Eastman Chemical Company — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited results; amounts are in millions of dollars except per-share data. Eastman reported four segments: Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. Segment reporting was reorganized in 2016, with prior-period segment comparisons presented under the revised structure.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First six months 2016 | First six months 2015 |
|---|---|---|---|---|
| Sales | $2,297 | $2,533 | $4,533 | $4,976 |
| Gross profit | $605 | $720 | $1,239 | $1,376 |
| Operating earnings | $376 | $469 | $775 | $780 |
| Net earnings attributable to Eastman | $255 | $297 | $506 | $468 |
| Diluted EPS | $1.71 | $1.98 | $3.40 | $3.12 |
| Cash from operating activities | Not separately stated for quarter | $541 | $682 |
- Sales fell 9% in both the quarter and first half. Lower selling prices were the main driver: price reduced sales by $207 in Q2 and $433 in the first half. Q2 volume/product mix reduced sales by $33; exchange rates added $4.
- Approximate gross margin was 26.3% in Q2 versus 28.4% a year earlier; first-half gross margin was 27.3% versus 27.7%. Approximate operating margin was 16.4% versus 18.5% in Q2 and 17.1% versus 15.7% for the first half.
- Management’s non-GAAP operating earnings excluding identified non-core items were $376 in Q2 versus $480, down 22%; first-half adjusted operating earnings were $782 versus $915, down 15%. First-half GAAP operating earnings were nearly flat partly because 2015 included $109 of impairment and restructuring charges.
- First-half operating cash flow decreased $141, primarily due to lower earnings excluding non-core items and higher tax payments. Capital expenditures were $234, versus $266; cash and equivalents ended at $240, down from $293 at year-end 2015.
Segments and material changes
- CI: Q2 sales declined 15% to $633 and operating earnings fell 83% to $15. First-half sales fell 18% to $1,253 and operating earnings fell 60% to $82. Lower market prices and competitive pressure, particularly in Asia Pacific, reduced results; lower selling prices more than offset lower input costs, and planned maintenance costs were higher.
- Fibers: Q2 sales declined 22% to $234 and operating earnings declined 23% to $72. Lower acetate tow and flake volumes and lower tow prices contributed; China customer inventory destocking and shipment timing were cited. First-half adjusted operating earnings declined to $158 from $181.
- AFP: Q2 sales declined 7% to $770 and operating earnings declined 6% to $168, mainly due to lower prices. First-half adjusted operating earnings were $319 versus $335.
- AM: Q2 sales were broadly flat at $646 and operating earnings were $132 versus $135. First-half sales rose 2% to $1,235 and adjusted operating earnings rose 14% to $240, supported by premium-product volume, mix, and capacity utilization.
Debt, liquidity, and capital allocation
- Total borrowings were $6,804 at June 30, 2016, including $722 due within one year; long-term borrowings were $6,082. Cash was $240. Borrowings totaled $7,008 at December 31, 2015.
- Eastman issued €550 million of 1.50% notes due 2023 and used proceeds in part to redeem $500 of 2.4% notes due 2017 and repay other borrowings. The transaction produced a $9 early-extinguishment charge. The company said it expected to refinance the remaining $500 principal of the 2017 notes in 2017.
- Available borrowing capacity under the revolving credit and receivables facilities was $1,058. The company reported covenant compliance. It had $222 of commercial paper borrowings and $200 outstanding under its $250 receivables facility.
- First-half dividends paid were $136 and share repurchases were $45. The quarterly dividend declared was $0.46 per share. Management’s 2016 cash-use priorities included dividends, debt repayment, targeted growth initiatives, and share repurchases.
Outlook, commentary, and risks
- Management expected 2016 diluted EPS excluding specified non-core and unusual items to be up to 10% below 2015 adjusted EPS. It forecast approximately $1.6 billion of operating cash flow, capital spending of $600–$625, and a 24%–25% full-year effective tax rate excluding non-core items.
- Management expected organic growth and improved specialty-product mix to support results; cost-reduction savings of approximately $100 in 2016 and additional actions intended to generate approximately $100 in 2017; and continuing negative effects from a strong U.S. dollar. It said commodity hedges, particularly for propane, would limit the benefit of lower crude and related commodity prices to input costs.
- Q2 and first-half tax rates were 21% and 22%, respectively, versus 26% and 29% a year earlier. The 2016 rates included a $16 one-time tax benefit; the first-half rate also included a $9 benefit primarily from finalizing 2014 foreign tax returns.
- Other unusual items included a $17 gain from selling Eastman’s 50% Primester joint-venture interest for $35, and a $9 early-debt-extinguishment charge. First-half non-core adjusted net earnings attributable to Eastman were $505, or $3.39 per diluted share, versus $576, or $3.85, in 2015.
- Environmental contingency reserves were $332, with estimated future remediation costs ranging from a best estimate of $304 to a reasonably possible maximum of $512. Management did not expect these matters, individually or collectively, to materially affect financial position or cash flows, but noted possible material effects on results in the period recognized.
- Risks highlighted include global economic and market uncertainty, commodity cost or supply volatility, customer loss, manufacturing and cyber disruption, execution and integration of growth initiatives and acquisitions, foreign-market and currency exposures, and increased regulatory or environmental compliance costs. Management said pending legal matters were not expected to have a material adverse effect based on facts then available.
Most important facts for investors to verify
- Whether CI pricing, competitive pressure, and planned maintenance continue to weigh on segment earnings.
- Whether the full-year outlook is achieved, especially adjusted EPS, operating cash flow, cost savings, tax rate, and capital spending.
- Debt refinancing plans for the remaining $500 of 2017 notes, near-term maturities, and continued covenant compliance.
- Actual cash generation and returns of dividends and repurchases relative to capital investment and debt reduction.
- Changes in environmental remediation estimates, hedging impacts, and the effects of currency, commodity, and operational risks.