Eastman Chemical Company — Q2 2013 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2013. The comparison with 2012 is affected by the July 2, 2012 Solutia acquisition: 2013 includes Solutia, while the reported 2012 periods do not. Management also provides pro forma combined comparisons to help assess underlying trends.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Sales | $2,440 million | $1,853 million | $4,747 million | $3,674 million |
| Gross profit | $677 million | $481 million | $1,293 million | $912 million |
| Operating earnings | $428 million | $317 million | $821 million | $581 million |
| Eastman earnings from continuing operations | $264 million | $177 million | $511 million | $336 million |
| Diluted continuing-operations EPS | $1.69 | $1.26 | $3.26 | $2.38 |
| Operating cash flow | Not separately provided for the quarter | $367 million | $335 million |
Margins. Calculated from reported figures, gross margin was approximately 27.7% in Q2 2013 versus 26.0% in Q2 2012; operating margin was 17.5% versus 17.1%. For the first six months, gross margin was 27.2% versus 24.8%, and operating margin was 17.3% versus 15.8%.
- Reported sales increased 32% in Q2 and 29% for the first six months, primarily reflecting acquired Solutia sales volume. On a pro forma combined basis, sales grew 3% in Q2 and 1% for the first six months.
- On a pro forma combined basis, operating earnings excluding specified transaction, integration, impairment and restructuring items rose 13% in Q2 and 12% for the first six months.
- Q2 segment performance was mixed: reported sales and operating earnings increased in Additives & Functional Products, Advanced Materials, Fibers, and Specialty Fluids & Intermediates; Adhesives & Plasticizers sales fell 9% and operating earnings fell 32%. The latter segment cited weaker adhesives-resin demand, customer destocking, and competitive pricing pressure.
Cash, debt and liquidity
- At June 30, 2013, cash was $234 million, current assets were $2,838 million, and current liabilities were $1,309 million (current ratio approximately 2.2). Long-term borrowings totaled $4,679 million; total liabilities were $8,389 million and total equity was $3,373 million.
- Six-month operating cash flow of $367 million increased from $335 million. Working-capital needs, including higher receivables, and higher tax and interest payments partly offset increased cash earnings.
- Capital expenditures were $187 million. Investing cash outflow was $191 million; financing cash outflow was $190 million. Cash declined $15 million from year-end 2012.
- Debt repayment and refinancing included $550 million of Term Loan repayments, funded in part with $300 million of commercial paper and $150 million drawn under the receivables facility. At period-end, $300 million of commercial paper and $150 million of receivables-facility borrowings were outstanding. The company reported $450 million available under its revolving facility and $100 million under the receivables facility, and stated it was in compliance with debt covenants.
Outlook, commentary, risks and unusual items
- Management forecast 2013 diluted EPS from continuing operations of $6.40–$6.50, excluding non-recurring and non-core items; operating cash flow of approximately $1.3 billion; capital spending of approximately $525 million; and a full-year tax rate of approximately 31%.
- Management expected global growth slightly above 2% in 2013, including about 2% in the U.S., approximately zero in Europe, and near 8% in China. It noted slow growth and weakness in areas including European autos and adhesives resins, and anticipated continued raw-material and energy-price volatility.
- Q2 included $18 million of net asset impairment and restructuring charges; the six-month total was $21 million. Items included the planned closure of a German Photovoltaics production facility, severance, and a $4 million reduction of previously recorded Brazil site charges. Solutia integration costs were $8 million for Q2 and $15 million for the six months.
- Environmental contingencies were reserved at $379 million at June 30. Estimated remediation costs ranged from a best estimate of $350 million to a reasonably possible maximum of $606 million. Management did not expect these matters, individually or in aggregate, to be material to financial position or cash flows, but said they could materially affect results in the period recognized.
- Other disclosed exposures include $2.9 billion of purchase obligations over approximately 15 years, $218 million of lease commitments, and up to $55 million of potential payments under other guarantees; management considered payment under those guarantees remote. The filing also identifies economic and financial-market uncertainty, commodity supply and price volatility, manufacturing disruption, customer concentration, acquisition-integration execution, and environmental regulation as risks.
- Management said pending legal matters were not expected to have a material adverse effect based on available facts. On July 26, 2013, the Eleventh Circuit affirmed dismissal of the DOJ Medicare reimbursement case involving Solutia and other defendants; further review remained possible.
Important facts for investors to verify
- How much reported growth and earnings improvement reflects Solutia versus comparable underlying performance; review the pro forma combined results and their stated limitations.
- Whether the $6.40–$6.50 adjusted EPS and approximately $1.3 billion operating-cash-flow outlook were achieved, and how non-GAAP adjustments reconcile to GAAP results.
- Debt repayment, interest expense, available borrowing capacity, and cash conversion as acquisition-related financing is managed.
- Progress and costs for Solutia integration, capacity projects, and the German Photovoltaics facility closure.
- Changes in environmental estimates, particularly the gap between the $350 million best estimate and the $606 million reasonably possible maximum, and developments in legal contingencies.