Eastman Chemical Company — Q1 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2012, compared with Q1 2011. Eastman reported four continuing-operations segments: CASPI, Fibers, Performance Chemicals and Intermediates (PCI), and Specialty Plastics. The PET business was sold in January 2011 and is presented as discontinued operations.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Sales | $1,821 million | $1,758 million |
| Gross profit; gross margin | $431 million; 24% | $458 million; 26% |
| Operating earnings | $264 million | $314 million |
| Continuing-operations earnings | $159 million | $201 million |
| Net earnings | $158 million | $240 million |
| Diluted EPS | $1.12 | $1.66 |
| Cash from operating activities | $19 million | $(146) million |
| Capital expenditures | $90 million | $97 million |
Sales rose 4%, primarily from higher selling prices across segments in response to higher raw-material and energy costs; total volume was approximately flat. Gross margin declined to about 23.7% from 26.1%, and operating margin to about 14.5% from 17.9%. Management’s adjusted operating earnings, excluding Solutia transaction costs and the prior-year pension/OPEB mark-to-market gain, were $273 million versus $299 million. Adjusted continuing-operations diluted EPS was $1.22 versus $1.32.
Operating cash flow improved by $165 million year over year, mainly reflecting lower working-capital use and pension contributions of $25 million versus $100 million. Cash and cash equivalents were $569 million at quarter-end; short-term deposits were $80 million. Total borrowings were $1.595 billion, including $151 million due within one year. The $750 million revolving facility and $200 million receivables facility were undrawn, and the company reported covenant compliance. Current assets were $2.264 billion and current liabilities $997 million. Dividends paid were $36 million.
Segment sales and operating earnings were: CASPI $470 million and $98 million; Fibers $323 million and $101 million; PCI $736 million and $77 million; Specialty Plastics $292 million and $30 million. Fibers earnings improved, while the other three segments reported lower earnings. The filing reports no material change in market risks from the 2011 Form 10-K.
Material changes and unusual items
- The company retrospectively adopted a pension and other postretirement benefit accounting method that recognizes actuarial gains and losses in the period incurred, generally through fourth-quarter mark-to-market adjustments. It also changed the allocation of certain pension costs between segments and corporate expense. The change reduced beginning retained earnings by $676 million and increased accumulated other comprehensive income by the same amount, with no change to total equity. It increased reported Q1 2012 continuing-operations earnings by $12 million and diluted EPS by $0.08 relative to the previous method.
- Q1 2012 included $9 million in Solutia acquisition transaction costs and $5 million in financing costs. Q1 2011 included a $15 million pension/OPEB mark-to-market gain and $30 million after-tax gain on disposal of discontinued operations.
- In February 2012, Eastman arranged a $1.2 billion five-year term loan and a $2.3 billion bridge loan to help finance its pending Solutia acquisition. The company expected approximately $2.7 billion in cash consideration, subject to closing and related obligations. The $147 million of 7% notes due in Q2 2012 were repaid in April.
Outlook, commentary, and risks
Management forecast full-year 2012 diluted EPS from continuing operations of approximately $5.30, excluding acquisition-related costs and charges, asset impairments and restructuring charges, and pension/OPEB mark-to-market adjustments. The forecast assumed modest global economic growth, less volatile raw-material and energy prices, benefits from growth initiatives and integration of 2011 acquisitions, and a mid-2012 Solutia closing. Excluding the expected acquisition impact, the company anticipated approximately $400 million of 2012 capital spending and $100 million of U.S. pension contributions.
Management cited weak demand in parts of Asia and Europe, higher input costs, and lower Specialty Plastics volumes as pressures; it viewed the Specialty Plastics slowdown as temporary. Key risks include economic weakness, commodity cost or supply disruptions, manufacturing interruptions, customer losses, growth-project execution and spending, and regulatory or environmental costs. Solutia-related risks include failure or delay of closing, higher financing costs, additional debt, integration challenges, and failure to realize expected benefits. Shareholder litigation challenged the proposed acquisition. A May 3, 2012 memorandum of understanding provided for additional deal disclosures and settlement subject to final documentation, court approval, and consummation of the acquisition; plaintiffs’ counsel could seek fees.
Environmental reserves were $39 million; management did not expect environmental matters or ordinary-course legal proceedings to materially affect the company, based on currently available information. Purchase obligations were approximately $1.5 billion over about 15 years. Residual-value lease guarantees totaled $110 million, with material payment considered remote by management.
Important facts for investors to verify
- Whether the Solutia acquisition closed on expected terms and timing, and the resulting debt, financing costs, and integration performance.
- Whether the $5.30 EPS outlook assumptions were achieved; this is adjusted guidance, not reported GAAP EPS.
- Whether margin pressure, weaker demand in some markets, and Specialty Plastics volume weakness persisted or reversed.
- How much operating cash flow was generated after working-capital movements, pension contributions, capital expenditures, and dividends.
- The continuing effect of the pension accounting change and the assumptions underlying pension obligations and funding.
- Final court approval and completion of the Solutia shareholder-litigation settlement, including any attorneys’ fee award.