Good day, everyone, and welcome to the Eastman Chemical Company Second Quarter Twenty 18 Conference Call. 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, sir.
Thanks, Marguerite, and good morning, everyone, and thank you for joining us. On the call with me today are Mark Costa, Board Chair and CEO. Kurt Espolon, 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 second quarter 2018 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 Q filed for first quarter 20 and the Form 10Q to be filed for second quarter 2018.
2nd, earnings referenced in this presentation exclude certain non core and unusual items and have been adjusted for the forecasted tax rate as of the end of the interim periods. 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 2018 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 items and assume that the adjusted tax rate for 1st 6 months 2018 will be the actual tax rate for the projected periods.
We continue to make great progress in executing our strategy with strong 2nd quarter operating results, consistent with our expectations. Our results demonstrate the strength of our specialty portfolio with 8% volume growth in Advanced Materials and Additives and Functional Products combined during the quarter. As I've said many times before, we are creating our own growth through innovation and leadership in specialty markets. We're seeing excellent progress in converting our top innovation programs to commercial orders across AM and AFP. In a few moments, I'll share a couple of examples of the ways we're winning with customers through innovation, and our enhanced commercial capabilities.
In addition to this specialty volume growth, we are making good progress stabilizing our Fibers business. As a result during the quarter and in the first half of the year demonstrate. In particular, we're making excellent progress in accelerating growth with our textiles innovation platform, leveraging our tow assets into new market applications. During the quarter, acetate yarn volumes increased by about 30% and we are expecting continued growth in the back half of the year. We continue to be disciplined in our cost management with productivity offsetting inflation.
While we ramp up our investment in growth programs, which are delivering above market growth. Cash flow remains a strength as we We remain on track to generate $1,100,000,000 of free cash flow for the year. And we allocated our strong free cash flow in a disciplined manner and in line with our priorities during the first half of the year. We returned $410,000,000 to shareholders with $250,000,000 of share repurchases and $160,000,000 of dividends. And we remain committed to make progress improving our ratio of net debt to EBITDA.
Our second quarter results demonstrate that we continue to execute on what we can control, namely innovating through our enterprise and A key driver of success in growing our specialty businesses is our continued upgrade of our product mix. We're driving double digit growth in our high margin specialty products, through execution of which is driving growth today and into the future and improving the quality of earnings with a higher percentage coming from our specialty products. We continue to be on track to deliver saw a 25% increase in the new business close rate during the first half of twenty eighteen year over year. So we're off to a very strong start. Here are two of the many ways we're creating our own growth, improving the quality of earnings and winning with customers.
We've talked in the past about how we leverage our diverse print identified disruptive macro trends that will drive growth at 2 to 3 times the underlying market growth rates. We also talked about how we spend a lot of time to segment the market carefully select the right partners to drive innovation and change. The result is that many of our core and premium products are growing faster than the market. One example that brings this approach to life in a relatively new category is our paint protection film and advanced materials. We've combined the technology platform from our commonwealth acquisition with Eastman's deep capabilities in polyester and coatings.
And our in-depth experience in adhesives and functional films to deliver interior protective surface, which can virtually repair itself when scratched because of its product's self healing properties. Plus, it helps consumers' cars stay cleaner longer. The market response has been tremendous. Consumers love the added functionality and channel partners appreciate the opportunity to grow their business. And to accelerate growth on the commercial front, we've expanded our Lumar and SunTech dealer network by 15% in the U.
S. Creating elite dealers who provide differentiated service to consumers. We also increased our focus on activating a new channel, car dealerships, to sell and install paint protection films as part of the car buying process, increasing distribution points by 30% in the U. S. Globally, the overall paint protection film category grew greater than 10% last year.
2018, we are on track to grow that business more than 3 times that underlying market rate. Another example I would highlight is Crawford as part of the Tamingco acquisition. In the crop protection sector, farmers want to maximize yields, which means reducing the number of plants that have fallen over making crops difficult to harvest and producing lower yields. Eastman has introduced a premium version of a growth regulator product, which was pioneered in Europe and has recently been launched in Canada. For 1st year sales have exceeded our expectations, we are confident doubling those sales in Canada in 2019.
This innovative specialty product called Adjust, which will soon be introduced in the U. S, shortens the plant and strengthens the stems, and allows for improved and earlier harvesting that maximizes yield. The product also allows for a much broader application window compared to other products in the market today. This allows farmers supply adjust throughout the year and harvest in a timely way, especially if they focus on dual cropping systems, such as winter and summer wheat. Both these products launches are great examples of creating revenue synergies from our acquisitions as we build capability in a market with compelling growth drivers where we're winning with innovation.
With that, I'll turn it over to Kirk.
Thanks, Mark, and good morning, everyone. I'll start with our second quarter corporate results on Slide 5. Sales revenue grew across all segments, as we did a nice job driving volume growth in our more specialty product lines. This continues to demonstrate the power of our innovation driven growth model enabling us to deliver 2 to 3 times underlying growth in the market and demonstrating we can grow around the globe with our specialties EBIT increased as higher EBIT in Advanced Materials and added to the functional products, more than offset a decline in chemical intermediate We are continuing to invest in growth across solid earnings performance during the quarter was partially offset by $20,000,000 of planned maintenance in our Longview site, as well as $25,000,000 impact of industrial gas supplier disruptions at both our Texas City and Longview Texas sites. Overall, we remain on track for strong EPS growth in 2018, reflecting growth in our specialty businesses stabilization of fibers and the impact of our compelling free cash flow.
Moving next to the segment results and starting with Advanced Materials on Slide 6, which delivered strong 10% EBIT growth in the first half of the year. For the quarter, sales revenue increased due to higher sales volume across the segment, including premium products such as Triton Co polyester, Saflex heads up display and performance films, as well as a favorable shift in foreign currency exchange rate. EBIT increased primarily due to higher sales volume and improved product mix as well as a favorable shift in foreign currency exchange rates partially offset by increased investment in growth and higher raw material energy costs. We continue to invest in this business, accelerating our Girl spend in premium product lines like Triton Co polyester and PVB resin for Saflex heads up display and acoustics. For the back half driving mid single digit volume growth, mix improvement and fixed cost leverage.
With our strong first half results, and our expectations for the back half of the year, we continue to expect earnings growth to be approaching the top end of the 7% to 10% range we communicated at our Investor Day earlier this year. Now do Additives and Functional Products on Slide 7, which had a strong second quarter and an outstanding first half of the year. Sales revenue increased primarily due to higher sales volume across the segment, a favorable shift in foreign currency exchange and coatings and inks, attributed to both improved commercial execution and improving end markets. EBIT increased due to the higher sales volume and a favorable shift in foreign currency exchange rates, partially offset by an increased investment in growth. Looking at full year 2018, our expectations remain the same as the guidance on our first quarter call.
Strong volume growth across the segment, well above underlying markets, driven by great commercial execution ability and innovation. However, the second half will not be as a tough comp, particularly in the third quarter due to strong solar fields for heat transfer fluids in a year ago period. Increased investment in growth, both new assets and growth resources. And lastly, lower industry operating rates for hydrogenated hydrocarbon resins due to a competitor capacity addition. All in, we expect AFP's EBIT growth to be in the top Now to chemical intermediates on Slide 8, sales revenue increased due to higher selling prices attributed to higher raw material costs, and continued improvement in competitive conditions.
Sales volume was driven by improvement in acetyls across a range of markets and a means in agriculture and energy. We're more than offset by lower volume due to both planned and unplanned outages, Regarding the unplanned outages, these were supply disruptions from our industrial gas suppliers at our Texas site. Unfortunately, the length of time required to return to normal operations was longer than committed to by our suppliers. And therefore, the magnitude of the impact of approximately $25,000,000 was larger than we expected earlier in the quarter. We are now back at normal operations and happy to see these unfortunate events behind EBIT decreased in the quarter, primarily due to higher scheduled maintenance shutdown costs and the supplier disruptions.
Partially offset by higher selling prices and stronger volume in some derivatives. Lastly, I'd like to take a moment to address our excess ethylene position. We have taken steps to significantly reduce the amount of excess ethylene we produce for both this year and next. Looking to the back half with purchased propylene only incrementally higher to support downstream derivatives. We are maximizing the propane feed and the crackers to maximize propylene production.
I remind you that our crackers are unique in their design to make as much propylene as possible. This configuration includes leveraging a high lever level of propylene inventory accumulated through the second quarter. We are also leveraging our storage capability for ethylene. As a result, our ethylene spot sales will be limited in the second half of the year In 2019, we are making a modest investment in our cracker flexibility to include refinery grade propylene in our feedstock slate. This enhancement will enable us to ramp up our polymer grade propylene production, while dramatically reducing both our ethylene production as well as our propane would also note that this project retains our flexibility to operate under normal operating conditions when market conditions improve.
For the remainder of this year and next spot ethylene price risk is not expected to have a material impact on our earnings. So now looking at full year for the segment, we expect EBIT in the second half to be similar to the first half as the costs from outages do not repeat in the 2nd half, partially offset by normal seasonality, particularly in the 4th quarter, and then less ethylene volume being sold. I'll finish up the segment review with fibers on Slide 9. Where results were in line with our expectations. Sales revenue increased due to the sale of non woven products previously reported in other higher sales volume for acetate tow, primarily attributed to customer buying patterns and to continued growth in our Textiles innovation platform.
EBIT increased slightly due to higher sales volume and earnings from non wovens innovation platform products. Mostly offset by lower selling prices, particularly for acetate tow and an increased investment in growth, including costs previously reported in other. As was mentioned earlier, we are making excellent progress on our growth initiatives, which is a significant contributor to stabilizing this business. Looking at the full to be stable for the year, the impact of our productivity gains will continue to flow through, and the progress of our growth initiatives will contribute to earnings stability. Of course, we had a tough comp in the third quarter due to customer borrowing patterns last year.
But sequentially, we expect third quarter to be about the same as 2nd and the full year, we expect EBIT to be about the same as the prior year. On Slide 10, excuse me, I'll transition to an overview of our cash flow and other financial highlights for second quarter. We continue to do an excellent job of generating cash with 1st 6 months operating cash flow of $408,000,000. Capital expenditures for the first half of twenty eighteen totaled $244,000,000. We continue to expect our full year capital expenditures to be approximately $550,000,000.
And we remain confident in our ability to generate $1,100,000,000 of free cash flow for the year. Looking at the balance sheet, which we expect will occur in the second Through the 1st 6 months, we returned $410,000,000 through $160,000,000 in dividends and $250,000,000 in share repurchases. We expect our full year reflecting the continued benefits of our improved business operations and resulting impact of expected tax events. As a whole, our first half results gives us confidence that we are on track with our strategy. And with that, I'll turn it back to Mark.
Thanks, Kurt. On Slide 11, I'll discuss our 2018 outlook which is consistent with what we've told you before. As you've seen from the strong volume growth in our specialty segments in the first half of the year, continue to benefit from the commercial execution capabilities and leveraging our combined technical capabilities to accelerate new product introductions. Our continued aggressive productivity is expected to more than offset inflation, and we're reinvesting a portion of that savings in our growth initiatives. Our refinery grade propylene investment to improve our cracker flexibility significantly reduces our exposure to ethylene price risk.
Risk, while keeping the upside available. And the improvement in our tax rate is also contributing to growth. Finally, disciplined capital allocation has allowed us to accelerate our share repurchase program in 2018 compared to 2017. Putting this all together, our expectations for EPS growth remain the same at 10% to 14% compared with 2017. And will likely be in the middle of this range.
Our underlying performance is strong as we focus on the things that we can control. And as Curt noted, third quarter is a tough comp to last year. One sensitivity is trade and the tariffs that could be implemented by the U. S. And China in the coming months.
At this point, we see no exposure to any of the U. S. Tariffs that have been implemented or proposed, which highlights another benefit or vertical integration for most of our raw materials. Regarding the proposed tariffs, we see some modest but manageable exposure with our mitigating actions. When we consider this potential impact, we expect to be safely in the range of our guidance.
Lastly, we remain committed to our $1,100,000,000 of free cash flow target. Which is one of the strongest in the industry. As you think about our portfolio, we continue to march down the path to make 2 specialty businesses a much bigger percentage of the total, with our goal of driving from 70 towards 80%. And we're making great progress in stabilizing fibers and reducing volatility in CI. This all comes together for a terrific bottom line.
We can grow faster than the underlying market. We can sustain and improve our margins through mix upgrade. We also do this through scale and integration and investing in the unique capabilities we have in place to drive it. And finally, through our disciplined portfolio management. That leads you to one of the strongest free cash flows in the industry, a strong return on invested capital is growing.
A compelling compounded EPS growth rate through 2020 and beyond. When you put this all together, we are well positioned for long term attractive earnings growth sustainable value creation for our owners.
Morning, and we'd really like to get to as many questions as possible. So I ask you to please limit yourself to one question and one follow-up. And Marguerite, with that, we are ready for questions.
We can now take our first question from Vincent Andrews from Morgan Stanley. Please go ahead.
Just curious, so just curious on the adhesives, competitive activity, just if you have any more visibility into that yet, I know these plant startups can move around and what have you, but is it proceeding as anticipated?
The plant that was completed by our competitor, effectively came online towards the end of, the second, first half of the year. So served recently. So we are expecting some impact there, as they bring that capacity online. But I would remind you that while they added a lot of capacity, demand growth has been incredibly strong in this business, generally markets 5% to 7%. There's a lot of pent up demand because the market was capacity wasn't available.
So we're seeing sort of a leap in demand just because there was the need to use this product And then rosin to resin conversions accelerating as the market is, looking for an odor free water white kind of adhesive, which you can't get with rosins. So it's important to keep in mind the rosin markets as big as the resin market. So all those things come in together to give us confidence that demand will fill this plan out relatively quickly. But there are some limitations on how we can manage price, upward right now relative to an increasing raw material environment with oil increasing But overall, it's actually playing out as we expected.
Okay, great. And then, Kurt, if I could just ask you on the free cash flow, just looking at the cash flow statement and kind of recall this either happened last year 2016. I can't remember, but your cash flow from operations is actually a bit lower this year versus last year. And it looks like from working capital receivables inventories. But what so, 1, sort of why is that happening?
And then, 2, remind us of the mechanism of how you make that up in the second half of the year?
Is it just seasonality
or what's going on?
Sure, Vince. No problem. Yes, it's normal for our seasonal increase in working capital the first half of twenty eighteen. It's probably a little more dramatic this year than last year, just because of the rising raw material environment. As well as flawlessly just stronger sales, which is a good problem to have, by the way.
So as you think about those stronger sales and higher input costs flowing through the system, that did have a kind of a net negative impact on a free cash flow first half of the year, as well as some lingering negative impact from the coal operational incident in the first half of this year. So if you think about, though, the trend in the second half of the year, cash flows will be expected to improve. One is we expect working capital needs will reverse especially in the fourth quarter. The net proceeds from the insurance from the operationalist incident, we do expect some of that more in the second half whereas the costs are pretty much now behind us. And also, don't forget that we expect a reduction of capital expenditures of $100,000,000 for the year only saw $30,000,000 of that in the first half of the year.
So you'll see a $70,000,000 impact of reduced capital expenditures in the second half of the year on a year over year basis. So again, We remain on track to generate $1,000,000,000 of free cash flow in 2018, continuing to demonstrate the quality of the portfolio our capabilities. There's been no material change in our free cash flow goals and we're excited about what we can deliver.
And just to be clear, that was 1.1 $1,000,000,000?
I'm sorry, guys. Yes, to be clear, one $100,000,000 is free cash flow, sorry for the split.
All right. Thanks very much.
We can now take our next question from David Begleiter from Deutsche Bank. Please go ahead.
Mark, since you last gave guidance back in April, FX and by ethylene margins have gotten worse. So can you tell us in terms of your second half guidance expectations, what's the negative impact of or the impact of the deterioration in both those metrics since your last guidance?
Thanks, David. So first of all, I think we're on track for tremendous earnings growth for the year. 10% to 14% middle of that range is great results, improvement in tax to help a bit as well in the back half So we feel great about what we're doing on earnings growth. And the second half is a bit different than the first half. As you noted, with ethylene, the price of ethylene are quite low right now.
And we've made all these investments and changes to avoid, basically participating in that spot market and not incur those negative margins. So that's actually quite helpful, but of course, you have less volume you're selling relative to last year. So that's a change from where we were in April. When you think about the specialty businesses, very much on track with everything we've said, we see strong volume and variable margin growth. Some of that's tamped down a bit by, growth investments we're making that are accelerating as we go through the year.
So that's weighs a bit more on margins in the back half versus the first half. So you see a bit of that dynamic going on. But overall, it feels like we're very much on track and that ethylene headwind is not as material of an event.
And David, on the currency, you think about us, that's predominantly the euro. The currency was a tailwind for us first half year over year, but when you see rates, if they stand where they are now, It's neither a headwind or a tailwind for the second half of the year on a year over year basis.
Understood. And Mark, just on Advanced Materials, you didn't get any pricing in Q2. So what do you stand in that segment price versus raws?
Yes. So first of all, Advanced Materials had a great first half of the year with 10% range growth. And very much on strategy, we've told you all along that our focus in this business is driving volume and mix upgrade. Every year consistently for many years now and we're demonstrating another strong performance on that front. So as you look at the margins, in AM, you have margins actually improving as that mix upgrade, delivers value year over year and sequentially.
That's been been offset by increased growth spend. And just to step back the corporate level for a second, we've told you that we're increasing our gross spend between the new operating assets we're bringing online like Triton and our PBB asset in AM as well as our Crystex plant in ketones expansion in AFP. So overall, we're at the high end of that range of about $50,000,000 of gross spend, for the company on an annual basis that actually divides out across the segments roughly $25,000,000 in AM, $20,000,000 in AFP and about $5,000,000 in fibers of additional spend. So when you take that sort of 25, and realize it's ramping up. So not much of that was in the first quarter, but it's ramping up into 3rd through 4th.
The margins of mix improvement that we delivered year over year and sequentially were offset by about 100 points of into fixed cost leverage as you move forward. So we don't expect the same step up in investment growth investments next year across the company that you're seeing this year. Will be some carryover from this year, of course, but, there is no big next step in terms of growth margin leverage. So that sort of deals with some of the margin story on the, On the actual pricing side of the equation, David, we had great success in increasing prices with, raw materials on the polyester side of the equation. And are doing just fine.
The spreads are holding in quite well. The place where we offset that is, as we discussed at Innovation Day, we intentionally had some price concessions in the interlayer business and the annual contract negotiations last fall to achieve significantly improved mix on our heads up display and acoustic sales that are much higher margins than our standard. So while we gave up some price, we gained significantly on the mix and earnings as a result of that, which is consistent with our strategy. So everything in AM is playing out exactly as we intended. Driving a lot of earnings growth.
And from both the first half of the year on a full year basis, being at the high end of our guidance range is very attractive growth.
Very good. Thank you.
We can now take our next question from Jeff Zekauskas from JP Morgan. Please go ahead.
Thanks very much. In your commentary, I think you said that because of some in supplier difficulties that cost you $25,000,000 and maybe there's another $25,000,000 from turnarounds. So basically, are you saying that you would have earned $50,000,000 more in the second quarter if you hadn't had these events? And maybe you can place that in context. In other words, what are the what's the normal maintenance spending or the normal outage costs such that we can gauge whether this is a normal event for Eastman or this is above average?
Sure. So to answer your question, if you take second quarter by itself, that's the supplier disruption was cost us about $25,000,000 and the maintenance spend would have been was $20,000,000. So if you didn't have both of those EPS, our earnings would have been up 45%. But normally, if you look at total maintenance for the year, for this year compared to last year, it's about the same. So this is more about timing within the year.
And so that's why it was more of $20,000,000 in the second quarter. Greg, did you mind asking?
Just from a planned maintenance standpoint, it was about the same. The supplier disruption was certainly in addition to what would be normal for the year. Correct.
Okay. So for my follow-up, the conceptualization of Eastman by management is that the quality of the business is getting better. But there really hasn't been any material change in the overall gross margin of Eastman. Do you is your idea that the quality of the business is going to be better and that your gross margins are going to rise to, I don't know, 30% instead of 25 Or is the idea that the natural rate of volume growth will be faster because of the new initiatives you have So there isn't really much margin difference?
Yes. So, Jeff, no, the idea is very much that the gross margins are going to get better. And certainly, if you exclude, the operational outages, I'm just going to make this on a full year basis Jeff, exclude the operational outages that we've incurred and think about that $50,000,000 of gross spend that we're investing for future growth this year. The gross margins this year are quite better. And so as you move into next year, you're going to see that happen because obviously, we don't intend to have the same operational problems, as well as this fixed cost doesn't step up again next year.
So the variable margin grows creates leverage, fixed gross margins will improve. So there's every intention of those gross margins and getting better as we move forward.
If I could add, Jeff, 2 things. Yes, we do expect in that volume growth better than market because of the innovation program. I'd also remind you, because it worked the opposite way input costs came down, so did revenue. In the future, revenue is going to go up and thus, by nature, even as we grow gross margin dollars, the percentage can move around a little bit on you just because of that inflationary pressure. We really look at it as a gross margin as a per unit basis and we're seeing good growth in that per unit basis.
We can now take our next question from Alexei from Nomura Instinet. Please go ahead.
Good morning, everyone. Thank you. Could you give us an update on your CRISSTA CRISSTEX technology project, where does it stand currently?
Sure. So Krystex is online producing in spec material with our new, Cure and Cure Pro products that provide far superior performance. To what's available in the marketplace for anyone, including our own historical technology, much better thermal stability, much better dispersion, customer are verifying and validating significant improvement in their manufacturing efficiency using the product. So feel great about the program.
Thank you, Mark. And then just to follow-up on the comments on refinery grade propylene, are you what are you actually doing there? Are you adding to convert refinery grade to chemical grade? Is it some new capability that you're adding? And can you just explain what's happening there?
Sure. So it's, it's been enabled by the shutdown we just completed. So we are modifying the front end of our cracker, and refining capability on the front end to be able to add RGP to the mix instead of just using ethane and propane. And the great thing about the story is we had to make some large capital investments, as all of you know, in our 2 smaller crackers for safety reasons. And this was the 2nd cracker that we just finished modifying.
It made available equipment that was being used, historically now not needed. And we can modify that equipment, to now be the refining capability for RGP to include it in the mix. So, so it's a modest capital investment, that normally would have caused a significantly more amount of capital taking a lot longer time to do, but now we can do it quickly and have it online by the end of the year. And so it's a great flexibility. So now we can move some of our exposure to an RGP, PGP spread, which is much more stable than where olefin prices and propane have been reduced the ethylene dramatically that we produce, which we've never wanted to make.
You have to remember our entire strategy is based on making propylene and specialty propylene derivatives. So it sort of gives us the flexibility to be out of that market. And but it's very flexible to switch back. So we can move back towards ethylene if the prices get attractive. And as you look at it, when the ethylene export capacity comes online in 2020, it probably will be attractive again.
Great. Thank you, Mark.
Next question comes from P. J. J. Juvekar from Citi. Please go ahead.
Yes. Good morning, Mark. Good morning.
Mark, as ethylene prices fell, you're taking some downtime at the crackers. You're investing in CapEx. To change your feedstocks. How does that impact your sale process of the crackers? And have you thought about shutting down the smallest cracker?
Well, I'll start with the sale process, P. J, this is Kurt. This is a reminder, again, I want to reemphasize what Mark is that our crackers are still good reliable assets that create that competitive advantage for our high value propylene derivatives by leveraging shale gas. And so the primary objective of our recent efforts was to monetize our excess ethylene position and then potentially certain ethylene derivatives to eliminate the earnings volatility that came from products. Over the past few years, we've engaged with multiple parties on a variety of options to sell or otherwise monetize this excess ethylene.
However, current market conditions combined with the current geopolitical environment on trade has made it very difficult to move forward at this time. Until conditions improve, we have taken these steps then to, such that spot ethylene pricing will not have a material impact on our earnings the remainder of this year. And going into 2019.
And to answer your question on the crackers, we are shifting the mix hard. We are going to reduce rates on the crackers. And we're until this investment's in place for next year, because we accumulated so much propylene inventory, and have some storage available for ethylene, we're able to mitigate, the need to buy much additional propylene to normal, which is great. Even though we're reducing the cracker run rates and avoid selling ethylene to market at these prices.
Thank you. And just as a follow-up in Advanced Materials, you had nice 9% volume growth. But pricing seemed to have lagged for last couple of quarters. You know, you talked about pricing reduction in heads up display, products, What's going on with pricing in Tryton And Cephlix and other other products in that segment?
Thank you. Yes, as
I mentioned earlier, we're managing a complex mix there, right? So mix improved dramatically, as it has for years now, improving margins in that segment. We, have offset that with about 100 basis points increase in growth investments. So those sort of net out and then prices didn't increase. What I said is they increased across the polyester So we are increasing prices there and keeping up with raws.
No issue there, doing a great job by the commercial teams there. But we did intentionally reduce prices on the interlayer products. So that's sort of netted out.
Thank you.
We can now take our next question from Arun Viswanathan from RBC. Please go ahead. Good
morning, thanks.
Good morning, everyone. Just curious on
the outlook here. You have a slightly lower rate. I guess it's, on our math around $0.03 to $0.05 or so. You're still guiding to the, the midpoint of the range. So, I guess, would you characterize potentially some of the swing factors maybe for us?
I guess, is it mainly FX And then, I guess, some raw material headwinds or how would you kind of look at that?
So just to clarify, are you asking about the outlook for the second half of the year and those factors and how it impacts it?
Yes. Thank you.
So from a second half year point of view, 1st of all, it starts with a tough comp. So last year, we had incredibly strong volume, in some areas, the company, the solar fills, that we mentioned to you and the higher the share gain we got in the last the second half of last year due to environmental enforcement in AFP. As well as, as we noted, the customer buying patterns, being a bit high in the third quarter, last year in tow, which won't repeat this year. And then of course, we're not selling ethylene. We sold a bunch of ethylene last year.
It's a margin and this year, we're not selling it. So Those all create a tough comp relative to last year. So that's the largest, you know, difference, year over year. 2nd is you've got the higher gross spend this year, that's been accelerating through the first half of the year and continues into the next into the second half. And then you have some margin coming off and adhesives as we've discussed a few moments ago.
So those all sort of play into why the second half doesn't grow as fast as the first half. And as Kurt noted, currency is in the tailwind. So they're all dynamics. They don't give any concerns. We still feel we're on track to deliver very strong growth this year and well positioned to grow into next year.
You got to remember the operational problems unplanned and and, and the growth investments are all fixed cost leverage next year as we continue to grow variable margin.
And if I could add on top of it, when I think about the second half of the year, Arun, the way I look over that is that some moving parts that Mark described, but generally speaking, our outlook for the second half of the year hasn't changed. And then on top of it, you have roughly $0.05 benefit from tax. So that's how I look at the outlook for the second half of
the year. Yes, we think we'll hold on to that benefit on the tax side.
Okay, great. And then, just wanted to get your thoughts, I guess, longer term, would you consider something potentially more creative on the ethylene side, either an asset swap or something or would you even consider maybe down the line at some point looking into constructing a PDH unit? Thanks.
Well, we'll look at good thing is I would argue we've come up with a pretty creative option, deal with ethylene right now. And so that kind of takes care of that ethylene volatility risk, which as a reminder, is the primary driver of volatility within the Chemical Intermediates group. So we've done a pretty creative thing now. That buys us time to see how market conditions improve and see whether the sale option goes back to life or other options may be available to us. But right now, I think we've been pretty creative in dealing with our excess ethylene issue.
No, I understand. I just wanted to get you potentially consider constructing a PDH unit. Thanks.
We're not looking at capacity, but no greenfield expansions. Our strategy is growing, investing in specialty businesses. We're delivering tremendous volume and mix improvement across AM and AFP and accelerating growth in fiber. So that's where our capital is focused, plus both on M and A, if it's not share repurchases.
We can now take our next question from Bob Koort from Goldman Sachs. Please go ahead.
Hey, Mark. Good morning, Bob. One of the giant guys over in Germany had some comments today that I thought were kind of interesting. Curious about the Eastern philosophy. And the question or the comment was basically there are some specialty markets where if you react too aggressively to raw material inflation, it sort of compromises or could compromise the value add approach to a product line.
And therefore, when the raws go the other way, you're stuck giving back some relief. Just curious when you think about your portfolio, how do you differentiate across that portfolio and the ability to get price to recover some of these raw materials?
So, Bob, it's a great question and a really important one. We really get into the nuances of running a great specialty business, which I think we've built. You have to be very thoughtful about how you manage prices, with, with your customers because you want to capture the value for the products that you have. You want to treat your with respect because they're aware of how raw materials change both up and down. But most importantly, you want to keep them highly engaged to continue working with you on innovation.
Right? The vast majority of innovation isn't with new customers. It's with existing customers helping bring them additional new products. So you have to when the tires business, the coatings business, glass business. You've got the same set of customers for a very long time.
So that has to be a very collaborative relationship that includes working on innovation. So yeah, you are careful about how you manage price and you want to provide price stability to them. So when raws go up, you increase prices, but you do it carefully and you don't be abusive about it. And when raws go down, you hold on to some of the value, but ultimately you have to share some of it. And if you go back to our transcripts over the last 3 years, I think I've been pretty consistent in talking about that, and how we've managed it both in 2015 2016 and how we've managed it over the last couple of years.
But what I would highlight is we have done a great job, in managing price relative to raws,
especially in CI and AFP right now.
We've done a we've been able to keep pace with raws and distribution costs. And I think I've thoroughly covered the AM discussion on that topic where we're doing great in polyesters and made some intentional choice to improve mix with our interlayer customers. So yes, you got to think about that and be very careful on what you do.
And then you, you acknowledge that there have been some price down on your auto interlayer business. Is that a one time event? Is that something that we should expect to continue? And then you offset it as you're saying by seeking out mix benefits? Is this one time correction because they're under a little bit of pressure?
Can you give us some help there?
Sure. So the nature of that business is, as we shared with you at Innovation Day, the price difference between our premium products and our and our sort of standard products, in that segment are quite different. So as you gain scale and see in making these premium products, you tend to give back a little bit of price on those premium products as they're buying significantly more volume and your cost efficiency is also higher from a fixed cost leverage point of view as they grow. So from a margin point of view, you're not taking much of a hit. But you do have to share some of that high sort of value created by them buying a lot more with some price reductions.
So There's always a natural amount of that that occurs happened last year, happened this year. There'll be a little bit of next year. The tricky part is you put these annual contracts in place And if you go back to what we were negotiating in the fall, raws of our come in a bit higher than we expected this year, the key drivers of raw material prices for interlayers is international ethylene prices, not local, and acetic acid prices, because we're buying VAM and PVOH. So you can imagine that's created some pressure relative to where we thought we were last year. So that's part of the story, but it's the key thing is focus on the 9% volume and mix that is a significant upgrade in margins.
And when you back out the growth investments, the margins are great.
Next question comes from John Roberts from UBS. Please go ahead.
Thank you. Good morning. In chemical intermediates, you noted higher pricing in acetyl derivatives. Sellanese has this initiative in their acetyls business to connect producers and customers, which they talk about network terms like activating nodes Are you participating in something similar or is that contributing to the higher pricing that you're talking about? So first, Seak acid is not a priority business for us.
We have a huge acetyl stream that is focused on producing acetic and hydride cedic acid is a co product of our downstream derivative operations that we have to sell, to sort of clear the system. So we're not in the global acetyl business, like some other people are. We're really in a sort of North American Centric acid acetic acid business where we're clearing out the co product in our operations. So just entirely different business model relative to, you know, what Celanese referred to. The reality is just prices are higher in the seedy acid right now due to decent demand growth in that business as well as, number of supplier outages, both here, including us for a while, and be and people in China.
So that's really driven the improvement in our steel pricing for us versus the very different business model that, that Celanese has here, because even our acetic and hydride isn't about selling it, right? It's about converting it all the specialties downstream. And we sell what's left over. So it's just entirely different business model. And then secondly, do you need to make a bolt on acquisition at some point in specialty agchemicals.
Today, you highlighted the, growth stimulation, growth regulation products earlier, you highlighted the animal nutrition additives you have, but it doesn't seem like you have critical mass in ag, and it's much smaller than many of the other easement businesses. Yes, it's a great business. And, it was under invested in, especially on the animal nutrition side. So we've been able to add a lot of organic capability and commercially taking it from a European to more of a global business, and accelerating product development by combining our technology people with there. So we feel good about what we're getting done in organic.
You're right. We're not a big player in that space. This is an area where we'd be open to sort of bolt on M And A. But we're very disciplined. So we'll have to see if there's M and A out there in the marketplace here and other places that we're looking that meet our financial criteria, not just our strategic ones.
And, we continue to look for those opportunities, but we're going to be careful we don't overpay.
Next question comes from Jim Sheehan from SunTrust. Please go ahead.
Good morning.
Can you talk about the tone of business so far in third quarter? Are there any changes positive or negative?
Business is continuing as expected. So demand primary demand is in the marketplace continues to be solid around the world. Obviously, things like tax reform and less regulation here, recovery in Europe help, tax concerns around trade or creating some caution, but overall, net good Most importantly, we're focused on creating our own growth, and have demonstrated our ability to grow sort of 2 to 3 times underlying industrial production rates. And so we feel great about, how we're continuing to create our own growth and drive growth and how that continues into 2019. It's been the center of our strategy.
I think our growth model is alive and well and demonstrating, value every day.
Terrific. And can you talk about the BP distribution agreement that was announced? So what was the strategic rationale for that? And how do you expected to impact your business?
Yes, as I mentioned, so cic acid is not an on purpose business. It's a co product And we already have relationship with BP at our Texas City site. And we're able to find a way to work with them to sort of represent and sell our non specialty acetic acid in a more efficient manner that gives us some earnings upside relative to what we could do with our position in the market. So it just made sense.
Next question comes from Lawrence Alexander from Jefferies. Please go ahead.
Good morning. 2 questions. 1, can you quantify the spread between price and raws excluding chemical intermediates who are in aggregate? And secondly, are you seeing any signs of an inventory overhang in either crop chemicals or automotive? And I guess on automotive, particularly in Europe, but I guess any perspective on those 2 markets?
I'm asking your second question first and then ask for clarification on the first. So on the on your second question, Lawrence, We don't see any inventory overhang in the marketplace that we're aware of. I'm not sure I understood your first question. Could you repeat it?
Yes, I might have missed it earlier. Did you have you quantified the spread between your realized pricing and your raw material cost inflation in Q2?
No, we don't provide that kind of detail. What I can tell you is in AFP PNCI, they've done a great job of managing price relative Verizon distribution costs. In fact, their margins per kg are up a little bit. To remind you, as Curt noted, when raw materials go up and you hold your spreads constant, your margin percentage goes down. Because, it's just of the math.
But we're doing a great job in those two areas, and as, and I think we've thoroughly discussed the AM top on how we're managing, the total margin there. So overall, I feel like we're in better shape than we ever have been on how we're managing price relative for us.
Okay. Thanks.
Next question comes from Kevin McCarthy from Vertical Research Partners. Please go ahead.
Yes, good morning. Smart, you've got a lot going on at Longview. You mentioned throttling back on the cracker operating rates, changing the feedstock mix to be increasingly geared to propane feed. And then the RGP investment. If we were to boil all that down, what is the net impact on your net short position in propylene going forward?
So, for this year, it has no impact. We have to incrementally increase our propylene purchases relative to last year with some degree and not selling ethylene to the combination of, actions we've taken. We're not incurring a material increase in purchase propylene costs, which is great. 2nd, with the RGP investment next year, we would buy less propylene than this year, because of leveraging the RGP to make propylene. So it mitigates some of that exposure for us improves our spread exposure by getting into the RGP PGV game versus propane to propylene.
And
that reduces ethylene production. So it's a win on all fronts. And Kevin, if I could if I could add, just as you think about that change in mix, Most of the benefit of that change is going to be felt in chemical intermediates. There'll be a little hurt moving to AFP as we as we see some additional costs from the crackers running at reduced rates, but generally a good positive, mostly in CI, a little hurt in AFP going forward.
That's helpful. And then as a follow-up, I think you mentioned that you anticipate operating earnings in CI in the second half to be roughly equal to the first half. Can you help us out a little bit with the expected quarterly cadence? For example, Was there any spillover in July from the various supplier disruptions that you indicated and the actions you're taking in Longview? How should we about kind of 3Q versus 4Q there?
Yes. I think if you look at the seasonal trend, Kevin, yes, there's some spillover, but we're expecting some of that to moderate you'll see most of that seasonal impact in the 4th quarter.
Thank you. Make the last question or the next question, excuse me, the last one, please.
Last question from Matthew Blair from Tudor, Pickering, Holt. Please go ahead.
Hey, good morning, everyone. Thanks for taking my question here. I'm not sure if I heard this correctly, but was there a comment that you're looking to accelerate share repurchases in 2018? And If so, could you share your target here? I know you have the 2,000,000,000 share repurchase target for 2018 through 2020.
And then maybe related to that, in your slides, it mentions a $300,000,000 debt reduction target for this year. I want to say that that used to be more like $350,000,000. So is this just the case of a little bit less debt reduction this year, a little bit more repurchases? Thanks.
Yes, Matt. So first of all, it starts with $1,100,000,000 of free cash flow. But what Mark was talking about at the acceleration was we're doing more share repurchases in 2018 than we did in 2017. Part of that is less deleveraging. So we're targeting $300,000,000 this year as we did $350,000,000 last year.
So you got the combination of growth and free cash flow, a little less deleveraging, an attractive dividend that leaves a lot of free cash flow available to do share repurchases in absence of a bolt on acquisition.
I would just emphasize the $1,100,000,000 of free cash flow, as we wrap things up. But no, we feel great about the strategy. We feel great about the progress we're making on the volume and mix improvement, driving earnings growth this year. And positioning us really well for growth next year. And obviously, the cash has been great and we will continue on the track that we, committed to in the beginning of the year.
Okay. Thank you. And thanks everyone for joining us this morning. There'll be a replay online later this afternoon. Thanks again.
That concludes today's conference. Thank you for your participation. Ladies and gentlemen, you may now disconnect.