Business context and reporting period
Eastman Chemical Company’s Form 10-K covers the fiscal year ended December 31, 2014. Eastman is a global specialty chemicals, advanced materials, and fibers producer, organized into five reporting segments: Additives & Functional Products (AFP), Adhesives & Plasticizers (A&P), Advanced Materials (AM), Fibers, and Specialty Fluids & Intermediates (SFI). Approximately 55% of 2014 sales came from outside the United States and Canada.
The year included four acquisitions: the BP aviation turbine oil business, Knowlton Technologies, Taminco, and Commonwealth Laminating & Coating. Taminco was acquired December 5 and Commonwealth December 11, so their 2014 contributions were limited. Taminco contributed $84 million in sales and a $9 million operating loss from its acquisition date, including acquisition-related items.
Financial performance and liquidity
| Metric | 2014 | 2013 |
|---|---|---|
| Sales | $9.527 billion | $9.350 billion |
| Operating earnings | $1.162 billion | $1.862 billion |
| Operating earnings, excluding specified non-core items | $1.613 billion | $1.591 billion |
| Continuing-operations earnings attributable to Eastman | $749 million | $1.165 billion |
| Diluted EPS from continuing operations | $4.95 | $7.44 |
| Adjusted diluted EPS from continuing operations | $7.07 | $6.44 |
| Cash provided by operating activities | $1.408 billion | $1.297 billion |
| Capital expenditures | $593 million | $483 million |
| Total borrowings at year-end | $7.549 billion | $4.254 billion |
Sales rose 2%, driven principally by higher volume in AFP, A&P, and AM and higher Fibers selling prices, partly offset by lower Fibers volume. GAAP gross margin was approximately 23.3%, versus 29.7% in 2013; operating margin was approximately 12.2%, versus 19.9%. These comparisons were substantially affected by pension mark-to-market items. Excluding specified non-core items, operating earnings increased about 1% to $1.613 billion.
Operating cash flow increased by $111 million, primarily from higher cash earnings and lower income tax payments, partly offset by higher variable compensation and working-capital needs. Investing cash outflow was $4.091 billion, including $3.509 billion for acquisitions and investments and $593 million of capital spending. Financing cash inflow was $2.664 billion, including debt proceeds used in part to fund Taminco. Cash and equivalents ended the year at $214 million.
Year-end borrowings were $7.549 billion, including $301 million due within one year and $7.248 billion classified as long-term. Cash plus unused availability under the revolving credit and receivables facilities was supported by $1.265 billion of total available borrowing capacity. The company reported compliance with its financial covenants. Net interest expense was $187 million, up from $180 million; management expected it to rise in 2015 due to a full year of Taminco-related borrowings.
Reported full-year net earnings attributable to Eastman were $751 million, including $749 million from continuing operations and $2 million from discontinued operations. The consolidated statement reports $755 million of continuing-operations earnings before the noncontrolling-interest allocation.
Material changes versus prior comparable period
- Reported operating earnings fell 38%, largely because 2014 included a $304 million pension and postretirement mark-to-market loss, while 2013 included a $383 million gain. Excluding specified non-core items, operating earnings were nearly flat year over year.
- Reported continuing-operations earnings attributable to Eastman and diluted EPS declined; adjusted continuing-operations EPS increased from $6.44 to $7.07.
- Debt increased materially, principally to finance the Taminco acquisition. The company issued notes and drew a $1.0 billion term loan; total borrowings rose about $3.3 billion.
- Four acquisitions expanded the portfolio, notably Taminco’s amines and crop-protection businesses and Commonwealth’s window and protective films. Acquired businesses added $1.9 billion of goodwill and $1.3 billion of definite-lived intangible assets in 2014.
- Segment sales and operating earnings diverged: A&P operating earnings rose 14% to $196 million; AM rose 7% to $276 million; Fibers rose 3% to $474 million; AFP fell 19% to $329 million; and SFI fell 20% to $289 million. Segment results include acquisition timing and, where applicable, specified unusual costs.
- Quarterly results were especially weak in fourth quarter: sales were $2.349 billion, gross profit $333 million, and net earnings attributable to Eastman $16 million. The quarter included the annual pension mark-to-market loss.
Outlook, commentary, risks, and unusual items
For 2015, management forecast diluted EPS similar to 2014 adjusted EPS of $7.07, operating cash flow of approximately $1.6 billion, and capital spending of $700–$725 million, including about $80 million for Taminco. Management expected results to benefit from acquisitions, organic growth, and improved product mix; expected global growth of about 3% (U.S. 3%, Europe 1%, China near 7%); and projected a 26%–27% tax rate on reported continuing-operations pretax earnings, excluding non-core items.
Management cautioned that the stronger U.S. dollar would weigh on results and that lower crude and related commodity prices might not fully reduce Eastman’s input costs in 2015, in part because of existing hedges, particularly for propane. Raw-material and energy prices, supply disruptions, economic weakness, foreign exchange, customer concentration, manufacturing interruptions and cyber risks, acquisition integration and synergy delivery, and regulatory or environmental costs were identified risks. The company also noted cyclicality in intermediates and seasonal weakness in certain fourth-quarter markets.
Unusual items included the $304 million pension and postretirement mark-to-market loss; $77 million of asset impairments and restructuring charges; $24 million of additional acquired-inventory costs; $24 million of acquisition integration costs; and $22 million of acquisition transaction costs. AFP recorded a $22 million Crystex tradename impairment. The environmental contingency reserve was $345 million; estimated future remediation costs ranged from $324 million to a reasonably possible maximum of $548 million. Management stated environmental matters were not expected to materially affect consolidated financial position or cash flows, while acknowledging that resolution could materially affect results in the period recognized.
Planned growth investments include capacity expansions in Tritan copolyester, Crystex insoluble sulfur, PVB resin, and Therminol heat-transfer fluids. Eastman also announced a consultation process on a proposal to close its 24,000-metric-ton-per-year Workington, U.K. acetate-tow facility, subject to local requirements. The auditor reported that the financial statements were fairly presented under U.S. GAAP and internal control over financial reporting was effective; Taminco and Commonwealth were excluded from the year-end internal-control assessment because they had been recently acquired.
Important facts for investors to verify
- Whether adjusted earnings and EPS reconcile to GAAP results, with particular attention to pension mark-to-market adjustments and other exclusions.
- Whether management delivers the 2015 EPS, operating-cash-flow, capital-spending, and tax-rate outlook, and how currency and commodity hedges affect results.
- How quickly Taminco and Commonwealth are integrated, whether expected synergies materialize, and the effect of acquisition debt and higher interest expense on cash available for debt repayment and investment.
- Whether segment trends persist, especially lower AFP and SFI earnings and Fibers volume pressure from additional acetate-tow capacity.
- Developments in the Crystex impairment, environmental remediation exposure, pension obligations, and the proposed Workington facility closure.