Eastman Chemical Company — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited results; financial amounts in U.S. dollars, millions except per-share data.
Business context and results
Eastman operates five segments: Additives & Functional Products, Adhesives & Plasticizers, Advanced Materials, Fibers, and Specialty Fluids & Intermediates. Management cited modest global economic growth and growth in selected end markets, alongside volatile raw-material and energy costs.
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Sales | $2,413 | $2,338 | $7,178 | $7,085 |
| Gross profit | $636 | $689 | $1,888 | $1,982 |
| Operating earnings | $338 | $479 | $1,135 | $1,300 |
| Eastman-attributable continuing earnings | $210 | $308 | $733 | $819 |
| Diluted continuing EPS | $1.39 | $1.97 | $4.83 | $5.23 |
| Operating cash flow | Not separately presented | Not separately presented | $949 | $794 |
Q3 sales increased 3%, driven by higher volume and prices; nine-month sales rose 1%. Reported Q3 gross and operating margins were approximately 26.4% and 14.0%, respectively, versus 29.5% and 20.5% a year earlier. Excluding identified non-core or non-recurring items, Q3 operating earnings were $427 million versus $405 million, and diluted EPS was $1.89 versus $1.68. For the first nine months, adjusted operating earnings were $1,251 million versus $1,262 million and adjusted diluted EPS was $5.43 versus $5.09. These are company-presented non-GAAP measures, not substitutes for GAAP results.
Financial position, cash flow, and liquidity
- At September 30, cash was $212 million; total borrowings were $4.563 billion, all classified as long-term. Net debt was approximately $4.351 billion. Total equity was $3.979 billion.
- Current assets were $2.890 billion and current liabilities $1.398 billion. Available borrowing capacity under the then-current credit and receivables facilities was reported as $1.01 billion; the company was in compliance with facility covenants.
- Nine-month operating cash flow of $949 million exceeded the prior-year $794 million, primarily due to lower tax payments and pension-funding timing. Investing used $718 million, including $406 million of capital expenditures and $325 million for acquisitions. Financing used $251 million, including $410 million of share repurchases and $159 million of dividends.
- Capital expenditures were expected to be approximately $575 million for full-year 2014. The company issued $500 million of 4.65% notes due 2044 in May.
Material changes and unusual items
- Q3 GAAP operating earnings fell 29%; nine-month earnings fell 13%. The comparisons include 2013’s $86 million pension and postretirement mark-to-market gain, while 2014 included $71 million of Q3 and $77 million of nine-month asset impairment and restructuring charges.
- Major 2014 charges included $42 million for the planned closure of a Crystex research facility in France and a $22 million impairment of the Crystex tradename, reflecting lower projected revenue. The planned closure is subject to local requirements.
- Eastman acquired BP’s global aviation turbine oil business for $283 million in June and Knowlton Technologies for $42 million in August. Purchase-accounting inventory costs reduced earnings by $6 million in Q3 and $8 million year to date.
- The company agreed to acquire Taminco for $26 per share, with stated transaction value of $2.8 billion including approximately $1 billion of assumed net debt; completion was expected by year-end 2014. It also agreed to acquire Commonwealth Laminating & Coating, with completion expected by year-end. Financing arrangements for Taminco were entered into after quarter-end and remained unfunded as of the filing.
- Cash dividends declared were $0.35 per share in Q3, up from $0.30, and $1.05 per share year to date, up from $0.90. Eastman repurchased 4.95 million shares for approximately $410 million in the first nine months.
Outlook, risks, and contingencies
Management expected Q4 2014 revenue growth approximately in line with global GDP and projected full-year EPS to approach $7.00, excluding non-core or non-recurring items. Other 2014 expectations included approximately $1.4 billion of operating cash flow, $575 million of capital spending, and a reported tax rate of approximately 28% excluding such items. Management noted expected benefits from capacity expansions and product mix, but also a planned Q4 maintenance shutdown at the Longview olefins unit.
- Environmental reserves totaled $350 million at September 30, including $329 million for remediation liabilities. Estimated future remediation costs ranged from a best estimate of $329 million to a reasonably possible maximum of $568 million. Management did not expect these matters, in aggregate, to be material to financial position or cash flows, but acknowledged possible material effects on results in the period recognized.
- Other guarantees had maximum potential payments of $32 million; management considered payment remote. Residual-value guarantees totaled $121 million and material payments were considered remote.
- Management identified exposure to economic and market volatility, raw-material and energy supply/cost changes, manufacturing or infrastructure disruptions, customer concentration, acquisition and integration execution, and increased environmental or regulatory costs. The filing notes prior cyberattacks, none of which had materially affected operations.
- Management did not believe pending legal matters would materially affect overall financial condition, results, or cash flows based on information then available. Actual outcomes remain uncertain.
Important facts for investors to verify
- Whether earnings and cash generation meet the stated full-year outlook, and how GAAP results compare with management’s adjusted measures.
- Completion, financing, assumed debt, integration costs, and expected benefits of the Taminco and CLC transactions.
- Progress and remaining costs for the Crystex facility closure and other restructuring; whether further impairment indicators emerge, particularly for specialty fluids goodwill, whose fair value exceeded carrying value by only 5%.
- Evolution of environmental remediation estimates and the timing of related cash expenditures.
- Effects of raw-material and energy prices, operating disruptions, and planned capacity expansions on segment margins and cash needs.