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Executives

Ed Bisno – IR, Bisno Communications

Michael Hoffman – President and CEO

Walter Sobon – CFO

Analysts

Bruce Klein – Credit Suisse

Frank Longobardi – Alcentra

Oliver Corlett [ph] – RW Press Ridge & Company

Aaron Rickles – Oppenheimer

Andrew Chan – Lehman Brothers

Heather Ruff [ph] – Caritas

Constar International Inc. (CNST) Q2 2008 Earnings Call Transcript August 14, 2008 9:00 AM ET

Operator

Please standby. We’re about to begin. Good day, everyone, and welcome to the Constar International Incorporated 2008 second quarter conference call. Your lines have been placed into a listen-only mode until the question-and-answer session. Please be advised that this conference is being recorded. I would now like to turn the conference over to Mr. Ed Bisno. Mr. Bisno, you may now begin.

Ed Bisno

Good morning, everyone, and welcome to Constar International’s second quarter 2008 conference call. This includes a live broadcast over the Internet that can be accessed at the company’s Web site, www.constar.net. A copy of today’s release is also available there.

Now, for some housekeeping matters, before management begins the formal remarks, we would like to remind you that earnings guidance and other information to be discussed during this call consists of forward-looking statements within the meaning of the Federal Securities Law. These forward-looking statements involve a number of risks and uncertainties and other factors, which may cause the actual results to be materially different from those expressed or implied in the forward-looking statements.

Important factors that could cause the statements made during this conference call, or the actual results of operations, or financial condition of the company to differ include the company’s relationship with its largest customers, the outcome of the company’s negotiation to renew its contract with its largest customer, whether such contract is signed on terms consistent with the company’s current expectations, whether expected future volumes under such contracts are realized, whether the future product mix under such contract is consistent with the company’s expectations, whether the company achieves expected restructuring savings associated with such contract, the impact of self manufacturing on the company’s business, the company’s ability to secure new business, expand sales of custom products, and improve operating performance of its European business, and the impact of the foregoing factors on the company’s financial position. Other factors are discussed under the caption risk factors in the company’s Form 10-K annual report for the year ended December 31, 2007, and in subsequent filings with the Securities and Exchange Commission made prior to, on, or after today.

The company does not intend to review, revise, or update any particular forward-looking statements in light of future events. Lastly, in view of regulations adopted by the SEC, Constar does not intend to provide non-GAAP financial measures beyond those already contained in this morning’s release. A reconciliation of such non-GAAP financial measures to GAAP measures is also provided on the company’s Web site in the Investor Relations section.

With us on the call this morning are Michael Hoffman, President and CEO, and Walter Sobon, Executive Vice President and Chief Financial Officer. Once management has concluded their formal remarks, we’ll then open the call up to questions. Now, I’d like to turn the call over to Mike Hoffman, Mike.

Michael Hoffman

Thanks, Ed. Good morning, everyone, and thank you for joining us this morning on our second quarter earnings call. This morning, I’ll provide an update on our second quarter performance and recent events. And then I’ll turn it over to Walter who will provide more details on the financials and an outlook for the balance of the year. Following that, we’ll open it up to questions.

The second quarter was a disappointing quarter due to escalating cost and lower than expected conventional line. The impact in these challenges was partially offset by higher prices, higher custom unit sales, and overhead cost reductions. We finished the quarter with strong availability under our revolver, and our borrowings only increased to $5 million since our last call. Additionally, we believe that we have significant opportunities to improve working capital when we re-entered June. Going forward, we have implemented further price increases, and expect continued double-digit in our custom line as new products under contract are commercialized.

In the second quarter, we experienced significant challenges with rising energy costs in both the US and European business, inflationary cost on non-resin and non-energy materials, and lower demand for single-serve products. Throughout the quarter, our electricity rates increased 30% in the US business, and almost 70% in our UK business. As a result, we have announced a 3% general price increase to our customers to partially recover higher energy and material costs for the balance of the year. So far, we’ve had good success in implementing this increase.

On the last call, we discussed the impact of transportation costs. I am pleased to announce that we have been successful in passing on almost all of these increased costs, and will continue to do so if further increases occur.

In the quarter, PET resin cost reached record highs. And by market indexes, it’s 15% higher than second quarter of last year. While we have contractual pass through mechanisms that allow us to pass through these costs to our customers, it is forcing them to raise prices through to consumers, which has a negative impact on demand.

Our conventional volume in the quarter was down 20%. A significant portion of this decrease was lost business, which I previously announced, including further losses to more customers blowing their own bottles. As a reminder, the two customer losses included a sizeable pre-formed customer in our Holland operation, which prompted a restructuring of that facility last year, and to a lesser degree, our bottle customer in the US.

Beyond these known losses, practically all of our beverage customers have experienced significant reductions in demand for single-serve PET packages, especially in the convenience and gas distribution channels where the majority of our single-serve packages are sold. The primary reason for the drop stems from the continued high gas prices, higher PET prices, and the impact the economy is having on discretionary spending. As gas prices increase throughout the quarter, volume declines exceeded what was forecasted by our customers at the end of the first quarter.

Consumer preference for alternative beverages such as energy drinks, which are predominantly in cans, is also a significant factor in the decline in conventional volume. Unfortunately, we do not expect to see much recovery for the balance of the year.

On the more positive note, we continue to make good progress on the custom side of our business. As consumers switch from CSDs, carbonated soft drinks, to enhanced waters, teas, and other beverage categories, the demand for new bottle designs with barrier and innovative features increases. We are seeing many new sales opportunities in the custom beverage category as a result. All these new products we secured – all the new products we secured for this year were introduced on time as anticipated. However, volumes had been below expectations as the majority of these items are distributed through the gas and convenience channels. They too have been impacted by the higher fuel prices and the impact of inflation.

During the quarter, we have secured additional customer agreements to expand the custom business. And some will begin later this year, but most of the volume will occur in 2009. For the quarter, custom volume was up 17%, and year-to-date were up 19%. For the second half of the year, we are anticipating custom unit growth of between 23% and 28%.

Constar custom growth continues to be driven by our strong portfolio of proprietary oxygen barrier and design technologies, which accounted for 75% of the custom unit growth in the quarter. Our newest at Diamond Clear formulation has cleared all required FDA testing to date, and we are optimistic that we will be in a position to submit for FDA approval by the end of the year. And we expect to have approval from the FDA 128 days following that event.

While we are not pleased by our EBITDA is behind last year’s level by $800,000, with 20% in volume loss in conventional, 12.7% in volume loss overall, and dramatic increases in energy cost, I’m proud of my team’s response to this to quickly execute cost reductions, bank consolidations, and price increases to substantially offset the financial impact caused by those headwinds.

One final topic before I turn it over to Walter, and that’s the Pepsi Cola contract renewal. While there’s no signed agreement, my feeling is that we’re getting very close wrapping this up. When this agreement is signed, we will make public disclosures to keep you informed. Why I expect to have – why I expected to have completed these negotiations for now, it’s not because there are insurmountable issues. It has taken longer than expected to reach a middle ground that was acceptable to both parties. The new agreement with Pepsi will be at significantly lower volume and with a mix shift towards fewer bottles and more pre-forms. While we value the Pepsi relationship, this will help us alleviate a strategic weakness we’ve had with too much reliance on a single customer.

In conjunction with the reduced volume, we expect to take restructuring measures to lower both fixed and variable costs so that they can become leaner, and accelerate our focus in resources on growing higher margin product categories using freed up bottle making assets.

On balance and mostly due to the benefits of restructuring, we expect that our profitability and cash flows from the Pepsi business will be slightly improved in the future years. In this way, we can prove our strategic positioning without sacrificing earnings. While restructuring measures will be painful for members of the Constar family, we must take these steps to improve the long term health of our company.

With that, I’ll turn it over to Walter.

Walter Sobon

Thanks, Mike, and good morning. First of all, we continue to have excess (inaudible) liquidity. We have liquidity of $43.7 million at the end of June, including cash on the balance sheet of about $3.6 million. It is also important to note that we made our semi-annual $9.6 million interest payment on our 11% bonds in June. As a reminder, because of the seasonal nature of the business, operating cash requirements have historically been the heaviest in the first quarters of the year. Average borrowing levels during the first six months of 2008 were approximately a third of our $75 million revolving credit facility.

At this time, I’ll cover some of the key financial elements of our second quarter results. Consolidated sales were $244.3 million in the second quarter, compared to $240.2 million in the second quarter of 2007. The increase in sales was related to resin and foreign currency increases of approximately $21 million. The positive price adjustments amounted to about, $1.4 million in the quarter.

The balance of changes in sales is related to an overall decline in unit volume of 12.7% from the second quarter of last year. Conventional unit sales were down 7.7% as a result of the expected continued shift of water bottlers to self-manufacturer. Conventional volumes were down 7.8% due to the previously disclosed loss of customers in Holland and the US. And finally, conventional volumes were down 4.7% due to the slide in demand for carbonated soft drink packages that our customers are experiencing. This amounted to a total decline in conventional units of about 20% compared to last year.

The impact of the conventional volume declines were partially offset by custom volume growth of 17%. Based upon publicly available indices, resin increased by approximately 12% in June 2008, from June of 2007, and by 7% since December of 2007. As we have previously disclosed, we have mechanisms in place to pass through essentially all of our resin increases to our customers.

In the US, net sales were $190.3 million in the second quarter, compared to $182.9 million in the second quarter of last year. The increase in US net sales was partially driven by resin pass through cost to customers, along with an increase in price, offset by decrease in unit volume. Total US unit volume decreased 8.3% over the second quarter of 2007. Custom unit volume increased 17%, while conventional volume in the US declined 17.7% from last year’s second quarter.

In Europe, net sales were $54 million compared to $57.3 million in the second quarter of 2007. This decrease in European net sales in the quarter was primarily due to lower unit volume offset by pass through resin cost to customers and a positive impact of foreign currency translation. Total European unit volume declined by 19.8% compared to 2007, due to the previously disclosed loss of a customer in our Holland operation.

Gross profit, excluding depreciation expense as a percentage of net sales, decreased to 8.5% for the quarter, from 9.4% in the same period last year. This decrease was a result of lower unit volumes offset in part by increases in price. After resin and labor, the largest components of our cost of sales are energy costs and day costs. Day costs are principally passed on to our customers as Mike has indicated. We also pass through elements of energy costs. However, the net impact of energy costs in the second quarter was almost $3 million, compared to the second quarter of 2007.

Selling and administrative, and resource and technology expenses of $7.1 million in the second quarter increased by about $200,000 from the same period of last year due to the non-cash expenses related to restricted stock. Interest expense decreased $800,000 during the quarter as a result of a lower effective interest rate.

Net loss for the quarter was $5 million or $0.41 per basic and diluted shares, compared to a net loss in the second quarter of 2007 of $4.8 million or $0.39 loss per basic and diluted shares. A credit agreement EBITDA, excluding restructuring charges in the second quarter, decreased by $800,000 or 5% to $14.9 million. During the quarter, we narrowed the gap in year-over-year performance when compared to the first quarter of 2008. And our objective is to achieve strong increases during the second half of the year. However, we are in the process of a reforecast of a full year that will reflect current market and economic conditions.

During the second quarter of 2008, the company recorded total restructuring charges of $700,000, of which approximately $400,000 will be cash restructuring charges, which consisted of severance cost to the closure of Houston facility. We had previously disclosed that at the end of April of 2008 in our 8-K filing.

For the six months, consolidated sales were $457.6 million, compared to $452.9 million in the first six months of 2007. The increase in sales related to resin or foreign currency was approximately $37.5 million. Positive price adjustments amounted to approximately $2.9 million, a balance of change in sales related to an overall volume decline of despite a constant volume increase of almost 19%. The decline in conventional unit volume was slightly over 16% for the six months.

Credit agreement EBITDA, excluding restructuring charges, in the first six months decreased by $3.1 million to $25.5 million in the first half of 2008. Net loss for the six months ended June 30th was $12.5 million or a $1.01 loss per basic and diluted share, compared to a net loss for the first six months of 2007 of $11 million or $0.89 per loss per basic and diluted share.

Moving on to cash flow, cash flow was negative 24 million dollars during the first six months of 2008, compared to the negative cash flow of almost $10 million in 2007. And is primarily the result of higher investments and working capital to support the seasonal sales pattern of the business.

Day sales and accounts receivable were 1.7 days higher than at June of 2007 due to cash received shortly following the end of June related to customer payment patterns; customer mix and accounts receivable; and, a customer dispute, which we expect to resolve during the third quarter by cash collection.

In addition, we were able to negotiate an improvement in payment terms with the customers that contributed to the increase in VSO at the end of June of 2008. This will improve our day sales outstanding and accounts receivable in the second half of 2008. Accounts receivable also increased by $1.4 million related to higher dollar sales this year.

Inventory of resin and finished goods were higher than typical at month-end, partially due to declining sales and partially to mitigate the significant increase in resin prices amounts for July. This resin and excess inventory was mostly depleted during the month of July.

Moving on to liquidity, again, total liquidity was almost $44 million at the end of June. The calculated borrowing base was in excess of $97 million. Total liquidity as of yesterday, August 13th, was $40 million, with availability slightly more than $36 million. As of yesterday, borrowing was $27.6 million, which is up about $5 million from the time of our last call in May. The calculated borrowing base at the end of July was approximately $91 million.

Moving on to guidance, during the quarter, we will be completing a detailed forecast of our financial performance for the balance of the year. As part of this process, we’re getting updated volume forecasts from our major customers. As part of this process, we will also be reviewing our cost and expenses as well as capital expenditures. Until we complete this process during the quarter in time for our next call, we will refrain from providing guidance although we remain committed to achieve full year EBITDA before restructuring growth over last year.

As Mike had indicated, we’re targeting consolidated custom unit growth of 23% to 28% for the second half of the year, which demonstrates a continued acceleration of our growth in this segment due to our superior technology. We expect this increase to come from customers in alternative beverage and food market sectors, with the vast majority of the unit volume covered by customer contracts. We also anticipate cash savings from our restructuring activities of approximately $2 million. We continue to aggressively manage working capital. And we have taken actions to achieve lower day sales and accounts receivable by the end of December. We also plan to further reduce inventory supply by the end of the year.

In summary, we continue to target EBITDA before restructuring in the second half of 2007, and we have excess liquidity as we move into the second half of 2008. With that, Sarah, we are ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we’ll pause for a moment to assemble our roster. Well then we’ll take our first question from Sam McGovern with Credit Suisse. Please go ahead.

Bruce Klein – Credit Suisse

Hi it’s Bruce Klein. Good morning. Just on the Pepsi business, I guess it’s – I’m just not clear, I guess the expected profits in cash are going to be better post the Pepsi lower volume. Is that a function because you expect to replace that business or is that a function of just apples-to-apples? Having lower Pepsi business, by definition, is going to give you higher profits. Was it one or the other? I was –

Michael Hoffman

Yes, I know. And let me make that clear. And I want to be careful how much to say about this because we are still finalizing that deal. But it’s not the result of replacing of any of the business. It’s a result of taking fixed and variable cost out of the business that we’re associated with that volume will allow us to increase the profit and the cash flow associated with the reduced volume. So it’s directly related. It’s getting out of outside warehouses. It’s taking variable cost down. It’s unfortunately a result of layoffs, and we went out to our plants yesterday and began talking to our people about expediting closures of our – we have two plants in Dallas, one of the plants in Dallas, expediting and consolidation of the two plants we have in Orlando, and other activities that will take fixed cost and variable out that was associated with that business, which is a significant amount of money.

Bruce Klein – Credit Suisse

Okay. And the lower Pepsi volume is driven by their needs are changing? Are they more in-house or is it – any other color on that?

Michael Hoffman

It’s really we’re – we settled out. We settled out on a lower base and a different mix. It allows us to provide Pepsi out of our lowest cost plants, to give them the best economics, to take with that as some of our highest cost mix. It’s a various amount of reasons how we landed where we landed, but we’re real pleased with where we came out. Unfortunately, it results in some layoffs, but at the end of the day, we think and our confident that we have a healthier business as a result. And it does provide us with assets that we can target towards the custom growth. And we also have some (inaudible) things going on in that side of business. It took a while to get where we’ve gotten, but I think both parties are very satisfied with where we ended up.

Bruce Klein – Credit Suisse

And lastly, the water business is less than a part of your business overall. But I don’t have a sense how much – because some of that as you mentioned has gone in-house.

Michael Hoffman

Yes. Bruce, I’m going to give a rough estimate. And I’m looking at Walter to make sure I don’t make a mistake here. But now I’m letting you know that much excludes the Pepsi part of the business. If you look at the net result, it’s about 8.5% of our total volume. So it’s a – in fact, I think I indicated at the end of last year it was below 10%, but it’s roughly about 8.5% of our main volume.

Bruce Klein – Credit Suisse

Currently roughly?

Michael Hoffman

Currently roughly.

Bruce Klein – Credit Suisse

Okay. Great. Okay. I’ll pass this on. Thanks, guys.

Michael Hoffman

Thanks, Bruce.

Operator

Thank you. And we’ll take our next question from Frank Longobardi with Alcentra. Please go ahead.

Frank Longobardi – Alcentra

Good morning. Can you give me a sense of the volume development over the quarter? Did volumes at a – declined throughout the quarter? Or was your development – I shouldn’t say decline, custom growth actually increased. But over the quarter, what was the development of volumes? Was it kind of a steady development? Or do you see a significant change as you got to the end of the quarter?

Michael Hoffman

We really saw significant change at end of the quarter. And I’m comparing quarter to quarter now. So (inaudible) different references that I want to make sure that I address your question. When we finished the first quarter, as it was compared to first quarter of 2007, our conventional volume was down about 10%. As we went into the second quarter – but that was a rate that we were – it’s a little bit more than we had anticipated, but we were comfortable with that within the forecast limits that we had. In the second quarter, conventional volume went down 20%, so an additional 10% year-on-year. So the magnitude was significant, and we really did see the majority of that drop off in the May-June time period, and a lot towards the latter part of May and June.

So it was significant. It was unanticipated. I mean our customers have similarly announced drops in volumes that they didn’t forecast. So unfortunately, again, that was an impact of the economy and the recent (inaudible).

Frank Longobardi – Alcentra

And you’re talking –

Michael Hoffman

Okay. I’m going to leave it at that.

Frank Longobardi – Alcentra

Sure. And on the custom side, obviously, you’ve had an increase. Did that increase decelerate towards the end of the third – towards the end of the quarter? Or was that kind of even development over the quarter?

Michael Hoffman

It was fairly even development over the quarter. Everything that we had said – we had the one qualification issue that we talked about in the first quarter. That’s well behind us. Everything else that we had slated for this year has happened on time in full, but similar to what we talked about on the conventional side because it goes through mainly the same distribution channels and has been impacted by the same reasons. So that volume has been secured. That volume is under contract. All those products have been commercialized. They’re just being impacted the same way as everything else in those distribution channels.

Frank Longobardi – Alcentra

Okay. And then final question on the custom volume, at first half it kind of averaged 18.5%, you’re expecting second half to be 23% to 28%. I guess you signed some additional customers since the last call. I’m just trying to get –

Michael Hoffman

Yes. There’s a lot of activity. I think we’re going into alternate beverages. There are new packages being developed, and the vitamin waters and the teas. And we’re looking at sauces. A lot of categories we’re giving a lot of attention. And we’re beginning to secure those contracts. With the time it takes to get re-tooled, qualified. We’re going to see some of them the back half of this year. But most of that impact you’ll see in 2009.

Frank Longobardi – Alcentra

So it’s –

Michael Hoffman

It’s in those categories. It’s mostly in the beverage category that we’re seeing the activity. And it’s in the categories where their hits at several of them using our proprietary panelists, high flow technology as well as our barrier technology. So we’re continuing to focus in that proprietary segment where we have a strategic advantage.

Frank Longobardi – Alcentra

Okay. So just one quick follow-up, so that 23% or 28%, your confidence in that is really based on new customers that you signed up since last call?

Michael Hoffman

The increment, yes.

Frank Longobardi – Alcentra

What do you mean by increment?

Michael Hoffman

I’m just saying that the increment over our base is 19%, yes. That additional volume is coming from those new contracts we signed.

Frank Longobardi – Alcentra

Okay. Great. Thank you very much.

Michael Hoffman

Yes.

Operator

Thank you. And we’ll take our next question from Oliver Corlett [ph] with RW Press Ridge & Company. Please go ahead.

Oliver Corlett – RW Press Ridge & Company

Good morning. Just a little bit more on the custom there, the full cost that you’ve made previously, that’s 30% plus, it’s kind of hard to see how it comes down that much considering that you said they were kind of mature products and very predictable volumes. Can you tell us what’s the mix between the food type, a more stable demand product from the beverage, which I guess looks to be a little bit more discretionary.

Michael Hoffman

Yes. Oliver, we talked about in the first quarter, I actually think it was your question when we talked about the mix of products. We talked about the food products where we had growth for mature products, but they were by far the minority of the growth, which was mostly in beverage, which did have a seasonal aspect to it as well as there were new product launches. I’m going to say it again, the beverage products that we had, in fact, all of the products that we had announced and secured were certainly on time, in full, and were projected to be at the rate we had disclosed. Just look at what’s happening on the conventional side and you can tie that into what’s happening in the same distribution channel on these custom products that are distributed through them, so.

Yes. It is significant. And other fact I will throw in there is some of these products, as they were introduced, certainly they’ve grown, but have experienced a lot of competition from new brands being introduced at the same time. If you’ve seen what’s happened in the vitamin water category, there has been a proliferation of brands being pursued there. So it’s a combination of issues, but I want to repeat. All of the products that we had been awarded were launched and commercialized on time. And it was just misforecasted demand.

Oliver Corlett – RW Press Ridge & Company

Right. Okay. Now, I didn’t quite understand on the Diamond Clear approval process. Could you run through that again? You said it would be approved by the end of the year, and then 120 after that.

Michael Hoffman

Yes. When you submit your FCN for a new product, if there are no deficiencies, if there are no questions asked that you can’t answer in a period of time, it naturally gets approved within 120 days. We’ve been through a lot on this product. And we’ve been through a lot of testing, and all the testing has gone well, and all the testing that we’re currently doing continues to deliver very good results. So we don’t anticipate having any problems. So as we submit at the end of the year, there’s a 120-day waiting period before you get the release. And we’re hoping that goes as smoothly as we think it will go now.

Oliver Corlett – RW Press Ridge & Company

Okay. So right now, it’s approved for one use, but basically, within the first –?

Michael Hoffman

Yes. Let me get – I want to just get that clarification real quick because that’s a very good question. We had the – what we call the Diamond Clear 100 with the initial product that was FDA-approved and that had been initially approved for catsup. It was then released in the beginning of this year for application on several different product lines. The new DC, Diamond Clear 300 we’re calling it, has broader applications, has better recycling capabilities, has a whole bunch of improved features over the initial Diamond Clear formulation. So again, it’ll have much broader applications and we’re pretty excited that. And that’s the difference between the two.

Oliver Corlett – RW Press Ridge & Company

Okay. I got you. Speaking of recycling, it seems there’s been a lot of – quite a lot of bad press recently about – as a container material. I mean how do you view that? Do you see any kind of threat? Do you see any impact on your business from people trying to transfer to other container types?

Michael Hoffman

Well first, I want to get real clear. A lot of the bad press is improperly publicized. (inaudible), all these other additives that they talk about have absolutely zero to do with PET. So there are other resins that have nothing to do with our business. The only publicity that we’ve been seeing is on water bottles, in the proliferation of water bottles and a lot of recycling concerns with those bottles.

Honestly, I think the water companies have done a great job of taking significant gram weight of the package, as much as 30%. So there’s been a significant reduction in the amount of PET consumed. And I think that has helped significantly. But we’re really not making much more water bottles as I told Bruce earlier. It’s down to about 8.5% of our business. And we’re really not too dependent on that. I don’t see that same issue with other packages.

But I’ll tell you, our customers have got us, and we’ve got independent efforts using recycled material. We’re growing significantly year-on-year on our consumption of bottle-to-bottle recycling. We’ll continue to make that drive, and I think that’ll make the expansion of the plastic bottle business more acceptable.

Oliver Corlett – RW Press Ridge & Company

Okay. Great. Just finally, can you give us a picture of how the PET market is behaving right now? And also, the energy – as oil costs, if they do decline, how soon do you think any kind of declines in those sources will be reflected in your energy freight and PET costs?

Michael Hoffman

Well Oliver, I wish I had a crystal in this area at the end of last year, but unfortunately, I didn’t. I do think that it’s different region to region in the areas that we operate. Some, the lag is electricity cost for me. (inaudible) electricity cost first, but the lag is longer than others. But I do think if the oil continues to drop or stay in the $1.13, $1.15 range that we will see some relief in the back half of the year.

There is some correlation on the PET side. So we have begun to see some forecasted drops in PET pricing. We did take significant increases in July. And so, we hope to see significant decreases. And we’re beginning to hear about them for the balance of the year. So I think those directly relate, and you start talking about hurricanes, and people talking about things that are already developing out there. We’ll see if they have an impact on – but right now, my projection is that we’re going to see a decline for the balance of the year in the PET arena. And we should see some relief as long as the (inaudible) markets behave as they been on the energy side.

Oliver Corlett – RW Press Ridge & Company

Okay. Just one final question on your CapEx, you’re not making a forecast for this year? Or have you changed your assumptions?

Walter Sobon

As we said earlier, we’re not providing guidance at this time. And part of our overall process to reforecast will include a review of our capital investments.

Oliver Corlett – RW Press Ridge & Company

Okay. That’s all I have. Thank you very much.

Michael Hoffman

Thank you, Oliver.

Operator

Thank you. We’ll take our next question from Aaron Rickles with Oppenheimer. Please go ahead.

Aaron Rickles – Oppenheimer

Hi. Good morning, guys.

Michael Hoffman

Good morning.

Aaron Rickles – Oppenheimer

If we can spend a few more minutes on the Pepsi contract? I guess, the first question is the – it sounds like it’s not inked, but it’s very, very close. Can you give us a sense of what you think the risks are to that falling apart? And also, what you expect the timing to be?

Michael Hoffman

As I said earlier, I think we are very, very close, and we’re essentially there on economics, in terms of conditions. Obviously, at any time, anything can fall apart before it’s signed, but I anticipate that this will stay on track. And we should be able to get the final wording completed, and hopefully have this thing announced in the next couple of weeks.

Aaron Rickles – Oppenheimer

And then, to think a little bit more about the restructuring costs that are going to be tied to the reduction in volume, and I know it’s early and you probably don’t want to say too much, but can you give us a sense – you mentioned at least two facilities here you need to consolidate. Can you give us a sense of the cash cost that you might expect to have to incur?

Michael Hoffman

Yes. I know it’s a little too early to comment on that. I mean the significant savings and the cash flow that I commented about earlier is inclusive of those costs. So it’s not positive, so. Let’s get the deal done.

Aaron Rickles – Oppenheimer

Okay. Fair enough. I’ll come back to that later. The volumes that you’ve seen – I know you talked a little bit about trends for the first month of the third in July and for a couple of weeks in August. Can you give us a sense of what you’d seen?

Michael Hoffman

Yes. As I said, I might open this – we don’t expect the conventional business to recover. I mean we’re seeing the same trends that we were seeing in the first half of the year. The question is whether it will get worse or whether it will get better. So we’re monitoring it very closely, and that’s why we’re a little hesitant. And we do want to go back to our customers to get updated forecast, so we get what they’re currently thinking.

There’s a lot of innovation going on out there. Whether that will help it or not, is again, is an unknown. But we do feel real good about the custom activity that we do have going on, the new business that we have secured. So we feel comfortable in the guidance that we gave you there. But there are some unknowns about where the conventional business will go the balance of the year. Trends are similar as to what we’ve seen in the second quarter.

Aaron Rickles – Oppenheimer

I’ve seen a lot – there are some press releases from, I guess, some competitive PET providers. They’re talking about entering the North American markets (inaudible) with that. Have you seen much in the way of competition heating up?

Michael Hoffman

No. Have you? We really haven’t. I’m curious as to what you’re referring to. We track that fairly closely. I mean we’re not seeing increased competition. We do anticipate with these decreased demands or requirements, there will be some open capacity. But we have taken great measures to retire our capacity. Older blow (inaudible) taking note out of action as well as using them, so we’re hoping that the same discipline exists in the industry. And so to answer your question, no. We have not.

Aaron Rickles – Oppenheimer

That’s helpful. I guess a couple more questions, if I can. In terms of your pricing, I know you talked about I think a 3% price increase. Can you give us a sense of maybe dollar amount that you are still on lag in terms of recouping a higher resident energy cost and maybe how you expect to recapture some of that over the next half of the year?

Michael Hoffman

Are you talking about resin? I mean we – substantially, all of our contracts will have pass through (inaudible) them so it doesn’t materially impact our margins. There are some timing delays. I couldn’t quantify. And I don’t want to quantify what the impact of that timing to land some of the contracts.

As far as the energy, when we announced the energy price increase in 2006, we did get several customers on mechanisms that allowed us to pass through energy at that point. So we’ve continued to do that. On the balance of the business, there are contractual terms that allow us to pass through energies. Plus, there are some that are, quite frankly, left unaddressed in the contract. And we feel very confident we have the right to pass through on that, so. It’s hard for me to have to give you a number, but we believe it will pass through a good portion of the energy cost increase in the back half.

Aaron Rickles – Oppenheimer

And this is the last one, I guess. You talked a little bit about the working capital and the timing of some of the payments. But just to clarify, did you basically say that you would expect a pretty big source of cash and working capital as some of that timing –?

Michael Hoffman

Yes. Let me clarify my comment on that. We did end the second quarter with higher than we would have liked inventories. And that’s inventory of resin as well as inventory of finished goods. However, we didn’t get too excited about it. I mean we’re pretty aggressive on our working capital inventory, but resin prices spiking in July, we did elect to keep that inventory. So we had volumes coming down. We got caught with higher trends of inventory. We kept those trends because resin prices were spiking in July. So we helped – we thought that it would help mitigate the spike. And the maturity of that excess inventory was depleted in the month of July.

Walter Sobon

From an accounts receivable standpoint, as I said earlier, when we are up from last year in day sales outstanding and accounts receivable by 1.7 days. Based upon settling a customer dispute in the third quarter, and collections that were immediately made following the end of the month of June, and the negotiation that we completed with the customer to improve their payment terms, we would have had day sales outstanding and accounts receivable comparable to last year’s level. In fact, as we look to the balance of the year, as I said earlier, we expect that DSO will go down between now and the end of the year.

Aaron Rickles – Oppenheimer

Very good. Thank you.

Operator

Thank you. And we’ll take our next question from Andrew Chan with Lehman Brothers. Please go ahead.

Andrew Chan – Lehman Brothers

Actually, my questions have been answered. Thank you.

Operator

Thank you. And we’ll take our next question from Heather Ruff [ph] with Caritas. Please go ahead.

Heather Ruff – Caritas

Hi. I know that you’re not in a position to give guidance right now, but is there any way you can kind of let us know year-to-date how below you’ve been tracking your original guidance?

Walter Sobon

At this point, in terms of where we are during the first six months of the year, we are off of our original guidance. However, it’s very difficult for us to quantify where we expect to wind up the full year without going through the exercise. Some of the differences in performance are related to timing, related to customer. So it’s difficult to quantify the sensitive year-to-date performance.

Michael Hoffman

And we don’t give quarterly guidance. But we did state in the fourth quarter that, certainly, we had a back half because some of the new products that we’re commercializing. Of the guidance that we gave, we did have a higher impact on the back half of the year.

Heather Ruff – Caritas

Okay.

Walter Sobon

And certainly, related to energy costing during the quarter, about $3 million from last year. Certainly, I don’t think anybody would have expected that energy costs would have gone up that high during the second quarter of 2008.

Heather Ruff – Caritas

Okay. Just a couple of questions on your revolver, the mat clause, that is only – only goes into effect if you completely don’t renew the Pepsi contract. It isn’t impacted by any sort of volume declines, is it?

Walter Sobon

You’re talking about the –

Heather Ruff – Caritas

Material average change clause on your revolver.

Walter Sobon

The mat clause that we have on the revolver is a typical mat clause.

Heather Ruff – Caritas

Yes. But I know there was some discussion, I think, in the quarterly report or the 10-K that it was tied to – something specifically tied to the Pepsi contract. I just want to make sure that –

Walter Sobon

Actually, the mat clause in relationship to – first of all, if you go back to what Mike said about the Pepsi contract. The Pepsi contract itself, we think, is an improvement over where we are after you consider restructuring. And the mat clause is not applicable at all in this particular case.

Heather Ruff – Caritas

Okay. Great. And when you give your stated revolver availability, does that factor out your minimum availability requirement, I think that covenant under your revolver? Or is that amount included?

Walter Sobon

It factors that out. When we provide availability, it is actually the amount of money that I can draw down at the moment that I provide that number.

Heather Ruff – Caritas

And then, can you give me a little bit of, I guess, explanation on your CapEx? It looks like maintenance CapEx, I think you said in the past, is about $10 million to $12 million, and the rest is growth. Can you talk a little bit about the timing of that growth and how that works? Is it upfront when you get new custom contracts? Do you have to do a lot of changes, and equipment, or what not?

Michael Hoffman

Yes. I’m going to answer your question. I’d give you how the capital is upfront. And depending on what you’re investing in, if you were to put a brand new line for a customer for growth that takes about fourth place amongst to put that line in, and you have a lot of downpayment for that. I’d be happy to put in place before that line gets up and starts running. So there is a lot of upfront. The maturity of the capital is upfront. There are some payment terms that you do get that allow to spread over a period of time. And that’s if you put the CapEx upfront. There are these options that are pursued on occasion. But generally, CapEx is upfront. And a line takes six months to install.

Heather Ruff – Caritas

And so would we – I mean as we continue to see custom growth, would we expect to see this large CapEx?

Michael Hoffman

Well, that’s a more interesting question because as what we’ve been doing in the past because of this demand on the business, we’ve had to install new lines. But as demand has weakened and water business has gone in-house, we’ve been able to use existing assets and convert them. So it’s a much lower cost of capital. And we’ve been able to take injection machines and just put them in moulds or rig to existing moulds, and be able to make (inaudible) pre-forms. And we’ve able to take lines that make conventional products and just do some modifications to them. So they become (inaudible) product.

So as we go forward, the amount of CapEx will be reduced to be able to capitalize on that as I said on my opening script, so. And furthermore, as we go forward, as the line has decreased with the working capital, I mean maintenance capital also decreases because the majority of the maintenance capital that we have is a result of having to refurbish injection tools. And as you could take some of those out of service, the cost to refurbish those will be decreased.

Heather Ruff – Caritas

Okay. That’s all I have. Thanks.

Michael Hoffman

Thank you.

Operator

Thank you. And we’ll take a follow-up question from Frank Longobardi with Alcentra. Please go ahead.

Frank Longobardi – Alcentra

Hi. Can you talk just quickly about your color – so I’m assuming you’re going to pass into the second quarter, do you anticipate – any issues with the third or fourth quarter? Are they getting tighter? So a little color there would be helpful.

Walter Sobon

We have no financial covenants.

Frank Longobardi – Alcentra

Oh right. Okay. Not even for the revolver?

Walter Sobon

There are no financial covenants in the revolver.

Frank Longobardi – Alcentra

Okay. And then, can you just quickly remind me what you said about the sales increases. Did you say $21 million of the increase or there’s $21 million positive in tax from pass through in FX for the quarter?

Walter Sobon

That is correct.

Frank Longobardi – Alcentra

And did you provide a total – sorry, I didn’t hear if you did. Did you provide a total resin impact for the quarter?

Walter Sobon

No. We combined it with currency, but the currency is a rather small portion of change.

Frank Longobardi – Alcentra

Right. But the resin that you just pass through, is that – that wasn’t 100% of the resin impact, right?

Walter Sobon

The amount that we disclosed for both resin and foreign currency of around $21 million if the increase in cost were related to resin pass through.

Frank Longobardi – Alcentra

Okay. Great. Thank you.

Operator

Thank you. At this time, there are no further questions. I’d like to turn it back over to Mr. Michael Hoffman for any additional or closing remarks.

Michael Hoffman

Thank you, Sarah. It was obviously a difficult quarter for the business and shaping up to be a pretty tough year based on the economic trends. However, I am pleased with the resiliency of the business, and more importantly, the timely execution of the cost reductions to price increases, while at the same time maintaining our customer growth. Additionally, I’m pleased with the progress we made towards securing a renewal with our largest customer, and hope to announce that, as I said, in the next several weeks.

So with that, I thank you for your participation today, and look forward to updating you on the progress at the end of the third quarter.

Operator

Thank you. Once again, we thank you for your participation. You may now disconnect. H

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Source: Constar International Inc. Q2 2008 Earnings Call Transcript
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