Eastman Chemical Company — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless stated otherwise. Figures are unaudited and in U.S. dollars.
Business context and results
Eastman operates through Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. Sales rose on stronger volume and product mix in several segments, partly offset by a sharp Fibers decline.
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $2.303 billion | $2.236 billion | +$67 million; 3% |
| Gross profit | $625 million | $634 million | Down $9 million |
| Operating earnings | $397 million | $399 million | Down $2 million |
| Net earnings attributable to Eastman | $278 million | $251 million | Up $27 million |
| Diluted EPS | $1.89 | $1.69 | Up $0.20 |
| Net interest expense | $60 million | $64 million | Down $4 million |
| Effective tax rate | 18% | 22% | Down 4 percentage points |
Gross margin was approximately 27.1%, versus 28.4% a year earlier; operating margin was approximately 17.2%, versus 17.8%. Sales increased 4% from volume/product mix and were slightly higher from price, while foreign exchange reduced sales by 1%.
Segment performance and notable changes
| Segment | Sales | Operating earnings | Year-over-year highlights |
|---|---|---|---|
| AFP | $773 million; +5% | $152 million; approximately flat | Higher volume offset lower prices, raw material and energy costs, and unfavorable currency. |
| AM | $634 million; +8% | $121 million; +12% | Premium-product volume/mix and higher utilization supported earnings. |
| CI | $670 million; +8% | $82 million; +22% | Higher prices and a reduced negative effect from commodity hedges helped results. |
| Fibers | $213 million; down 24% | $52 million; down 40% | Lower acetate tow volume and prices, including weaker China sales and customer buying patterns, weighed on results. |
Reported operating earnings were $397 million versus $399 million; on management’s non-GAAP basis excluding identified non-core items, operating earnings were $397 million versus $406 million. Adjusted net earnings were $269 million, or $1.83 per diluted share, versus $255 million, or $1.71, in Q1 2016. The 2017 adjusted figure includes a $9 million tax-provision adjustment; management cautions that non-GAAP measures are not GAAP measures and may not be comparable across companies.
Cash flow, debt, and liquidity
- Operating cash flow was $52 million, compared with $51 million. Seasonal working-capital increases included $149 million of receivables and $82 million of inventory cash use.
- Capital expenditures were $133 million, versus $110 million. Investing cash use was $136 million. Operating cash flow less capital expenditures was negative $81 million, calculated from reported figures.
- Cash increased $16 million during the quarter to $197 million. Financing provided $102 million, including $250 million of A/R Facility borrowings; the company also paid $75 million in dividends and repurchased $75 million of shares.
- Total borrowings were $6.883 billion, including $305 million due within one year; long-term borrowings were $6.578 billion. Borrowings increased from $6.594 billion at December 31, 2016.
- Current assets were $3.165 billion and current liabilities $1.637 billion. Eastman reported approximately $620 million of available borrowing capacity under its A/R and revolving credit facilities, constrained by a financial-ratio covenant and seasonal borrowings. The company said it was in compliance with all covenants.
Outlook, risks, and contingencies
- For 2017, management expected adjusted EPS to be 8%–12% above adjusted 2016 EPS of $6.76. The forecast excludes non-core, unusual, or non-recurring items; management said it could not reconcile the forecast to GAAP EPS without unreasonable effort.
- Management expected approximately $1.6 billion of operating cash flow, approximately $575 million of capital spending, and approximately $100 million of cost savings in 2017. Cash priorities included dividends, debt repayment, growth initiatives, and share repurchases.
- Management anticipated slow global economic growth and continued Fibers challenges; volatile commodity prices and raw-material and energy costs; and a continued negative effect from the strong U.S. dollar. It expected the negative impact of commodity hedges to be less than in recent years.
- Environmental reserves totaled $318 million, including $30 million current and $288 million long-term. Estimated undiscounted future remediation costs ranged from $291 million to $497 million. Management did not expect environmental liabilities to be material to consolidated financial position or cash flows, though recognition of uncertainties could materially affect results in the period recognized.
- Purchase obligations were approximately $3 billion over about 30 years. Operating lease commitments were $272 million over about 40 years. Residual-value guarantees were $88 million; management considered material payments remote. Other guarantees had maximum potential payments of approximately $35 million.
- Management did not believe pending legal matters would materially affect overall financial condition, results, or cash flows based on currently available facts. Key disclosed risks include global economic weakness, raw-material/energy price or supply volatility, major-customer loss, manufacturing disruptions and cyber risks, growth-project execution, international operations, regulatory costs, and acquisition integration.
Most important facts for investors to verify
- Whether Fibers’ volume, pricing, and customer buying patterns improve, given its substantial year-over-year sales and earnings declines.
- Whether the expected earnings growth, $1.6 billion operating cash flow, $575 million capital spending, and $100 million savings targets are achieved; compare adjusted guidance with reported GAAP results.
- Whether working-capital needs and capital spending allow operating cash generation to support dividends, debt reduction, growth investment, and repurchases.
- How debt, facility availability, covenant headroom, and the use of A/R securitization evolve.
- Whether environmental remediation estimates, commodity-hedge effects, foreign exchange, and other disclosed contingencies change materially.