Good day, everyone, and welcome to the Eastman Chemical Company Second Quarter 2019 Conference Call. This call is being broadcast live on the Eastman's website, www.eastman.com. As a reminder, today's conference is being recorded. We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company, Investor Relations.
Please go ahead, sir.
Okay. Thank you, Ebony, and good morning, everyone, and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO. Curt Vespalon, Executive Vice President and CFO and Jake LaRoux, 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 second quarter 2019 financial results news release, 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, the Form 10 Q for first quarter 2019, and the Form 10 Q to be filed for second quarter 2019. 2nd, earnings referenced in this presentation exclude certain non core and unusual items and interim period earnings using adjusted forecasted tax rate 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 second 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 non core unusual or non recurring items.
With that, I'll turn the
call over to Mark. Thanks, Greg, and good morning, everyone. I'll begin on Page 3. I'll start with our strategic highlights from the second quarter. We continued on our path of solid, sequential earnings growth after a challenging fourth quarter of 2008 and start to this year.
Adjusted EBIT increased 11% sequentially in the face continued global uncertainty and weak underlying demand in many of our end markets. From our perspective, the uncertainty around trade began in the fourth quarter of last year and was escalated in May and has resulted in a challenging global macroeconomic environment, which we're continuing to work through. Despite these challenges, we're still on track for greater than $400,000,000 in new business revenue closes from innovation in 2019. With a 27% growth in the second quarter year over year.
I've been on the road
globally with many of our customers recently, and their focus and strong engagement with us on innovation has never been higher, especially on sustainability, which is encouraging in this environment. Leading the charge and innovation of market development is Advanced Materials, which posted excellent sequential growth in the 2nd quarter. The sequential growth was delivered by Specialty Plastics led by Triton. We also offset the underlying decline in the auto market with strong growth in premium products like our paint protection film, premium auto interlayers, as well as strong growth in architectural interlayers. These prox among others show the resiliency of our innovation models initiatives and as in functional products with commercial orders confirming the value in what we do.
That said, we're in a much earlier stage of development in AFP than in AM. As we've discussed before, we're aggressively managing costs in this challenging business environment. Overall, we're reducing costs by $120,000,000, that includes $80,000,000 in offsets of inflation. In addition, in this environment, we have another $40,000,000 in cost actions that we took in April that will mostly impact second half of the year, which were on track to deliver. Consistent with our strategy, we remain disciplined on capital deployment, we recently completed a small bolt on acquisition of Inoxa.
A Spanish cellulistic yarn company that will accelerate the growth of our tech sales innovation products like Naya. We're excited to have the NOxad team part of Eastman and the integration is off to a great start. Lastly, we returned $423,000,000 to stockholders in the 1st 6 months of 2019. Through a combination of share repurchases and an increasing dividend. This includes $125,000,000 of share repurchases in the 2nd quarter.
Before I turn over to Kurt for a review of the corporate and segment performance in the quarter, I'd like to add how proud I am of our employees around the world continue to execute our strategy while also aggressively managing costs in this challenging environment.
Kirk? Thanks, Mark, and good morning, everyone. I'll start on Slide 4 with a review of our corporate results. And I'll begin with the sequential comparison, where our 2nd quarter revenue declined slightly and adjusted EBIT increased 11%. The increase in earnings was driven by a strong sequential volume and mix growth in Advanced Materials.
And continued cost management across the company. On a corporate basis, EBIT increased 170 basis points sequentially, with the margin increase Turning next to the year over year comparison, revenue and earnings decreased as macroeconomic uncertainty and the slower demand in some of our key end markets in China and Europe, both of which we believe are primarily related to global trade issues, negatively impacted volume and mix. The decrease was also attributed Before I get to the segments, I'll give you our macroeconomic assumptions for the remainder of the year, which have changed. We are now expecting current challenging global market conditions to continue driven by uncertainty around trade issues. And just to be clear, we are not expecting underlying macroeconomic conditions to improve or deteriorate from what we experienced in the second quarter.
We do believe that inventory destocking is mostly behind us and therefore our specialty volumes will grow, but will be modestly offset by higher shutdown schedule in second half of twenty nineteen impacting volumes and chemical intermediates. And we are expecting oil prices and the related raw materials to remain around current levels, which will benefit via benefit to 2nd half as we as those lower costs flow through inventory. Turning now to Slide 5 in Advanced Materials, where significant progress on innovation and market development is positioning us to be resilient despite the challenging global economy. Starting with the sequential comparison, volume and mix increased 7% due to an easing of customer destocking, particularly with specialty plastic product lines such as Triton, and continued great progress on innovation and market development. Adjusted EBIT increased 42% sequentially, roughly 2 thirds of the increase, driven by improved volume and mix, and the remainder from a combination of improved spreads as lower cost paraxylene is beginning to flow through and cost management.
And the EBIT margin increased 5.30 basis points sequentially given these factors plus improved fixed cost leverage. Turning to the year over year comparison, revenue declined due to lower sales volume in the stronger dollar. While we had strong volume growth sequentially as destocking slowed, We still haven't reached our One market in particular that has been under pressure is transportation, which represents about a third of the revenue for this segment. Despite this exposure, EBIT increased as improved mix due to strong growth of premium products, including paint protection film and acoustic and architectural interlayers more than offset the lower volume and the impact of the stronger dollar. Advancement areas also did a nice job holding on to prices and managing their costs.
The EBIT margin year over year was up 110 basis points. Looking ahead, we expect our earnings in the second half of the year to be higher than the first half for a few reasons. First, lower cost raw materials are set to flow through in the back half of the year, 2nd, while we don't project underlying demand fundamentals to improve in the second half of the year, destocking looks like it is mostly behind us and is therefore no longer expected to be a headwind. And third, we expect to realize lower costs from the actions we have taken. When we put it which would be an outstanding results in this Adjusted EBIT was a solid at $147,000,000, relatively flat from the first quarter as we saw stability and volume mix with a modest decline in prices, prices offset by cost actions.
Year over year revenue declined due to lower volume and mix as well as lower selling prices and an unfavorable currency. Volume growth in Care Chemicals And Architectural Coatings was more than offset by declines in adhesives and tires and some consumer discretionary markets. In particular, China and Europe has slowed due to the anxiety caused by global trade issues, particularly the U. S.-China dispute. At the same time, we believe destocking that began in the fourth quarter continued through the second quarter.
As we look forward, we believe that destocking should mostly be behind us so volume should improve in second half of twenty nineteen. Mix was unfavorable primarily due to lower sales of high value celluloseic additives into the auto OEM markets in China and Europe compared to the prior year, which Quadancia was a tough comp. Pricing was somewhat lower with the largest contributor being cost pass through contracts in Care Chemicals and a few other products, with the remainder due to competitive rivalry in Adhesives and tire additives. And the impact of swine fever in China increased competitive rivalry in the animal nutrition business in the 2nd quarter. EBIT declined year over year due to the lower volume and mix as well as the stronger dollar, partially offset by continued cost management.
Spreads were similar to last year as lower raw material costs were offset by price declines. With spreads stable, the entirety of the margin decline in AFP is due to lower asset utilization related to sluggish demand. Looking forward, given our economic assumptions, we expect EBIT in the second half of the year to increase slightly versus the first half due to higher volume as we believe the destocking is mostly behind us. On Slide 7, I'll move to Chemical Intermediates. Year over year revenue decreased primarily due to lower selling prices for both olefins and acetyl products, resulting from raw material price declines and increased competitive activity.
As the trade dispute continues to drag out, competitors in China are getting increasingly aggressive and are starting to In addition, sales revenue was impacted by lower functional meats product sales volume attributed to weakened demand in agricultural end markets, due in part to wet weather in North America. EBIT decreased slightly as lower spreads were mostly offset by lower costs. These lower costs included the supplier operational disruptions in the second quarter of 2018 not recurring this year. Lower planned maintenance costs in the quarter and continued cost management. Looking to the back half of the year, we are seeing spreads in acetyls and glycol stabilizing at 2nd quarter levels, and we expect to carry this run rate into the remainder of the year.
And consistent with our corporate guidance, we are not projecting an improvement in underlying demand in the back half. The stabilized but lower spreads coupled with higher shutdown schedule in the second half of the year compared to the first, led us to expect that EBIT in the second half will be lower than the first half. Finishing up the segment reviews on Slide 8 with Fibers. Starting with the sequential comparison, sales revenue was flat while adjusted EBIT increased $9,000,000 or 21 percent. The sequential increase was due primarily to cost management and slightly higher tool sales.
And I'd add that the EBIT margin increased 4 20 basis points sequentially to 24%. Year over year sales revenue decreased primarily due to lower acetate tow sales volume attributed to weaker weakened market demand resulting from global trade related pressures and general market was unusually high in the first half of the year due to trade issues and multinational customers buying patterns. EBIT decreased due to lower acetate tow sales volume, partially offset by lower raw material costs and continued cost management. As we move into the second half of the year, we expect earnings improvement compared to the first half for a few reasons. First, we continue to make progress qualifying tow at our Korean facility With CMTC and as a result, we expect improved Chinese demand for the remainder of the year.
2nd, the overall textile market was soft in the first half due to general macro uncertainty resulting in destocking for some of the traditional end market applications. We see signs that the dynamic is improving in the second and will continue to benefit from greater than 25% growth in our Textiles innovation initiatives. And finally, we continue to aggressively manage costs in this business. Putting it all together, including the promised improvement in the second half, we expect fiber's adjusted EBIT to be in the $200,000,000 to $200,000,000 range for full year of 2019. Finally, on Slide 9, I'll cover some financial highlights.
First of all, let me just correct the EBIT for fibers will be the $200,000,000 to $210,000,000 range. Thank you. Finally, on Slide 9, I'll cover some financial highlights. We plan to continue our track record of solid free cash flow conversion and expect to generate free cash flow approaching 1,100,000,000 in 20.19. Despite lower projected net income, we remain confident in our ability to generate solid free cash flow through a variety of levers, including aggressive working capital management.
Consistent with our capital deployment, $3,000,000 to stockholders in the 1st 6 months of 2019. We are excited about the value creation from our recent 2 bolt on acquisitions. 1st in the first quarter and the last one that Mark mentioned here in July and continue to look forward to value creating opportunities. Consistent with previous expectations, we'll de lever as needed to keep our solid investment grade credit rating, likely in the 250 to $300,000,000 range this year. For corporate other, consistent with the run rate in the first half, we expect the full year to be around $60,000,000.
And finally, we continue to expect our full year projected tax rate to be between 16% 17%. And with that, I'll turn it back to Mark.
Thanks, Kurt. On Slide 10, I'll provide an update on our 2019 outlook. In the first half of the year, we've been challenged by a weak macroeconomic environment, which began the fourth quarter of 2018. We believe it's primarily caused by global trade tensions, including the U. S.
And China trade dispute. Dispute was escalated in May and there are no signs of when it will be resolved. The impact has been significant destocking in cry supply chains as well as reduced demand, and we've seen this most prominently in China and Europe. In particular, we have seen a meaningful impact on consumer discretionary markets like autos and consumer durables, especially in China and Europe. We've also seen challenges in ag and animal nutrition in markets with weather in the swine flu in China.
This is all much different than what we'd in our last call in April, and I would add this dynamic environment has made order patterns more volatile and the outlook for global demand more opaque. We expect the lower volume will continue to negatively impact fixed cost leverage in the back half of the year. With that said, we're taking actions on what we can control to offset the impact of this environment. Continue to make significant progress driving growth in our new business, revenue closes from innovation as we leverage our innovation driven growth model. You're seeing how this works with the first half results of Advanced Materials and our expectations for the year in this business, which reflect a strong contribution for new business revenue close innovation to offset weakness in key end markets like autos.
And I'm confident you'll see accelerating new business revenue growth in AFP that will add to their resiliency as we scale up their innovation in the future. In addition, we're aggressively managing costs in this business environment by taking out $120,000,000 of cost to deliver a net $40,000,000 reduction in costs. Finally, we're expecting lower cost raw materials to flow through into our results in the second half. Improving spreads over last year in the specialty businesses. As we think about Q3, we have an unusually high shutdown schedule, potential for a limited amount of additional destocking, and we can all recognize the exceptionally uncertain environment we live in today.
So expect Q3 will be similar to Q2 and EPS, and you will not see the normal drop in Q4. When I put this all together, we expect our full year adjusted EPS to be in the range of $7.50 to $8 a share. And this includes a headwind of about $0.50 a share from currency and pension. On cash we expect our free cash Given the challenges we're facing, I view these as solid results and again a testament to the resiliency of our business model and the execution of our team. Since robustness, it gives me confidence in our future.
Despite the exceptionally challenging environment, we're well positioned for long term attractive earnings growth in of our stakeholders. Our results demonstrate that our innovation driven growth model is delivering, as we create our own growth through innovation and leadership in specialty markets. We continue to win with customers every day. And as I saw in my travels around the world, recently, we have unparalleled engagement levels with our customers innovate, a hallmark of what differentiates us. Focus on what we can control is working as we continue to reduce our costs to accelerate top line growth to the bottom line.
And most important, we have the dedication drive of people of Eastman who rise the challenge every day and prove that they won't win no matter what the headwinds are. They're the figured out team and the reason we're winning with so many customers today. In the end, it's our collective determination and the face of challenges that make me so confident in our future. With that, I'll turn it over to Greg.
Thank you, Mark. There are a lot of people on the line as usual this morning, and we'd like to get to as many questions as possible So I ask you to please limit yourself to one question and one follow-up.
Thank We'll take our first question from Vincent Andrews with Morgan Stanley. Please go ahead.
Thank you. Good morning, everyone. I guess my question is just, as we exit 2019 and if we assume there's some trade resolution, hypothetically for the start of 2020, should we envision a snapback in earnings, sort of 19s a throwaway year and 20 goes back to the trend rate you were on before then? Or should we think about 2019 being a new base off of which there'll be some level of growth in 2020?
So first of all, I think it's a little hard to predict 2020 at this point. But, to answer your question, the challenges that we have predominantly this year, 4th quarter last year as well as this year are a volume mix based story And it's important to emphasize the mix part of this too, because a lot of the consumer discretionary marks that we sell to are very high value additives. So if the trade war gets resolved or stimulus in China works despite a neutral trade situation, it starts getting the business confidence and China confidence back up that drives China growth back into gear, which also will prove European economy as well in a substantial way, you would get a snapback. You'll get not just volume recovery, primary demand, but restocking association associated people going back to more normal inventory levels compared to where they are now, which is exceptionally low. And that it's a mere image.
The earnings on the volumemix side come back the same way they had dropped this year. So you would get a very good recovery on that front. On the volumemix side. We obviously have taken cost out and so you get the fixed cost leverage that comes with that as well as you go into next year. On spreads, though, I would assume spreads stay relatively neutral, because in a recovering economy, raws will go up, we'll keep will increase prices to keep up with raws like we did last year.
So it'll still be a volume mix story just on the other side.
Okay. And Kurt, if I could just ask you on the cash flow. Obviously very strong performance here to date despite the earnings challenges. When you talk about improved working capital performance, we be thinking that the work you're doing this year is going to lead to sustainably different or better working capital ratios that we can build into next year or is this these just extraordinary efforts you're making this year given the challenging macro circumstances? Thanks, Vince.
What you see right now is our free cash flow been kind of running similar to last year. And again, we got a lot of talented people helping us manage cash flow across the company. What I'd say is on the working capital side, it will be aggressive. Normally, we'd see working capital relief, excuse me, second half of the year. In addition, you're getting some benefits of the flow through of lower raw material value.
So that's helping. And then we are taking some additional steps to address our working capital across different fronts, multiple fronts, quite honestly. And so yes, I would expect that to improve some of our working capital statistics. I would say that's not an improvement this year. I think it's a multiyear effort as well that will help contribute to, again, a wonderful free cash flow story with our business, which following up on Mark's other question, we'd also expect our free cash flow to improve in that kind of environment as well.
And so, flow of this company that reflects the quality of our businesses and free cash flow is coming to you for those that decide
to lower our stock at
a free cash flow yield approaching 10%.
Yes, I would just add on that, on the Kurt's comment on the 2020, not only do you get the earnings back, when the demand recovers and the cash comes with it, you also pull inventory down in that environment. So it could be quite strong.
Thanks very much.
We'll take our next question from Jeff Zekauskas with JP Morgan. Please go ahead.
Thanks very much. Your sales were down in the United States. In the second quarter year over year. Why was that? What's shrinking in the U.
S. And what's growing?
Sure, Jeff. The principal driver of the drop in revenue in the U. S. Is price in chemical intermediates. So you have to remember that unlike many other companies out there, the predominance of our chemical and abuse business is located in North America.
So the vast majority of that revenue and the price decline is reflected there. So we don't the good news is we also don't face the much more competitive dynamics, in Asia or Europe for those kind of products where the prices are even much lower than where we are today. So that's part of the story. And then demand's just a bit off with some destocking and careful behavior like as well as things like the wet weather and ag that's driven that revenue down with the planting season being curtailed.
Okay. And And secondly, perhaps I missed it in your discussion. So far, fiber's demand this year is down 11% roughly in volume terms. What's behind that? And was that your outlook at the beginning of the year?
The outlook was for the first half to be challenged on volume relative to the second half. So that was our outlook. This is playing out as we expected. It's really about, timing of orders in two fronts, Jeff. So on the customer buying patterns with the big multi mills.
2018 first half was just exceptionally high relative to second half of last year. There just tends to be chunkiness in how they order and that's what was the pattern last year. And then on top of that, you had some trade related issues as well that drove some pre buy in Q2 not in China, but in some other countries worried about trade that pre bought around trade uncertainty. And then you had, of course, good orders in shine in the first half of the year, for tow imports that dropped, pretty significant as we went into the second half. So it's all a timing issue.
So what you'll see is we had these 2, the first half drop and then the second half will be some improvement over last year.
Our next question will come from David Begleiter with Deutsche Bank. Please go ahead.
Thank you. Mark, in ASMP, given the challenge results first half of the year and a full year. Any concerns that this business may not be as special as perhaps you thought it might be?
I was, I was guessing that question might come this morning. No, I'm not concerned about the specialty nature of this business. Let's just start off with the fact that in Q2, which is obviously a challenging quarter for us. We had 25% EBITDA margins, which I think demonstrate very high quality earnings. But much more importantly, you got to decompose this story into its its components, to really understand what's going on.
So First of all, the price side of the equation, which I think is the bigger test than the volume question, around the specialty nature of business. I think we're actually doing quite well on managing price here. So when you look at a price decline of 3%. Half of that, as we told you, is cost pass through contracts, predominantly in Care Chemicals and then a few other products. So the spreads are absolutely stable.
And we're driving good volume growth in those product areas, but there's so much volatility in the raws on those specific products. We neutralize that volatility with the CPT. The other half is competitive pressures. We're talking about a 1.5% decline here. Year over year due to some competitive factors.
And in that, there's really sort of three stories, but the underlying story is the same at a high level in all three. So you've got some pressure in so it will sulfur and tires, you have some pressure, in adhesive resins and a few animal nutrition products. And if you look at the last decade, we've always had tremendous growth in China, leading the world, in growth. And as as you look at these product areas, we're running out of capacity in all of them. And because demand was so strong globally, that we added capacity serve growth in these areas and our competitors did too.
So you suddenly have this capacity being added in the last year to support growth because the markets were tight. At the same time, for the first time in the last decade, we've had a big drop in demand in China. So you have a competitive situation. But the good news about all three of those things is there's strong underlying growth. There's a long term belief that China is going to grow as a market.
Beyond what's going on here in the short term. And importantly, and key to our strategy unlike our competitors in these specific areas, is that we have innovation strategies to extend and add more differentiation and growth to these businesses. So in all three, we've launched a new Kristex CurePro product that demonstrates far superior mixing efficiency to our competitors. Product trials going on everywhere, getting orders, but it's early. Same thing in adhesives, very strong underlying market growth in hygiene and other products that will absorb the capacity over time but a hit in packaging tapes labels right now creating some demand space.
But more importantly, we're adding a new no odor, no volatile organic product that is a significant differentiator that has very high demand that will be online by the end of this year. Same thing in our nutrition, we're moving from just selling the organic acids into to formulate our products and have tremendous growth there. So while the timing is not great, if this had happened, this trade war had happened 2 years from now into the future, it'd look more like AM. These products would all be a market having a lot more traction helping offset some of the underlying demand problem. So net spreads are flat.
We don't have spread compression in this segment. It's, but some of the raw material tailwind has been offset by some of these prices. The key here is the volume mix story. And as Kurt mentioned, the volume parts, the unit volumes that are coming off, principally because of demand, then you've got the mix story, with cellulosic additives and a few other high margin additives. So it's a volume mix story some negative fixed cost leverage that comes with that.
And the and that's the entirety of the margin percentage story. So we don't think this is commoditizing.
Very helpful. And Kirk, just on the shutdown costs in Q3, could you quantify those versus Q2?
Yes. What I'd say, just in general, on shutdown costs as a whole, they're only a modestly higher year over year, but the trend of the shutdown costs are different. Where the last couple of years, we've had higher shutdown costs in second quarter 4th quarter. This year, it's more going to be in third quarter 4th quarter. So that sequential year over year impact on third quarter is going to be just over $30,000,000 higher shutdown quarter costs third quarter of this year compared to 3rd quarter of last year.
Now what that means is you won't have last couple of years, you'd had more headwind from 3rd quarter going into 4th quarter where this year the shutdown costs will be roughly the same third quarter 4th quarter. Thank you.
We'll take our next question from Alexei Yefremov with Nomura Instinet.
Thank you. Good morning, everyone. Entire Additives market, could you describe what's happening with demand there? And also, could you tell us whether pricing continues to come down or has stabilized after the recent declines?
So, on the demand side, this is actually predates the trump initiated China U. S. Trade dispute. There was a number of anti dumping duties put in place by Europe and the U. S.
On truck tires that dramatically constrained where the Chinese tire producers could sell their products backing up a lot of that production into China. Help the multinationals and we've benefited from that in North American Europe. But obviously, China is a huge, tire production market and that got very competitive when those companies didn't have any market access. And the market had been growing really fast. So not only did tire companies add a lot of capacity to support this growth that they were expecting that did not materialize.
We have some, competitors who are also adding capacity.
To serve that growth.
So, I mean, that really is a story on the demand side. And overall market's obviously down. The truck tire market is off with lower commercial activity. The OEM production market is off, but it's important to remember that 75% of tires are replacement, as opposed to, new production, but it's still connected to commercial activity. And we are highly levered to commercial activity in our product that we sell our largest solar sulfur.
So when that comes off, you're going to feel that demand hit. On the price side, I think prices have come off due to that competitive dynamics we've described. And it appears to have stabilized in the second quarter from what we can see demand is going to improve as we work through destocking as we go in the back half of the year.
Thank you. And as a follow-up on amines, you mentioned a few challenges with demand, how is your inventory in the means and how is the inventory across the industry?
Well, the I can't speak to the industry. I would say, what you have across many of our businesses, whether it's a means or others We kind of that are production planning for an improvement for the second half of the year versus the first. And so now we're just adjusting operating rates where some areas weren't as strong, including the means where he didn't have that seasonal improvement in demand as much as we had hoped given the weather. But we're managing our inventory and operations as we adjust to demand as we do Crestall our portfolio. Thank you.
Moving next to Duffy Fischer with Barclays. Please go ahead.
First question is just around the cost cutting program. You had the net $40,000,000 in kind of before things got worse than you expected. Should we expect another major program in the
So as we look at our cost structure, obviously, we saw some uncertainty in the macroeconomic environment you know, back in April, we took additional actions to cut costs, and $40,000,000 is on top of the $80,000,000, inflation is a pretty aggressive program. We don't think there's another step of additional costs that we're going to take in this current economic environment. You know, that's substantial. I mean, we're obviously going to manage cost aggressively wherever we can. But, we have a tremendous amount of growth where we have an innovation.
We are have tremendous engagement customers that we have to serve we have to maintain and run our plants reliably in this environment. And I think we're getting to that point. And we have one of the lowest costs of SG And R&D as a percentage of sales in the industry for the kind of innovation we're doing. We're in the bottom quartile. So I think we've always run our company very efficiently.
Now obviously if we go into a bigger, more significant drop in demand, due to a global recession kind of environment, we will have additional actions we can take and cut in costs because we have a good amount of variable cost in our large integrated plants and how we run them with over time and, and contractors.
Thank you. And then just on your commentary that Q3 looks like Q2, so right at $2 a share. And then to get to the midpoint of your annual guidance that'd be about $2 a share then in the fourth quarter, which is up almost 45% year on year. Can you either walk from Q3 into Q4, how you keep things flat or Q4 over Q4, how you would improve at 40%. Why does fourth quarter look so much different than it has historically?
Yes. So it first starts with why is Q3 so different? And then I think it's easier to talk about Q4. So in Q3, We do accept expect improvement to be sequentially strong, from Q2 to Q3, but it's been offset to due to the higher shutdown schedule, normally a high shutdowns in Q2 and Q4. This year is just different we have our largest cracker that we're taking down and a bunch of other shutdowns that we're doing in Q3.
So you've got this headwind from Q2 to Q3 and on a year over year based as Curt noted, about $30,000,000 difference versus last year in Q3, due to that shutdown schedule. Now we're taking overall cost down, just to be clear, it's just timing issue about when costs show up, and you have these period costs with a shutdown in Q3. So as you go to Q4, you would normally have this headwind, it was roughly $30,000,000 last year from Q3 to Q4 that knocks earnings down sequentially Q3 to Q4. You're not going to have that this year. So that's part of the explanation.
You don't have that headwind. 2nd, Q4, I think, is not going to be your typical Q4. You've got innovation market development that's continuing to drive growth and create growth, which is great, that will help, have volume be better. You know, companies that already destocked to some degree, there will still be volume lower in Q4 versus Q3 due to seasonal patterns. But probably not as much destocking as normal.
You've got costs flowing through on raw materials. And because volume isn't as been as strong, taking longer for that to flow through, but it will certainly start showing up in Q4 as we look at it, as well as the manufacturing cost reductions flowing through. And we're a LIFO counting shop to keep in mind. So you have all these dynamics playing on that allowed Q4 to be quite good. And if you're comparing it specifically to last year, You got to remember that last year, it was a really easy comp.
It was extremely not only did you have the $3,000,000 headwind and shutdowns Q3 to Q4 last year, we had dramatic reduction in plant rates to adjust the destocking and volume drops last year and high cost raws flow through last year versus this year of low cost raws flowing through. So all that combines together to give us confidence about how we're guiding.
And if I could just add the sequential impact of those shutdown impacts, the quarter 3rd is roughly $20,000,000 compared to that 30 year over year period comment.
Great. Thank you guys.
We'll take our next call from Jim Sheehan with SunTrust. Please go ahead.
Good morning. Thanks for taking my question. So longer term, I think you planned for innovation led, the innovation led business model to lift your gross margins higher than they are today, where are your gross margins per unit tracking? And how do you plan to improve that metric over the next 12 months?
Well, you can see we at our innovation day, we talked about a growing EBITDA margin. We're probably a couple of percentage points below that. Part of that's going to be that volume mix because we're not getting all the specialty of business sales, we'd premise backed at our Innovation Day and that's just because of the macroeconomic environment. So I still believe we can get back to those margins that we talked about at our Innovation Day across the portfolio. Part of that is, again, getting those specialty sales back to where we think they're going to be, and that was one of the earlier comments today, getting competing back to what a robust economy would support.
And then on top of it is to fix cost leverage you get across the portfolio. Because with Mark, we've added some areas of new capacity. We have room to grow into those and then just we have an environment where it's kind of sluggish. But once we get back on track in those specialty areas, you're going to love the free free, the fixed cost leverage we're going to get in both Advanced Materials and Additives of Functional Products.
Yes, I just want to add mixes, an incredibly powerful tool in the center and heart of our strategy. So as we're growing high margin products, through innovation, in above segment and company average in AM and AFP, you just get a powerful lift in your margin, and you see that and how AM recovered from Q1 to Q2, and how it's going to deliver earnings growth for the full year. But unfortunately, if you have a demand contraction, like AFP has right now, you're going to feel that mix hit. I mean, and really in Q2, it was really substantial The sales added additives that we sell and a few of these other additives that go into automotive market are very high value. And so we really felt that mix hit to this year.
And last year, Kirk mentioned there was a tough comp. The last year, it wasn't just demand that was good. We also had some pre buy associated with sort of trade fear in China and some restocking with the coal gas event in Q2. So It was really tough comp for that specific area in inside AFP, versus last year.
Great. And then adhesive resins, you've been talking about competitive pressure in that market for quite some time. When do you expect to see some easing in the general market conditions? And also, when do you expect your low VOC product to start gaining traction and we start seeing better numbers in that business?
So I think 2019 is the year where things are bottoming out. It's a little hard to call the quarter on it, but prices have stabilized The demand situation is great in hygiene, which continues to drive growth and absorb capacity. But a few of the other markets that are more packaging, tapes labels, things like that is obviously more caught up in the macro environment and demands off. Will obviously, I think stabilizing it better as we move forward. So I think that it's playing out this year.
When it comes to the innovation products, There are 2 sets of innovation products directly in resins. We have this, you know, load or lowvolatile product that has been verified by our customers to be the best in the market. We're getting all the trials going on now. The plants being modified, to be able to make it The good news is just a modification of existing asset. We don't have to build a new plant.
So we'll be online selling that product. Next year and that will really help. We also have great success in polyolefins. So we make some amorphous polyolefins for this market. Having great growth, and that's a new area for us that we haven't been in.
And we're really getting a lot of adoption on some new products there that dramatically improve the hot melt adhesives for hygiene and some other applications. So several avenues of growth to stabilize and grow that business while we work through this new capacity in the market.
We'll take our next question from PJ Juvekar with Citi. Please go ahead.
Yes. Hi. Good morning. So you mentioned that due to the weakness in China, producers there are getting more aggressive and placing product in Europe. Can you talk about what products or what chains is this occurring in?
Is that a long term do you see or is this something near term short term because of weakness in China?
So the example I think would be adhesives where you see some of that capacity in Asia getting placed, in Europe that was intended to support growth in China. So that would be an example, animal nutrition would be the other example where you have a bunch of capacity that was added in China to serve animal nutrition. I mean, with the swine population being decimated in China, people are looking for another home for that. None of the none of these actually create long term concern for us, P. J, because obviously, the Chinese have to eat.
And so they're going to grow more pigs and absorb that capacity again. Same thing is true about hygiene growth and everything else in adhesives. As that demand recovers, it'll start absorbing it back into China. That applies to the rest of the story. We've just ever been through the industry has never been through a story where China is the problem and they've been the source of growth to absorb capacity being added in it in Asia as well as other markets and now they're not.
Just creates a different dynamic.
Okay, fair enough. Thank you. And then a quick question for Kurt. Curt, you talked about doing bolt on M and A like you did in the first half. Has there been any change in valuations of deals you're looking at given the downturn?
And would you say that would you look at deals more abroad given you're more of a heavy footprint in the U. S? Thank you.
Yes, thanks for the question. We're excited about, again, the bolt ons we've completed so far this year, good businesses, great people, nice synergies, all the things we look for in acquisitions. We continue to have an active pipeline. I wouldn't say our activity is increasing because multiples coming down because we've always been a disciplined party. Maybe it is a contributing factor.
We're able to get deals done more. But the businesses we've been talking to had reasonable valuation expectations. And so, to the extent the market is more conducive to reasonable multiples, will continue to increase our activity. When I think about the rest of this year, just to kind of level set that, we'll continue to be active I mentioned some amount of acquisitions we can do roughly $100,000,000 this year. It's possible, but right now we have nothing imminent in our portfolio.
On acquisitions, but we're still working actively working our pipeline. And we'll continue to be disciplined as you've seen over the years with our acquisition strategy. Thank you.
We'll take our next question from Frank Mitsch with Varian Research. Please go ahead.
Hi, good morning folks. Eastman started to see a return in rush orders in the May early June timeframe, which kind of indicated that business was getting a bit better and there was no inventory at the customer levels and EPS growth for 2019 was very much still on the table. So I'm curious, what what have you specifically seen since the mid June, till today timeframe to, to take, any EPS growth off the table?
Sure, Frank. Yes, it's obviously been a pretty dynamic time in predicting demand and orders has been tricky for a while now. In the second quarter, we were on track through the 1st week of June. With demand, the trends we saw that we thought were in the range that we gave you in April. And then in the last 2 weeks of June, we just saw dramatic slowdown in the relative to what should have been a normal order pattern in June leading up to the G20 meeting.
So from what I can figure out, people got very nervous about what's going to happen in that meeting and they all decided to start managing inventory down and reducing their orders given that risk. And we actually saw the exact same thing in the last 2 weeks of February headed up to the March 1 deadline when people were worried about the U. S. Tariff. So I think there is this sort of push pull kind of thing around economic uncertainty that's driving some behavior.
And so that was part of it. There's no question that we saw. There was more risk on the table after the May escalation in the trade war. And that risk, as we got through G20, got confirmed, that there was no end in sight about this trade war now at a higher level of tariffs and more disagreement than less, certainly from where we you saw the world in April on how this was going to get settled. So as you looked at that, we had to step back and revise our assumptions.
I think everyone in April thought and through the beginning of May at least, that the economy was going to get better in the back half of the year. Trade war was going to sort of settle, certainly not escalate And now we're in just a very different world where I don't think that's true. And I think many of our peers and other people in the macro data support that there's not a lot of signs of economic recovery coming in the second half. So we had to revise our assumption down on that. And it's not just about China.
When you think about that, Europe is highly dependent on trade to China. And there's other factors obviously going on in Europe. So that economy has slowed down. That's led to a lot of destocking and expectation of lower demand. Automotive and other consumer discretionary markets taking the primary hit as people are cautious.
I mean, reality is if you look at the last three quarters, You can say we're in an industrial recession now. Industrial production is down. Even in AFP, as I look at the demand story there, 3rd of its mix and the other part being unit volume. We're not really losing much share. Maybe 1% of that 8 is about share loss in these competitive stories I was just telling, demand is down.
Even in AFP, if you look at all of our peers who are industrial exposed, we're in a negative demand situation. So that environment we now have to adjust to. And we thought it would stabilizing it better and we revised our assumption. Now, obviously, if the economy gets better, So we're all results, but that's what we're operating under. And then you've got some additional things like this ag and Almatrition story as well.
So that's really sort of what drove our reduction combined with spreads being a little bit more challenged in CI than we had expected. That we will expect to sort of continue at this level going forward. We don't think it'll get worse, but we don't see why it will get better.
That's very helpful, Mark. And then, and, Kurt, you know, the company's been doing a nice job and it's $125,000,000 per quarter pace on share buybacks. Are there any factors that might influence either up or down, or should we really to pay Eastman continuing on that pace?
As we know, capital allocation is dedicated and committed to a lot of different areas. One of those is also debt repay down that $250,000,000 to $300,000,000 level. Share repurchases will be pretty disciplined. The only thing that could adjust it, if we do an acquisition, that'll take, come out of that, share repurchase bucket. So, you can do the math off that, Frank.
I mean, we typically do a pretty average dollar average approach throughout the year.
Our next question will come from John Roberts with UBS. Please go ahead.
Thank you. I think I saw some IHS data that said cigarette demand in China was up 6% to 7% year to date. I guess people maybe smoke a little bit more in a weaker economic or in more uncertain environment. So Do you think that's correct? And maybe could you reconcile that to your outlook for your business?
Sure. So as you know, since 2014 and now, there's been a dramatic drop in the amount of imports into China. And we do have a JV in China. It's running full and making good profits to the story of the demand you're talking about. But The import total imports into China now are just incredibly low in total, compared to where we were.
So the growth that you're talking about is being served by plants owned by CNTC in China. And then on top of it with the trade war, We're not seeing that benefit in the last three quarters because the CNTCs chose not to buy from plants in the U. S. Now we'll get some of that demand back and benefit from some of the story you're talking about we get the Korea plan qualified into the back half of this year. But that's really sort of the difference.
Moving next to Mike Sison with KeyBanc. Please go ahead.
Mark, if you think about the earnings reduction from April, it's about $1.10 from FX a little bit from the shutdown. How much volume do you need to get in the businesses to sort of recoup the rest at some point in time?
Yes. So our current guidance assumes, as Kurt indicated, that there's going to be some modest improvement in demand principally because destocking is not occurring anymore as a way specialties, you know, can grow. Obviously, we'll not be selling a bunch of chemical intermediates products that we're just not producing because of the large shutdown. So that sort of nets the corporate volume down, to being more modest So that's embedded in our guidance, and what we expect. And that's really by far the largest driver in the change of our guidance from April to now is this revision on the volume mix expectation going forward combined with a bit lower spreads in CI and this currency headwind.
I would also note that you're probably not going to get quite as much raw material tailwind out of AFP, but that's a minor part of the story relative the volume mix part of it. And that's the change in our outlook. Something I'd emphasize on this and why I'm very confident about it moving forward is we just need the economy get a bit better and confidence return where people get to normal inventory want to go back to normal inventory levels and we can get a strong recovery in earnings at some point back to, comments I made earlier. And that's, I think, a compelling position to be in, while we manage costs very aggressively, chemical intermediates that's in the specialties. In chemical intermediates, you have to get markets to get really tight again, for those spreads to come back.
Is not only is demand off, but supply has been added in a lot of those kind of products. So I feel really good about how specialties can recover. I feel good about that 70% of our earnings, where chemical intermediates has now been reduced to a much smaller percentage of our portfolio And I'm also proud of the actions we've taken to mitigate some of that volatility with the RGP investment. So I even think Chemical intermediates is performing relatively well to the market and how we both kept price reductions at a minimal level given our North American position. Our great team execution as well as investments like RGP to reduce volatility.
Right. So as a quick follow-up then, in AFP and AM, the is it fair to say the bulk of the volume that you need in the second half is kind of new products and to some degree within your control?
It's in our control to some degree, which is no question innovation is driving a lot of growth, especially in a as I mentioned, the innovation platforms are really exciting in AFP, but just at an earlier stage. And that's why you see the difference between AM and AFP on sort of the demand story. But we'll get there over the next couple of years. And we are assuming destocking is playing its way out. I think a key macroeconomic assumption we're making.
We're assuming some residual destocking in Q3. But that is a key assumption about why demand gets better in the second half versus first half.
Great. Thank you.
We'll take our next question from Bob Cork with Goldman Sachs. Please go ahead.
Thank you. I was wondering if you could talk a little bit about the way you guys by paraxylene and how that would flow through into the income statement, what the lag is till we actually see it on a cost of goods line?
If I think about the Advanced Materials segment specifically, especially plastics, I think if their inventory turns probably in that, 5 to 6 month range. So the inventory turns are long just because there's a supply chain that we have there. Maybe 4 to 6 months is how I'd characterize the inventory turn and how long it takes for that lower pairs on to show itself.
Would that imply that we'd see this nice decline in the last couple
of months will show up probably in fourth quarter
or maybe early next year?
That would be a good way. Just the only thing I'd add on top is just don't forget where a life will shop. But yeah, I would take that kind of time period to see this kind of parasolian flow through. And this business does a nice job getting pricing relative to its performance characteristics. And so that should help the margins of this business second half of this year and definitely going into next year.
Then on AM, I haven't heard
you guys call out architectural interlayers that often. Could you give us some scale or scope of how big that business is and how those margins might stack up against the segment average?
Yes. Architectural is about half of the interlayer business inside Advanced Materials, and it's been great. It's primarily commercial buildings. Predominantly in Europe where the code drives use of laminated glass. And it's just been delivering strong growth last year and this year, with the amount of commercial building activity there.
It's it's and we have a lot of good premium products as well.
We'll take our next question from Kevin McCarthy with Vertical Research Partners. Please go ahead.
Good morning. Mark, as you look broadly across the portfolio. Are there examples of product lines where your July order books or your visibility into 3Q is materially better or worse than the average 2Q levels? Any outliers on that front?
I mean, when I look at it, demand in July is holding up quite well across the company on the order books. We're seeing good growth, and I should say stability relative to June in July I've also learned my lesson, at this point not to predict demand for the quarter, based on order books, in any one month. Because there's just too much volatility out there. But what I'd say overall is orders are holding up well.
Materials just to kind of follow-up on the prior thread of discussion. I think you indicated back half better than the front half terms of the earnings prospects there. If I look at the 5 years prior, the opposite has been true. And so I guess my question is, are there other factors besides the flow through of lower paraxylene costs that are helping you in the back half in that business that you would call out? So a couple of things.
1, again, what you already mentioned, the flow through lower raw material Also keep in mind, the fourth quarter of last year was a pretty down year for that segment just because of the amount of destocking that occurred in the fourth quarter. And so that to me is a big factor as well. And then the cost reduction activities will help benefit that businesses like it will the rest of the segments. The other key is there's a
lot of destocking in the first half of this year that's not remotely normal that we believe has played itself out as we go into the back half. And obviously that creates the distortion first half back half.
Great. Thank you very much.
Ebony, let's make the next question the last one, please.
Thank you. And everyone, we'll take our final question from Laurence Alexander with Jefferies. Please go ahead, sir.
Hi, just quickly then. Can you try your comments on destocking to how you're about the risk of extended customer shutdowns in either August or into year end? And can you touch briefly on as we back to the discussion about the snapback scenario, whether your customers are giving feedback that they were concerned about the about future, you know, of occurrence of trade wars and therefore tighter inventory policies, even if this trade war is resolved?
Yes. So in general, what I'd say is people have taken a very tight inventory strategy, for the last three quarters. I mean, we've been working things down pretty aggressively given the level of uncertainty that we face. And there's a limit to once you get inventory really low, you can't go any further than that unless there's a fundamental step down in demand. So I think we're have customers already live in sort of at very short order patterns, and very tight inventory management.
To your first question, Lawrence, on the, on extended shutdowns. I mean, that would be potential risk to our forecast. If there was very significant shutdown of the auto industry, that's not in our current forecast.
Thank you.
That would push us to the lower end of our range as opposed to somewhere else.
Okay. Thanks again everyone for joining us this morning. This call will be available on replay on our website this afternoon. We hope you have a great day.
Again, this does conclude today's call. Thank you for your participation. You may now disconnect.