Eastman Chemical Company — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unless otherwise stated, financial amounts are in millions of dollars. Comparisons are with the corresponding 2010 periods.
Business context and results
Eastman reported four continuing operating segments: Coatings, Adhesives, Specialty Polymers, and Inks (CASPI); Fibers; Performance Chemicals and Intermediates (PCI); and Specialty Plastics. The PET business, substantially all of the former Performance Polymers segment, was sold January 31, 2011 and is presented as discontinued operations.
| Metric | Q2 2011 | Q2 2010 | First six months 2011 | First six months 2010 |
|---|---|---|---|---|
| Sales | $1,885 | $1,502 | $3,643 | $2,872 |
| Gross profit | $463 | $384 | $896 | $701 |
| Gross margin | 25% | 26% | 25% | 24% |
| Operating earnings | $318 | $246 | $602 | $435 |
| Earnings from continuing operations | $210 | $141 | $392 | $246 |
| Net earnings | $211 | $148 | $431 | $249 |
| Diluted EPS, continuing operations | $2.90 | $1.92 | $5.40 | $3.35 |
| Diluted EPS, total | $2.91 | $2.02 | $5.94 | $3.38 |
Management attributed sales growth to higher prices—reflecting higher raw-material and energy costs, stronger demand and tight supply—and higher volume. Q2 sales rose 26%; first-half sales rose 27%. Higher prices and volume more than offset increased input costs. First-half 2010 results included about $25 million of net costs from a Texas facility outage and $12 million of acetyl license revenue.
Cash flow, balance sheet and liquidity
- First-half operating cash flow: $61, versus cash used of $19 in 2010. The 2011 amount followed a $100 pension contribution, $55 of tax payments related to the PET sale, and a $263 increase in working capital, principally receivables and inventory.
- Investing cash flow: $227 provided, including $615 proceeds from the PET sale, offset in part by $206 of capital expenditures and $200 placed in short-term time deposits. Financing used $170, including $177 of share repurchases and $67 of dividends.
- Cash and liquidity: June 30 cash and equivalents were $634; short-term deposits were $200. The company had undrawn $700 revolving credit and $200 accounts-receivable facilities and reported compliance with their covenants.
- Debt: Total borrowings were $1,601, including $155 due within one year; long-term borrowings were $1,446. The $150 of 7% notes due in 2012 were reclassified as current. No borrowings were outstanding under either facility.
- Capital and distributions: Stockholders’ equity was $1,907. First-half repurchases totaled $177; quarterly dividend declared was $0.47 per share.
- Free cash flow outlook: Management expected approximately $200 for full-year 2011, defined as operating cash flow less capital expenditures and dividends, excluding PET-sale tax payments. First-half reported free cash flow under the filing’s stated calculation was $(157).
Changes, unusual items and management outlook
- Q2 operating earnings included a $15 gain on the sale of previously impaired Beaumont methanol and ammonia assets; Q2 2010 included $3 of restructuring charges. Excluding these items, operating earnings were $303 versus $249 in Q2 and $587 versus $438 for the first half.
- The PET divestiture generated $615 in sale proceeds and an approximately $30 after-tax gain in the first half. First-half 2011 net earnings also included $8 from discontinued operations and the $31 after-tax disposal gain; Q2 included a $1 after-tax disposal adjustment.
- All four continuing segments reported higher sales and operating earnings for the first half. PCI had the largest sales increase, up 39% to $1,423; its operating earnings rose 71% to $176. Q2 operating earnings were CASPI $99, Fibers $93, PCI $88 and Specialty Plastics $37.
- Management expected full-year 2011 EPS to be slightly above $9.25, excluding first-half asset impairment and restructuring gains, and Q3 EPS slightly above Q3 2010’s $2.22. It expected raw-material and energy costs to remain volatile and above 2010 levels.
- Planned and unplanned second-half shutdown costs were expected to be about $25 higher than in the first half. Expected 2011 capital spending was approximately $450. The $100 Sterling Chemicals acquisition was expected to close in Q3, subject to customary conditions, and to be slightly accretive to full-year EPS excluding acquisition costs and charges.
- Other growth plans included capacity expansions in resins, Tritan copolyester and cellulose triacetate, and a China acetate-tow joint venture expected to begin operations in 2013. Management cautioned that growth projects and acquisitions may not achieve expected returns or timing.
Risks, contingencies and items to monitor
- Key stated risks include global economic and financial-market weakness; raw-material and energy price or supply volatility; manufacturing or infrastructure disruptions; loss or financial weakness of major customers; execution, cost and commercialization risks for growth initiatives; and increased environmental, health and safety compliance costs.
- Environmental reserves were $34 at June 30; estimated future remediation expenditures ranged from a best estimate of $9 to a maximum of $26. Management did not expect environmental matters to be material overall.
- Residual-value guarantees on leases totaled $160; management considered material payments remote. The filing also describes ordinary-course litigation and claims, which could affect earnings or cash flow in a particular period, though management did not expect a material adverse effect overall.
- Purchase obligations totaled approximately $1.5 billion over about 15 years. Other liabilities, primarily pension and post-employment obligations, totaled approximately $1.3 billion. A $100 estimated cash payment for the Sterling acquisition was excluded from the contractual-obligations table.
- Approximately $11 of hedge losses in accumulated other comprehensive income were expected to be reclassified into earnings over the following 12 months. The company said market risks had not materially changed from its 2010 Form 10-K disclosures.
Important facts for investors to verify
- Whether pricing and volume gains persist as input costs, supply conditions and end-market demand change.
- Whether operating cash flow and the approximately $200 full-year free-cash-flow outlook are achieved, given working-capital needs, pension funding, tax payments and capital spending.
- Progress and final economics of the Sterling acquisition, including closing, restart plans and expected accretion.
- Timing, costs and returns of planned shutdowns and capacity expansions, and whether second-half shutdown costs meet management’s estimate.
- Effects of the PET divestiture and discontinued-operations presentation when comparing reported earnings across periods.
- Upcoming liquidity needs, including the $150 of 7% notes due in 2012 and renewal or replacement of the revolving credit facility tranche expiring in April 2012.