Eastman Chemical Company — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Figures are in millions of dollars except per-share amounts. Solutia’s results are not included; Eastman completed its approximately $4.8 billion acquisition on July 2, 2012.
Financial performance
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Sales | $1,853 | $1,885 | $3,674 | $3,643 |
| Gross profit | $481 | $474 | $912 | $932 |
| Gross margin | 26.0% | 25.1% | 24.8% | 25.6% |
| Operating earnings | $317 | $333 | $581 | $647 |
| Operating margin | 17.1% | 17.7% | 15.8% | 17.8% |
| Continuing-operations earnings | $177 | $219 | $336 | $420 |
| Diluted EPS from continuing operations | $1.26 | $1.51 | $2.38 | $2.89 |
| Net earnings | $179 | $220 | $337 | $460 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $335 | $61 |
Q2 sales slipped 2%; first-half sales rose 1%. Reported operating earnings declined 5% in Q2 and 10% in the first half. Eastman reported Q2 diluted EPS of $1.27 including discontinued-operation disposal gains; continuing-operations diluted EPS was $1.26. First-half net earnings and EPS were also affected by prior-year discontinued-operation earnings and disposal gains.
Cash and cash equivalents were $3.0 billion at June 30, versus $577 million at December 31, 2011. Total borrowings rose to $3.835 billion from $1.598 billion, including $2.4 billion principal amount of notes issued in June to help fund Solutia. The resulting cash balance included the net proceeds of that offering and was largely intended for the acquisition. At June 30, current assets were $4.630 billion and current liabilities $899 million. Eastman reported no borrowings under its $750 million revolving facility or $250 million receivables facility at quarter-end; it said it was covenant-compliant and had full availability under those facilities then.
First-half investing cash flow was an outflow of $19 million, including $177 million in capital expenditures. Financing cash flow was $2.107 billion, primarily reflecting acquisition-related note proceeds. Dividends paid were $71 million.
Drivers and changes versus prior year
- Q2 gross profit increased slightly despite lower sales, with improvement in CASPI and PCI partly offset by weaker Fibers and Specialty Plastics results. First-half gross profit fell 2%.
- PCI Q2 operating earnings increased 11% to $104 million, benefiting from lower raw-material and energy costs, including producing rather than purchasing olefins. First-half PCI earnings declined 4% amid weaker demand and cost pressures outside the U.S.
- Specialty Plastics Q2 sales fell 6% and operating earnings fell 10%; first-half earnings fell 12%, principally from weaker copolyester volumes and lower capacity utilization.
- CASPI Q2 earnings rose 10% to $114 million. Fibers Q2 earnings were nearly flat at $96 million; first-half earnings rose 8% to $197 million.
- Reported comparisons include Solutia transaction, integration and financing costs in 2012. Prior-year comparisons included a $15 million gain on sale of impaired assets; first-half 2011 also included a $15 million pension/OPEB mark-to-market gain. Excluding specified items, management reported Q2 continuing-operations earnings of $197 million ($1.40 diluted EPS), versus $209 million ($1.44); first-half earnings were $369 million ($2.62), versus $400 million ($2.76).
- SG&A and R&D expenses rose, reflecting growth initiatives and Solutia acquisition costs. Reported effective tax rate was 34%, versus 32%; management attributed the increase mainly to a greater U.S. earnings mix and nondeductible Solutia transaction costs.
Outlook, acquisition and risks
- Management expected full-year 2012 diluted EPS from continuing operations of approximately $5.30, excluding acquisition-related costs and charges, asset impairments and restructuring charges, and pension/OPEB mark-to-market adjustments. The forecast assumed a full-year tax rate of approximately 34% and cited persistent economic uncertainty.
- Management expected approximately $50 million of Solutia transaction, integration and restructuring costs in Q3, plus charges from selling acquired inventory at fair value. It expected 2012 capital expenditures of approximately $500 million and U.S. pension contributions of $135 million, including Solutia plans. Net interest expense was expected to increase in the second half because of acquisition borrowing.
- Solutia consideration was $22 cash and 0.12 Eastman shares per Solutia share; 14.7 million Eastman shares were issued. Eastman borrowed $1.2 billion under its five-year term loan on July 2 and drew the full $250 million receivables facility that day. Acquisition accounting and asset/liability valuations were incomplete at filing, and expected synergies were not included in pro forma results.
- Management cited risks from uncertain global demand, especially Europe; raw-material and energy cost or supply volatility; manufacturing or infrastructure disruptions; customer losses; growth-project execution; and Solutia integration, added debt and failure to achieve expected synergies. It identified environmental regulation and remediation costs as additional exposures.
- Eastman’s pre-acquisition environmental reserve was $39 million. Solutia had reported approximately $250 million of environmental remediation reserves as of March 31, 2012; Eastman had not completed its valuation of acquired environmental liabilities. Eastman said the final acquisition valuation was expected during 2012.
- Other commitments included approximately $2.2 billion of purchase obligations over about 15 years, $140 million of operating lease commitments, $110 million of residual-value guarantees, and up to $80 million of other guarantees; management considered material payments under the guarantees remote. Eastman also disclosed inherited Solutia litigation and an EPA administrative matter, while stating it did not believe pending matters would materially harm its overall financial condition, results or cash flows.
- Eastman changed its pension and OPEB accounting to recognize actuarial gains and losses in the year incurred, with annual mark-to-market adjustments generally in Q4. The retrospective change reduced December 2011 retained earnings by $676 million and increased accumulated other comprehensive income by the same amount, leaving total equity unchanged; reported period comparisons and segment expense allocation were affected.
Key facts for investors to verify
- Post-acquisition debt, cash, liquidity and covenant capacity after the July term-loan borrowing and receivables-facility draw, and the resulting interest burden.
- Whether Solutia integration delivers the expected earnings, growth and synergies, and the realized acquisition-related costs and inventory step-up charges.
- Performance against the approximately $5.30 adjusted EPS outlook, including the exclusions used and the effect of weaker demand, pricing, raw-material costs and exchange rates.
- Final purchase accounting for Solutia, particularly environmental, pension, legal and other contingent liabilities; monitor the disclosed Solutia environmental reserve and litigation exposures.
- Cash generation after capital spending, dividends and pension contributions, and the impact of pension accounting and funding changes on reported results and cash needs.