Eastman Chemical Company — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Comparisons are with the corresponding 2014 periods. Amounts are in U.S. dollars; financial amounts are in millions unless stated otherwise. Results include the Taminco and Commonwealth acquisitions completed in December 2014, affecting year-over-year comparability.
Financial performance
| Metric | Q3 2015 | Q3 2014 | First 9 months 2015 | First 9 months 2014 |
|---|---|---|---|---|
| Sales | $2,447 | $2,413 | $7,423 | $7,178 |
| Gross profit | $695 | $636 | $2,071 | $1,888 |
| Operating earnings | $432 | $338 | $1,212 | $1,135 |
| Net earnings attributable to Eastman | $256 | $210 | $724 | $735 |
| Diluted EPS | $1.71 | $1.39 | $4.83 | $4.83 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $1,050 | $949 |
Q3 gross margin was approximately 28.4% versus 26.4%; operating margin was approximately 17.7% versus 14.0%. Sales rose 1% in Q3 and 3% year to date. Reported Q3 operating earnings increased 28%, while year-to-date operating earnings increased 7%. Excluding the non-GAAP items identified by management, operating earnings were $459 million versus $427 million in Q3 and $1,374 million versus $1,251 million year to date. Adjusted diluted EPS was $1.84 versus $1.89 in Q3, and $5.69 versus $5.43 year to date. These adjusted measures are company-defined, non-GAAP measures.
Management attributed sales growth mainly to acquired businesses; lower selling prices and unfavorable currency effects offset much of their contribution. Lower raw material and energy costs exceeded lower selling prices by $83 million in Q3 and $232 million year to date, but commodity hedges, particularly propane, reduced earnings by $60 million and $140 million, respectively. Currency effects were also unfavorable.
Segments and notable period changes
- Additives & Functional Products: Q3 sales $602 million, up 31%; operating earnings $126 million versus $37 million. Growth reflected Taminco and lower input costs, partly offset by price, currency, and commodity hedges.
- Adhesives & Plasticizers: Q3 sales $305 million, down 12%; operating earnings $74 million versus $52 million. Lower input costs more than offset lower selling prices.
- Advanced Materials: Q3 sales $624 million, up 3%; operating earnings $98 million versus $76 million. Acquired Commonwealth sales, volume, and mix supported results. A $18 million impairment was recorded for window-film trade names, mainly V-Kool, amid weaker projected revenue associated with slower Asian car-market growth.
- Fibers: Q3 sales $320 million, down 8%; operating earnings $102 million versus $112 million. Lower volume weighed on results. Year-to-date earnings included $95 million of impairment and restructuring charges related principally to closing the Workington, UK acetate tow facility. Completion was expected in 2015, with approximately $20 million of annual savings anticipated thereafter.
- Specialty Fluids & Intermediates: Q3 sales $584 million, down 10%; operating earnings $48 million versus $90 million. Lower prices, volume, and commodity-hedge losses outweighed acquired-business contributions.
Year-to-date net earnings attributable to Eastman declined to $724 million from $735 million despite higher operating earnings, with higher net interest expense ($198 million versus $132 million) and greater impairment and restructuring charges among the factors. Q3 net interest expense was $66 million versus $45 million, primarily reflecting acquisition-related debt.
Cash, debt, and liquidity
- Cash and cash equivalents were $309 million at September 30, 2015, versus $214 million at December 31, 2014. Total assets were $15.88 billion and equity was $3.96 billion.
- Total borrowings were $7.28 billion, including $251 million due within one year; long-term borrowings were $7.03 billion. Cash less total borrowings implies net debt of approximately $6.97 billion.
- Current assets of $3.18 billion exceeded current liabilities of $1.80 billion; the current ratio was approximately 1.77.
- Nine-month operating cash flow was $1.05 billion, investing cash outflow $467 million, and financing cash outflow $481 million. Capital expenditures were $426 million. Operating cash flow increased mainly from acquired-business earnings, partly offset by higher interest and pension payments.
- Available borrowing capacity under the revolving credit and receivables facilities was $883 million. The company reported compliance with facility covenants. Its $1.25 billion revolving credit facility was extended in October 2015 to October 2020; the $250 million receivables facility was extended to April 2018.
Outlook, risks, and contingencies
- Management expected 2015 operating results to benefit from acquisitions, organic growth, and improved product mix. It expected full-year adjusted EPS to exceed 2014 adjusted EPS.
- 2015 outlook included approximately $1.6 billion of operating cash flow, $675 million of capital spending, and a 26%–27% effective tax rate on reported earnings before tax excluding non-core items. Management expected to repay the $250 million 3% notes due in 2015 with available cash.
- Management anticipated approximately 3% global economic growth and continued negative effects from a strong U.S. dollar and volatile commodity prices. Existing hedges were expected to limit the benefit of falling crude and related commodity costs, particularly propane.
- Environmental reserves totaled $339 million, including $315 million for remediation liabilities; estimated remediation costs ranged from $315 million to a reasonably possible maximum of $526 million. Management did not expect these matters, individually or collectively, to be material to financial position or cash flows, but noted possible material effects on results in the period recognized.
- Other exposures include chemical-manufacturing and supply disruptions, cyber incidents, customer weakness, acquisition integration and returns, regulatory costs, and competition in end markets. The company disclosed $1.6 billion of purchase obligations over approximately 30 years and $272 million of lease commitments over approximately 45 years.
- Management reported no material adverse effect expected from pending legal matters based on currently available information. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- Whether the expected $20 million annual Workington closure savings are realized and whether closure costs or timing change.
- How commodity hedges, particularly propane, and lower product prices affect margins; $142 million of net hedge losses were expected to be reclassified into earnings over the following 12 months if realized.
- Whether specialty fluids performance supports its goodwill valuation: estimated fair value exceeded carrying value by only 5%, and adverse changes in key assumptions could trigger impairment.
- Progress on Taminco integration and final purchase-price allocation, scheduled for completion in Q4 2015; the allocation was still preliminary at quarter-end.
- Delivery against cash-flow, capital-spending, adjusted-EPS, debt repayment, and tax-rate outlook, alongside environmental and other contingent obligations.