Business context and reporting period
Eastman Chemical Company’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011. Results are from continuing operations unless noted. Prior-period per-share amounts and share counts were adjusted for the two-for-one stock split distributed October 3, 2011.
The company reported four 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 in January 2011 and is presented as discontinued operations.
Financial performance and position
| Metric | Third quarter 2011 | Third quarter 2010 | First nine months 2011 | First nine months 2010 |
|---|---|---|---|---|
| Sales | $1.812 billion | $1.507 billion | $5.455 billion | $4.379 billion |
| Gross profit (margin) | $420 million (23%) | $422 million (28%) | $1.316 billion (24%) | $1.123 billion (26%) |
| Operating earnings | $256 million | $266 million | $858 million | $701 million |
| Continuing-operations earnings | $165 million | $162 million | $557 million | $408 million |
| Diluted EPS from continuing operations | $1.16 | $1.11 | $3.86 | $2.77 |
| Net earnings | $165 million | $170 million | $596 million | $419 million |
Third-quarter sales rose 20%, principally from higher prices; nine-month sales rose 25%, reflecting higher prices and volume. The nine-month sales increase was broad-based, with PCI sales up 39%. Third-quarter operating earnings declined 4%, while nine-month operating earnings increased 22%. The reported third-quarter net earnings comparison includes $8 million of discontinued-operations earnings in 2010; nine-month 2011 net earnings include a $31 million after-tax gain on the PET sale.
At September 30, 2011, cash and cash equivalents were $448 million and short-term time deposits were $201 million. Current assets were $2.354 billion and current liabilities $1.201 billion. Total borrowings were $1.599 billion, including $154 million due within one year; long-term borrowings were $1.445 billion. Cash and time deposits less total borrowings imply net debt of approximately $950 million. The company had no borrowings under its $700 million revolving credit facility or $200 million accounts-receivable facility and was in compliance with facility covenants.
For the first nine months, operating cash flow was $273 million, investing cash use was $16 million and financing cash use was $326 million. Capital expenditures were $333 million, dividends paid $100 million, and cash declined $68 million to $448 million. Management’s defined free cash flow, excluding PET-sale tax payments, was negative $77 million. Working capital increased $338 million, mainly from higher inventory and receivables. The company contributed $102 million to U.S. defined-benefit pension plans.
Material changes versus comparable periods
- Sales growth was driven by pricing in response to higher raw-material and energy costs; nine-month volume also benefited from plasticizer growth, the Longview olefins unit restart, and stronger demand in some end markets.
- Gross margin compressed: 23% versus 28% in the quarter and 24% versus 26% for nine months. In the quarter, higher input costs, an $11 million olefins-unit outage cost and an $8 million acetyl-technology license cost weighed on results; the 2010 comparison benefited from a $22 million insurance settlement.
- Nine-month operating earnings improved despite higher input costs, supported by price, volume and lower-cost propane cracking benefits. The period included $7 million of Sterling-related restructuring charges and a $15 million gain on sale of previously impaired Beaumont project assets.
- Net interest expense declined to $20 million from $25 million in the quarter and to $57 million from $75 million for nine months, mainly reflecting lower borrowing costs and increased capitalized interest.
- Eastman acquired Sterling and Scandiflex in the third quarter for a combined purchase price of $133 million, and acquired Dynaloy in July. It also completed the $615 million PET business sale, recognizing an approximately $30 million after-tax gain.
Outlook, commentary, risks and contingencies
Management expected full-year 2011 diluted EPS of approximately $4.62, excluding asset-impairment and restructuring charges or gains, and fourth-quarter EPS above fourth-quarter 2010’s $0.70. It expected full-year free cash flow of $175–$200 million, excluding PET-sale tax payments, and capital spending of approximately $475 million. The company expected a full-year tax rate of approximately 32%.
Management anticipated normal seasonality and customer inventory destocking would reduce fourth-quarter sales volume. It expected raw-material and energy costs to remain volatile and exceed 2010 levels, with pricing and hedging used to mitigate exposure. Growth plans included acquisitions, capacity expansions, a China acetate-tow joint venture expected to begin operating in 2013, and new-product initiatives.
Key risks identified include weaker global economic or financial-market conditions; raw-material and energy price or supply disruptions; manufacturing or infrastructure interruptions; loss or financial weakness of major customers; growth investments failing to meet objectives or exceeding budget; and higher environmental, health and safety compliance or remediation costs. Environmental reserves were $39 million at quarter-end. Management did not expect pending legal matters or environmental contingencies to materially affect the company overall, but noted adverse developments could affect a particular period. A Pennsylvania environmental consent decree was agreed in September; its resolution was not material to financial condition, results or cash flows. The company reported no material change in market risks and stated disclosure controls were effective.
Most important facts for investors to verify
- Whether pricing continues to offset higher raw-material and energy costs, and whether the margin decline stabilizes.
- Progress against the approximately $4.62 EPS and $175–$200 million free-cash-flow outlook, including the stated exclusions and fourth-quarter volume assumptions.
- Working-capital needs, capital spending and pension contributions, given negative management-defined free cash flow through September.
- Funding of the $149 million 7% notes due in April 2012 and renewal or replacement of the revolving facility tranche expiring in April 2012.
- Integration and returns from Sterling, Scandiflex and Dynaloy, and execution of planned capacity expansions and growth projects.
- Exposure to environmental, legal and other contingent obligations, including whether estimates or expected payments change.