EASTMAN CHEMICAL CO - 10-Q Quarterly Report

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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, 2004

	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 incorporation or organization)	(I.R.S. Employer Identification No.)

100 N. Eastman Road Kingsport, Tennessee	37660
(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 is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ] 

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, 2004
Common Stock, par value $0.01 per share	77,849,256
(including rights to purchase shares of
Common Stock or Participating Preferred Stock)

PAGE 1 OF 74 TOTAL SEQUENTIALLY NUMBERED PAGES 

EXHIBIT INDEX ON PAGE 67 

TABLE OF CONTENTS 

ITEM 

PAGE

PART I. FINANCIAL INFORMATION 


1.	Financial Statements
	Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings	3
	Consolidated Statements of Financial Position	4
	Unaudited Consolidated Statements of Cash Flows	5
	Notes to Unaudited Consolidated Financial Statements	6-27
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28-61
4.	Controls and Procedures	62

PART II. OTHER INFORMATION 

1.	Legal Proceedings	63-64
2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	64
4.	Submission of Matters to a Vote of Security Holders	65
6.	Exhibits and Reports on Form 8-K	65

SIGNATURES 

Signatures 

66

2

UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS, COMPREHENSIVE 

INCOME, AND RETAINED EARNINGS 

			Second Quarter				First Six Months
(Dollars in millions, except per share amounts)		2004			2003		2004		2003


Sales	$	1,676		$	1,481	$	3,273	$	2,922
Cost of sales		1,406			1,240		2,768		2,497

Gross profit		270			241		505		425

Selling and general administrative expenses		112			108		222		208
Research and development expenses		38			42		81		85
Asset impairments and restructuring charges, net		79			16		146		18
Other operating income		--			--		--		(20)

Operating earnings		41			75		56		134

Interest expense, net		30			31		59		62
Other (income) charges, net		1			(5)		--		(6)

Earnings (loss) before income taxes and cumulative effect of changes in accounting principles		10			49		(3)		78
Provision (benefit) for income taxes		(74)			14		(81)		25

Earnings before cumulative effect of changes in accounting principles		84			35		78		53
Cumulative effect of changes in accounting principles, net		--			--		--		3

Net earnings	$	84		$	35	$	78	$	56


Earnings per share
Basic
Before cumulative effect of changes in accounting
principles	$	1.08		$	0.46	$	1.01	$	0.69
Cumulative effect of changes in accounting principles, net		--			--		--		0.04

Net earnings per share	$	1.08		$	0.46	$	1.01	$	0.73


Diluted
Before cumulative effect of changes in accounting
principles	$	1.07		$	0.46	$	1.00	$	0.69
Cumulative effect of changes in accounting principles, net		--			--		--		0.04

Net earnings per share	$	1.07		$	0.46	$	1.00	$	0.73


Comprehensive Income
Net earnings	$	84		$	35	$	78	$	56
Other comprehensive income (loss)
Change in cumulative translation adjustment		(10)			45		(18)		73
Change in minimum pension liability, net of tax		1			--		(1)		--
Change in unrealized gains (losses) on investments, net of tax		--			(1)		--		(2)
Change in unrealized gains (losses) on derivative
instruments, net of tax		(1)			(3)		(2)		(5)

Total other comprehensive income (loss)		(10)			41		(21)		66

Comprehensive income	$	74		$	76	$	57	$	122


Retained Earnings
Retained earnings at beginning of period	$	1,436		$	1,869	$	1,476	$	1,882
Net earnings		84			35		78		56
Cash dividends declared		(34)			(34)		(68)		(68)

Retained earnings at end of period	$	1,486		$	1,870	$	1,486	$	1,870

The accompanying notes are an integral part of these financial statements. 

3

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION 

	June 30,		December 31,
(Dollars in millions, except per share amounts)		2004		2003

		(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	145	$	558
Trade receivables, net of allowance of $21 and $28		670		614
Miscellaneous receivables		69		87
Inventories		589		698
Other current assets		52		53
Current assets held for sale		192		--

Total current assets		1,717		2,010


Properties
Properties and equipment at cost		9,434		9,861
Less: Accumulated depreciation		6,228		6,442

Net properties		3,206		3,419


Goodwill		315		317
Other intangibles, net of accumulated amortization of $4 and $218		21		33
Other noncurrent assets		481		451
Noncurrent assets held for sale		68		--

Total assets	$	5,808	$	6,230


Liabilities and Stockholders’ Equity
Current liabilities
Payables and other current liabilities	$	942	$	973
Borrowings due within one year		1		504
Current liabilities related to assets held for sale		66		--

Total current liabilities		1,009		1,477


Long-term borrowings		2,153		2,089
Deferred income tax liabilities		240		316
Postemployment obligations		1,157		1,126
Other long-term liabilities		197		179
Long-term liabilities related to assets held for sale		7		--

Total liabilities		4,763		5,187


Stockholders’ equity
Common stock ($0.01 par value – 350,000,000 shares authorized; shares issued – 85,638,077 and 85,177,467)		1		1
Additional paid-in capital		135		122
Retained earnings		1,486		1,476
Accumulated other comprehensive loss		(142)		(121)

		1,480		1,478
Less: Treasury stock at cost (7,933,646 shares for 2004 and 2003)		435		435


Total stockholders’ equity		1,045		1,043


Total liabilities and stockholders’ equity	$	5,808	$	6,230

The accompanying notes are an integral part of these financial statements. 

4

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS 

		First Six Months
(Dollars in millions)		2004		2003


Cash flows from operating activities
Net earnings	$	78	$	56


Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization		165		193
Cumulative effect of changes in accounting principles, net		--		(3)
Asset impairments		103		15
Gains on sale of assets		--		(20)
Provision (benefit) for deferred income taxes		(84)		28
Changes in operating assets and liabilities:
Increase in receivables		(152)		(114)
Increase in inventories		(6)		(6)
Increase (decrease) in trade payables		70		(52)
Increase (decrease) in liabilities for employee benefits and incentive pay		14		(164)
Other items, net		(6)		(28)


Net cash provided by (used in) operating activities		182		(95)


Cash flows from investing activities
Additions to properties and equipment		(117)		(100)
Proceeds from sale of assets		1		28
Additions to capitalized software		(7)		(8)
Other items, net		(4)		18


Net cash used in investing activities		(127)		(62)


Cash flows from financing activities
Net increase (decrease) in commercial paper, credit facility and other short-term borrowings		89		(32)
Proceeds from long-term borrowings		--		248
Repayment of borrowings		(500)		--
Dividends paid to stockholders		(68)		(68)
Other items		13		1


Net cash provided by (used in) financing activities		(466)		149


Net change in cash and cash equivalents		(411)		(8)

Cash and cash equivalents at beginning of period		558		77


Cash and cash equivalents at end of period	$	147	$	69

The accompanying notes are an integral part of these financial statements. 

5

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 

1.  BASIS OF PRESENTATION 

The accompanying unaudited consolidated financial statements have been prepared by Eastman Chemical Company (the "Company" or "Eastman") in accordance and consistent with the accounting policies stated in the Company's 2003 Annual Report on Form 10-K and should be read in conjunction with the audited consolidated financial statements appearing in the Form 10-K. In the opinion of the Company, all normal recurring adjustments necessary for a fair presentation have been included in the unaudited consolidated financial statements. The unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and, of necessity, include some amounts that are based upon management estimates and judgments. Future actual results c
ould differ from such current estimates. The unaudited consolidated financial statements include assets, liabilities, revenues and expenses of all majority-owned subsidiaries. Eastman accounts for joint ventures and investments in minority-owned companies where it exercises significant influence on the equity basis. Intercompany transactions and balances are eliminated in consolidation. 

In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities." FIN 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applied immediately to variable interest entities ("VIEs") created after January 31, 2003, and to VIEs in which a public company obtains an interest after that date. In December 2003, the FASB published a revision to FIN 46 ("FIN 46R") 
to clarify some of the provisions of the interpretation and to defer the effective date of implementation for certain entities. Under the guidance of FIN 46R, public companies that have interests in VIEs that are commonly referred to as special purpose entities were required to apply the provisions of FIN 46R for periods ended after December 15, 2003. A public company that did not have any interests in special purpose entities but did have a variable interest in a VIE created before February 1, 2003, must apply the provisions of FIN 46R by the end of the first interim or annual reporting period ended after March 14, 2004. During the fourth quarter of 2003, the Company assessed certain of its lease arrangements as well as its accounts receivable securitization program according to the provisions of 
FIN 46R. The Company concluded that such entities did not meet the criteria for consolidation under FIN 46R. In addition, the Company has identified certain joint venture partnerships, as well as other contractual arrangements created before February 1, 2003, as potential VIEs. See Note 17 for more information about the Company’s implementation of FIN 46R. 

In December 2003, the FASB issued a revision to Statement of Financial Accounting Standards ("SFAS") No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits". This statement requires additional disclosures related to the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. It does not change the measurement or recognition of those plans. The Company has adopted the provisions of this statement. See Note 9 to the unaudited consolidated financial statements for more information. 

The Company has reclassified certain 2003 amounts to conform to the 2004 presentation. 

6

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2.  STOCK OPTIONS 

As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," Eastman continues to apply intrinsic value accounting for its employee stock options. Compensation cost for stock options, if any, is measured as the excess of the quoted market price of the stock at the date of grant over the amount an employee must pay to acquire the stock. Eastman has adopted disclosure-only provisions of SFAS No. 123 and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," an amendment of FASB Statement No. 123. The Company’s pro forma net earnings and pro forma earnings per share based upon the fair value at the grant dates for awards of Eastman’s employee stock options are disclosed below. 

If the Company had elected to recognize compensation expense based upon the fair value at the grant dates of these awards, the Company's net earnings and earnings per share would have been reduced as follows: 

 
Second Quarter 

First Six Months 

(Dollars and shares in millions, except per share amounts) 

2004 

2003 

2004 

2003 

Net earnings, as reported 

$ 

84 

$ 

35 

$ 

78 

$ 

56 

Add: Stock-based employee compensation expense included in net earnings, as reported 

1 

-- 

1 

-- 

Deduct: Total additional stock-based employee compensation cost, net of tax, that would have been included in net earnings under fair value method 

2 

3 

4 

6 

Pro forma net earnings 

$ 

83 

$ 

32 

$ 

75 

$ 

50 

Basic earnings per share 

As reported 

$ 

1.08 

$ 

0.46 

$ 

1.01 

$ 

0.73 

Pro forma 

$ 

1.07 

$ 

0.42 

$ 

0.97 

$ 

0.65 

Shares 

77.4 

77.1 

77.3 

77.1 

Diluted earnings per share 

As reported 

$ 

1.07 

$ 

0.46 

$ 

1.00 

$ 

0.73 

Shares 

78.1 

77.3 

78.0 

77.3 

Pro forma 

$ 

1.07 

$ 

0.42 

$ 

0.97 

$ 

0.65 

Shares (1) 

77.9 

77.2 

77.7 

77.2

(1) Diluted shares calculated under FAS 123/148 are computed differently than under FAS 128 using the treasury stock method. 

7

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

3. ASSETS HELD FOR SALE

During the second quarter 2004, the Company entered into an agreement to sell certain businesses and product lines and related assets within its Coatings, Adhesives, Specialty Polymers, and Inks ("CASPI") segment and recorded an asset impairment charge of $62 million to adjust the asset values to the sales proceeds less cost to sell. Following the completion of the divestiture, further gains and losses could be recognized in future periods depending upon the final sales proceeds as well as adjustments for possible pension and other postemployment benefit curtailments. These businesses and product lines include acrylate ester monomers, composites (unsaturated polyester resins), inks and graphics arts raw materials, liquid resins, powder resins and textile chemicals. The sale was complete
d on July 31, 2004.  For additional information, see Note 20 to the unaudited consolidated financial statements. 

Summarized balance sheet information for assets and related liabilities classified as held for sale are below: 

		June 30,
(Dollars in millions)		2004

Current assets
Cash	$	2
Trade receivables, net		86
Miscellaneous receivables		1
Inventories		98
Other current assets		5

Total current assets		192


Non-current assets
Properties and Equipment, net		61
Other intangibles, net		5
Deferred income tax assets		2

Total non-current assets		68

Total assets	$	260


Current liabilities
Payables and other current liabilities, net	$	66

Total current liabilities		66


Long term liabilities
Deferred income tax liabilities		4
Other long term liabilities		3

Total noncurrent liabilities		7

Total liabilities	$	73

8


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

4.  INVENTORIES 

		June 30,		December 31,
(Dollars in millions)		2004		2003


(At average cost (which approximates FIFO))
Finished goods	$	530	$	583
Work in process		174		175
Raw materials and supplies		173		228

Total inventories		877		986
Reduction to LIFO value		(288)		(288)

Total inventories at LIFO value	$	589	$	698

Inventories valued on the LIFO method were approximately 65% of total inventories at each period end. 

5.  GOODWILL AND OTHER INTANGIBLE ASSETS 

The following are the Company’s amortizable intangible assets and indefinite-lived intangible assets. The difference between the gross carrying amount and net carrying amount for each item presented is attributable to impairments and accumulated amortization. 

		As of June 30, 2004				As of December 31, 2003
(Dollars in millions)		Gross Carrying Amount		Net Carrying Amount		Gross Carrying Amount		Net Carrying Amount


Amortizable intangible assets
Developed technology	$	3	$	2	$	124	$	6
Customer lists		6		4		62		6
Other		3		2		18		2

Total	$	12		8	$	204		14


Indefinite-lived intangible assets
Trademarks				13				19


Other intangible assets			$	21			$	33

Changes in the carrying amount of goodwill follow: 

(Dollars in millions)		CASPI Segment		Other Segments		Total Eastman Chemical


Reported balance at December 31, 2003	$	306	$	11	$	317
Foreign currency translation effect		(2)		--		(2)

Reported goodwill balance at June 30, 2004	$	304	$	11	$	315

Amortization expense for definite-lived intangible assets was approximately $1 million for the first six months 2004 and $8 million for the first six months 2003. Estimated amortization expense for the five succeeding years is approximately $1 million per year. 

9


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

6. PAYABLES AND OTHER CURRENT LIABILITIES

		June 30		December 31,
(Dollars in millions)		2004		2003


Trade creditors	$	485	$	478
Accrued payrolls, vacation, and variable-incentive compensation		113		135
Accrued taxes		38		63
Interest payable		33		45
Bank overdrafts		34		22
Other		239		230

Total	$	942	$	973

7.  BORROWINGS 

		June 30,		December 31,
(Dollars in millions)		2004		2003


Borrowings consisted of:
6 3/8% notes due 2004	$	--	$	504
3 1/4% notes due 2008		250		250
6.30% notes due 2018		244		249
7% notes due 2012		386		394
7 1/4% debentures due 2024		497		496
7 5/8% debentures due 2024		200		200
7.60% debentures due 2027		297		297
Commercial paper and credit facility borrowings		271		196
Other		9		7

Total borrowings		2,154		2,593
Borrowings due within one year		(1)		(504)

Long-term borrowings	$	2,153	$	2,089

Eastman has access to a $700 million revolving credit facility (the "Credit Facility") expiring in April 2009. Any borrowings under the Credit Facility are subject to interest at varying spreads above quoted market rates, principally LIBOR. The Credit Facility requires facility fees on the total commitment that vary based on Eastman's credit rating. The rate for such fees was 0.15% as of June 30, 2004 and December 31, 2003. The Credit Facility contains a number of covenants and events of default, including the maintenance of certain financial ratios. 

Eastman typically utilizes commercial paper to meet its liquidity needs. The Credit Facility provides liquidity support for commercial paper borrowings and general corporate purposes. Accordingly, outstanding commercial paper borrowings reduce borrowings available under the Credit Facility. Since the Credit Facility expires in April 2009, the commercial paper borrowings supported by the Credit Facility are classified as long-term borrowings because the Company has the ability to refinance such borrowings on a long-term basis. At June 30, 2004, the Company’s commercial paper and revolving credit facility borrowings were $271 million at an effective interest rate of 2.00%. At December 31, 2003, the Company's commercial paper borrowings were $196 million at an effective interest rate of 1.85%
. 

On June 16, 2003, the Company issued notes in the principal amount of $250 million due 2008 and bearing interest at 3 1/4% per annum. Proceeds from the sale of the notes, net of $2 million in transaction fees, were $248 million and were used to repay portions of commercial paper borrowings. 

10


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

On November 12, 2003, the Company issued notes in the principal amount of $250 million due 2018 and bearing interest at 6.30% per annum. Proceeds from the sale of the notes, net of approximately $2 million in transaction fees, were $246 million and were used, along with cash generated from business activities and other borrowings, for the repayment of the Company’s outstanding $500 million 6 3/8% notes due January 15, 2004. 

On January 15, 2004, the Company repaid at maturity $500 million of notes bearing interest at 6 3/8% per annum. These notes were reflected in borrowings due within one year in the Consolidated Statements of Financial Position at December 31, 2003. These notes were repaid with cash generated from business activities, new long-term borrowings and available short-term borrowing capacity. 

In the third quarter 2003, the Company entered into interest rate swaps that converted the effective interest rate of $250 million of the $400 million 7% notes due in 2012 to variable rates. In the second quarter of 2004, the Company entered into interest rate swaps that converted the effective interest rate of $100 million of the $400 million 7% notes due in 2012 to variable rates. The average rate on the variable portion was 4.04% at June 30, 2004 and 3.69% at December 31, 2003. The recording of the fair value of the interest rate swaps and the corresponding debt resulted in a decrease of $8 million in long-term borrowings and other noncurrent assets in the first six months of 2004. The fair values of the interest rate swaps were liabilities of $11 million and $3 million at June 30, 2004 and 
December 31, 2003, respectively. 

In the fourth quarter 2003, the Company entered into interest rate swaps that converted the effective interest rate of $150 million of the $250 million 6.30% notes due in 2018 to variable rates such that the average rate on the variable portion was 2.55% at June 30, 2004 and 2.15% at December 31, 2003. The recording of the fair value of the interest rate swaps and the corresponding debt resulted in a decrease of approximately $5 million in long-term borrowings and other noncurrent assets in the first six months of 2004. The fair values of the interest rate swaps were a liability of $4 million and an asset of $1 million at June 30, 2004, and December 31, 2003, respectively. 

8.  EARNINGS AND DIVIDENDS PER SHARE 

	Second Quarter		First Six Months
	2004	2003	2004	2003


Shares used for earnings per share calculation:
Basic	77.4	77.1	77.3	77.1
Diluted	78.1	77.3	78.0	77.3

Certain shares underlying options outstanding during the second quarter and the first six months 2004 and 2003 were excluded from the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares during those periods. For the second quarter and first six months 2004, common shares underlying options to purchase 6,821,997 shares of common stock at a range of prices from $45.17 to $67.50 and 6,847,998 shares of common stock at a range of prices from $42.75 to $67.50, respectively, have been excluded from the calculation of diluted earnings per share. Excluded from the second quarter and the first six months 2003 calculations were shares underlying options to purchase 8,400,507 shares of common stock at a range o
f prices from $35.90 to $73.94. 

The Company declared cash dividends of $0.44 per share in the second quarter 2004 and 2003 and $0.88 per share in the first six months 2004 and 2003. 

11

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

9. RETIREMENT PLANS

Eastman maintains defined benefit plans that provide eligible employees with retirement benefits. Costs recognized for these benefits are recorded using estimated amounts, which may change as actual costs derived for the year are determined. Below is a summary of the components of net periodic benefit cost recognized for Eastman's significant defined benefit pension plans: 

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Components of net periodic benefit cost:
Service cost	$	9	$	10	$	21	$	21
Interest cost		20		21		41		42
Expected return on assets		(21)		(20)		(41)		(41)
Amortization of:
Prior service credit		(2)		(3)		(5)		(5)
Actuarial loss		6		5		13		9
Curtailment		--		--		2		--

Net periodic benefit cost	$	12	$	13	$	31	$	26

In its 2003 annual report on form 10-K, the Company disclosed that it expected to contribute between $0 and $40 million to its U.S. defined benefit plans for 2004. As of June 30, 2004, no contributions have been made and, due to the passage of the Pension Funding Equity Act of 2004, the Company does not anticipate making any contributions during 2004. 

A curtailment charge of approximately $2 million was recognized during first quarter 2004 in connection with the closure of the Company’s Hartlepool, United Kingdom manufacturing facility. 

POSTRETIREMENT WELFARE PLANS 

Eastman provides life insurance and health care benefits for eligible retirees, and health care benefits for retirees' eligible survivors. In general, Eastman provides those benefits to retirees eligible under the Company's U.S. pension plans. Similar benefits are also provided to retirees of Holston Defense Corporation ("HDC"), a wholly-owned subsidiary of the Company that, prior to January 1, 1999, operated a government-owned ammunitions plant. HDC’s contract with the Department of Army ("DOA") provided for reimbursement of allowable costs incurred by HDC including certain postretirement welfare costs, for as long as HDC operated the plant. After the contract was terminated at the end of 1998, the Army has not contributed further to these costs. The Company continues to accrue for the co
sts related to HDC retirees while pursuing extraordinary relief from the DOA for reimbursement of these and other previously expensed employee benefit costs. Given the uncertain outcome of discussions with the DOA, the Company will recognize the impact of any reimbursement in the period settled. 

During the second quarter 2004, the Company announced an amendment to its health and dental benefit plans such that future health and dental benefits to certain retirees will be fixed at a certain contribution amount, not to be increased. As a result, the Company remeasured these plans as of June 1, 2004 resulting in a reduction of the Company’s benefit obligation by approximately $240 million. The discount rate used at the time of the remeasurement was adjusted from 6.25% at December 31, 2003 to 6.50% at June 1, 2004 based on increases in interest rates. The effect of this change is reflected in the results below. 

A few of the Company's non-U.S. operations have supplemental health benefit plans for certain retirees, the cost of which is not significant to the Company. 

12


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following tables set forth the status of the Company's U.S. plans at June 30, 2004 and December 31, 2003: 

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Components of net periodic benefit cost:

Service cost	$	1	$	1	$	4	$	4
Interest cost		14		13		29		29
Expected return on assets		--		--		--		--
Amortization of:
Prior service credit		(3)		(1)		(4)		(2)
Actuarial loss		5		3		9		6

Net periodic benefit cost	$	17	$	16	$	38	$	37

Summary Balance Sheet
(Dollars in millions)		June 30, 2004		December 31, 2003


Change in benefit obligation:
Benefit obligation, beginning of period	$	977	$	896
Service cost		4		8
Interest cost		29		58
Plan participants’ contributions		--		4
Actuarial (gain) loss		(13)		70
Plan amendments		(241)		(10)
Benefits paid		(28)		(49)

Benefit obligation, end of period	$	728	$	977


Change in plan assets:
Fair value of plan assets, beginning of period	$	19	$	26
Company contributions		23		38
Plan participants’ contributions		--		4
Benefits paid		(28)		(49)

Fair value of plan assets, end of period	$	14	$	19


Benefit obligation in excess of plan assets	$	714	$	958
Unrecognized actuarial loss		(316)		(338)
Unrecognized prior service credit		272		36

Net amount recognized, end of period	$	670	$	656


Amounts recognized in the Statements of Financial Position consist of:
Accrued benefit cost	$	670	$	656

Net amount recognized, end of period	$	670	$	656

Weighted-average assumptions as of 6/30/04 and 12/31/2003	2004	2003

Discount rate	6.50%	6.25%
Rate of compensation increase	3.75%	3.75%
Health care cost trend
Initial	10.00%	10.00%
Decreasing to ultimate trend of	5.00%	5.00%
In year	2009	2009

13


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

10.  ASSET IMPAIRMENTS AND RESTRUCTURING CHARGES , NET 

During the second quarter 2004, the Company recognized pre-tax asset impairments and restructuring charges of $79 million, consisting of non-cash charges of $62 million and cash charges for severance and site closure costs of $17 million. For the first six months 2004, pre-tax asset impairments and restructuring charges totaled $146 million, with non-cash impairments and cash restructuring charges totaling $103 million and $43 million, respectively. 

The following table summarizes both second quarter and year to date 2004 and second quarter and year to date 2003 charges: 

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Eastman Division segments:
CASPI segment:
Fixed asset impairments	$	56	$	--	$	57	$	--
Intangible asset impairments		6		--		6		--
Severance costs		5		1		9		3
Site closure costs		2		--		3		--

Total – CASPI segment		69		1		75		3

PCI segment:
Fixed asset impairments		--		15		--		15
Severance costs		4		--		7		--

Total – PCI segment		4		15		7		15

SP segment:
Fixed asset impairments		--		--		40		--
Severance costs		2		--		8		--
Site closure costs		2		--		2		--

Total – SP segment		4		--		50		--

Total Eastman Division		77		16		132		18



Voridian Division segments:
Polymers segment
Severance costs		1		--		12		--

Total – Polymers segment		1		--		12		--

Total Voridian Division		1		--		12		--


Developing Businesses Division segment:
Developing Businesses segment:
Severance costs		1		--		2		--

Total – Developing Businesses segment		1		--		2		--


Total Eastman Chemical Company	$	79	$	16	$	146	$	18

14


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2004

Asset Impairments and Restructuring Charges 

In the second quarter 2004, the company recognized $62 million in asset impairment charges related to assets held for sale. The assets are part of the Company’s sale of certain businesses and product lines within the CASPI segment, which was completed July 31, 2004. The charges reflect adjustment of the values of these assets to the expected sales proceeds. Also in second quarter 2004, the Company recognized an additional $4 million of site closure costs related primarily to previously announced closures of the Company’s Hartlepool, Waterford, and Bury manufacturing facilities. These charges had an impact of approximately $2 million each to the CASPI and SP segments. 

In the first six months 2004, the Company recorded asset impairments of $103 million, consisting of $62 million as described above as well as the charges explained below: 

$40 million related to the closure of its copolyester manufacturing facility in Hartlepool, United Kingdom. The decision to close the Hartlepool site, which manufactures products that are within the Company’s Specialty Plastics ("SP") segment’s product lines, was made in order to consolidate production at other sites to create a more integrated and efficient global manufacturing structure. Accordingly, the carrying value of the manufacturing fixed assets was written down to fair value, as established by appraisal and available market data.
the Company recognized $1 million of fixed asset impairments and $1 million of site closure costs related to additional impairments associated with the CASPI reorganization and changes in estimates for previously accrued amounts.

Severance Charges 

In the second quarter 2004, the Company recognized approximately $13 million in severance charges related to separations stemming from the Company’s voluntary termination program announced in April, 2004. In the first six months 2004, the Company recognized $38 million in severance charges as explained below: 

the decision to close the Hartlepool manufacturing site as discussed above, resulting in severance charges of $5 million within the SP segment; and,
ongoing cost reduction efforts throughout the Company and costs related to the Company’s employee separation programs announced in April 2004, resulting in severance charges to the CASPI, Performance Chemical and Intermediates ("PCI"), SP, Polymers, and Developing Businesses segments of $9 million, $7 million, $3 million, $12 million, and $2 million respectively.

2003

Asset Impairments and Restructuring Charges 

As discussed in Note 15 below, effective January 1, 2004, certain commodity product lines were transferred from the PCI segment to the CASPI segment, which resulted in the reclassification of asset impairment charges of $42 million for 2003. 

15


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

CASPI Segment

In the third quarter 2003, the Company reorganized the operating structure within its CASPI segment and changed the segment’s business strategy in response to the financial performance of certain underlying product lines. Those product lines include: acrylate ester monomers; composites (unsaturated polyester resins); inks and graphic arts raw materials; liquid resins; powder resins; and textile chemicals. Prior to the third quarter, management was pursuing growth strategies aimed at significantly improving the financial performance of these product lines. However, due to the continued operating losses and deteriorating market conditions, management decided to pursue alternative strategies including restructuring, divestiture, and consolidation. This change affected both the manner in whic
h certain assets are used and the financial outlook for these product lines, thus triggering the impairments and certain restructuring charges. 

The third quarter fixed asset impairment charges of $236 million primarily related to assets associated with the above mentioned product lines, and primarily impacted manufacturing sites in the North American and European regions that were part of the Lawter International, Inc. ("Lawter"), McWhorter Technologies, Inc ("McWhorter"), and Chemicke Zavody Sokolov ("Sokolov") acquisitions. Within these product lines, nine sites in North America and six sites in Europe were impaired. As the undiscounted future cash flows could not support the carrying value of the assets, the fixed assets were written down to fair value, as established primarily by appraisal. 

The third quarter intangible asset impairment charges related to definite-lived intangible assets of approximately $128 million and indefinite-lived intangibles of approximately $47 million. The definite-lived intangibles related primarily to developed technology and customer lists, and the indefinite-lived intangibles primarily related to trademarks. These intangible assets were primarily associated with the acquisitions of Lawter and McWhorter. As the undiscounted future cash flows could not support the carrying value of the definite-lived intangible assets, these assets were written down to fair value, as established primarily by appraisal. Indefinite-lived intangible assets were written down to fair value, as established by appraisal. 

Upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," the Company defined reporting units as one level below the operating segment level and considered the criteria set forth in SFAS No. 142 in aggregating the reporting units. This resulted in the CASPI segment being deemed a single reporting unit. In the third quarter 2003, the reorganization of the operating structure within the CASPI segment resulted in new reporting units one level below the operating segment. Due to the change in strategy and lack of similar economic characteristics, these reporting units did not meet the criteria necessary for aggregation. As a result, the goodwill associated with the CASPI segment was reassigned to the new reporting units based upon relative fair values. The reporting unit that containe
d the above-mentioned product lines was assigned $34 million of goodwill out of the total CASPI segment goodwill of $333 million. Because the Company determined that this reporting unit could no longer support the carrying value of its assigned goodwill, the full amount of that goodwill was impaired. The fair value of the other reporting unit within CASPI was sufficient to support the carrying value of the remainder of the goodwill. 

In the fourth quarter, the Company recognized fixed asset impairments and site closure costs of $1 million and $3 million, respectively. The fixed asset impairments related to additional impairments associated with the CASPI reorganization, as discussed above. 

Severance charges of $13 million for 2003 are discussed in further detail below. 

16


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

PCI Segment

In the second quarter, the Company recorded an asset impairment charge of approximately $15 million related to the impairment of certain fixed assets used in the PCI segment’s fine chemicals product lines that are located in Llangefni, United Kingdom. In response to industry conditions, during the second quarter 2003 the Company revised its strategy and the earnings forecast for the products manufactured by these assets. As the undiscounted future cash flows could not support the carrying value of the assets, the fixed assets were written down to fair value, as established primarily by discounted future cash flows of the impacted assets. 

In the third and fourth quarter, the PCI segment incurred charges of $38 million related to the impairment of fixed assets used in certain performance chemicals product lines as a result of increased competition and changes in business strategy in response to a change in market conditions and the financial performance of these product lines. Within the performance chemicals product lines, the fixed asset impairments charge related to assets located at the Kingsport, Tennessee facility. 

Severance charges of $4 million for 2003 are discussed in further detail below. 

SP Segment

Severance charges of $1 million for 2003 are discussed in further detail below. 

Polymers Segment

In the fourth quarter, an asset impairment charge of $1 million was recorded related to assets classified as held for sale at the Company’s Kirkby, United Kingdom site. The fair value of these assets was determined using the estimated proceeds from the sale less the cost to sell. 

Severance charges of $1 million for 2003 are discussed in further detail below. 

Severance Charges 

In the first half of 2003, severance costs of $3 million were incurred within the CASPI segment related primarily to consolidation and restructuring activities and changes in previously accrued amounts. In the third quarter 2003, the Company recognized $14 million in restructuring charges related to the actual and probable involuntary separations of approximately 300 employees. These workforce reductions were the result of decisions made as part of the restructuring of the CASPI segment discussed above, the Company’s annual budgeting process, and site closure costs associated with the PCI segment. During the fourth quarter, severance charges were recorded in the CASPI and Fibers segment totaling $2 million and $1 million, respectively, due to the ongoing restructuring of the CASPI segment 
and the annual budgeting process discussed above. 

17


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Asset impairment and restructuring charges reserve roll forward 

The following table summarizes the beginning reserves, charges to and changes in estimates to the reserves as described above, and the cash and non-cash reductions to the reserves attributable to asset impairments and the cash payments for severance and site closure costs: 

(Dollars in millions)		Balance at January 1, 2003		Provision/ Adjustments		Noncash Reductions		Cash Reductions		Balance at December 31, 2003


Non-cash charges	$	--	$	500	$	(500)	$	--	$	--
Severance costs		2		20		--		(12)		10
Site closure costs		7		3		--		(5)		5

Total	$	9	$	523	$	(500)	$	(17)	$	15


		Balance at January 1, 2004		Provision/ Adjustments		Noncash Reductions		Cash Reductions		Balance at June 30, 2004


Non-cash charges	$	--	$	103	$	(103)	$	--	$	--
Severance costs		10		38		--		(11)		37
Site closure costs		5		5		--		(4)		6

Total	$	15	$	146	$	(103)	$	(15)	$	43

As of June 30, 2004, out of approximately 1,200 actual and probable employee separations that were identified and for which charges were recorded during 2003 and 2004, approximately 1,100 were completed. The remaining severance and site closure costs are expected to be applied to the reserves within one year. 

11.  DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING 

The Company is exposed to market risk, such as changes in foreign currency exchange rates, raw material and energy costs and interest rates. The Company uses various derivative financial instruments pursuant to the Company's hedging policies to mitigate these market risk factors and their effect on the cash flows of the underlying transactions. Designation is performed on a specific exposure basis to support hedge accounting. The changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the cash flows of the underlying exposures being hedged. The Company does not hold or issue derivative financial instruments for trading purposes. Financial instruments held as part of each hedging program are more fully described in Note 8 "Fair Value of Finan
cial Instruments" to the Company’s audited consolidated financial statements contained in the 2003 Annual Report on Form 10-K. 

At June 30, 2004, the Company had no material mark-to-market gains or losses from foreign currency and raw material and energy hedges. The gains from certain interest rate hedges that were included in accumulated other comprehensive income (loss) were $3 million. This balance will be reclassified into earnings over the next 10 years. The mark-to-market gains or losses on non-qualifying, excluded and ineffective portions of hedges are recognized in cost of sales or other income and charges immediately. Such amounts did not have a material impact on earnings for any of the periods presented. 

18


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

12.  OTHER OPERATING INCOME AND OTHER (INCOME) CHARGES, NET 

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Other operating income	$	--	$	--	$	--	$	(20)



Other income	$	(6)	$	(12)	$	(12)	$	(16)
Other charges		7		7		12		10

Other (income) charges, net	$	1	$	(5)	$	--	$	(6)

Other Operating Income 

Other operating income for the first six months 2003 reflected a gain of approximately $20 million on the sale of the Company’s high-performance crystalline plastics assets, which were formerly a part of the Company’s SP segment. 

Other (Income) Charges, net 

Included in other income are the Company’s portion of earnings from its equity investments, royalty income, net gains on foreign exchange transactions and other miscellaneous items. Included in other charges are net losses on foreign exchange transactions, the Company’s portion of losses from its equity investments, fees on securitized receivables and other miscellaneous items. 

Other income for the second quarter and first six months 2004 primarily reflected the Company’s portion of earnings from its equity investment in Genencor International of approximately $6 million and $10 million, respectively. Other charges for the second quarter and first six months 2004 consist primarily of write downs to fair value of certain technology business ventures due to other than temporary declines in value, net losses attributable to foreign exchange transactions and fees on securitized receivables. 

Other income for the second quarter and first six months 2003 primarily included net gains on foreign currency transactions, net of hedging, primarily attributed to the strengthening of the euro, and results from the Company’s equity investments. Other charges for the second quarter and first six months 2003 primarily reflected fees on securitized receivables and other miscellaneous items. 

13.  CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES, NET OF TAX 

SFAS No. 143 

Effective January 1, 2003, the Company’s method of accounting for environmental closure and post closure costs changed as a result of the adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations." Upon the initial adoption of the provision, entities are required to recognize a liability for any existing asset retirement obligations adjusted for cumulative accretion to the date of adoption of this Statement, an asset retirement cost capitalized as an increase to the carrying amount of the associated long-lived asset, and accumulated depreciation on that capitalized cost. In accordance with SFAS No. 143, the Company recorded asset retirement obligations primarily related to closure and post closure environmental liabilities associated with certain property plant and e
quipment. This resulted in the Company recording asset retirement obligations of $28 million and an after-tax credit to earnings of $3 million. 

19


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

14.  ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) 

(Dollars in millions)		Cumulative Translation Adjustment		Unfunded Minimum Pension Liability		Unrealized Gains (Losses) on Investments		Unrealized Gains (Losses) on Derivative Instruments		Accumulated Other Comprehensive Income (Loss)


Balance at December 31, 2002	$	(31)	$	(261)	$	(2)	$	(1)	$	(295)
Period change		150		19		--		5		174

Balance at December 31, 2003		119		(242)		(2)		4		(121)
Period change		(18)		(1)		--		(2)		(21)

Balance at June 30, 2004	$	101	$	(243)	$	(2)	$	2	$	(142)

Except for cumulative translation adjustment, amounts of other comprehensive income (loss) are presented net of applicable taxes. Because cumulative translation adjustment is considered a component of permanently invested unremitted earnings of subsidiaries outside the United States, no taxes are provided on such amounts. 

15.  SEGMENT INFORMATION 

The Company’s products and operations are managed and reported in three divisions comprised of six operating segments. Eastman Division consists of the CASPI segment, the PCI segment and the SP segment. Voridian Division contains the Polymers segment and the Fibers segment. The Developing Businesses Division consists of the Developing Businesses segment. 

Goods and services are transferred between the divisions at predetermined prices that may be in excess of cost. Accordingly, the divisional structure results in the recognition of interdivisional sales revenue and operating earnings. Such interdivisional transactions are eliminated in the Company’s consolidated financial statements. 

Effective January 1, 2004, certain commodity product lines were transferred from the PCI segment to the CASPI segment. This realignment resulted in approximately $86 million in sales revenue and an operating loss of $45 million, of which $42 million related to asset impairments recorded in the third quarter of 2003, being transferred from the PCI segment to the CASPI segment for 2003. The realignment also resulted in segment assets of $56 million being transferred from the PCI segment to the CASPI segment as of December 31, 2003. In addition, during the first quarter of 2004, the Company reclassified assets within the Voridian Division to reflect the current allocation of certain shared assets. These changes had no effect on the unaudited consolidated financial statements. 

20


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

	Second Quarter, 2004
(Dollars in millions)		External Sales		Interdivisional Sales		Total Sales

Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	476	$	--	$	476
Performance Chemicals and Intermediates		313		140		453
Specialty Plastics		154		13		167

Total Eastman Division		943		153		1,096


Voridian Division
Polymers		515		15		530
Fibers		181		23		204

Total Voridian Division		696		38		734


Developing Businesses Division
Developing Businesses		37		111		148

Total Developing Businesses Division		37		111		148


Total Eastman Chemical Company	$	1,676	$	302	$	1,978

	Second Quarter, 2003*
		External Sales		Interdivisional Sales		Total Sales

Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	441	$	--	$	441
Performance Chemicals and Intermediates		286		115		401
Specialty Plastics		138		12		150

Total Eastman Division		865		127		992


Voridian Division
Polymers		434		19		453
Fibers		166		19		185

Total Voridian Division		600		38		638


Developing Businesses Division
Developing Businesses		16		94		110

Total Developing Businesses Division		16		94		110


Total Eastman Chemical Company	$	1,481	$	259	$	1,740

*Sales revenue for 2003 has been reclassified to reflect the Company’s new organizational structure and segments effective in the first quarter 2004. 

21


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

	First Six Months, 2004
(Dollars in millions)		External Sales		Interdivisional Sales		Total Sales

Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	915	$	--	$	915
Performance Chemicals and Intermediates		603		281		884
Specialty Plastics		311		25		336

Total Eastman Division		1,829		306		2,135


Voridian Division
Polymers		1,030		33		1,063
Fibers		353		44		397

Total Voridian Division		1,383		77		1,460


Developing Businesses Division
Developing Businesses		61		220		281

Total Developing Businesses Division		61		220		281


Total Eastman Chemical Company	$	3,273	$	603	$	3,876

	First Six Months, 2003*
		External Sales		Interdivisional Sales		Total Sales

Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	852	$	--	$	852
Performance Chemicals and Intermediates		583		240		823
Specialty Plastics		282		26		308

Total Eastman Division		1,717		266		1,983


Voridian Division
Polymers		864		40		904
Fibers		312		40		352

Total Voridian Division		1,176		80		1,256


Developing Businesses Division
Developing Businesses		29		192		221

Total Developing Businesses Division		29		192		221


Total Eastman Chemical Company	$	2,922	$	538	$	3,460

*Sales revenue for 2003 has been reclassified to reflect the Company’s new organizational structure and segments effective in the first quarter 2004. 

22


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003 ⁽³⁾		2004		2003 ⁽³⁾


Operating Earnings (Loss) by Division and
Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks ^{(1) (2)}	$	(24)	$	19	$	6	$	16
Performance Chemicals and Intermediates ^{(1) (2)}		12		3		20		9
Specialty Plastics ^{(1) (2)}		19		9		(4)		41

Total Eastman Division		7		31		22		66


Voridian Division
Polymers ^{(1) (2)}		20		26		8		54
Fibers		33		36		66		61

Total Voridian Division		53		62		74		115


Developing Businesses Division
Developing Businesses ^{(1) (2)}		(19)		(16)		(39)		(39)

Total Developing Businesses Division		(19)		(16)		(39)		(39)


Eliminations		--		(2)		(1)		(8)

Total Eastman Chemical Company	$	41	$	75	$	56	$	134

(1) Second quarter 2004 operating earnings for the CASPI segment included asset impairments and restructuring charges of approximately $69 million. Second quarter 2003 operating earnings for the CASPI segment included restructuring charges of approximately $1 million. Second quarter 2004 operating earnings for the PCI segment included restructuring charges of approximately $4 million. Second quarter 2003 operating earnings for the PCI segment included an asset impairment charge of approximately $15 million. Second quarter 2004 operating earnings for the SP segment included restructuring charges of approximately $4 million. Second quarter 2004 operating earnings for the Polymers segment incl
uded restructuring charges of approximately $1 million. Second quarter 2004 operating earnings for the Developing Businesses segment included restructuring charges of approximately $1 million. 

(2) First six months 2004 operating earnings for the CASPI segment included asset impairments and restructuring charges of approximately $75 million. First six months 2003 operating earnings for the CASPI segment included net restructuring charges of approximately $3 million. First six months 2004 operating earnings for the PCI segment included restructuring charges of approximately $7 million. First six months 2003 operating earnings for the PCI segment included an asset impairment charge of approximately $15 million. First six months 2004 operating results for the SP segment included asset impairment and restructuring charges of approximately $50 million. First six months 2004 operating e
arnings for the Polymers segment included restructuring charges of approximately $12 million. First six months 2004 operating earnings for the Developing Businesses segment included restructuring charges of approximately $2 million. 

(3) Operating earnings (loss) for 2003 have been realigned to reflect certain product movements between the CASPI and PCI segments effective in the first quarter of 2004. 

23


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

		June 30,		December 31,
(Dollars in millions)		2004		2003


Assets by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	1,258	$	1,700
Performance Chemicals and Intermediates		1,589		1,697
Specialty Plastics		742		821

Total Eastman Division		3,589		4,218


Voridian Division
Polymers		1,316		1,347
Fibers		593		614

Total Voridian Division		1,909		1,961


Developing Businesses Division
Developing Businesses		50		51

Total Developing Businesses Division		50		51


Assets held for sale		260		--


Total Eastman Chemical Company	$	5,808	$	6,230

16. LEGAL MATTERS

General 

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, including the sorbates litigation and the asbestos litigation described in the following paragraphs, will have a material adverse effect on its overall financial condition, results of operations or cash flows. However, adverse developm
ents could negatively impact earnings or cash flows in a particular future period. 

Sorbates Litigation 

As previously reported, on September 30, 1998, the Company entered into a voluntary plea agreement with the U.S. Department of Justice and agreed to pay an $11 million fine to resolve a charge brought against the Company for violation of Section One of the Sherman Act. Under the agreement, the Company entered a plea of guilty to one count of price-fixing for sorbates, a class of food preservatives, from January 1995 through June 1997. The plea agreement was approved by the United States District Court for the Northern District of California on October 21, 1998. The Company recognized the entire fine as a charge against earnings in the third quarter of 1998 and paid the fine in installments over a period of five years. On October 26, 1999, the Company pleaded guilty in a Federal Court of Canada 
to a violation of the Competition Act of Canada and was fined $780,000 (Canadian). The plea in Canada admitted that the same conduct that was the subject of the United States guilty plea had occurred with respect to sorbates sold in Canada, and prohibited repetition of the conduct and provides for future monitoring. The Canadian fine has been paid and was recognized as a charge against earnings in the fourth quarter of 1999. 

 24

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Following the September 30, 1998 plea agreement, the Company, along with other defendants, was sued in federal, state and Canadian courts in more than twenty putative class action lawsuits filed on behalf of purchasers of sorbates and products containing sorbates, claiming those purchasers paid more for sorbates and for products containing sorbates than they would have paid in the absence of the defendants’ price-fixing. Only two of these lawsuits have not been resolved via settlement. One of those cases was dismissed for want of prosecution.  In the other case, an intermediate appellate court affirmed in 2004 a trial court ruling that the case could not proceed as a class action. That decision has been appealed. In addition, six states have sued the Company and other defendants in co
nnection with the sorbates matter, seeking damages, restitution and civil penalties on behalf of consumers of sorbates in those respective states. Two of those six cases have been settled; defense motions to dismiss were granted in two other cases and those dismissals are now final. The dismissal of a third has been appealed by the state. A defense motion to dismiss another state case has been fully briefed.  Seven other states have advised the Company that they intend to bring similar actions against the Company and others. A settlement with those seven states has tentatively been reached. 

The Company has recognized charges to earnings for estimated and actual costs, including legal fees and expenses, related to the sorbates fine and litigation. While the Company intends to continue to defend vigorously the remaining sorbates actions unless they can be settled on acceptable terms, the ultimate outcome of the matters still pending and of additional claims that could be made is not expected to have a material impact on the Company's financial condition, results of operations, or cash flows, although these matters could result in the Company being subject to monetary damages, costs or expenses, and charges against earnings in particular periods. 

Asbestos Litigation 

Over the years, Eastman has been named as a defendant, along with numerous other defendants, in lawsuits in various state courts in which plaintiffs alleged injury due to exposure to asbestos at Eastman’s manufacturing sites and sought unspecified monetary damages and other relief. Historically, these cases were dismissed or settled without a material effect on Eastman’s financial condition, results of operations, or cash flows. 

In recently filed cases, plaintiffs allege exposure to asbestos-containing products allegedly made by Eastman.  Based on its investigation to date, the Company has information that it manufactured limited amounts of an asbestos-containing plastic product between the mid-1960’s and the early 1970’s.  The Company’s investigation has found no evidence that any of the plaintiffs worked with or around any such product alleged to have been manufactured by the Company. The Company intends to defend vigorously the approximately 3,000 pending claims or to settle them on acceptable terms. 

The Company continues to evaluate the allegations and claims made in recent asbestos-related lawsuits and its insurance coverages. Based on such evaluation to date, the Company continues to believe that the ultimate resolution of asbestos cases will not have a material impact on the Company’s financial condition, results of operations, or cash flows, although these matters could result in the Company being subject to monetary damages, costs or expenses, and charges against earnings in particular periods. To date, costs incurred by the Company related to the recent asbestos-related lawsuits have not been material. 

25


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

17. COMMITMENTS

Accounts Receivable Securitization Program 

In 1999, the Company entered into an agreement that allows the Company to sell certain domestic accounts receivable under a planned continuous sale program to a third party. The agreement permits the sale of undivided interests in domestic trade accounts receivable. Receivables sold to the third party totaled $200 million at June 30, 2004 and December 31, 2003. Undivided interests in designated receivable pools were sold to the purchaser with recourse limited to the purchased interest in the receivable pools. Fees paid by the Company under this agreement are based on certain variable market rate indices and totaled approximately $1 million in the second quarters 2004 and 2003 and approximately $2 million in the first six months 2004 and 2003, respectively. Average monthly proceeds from collecti
ons reinvested in the continuous sale program were approximately $265 million and $267 million in the second quarter 2004 and 2003, respectively, and approximately $249 million and $252 million in the first six months 2004 and 2003, respectively. The portion that continues to be recognized in the Statements of Financial Position is domestic trade receivables of $183 million and $91 million at June 30, 2004 and December 31, 2003, respectively. 

Guarantees 

In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies," relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The Company adopted the disclosure requirements of the interpretation as of December 31, 2002. Disclosures about each group of similar guarantees are summarized in the following table: 

(Dollars in millions)		June 30, 2004


Obligations of equity affiliates	$	131
Residual value guarantees		84

Total	$	215

Obligations of Equity Affiliates 

Eastman has long-term commitments relating to joint ventures and guarantees of up to $131 million of the principal amount of the joint ventures’ third-party borrowings. The Company believes, based on current facts and circumstances and the structure of the ventures, that the likelihood of a payment pursuant to such guarantees is remote. For more information concerning the joint ventures described above, see Note 5 in the notes to the audited financial statements contained in the Company’s 2003 Annual Report on Form 10-K. 

Residual Value Guarantees 

If certain operating leases are terminated by the Company, it guarantees a portion of the residual value loss, if any, incurred by the lessors in disposing of the related assets. Under these operating leases, the residual value guarantees at June 30, 2004 totaled $84 million and consisted primarily of leases for railcars and other equipment. The Company believes, based on current facts and circumstances, that a material payment pursuant to such guarantees is remote. 

26


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Variable Interest Entities 

The Company has evaluated material relationships including the guarantees related to the third-party borrowings of joint ventures described above and has concluded that the entities are not VIEs or, in the case of Primester, the Company is not the primary beneficiary of the VIE. As such, in accordance with FIN 46R, the Company is not required to consolidate these entities. In addition, the Company has evaluated long-term purchase obligations with two entities that may be VIEs. These potential VIEs are joint ventures from which the Company purchases approximately $40 million of raw materials and utilities on an annual basis. The Company has no equity interest in these entities and has confirmed that one party to each of these joint ventures does consolidate the potential VIE. However, due to com
petitive and other reasons, the Company has not been able to obtain the necessary financial information to determine whether the entities are VIEs, and if one or both are VIEs, whether or not the Company is the primary beneficiary. 

18.  INCOME TAXES 

As a result of the classification of assets as held for sale as described in Note 3, the Company recorded a deferred tax asset of $135 million for capital loss carryforwards resulting from the differences between the book basis and tax basis of certain subsidiaries that are a part of the sale. Based on current tax planning strategies the Company expects to utilize a portion of these loss carryforwards and recorded an $82 million tax benefit. A valuation allowance was recorded for the amount of the deferred tax asset that is not expected to be realized outside of these tax planning strategies. 

As described in Note 18 to the Company's 2003 Annual Report on Form 10-K, the Company has significant net operating loss carryforwards and related valuation allowances. Future tax provisions may be positively or negatively impacted to the extent that the realization of these carry forwards is greater or less than anticipated. 

19.  RECENTLY ISSUED ACCOUNTING STANDARDS 

On December 7, 2003, Congress passed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("the Act"). The Act introduced a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy to sponsors of retirement health care plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. As permitted by FASB Staff Position 106-1, the Company elected to defer recognizing the effects of the Act on the accounting for its retirement health care plans in Fiscal 2003. In May of 2004, the FASB issued Staff Position 106-2, providing final guidance on accounting for the Act. The Company has completed its evaluation of the impact of FSP 106-2. As the Company’s current healthcare plans are not considered to be actuarially equivalent to M
edicare Part D, the Act has no effect on the Company’s financial condition, liquidity or results of operations. 

20.  SUBSEQUENT EVENTS 

On July 31, 2004 the Company completed the sale of certain businesses and product lines and related assets in the CASPI segment for approximately $175 million including cash and the receipt of a $50 million note receivable. The Company retained approximately $40 million of accounts receivable related to these businesses and product lines. The final purchase price is subject to adjustment based upon meeting working capital and other targets established in the agreement. In accordance with the terms of the sales agreement, the Company will continue to produce certain products for the buyer under ongoing supply agreements with terms in excess of one year. In addition, the Company indemnified the buyer against certain liabilities primarily related to taxes, legal matters, environmental matters
, and other representations and warranties. 

27

 ITEM 2.          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION     AND RESULTS OF OPERATIONS 

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company's audited consolidated financial statements, including related notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the 2003 Annual Report on Form 10-K, and the unaudited interim consolidated financial statements included elsewhere in this report. All references to earnings per share contained in this report are diluted earnings per share unless otherwise noted. 

CRITICAL ACCOUNTING POLICIES 

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, the Company’s management must make decisions which impact the reported amounts and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and assumptions on which to base estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to customer programs and incentives, doubtful accounts, impaired assets, environmental costs, pensions and other postemployment benefits, income taxes, and litigation. The Com
pany bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s management believes the critical accounting policies described below are the most important to the fair presentation of the Company’s financial condition and results. These policies require management’s more significant judgments and estimates in the preparation of the Company’s unaudited consolidated financial statements. 

Customer Programs and Incentives 

The Company records estimated obligations for customer programs and incentive offerings, which consist primarily of revenue or volume-based amounts that a customer must achieve over a specified period of time, as a reduction of revenue to each underlying revenue transaction as the customer progresses toward reaching goals specified in incentive agreements. These estimates are based on a combination of forecast of customer sales and actual sales volumes and revenues against established goals, the customer’s current level of purchases, and Eastman’s knowledge of customer purchasing habits and industry pricing practice. The incentive payment rate may be variable, based upon the customer reaching higher sales volume or revenue levels over a specified period of time in order to receive an 
agreed upon incentive payment. 

Since the volume incentives and their usefulness to the Company are largely based on the overall supply and demand in the markets for the products the Company produces, significant changes in supply and demand can positively or negatively impact the effectiveness of the Company’s customer programs and incentives. This has been particularly true for the Company’s PET Polymers business. 

The Company’s reserve for customer programs and incentives was $48 million and $45 million at June 30, 2004 and December 31, 2003, respectively, and was recorded as a reduction of trade receivables. If market conditions change, the Company could be forced to take actions to adjust customer incentive offerings to maintain market share and capacity utilization. 

28

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

Allowances for Doubtful Accounts 

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowances are based on the relative age of each individual receivable and management’s regular assessment of the credit risk of the Company’s customers. Additionally, management regularly reviews credit limits based on payment activity, financial condition and other customer related factors to determine whether or not to extend credit and what other limiting terms, such as prepayment requirements, will be levied on given customers. The Company adjusts the allowances based on a monthly evaluation of the aged receivables, and quarterly writes off those deemed uncollectable. These expectations have historically been relatively accurate 
with regard to most of the Company’s customers. However, under certain circumstances, such as a customers’ bankruptcy, the Company will increase the allowance to reflect the collectability of the receivable. 

The Company believes, based on historical results, the likelihood of actual write offs having a material impact on financial results or earnings per share is low. However, if one of the Company’s key customers were to file for bankruptcy, or otherwise be unable to make its required payments, or there was a significant slow down in the economy, the Company could be forced to increase its allowances. This could result in a material charge to earnings. 

The Company’s allowances were $21 million and $28 million at June 30, 2004 and December 31, 2003, respectively. 

Impaired Assets 

The Company evaluates the carrying value of long-lived assets, including definite-lived intangible assets, when events or changes in circumstances indicate that the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such assets are separately identifiable and are less than its carrying value.  In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. For long-lived assets to be held and used, fair value of fixed (tangible) assets and definite-lived intangible assets is determined primarily using either the projected cash flows discounted at a rate commensurate with the risk involved or appraisal. For long-lived a
ssets to be disposed of by sale or other than by sale, fair value is determined in a similar manner, except that fair values are reduced for disposal costs. 

As the Company’s assumptions related to long-lived assets are subject to change, additional write-downs may be required in the future. If estimates of fair value less costs to sell are revised, the carrying amount of the related asset is adjusted, resulting in recognition of a charge or benefit to earnings. The Company recorded fixed (tangible) asset impairments of $103 million during the first six months 2004 and $15 million during the first six months 2003. For more information, see Note 10 to the Company’s unaudited consolidated financial statements. 

Environmental Costs 

The Company accrues environmental remediation costs when it is probable that the Company has incurred a liability and the amount can be reasonably estimated. When a single amount cannot be reasonably estimated but the cost can be estimated within a range, the Company accrues the minimum amount. This undiscounted accrued amount reflects the Company’s assumptions about remediation requirements at the contaminated site, the nature of the remedy, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. Changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in health, safety, environmental, and chem
ical control regulations and testing requirements could result in higher or lower costs. Estimated future environmental expenditures for remediation costs range from the minimum or best estimate of $30 million to the maximum of $51 million at June 30, 2004. 

29

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

In accordance with SFAS No. 143 "Accounting for Asset Retirement Obligations," the Company also establishes reserves for closure/postclosure costs associated with the environmental and other assets it maintains. Environmental assets include but are not limited to land fills, water treatment facilities, and ash ponds. When these types of assets are constructed, a reserve is established for the future environmental remediation anticipated to be associated with the closure of the site based on an expected life of the environmental assets. These future expenses are accreted into earnings over the estimated useful life of the assets. Currently, the Company estimates the useful life of each individual asset up to fifty years. If the Company changes its estimate of the asset retirement obligation cost
s or its estimate of the useful lives of these assets, the future expenses to be accreted into earnings could increase or decrease. 

The Company’s reserve for environmental contingencies was $59 million and $61 million at June 30, 2004 and December 31, 2003, respectively, representing the minimum or best estimate for remediation costs and, for asset retirement obligation costs, the amount accrued to date over the facilities’ estimated useful lives. 

United States Pension and Other Postemployment Benefits 

The Company maintains defined benefit pension plans that provide eligible employees with retirement benefits. Additionally, Eastman provides life insurance and health care benefits for eligible retirees and health care benefits for retirees’ eligible survivors. The costs and obligations related to these benefits reflect the Company’s assumptions related to general economic conditions (particularly interest rates), expected return on plan assets, rate of compensation increase for employees and health care cost trends. At the June 1, 2004 remeasurement date, for the other U.S. postemployment benefit plans, the Company assumed a discount rate of 6.50%; an expected return on assets of 9%; a rate of compensation increase of 3.75%; and an initial health care cost trend of 10%. The cost of p
roviding plan benefits also depends on demographic assumptions including retirements, mortality, turnover and plan participation. 

The following table illustrates the sensitivity to a change in the expected return on assets and assumed discount rate for U.S. pension plans and other postretirement welfare plans: 

Change in Assumption	Impact on 2004 Pre-tax U.S. Pension Expense	Impact on December 31, 2003 Projected Benefit Obligation for U.S. Pension Plans	Impact on June 1, 2004 Benefit Obligation for Other U.S. Postretirement Plans


25 basis point decrease in discount rate	+$5 Million	+$48 Million	+$20 Million

25 basis point increase in discount rate	-$5 Million	-$46 Million	-$19 Million

25 basis point decrease in expected return on assets	+$2 Million	No Impact	N/A

25 basis point increase in expected return on assets	-$2 Million	No Impact	N/A

30

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

The expected return on assets and assumed discount rate used to calculate the Company’s pension and other postemployment benefit obligations are established each December 31 or when events or circumstances indicate they should be evaluated more frequently. The expected return on assets is based upon the long-term expected returns in the markets in which the pension trust invests its funds, primarily the domestic, international, and private equities markets. The assumed discount rate is based upon an index of high-quality, long-term corporate borrowing rates. If actual experience differs from these assumptions, the difference is recorded as an unrecognized gain (loss) and then amortized into earnings over a period of time, which may cause the cost of providing these benefits to increase or 
decrease. The charges applied to earnings in the first six months of 2004 and 2003 due to the amortization of unrecognized actuarial losses were $22 million and $16 million, respectively. 

The Company does not anticipate that a change in pension and other post-employment obligations caused by a change in the assumed discount rate will impact the cash contributions to be made to the pension plans during 2004. However, an after-tax charge or credit will be recorded directly to accumulated other comprehensive income (loss), a component of stockholders’ equity, as of December 31, 2004 for the impact on the pension’s projected benefit obligation of the change in interest rates, if any. While the amount of the change in these obligations does not correspond directly to cash funding requirements, it is an indication of the amount the Company will be required to contribute to the plans in future years. The amount and timing of such cash contributions is dependent upon interest 
rates, actual returns on plan assets, retirement and attrition rates of employees, and other factors. 

For additional information see Note 9 to the Company’s unaudited consolidated financial statements. 

Income Taxes 

The Company records deferred tax assets and liabilities based on temporary differences between the financial reporting and tax bases of assets and liabilities. Based on an evaluation of future taxable income and reasonable tax planning strategies, the Company records a valuation allowance to reduce its deferred tax assets to an amount that is more likely than not to be realized. In the event that the Company were to determine that it would not be able to realize all or part of its deferred tax assets for which a valuation allowance had not been established, or is able to utilize capital and/or operating loss carryforwards for which a valuation allowance has been established, an adjustment to the deferred tax asset will be reflected in the period such determination is made. 

At December 31, 2003, the Company had net deferred tax assets totaling $580 million, after a valuation allowance of $175 million. Included in these amounts are deferred tax assets for tax loss carryforwards of $39 million, after a valuation allowance of $156 million. As described in Note 18 of the unaudited consolidated financial statements, in second quarter 2004 the Company recorded a net deferred tax asset of $82 million, after a valuation allowance of $53 million, to reflect the expected utilization of capital loss carryforwards that will result from assets held for sale. Future tax provisions may be positively or negatively impacted to the extent that the realization of these carryforwards is gr
eater than or less than anticipated. 

Litigation 

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 handled and defended in the ordinary course of business. The Company accrues a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. The Company believes the amounts reserved are adequate for such pending matters; however, results of operations could be affected by significant litigation adverse to the Company. 

31

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

OVERVIEW 

During the second quarter 2004, the Company entered into an agreement to sell certain businesses and product lines and related assets within its CASPI segment. These businesses and product lines include acrylate ester monomers, composites (unsaturated polyester resins), inks and graphics arts raw materials, liquid resins, powder resins and textile chemicals. On July 31, 2004, the Company completed the sale, which is an important step in the Company’s continued efforts to improve profitability and cash flows. 

Over the past several years, key determinants of profitability for the Company have included: generally slow economic growth, particularly for manufacturing; fluctuations in raw material and energy costs, with those costs increasing substantially in late-2002 and remaining at historically high levels through 2003 and the first six months of 2004; and the ability to obtain sales price increases for the Company’s products necessary to preserve or expand margins. In addition, certain markets in which Eastman competes have been impacted by substantial capacity additions that led to lower capacity utilization levels and increased competition, limiting the Company’s ability to obtain sales price increases for some of its products. 

In the second quarter and first six months of 2004, the Company experienced increase sales volume across all segments primarily attributed to a strengthening economy. Additionally, sales and operating earnings were positively impacted by an increased focus on more profitable businesses and product lines, particularly in the Company’s Eastman Division and cost reduction measures including the benefit of labor reductions, benefit plan changes and the implementation of process improvement technologies. These improved economic conditions and Company actions were partially offset by higher raw material and energy costs and an inability to obtain selling price increases sufficient to offset those costs. 

In addition to the above, in the second quarter 2004, operating earnings were negatively impacted by asset impairments and restructuring charges of $79 million primarily related to the CASPI segment and the Company’s employee separation programs. Additionally, in the second quarter 2004, the Company recorded a tax benefit of $82 million related to assets held for sale. For more information, see Notes 3and 18 to the unaudited consolidated financial statements. 

The key determinants of operating cash flow have historically been operating earnings, seasonal changes in working capital, and the timing and extent of payments for employee benefits and incentive pay. Typically, the Company generates less operating cash flow in the first half of the year largely due to seasonal increases in working capital and the timing of payments for employee benefits and incentive pay. Over the remainder of the year, operating cash flow typically increases as the Company reduces working capital. 

For the first six months of 2004, the Company’s operating cash flow increased $277 million compared to the first six months 2003. In addition to the impact of net earnings, the significant factors that contributed to this increase included a decrease in working capital requirements and decreased U.S. defined benefit pension plan contributions. 

The Company expects profitability and operating cash flows to continue to improve in 2004 compared to 2003 due to the cost reduction measures being implemented across all segments, the divestiture, consolidation, and restructuring of portions of the CASPI segment, and generally improved economic conditions. In addition, the Company expects raw material and energy costs to increase in 2004 compared with 2003, and that the ability to obtain sales price increases will be a key driver of profitability. 

32

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

RESULTS OF OPERATIONS 

		Second Quarter				Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect
(Dollars in millions)		2004		2003	Change	Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect


Sales	$	1,676	$	1,481	13 %	10 %	-- %	1 %	2 %

The increase in sales revenue for the second quarter 2004 compared to the second quarter 2003 was primarily due to increased sales volume across all segments, which had a positive impact on sales revenue of $145 million. Additionally, favorable shifts in foreign currency exchange rates, particularly for the euro, had a positive impact on sales revenue of $26 million. 

		First Six Months				Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect
(Dollars in millions)		2004		2003	Change	Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect


Sales	$	3,273	$	2,922	12 %	8 %	1 %	-- %	3 %

The increase in sales revenue for the first six months 2004 compared to the first six months 2003 was primarily due to increased sales volume, particularly in the Polymers and Fibers segments, which had a positive impact on sales revenue of $229 million. In addition, favorable shifts in foreign currency exchange rates, particularly for the euro, positively impacted sales revenue by $83 million. 

		Second Quarter					First Six Months
(Dollars in millions)		2004		2003	Change		2004		2003	Change


Gross Profit	$	270	$	241	12 %	$	505	$	425	19 %
As a percentage of sales		16 %		16 %			15 %		15 %

Gross profit for the second quarter and first six months 2004 increased compared to the second quarter and first six months 2003 primarily due to increased sales volume, an increased focus on more profitable businesses and product lines and cost reduction measures that were offset by higher raw material and energy costs. 

The Company expects that higher raw material and energy costs for key raw materials including paraxylene, ethylene glycol, propane, natural gas, and coal will continue to negatively impact operating results unless the Company is able to offset this impact in part through price increases for certain of its products and through various cost control measures. 

Gross profit for the first six months 2003 included an insurance settlement of approximately $14 million related to the 2002 operational disruptions at the Company’s Rotterdam, the Netherlands, and Columbia, South Carolina facilities. 

33

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS

The Company continues to implement a variety of cost control measures including labor reductions, benefit plan changes and continued productivity improvements. As part of these efforts, in March 2004, the Company announced the closing of its manufacturing facility located in Hartlepool, United Kingdom. In May 2004, the Company completed a voluntary separation program for certain retirement-eligible employees in the United States. In June 2004, the Company amended certain post employment benefit plans as discussed in Note 9 to the unaudited consolidated financial statements and expects that these changes will result in a reduction to employee benefit expense of approximately $15 million for the remainder of 2004. The Company expects that these cost control and productivity improvement efforts wi
ll continue to positively impact gross profit in 2004. 

The Company continues to review its portfolio of businesses and product lines, which could result in further restructuring or consolidation. 

		Second Quarter					First Six Months
(Dollars in millions)		2004		2003	Change		2004		2003	Change


Selling and General
Administrative Expenses	$	112	$	108	4 %	$	222	$	208	7 %
Research and Development
Expenses		38		42	(10) %		81		85	(5) %

	$	150	$	150	-- %	$	303	$	293	3 %

As a percentage of sales		9 %		10 %			9 %		10 %

The increase in selling and general administrative expenses for the second quarter and first six months 2004 compared to the second quarter and first six months 2003 was primarily due to higher compensation and employee benefit costs, costs associated with the restructuring and other efforts by the Company to improve profitability, and the impact of foreign currency exchange rates. These costs were partially offset by recent cost reduction efforts. 

Research and development expenses for the second quarter and the first six months 2004 decreased compared to the second quarter and the first six months 2003 primarily due to the Company’s divestiture of certain businesses and product lines and related assets, which has reduced research and development activity related to the product lines targeted for divestiture. 

For 2004, the Company expects combined costs related to S&GA expenses and R&D expenses to be at or below 10 percent of sales. 

34

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

Asset Impairments and Restructuring Charges, Net 

During the second quarter 2004, the Company recognized pre-tax asset impairments and restructuring charges of $79 million, consisting of non-cash charges of $62 million and cash charges for severance and site closure costs of $17 million. For the first six months 2004, pre-tax asset impairments and restructuring charges totaled $146 million, with non-cash impairments and cash restructuring charges totaling $103 million and $43 million, respectively. 

The following table summarizes both second quarter and year to date 2004 and second quarter and year to date 2003 charges: 

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Eastman Division segments:
CASPI segment:
Fixed asset impairments	$	56	$	--	$	57	$	--
Intangible asset impairments		6		--		6		--
Severance costs		5		1		9		3
Site closure costs		2		--		3		--

Total – CASPI segment		69		1		75		3

PCI segment:
Fixed asset impairments		--		15		--		15
Severance costs		4		--		7		--

Total – PCI segment		4		15		7		15

SP segment:
Fixed asset impairments		--		--		40		--
Severance costs		2		--		8		--
Site closure costs		2		--		2		--

Total – SP segment		4		--		50		--

Total Eastman Division		77		16		132		18



Voridian Division segments:
Polymers segment
Severance costs		1		--		12		--

Total – Polymers segment		1		--		12		--

Total Voridian Division		1		--		12		--

Developing Businesses Division segment:
Developing Businesses segment:
Severance costs		1		--		2		--

Total – Developing Businesses segment		1		--		2		--


Total Eastman Chemical Company	$	79	$	16	$	146	$	18

35

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

2004

Asset Impairments and Restructuring Charges 

In the second quarter 2004, the company recognized $62 million in asset impairment charges related to assets held for sale. The assets are part of the Company’s sale of certain businesses and product lines within the CASPI segment, which was completed July 31, 2004. The charges reflect adjustment of the values of these assets to the expected sales proceeds. Also in second quarter 2004, the Company recognized approximately $4 million of site closure costs related primarily to previously announced closures of the Company’s Hartlepool, Waterford, and Bury manufacturing facilities. These charges had an impact of approximately $2 million each to the CASPI and SP segments. 

In the first six months 2004, the Company recorded asset impairments of $103 million, consisting of $62 million as described above as well as the charges explained below: 

$40 million related to the closure of its copolyester manufacturing facility in Hartlepool, United Kingdom. The decision to close the Hartlepool site, which manufactures products that are within the Company’s Specialty Plastics ("SP") segment’s product lines, was made in order to consolidate production at other sites to create a more integrated and efficient global manufacturing structure. Accordingly, the carrying value of the manufacturing fixed assets was written down to fair value, as established by appraisal and available market data.
the Company recognized $1 million of fixed asset impairments and $1 million of site closure costs related to additional impairments associated with the CASPI reorganization and changes in estimates for previously accrued amounts.

Severance Charges 

In the second quarter 2004, the Company recognized approximately $13 million in severance charges related to separations stemming from the Company’s voluntary termination program announced in April, 2004. In the first six months 2004, the Company recognized $38 million in severance charges as explained below: 

the decision to close the Hartlepool manufacturing site as discussed above, resulting in severance charges of $5 million within the SP segment; and,
ongoing cost reduction efforts throughout the Company and costs related to the Company’s employee separation programs announced in April 2004, resulting in severance charges to the CASPI, Performance Chemicals and Intermediates ("PCI"), SP, Polymers, and Developing Businesses segments of $9 million, $7 million, $3 million, $12 million, and $2 million respectively.

2003

Asset Impairments and Restructuring Charges 

As discussed in Note 15 to the unaudited consolidated financial statements, effective January 1, 2004, certain commodity product lines were transferred from the PCI segment to the CASPI segment, which resulted in the reclassification of asset impairments of $42 million for 2003. 

36

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

CASPI Segment

In the third quarter, the Company reorganized the operating structure within its CASPI segment and changed the segment’s business strategy in response to the financial performance of certain underlying product lines. Those product lines include: acrylate ester monomers; composites (unsaturated polyester resins); inks and graphic arts raw materials; liquid resins; powder resins; and textile chemicals. Prior to the third quarter, management was pursuing growth strategies aimed at significantly improving the financial performance of these product lines. However, due to the continued operating losses and deteriorating market conditions, management decided to pursue alternative strategies including restructuring, divestiture, and consolidation. This change affected both the manner in which cer
tain assets are used and the financial outlook for these product lines, thus triggering the impairments and certain restructuring charges. 

The third quarter fixed asset impairment charges of $236 million primarily related to assets associated with the above mentioned product lines, and primarily impacted manufacturing sites in the North American and European regions that were part of the Lawter International, Inc. ("Lawter"), McWhorter Technologies, Inc ("McWhorter"), and Chemicke Zavody Sokolov ("Sokolov") acquisitions. Within these product lines, nine sites in North America and six sites in Europe were impaired. As the undiscounted future cash flows could not support the carrying value of the assets, the fixed assets were written down to fair value, as established primarily by appraisal. 

The third quarter intangible asset impairment charges related to definite-lived intangible assets of approximately $128 million and indefinite-lived intangibles of approximately $47 million. The definite-lived intangibles related primarily to developed technology and customer lists, and the indefinite-lived intangibles primarily related to trademarks. These intangible assets were primarily associated with the acquisitions of Lawter and McWhorter. As the undiscounted future cash flows could not support the carrying value of the definite-lived intangible assets, these assets were written down to fair value, as established primarily by appraisal. Indefinite-lived intangible assets were written down to fair value, as established by appraisal. 

Upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," the Company defined reporting units as one level below the operating segment level and considered the criteria set forth in SFAS No. 142 in aggregating the reporting units. This resulted in the CASPI segment being deemed a single reporting unit. In the third quarter 2003, the reorganization of the operating structure within the CASPI segment resulted in new reporting units one level below the operating segment. Due to the change in strategy and lack of similar economic characteristics, these reporting units did not meet the criteria necessary for aggregation. As a result, the goodwill associated with the CASPI segment was reassigned to the new reporting units based upon relative fair values. The reporting unit that containe
d the above-mentioned product lines was assigned $34 million of goodwill out of the total CASPI segment goodwill of $333 million. Because the Company determined that this reporting unit could no longer support the carrying value of its assigned goodwill, the full amount of that goodwill was impaired. The fair value of the other reporting unit within CASPI was sufficient to support the carrying value of the remainder of the goodwill. 

In the fourth quarter, the Company recognized fixed asset impairments and site closure costs of $1 million and $3 million, respectively. The fixed asset impairments related to additional impairments associated with the CASPI reorganization, as discussed above. 

Severance charges of $13 million for 2003 are discussed in further detail below. 

37

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

PCI Segment

In the second quarter, the Company recorded an asset impairment charge of approximately $15 million related to the impairment of certain fixed assets used in the PCI segment’s fine chemicals product lines that are located in Llangefni, United Kingdom. In response to industry conditions, during the second quarter 2003 the Company revised its strategy and the earnings forecast for the products manufactured by these assets. As the undiscounted future cash flows could not support the carrying value of the assets, the fixed assets were written down to fair value, as established primarily by discounted future cash flows of the impacted assets. 

In the third and fourth quarter, the PCI segment incurred charges of $38 million related to the impairment of fixed assets used in certain performance chemicals product lines as a result of increased competition and changes in business strategy in response to a change in market conditions and the financial performance of these product lines. Within the performance chemicals product lines, the fixed asset impairments charge related to assets located at the Kingsport, Tennessee facility. 

Severance charges of $4 million for 2003 are discussed in further detail below. 

SP Segment

Severance charges of $1 million for 2003 are discussed in further detail below. 

Polymers Segment

In the fourth quarter, an asset impairment charge of $1 million was recorded related to assets classified as held for sale at the Company’s Kirkby, United Kingdom site. The fair value of these assets was determined using the estimated proceeds from the sale less the cost to sell. 

Severance charges of $1 million for 2003 are discussed in further detail below. 

Severance Charges 

In the first half of 2003, severance costs of $3 million were incurred within the CASPI segment related primarily to consolidation and restructuring activities and changes in previously accrued amounts. In the third quarter 2003, the Company recognized $14 million in restructuring charges related to the actual and probable involuntary separations of approximately 300 employees. These workforce reductions were the result of decisions made as part of the restructuring of the CASPI segment discussed above, the Company’s annual budgeting process, and site closure costs associated with the PCI segment. During the fourth quarter, severance charges were recorded in the CASPI and Fibers segment totaling $2 million and $1 million, respectively, due to the ongoing restructuring of the CASPI segment 
and the annual budgeting process discussed above. 

38

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

Asset impairment and restructuring charges reserve roll forward 

The following table summarizes the beginning reserves, charges to and changes in estimates to the reserves as described above, and the cash and non-cash reductions to the reserves attributable to asset impairments and the cash payments for severance and site closure costs: 

(Dollars in millions)		Balance at January 1, 2003		Provision/ Adjustments		Noncash Reductions		Cash Reductions		Balance at December 31, 2003


Non-cash charges	$	--	$	500	$	(500)	$	--	$	--
Severance costs		2		20		--		(12)		10
Site closure costs		7		3		--		(5)		5

Total	$	9	$	523	$	(500)	$	(17)	$	15


		Balance at January 1, 2004		Provision/ Adjustments		Noncash Reductions		Cash Reductions		Balance at June 30, 2004


Non-cash charges	$	--	$	103	$	(103)	$	--	$	--
Severance costs		10		38		--		(11)		37
Site closure costs		5		5		--		(4)		6

Total	$	15	$	146	$	(103)	$	(15)	$	43

As of June 30, 2004, out of approximately 1,200 actual and probable employee separations that were identified and for which charges were recorded during 2003 and 2004, approximately 1,100 were completed. The remaining severance and site closure costs are expected to be applied to the reserves within one year. 

The Company expects additional severance charges related to the previously announced employee separation programs and continuing cost reduction efforts to be recognized in the second half of 2004. 

Interest Expense, Net 

		Second Quarter					First Six Months
(Dollars in millions)		2004		2003	Change		2004		2003	Change


Gross interest costs	$	32	$	34		$	64	$	67
Less capitalized interest		1		1			2		2

Interest expense		31		33	(6) %		62		65	(5) %
Interest income		1		2			3		3

Interest expense, net	$	30	$	31	(3) %	$	59	$	62	(5) %

Lower gross interest costs for the second quarter 2004 compared to the second quarter 2003 reflected lower average interest rates that more than offset higher average borrowings. Lower interest income reflected lower average interest rates on invested cash balances. Due to these factors, net interest expense declined for the second quarter 2004. 

39

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

For the first six months 2004 compared to the first six months 2003, lower gross interest costs reflected lower average interest rates that more than offset higher average borrowings. Interest income was unchanged as higher average invested cash levels, resulting from improving sales and operating earnings and preparation for the repayment of borrowings maturing in January 2004, were offset by lower average interest rates on investments. Due to these factors, net interest expense declined for the first six months 2004. 

For 2004, the Company expects net interest expense to decrease compared to 2003 due to lower expected gross interest costs as a result of lower average interest rates on borrowings and anticipated lower average borrowings. 

Other Operating Income and Other (Income) Charges, Net 

		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Other operating income	$	--	$	--	$	--	$	(20)



Other income	$	(6)	$	(12)	$	(12)	$	(16)
Other charges		7		7		12		10

Other (income) charges, net	$	1	$	(5)	$	--	$	(6)

Other Operating Income 

Other operating income for the first six months 2003 reflected a gain of approximately $20 million on the sale of the Company’s high-performance crystalline plastics assets, which were formerly a part of the Company’s SP segment. 

Other (Income) Charges, net 

Included in other income are the Company’s portion of earnings from its equity investments, royalty income, net gains on foreign exchange transactions and other miscellaneous items. Included in other charges are net losses on foreign exchange transactions, the Company’s portion of losses from its equity investments, fees on securitized receivables and other miscellaneous items. 

Other income for the second quarter and first six months 2004 primarily reflected the Company’s portion of earnings from its equity investment in Genencor International of approximately $6 million and $10 million, respectively. Other charges for the second quarter and first six months 2004 consist primarily of write downs to fair value of certain technology business ventures due to other than temporary declines in value, net losses attributable to foreign exchange transactions and fees on securitized receivables. 

Other income for the second quarter and first six months 2003 primarily included net gains on foreign currency transactions, net of hedging, primarily attributed to the strengthening of the euro, and results from the Company’s equity investments. Other charges for the second quarter and first six months 2003 primarily reflected fees on securitized receivables and other miscellaneous items. 

40

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

Provision for Income Taxes 

		Second Quarter					First Six Months
(Dollars in millions)		2004		2003	Change		2004		2003	Change


Provision (benefit) for income taxes	$	(74)	$	14	>(100) %	$	(81)	$	25	>(100) %
Effective tax rate		>100 %		29 %			>100 %		32 %

The effective tax rate for second quarter and first six months 2004 was impacted by $82 million of deferred tax benefits resulting from the expected utilization of capital loss carryforwards for assets held for sale in the CASPI segment. The Company recorded a deferred tax asset of $135 million for capital loss carryforwards resulting from the difference between the book basis and tax basis of certain subsidiaries that are a part of the sale. In addition, the effective tax rates for second quarter 2004 and six months 2004 were impacted by the treatment of the asset impairments and restructuring charges resulting in lower expected tax benefits in certain jurisdictions. 

Excluding the above items, the company’s effective tax rate for second quarter 2004 was approximately 28 percent. This tax rate reflects the impact of favorable foreign rate variances and extraterritorial income exclusion benefits on normal taxable earnings. The Company expects these benefits to continue for the remainder of 2004 resulting in an effective tax rate at or below 30 percent on normal taxable earnings. 

As described in Note 18 to the Company's 2003 Annual Report on Form 10-K, the Company has significant net operating loss carry forwards and related valuation allowances. Future tax provisions may be positively or negatively impacted to the extent that the realization of these carry forwards is greater or less than anticipated. 

Cumulative Effect of Change in Accounting Principles, Net of Tax 


		Second Quarter				First Six Months
(Dollars in millions)		2004		2003		2004		2003


Cumulative effect of change in accounting principles, net	$	--	$	--	$	--	$	3

SFAS No. 143 

Effective January 1, 2003, the Company’s method of accounting for environmental closure and post closure costs changed as a result of the adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations." Upon the initial adoption of the provision, entities are required to recognize a liability for any existing asset retirement obligations adjusted for cumulative accretion to the date of adoption of this Statement, an asset retirement cost capitalized as an increase to the carrying amount of the associated long-lived asset, and accumulated depreciation on that capitalized cost. In accordance with SFAS No. 143, the Company recorded asset retirement obligations primarily related to closure and post closure environmental liabilities associated with certain property plant and e
quipment. This resulted in the Company recording asset retirement obligations of $28 million and an after-tax credit to earnings of $3 million. 

41

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

SUMMARY BY OPERATING SEGMENT 

The Company’s products and operations are managed and reported in three divisions comprised of six operating segments. Eastman Division consists of the CASPI segment, the PCI segment and the SP segment. Voridian Division contains the Polymers segment and the Fibers segment. The Developing Businesses Division consists of the Developing Businesses Segment. The divisional structure has allowed the Company to align costs more directly with the activities and businesses that generate them. 

Goods and services are transferred between the divisions at predetermined prices that may be in excess of cost. Accordingly, the divisional structure results in the recognition of interdivisional sales revenue and operating earnings. Such interdivisional transactions are eliminated in the Company’s consolidated financial statements. 

The CASPI segment manufactures raw materials, additives and specialty polymers, primarily for the paints and coatings, inks and graphic arts, adhesives and other markets. The CASPI segment's products consist of binders and resins, liquid vehicles, additives, unsaturated polyester resins and polyester and acrylic emulsions. Binders and resins, such as alkyd and polyester resins, hydrocarbon resins and rosins and rosin esters, are used in adhesives and as key components in paints and inks to form a protective coating or film, and bind color to the substrate. Liquid vehicles, such as ester, ketone and alcohol solvents, maintain the binders in liquid form for ease of application. Additives, such as cellulosic polymers, Texanol TM ester alcohol and chlorinated polyolefins, provide di
fferent properties or performance enhancements to the end product. Unsaturated polyester resins are used primarily in gel coats and fiberglass reinforced plastics. Polyester and acrylic emulsions are traditionally used as textile sizes to protect fibers during processing in textile manufacturing, and the technology is also used in water-based paints, coatings and inks. Additional products are developed in response to, or in anticipation of, new applications where the Company believes significant value can be achieved. On July 31, 2004, the Company completed the sale of certain businesses and product lines and related assets within the CASPI segment. The divested businesses and product lines include acrylate ester monomers, composites (unsaturated polyester resins), inks and graphics arts raw materials, liquid resins, powder resins and textile chemicals. 

The PCI segment, comprised of the performance chemicals and intermediates product groups, manufactures a variety of intermediates chemicals based on oxo and acetyl chemistries. The Company is the largest marketer of acetic anhydride in the United States, a critical component of analgesics and other pharmaceutical and agricultural products, and is the only U.S. producer of acetaldehyde, a key intermediate in the production of vitamins and other specialty products. PCI also manufactures the broadest range of oxo aldehyde derivatives products in the world as well as complex organic molecules such as diketene derivatives, specialty ketones, and specialty anhydrides for fiber and food and beverage ingredients, which are typically used in market niche applications. Additionally, performance chemicals
 produces nonanoyloxybenzenesulfonate ("NOBS") bleach activator for a key customer. 

The SP segment’s key products include engineering and specialty polymers, specialty film and sheet products, and packaging film and fiber products. Included in these are highly specialized copolyesters and cellulosic plastics that possess unique performance properties for value-added end uses such as appliances, store fixtures and displays, building and construction, electronic packaging, medical devices, personal care and cosmetics, performance films, tape and labels, fibers/nonwovens, photographic and optical film, graphic arts and general packaging. 

The Polymers segment manufactures and supplies PET polymers for use in beverage and food packaging and other applications such as custom-care and cosmetics packaging, health care and pharmaceutical uses, household and industrial products. PET polymers serve as source products for packaging a wide variety of products including carbonated soft drinks, water, beer and personal care items and food containers that are suitable for both conventional and microwave oven use. The Polymers segment also manufactures low-density polyethylene and linear low-density polyethylene, which are used primarily in extrusion coating, film and molding applications. 

42

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

The Fibers segment manufactures EstronTM acetate tow and EstrobondTM triacetin plasticizers which are used primarily in cigarette filters; EstronTM and ChromspunTM acetate yarns for use in apparel, home furnishings and industrial fabrics; acetate flake for use by other acetate tow producers; and acetyl chemicals. 

The Developing Businesses segment includes new businesses and certain investments in non-traditional growth opportunities that leverage the Company’s technology expertise, intellectual property and know-how into business models that extend to new customers and markets. The segment includes, among other new and developing businesses, Cendian Corporation ("Cendian"), a logistics provider for chemical companies; Ariel Research Corporation ("Ariel"), a provider of international chemical and regulatory compliance solutions for environmental, health and safety operations; and Eastman’s gasification services. 

Effective January 1, 2004, certain commodity product lines were transferred from the PCI segment to the CASPI segment. This realignment resulted in approximately $86 million in sales revenue and an operating loss of $45 million, of which $42 million related to asset impairments recorded in the third quarter of 2003, being transferred from the PCI segment to the CASPI segment for 2003. The realignment also resulted in segment assets of $56 million being transferred from the PCI segment to the CASPI segment as of December 31, 2003. In addition, during the first quarter of 2004, the Company reclassified assets within the Voridian Division to reflect the current allocation of certain shared assets. These changes had no effect on the unaudited consolidated financial statements. 

For additional information regarding the CASPI segment's sales revenue, operating earnings, and asset impairments and restructuring charges related to restructured, divested, or consolidated businesses and product lines, please refer to Exhibit 99.01 filed with this report.

43

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

EASTMAN DIVISION 

CASPI Segment
			Second Quarter					First Six Months
(Dollars in millions)			2004		2003	Change		2004		2003	Change


Total external sales		$	476	$	441	8 %	$	915	$	852	7 %
Sales – restructured, divested, and consolidated product lines ⁽¹⁾			193		190	2 %		367		364	1 %
Sales – continuing product lines			283		251	13 %		548		488	12 %

	Volume effect					7 %					4 %
	Price effect					(1) %					-- %
	Product mix effect					-- %					(1) %
	Exchange rate effect					2 %					4 %

Interdivisional sales			--		--	-- %		--		--	-- %

Total operating earnings			(24)		19	> (100) %		6		16	(63) %
Operating earnings – restructured, divested, and consolidated product lines (1) (2)			(72)		(28)	> (100) %		(83)		(59)	(41) %
Operating earnings – continuing product lines			48		47	2 %		89		75	19 %

Total asset impairments and restructuring charges			69		1			75		3
Asset impairments and restructuring charges – restructured, divested, and consolidated product lines ⁽¹⁾			66		1			71		2
Asset impairments and restructuring charges – continuing product lines			3		--			4		1

(1) Product lines that have been sold or eliminated as a result of restructuring, divestiture, or consolidation including those associated with assets held for sale. 

(2) Includes allocated costs consistent with the Company’s historical practices, some of which may remain and could be reallocated to the remainder of the segment and other segments. 

On July 31, 2004, the Company completed the sale of certain businesses and product lines and related assets within the CASPI segment. This sale includes portions of the resins and monomers and inks and graphic arts product groups. As a result, the Company has presented sales revenue, operating earnings, and asset impairments and restructuring charges above for restructured, divested, and consolidated product lines and continuing product lines. The results are discussed below for the CASPI segment as a whole. 

The increase in external sales revenue for the second quarter 2004 compared to the second quarter 2003 was primarily due to increased sales volume, particularly in the coatings, additives, and solvents and adhesives raw materials product groups, which had a positive impact on sales revenue of $32 million. In addition, favorable foreign currency exchange rates, primarily for the euro, had a positive impact on sales revenue of $10 million. 

44

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

For the first six months 2004 compared to the first six months 2003, external sales revenue increased primarily due to increased sales volume and favorable foreign currency exchange rates. The increased sales volume primarily related to the coatings, additives, and solvents, and adhesives raw materials product groups and positively impacted sales revenue in the amount of $34 million. Favorable foreign currency exchange rates, particularly for the euro, had a positive impact on sales revenue of $32 million. 

The increase in operating results throughout the segment for the second quarter and first six months 2004 compared to the second quarter and first six months 2003 was primarily attributable to factors impacting results within the coatings additives and solvents and adhesives raw materials product groups. These factors included increased sales volume primarily as a result of an improving economy, an increased focus on more profitable businesses and product lines, and cost reduction measures, including the shutdown and consolidation of several manufacturing sites as well as impairment of certain asset groups, which has resulted in decreased operating costs and lower depreciation and amortization expense. 

Operating earnings for the second quarter and first six months of 2004 were negatively impacted by restructuring charges totaling approximately $69 million and $75 million, respectively. These charges are more fully described above and in Note 10 to the Company’s unaudited consolidated financial statements. 

The completion of the initiative to restructure, divest and consolidate the CASPI segment is an important step in the Company’s efforts to improve profitability and cash flows. 

45

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

PCI Segment
			Second Quarter					First Six Months
(Dollars in millions)			2004		2003	Change		2004		2003	Change


External sales		$	313	$	286	10 %	$	603	$	583	4 %
	Volume effect					8 %					2 %
	Price effect					3 %					4 %
	Product mix effect					(2) %					(3) %
	Exchange rate effect					1 %					1 %

Interdivisional sales			140		115	21 %		281		240	17 %

Operating earnings			12		3	> 100 %		20		9	>100 %

Asset impairments and
restructuring charges, net			4		15			7		15

External sales revenue for the second quarter and first six months 2004 increased compared to the second quarter and first six months 2003 primarily due to increased sales volume throughout the segment primarily due to a strengthening economy, which had a positive impact on sales revenue of $22 million and $12 million, respectively. Increased selling prices also had a positive impact on sales revenue of $8 million and $22 million for the second quarter and first six months of 2004, respectively. These increases were partially offset by an unfavorable shift in product mix of $4 million and $18 million in the second quarter and first six months of 2004, respectively. The increase in interdivisional sales revenue was primarily due to higher selling prices implemented as a result of higher raw mate
rial and energy costs. 

Second quarter 2004 operating earnings increased $9 million compared to second quarter 2003 primarily due to lower asset impairment and restructuring charges of $4 million and $15 million in the second quarter 2004 and 2003, respectively. Operating earnings were also impacted by increased sales volume, higher selling prices, particularly for intermediate chemicals products, and cost reduction efforts that were more than offset by higher raw material and energy costs. 

First six months 2004 operating earnings increased $11 million over first six months 2003 primarily due to asset impairments and restructuring charges of $7 million and $15 million in the first six months 2004 and 2003, respectively. Additionally, increased sales volume, higher selling prices, particularly for intermediate chemicals products, and cost reduction efforts were mostly offset by higher raw material and energy costs. 

The PCI segment continues to identify and implement projects to reduce costs and improve the results of underperforming product lines, which could result in further restructuring or consolidation. 

46

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

SP Segment
			Second Quarter					First Six Months
(Dollars in millions)			2004		2003	Change		2004		2003	Change


External sales		$	154	$	138	12 %	$	311	$	282	10 %
	Volume effect					11 %					6 %
	Price effect					(1) %					1 %
	Product mix effect					-- %					-- %
	Exchange rate effect					2 %					3 %

Interdivisional sales			13		12	8 %		25		26	(4) %

Operating earnings (loss)			19		9	>100 %		(4)		41	> (100) %

Asset impairments and
restructuring charges, net			4		--			50		--

Other operating income			--		--			--		20

External sales revenue for the second quarter and first six months of 2004 increased compared to the second quarter and first six months of 2003 primarily due to increased sales volume resulting from strengthening economies and improved demand, which had a positive impact on sales revenue of $15 million and $16 million, respectively. Favorable foreign currency exchange rates also contributed to increased sales revenue in the amount of $3 million and $9 million for the second quarter and first six months of 2004, respectively. 

Operating earnings for the second quarter 2004 increased compared with the second quarter 2003 primarily due to higher sales volume, an increased focus on more profitable businesses and product lines, and cost reduction efforts that were partially offset by restructuring charges and higher raw material and energy costs. The restructuring charges include severance charges of $2 million related to the Company’s employee separation programs announced in April 2004 and site closure costs of $2 million. 

Operating results for the first six months 2004 declined compared with the first six months 2003 primarily due to asset impairments and restructuring charges of $50 million related to the closure of the Company’s Hartlepool, United Kingdom manufacturing facility in the first quarter of 2004 and the Company’s employee separation programs, and a $20 million gain on the sale of the Company’s high performance crystalline plastics assets in the first quarter of 2003. The decision to close the Hartlepool site was made in order to consolidate production at other sites to create a more integrated and efficient global manufacturing structure. Operating earnings were positively impacted by increased sales volume, an increased focus on more profitable businesses and product lines, favorable
 shifts in foreign currency exchange rates and cost reduction efforts. 

The Company believes that continued emphasis on more profitable product lines, higher selling prices and cost reduction efforts will continue to positively impact earnings in 2004. 

47

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

VORIDIAN DIVISION 

Polymers Segment
			Second Quarter					First Six Months
(Dollars in millions)			2004		2003	Change		2004		2003	Change


External sales		$	515	$	434	19 %	$	1,030	$	864	19 %
	Volume effect					16 %					13 %
	Price effect					1 %					2 %
	Product mix effect					-- %					-- %
	Exchange rate effect					2 %					4 %

Interdivisional sales			15		19	(21) %		33		40	(17) %

Operating earnings			20		26	(23) %		8		54	(85) %

Asset impairments and
restructuring charges, net			1		--			12		--

The increase in external sales revenue for the second quarter and first six months of 2004 compared to the second quarter and first six months of 2003 was primarily due to increased sales volume, particularly for PET polymers, which had a positive impact on sales revenue of $68 million and $116 million, respectively. Favorable foreign currency exchange rates also had a positive impact on sales revenue of $9 million and $33 million in the second quarter and first six months 2004, respectively. 

Operating earnings declined in the second quarter 2004 compared with the second quarter 2003, as higher sales volume and cost reduction efforts were more than offset by higher raw material and energy costs. Additionally, $1 million in severance charges, primarily related to the Company’s employee separation programs, were recorded in the second quarter 2004. The ability to increase selling prices sufficient to offset higher raw material and energy costs, particularly for paraxylene and ethylene glycol that are used in PET polymers, was limited by the impact of capacity additions in North America in 2003 that management believes continued to be absorbed through the first quarter 2004. 

Operating earnings declined in the first six months 2004 compared with the first six months 2003 as higher sales volume, cost reduction efforts, and favorable shifts in foreign currency exchange rates were more than offset by higher raw material and energy costs. Additionally, $12 million in severance charges were recorded in the first six months 2004. The ability to increase selling prices sufficient to offset higher raw material and energy costs, particularly for paraxylene and ethylene glycol that are used in PET polymers, was limited by the impact of capacity additions in North America in 2003 that management believes continued to be absorbed through the first quarter 2004. Operating earnings for the first six months 2003 were positively impacted by an insurance settlement of approximately 
$14 million related to the 2002 operational disruptions at the Company’s Rotterdam, the Netherlands, and Columbia, South Carolina facilities. 

For the remainder of 2004, the Polymers segment expects to intensify its focus on lowering costs and expects its PET polymers product line to continue to grow along with overall market demand growth. In addition, operating earnings will continue to be impacted by the Company’s ability to obtain selling price increases to offset higher raw material and energy costs. 

48

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

Fibers Segment
			Second Quarter					First Six Months
(Dollars in millions)			2004		2003	Change		2004		2003	Change


External sales		$	181	$	166	9 %	$	353	$	312	13 %
	Volume effect					5 %					16 %
	Price effect					(2) %					(3) %
	Product mix effect					5 %					(2) %
	Exchange rate effect					1 %					2 %

Interdivisional sales			23		19	21 %		44		40	10 %

Operating earnings			33		36	(8) %		66		61	8 %

The increase in external sales revenue for the second quarter 2004 compared to the second quarter 2003 was primarily due to favorable shifts in product mix and increased sales volume, which had a positive impact on sales revenue of $10 million and $8 million, respectively. The favorable shift in product mix and the increase in sales volume was primarily attributable to acetyl chemicals and acetate tow in the Asia Pacific region. These increases were partially offset by lower selling prices, which had a negative impact on sales revenue of $4 million. 

The increase in external sales revenue for the first six months 2004 compared to the first six months 2003 was primarily due to increased sales volume throughout the segment, which had a positive impact on sales revenue of $50 million. Additionally, favorable foreign currency exchange rates, particularly for the euro, had a positive impact on sales revenue of $5 million. These increases were partially offset by lower selling prices and an unfavorable shift in product mix, which had a negative impact on sales revenue of $9 million and $5 million, respectively. 

Operating earnings for the second quarter 2004 declined compared to second quarter 2003 primarily due to increased sales volume and favorable shifts in product mix that were more than offset by higher raw material and energy costs and lower selling prices for certain key products. 

Operating earnings for the first six months 2004 increased compared to the first six months 2003 primarily due to increased sales volume that was partially offset by lower selling prices and higher raw material and energy costs. 

For 2004, the Company expects operating earnings for the Fibers segment to be similar to 2003. 

49

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

DEVELOPING BUSINESSES DIVISION 

Developing Businesses Segment
		Second Quarter					First Six Months
(Dollars in millions)		2004		2003	Change		2004		2003	Change


External sales	$	37	$	16	> 100 %	$	61	$	29	> 100 %

Interdivisional sales		111		94	18 %		220		192	15 %

Operating loss		(19)		(16)	(19) %		(39)		(39)	-- %

Asset impairments and restructuring charges		1		--			2		--

The increase in external sales revenue for the second quarter and first six months 2004 compared to the second quarter and first six months 2003 was primarily due to implementation of customer contracts at Cendian, the Company’s logistics subsidiary. External sales revenue in the Developing Businesses segment is expected to increase in 2004 compared to 2003. The increase in interdivisional sales revenue for the second quarter and first six months 2004 compared to the second quarter and first six months 2003 was primarily due to an increase in logistics services provided by Cendian to Eastman Division and Voridian Division. 

Operating results for the segment for the second quarter and first six months 2004 compared to the second quarter and first six months 2003 were impacted by a slight improvement in operating results at Cendian due to cost reduction efforts, offset by increased spending in other growth initiatives. 

For the first six months 2004, the operating results for Developing Businesses segment have not been sufficient to achieve the previously communicated expectations, primarily due to the inability of Cendian to achieve sufficient margins to offset operating costs. As a result, Cendian will not be pursuing new customers or renewing contracts with existing customers. The Company is currently evaluating various options with Cendian and other components of the Developing Businesses segment which could lead to restructuring, divestiture or consolidation of some of its activities. 

50

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

SUMMARY BY CUSTOMER LOCATION 

Sales Revenue 

	Second Quarter

(Dollars in millions)		2004		2003	Change	Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect


United States and Canada	$	949	$	849	12 %	10 %	1 %	1 %	-- %
Europe, Middle East, and Africa		394		355	11 %	5 %	(2) %	1 %	7 %
Asia Pacific		186		162	14 %	6 %	3 %	4 %	1 %
Latin America		147		115	29 %	29 %	(3) %	3 %	-- %

	$	1,676	$	1,481

Sales revenue in the United States and Canada increased for the second quarter 2004 compared to the second quarter 2003 primarily due to increased sales volume across all segments, especially for PET polymers. The increases in sales volume had a positive impact on sales revenue of $86 million. 

Sales revenue in Europe, Middle East and Africa increased for the second quarter 2004 compared to the second quarter 2003 primarily due to favorable foreign currency exchange rates, particularly for the euro, and increased sales volume that had a positive impact on sales revenue of $24 million and $16 million, respectively. The increased sales volume was primarily related to sales of PET polymers. Additionally, a favorable shift in product mix was more than offset by lower selling prices. 

Sales revenue in Asia Pacific increased for the second quarter 2004 compared to second quarter 2003 primarily due to increased sales volume and a favorable shift in product mix, particularly for the Fibers segment, which had a positive impact on sales revenue of $10 million and $7 million, respectively. Higher selling prices and favorable foreign currency exchange rates also had a positive impact on sales revenue of $4 million and $2 million, respectively. 

Sales revenue in Latin America increased for the second quarter 2004 compared to second quarter 2003 primarily due to increased sales volume, particularly for PET polymers. This increase in sales volume had a positive impact on sales revenue of $33 million. Additionally, favorable shifts in product mix of approximately $4 million were offset by lower selling prices. 

The majority of the revenues associated with assets held for sale are in the North America and Europe, Middle East, and Africa regions. 

With a substantial portion of sales to customers outside the United States of America, Eastman is subject to the risks associated with operating in international markets. To mitigate its exchange rate risks, the Company frequently seeks to negotiate payment terms in U.S. dollars. In addition, where it deems such actions advisable, the Company engages in foreign currency hedging transactions and requires letters of credit and prepayment for shipments where its assessment of individual customer and country risks indicates their use is appropriate. For additional information, refer to Note 11 to the Company’s unaudited consolidated financial statements. 

51

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

	First Six Months

(Dollars in millions)		2004		2003	Change	Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect


United States and Canada	$	1,815	$	1,673	8 %	7 %	3 %	(2) %	-- %
Europe, Middle East, and Africa		804		697	15 %	6 %	(2) %	-- %	11 %
Asia Pacific		370		321	15 %	7 %	2 %	5 %	1 %
Latin America		284		231	23 %	21 %	(1) %	2 %	1 %

	$	3,273	$	2,922

Sales revenue in the United States and Canada increased for the first six months 2004 compared to the first six months 2003 primarily due to increased sales volume across all segments, especially for PET polymers. The increases in sales volume had a positive impact on sales revenue of $119 million. Additionally, higher selling prices, particularly for Polyethylene, had a positive impact on sales revenue of $44 million. These increases were partially offset by an unfavorable shift in product mix that had a negative impact on sales revenue of $22 million. 

Sales revenue in Europe, Middle East and Africa increased for the first six months 2004 compared to the first six months 2003 primarily due to favorable foreign currency exchange rates, particularly for the euro, and increased sales volume that had a positive impact on sales revenue of $76 million and $39 million, respectively. The increased sales volume was primarily related to sales of PET polymers. These increases were partially offset by lower selling prices, particularly for acetate tow. 

Sales revenue in Asia Pacific increased for the first six months 2004 compared to first six months 2003 primarily due to increased sales volume and a favorable shift in product mix, particularly for acetate tow, which had a positive impact on sales revenue of $23 million and $14 million, respectively. Higher selling prices also had a positive impact on sales revenue of $7 million. 

Sales revenue in Latin America increased for the first six months 2004 compared to first six months 2003 primarily due to increased sales volume, particularly for PET polymers. The increase in sales volume had a positive impact on sales revenue of $48 million. 

The majority of the revenues associated with assets held for sale are in the North America and Europe, Middle East, and Africa regions. 

With a substantial portion of sales to customers outside the United States of America, Eastman is subject to the risks associated with operating in international markets. To mitigate its exchange rate risks, the Company frequently seeks to negotiate payment terms in U.S. dollars. In addition, where it deems such actions advisable, the Company engages in foreign currency hedging transactions and requires letters of credit and prepayment for shipments where its assessment of individual customer and country risks indicates their use is appropriate. For additional information, refer to Note 11 to the Company’s unaudited consolidated financial statements. 

52

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS

LIQUIDITY, CAPITAL RESOURCES, AND OTHER FINANCIAL INFORMATION 

	First Six Months

(Dollars in millions)		2004		2003


Net cash provided by (used in)
Operating activities	$	182	$	(95)
Investing activities		(127)		(62)
Financing activities		(466)		149

Net change in cash and cash equivalents	$	(411)	$	(8)


Cash and cash equivalents at end of period	$	147	$	69

Cash Flows 

Cash provided by operating activities of $182 million in the first six months 2004 increased $277 million compared to the first six months 2003. In the first six months of 2004 and 2003, the Company made $0 million and $140 million in contributions to its U.S. defined benefit pension plans, respectively. In addition, cash provided by operating activities benefited from lower working capital requirements primarily due to an increase in trade payables. The increase in trade payables was largely the result of higher raw material and energy costs, increased sales volume and timing of payments. 

The net increase of $65 million in cash used in investing activities in the first six months 2004 compared to first six months 2003 primarily reflects a $17 million increase in additions to properties and equipment in the first six months 2004 as well as $28 million in proceeds from the sale of assets in the first quarter 2003. The proceeds from the sale of assets were due to the sale of the Company’s high-performance crystalline plastics assets. 

Cash used in financing activities in the first six months 2004 reflects the January 2004 repayment of $500 million of 6 3/8% notes and an increase in commercial paper and credit facility borrowings of $89 million. The payment of dividends is reflected in all periods. 

In 2004, priorities for use of available cash from operations are to pay the dividend, reduce outstanding borrowings and fund targeted growth initiatives such as small acquisitions and other ventures. 

Liquidity 

Eastman has access to a $700 million revolving credit facility (the "Credit Facility") expiring in April 2009. Any borrowings under the Credit Facility are subject to interest at varying spreads above quoted market rates, principally LIBOR. The Credit Facility requires facility fees on the total commitment that vary based on Eastman's credit rating. The rate for such fees was 0.15% as of June 30, 2004 and December 31, 2003. The Credit Facility contains a number of covenants and events of default, including the maintenance of certain financial ratios. The Company was in compliance with all such covenants for all periods presented. 

Eastman typically utilizes commercial paper to meet its liquidity needs. The Credit Facility provides liquidity support for commercial paper borrowings and general corporate purposes. Accordingly, outstanding commercial paper borrowings reduce borrowings available under the Credit Facility. Because the Credit Facility expires in April 2009, the commercial paper borrowings supported by the Credit Facility are classified as long-term borrowings because the Company has the ability to refinance such borrowings on a long-term basis. At June 30, 2004, the Company’s commercial paper and revolving credit facility borrowings were $271 million at an effective interest rate of 1.83%. At December 31, 2003, the Company's commercial paper borrowings were $196 million at an effective interest rate of 1.8
5%. 

53

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

As of June 30, 2004, the Company has effective shelf registration statements filed with the Securities and Exchange Commission to issue a combined $1.1 billion of debt or equity securities. 

On January 15, 2004, the Company repaid at maturity $500 million of notes bearing interest at 6 3/8% per annum. These notes were reflected in borrowings due within one year in the Consolidated Statements of Financial Position at December 31, 2003. These notes were repaid with cash generated from business activities, new long-term borrowings and available short-term borrowing capacity. 

Cash flows from operations and the sources of capital described above are expected to be available and sufficient to meet foreseeable cash flow requirements. However, the Company’s cash flows from operations can be affected by numerous factors including risks associated with global operations, raw materials availability and cost, demand for and pricing of Eastman’s products, capacity utilization and other factors described under "Forward-Looking Statements and Risk Factors" below. 

Capital Expenditures 

Capital expenditures were $117 million and $100 million for the six months 2004 and 2003, respectively. The Company continues its emphasis on cash flow management and, for 2004, expects that capital spending and other directed investments for small acquisitions and other ventures will increase compared to 2003, but be no more than depreciation and amortization. 

Other Commitments 

At June 30, 2004, the Company’s obligations related to notes and debentures totaled approximately $1.9 billion to be paid over a period of 25 years. Other borrowings, related primarily to commercial paper and credit facility borrowings, totaled approximately $271 million. 

The Company had various purchase obligations at June 30, 2004 totaling approximately $2.0 billion over a period of approximately 15 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 approximately $193 million over a period of several years. Of the total lease commitments, approximately 22% relate to machinery and equipment, including computer and communications equipment and production equipment; approximately 50% relate to real property, including office space, storage facilities and land; and approximately 28% relate to railcars. 

54

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

In addition, the Company had other liabilities at June 30, 2004 totaling approximately $1.2 billion related to pension, retiree medical, and other post-employment obligations. 

The obligations described above are summarized in the following table: 

(Dollars in millions) 

Payments Due For 

Period 

Notes and 
Debentures 

Commercial Paper and Credit Facility Borrowings 

Purchase Obligations 
(a) 

Operating 
Leases 

Other Liabilities (b) 

Total 

Remaining in 2004 

$ 

1 

$ 

-- 

$ 

145 

$ 

22 

$ 

21 

$ 

189 

2005 

-- 

-- 

278 

39 

131

448

2006 

7 

-- 

273 

33 

171

484

2007 

-- 

-- 

270 

23 

141

434

2008 

250 

-- 

165 

13 

96 

 524

2009 and beyond 

1,625 

271 

929 

63 

682 

3,570 

Total 

$ 

1,883 

$ 

271 

$ 

2,060 

$ 

193 

$ 

1,242 

$ 

5,649

(a) Amounts represent the current estimated cash payments to be made by the Company in the periods indicated based on market prices and the assumption that the plants utilizing these contracts will remain in operation. Many of the purchase obligations are tied to market prices for various raw materials that fluctuate from time to time. Therefore, the Company’s actual obligation could be significantly higher or lower than presented above. Also, many of the Company’s contracts are cancelable for a certain fee, which, in the case of a plant closure could result in a lower total cost related to the obligation. 

(b) Amounts represent the current estimated cash payments to be made by the Company in the periods indicated. The amount and timing of such payments is dependent upon interest rates, health care trends, actual returns on plan assets, retirement and attrition rates of employees, continuation or modification of the benefit plans, and other factors. Such factors can significantly impact the amount and timing of any future contributions by the Company. 

The Company also had outstanding guarantees at June 30, 2004. Additional information related to these guarantees is provided in Note 17 to the Company’s unaudited consolidated financial statements. 

Off Balance Sheet and Other Financing Arrangements 

If certain operating leases are terminated by the Company, it guarantees a portion of the residual value loss, if any, incurred by the lessors in disposing of the related assets. The Company believes, based on current facts and circumstances, that a material payment pursuant to such guarantees in excess of the payments included above is remote. Under these operating leases, the residual value guarantees at June 30, 2004 totaled $84 million and consisted primarily of leases for railcars and other equipment. 

55

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

The Company has long-term commitments relating to joint ventures as described in Note 17 to the Company’s unaudited consolidated financial statements. These joint ventures allow the Company to gain access to markets the Company otherwise would not be able to gain access to. The guarantees related to the joint ventures provide borrowing capability in excess of what the joint venture would have access to based on its own resources. The Company guarantees up to $131 million of the principal amount of the joint ventures’ third-party borrowings, but believes, based on current facts and circumstances and the structure of the ventures, that the likelihood of a payment pursuant to such guarantees is remote. For more information concerning the joint ventures described above, see Note 5 in the 
notes to the audited financial statements contained in the Company’s 2003 Annual Report on Form 10-K. 

As described in Note 17 to the Company’s unaudited consolidated financial statements, Eastman entered into an agreement in 1999 that allows it to generate cash by reducing its working capital through the sale of undivided interests in certain domestic trade accounts receivable under a planned continuous sale program to a third party. Under this agreement, receivables sold to the third party totaled $200 million at June 30, 2004 and December 31, 2003. Undivided interests in designated receivable pools were sold to the purchaser with recourse limited to the purchased interest in the receivable pools. 

The Company has evaluated material relationships including the guarantees related to the third-party borrowings of joint ventures described above and has concluded that the entities are not variable interest entities ("VIEs") or, in the case of Primester, the Company is not the primary beneficiary of the VIE. As such, in accordance with FIN 46R, the Company is not required to consolidate these entities. The Company has evaluated long-term purchase obligations with two entities that may be VIEs. These potential VIEs are joint ventures from which the Company purchases approximately $40 million of raw materials and utilities on an annual basis. The Company has no equity interest in these entities and has confirmed that one party to each of these joint ventures does consolidate the potential VIE. H
owever, due to competitive and other reasons, the Company has not been able to obtain the necessary financial information to determine whether the entities are VIEs, and if one or both are VIEs, whether or not the Company is the primary beneficiary. 

The Company did not have any other material relationships with unconsolidated entities or financial partnerships, including special purpose entities, for the purpose of facilitating off-balance sheet arrangements with contractually narrow or limited purposes. Thus, Eastman is not materially exposed to any financing, liquidity, market, or credit risk related to the above or any other such relationships. 

For more information on the above off balance sheet and other financing arrangements, see Note 17 to the unaudited consolidated financial statements. 

Treasury Stock Transactions 

The Company is currently authorized to repurchase up to $400 million of its common stock. No shares of Eastman common stock were repurchased by the Company during the first six months of 2004 and 2003. A total of 2,746,869 shares of common stock at a cost of approximately $112 million, or an average price of approximately $41 per share, have been repurchased under this authorization. Repurchased shares may be used to meet common stock requirements for compensation and benefit plans and other corporate purposes. 

Dividends    

The Company declared cash dividends of $0.44 per share in the second quarters 2004 and 2003 and $0.88 per share in the first six months 2004 and 2003. 

56

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

RECENTLY ISSUED ACCOUNTING STANDARDS 

On December 7, 2003, Congress passed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("the Act"). The Act introduced a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy to sponsors of retirement health care plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. As permitted by FASB Staff Position 106-1, the Company elected to defer recognizing the effects of the Act on the accounting for its retirement health care plans in Fiscal 2003. In May of 2004, the FASB issued Staff Position 106-2, providing final guidance on accounting for the Act. The Company has completed its evaluation of the impact of FSP 106-2. As the Company’s current healthcare plans are not considered to be actuarially equivalent to M
edicare Part D, the Act has no effect on the Company’s financial position, results of operations, or cash flows. 

57

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

OUTLOOK 

For 2004, the Company expects: 

that historically high raw material and energy costs will continue throughout much of 2004, and that the Company will continue to implement price increases to offset these increases;
that pension and other postemployment benefit expenses in 2004 will be similar to 2003 as a result of the amendment of certain postemployment benefit plans;
to make no contribution to the Company’s U.S. defined benefit pension plans in 2004;
net interest expense to decrease compared to 2003 due to lower expected gross interest costs as a result of lower average interest rates on borrowings and anticipated lower average borrowings;
that depreciation and amortization expense for 2004 will decrease by approximately $35 million compared to 2003;
cash flow from operating activities to increase in 2004 compared to 2003 and that priorities for use of available cash will be to pay the quarterly cash dividend, reduce outstanding borrowings, and fund targeted growth initiatives such as small acquisitions and other ventures;
capital expenditures to increase in 2004 compared to 2003, but to continue to be no more than depreciation and amortization;
the effective tax rate to be at or below 30%, and certain tax benefits from favorable foreign rate variances and the extraterritorial income exclusion to continue through 2004;
combined costs related to selling and general administrative expenses and research and development expenses to be below 10% of sales revenue;
cost reduction and productivity improvement efforts will positively impact results in 2004;
the completion of the initiative to restructure, divest and consolidate the CASPI segment to improve profitability and cash flows.;
the PCI segment to continue to identify and implement projects to reduce costs and improve the results of underperforming product lines, which could result in further restructuring or consolidation.
continued emphasis in the SP segment on more profitable product lines, higher selling prices and cost reduction efforts will continue to positively impact earnings in 2004;
the Polymers segment will intensify its focus on lowering costs and expects its PET polymers product line to continue to grow along with overall market demand growth; and
operating earnings in the Fibers segment to be similar to 2003; and,
to evaluate various options with Cendian and other components of the Developing Businesses segment that could lead to restructuring, divestiture or consolidation of some of its activities.

58

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

Due to the above factors, continued strong sales volume and improving economic conditions, the Company expects third quarter 2004 net earnings to be between $0.63 and $0.82 per share. 

Longer term, the Company expects: 

Global demand for PET polymers to grow at an average rate of approximately 10% annually over the next several years; and
Aggressive management of costs in the PCI segment will help improve margins and position it to take full advantage of the cyclical upturn in the ethylene market expected in the 2005 through 2006 timeframe and to aggressively identify and implement projects to reduce costs and improve performance.

See "Forward-Looking Statements and Risk Factors" below. 

FORWARD-LOOKING STATEMENTS AND RISK FACTORS 

The expectations under "Outlook" and certain other statements in this report may be forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. These statements and other written and oral forward-looking statements made by the Company from time to time 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; legal proceedings; exposure to, and effects of hedging of, raw material and energy costs and foreign currencies; global and regional economic, political, and business conditions; competition; growth opportunities; supply and demand, volume, price, cost, margin, and sales; earnings, cash flow, dividends and other exp
ected financial conditions; expectations, strategies, and plans for individual products, businesses, segments and divisions as well as for the whole of Eastman Chemical Company; cash requirements and uses of available cash; financing plans; pension expenses and funding; credit rating; cost reduction and control efforts and targets; integration of acquired businesses; development, production, commercialization and acceptance of new products, services and technologies and related costs; asset, business and product portfolio changes; and expected tax rate. 

These plans and expectations are based upon certain underlying assumptions, including those mentioned with the specific statements. Such assumptions are in turn based upon internal estimates and analyses of current market conditions and trends, management plans and strategies, economic conditions and other factors. These plans and expectations 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. In addition to the factors described in this report, the following are some of the important factors that could c
ause the Company's actual results to differ materially from those in any such forward-looking statements: 

59

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

The Company has manufacturing and marketing operations throughout the world, with approximately 45% of the Company's sales revenue attributable to sales outside the United States. Economic factors, including foreign currency exchange rates, could affect the Company's sales revenue, expenses and results. Although the Company utilizes risk management tools, including hedging, as appropriate, to mitigate market fluctuations in foreign currencies, any changes in strategy in regard to risk management tools can also affect sales revenue, expenses and results and there can be no assurance that such measures will result in cost savings or that all market fluctuation exposure will be eliminated. In addition, changes in laws, regulations, or other political factors in any of the countries in which the Company operates could affect business in that country or region, as well as the Company's results of operations and financial condi tion.
The Company has made and may continue to make acquisitions, divestitures and investments, and enter into alliances, as part of its strategies for growth and improved profitability. The completion of such transactions is subject to the timely receipt of necessary regulatory and other consents and approvals needed to complete the transactions which could be delayed for a variety of reasons, including the satisfactory negotiation of the transaction documents and the fulfillment of all closing conditions to the transactions. Additionally, there can be no assurance that such transactions will be successfully completed on a timely and cost-efficient basis or that they will achieve projected operating earnings or cost reduction targets.
The Company has deferred tax assets related to capital and operating losses. The Company establishes valuation allowances to reduce these deferred tax assets to an amount that is more likely than not to be realized. The Company’s ability to utilize these deferred tax assets depends on projected future operating results, the reversal of existing temporary differences and the availability of tax planning strategies. Realization of the these assets is expected to occur over an extended period of time. As a result, changes in tax laws, assumptions with respect to future taxable income and tax planning strategies could result in adjustments to these assets.
The Company has made strategic investments in technology, services businesses, and other ventures in order to build certain Eastman capabilities. There can be no assurance that such investments will achieve their objectives or that they will be beneficial to the Company's results of operations.
The Company owns assets in the form of equity in other companies, including joint ventures, technology investments and Genencor. Such investments are minority investments in companies which are not managed or controlled by the Company and are subject to all of the risks associated with changes in value of such investments including the market valuation of those companies whose shares are publicly traded.
The Company has undertaken and will continue to undertake productivity and cost reduction initiatives and organizational restructurings to improve performance and generate cost savings. There can be no assurance that these will be completed as planned or beneficial or that estimated cost savings from such activities will be realized.
In addition to cost reduction initiatives, the Company is striving to improve margins on its products through price increases, where warranted and accepted by the market; however, the Company's earnings could be negatively impacted should such increases be unrealized, not be sufficient to cover increased raw material and energy costs, or have a negative impact on demand and volume. There can be no assurances that any price increases will be realized or will be realized within the Company’s anticipated timeframe.
The Company is reliant on certain strategic raw materials for its operations and utilizes risk management tools, including hedging, as appropriate, to mitigate short-term market fluctuations in raw material costs. There can be no assurance, however, that such measures will result in cost savings or that all market fluctuation exposure will be eliminated. In addition, changes in laws or regulations, war or other outbreak of hostilities, or other political factors in any of the countries or regions in which the Company operates or does business, or in countries or regions that are key suppliers of strategic raw materials, could affect availability and costs of raw materials.

60

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL 

CONDITION AND RESULTS OF OPERATIONS 

While temporary shortages of raw materials and energy may occasionally occur, these items are generally sufficiently available to cover current and projected requirements. However, their continuous availability and price are subject to unscheduled plant interruptions occurring during periods of high demand, or due to domestic or world market and political conditions, changes in government regulation, war or other outbreak of hostilities. Eastman’s operations or products may, at times, be adversely affected by these factors.
The Company's competitive position in the markets in which it participates is, in part, subject to external factors. For example, supply and demand for certain of the Company's products is driven by end-use markets and worldwide capacities which, in turn, impact demand for and pricing of the Company's products.
The Company has an extensive customer base; however, loss of certain top customers could adversely affect the Company's financial condition and results of operations until such business is replaced and no assurances can be made that the Company would be able to regain or replace any lost customers.
Limitation of the Company's available manufacturing capacity due to significant disruption in its manufacturing operations could have a material adverse affect on sales revenue, expenses and results of operations and financial condition.
The Company's facilities and businesses are subject to complex health, safety and environmental laws and regulations, which require and will continue to require significant expenditures to remain in compliance with such laws and regulations currently and in the future. The Company's accruals for such costs and associated liabilities are subject to changes in estimates on which the accruals are based. The amount accrued reflects the Company’s assumptions about remedial requirements at the contaminated site, the nature of the remedy, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. Changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in health, safety, environmental, chemical control regulations and testing requir ements could result in higher or lower costs.
The Company accesses the capital and credit markets on a regular basis. Access to these markets and the cost of capital is dependent in part upon the Company's credit rating received from independent credit rating agencies. An adverse change in the Company's credit rating could affect the renewal of existing credit facilities or the Company's ability to obtain access to new credit facilities or other debt financing in the future, could adversely affect the terms under which the Company can borrow, and could increase the cost of new borrowings, other debt, or capital.
The Company’s operations from time to time 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 handled and defended in the ordinary course of business. The Company believes amounts reserved are adequate for such pending matters; however, results of operations could be affected by significant litigation adverse to the Company.

The foregoing list of important factors does not include all such factors nor necessarily present them in order of importance. This disclosure, including that under "Outlook" and "Forward-Looking Statements and Risk Factors," and other forward-looking statements and related disclosures made by the Company in this report and elsewhere from time to time, represents management's best judgment as of the date the information is given. The Company does not undertake responsibility for updating any of such information, whether as a result of new information, future events, or otherwise, except as required by law. Investors are advised, however, to consult any further public Company disclosures
 (such as in filings with the Securities and Exchange Commission or in Company press releases) on related subjects. 

61

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. An evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the Company’s disclosure controls and procedures. Based on that evaluation, the CEO and CFO have concluded that the Company's disclosure controls and procedures are effective as of June 30, 2004. 

There has been no change in the Company's internal control over financial reporting that occurred during the second quarter of 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. 

62

PART II. OTHER INFORMATION 

ITEM 1. LEGAL PROCEEDINGS 

General 

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, including the sorbates litigation and the asbestos litigation described in the following paragraphs, will have a material adverse effect on its overall financial condition, results of operations or cash flows. However, adverse developm
ents could negatively impact earnings or cash flows in a particular future period. 

Sorbates Litigation 

As previously reported, on September 30, 1998, the Company entered into a voluntary plea agreement with the U.S. Department of Justice and agreed to pay an $11 million fine to resolve a charge brought against the Company for violation of Section One of the Sherman Act. Under the agreement, the Company entered a plea of guilty to one count of price-fixing for sorbates, a class of food preservatives, from January 1995 through June 1997. The plea agreement was approved by the United States District Court for the Northern District of California on October 21, 1998. The Company recognized the entire fine as a charge against earnings in the third quarter of 1998 and paid the fine in installments over a period of five years. On October 26, 1999, the Company pleaded guilty in a Federal Court of Canada 
to a violation of the Competition Act of Canada and was fined $780,000 (Canadian). The plea in Canada admitted that the same conduct that was the subject of the United States guilty plea had occurred with respect to sorbates sold in Canada, and prohibited repetition of the conduct and provides for future monitoring. The Canadian fine has been paid and was recognized as a charge against earnings in the fourth quarter of 1999. 

Following the September 30, 1998 plea agreement, the Company, along with other defendants, was sued in federal, state and Canadian courts in more than twenty putative class action lawsuits filed on behalf of purchasers of sorbates and products containing sorbates, claiming those purchasers paid more for sorbates and for products containing sorbates than they would have paid in the absence of the defendants’ price-fixing. Only two of these lawsuits have not been resolved via settlement. One of those cases was dismissed for want of prosecution.  In the other case, an intermediate appellate court affirmed in 2004 a trial court ruling that the case could not proceed as a class action. That decision has been appealed. In addition, six states have sued the Company and other defendants in co
nnection with the sorbates matter, seeking damages, restitution and civil penalties on behalf of consumers of sorbates in those respective states. Two of those six cases have been settled; defense motions to dismiss were granted in two other cases and those dismissals are now final. The dismissal of a third has been appealed by the state. A defense motion to dismiss another state case has been fully briefed.  Seven other states have advised the Company that they intend to bring similar actions against the Company and others. A settlement with those seven states has tentatively been reached. 

The Company has recognized charges to earnings for estimated and actual costs, including legal fees and expenses, related to the sorbates fine and litigation. While the Company intends to continue to defend vigorously the remaining sorbates actions unless they can be settled on acceptable terms, the ultimate outcome of the matters still pending and of additional claims that could be made is not expected to have a material impact on the Company's financial condition, results of operations, or cash flows, although these matters could result in the Company being subject to monetary damages, costs or expenses, and charges against earnings in particular periods. 

63

Asbestos Litigation 

Over the years, Eastman has been named as a defendant, along with numerous other defendants, in lawsuits in various state courts in which plaintiffs alleged injury due to exposure to asbestos at Eastman’s manufacturing sites and sought unspecified monetary damages and other relief. Historically, these cases were dismissed or settled without a material effect on Eastman’s financial condition, results of operations, or cash flows. 

In recently filed cases, plaintiffs allege exposure to asbestos-containing products allegedly made by Eastman.  Based on its investigation to date, the Company has information that it manufactured limited amounts of an asbestos-containing plastic product between the mid-1960’s and the early 1970’s.  The Company’s investigation has found no evidence that any of the plaintiffs worked with or around any such product alleged to have been manufactured by the Company. The Company intends to defend vigorously the approximately 3,000 pending claims or to settle them on acceptable terms. 

The Company continues to evaluate the allegations and claims made in recent asbestos-related lawsuits and its insurance coverages. Based on such evaluation to date, the Company continues to believe that the ultimate resolution of asbestos cases will not have a material impact on the Company’s financial condition, results of operations, or cash flows, although these matters could result in the Company being subject to monetary damages, costs or expenses, and charges against earnings in particular periods. To date, costs incurred by the Company related to the recent asbestos-related lawsuits have not been material. 

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES 

(e) Purchases of Equity Securities by the Issuer and Affiliated Purchasers 

Period	Total Number of Shares Purchased (1)		Average Price Paid Per Share (2)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (3)		Approximate Dollar Value (in millions) that May Yet Be Purchased Under the Plans or Programs (3)

April 1- 30, 2004	--	$	--	--	$	288
May 1-31, 2004	3,876	$	44.56	--	$	288
June 1-30, 2004	23,301	$	46.31	--	$	288

Total	27,177			--	$	288

(1) Shares surrendered to the Company by employees to satisfy individual tax withholding obligations upon vesting of previously issued shares of restricted common stock and shares surrendered by employees as payment to the Company of the purchase price for shares of common stock under the terms of previously granted stock options.  Shares are not part of any Company repurchase plan. 

(2) Average price paid per share reflects the average closing price of Eastman stock on the business date the shares were surrendered by the employee stockholder as a result of vesting of the restricted shares to which the tax withholding obligation relates or the exercise of stock options. 

(3) The Company is authorized by the Board of Directors to repurchase up to $400 million of its common stock. Common share repurchases under this authorization in 1999, 2000 and 2001 were $51 million, $57 million and $4 million, respectively. The Company has not repurchased any common shares under this authorization in 2002, 2003 and through the first six months 2004. For additional information see Note 13 to the audited financial statements included the Company’s 2003 annual report on Form 10-K. 

64

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 

The 2004 Annual Meeting of the Stockholders of Eastman Chemical Company was held on May 6, 2004. There were 77,432,840 shares of common stock entitled to be voted, and 63,602,288 shares represented in person or by proxy, at the Annual Meeting. 

Three items of business were acted upon by stockholders at the Annual Meeting: 

the election of three directors to serve in the class for which the term in office expires at the 2007 Annual Meeting of Stockholders and their successors are duly elected and qualified;
the ratification of the action by the Audit Committee of the Board of Directors appointing PricewaterhouseCoopers LLP as independent accountants for the Company for the year ended December 31, 2004; and
a stockholder proposal to utilize restricted shares in lieu of stock options as executive stock-based compensation.

The results of the voting for the election of directors were as follows: 

Nominee	Votes For	Votes Withheld	Abstentions	Broker Non-Votes
Renee J. Hornbaker	56,044,260	7,558,028	-0-	-0-
Thomas H. McLain	56,052,559	7,549,729	-0-	-0-
Peter M. Wood	56,062,977	7,539,311	-0-	-0-

Accordingly, the three nominees received a plurality of the votes cast in the election of directors at the meeting and were elected. The other directors whose term of office continued after the meeting were Messrs. Calvin A. Campbell, Jr., J. Brian Ferguson, Donald W. Griffin, Stephen R.Demeritt, Robert M. Hernandez and David W. Raisbeck. 

The results of the voting on the ratification of the appointment of PricewaterhouseCoopers LLP as independent accountants were as follows: 

Votes For	Votes Against	Abstentions	Broker Non-Votes
61,558,028	1,623,841	420,419	-0-

Accordingly, the number of affirmative votes cast on the proposal constituted more than a majority of the votes cast on the proposal at the meeting, and the appointment of PricewaterhouseCoopers LLP as independent accountants was ratified. 

The results of the voting on the stockholder proposal to utilize restricted shares in lieu of stock options as executive stock-based compensation were as follows: 

Votes For	Votes Against	Abstentions	Broker Non-Votes
4,306,371	44,080,183	750,004	14,465,730

Accordingly, the number of affirmative votes cast on the proposal constituted less than a majority of the votes cast on the proposal at the meeting, and the stockholder proposal was not approved. 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 

(a) Exhibits filed as part of this report are listed in the Exhibit Index appearing on page 68. 

(b) On April 29, 2004, the Company furnished under Item 12 of Form 8-K the text of its publicly released financial results for the first quarter of 2004. 

65

SIGNATURES 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. 

              Eastman Chemical Company 

Date: August 9, 2004	By:	/s/ Richard A. Lorraine

		Richard A. Lorraine
		Senior Vice President and Chief Financial Officer

66

EXHIBIT INDEX 

Exhibit		Sequential
Number	Description	Page Number


3.01	Amended and Restated Certificate of Incorporation of Eastman Chemical Company, as amended (incorporated by reference to Exhibit 3.01 to Eastman Chemical Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001)

3.02	Amended and Restated Bylaws of Eastman Chemical Company, as amended December 4, 2003 (incorporated herein by reference to Exhibit 3.02 to Eastman Chemical Company’s Annual Report on Form 10-K for the year ended December 31, 2003)

4.01	Form of Eastman Chemical Company Common Stock certificate as amended February 1, 2001 (incorporated herein by reference to Exhibit 4.01 to Eastman Chemical Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (the "March 31, 2001 10-Q"))

4.02	Stockholder Protection Rights Agreement dated as of December 13, 1993, between Eastman Chemical Company and First Chicago Trust Company of New York, as Rights Agent as amended December 4, 2003 (incorporated herein by reference to Exhibit 4.2 to Eastman Chemical Company's current report on Form 8-K dated December 5, 2003)

4.03	Indenture, dated as of January 10, 1994, between Eastman Chemical Company and The Bank of New York, as Trustee (the "Indenture") (incorporated herein by reference to Exhibit 4(a) to Eastman Chemical Company's current report on Form 8-K dated January 10, 1994 (the "8-K"))

4.04	Form of 6 3/8% Notes due January 15, 2004 (incorporated herein by reference to Exhibit 4(c) to the 8-K)

4.05	Form of 7 1/4% Debentures due January 15, 2024 (incorporated herein by reference to Exhibit 4(d) to the 8-K)

4.06	Officers’ Certificate pursuant to Sections 201 and 301 of the Indenture (incorporated herein by reference to Exhibit 4(a) to Eastman Chemical Company's Current Report on Form 8-K dated June 8, 1994 (the "June 8-K"))

4.07	Form of 7 5/8% Debentures due June 15, 2024 (incorporated herein by reference to Exhibit 4(b) to the June 8-K)

4.08	Form of 7.60% Debentures due February 1, 2027 (incorporated herein by reference to Exhibit 4.08 to Eastman Chemical Company's Annual Report on Form 10-K for the year ended December 31, 1996 (the "1996 10-K"))

67

Exhibit		Sequential
Number	Description	Page Number


4.09	Form of 7% Notes due April 15, 2012 (incorporated herein by reference to Exhibit 4.09 to Eastman Chemical Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002)

4.10	Officer's Certificate pursuant to Sections 201 and 301 of the Indenture related to 7.60% Debentures due February 1, 2027 (incorporated herein by reference to Exhibit 4.09 to the 1996 10-K)

4.11	$200,000,000 Accounts Receivable Securitization agreement dated April 13, 1999 (amended April 11, 2000), between the Company and Bank One, NA, as agent. Pursuant to Item 601(b)(4)(iii) of Regulation S-K, in lieu of filing a copy of such agreement, the Company agrees to furnish a copy of such agreement to the Commission upon request

4.12	Amended and Restated Credit Agreement, dated as of April 7, 2004 (the "Credit Agreement") among Eastman Chemical Company, the Lenders named therein, and Citicorp USA, Inc., as Agent (incorporated herein by reference to Exhibit 4.12 to Eastman Chemical Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004)

4.13	Form of 3 1/4% Notes due June 16, 2008 (incorporated herein by reference to Exhibit 4.13 to Eastman Chemical Company’s Quarterly Report on Form 10-Q for the quarter ending June 30, 2003)

4.14	Form of 6.30% Notes due 2018 (incorporated herein by reference to Exhibit 4.14 to Eastman Chemical Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003)

12.01	Statement re: Computation of Ratios of Earnings to Fixed Charges	69

31.01	Rule 13a – 14(a) Certification by J. Brian Ferguson, Chairman of the Board and Chief Executive Officer, for the quarter ended June 30, 2004	70

31.02	Rule 13a – 14(a) Certification by Richard A. Lorraine, Senior Vice President and Chief Financial Officer, for the quarter ended June 30, 2004	71

32.01	Section 1350 Certification by J. Brian Ferguson, Chairman of the Board and Chief Executive Officer, for the quarter ended June 30, 2004	72

32.02	Section 1350 Certification by Richard A. Lorraine, Senior Vice President and Chief Financial Officer, for the quarter ended June 30, 2004	73

99.01	CASPI segment detail of sales revenue, operating earnings (loss) and asset impairments and restructuring charges	74

68

			Second Quarter				First Six Months
(Dollars and shares in millions, except per share amounts)			2004		2003		2004		2003


Net earnings, as reported		$	84	$	35	$	78	$	56


Add: Stock-based employee compensation expense included in net earnings, as reported			1		--		1		--

Deduct: Total additional stock-based employee compensation cost, net of tax, that would have been included in net earnings under fair value method			2		3		4		6

Pro forma net earnings		$	83	$	32	$	75	$	50


Basic earnings per share	As reported	$	1.08	$	0.46	$	1.01	$	0.73
	Pro forma	$	1.07	$	0.42	$	0.97	$	0.65
	Shares		77.4		77.1		77.3		77.1

Diluted earnings per share	As reported	$	1.07	$	0.46	$	1.00	$	0.73
	Shares		78.1		77.3		78.0		77.3

	Pro forma	$	1.07	$	0.42	$	0.97	$	0.65
	Shares ⁽¹⁾		77.9		77.2		77.7		77.2

(Dollars in millions)		Payments Due For

Period		Notes and Debentures		Commercial Paper and Credit Facility Borrowings		Purchase Obligations (a)		Operating Leases		Other Liabilities (b)		Total


Remaining in 2004	$	1	$	--	$	145	$	22	$	21	$	189
2005		--		--		278		39		131		448
2006		7		--		273		33		171		484
2007		--		--		270		23		141		434
2008		250		--		165		13		96		524
2009 and beyond		1,625		271		929		63		682		3,570

Total	$	1,883	$	271	$	2,060	$	193	$	1,242	$	5,649