Eastman Chemical Company

Good day and welcome to the Eastman Chemical third quarter 2020 conference call. Today's conference is being recorded. This call is being broadcast live on the Eastman's website, www.eastman.com. We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Please go ahead, sir.

Thank you, Malia, and good morning, everyone, and thanks for joining us. On the call to me today are Mark Costa, Board Chair and CEO, Willie McLean, Senior Vice President and CFO, and Jake Leroux, Manager of Investor Relations. Yesterday after market closed, in addition to our third quarter 2020 financial results news release and SEC 8K filing, we posted slides and related prepared remarks in the investor section of our website, www.eastman.com. 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 third quarter 2020 financial results news release. During this call, in the slides and prepared remarks, and in our filings with the Securities and Exchange Commission, including the Form 10-Q filed for second quarter 2020, and the form 10-Q to be filed for third quarter 2020. Second, earnings referenced in this presentation exclude certain non-core and unusual items and use an adjusted effective tax rate using the forecasted tax rate for the full year. 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 a third quarter financial results news release. With that, I'll turn the call over to Mark.

Thanks, Greg. Before we answer your questions, I want to take a few minutes to make some comments. We've had a strong recovery in the third quarter and solid performance through the first nine months of 2020, despite the challenges associated with COVID-19. Our employees around the world have done a great job of taking actions necessary to keep their coworkers and themselves safe and healthy. We remain steadfast in this effort, especially as we see a resurgence of COVID-19 and continue to be committed to building more inclusive teams so everyone can fully contribute at work. As we think about the impact of the pandemic on our business, we're leading from a position of strength with our innovation-driven growth model, which continues to be at the heart of how we win. As we move through the third quarter, demand across our business has improved, particularly for markets most impacted by COVID-19, especially auto, building construction, consumer durables, and some other markets. Our earnings were strong with almost a 60% improvement from the second quarter, driven by innovation and market development, and the outstanding work of Eastman employees as they navigate this challenging and unprecedented environment. Additionally, we made progress in our plans to generate $25 to $15 million of licensing technology earnings over the next few years, with $14 million of earnings in the third quarter. In-markets are recovering as the third quarter reflected a strong improvement. We saw a 10% sequential recovery in volume and mix from Q2 that got us back to within 5% of last year, which was limited by our planned shutdowns in CI. On a nine-month basis, our volume and mix is down 6%, which is well above underlying markets. This resilient performance is due to our robust and diverse in market positions and the strength of our innovations. We realized a strong improvement in our most impacted and mixed impacted markets. In our resilient markets, the benefit we enjoyed in the first part of the year moderated as expected. That said, volume in our resilient markets is approximately flat year over year through the first nine months. We see continued momentum in October and into November. Based on what we know today, we project that volume and mix of Eastman will approach fourth quarter levels of 19. A testament to the resiliency of our portfolio and the great work of the Eastman team has done to mitigate the impacts of COVID-19. All that said, we continue to be focused on what we can control. Across the portfolio, we continue to create our own growth through our innovation-driven growth model. Whether it's in performance films, specialty plastics, or architectural coatings, among others, we are performing better than our recovering in markets. Prepared remarks are shared with you how we're leading the way in innovation market development. I'm excited about the early strong customer engagement with a new potentially revolutionary product in architectural space, which has the potential to become one of Eastman's top three growth platforms. We've expanded our paint protection portfolio by launching a black PPF, expanding our position from clear products to opaque, a market with tremendous growth. In a world where sustainability is driving consumer behavior, we've had a number of wins across our sustainable product offering that leverage our innovative molecular recycling technologies. Assuming economic conditions remain as they currently are, we expect our fourth quarter adjusted EBIT will be similar to the fourth quarter of 2019 adjusted EPS of $1.42. If the volume of mixed strength in October continues the remainder of the quarter, our UPS could be above the prior year. Obviously, there's uncertainty of the impact of COVID resurgence, but we expect to provide an update in Q4 December. Finally, on cash, we've made a priority given the uncertainty. We've done a great job managing working capital and, in particular, inventory. As a result, a free cash flow for the first nine months is the highlight of our company's history. and we are on track for a fourth consecutive year of greater than $1 billion of free cash flow. All this gives me confidence we continue to be well-positioned to manage in this uncertain environment and deliver long-term attractive earnings growth and sustainable value creation for our owners and all of our stakeholders. With that, I'll turn it over to Greg.

Thanks, Mark. Malia, we are now ready for questions.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star 1 to ask a question. We will pause for just a moment to allow everyone an opportunity to signal. Our first question today will come from Jeff of JPMorgan. Please go ahead. Your line is now open.

Thanks very much. In your script, you say that the impact of lower capacity utilization was 60 million in the third quarter versus 140 in the second quarter. And then I think you also said that You thought your volumes in the fourth quarter year over year wouldn't be so different than what they were last year. And you also said that earnings would be flat relative to last year. But if you have a 60 million penalty in the third quarter and that seems to go away in the fourth, shouldn't you just earn a lot more in the fourth quarter?

So, Jeff, this is Willie. So let me start with the response. As you've highlighted, in Q3, we had a headwind on a year-over-year basis of roughly $60 million. And what I would highlight, in Q3, we actually sequentially reduced our inventories about 5%, while volume was increasing 10%. As we think about where we sit at this point in time, we see... volume levels being similar and approaching last year's level, while we expect, I'll call it, to slightly have higher capacity utilization. So, as we think about the year-over-year performance in Q4 and or sequentially, we should have a slight tailwind, but it's not a full $60 million impact because you'll have to recall that volume was down quite substantially on a year-over-year basis, whereas it'll be coming back. So you have to take the volume component of that that partially offsets the $60 million.

And look, the cost actions we took, Jeff, and good morning, Jeff, as well as improving utilization certainly is going to help the quarter. We said volumes are going to approach 19 levels, not get all the way back there. So we're seeing great recovery in the you know, the auto markets and BNC, et cetera. But you also have some markets that are off, like aviation, some specific coating additives in China that are still in the process of recovering. So we have a few markets off, netting out some of the recovering markets, and the ones that are off are very high mixed value. So, you know, it's strong recovery, great momentum as we go into 21, but not quite all the way back on the sort of volume mix side. And you've got a bit of spread pressure as well as you go into the Q4 number. with the improvement in increase in raw materials and energy costs. We've got some, you know, price contracts that lag and how you catch up to that. Not a problem over time, just, you know, in a quarter you get caught in that lag and some of the competitive pressures and tires. So when you net it all together, you know, we definitely see a way to get back to 19 levels in earnings and potentially better if, you know, if the strength holds up, but obviously with COVID-19, you know, lockdowns in Europe, et cetera, et cetera. We're going to have to see how that, you know, plays out.

Okay. You said you have a goal of $25 to $50 million in licensing revenues. And through the first nine months, I think you reported $18 million. So does that mean there's, you know, $7 million to go on the bottom end, or is this 25 to 50, some kind of annual number.

Jeff, just to refer back to our January call, the 25 to 50 million was between 20 and 22. So what I would say is this is great progress by the team. We're delivering on that front. And what you should expect is we'll probably have the confidence that we're at least in the middle of the range. And over the next couple of years, we can deliver on top of that.

Yeah, it's a great multi-year program, Jeff. We have a lot of incredibly valuable technology, some of which very much is on strategy for where we're growing our specialties and some of which we've developed over time that doesn't really fit with where we want to go. So this is an MAG technology that allows you to successfully convert through gasification, coal gasification, into making a high-quality MAG product, which the current technology in China does not do. So we've seen strong engagement, and this is the first license to sort of do this. Obviously, there are other companies who are very interested in being in the MEG business in China. So we expect to get, you know, more of these licenses in the future, building on this first one. And then there's other normal licensing activity we have and some of our other technologies that are a little bit, you know, lower in value per license. But this is, you know, a great example. It's a little chunky when it shows up. but it is one we would expect to repeat again and again in the coming years.

Okay. Thanks very much.

Thank you. Our next question will come from Bob Court from Goldman Sachs. Please go ahead.

Thank you very much. Mark, you talk about the October conditions prevail for the quarter. So does that mean Better than typical from a seasonality standpoint, when I would presume November and December are usually weaker months, or does it just mean typical seasonality from that October level, trying to sort of gauge what you've baked in in terms of what may or may not be atypical this fourth quarter?

Yeah, this is in the atypical category, Bob. So normally you have a really strong third quarter and second quarter, and then things trail off into the fourth quarter as people – you know, we as well as our customers sort of destock, you know, for cash reasons and, you know, the primary demand in some markets like BNC and other things, you know, slow down. So that's normal. You know, on a primary demand basis, some things will still slow down like building construction to some degree, but even that is, you know, showing some more strength than normal because of all the delays that occurred in the summer. So primary demand seems a little bit stronger, but the more significant driver of why we're going to have much better performance than a normal seasonal pattern is a number of our customers were like us, aggressively destocked inventory through the summer. I think we can all acknowledge and see the demand came back in the third quarter better than we expected. So people are really tight on inventory. The automotive companies are really tight. BNC is obviously very tight relative to the way demands come back, and that's true in consumer durables and a bunch of other markets. And so what you see is people trying to build back to normal inventory levels. I don't think they're trying to build to something excessive. They're just trying to get back to stable, natural inventory levels to support the better demand than we probably expected in the second quarter. So that's all sort of good news. But normally, you know, you've got this destocking going on. Instead, you've got this sort of restocking back to normal levels that we can see. So that's going to give us a lot more stability, especially true in AM. We're seeing this both in the auto side as well as some of the durables. But also true everywhere else. I mean, we're running utilization flat out in CI. You know, a number of products we're running flat out to support, you know, this demand and building action in the quarter. Does that answer your question, Bob?

Yep. Yeah, absolutely. I mean, obviously, typically the fourth quarter, the stock ramifications can be pretty negative, but it sounds like just the reverse this year. As you look to next year, your cash flow has been very impressive. As you contemplate having to rebuild that working capital in your own franchise for next year, have you sort of reconciled what that might be, what kind of drag on cash flow that could be for next year?

Bob, this is Willie. Let me highlight, you know, we have factored, I'll call it, in the increased business activity, but I'd also highlight to you that we've made significant progress this year on, I'll call it structurally, changing the levels, and we're making investments in our integrated business planning on an advanced level such that we, you know, ultimately have a pathway to preserve the gains this year and mitigate any headwinds on inventory with business activity. Additionally, I would highlight that we will continue to leverage our accounts receivable and accounts payable programs. So as I sit here today, I see a pathway to a fifth consecutive year to greater than a billion in free cash flow.

Some of it is a natural head bob where you've got earnings improving, You know, an inventory, you know, to some degree will come up, but lesser than in the past because of the investments Willie made. But those sort of naturally had each other, right? So if the EBITDA grows, you know, the inventory comes, the value of the EBITDA is greater than the cost of the inventory, and that sort of balances each other out. CapEx will be a little bit higher, too, as we start ramping up some of our circular investments. But we've modeled this a lot and netted it out. We think it's going to be roughly, you know, sort of similar to this year.

Thanks for the help.

Thank you. Our next question will come from Matthew Dio of Bank of America. Please go ahead.

Hi, yes. So performance films seem to have somewhat of a blowout quarter. Why are we seeing so much demand for window tinting? Is this expected to continue or is there some sort of pent up demand trend that wouldn't necessarily be obvious kind of on the back of all the lockdowns?

Yeah, well, let's start with Performance Films had a blowout a couple of years and a blowout first nine months of the year. So, you know, on the first nine months, their volume mix is only down 5% in a market that's down 20. And they're up year over year in the third quarter. So they're having a great year. And it's a combination of things. One, the window film business is very solid and always growing. Two, our paint protection films are growing tremendously fast at very high values. That marketplace has just taken off, and we've talked to you about that over the years, and now we're even expanding from just clear into black or opaque products as we go into next year, which is going to give us a whole new addressable market. So a lot of growth potential there. But it's not just that. The bigger part, frankly, is an excellent channel strategy and a service model. We have an incredible team out there, especially in the key markets we serve, like North America, China, and the rest of Asia. that have instituted a far superior model in how we support both the aftermarket dealers, but also building these auto dealership programs where they can now sell these products as a value up with the car, which they're always looking for, and where we sort of train, develop, support them in doing that at the auto dealerships. And we have huge relationships with the top two auto chains here in the US, as well as the big auto chains in China. It's a combination of multiple things that's getting us to win great products, great new markets growing, but an excellent service model that gives us durability. And now we're going to add on also a whole new digital tool that dramatically improves the installability of the product with the installers, and that's very attractive and launching as we speak.

All right, that's helpful. And I was interested – to pick your brain a little bit more on the new market for the heat transfer fluids. I mean, I think that's one of the higher margin businesses in ANF or yeah, in INFP and clearly expectations are pretty soft on the aero side. So can you talk maybe about growth there and the margin profile associated with that growth?

Sure. So if you go back, you know, five, 10 years ago and say, what was the business? It was primarily heat transfer fluids for chemical plants like polyester plants, et cetera. And that was really the predominant source. Very attractive business, lots of growth in China consuming it. But the market, in markets have dramatically diversified. The first big new market was solar. So you have to use, when you heat up these panels, these reflective panels out in the desert, you got to get the heat transferred to the turbine engine and our fluid does that. So solar has been a huge driver of growth for us over the last few years. And a new market that's really taken off for us is LNG. So they also consume and use these products in those facilities, and that's added on a whole other dimension. So while some of the traditional chemical markets, you know, are slowing down a bit, obviously with different capital cycles, you know, we are seeing these other markets deliver growth and enable us to have a lot more stability as well going forward in this business.

All right, thank you.

Thank you. Our next question will come from PJ Yuvikar from the Citi Group. Please go ahead.

Yes, good morning. In CI you mentioned that you're running flat out. Where are propane to propylene spreads? And also you're using more refinery propylene. How did all that play out in the quarter? And then just in CI you also have a smaller ag business. How did that do? I guess last year you had some tough comps. I guess this year should have more stability in that ag business. Thank you.

Good morning, PJ. Just first on the spreads, obviously as we think about the integrated spreads to our derivatives with raw materials increasing here during the quarter, our pricing lagged. So there was, I'll call it, some compression within the olefins Obviously, on our RGP investment, we're still very positive on how that has provided a return and paid off and given us a little more stability. But again, I thought the key thing is it's slight compression. And we also, at Highlight, had some, I'll call it, planned turnarounds, like at our Singapore facility. That will give us some opportunity for a little bit higher volumes than we had in Q3 as we come out of those planned turnarounds.

And in ag, you know, seasonally ag always declines for us in the third quarter, PJ. You know, there's a lot of build to, you know, get the products to the customers, the farmers. And by the third quarter, you know, the planting's over. So, you know, that always turns off for us. But this year was also more of a headwind than normal because one of our largest customers there had a very long shutdown period. in the quarter. And so that has a real mix impact. It's not just a volume impact on CI because the means business is very high value attractive business in CI. And so you feel both on the volume and mix. Some of it normal, some of it was unique to this quarter.

Great. And, you know, in your prepared comments, you talked about molecular recycling. Clearly, there's something that the world needs today. You talked about, you know, that the happening in Trion and Nya yarn fiber. Can you talk about what are the inputs to this molecular recycling, you know, and was the product quality and, you know, when does it become economical? Thank you.

Sure. So we're incredibly excited about the circular economy. You know, over a decade ago we've been focused on sustainability and how that is a critical driver of change and innovation in our industry. We saw that all the way back to Triton when we were launching that in 2009 around health and wellness. natural resource efficiency, feeding a world. All those trends have been core. You've heard us talk about all of them and essential to our innovation. In fact, we require every new product development program to be connected to something sustainable if it's going to be durable. That's been true for the last decade. The circular economy is a whole new dimension of growth for the company. We're really excited about it. The reality is plastic waste is a crisis. It's just also ridiculous to waste that much carbon in the environment. We should be capturing it, keeping it in the environment, and reusing it. A lot goes into making that happen, and we can play a critical role in that. Obviously, a lot of infrastructure outside of our scope to get it to us, but we need to prove that it can be, you know, reprocessed, reused effectively. You know, mechanical recycling, which is the way it's done today, you know, is very energy efficient, so wherever you can do it, you should do it. The problem is it requires extremely clean feedstock, And it has limitations on its quality as well as how many times you can reuse it mechanically. So while important, very limited to solving the total plastic problem. So molecular recycling is required. It's not an option. It's required to actually solve the plastic waste problem. And we're excited because we have two technologies that are commercial now that are going to prove that it's both commercial and scalable and economic returns for our shareholders to do so. And so those technologies, the first is what you were mentioning around cellulosics. So we have the ability to do reforming with our gasifier. And so instead of gasifying coal, we can reform waste plastic and return that into feedstocks for making our cellulosic plastics. That includes our NIA yarns as well as the thermoplastics we sell, especially plastics. And it's a huge opportunity. We already were picking up a lot of momentum from sustainability on these products because You know, in the orange, 60% is bio content from, you know, FSE certified, sustainably grown forests. That alone was driving a lot of growth for us. I mean, if you look at women's wear this year for us, our volume is flat relative to last year where the market's down 30%. So we're seeing tremendous success there in that part of the market. And that also will go into thermoplastic. So we, you know, are the largest player by far in ophthalmics, you know, sunglasses, eyewear. for the high-end plastic that goes in those frames. Marshawn, one of the key leaders in that market, has already launched with us using our recycled content to have that offer. So we see a lot of opportunities to grow the cellulose plastics, even opportunities in electronics, toys, even significant plastics is an opportunity in a market that we see. So on that side tremendous opportunity a lot of growth it allows us to grow in existing applications It allows us to grow new applications like electronics where we're not today and opaque applications And it comes at a higher margin and the polyester technology is the same thing PJ you know we've got our Try your new product already getting orders from two iconic brands like Camelback and Nalgene We have a number of customers working with us in cosmetics in ophthalmics as well, durables, more hydration customers, as well as single-use plastics. So we look across those two markets. As of now, we already have 100 customers doing trialing with us across all these different markets and opportunities around these two technologies to grow the volumes as well as get a better premium. And we know we can get the better premium. We're getting it now. And if you look at a better, broader market about how important this is, food-grade PETs, recycled in Europe is going at a substantial premium to sort of virgin PET. So markets are willing to pay and support the investment necessary to solve this problem, so a great return on investment for everyone. So we're really excited about this. We think it's a great way to defend our existing business, grow our businesses, and solve a real challenge in the world that we need to resolve. Great. Thank you.

Thank you. Our next question will come from Alex Yefremov of KeyBank. Please go ahead.

Thank you. Good morning, everyone. Mark, just to continue on the subject, have you made any progress in your decision-making on methanolysis project? Are you any closer to investment or defining the economics for that business?

Yeah, so methanolysis is key to our strategy. It is a meaningful investment to build one of those plants, and we're close to refining and finalizing the details of exactly when we're going to build it. We're committed to making this investment. We believe it's the right thing to do. The economics are very attractive for all the reasons I just mentioned. And the January call and the fourth quarter call will provide you more details as we're just finishing up the final analysis of timing and capital scope, et cetera.

And just to follow up on that, Mark, is it fair to say that, you know, regardless of what decision you make with that methanolysis project, your kind of free cash flow parameters that you outlined for next year are still there, $1 billion plus with potential methanolysis capex?

Yeah, that includes, when we were talking about the free cash flow earlier, That includes the capo for methanol, so that's the reason CapEx would go up next year. We've already built a lot of specialty capacity, so where we believe we'll have tremendous growth, already seeing great recovery, where we could get back to almost 19 levels in the fourth quarter of this year. You've got to remember, back in 2018, we built a lot of plants, a lot of different specialty plants to support growth, and Triton, and a number of other products, ketones, et cetera. So we're well positioned in our cost structure to support growth. The one exception is the circular economy, which is relatively new. And we are completing in this year an expansion of our performance films capacity to support its tremendous growth. So I think we're in good position on that. It's really our ability to do all that is a testament to our team's operational excellence. We've made a lot of investments in the business operating model and how we operate our company in the systems on how we're managing production, and we're continuing to make more investments on this to be much more efficient in our working capital so we can transfer that improvement into growth capital.

Thank you.

Our next question comes from David Baglitter from Deutsche Bank. Please go ahead.

Thank you. Good morning. Mark, just in your cost savings, I believe about 100 million of these 150 are somewhat temporary interim cost savings. How should we think about how they flow back into the cost base in 2021? Good morning, David. I'm going to let Willie take that one. Sure.

Good morning, David. Thanks. As we think about the 150 million of actions that we're taking this year, and we've highlighted two-thirds of those are discretionary, we're trying to match those as you think about with the level of business activity. I would highlight that we do expect over the long term that some of that discretionary spend would become structural as well as we think about the leveraging of technologies and how we do business. Fundamentally, as we think about 2021, we have cost actions that include site shutdowns as well as I'll call it labor cost actions that are going to approach $100 million. And we're taking actions on those this year. So as you think about 2021, we will not only generate, you know, cost savings that offset any of the discretionary that's flowing back, we actually expect through digitization, the integrated business planning, and other network optimizations to actually give us capacity to invest in growth and capabilities. And it's with that confidence that we're gonna deliver 150 million net, but about 225 million gross as we go into 2021. And much of those actions are already in play and we're making strong progress this year so that those structural actions are in place as we start 2021. As we think about 2022, we expect that to grow to a total of $200 million net and beyond.

Very helpful. And, Mark, just on the one-third of AFMP that has performed poorly over the years, I know you suspended, in a sense, any actions during the pandemic, but if you head into 2021, first, have you been able to improve these businesses through further cost actions? And is your thinking any different about the role of this one-third of the business going forward in the Eastman portfolio? Thank you.

Thanks, David. So look, we've always been a disciplined portfolio manager. It was a while ago when we had our significant portfolio transformation. But we've sold off a lot of underperforming businesses in our history. And we've had very successful acquisitions of great specialty businesses to give the portfolio the strength, not just in the stability of revenue that you're seeing this year. And let's not forget, we started with a trade war and then COVID. Over the last two years, we've shown, I think, good resilience in the top line with this portfolio, but also tremendous cash flow with the value of the acquisitions. So I think we're good at being disciplined. And as we said, we saw two businesses, tires and adhesives, that were developing instability that wasn't consistent with our strategy, especially as part of AFP, and needed to address that. I think we've made great progress on managing the cost structures, especially in tires, where we're going to take out a couple plants and improve its cost structure in a meaningful way, as well as, and that allows us to lever up our new plant that's a much lower cost plant as well in tires. And then innovation is also going really well in both businesses. But, you know, the reality is, you know, the tires business is really challenged in the competitive dynamics. The, you know, the ADD tariffs that got put in place shoving China tires back into China, Then the broader trade war with China kicked off by Trump just created a huge drop in demand while competitive capacity was coming online, and that just created a food fight at the tire company level, as you can see, and at our level with our competitors in this business. So the volume recovery has been great in the back half of this year, and the earnings in the back half of tires will be much better than the first half. But it's still a competitive environment and a headwind relative to 19. And so, you know, that's one where we're going to do everything we can to improve the business. The innovation is giving us the ability to sustain premiums above our competitors in a meaningful way. But it's a business where, you know, we're going to continue looking for either JV or divestiture options. And as hopefully we'll get to stability at some point here with COVID and be able to sort of pursue that. But we're committed to dealing, you know, with, you know, the portfolio. Adhesives is actually holding up relatively well in 2020 relative to 19. Volume's actually up about 5%. Price is stable to the back half of 19. You know, managing cost there like everywhere else. So that business is stable. Innovation's getting a lot of great traction. Our APOs are really winning in the marketplace with, you know, superior environmental footprint as well as better sprayability and allows you to lose resistance Less resin, so great growth there. Great growth. We've talked to you a number of times about our low odor, low VOC resins that we've launched. So it's stabilizing, but we're also still looking for opportunities to improve its performance if we can through partnership and how we continue to improve that business. So we're still working it. It's not going as fast as we liked at the beginning of the year with COVID. Thank you very much.

Our next question comes from Vincent Andrews of Morgan Stanley. Please go ahead.

Thank you. Mark, maybe you could just touch on what you're seeing in building and construction. In the prepared remarks, you talked about benefiting from the DIY market. So how big is that for you versus sort of regular construction? And as we think about going into next year, I know you have some innovation. I see the Optifilm. in the deck, but as we go into next year, if DIY sort of softens a little bit, how is that going to impact the portfolio, or do you have other things that will come back to offset that?

So, good morning, Vince. How are you doing?

Good, thank you.

So, in our coatings business, roughly half of our coatings business is B&C, and half is transportation, roughly. And on the auto side, remember our Again, half OEM, half refinished. But on the BNC side, we are more weighted towards residential than commercial, which positions us well for benefiting from the DIY demand buildup. So we certainly are seeing the benefit. Our sort of additives that go into architectural paint did quite well, consistent with what you've heard from the architectural coating companies in the third quarter. So we're tracking with that fairly well. It's not a huge part of the total revenue of AFP, But it is helpful combined with the stability we're getting in care chemicals, the great performance we've had in heat transfer fluids that's offset the headwinds, or some of the headwinds, I should say, and aviation fluids. And innovation is helping, too, as we talked about in the growth story around OptiFilm. So it's market recovery. It's good positions with the winners in the marketplace that we always focus on. And a great example of the sort of resiliency of our portfolio and how it provides stability where you know, while some things might be challenged, other parts do well, and that sort of balances out nicely.

Okay, and just on advanced materials, you know, obviously the volume performance all year, and obviously what's been a challenging year has been very strong, and it seems like a lot of it's innovation-driven. But as we think about going into next year, presumably the innovation, you know, continues to compound. But are there parts of that portfolio that have struggled this year that we will actually see some recovery in next year, or is it just going to kind of be steady as she goes.

No, AM's doing really well. So I wouldn't call it struggling, but obviously demand and transportation was down this year. So we certainly took an impact in advanced materials, especially in the second quarter when our customers shut their plants down, and we shut our plants down accordingly in interlayers. So we took a hit there. Obviously, even performance films, while it did well, was still down year over year. and face some challenges there. But overall, I'd say the portfolio is doing great. I mean, it's got innovation driving growth across all three main elements of it, especially plastics has been incredibly steady through this year where things like some durables were off in the second quarter, but we had tremendous sort of COVID-driven strength and shrink for packaging that goes into grocery stores. Our Our sneeze guards, the polymer that we make has great chemical resistance for cleaning, so it's very popular for all these sneeze guards you're seeing in stores or restaurants, et cetera. You can see growth in that offsetting some of the weakness and good price stability relative to raw materials delivering good success. You've seen the snapback already. The earnings in the third quarter are better than the first quarter of this year. So we've had, you know, great snapback volumes almost getting back to last year's level with the rebound in automotive and the great performance in performance films that I talked about earlier. So I think this business is really on track to deliver, you know, a great result this year, but build on it with continued great result next year. You know, even in interlayers, which we didn't talk much about, we've launched a number of new products. We've enjoyed a lot of success with our acoustics and heads-up display premium products. We've told you we've been working on next-gen for all those, and we've had great wins on all three fronts. We've had a next-gen acoustic product with superior sound dampening just get selected by one of the leading EV OEMs out there on two of their iconic models. Noise is a huge issue in EVs because you've lost the sound of the combustion engine. So sound dampening in a variety of places in the car is critical, and the biggest place where you get sound coming into a car is actually the window So we play a critical role in addressing some of those issues. We've had a multifunctional product we've been working on that is much more difficult for our competitors to do that combines solar rejection, acoustic, and HUD all in one. And it's been just adopted by a leading Japanese OEM, and we've had great success also on our next-gen HUD. It's in trials right now with a leading German OEM that's going to be part of their augmented reality HUD that they're building, and that market will continue to grow. A lot of success there. Triton's doing great. And then you've got the circular economy piling on top of this, as I mentioned earlier, delivering a lot of growth on many different fronts. And the portfolio is diverse and gave it stability. So we feel good about that.

Great. Thanks so much.

Yep.

Our next question will come from Frank Mitch of Fermium Research. Please go ahead.

Good morning, folks. Hey, Mark, just to follow up on kind of the auto side, you just talked about acoustics and heads-up displays, et cetera. But I guess part of the reason why you're outperforming the auto OEM builds is due to paint protection that got some nice airplay in your remarks. Can you talk about the growth prospects there, I guess, and the market segmentation there? Because I guess my thought was that that was more geared towards kind of higher-end So that might suggest that you're in the early innings of being able to roll out that product as you move to more mainstream. Can you spend a moment or two describing the growth prospects there?

Yeah, it's tremendous growth opportunities, Frank. It's a segment that's been growing, and it's got growth opportunities both geographically as well as within the category. So you're right, it started out with very high-end hypercars and very expensive cars where people wanted to protect them. It's already starting to move into that normal luxury market and the mid-tier market even, especially in China. It's amazing the number of people who are interested in protecting their car, which for them is a very significant investment. And so there's a lot of growth and addressable market in front of us on the markets. And while it's growing really well in China and North America, we're at very early stages of this growing in Europe. So that's a whole other region of growth for us on top of growing the category. So we believe these sort of very strong double-digit growth rates will continue for quite some time.

So we should be dialing in greater than auto OEM growth for EMN for the near future, near midterm future.

Absolutely. In advanced materials, that's true. In automotive, in coatings, I'd say we're tracking more with the market.

Okay, great, great. And then a question for Willie. You talked about $600 million-plus in net debt paydown in 2020 implying $250 million or so. Here in the fourth quarter, how should we start thinking about 21 in terms of the priority uses of cash and expectations on debt pay down in 21?

Yes, Frank, good morning. On the capital allocation front, our priorities have not changed. We've increased our dividend for 10 consecutive years, and that's an important mechanism for us returning cash to stockholders. Also, to your point, we're committed to our investment-grade credit ratings. And, you know, 2021 will really depend on the pace of economic and economic recovery. But we will continue to stay focused on, you know, getting our debt to EBITDA ratio closer to that two and a half times. Here at the end of Q3, our net debt is about, I'll call it three times our leverage. And also, we're committed to offsetting the dilution right now. And, you know, obviously the pace of EBITDA growth will be, you know, as we think about allocating beyond that in 2021.

Got you. Thank you.

Our next question will come from Kevin McCarthy of Vertical Research Partners. Please go ahead.

Yes, good morning. Mark, you've done a tremendous amount on the innovation front in recent years, and I would like to hear more about Optifilm, as you highlighted in the prepared remarks. But more broadly, I'm tempted to ask, is there a way to quantify the benefit that you anticipate from new products, either on a top-down basis across the portfolio or perhaps bottom-up, thinking about what the top two or three contributors could be in coming years.

Good morning, Kevin. We gave you a metric called new business revenue from innovation. There's lots of new business revenue, which is when you market share and things like that, but we isolate out what comes from innovation platforms. We had a target of this year getting to $500 million. We were well on track at $400 million last year, even in the trade war. And we continue to have great engagement, even virtually with customers. We've told you about all kinds of wins we're having in this year across our product portfolio. So we feel good about it, but it's not going to be at the level that we aim for. So we'll always give that to you. And I would note that that new business innovation will build. And I think we can get back to that level, that target next year in 2021. So I feel good about, you know, the growth that we can sort of put together there. And it really fits with, you know, where I think we're headed for delivering, you know, a very attractive, you know, 2021. So, you know, Willie's told you we've got fixed costs basically flat. We've told you that we have a $100 million tailwind in asset utilization next year relative to this year. Volumes are just flat in 21 versus 20, right? Because we took all these aggressive inventory management actions this year to you know, go beyond demand to, you know, generate cash. And we're quite happy we did that. And that inverts, you know, and becomes $100 million tailwind at flat volumes. And this innovation from new business that we're just talking about here, the market recovery that you might, you know, have at some level, you know, depending on how COVID and everything plays out, you know, all create incremental growth above that. And because of the inventory actions we've taken this year, The innovations that, you know, the growth that we're getting there is above average margins for the company. Because of the inventory management we've done, you know, we don't have any fixed cost headwinds. You know, the incremental margins for growth next year are probably going to be 60%, you know, 50% to 60%. So very attractive margins. So that growth, you know, flows the bottom line. And, you know, we put out together 60 cents just with flat volume on utilization and flat costs. And then, you know, growth on top of it could get us back to 19 levels.

Okay, that's helpful. Secondly, Mark, I want to ask about interlayer films. You talked about the acoustic films and heads-up displays. Do you feel as though you're gaining market share in that business, or is it more a situation where volumes could be exceeding auto sales as a function of restocking or perhaps both of those things? How would you characterize the market dynamics in interlayer films?

Interlaracy is a great business. You know, it's more directly tied to OEM production, obviously. So as that production goes up and down, so will our, you know, volume. We still benefited and did better than the underlying market this year, Kevin, with acoustic and heads-up display, but not to the same extent as performance films because performance films is expanding its overall market that it serves. And so it's doing well, HUD and Acoustic doing well. This next-gen set of products I just mentioned are going to give us additional tailwind as we go into next year. So we feel that it will continue on a volume mix basis. It'll do well. The mix is incredibly important to keep in mind about the entire company, especially in AM. So when you're selling paint protection films or window films or acoustic or heads-up display, that's way above, you know, segment average margins in AM. including Triton and the circular economy products we're selling, same thing. So all those growing isn't just volume. It's a mixed upgrade. Okay.

Thank you very much.

Our next question will come from Mike Sisson of Wells Fargo. Please go ahead. Your line is now open.

Hey, guys. Nice quarter. Just curious, and I think I'm doing the math right. It looks like sales will be up sequentially, right? fourth quarter versus third quarter, and I apologize, I missed this, but why is EBIT, your guidance would imply EBIT is down, right? So anything I'm missing, I would have thought maybe you'd have flow through up on an EBIT basis.

So, good morning, Mike. So thanks for the question. So on the volume mix, we expect it to be approaching Q4 levels of prior year. As we think about raw materials continuing to be, I'll call it, increasing, we would expect to continue to potentially have some, I'll call it, slight spread compression as we think about our chemical intermediates and some of the AFD one-third, potentially tires. So as we think about the balance of that, also we'll have a little less of the cost actions benefits. So I'll remind you, in Q3 we had roughly $50 million. Q4 we'll have roughly $40 as the activity continues to increase. So all in, that's a sequential view as well as some of the key inputs on a year-over-year. So as we think about it, if it being similar to prior year is where we come out as we look through that.

Yeah, there's always some normal. I mean, while we don't have normal seasonality of the drops based on things I said earlier, we still demand to be a little bit less, you know, in products with some seasonality. So tremendous strength, you know, to get back, you know, to last year's levels and earnings. So I think, you know, that's a great accomplishment as we look at it, but a little bit less than third quarter.

Right. No, I agree. And then in terms of if demand levels stay, sort of around this third quarter level or second half level, and then, you know, given some of the cost-saving efforts you have for 21, where do you think your run rate level of earnings is tracking? And I know it's maybe too early to give specific guidance, but, you know, are you above 19? Are you closer to 18? Maybe just give me a sense of where earnings should maybe lay out if things stay at these levels.

Yeah, so I was trying to get at that, you know, around the growth question a moment ago. You know, assume fixed cost flat, assume a tailwind of, you know, 60 cents a share and asset utilization of flat volumes. So then you build on that with volume growth, mix improvement. You know, as I was just talking about, the power of mix is incredible in this. So it's not just volume, you know, that was the headwind this year. It was mix as a big driver because the markets that were impacted by COVID were our highest value markets. So you're already seeing the value of them coming back in the third quarter. You'll see that, you know, more progress in the fourth quarter, but next year you'd expect to get all the way back there on mix. And then the asset leverage of that fixed cost, you know, with sort of that 50% to 60% incremental margins. I think when you put all that together, there's still some spread headwinds you're going to have with pricing catching up to ROS because we assume ROS will be increasing next year with an improving economy. So you have a little bit of that as a headwind and some competitive pressure in tires and acetils, offsetting some of that growth and success. So put it all together, you know, we think we can get back to around 2019 levels, could be a bit better, you know, but there's a lot of moving parts on that. And we got to see, you know, how we get through this COVID crisis, which obviously is going to have some amount of impact. And there's the selection, there's China trade tensions, et cetera. So there's a lot of things to factor in and refine that outlook, which we'll give you in January.

Got it. Thank you.

Our next question will come from John Roberts from UBS. Please go ahead.

Thank you. You have all these great ESG initiatives. How does the SIGTOE business fit into that mosaic, and do you have to carve that out at some point, or can it coexist as you ramp up the other ESG initiatives?

So obviously we've considered carving TOE out of the portfolio a number of times, especially back in 2015. Unfortunately, it can't be carved out, John. It's so integrated into the Kingsport site and so interdependent with all the cellulosic growth we have in AFP and AM and shared assets and recycle loops. You just can't separate it. It would be a disaster. So you have to grow out of it, and that's what we're doing. So our strategy is ultimately, if you go long-term enough, replace all the tow with textiles and other applications with that growth. Obviously, that's going to take some time. But, you know, our strategy and the answer to that question when it comes up is, you know, we have to maintain the economic integrity of the company to invest in growth and support our success. So, you know, tow is part of that. But we're going to work as hard as we possibly can to grow in textiles, which also has attractive margins, and grow that business as the tow business, you know, declines over time. So that's sort of the answer to the question, and it's also a way to leverage a lot of excess tow capacity that we have right now that has great incremental margins and will grow textile against zero.

Okay, and then secondly, back to the performance films, the interlayer business is almost all OEM. Can the paint protection in the opaque films go OEM as well? And maybe just give us a little bit of parameters. If interlayer profitability is or content is 1X for a car, the opaque films go on the side windows and rear windows, so that's got to be much bigger than 1X. And then the paint protection goes on a much larger surface area, and so that's got to be even higher than the darkening films. Can you give us what are the 1X and then the interlayers and what are the opaque films and the paint protection films?

Yeah, so, John, I don't have a quick, easy answer to that question. What I can tell you, and I sort of refine a little bit about what the paint protection film is. So paint protection film comes in two versions. One is the full wrap of the car, but a lot of people just wrap the vulnerable, put the film on just the vulnerable parts of the car, the front, the side, the door handles, et cetera. So it comes in two different versions on how much you sell per car when you do PPF. And it is certainly additive when you think about our presence on a car because the interlayers is doing one thing in acoustics and HUD. The films on the windows are, as you noted, it's not just tinting. It's actually solar rejection is the big value proposition. So we saw a lot more in hot locations than cool locations because the films are much more advanced today than they were 20 years ago. And the big value proposition isn't just the tinting. It actually rejects a tremendous amount of solar heat that actually gives you better fuel efficiency since you use less air conditioning. And so that's you know additive and then you've got the PPF But we don't break it down on a sort of you know ratio basis like that It's something we probably should do and we'll take a look at that but But what we do know is we're getting a lot of present more presence on each car sold and the dealers as you mentioned are really getting interested in this right it used to be very much an aftermarket business in PF and And a lot of our growth is now in collaboration with these programs we're doing with the auto dealers where they sell it as an upsell on the car. Sometimes it's pre-installed on luxury cars so you don't have a choice about it when you're buying it. A lot of it is sort of an upsell at the point of sale. So a lot of different ways to grow. Thank you.

Our next question comes from Matthew Blair of Tudor Pickering Holt & Co. Please go ahead.

Hey, good morning, everyone. I wanted to circle back to tire additives. The Michelin data showed pretty rapid improvement in replacement tire demand through Q3. I think they had both North America and China up 9% year over year in September. So I just wanted to see, you know, does that match with what with what you have. I know your tire market is much more commercial, but any comments there?

No, we've seen the same rapid recovery demand in tires in the third quarter has been quite good and consistent with what you're talking about.

Sounds good. And then, you know, all these forest fires have caused a pretty big wood shortage, lumber shortage. Is that having any impact on, I guess, either fibers or any other parts of your business?

No, where those fires are occurring are not where we would be getting our wood. We only get wood pulp from sustainably grown forests. They're grown purposely to be regenerated and taken care of and in very different locations than where these fires are occurring in the East Coast, Brazil, different locations than the West Coast.

Got it. Thanks.

If we could make the next question the last one, please.

Our last question today will come from Arun Viswanathan of RBC Capital Markets. Please go ahead.

Great, thanks. Good morning. Thanks for taking my question. Just two quick ones. So first off, could you just remind us sequentially what was the benefit from lower EIDL facility charges, I guess Q2 to Q3? And then secondly, if you could just address maybe the benefits to Eastman from a potential infrastructure bill if there's a maybe a percent of your portfolio that's weighted there, and how potentially Eastman would be positively impacted by that. Thanks.

Sure. So if I answer the question, so I'll answer it two ways. One, which is you saw our decremental margins go down roughly 60% from Q1 to Q2, and our incrementals be about 60%. I would say over 90% of our period costs associated with our facilities basically went away in the quarter on a sequential basis as our plants came back and became fully operational throughout the quarter.

And then on the infrastructure question, it will benefit us. We're not really focused on large infrastructure projects and the kind of materials we make. We tend to go more into consumer durables, cars, building construction, but more commercial than bridges. And so it depends on the nature of what the infrastructure is. What's great about that is it just creates broader economic growth, which we're highly levered to. So while we may not be participating directly in some of the infrastructure projects, we are certainly tied to macroeconomic demand. People have more pickup trucks going to work in construction, which is good for us, et cetera. So we'll certainly benefit, like everyone does, from the improving economy driven by it.

Thanks.

Thanks again, everyone, for joining us this morning. We appreciate you dialing in and look forward to talking with you again soon. Have a great day.

This will conclude today's conference call. Thank you all for your participation. You may now disconnect.