Eastman Chemical Company (EMN) — Q1 2016 Earnings Call Transcript

Good day, everyone, and welcome to the Eastman Chemical Company First Quarter 2016 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. Okay. Thank you, Taylor, and good morning, everyone, and thanks for joining for us. On the call with me today are Mark Costa, Chairman and CEO; Curt Espeland, Executive Vice President and CFO; and Louis Reavis, Manager-Investor Relations. Before we begin, I'll cover two items. First, during this presentation, you will hear certain forward-looking statements concerning our plans and expectations. Actual events or results could differ materially. Certain factors related to future expectations are or will be detailed in the company's first quarter 2016 financial results news release and our filings with the Securities and Exchange Commission, including the Form 10-K filed for 2015 and the Form 10-Q to be filed for the first quarter 2016. Second, earnings per share and operating earnings referenced in this presentation exclude certain non-core costs, charges, and gains. A reconciliation to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded items, are available in the first quarter 2016 financial results news release, which can be found on our website, www.eastman.com, in the Investors section. Projections of future earnings also exclude any non-core unusual or non-recurring items. I'll turn the call over to Mark.

Good morning, everyone. I'll start on slide three. We had a solid start of the year with the first quarter results, which were slightly better than our expectation. Overall our strategy is working. We did a great job of holding onto value to the quarter, as we increased our operating margin by 40 basis points to over 18%. We continue to upgrade the quality of our product mix by growing high-margin specialty product lines, a key component of our winning strategy. See, more of our strategy in action, I recently traveled to visit customers in Asia. I'm really excited about all the innovation and customer engagement that's gaining traction across the region from India to China to Japan. In India, we secured our first commercial success on our next-generation polyester coatings platform with the leading manufacturer of SUVs and tractors. As I met with them, I was excited to see their engagement and enthusiasm for our solution and how it could significantly improve their ability to maintain their leadership cost effectively. With increasing expectations from the emerging middle-class in India and new western competitors, this customer faces a challenge. Upgrade the durability in glass retention of their monocoat coating or spend significant money to build a more expensive two-coat system. Our revolutionary next-gen polyester coating enables them to achieve best-in-class performance within monocoat instead of moving to a much more expensive two-coat solution. We were there last September when the first SUVs rolled off the assembly line, a short 15 months after the project started. And now, there are more than 30,000 SUVs on the road. Key to the success was a tremendous partnership built between this auto OEM, their exceptional coatings formulator, and Eastman. We've started with auto coatings and we're making tremendous progress in industrial and package coatings as well. In China, we've recently partnered with a leading local housewares brand to launch a product line that utilizes our Tritan copolyester, as we're seeing the increased local need for greater product safety and durability. Similar to our success in India, these customers are looking for a way to differentiate themselves from other local competitors. I'm very bullish on this market expansion into China for a product that has predominantly been sold to North America and European consumers. As part of our success, we're providing training to the company's 20,000-person sales force that works throughout department stores in China, who are pitching our Tritan value proposition for us every day. These are just two of many examples where we're succeeding by helping our customers through innovation. On the cost management front, we are well on track with our corporate cost reduction efforts, without sacrificing our long-term growth initiatives. Our SG&A and R&D as a percentage of sales remains the lowest quartile of our peers, which is a function of our scale and integration and the great discipline of our employees. We've also made excellent progress in reducing manufacturing costs. Productivity is in the DNA of Eastman, and we continue to succeed. Cash flow is consistent with our expectations and we are on track to deliver another strong year of free cash flow, enabling an increasing dividend, deleveraging, and repurchasing shares in the back half of the year. Beyond these great results, we've also been the recipient of numerous awards over the past several months, which highlight many of the qualities our stakeholders have come to expect from Eastman. We received a Glassdoor Employees' Choice Award honoring the best places to work. What I love most about this award is that it's based solely on the input of employees. We're the only chemical company to be in the top 50 best places to work ever, and this is our third year in a row we've been honored. The award speaks to our winning culture, which enables us to innovate with our customers and integrate our acquisitions successfully. We're also named among the world's most ethical companies for the third consecutive year by Ethisphere for outstanding corporate ethics and corporate responsibility. Characteristics highly valued by our employees, our communities, and our customers. Finally, we have been recognized by the EPA as an ENERGY STAR Partner of the Year award, becoming the only chemical company to have received this recognition consecutively for five years in a row. And only two other chemical companies have received it once. This is a great win for both the environment and our cost structure. Our solid first quarter results and the continued recognition we're receiving are a direct result of the great work being done by Eastman employees around the world. I want to thank them for their outstanding contribution. With that, I'll turn it over to Curt.

Okay. Thanks, Mark, and thanks, everyone, for joining us today. I know it's been a busy week for you. I want to go off script for a second here just to build on a little of Mark's comment. I've now been the CFO for almost eight years, and I just wanted to express the excitement we have with our various growth programs. When I look through my finance plans, I'm convinced that these growth programs will lead to meaningful revenue growth and strong returns for the coming years. It's a real pleasure to watch a winning strategy get executed by Mark and our business technology and strategy teams despite the business climate that we’re facing, and to be a part of that high-performing winning culture that Mark talked about. So, many of you know this already, good things are happening at Eastman that will benefit both 2016 and beyond. So, with that, let me get back to my prepared remarks. I'll start on our first quarter corporate results on slide four. Overall, we delivered a solid quarter in a challenging business climate. Sales revenue declined, as solid sales volume growth was more than offset by lower selling prices. As we expected, the largest decline was in the Chemical Intermediates segments where low oil has its greatest impact. Our operating earnings decreased as strong performance in Advanced Materials was more than offset by a decline in Chemical Intermediates. Overall, earnings per share was solid, reflecting good quality earnings and a lower tax rate. I'm proud of how our commercial teams are finding the right balance of retaining appropriate value given the attributes and value proposition of our specialties and sharing some of that benefit of lower raw materials with our customers. On slide five, I'll transition to an overview of our cash flow and other finance highlights for the quarter. We continue to do an excellent job of generating cash with first quarter operating cash flow of $47 million in what is typically our lowest quarter. These results reflect our normal beginning of the year working capital build. Capital expenditures totaled $110 million. We continue to manage the pace of capital spending with the current economic environment while maintaining growth investments. We expect full-year capital expenditures to be approximately $650 million, maybe a little less as the year unfolds. Free cash flow was a negative $63 million for the quarter, consistent with our expectations. Our first quarter dividend was $68 million. Our effective tax rate for the first quarter improved to approximately 24%. We continue to expect our full-year tax rate will be between 24% and 25%, reflecting the continued benefits of our improved business operations, and we'll continue doing what we can to be at the lower end of that range. For free cash flow, we'll remain on track to be above $900 million. As a whole, I’m pleased with our earnings and cash flow performance at the start of the year. On slide six and seven, I'll provide an overview of the two segments most affected by our business restructuring. This is the first quarter we're reporting under the new business structure, so we thought this would be helpful. First under our new structure, Additives & Functional Products is well positioned for GDP plus growth, with an attractive market footprint and diverse geographic profile. Our transportation exposure is about 75% replacement, 25% OEM. This split is similar for building and construction. Performance drivers for this segment include increasing demand for quality vehicles, improvement in the housing market, and increasing use of consumables by the growing middle class. We remain focused on attractive secular growth end markets, where innovation and deep customer connection offer a clear competitive advantage. As we look forward, I'm excited about the growth we expect from our innovation projects. Mark already shared an exceptional story of rapid innovation in India. We continue to see strong growth in our tire resins as a performance additive and strong growth in our low-VOC, low-odor coalescent for architectural paints. And we are just getting started with innovation efforts in alkylamines specialty. Next on slide seven, the new Chemical Intermediates segment, which now comprises the majority of our olefins exposure, will benefit from advantageous market positions in key intermediates, particularly in North America. Performance drivers for this next segment include a growing middle class, continued adoption of non-phthalate plasticizers, and North America shale gas advantage. In addition, a flexible market outlook will drive our asset utilization and support growth for our strategic specialty product line. Overall, the segment has a set of good value-adding businesses, which benefit from scale, integration, and reliability, and are essential to supporting the growth in our specialty businesses. Moving next to the segment results and starting with Advanced Materials on slide eight, which delivered a strong quarter. Sales revenue increased due to higher sales volume of premium products, including Eastman Tritan copolyester and Saflex acoustic interlayers. This was partially offset by lower selling prices, primarily for copolyesters, attributed to lower raw material costs. Earnings increased primarily due to higher sales volume and improved product mix of premium products, and lower unit costs due to higher capacity utilization. Looking at the full year, we continue to expect strong results for Advanced Materials as they progress on our strategy for this business of volume growth, mix improvement, and fixed cost leverage. Sequentially, we expect volume will increase due to normal seasonality for our copolyester customers. We had strong sales in March and that has continued into April. Interlayer volumes remain strong as OEM auto build remains solid, acoustic growth continues, and the overall building and construction market in Europe is improving. As a result for the year, we expect greater than GDP volume growth for this business. In addition to the strong volume growth, we expect further robust mix improvement with continued growth in high-margin products, such as Tritan copolyester and acoustic interlayers. As we continue to fill out our existing capacity, we benefit from fixed cost leverage. We expect all of these factors will result in strong earnings growth for Advanced Materials. Now to the Additives & Functional Products on slide nine. Overall, a solid quarter despite the short-term challenges. Revenue declined primarily due to lower selling prices, attributed to lower raw material and energy costs, and competitive pressure for certain products, particularly in Asia Pacific. Operating earnings decreased primarily due to an unfavorable shift in foreign currency rates. Looking at the full-year 2016, we expect solid volume growth for AFP, in line with the end market growth. In particular, we expect volume growth in the transportation, building and construction, and consumables end markets. We also expect lower selling prices reflecting both lower raw material costs, and as we discussed in January, we did an excellent job holding onto value last year, but we also started to share this value with our customers towards the end of 2015 and through the first quarter of this year. Overall, we expect Additives & Functional Products to be stable to slightly down, which would be a solid result in the current business climate. Now to Fibers on slide 10. Results for this segment were as expected. Sales revenue declined, primarily due to lower acetyl chemical sales volume and lower acetate tow selling prices, mostly offset by higher acetate tow sales volume. The higher acetate tow sales volume was attributed to customer buying patterns. The decline in acetyl chemicals was due to lower-cost internal sourcing of cellulose acetate flake raw materials rather than obtaining these raw materials from our joint venture in Kingsport. Earnings for the quarter declined moderately as lower selling prices were partially offset by higher acetate tow sales volume, lower raw material energy costs, and reduced operating costs resulting from recent actions. Looking at the full-year 2016, our current expectations are in line with the guidance I provided at an investor conference in March. We expect acetate tow sales volume to be down about 10% for the year, mainly reflecting customer backward integration and destocking in China. We also expect selling prices to decline but to be mostly offset by lower raw material costs, as well as the benefit of cost actions we have taken. As a result, we are expecting earnings to be down close to 15% for the year. I'll finish up the segment review of Chemicals Intermediates on slide 11. Chemicals Intermediates delivered a solid quarter despite significant volatility impacting their business. Sales in the first quarter declined, primarily reflecting lower selling prices attributed to lower raw material costs. Chemicals Intermediates is also impacted by continued competitive pressure resulting from weak demand in Asia Pacific. Operating earnings declined in part due to a difficult comparison. In the first half of 2015, we did a great job of holding onto value during a period of significant raw material cost decline. In the first quarter of 2016, selling prices were down, reflecting the lower raw material costs, and therefore margins declined. Looking at the full year 2016, we expect a number of factors to impact results. We expect solid volume growth due to continued plasticizers growth, particularly in the building and construction market, as well as overall modest growth in North America, which is almost 70% of the overall segment revenue. We also expect olefin margins to remain under pressure as the recent increase in oil price has not yet translated to improving olefin prices, particularly ethylene. We expect lower methanol prices to enable lower pricing by competitors in some of our acetyl and amines product lines. Therefore, for 2016, we expect earnings to be meaningfully lower given the low oil environment and the pressure on spreads. And I'd add that when you think about how the year will unfold, we expect second quarter operating earnings will be lower than first quarter due to both significantly higher maintenance shutdown costs and how our propane hedge flows through costs. Lastly, I'll give you a quick update on our process for divesting our merchant ethylene position and potentially other commodity olefin product lines. As we mentioned in January, we're moving forward with this process and have engaged bankers. The books are now out and we're talking with potential buyers and are pleased with the initial interest. We will be disciplined, patient sellers as we move through this process, and we will update you further as the process continues to progress. With that, I'll turn it back over to Mark.

Thanks, Curt. I'll transition to our outlook on slide 12. We have a strong portfolio of specialty businesses. We have delivered over the last six years, and we expect that to continue in 2016. We expect our innovative specialty products will continue to grow strongly, improving product mix and accelerating overall earnings growth. We're equally committed to meeting our aggressive cost reduction targets. Additionally, we expect to achieve further cost synergies from our acquisitions. After deleveraging, we also expect to repurchase shares in the back half of the year. In the near-term, however, slow global economic growth, combined with low oil and weak Asian and European currencies are increasing competitive pressure in some products. As we guided early in the year, we expect some inventory destocking in China to impact Fibers' results. We will continue to drive hard to deliver EPS that approaches our 2015 EPS, and we are maintaining our guidance for EPS to be flat to down 5%. Given where olefin spreads are today, we are likely to be more towards the lower end of that range. I'd also note that the first half of the year will be a tougher comp in the back half. As I look beyond 2016, we're well-positioned for growth as these short-term challenges recede and our strong growth drivers continue. Altogether, I'm confident we'll continue to deliver attractive earnings growth in the long term as we transform towards a specialty portfolio. Thanks for joining us this morning, and I look forward to your questions.

Okay. Thanks, Mark. We've got a lot of people on the line this morning and we'd like to get to as many questions as possible. So I ask you to please limit yourself to one question and one follow-up. With that, Taylor, we are ready for questions.

Thank you. Good morning.

Good morning, David.

Mark – good morning. On the guidance, you have strong Q1 beats, the outlook has gotten probably a little bit better since late January, FX a little bit better as well, yet you're now guiding towards the lower half of that slight to down 5% range. It seems awfully conservative; help me with that if you can?

Sure, Dave. Obviously, it's a pretty dynamic environment out there with oil and currency, and it's difficult to predict the next month, let alone the remainder of the year. What I love about our portfolio right now is we're growing the way we should in our specialties. We're driving a lot of strong volume growth, a lot of mixed improvement through innovation and Advanced Materials. Doing a great job of holding on to value in Additives & Functional Products. We feel good about that and feel great about the cost reductions coming through as we expected. But what we're not seeing right now as we expected in January is the improvement in olefins spreads. Oil has certainly gone up, as we all know, to $45. But we're not seeing the olefins prices recover in the way we would've expected, especially on the ethylene side. It should have been more in the low 30% range, and we'll get spot down at 25%. So that's really the main issue, Dave. There's some increase in competitive activity with currencies. Currencies and just about FX translation, it includes how people use that improved cost structure to pursue volume unsuccessfully, I might add. But they give it a good shot. And that put some price pressure in the marketplace that you have to respond to. So we're seeing a little bit out here and there, but principally it's an olefins issue. Overall, though, I feel very much on track with our strategy and how we're going to create earnings growth, especially as you look at it from 2016 through 2017 and beyond. The one interesting upside that's coming out of all this is we're finding customers highly motivated to find innovation these days because we're all living in a tough world. We're seeing tremendous engagement even from Asian customers, looking at how to innovate value of their product portfolio. We're really starting to see some acceleration on that front, which is great to see.

Understood. And just on Fibers, Mark, destocking; when do you think it will end? Will it grow into 2017? And post destocking ending, what's your net view of long-term secular volume trends in this business?

Sure. So I'll break it down, both from a cigarette demand point of view and a tow point of view. On the cigarette side, we see primary demand being very consistent with our views we've shared in all the previous calls. Outside of China, it's sort of down 1% to 2% like it's been for years. Inside China, we're still not seeing any signs that there’s some significant change in primary consumption of cigarettes, so I'd call it sort of flat, maybe up 1%. But there's some uncertainty here in the short-term as the economic pressure in China could affect people's rate of purchasing cigarettes. Overall, I'd say it's very stable. Especially when you think inside China, the Chinese National Tobacco Company’s principal goal is to grow tax revenue. They're assigned a target to grow at stated China GDP, around 6.5%, 7%. They've never missed their target ever, from what I know. I think we should expect stability there when it comes to primary demand. So then you get back to what's going on in destocking, and what we see is at the tow level, the Chinese National Tobacco Company has set a pretty aggressive destocking target for tow this year. You have to remember that demand drop last year and this year is a function of two things. The first driver is CNTC backward integrating with us in 2014, with ISO in 2015. Certain amounts of import demand were just replaced by internal production inside China, and that's actually a little bit bigger driver than destocking relative to primary demand. You’ve got that happening, plus they built up too much tow inventory in their imports as they did this backward integration, so now they're pulling the inventory down. Their target puts it to a very low level, so I think that destocking will be complete. We're now really looking at what other decisions they make around cigarette inventory in the marketplace in between tow and primary demand. That's very opaque. We think they're making good progress on that and they've got this mandate to keep on growing. I think the vast majority of the destocking should be behind us, but I'm not going to forecast inventory of cigarettes in China.

Thank you very much.

Hi. Good morning, everyone.

Good morning.

Can you talk a little bit more about – last quarter you mentioned that on the specialty side of the house you were worried about sort of the spreads that it opened up and you're actively sort of stepping out in trying to partner with your customers, and trying to find a spread that would be conducive to both of you being happy and sort of remove the risk that the customers would kind of come in and try to reformulate – sorry, competitors will try to come in and reformulate customers away from you. Can you talk a little bit about where you are in that process? And do we know how it's going play out over the balance of the year or not?

Well, I think you described the situation pretty well, I'm not sure I need to say anything else. But that's exactly what we've been doing. In Advanced Materials, we've been growing through volume and mix, and spreads have been relatively stable when it comes to raw materials. That is a volume mix story and how we're improving the margins there and how we're growing and delivering results. I'd take that off the table and we feel very stable about how we're going to grow there. AFP, as you saw, prices came off a bit in the first quarter. What we did last year, on a restated basis, if you look at Additives & Functional Products provides last year from 2014 to 2015, prices were only down about 3%. We had great success last year in holding on to value through the beginning half of last year, really through the third quarter, expanding our margins and tremendous growth in earnings, as you can now see in Additives & Functional Products and our specialty businesses from 2014 to 2015. So we started giving some of that value back and sharing the value of raw materials with our customer in the fourth quarter last year through the first quarter of this year, which is the right thing to do. It's the way you create value because in the end of the day, what you all want is us to grow long term, not just short-term earnings. You've got to have market share, and more importantly, you've got to have customers that are motivated and engaged with you to work on innovation for the next generation of products. I think we're walking that balance as carefully as we can. The margins, I would expect, will normalize around sort of what you're seeing in the first quarter. I think that's what we'll see for the rest of the year. The business is doing well, and there is always a choice to hold prices high, be aggressive, and deliver great earnings relative to raw materials in the short term. But sooner or later, you're setting yourself up for volume fall, and certainly a lack of innovation in that portfolio if you do that because customers aren't very motivated when they can see how much raw materials have improved to work with you. We're not going to make that choice. I think that's a mistake, and I'm proud of how the teams are walking that balance. It's not that easy in a tough environment where we're pushing hard for earnings growth every day. But I think that's going to work out well for us long term.

And then just quickly, I heard your comments in your prepared remarks about still expecting to repurchase shares in the back half of the year. You didn't mention M&A at all, the landscape, how that's changing a little bit with different companies, splitting off and spinning off and things like that. I guess evaluations are still high. But any change in your view on M&A?

On the M&A front, we're certainly not looking at any large M&A. I view the valuations of assets trading lately as very high and would struggle to see how I'd be delivering a good return on invested capital to our investors. So I think we're staying away from that. Bolt-on M&A is always something that you'll consider when it's reinforcing an existing business to improve its competitive position or relevance to consumers, customers. But right now, even there we're not really looking at anything in the short term. So I think that as you think about our very strong free cash flow that's outstanding for this industry, you should think about our supporting increasing dividends and repurchasing shares after we finish the deleveraging.

Good morning. This is Ryan Berney on for Bob Koort. Being, again, back into that cash flow question, would you say that with large scale M&A kind of off the table, is an investment grade credit rating still a high priority for you? And is that going to be a significant use of your cash flow proceeds, or has your kind of thinking shifted more towards returning cash to shareholders?

What you're seeing from us, and will continue to see from us, is a balanced discipline across all the buckets where we can deploy our cash. Mark already addressed M&A, as well as the share repurchases. From an investment grade standpoint, yes, we are committed to maintaining our investment grade credit rating, and we'll continue to take the actions necessary to sustain that credit rating. However, I think you have to see balanced use of our cash flow going into 2017.

Great. Thank you. And then on the acquisition synergies you mentioned in your outlook, could you give us a sense for how much of that you estimate you're going to capture in 2016?

If you look at the synergies in 2015, we achieved roughly $25 million. For 2016, we expect that to be roughly $50 million of cost and operational synergies, as well as some additional tax synergies. You're seeing those tax synergies showing up on our effective tax rate.

Hi. Good morning, this is Jagan Pisharath sitting in for Aleksey. So question, in Advanced Materials, could you provide a little bit more color on your comments between volume and mix? What products and maybe even regions do you see mix upgrades versus volume?

Great question; I love answering that one. Advanced Materials is just rocking it again this year, building on a great year last year; incredibly proud of that team in driving innovation across the portfolio. So we're seeing strong growth in Tritan, as we've seen for several years now, in housewares, with some early and very encouraging wins around medical, and that's going to continue. Also, continued great success in our new displays products, growing with mobile devices, delivering very attractive margins, as well as growth. Interlayers are having another phenomenal year, building on top of last year. In addition to OEM growth rates, which have clearly been pretty good around the world, especially in North America and Europe, we're seeing a significant increase in our real estate of the car, so we're moving from windshields to side lamps to sunroofs, as they're adding more, not just laminate glass, but typically acoustic laminated glass to quiet the cabin for a better rider experience. We're seeing great engagement there. In fact, when I was with a key glass customer in Japan last week, it was very exciting to hear about how much they’re looking forward to our next-gen acoustics and heads-up display products. We’ve added a lot of value to this industry already, and we've got a new acoustic product that's going to allow them to lightweight the glass, maybe take as much as 25% of the weight of the glass out, which is a big deal. We've got a far superior heads-up display product coming out as well that's going to dramatically increase the size and clarity, allowing a lot of mobility to be added of information to the car for the whole new Internet of Things trend in the car. So a lot of engagement, a lot of innovation there, so a great success. And then even in performance films, we rolled out a very successful new channel strategy in performance films where we're growing, especially in North America, bringing a lot more people into the category, seeing the value proposition of greater solar rejection, skin protection from skin cancer, as well as aesthetics and security. So just all fronts are hitting really well right now. We're really excited about what those teams are getting done.

And do you think you can grow interlayers from secular growth, even in a slower auto OEM growth environment?

We do. We see that – we're always going to be tied to OEM growth rate to some extent. That business is about 75% OEM, 25% replacement, where – for transportation – by the way, Additives & Functional Products is the reverse, 25% OEM, 75% replacement. We're going to be tied to OEM growth rate to some degree, but I think that the ability to grow in the real estate, and most importantly, the value of the mix where we're selling much higher margin acoustic and heads-up display products at a much higher rate than the OEM growth rate allows us to continue to grow our earnings.

Yes. Hi, good morning.

Good morning.

Good morning.

Question on your Additives & Functional Products. Your prices dropped 8%. Now, some of these products like coatings, additives, I know you had to lower prices to your customers. What is the range of price declines in this segment? Is Crystex flat and some products down double digits? Can you just help us sort through the pricing?

Sure. As I said, this is a place where we've had a lot of margin expansion last year relative to raw materials dropping. In particular, the place where we saw the tightest conditions last year was in adhesives where we were able to maintain very good price discipline while raw material prices improved. In that place, we're giving back some price as the market for some of the products are moving to a more balanced position versus tight. And we knew that this was coming. We've told the investors about that for several quarters now, and that's sort of playing out as expected; that’s some of the price decline. The other place is in the olefin-related products, the specialty products like our coalescents where we're seeing some price being shared with our customers. As raw materials improved last year, we held prices fairly well and now we're reducing some prices there to share the value with our customers. We are seeing prices come off a bit in the Crystex product as we are growing in that business and defending our share. Again, very much as we expected that some of the price is coming off there, especially in Asia. What I would say is quite encouraging about the tire market is we're seeing a nice recovery in demand in tires, especially in the first quarter here relative to last year, and that market getting back on stable footing and well positioned to deliver some nice volume growth this year. So overall, I'd say the prices are more or less playing out the way we expected. It's important that we defend our markets and keep these customers engaged as we work on this next generation of product introductions. Really excited about the Crystex process that we're launching. We've got the retrofit line in Germany up and running. That'll improve our cost and enable us to have a much superior product, and the Kuantan project is going well. So it's all coming together nicely.

And just a question on oil price. The recent bounce back is not necessarily helping you, but do you see less of a negative impact from propane hedges as a result? Thank you.

I'll let Curt answer the hedge question first and then I'll just talk about the overall olefins market.

The way we're seeing the hedges, the hedges as we talked about at the start of the year, we do expect some of the propane hedges to roll off, but yet the out-of-money condition has gotten a little worse. Still, when I look across the hedging portfolio, both currency and propane hedges, the impact of roughly $0.60 a share last year net is still roughly the same amount of impact we're expecting this year.

So it's not a cost structure issue that's sort of out of line with what we would've expected, it's an olefin price issue, P.J. So we're just not seeing olefin prices, especially ethylene prices sort of come up as we would've expected in the second quarter right now. So we're being a bit cautious on how that's going to play out.

Morning.

Morning.

Good morning, John.

Could you close the transaction at Longview without settling with Westlake or having them drop their appeal, or maybe they've already dropped their appeal and we just don't know it?

Well, just on the pipeline dispute, there's no material update with regard to the pipeline dispute. We've been successful at both the Texas Railroad Commission and the appeal efforts to ensure the pipeline offers bi-directional flow and exchanges. Again, while we recognize there's a few more potential steps to completely resolve the dispute, we're confident we can move forward because quite honestly, those remaining steps, the timing of those are probably roughly the same amount of time we think it's going to take to execute the transaction. We feel very comfortable that the pipeline dispute will not be a reason we don't move forward with the process.

Okay. And then secondly, Philip Morris has a new product called the iQOS, which I guess is the latest incarnation of the heat stick. I was reading The Economist that it's getting traction in Japan. Does that have a filter component?

It does have a filter component. It's not quite as large as a normal cigarette, but it does include a filter, from my knowledge. I haven't looked specifically at the details of this product, but I know the past versions have.

Hi. Good morning.

Good morning.

Good morning, Jeff.

When I look at your gross profit margin on a sequential basis, it went up about 180 basis points from 26.6% to 28.4%, even though the revenues really didn't change all that much from the fourth quarter of 2015 and the first quarter of 2016. Can you talk about why there was such a large gross margin change even though there really wasn't a meaningful revenue change?

Well, I think what that reflects is that relationship between pricing raw materials and the value that Mark talked about, as well as what you're continuing to see is improved mix. So what you see and what you're exchanging is maybe some lower value revenue for some better value revenue through the revenue you saw through the first quarter.

The other factor, fourth quarter has quite a bit of propane hedge in it, Jeff; first quarter restarts. So hedge starts falling in the inventory, and COGS doesn't come out of inventory until the second quarter. The biggest delta you're seeing on the cost side is going from quite a bit of the propane hedge to basically none in the first quarter.

I'm sorry to focus on commodities, but – so propane hedge this year, is it the case that the first quarter has the smallest amount and the fourth quarter will have the largest amount? And before you were reflecting on ethylene values, but contract prices have really moved up to, I don't know, $0.30 a pound. Why is it that spot matters so much more to Eastman than contract matters in terms of ethylene prices? So there's sort of two questions in there.

Well, I'll talk about the hedge. You're right; the hedge impact is the lowest in the first quarter. I'm not sure I'd characterize it as the heaviest in the fourth quarter. It's pretty well weighted across the rest of the quarters as inventory turns, but it's definitely lower in the first quarter.

Okay.

On the ethylene question, Jeff. For us, our bulk ethylene sales, it's better to think of them tracking spot than in terms of pricing.

Good morning, gentlemen.

Good morning, Frank.

Good morning.

I'm almost thinking about asking a question for Bob Patel since we're talking about ethylene so much. With that said, Mark, if I gave you and Eastman Chemical without exposure to ethylene, looking at 2016 versus 2015, how would you change the phrase driving hard to deliver 2016 EPS approaching 2015? Would you be confident in saying you'd meet or exceed, or how would that change the dynamic of your guidance?

Frank, if you didn't have the sort of olefins dynamic going on that we're going through right now, we'd have earnings growth this year over last year and be locking in our seventh consecutive year of earnings growth. Take that another step further, if you look at the quality of our operating earnings in our company right now, it's substantially better, right? It's about $0.60 a share better if you strip out both the propane hedge and the currency hedge, which I think gives us financial activity. We'd have had very strong earnings last year and very strong earnings this year relative to sort of what you're seeing because of this financial hedging. That's why we're divesting the bulk ethylene and some of these other associated chemical intermediates, to eliminate this volatility noise from our story because the real story for Eastman is tremendous growth in specialties, tremendous innovation across a wide range of very attractive markets, a very consistent strategy in driving that. We fundamentally believe in the integration of value that’s created for us; I’m very happy to have our large integrated asset supporting our specialty. But for these intermediates and the bulk ethylene that we don't need for the specialty strategy, our objective, as it has been since 2013, is to get it out of our portfolio to focus on the great successes we're having in our specialties.

And Mark, if I could add, another way to look at it, Frank, if you looked at a couple of years ago, our access to ethylene contributed about 5% of our overall EBIT as a percentage of revenue. If you look at this year, it's probably going to contribute 11%, so that gives you an order of magnitude.

Okay. All right, that's very helpful. In terms of the asset disposal you talked about, I'd love to ask about the potential timing. But having known Curt being in the CFO role for eight years – coming up on eight years, I know there's 0% chance he'd answer that with something that I could actually use. So I'll ask another question, you talked about significantly increasing your cost reduction efforts; can you give us some color there or some quantification as to what's going on there? What are the mileposts? What did you achieve in Q1 and beyond besides the acquisition synergies?

Sure, Frank, I'll answer that since – I'll answer both of your questions. Look, what I'm going to answer is you know what I'm going to say; the timing of this effort is we're going to be a disciplined seller, but this is a priority for us, but I think it's going to take later part of this year to execute that transaction. As it relates to cost reduction, we're continuing the cost reduction program we discussed last quarter. It's a continued strong driver of our organization to see where we can eliminate ways, take out costs, and drive our productivity. We're making great progress towards our goal of $200 million of productivity gains, and we're confident that about $100 million of that will drop to the bottom line after we offset that growth spend in related projects and normal inflation. We're very much on track with what we started this year with.

Yeah. I think what we're trying to say is that the benefits of it are going to start showing up more in the second, third and fourth quarter relative to the first because the headcount reductions didn't really complete until the end of February. That’s still flowing into COGS to flow out of inventory on the manufacturing side. Obviously, yeah, the SG&A will shift a little bit faster, but that's what we're trying to get at.

Yes, good morning.

Good morning.

Good morning.

In your outlook statement, you guys added the phrase about increasing competitive pressures. Can you walk through the three or four SBUs that are most impacted by that? In your mind, is that a structural change, or is it just a cyclical change, maybe around raw materials and some activity there?

It's a combination of those factors. So principally, we're seeing this in Chemical Intermediates, and it's not surprising that you would see it in those kinds of products. It's really a combination of the world is growing slowly, in particular, China is growing slowly and not consuming a lot of capacity that they've added for a variety of products that sit in Chemical Intermediates. When you combine that excess capacity with the low oil environment and in some other places, some weakening currencies, you can get competitors chasing volume with their improved cost structure. Basically, that's what you're seeing. You see some pressure in olefin-related products in Chemical Intermediates; you see some pressure in acetyls. As methanol price gets low, that allows the Asians, and particularly the Chinese, to drop their acetic acid, acetic anhydride prices, and you have to respond to that as it works its way across the world. Even in alkylamines, we have some formula contracts that attract methanol. We have a very advantaged methanol contract that goes into our cost structure, so just like our coal gasification or shale gas position; if our competitors have lower methanol prices, some of that prices don't come down, you're going to get a bit of the compression. That's what you're seeing. I'd say added to that; there is some structural pressure in things like plasticizers; we've been talking about that since 2013, where the Koreans have been dumping their products all over the world since they can't get it into China anymore. You see some pressure in a few products like that. It's principally there; there are a few products that I already discussed in the prior question around Additives & Functional Products, so I think I've already addressed that.

Okay. Great. Thanks. And then in tow, pretty divergent numbers between you and your biggest competitor. Now sometimes tow can be lumpy in any given quarter; should we chalk it up to that or is there again something structural going on there, or maybe we'll see continued large variances in the volume and the pricing numbers between the two of you?

No, I think the answer is two things. One is that it is lumpy, so there are lumpy buying patterns, and so you have to be extremely careful about trying to over interpret any quarter when you're comparing us to our tow peers. However, there’s also a difference that we've discussed in the past, which is we've been incredibly successful in having a very large share of imports into China, allowing us to grow a lot of earnings and generate a lot of cash for shareholders in the past 10 years. Of course, there is the flipside of that now when imports are dropping; we're going to feel the pressure of that more than our peers with the drop in imports in China. So, I'd say right there, that's sort of the key difference. On a global basis, I think our market shares are very stable, and we certainly have every intention of maintaining our position from a share point of view. What I like about Eastman and our long-term future here is we have the lowest cost, largest scale, fully integrated back to coal flake and tow position for the world, and we've got a great asset here in flake that allows us to support all of our assets both here, Korea, and China. Because of the integration, because of the great value creation we get from our other cellulosic products and as with Functional Products and Advanced Materials, we also have more innovation capability than anyone else and sort of keeping that integrated asset base running. I am very confident in our long-term position, and we're committed to doing it. We'll see how it plays out, but I think we're the winner in the end of this game.

Great. Thanks, guys.

Good morning, and thanks for taking my question. With respect to the sale of the olefins business, I'm curious as to how you're thinking about that in terms of potential tax leakage, I would assume that the olefins asset is pretty well depreciated. What are your thoughts in terms of doing a spin as opposed to a sale?

What we're doing is – well, it's not only tax because there's a lot of variety of factors we're looking at. We recognize the current market conditions with oil and olefins, but our belief is that any potential strategic buyer will understand the long-term value of olefins produced with these good quality assets and will look at it that way. You know us, we have a talented team at Eastman that knows how to buy and sell businesses. We'll be disciplined with valuation and patient on timing if need be. I've already mentioned, there are parties expressing interest. As it relates to a spin, that's a little tougher one because we're not quite sure this would be the scale of an asset that would really result in a value-creating spin. We're open to all options. We're pretty flexible with the scope of the assets and the products involved. We'll just see how this all plays out, and that's why I said earlier, this will probably take the greater part of this year to run this process.

Great. And then just kind of a follow-up in terms of the pricing. Obviously, there's been a lot of discussion around giving some price back to customers to share that value. Just thinking over the long term, over three to five years, what type of underlying price increase do you think you should be able to get for the innovation of your products in your portfolio?

I think that the innovation always commands a nice premium, especially if you've got a proprietary product like Tritan, like our next-gen acoustics and heads-up display products that are going to come out, and a variety of our cellulosics and other display products. Those are great. Even in the places where you do have some competitors, but we're still a dominant, strong leader in that space, you've got to have some discipline about how you price relative to your competitors. I feel very confident about our ability to grow in value of mix, command very attractive margins. I think we have one of the strongest EBITDA margins in the industry and have every intention of keeping them stable as we go forward, leveraging our fixed cost as well as mix improvement. Overall, I think we're on the right strategy. As I look beyond this year, we're clearly doing a lot of adjustments. When you have such significant changes in margin – not margin but in oil prices and currency, you are going to get margins flying up and down as you sort of normalize around stable levels. You're going to see that stabilize. That's not unique to us; it's going to be true for any company connected to petrochemicals or a global business. But what I like is as you look beyond this year, we've got a lot of great drivers to deliver growth going forward. We’ve got the strong product mix and innovation, we've got the cost management that is going to continue to deliver great results, and we'll continue being very disciplined in the cost. We've got the hedges rolling off, so that $0.60 a share I mentioned earlier will come back to earnings over the next two years. You've got a very strong free cash flow that will continue to get better as we go from this year forward, and that – once the deleveraging is completed, you've got it repurchasing shares and increasing the dividend. It all adds up. There is a lot we can't control around the economy when it comes to how it's going to play out or oil and currency, but I like the fact that we have a lot in our control. The company is very focused on innovation, very focused on customer engagement, which is the only way you get to innovate, and that's how we are going to deliver results for our owners.

Great. Thanks a lot.

Good morning. In your full-year outlook for down 5% earnings, how much of that is impacted by currency, please?

When we look at the currency, it's a small percentage of that piece. I would guess – well, currency is actually normalized if you think about this year versus last year. I don't see currency as a major driver. You see some of it in the other income line item. For example, you see a good variation between this quarter versus last year, but as it relates to our gross margins, currency will not have a dramatic impact this year.

On translation?

Great. And your comments earlier on the tire market picking up, you've got more exposure to commercial vehicles there. Could you just give a little more color; are you seeing this only in commercial tires or is it across the passenger tire space as well?

No, it's across the market. We're seeing good recovery; obviously, OEM growth rates are good on the auto side. The replacement business has been solid. The TBR business, the truck business is where we really felt some significant destocking out of China last year, which seems to be getting behind us now. We've seen particularly stronger improvement in demand in the first quarter in Asia for TBR, consistent with what I think you're seeing from some of the tire companies. Overall, I'd say it feels really good. I wouldn't say it's going to be strong all year; I think some of this is a restocking event. We expect solid growth out of the tire industry this year.

Thank you.

Good morning, this is Dan Rizzo on for Laurence. You indicated that innovating new products and that’s a large part of the growth strategy. Just in terms of, I think, how many products are we talking about aside from Tritan and acoustic interlayer, just in terms of scale, what's the number?

Well, that raises an interesting question about product numbers. There's a lot of people who talk about product introductions and you have to be very careful on how you compare it relative to our peers because you can count it in very different ways. I think about technology platforms that lead to many customer wins and many applications, as opposed to talking about every individual customer application I win. We've got great platforms across Advanced Materials. We've got Tritan, as you've said; we've got a wide range of both cellulosic and some other technology products in the displays industry. As I mentioned, a whole portfolio of acoustic and heads-up display products and a next-generation of performance film products. Basically, we are introducing new products in Advanced Materials. Additives & Functional Products have tremendous success that we're now starting to see in our new polyester coating platform, which is taking the Tritan chemistry into polyester coatings. That's a huge market when you look at the downstream market from auto to industrial to packaging. Tremendous amount of opportunities and wins we'd expect there. A nice set of portfolios for next-gen on coalescent products, the tire resins, next-gen Crystex products rolling out. So everywhere you go, we're a leader in a specialty product; we have multi-generation product plans delivering sustainable growth and sustainable margins into the future. But we're not going to start throwing out individual product wins because I find those numbers not to make a lot of sense, but I've seen in some other places.

All right. Actually, that was helpful. Thank you very much.

Taylor, let's make the next question our last one, please.

Hey, guys. Nice start to the year.

Thank you.

Mark, I wanted to gauge your sentiment into – from your guidance from the last quarter into this quarter. The specialty chemical side, does your specialty business seem to be coming a little bit better? So, I mean, are you effectively saying that your specialty businesses are doing better in terms of your – prior to your guidance for this year and then your tougher businesses like Fibers and Chemical Intermediates doing worse?

Mike, I think that's directionally correct. Certainly, Advanced Materials is doing better than we expected, delivering great growth the way you want to do it through volume and mix. I'd say as the Functional Products are coming in as expected, so no surprises there - sort of solid volume growth. Prices are coming off a bit from last year as we knew that would occur. Fibers are coming in as we expected, maybe slightly lower than where I thought in January but not materially. And then the challenges sit in Chemical Intermediates with all the dynamics we've discussed. Yes. Thank you, Mike. And thanks again, everyone, for joining us this morning. A web replay and a replay in downloadable MP3 format will be available on our website later this morning. I hope you have a great day.

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