Eastman Chemical Company — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Eastman is a specialty chemicals manufacturer with five reporting segments: Additives & Functional Products, Adhesives & Plasticizers, Advanced Materials, Fibers, and Specialty Fluids & Intermediates.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | First six months 2014 | First six months 2013 |
|---|---|---|---|---|
| Sales | $2.460 billion | $2.440 billion | $4.765 billion | $4.747 billion |
| Gross profit | $657 million | $677 million | $1.252 billion | $1.293 billion |
| Operating earnings | $436 million | $428 million | $797 million | $821 million |
| Continuing earnings attributable to Eastman | $290 million | $264 million | $523 million | $511 million |
| Diluted EPS from continuing operations | $1.92 | $1.69 | $3.43 | $3.26 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $389 million | $367 million |
Q2 gross margin was approximately 26.7%, versus 27.7% a year earlier; operating margin was approximately 17.7%, versus 17.5%. The six-month effective tax rate was 27%, compared with 29% in 2013. Q2 net earnings attributable to Eastman were $292 million, including $2 million from discontinued operations relating to a final PET-business litigation settlement.
At June 30, cash was $175 million, total assets were $12.238 billion, current assets $2.986 billion, and current liabilities $1.274 billion. Total borrowings were $4.773 billion, up from $4.254 billion at year-end 2013; there were no borrowings due within one year. Available capacity under the revolving credit and receivables facilities was $799 million, and the company reported covenant compliance. Equity totaled $3.959 billion.
Six-month investing cash outflow was $524 million, including $283 million for the BP aviation turbine oil acquisition and $254 million of capital spending. Financing provided $71 million, including $490 million net proceeds from a new long-term note issuance; Eastman also repurchased $360 million of shares and paid $106 million in dividends.
Material changes and operating drivers
- Q2 sales rose 1%, while six-month sales were nearly unchanged. Q2 reported operating earnings increased 2%, but six-month operating earnings fell 3%. Excluding management-identified non-core items, operating earnings declined 3% for Q2 and 4% for the six-month period.
- Specialty Fluids & Intermediates was the principal earnings pressure: adjusted operating earnings declined $22 million in Q2 and $53 million for the first six months, reflecting lower volumes and higher feedstock and energy costs, particularly propane. Segment sales fell 6% and 4%, respectively.
- Fibers operating earnings increased to $123 million in Q2 and $240 million for the first six months, supported by higher selling prices, partly offset by lower acetate tow volume and capacity utilization. Adhesives & Plasticizers also improved earnings, helped by volume and cost reductions, despite pricing pressure.
- A Kingsport, Tennessee unplanned shutdown reduced Q2 earnings by approximately $10 million, primarily through costs in Advanced Materials, Fibers, and SFI. A weather-related Longview, Texas outage also affected first-half SFI results.
- On June 2, Eastman acquired BP’s global aviation turbine engine oil business for $283 million, reported in SFI. Preliminary purchase accounting included $162 million of intangible assets and $68 million of goodwill. Acquisition-related inventory accounting reduced Q2 earnings by $2 million.
Outlook, risks, and contingencies
- Management expected second-half 2014 revenue growth to approximate global GDP growth and forecast full-year diluted EPS of $6.70–$7.00, excluding non-core or non-recurring items. It expected approximately $1.4 billion of operating cash flow, $575 million of capital spending, and a full-year tax rate of approximately 28% on reported pretax earnings, excluding such items.
- Management cited expected benefits from capacity expansions and product mix, while noting ongoing volatility in commodity prices and raw material and energy costs. Planned investments included Tritan capacity at Kingsport and Therminol capacity in Wales; completion of the Commonwealth Laminating & Coating acquisition was expected in the second half of 2014.
- Environmental reserves totaled $354 million. Estimated remediation costs ranged from a best estimate of $334 million to a reasonably possible maximum of $570 million. Management did not expect these matters to be material to financial position or cash flows, but noted potential material effects on results in the period recognized.
- Other disclosed risks include global economic and market conditions, commodity availability and pricing, manufacturing interruptions, customer concentration, acquisition integration and growth-project execution, and regulatory or environmental compliance costs. A Texas environmental enforcement notice alleged air-quality violations; Eastman intended to defend the matter and did not expect a material impact. Management also said ordinary-course legal matters were not expected to have a material adverse effect.
- Purchase obligations were $2.1 billion over approximately 30 years; operating lease commitments were $261 million. The company reported $121 million of residual-value guarantees, with material payments considered remote, and up to $22 million in aggregate potential payments under other guarantees, also considered remote.
Important facts for investors to verify
- Whether the $6.70–$7.00 EPS and $1.4 billion operating-cash-flow outlook was achieved, and how the company defines excluded non-core items.
- The duration and financial effects of the Kingsport and Longview disruptions, and whether SFI margins recover amid propane and other input-cost volatility.
- Progress and returns from the BP aviation-oil acquisition and announced growth projects, including associated integration costs and capital requirements.
- Developments in environmental remediation estimates and the Texas enforcement proceeding.
- Debt and liquidity trends alongside planned capital spending, pension funding, dividends, and share repurchases.