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Edited Transcript of EMN earnings conference call or presentation 26-Apr-19 12:00pm GMT

Q1 2019 Eastman Chemical Co Earnings Call

KINGSPORT Apr 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Eastman Chemical Co earnings conference call or presentation Friday, April 26, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Curtis E. Espeland

Eastman Chemical Company - Executive VP & CFO

* Gregory A. Riddle

Eastman Chemical Company - VP of IR & Communications

* Mark J. Costa

Eastman Chemical Company - Chairman & CEO

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Conference Call Participants

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* Daniel Dalton Rizzo

Jefferies LLC, Research Division - Equity Analyst

* David L. Begleiter

Deutsche Bank AG, Research Division - MD and Senior Research Analyst

* Frank Joseph Mitsch

Fermium Research - Senior MD

* Jeffrey John Zekauskas

JP Morgan Chase & Co, Research Division - Senior Analyst

* John Ezekiel E. Roberts

UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst, Chemicals

* Kevin William McCarthy

Vertical Research Partners, LLC - Partner

* Matthew Stephen Skowronski

Nomura Securities Co. Ltd., Research Division - Research Analyst

* Michael Joseph Sison

KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst

* P.J. Juvekar

Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD

* Patrick Duffy Fischer

Barclays Bank PLC, Research Division - Director & Senior Chemical Analyst

* Vincent Stephen Andrews

Morgan Stanley, Research Division - MD

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Eastman Chemical Company First Quarter 2019 Conference Call. Today's conference is being recorded. This call is being broadcast live on the Eastman's website, www.eastman.com.

We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Please go ahead.

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Gregory A. Riddle, Eastman Chemical Company - VP of IR & Communications [2]

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Okay. Thank you, Kim, and good morning, everyone, and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO; Curt Espeland, Executive Vice President and CFO; and Jake LaRoe, Manager, Investor Relations.

Before we begin, I'll cover 2 items. First, during this presentation, you will hear certain forward-looking statements concerning our plans and expectations. Actual events or results could differ materially. Certain factors related to future expectations are or will be detailed in the company's first quarter 2019 financial results news release, also during this call and in the accompanying slides, and in our filings with the Securities and Exchange Commission, including the Form 10-K filed for 2018 and the Form 10-Q to be filed for first quarter 2019.

Second, earnings referenced in this presentation excludes certain noncore and unusual items. In addition, historic quarterly earnings use an adjusted tax rate, using the forecasted tax rate for the full year that excludes the provision for income taxes for the same noncore and unusual items. Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded and adjusted items, are available in the first quarter 2019 financial results news release, which can be found on our website, www.eastman.com in the Investors section. Projections of future earnings exclude any noncore, unusual or nonrecurring items.

With that, I'll turn the call over to Mark.

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [3]

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Thanks, Greg, and good morning, everyone. I'll start on Page 3. In the first quarter of 2019, we had a number of accomplishments we can be proud of and a number of challenges to take on. Before we get into the financial results of the quarter, I'd like to pause and take a moment to discuss some of the important highlights from the quarter.

First, after challenging fourth quarter, we delivered a 28% sequential improvement in our earnings and we expect this momentum to continue on to the second quarter. We also received an ENERGY STAR Partner of the Year award for the eighth consecutive year, demonstrating our commitment to operate our facilities responsibly and efficiently. Eastman is always searching for ways to leverage our world-class operations and macro trends like sustainability, and I'm proud of the investments we're making in methanolysis and the carbon renewal technology, which provides serious solutions to enable the circular economy.

In this environment, we continue to see strong customer engagement with our innovation programs and delivered an 8% increase in new business revenue closes from our innovative products. As always, we also continue to aggressively execute on cost management, running a highly productive organization, and we've increased our cost-reduction actions given the short-term macroeconomic challenges.

Consistent with our strategy to pursue bolt-on acquisitions in our specialty businesses, we completed the acquisition of Marlotherm heat transfer fluids from Sasol, opening up their product offerings to new regions, and we'll continue to pursue bolt-on M&A where it makes sense. Core to how we win is our ethics and integrity, and we appreciate the recognition is one of the World's Most Ethical Companies by Ethisphere for the sixth consecutive time.

And finally, these awards and the focus of our strategy comes back to our owners, where we consistently return cash to our shareholders. We returned $212 million to shareholders in the first quarter of 2019, an 18% increase over the first quarter of '18.

On Slide 4, we continue to execute our innovation-driven growth model to create superior value. Today, I'd like to highlight 2 specialty product lines: one is Advanced Materials and another is Additives & Functional Products, both in a challenging end market: transportation. Although we've seen weakness in global transportation markets over the past 2 quarters, especially in Asia, I'm very excited to report that our team continues to deliver strong growth in our premium innovative products. One example, fueling this growth is Saflex heads-up display, where we are delivering double-digit growth, including an impressive 20% growth in Europe. We're well positioned to create growth in an even challenging transportation market for a number of reasons.

Our world-class PVB technology platform enables us to continue to introduce new products to meet the evolving needs of the marketplace. We are deeply engaged both with our customers and equally important across the entire value chain, including the premium auto OEM brands and projector manufacturers. And our application development capabilities enable us to tune our products for the unique challenges associated with each model, including standards for optical clarity and the complexity of the design. The end result is our products sold at a premium price, growing at multiples of the underlying market to meet this reinforce of the value of our innovation-driven growth model.

Another innovation in transportation is where we're winning with customers in our next-generation Crystex product, which is essential in a challenging tires market. It is produced at our new facility in Kuantan, Malaysia, which is now fully operational and we're seeing accelerated adoption of our new and innovative product, Crystex Cure Pro. Tire makers, to win in their markets, are under constant pressure to improve tire performance as well as operational efficiency. Working closely with our customers to better understand these challenges drove us to develop a superior product, and we're getting validation from customers that they're seeing significant benefit in line speed improvements, scrap reduction and energy savings.

As a testament to the tire additives team's relentless engagement with the market, we're now working with more than half of the top 30 tire makers in the world on our next-generation Crystex and have 9 new plant trials in progress in the first quarter.

Finally, we're proud that Crystex Cure Pro is recognized as a finalist in the 2019 Tire Technology International Awards for Innovation and Excellence. And we're the only innovation honored that was now created by a tire company. While the tires markets will be challenging for us in this year given our legacy products, Cure Pro is already demonstrating that we can extend our differentiated position as we move forward in filling out this new plant. These are just 2 of many great examples we have that demonstrate how our specialties are delivering today and our innovation and market connections position us to continue to win in the future.

With that, I'll turn it over to Curt.

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [4]

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Thanks, Mark, and good morning, everyone. It's always a pleasure to spend this hour together. I'll begin with a review of our corporate results on Slide 5. Although challenges from the fourth quarter persisted into the first, we increased EBIT by 28% sequentially with growth in 3 of our 4 segments. Driving this improvement was a seasonal increase in volume, improved product mix and higher spreads.

On a year-over-year basis, sales revenue and earnings decreased mostly due to lower volume. We managed our controllable cost down significantly in the quarter. These actions were more than offset by a stronger dollar and cost in which we have less discretion such as higher pension costs, netting out to greater than a $30 million headwind year-over-year.

Looking across to our end markets, we experienced volume softness, particularly in transportation, consumables and consumer durables, especially in Asia and Europe. Global economic uncertainty persisted throughout the first quarter, which contributed to the softness, and in particular, higher-margin specialty businesses such as tire additives, adhesives and specialty plastics were most impacted by the challenges in these end markets. The primary driver continues to be the U.S.-China trade wars impact on demand in China and its associated impact on Europe, which is highly dependent on exports to Asia.

Looking at the cadence through the quarter. January was about as expected, but after Chinese New Year, demand was sluggish and did not pick up as we had hoped. Destocking was evident throughout the quarter and a substantial contributor to our volume decline. That said, March was a strong month and April orders gave us confidence we'll continue the trend upwards into the second quarter, and we're seeing signs of destocking coming to an end across many of our end markets.

Moving now to our segment reviews and beginning with Advanced Materials on Slide 6. Both sales revenue and EBIT increased sequentially with EBIT up $30 million or 42%. Higher sales volume and improved product mix drove the sequential improvement in first quarter. On a year-over-year basis, sales revenue decreased primarily due to lower specialty plastics sales volume and an unfavorable shift in foreign currency exchange rates.

Lower volume in specialty plastics was due to continued customer inventory destocking, particularly consumer durables related to the uncertainty caused by the U.S.-China trade dispute. As a highlight for the quarter, performance films and advanced interlayers volume and mix were relatively unchanged, despite declining vehicle build rates globally. Growth in high-margin innovation products such as paint protection film, heads-up display interlayers and architectural interlayers is offsetting declines in the underlying auto market.

EBIT declined year-over-year primarily due to lower sales volume and unfavorable exchange rates, and we're also still working of our high-cost inventory from last year. Looking forward, we expect strong sequential improvement for revenue and EBIT in the second quarter due to a few factors. Tritan destocking coming to an end with primary demand intact, continued mix upgrade due to products like paint protection films and premium interlayer products, typical seasonality and improvement in the flow of the lower raw material costs in our inventory. Taking these factors together, we expect EBIT in the segment will be similar to the second quarter of 2018. Looking at the full year, given the positive trends in the business, we continue to expect Advanced Materials will grow EBIT between 7% and 10% relative to 2018.

Moving now to Slide 7. Additives & Functional Products also had strong sequential improvement with EBIT up $27 million or 22%. The sequential improvement was due to improved product mix and increased spreads. Sales revenue decreased year-over-year particularly for adhesives resins due to continued competitive pressures and for tire additives products attributed to trade-related pressures. In tire additives, in particular, trade-related uncertainty has had a significant impact on Chinese tire production during the time when overall Chinese economic demand is going down. Chinese tire producers have adjusted accordingly by destocking their inventories.

As a result, tire additive competitors have excess capacity in China, which has caused some short-term competitive dynamics in our legacy products. We have confidence that dynamics will improve as we continue to see great adoption of our next-generation Crystex Cure Pro in the marketplace. For adhesives, we face competitive pressure from new competitor capacity as we have discussed in prior calls.

Revenues were also negatively impacted by a stronger dollar. Lower selling prices year-over-year were largely attributed to Care Chemicals due to cost pass-through contracts, producing stable earnings.

Looking at EBIT, the year-over-year decrease was primarily due to lower sales volume and an unfavorable shift in foreign currency exchange rates. To a lesser extent, excluding the Care Chemicals cost pass-through contracts, prices were relatively flat sequentially with higher costs raw material flow through creating some pressure on spreads year-over-year.

Looking at the second quarter, we expect sequential improvement in both revenue and EBIT due to seasonally stronger volume, an increase in spreads as lower cost raw materials continue to flow through inventory, but earnings will not get back to last year's levels due to volume still recovering and unfavorable currency. And we expect spreads to be similar to last year.

As we move to the second half of the year, we expect demand to improve for coatings, adhesives and tire additives, assuming the trade dispute with China is resolved. There may also be some upside as China appears to be stepping up the environmental enforcement actions. For the full year, we expect 2019 EBIT to be similar to, or slightly better than 2018.

Now the Slide 8, and Chemical Intermediates, which delivered a strong improvement in sequential earnings. On a year-over-year basis, sales revenue decreased primarily due to lower sales volume, mostly because of the refinery-grade propylene project, reducing bulk ethylene sales as planned. Remember in the first quarter of 2018, we were still selling ethylene at attractive prices due to market conditions.

Lower raw material prices in a few products also led to reduced pricing in the segment. EBIT decreased primarily due to lower sales volume and lower selling prices declining slightly more than raw material cost for our few olefin products, particularly glycols.

Looking at the second quarter, while we don't have the headwinds of the industrial gas supplier outages, market conditions have changed from a year ago. The benefit of not having supplier outages from last year is being offset by a sequential decline in spreads and acetyls and some continued pressure in glycols. Similarly, in the full year, we expect the benefit from the lack of some of the 2018 headwinds in 2019 to be offset by weakening market conditions, especially impacting spreads in acetyls and glycols, leading us to expect EBIT in 2019 to be similar to 2018.

Finishing up the segment reviews of Fibers on Slide 9. Sales revenue decreased year-over-year primarily due to lower acetate tow sales volume, attributed to China trade-related issues and other customer volume patterns as well as lower acetate tow selling prices. EBIT decreased primarily due to lower acetate tow sales volume, somewhat offset by growth in textiles and lower raw material costs. This is consistent with the guidance we gave you on our fourth quarter call that first quarter EBIT will be the lowest quarter for the year.

For the full year, we expect acetate tow volume declines consistent with the underlying market plus the impact of the headwinds from China trade issues from the first half of the year, offset by growth in textile market and cost-reduction actions. Therefore, we continue to expect Fibers' EBIT to be about the same as 2018.

On Slide 10, I'll transition to some corporate financial highlights. In the first quarter, we did a nice job managing our cash flows and remain on track to deliver greater than $1.1 billion of free cash flow in 2019. Priorities for use of this cash will remain balance between deleveraging, funding an increasing dividend. And in the absence of bolt-on M&A, we will use the remainder of our cash for share repurchases.

I'll add that you should always assume that we fully deploy our cash. We've returned $212 million to stockholders in the first quarter through share repurchases and dividends, and we remain committed to an investment-grade credit rating and we'll delever as needed to maintain our solid balance sheet, likely in the $250 million to $300 million range. Our effective tax rate in the first quarter was roughly 16.5%, consistent with our full year expectation of between 16% to 17%.

With that, I'll turn it back over to Mark.

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [5]

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Thanks, Curt. On Slide 11, I'll provide an update on our 2019 outlook. Our earnings challenge in the first half of the year is predominantly a volume challenge for our high-value specialties and the slow growth world, especially in Asia and Europe compounded by the destocking.

Spreads in the specialties in the second quarter improving and are expected to be similar to last year's level. The volume challenge we see is primarily trade-related and to a lesser extent due to slowdown in the global transportation market. That said, we are encouraged by the improvement in our orders through March into April and believe most of the destocking is behind us.

And as the 16th largest exporter by volume in the U.S., with Exxon as the only chemical company above us, we're probably more exposed to trade disruptions we've seen for the last 2 quarters. The stronger U.S. dollar is having a negative impact, which is a challenge given our U.S. manufacturing footprint. We've assumed that on average, the dollar-euro exchange rate will be around $1.14 for the year. And we expect the impact of the first half to be around $30 million with AFP and AM most impacted and with limited impact in the second half. You recall from our fourth quarter call that we discussed that slow flow through of high-cost raw materials from last year would impact our earnings in the first quarter, which it did.

Given this lower-than-expected volume in the first part of this year, this impact was greater than we expected. So the benefits of the lower cost raw materials will now be more of a second half impact.

Lastly, we're expecting higher pension costs for the year, and this is approximately $30 million split relatively evenly between the quarters. Putting this together, we're expecting second quarter EBIT to increase between 15% and 20% compared to the first quarter.

Moving next to the second half of the year. We're assuming that the U.S.-China trade dispute is settled at some point here in the second quarter, removing uncertainty that is impacting the Chinese economy. We're also expecting improving global demand, and we are starting to see it already with strong demand in March and April compared with January and February. I will describe April at more normal levels, plus innovation is creating our own growth. As demand improves, our asset utilization levels will pick up and that should result in lower cost raw materials and conversion costs flowing through. And roughly $30 million first half year-over-year headwind from the stronger dollar is expected to be much lower in the second half of the year. Then we have the additional $40 million of cost actions we're taking.

Moving on to the full year. Obviously, we have to offset a substantial earnings decline in the first half. It's also important to remember that we have an easy comp in Q4. With all of the growth drivers in the second half that I have mentioned, we have confidence that we can deliver low single-digit EBIT growth for the year. And then with returning cash to shareholders and share repurchases and lower interest expense, we expect our EPS can grow at the low end of the 6% to 10% range that we provided in the fourth quarter call.

As Curt mentioned earlier, we continue to see a pathway to free cash flow of greater than $1.1 billion. I often get asked what makes me confident of Eastman's future. And here is the bottom line for me. Big picture, we continue to focus on what we can control and are winning with customers because of our innovation-driven growth model. And at the same time, we're aggressively reducing our cost to accelerate top line growth to the bottom line. Nothing happens without the dedication and drive of the people of Eastman throughout the world who face challenges and opportunities head on and every day they find ways to overcome them and are determined to win. And that's why I'm confident we're going to win today and far, far into the future.

With that, I'll turn it back to Greg.

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Gregory A. Riddle, Eastman Chemical Company - VP of IR & Communications [6]

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Okay. Thanks, Mark. We've got a lot of people on the line this morning, and we'd like to get to you as many questions as possible. So as always, I ask you to please limit yourself to one question and one follow-up.

With that, Kim, we are ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today is from David Begleiter from Deutsche Bank.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [2]

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On your full year guidance, it looks like you lowered segment guidance in one segment AFP, but maintained in the other 3. You maintained a full year guidance. Can you talk about that dynamic? And why you didn't take the opposite -- opportunity now to trim the full year guide given the challenging macro?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [3]

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Thanks, Dave. And in your observation around the guidance is sort of directionally correct. Obviously, in the first quarter, our earnings came in a little bit lower than we expected, and we have that adjustment in the second quarter. And that's why you saw us take the aggressive cost actions that we announced in late March. So while we have these challenges, we stepped up our cost reductions to take another $40 million out relative to the plans we had in the beginning of the year. That sort of balances that equation out and allows us to stay on track for our guidance. And we also feel very encouraged by the improvement in volume we saw in March and the continued improvement in the volume that we're seeing as we go into April and getting our mix back. One of the bigger challenges we've had here is mix of our high-value products and that gives us confidence. We're on the right track for the rest of the year.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [4]

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And Mark, on these additional cost actions, how permanent are these actions? And where are they coming from?

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [5]

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So David, as we started the year, as a reminder, we had already taken aggressive cost actions to kind of help offset higher turnaround costs and other anticipated challenges at that time. So as Mark mentioned, as we started the year, we decided to take additional actions, which are primarily headcount, contractors and discretionary spend. So the additional actions are expected to contribute $40 million to our 2019 results. So I'd call those pretty permanent kind of reductions and again predominantly in the second half of the year. So these factors plus the additional expectation -- expected improvements in '19 should provide us good momentum going into 2020.

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [6]

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I'd also note about 3 quarters of those cost reductions going to manufacturing, and they'll go into our COGS and then they will have to flow out. So that's why they're going to very back-end loaded and where the benefits shows up.

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Operator [7]

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Moving on, we'll hear from Jeff Zekauskas from JPMorgan.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [8]

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What was the magnitude of the cash restructuring charge that you took in the first quarter?

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [9]

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So you saw the restructuring charge, I believe, it was about $28 million. A good portion of that is the anticipated severance of our restructuring programs. There will be a little bit more in the second quarter and maybe a small tail in the second half of the year, but a good portion of that is that $28 million of severance charge accruals that we took in the first quarter. That will be the cash impact. Now not all that cash flows out. This year, it could go over a 12-month time period, too. So some of these severances accruals get paid out over a 12-month period.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [10]

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And then for my follow-up, your prices in Advanced Materials in the quarter, I think, were up 1%. And if you -- and you had negative volumes in the quarter of some mid-single-digit level. And like if you think about the Celanese's earnings, I think in their engineered materials, their prices were up 7% and they had a similar volume decline to you. When you look at your businesses versus their businesses, do you find them in any way comparable? Do you think you're more disadvantaged in terms of being able to raise price? Or do you think that there is an opportunity where you could have been more aggressive and you plan to be more aggressive in the future? Can you kind of assess those difference? Can you assess that comparison?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [11]

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Sure, Jeff. First of all, the Celanese's business and our business are just fundamentally different. So it really doesn't make sense to make a lot of comparisons. They're primarily a compounding business with a completely different set of polymers and different set of applications. So I'm really focused on us. The business that we have has been incredibly successful, delivering very strong earnings growth for the last 6 years, and this year it will be the seventh. And the underlying driver of that is volume and mix improvement as the key to sort of driving that growth, where we're selling a very high-growth rates, very high value, high-margin products like Tritan and heads-up display interlayers, performance films, et cetera, relative to the segment average, and we keep on driving the weighted average mix growth up. So that's the core and heart of our strategy.

Pricing is, obviously, a key part of how you manage your spreads for any product relative to raw materials. And our goal is always to keep it stable because that's how you keep a solid relationship with your customers long-term for innovation. So in our business -- and SP was probably -- the specialty plastics guys are probably up about 3% in price and then that was offset by some price declines in advance interlayers for a high-value products. We discussed this all back at Innovation Day. When you have these very high-value products and you're in the early phases of adoption, your prices gets your cost structure quite high. And then as you develop scale and volume and growth of that you, you share some of that benefits of scale with your customers and price declines, which is especially typical in the automotive industry where those products go.

So you see that going on, but the volume mix growth is so strong double-digit levels that the earnings grow despite those modest price declines. So in general, that's sort of where it played out. What I'd say is that when you're trying to build a business and have innovation be at the heart of your business. And the markets we serve, we work with the same large customers forever, right, the glass customers or even the tires and coatings customers in the AFP side. You got to have a relationship where they have trust in you and that you're being balanced on how you manage your price versus raws which we do very well. Our spreads are relatively stable, but you can't be greedy, right? So when you have a declining raw material situation, raising prices aggressively at the same time, it creates a significant amount of tension with your customers where they are not as excited about innovating with you and they are certainly very motivated to find alternative suppliers to you if you do that. And in specialty business, you can do that for a short period of time in our kind of businesses, but then you suffer the consequence later on about losing volume 12 months or so later as they work to find alternatives. So we think we have a good balanced relationship with our customers. They understand what we're trying to do. We keep our spread steady, and we drive volume/mix growth and set around innovation.

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Operator [12]

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Our next question today is from Robert Koort from Goldman Sachs.

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Unidentified Analyst [13]

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This is Ragnel filling on for Bob. You're highlighting some sequential earnings improvements through the year, and the 4Q to 1Q improvement was notable. But when you fast-forward to 4Q '19, what kind of year-over-year growth is possible given the easier comp?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [14]

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So great question, and it's an important one to remember when we talk about our back half guidance. With macroeconomic growth occurring, with innovation in our high-value specialties also creating our own growth, we're assuming that '18 -- I mean, '19 is going to be materially better and the fourth quarter is an easy comp, right? So if we can just get back to 2017 levels in Q4, that's $80 million of the hole we have to fill in the first half. And then we look at for both the third and fourth quarter, volume and mix growth being better than '17. So you've got that as a tailwind to help the back half of the year. And you got the cost flow through which will flow through, through the back of the year, especially as you go into the fourth quarter. So I expect the fourth quarter to be very strong compared to the past.

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [15]

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And what I might add on top of it, I'll remind you that roughly $30 million of impact of foreign currency you're expecting in the first half of the year goes away to a greater extent in the second half of the year, so we don't have that headwind overcome any more in both third and fourth quarters.

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [16]

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Right. So you put all that together and the cost reductions, you've got the hole basically being filled in the front half and you've got to just believe in some reasonable volume mix growth and some raw material tailwinds and you can get to our guidance.

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Unidentified Analyst [17]

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Okay. And are you seeing any signs that the specialty plastics destocking has ended? Any indication on volume changes for that for quarter-over-quarter and may be also year-over-year for 2Q?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [18]

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Yes. We've already seen that. So January, in particular February were rough. The destocking in the fourth quarter that continued in those first 2 months was pretty significant. You have to remember that the vast majority of what we sell into China from specialty plastics is made into products that are predominantly exported back to the U.S. and to some extent Europe. So when you get into this trade war issue, a lot of those producers really lost confidence in their ability to sort of export back to the U.S. because they fear the trade tariff is going back to 25%. That's what held them in the fourth quarter last year as well as the uncertainty what would happen on March 1. As things started to sort of stabilize and look like things were to going to get settled to some degree, people starting to getting back to business and we saw a pretty good recovery in Tritan orders, in particular in March, and March was -- as a month pretty strong and those orders are holding up as we go into April. So we feel pretty good about the destocking question when it comes to specialty plastics. And when you combine that with raw materials, finally starting to flow through at a benefit in the second quarter. It leads to a pretty strong second quarter from -- sequentially from the first.

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Operator [19]

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We'll take our next question from Vincent Andrews from Morgan Stanley.

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Vincent Stephen Andrews, Morgan Stanley, Research Division - MD [20]

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Just kind of maybe a little bit of a follow-up on the last one. As it relates to trade and the settlement of the trade dispute, what's your sort of sense from talking to customers about how activity or behavior or buying patterns will improve? It sounds like there's already been some improvement sort of as people sense that a resolution is within sight. So how much of an incremental step up would you anticipate right away post settlement? Or is this something that's going to take a few months or a quarter before we sort of have a real sense of how much of a snap back there's going to be?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [21]

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Vincent, a great question and it's obviously a pretty difficult one to forecast since we're dependent on President Trump settling a trade dispute with President Xi, and the timing of that is unknown or -- and the details of it are unknown. But based on everything we've seen, which is the same stuff you've seen, it seems like they're making good progress and the odds of escalation now are going down. And I'd say that's very well covered here in the press in the U.S. But from what we can tell in China, they're pretty quiet. They're very being very careful about declaring any kind of victory or possible victory with their -- inside their country because they just don't know what's going to happen with President Trump. So there's still a lot of caution and uncertainty in China today. But I'd say, the destocking is mostly playing out and behind us, so you've got the removal of that headwind.

And primary demand is still out there, including exports to some degree, but we really haven't seen any restocking yet that could be material at some point, and we're not banking on much of that in our forecast, so that would be upside. So what we need is a trade settlement to sort of get settled, not escalate and the Chinese government to send the all-clear signal to their companies and their consumers that things are going to get back to normal. You've also got them dumping a ton of stimulus into their economy, which is also, of course, helping improve things right now. We can see some of that benefit. So when we put that altogether, we feel like it is stabilizing. News is getting out that the things are going to be okay in China, but we're not really seeing a dramatic recovery yet, but we're a lot better off than where we were in January and February.

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Vincent Stephen Andrews, Morgan Stanley, Research Division - MD [22]

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Okay. And on adhesives rises competitive activity, has that been sort of made worse by the trade issue and -- or just weak demand? And if that's something that potentially were about to lap or could snap back post resolution?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [23]

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Yes. So far on adhesives, the global underlying market growth rates for adhesives is very strong, it's in your consumables, hygiene applications. And overall, I'd say, it's pretty good. There's no question in China demand has been a bit off, especially in some applications. They are a little bit more consumer discretionary, and that's contributed to some of the pressure in the marketplace. But adhesives is more of a supply-driven issue than it is a demand-driven issue. As we told you in the past, we've had new capacity come in the marketplace in Asia and the growth slowing down a bit doesn't help in that equation. The good news is, this business has very strong underlying market growth rates that will continue, that are really not that discretionary. We got to use the diapers and we got to use them. And so we feel good about observing this capacity that's been added. On top of that, we've got innovation rolling out in the marketplace this year. That is a huge sustainability trend. This market is no order -- preferably no order, no VOC kind of product. We've now launched the best-in-class product for those applications with this sensitivity on the environment out there. And it's expected to grow quite well. We'll get that in the marketplace in the back half of this year towards the end, and that gives us another way to grow out of this business. And the rosin and resin conversions also continues where same environmental trend rosins have a lot of odor and smell, too. Consumers don't want that. And so that's another way we're picking up resin growth to fill up the capacity. We expect second half to be better.

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Operator [24]

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P.J. Juvekar from Citi has our next question.

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P.J. Juvekar, Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD [25]

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I'm looking at ethylene prices. Ethylene prices have collapsed. They're down to what $0.13. And I know you don't sell as much ethylene now with the RGP project. But then looking at propylene, it's also down with propylene inventories close to 6 million barrels. So I guess, my question is if one or more complex remains weak, are you able to get pricing on your derivative products?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [26]

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Yes. Good question. So on the ethylene side, as you just mentioned, we had a considerable headwind in ethylene last year, and the RGP investment we made this year, which is up and running incredibly well and actually performing better than we expected, is taking us a long way in reducing the ethylene we sell this year in the merchant market and that helps mitigate a lot of that headwind, giving us a year-over-year benefit. So that's been great. When it comes to derivatives, you're right to point out that propylene and ethylene don't define the price of a derivative. It's just an indicator of the underlying market conditions. And in a lot of places, prices are holding up well in our derivatives from propylene and ethylene, but there are few places where, Curt called out that, we do see some price pressure, in particular glycols, NPG, MEG and glycol ether sort of places where we're seeing some price pressure creating some spread compression. So that's factored into our guidance. And to some degree, that's what offsets the benefits we've created through RGP and not having the industrial gas outages from last year, those sort of net out those benefits to sort of keep the segment stable this year.

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P.J. Juvekar, Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD [27]

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Okay. And then you added a lot of new capacity in products like Tritan, Crystex and PVB. So if I look at all of them together in aggregate, what sort of ballpark EBITDA do you expect in 2019 from that?

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [28]

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P.J., we don't breakout the EBITDA growth just from distinct projects. What they are really driving is the underlying growth in the markets we serve that we've been providing in our guidance. So like Advanced Materials where we're talking about earlier, again that business is looking to grow EBIT, 7% to 10% EBITDA would be reciprocal to that other than the factors a little different. So overall, those projects are typically greater than cost of capital returns, driving good returns, and there will be one of the factors that long term contribute to our EBITDA growth as a percentage.

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [29]

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I mean, what I'd add is that, the fact that we did all those plants is because our volume growth has been so strong from '15 through '17. We're running out of capacity on all those products last summer, and they started up just in time. And obviously, we didn't predict a trade war impacting demand in the short term. But as those markets come back through this sort of short-term disruption on the macro, the fixed cost leverage of all that's going to be very attractive when that volume from those high-value products come in and as we work through the back half of this year-end and even more so in 2020.

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Operator [30]

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Next we'll go to Aleksey Yefremov from Nomura Instinet.

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Matthew Stephen Skowronski, Nomura Securities Co. Ltd., Research Division - Research Analyst [31]

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It's Matt Skowronski on Aleksey this morning. On the last call, you kind of gave out a Brent crude prediction for the year. It seems to change since then. Can you just tell us how this changes your outlook?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [32]

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It doesn't really have much of an impact on our outlook. We're in sort of the $70 range. We're now, what, $74 before. So I think it's important to remember that oil is part of an indicator of how raw material prices move, but it's not the only indicator. Last year, oil did move up quite a bit, especially as we got into the third quarter, but the spreads above oil also dramatically increased. So if you've looked at something like paraxylene, normal spreads above naphtha are like $300 a ton. You at history, we were well over $700 in the third quarter last year and we're now back to sort of in the $500 range. And even with the oil up, we expect that $500 keep moving its way back to normal because there's a lot of capacity coming along in PX in the back half of this year. So you got to remember that those are indicators, but they're not -- there's a lot more going on in any of these markets. So even if with oil being a bit higher than we expected, a lot of the raw materials that we buy, we don't expect those prices to move up much. And in places where they do, we'll increase prices. We've have demonstrated. We're very disciplined about managing prices. We offset all the raw material increases through the third quarter last year with price increases. And as we look at the price raw trade-off in the specialties, we expect to get back to the second quarter spreads of last year by the second quarter of this year and then that becomes a tailwind as we go to the back half. So we can manage that.

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Matthew Stephen Skowronski, Nomura Securities Co. Ltd., Research Division - Research Analyst [33]

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And then in Fibers, on the last call, you kind of noted it will be the weakest quarter, which it was. How did trends look so far in April? And can you give an outlook on pricing for the remainder of the year?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [34]

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Sure. So on the volume side, as Curt mentioned, we expect volumes for the year to be slightly down with the overall market decline. So what's underneath that assumption is customer buying patterns in this business, as you look at our history, bounce around a lot. So Q1 was just uniquely low customer buying pattern outside of China. In China, this is a trade-related issue where they stop buying tow from us made in the U.S. And we had to start shifting to our Korean facility to import in the U.S. We have orders now from the Korean facility, but we're still in the qualification process with some of the customer plants there. But we feel like we'll get back to sort of where we needed to be on that volume relative to last year as well. So I think we're fine. It's just going to be lumpy in how it spreads out. I mean, second quarter will be a lot better than the first quarter in volume. And price, another good question, prices were down a little bit more in the first quarter versus the rest of the year because some of the price declines we put in place last year didn't go effective until April 1. So you're going to just see a bit more of a drop in Q1 than what you'll see for the rest of the year. On a full year basis, prices won't be down very much at all.

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Operator [35]

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Moving on, we'll hear from Frank Mitsch from Fermium Research.

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Frank Joseph Mitsch, Fermium Research - Senior MD [36]

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Curt, you were talking about the use of that $1.1 billion plus free cash flow, that bolt-ons are part of that equation. How is that market looking to you right now? How should we think about the probabilities or the possibilities of Eastman doing more than just Marlotherm?

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [37]

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Yes. I would say, our bolt-on acquisition pipeline is active. There are several opportunities we're looking at. As always, it's got to make sure you do the right diligence, pay a fair price and hopefully don't find big bid-ask spreads. I'd say right now it's possible. You might see 1 or 2 more small acquisitions during the course of the year, but we'll see how those play out.

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Frank Joseph Mitsch, Fermium Research - Senior MD [38]

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And small -- just for definitional purposes, less than $100 million sort of a ballpark?

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [39]

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Yes. I would say less than $100 million in that ballpark, yes, in aggregate.

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Frank Joseph Mitsch, Fermium Research - Senior MD [40]

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All right. Terrific. And Mark, you did a nice job talking about how March came back in terms of volumes and certainly you're seeing that through the month of April as well. So I'm wondering if you can give some granularity by region on what you're seeing there? And what the expectation is for the second quarter?

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [41]

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Sure. So the biggest hit across all regions when it comes to value was China. It's important to keep in mind that different regions have very different margin profile. So when you look at our specialty businesses, 2/3 of their revenue is outside the U.S. And so when you are in China, we sell very few commodity products in there. It's almost all specialties, variable margins are substantially higher than the U.S. average that includes a lot of CI and a very little of that is exported. So the big volume and what I'm saying is mix hit was China and mostly that was where we also saw the most extreme amount of destocking going on things like Tritan, tires, even a little bit of adhesives and some coatings. And so when we got to March, we saw a good recovery in Tritan. We saw a good recovery in some of our highest value specialties in coatings and tires are still sort of working itself out. So China has been a pretty big -- pretty attractive snapback towards the end of the quarter, and it seems to be holding up so far through April. Europe, it's a little bit late different story. And I would say, Europe is still very much attached to the China trades issue. When the Chinese cut back on imports, it's not just a U.S. impact, it actually has a bigger impact on Germany than it does on us because they are so dependent on exports. So you're seeing that economy slowdown, all connected to the same issue. We're seeing demand recover there as well, but it's more of a lag effect. So a little bit slower in its recovery. And that's why you see AFP having a bit more challenge in recovering its earnings to last year versus AM, which is much more sort of China dependent on where the impact occurred. The U.S. has been sort of stable and moving along just fine.

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Operator [42]

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And up next, we have Mike Sisson from KeyBanc.

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Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [43]

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In terms of Advanced Materials, they're still may be struggling a little bit to see the growth in the second half. I did the math. The EBIT growth -- operating growth needs to be somewhere around 30%. You have -- 3 kind of factors you noted like lower raw materials, volume and may be less FX. Can you may be help us understand what -- are they about even in terms of the recovery for the second half? Or am I missing a couple of other variables that help to grow that?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [44]

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Volume mix is a primary driver, Mike. Obviously, we don't have the currency headwind that we had in the first half of the year. So you don't have that $15 million headwind. That is on AM in the first half of the year, repeating in the second half. So there's that. There's raw material flow tailwind. Of course, with PX, that's going to help as that price comes off relative to a very high price last year. But the biggest driver by far is volume mix. You got to remember that -- what we're saying is we're going to grow volume mix through the back half of this year relative to the first half of this year, which means it's going to be materially better than 2017. And when you look at the drop in earnings in the fourth quarter of '18 due to volume and mix and the higher raw material costs, you're going to fill that entire hole and then add to it with some additional volume and mix, especially when we got all these products like heads-up display, interlayers and performance films growing at double digits. So when we put all the math together, you can get to the guidance we're giving you.

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [45]

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And on that fact, I'll add just 2 comments on top of it. Don't forget that easy comp on the fourth quarter basis -- look at what they did in fourth quarter '17 versus fourth quarter of '18, and we expect that to be growing on top of what we saw back in the fourth quarter of '17. So that is a good fillar. The second thing I'd add is this not only for Advanced Materials but for the corporation as a whole is this benefit of the flow through of lower raw material costs. And so to give you some sense, if you think about just the first quarter, the flow through of lower raw material costs was only a benefit of roughly $10 million, and that is only a small piece. And within that, it was mostly a benefit in the commodities and still a headwind in these specialties. So as these lower raw materials slow the second quarter as well second half of the year, you will see improved EBIT resulting from the flow through lower raws on top of the utilization and the volume/mix growth.

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [46]

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Yes. I also want to emphasis, asset utilization is a big deal, guys. So when you have to slow the plants like we did last year in the fourth quarter to adjust the demand situation and even run them a little bit slow in the first quarter, your asset utilization, your fixed cost per kg goes up in a meaningful way. So as volume picks up, that starts to accelerate how all the cost cuts we're doing can flow into a lower cost per kg and benefit earnings in the back half of the year.

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Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [47]

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Okay. Great. And then a quick follow-up. You spent a lot of time over the years moving your portfolio into more specialty areas. If you look at the the fourth and first quarter results for the specialty businesses, I'm still a little bit surprised the earnings got hit so much. So when you think about the performance that you expect to see and I understand there are much higher-margin businesses, but what's kind of the takeaway you want us to see in terms of supporting the notion that your portfolio is much more special than it was?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [48]

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Yes. So I mean, the growth in the specialties has really been a tremendous success story. If you even just go back and look at history here from '14 to now, we've done a series of acquisitions here. We've delivered a significant amount of innovation, growth on top of that. And we've grown the EBITDA from these 2 segments by over $500 million from 2014, and if you put on our constant-currency basis over $600 million. So this is a great story of delivering a phenomenal amount of earnings growth in the last 5 years, all due to our growth model and our innovation that allows us to sustain our spreads and drive volume, and importantly mix upgrade. And I don't think anything of that story has changed from a long-term point of view as I look forward. No question, we, in our portfolio, have a high exposure to consumer discretionary spend. Transportation, B&C, consumer durables, it's about 45% of the company's total revenue. So if you have a situation where there is a correction and demand in those spaces, and that is clearly what we saw in 4Q, 2Q and for 4Q and 1Q and a little bit still dragging on into 2Q for AFP. When you lose that very high variable margin demand with destocking to correct to the sort of trade economic situation, you're going to take a hit, given the value of those kgs relative to the company average. But the good news is we've already seen demand coming back in March and April. So that demand comes back, the economies improve and that value that we've created over the last 5 years through volume and mix growth comes back in a pretty dramatic fashion on the other side of the equation just like it went away comes back the same way. And so there's sort of sensitivity we have to consumer discretionary. I don't think that's a secret about our portfolio. And the good news is we make a lot of money in China. And I believe long term, China is going to be an attractive growth market to continue to deliver a lot of growth in the future.

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Curtis E. Espeland, Eastman Chemical Company - Executive VP & CFO [49]

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Mike, one other just takeaway as you think about all those long-term benefits that Mark talked about. On a short-term basis, don't forget that these specialties have a long supply chain. And so when you have a disruption like these trade wars, that's where you have some of the negative impact like you see in the fourth quarter and first quarter. Those will return to more normal levels, and we have -- also might have a bounce back at some point as those supply chains fill back in. So just keep in mind, short-term, it's been impacted by those supply chains in those of market dynamics.

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Operator [50]

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Our next question today is from Laurence Alexander from Jefferies.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [51]

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It's Dan Rizzo on for Laurence. I just really just have one question, the softness in auto and tire has been well documented. Can you just tell us what you're seeing in your construction and ag end markets?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [52]

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So on the ag market, obviously, things are a little bit slower with the wet weather in the first quarter, and we saw some of that impact particularly in CI. But everything we can see in those markets are all coming back as we'd expect. So we feel good about the ag market this year on a full year basis, and we're seeing some innovative growth with a few of our customers to help us create our own growth there as well. When it comes to the construction market, it's been relatively stable. So from an architectural interlayers point of view, it has been great. Vast majority of where we're selling the layers is in Europe, where they do laminated glass and we've seen strong growth there through '18 and that's continuing on through '19 and that's pretty visible at the back order that you can see in construction.

On the architectural side, North America has been fine. Obviously, China and Europe have been a bit off, but we're seeing some recovery there.

One other thing I'd mentioned is environmental enforcement does create benefits as well. With this unfortunate accident that's occurred in China, we do see an impact on a few produces that we compete with being shut down for environmental inspections and things like that. That's giving us a modest tailwind. We're not banking on much of that. But if that continues -- that enforcement continues, there will be an upside to our forecast.

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Operator [53]

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Duffy Fischer from Barclays is up next.

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Patrick Duffy Fischer, Barclays Bank PLC, Research Division - Director & Senior Chemical Analyst [54]

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First question just around the raws, again. I know you've got an accounting benefit that will flow through in the back half, but a lot of your suppliers would talk about kind of the same destocking events happening that you are seeing with your products. So if you get that back half pickup in economic activity like you're expecting, what do you think the odds are when you look at all your raw materials and kind of the supply demand that actually prices there will rise fairly rapidly and maybe we're talking about raw material headwinds in the back half of the year?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [55]

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Yes. When we look at the specific products that we buy, Duffy, I don't see there is a significant risk there. I mean, you can always get into oil price scenarios. And if demand driven where oil goes up, then we'll have the demand market conditions to raise prices and we'll be fine. Supply-driven events in oil is a different discussion. But we're not really worried about that with the raws that we buy, especially because the one that was a biggest problem for us in the back half of last year was [paraxylene] (corrected by the company after the call) and there's so much new capacity coming online.

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Patrick Duffy Fischer, Barclays Bank PLC, Research Division - Director & Senior Chemical Analyst [56]

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Fair enough. And then just to jump to Fibers, can you breakout, if you just look at, say, the EBITDA year-over-year kind of they're down $14 million, how much of that was China versus ex China? And then do you think it will be difficult to get your Chinese business back once the deal is settled because, obviously, they are players inside China that have excess capacity they're probably back filling that today. Is that a structural step down do you think? Or will that be pretty quick to come back?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [57]

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Yes. As far as the demand goes in the first quarter, I would say, it's sort of balanced between the China factor and sort of just customer buying patterns across the quarters for this year with another customers. In regards to your second question, there is no competitor in China backfilling us. The -- all the companies -- or the plants that make tow in China are joint ventures with CNTC, our customer. They run those plans flat out every day as best as they possibly can every year, which is why imports dropped when they add that capacity over the last 5 years. So the imports, and we're now down to pretty small levels, are just being shifted around from plants -- to different plants that are not outside of the U.S. But we have a great relationship with our customer there, and they are working with us and we believe we'll get back in.

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Operator [58]

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Moving on, we'll hear from John Roberts from UBS.

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John Ezekiel E. Roberts, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst, Chemicals [59]

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You mentioned the coming paraxylene capacity, I think it's the primary target of some of the new crude to chemical projects coming online globally. So I guess, this could be a multiyear kind of weakness in paraxylene. Do you think structurally you'll end up passing some of that through because the whole polyester, I guess, complex could come under pressure with weaker paraxylene over time here?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [60]

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Yes. So there's a lot of paraxylene coming online. The big chunks in the back half of this year are just traditional PX plants, not the sort of oil or the chemical things. But there will be some passing along with some of that paraxylene value to some of our customers, which is natural and the logic I started with in the beginning of the Q&A session here, I'll reference you back to, which is you got to have a balanced approach to the customers if you want them continuing buy from you and we work with the same customers for the last decade and I hope the next decade. And so we got to have respect and trust and innovation together.

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Operator [61]

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And that will come from Kevin McCarthy from Vertical Research Partners.

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Kevin William McCarthy, Vertical Research Partners, LLC - Partner [62]

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Mark, I had a question for you on interlayers. In your prepared remarks, I think you referenced double-digit growth prospects for Saflex. And you threw out, I believe, 20% in Europe. And so I was just wondering if you could elaborate on what is driving that? The build rates have obviously been tough and my recollection is that Sekisui was adding some capacity in the Netherlands. So perhaps you could elaborate, are you gaining share? Is it penetration mix, heads-up displays, construction, what would be driving that premium?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [63]

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Yes. So specifically, that 20% applies to heads-up display interlayers in Europe, not the overall interlayer business. So what you're doing is you're replacing standard interlayers with one that includes acoustics and heads-up display. And we're the world leader in that specific product, but it's a very small percentage of the overall market right now. There's not that many heads-up displays in cars yet. So we're seeing just tremendous growth as we're adding that feature because auto OEMs are always looking us a way to value up cars, especially in the slow growth markets. They want more feature packages to offer -- to get more volume per car, which is a great lever for us in the different kind of features we had. So that's going quite well. And I'd also add, the architectural is also growing really well in Europe as well. So that gives us a way to offset the underlying auto market trends. It's very impressive that performance films and interlayers is stable in this auto market.

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Kevin William McCarthy, Vertical Research Partners, LLC - Partner [64]

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So Mark, how would you characterize the all-in structural growth rate in the interlayers business, I don't know, over the next 3-plus years or so?

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Mark J. Costa, Eastman Chemical Company - Chairman & CEO [65]

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Well, I think that again volume mix, we continue to expect that the Advanced Materials segment, including [specialty plastics] (corrected by the company after the call), will grow sort of double the underlying market growth rates. So any one guess on what the automotive growth rate is going to be, but we're real better in there.

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Gregory A. Riddle, Eastman Chemical Company - VP of IR & Communications [66]

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All right. Thanks, again, everyone for joining us this morning. A replay of this call will be available on the website later today. And hope you all have a great day.

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Operator [67]

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And that does conclude our conference today. Thank you for your participation. You may now disconnect.