WLK

Westlake Chemical Corporation: Q3 2006 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended September 30, 2006. Westlake Chemical Corporation is a vertically integrated manufacturer and marketer of petrochemicals, polymers, and fabricated products, operating primarily through two segments: Olefins and Vinyls. The company reported strong operational results driven by higher selling prices that outpaced increased feedstock costs, despite volume headwinds from an unscheduled outage at its Lake Charles ethylene unit.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 11.1% in Q3 and 8.6% year-to-date (YTD), driven primarily by higher average selling prices (+15.7% company average in Q3) which offset lower production volumes (-5.3% in Q3).
• Profitability: Net income rose 41.8% in Q3 and 17.6% YTD. Operating margins improved to 12.9% in Q3 from 11.6% in the prior year.
• Debt Restructuring: In Q1 2006, the company refinanced its debt, issuing $250 million in 6 5/8% senior notes due 2016 to redeem 8 3/4% notes and a term loan. This resulted in a one-time $25.9 million debt retirement cost in Q1 2006, reducing YTD net income by approximately $16.3 million after-tax.
• Operational Disruptions: An unscheduled outage at the Lake Charles ethylene unit in September 2006 reduced volumes and increased maintenance expenses. Additionally, a planned turnaround in Calvert City impacted YTD results.
• Segment Performance:
  • Olefins: Sales up 9.1% in Q3; Operating income down 7.1% due to volume declines from the outage.
  • Vinyls: Sales up 13.4% in Q3; Operating income up 69.2% driven by higher PVC resin volumes and prices.

Guidance, Outlook, and Risks

• Acquisition: On October 9, 2006, Westlake agreed to acquire Eastman Chemical Company's polyethylene and Epolene polymers businesses for $255 million in cash. The deal is expected to close in Q4 2006 and will increase total polyethylene capacity to over 2.5 billion pounds per year.
• Trinidad Project: The company is pursuing a $1.5 billion ethane-based ethylene project in Trinidad and Tobago, with construction targeted for late 2007 and operations in late 2010.
• Liquidity: Management believes cash, cash equivalents, and the $300 million revolving credit facility are sufficient to fund operations and the Eastman acquisition.
• Legal & Environmental:
  • Goodrich/PolyOne: Ongoing litigation regarding environmental remediation costs at the Calvert City facility. A settlement regarding past due payments was reached in 2005, but counterclaims remain.
  • Royal/Georgia Gulf: A dispute over VCM pricing with Royal Polymers was settled in October 2006 following Georgia Gulf's acquisition of Royal. The company forgave a $10.2 million shortfall that had already been reserved.
  • EPA: Settlement discussions are ongoing regarding environmental violations at the Calvert City facility; penalties are expected but amounts are not yet finalized.
• Risk Factors: Key risks include volatility in raw material (ethane, propane) and energy prices, the cyclical nature of the chemical industry, and potential operating interruptions.

Investor Verification Checklist

• Eastman Acquisition Closing: Verify the final closing date and any working capital adjustments to the $255 million purchase price.
• Debt Covenant Compliance: Confirm the company's fixed charge coverage ratio remains above the 2.0 threshold required for dividends under the new senior notes indenture.
• Environmental Liabilities: Monitor the resolution of the Goodrich/PolyOne litigation and EPA settlement to assess potential future remediation costs.
• Feedstock Costs: Track ethane and propane prices, as these are the primary drivers of gross margin volatility.
• Trinidad Project Feasibility: Review the outcome of the detailed feasibility study for the proposed $1.5 billion project.