Eastman Chemical Company — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise stated. Eastman reorganized its reporting structure in January 2016 into four segments: Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. Segment comparisons reflect the revised presentation.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Sales | $2.236 billion | $2.443 billion |
| Gross profit / margin | $634 million / 28.4% | $656 million / 26.9% |
| Operating earnings / margin | $399 million / 17.8% | $311 million / 12.7% |
| Net earnings attributable to Eastman | $251 million | $171 million |
| Diluted EPS | $1.69 | $1.14 |
| Operating cash flow | $47 million | $91 million |
| Capital expenditures | $110 million | $125 million |
| Cash and cash equivalents | $202 million | $293 million at Dec. 31, 2015 |
| Total borrowings | $7.078 billion | $7.008 billion at Dec. 31, 2015 |
| Current assets / current liabilities | $2.863 billion / $1.847 billion | $2.878 billion / $2.056 billion at Dec. 31, 2015 |
Sales declined 8%, with reported price effects of negative $229 million, volume/product mix gains of $46 million, and foreign-exchange effects of negative $24 million. Net interest expense was $64 million versus $66 million. The effective tax rate was 22%, compared with 33%; Q1 2016 benefited from a $9 million tax benefit, including finalization of 2014 foreign tax returns and favorable U.S. tax provisions.
Management’s non-GAAP measure of operating earnings excluding specified non-core items was $406 million versus $435 million. Adjusted net earnings were $255 million, or $1.71 per diluted share, versus $276 million, or $1.84. Thus, the increase in GAAP earnings chiefly reflects the absence of substantial prior-year impairment and restructuring charges and a lower tax rate; adjusted earnings declined.
Operating cash flow fell by $44 million, primarily because of higher working-capital demands relative to the prior-year period. Investing cash use was $126 million, including $110 million of capital expenditures and $21 million for acquisitions. Financing cash use was $12 million; dividends paid were $68 million and share repurchases were $20 million. Cash declined by $91 million during the quarter. Simple operating cash flow less capital expenditures was negative $63 million, versus negative $34 million in Q1 2015.
Borrowings were $7.078 billion, including $513 million due within one year; long-term borrowings were $6.565 billion. Commercial paper outstanding was $512 million at a weighted-average rate of 0.81%; the company had no borrowings under its $1.25 billion revolving credit facility. Borrowings under its $250 million receivables facility were $190 million. Available capacity under the revolving and receivables facilities totaled $769 million. The company reported compliance with debt covenants. Total liabilities were $11.331 billion and total equity was $4.285 billion.
Material changes and segment results
- CI: Sales fell 21% to $620 million and operating earnings fell 43% to $67 million. Lower selling prices, amid lower feedstock and energy costs and weak demand/competitive pressure in Asia Pacific, drove the decline.
- AM: Sales rose 5% to $589 million and operating earnings rose 59% to $108 million (44% excluding the prior-year acquired-inventory charge), supported by premium-product volume, mix, utilization, and lower unit costs.
- AFP: Sales declined 8% to $737 million and adjusted operating earnings declined 4% to $151 million, reflecting pricing pressure and unfavorable currency effects.
- Fibers: Sales were down 1% to $280 million. Operating earnings were $86 million versus a prior-year loss of $7 million, which included $97 million of impairment and restructuring charges. Excluding that item, Fibers earnings declined 4% to $86 million.
Q1 2016 included a $2 million restructuring/impairment gain in AFP. Q1 2015 included $109 million of net impairment and restructuring charges, principally related to closure of the Workington, UK acetate tow facility, as well as $7 million of acquired-inventory costs. The company reported $15 million of cumulative savings through Q1 2016 from the Workington closure, against expected annual savings of approximately $20 million. Q1 2016 also included $9 million of acquisition integration and transaction costs and $5 million of costs to dispose of claims related to discontinued Solutia operations.
Outlook, risks and contingencies
Management expected 2016 operating results to benefit from organic growth and specialty-product mix, and targeted approximately $100 million in annual cost savings. It forecast operating cash flow of approximately $1.6 billion, capital spending of approximately $650 million, and a full-year effective tax rate of 24%–25% excluding non-core items. Management expected 2016 EPS, excluding non-core and unusual or non-recurring items, to approach 2015 adjusted EPS of $7.28. It cautioned that commodity prices and raw-material and energy costs would remain volatile, hedges—particularly for propane—could limit the benefit of lower commodity prices, and a strong U.S. dollar could weigh on results.
Key exposures include global economic weakness, raw-material and energy cost or supply volatility, customer concentration, manufacturing and infrastructure interruptions (including cyber incidents), acquisition and growth-project execution, foreign-currency and international-market risks, and changing health, safety, and environmental requirements. Environmental contingency reserves totaled $332 million; estimated remediation costs ranged from $305 million (best estimate) to a reasonably possible maximum of $507 million. Management did not expect these matters, individually or together, to be material to financial position or cash flows, though recognized costs could materially affect results in a period. Other guarantees had maximum potential payments of approximately $35 million, which management considered remote; residual-value guarantees totaled $122 million, with material payments considered remote. The company stated pending legal matters were not expected to have a material adverse effect based on currently available facts.
Management said cash flows, cash and other liquidity sources should be sufficient for foreseeable requirements, while noting that operating cash flow depends on demand, pricing, raw-material availability and cost, utilization, and other risks. Disclosure controls were assessed as effective at March 31, 2016; no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether CI pricing and demand stabilize, and whether the Q1 decline in adjusted operating earnings persists.
- Progress toward the approximately $100 million cost-savings target and expected Workington savings.
- Conversion of the $1.6 billion operating-cash-flow outlook into cash, given Q1 working-capital use and negative cash flow after capital expenditures.
- Debt maturities, short-term borrowings, facility availability, covenant compliance, and the company’s ability to maintain investment-grade financial flexibility.
- Realized effects of commodity and currency hedges, including the filing’s estimate that $133 million of net hedge losses could be reclassified into earnings over the next 12 months.
- Environmental remediation assumptions and any changes in legal, regulatory, operating, cyber, or acquisition-related exposures.
- Whether the full-year EPS outlook is achieved; it is a management expectation, not a guarantee, and excludes non-core or unusual items.