Eastman Chemical Company

Good day, everyone, and welcome to the second quarter 2023 Eastman Conference Call. Today's conference is being recorded. This call is being broadcast live on the Eastman website, www.eastman.com. We'll now turn the call over to Mr. Greg Riddle of Eastman. Investor Relations, please go ahead, sir.

Thank you, Elliot, and good morning, everyone, and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO, Willie McClain, Executive Vice President and CFO, and Jake Leroux, Manager, Investor Relations. Yesterday, after market closed, we posted our second quarter 2023 financial results news release and SEC 8K filing. Our slides and the related prepared remarks in the investor section of our website, www.e-spend.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 our second quarter 2023 financial results news release during this call, in the preceding slides and prepared remarks, and in our filings with the Securities and Exchange Commission, including the Form 10-K filed for full year 2022 and the Form 10-Q to be filed for second quarter 2023. Second, earnings referenced in this presentation exclude certain non-core and unusual items. Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded and adjusted items, are available in the second quarter 2023 financial results news release. As we posted the slides and accompanying prepared remarks on our website last night, we will now go straight into Q&A. Elliot, please, let's start with our first question.

Thank you. As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. If you'd like to withdraw your question, please press star followed by 2. When preparing to ask your question, please ensure your device is unmuted locally. Our first question today comes from Josh Spector with UBS. Your line is open.

Yeah, hi. Thanks for taking my question. I guess first I was just wondering if you could talk about the cadence of earnings here in the second half. Obviously, you're talking about a number of inventory adjustments impacting 3Q. But if you could talk towards what you're thinking more of the steady state looks like, whether it's 4Q or maybe beyond that, and what that implies for longer-term earnings here. Thanks.

Good morning, Josh, and thanks for the question. So there's a lot embedded in that question about the back half of the year and how that indicates where we go into next year. So first of all, I'd start with, you know, we obviously in April thought demand was going to be better in the back half of the year, which was principally an assumption based on destocking, you know, really being complete by the end of the second quarter. Obviously, we and everyone else in the sector has come to a different point of view that, well, demand at the primary level I don't think is changing that much. It's not getting worse in our perspective, and I haven't heard anyone else suggest that. We are expecting that there's a lot more destocking that – continues to go on in some end markets, which has really been the impact to our outlook in the back half of the year. So some areas, whether it's this year or next year, for example, automotive, we have, you know, solid growth in this quarter. We expect that to continue to be solid through the back half of the year. And there's so much pent up demand. And when you think about 24, you know, I would expect it to continue to be a tailwind next year relative to this year. So that market, aviation, same story, you know, in very good shape. You have a lot of, you know, sort of stable in markets where demand's been off in that sort of 3%, 4%, 5% range. You know, when you look at all the, you know, fast-moving consumer goods companies out there fully recognizing that they're holding price and being very disciplined to expand their margins that way with raw material tailwinds and accepting that they probably wouldn't gain much volume if they reduced price. So, you know, discipline like we're maintaining, frankly, in our specialties. But in addition to that, they're managing cash too. And so we saw, you know, an additional sort of 8% to 12% destocking on top of that demand in the fourth quarter, first quarter. But fortunately, as we go into the second quarter, lessening on that destocking and expect much less destocking in those kind of stable markets like packaging, personal care, water treatment. So that feels, you know, like it's moving in the right direction as we go to the second half. And, of course, that would continue also into 24. When you look at, you know, the – the consumer discretionary markets actually i'm going to take two other stable markets just to deal with them so there's a couple that also um took some sort of extreme negatives in the you know in additional destocking and in q2 which was packaging and medical in the advanced materials segment um and uh that's you know they were carrying a bunch of safety stock from last year uh demand wasn't improving as they expected and so you know You know, they really started destocking in the second quarter, but they also seem to have addressed their issues predominantly in the second quarter. So that's also expected to get a bit better as we go into the back half of the year. You know, as that destocking reduces through the third quarter and certainly seems to run its course by the fourth. So, again, improvement relative to next year, especially when you think about, you know, all these markets had a certain amount of destocking that won't repeat in 24. That's a tailwind. So the two bigger markets that drive a huge amount of value for us on a profitability point of view, like automotive, that had the most demand impact is sort of in the consumer discretionary area as well, like durables and building construction. When you look at the durable market, that's the one that's gone through the most extensive destocking of any market. And it really goes all the way back to last May of last year when the retailers sort of got 2x the amount of inventory they needed because they were buying everything they could think of because of supply chain crisis. And then they started destocking over 14 months ago. That bullet finally hit us in the fourth quarter of last year. you know, really knocked us down about 40% when the underlying market was only down 10 to 15. So a lot of destocking got even worse, 10% worse into the first quarter. And then fortunately, we saw that destocking start to abate in the second quarter, got 22% better in the second quarter versus the first quarter. So we saw momentum there. You just don't see the results because of the medical and packaging destocking that occurred. So that destocking will continue to lessen as we go in the back half of the year and be another tailwind. as you go into it. And then, of course, building construction, I'd say, is one that's been doing some destocking this year, demand's down, and we expect that to be sort of flat to the first half because that market still has more action taken. There's also maybe some more hope with first home builds. So there's a spectrum of things going on when you look at it, but it's, you know, each of them sort of add up to less destocking But it's not as much as we had hoped for in April, and that's really the predominance of how our volume forecast came down, which is the entirety of our earnings reduction. When you combine that with the need to take inventory actions for this lower demand outlook to make sure we hit the $1.4 billion of demand. cash. So all those then feed into a year next year that's going to look better, right? You know, when you don't have all this destocking going on, which we're assuming for 24, you have, you know, some normal seasonality coming back into the demand outlook, you know, for next year, that's going to help improve things. And you've got the recovery of all this volume in our most, you know, sort of down markets are our highest value markets, right? So it's been a huge mix hit to us this year. And as we've shown in past recessions, you know, when the mix comes back and even if there's a little bit of restocking, the high value of these markets, you know, drops to the bottom line pretty significantly, especially with the costs we've taken out of our fixed cost structure. So it all comes together, which is building momentum in the second half to having a much better year in 2024. Okay, thanks.

If I could just ask very quickly then, So your volumes were down 15% in the first half. What's your baked-in assumption on the second half, all those things put together?

You're saying what is our specific volume forecast that we've got as a combined company for the second half relative to the first half? Is that what your question is?

Yeah. Are you assuming down 15% for the majority, down 10%, down 5%? I'm just trying to get a kind of quantum of what you're considering.

So as we look at it, I think it's altogether, you know, the volumes in the back half of the year are going to be a bit less than the first half of the year, but I don't think we're going to provide a quantitative number to it. You know, it's basically just a little bit down when you put it all together. I mean, the real headwinds in the back half of the year is the, you know, from a sequential point of view, first half, second half, the entirety of our earnings decline is the inventory management. So that $75 million of additional headwind sort of aligns with where our earnings outlook has now moved. So volumes are relatively stable when you put all the ups and downs. So some down in AFP, some up in AM, stability in fibers and CI is sort of a flat volume number from a sequential point of view.

But Josh, I would also say the mix should be more favorable as Mark has outlined with our durables markets recovering in the back half.

And if I could just add one more point, which is third quarter, year over year, the volume mix decline would be less than what you've seen in the first half, but still meaningful. When you get to the fourth quarter, again, on a year over year basis, the comp is a little bit different. And so you get to a point where that decline in volume mix is even less still than it was in the first half of the year.

Okay, understood. Thank you.

Our next question comes from Vincent Andrews with Morgan Stanley. The line is open.

Thank you, and good morning. In advanced materials and in AFP, when you talk to your customers about what's going on volumetrically, what are they indicating in terms of you know, the desire on a go forward basis where they want to have inventories and where things might get back to. And I guess what I'm trying to understand is whether what's going on right now is just sort of a structural reset in terms of how they're going to manage their own business versus something that maybe is just temporary that snaps back. It's just, it's been going on for a long time. So it's starting to feel like, you know, and whether it's interest rates or whatever else has happened, it's just starting to feel like,

um you know the entire supply chain doing is doing a reset so i'm just curious what your customers are telling you in regards to their sort of medium to long-term intentions in terms of holding inventory that's a great question vincent and i mean i'll try and keep it simple since my last answer was rather long but um you know it's very different by in market um on what's going on on the stability of underlying demand and then what they're trying to do in destocking right so a lot of these stable markets you know, it's more fine tuning, right? They, you know, they, they, everyone built safety stocks last year, you know, through 21 and 22. And they're, they're trying to generate cash and adjust those inventory levels to different perspectives on in markets. So if you're in the personal care world, medical world, you know, these markets are stable at the end, they may be down a little bit, but they're very stable. So, you know, destocking is clearly the entirety of what's going on there in many of those sort of in markets. you know, when you get to some of these other markets, you know, where the supply chain is incredibly long, like durables, um, you know, we're, we're making things that go to China that get made into products and come back to Europe or the U S uh, you know, really understanding just how much inventory is out there through that entire chain is, is, you know, difficult for everyone in these markets and exactly where in market demand is on these more discretionary markets, I think is a little bit more difficult to judge. But what I'd say we've seen, you know, is a couple of cycles, right? So there's a lot of stocking in the fourth quarter. Demand was really low in January, got a bit better through March. And then there was a realization that, you know, the banking crisis, people got nervous about what's going on in the broader economy. And so, you know, they went into a really low level of demand in April, which was probably the low point for the year. And then, you know, started to, you know, do a little bit less destocking you know, or a lot less destocking and durables, you know, through the second quarter. So as we get into the back half of this year, I think what happened with customers in the June timeframe is everyone assuming the back half was going to be a bit better in our downstream customers across, you know, most markets, especially maybe the more sensitive ones, that, you know, things would stabilize. Destocking, you know, after 14 months, to your point, you know, would have played its course. or, you know, back in June after 12 months. And they realized, you know, they all had that built in their plans. They sort of said that's not going to happen. You know, demand's going to be flat, which is all of our collective assumption now, and everyone's in new stocking mode to that assumption relative to things getting better. But it's not because the markets are getting worse, Vincent. It's just, you know, they'd assume things would get a little bit better. They're not, and they're sort of correcting for that. And it's important that it's a lack of expected growth as opposed to I think things are getting worse. I don't see anyone saying things are getting worse at the primary demand level. Does that make sense?

Yep, thanks so much. Our next question comes from Frank Mitch with Famium Research. Your line is open.

Hey, good morning. With much of the discussion regarding inventory management and so forth, I'm just curious You know, obviously the queue hasn't come out yet, so we don't know where the second quarter inventory levels are, but can you give us an idea where they are relative to the 1.94 that was in the first quarter? And what are your expectations as to when you go through these actions, how much further down will you be drawing your own inventories?

Morning, Frank. It's Willie. Yes, so as we think about inventory levels, I'll call it from Q1 to Q2, inventories are about flat. So as we think about the level of the supply chains and the demands that Mark has just outlined, we have about $300 million that we would expect inventory to decline in the back half of the year. That's also essential to getting us to generating roughly $100 million from working capital on a full year basis. And I'm confident that our business teams and supply chain, that we have a plan in place that we've already activated to execute and deliver that cash flow.

Terrific. Thank you. And, you know, Mark, I was wondering if you could talk to the raw material benefits that you're seeing in your specialty businesses, you know, any way you can provide some order of magnitude in terms of, you know, what sort of benefits are you seeing and what your outlook is there? Thank you.

Yeah, so I think in advanced materials, we're certainly seeing some pretty meaningful raw material benefits, Frank. If you remember last year, we had a tremendous spike upward in VAM and PVOH prices that created a pretty significant headwind for the interlayers part of that business. Those prices have now collapsed and dropped pretty significantly versus last year, and that's translated into a tailwind for us to recover our margins there. PX has not been as much of a tailwind. Those prices have been holding up significantly. Relative to last year, there's been a bunch of outages in that industry, new plants having trouble starting up, alternative fuel value, all those typical explanations with PX. So not as much of a tailwind there, but we're still well over $100 million of spread tailwind in that segment for the year. And I think that is obviously helping with some of the demand challenges and building us into a very good margin position as we go into next year when mix comes back and how those margins will flow through to the bottom line. in our fixed cost leverage. In AFP, again, we've got, you know, good raw material tailwinds in that business as well. But the spread improvement is not as significant because we really have a lot of cost pass-through contracts, especially in the means business. So, you know, we had very stable margins last year. That means they're also going to be stable this year by the nature of those contracts. But those spreads, you know, are also coming in, you know, relatively good when you think about, you know, ammonia, And, you know, some of the olefin-related, you know, propane, ethane-type products going into the specialty. So, overall, spreads are better there as well as, you know, on a full-year basis, helping this year. And we'll, of course, build momentum as volume comes back with better margin as we go into next year. Gotcha. Thanks so much.

We now turn to Alexa Yamifroth with KeyCorp. Your line is open.

Thanks, and good morning, everyone. You discussed lower conversions of MOUs to definitive agreements in France. Can you just elaborate on that? Is it just in France, or is it related to your second plant in the U.S. as well? And is this really related to demand uncertainty or price volatility in the plastics markets? What's happening there?

You broke up a little bit, Alexi. I just want to make sure I understood the question. You're asking what's happening with the pace of contracting in France, you know, given the current market conditions. Was that the question?

Yes, it was. Apologies. You're talking about MOU conversions to definitive agreements. Could you just elaborate on what's going on there?

Yeah, sure. So, first of all, you know, The commitment and desire to get recycled content and products remains very strong. So when you look at the specialty businesses we're in right now from our Kingsport plant, the demand commitment, which is global, not just in North America, but across the world for products and durables, cosmetics, packaging for recycled content remains very strong. We've got 70% of our potential output where customers are very committed, as you saw in the prepared remarks. When it comes to these PT or textile contracts, you know, that are the long-term sort of, you know, take or pay kind of structures for those markets like the Pepsi contract, we are having great engagement, good discussions with a number of companies about those contracts. Like Pepsi, it takes a long time to negotiate these. They're very complicated contracts. And the current market conditions, I would say, are sort of slowing those discussions down a little bit. So if you're looking at the PET market, whether it's VPAT or RPAT, those market prices have come off in a pretty significant way, which is purely just the story of everything else in the current macro, right? Demand is off in beverages. People are downscaling the sort of cheaper water bottles that have less material. A lot of that RPED also goes into carpet and textiles where it demands down 20, 30%. So that's just a temporary thing. The key thing to keep in mind in these contracts is we are targeting applications within these brands where mechanical recycling doesn't really work. So if they want to have recycled content in those applications, they're going to have to use chemical recycling Because the performance requirements in a variety of different technical aspects, you know, the mechanical is just not going to actually work. And I'm not going to get into the details of that because I think that's a competitive advantage for us given our deep polyester expertise relative to other companies out there. But that's definitely a key part of, you know, how we're going to win. The second part is the degradation of polymers already becoming clear in some markets that you can't mechanically get to 100% recycled content. Well, regulatory requirements may be only 25% in 2025. A lot of brands have set targets for some key applications to be 100% recycled content. And to maintain quality, you know, they're not going to be able to do that with mechanical. So we feel very confident that these contracts will get resolved and we're going to get them in place. You know, the engagement's high and the regulatory requirements, you know, especially in Europe, are going to require, you know, people to have recycled content. And you look at The market situation there, right now only about 12.5% of PET is sort of recycled. Mechanical industry does not have the ability to double that capacity between now and 2025 when that number needs to be 25% recycled content or you can't put the packages on the shelf. So, you know, we feel like we're in a good position and working really productively with our customers. And we're aiming to have those contracts done by end of year.

Thanks, Mark.

Our next question comes from Mike Sison with Wells Fargo. Your line is open.

Hey, good morning, guys. You know, I was thinking about advanced materials a little bit. It feels like this year, obviously, maybe, hopefully, a trough adjusted EBIT. You know, the sustainable day you had a couple of years ago, you had pointed to adjusted EBIT for the segment, you know, maybe closer to $700 million. Do you still think that that's the longer-term upside? And how do you bridge... sort of the gap between the two to sort of get there from these levels.

Sure, Mike. And yes, we still think that's the destination for this business. Obviously, it's been a pretty volatile time over the last few years, from the pandemic to supply chain crisis to recession. And as I said a bit earlier, the extremity of what's happened in This switch from a COVID life to an experiences life and the impact of inflation, interest costs, and how people can afford to spend on goods when they're just trying to afford everyday life and maximize their experiences at very high prices when it comes to hotels and everything else. It's created a short-term constraint in how people can afford goods. Consumer durables, as an example, is one of the places that is most discretionary, especially after they bought a lot during COVID. So demands are way below anything normal in consumer durables, and then you've got this huge amount of destocking on top of it on a very high-value mixed product. So as that market stabilizes, you'll see some recovery coming in the back after the year, especially if you back out the inventory utilization headwinds. And we'll build good momentum, you know, into next year from an underlying market point of view. And then you add on top of that recycled content, allowing us to add, you know, additional incremental value, you know, and substantial new volume from, you know, those applications. And as we said, just getting started to $75 million adder to next year in EPS for the advanced materials segment. So that obviously is going to be significantly helpful. The fixed cost leverage in this business, as we've demonstrated in the last 10 years, is significant, right? This world's always grown double digits for us when the underlying markets are typically growing 3% because we win so many applications because of better value proposition just because of product performance and product safety. And now you're adding on recycled content to further accelerate that curve. The problem is in a market like this, Um, there's not a lot of new product launches, right? But we're continuing to win new business even now that it's going to help volume in the back half of the year on top of just waiting for Leslie stocking. We've won a lot of applications, but they'll really ramp up next year when things stabilize and they start launching new products. So all that sort of brings in better value from that side. And then of course, the last couple of years, you know, the inflation has been really high. We've been trying to keep up with it, but you know, now we're finally recovering our margins in this space. So you've got better margins on top of this volume recovery to sort of lever you to better earnings. So as you go through 24-25, driving towards that 700 is very much what we expect to do.

Got it. And just a quick follow-up for just kind of overall volume growth in 24, which I know is a long way from here. But when you look at your customers' inventories, do you think they will need to restock? And if that's the case... when do you think a restocking event would occur? And if not, is it possible you just sort of plug along low single digit or some volume growth in 24 to 526 and maybe they don't need to replenish?

Well, first of all, I think, you know, what happened from April to now, the whole industry from us all the way down to retailers have gone to group think that it's going to be bad for the rest of the year, right? You know, and everyone's acting under that assumption. and pulling inventory down, managing of that context. But there's a limit to how much destocking can occur. At some point, warehouses go empty. And in some of these markets, especially like durables, it's been emptied out for a long time, where automotives, there's a huge amount of pent-up demand because we're talking about demand being better this year, but it's from a really bad level last year. So there's still plenty of pent-up demand there, and there's going to be plenty of pent-up demand in building construction. you know, with the dynamics of what's going on this year, constraining both demand and production of homes. You know, there's a lot of upside across, you know, the whole corporation when you think about it from both the demand point of view. And you got to remember these destocking levels are huge, right? So destocking is two or three times more than the underlying demand. And if that goes away, you know, that's all volume recovery at some point, even if the underlying market demand doesn't improve. And then to your question around inventory, I think with the actions that we're taking and everyone else is taking, you can see people driving inventory at very low levels. It's more likely than not that they're going to go below what they need in an improving demand environment. And so there will be some amount of restocking. Now, our back half, just to be clear, has no restocking assumed in the guide that we gave you. So if that happens, that's upside. But if you look at 24 and say, you know, destocking has got to run its course eventually so that you don't have that as a headwind for next year, and then just a little bit of restocking just to get to levels to serve that demand, I think you can get a much better picture of volume next year than this year.

Thank you.

Our next question comes from David Begleiter with Deutsche Bank. Your line is open.

Thank you. Good morning. Mark, thanks for the update on Kingsport. On the project, do you have any forecast for estimated losses this year as you ramp up? And do you have an updated cost of the Kingsport project? Thank you.

Thanks, David. First, I'll just highlight that the operating costs are going to be approximately neutral on a year-over-year basis. If you think about the pre-production that we're incurring this year, as well as the startup expenses, and also as we're using our bridge technology with glycolysis to seed the market, that's at a higher cost to bridge. So on a year-over-year basis, the way I think about this is revenue growth is actually accretive to EBITDA. And as we outlined within our guidance on the $75 million of EBITDA on a year-over-year basis, roughly $50 million of that will be in advanced materials and the absence of the pre-production and startup costs in our corporate other. So as I see it, that's roughly where we're getting the $75 million. Also, if I think about our CapEx this year, we started the year at roughly $700 to $800 million for the project. We took that up to $800. You can think about the combination of that and how we're managing our overall CapEx as the increases into the project this year for the Kingsport project.

I apologize. I meant to ask, what was the updated capital cost for the project itself, not total company capex?

Yeah, I don't think at this time we're given the capital costs for the Kingsport project. So we're not going to provide that at this time, David.

Understood. And just, Mark, just on fibers in tow, do the contracts next year have price increases embedded in them?

They don't have price increases embedded in them for next year versus this year, David, if that's your question. Obviously, prices have gone up considerably from last year. But the idea of these contracts is to prove our margins and profitability to a level where we can continue to reinvest in this business to be a reliable supplier to our customers And we've achieved that type of pricing with our customers in these contracts. We've also put formulas in them to adjust for changes in energy costs to give stability for us and for our customers, which we have not had in the past. So we feel great about what we've achieved in improving our sort of ability to support our customers and our current profitability. Um, and these contracts, um, you know, are now in place where about, uh, 75% is, is fully contracted now, uh, you know, through the next 24, many of those are multi-year contracts. You know, hopefully by the end of the year, we'll have, you know, that number up to 90%. Um, so, uh, you know, great improvement, this business, uh, from its, uh, you know, performance last year, and we're very focused on stabilizing it, you know, on the tow side. to provide, you know, very attractive cash flow to support our growth investments across the company. I would also note the textile business continues to do great on top of that. We're even in a 20% down market that we have this year in textiles. You know, we're growing that business. So we're winning a lot of market share versus other materials because the value proposition of Nye is, you know, very compelling. It's a great beginning of life story, you know, being based on bio content and recycled plastic. And importantly, a bigger issue going forward now is microplastics, which are the fibers breaking up and getting into the ocean. And our fibers are fully certified to biodegrade when they do end up in the environment. And so that's a very significant positive as the world's becoming more concerned about that as well. So it's just a great business.

Thank you very much.

Our next question comes from John Roberts with Credit Suisse. Your line is open.

Thank you. On the second USPET project, are you going more slowly on that?

We're not going more slowly, you know, in any significant way, John. I mean, right now what we're doing is really focusing, you know, we haven't made a site announcement, so you could ask that question too. because we're really looking at the incentives across several states. We've got three sites that are all very attractive, and the engineering work is continuing for whichever site we pick. And so we're just trying to get those incentives in place. We feel great about our partnership with Pepsi as a significant baseload customer in that project, and we are sort of moving forward with that project. you know, to make sure we can serve their needs and, you know, put that together with the Friends Project and Kingsport to get that $450 million EBITDA of value for our owners, which is a, you know, great return on the capital required across those three projects.

And then on the fibers business, assuming raw materials are sequentially stable, is all of the earnings stepped down in the third quarter? Just remind us of the frequency of the reset on the price versus cost.

The contracts are quarterly, so a little bit of the step down from Q2 to Q3 is just the prices adjusting for a lower energy environment.

Thank you. Our next question comes from Kevin McCarthy with Vertical Research Partners. Your line is open.

Yes, good morning. Mark, with regard to advanced materials, do you have a sense today as to whether your third quarter earnings are likely to be flat up or down sequentially versus the $99 million that you posted in the second quarter? The reason I ask is, reading the prepared remarks last night, it looks like you have a $40 million increase inventory-related hit in the third quarter, but you also say the second half should be better than the first half. So it seems like there's some countervailing trends there. So any comments on the seasonal cadence would be helpful.

So, Kevin, I think we highlighted earlier that most of the $40 million headwind on the utilization rate will be in Q3. So as a result, I would expect it to be similar to slightly down sequentially in advanced materials.

slightly down versus 2Q, Willie? Correct.

Yeah, of course, there'll be the lack of that sequentially from Q3 to Q4, you know, where that improving in volume and spread will, you know, pop back up. So you can't think of normal seasonality around the back half of the year really for either AM or AFP because most of the inventory reduction actions are happening in Q3 much more so than Q4. but the volume momentum and margin improvement is continuing through 3Q and into 4Q, not just because of our inventory actions, but because our customers are doing the same thing, right? They're also taking inventory down more in Q3 and oddly less in Q4 when you think about it, you know, the sort of odd year we're living in right now.

Yeah, it is odd, isn't it? Thank you for that. That's very helpful. Secondly, I wanted to... ask about ANFP. I think you referenced a heat transfer fluid project that caused $15 million to be pulled into the second quarter. Can you just elaborate on what you're doing there and how that is translating to a meaningful earnings swing?

Yeah, sure. So the fluid business is a bit sort of chunky in how volume shows up, right? Because you have these very large projects And at some point, they complete the project, and at the end of the completion, they need to charge that plant with heat transfer fluid to then start up the plant. And in this case, this was an extremely large LNG project that had been under construction for several years. And their completion actually happened a little bit sooner than they expected and moved forward with wanting to charge that system. And so we shipped that volume. We thought it was going to be in the third quarter. It turned out to be in the second quarter. But this overall business is a great business and something I'd say that we've really accomplished a lot in this business is diversifying our market exposure to different end markets. So historically, it's been very driven by the polyester industry and a few other sort of chemical facilities that use a lot of heat transfer fluid. But we've seen a huge growth in LNG, as you know well with the geopolitical dynamics going on right now with Ukraine and Europe. And there's a lot of heat transfer fluid in those plants too. So we're diversifying, you know, out of China into other applications like this project that creates a lot of value for this business. And they're very high value projects. So, you know, when they do show up, they, you know, drop a lot of earnings, you know, to the bottom line. And so it just happened to be in Q2, which then means as you sequentially go from Q2 to Q3, you get a $30 million swing in earnings.

Okay. Perfect. Thank you so much.

Our next question comes from Matthew Dio with Bank of America. Your line is open.

Morning, everyone. To talk a little bit about NIA and textiles, what's the opportunity for EBIT if we think about next year and growth? I'm just thinking given the margin recovery in cigarette filter tow, does it even make sense to rotate tonnage from filters to fibers? And is NIA still growing into your excess capacity, or are you now transitioning filter capacity to textiles?

So, first of all, NIA is a great business. The margins are very good. Obviously, recent improvements in tow margins are better. But the reality is, while we're really excited about the improvement in the tow business, It is a stable business that's still going to decline in volume about 1% a year. It's not a growth business. We continue to be very focused on serving our customers. These heat, not burn products are certainly growing at 15% and need more filter tow, but that's just offsetting some underlying natural decline of cigarettes to get you to that net 1% decline. you know, we're not conflicted capacity-wise between this and growing our NIA business. But we are getting to the point where we are going to start using up the available capacity and we're looking at capacity expansion options to continue to support the growth, right? Because our goal here with cellulosics is not to optimize the stream, is to turn it into a growth stream, right? Our goal here is to win in a variety of applications. So like polyester being a very high growth, you know, stream for environmental reasons and providing sustainable products. Our strategy as we laid out Innovation Day is to get $200 million of EBITDA growth out of this stream on top of the tow business. So when we talked to you in 2021, we weren't including improvements in tow. Tow is a new base, and we're still aiming to grow $200 million EBITDA on top of that new base. That's a very significant change from where we were in 2021. We've got growth in NIA, which we're really excited about, as I explained the value proposition a moment ago. We have great growth prospects and some early wins in Aventa. This is our foamed cellulosic that can replace polystyrene in packaging. Clearly, polystyrene is being banned in many places for packaging, whether it's food packaging in protein trays for meat or the clamshells, etc. And we validated that our Venta product will biodegrade both in, not just industrial, but in residential composting, which is sort of the equivalent of landfill. So it really is a true end-of-life solution. So customers are super interested in that. Huge market, lots of volume growth opportunity there. Then you've got microbeads, which is a super high-value opportunity in cosmetics. We've got success in recycled content in the ophthalmics business with how we're recycling the – eyewear back into the product. So there's a lot of growth going on across the cellulose extreme. And so we're going to be looking at incremental capacity expansion to support all these growth opportunities as we move forward. Fortunately, we have a very large installed asset base, so it's not like building methanolysis plants. We can really leverage the capability we have here, but there'll still be capacity routing for NIA and all these other products between flake and fiber.

Matt, are you good?

Our next question comes from Patrick Cunningham with Citigroup. The line is open.

Hi, good morning. Thanks for taking my questions. I know you have no expectations for any sort of restocking embedded in the full year guide, but which end markets do you think are potentially best set up for restocking, whether it be in 4Q or into 2024? And how should we think about this in the context of upside to earnings from specialty businesses?

Well, I think that it doesn't matter what end market we're in right now, there's a lot of destocking going on as everyone focuses on generating cash. And so I think there's probably opportunities for restocking pretty much across the markets. Building construction might be the one exception where I think there's a lot of destocking still to be done from what we've seen from our customers in that space. But everywhere else, I think there's some degree. And then it just gets into proportions, right? So, you know, where the destocking numbers are bigger, like consumer durables, then the potential for restocking is higher. You know, in more stable markets like personal care and water treatment and medical, I think the restocking opportunities are still there, but, you know, muted because they're just not doing as much. As far as earnings opportunity for next year... Relative to this year, we're not going to sort of get into that yet. It's a little early.

Yeah, that makes sense. And what's driving strength in acetic anhydride? And I think you referenced overall resilience and acetyls. I would have expected some weakness given declining spreads and some of your end market commentary.

Well, acetic anhydride goes more into food pharma feed type applications where the demand is actually really stable. So it's not You know, acetic acid goes into, you know, polyester where demands, you know, down a lot in textiles. You know, VAM goes into coatings and a bunch of other more economically sensitive applications. When you think about different acetyl derivatives, you know, acetic anhydride just has much more stable in markets. And large customers that place a lot of value on security of supply of that product for those kind of applications. So they tend to be, you know, more focused on supply than just what's the best price. So that just allows that business to be, you know, relatively stable. I mean, we're still, you know, have some price pressure there, but it's not nearly as much as some of these other sort of derivatives or olefins, you know, which is the bigger part of our portfolio where the price pressure and spread compressions occurring in CI is really more of an olefin and plasticizer story.

Very helpful.

Thank you.

As a reminder, if you'd like to ask any questions, please press star 1 on your telephone keypad now. We now turn to Lawrence Alexander with Jefferies. Your line is open.

Lawrence Alexander Just two quick ones. As you think about the dynamics around inventories and fixed cost absorption, should incremental margins next year be above 60 percent, or do you think some of the inventory reduction efforts you're doing now will spill over into Q1?

Lawrence, this is Willie. To your point, I think we've demonstrated through various environments, one, that we can deliver strong cash flow, and that's what we're focused on doing now. As we think about the fixed cost utilization, I don't expect any spillovers into 2024. The action that we're taking will be complete this year. Also, on the incrementals, I think you've seen the decrementals that we're talking about. The incrementals will be equally positive, and I would add on to that to your point to get to the levels that you're talking about. That includes the mix upgrade and the high-value products as we think about our advanced materials and the more specialty nature there.

And secondly, kind of now that your peers are facing kind of more pressure from the credit cycle, You've always seemed to have a sweet spot in M&A around finding people who are under investing in the engineering. Has your M&A pipeline changed or can you characterize kind of how actively you're looking at opportunities?

Yes, we're more focused on the bolt-on pipeline. We did a great bolt-on earlier this year in our performance films business. We're right now focused on our organic growth strategy with our investment in the three circular platforms. We are looking – our pipeline is mostly focused in smaller bolt-ons and advanced materials and additives and functional products. And we're going to be disciplined with that strategy and stay focused on executing it and executing it well.

Yeah, the recent acquisition we did of – A manufacturing site in China is a great example. Performance films business has been performing incredibly well in this auto market last year. In this auto market this year, it's very hard margin business. And that acquisition allows us to be domestically based in how we support customers in China, which is definitely where the China government wants to go is things made in China. And those are great tuck-in acquisitions, very highly accretive. Those are the kind of things we're focused on right now because our real priority is growing our dividend and creating this sort of organic-driven growth story around being a leader in the circular economy, both polyester and cellulose.

And then just lastly, can you characterize or give a little bit more detail on what you think is going on with the agriculture chain inventories? I guess the the timing and the severity of the adjustments due to cut a lot of the industry a little bit flat footed. And so just curious about what you're hearing in terms of when people think it will end, because I think you have a comment in the remarks about it accelerating into Christmas.

Yeah. So I wouldn't say it's accelerating to Christmas necessarily. So, but what, what happened, I think, you know, is pretty well discussed out there, you know, two things really last year, you know, with all the Ukraine events around ammonia and other uncertainties around supply chain, you know, farmers around the world were stocking up on safety stock, and their warehouses, the retailers were stocking up on safety stock, their distributors were stocking up on safety stock, all the way back to, you know, the big players that make the products like us in Gent, Arkata, et cetera. And so demand was really good. That was true through the first quarter, and as... this chain started looking at a season that wasn't going to quite need quite as much product because of the dry weather and not needing it as much, and feeling like supply chains were now safe to rely on, sort of in the middle of Q2 kicked in significant destocking downstream of us. So we started to feel some of that destocking from our direct customers in the second quarter and it ramped up to full destocking as we go into the third quarter and to some degree in the fourth quarter. There's a lot of debate going on, I'd say, about just when does that destocking end and when they have to start ramping up on production to meet the growing season next year. It's important to realize that the final end demand for the farmers is good this year and expected to be good next year. This really is a whole inventory management cycle we're in. And at some point, they'll have to kick back into gear to make sure they have enough supply for next year, whether that's in the fourth quarter or the beginning of the first quarter. It has to happen sometime around then or they won't have enough inventory for the next growing season.

Our next question comes from Aaron Viswanathan with RBC Capital Markets. Your line is open.

Great. Thanks for taking my question. I guess I just wanted to go to AM and AFP. There are some markets which you are seeing, which we're seeing some strength in, notably maybe the aerospace side and aviation food side. Is that what you're seeing as well? And, you know, some of those stronger markets, do you expect that to persist through the second half? How would you comment on some of your stronger markets? Thanks.

So when it comes to aviation, our view is the market was has really improved through the first half of the year and will stay strong in the back half of the year. I wouldn't say it's necessarily going to grow relative to the first half of the year because it's been pretty strong, but it'll stay that way. The airlines are obviously very confident about their demands going forward, and we'll track with wherever their demand goes right now. That's their viewpoint, and we're using their view to build our forecasts.

And then just as a quick follow-up, you know, some other markets are notably on the weaker side. You know, you addressed, you know, some of the destocking that's going on in amines and the ag side. What are some of the other areas that maybe turned out worse than you expected? And, you know, you've addressed a couple on the call already, but if you were to reiterate some of the weaker areas, what would those be? Thanks.

From a Q2 point of view, yeah, in-market-wise, I'd say from an in-market growth point of view, I don't think much has changed in our view across all of our in-markets. We haven't seen different in-markets, you know, get worse or better. Auto's strong. You know, obviously, you know, structuring markets are under pressure. The personal, you know, care, water treatment, those kind of markets, you know, are off, you know, 3% to 5%, you know, as all those downstream, you know, customers of ours that you can see in the fast-moving goods and everything else reporting that they're focusing on pricing, discipline, and as a result, having a little bit less volume. I don't think anything that's changed. Really, it's all about inventory management. It's the entire story for some of the negative surprises like medical packaging and ag in the second quarter. and, you know, and destocking, dragging out into the back half of the year, right? I just think that, you know, the extremity of COVID and then the following stimulus and the supply chain crisis has just led to a lot more inventory being, you know, built throughout the world than I think any of us really understood. And it's taking, obviously, a lot longer to pull it down, especially when, you know, demand is, you know, soft to some degree in every market.

Okay, I believe that was our last question. So thanks very much for your interest in Eastman and for joining us this morning. I hope everybody has a great day.

This concludes today's call. Thank you for joining. You may now disconnect your lines.