Eastman Chemical Company — 2018 Q3 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and nine months ended September 30, 2018. Eastman reports four operating segments: Additives & Functional Products (AFP), Advanced Materials (AM), Chemical Intermediates (CI), and Fibers. Figures below are in millions of dollars unless stated otherwise. Comparisons are with 2017; segment presentation and revenue accounting changed in 2018.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $2,547 | $2,465 | $7,775 | $7,187 |
| Gross profit | $728 | $671 | $2,013 | $1,906 |
| EBIT | $517 | $464 | $1,417 | $1,285 |
| Net earnings attributable to Eastman | $412 | $323 | $1,046 | $893 |
| Diluted EPS | $2.89 | $2.22 | $7.28 | $6.10 |
| Adjusted diluted EPS, non-GAAP | $2.34 | $2.19 | $6.79 | $5.99 |
- Sales rose 3% in Q3 and 8% year to date. Nine-month growth reflected volume/product mix (+$220), pricing (+$246), and foreign exchange (+$122); Q3 growth was primarily price-driven (+$82), with volume/mix contributing $5 and exchange rates reducing sales by $5.
- Reported Q3 gross margin was approximately 28.6%, versus 27.2%; nine-month gross margin was approximately 25.9%, versus 26.5%. Comparability is affected by the coal-gasification insurance proceeds described below.
- Adjusted EBIT, excluding identified non-core and unusual items, was $451 million in Q3, down 2%, and $1.357 billion for nine months, up 6%. Adjusted net earnings and EPS are non-GAAP measures.
- Net interest expense was $58 million in Q3 and $178 million year to date, down from $61 million and $182 million, respectively.
Segments and operating trends
- AFP: Q3 sales increased 3% to $915 million, while EBIT excluding unusual items decreased 2% to $182 million, reflecting higher raw-material and energy costs and growth investment. Nine-month adjusted EBIT increased 10% to $548 million.
- AM: Q3 sales rose 10% to $709 million and adjusted EBIT rose 4% to $147 million. Higher volume and improved premium-product mix more than offset higher input costs. Nine-month adjusted EBIT increased 7% to $429 million.
- CI: Q3 sales rose 1% to $703 million; adjusted EBIT declined 2% to $79 million. Nine-month adjusted EBIT fell 6% to $232 million, affected by supplier disruptions, maintenance shutdowns, and lower volume, partly offset by higher prices.
- Fibers: Q3 sales declined 2% to $220 million and adjusted EBIT declined 16% to $57 million, mainly due to lower acetate tow prices and volume. Nine-month adjusted EBIT declined 3% to $171 million.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $803 million, down from $1.011 billion. The filing attributes the decrease partly to increased working capital, especially inventories; $85 million of operating cash use related to the coal-gasification incident.
- Capital expenditures were $381 million, versus $438 million. Investing cash use was $315 million, including $65 million of insurance proceeds for property damage. Cash at September 30 was $193 million, compared with $191 million at year-end 2017.
- Total borrowings were $6.626 billion, compared with $6.540 billion at year-end; $728 million was due within one year. Commercial paper and short-term borrowings were $727 million. The company had no borrowings under its revolving credit facility at quarter-end and reported covenant compliance.
- In October 2018, the revolving credit facility was increased from $1.25 billion to $1.50 billion and extended to October 2023. Eastman repaid the remaining $100 million balance on its term loan during Q3.
- Eastman paid $240 million of dividends and repurchased $375 million of shares during the first nine months. The quarterly dividend declared was $0.56 per share. A new $2 billion repurchase authorization was approved in February 2018; $223 million had been used under it by quarter-end.
Outlook, unusual items, and risks
- Management expected 2018 operating cash flow of approximately $1.6 billion and capital expenditures of $525 million to $550 million, excluding $65 million of coal-incident property insurance proceeds. Cash-use priorities include dividends, debt repayment, growth investment, and share repurchases.
- Management expected adjusted 2018 EPS to be 10%–14% above adjusted 2017 EPS of $7.61, assuming the forecast adjusted tax rate. The forecast excluded fourth-quarter non-core or unusual items; management said it could not reconcile the adjusted forecast to GAAP without unreasonable effort.
- The Kingsport coal-gasification incident generated $86 million of net insurance income in excess of costs in the first nine months, including $67 million in Q3. The final $65 million property-insurance payment was received in October. Management reported cumulative net incident costs of $26 million, and said the incident had reduced 2017 earnings by $112 million.
- The Q3 effective tax rate was 10% and the nine-month rate was 15%, affected by U.S. tax reform, tax-return adjustments, credits, and other discrete items. Several tax-reform calculations remained provisional and could be adjusted in future periods.
- Key risks include global economic uncertainty; volatile or disrupted raw-material and energy supply; customer concentration; manufacturing, infrastructure, and cyber disruptions; execution and returns from growth projects; foreign-exchange, trade, and geopolitical exposure; and changing health, safety, and environmental requirements. Environmental reserves were $297 million at September 30; estimated undiscounted remediation costs ranged from a best estimate of $273 million to a maximum of $513 million.
- Purchase obligations totaled approximately $2.8 billion over about 30 years. The filing states that pending legal matters were not expected, based on currently available facts, to materially affect overall financial condition, results, or cash flows; outcomes remain uncertain.
Important facts for investors to verify
- How much reported earnings growth depended on incident-related insurance, and how adjusted performance compares with GAAP results.
- Whether working-capital use, especially inventory growth, reverses and operating cash flow meets management’s approximately $1.6 billion outlook.
- Whether segment-level volume, pricing, and input-cost trends—particularly in CI and Fibers—support the adjusted EPS outlook.
- Potential changes to provisional tax accounting, including the finalization of Tax Reform Act estimates and treatment of GILTI.
- Debt maturities, short-term borrowing levels, capital spending, and the pace of dividends and share repurchases.
- Environmental reserve estimates and any developments in manufacturing disruptions, regulatory matters, or litigation.