Good day, everyone and welcome to the Eastman Chemical Second Quarter 2020 Conference Call. Today's conference is being recorded. This call is being broadcast live on Eastman's website, which is www.eastman.com. We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company, Investor Relations. Please go ahead, sir. Thank you, Brian and good morning, everyone and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO; Willie McLain, Senior Vice President and CFO; and Jake LaRoe, Manager, Investor Relations. In case you missed it yesterday after market close, in addition to our first quarter of 2020 financial results press release and SEC 8-K filing, we posted slides and related prepared remarks in the Investor section of our website, which is www.eastman.com. We've continued this practice from the first quarter, and I hope it continues to be helpful to you. Before we begin, I'll cover two items. First, during this presentation, you will hear certain forward-looking statements concerning our plans and expectations. Actual events or results could differ materially. Certain factors related to future expectations are or will be detailed in the Company's second quarter 2020 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-Q filed for first quarter 2020 and the Form 10-Q to be filed for second quarter 2020. Second, earnings referenced in this presentation exclude certain non-core and unusual items and use an adjusted effective tax rate using the forecasted tax rate for the full year. Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded and adjusted items, are available in the second quarter financial results news release, which can be found on our website in the Investors section. With that, I'll turn the call over to Mark.

Thanks, Greg. Before I turn it over to questions, I want to take a few minutes to make some comments. The first half of 2020 has been unprecedented given the serious threat to health and safety, the reminders of racism and the need for positive change, the incredible amount of economic volatility, and the lingering uncertainties that confront us all. I'm grateful to the healthcare community, our first responders, along with government local leaders who are helping at this difficult time. As importantly, I want to thank the women and men of Eastman, their families who continue to come together in tremendous ways. They've gone above and beyond, working long hours many times in challenging conditions. Most importantly, they have been diligent to keep people safe, continue to support our customers, and keep our businesses going. While COVID-19 has caused us to shift some priorities this year, we are renewing our commitment to drive a more inclusive and diverse workforce, which is a core value of Eastman and critical to our growth strategy and ability to innovate. During the quarter, we took steps to strengthen our efforts to build more inclusive teams by increasing our efforts to mitigate the impact of unconscious bias and expanding resources to equip employees for their role in driving a more inclusive culture. We're making progress and have much more work to do to ensure every team can show up and contribute fully at work and in their communities. As we look at our first half performance, we believe that we have performed relatively well with our focus on free cash flow. Sales revenue for the quarter and for the first half of the year when compared to peer results demonstrated resilience, which is a function of our innovation-driven growth model as well as the diversity of our end markets, and a testament to the great work of Eastman employees as they navigate this challenging and unprecedented environment. We also made great progress in our $150 million cost reduction program in the quarter and are on track to hit our full-year target. With our focus on free cash flow, we'd also managed our inventory aggressively to respond to the fall in demand and go beyond that, to generate even more cash, delivering our best free cash flow for the first half. Turning now to our expectations for 2020. In the second quarter, the cost from the lower capacity utilization was $120 million sequentially. We expect this will decline by about half in the third quarter and be partially offset by increasing maintenance spending and a moderation of the impact from cost reduction actions as we ramp back up. Advanced Materials will have the biggest impact from the improvement in capacity utilization, between $30 million and $35 million for the quarter. AFP will see some benefit, and CI will face a net headwind as higher maintenance shutdowns will be more than the utilization tailwind. The third quarter is off to a strong start as we benefit from volume recovery and start to realize the benefits of inventory management actions we took in the second quarter. As a result, we expect a substantial sequential increase in earnings. Most importantly, we are maintaining our focus on cash generation, which is our priority for the year. Early on, a very strong start in the first half of the year, we are on track to generate over $1 billion of free cash flow for the year. Given the continued uncertainty related to COVID-19, we are not providing 2020 guidance. While the actions we're taking today are making a significant difference, we remain focused on our innovation strategy and are continuing to invest in our growth and our commercial capabilities. At the same time, we will be driving an operational transformation program to structurally remove costs by greater than $200 million by the end of 2022 with a significant impact in '21. Altogether, these actions we've taken in 2020 are well-positioned to benefit from the return of economic growth as we look at the future in '21 and beyond. As we lead from a position of strength with our innovation-driven growth model, it's the heart of how we win. Our strengths have never been clearer during this pandemic. Our portfolio transformation, especially businesses, the outstanding innovation capability we've built along with our decisive operational execution capability. Generating excellent free cash flow is a top financial priority, our balance sheet is strong, and we have significant sources of liquidity. With that, I'll turn it back to Greg.

Okay. Thanks, Mark. And Brian, we're now ready for questions.

We'll now take our first question from Vincent Andrews from Morgan Stanley. Please go ahead, your line is open.

Hi, good morning. This is Andrew Castillo asking on behalf of Vincent. I have a quick question about your carbon renewal technology. It seems like customers are responding positively. Could you elaborate on the economics, specifically what premiums you're receiving compared to non-recycled products? Additionally, as we look towards the revenue targets of $200 million to $300 million that you mentioned, can you provide insight into the key milestones you have in mind and the timeline for transitioning from a pilot plant to full-scale production?

Sure. We have been focusing on one of our most promising growth platforms at Eastman for about 18 months. As many of you know, addressing carbon footprints and the issue of plastic waste in landfills and oceans is crucial for our industry. It’s also a significant waste of carbon to let these materials end up in the environment instead of recycling them. Eastman plays a leading role with commercial-scale investments aimed at creating a circular economy that benefits both the economy and the environment. One of our key technologies is our carbon renewal technology, which involves repurposing waste plastics through our gasifier to break them down to their molecular components and reconstruct valuable products. We began commercial operations some time ago and are now scaling our output for various customers, particularly those in textiles, with our new NAYO products containing 50% bio content from sustainable sources, while the other half will come from recycled plastic. These products are also biodegradable as microfibers in the ocean, making them an ideal choice in textiles, combining bio and recycled content with no issues regarding microfibers. We are experiencing strong interest from numerous customers; a notable recent success is with H&M, which has featured our products in their conscious collection, and we anticipate additional companies will follow suit. Despite the challenges posed by COVID-19, particularly in the textile market, we have seen a slight decline of only 15% in women’s wear, while the overall market has dropped 30%. This indicates a promising growth in substitution, even within a difficult environment, as consumers gravitate toward sustainable solutions, often at a premium price compared to other market alternatives. As the textile market recovers, we expect this trend to accelerate. This success is also reflected in our cellulosic plastic offerings, particularly in eyewear, where we have several customers committed to recycling their cellulosic waste for sunglasses and eyeglasses. We hold a leading position in this area and are focused on implementing a true circular solution for these products. Another technology we offer is our polyester recycling, which allows us to reclaim polyester, convert it back into intermediates, and reintroduce it to the market. Both technologies offer true circular solutions, maintaining high-quality application levels without down-cycling like many other methods. Our molecular recycling ensures that the performance of the recycled products matches that of fossil fuel-based products, maintaining safety and quality as we purify materials down to the molecular level. This process is infinitely repeatable, akin to aluminum recycling, as opposed to mechanical recycling, which has limitations on the number of times materials can be reused. We see significant potential here, estimating an additional $200 million to $300 million in incremental revenue from market share gains and price premiums, presenting an attractive return on investment.

That's very helpful. Thank you. And then just in terms of the portfolio optimization. So you're doing some savings, cost savings initiatives. I think on your last earnings call you had mentioned that perhaps in this environment, it's a little bit hard to look at monetizing some of the maybe one-third of AFP that's struggling a little bit more. I was wondering if you could give us an update on how you're viewing this strategically, and if there are opportunities to do some of that as well on top of the cost reductions.

Yes. This is Willie speaking. So on the one-third of AFP first, let me just reiterate that we're taking action now, actions to improve the business including progress on our innovation as well as the restructuring of our footprint. You'll see that we announced the closure of an asset in Asia, and we continue to work through other actions and choices that we have to improve the near-term business performance. We're pursuing all options which include partnerships to improve the overall business performance and reduce our exposure. In addition to that, we would be looking at, also divestitures over time. So we're looking at all fronts and we're taking action now to improve that performance. As you can imagine, in this environment, it is a more difficult environment, but I would say that we've gotten through, I'll call it the first phase of COVID; there has been renewed engagement and interest on multiple fronts. And we're pleased with those engagements. On the $150 million of cost savings to pivot there, what I would highlight again is, we are on track to achieve that, in Q2 we were a little ahead. And on, you would expect Q4 to be the lowest quarter and Q3 to be about average, but again on track to achieve that. And as we highlighted, we're looking to also make structural changes of which we think roughly a third will be structural from that. Our objective right now is to ensure that as the discretionary spend comes back in 2021 that we have structural actions that at least offset that as we move forward.

Very helpful. Thank you.

Moving on to our next question from Ben Isaacson from Scotiabank. Please go ahead. Your line is open.

Thank you. I noticed that your sales by customer location was down about 20% in the US, 20% in Europe, but only around 9% in Asia. So, could you split that between China and the Rest of Asia, remind us what your China exposure is? And are you working on any risk mitigants with respect to potentially a worsening US-China trade situation? Thanks.

Just to give a little bit of color around our Asia Pacific exposure, what we've previously said is, roughly half of that exposure is in China, half of it is outside of China. As you think about also the way COVID impacted around the world, the impact of COVID was much more significant in Q1 in Asia, and as the economy returned, you saw that pick up. Basically, I think what you're seeing in the revenue is how it impacted Europe and North America more so in Q2.

As you consider the trade war issue, it's important to remember that we are focused on Phase 2. The trade war started in 2019, and the pandemic has added another layer of complexity this year. We are already experiencing some effects of the trade war that haven't completely faded; it seemed to stabilize at the start of this year, but it hasn’t disappeared. We've managed to navigate through it well last year, and we are definitely observing strong improvements in our results since things stabilized in January and February of this year. Our diverse end markets have shown stability across various regions. There's significant potential for growth in North America and Europe, along with a recovery from the pandemic, which could help lessen some risks associated with China as we progress. Overall, we have a solidly diversified position not only geographically but also in terms of markets, and we've already proven our capability to manage during this trade war.

Thank you.

We'll take our next question from Kevin McCarthy from Vertical Research Partners. Please go ahead. Your line is open.

Yes. Good morning. Can you speak to the inventory reductions in the second quarter as well as where you ended the quarter and what that might mean for your operating rates moving forward?

Thanks, Kevin. This is Willie. We've made very strong progress on working capital and specifically inventory in the quarter. I think sequentially you saw inventory down roughly 15%. And again, I applaud all of our business teams and operations and supply chain for executing on that very effectively. We would expect only, I'll call it, very modest additional inventory reductions throughout the year. So you can expect, I'll call it, the utilization rates to pick up quite substantially here in Q3, as we bring our other plants back on board and definitely in the transportation end markets. I'd also reference that as you look at that on a year-over-year basis, we were building inventory. So it's in that 20% to 25% level year-over-year of inventory reductions. So great progress, still more to do, as we think about our receivables and payables, as those, I'll call it get back to more normal levels in the back half of the year, but effectively improving overall.

Yes. I want to highlight that regarding utilization, the challenges we faced this year are rooted in 2021. We've generated a significant amount of cash this year, and I'm proud of the progress our teams have made through their exceptional efforts. We didn't just respond to demand; we actively managed our inventory to generate cash, which contributed to some of the utilization challenges. In the second quarter, we experienced a $140 million year-over-year headwind in utilization, with half of that attributed to our proactive inventory management. Looking ahead to next year, if we assume volumes remain the same as this year, we can expect that half of that $140 million will turn into an earnings boost. We are also keeping costs steady through our structural initiatives for next year. The actions we took regarding utilization in the second quarter, and to some extent in the third quarter, will provide a substantial earnings advantage for next year, as long as volumes match this year. If volumes improve, we will see even greater benefits, as the additional margins from increased volume and mix growth will be significant. Our focus on utilization has been beneficial for cash this year, and we've made it clear that cash generation is our priority over accounting earnings, particularly with the period charges in the second quarter. This positions us well for a recovery next year.

I see. Thank you for that. And then secondly, I wanted to ask you to elaborate on restructuring. It looks like, do you foresee $200 million or more savings to the end of '22, a fairly large number there. Where will that be coming from in terms of your businesses and regions? Perhaps you could talk about how much is headcount versus asset rationalization and other sources of savings.

Kevin, let me start out here. As you think about the actions that we're taking, first and foremost, we look to optimize our asset footprint, specifically in the one-third as well as the Singapore announcement that we previously announced. So you can see that number being at least $50 million or greater. Additionally, as we highlighted earlier this year, we were talking about continuing to improve our site utilization. So as you think about leveraging our integrated facilities, we've highlighted with Air Products and other assets along the Gulf Coast, the benefits that will achieve in earnings there. Additionally, we're looking at how do we use digital solutions as well as transform how we do maintenance on our sites and optimize our networks around the globe post-trade war and post-environment, and those will be additional earnings on top of that.

Yes. There's quite a bit of value around network optimization and we've done a lot of acquisitions over the years as you all know, building up our specialty portfolio. So as you look at those plants, warehouses, networks and how we do everything, there are opportunities to optimize all of that. And there are headcount reductions as well. So as we optimize our business operating model and our investments about making us more effective and nimble in our commercial operations, all the way through how we improve our effectiveness of operations, especially with a lot of lessons learned here in the last four months, we see a real opportunity to sort of streamline the organization and take costs out there. So there's a lot of different levers. It's all line of sight. There are very detailed programs to that total number, Kevin, and how we get there. It's no one silver bullet, but a lot of heavy lifting by people across the entire organization to make it happen. But it's a great year to sort of step back and say, how do we complete the transformation to a specialty company, both on the commercial capability and innovation investments which we're continuing to do, but also on how we become very cost competitive to create value for our shareholders and stay competitive against the people we face in the marketplace. So a lot of great work there, but a very clear set of action plans.

All right. Thank you very much.

We'll now take our next question from Matthew DeYoe from Bank of America. Please go ahead. Your line is open.

Hi. So one of your competitors has talked about the fact that they outperformed autos in Q2, given their position on the supply chain and the fact that they insulated them from the sell-off initially. However, that would represent a lag both in operating rates and demand pull-through as transportation rebounded. Are you seeing similar implications on your businesses, particularly as it relates to those on OEM? Or do you see orders already coming through your system?

I believe the responses differ between Advanced Materials and Advanced Functional Products, so I'll address both. In Advanced Materials, the supply chain is quite short, which means we quickly notice changes in OEM production or sales levels for the Performance Films business as it’s closely tied to the point of sale. This is why Advanced Materials was more significantly impacted by COVID in the first quarter, while earnings in AFP recovered more sequentially from the fourth to the first quarter. We felt the impact rapidly and took swift action, leading to the closure of more operating facilities in Advanced Materials. The demand decline occurred from March through May, and it was easier to shut down our standalone facilities in AM, leading to a quick response. We then observed a fast recovery in those segments by June, contributing to a stronger earnings recovery forecast and utilization benefits for Advanced Materials in the third quarter. This occurred much faster than in Advanced Functional Products, which has a longer supply chain. Therefore, we didn’t experience the same impact in the first quarter, resulting in stronger earnings performance and a more significant drop when the lag finally hit us in the second quarter for AFP. Coatings and aviation also faced longer supply chains, affecting them as well. The recovery for AFP won’t be as quick in the third quarter. Additionally, aviation is not rebounding as fast in transportation, and about half of our automotive coatings comes from refinish rather than OEM. That means AFP isn't seeing the same rapid recovery in OEM production because, as our customers indicate, the refinish segment will take longer to bounce back. We do notice an improvement in traffic and anticipate a solid recovery, but it won’t be as rapid.

Okay. And so the $200 million number is pretty chunky, and in that light, I guess, absent an acquisition, is it reasonable to think you can get back to that $600 million in EBIT range for AFP by 2023? And if not, what is a reasonable assumption for mid-cycle kind of earnings in that business?

Well, I think that as you look at AFP and earnings, first of all, we're not going to be giving forecasts out to 2023. But what I can say is that it's a great business, and the vast majority of the impact this business has faced since 2018, which is where I think about where earnings were in a stable environment before the trade war started, compounded by a pandemic. The vast majority of our hit between now and then was volume mix, right, less auto demand, B&C demand, a variety of different places where we realize some impact on demand. And all of that demand will come back with the market, and you've got to remember that mix is a huge part of the story in both AM and AFP. When that volume dropped in transportation or B&C or in consumer durables, that's the highest margins we have relative to the company average. So big impact on the way down last year, this year, and big impact on the mirror image of it recovering. It's not just about volume recovery; that mix is a huge impact in driving value and earnings and cash. So we expect that all to come back. The other part, of course, is we're taking aggressive action on the cost side. If we take $150 million out this year, make that structural into '21, and even add on another $100 million. That means we've taken out $150 million relative to 2018, '19, that offset some of the spread and competitive pressure, more than offset the spread and competitive pressure that we've seen in tires and adhesives. So there's no reason for the earnings not to be able to come back for the Company to a pretty substantial level and get back when volumes come back; we should get back to earnings being better than '19 or '18 when the volumes get back to that level.

Okay. So the message being just structural cost cuts plus volume recovery equals pressure on adhesives and once you shouldn't businesses like that, maybe, give or take, plus volume growth from there.

It's primarily about the mix; a significant portion of the margin is influenced by that mix, not just the volume. We have emphasized this since Innovation Day in 2018 to illustrate the importance of mix. It plays a crucial role in our story and growth, although it can also be affected when demand decreases.

Yes. Thank you.

We will now take the next question from Duffy Fischer from Barclays. Please go ahead. Your line is open.

Good morning, guys. Could you just talk, because there have been a couple of cost takeout programs, some temporary, some permanent, if we just use Q2 as the base, how much comes out the rest of this year and how much of that’s permanent versus temporary, then how should we think about the sequencing in '21 and '22?

So, Duffy, as we think about this year, there is an additional $100 million which will take out; and I'll say, let's think about roughly half of that being more discretionary and half of that being structural as we make momentum on the structural aspects here in the second half. As we pivot into the next year, I think I highlighted earlier that we're making decisions and taking actions this year that will build roughly $50 million more structural as we look at our asset footprint. I'll build that connection to what Mark highlighted, and we expect network optimization to be a major driver of structural changes also in 2021. So that was basically in that sense keep you cost neutral year-over-year as the discretionary goes away and we replace it with structural. Then on top of that, we see a pathway to an additional $50 million to $100 million in '21 and '22 to grow them the additional increases and deliver to the bottom line.

Okay. And then, if we look at your outlook, the $120 million, half of that back $60 million offset by $10 million, that would walk to an improvement of $50 million from Q2 to Q3. Is that the baseline that we should think about making adjustments for kind of the pricing trends in these cost take-outs, or that's your best view on kind of all in incorporating everything, but just a way to get us to that $50 million number? How can you parse those two?

So the first step I would take is, to your point, the removal of the inventory and the impact of that in Q2, partially offset by, I'll call it, the reduced maintenance and the slightly lower cost actions, that gets us, I'll call it, to that $30 million to $40 million range as we think about structural cost and operational improvement. And then on top of that would be, I'll call it, the variable margin improvement for volume growth that we have sequentially.

And we're seeing a good build in volume, right. So we saw an 8% increase in July and June compounded by another 4% in July, order book, so far, it's early August. But the orders being similar to July and August is good compared to the normal seasonal decline you see in August with Europe shutdowns and everything else. So far off to a good start, but as we know painfully well, it's a very unpredictable year; we will have to see how economies are impacted by the resurgence. And if there's things we don't see coming that mitigate demand.

Perfect. Thanks, guys.

Moving on to your next question, we'll take Frank Mitsch from Fermium Research. Please go ahead. Your line is open.

If I could follow up on that. Really appreciate slide 5; it gives us a good confidence level in terms of the snap back in most impacted, in the mixed impacted businesses, the resilient business looks like it is down 10% year-over-year in July. In the text, you suggested a moderation in that area as consumers go back to a new normal. Can you elaborate on that? And perhaps offer thoughts on when that moderation may be over and what you're seeing, what your order books are seeing in August?

Sure. Frank, and thanks for the question. As far as the resilient markets go, obviously some of those markets had a real benefit from the people stocking up for COVID from grocery stores and things like that, or care chemicals, same type of product. So packaging care chemicals did well. There were some people buying some products ahead of time because they were worried about security of supply and wanted to make sure that there was enough inventory they had to run their operations. So you saw a little bit of that going on in some of these resilient markets. Really what we see is demand coming off in some of those cases to what we call more normal than that additional buying. So that's part of the story and some of those packaging consumer markets that we all talk about and read about. You also just remember, there’s a seasonal trend down in volume from 2Q to 3Q in some markets like Ag, right? So some of this volume is coming off because those markets just naturally seasonally come off sequentially from 2Q to 3Q. So you got those dynamics going on. I wouldn't say there's anything more dramatic than that. The only other place I can think of is in medical, we had very high-value products in Advanced Materials where people were buying to make sure that inventory; then elective surgeries obviously didn't play out as well, so some of the demand for those products wasn't as great as they expected. There is some of that destocking going on, but I think from a timing point of view, frank, it's this month, July-August is where people are sort of adjusting their inventories. I don't think it extends through the rest of the year as far as some of that volume adjustment goes. And we just sort of level back out to more normal in these end markets. But we're not, we're not seeing a steady decline for a long period of time.

That's very helpful. One of the key focuses of the new Eastman is innovation, and these are obviously unusual times. It would be beneficial to provide some metrics regarding the pace of progress in innovation. Can you share any quantification on that front?

I believe the key metric we've used in the past will continue to be relevant, although it may not be as useful right now. This metric is the amount of new business revenue generated from innovation products. We have a comprehensive tracking system with our digital tools that monitors every business win, whether it stems from innovation, effective market segmentation, or transactional sales, as well as analyzes why we lose business and how we can improve. We have been aiming for $500 million in new business from innovation this year and are on track to achieve it despite the challenges faced during the trade war last year. However, this year, we will not reach that $500 million target due to the significant time people spent sheltered in place. On the positive side, we are noticing continued engagement from customers. We've secured several wins in the circular economy, like our collaboration with H&M, and shared success stories about Tritan Renew in the hydration sector with Nalgene and other brands embracing our recycled content offerings that resonate well with their customers. We are witnessing encouraging wins, but there are still many areas where we continue to work with customers on coating additives, tire additives, odor-free adhesives, and the next generation of HUD and acoustic interlayers. There is ongoing activity across all sectors where customers are advancing their innovation agendas, which is essential for growth. Although we may not reach the $500 million goal in the current situation, I anticipate that the activity we are observing will rebound quickly once we enter recovery mode and people can engage with one another physically.

Terrific. Thanks so much.

We will now take our next question from Jeff Zekauskas from J.P. Morgan. Please go ahead. Your line is open. Thanks very much.

Your Fluids business, I think in 2019 was $460 million in revenues. How much of that is aviation fluid? And how much is the aviation fluid down or what do you expect it to be down this year?

So when I look at the fluids business, Jeff, I'd say it's about half and half, and clearly, the aviation side of the portfolio which is very high-margin business is down dramatically consistent with the milestone of airplanes. We are very milestone driven with that business, and so it's going to recover slowly when it comes to the other side. I want to highlight, the heat transfer fluids business is actually doing great and actually going to deliver growth this year over last year. So one of the bright spots in the two-thirds of AFP, in addition to care chemicals and pharma and packaging, and even residential architectural businesses. We got a lot of growth going on in a number of those businesses, which has held in fairly well.

And secondly, you talked a lot about cost achievements, but as best as I can tell, SG&A was down $10 million in the quarter, which is about 6%, and your sales were down, I don't know 19%. Why isn't SG&A down more? Do you have an SG&A target in terms of cost reductions?

Jeff, this is Willie. What I would highlight is, if you think about the $150 million, we're going to get roughly $100 million of that, I'll call it manufacturing cost line and roughly $50 million through the SG&A/R&D line. As you've seen from Q1 to Q2, we've got some, I'll call it variable compensation plans that are linked to market-based and with the recovery and the stock market that occurred in Q2, that basically offset the cost savings within the quarter.

How much was that? How much got offset?

So, the way I think about that, roughly it is about the $10 million range.

Okay, great. Thank you so much.

Moving on to our next question, we will take David Begleiter from Deutsche Bank. Please go ahead. Your line is open.

Thank you. Good morning. Mark, can you discuss trends in raw materials, what you saw in Q2 and what you were expecting in the back half of the year?

Sure. Good morning, Dave. So the raw material trends, as you think about it, obviously have come off in first quarter and second quarter. And it's actually helpful to think about raw material trends, you know, are back to the third quarter of 2018, right? So, with the trade war, we saw, you know, the price of our petrochemical derivatives that we're buying, for example, come off a lot last year faster than oil did. So even though oil came off a lot this year, many of the derivatives of oil had already come off pretty substantially. A big part of the raw material trend from all of this happened last year as opposed to this year. We certainly have seen some benefits in raw materials in the first half of this year; as we look to the second half of the year, as some raw materials, I think, will stay relatively flat or moderated, if you look at something like paraxylene. But then you've got other places like you saw already in the second quarter where propane moved up pretty dramatically and PGP didn't. So you've got things moving around a lot of different directions. We're not expecting a huge raw material headwind as we look at the back half of the year. Our forecasting and plans assume that there will be some increase in some of those raw material costs. But we have a bunch of plans in place, and like in chemical intermediates, we're moving prices up already consistent with the raw material environment to stay on track. But we think we're in good shape as far as spreads go when it comes to the back half of the year.

Very good. And can you just discuss capital allocation priorities in the back half of the year? And some buybacks in Q1, Q2 and discuss buybacks versus debt reduction as well as other actions.

Thanks, David, for the question. Obviously, first and foremost, we are focused on our strong and solid dividend being the first priority. Also, as we've highlighted, expecting to pay back greater than $600 million of our net debt down almost $200 million in the first half. We would expect that to grow to roughly greater than $600 million in the back half. And we've paused the share buybacks until we meet those objectives. As we look into 2021 with growth and recovery, we'll re-evaluate the pace at which we do that.

We will now take our next question. Please go ahead. Your line is open.

Yes. Hi, good morning. Mark, can you talk about your intermediate business and some products like glycols? You had new capacity in place before the pandemic, and there was also a weakness in acid base for you. Can you share what transpired and your outlook for the second half?

Sure. You know, obviously, you know, in an environment where demand drops significantly relative to capacity available in chemical intermediates products, you know, the prices are going to fall or rise, which is predominantly what we've seen. The only place where we've really seen material spread compression due to competitive activities is in the disconnect we saw in the second quarter between propane and propylene, and that really resulted in some challenging raw material costs in the market that sets the price in the marketplace, which is PGP, obviously didn't go up and went down. That was a tough combination. Fortunately, we've already seen that corrected back to a more normal relationship through July and the beginning of August here where PGP has gone up dramatically, while propane has been sort of holding steady. So we feel good about how that's corrected already into this quarter. On the acid fuel side, we've seen some compression, obviously, as oil prices and methanol that's priced the marketplace comes off. We feel some of that compression relative to our cost structure, which is principally based on coal. So those are the places where we're seeing some of the pressure but spreads overall have been relatively good; so that's not the story. As you can see in our revenue table, the bigger impact for us has been volume as opposed to price on a first half basis where you've really especially in the second quarter, it had that impact on COVID related demand not being there and some of the export markets that we would normally clear capacity, not being as available when oil prices dropped so much. Generally, that's not a high margin business for us, but still it has a significant impact on the volume and that contribution margin comes in to pay for some of the integrated fixed costs to the overall complex. Those are really the key stories there. I think they're all due to extraordinary circumstances in the second quarter; a lot of this will continue into the third quarter, but there's no reason this won't recover as we go into next year.

Okay. And my second question is on the charge that you took in tire additives; it was quite a large charge of $228 million in that segment. What triggered that? Is that due to low utilization? And then what happens when volumes come back next year?

Sure PJ. This is Willie. So as you think about the impacts that COVID has had on the transportation market more broadly, as well as the impact on utilization, which you've highlighted, we have to assess the value of certain businesses and specifically tire additives. So the biggest piece of the impairment was related to, I'll call it, the trade names Chris Tex and Zanaflex. And that's related to a revenue outlook; as you look at valuing those on a royalty basis, as the revenue outlook has much deteriorated, that the starting point of where we're valuing this, as well as the rates being lower resulted in the impairment that you see. Obviously, with accounting, once you write it off, you don't get to run it back on when things recover.

Is a great part of accounting, which is we've dramatically improved the value of businesses like performance films and interlayers from what we bought it, but you don't get to write up the asset values, but you have to take the impairments whenever these kinds of issues occur.

Right, you're not alone in taking these charges this quarter. But does that mean that margins look better next year when volumes come back?

PJ, I think as we've highlighted through this if you take roughly half of the $140 million across the company, $70 million of that was due to the current utilization impacts across the company and that will result in a tailwind at even flat volumes. So as we think about growing volumes next year in recovery, holding costs flat, this will result in good momentum as we go into 2021.

We are seeing a strong recovery in tire volumes as we move into the third quarter. This is evident in the volume recovery noted on Page 5. A significant portion of this volume increase is attributed to tires. While competitive dynamics remain, which will keep pricing from improving for some time, we are observing a genuine resurgence in volume.

Thank you very much.

We'll now take our next question from John Roberts from UBS. Please go ahead. Your line is open.

Thank you. It used to be that cig tow held up well in a recession because people smoke more when they're under stress. It was down a little in the third quarter. It looks like the outlook is to be down a little bit further. How comfortable are you that this is just a pattern or that maybe there's something else going on here?

So we don't have any evidence that there's something else going on, John. As you said, it was incredibly stable in the 2008, 2009 recession. There is a general trend where the market is always sort of declining in that 2% to 3% range as we've said in the past, and we expect that to be the story this year. There are a lot of different stories out there at the moment that are all sort of breaking in the last couple of weeks where different cigarette companies are doing well and others are not doing well. So you really have to get into the details of what's going behind each of those companies. But overall, when we put it all together, we think market demand is declining that 2% to 3% range outside of China. China, the data suggests it's stable to kind of up maybe 2% which is about half of the cigarette demand of the world. So that's all sort of put together in the market outlook. When it comes to customer buying patterns as we have discussed many times in the past, it is a bit as we call it chunky, and what we saw was good demand, obviously, in the first quarter as well as good demand in the second quarter. Some of that was buying some incremental tow for security reasons, with all the uncertainty of COVID. That's why we expect volumes to trend off modestly as we go into the third quarter, but overall we still view this as tow is very stable especially with the cost actions we're taking at the earnings and cash flow level. On the textile side, of course, which has been growing offset some of this underlying market decline on tow. We're not going to get that this year with the textile market being so challenged. It doesn't give us any concern for the long term. I think textiles is an incredibly exciting opportunity for us, especially now with the circular economy as I answered in the first question. We really see a lot of opportunities to grow in the target markets, right. So if you think about women's wear down about 15% year-over-year in the first half of the year, versus the market of 30%. As I said, when we look at the forecast for this quarter, probably a 40% sequential improvement off of the second quarter in women's wear; the problem right now is some of the traditional markets that we've gone into like suit linings, obviously not much demand for those right now in this environment as everyone's working virtually. That's offsetting some of those, but that will correct itself, and we expect good growth out of that in next year as a way to continue filling the assets and leveraging the integrated complex.

Then are you having any issues getting recycled material for your gasification process? Is pricing for green material an issue now that virgin raw material is cheaper or virgin materials are cheaper?

Yes, it is a very complicated market when you look at recycled content and we are doing our best to segment it. What's great about our strategy is molecular recycling does not require high-quality recycled content. We can use a product that has no other use. So we can take carpet, we can take textiles, we can take plastic that cannot be used in mechanical recycling and grind it up and use it in the methanol analysis plan for polyester recycling. We don’t have to compete against that high-quality stuff and the price there is going up a lot; significantly higher than virgin PET in Europe right now, last year almost 60%. But we don't have to compete with that. There's a little bit of that we'll buy in the beginning, but we can really access what is truly has no alternative use that's going into landfills.

We will now take our final question from Mike Sison from Wells Fargo. Please go ahead. Your line is open.

Hey, guys. Good morning. Just curious how you think about the fourth quarter, and I know it's a lot of variables there. But can you get sequential improvement in earnings again? You do have cost savings, pick up some of the inventory reductions, but clearly the question is what you're hearing from your customers? Do we see a normal seasonal downtick in the fourth quarter? Is it possible that we can continue to improve sequentially? So just curious on your thoughts there on the fourth quarter.

I think that the fourth quarter is awfully difficult to call at this point with all the uncertainties of what's going to happen with COVID, the election, etc. But what I do think will happen is there will be some markets where you'll have just normal seasonal decline demand like construction activity in the winter. But I don't think you're going to see the same kind of inventory destocking that you've seen in the past because we've all been doing it pretty aggressively in the second quarter and in the third quarter, so I think you avoid that relative to what happened last year. If people are looking at next year and the economy is looking positive, you're going to actually probably have some people start building inventory to serve that demand as they go into the first quarter. I couldn't pretend to know how all those are going to balance together. I know that we've managed our inventory aggressively in the second and third quarters, so we're not going to be doing much destocking in the fourth quarter. That's certainly going to help not just where we go with inventory but also asset utilization will continue to get better as we go from 3Q to 4Q. I think we'll have some benefits on the cost structure side, both and asset utilization getting better as well as the cost actions we're taking. Demand could be a bit better than you might think. We look at it as sequential improvement from 3Q; I'm not sure we can get all the way back to 4Q of last year, but somewhere in that range seems feasible. But I got to emphasize, we're not giving guidance for the year for a reason, which is, we have no idea what fourth quarter will look like at this stage, no one does.

Understood. And then one quick one on the inventory reduction; $140 million number that was reduced by EBIT. I think you said that you got $70 million or half back on flat volume; what volume level did you get it all back in '21?

Yes. So the way I think about that, Mike is you’ve got to get back to 2019 levels as we think about fully absorbing all of that. Because at the end of the day, what we did is we pulled in fixed costs from 2019 inventory levels into the P&L here in 2020 as we've reduced it.

And we used the $140 million number for the year-over-year number when you think about 2021 versus 2020, not the $120 million sequential from 1Q to 2Q; so it's about half of that $140 million. You definitely get back with just flat volumes and then the rest is upside with volume growth.

Understood, thank you.

We will now take our next question from Alex Yefremov from Keybank. Please go ahead. Your line is open.

Thank you. Good morning, everyone. Based on what you saw in July and early August, how are volumes tracking for the third quarter versus the second quarter year-over-year basis for the company overall?

I think as we had highlighted earlier, we've got good momentum. We had an 8% growth from June to July, and we continue to see things in August to be roughly flat with July, which is, I would say, positive overall. Well, normally we would see a seasonal decline in August in Europe, but continued good momentum.

Right. It's just hard to do the math because the base effect is so difficult. Maybe I'll try it a little bit differently. In your monthly volume slide, it appears to show that you were about down 12% year-over-year in July for corporate average. So that seems to be roughly in line with minus 13% that you posted for the second quarter on average. Am I looking at this correctly? And do you expect on a year-to-year basis, August and September to be better from a volume perspective than July?

Alex, I think that's a reasonable assumption based on the momentum that we're seeing.

Let's make the next question the last one, please.

Sure, and that comes from Lawrence Alexander from Jeffries. Please go ahead. Your line is open.

Good morning. Can you help on two things? In the markets where you are outgrowing the end markets because of innovation and better market relevance, should we expect a slingshot effect where the volumes come back, you should have a multiplier on that? Or should we see the spread as being roughly stable in the recovery because it makes quite a difference in how we think about operating leverage over the next two, three years? And secondly, to the extent that the structural realignment that you're doing, to what extent should this be viewed as establishing a playbook so that future acquisitions will be integrated with a higher level of synergies upfront? Or is this a kind of one-off geometry and we shouldn't read beyond that?

I'll take the first part and let you take the second part, Willie. On the revenue side, we expect recovery, and as I said the mix hit that we took on the way down was our highest value segments. The innovation we're driving also tend to have margins way above company average in all the different products we've launched. So as you see volume recovery come, that mix leverage is pretty significant. You'll see that in advanced materials this quarter and you've seen it for years in advanced materials. We expect a lot of pretty high incremental margins in a recovery scenario, especially with the cost actions we've taken. So you don't have any fixed cost headwinds offsetting that variable margin growth, and you've got this utilization benefit we've identified. So I think we're feeling pretty good about how the earnings can come back in that scenario, but it requires economies to recover. We're not about to try and tell you when we think we're going to get back to 2019 or 2018 levels in this economy, but we certainly expect given what we know today 2021 to be better than 2020. When it comes to economy and demand and innovation, I think it's still key. You got markets where we've had incredible success innovation like performance films where we set a record in revenue in June in this very down automotive market; heads up display, Tritan, the circular economy, new coalescence and architecture, etc. We have a lot going on across all three segments, including fibers where we're creating our own growth despite the economic circumstances.

On the synergy question, what I would say is we were very pleased with the synergy levels that we achieved on our previous acquisitions with above, I’ll call it industry benchmark levels. But what I would say is obviously, we've gone through a trade war, we're going through a pandemic, and also on the digital front, there are more solutions today than when we did those acquisitions. We continue to learn and we will apply those as we move forward and as we think about future acquisitions and portfolio changes.

Okay, thanks again, everyone for joining us this morning. We appreciate your time. Hope you have a great day.

That concludes today's call. Thank you for your participation. You may now disconnect.