Eastman Chemical Company — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Dollar amounts are in millions except per-share data. Eastman is a global specialty chemicals company reporting four segments: Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First six months 2017 | First six months 2016 |
|---|---|---|---|---|
| Sales | $2,419 | $2,297 | $4,722 | $4,533 |
| Gross profit | $651 | $605 | $1,276 | $1,239 |
| Operating earnings | $420 | $376 | $817 | $775 |
| Net earnings attributable to Eastman | $292 | $255 | $570 | $506 |
| Diluted EPS | $2.00 | $1.71 | $3.89 | $3.40 |
| Net interest expense | $61 | $63 | $121 | $127 |
- Sales increased 5% in Q2 and 4% for the first six months. Q2 growth reflected $70 million from volume/product mix and $75 million from pricing, partly offset by a $23 million unfavorable currency effect.
- Gross margin was approximately 26.9% in Q2 versus 26.3% a year earlier; first-half gross margin was approximately 27.0% versus 27.3%. Operating margin was approximately 17.4% and 17.3%, respectively, compared with 16.4% and 17.1% in 2016.
- Q2 net earnings rose 14% and diluted EPS rose 17%; first-half net earnings rose 13% and diluted EPS rose 14%. The 2017 tax provision includes a $22 million benefit related to prior-year tax returns. Reported effective tax rates were 18% for Q2 and the first half; management’s adjusted rates were 19% and 20%, respectively.
- First-half operating cash flow was $483, down from $545, mainly because of higher working capital, particularly inventory, partly offset by higher earnings. Capital expenditures were $279, versus $234; operating cash flow less capital expenditures was $204, versus $311.
- At June 30, cash was $222; total borrowings were $6,881, including $212 due within one year. Long-term borrowings were $6,669, up from $6,311 at year-end 2016. Total liabilities were $11,074 and equity was $4,890. Available borrowing capacity under the credit and A/R facilities was approximately $785; the company was covenant-compliant.
- Current assets were $3,262 and current liabilities $1,596, for a current ratio of approximately 2.0. Cash and cash equivalents increased from $181 at year-end 2016.
Material changes and segment performance
- CI: Sales rose 11% in Q2 and 10% year to date; operating earnings increased to $83 from $15 in Q2 and to $165 from $82 year to date. Higher selling prices, improved competitive conditions, reduced adverse commodity-hedge impacts, and lower maintenance costs supported results.
- AM: Sales rose 2% in Q2 and 5% year to date; operating earnings increased 4% and 8%, respectively, helped by volume, utilization, product mix, and lower maintenance costs.
- AFP: Sales increased 8% in Q2 and 6% year to date, but operating earnings fell 5% and 3%. Higher raw-material and energy costs outweighed pricing and volume benefits.
- Fibers: Sales declined 8% in Q2 and 17% year to date; operating earnings fell 24% and 32%. Lower acetate tow pricing, weaker industry utilization, and lower first-quarter volume were key factors.
- Share repurchases totaled $175 in the first half, and dividends declared were $149 ($1.02 per share). Shares outstanding at June 30 were approximately 144.9 million.
Outlook, risks, and unusual items
- Management expected adjusted 2017 EPS to be 10%–12% above adjusted 2016 EPS of $6.76, assuming a full-year adjusted tax rate consistent with its forecast. This is non-GAAP guidance; the company said it could not reconcile the projection to GAAP without unreasonable effort.
- Other 2017 expectations: approximately $1.6 billion of operating cash flow, $575 of capital spending, about $100 of cost savings, and repayment of $350 of debt. Management expected organic growth and specialty-product mix to benefit results, while anticipating slow global growth, continued Fibers challenges, commodity and energy cost volatility, and an overall negative effect from a strong U.S. dollar.
- Environmental reserves were $318, including $291 for remediation; estimated undiscounted future remediation costs ranged from a best estimate/minimum of $291 to a maximum of $500. Management did not expect these matters to materially affect financial position or cash flows, though resolution could materially affect results in the period recognized.
- Purchase obligations totaled approximately $2.9 billion over about 30 years. Residual-value guarantees were $71; management considered material payments remote. Other guarantees had maximum potential payments of approximately $35, also considered remote. Ordinary-course litigation was not expected to have a material adverse effect based on available facts.
- Key risks include global economic and market weakness, raw-material and energy price or supply disruptions, customer losses, manufacturing and cyber incidents, foreign-exchange and geopolitical exposure, regulatory and environmental costs, and execution risks for growth initiatives and acquisitions. No material change in disclosed market risks was reported.
- Q2 2017 had no asset impairment or restructuring charges. First-half 2016 included a $2 gain on asset sales, $9 of acquisition integration and transaction costs, $9 of early debt-extinguishment costs, and a $17 Primester investment-sale gain; these affect year-over-year comparability.
Investor verification priorities
- Confirm the sustainability of CI’s unusually large earnings improvement and the factors supporting pricing and lower hedge impacts.
- Assess whether Fibers’ pricing, utilization, and volume trends stabilize, and whether AFP can offset input-cost pressure.
- Track working-capital requirements and operating cash flow against management’s $1.6 billion full-year expectation and $575 capital-spending plan.
- Monitor debt levels, borrowing capacity, debt repayment, and the effect of the facility covenant on liquidity.
- Evaluate the quality and repeatability of earnings, particularly the prior-year tax-return benefit and other non-GAAP adjustments.
- Review environmental remediation estimates, commodity and currency hedges, and the assumptions underlying management’s adjusted EPS outlook.