Eastman Chemical Company — Q1 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2018, compared with Q1 2017. Eastman operates through Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. The company adopted the new revenue recognition standard on January 1, 2018; reported comparisons are therefore not fully like-for-like.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $2.607 billion | $2.303 billion | +13% |
| Gross profit | $581 million | $605 million | -4% |
| EBIT | $409 million | $401 million | +2% |
| Net earnings attributable to Eastman | $290 million | $278 million | +4% |
| Diluted EPS | $2.00 | $1.89 | +6% |
| Operating cash flow | $(35) million | $52 million | Down $87 million |
Reported gross margin was approximately 22.3%, versus 26.3% a year earlier. Management reported adjusted EBIT of $459 million, up 14%, excluding $50 million of non-core and unusual items; adjusted diluted EPS was $2.23 versus $1.83. Sales growth reflected volume/product mix (+6%), price (+4%), and foreign exchange (+3%).
Segment sales and EBIT were: AFP $939 million and $176 million; AM $693 million and $135 million; CI $730 million and $70 million; Fibers $245 million and $43 million. Excluding the coal gasification incident, EBIT increased in AFP, AM, CI, and Fibers; CI and Fibers reported lower GAAP EBIT than a year earlier.
Cash, debt, and liquidity
Cash and cash equivalents were $194 million at March 31, 2018, versus $191 million at year-end 2017. Total borrowings rose to $6.900 billion from $6.540 billion; current borrowings were $589 million and long-term borrowings $6.311 billion. Net cash used in investing was $78 million, including $128 million of capital expenditures and $50 million of insurance proceeds. Financing provided $116 million, including net borrowing proceeds, alongside $80 million of dividends paid and $100 million of share repurchases.
Cash used in operations reflected higher working capital, including receivables, and the incident’s cash effects. Management cited approximately $729 million of available borrowing capacity under the A/R and revolving credit facilities, with availability limited by a financial covenant. The company was in compliance with its debt covenants. Current assets were $3.483 billion and current liabilities $2.029 billion.
Material changes, unusual items, and management commentary
- The Kingsport coal gasification incident disrupted operations, particularly in CI and Fibers. Q1 incident costs were $37 million net of insurance in the EBIT reconciliation; gross profit included $87 million of net incident costs, while other income included a $50 million insurance gain. The company reported cumulative net incident costs of $149 million through Q1 and expected further insurance recoveries. It estimated the total earnings impact, net of insurance, at $25 million to $50 million across 2017 and 2018, and expected 2018 insurance recoveries to more than offset 2018 incident costs.
- Q1 also included $11 million of costs related to tax-law changes and reorganizations, and $2 million of restructuring charges. Adjusted results exclude these items as well as incident costs.
- Adoption of ASC 606 increased opening retained earnings by $53 million after tax. For Q1, the new standard increased reported sales by $30 million and diluted EPS by $0.10 versus the former standard, primarily from recognizing revenue at shipment rather than delivery. Management expected some effect on seasonal revenue and EBIT trends.
- The effective tax rate was 17%, versus 18% in Q1 2017. Tax Reform Act accounting remained provisional, including aspects of the transition tax, deferred taxes, and GILTI treatment.
Outlook and principal risks
For 2018, management expected operating cash flow of approximately $1.6 billion and capital expenditures of approximately $550 million. It forecast adjusted EPS growth of 10% to 14% over adjusted 2017 EPS of $7.61, excluding future non-core or unusual items and assuming the forecast adjusted tax rate. Management cited specialty-product growth and a modestly lower tax rate as potential benefits, offset by strategic growth costs, higher scheduled maintenance, and volatile commodity, raw-material, and energy prices, particularly olefins. Cash priorities included dividends, debt repayment, targeted growth investment, and share repurchases. The board authorized an additional $2 billion share repurchase program in February 2018.
Key risks include raw-material and energy price or supply volatility; manufacturing disruptions, including safety, cyber, and infrastructure events; global economic, currency, trade, and political conditions; customer concentration; execution and returns on growth initiatives and acquisitions; and environmental, regulatory, and legal contingencies. Environmental reserves totaled $302 million, with estimated undiscounted remediation expenditures ranging from $278 million to $478 million. Management did not expect environmental liabilities or pending legal matters to materially affect overall financial condition, results, or cash flows, but noted outcomes can be uncertain.
Most important facts for investors to verify
- Whether the reported adjusted EBIT and EPS reconciliations appropriately distinguish recurring performance from incident, restructuring, and tax-reorganization items.
- The timing, amount, and collectability of further Kingsport insurance recoveries, and the incident’s remaining operational and earnings effects.
- How much Q1 sales and EPS growth reflects ASC 606 timing, segment reclassifications, currency, price, and underlying volume or mix.
- Whether working-capital needs and operating cash generation support the $1.6 billion full-year cash-flow outlook, capital spending, dividends, and repurchases.
- Debt maturities, facility availability under covenant limits, and the company’s ability to maintain investment-grade financial flexibility.
- Final Tax Reform Act accounting and potential changes to the effective tax rate, including GILTI and transition-tax estimates.