Good day everyone, welcome to the Eastman Chemical Company second quarter 2018 conference call. Today's conference is being recorded. This call is being broadcast live on 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, good morning everyone, thank you for joining us. On the call with me today are Mark Costa, Board Chair and CEO, Curtis Espeland, Executive Vice President and CFO, Jake LaRoe, Manager Investor Relations. Before we begin, I'll cover two 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 2018 and the Form 10-Q to be filed for second quarter 2018.
Second, earnings referenced in this presentation excludes certain non-core and unusual items and have been adjusted for the forecasted tax rate as of the end of the interim periods. Reconciliation 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 first six months 2018 will be the actual tax rate for the projected periods. With that, I'll turn the call over to Mark.
Good morning, thanks for joining us. I'll start on slide three. We continue to make great progress in executing our strategy with strong second 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 & 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 are seeing excellent progress in converting our top innovation programs into 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 results 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 remain on track to generate $1.1 billion of free cash flow for the year. 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 million to shareholders with $250 million of share purchases and $160 million of dividends. 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 allocating our strong free cash flow in a disciplined manner. On slide four, a key driver of success in growing our specialty businesses is our continued upgrade of our product mix. We are driving double-digit growth in our high-margin specialty products through execution of our innovation-driven growth model. Our top innovation programs in AM and AFP are accelerating as more customers validate our innovative, differentiated products, 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 more than $350 million in new business closes this year.
In fact, we saw a 25% increase in the new business close rate during the first half of 2018 year-over-year. 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 footprint to identify disruptive macro trends that will drive growth at two to three times the underlying market growth rates. We also talked about how we spend a lot of time to segment the market and 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 in 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 the best product in the market. We launched a next-generation paint protection film that delivers a superior protective surface, which can virtually repair itself when scratched because of its product's self-healing properties. 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. To accelerate growth on the commercial front, we've expanded our LLumar and SunTek 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. In 2018, we are on track to grow that business more than three times that underlying market rate. Another example I would highlight is crop protection as part of the Taminco 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. Our first-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 much broader application window compared to other products in the market today. This allows farmers to apply 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 product 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 Kurtis.
Thanks, Mark, and good morning, everyone. I'll start with our second quarter corporate results on slide five. 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 two to three 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 Additives & Functional Products more than offset a decline in Chemical Intermediates. We are continuing to invest in growth across most of our portfolio and seeing the positive impact of those investments.
Solid earnings performance during the quarter was partially offset by $20 million of planned maintenance in our Longview site, as well as $25 million 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. We're 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 six, 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 Tritan copolyester, Saflex heads-up display, and performance films, as well as a favorable shift in foreign currency exchange rates.
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 growth spend in premium product lines like Tritan copolyester and PVB resin for Saflex heads-up display and acoustics. For the back half of the year, we expect underlying business performance to remain strong as Advanced Materials executes its strategy of driving mid-single-digit volume growth, mix improvement, and fixed cost leverage. With their 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%-10% range we communicated at our Investor Day earlier this year.
Now to Additives & Functional Products on Slide seven, 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 rates, and higher selling prices more than catching up to raws. Volume growth was strong, in particular for animal nutrition 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.
The second half will not be as quite as strong as the first due to a few factors. In the first half of the year, a tough comp, particularly in the third quarter due to strong solar fills for heat transfer fluids in a year ago period. Increased investment in growth, both new assets and growth resources. 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 end of the 5%-7% range we communicated at our Innovation Day. Now to Chemical Intermediates on Slide eight. 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 amines in agriculture and energy.
Were 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 sites. 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, approximately $25 million, was larger than we expected earlier in the quarter. We are now back at normal operations and happy to see these unfortunate events behind us. 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 of the year, we are configuring to run our crackers at reduced rates with purchased propylene only incrementally higher to support downstream derivatives. We are maximizing the propane feed in 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 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 purchases, which minimizes Eastman's exposure to spot ethylene sales. I 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. 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 second half, partially offset by normal seasonality, particularly in the fourth quarter, less ethylene volume being sold. I'll finish up the segment review with Fibers on slide nine, where results were in line with our expectations.
Sales revenue increased due to the sale of nonwoven 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 nonwovens 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 year, we expect EBIT to be stable compared to last year. Acetate tow volume is expected 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 buying patterns last year. Sequentially, we expect the third quarter to be about the same as the second, the full year, we expect EBIT to be about the same as the prior year. On slide 10, I'll transition to an overview of our cash flow and other financial highlights for the second quarter. We continued to do an excellent job of generating cash, with the first six months operating cash flow of $408 million. Capital expenditures for the first half of 2018 totaled $244 million. We continue to expect our full-year capital expenditures to be approximately $550 million. We remain confident in our ability to generate $1.1 billion of free cash flow for the year.
Looking at the balance sheet, we continue to expect to use $300 million of our free cash flow to reduce debt this year, which we expect will occur in the second half of the year. We remain committed to returning cash to stockholders. Through the first six months, we returned $410 million through $160 million in dividends and $250 million in share repurchases. We expect our full-year tax rate to be approximately 18%, at the bottom of our previous range, 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. 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 told you before. As you've seen from the strong volume growth in our specialty segments in the first half of the year, we continue to benefit from the high-value innovative products with leading positions in attractive niche markets. We're also delivering revenue synergies of our acquired businesses through improvements in our 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 are investing 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 while keeping the upside available. The improvement in our tax rate is also contributing to growth.
Disciplined capital allocation has allowed us to accelerate our share repurchase program in 2018 compared with 2017. Putting this all together, our expectations for EPS growth remain the same at 10%-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. As Kurt 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 of our 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. We remain committed to our $1.1 billion of free cash flow target, which is one of the strongest in the industry. On slide 12, I'll summarize where we are. As you think about our portfolio, we continue to march down the path to make two specialty businesses a much bigger percentage of the total, with our goal of driving from 70%-80%. 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 do this through our unique innovation-driven growth model, which is at the heart of how we win.
We also do this through scale and integration and investing in the unique capabilities we have in place to drive it. Finally, through our disciplined portfolio management. That leads you to one of the strongest free cash flows in the industry. Our strong return on invested capital is growing, and 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 and sustainable value creation for our owners. With that, I'll turn it back to Greg.
Thank you, Mark. As usual, we've got a number of people on the line this morning, and we'd really like to get to as many questions as possible. I ask you to please limit yourself to one question and one follow-up. Marguerite, with that, we are ready for questions.
Perfect. Thank you. If you would like to ask a question on the telephone, please press star one. We can now take our first question from Vincent Andrews from Morgan Stanley. Please go ahead.
Thank you. Good morning, everyone.
Morning, Vince.
I'm 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 first half of the year, so sort of recently. We are expecting some impact there as they bring that capacity online. I would remind you that while they added a lot of capacity, demand growth has been incredibly strong in this business, underlying market's 5%-7%. There's a lot of pent-up demand because capacity wasn't available. We're seeing sort of a leap in demand just because there was the need to use this product. Rosin to resin conversion is accelerating as the market is looking for an odor-free, water-white kind of adhesive, which you can't get with rosins. It's important to keep in mind the rosin market's as big as the resin market.
All those things come together to give us confidence that demand will fill this plant out relatively quickly. There are some limitations on how we can manage price upward right now relative to an increasing raw material environment with oil increasing. Overall, it's actually playing out as we expected.
Okay, great. Curtis, if I could just ask you on the free cash flow, just looking at the cash flow statement, I kind of recall this either happened last year or 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. One, sort of why is that happening? Two, 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. It's normal for our seasonal increase in working capital the first half of 2018. It's probably a little more dramatic this year than the last year just because of the rising raw material environment. As well as quite honestly, just stronger sales, which is a good problem to have, by the way. As you think about those stronger sales and higher input costs flowing through the system, that did have kind of a net negative impact on 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. 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 operational incident, we do expect some of that more in the second half, whereas the costs are pretty much now behind us. Also, don't forget, we expect a reduction of capital expenditures of $100 million for the year. You only saw $30 million of that in the first half of the year. You'll see a $70 million impact of reduced capital expenditures the second half of the year on a year-over-year basis. Again, we remain on track to generate $1.1 Billion of free cash flow in 2018, continuing to demonstrate the quality of the portfolio and our capabilities. There's been no material change in our free cash flow goals, we're excited about what we can deliver.
Just to be clear, that was $1.1 billion?
I'm sorry. Yeah. To be clear, $1.1 billion free cash flow. Sorry for the slip.
All right. Thanks very much.
We can now take our next question from David Begleiter from Deutsche Bank. Please go ahead.
Thank you. Good morning.
Morning.
Mark, since you last gave guidance back in April, FX and spot ethylene margins have gotten worse. 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?
Well, thanks, David. 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. We feel great about what we're doing on earnings growth. The second half is a bit different than the first half. As you noted, with ethylene, the prices of ethylene are quite low right now. We've made all these investments and changes to avoid basically participating in that spot market, and not incur those negative margins. That's actually quite helpful. Of course, you have less volume you're selling relative to last year. That's a change from where we were in April. When you think about the specialty businesses, very much on track, consistent with everything we said.
We see strong volume and variable margin growth. Some of that's tamped down a bit by the growth investments we're making, and that are accelerating as we go through the year. That weighs a bit more on margins in the back half versus the first half. You see a bit of that dynamic going on. Overall, it feels like we're very much on track and that ethylene headwind is not as material an event. 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. 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. Mark, just on Advanced Materials, you didn't get any pricing in Q2. Where do you stand in that segment in price versus raws?
First of all, Advanced Materials had a great first half of the year with 10% earnings growth. 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. 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 offset by increased growth spend. Just to step back to the corporate level for a second, we've told you that we are increasing our growth spend between the new operating assets we're bringing online, like Tritan and our PVB asset in AM, as well as our Crystex plant and ketones expansion in AFP.
Overall, we're at the high end of that range of about $50 million of growth spend for the company on an annual basis. That actually divides out across the segments, roughly $25 million in AM, $20 million in AFP, and about $5 million in Fibers of additional spend. When you take that sort of 25, and realize it's ramping up, not much of that was in the first quarter, but it's ramping up into third through fourth. The margins of mix improvement that we delivered year-over-year and sequentially were offset by about 100 basis points of higher growth spend in the second quarter. That sort of nets each other out, and the great thing about that is it turns into fixed cost leverage as you move forward.
We don't expect the same step up in growth investments next year across the company that you're seeing this year. There'll be some carryover from this year, of course, but there's no big next step in terms of growth margin leverage. That sort of deals with some of the margin story. 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 in 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.
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. 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 JPMorgan. Please go ahead.
Thanks very much. In your commentary, I think you said that because of some supplier difficulties, it cost you $25 million, and maybe there's another $25 million from turnarounds. Basically, are you saying that you would have earned $50 million more in the second quarter if you hadn't had these events? And maybe you can place that in context. In other words, 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. To answer your question, if you take second quarter by itself
The supplier disruption cost us about $25 million, the maintenance spend was $20 million. If you didn't have both of those events, yes, our earnings would have been up $45 million. Normally, if you look at total maintenance for this year compared to last year, it's about the same. This is more about timing within the year. That's why it was more of $20 million in the second quarter. Greg, did you want to add to that?
Just from a planned maintenance standpoint, it was about the same.
Correct.
The supplier disruption was certainly in addition to what would be normal for the year.
Correct.
Okay. For my follow-up, the conceptualization of Eastman by management is that the quality of the business is getting better, there really hasn't been any material change in the overall gross margin of Eastman. 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%? Is the idea that the natural rate of volume growth will be faster because of the new initiatives you have, there isn't really much margin difference?
Yeah. Jeff, no, the idea is very much that the gross margins are going to get better. Certainly, if you exclude the operational outages, I'm just going to make this on a full year basis, Jeff.
Yeah.
Exclude the operational outages that we've incurred, and think about that $50 million of gross spend that we're investing for future growth this year. The gross margins this year are quite better. 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. The variable margin grows, creates leverage, fixed gross margins will improve. There's every intention of those gross margins are getting better as we move forward.
If I could add, Jeff, two things. Just, yes, we do expect then that volume growth better than market because of the innovation program. I'd also remind you, because it worked the opposite way, as 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.
Okay, great. Thank you so much.
We can now take our next question from Aleksey Yefremov from Nomura Instinet. Please go ahead.
Good morning, everyone. Thank you. Could you give us an update on your Crystex technology project? Where does it stand currently?
Sure. Crystex 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 from anyone, including our own historical technology. Much better thermal stability, much better dispersion. Customers are verifying and validating significant improvement in their manufacturing efficiency using the product. Feel great about the program.
Thank you, Mark. Then just to follow up on the comments on refinery-grade propylene, what are you actually doing there? Are you adding capacity to convert refinery grade to chemical grade? Is it some new capability that you're adding? Could you just explain what's happening there?
Sure. It's been enabled by the shutdown we just completed. 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. The great thing about this story is we had to make some large capital investments, as all of you know, in our two smaller crackers for safety reasons. This was the second 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. It's a modest capital investment that normally would have cost a significantly more amount of capital, taken a lot longer time to do.
Now we can do it quickly and have it online by the end of the year. It's a great flexibility. 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. Reduce 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 especially propylene derivatives. It sort of gives us the flexibility to be out of that market. It's very flexible to switch back so we can move back towards ethylene if the prices get attractive. As you look at it, when the ethylene export capacity comes online in 2020, it probably will be attractive again.
Great. Thank you, Mark Costa.
Next question comes from P.J. Juvekar from Citi. Please go ahead.
Yeah. 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 it impact your sale process of the crackers? Have you thought about shutting down the smallest cracker?
Well, I'll start with the sale process, P.J. This is Curtis. Just a reminder, again, I want to reemphasize what Mark sort of said. Our crackers are still good, reliable assets that create that competitive advantage for our high-value propylene derivatives by leveraging shale gas. The primary objective of our recent efforts was to monetize our excess ethylene position and in potentially certain ethylene derivatives to eliminate the earnings volatility that came from those 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.
To answer your question on the crackers, we are shifting the mix hard. We are going to reduce rates on the crackers. 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 than normal, which is great, even though we're reducing the cracker run rates and avoid selling ethylene in the market at these prices.
Thank you. 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 talked about pricing reduction in heads-up display products. What's going on with pricing in Tritan and Saflex and other products in that segment? Thank you.
Yeah, as I mentioned earlier, we're managing a complex mix there. 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, those sort of net out and then prices didn't increase. What I said is they increased across the polyester spectrum, we are increasing prices there and keeping up with raws. No issue there. Doing a great job by the commercial teams there. We did intentionally reduce prices on the interlayer products. That sort of netted out.
Thank you.
We can now take our next question from Arun Viswanathan from RBC. Please go ahead.
Morning. Thanks. Morning. Just curious on the outlook here. You have a slightly lower tax rate. I guess that's on our math around $0.03-$0.05 or so. You're still guiding to the midpoint of the range. I guess, would you characterize potentially some of the swing factors maybe for us? I guess, is it mainly FX? I guess some raw material headwinds, or how do you kind of look at that?
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.
From a second half year point of view, first of all, it starts with a tough comp. Last year, we had incredibly strong volume, in some areas of the company, the solar films that we mentioned to you, and the share gain we got in the second half of last year due to environmental enforcement, in AFP. As well 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. Of course, we're not selling ethylene. We sold a bunch of ethylene last year at some margin, and this year we're not selling it. Those all create a tough comp relative to last year. That's the largest difference year-over-year.
Second is you've got the higher growth spend this year that's been accelerating through the first half of the year and continues into the second half. You have some margin coming off in adhesives, as we've discussed a few moments ago. Those all sort of play into why the second half doesn't grow as fast as the first half. As Kurt noted, currency is in the tailwind. They're all dynamics. They don't give us any concerns. We still feel we're on track to deliver very strong growth this year and well-positioned to grow into next year. Got to remember the operational problems, unplanned, and the growth investments are all fixed cost leverage next year as we continue to grow variable margin.
If I could add on top of it, when I think about the second half of the year, Arun, the way I look at that is that some moving parts that Mark described, but generally speaking, our outlook for the second half of the year hasn't changed. On top of it, you have roughly $0.05 benefit from tax. That's how I look at the outlook for the second half of the year.
Yeah, we think we'll hold on to that benefit on the tax side.
Okay, great. 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, the good thing is I would argue we've come up with a pretty creative option deal with ethylene right now. 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. We've done a pretty creative thing now. That buys us time to see how market conditions improve and see whether the sale option comes back to life or other options may be available to us. Right now, I think we've been pretty creative in dealing with our excess ethylene issue.
No, I understand. Just wondering if you would potentially consider constructing a PDH unit. Thanks.
We're not looking at capital deployment on the Chemical Intermediates side. We always develop that construction 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 Fibers, so that's where our capital's focused, plus both on M&A, if it's not share purchases.
Thanks.
We can now take our next question from Bob Koort from Goldman Sachs. Please go ahead.
Thank you. Good morning.
Hey, Bob.
Morning, Bob.
Morning, Bob.
One of the giant guys over in Germany had some comments today that I thought were kind of interesting. I'm curious about the Eastman philosophy. 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. 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?
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 your customers, because you want to capture the value for the products that you have. You want to treat your customers with respect because they're aware how raw materials change both up and down. 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. You have to, in the tires business, the coatings business, the glass business, you got the same set of customers for a very long time.
That has to be a very collaborative relationship that includes working on innovation. Yeah, you are careful about how you manage price, and you want to provide price stability to them. When raws go up, you increase prices, but you do it carefully, and you don't be abusive about it. When raws go down, you hold onto some of that value, but ultimately, you have to share some of it. 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 and 2016 and how we've managed it over the last couple of years. 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 been able to keep pace with raws and distribution costs. I think I've thoroughly covered the AM discussion on that topic, where we're doing great in the polyesters and made some intentional choices to improve mix with our interlayer customers. Yep, you got to think about that and be very careful in what you do.
Then you acknowledged that there had 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 a one-time correction because they're under a little bit of pressure? Can you give us some help there?
Sure. The nature of that business is, as we shared with you at Innovation Day, that the price difference between our premium products and our sort of standard products in that segment are quite different. As you gain scale and efficiency 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. Your cost efficiency is also higher from a fixed cost leverage point of view as they grow. From a margin point of view, you're not taking much of a hit. You do have to share some of that sort of value created by them buying a lot more with some price reduction. 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. If you go back to what we were negotiating in the fall, raws have come in a bit higher than we expected this year. The key drivers for raw material prices for interlayers is international ethylene prices, not local, and acetic acid prices, because we're buying VAM and PVOH. You can imagine that's created some pressure relative to where we thought we were last year. That's part of the story, but the key thing is focus on the 9% volume in mix. That is a significant upgrade in margins. When you back out the growth investments, the margins are great.
Got it. Thanks very much.
Next question comes from John Roberts from UBS. Please go ahead.
Thank you. Good morning.
Morning, John.
In Chemical Intermediates, you noted higher pricing in acetyl derivatives. Celanese 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?
First, acetic acid is not a priority business for us. We have a huge acetyl stream that is focused on producing acetic anhydride. Acetic acid is a co-product of our downstream derivative operations that we have to sell to sort of clear the system. We're not in the global acetyl business like some other people are. We're really in a sort of North American centric acetic acid business where we're clearing out the co-product in our operations. Just entirely different business model relative to what Celanese referred to. The reality is just prices are higher in acetic acid right now due to decent demand growth in that business as well as a number of supplier outages, both here, including us for a while, and BP and people in China.
That's really driven the improvement in acetyl pricing for us versus the very different business model that Celanese has here. Because even our acetic anhydride isn't about selling it, right? It's about converting it all to specialties downstream, and we sell what's left over. It's just entirely different business model.
Secondly, do you need to make a bolt-on acquisition at some point in specialty ag chemicals? 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 Eastman businesses.
Yeah. It's a great business, and it was under-invested in, especially on the animal nutrition side. 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 theirs. We feel good about what we're getting done on 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&A. We're very disciplined, so we'll have to see if there's M&A out there in the marketplace here and other places that we're looking that meet our financial criteria, not just our strategic ones. We continue to look for those opportunities, but we're going to be careful we don't overpay.
Okay. Thank you.
Next question comes from Jennifer Sheehan from SunTrust. Please go ahead.
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, Primary demand in the marketplace continues to be solid around the world. Obviously things like tax reform and less regulation here, recovery in Europe helps. Concerns around trade are creating some caution, Overall, net good. Most importantly, we're focused on creating our own growth, Have demonstrated our ability to grow sort of two to three times the underlying industrial production rates. 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. Can you talk about the BP distribution agreement that was announced? What was the strategic rationale for that, and how do you expect it to impact your business?
Yeah. As I mentioned, Acetic acid is not a on-purpose business, it's a co-product. We already have a relationship with BP at our Texas City site. We were 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, It just made sense.
Thank you.
Next question comes from Laurence Alexander from Jefferies. Please go ahead.
Good morning. Two questions. One, can you quantify the spread between price and raws, excluding Chemical Intermediates or in aggregate? Secondly, are you seeing any signs of an inventory overhang in either crop chemicals or automotive, and I guess on automotive, particularly in Europe, I guess any perspective on those two markets?
I'm going to answer your second question first, then ask for clarification on the first. On your second question, Laurence, 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. 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 and CI, they've done a great job of managing price relative to raws in distribution costs. Their margins per kg are up a little bit. To remind you, as Curtis noted, when raw materials go up and you hold your spreads constant, your margin percentage goes down, because it's just of the math. We're doing a great job in those two areas. I think we've thoroughly discussed the AM topic on how we're managing the total margin there. Overall, I feel like we're in better shape than we ever have been on how we're managing price relative to raws.
Okay, thanks.
Next question comes from Kevin McCarthy from Vertical Research Partners. Please go ahead.
Yes, good morning. Mark, 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?
For this year, it has no impact. We have to incrementally increase our propylene purchases relative to last year with all the actions that we're taking. Even though we're obviously reducing our cracker run rates to some degree and not selling ethylene, through the combination of actions we've taken, we're not incurring a material increase in purchased propylene costs, which is great. Second, with the RGP investment next year, we would buy less propylene than this year because of leveraging the RGP to make propylene. It mitigates some of that exposure for us, improves our spread exposure by getting into the RGP, PGP game versus propane to propylene, and reduces ethylene production. It's a win on all fronts.
Kevin, 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 see some of the additional costs from the crackers running at reduced rates. Generally, a good positive, mostly in CI, little hurt in AFP going forward.
That's helpful. 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 think about 3Q versus 4Q there?
Yeah. I think if you look at the seasonal trend, Kevin, yes, there's some spillover, but we're expecting some of that to moderate, and you'll see most of that seasonal impact in the fourth quarter.
Okay. Thank you.
Take 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. Was there a comment that you're looking to accelerate share repurchases in 2018? If so, could you share your target here? I know you have the $2 billion share repurchase target for 2018 through 2020. Maybe related to that, in your slides, it mentions a $300 million debt reduction target for this year. I want to say that used to be more like $350 million. Is this just a case of a little bit less debt reduction this year, a little bit more repurchases? Thanks.
Yeah, Matt. First of all, it starts with $1.1 billion of free cash flow. 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. We're targeting $300 million this year versus we did $350 million last year. You got the combination of growth in 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.
Great. Thank you.
I would just emphasize the $1.1 billion of free cash flow as we wrap things up. 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. Obviously, the cash has been great, and we will continue on the track that we committed to in the beginning of the year.
Thank you.
Okay. Thank you. 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.