Eastman Chemical Company — Q2 2010 Form 10-Q
Business context and period. Unaudited results for the quarter and six months ended June 30, 2010, compared with the corresponding 2009 periods. Eastman operates five reportable segments: CASPI, Fibers, Performance Chemicals and Intermediates (PCI), Performance Polymers, and Specialty Plastics. Dollar amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First six months 2010 | First six months 2009 |
|---|---|---|---|---|
| Sales | $1,724 | $1,253 | $3,288 | $2,382 |
| Gross profit | $404 | $260 | $725 | $439 |
| Gross margin | 23% | 21% | 22% | 18% |
| Operating earnings | $257 | $131 | $439 | $156 |
| Net earnings | $148 | $65 | $249 | $67 |
| Diluted EPS | $2.02 | $0.89 | $3.38 | $0.91 |
| Operating cash flow | Not stated for quarter | $(19) | $337 |
- Growth and margins: Sales rose 38% in both comparative periods. Management attributed the increase mainly to higher volume from improving demand and growth initiatives, plus higher prices responding to raw-material and energy costs. Gross profit increased 55% in Q2 and 65% year to date; higher volume and capacity utilization lowered unit costs, while price increases more than offset higher input costs.
- Earnings: Q2 operating earnings increased 96%; first-half operating earnings rose to $439 from $156. First-half diluted EPS excluding restructuring charges was $3.41 versus $1.11 in 2009; this is a company-presented non-GAAP measure.
- Segment highlights, Q2 sales / operating earnings: CASPI $416 / $94; Fibers $274 / $83; PCI $541 / $69; Performance Polymers $222 / $6; Specialty Plastics $271 / $21. PCI and Specialty Plastics recorded particularly strong year-over-year earnings improvement. Performance Polymers remained pressured by difficult PET market conditions and input costs.
- Cash flow and spending: First-half operating cash flow was negative $19, including a $200 reduction from an accounting change that brought previously sold receivables onto the balance sheet. Excluding that item, operating cash flow was $181 versus $337 in 2009. The filing reports first-half free cash flow of $41, defined as operating cash flow excluding that accounting impact, less capital expenditures and dividends. Capital expenditures were $76 versus $204; dividends paid were $64.
- Liquidity and debt: Cash was $435 at June 30, down from $793 at year-end 2009. Total borrowings were $1,611, including $6 due within one year; long-term borrowings were $1,605. Eastman had no borrowings under its $700 revolving credit facility or $200 accounts-receivable facility and reported compliance with their covenants. The receivables facility was renewed in July 2010.
- Other balance-sheet metrics: Total assets were $5,799 and stockholders’ equity was $1,677. Current assets were $1,909 and current liabilities $886.
Material changes and unusual items
- Eastman acquired Genovique Specialties on April 30 for approximately $160, including assumed debt, adding specialty plasticizers and other products to PCI. Management expected the acquisition to be accretive to full-year 2010 EPS. The filing also records acquisition of a Korean acetate tow facility for $111; it began production in Q1, with customer qualifications starting in Q2 and full integration expected in 2011.
- The Longview, Texas power outage reduced first-half 2010 operating earnings by approximately $25 net of partial insurance proceeds. Management expected additional insurance proceeds in the second half. First-half 2010 earnings also included $12 of acetyl license revenue.
- Q2 and first-half 2010 included $3 of restructuring charges, primarily Genovique-related severance. First-half 2009 included $23 of net restructuring charges and approximately $20 of Longview reconfiguration costs.
- Eastman repurchased 859,900 shares for approximately $53 in the first half. The company had approximately $42 remaining under its share repurchase authorization at June 30.
- The company announced a review of strategic options, including a possible divestiture, for its PET business, targeted for completion by year-end.
Outlook, risks, and contingencies
- For 2010, management forecast diluted EPS of $6.20–$6.40, excluding restructuring charges; approximately $300 of positive free cash flow; capital spending of approximately $250; U.S. defined-benefit pension contributions of approximately $25; and an effective tax rate of approximately 33%. Management expected higher net interest expense than in 2009.
- Management expected improving volumes, continued volatility and higher 2010 raw-material and energy costs, and continued use of pricing and hedging strategies. Cash-use priorities were dividends, targeted growth investments and share repurchases.
- Key risks include renewed economic weakness, commodity cost or supply disruptions, manufacturing interruptions, customer financial weakness, and growth projects or acquisitions failing to meet projected returns or timing. Environmental regulation and compliance costs may also rise.
- Environmental reserves were $40 at June 30; estimated future remediation expenditures ranged from $10 to $21. The company disclosed environmental proceedings in Pennsylvania, Tennessee, and Virginia, each with potential penalties not considered reasonably likely to be below $100,000; management did not expect the proceedings to materially affect overall financial condition, results, or cash flows. Other ordinary-course legal matters could adversely affect a particular future period.
- Purchase obligations totaled approximately $1 billion over about 15 years; operating lease commitments were $85. Residual-value guarantees totaled $160, with a material payment considered remote. Management stated that available liquidity should be sufficient for foreseeable requirements.
Important facts for investors to verify
- Whether the expected second-half insurance proceeds for the Longview outage materialized, and how they affected reported earnings.
- Progress against the $6.20–$6.40 EPS and approximately $300 free-cash-flow outlook, including the company’s stated free-cash-flow definition and the receivables accounting adjustment.
- Genovique integration, contribution to earnings, and the Korean facility’s progress toward full integration.
- Outcome of the PET strategic-options review and implications for Performance Polymers.
- Developments in environmental proceedings, remediation estimates, and the company’s substantial pension and other post-employment obligations.