Eastman Chemical Company — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Eastman is a specialty chemicals manufacturer reporting in Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First six months 2018 | First six months 2017 |
|---|---|---|---|---|
| Sales | $2.621 billion | $2.419 billion | $5.228 billion | $4.722 billion |
| Gross profit | $704 million | $630 million | $1.285 billion | $1.235 billion |
| EBIT | $491 million | $420 million | $900 million | $821 million |
| Net earnings attributable to Eastman | $344 million | $292 million | $634 million | $570 million |
| Diluted EPS | $2.39 | $2.00 | $4.39 | $3.89 |
| Operating cash flow | Not separately stated for the quarter | $408 million | $483 million |
- Sales rose 8% in Q2 and 11% for the six-month period. Management attributed growth to higher volume/product mix, selling prices, and favorable foreign exchange.
- Approximate gross margin was 26.9% in Q2 versus 26.0% a year earlier; approximate EBIT margin was 18.7% versus 17.4%. These are calculated from reported figures.
- Excluding non-core and unusual items, EBIT was $447 million in Q2, up 6%, and $906 million for the first six months, up 10%. Adjusted diluted EPS was $2.22 for Q2 and $4.45 for the first six months; these are non-GAAP measures.
- AFP and AM led segment EBIT gains. CI adjusted EBIT declined 23% in Q2 and 7% in the first six months; Fibers adjusted EBIT increased 4% and 6%, respectively.
- Cash and cash equivalents were $193 million at June 30. Total borrowings were $6.695 billion, including $662 million due within one year. Total borrowings were $6.540 billion at year-end 2017. Net cash provided by operating activities fell $75 million year over year, with higher receivables and inventory contributing to the decline.
- Capital expenditures were $244 million in the first six months. Investing cash outflow was $179 million, including $65 million of property-insurance proceeds; financing cash outflow was $223 million, including $250 million of share repurchases and $160 million of dividends paid.
- Available borrowing capacity under the revolving credit and accounts-receivable facilities was approximately $1.0 billion, constrained in part by a financial-ratio covenant. The company reported compliance with its debt covenants.
Changes, outlook, and important items
- Compared with Q2 2017, reported sales increased $202 million and EBIT increased $71 million. For the first six months, sales increased $506 million and EBIT increased $79 million. Insurance proceeds related to the Kingsport incident materially affected reported comparisons: Q2 included $56 million of insurance proceeds in excess of costs; the six-month period included $19 million net proceeds in excess of costs.
- Management expects 2018 operating cash flow of approximately $1.6 billion and capital spending of approximately $550 million. It expects adjusted 2018 EPS to be 10%–14% above adjusted 2017 EPS of $7.61, excluding non-core and unusual items and assuming the stated adjusted tax-rate assumptions. This is a non-GAAP outlook; the company said it could not reconcile the projection to GAAP without unreasonable effort.
- Management cited specialty businesses, growth in innovative high-margin products, and a lower tax rate as earnings supports. Expected pressures include growth-initiative spending, scheduled maintenance, volatile commodity and raw-material/energy costs—particularly ethylene—and planned or possible tariffs and trade actions.
- The coal gasification incident at Kingsport disrupted operations after an October 2017 explosion. Management expects the incident to reduce earnings by $25 million–$50 million across 2017 and 2018, net of insurance recoveries, and anticipated 2018 insurance recoveries would exceed costs recognized in 2018. Further recoveries were expected.
- Eastman adopted ASC 606 revenue recognition in 2018, generally recognizing product revenue at shipment rather than delivery. Against the former method, adoption reduced first-half 2018 sales by $35 million and diluted EPS by $0.11; management expected some effect on seasonal revenue and EBIT trends. Fibers’ first-half sales also included $30 million from timing of recognition under the new standard.
- The effective tax rate was 20% in Q2 and 19% for the first six months, versus 18% in both comparable 2017 periods. A $10 million adjustment to provisional Tax Reform Act benefits and related entity reorganizations increased the 2018 tax provision; some tax accounting remained provisional.
- Environmental reserves totaled $301 million at June 30, including $276 million for estimated remediation. The estimated undiscounted remediation range was $276 million–$517 million. The filing says resolution could affect results in the period recognized, but management did not expect these matters to be material to consolidated financial position, results, or cash flows.
- Other exposures include approximately $2.9 billion of purchase obligations over about 30 years and $268 million of operating lease commitments over about 40 years. Management considered material payments under residual-value and other guarantees remote. It did not expect pending legal matters, based on then-available facts, to materially affect overall financial condition, results, or cash flows.
- Key risks include global economic and market uncertainty, commodity and energy cost or supply disruption, loss or weakening of major customers, manufacturing and cyber incidents, growth-project execution, international and foreign-exchange exposure, trade restrictions, and regulatory or environmental compliance costs.
Most important facts for investors to verify
- Whether underlying segment growth and margins persist after separating Kingsport insurance proceeds and other unusual items.
- Progress on the Kingsport recovery, cumulative incident costs, and expected timing and amount of further insurance proceeds.
- Whether working-capital demands reverse and management achieves its $1.6 billion operating-cash-flow and $550 million capital-spending expectations.
- Debt maturities, short-term borrowing levels, covenant headroom, and the effect of share repurchases and dividends on liquidity.
- Whether 2018 adjusted EPS guidance is achieved, including the assumptions for tax rates, tariffs, commodity costs, maintenance, and the revenue-recognition timing effects.
- Updates to provisional Tax Reform Act accounting and environmental remediation estimates, including the range above the recorded reserve.