Business context and reporting period
Eastman Chemical Company’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016, compared with the same 2015 periods. Results are reported across four segments: Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers; management reorganized segment reporting in 2016, and prior-period segment data was recast.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Sales | $2.287bn | $2.447bn | $6.820bn | $7.423bn |
| Gross profit | $621m | $695m | $1.860bn | $2.071bn |
| Operating earnings | $356m | $432m | $1.131bn | $1.212bn |
| Net earnings attributable to Eastman | $232m | $256m | $738m | $724m |
| Diluted EPS | $1.56 | $1.71 | $4.96 | $4.83 |
Q3 gross margin was approximately 27.2% versus 28.4% a year earlier; operating margin was approximately 15.6% versus 17.7%. For the first nine months, gross margin was approximately 27.3% versus 27.9%, and operating margin approximately 16.6% versus 16.3%. Adjusted operating earnings, excluding the items management identifies as non-core, were $416m in Q3 versus $459m and $1.198bn for nine months versus $1.374bn. Adjusted diluted EPS was $1.86 versus $1.84 in Q3 and $5.25 versus $5.69 for nine months.
Operating cash flow was $991m for nine months, compared with $1.050bn in 2015. Investing used $359m, including $375m of capital expenditures; financing used $717m. Cash ended the period at $207m, down from $293m at year-end 2015. Total borrowings were $6.608bn, down from $7.008bn at year-end; current borrowings were $675m and long-term borrowings $5.933bn. Current assets were $2.900bn and current liabilities $2.206bn. Eastman reported $1.275bn of available borrowing capacity under its credit and receivables facilities and compliance with applicable debt covenants.
Material changes and segment performance
- Q3 sales fell 7%; nine-month sales fell 8%. Lower prices across all segments were the principal driver, with Q3 volume/mix slightly positive overall. Lower Fibers volume further weighed on revenue.
- CI was the largest earnings pressure: sales declined 8% in Q3 and 15% year to date; operating earnings fell 46% and 56%, respectively, as lower selling prices outpaced lower input costs.
- AM improved: Q3 sales rose 2% and operating earnings rose 44%; nine-month sales rose 2% and operating earnings rose 27%. Premium-product volume/mix and capacity utilization contributed.
- AFP sales declined 5% in Q3 and 7% year to date, mainly from lower prices; operating earnings declined 9% and 6%. Fibers sales fell 23% in Q3 and 16% year to date, reflecting lower acetate tow volume and pricing; Q3 operating earnings fell 23%.
- Reported nine-month net earnings increased despite lower sales and operating earnings, supported in part by a lower effective tax rate (21% versus 28%). The 2016 rate included specified tax benefits and should not be assumed to recur.
Outlook, commentary, risks and unusual items
- Management projected 2016 diluted EPS of $6.70–$6.80 excluding identified non-core items and any unusual or non-recurring Q4 items; it said a GAAP reconciliation was not available without unreasonable effort. It expected operating cash flow of approximately $1.5bn, capital spending of $600m–$625m, and a full-year effective tax rate of 22%–23% excluding non-core items.
- Management expected specialty-product adoption and organic growth to support results, and estimated approximately $100m of cost savings in 2016 plus a further approximately $100m, primarily in 2017, from additional actions. It warned that commodity prices, raw-material and energy costs, hedges, and U.S. dollar strength could affect results.
- Q3 included $30m of severance restructuring charges and a $30m UK pension mark-to-market loss. Nine-month items also included $9m of early debt-extinguishment costs, a $17m gain on sale of the Primester joint venture, and other specified acquisition, restructuring, and claim-related items.
- In May, Eastman issued €550m principal amount of 1.50% notes due 2023 and used proceeds in part to repay $500m of 2.4% notes due 2017. After quarter-end, it announced a tender offer for up to $400m of selected notes and gave notice to redeem all outstanding 6.30% notes due 2018; it also expected to refinance the remaining $500m of 2017 notes before maturity.
- Environmental reserves totaled $325m, with estimated remediation costs ranging from $300m (best estimate) to $510m. Management said uncertainty could materially affect results in the period recognized, but did not expect the liability to be material to consolidated financial position or cash flows. Management did not expect pending legal matters to materially adversely affect overall financial condition, results, or cash flows.
- Other disclosed risks include global economic and market weakness, commodity and energy price or supply volatility, customer concentration, operational disruptions and cyber incidents, execution of growth projects and acquisitions, foreign-market and currency risks, and changing environmental or other regulation. The filing also reports a $47m correction to prior-period cumulative foreign-currency translation adjustments related to the Solutia and Taminco acquisitions.
Important facts for investors to verify
- Whether price pressure and the CI segment’s earnings decline persist, and whether AM’s premium-product growth can offset weakness elsewhere.
- Performance against the $6.70–$6.80 adjusted EPS outlook, including the effect of Q4 non-core or unusual items and the tax benefits embedded in 2016 results.
- Cash generation, planned capital spending, dividends and repurchases, and refinancing progress for the 2017 maturities and announced post-quarter debt transactions.
- Realization and timing of the projected cost savings, alongside the environmental reserve range and related regulatory or legal developments.
- The impact of the 2016 segment reorganization and the $47m translation-adjustment correction when comparing reported periods.