particularly second quarter of last year.

With reference to your question, Dmitry, around selling prices, you know there’s no doubt our customers are under pressure and they put pressure on us. And I guess our view on this is we always try to provide good value for the customers and we try to be competitive. But at the same time it doesn’t make a lot of sense to do business with someone if you can’t get a win out of it. It has to be something that works for both sides. So, you know, many of our customers really understand this. The longer term view is look, PolyOne can’t help us if they’re not around and neither can a competitor if they’re not around. So I think there’s a reasonableness that sets in.

Of course they’re under pressure and of course they’re always asking for you to reduce price. But we try to remain fairly competitive, but we feel we’re worth a premium and I would just tell you that we’re fighting hard to hang on to the price increases that we received knowing that we never received enough pricing to fully offset the expansion in raw materials that came through last year. We just felt that metering some of that out, the sticker-shock that the customers had to endure was more than people could bear in an immediate basis. And so it was always our plan to keep working through it and recover those margins. And as it will continue to work on.

Dmitry Silversteyn – Longbow Research

So if I understand you correctly, it sounds like you’re still in a price increase mode from you’re end, that you’re still trying to catch up to the price increases – to the raw material increases from 2008?

Stephen Newlin

So if that’s your take I didn’t, Dmitry, explain it very well. We took our pricing and we’re now in a process of holding our pricing. We took pricing as raws went up, but not enough to sustain margins or expand margins. Now that raws have dropped. We can’t give back what we didn’t get. So we’re fighting to hang on to the price increases that we did realize the latter part of last year.

Dmitry Silversteyn – Longbow Research

I understand, okay.

Stephen Newlin

Okay. The exception might be distribution where, you know, that’s such an immediate pass-through of products that are purchased that are really, the pricing is really set in the marketplace and we basically deal with that on a pretty rapid response basis. And so those price increases take effect with more urgency and immediacy. And although sometimes they’re announced, they just, nobody really necessarily listens and they’ll withhold purchases et cetera, and then the natural price will find it’s price point. And we’ll just react accordingly.

Dmitry Silversteyn – Longbow Research

Got you. Okay, thanks.

I was encouraged to hear that your healthcare sales were up very strong in 2008. You know the healthcare market is not immune to the economy but it is somewhat resilient. What are you seeing in the first quarter and what are your expectations for this business in 2009. Obviously – well, maybe not obviously – I wouldn’t expect you to maintain a near 30% growth rate for the business. But do you continue to expect this to be a strong performer or just a relatively strong performer in a weak economy?

Stephen Newlin

You know we aren’t going to project first quarter, but here’s what I would say about that. I think I can answer your question. We’ve put some resources behind healthcare, without question. We have a head marketing leader who develops business and helps our people understand the markets and the opportunities and the prospects and where we have competitive advantage and where we really add value for customers. Same thing we’ve done is directed activities of the sellers to go out. I don’t think it’s rocket science to understand that you’re probably better off calling on a major healthcare producer than one of the big three right now. And so that’s kind of what we’re doing, that’s been our approach. And so we’ve redirected people and said here’s where you should spend your time. Bills will be paid, it’s never easy of course, but bills will be paid. They’ll allow you to make a reasonable profit because they appreciate what you’re brining to the table. And I don’t see that changing.

I really can’t comment or speculate on growth rates but I would also say it wouldn’t surprise me if we were able to continue to deliver those kind of growth rates in healthcare. And that’s sort of been a cornerstone of our strategy, is to redirect our activities into places that will get us away from these highly, highly cyclical markets that have been our legacy.

So I can’t give you a number but I’ll be disappointed if our growth rate slows in healthcare.

Dmitry Silversteyn – Longbow Research

Okay, that’s good to hear. And then final question on the performance of your joint venture. The forced (inaudible), has it run its course, are you back to normal – whatever normal is in this environment – operating in that business, or are you still suffering some lagging aftereffects?

Robert Patterson

No, we’re back to normal as it may be defined. But the forced (inaudible 00:43:20) most recently was for the last two weeks in December and the plant is fully operational now.

Dmitry Silversteyn – Longbow Research

Okay. Alright, thank you very much.

Robert Patterson

Thanks, Dmitry.

Operator

Your next question comes from the line of Mr. Steve Schwartz of First Analysis. Please proceed, sir.

Steven Schwartz – First Analysis

Good morning.

Stephen Newlin

Hi, Steve.

Steven Schwartz – First Analysis

Can you go through the separation and phase-out costs, how they split between cost of sales and SG&A?

Robert Patterson

We announced that the total costs would be about $35 million of cash, $10 million of non-cash. The $10 million of non-cash is largely accelerated depreciation, so that will show up in cost of sales. And then I would say that the remaining cash costs are split probably about 50-50, SG&A versus cost of sales. The expectation is that of the total run rate savings of $40 million that about 18 of that should be in SG&A.

Steven Schwartz – First Analysis

Okay. And that 50-50 split, does that apply to the 27 that you took in the fourth quarter?

Robert Patterson

Well part of what we took – we only took 18 in the fourth quarter, and the remainder of that was related to actions previously announced. So of the 18 there was, I think the split was roughly the same as I just mentioned.

Steven Schwartz – First Analysis

Okay, yes, I recall the 18. As far as the special items are concerned, you show 26.6?

Robert Patterson

Yes, that’s right. The difference between the 26.6 and the 18 are restructuring costs associated with the actions that we announced in July.

Steven Schwartz – First Analysis

Okay, alright. So how did the 26.6 split up?

Robert Patterson

Most of the incremental beyond the 18 was cost of sales and I’m saying that the 18 was roughly 50-50.

Steven Schwartz – First Analysis

Okay. And then as far as the NOLs are concerned, so you have the $98 million available for use now, is that correct?

Robert Patterson

That is correct.

Steven Schwartz – First Analysis

Are you planning on using any of those in 2009?

Robert Patterson

Well, we can’t as right now we’re forecasting a loss in the U.S. and that was mentioned in our outlook update. The reason why we recorded the valuation was because of that. So we would apply those NOLs to future profitability but expect that won’t be until sometime after this year.

Steven Schwartz – First Analysis

Okay, very good. Thank you.

Robert Patterson

Alright, thanks.

Operator

Your next question comes from the line of Rosemarie Morbelli of Ingalls and Snyder. Please proceed, ma’am.

Rosemarie Morbelli – Ingalls & Snyder

Good morning, all.

Robert Patterson

Hi, Rosemarie.

Rosemarie Morbelli – Ingalls & Snyder

Could you talk, Steve, about your feelings regarding your customers’ inventory, based on conversations with customers? Do you have a feel that they will be done impeding them and will need to replenish some of it regardless of what the level of demand is by the end of the second quarter for example, or you have no visibility whatsoever?

Stephen Newlin

You know, it’s a really good question. I wish I could just nail the answer to it but unfortunately we don’t have the kind of visibility I’d like to have. We don’t have sort of telemetry inventory data from all of our customers. So you’re dealing with sort of patterns and anecdotal stories from the sellers. I’ll give you my instinctive beliefs on this. You know it’s very, very difficult to know how much de-stocking we’ve had and how much is just pure sort of structural downturn that may sustain itself for some time. And there certainly is some of both that’s gone on over the last four or five months. I would say that we’re in a new era though for business with this environment where the scrutiny of inventory management is going to be higher than ever. And we’re doing that ourselves – I mean we’re watching and going to have even more focus on our raw material inventory as well as our finished good inventory. And I suspect, you know, we have very smart customers and they’re doing the same sort of thing.

I would just say that I don’t know how much business is really being temporary halted by this de-stocking, but I would say we’re getting to a point where most of that should be working through the system. I would guess by the end of the first quarter, if we get to some steady state demand we’ll see that the de-stocking has fairly well evaporated. But as long as we continue to have decline people are going to have less on the shelf than they possibly could, you could have imagined in the past. And, you know, we haven’t helped this by improving our delivery performance to the degree that we have. They’ve come to rely on us to get things, to get products to them pretty quickly. So that’s sort of the double-edged sword of delivery performance. But I guess we have to take it because in the end if the customers are satisfied and they’re buying from you for that among other reasons, it’s overall a good thing.

So I just don’t know how much of this is de-stocking. I think we’ll get some clarity over the next 90 days on that and we’ll see.

Rosemarie Morbelli – Ingalls & Snyder

So now, the same question – you touched on it very briefly – but if you could give us a little more details. Regarding your own inventories, they were down about 11.5% year-over-year and revenues were down 14.2%. Do you have some kind of a goal as to how much lower you want to get them and generate cash?

Robert Patterson

Well we do have an internal goal that we’re not sharing publicly, but certainly want to see that decline from the yearend balance to the middle point of the year. Historically PolyOne has built working capital in the first half of the year in anticipation of greater demand in the middle to the end of the year and recovered that in cash flow upside in the fourth quarter. That’s kind of how 2008 played out. I mean I would just tell you and appreciate you citing those statistics, inventory didn’t drop as far as sales and that’s a disappointment for me. And I’d like to see us improve that and go beyond that in 2009.

Rosemarie Morbelli – Ingalls & Snyder

Given this environment are you going to build capital in the first half of ’09? I mean that is most likely going to be the worst period of the year.

Robert Patterson

Yes, our goal is to do the exact opposite, which is to try to reduce capital in the first half of the year.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And quickly, on the performance product and solutions operating income of 16% had and 8.3% margin. This is the highest that I can find, at least for the year, and the fourth quarter was worse. Is there anything special in those numbers?

Robert Patterson

It’s heavily influenced by LIFO and I would also connect my next observations back to Dmitry’s observation about reporting earnings in the fourth quarter improved where other companies are not. You know LIFO does have a significant effect on our cost structure and how we report earnings when prices are falling. So the largest beneficiary of that is performance products and solutions. And the fourth quarter adjustment to the LIFO reserve was about 16.5 million, most of which was in performance products and solutions. So that’s one of the reasons why you see the margins as high as you do.

Rosemarie Morbelli – Ingalls & Snyder

So that is since your raw material I mean your LIFO is still going to help first quarter. Can we anticipate that that particular margin will last for a little longer?

Robert Patterson

I think that’s a very high margin. I would think that LIFO could help in the first quarter if raw material costs continue to decline as well as inventory balances. The one thing I would like to point out is while that may seem like an anomalous effect in the fourth quarter I would point out that we built that LIFO reserve in the first nine months of the year and we recorded $12 million of additional expense. So as you compare us to other companies who are on FIFO, we were in fact looking worse during that time period than we are in the fourth quarter. Just very important to bear that in mind.

Rosemarie Morbelli – Ingalls & Snyder

Okay, and then I actually do have another question. Based in the fourth quarter, December experienced a lot of shutdowns from your customers, and I am assuming that they were probably double that of the previous year. Based on January results, shouldn’t the first quarter be better than the fourth quarter sequentially because you won’t have all of those shutdowns that you did in December?

Robert Patterson

Well we’re not making any further remarks about our expectations for 2009. But if that proved to be the case then it certainly makes sense. I will tell you that some of the shutdowns have in fact gone into January and companies have in fact announced shutdowns beyond the holiday period, some of which go into the first week of February or they’re taking off a week at the end of January. So there’s still a lot of what I would describe as unusual or not normal activity going on from a shutdown standpoint. Steve?

Stephen Newlin

No, I would just echo that. It’s just it’s really difficult for us to see into the organizations of our customers in terms of where their business orders are coming from. But there is just extreme caution, conservatism, around the world and frankly it’s worse in Europe and Asia than it is in the U.S. right now, from the standpoint of our customer profile.

Rosemarie Morbelli – Ingalls & Snyder

Okay, that is very helpful. Thank you.

Stephen Newlin

We have time for one more question.

Operator

Your final question comes from the line of Mr. Christopher Butler of Sidoti and Company. Please proceed, sir.

Christopher Butler – Sidoti and Company

Good morning, guys.

Stephen Newlin

Hi, Chris.

Robert Patterson

Hi, Chris.

Christopher Butler – Sidoti and Company

Just wanted to get back to the inventory correction question a little bit. I know that Dow Chemical mentioned that they were putting through price increases for some of their petrochemicals for February 1st. Even if customers weren’t at low or out of inventory, would something of this nature be a precursor to and end of inventory correction due to the prospects of higher prices as we move into 2009?

Stephen Newlin

Yes, I think, Chris, in normal times it certainly would be. I mean buying ahead of an impending event that’s announced like that is something, it’s a pattern that we’ve seen over the years. But you know right now for some companies it’s a trade-off and they might wish to have that lower price but cash may be more important to them. So I just couldn’t – I couldn’t speculate on that. I think it’s very case by case. I think the healthier, more prosperous companies will clearly take advantage. I think those that are facing difficult straits will probably ignore it and hope that the increase doesn’t stick and deal with the buying when they need to buy and just not hold the inventory. That’s, again, an instinctive response versus a data-driven response.

Christopher Butler – Sidoti and Company

I appreciate your time.

Stephen Newlin

Okay.

Christopher Butler – Sidoti and Company

Alright, thank you.

Stephen Newlin

Okay, thank you all. We appreciate everybody attending today and I know that Bob is going to be available for further questions later on. At this time we need to excuse ourselves, we’ve got a group of employees that are waiting to hear from us. So thank you all for your time and attention.

Operator

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

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Source: PolyOne Corporation Q4 2008 Earnings Call Transcript
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