Eastman Chemical Company — Q3 2010 Form 10-Q
Reporting period: Quarter ended September 30, 2010; comparisons are with Q3 and the first nine months of 2009. Unaudited consolidated financial statements; dollars in millions except per-share data.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Sales | $1,729 | $1,337 | $5,017 | $3,719 |
| Gross profit | $445 | $328 | $1,170 | $767 |
| Gross margin | 26% | 25% | 23% | 21% |
| Operating earnings | $280 | $191 | $719 | $347 |
| Net earnings | $170 | $101 | $419 | $168 |
| Diluted EPS | $2.33 | $1.38 | $5.70 | $2.29 |
- Revenue increased 29% in Q3 and 35% year to date, driven by higher volumes, selling prices, product mix, and growth initiatives. Management attributed demand improvement to economic recovery and stronger packaging, durable goods, and other end markets.
- Operating earnings rose 47% in Q3 and more than doubled year to date. Benefits from volume, utilization, and pricing were partly offset by higher raw-material and energy costs. Q3 included a $22 million Longview outage insurance recovery; nine-month results included $32 million of outage insurance proceeds and $12 million of acetyl license revenue.
- Net interest expense was $25 million in Q3 and $75 million year to date, up from $19 million and $58 million, respectively, primarily due to lower capitalized interest and higher average borrowings. The effective tax rate was 34% versus 40% in Q3 2009 and 39% for the nine months, when discrete tax charges affected the comparison.
- Operating cash flow was $297 million for the nine months, versus $668 million in 2009. Excluding the $200 million cash-flow presentation impact from adoption of receivables-transfer accounting, it was $497 million. The company-defined free cash flow measure was $268 million after capital expenditures and dividends.
- Capital expenditures were $133 million, down from $268 million. Dividends paid were $96 million; share repurchases were $68 million. Cash declined to $642 million from $793 million at year-end 2009.
- At September 30, cash was $642 million, current assets $2,101 million, and current liabilities $940 million. Total borrowings were $1,606 million ($4 million due within one year); stockholders’ equity was $1,810 million. The company had no borrowings under its $700 million revolving facility or $200 million receivables facility and was in compliance with facility covenants.
Material changes and business developments
- All five reporting segments grew sales in Q3. PCI had the largest reported Q3 sales increase, to $534 million from $377 million, and operating earnings of $77 million versus $31 million. Year-to-date PCI sales were $1,557 million versus $997 million. Segment results also benefited from acquisition-related additions and, for some segments, outage insurance proceeds; segment reporting was retrospectively adjusted for a product-line transfer to PCI.
- Eastman acquired Genovique, a specialty plasticizer producer, for approximately $160 million including assumed debt, and acquired a Korean acetate tow facility for $111 million. Management expected Genovique to be accretive to full-year 2010 EPS.
- Cash-flow comparability is affected by a 2010 accounting change: $200 million of receivables previously treated as sold are now included on the balance sheet and reduced reported operating cash flow. The filing presents adjusted cash flow for comparison.
- After quarter-end, Eastman agreed to sell its PET business and related Columbia, South Carolina assets and technology to DAK Americas for expected cash proceeds of $600 million, before fees and working-capital adjustments. Closing was expected in Q4, subject to approvals and customary conditions. The PET assets had $547 million of stated net property, plant, equipment, other noncurrent assets, and net working capital at September 30. Eastman expected $20–$25 million of Q4 severance restructuring charges.
Outlook, risks, and contingencies
- 2010 guidance: diluted EPS above $7.00 excluding restructuring charges; free cash flow above $300 million using the company’s stated adjusted operating-cash-flow definition; capital spending about $225 million; U.S. pension contributions of $135 million, including $100 million expected in Q4; and an approximately 34% effective tax rate.
- Management expected higher 2010 raw-material and energy costs than in 2009, continued pricing and hedging actions, higher net interest expense, and slightly higher depreciation and amortization. It expected the Korean facility to be fully integrated in 2011 and continued expansion and commercialization of Tritan and other growth initiatives.
- Key disclosed risks include global economic weakness, commodity and energy cost or supply volatility, manufacturing or infrastructure disruptions, loss or financial weakness of major customers, execution and returns of growth investments, and increased environmental and regulatory costs. Management cautioned that forward-looking results could differ materially.
- Environmental contingency reserves were $40 million; estimated remediation expenditures ranged from a best estimate of $10 million to a maximum of $21 million. The company also disclosed environmental proceedings in Pennsylvania, Tennessee, and Virginia, each with potential civil penalties not reasonably likely to be below $100,000; management did not expect material financial impact. The filing says pending legal matters could affect earnings or cash flows in a particular period, but were not expected to materially affect overall financial condition, results, or cash flows.
- Other commitments included approximately $1 billion of purchase obligations over about 15 years, $88 million of lease commitments, and $160 million of residual-value lease guarantees; management considered material guarantee payments remote. Pension and other post-employment obligations were significant.
Most important facts for investors to verify
- Whether the PET divestiture closed on the expected terms and generated the anticipated proceeds, and the resulting discontinued-operations presentation and restructuring costs.
- Whether full-year EPS and free-cash-flow guidance was achieved, including the company’s $200 million accounting adjustment and planned pension funding.
- How much earnings improvement was recurring versus attributable to outage insurance proceeds, license revenue, acquisitions, and unusually strong volume/utilization.
- Whether working-capital growth—especially receivables and inventory—continues to constrain cash conversion as sales grow.
- Developments in raw-material and energy costs, growth-project execution, environmental proceedings, and pension funding requirements.