Eastman Chemical Company — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise. Comparisons are with 2014.
Business context and results
Eastman operates five reporting segments: Additives & Functional Products (AFP), Adhesives & Plasticizers (A&P), Advanced Materials (AM), Fibers, and Specialty Fluids & Intermediates (SFI). Comparisons include contributions from businesses acquired in 2014, especially Taminco.
| Metric | Q2 2015 | Q2 2014 | First six months 2015 | First six months 2014 |
|---|---|---|---|---|
| Sales | $2,533 | $2,460 | $4,976 | $4,765 |
| Gross profit | $720 | $657 | $1,376 | $1,252 |
| Operating earnings | $469 | $436 | $780 | $797 |
| Earnings attributable to Eastman | $297 | $292 | $468 | $525 |
| Diluted EPS from continuing operations | $1.98 | $1.92 | $3.12 | $3.43 |
| Cash from operating activities | Not stated separately for the quarter | $682 | $389 |
Q2 gross margin was approximately 28.4%, versus 26.7%; first-half gross margin was approximately 27.7%, versus 26.3%. Operating margin was approximately 18.5% versus 17.7% in Q2, and 15.7% versus 16.7% for the first half. Management’s adjusted, non-GAAP operating earnings were $480 million for Q2 and $915 million for the first half, versus $441 million and $824 million, respectively. Adjusted diluted EPS was $2.01 for Q2 and $3.85 for the first half, versus $1.92 and $3.54. These adjusted measures exclude specified non-core items.
Financial position, cash flow, and liquidity
- At June 30, cash was $268 million; current assets were $3.167 billion and current liabilities $1.821 billion. Total assets were $15.886 billion and total equity $3.845 billion.
- Total borrowings were $7.323 billion, down from $7.549 billion at December 31, 2014. Cash-adjusted borrowings were approximately $7.055 billion. Net interest expense rose to $66 million in Q2 and $132 million in the first half, from $45 million and $87 million.
- First-half operating cash flow was $682 million; investing cash use was $265 million, including $266 million of capital expenditures; financing cash use was $359 million. Cash increased $54 million from year-end.
- Eastman repaid $625 million of term-loan borrowings in the first half, while drawing $157 million net under commercial paper and $250 million under its receivables facility. It reported $858 million of available borrowing capacity under its credit and A/R facilities and compliance with facility covenants.
- Cash dividends declared were $0.40 per share in Q2 and $0.80 per share for the first half. First-half share repurchases were $31 million.
Material changes and management commentary
- Sales increased 3% in Q2 and 4% in the first half. Acquired businesses added $364 million and $752 million, respectively; lower prices and unfavorable currency effects partly offset acquisition contributions and volume gains.
- Lower raw-material and energy costs exceeded lower selling prices, improving spread by $89 million in Q2 and $149 million in the first half. However, commodity hedges, particularly propane, reduced results by $58 million and $80 million, respectively; currency effects were also unfavorable.
- First-half reported operating earnings included $109 million of net asset impairment and restructuring charges. These primarily reflected the planned closure of the Workington, UK acetate tow facility, including $81 million of impairments and $14 million of restructuring charges in Fibers. Management expected substantial completion in 2015 and annual savings of about $20 million thereafter.
- Segment performance was mixed: Q2 sales and operating earnings rose in AFP and AM, while Fibers sales fell 23% and operating earnings fell 24%. First-half Fibers operating earnings fell to $86 million from $240 million, reflecting lower acetate tow volume and closure-related charges. A&P sales declined, while operating earnings increased; SFI sales rose with acquisitions, but Q2 operating earnings declined amid hedge impacts.
- Management said it had increased its 2015 earnings outlook since the Q1 filing and expected a “solid increase” in full-year EPS excluding non-core and non-recurring items. It forecast approximately $1.6 billion of operating cash flow, $700–$725 million of capital spending, a 26%–27% full-year effective tax rate excluding non-core items, and $100 million of U.S. defined-benefit pension funding. No specific EPS target was provided.
Risks, contingencies, and unusual items
- Management expected commodity-price volatility and a continuing negative effect from U.S. dollar strength. It cautioned that current commodity hedges would offset much of the benefit from lower input costs in 2015.
- Environmental contingency reserves were $337 million at June 30; estimated remediation costs ranged from $314 million to $539 million. Management did not expect these matters, individually or in aggregate, to be material to financial position or cash flows, but noted possible adverse effects on results in the period recognized.
- Other disclosed risks include global economic weakness, raw-material availability and costs, manufacturing and cyber disruptions, customer concentration, acquisition integration and added debt, and changing environmental or safety regulation. Management said ordinary-course legal matters were not expected to materially affect financial condition, results, or cash flows.
- Non-recourse factoring facilities had $124 million of receivables outstanding; Eastman retained exposure to credit losses of up to 10% on sold receivables. The A/R facility maturity was extended to April 2018 in July 2015.
- The specialty fluids reporting unit had fair value near carrying value in the 2014 impairment test; management reported improvement in the first half of 2015 but said weaker performance or adverse assumptions could lead to an impairment charge.
Key facts for investors to verify
- How much of sales, earnings, and cash-flow improvement is organic versus attributable to Taminco and other 2014 acquisitions.
- Whether the expected $20 million annual Workington savings are realized and whether further Fibers restructuring or impairment charges arise.
- The 2015 effects of propane and other commodity hedges, foreign exchange, and lower selling prices on margins and cash flow.
- Progress toward management’s $1.6 billion operating-cash-flow and $700–$725 million capital-spending expectations, alongside debt repayment and pension funding.
- Developments in environmental remediation estimates, acquisition integration, and the specialty fluids reporting unit’s impairment sensitivity.