UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One) | |
[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2017 | |
OR | |
[ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ______________ to ______________ | |
Commission file number 1-12626
EASTMAN CHEMICAL COMPANY
(Exact name of registrant as specified in its charter)
Delaware | 62-1539359 |
(State or other jurisdiction of | (I.R.S. employer |
incorporation or organization) | identification no.) |
200 South Wilcox Drive | |
Kingsport, Tennessee | 37662 |
(Address of principal executive offices) | (Zip Code) |
Registrant's telephone number, including area code: (423) 229-2000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | [X] | Accelerated filer | [ ] | |
Non-accelerated filer | [ ] | (Do not check if a smaller reporting company) | Smaller reporting company | [ ] |
Emerging growth company | [ ] | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
YES [ ] NO [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class | Number of Shares Outstanding at June 30, 2017 |
Common Stock, par value $0.01 per share | 144,879,098 |
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1
TABLE OF CONTENTS
ITEM | PAGE | |
PART I. FINANCIAL INFORMATION
PART II. OTHER INFORMATION
SIGNATURES
EXHIBIT INDEX
2
FORWARD-LOOKING STATEMENTS
Certain statements made or incorporated by reference in this Quarterly Report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities and Exchange Act of 1934, as amended. Forward-looking statements are all statements, other than statements of historical fact, that may be made by Eastman Chemical Company ("Eastman" or the "Company") from time to time. In some cases, you can identify forward-looking statements by terminology such as "anticipates," "believes," "estimates," "expects," "intends," "may," "plans," "projects," "will," "would," and similar expressions or expressions of the negative of these terms. Forward-looking statements may relate to, among other things, such matters as planned and expected capacity increases and utilization; anticipated capital spending; expected depreciation and amortization; environmental matters; exposure to, and effects of hedging of, raw material and energy costs; foreign currencies and interest rates; disruption of raw material or energy supply; global and regional economic, political, and business conditions; competition; growth opportunities; supply and demand, volume, price, cost, margin and sales; pending and future legal proceedings; earnings, cash flow, dividends and other expected financial results, events, and conditions; expectations, strategies, and plans for individual assets and products, businesses, and operating segments, as well as for the whole of Eastman; cash requirements and uses of available cash; financing plans and activities; pension expenses and funding; credit ratings; anticipated and other future restructuring, acquisition, divestiture, and consolidation activities; cost reduction and control efforts and targets; the timing and costs of, and benefits from, the integration of, and expected business and financial performance of, acquired businesses; strategic initiatives and development, production, commercialization and acceptance of new products, services and technologies and related costs; asset, business, and product portfolio changes; and expected tax rates and net interest costs.
Forward-looking statements are based upon certain underlying assumptions as of the date such statements were made. Such assumptions are based upon internal estimates and other analyses of current market conditions and trends, management expectations, plans, and strategies, economic conditions, and other factors. Forward-looking statements and the assumptions underlying them are necessarily subject to risks and uncertainties inherent in projecting future conditions and results. Actual results could differ materially from expectations expressed in the forward-looking statements if one or more of the underlying assumptions and expectations proves to be inaccurate or is unrealized. The most significant known factors, risks, and uncertainties that could cause actual results to differ materially from those in the forward-looking statements are identified and discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors" in Part I, Item 2 of this Quarterly Report. Other factors, risks or uncertainties of which we are not aware, or presently deem immaterial, could also cause actual results to differ materially from those in the forward-looking statements.
The Company cautions you not to place undue reliance on forward-looking statements, which speak only as of the date such statements are made. Except as may be required by law, the Company undertakes no obligation to update or alter these forward-looking statements, whether as a result of new information, future events, or otherwise.
3
UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS,
COMPREHENSIVE INCOME AND RETAINED EARNINGS
Second Quarter | First Six Months | ||||||||||||||
(Dollars in millions, except per share amounts) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Sales | $ | 2,419 | $ | 2,297 | $ | 4,722 | $ | 4,533 | |||||||
Cost of sales | 1,768 | 1,692 | 3,446 | 3,294 | |||||||||||
Gross profit | 651 | 605 | 1,276 | 1,239 | |||||||||||
Selling, general and administrative expenses | 176 | 174 | 350 | 357 | |||||||||||
Research and development expenses | 55 | 55 | 109 | 109 | |||||||||||
Asset impairments and restructuring gains, net | — | — | — | (2 | ) | ||||||||||
Operating earnings | 420 | 376 | 817 | 775 | |||||||||||
Net interest expense | 61 | 63 | 121 | 127 | |||||||||||
Early debt extinguishment costs | — | 9 | — | 9 | |||||||||||
Other (income) charges, net | — | (20 | ) | (4 | ) | (8 | ) | ||||||||
Earnings before income taxes | 359 | 324 | 700 | 647 | |||||||||||
Provision for income taxes | 65 | 67 | 127 | 139 | |||||||||||
Net earnings | 294 | 257 | 573 | 508 | |||||||||||
Less: Net earnings attributable to noncontrolling interest | 2 | 2 | 3 | 2 | |||||||||||
Net earnings attributable to Eastman | $ | 292 | $ | 255 | $ | 570 | $ | 506 | |||||||
Basic earnings per share attributable to Eastman | $ | 2.01 | $ | 1.73 | $ | 3.91 | $ | 3.43 | |||||||
Diluted earnings per share attributable to Eastman | $ | 2.00 | $ | 1.71 | $ | 3.89 | $ | 3.40 | |||||||
Comprehensive Income | |||||||||||||||
Net earnings including noncontrolling interest | $ | 294 | $ | 257 | $ | 573 | $ | 508 | |||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||
Change in cumulative translation adjustment | 36 | (70 | ) | 43 | 36 | ||||||||||
Defined benefit pension and other postretirement benefit plans: | |||||||||||||||
Amortization of unrecognized prior service credits included in net periodic costs | (6 | ) | (7 | ) | (13 | ) | (14 | ) | |||||||
Derivatives and hedging: | |||||||||||||||
Unrealized gain (loss) during period | (18 | ) | 38 | (39 | ) | 20 | |||||||||
Reclassification adjustment for losses included in net income, net | 8 | 33 | 4 | 37 | |||||||||||
Total other comprehensive income (loss), net of tax | 20 | (6 | ) | (5 | ) | 79 | |||||||||
Comprehensive income including noncontrolling interest | 314 | 251 | 568 | 587 | |||||||||||
Less: Comprehensive income attributable to noncontrolling interest | 2 | 2 | 3 | 2 | |||||||||||
Comprehensive income attributable to Eastman | $ | 312 | $ | 249 | $ | 565 | $ | 585 | |||||||
Retained Earnings | |||||||||||||||
Retained earnings at beginning of period | $ | 5,925 | $ | 5,330 | $ | 5,721 | $ | 5,146 | |||||||
Net earnings attributable to Eastman | 292 | 255 | 570 | 506 | |||||||||||
Cash dividends declared | (75 | ) | (68 | ) | (149 | ) | (135 | ) | |||||||
Retained earnings at end of period | $ | 6,142 | $ | 5,517 | $ | 6,142 | $ | 5,517 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
June 30, | December 31, | ||||||
(Dollars in millions, except per share amounts) | 2017 | 2016 | |||||
Assets | |||||||
Current assets | |||||||
Cash and cash equivalents | $ | 222 | $ | 181 | |||
Trade receivables, net of allowance for doubtful accounts | 1,018 | 812 | |||||
Miscellaneous receivables | 419 | 399 | |||||
Inventories | 1,540 | 1,404 | |||||
Other current assets | 63 | 70 | |||||
Total current assets | 3,262 | 2,866 | |||||
Properties | |||||||
Properties and equipment at cost | 11,966 | 11,699 | |||||
Less: Accumulated depreciation | 6,563 | 6,423 | |||||
Net properties | 5,403 | 5,276 | |||||
Goodwill | 4,507 | 4,461 | |||||
Intangible assets, net of accumulated amortization | 2,433 | 2,469 | |||||
Other noncurrent assets | 359 | 385 | |||||
Total assets | $ | 15,964 | $ | 15,457 | |||
Liabilities and Stockholders' Equity | |||||||
Current liabilities | |||||||
Payables and other current liabilities | $ | 1,384 | $ | 1,512 | |||
Borrowings due within one year | 212 | 283 | |||||
Total current liabilities | 1,596 | 1,795 | |||||
Long-term borrowings | 6,669 | 6,311 | |||||
Deferred income tax liabilities | 1,286 | 1,206 | |||||
Post-employment obligations | 1,004 | 1,018 | |||||
Other long-term liabilities | 519 | 519 | |||||
Total liabilities | 11,074 | 10,849 | |||||
Stockholders' equity | |||||||
Common stock ($0.01 par value – 350,000,000 shares authorized; shares issued – 218,274,450 and 217,707,600 for 2017 and 2016, respectively) | 2 | 2 | |||||
Additional paid-in capital | 1,954 | 1,915 | |||||
Retained earnings | 6,142 | 5,721 | |||||
Accumulated other comprehensive income (loss) | (286 | ) | (281 | ) | |||
7,812 | 7,357 | ||||||
Less: Treasury stock at cost (73,446,150 shares for 2017 and 71,269,474 shares for 2016) | 3,000 | 2,825 | |||||
Total Eastman stockholders' equity | 4,812 | 4,532 | |||||
Noncontrolling interest | 78 | 76 | |||||
Total equity | 4,890 | 4,608 | |||||
Total liabilities and stockholders' equity | $ | 15,964 | $ | 15,457 | |||
The accompanying notes are an integral part of these consolidated financial statements.
5
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
First Six Months | |||||||
(Dollars in millions) | 2017 | 2016 | |||||
Operating activities | |||||||
Net earnings | $ | 573 | $ | 508 | |||
Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||
Depreciation and amortization | 292 | 291 | |||||
Early debt extinguishment costs | — | 9 | |||||
Gain on sale of equity investment | — | (17 | ) | ||||
Provision for deferred income taxes | 36 | 47 | |||||
Changes in operating assets and liabilities, net of effect of acquisitions and divestitures: | |||||||
(Increase) decrease in trade receivables | (166 | ) | (151 | ) | |||
(Increase) decrease in inventories | (108 | ) | 41 | ||||
Increase (decrease) in trade payables | (28 | ) | (76 | ) | |||
Pension and other postretirement contributions (in excess of) less than expenses | (56 | ) | (51 | ) | |||
Variable compensation (in excess of) less than expenses | (34 | ) | (67 | ) | |||
Other items, net | (26 | ) | 11 | ||||
Net cash provided by operating activities | 483 | 545 | |||||
Investing activities | |||||||
Additions to properties and equipment | (279 | ) | (234 | ) | |||
Proceeds from sale of assets | 1 | 41 | |||||
Acquisitions, net of cash acquired | (4 | ) | (22 | ) | |||
Other items, net | (1 | ) | 3 | ||||
Net cash used in investing activities | (283 | ) | (212 | ) | |||
Financing activities | |||||||
Net increase (decrease) in commercial paper and other borrowings | (95 | ) | (208 | ) | |||
Proceeds from borrowings | 500 | 807 | |||||
Repayment of borrowings | (250 | ) | (807 | ) | |||
Dividends paid to stockholders | (149 | ) | (136 | ) | |||
Treasury stock purchases | (175 | ) | (45 | ) | |||
Dividends paid to noncontrolling interest | (1 | ) | (4 | ) | |||
Proceeds from stock option exercises and other items, net | 12 | 8 | |||||
Net cash used in financing activities | (158 | ) | (385 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | (1 | ) | (1 | ) | |||
Net change in cash and cash equivalents | 41 | (53 | ) | ||||
Cash and cash equivalents at beginning of period | 181 | 293 | |||||
Cash and cash equivalents at end of period | $ | 222 | $ | 240 | |||
The accompanying notes are an integral part of these consolidated financial statements.
6
ITEM | Page | |
Derivative and Non-Derivative Financial Instruments | ||
Environmental Matters and Asset Retirement Obligations | ||
7
1. | BASIS OF PRESENTATION |
The accompanying unaudited consolidated financial statements have been prepared by Eastman Chemical Company ("Eastman" or the "Company") in accordance and consistent with the accounting policies stated in the Company's 2016 Annual Report on Form 10-K and should be read in conjunction with the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K. The December 31, 2016 financial position data included herein was derived from the audited consolidated financial statements included in the 2016 Annual Report on Form 10-K but does not include all disclosures required by accounting principles generally accepted in the United States ("GAAP").
In the opinion of management, the unaudited consolidated financial statements include all normal recurring adjustments necessary for fair presentation of the interim financial information in conformity with GAAP. These statements contain some amounts that are based upon management estimates and judgments. Future actual results could differ from such current estimates. The unaudited consolidated financial statements include assets, liabilities, sales revenue, and expenses of all majority-owned subsidiaries and joint ventures in which a controlling interest is maintained. Eastman accounts for other joint ventures and investments where it exercises significant influence on the equity basis. Intercompany transactions and balances are eliminated in consolidation. Certain prior period data has been reclassified in the consolidated financial statements and accompanying footnotes to conform to current period presentation.
2. | INVENTORIES |
June 30, | December 31, | ||||||
(Dollars in millions) | 2017 | 2016 | |||||
Finished goods | $ | 1,103 | $ | 997 | |||
Work in process | 220 | 198 | |||||
Raw materials and supplies | 478 | 473 | |||||
Total inventories at FIFO or average cost | 1,801 | 1,668 | |||||
Less: LIFO reserve | 261 | 264 | |||||
Total inventories | $ | 1,540 | $ | 1,404 | |||
Inventories valued on the last-in, first-out ("LIFO") method were approximately 60 percent of total inventories at both June 30, 2017 and December 31, 2016.
3. | PAYABLES AND OTHER CURRENT LIABILITIES |
June 30, | December 31, | ||||||
(Dollars in millions) | 2017 | 2016 | |||||
Trade creditors | $ | 675 | $ | 704 | |||
Accrued payrolls, vacation, and variable-incentive compensation | 125 | 196 | |||||
Accrued taxes | 90 | 106 | |||||
Post-employment obligations | 84 | 110 | |||||
Derivative hedging liability | 82 | 72 | |||||
Other | 328 | 324 | |||||
Total payables and other current liabilities | $ | 1,384 | $ | 1,512 | |||
The "Other" above consists primarily of accruals for dividends payable, interest payable, the current portion of environmental liabilities, and miscellaneous accruals.
8
4. | PROVISION FOR INCOME TAXES |
Second Quarter | First Six Months | ||||||||||||||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||||||||||||||
$ | % | $ | % | $ | % | $ | % | ||||||||||||||||||||
Provision for income taxes and tax rate | $ | 65 | 18 | % | $ | 67 | 21 | % | $ | 127 | 18 | % | $ | 139 | 22 | % | |||||||||||
The second quarter and first six months 2017 effective tax rates include a $22 million tax benefit to reflect finalization of prior years' income tax returns. The first six months 2017 effective tax rate also reflects a $22 million tax benefit due to planned amendments to prior years' income tax returns. The second quarter and first six months 2016 effective tax rates include a $16 million one-time benefit for the restoration of tax basis for which depreciation deductions were previously limited. The first six months 2016 effective tax rate also reflects a $9 million tax benefit primarily due to adjustments to the tax provision to reflect the finalization of 2014 foreign income tax returns.
5. | BORROWINGS |
June 30, | December 31, | ||||||
(Dollars in millions) | 2017 | 2016 | |||||
Borrowings consisted of: | |||||||
5.5% notes due November 2019 | $ | 250 | $ | 249 | |||
2.7% notes due January 2020 | 796 | 796 | |||||
4.5% notes due January 2021 | 184 | 184 | |||||
3.6% notes due August 2022 | 739 | 741 | |||||
1.50% notes due May 2023 (1) | 852 | 786 | |||||
7 1/4% debentures due January 2024 | 197 | 197 | |||||
7 5/8% debentures due June 2024 | 43 | 43 | |||||
3.8% notes due March 2025 | 690 | 689 | |||||
1.875% notes due November 2026 (1) | 563 | 519 | |||||
7.60% debentures due February 2027 | 195 | 195 | |||||
4.8% notes due September 2042 | 493 | 493 | |||||
4.65% notes due October 2044 | 871 | 870 | |||||
Credit facilities borrowings | 799 | 549 | |||||
Commercial paper borrowings | 200 | 280 | |||||
Capital leases and other | 9 | 3 | |||||
Total borrowings | 6,881 | 6,594 | |||||
Borrowings due within one year | 212 | 283 | |||||
Long-term borrowings | $ | 6,669 | $ | 6,311 | |||
(1) | The carrying value of the euro-denominated 1.50% notes due May 2023 and 1.875% notes due November 2026 will fluctuate with changes in the euro exchange rate. The carrying value of these euro-denominated borrowings have been designated as non-derivative net investment hedges of a portion of the Company's net investments in euro functional-currency denominated subsidiaries to offset foreign currency fluctuations. During the six months ended June 30, 2017 and 2016, pre-tax losses of $109 million and gains of $3 million, respectively, were recognized in "Other comprehensive income (loss)" ("OCI") for revaluation of these notes. |
9
Credit Facility and Commercial Paper Borrowings
In December 2014, Eastman borrowed $1 billion under a five-year term loan ("2019 Term Loan"). As of June 30, 2017 and December 31, 2016, the 2019 Term Loan agreement balance outstanding was $250 million with an interest rate of 2.48 percent and 2.02 percent, respectively. In December 2016, the Company borrowed $300 million under a second five-year term loan ("2021 Term Loan"). As of June 30, 2017 and December 31, 2016, the 2021 Term Loan agreement balance outstanding was $299 million with an interest rate of 2.48 percent and 1.95 percent, respectively. Borrowings under the 2019 Term Loan and 2021 Term Loan agreements are subject to interest at varying spreads above quoted market rates.
The Company has access to a $1.25 billion revolving credit agreement (the "Credit Facility") that expires October 2021. Borrowings under the Credit Facility are subject to interest at varying spreads above quoted market rates and a commitment fee is paid on the total unused commitment. The Credit Facility provides liquidity support for commercial paper borrowings and general corporate purposes. Commercial paper borrowings are classified as short-term. At June 30, 2017 and December 31, 2016, the Company had no outstanding borrowings under the Credit Facility. At June 30, 2017, the Company's commercial paper borrowings were $200 million with a weighted average interest rate of 1.44 percent. At December 31, 2016, the Company's commercial paper borrowings were $280 million with a weighted average interest rate of 1.12 percent.
The Company has access to a $250 million accounts receivable securitization agreement (the "A/R Facility") that expires April 2019. Eastman Chemical Financial Corporation ("ECFC"), a subsidiary of the Company, has an agreement to sell interests in trade receivables under the A/R Facility to a third party purchaser. Third party creditors of ECFC have first priority claims on the assets of ECFC before those assets would be available to satisfy the Company's general obligations. Borrowings under the A/R Facility are subject to interest rates based on a spread over the lender's borrowing costs, and ECFC pays a fee to maintain availability of the A/R Facility. At December 31, 2016, the Company had no borrowings under the A/R Facility. At June 30, 2017, the Company's borrowings under the A/R Facility were $250 million supported by trade receivables with an interest rate of 1.98%.
The Credit and A/R Facilities and other borrowing arrangements contain customary covenants and events of default, some of which require the Company to maintain certain financial ratios that determine the amounts available and terms of borrowings. The Company was in compliance with all covenants at both June 30, 2017 and December 31, 2016.
Fair Value of Borrowings
The Company has classified its long-term borrowings at June 30, 2017 and December 31, 2016, under the fair value hierarchy as defined in the accounting policies in Note 1, "Significant Accounting Policies", to the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K. The fair value for fixed-rate debt securities is based on current market prices and is classified as Level 1. The fair value for the Company's other borrowings under the Term Loans and the A/R Facility equals the carrying value and is classified as Level 2. The Company had no borrowings classified as Level 3 as of June 30, 2017 and December 31, 2016.
Fair Value Measurements at June 30, 2017 | ||||||||||||||||
(Dollars in millions) | Recorded Amount June 30, 2017 | Total Fair Value | Quoted Prices in Active Markets for Identical Liabilities (Level 1) | Significant Other Observable Inputs (Level 2) | ||||||||||||
Long-term borrowings | $ | 6,669 | $ | 7,069 | $ | 6,273 | $ | 796 | ||||||||
Fair Value Measurements at December 31, 2016 | ||||||||||||||||
(Dollars in millions) | Recorded Amount December 31, 2016 | Total Fair Value | Quoted Prices in Active Markets for Identical Liabilities (Level 1) | Significant Other Observable Inputs (Level 2) | ||||||||||||
Long-term borrowings | $ | 6,311 | $ | 6,586 | $ | 6,036 | $ | 550 | ||||||||
10
6. | DERIVATIVE AND NON-DERIVATIVE FINANCIAL INSTRUMENTS |
Overview of Hedging Programs
The Company is exposed to market risks, such as changes in foreign currency exchange rates, commodity prices, and interest rates. To mitigate these market risks and their effects on the cash flows of the underlying transactions and investments in foreign subsidiaries, the Company uses various derivative and non-derivative financial instruments, when appropriate, in accordance with the Company's hedging strategy and policies. Designation is performed on a specific exposure basis to support hedge accounting. The Company does not enter into derivative transactions for speculative purposes.
For further information on hedging programs, see Note 10, "Derivative and Non-Derivative Financial Instruments", to the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K.
Cash Flow Hedges
Cash flow hedges are derivative instruments designated as and used to hedge the exposure to variability in expected future cash flows that are attributable to a particular risk. The derivative instruments that are designated and qualify as a cash flow hedge are reported on the balance sheet at fair value and the changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the anticipated cash flows of the underlying exposures being hedged. The net of the change in the hedge instrument and item being hedged for qualifying cash flow hedges is reported as a component of "Accumulated other comprehensive income (loss)" ("AOCI") located in the Unaudited Consolidated Statements of Financial Position and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
Fair Value Hedges
Fair value hedges are defined as derivative or non-derivative instruments designated as and used to hedge the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk. The derivative instruments that are designated and qualify as fair value hedges are reported on the balance sheet at fair value and the changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the anticipated cash flows of the underlying exposures being hedged. The net of the change in the hedge instrument and item being hedged for qualifying fair value hedges is reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivatives representing hedge ineffectiveness are recognized in current earnings.
In second quarter 2016, the Company entered into a fixed-to-floating interest rate swap on a portion of the 3.8% notes due March 2025 to manage the Company's mix of fixed and variable rate debt.
Net Investment Hedges
Net investment hedges are defined as derivative or non-derivative instruments designated as and used to hedge the foreign currency exposure of net investments in certain foreign operations. The net of the change in the hedge instrument and item being hedged for qualifying net investment hedges is reported as a component of "Change in cumulative translation adjustment" within AOCI located in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings. Gains and losses representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. The foreign currency-denominated borrowings designated as net investment hedges are included as part of "Long-term borrowings'" within the Unaudited Consolidated Statements of Financial Position.
11
The Company designated the euro-denominated 1.50% notes due May 2023 in the principal amounts of €200 million ($213 million) in fourth quarter 2016 and €550 million ($614 million) in second quarter 2016 and the euro-denominated 1.875% notes due November 2026 in the principal amount of €500 million ($534 million) in fourth quarter 2016 as non-derivative net investment hedges of a portion of the Company's net investments in euro functional currency-denominated subsidiaries to offset foreign currency fluctuations.
Summary of Financial Position and Financial Performance of Hedging Instruments
The following table shows the notional amounts outstanding at June 30, 2017 and December 31, 2016 associated with the Company's hedging programs.
Notional Outstanding | June 30, 2017 | December 31, 2016 | ||||
Derivatives designated as cash flow hedges: | ||||||
Foreign Exchange Forward and Option Contracts (in millions) | ||||||
EUR/USD (in EUR) | €360 | €378 | ||||
EUR/USD (in approximate USD equivalent) | $411 | $398 | ||||
JPY/USD (in JPY) | ¥900 | ¥1,800 | ||||
JPY/USD (in approximate USD equivalent) | $8 | $15 | ||||
Commodity Forward and Collar Contracts | ||||||
Feedstock (in million barrels) | 10 | 11 | ||||
Energy (in million million british thermal units) | 20 | 23 | ||||
Derivatives designated as fair value hedges: | ||||||
Fixed-for-floating interest rate swaps (in millions) | $75 | $75 | ||||
Non-derivatives designated as net investment hedges: | ||||||
Foreign Currency Net Investment Hedges (in millions) | ||||||
EUR/USD (in EUR) | €1,239 | €1,238 | ||||
Fair Value Measurements
All the Company's derivative assets and liabilities are currently classified as Level 2 with fair values based on estimates using standard pricing models. These standard pricing models use inputs which are derived from or corroborated by observable market data such as interest rate yield curves and currency spot and forward rates. The fair value of commodity contracts is derived using forward curves supplied by an industry recognized and unrelated third party. In addition, on an ongoing basis, the Company tests a subset of its valuations against valuations received from the transaction's counterparty to validate the accuracy of its standard pricing models. Counterparties to these derivative contracts are highly rated financial institutions which the Company believes carry minimal risk of nonperformance. The Company diversifies its positions among such counterparties to reduce its exposure to counterparty risk and credit losses and monitors the creditworthiness of its counterparties on an on-going basis. The Company had no credit losses during second quarter and first six months 2017 and 2016.
For additional fair value measurement information, see Note 1, "Significant Accounting Policies", and Note 10, "Derivative and Non-Derivative Financial Instruments", to the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K.
12
The following table shows the financial assets and liabilities valued on a gross basis as of June 30, 2017 and December 31, 2016. Additionally, the table below indicates where the derivatives are reported on the Unaudited Consolidated Statements of Financial Position. During the periods presented, there were no transfers between fair value hierarchy levels.
The Financial Position and Fair Value Measurements of Hedging Instruments on a Gross Basis | ||||||||||
(Dollars in millions) | ||||||||||
Derivative Type | Statements of Financial Position Classification | June 30, 2017 Level 2 | December 31, 2016 Level 2 | |||||||
Derivatives designated as cash flow hedges: | ||||||||||
Commodity contracts | Other current assets | $ | 1 | $ | 5 | |||||
Commodity contracts | Other noncurrent assets | — | 2 | |||||||
Foreign exchange contracts | Other current assets | 35 | 49 | |||||||
Foreign exchange contracts | Other noncurrent assets | 16 | 47 | |||||||
Derivatives designated as fair value hedges: | ||||||||||
Fixed-for-floating interest rate swap | Other current assets | 1 | 1 | |||||||
Total Derivative Assets | $ | 53 | $ | 104 | ||||||
Derivatives designated as cash flow hedges: | ||||||||||
Commodity contracts | Payables and other current liabilities | $ | 75 | $ | 62 | |||||
Commodity contracts | Other long-term liabilities | 58 | 69 | |||||||
Foreign exchange contracts | Payables and other current liabilities | 1 | — | |||||||
Foreign exchange contracts | Other long-term liabilities | 1 | — | |||||||
Derivatives designated as fair value hedges: | ||||||||||
Fixed-for-floating interest rate swap | Long-term borrowings | 3 | 4 | |||||||
Total Derivative Liabilities | $ | 138 | $ | 135 | ||||||
Total Net Derivative Liabilities | $ | 85 | $ | 31 | ||||||
In addition to the fair value associated with derivative instruments designated as cash flow hedges and fair value hedges noted in the table above, the Company had a carrying value of $1.4 billion and $1.3 billion associated with non-derivative instruments designated as foreign currency net investment hedges at June 30, 2017 and December 31, 2016, respectively. The designated foreign currency-denominated borrowings are included in the "Long-term borrowings" line item of the Unaudited Consolidated Statements of Financial Position.
All the Company's derivative contracts are subject to master netting arrangements, or similar agreements, which provide for the option to settle contracts on a net basis when they settle on the same day and in the same currency. In addition, these arrangements provide for a net settlement of all contracts with a given counterparty in the event that the arrangement is terminated due to the occurrence of default or a termination event. The Company has elected to present the derivative contracts on a gross basis in the Unaudited Consolidated Statements of Financial Position. If the Company presented the derivatives contracts on a net basis, there would be no material difference in asset and liability positions. The Company does not have any cash collateral due under such agreements.
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The tables below present the effect of hedging instruments on OCI and the financial performance for second quarter and first six months 2017 and 2016:
(Dollars in millions) | Change in amount of after tax gain/(loss) recognized in OCI on derivatives (effective portion) | Pre-tax amount of gain/(loss) reclassified from Accumulated OCI into income (effective portion) | Additional pre-tax gain/(loss) recognized in earnings (effective portion) | |||||||||||||||||||||||
Second Quarter | Second Quarter | Second Quarter | ||||||||||||||||||||||||
Hedging Relationships | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | Income Statement Classification | |||||||||||||||||||
Derivatives in cash flow hedging relationships: | ||||||||||||||||||||||||||
Commodity contracts | $ | 9 | $ | 79 | $ | (20 | ) | $ | (65 | ) | $ | — | $ | — | Cost of sales | |||||||||||
Foreign exchange contracts | (20 | ) | 1 | 10 | 15 | — | — | Sales | ||||||||||||||||||
Forward starting interest rate and treasury lock swap contracts | 1 | (9 | ) | (1 | ) | (2 | ) | — | — | Net interest expense | ||||||||||||||||
Derivatives in fair value hedging relationships: | ||||||||||||||||||||||||||
Fixed-for-floating interest rate swaps | — | — | — | — | 1 | 3 | Net interest expense | |||||||||||||||||||
Non-derivatives in net investment hedging relationships: | ||||||||||||||||||||||||||
Net investment hedges (pre-tax) | (91 | ) | 3 | — | — | — | — | N/A | ||||||||||||||||||
Derivatives not designated as hedges: (1) | ||||||||||||||||||||||||||
Foreign Exchange Contracts | — | — | — | — | 10 | 23 | Other (income) charges, net | |||||||||||||||||||
(1) | The gains or losses on derivatives that are not designated as hedges are marked to market and represent foreign exchange derivatives denominated in multiple currencies and are transacted and settled in the same quarter. |
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(Dollars in millions) | Change in amount of after tax gain/(loss) recognized in OCI on derivatives (effective portion) | Pre-tax amount of gain/(loss) reclassified from Accumulated OCI into income (effective portion) | Additional pre-tax gain/(loss) recognized in earnings (effective portion) | |||||||||||||||||||||||
First Six Months | First Six Months | First Six Months | ||||||||||||||||||||||||
Hedging Relationships | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | Income Statement Classification | |||||||||||||||||||
Derivatives in cash flow hedging relationships: | ||||||||||||||||||||||||||
Commodity contracts | $ | (7 | ) | $ | 109 | $ | (27 | ) | $ | (85 | ) | $ | — | $ | — | Cost of sales | ||||||||||
Foreign exchange contracts | (30 | ) | (25 | ) | 22 | 30 | — | — | Sales | |||||||||||||||||
Forward starting interest rate and treasury lock swap contracts | 2 | (27 | ) | (2 | ) | (4 | ) | — | — | Net interest expense | ||||||||||||||||
Derivatives in fair value hedging relationships: | ||||||||||||||||||||||||||
Fixed-for-floating interest rate swaps | — | — | — | — | 2 | 7 | Net interest expense | |||||||||||||||||||
Non-derivatives in net investment hedging relationships: | ||||||||||||||||||||||||||
Net investment hedges (pre-tax) | (109 | ) | 3 | — | — | — | — | N/A | ||||||||||||||||||
Derivatives not designated as hedges: (1) | ||||||||||||||||||||||||||
Foreign Exchange Contracts | — | — | — | — | 4 | 14 | Other (income) charges, net | |||||||||||||||||||
(1) | The gains or losses on derivatives that are not designated as hedges are marked to market and represent foreign exchange derivatives denominated in multiple currencies and are transacted and settled in the same quarter. |
Pre-tax monetized positions and mark-to-market gains and losses from raw materials and energy, currency, and certain interest rate hedges that were included in AOCI included losses of $223 million at June 30, 2017 and losses of $57 million at December 31, 2016. Losses in AOCI increased June 30, 2017 compared to December 31, 2016 primarily as a result of an increase in foreign currency exchange rates, particularly the euro. If realized, approximately $43 million in pre-tax losses, as of June 30, 2017, will be reclassified into earnings during the next 12 months.
Any ineffectiveness from the hedging programs are immediately recognized in earnings. The Company had no material ineffectiveness from the hedging programs during second quarter and first six months 2017 and 2016.
7. | RETIREMENT PLANS |
Defined Benefit Pension Plans and Other Postretirement Benefit Plans
Eastman maintains defined benefit pension plans that provide eligible employees with retirement benefits. In addition, Eastman provides life insurance for eligible retirees hired prior to January 1, 2007. Eastman provides a subsidy for pre-Medicare health care and dental benefits to eligible retirees hired prior to January 1, 2007 that will end on December 31, 2021. Company funding is also provided for eligible Medicare retirees hired prior to January 1, 2007 with a health reimbursement arrangement. Costs recognized for these benefits are estimated amounts, which may change as actual costs derived for the year are determined.
For additional information regarding retirement plans, see Note 11, "Retirement Plans", to the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K.
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Components of net periodic benefit (credit) cost were as follows:
Second Quarter | |||||||||||||||||||||||
Pension Plans | Other Postretirement Benefit Plans | ||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||||||||||
(Dollars in millions) | U.S. | Non-U.S. | U.S. | Non-U.S. | |||||||||||||||||||
Components of net periodic benefit (credit) cost: | |||||||||||||||||||||||
Service cost | $ | 9 | $ | 4 | $ | 10 | $ | 3 | $ | 1 | $ | 1 | |||||||||||
Interest cost | 16 | 4 | 19 | 6 | 6 | 7 | |||||||||||||||||
Expected return on assets | (35 | ) | (9 | ) | (34 | ) | (8 | ) | (1 | ) | (1 | ) | |||||||||||
Amortization of: | |||||||||||||||||||||||
Prior service credit, net | (1 | ) | — | (1 | ) | — | (10 | ) | (10 | ) | |||||||||||||
Net periodic benefit (credit) cost | $ | (11 | ) | $ | (1 | ) | $ | (6 | ) | $ | 1 | $ | (4 | ) | $ | (3 | ) | ||||||
First Six Months | |||||||||||||||||||||||
Pension Plans | Other Postretirement Benefit Plans | ||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | ||||||||||||||||||||
(Dollars in millions) | U.S. | Non-U.S. | U.S. | Non-U.S. | |||||||||||||||||||
Components of net periodic benefit (credit) cost: | |||||||||||||||||||||||
Service cost | $ | 18 | $ | 7 | $ | 20 | $ | 6 | $ | 2 | $ | 3 | |||||||||||
Interest cost | 33 | 9 | 37 | 12 | 12 | 14 | |||||||||||||||||
Expected return on assets | (70 | ) | (17 | ) | (68 | ) | (16 | ) | (3 | ) | (3 | ) | |||||||||||
Amortization of: | |||||||||||||||||||||||
Prior service credit, net | (2 | ) | — | (2 | ) | — | (20 | ) | (20 | ) | |||||||||||||
Net periodic benefit (credit) cost | $ | (21 | ) | $ | (1 | ) | $ | (13 | ) | $ | 2 | $ | (9 | ) | $ | (6 | ) | ||||||
8. | COMMITMENTS AND OFF BALANCE SHEET ARRANGEMENTS |
Purchase Obligations and Lease Commitments
The Company had various purchase obligations at June 30, 2017, totaling approximately $2.9 billion over a period of approximately 30 years for materials, supplies, and energy incident to the ordinary conduct of business. The Company also had various lease commitments for property and equipment under cancelable, noncancelable, and month-to-month operating leases totaling $295 million over a period of approximately 40 years. Of the total lease commitments, approximately 45 percent relate to real property, including office space, storage facilities, and land; approximately 45 percent relate to railcars; and approximately 10 percent relate to machinery and equipment, including computer and communications equipment and production equipment.
Guarantees
The Company has operating leases with terms that require the Company to guarantee a portion of the residual value of the leased assets upon termination of the lease as well as other guarantees. Disclosures about each group of similar guarantees are provided below.
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Residual Value Guarantees
The Company has operating leases with terms that require the Company to guarantee a portion of the residual value of the leased assets upon termination of the lease. These residual value guarantees totaled $71 million at June 30, 2017 and consist primarily of leases for railcars that will expire beginning in third quarter 2018. Residual guarantee payments that become probable and estimable are recognized as rent expense over the remaining life of the applicable lease. Management's current expectation is that the likelihood of material residual guarantee payments is remote.
Other Guarantees
Guarantees and claims also arise during the ordinary course of business from relationships with customers, suppliers, joint venture partners, and other parties when the Company undertakes an obligation to guarantee the performance of others if specified triggering events occur. Non-performance under a contract could trigger an obligation of the Company. The Company's current other guarantees include guarantees relating to intellectual property, environmental matters, and other indemnifications and have arisen through the normal course of business. The ultimate effect on future financial results is not subject to reasonable estimation because considerable uncertainty exists as to the final outcome of these claims, if they were to occur. These other guarantees have terms up to 30 years with maximum potential future payments of approximately $35 million in the aggregate, with none of these guarantees being individually significant to the Company's operating results, financial position, or liquidity. Management's current expectation is that future payment or performance related to non-performance under other guarantees is remote.
Other Off Balance Sheet Arrangements
The Company has rights and obligations under non-recourse factoring facilities that have a combined limit of €150 million ($171 million) as of June 30, 2017 and are committed until December 2017. These arrangements include receivables in the United States, Belgium, and Finland, and are subject to various eligibility requirements. The Company sells the receivables at face value but receives funding (approximately 85 percent) net of a deposit amount until collections are received from customers for the receivables sold. The total amounts of cumulative receivables sold in second quarter and first six months 2017, were approximately $250 million and $500 million, respectively. The total amounts of cumulative receivables sold in second quarter and first six months 2016, were approximately $225 million and $460 million, respectively. As part of the program, the Company continues to service the sold receivables at market rates with no servicing assets or liabilities recognized. The amounts of sold receivables outstanding under the non-recourse factoring facilities were $122 million and $99 million at June 30, 2017 and December 31, 2016, respectively. The fair value of the receivables sold equals the carrying value at the time of the sale, and no gain or loss is recognized. The Company is exposed to a credit loss of up to 10 percent on sold receivables.
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9. | ENVIRONMENTAL MATTERS AND ASSET RETIREMENT OBLIGATIONS |
Certain Eastman manufacturing sites generate hazardous and nonhazardous wastes, the treatment, storage, transportation, and disposal of which are regulated by various governmental agencies. In connection with the cleanup of various hazardous waste sites, the Company, along with many other entities, has been designated a potentially responsible party ("PRP") by the U.S. Environmental Protection Agency under the Comprehensive Environmental Response, Compensation and Liability Act, which potentially subjects PRPs to joint and several liability for such cleanup costs. In addition, the Company will incur costs for environmental remediation and closure and post-closure under the federal Resource Conservation and Recovery Act. Reserves for environmental contingencies have been established in accordance with Eastman's policies described in Note 1, "Significant Accounting Policies", to the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K. Although the resolution of uncertainties related to these environmental matters may have a material adverse effect on the Company's consolidated results of operations in the period recognized, because of the availability of legal defenses, the Company's preliminary assessment of actions that may be required, and if applicable the expected sharing of costs, management does not believe that the Company's liability for these environmental matters, individually or in the aggregate, will be material to the Company's consolidated financial position or cash flows. The Company's total reserve for environmental contingencies was $318 million and $321 million at June 30, 2017 and December 31, 2016, respectively. At both June 30, 2017 and December 31, 2016, this reserve included $8 million related to sites previously closed and impaired by Eastman and sites that have been divested by Eastman but for which the Company retains the environmental liability related to these sites.
The Company's total environmental reserve that management believes to be probable and estimable for environmental contingencies, including remediation costs and asset retirement obligations, is included as part of "Payables and other current liabilities" and "Other long-term liabilities" in the Unaudited Consolidated Statements of Financial Position as follows:
(Dollars in millions) | June 30, 2017 | December 31, 2016 | |||||
Environmental contingent liabilities, current | $ | 30 | $ | 30 | |||
Environmental contingent liabilities, long-term | 288 | 291 | |||||
Total | $ | 318 | $ | 321 | |||
Remediation
Estimated future environmental expenditures for undiscounted remediation costs ranged from the best estimate or minimum of $291 million to the maximum of $500 million and from the best estimate or minimum of $295 million to the maximum of $503 million at June 30, 2017 and December 31, 2016, respectively. The estimated future costs are considered to be reasonably possible and include the amounts recognized at both June 30, 2017 and December 31, 2016.
Reserves for environmental remediation include liabilities expected to be paid within approximately 30 years. The amounts charged to pre-tax earnings for environmental remediation and related charges are included within "Cost of sales" in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings. Changes in the reserves for environmental remediation liabilities during first six months 2017 are summarized below:
(Dollars in millions) | Environmental Remediation Liabilities | ||
Balance at December 31, 2016 | $ | 295 | |
Changes in estimates recognized in earnings and other | 5 | ||
Cash reductions | (9 | ) | |
Balance at June 30, 2017 | $ | 291 | |
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Closure/Post-Closure
An asset retirement obligation is an obligation for the retirement of a tangible long-lived asset that is incurred upon the acquisition, construction, development, or normal operation of that long-lived asset. The Company recognizes asset retirement obligations in the period in which they are incurred if a reasonable estimate of fair value can be made. The asset retirement obligations are discounted to expected present value and subsequently adjusted for changes in fair value. The associated estimated asset retirement costs are capitalized as part of the carrying value of the long-lived assets and depreciated over their useful life. Environmental asset retirement obligations consist primarily of closure and post-closure costs. For sites that have environmental asset retirement obligations, the best estimate recognized to date over the sites estimated useful lives for these environmental asset retirement obligation costs was $27 million and $26 million at June 30, 2017 and December 31, 2016, respectively.
Other
The Company has contractual asset retirement obligations not associated with environmental liabilities. Eastman's non-environmental asset retirement obligations are primarily associated with the future closure of leased manufacturing assets at Pace, Florida and Oulu, Finland. These recognized non-environmental asset retirement obligations were $47 million and $46 million at June 30, 2017 and December 31, 2016, respectively.
10. | LEGAL MATTERS |
From time to time, the Company and its operations are parties to, or targets of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, asbestos, patent and intellectual property, commercial, contract, environmental, antitrust, health and safety, and employment matters, which are being handled and defended in the ordinary course of business. While the Company is unable to predict the outcome of these matters, it does not believe, based upon currently available facts, that the ultimate resolution of any such pending matters will have a material adverse effect on its overall financial condition, results of operations, or cash flows.
11. | STOCKHOLDERS' EQUITY |
A reconciliation of the changes in stockholders' equity for first six months 2017 is provided below:
(Dollars in millions) | Common Stock at Par Value | Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock at Cost | Total Stockholders' Equity Attributed to Eastman | Noncontrolling Interest | Total Stockholders' Equity | |||||||||||||||||||||||
Balance at December 31, 2016 | $ | 2 | $ | 1,915 | $ | 5,721 | $ | (281 | ) | $ | (2,825 | ) | $ | 4,532 | $ | 76 | $ | 4,608 | |||||||||||||
Net Earnings | — | — | 570 | — | — | 570 | 3 | 573 | |||||||||||||||||||||||
Cash Dividends Declared (1) ($1.02 per share) | — | — | (149 | ) | — | — | (149 | ) | — | (149 | ) | ||||||||||||||||||||
Other Comprehensive Income | — | — | — | (5 | ) | — | (5 | ) | — | (5 | ) | ||||||||||||||||||||
Share-Based Compensation Expense (2) | — | 27 | — | — | — | 27 | — | 27 | |||||||||||||||||||||||
Stock Option Exercises | — | 17 | — | — | — | 17 | — | 17 | |||||||||||||||||||||||
Other | — | (5 | ) | — | — | — | (5 | ) | (1 | ) | (6 | ) | |||||||||||||||||||
Share Repurchases | — | — | — | — | (175 | ) | (175 | ) | — | (175 | ) | ||||||||||||||||||||
Balance at June 30, 2017 | $ | 2 | $ | 1,954 | $ | 6,142 | $ | (286 | ) | $ | (3,000 | ) | $ | 4,812 | $ | 78 | $ | 4,890 | |||||||||||||
(1) | Cash dividends declared includes cash dividends paid and dividends declared, but unpaid. |
(2) | Share-based compensation expense is the fair value of share-based awards. |
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Accumulated Other Comprehensive Income (Loss), Net of Tax
(Dollars in millions) | Cumulative Translation Adjustment | Benefit Plans Unrecognized Prior Service Credits | Unrealized Gains (Losses) on Derivative Instruments | Unrealized Losses on Investments | Accumulated Other Comprehensive Income (Loss) | ||||||||||||||
Balance at December 31, 2015 | $ | (284 | ) | $ | 129 | $ | (234 | ) | $ | (1 | ) | $ | (390 | ) | |||||
Period change | (97 | ) | 34 | 172 | — | 109 | |||||||||||||
Balance at December 31, 2016 | (381 | ) | 163 | (62 | ) | (1 | ) | (281 | ) | ||||||||||
Period change | 43 | (13 | ) | (35 | ) | — | (5 | ) | |||||||||||
Balance at June 30, 2017 | $ | (338 | ) | $ | 150 | $ | (97 | ) | $ | (1 | ) | $ | (286 | ) | |||||
Amounts of other comprehensive income (loss) are presented net of applicable taxes. The Company recognizes deferred income taxes on the cumulative translation adjustment related to branch operations and income from other entities included in the Company's consolidated U.S. tax return. No deferred income taxes are provided on the cumulative translation adjustment of other subsidiaries outside the United States, as such cumulative translation adjustment is considered to be a component of indefinitely invested, unremitted earnings of these foreign subsidiaries.
Components of other comprehensive income recognized in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings are presented below, before tax and net of tax effects:
Second Quarter | |||||||||||||||
2017 | 2016 | ||||||||||||||
(Dollars in millions) | Before Tax | Net of Tax | Before Tax | Net of Tax | |||||||||||
Other comprehensive income (loss) | |||||||||||||||
Change in cumulative translation adjustment | $ | 36 | $ | 36 | $ | (70 | ) | $ | (70 | ) | |||||
Defined benefit pension and other postretirement benefit plans: | |||||||||||||||
Amortization of unrecognized prior service credits included in net periodic costs (1) | (11 | ) | (6 | ) | (11 | ) | (7 | ) | |||||||
Derivatives and hedging: (2) | |||||||||||||||
Unrealized gain (loss) during period | (28 | ) | (18 | ) | 62 | 38 | |||||||||
Reclassification adjustment for losses included in net income, net | 13 | 8 | 53 | 33 | |||||||||||
Total other comprehensive income (loss) | $ | 10 | $ | 20 | $ | 34 | $ | (6 | ) | ||||||
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First Six Months | |||||||||||||||
2017 | 2016 | ||||||||||||||
(Dollars in millions) | Before Tax | Net of Tax | Before Tax | Net of Tax | |||||||||||
Other comprehensive income (loss) | |||||||||||||||
Change in cumulative translation adjustment | $ | 43 | $ | 43 | $ | 36 | $ | 36 | |||||||
Defined benefit pension and other postretirement benefit plans: | |||||||||||||||
Amortization of unrecognized prior service credits included in net periodic costs (1) | (22 | ) | (13 | ) | (22 | ) | (14 | ) | |||||||
Derivatives and hedging: (2) | |||||||||||||||
Unrealized gain (loss) during period | (62 | ) | (39 | ) | 32 | 20 | |||||||||
Reclassification adjustment for losses included in net income, net | 7 | 4 | 60 | 37 | |||||||||||
Total other comprehensive income (loss) | $ | (34 | ) | $ | (5 | ) | $ | 106 | $ | 79 | |||||
(1) | Included in the calculation of net periodic benefit costs for pension and other postretirement benefit plans. See Note 7, "Retirement Plans". |
(2) | For additional information regarding the impact of reclassifications into earnings, see Note 6, "Derivative and Non-Derivative Financial Instruments". |
12. | EARNINGS AND DIVIDENDS PER SHARE |
The following table sets forth the computation of basic and diluted earnings per share ("EPS"):
Second Quarter | First Six Months | ||||||||||||||
(In millions, except per share amounts) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Numerator | |||||||||||||||
Earnings attributable to Eastman: | |||||||||||||||
Earnings, net of tax | $ | 292 | $ | 255 | $ | 570 | $ | 506 | |||||||
Denominator | |||||||||||||||
Weighted average shares used for basic EPS | 145.3 | 147.8 | 145.7 | 147.8 | |||||||||||
Dilutive effect of stock options and other awards | 1.1 | 1.1 | 1.1 | 1.1 | |||||||||||
Weighted average shares used for diluted EPS | 146.4 | 148.9 | 146.8 | 148.9 | |||||||||||
(Calculated using whole dollars and shares) | |||||||||||||||
EPS | |||||||||||||||
Basic | $ | 2.01 | $ | 1.73 | $ | 3.91 | $ | 3.43 | |||||||
Diluted | $ | 2.00 | $ | 1.71 | $ | 3.89 | $ | 3.40 | |||||||
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In second quarter and first six months 2017 options to purchase 850,970 and 1,008,667 shares of common stock, respectively, were excluded from the shares treated as outstanding for computation of diluted earnings per share because the total market value of option exercises for these awards was less than the total cash proceeds that would be received for these exercises. Second quarter and first six months 2017 reflect the impact of share repurchases of 1,232,977 and 2,176,676, respectively.
In second quarter and first six months 2016, options to purchase 1,056,961 and 1,076,935 shares of common stock, respectively, were excluded from the shares treated as outstanding for computation of diluted earnings per share because the total market value of option exercises for these awards was less than the total cash proceeds that would be received for these exercises. Second quarter and first six months 2016 reflect the impact of share repurchases of 344,790 and 632,071, respectively.
The Company declared cash dividends of $0.51 and $0.46 per share in second quarter 2017 and 2016, respectively, and $1.02 and $0.92 per share in first six months 2017 and 2016, respectively.
13. | ASSET IMPAIRMENTS AND RESTRUCTURING |
In second quarter and first six months 2017, there were no asset impairment and restructuring charges. In first six months 2016, there was a gain of $2 million in the Additives & Functional Products segment for the sale of previously impaired assets at the Crystex® insoluble sulfur research and development site in France.
Changes in Reserves for Asset Impairments, Restructuring Charges, Net, and Severance Charges
The following table summarizes the changes in asset impairments and restructuring charges and gains, the non-cash reductions attributable to asset impairments, and the cash reductions in restructuring reserves for severance costs and site closure costs paid in first six months 2017 and full year 2016:
(Dollars in millions) | Balance at January 1, 2017 | Provision/ Adjustments | Non-cash Reductions/ Additions | Cash Reductions | Balance at June 30, 2017 | ||||||||||||||
Severance costs | $ | 42 | $ | — | $ | — | $ | (22 | ) | $ | 20 | ||||||||
Site closure and restructuring costs | 13 | — | 1 | (2 | ) | 12 | |||||||||||||
Total | $ | 55 | $ | — | $ | 1 | $ | (24 | ) | $ | 32 | ||||||||
(Dollars in millions) | Balance at January 1, 2016 | Provision/ Adjustments | Non-cash Reductions/ Additions | Cash Reductions | Balance at December 31, 2016 | ||||||||||||||
Non-cash charges | $ | — | $ | 12 | $ | (12 | ) | $ | — | $ | — | ||||||||
Severance costs | 55 | 32 | — | (45 | ) | 42 | |||||||||||||
Site closure and restructuring costs | 11 | 1 | 4 | (3 | ) | 13 | |||||||||||||
Total | $ | 66 | $ | 45 | $ | (8 | ) | $ | (48 | ) | $ | 55 | |||||||
Substantially all severance costs remaining are expected to be applied to the reserves within one year.
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14. | SHARE-BASED COMPENSATION AWARDS |
The Company utilizes share-based awards under employee and non-employee director compensation programs. These share-based awards may include restricted and unrestricted stock, restricted stock units, stock options, and performance shares. In second quarter 2017 and 2016, $13 million and $7 million, respectively, of compensation expense before tax were recognized in "Selling, general and administrative expenses" in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings for all share-based awards. The impact on second quarter 2017 and 2016 net earnings of $8 million and $4 million, respectively, is net of deferred tax expense related to share-based award compensation for each period.
In first six months 2017 and 2016, $27 million and $20 million, respectively, of compensation expense before tax were recognized in "Selling, general and administrative expenses" in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings for all share-based awards. The impact on first six months 2017 and 2016 net earnings of $17 million and $12 million, respectively, is net of deferred tax expense related to share-based award compensation for each period.
For additional information regarding share-based compensation plans and awards, see Note 18, "Share-Based Compensation Plans and Awards", to the consolidated financial statements in Part II, Item 8 of the Company's 2016 Annual Report on Form 10-K.
15. | SUPPLEMENTAL CASH FLOW INFORMATION |
Included in the line item "Other items, net" of the "Operating activities" section of the Unaudited Consolidated Statements of Cash Flows are the following changes to Unaudited Consolidated Statement of Financial Position:
(Dollars in millions) | First Six Months | ||||||
2017 | 2016 | ||||||
Other current assets | $ | (3 | ) | $ | (13 | ) | |
Other noncurrent assets | 7 | 14 | |||||
Payables and other current liabilities | (30 | ) | 40 | ||||
Long-term liabilities and equity | — | (30 | ) | ||||
Total | $ | (26 | ) | $ | 11 | ||
The above changes resulted primarily from accrued taxes, deferred taxes, environmental liabilities, monetized positions from raw material and energy, currency, and certain interest rate hedges, prepaid insurance, miscellaneous deferrals, value-added taxes, and other miscellaneous accruals.
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16. | SEGMENT INFORMATION |
The Company's products and operations are managed and reported in four operating segments: Additives & Functional Products ("AFP"), Advanced Materials ("AM"), Chemical Intermediates ("CI"), and Fibers. For additional financial and product information for each segment, see Part 1, Item 1, Business -- Business Segments and Part II, Item 8, Note 20, "Segment Information", in the Company's 2016 Annual Report on Form 10-K.
Second Quarter | First Six Months | ||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Sales | |||||||||||||||
Additives & Functional Products | $ | 830 | $ | 770 | $ | 1,603 | $ | 1,507 | |||||||
Advanced Materials | 657 | 646 | 1,291 | 1,235 | |||||||||||
Chemical Intermediates | 703 | 633 | 1,373 | 1,253 | |||||||||||
Fibers | 215 | 234 | 428 | 514 | |||||||||||
Total Sales by Segment | 2,405 | 2,283 | 4,695 | 4,509 | |||||||||||
Other | 14 | 14 | 27 | 24 | |||||||||||
Total Sales | $ | 2,419 | $ | 2,297 | $ | 4,722 | $ | 4,533 | |||||||
Second Quarter | First Six Months | ||||||||||||||
(Dollars in millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Operating Earnings (Loss) | |||||||||||||||
Additives & Functional Products | $ | 159 | $ | 168 | $ | 311 | $ | 321 | |||||||
Advanced Materials | 137 | 132 | 258 | 240 | |||||||||||
Chemical Intermediates | 83 | 15 | 165 | 82 | |||||||||||
Fibers | 55 | 72 | 107 | 158 | |||||||||||
Total Operating Earnings by Segment | 434 | 387 | 841 | 801 | |||||||||||
Other | |||||||||||||||
Growth initiatives and businesses not allocated to segments | (32 | ) | (24 | ) | (60 | ) | (42 | ) | |||||||
Pension and other postretirement benefits income, net not allocated to operating segments | 18 | 13 | 36 | 25 | |||||||||||
Acquisition integration and transaction costs | — | — | — | (9 | ) | ||||||||||
Total Operating Earnings | $ | 420 | $ | 376 | $ | 817 | $ | 775 | |||||||
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