EASTMAN CHEMICAL CO quarterly report, Q3 FY2017

Business context and reporting period

Eastman Chemical Company filed this unaudited Form 10-Q for the quarter ended September 30, 2017. The company reports four operating segments: Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. Dollar amounts below are in millions unless noted.

Financial performance and position

Metric	Q3 2017	Q3 2016	First 9 months 2017	First 9 months 2016
Sales	$2,465	$2,287	$7,187	$6,820
Operating earnings	$460	$356	$1,277	$1,131
Net earnings attributable to Eastman	$323	$232	$893	$738
Diluted EPS	$2.22	$1.56	$6.10	$4.96

Q3 gross profit was $691 million versus $621 million; gross margin was approximately 28.0% versus 27.2%, and operating margin approximately 18.7% versus 15.6%. For the first nine months, gross profit was $1,967 million versus $1,860 million; gross margin was approximately 27.4% versus 27.3%, and operating margin approximately 17.8% versus 16.6%.

Operating cash flow for the first nine months was $1,011 million versus $995 million. Capital expenditures were $438 million versus $375 million, leaving cash flow after capital expenditures of approximately $573 million versus $620 million (simple calculation; not the company’s adjusted free-cash-flow measure). Cash at September 30 was $195 million.

Total borrowings were $6,694 million, including $369 million due within one year; long-term borrowings were $6,325 million. Total borrowings at December 31, 2016 were $6,594 million. Current assets were $3,245 million and current liabilities $1,771 million, a current ratio of approximately 1.83. The company reported approximately $1.06 billion of available borrowing capacity under its credit and receivables facilities and compliance with debt covenants.

Material changes versus prior comparable periods

Q3 sales increased 8%; management attributed the rise primarily to volume/product mix (+5 percentage points), price (+2 points), and foreign exchange (+1 point). Nine-month sales rose 5%.
Q3 reported operating earnings rose 29%; excluding non-core items, they increased 11% to $460 million from $416 million. Nine-month adjusted operating earnings increased 7% to $1,277 million from $1,198 million.
CI was a key earnings contributor: Q3 operating earnings more than doubled to $81 million from $39 million, largely reflecting less-negative commodity hedge effects and lower costs. AFP earnings increased 16% to $186 million. AM earnings were unchanged at $141 million. Fibers earnings fell 16% to $66 million, amid lower acetate tow prices.
For the first nine months, CI earnings increased to $246 million from $121 million, while Fibers earnings declined to $173 million from $237 million. AFP and AM earnings increased to $497 million and $399 million, respectively.
Q3 2016 included $30 million of restructuring charges and a $30 million pension mark-to-market loss; the comparable 2017 quarter had no such charges. Nine-month 2016 also included acquisition-related costs and other non-core items.
Q3 net interest expense declined 5% to $61 million. The first-nine-month effective tax rate was 19% versus 21% in 2016; 2017 included $44 million of tax benefits from prior-year return finalization and planned amendments.

Outlook, commentary, risks, and unusual items

Management expected adjusted 2017 EPS, excluding the Kingsport incident and fourth-quarter non-core items, to be 10%–12% above adjusted 2016 EPS of $6.76. The forecast assumed a 20% adjusted full-year tax rate. Management also expected approximately $1.6 billion of operating cash flow, $600 million of capital spending, and approximately $100 million in cost savings.
Management cited continued slow global economic growth, ongoing challenges in Fibers, volatile commodity prices and raw-material and energy costs, and a U.S. dollar expected to weigh on results. It expected continued benefits from organic growth and improved specialty-product mix.
Subsequent event: An October 4 explosion in the Kingsport coal-gasification area disrupted operations, particularly affecting Fibers and CI. All manufacturing operations had resumed except coal gasification, which was expected to be operable by year-end 2017. The company estimated a net operating-earnings reduction of $50–$100 million; related fourth-quarter costs were expected to be approximately $100 million, partly offset by insurance recovery expected in the first half of 2018.
Environmental reserves totaled $315 million at September 30. Management did not expect environmental liabilities to be material to consolidated financial position or cash flows, though changes in estimates could materially affect results in the period recognized. Estimated undiscounted remediation costs ranged from $289 million to $495 million, including amounts already reserved.
Other disclosed exposures include approximately $2.9 billion of purchase obligations over about 30 years, $287 million of lease commitments, and $71 million of residual-value guarantees; management considered material payments under the guarantees remote. The company also cited ordinary-course legal matters and risks involving manufacturing interruptions, raw-material supply and prices, global markets, customers, foreign exchange, regulation, and growth initiatives.
The company repurchased $275 million of shares in the first nine months of 2017 and declared dividends of $1.53 per share. It expected available cash and operating flows to meet foreseeable cash needs.

Important facts for investors to verify

Actual Kingsport incident costs, production recovery, insurance proceeds, and effects on Fibers and CI results.
Whether the adjusted EPS outlook and operating cash-flow and capital-spending expectations were achieved; note that the EPS outlook excluded the incident and non-core items.
CI and AFP earnings durability against raw-material, energy, and commodity-hedging movements, and continuing weakness in Fibers pricing and volumes.
Debt maturities, borrowing capacity and covenant headroom, alongside continued dividends and share repurchases.
Updates to environmental reserves, remediation estimates, and legal or other contingent exposures.