Attached files

file filename
EX-12.01 - STATEMENT RE: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES - EASTMAN CHEMICAL COexhibit12_01.htm
EX-10.01 - FORM OF PERFORMANCE SHARE AWARD TO EXECUTIVE OFFICERS - EASTMAN CHEMICAL COexhibit10_01.htm
EX-31.02 - RULE 13A - 14(A) CFO CERTIFICATION - EASTMAN CHEMICAL COexhibit31_02.htm
EX-31.01 - RULE 13A - 14(A) CEO CERTIFICATION - EASTMAN CHEMICAL COexhibit31_01.htm
EX-10.02 - FORM OF PERFORMANCE SHARE AWARD TO MARK J COSTA - EASTMAN CHEMICAL COexhibit10_02.htm
EX-32.02 - SECTION 1350 CFO CERTIFICATION - EASTMAN CHEMICAL COexhibit32_02.htm
EX-32.01 - SECTION 1350 CEO CERTIFICATION - EASTMAN CHEMICAL COexhibit32_01.htm
 
 
 

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 September 30, 2009
 
OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______________ to ______________

Commission file number 1-12626
 
EASTMAN CHEMICAL COMPANY
(Exact name of registrant as specified in its charter)

Delaware
 
62-1539359
(State or other jurisdiction of
 
(I.R.S. employer
incorporation or organization)
 
identification no.)
     
200 South Wilcox Drive
   
Kingsport, Tennessee
 
37662
(Address of principal executive offices)
 
(Zip Code)
     

Registrant’s telephone number, including area code: (423) 229-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X]  NO  [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES [X]  NO  [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
                                                                                                          Large accelerated filer [X]                             Accelerated filer [  ]
                                                                                                          Non-accelerated filer [  ]                                Smaller reporting company [  ]
                                                                                                                (Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES [  ]  NO  [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Number of Shares Outstanding at September 30, 2009
Common Stock, par value $0.01 per share
 
72,707,237
     

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PAGE 1 OF 50 TOTAL SEQUENTIALLY NUMBERED PAGES
EXHIBIT INDEX ON PAGE 49

 
1

 





TABLE OF CONTENTS

ITEM
 
PAGE

PART I.  FINANCIAL INFORMATION


PART II.  OTHER INFORMATION


SIGNATURES

 
48


 
2

 

COMPREHENSIVE INCOME AND RETAINED EARNINGS

   
Third Quarter
 
First Nine Months
(Dollars in millions, except per share amounts)
 
2009
 
2008
 
2009
 
2008
                 
$
1,337
$
1,819
$
3,719
$
5,380
Cost of sales
 
1,009
 
1,497
 
2,952
 
4,400
Gross profit
 
 328
 
 322
 
767
 
 980
                 
Selling, general and administrative expenses
 
104
 
107
 
296
 
324
Research and development expenses
 
33
 
39
 
101
 
120
Asset impairments and restructuring charges, net
 
--
 
2
 
23
 
22
Operating earnings
 
191
 
 174
 
347
 
 514
                 
Net interest expense
 
19
 
19
 
58
 
53
Other charges (income), net
 
2
 
7
 
11
 
7
Earnings from continuing operations before income taxes
 
 170
 
 148
 
278
 
 454
Provision for income taxes from continuing operations
 
69
 
48
 
110
 
124
Earnings from continuing operations
 
 101
 
 100
 
168
 
 330
                 
Earnings from disposal of discontinued operations, net of tax
 
--
 
--
 
--
 
18
Net earnings
$
 101
$
 100
$
 168
$
 348
                 
Basic earnings per share
               
Earnings from continuing operations
$
1.40
$
1.35
$
2.31
$
4.34
Earnings from discontinued operations
 
--
 
--
 
--
 
0.23
Basic earnings per share
$
   1.40
$
   1.35
$
   2.31
$
   4.57
                 
Diluted earnings per share
               
Earnings from continuing operations
$
1.38
$
1.33
$
2.29
$
4.27
Earnings from discontinued operations
 
--
 
--
 
--
 
0.23
Diluted earnings per share
$
  1.38
$
   1.33
$
   2.29
$
   4.50
                 
Comprehensive Income
               
Net earnings
$
 101
$
 100
$
 168
$
 348
Other comprehensive income (loss)
               
Change in cumulative translation adjustment, net of tax
 
2
 
(27)
 
17
 
(68)
Change in pension plans, net of tax
 
--
 
(1)
 
(2)
 
7
Change in unrealized gains (losses) on derivative instruments, net of tax
 
(7)
 
(6)
 
(6)
 
(3)
Total other comprehensive income (loss)
 
(5)
 
(34)
 
9
 
(64)
Comprehensive income
$
96
$
  66
$
177
$
 284
                 
Retained Earnings
               
Retained earnings at beginning of period
$
2,566
$
2,529
$
2,563
$
2,349
Net earnings
 
 101
 
 100
 
 168
 
 348
Cash dividends declared
 
(32)
 
(31)
 
(96)
 
(99)
Retained earnings at end of period
$
2,635
$
2,598
$
2,635
$
2,598

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

3

 


   
September 30,
 
December 31,
(Dollars in millions, except per share amounts)
 
2009
 
2008
   
(Unaudited)
   
Assets
     
 
Current assets
       
Cash and cash equivalents
$
668
$
387
Trade receivables, net
 
316
 
275
Miscellaneous receivables
 
68
 
79
Inventories
 
495
 
637
Other current assets
 
33
 
45
Total current assets
 
1,580
 
1,423
         
Properties and equipment
       
Properties and equipment at cost
 
8,636
 
8,527
Less:  Accumulated depreciation
 
5,363
 
5,329
Net properties and equipment
 
3,273
 
3,198
         
Goodwill
 
326
 
325
Other noncurrent assets
 
375
 
335
Total assets
$
5,554
$
5,281
         
Liabilities and Stockholders' Equity
       
Current liabilities
       
Payables and other current liabilities
$
827
$
819
Borrowings due within one year
 
1
 
13
Total current liabilities
 
828
 
 832
         
Long-term borrowings
 
1,440
 
1,442
Deferred income tax liabilities
 
274
 
106
Post-employment obligations
 
1,250
 
1,246
Other long-term liabilities
 
117
 
102
Total liabilities
 
3,909
 
3,728
         
Stockholders' equity
       
Common stock ($0.01 par value – 350,000,000 shares authorized; shares issued – 94,659,859 and 94,495,860 for 2009 and 2008, respectively)
 
1
 
1
Additional paid-in capital
 
649
 
638
Retained earnings
 
2,635
 
2,563
Accumulated other comprehensive loss
 
(326)
 
(335)
   
2,959
 
2,867
Less: Treasury stock at cost (22,035,296 shares for 2009 and 22,031,357 shares for 2008)
 
1,314
 
1,314
         
Total stockholders' equity
 
1,645
 
1,553
         
Total liabilities and stockholders' equity
$
5,554
$
5,281
         
The accompanying notes are an integral part of these consolidated financial statements.
 

4

 


   
First Nine Months
(Dollars in millions)
 
2009
 
2008
         
Cash flows from operating activities
       
Net earnings
$
168
$
348
 
       
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
       
Depreciation and amortization
 
203
 
199
Asset impairments charges
 
--
 
1
Gains on sale of assets
 
--
 
(13)
Provision (benefit) for deferred income taxes
 
165
 
(56)
Changes in operating assets and liabilities, net of effect of acquisitions and divestitures:
       
(Increase) decrease in trade receivables
 
(35)
 
(16)
(Increase) decrease in inventories
 
141
 
(170)
Increase (decrease) in trade payables
 
(8)
 
(49)
Increase (decrease) in liabilities for employee benefits and incentive pay
 
(14)
 
(6)
Other items, net
 
48
 
55
         
Net cash provided by operating activities
 
 668
 
 293
         
Cash flows from investing activities
       
Additions to properties and equipment
 
(268)
 
(430)
Proceeds from sale of assets
 
25
 
333
Acquisitions of and investments in joint ventures
 
--
 
(38)
Additions to capitalized software
 
(6)
 
(8)
Other items, net
 
(64)
 
(2)
         
Net cash used in investing activities
 
(313)
 
(145)
         
Cash flows from financing activities
       
Net increase in commercial paper, credit facility and other borrowings
 
23
 
42
Repayment of borrowings
 
(16)
 
(175)
Dividends paid to stockholders
 
(96)
 
(103)
Treasury stock purchases
 
--
 
(501)
Proceeds from stock option exercises and other items
 
15
 
38
         
Net cash used in financing activities
 
(74)
 
(699)
         
Effect of exchange rate changes on cash and cash equivalents
 
--
 
--
         
Net change in cash and cash equivalents
 
 281
 
(551)
         
Cash and cash equivalents at beginning of period
 
387
 
888
         
Cash and cash equivalents at end of period
$
 668
$
 337

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


 
5

 


Page
   
Note 1.    Basis of Presentation
7
7
Note 3.    Inventories
8
8
8
Note 6.    Borrowings
9
9
Note 8.    Retirement Plans
10
Note 9.    Environmental Matters
11
Note 10.  Commitments
12
13
15
16
16
17
Note 16.  Legal Matters
18
19

 
6

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


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 2008 Annual Report on Form 10-K and should be read in conjunction with the consolidated financial statements in Part II, Item 8 of the Company's 2008 Annual Report on Form 10-K.  The unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States ("GAAP") and, of necessity, include some amounts that are based upon management estimates and judgments.  Future actual results could differ from such current estimates.  The unaudited consolidated financial statements include assets, liabilities, revenues, and expenses of all majority-owned subsidiaries and joint ventures.  Eastman accounts for other joint ventures and investments in minority-owned companies where it exercises significant influence, but does not have control, on the equity basis.  Intercompany transactions and balances are eliminated in consolidation.  Certain prior period data has been reclassified in the Consolidated Financial Statements and accompanying footnotes to conform to current period presentation.

The Company has evaluated the period from September 30, 2009, the date of the financial statements, through October 23, 2009, the date of the issuance and filing of the financial statements and has determined that no material subsequent events have occurred that would affect the information presented in these financial statements or require additional disclosure.


In first quarter 2008, the Company sold its polyethylene terephthalate ("PET") polymers and purified terephthalic acid ("PTA") production facilities in the Netherlands and its PET production facility in the United Kingdom and related businesses for approximately $329 million.  The Company recognized a gain of $18 million, net of tax, related to the sale of these businesses which included the recognition of deferred currency translation adjustments of approximately $40 million, net of tax.  In addition, the Company indemnified the buyer against certain liabilities primarily related to taxes, legal matters, environmental matters, and other representations and warranties.

The sale of the manufacturing facilities in the Netherlands and United Kingdom, and related businesses completed the Company's exit from the European PET business and qualified as a component of an entity under GAAP for the impairment or disposal of long-lived assets, and accordingly their results are presented as discontinued operations and are not included in the results from continuing operations for the effected period presented in the Company's unaudited consolidated financial statements.

In fourth quarter 2007, the Company sold its PET polymers production facilities in Mexico and Argentina and the related businesses.  The results related to the Mexico and Argentina facilities were not presented as discontinued operations due to continuing involvement of the Company's Performance Polymers segment in the region including contract polymer intermediates sales under a transition supply agreement to the divested sites through 2008.

Operating results of the discontinued operations which were formerly included in the Performance Polymers segment are summarized below:
 
 
   
First Nine Months
(Dollars in millions)
 
2008
     
Sales
$
169
Earnings before income taxes
 
2
Gain on disposal, net of tax
 
18

 

 
7

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


3.  
 
 
September 30,
 
December 31,
(Dollars in millions)
2009
 
2008
       
At FIFO or average cost (approximates current cost)
     
Finished goods
$
535
$
634
Work in process
161
 
200
Raw materials and supplies
259
 
328
Total inventories
955
 
1,162
LIFO Reserve
(460)
 
(525)
Total inventories
$
495
$
637

Inventories valued on the LIFO method were approximately 70 percent as of September 30, 2009 and 75 percent as of December 31, 2008 of total inventories.

 
   
September 30,
 
December 31,
(Dollars in millions)
 
2009
 
2008
         
Trade creditors
$
403
$
390
Accrued payrolls, vacation, and variable-incentive compensation
 
110
 
129
Accrued taxes
 
60
 
41
Post-employment obligations
 
62
 
60
Interest payable
 
25
 
30
Bank overdrafts
 
25
 
4
Other
 
142
 
165
Total payables and other current liabilities
$
827
$
819

The current portion of post-employment obligations is an estimate of current year payments in excess of plan assets.
 

 
Third Quarter
 
First Nine Months
(Dollars in millions)
2009
 
2008
 
2009
 
2008
               
Provision for income taxes
$
69
$
48
$
110
$
124
Effective tax rate
 
40 %
 
33 %
 
39 %
 
27 %

Third quarter 2009 effective tax rate reflects a $12 million tax charge associated with the recapture of gasification investment tax credits.  Third quarter 2008 effective tax rate reflected an $8 million benefit from the reversal of a U.S. capital loss valuation allowance associated with the sale of businesses, and a $6 million benefit from the settlement of a non-U.S. income tax audit.  
 
First nine months 2009 effective tax rate reflects a $12 million tax charge associated with the recapture of gasification investment tax credits and a $7 million tax charge associated with a change in accounting method for tax purposes to accelerate timing of deductions for manufacturing repairs expense.  First nine months 2008 effective tax rate reflected the estimated benefit resulting from the gasification investment tax credit, an $8 million benefit from the reversal of a U.S. capital loss valuation allowance associated with the sale of businesses, and a $6 million benefit from the settlement of a non-U.S. income tax audit.  Including the above items, first nine months 2009 and 2008 effective tax rates reflect the Company's expected full year tax rate on reported earnings from continuing operations before income tax, of approximately 38 and 28 percent, respectively.

 
8

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The Company or one of its subsidiaries files tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions.  With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2004, or non-U.S. income tax examinations by tax authorities for years before 2003.

6.  

   
September 30,
 
December 31,
(Dollars in millions)
 
2009
 
2008
         
Borrowings consisted of:
       
7% notes due 2012
$
152
$
154
6.30% notes due 2018
 
206
 
207
7 1/4% debentures due 2024
 
497
 
497
7 5/8% debentures due 2024
 
200
 
200
7.60% debentures due 2027
 
298
 
298
Credit facilities borrowings
 
85
 
84
Other
 
3
 
15
Total borrowings
 
1,441
 
1,455
Borrowings due within one year
 
(1)
 
(13)
Long-term borrowings
$
1,440
$
1,442

At September 30, 2009, the Company had credit facilities with various U.S. and foreign banks totaling approximately $800 million.  These credit facilities consist of a $700 million revolving credit facility (the "Credit Facility"), as well as a 58 million euro credit facility ("Euro Facility").  The Credit Facility has two tranches, with $125 million expiring in 2012 and $575 million expiring in 2013.  The Euro Facility expires in 2012.  Borrowings under these credit facilities are subject to interest at varying spreads above quoted market rates.  The Credit Facility requires a facility fee on the total commitment.  In addition, these credit facilities contain a number of customary 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.  At September 30, 2009, the Company's credit facility borrowings totaled $85 million at an effective interest rate of 0.79 percent.  At December 31, 2008, the Company's credit facility borrowings totaled $84 million at an effective interest rate of 3.74 percent.

The Credit Facility provides liquidity support for commercial paper borrowings and general corporate purposes.  Accordingly, any outstanding commercial paper borrowings reduce borrowings available under the Credit Facility.  Given the expiration dates of the Credit Facility, any commercial paper borrowings supported by the Credit Facility are classified as long-term borrowings because the Company has the ability and intent to refinance such borrowings on a long-term basis.


In first nine months 2009, restructuring charges were $23 million, net.  The charges, primarily for severance, resulted from a reduction in force.

In third quarter and first nine months 2008, asset impairments and restructuring charges, net totaled $2 million and $22 million, respectively, primarily for severance, pension charges, and site closure costs in the Performance Chemicals and Intermediates ("PCI") segment resulting from the decision to close a previously impaired site in the United Kingdom, and in the Performance Polymers segment for restructuring at the South Carolina facility and the divestiture of the PET manufacturing facilities in Mexico and Argentina.


 
9

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Changes in Reserves for Asset Impairments, Restructuring Charges, and Severance Charges

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 for full year 2008 and first nine months 2009:
 
 
(Dollars in millions)
 
Balance at
January 1, 2008
 
Provision/ Adjustments
 
Non-cash Reductions
 
Cash Reductions
 
Balance at
December 31, 2008
                     
Non-cash charges
$
--
$
2
$
(2)
$
--
$
--
Severance costs
 
7
 
10
 
--
 
(12)
 
5
Site closure and other  restructuring costs
 
11
 
34
 
--
 
(20)
 
25
Total
$
18
$
  46
$
(2)
$
(32)
$
30
                     
   
Balance at
January 1, 2009
 
Provision/ Adjustments
 
Non-cash Reductions
 
Cash Reductions
 
Balance at
September 30, 2009
                     
Non-cash charges
$
--
$
--
$
--
$
--
$
--
Severance costs
 
5
 
24
 
--
 
(18)
 
11
Site closure and other  restructuring costs
 
25
 
(1)
 
--
 
--
 
24
Total
$
30
$
  23
$
--
$
(18)
$
35

A majority of the remaining severance and site closure costs is expected to be applied to the reserves within one year.
 

DEFINED BENEFIT PENSION PLANS

Eastman maintains defined benefit pension 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:
 
Summary of Components of Net Periodic Benefit Costs
       
   
Third Quarter
 
First Nine Months
(Dollars in millions)
 
2009
 
2008
 
2009
 
2008
                 
Service cost
$
10
$
11
$
31
$
34
Interest cost
 
22
 
22
 
65
 
66
Expected return on assets
 
(25)
 
(26)
 
(74)
 
(79)
Curtailment charge
 
--
 
--
 
--
 
9
Amortization of:
               
Prior service credit
 
(4)
 
(5)
 
(12)
 
(12)
Actuarial loss
 
8
 
7
 
25
 
21
Net periodic benefit cost
$
  11
$
   9
$
  35
$
  39

The Company contributed $30 million to its U.S. defined benefit pension plan in third quarter 2009.

The curtailment charge in 2008 was primarily related to the decision to close a previously impaired site in the United Kingdom.

 
10

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


POSTRETIREMENT WELFARE PLANS

Eastman provides a subsidy toward life insurance, health care, and dental benefits for eligible retirees hired prior to January 1, 2007, and a subsidy toward health care benefits for retirees' eligible survivors.  In general, Eastman provides those benefits to retirees eligible under the Company's U.S. plans.  Similar benefits are also made available to retirees of Holston Defense Corporation, a wholly-owned subsidiary of the Company that, prior to January 1, 1999, operated a government-owned ammunitions plant.

Eligible employees hired on or after January 1, 2007 have access to postretirement health care benefits, but Eastman does not provide a subsidy toward the premium cost of postretirement health care benefits for those employees.

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.

Costs recognized for benefits for eligible retirees hired prior to January 1, 2007 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 the Company's U.S. plans:

Summary of Components of Net Periodic Benefit Costs
       
   
Third Quarter
 
First Nine Months
(Dollars in millions)
 
2009
 
2008
 
2009
 
2008
                 
Service cost
$
2
$
2
$
6
$
5
Interest cost
 
12
 
11
 
34
 
33
Expected return on assets
 
(1)
 
(1)
 
(2)
 
(3)
Amortization of:
               
Prior service credit
 
(5)
 
(6)
 
(17)
 
(17)
Actuarial loss
 
4
 
2
 
10
 
7
Net periodic benefit cost
$
  12
$
   8
$
  31
$
  25


Certain Eastman manufacturing sites generate hazardous and nonhazardous wastes, the treatment, storage, transportation, and disposal of which are regulated by various governmental agencies.  In connection with the cleanup of various hazardous waste sites, the Company, along with many other entities, has been designated a potentially responsible party ("PRP") by the U.S. Environmental Protection Agency under the Comprehensive Environmental Response, Compensation and Liability Act, which potentially subjects PRPs to joint and several liability for such cleanup costs.  In addition, the Company could be required to incur costs for environmental remediation and closure and postclosure under the federal Resource Conservation and Recovery Act.  Reserves for environmental contingencies have been established in accordance with Eastman's policies described in Note 1, "Significant Accounting Policies", to the consolidated financial statements in Part II, Item 8 of the Company's 2008 Annual Report on Form 10-K.  Because of expected sharing of costs, the availability of legal defenses, and the Company's preliminary assessment of actions that may be required, management does not believe that the Company's liability for these environmental matters, individually or in the aggregate, will be material to the Company's consolidated financial position, results of operations or cash flows.  The Company's reserve for environmental contingencies was $42 million and $41 million at September 30, 2009 and December 31, 2008, respectively, representing the minimum or best estimate for remediation costs and the best estimate accrued to date over the facilities' estimated useful lives for asset retirement obligation costs.  Estimated future environmental expenditures for remediation costs range from the minimum or best estimate of $10 million to the maximum of $21 million at September 30, 2009, and $11 million to the maximum of $21 million at December 31, 2008.


 
11

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


10.  

Purchasing Obligations and Lease Commitments

At September 30, 2009, the Company had various purchase obligations totaling approximately $1.3 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 $103 million over a period of several years.  Of the total lease commitments, approximately 17 percent relate to machinery and equipment, including computer and communications equipment and production equipment; approximately 41 percent relate to real property, including office space, storage facilities and land; and approximately 42 percent relate to vehicles, primarily railcars.

Accounts Receivable Securitization Program

In 1999, the Company entered into an agreement that allows the Company to sell certain trade receivables on a non-recourse basis to a consolidated special purpose entity which in turn may sell interests in those receivables to a third party purchaser which generally funds its purchases via the issuance of commercial paper backed by the receivables interests.  The annually renewable agreement permits the sale of undivided interests in domestic trade accounts receivable.  The assets of the special purpose entity are not available to satisfy the Company's general obligations.  Receivables sold to the third party totaled $200 million at September 30, 2009 and December 31, 2008.  Undivided interests in designated receivable pools were sold to the purchaser with recourse limited to the purchased interest in the receivable pools.  Average monthly proceeds from collections reinvested in the continuous sale program were approximately $245 million and $370 million in third quarter 2009 and 2008, respectively, and $225 million and $345 million in first nine months 2009 and 2008, respectively.  The securitization program was fully drawn at September 30, 2009 and renewed in July 2009.
 
Guarantees

The Company has operating leases with terms that require the Company to guarantee a portion of the residual value of the leased assets upon termination of the lease.  These residual value guarantees at September 30, 2009 totaled $159 million and consisted of leases for railcars and aircraft.  Leases with guarantee amounts totaling $11 million, $138 million, and $10 million will expire in 2011, 2012, and 2014 and beyond, respectively.  The Company believes, based on current facts and circumstances, that the likelihood of a material payment pursuant to such guarantees is remote.

Variable Interest Entities

The Company has evaluated its material contractual relationships and has concluded that the entities involved in these relationships are not Variable Interest Entities ("VIEs") or, in the case of Primester, a joint venture that manufactures cellulose acetate at the Company's Kingsport, Tennessee plant, the Company is not the primary beneficiary of the VIE.  As such, in accordance with consolidations rules included in GAAP, the Company is not required to consolidate these entities.  In addition, the Company has evaluated long-term purchase obligations with an entity that may be a VIE at September 30, 2009.  This potential VIE is a joint venture from which the Company has purchased raw materials and utilities for several years.  The Company purchased approximately $50 million of raw materials and utilities during 2008 and expects to purchase approximately $35 million during 2009.  The Company has no equity interest in this entity and has confirmed that one party to this joint venture does consolidate the potential VIE.  However, due to competitive and other reasons, the Company has not been able to obtain the necessary financial information to determine whether the entity is a VIE, and whether or not the Company is the primary beneficiary.

 
 
12

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



Fair Value of Borrowings

GAAP requires public companies to disclose the fair value of financial assets and liabilities whenever summarizing financial information for interim reporting periods.  The fair value for fixed-rate borrowings is based on current interest rates for comparable securities.  The Company's floating-rate borrowings approximate fair value.

(Dollars in millions)
 
September 30, 2009
 
December 31, 2008
   
Recorded Amount
 
Fair Value
 
Recorded Amount
 
Fair Value
                 
Long-term borrowings
$
1,440
$
1,484
   $
1,442
$
1,369

Fair Value Measurements

On January 1, 2008, the Company began recording financial assets and liabilities subject to recurring fair value measurement at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  On January 1, 2009 the Company began recording non-recurring financial as well as all non-financial assets and liabilities subject to fair value measurement under the same principles.  These fair value principles prioritize valuation inputs across three broad levels.  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.  Level 3 inputs are unobservable inputs based on the Company's assumptions used to measure assets and liabilities at fair value.  An asset or liability's classification within the various levels is determined based on the lowest level input that is significant to the fair value measurement.

The following chart shows the financial assets and liabilities valued on a recurring basis.

(Dollars in millions)
 
Fair Value Measurements at September 30, 2009
Description
 
September 30, 2009
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Derivative Assets
$
12
$
--
$
12
$
--
Derivative Liabilities
 
(6)
 
--
 
(6)
 
--
 
$
   6
$
   --
$
6
$
   --


(Dollars in millions)
 
Fair Value Measurements at December 31, 2008
Description
 
December 31, 2008
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Derivative Assets
$
16
$
--
$
16
$
--
Derivative Liabilities
 
(14)
 
--
 
(14)
 
--
 
$
2
$
--
$
2
$
--
                 
Hedging Programs

The Company is exposed to market risk, such as changes in 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.  For further information, see Note 10, "Fair Value of Financial Instruments", to the consolidated financial statements in Part II, Item 8 of the Company's 2008 Annual Report on Form 10-K.
 
 
13

 
 
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
Fair Value Hedges
Fair value hedges are defined by GAAP as derivative or non-derivative instruments designated as and used to hedge the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk.  For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings.

As of September 30, 2009, the Company had no active fair value hedges.

Cash Flow Hedges
Cash flow hedges are defined by GAAP as derivative instruments designated as and used to hedge the exposure to variability in expected future cash flows that is attributable to a particular risk.  For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income, net of income taxes and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  Gains and losses on the derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

As of September 30, 2009, the total amount of the Company's foreign exchange forward and option contracts was a $5 million asset.  As of September 30, 2009, the total amount of the Company's feedstock/energy forward and option contracts was a $1 million asset.

Fair Value of Derivatives Designated as Cash Flow Hedging Instruments

 (Dollars in millions)
 
September 30, 2009
Asset Derivatives
 
Balance Sheet Location
 
Fair Value
Commodity contract
 
Other current assets
  $
2
Foreign exchange contracts
 
Other current assets
 
6
     
$
8
 
 
(Dollars in millions)
 
September 30, 2009
Liability Derivatives
 
Balance Sheet Location
 
Fair Value
Commodity  contract
 
Payables and other current liabilities
$
1
Foreign exchange contacts
 
Other noncurrent liabilities
 
1
     
$
2


 
14

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



Derivatives' Cash Flow Hedging Relationships

(Dollars in millions)
 
Third Quarter 2009
 
Derivatives Cash Flow Hedging Relationships
 
Amount after tax of gain/ (loss) recognized in Other Comprehensive Income on derivatives (effective portion)
 
Location of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
 
Pre-tax amount of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
 
September 30, 2009
   
September 30, 2009
Commodity  contract
$
1
 
Cost of sales
$
--
Foreign exchange contracts
 
(8)
 
Sales
 
5
 
$
(7)
   
$
5

(Dollars in millions)
 
First Nine Months 2009
 
Derivatives Cash Flow Hedging Relationships
 
Amount after tax of gain/ (loss) recognized in Other Comprehensive Income on derivatives (effective portion)
 
Location of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
 
Pre-tax amount of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
 
September 30, 2009
   
September 30, 2009
Commodity  contract
$
6
 
Cost of sales
$
(9)
Foreign exchange contracts
 
(12)
 
Sales
 
19
 
$
(6)
   
$
10

For third quarter and nine months ended September 30, 2009, there was no material ineffectiveness with regard to the Company's cash flow hedges.

Nondesignated / Nonqualifying Derivative Instruments
The gains or losses on nonqualifying derivatives or derivatives that are not designated as hedges are marked to market in the line item "Other charges (income), net" of the Statements of Earnings.  The Company recognized approximately $4 million net loss on nonqualifying derivatives during the quarter ended September 30, 2009.  The Company recognized less than $3 million net loss on nonqualifying derivatives during the nine months ended September 30, 2009.


A reconciliation of the changes in stockholders' equity in first nine months 2009 is provided below:

(Dollars in millions)
Common Stock at Par Value
$
Paid-in Capital
$
Retained Earnings
$
Accumulated Other Comprehensive Income (Loss)
$
Treasury Stock at Cost
$
Total Stockholders' Equity
$
Balance at December 31, 2008
1
638
2,563
(335)
(1,314)
1,553
             
Net Earnings
 --
 --
168
 --
 --
168
Cash Dividends Declared (1)
 --
 --
(96)
 --
 --
(96)
Other Comprehensive Income
 --
 --
 --
9
 --
9
Stock-Based Compensation Expense (2)
 --
13
 --
 --
 --
13
Other (3)
--
(2)
--
--
--
(2)
Balance at September 30, 2009
 1
649
2,635
(326)
 (1,314)
 1,645

  (1)
Includes cash dividends declared, but unpaid.
  (2)
The fair value of equity share-based awards recognized under GAAP for share-based payments.
  (3)
The tax benefits relating to the difference between the amounts deductible for federal income taxes over the amounts charged to income for book value purposes have been credited to paid-in capital.

 
15

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX

 
 
 
 
(Dollars in millions)
 
Cumulative Translation Adjustment
$
 Unrecognized Loss and Prior Service Cost
$
Unrealized Gains (Losses) on Derivative Instruments
$
 
Unrealized Losses on Investments
$
Accumulated Other Comprehensive Income (Loss)
$
Balance at December 31, 2007
157
(182)
(3)
--
(28)
Period change
(97)
(232)
23
(1)
(307)
Balance at December 31, 2008
60
(414)
20
(1)
(335)
Period change
17
(2)
(6)
--
9
Balance at September 30, 2009
77
(416)
14
(1)
(326)

Amounts of other comprehensive income (loss) are presented net of applicable taxes.  The Company records deferred income taxes on the cumulative translation adjustment related to branch operations and other entities included in the Company's consolidated U.S. tax return.  No deferred income taxes are provided on the cumulative translation adjustment of subsidiaries outside the United States, as such cumulative translation adjustment is considered to be a component of permanently invested, unremitted earnings of these foreign subsidiaries.


 
Third Quarter
 
First Nine Months
 
2009
 
2008
 
2009
 
2008
               
Shares used for earnings per share calculation (in millions):
             
Basic
72.6
 
74.2
 
72.5
 
76.1
Diluted
73.5
 
75.1
 
73.3
 
77.2

In third quarter and first nine months 2009, common shares underlying options to purchase 3,037,007 shares of common stock and 3,720,448 shares of common stock, respectively, were excluded from the computation of diluted earnings per share because the total market value of option exercises for these awards was less than the total proceeds that would be received for these awards.  There were no share repurchases in first nine months 2009.
 
In third quarter and first nine months 2008, common shares underlying options to purchase 655,884 shares of common stock and 596,784 shares of common stock, respectively, were excluded from the computation of diluted earnings per share because the total market value of option exercises for these awards was less than the total proceeds that would be received for these awards.  Third quarter and first nine months 2008 reflect the impact of share repurchases of 3.9 million and 8.1 million shares, respectively.
 
The Company declared cash dividends of $0.44 per share in third quarter 2009 and 2008 and $1.32 per share in first nine months 2009 and 2008.
 

The Company utilizes share-based awards under employee and non-employee director compensation programs.  These share-based awards may include restricted and unrestricted stock, restricted stock units, stock options, and performance shares.  In third quarter 2009 and 2008, approximately $4 million and $6 million of compensation expense before tax were recognized in selling, general and administrative expense in the earnings statement for all share-based awards.  The impact on third quarter 2009 and 2008 net earnings of $3 million and $4 million, respectively, is net of deferred tax expense related to share-based award compensation.

In first nine months 2009 and 2008, $13 million and $19 million, respectively, of compensation expense before tax were recognized in selling, general and administrative expense in the earnings statement for all share-based awards.  The impact on first nine months 2009 and 2008 net earnings of $8 million and $12 million, respectively, is net of deferred tax expense related to share-based award compensation.

 
16

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 
Additional information regarding share-based compensation plans and awards may be found in Note 16, "Share-Based Compensation Plans and Awards", to the consolidated financial statements in Part II, Item 8 of the Company's 2008 Annual Report on Form 10-K.


The Company's products and operations are managed and reported in five reportable operating segments, consisting of the Coatings, Adhesives, Specialty Polymers, and Inks ("CASPI") segment, the Fibers segment, the PCI segment, the Performance Polymers segment, and the Specialty Plastics ("SP") segment.  For additional information concerning the Company's segments' businesses and products, see Note 23, "Segment Information", to the consolidated financial statements in Part II, Item 8 of the Company's 2008 Annual Report on Form 10-K.

Research and development and other expenses not identifiable to an operating segment are not included in segment operating results for either of the periods presented and are shown in the tables below as "other" operating losses.

   
Third Quarter
(Dollars in millions)
 
2009
 
2008
Sales by Segment
       
CASPI
$
338
$
410
Fibers
 
257
 
269
PCI
 
355
 
594
Performance Polymers
 
187
 
293
SP
 
200
 
253
Total Sales
$
1,337
$
1,819

   
First Nine Months
(Dollars in millions)
 
2009
 
2008
Sales by Segment
       
CASPI
$
890
$
1,213
Fibers
 
779
 
783
PCI
 
943
 
1,768
Performance Polymers
 
563
 
886
SP
 
544
 
730
Total Sales
$
3,719
$
5,380

   
Third Quarter
(Dollars in millions)
 
2009
 
2008
Operating Earnings (Loss)
       
CASPI
$
84
$
55
Fibers
 
79
 
65
PCI (1)
 
33
 
62
Performance Polymers (2)
 
(10)
 
(1)
SP
 
13
 
6
Total Operating Earnings by Segment
 
 199
 
 187
Other
 
(8)
 
(13)
         
Total Operating Earnings
$
 191
$
 174

(1)  
Third quarter 2008 includes $1 million of asset impairments and restructuring charges, net primarily related to severance and pension costs from the decision to close a previously impaired site in the United Kingdom and $2 million in accelerated depreciation costs resulting from the previously reported shutdown of cracking units at the Company's Longview, Texas facility.
(2)  
Third quarter 2008 includes $1 million of asset impairments and restructuring charges, net related to previously divested manufacturing facilities in Mexico and Argentina and restructuring at the South Carolina facility using IntegRexTM technology, partially offset by a resolution of a contingency from the sale of the Company's polyethylene ("PE") and EpoleneTM polymer businesses divested in fourth quarter 2006, and $1 million of accelerated depreciation costs resulting from restructuring actions associated with certain assets in Columbia, South Carolina.
 

 
17

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



   
First Nine Months
(Dollars in millions)
 
2009
 
2008
Operating Earnings (Loss)
       
CASPI (1)(2)
$
148
$
167
Fibers (1)
 
222
 
195
PCI (1)(3)
 
35
 
160
Performance Polymers (1)(4)
 
(32)
 
(5)
SP (1)
 
3
 
36
Total Operating Earnings by Segment
 
 376
 
 553
Other
 
(29)
 
(39)
         
Total Operating Earnings
$
 347
$
 514

(1)  
First nine months 2009 includes a restructuring charge primarily for a severance program of $5 million, $4 million, $6 million, $4 million, and $4 million in the CASPI, Fibers, PCI, Performance Polymers, and SP segments, respectively.
(2)  
First nine months 2008 includes $2 million in gains for an adjustment to a reserve for asset impairments and restructuring charges, net for the first quarter 2008 divestiture of certain product lines.
(3)  
First nine months 2008 includes $20 million of asset impairments and restructuring charges, net primarily related to severance and pension costs from the decision to close a previously impaired site in the United Kingdom and $4 million of accelerated depreciation costs resulting from the previously reported shutdown of cracking units at the Company's Longview, Texas facility.
(4)  
First nine months 2008 includes $4 million of asset impairments and restructuring charges, net related to previously divested manufacturing facilities in Mexico and Argentina and restructuring at the South Carolina facility using IntegRexTM technology, partially offset by a resolution of a contingency from the sale of the Company's PE and EpoleneTM polymer businesses divested in fourth quarter 2006 and $4 million of accelerated depreciation costs resulting from restructuring actions associated with certain assets in Columbia, South Carolina.

   
September 30,
 
December 31,
(Dollars in millions)
 
2009
 
2008
Assets by Segment (1)
       
CASPI
$
1,132
$
1,150
Fibers
 
724
 
750
PCI
 
790
 
834
Performance Polymers
 
658
 
728
SP
 
903
 
818
Total Assets by Segment
 
4,207
 
4,280
Corporate Assets (2)
 
1,347
 
1,001
         
Total Assets
$
                   5,554
$
                   5,281

(1)  
Assets managed by segment are accounts receivable, inventory, fixed assets, and goodwill.
(2)  
Corporate assets includes approximately $230 million and $200 million at September 30, 2009 and December 31, 2008, respectively, for the Beaumont, Texas gasification project, which consists of land, capitalized front-end engineering and design, methanol and ammonia assets, intangible assets, and goodwill.

16.  

From time to time, the Company and its operations are parties to, or targets of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, asbestos, patent and intellectual property, commercial, contract, environmental, antitrust, health and safety, and employment matters, which are being handled and defended in the ordinary course of business.  While the Company is unable to predict the outcome of these matters, it does not believe, based upon currently available facts, that the ultimate resolution of any such pending matters will have a material adverse effect on its overall financial condition, results of operations or cash flows.  However, adverse developments could negatively impact earnings or cash flows in a particular future period.


 
18

 
 

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 
In June 2009, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 166, "Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140" ("SFAS No. 166").  This statement addresses the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets.  This statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter.  The Company is currently evaluating the effect SFAS No. 166 will have on its consolidated financial position, liquidity, or results of operations.

In June 2009, the FASB issued SFAS No. 167, "Amendments to FASB Interpretation No. 46(R)" ("SFAS No. 167").  This statement amends certain requirements of FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities", to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements.  This statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter.  The Company is currently evaluating the effect SFAS No. 167 will have on its consolidated financial position, liquidity, or results of operations.

 

 
19

 
 

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 Eastman Chemical Company's (the "Company" or "Eastman") audited consolidated financial statements, including related notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's 2008 Annual Report on Form 10-K, and the Company's unaudited consolidated financial statements, including related notes, included elsewhere in this report.  All references to earnings per share contained in this report are diluted earnings per share unless otherwise noted.

As described below in "Presentation of Non-GAAP Financial Measures", the Company sold its polyethylene terephthalate ("PET") manufacturing facility in Spain in the second quarter 2007 and sold its PET polymers and purified terephthalic acid ("PTA") manufacturing facilities in the Netherlands and its PET manufacturing facility in the United Kingdom and the related businesses in first quarter 2008.  Because the Company has exited the PET business in the European region, results from sales of PET products manufactured at the Spain, the Netherlands, and the United Kingdom sites, including impairments and restructuring charges of those operations, and gains and losses from disposal of those assets and businesses, are presented as discontinued operations for all periods presented and are therefore not included in results from continuing operations under accounting principles generally accepted in the United States ("GAAP").  For additional information, see Note 2, "Discontinued Operations", to the Company's unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.



 
20

 
 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


In preparing the consolidated financial statements in conformity with GAAP, 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, sales revenue and expenses, and related disclosure of contingent assets and liabilities.  On an ongoing basis, the Company evaluates its estimates, including those related to allowances for doubtful accounts, impairment of long-lived assets, environmental costs, pension and other post-employment benefits, litigation and contingent liabilities, and income taxes.  The Company 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 estimates listed and described in Part II, Item 7 of the Company's 2008 Annual Report on Form 10-K are the most important to the fair presentation of the Company's financial condition and results.  These estimates require management's most significant judgments in the preparation of the Company's consolidated financial statements.


During 2009, the Company recognized $23 million in restructuring charges, primarily for severance, resulting from a reduction in force.

During 2007 and 2008, the Company took strategic actions in its Performance Polymers segment to address its underperforming PET manufacturing facilities outside the United States.  In second quarter 2007, the Company completed the sale of its PET manufacturing facility in Spain and in first quarter 2008, the Company completed the sale of its PET polymers and PTA manufacturing facilities in the Netherlands and the PET manufacturing facility in the United Kingdom and related businesses.  Results from, charges related to, and gains and losses from disposal of the Spain, the Netherlands, and the United Kingdom assets and businesses are presented as discontinued operations.  In fourth quarter 2007, the Company completed the sale of its Mexico and Argentina manufacturing facilities.  As part of this divestiture, the Company entered into transition supply agreements for polymer intermediates from which sales revenue and operating results are included in the Performance Polymers segment results in 2008.

In fourth quarter 2006, the Company sold its polyethylene ("PE") and EpoleneTM polymer businesses and related assets of the Performance Polymers and the Coatings, Adhesives, Specialty Polymers, and Inks ("CASPI") segments.  As part of the PE divestiture, the Company entered into a transition supply agreement for contract ethylene sales, from which sales revenue and operating results are included in the Performance Chemicals and Intermediates ("PCI") segment results in 2009 and 2008.

Also in fourth quarter 2006, the Company made strategic decisions relating to the scheduled shutdown of cracking units in Longview, Texas and a planned shutdown of higher cost PET assets in Columbia, South Carolina.  Accelerated depreciation costs resulting from these decisions were $3 million and $8 million in third quarter and first nine months 2008, respectively.  For more information on accelerated depreciation costs, see "Gross Profit" in the "Results of Operations" section of this Management's Discussion and Analysis.

This Management's Discussion and Analysis includes the following non-GAAP financial measures and accompanying reconciliations to the most directly comparable GAAP financial measures.  The non-GAAP financial measures used by the Company may not be comparable to similarly titled measures used by other companies and should not be considered in isolation or as a substitute for measures of performance or liquidity prepared in accordance with GAAP.
·  
Company and segment sales excluding contract ethylene sales under a transition agreement related to the divestiture of the PE product lines;
·  
Company and segment sales excluding contract polymer intermediates sales under a transition supply agreement related to the divestiture of the PET manufacturing facilities and related businesses in Mexico and Argentina;

 
21

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


·  
Company and segment gross profit, operating earnings, and earnings from continuing operations excluding accelerated depreciation costs and asset impairments and restructuring charges; and
 ·  
Company earnings from continuing operations excluding net deferred tax benefits related to the previous divestiture of businesses.

Eastman's management believes that contract ethylene sales under the transition agreement related to the divestiture of the PE product lines and the contract polymer intermediates sales under the transition supply agreement related to the divestiture of the PET manufacturing facilities and related businesses in Mexico and Argentina do not reflect the continuing and expected future business of the PCI and Performance Polymers segments or of the Company.  In addition, for evaluation and analysis of ongoing business results and of the impact on the Company and segments of strategic decisions and actions to reduce costs and to improve the profitability of the Company, management believes that Company and segment earnings from continuing operations should be considered both with and without accelerated depreciation costs, asset impairments and restructuring charges, and deferred tax benefits related to the previous divestiture of businesses.  Management believes that investors can better evaluate and analyze historical and future business trends if they also consider the reported Company and segment results, respectively, without the identified items.  Management utilizes Company and segment results including and excluding the identified items in the measures it uses to evaluate business performance and in determining certain performance-based compensation.  These measures, excluding the identified items, are not recognized in accordance with GAAP and should not be viewed as alternatives to the GAAP measures of performance.


The Company generated sales revenue of $1.3 billion and $1.8 billion in third quarter 2009 and 2008, respectively.  Excluding the results of contract ethylene sales and contract polymer intermediates sales from third quarter 2008, sales revenue decreased by 21 percent.  The Company generated sales revenue of $3.7 billion in first nine months 2009 compared to $5.4 billion in first nine months 2008.  Excluding the results of contract ethylene sales and contract polymer intermediates sales from both periods, sales revenue decreased by 26 percent.  Sales revenue decreases for both third quarter and first nine months 2009 compared to the same periods in 2008 were due to lower selling prices in response to lower raw material and energy costs and lower sales volume primarily attributed to the global recession.

Operating earnings were $191 million in third quarter 2009 compared with $174 million in third quarter 2008.  Excluding accelerated depreciation costs and asset impairments and restructuring charges, operating earnings were $179 million in third quarter 2008.  The increase in third quarter 2009 was due to lower raw material and energy costs and cost reduction actions more than offsetting lower selling prices and lower sales volume.  The increased operating margin was attributed to a favorable shift in company product mix due to a higher percentage of overall sales revenue from the Fibers, CASPI, and Specialty Plastics ("SP") segments compared to the PCI and Performance Polymers segments.

Operating earnings were $347 million in first nine months 2009 compared with $514 million in first nine months 2008.  Excluding asset impairments and restructuring charges in first nine months 2009 and 2008 and accelerated depreciation costs in first nine months 2008, operating earnings were $370 million in first nine months 2009 compared with $544 million in first nine months 2008.  Eastman's reduced earnings reflect continued weakness in demand for the Company's products that caused lower sales volume and continued low capacity utilization which resulted in higher unit costs.  This weakness in demand, which is attributed to the global recession, has been moderating throughout 2009 resulting in sequential sales volume and operating earnings increases each quarter.  First nine months 2009 operating earnings also included approximately $20 million in costs related to the reconfiguration of the Longview, Texas facility.  Operating earnings benefited from cost reduction actions which will positively impact results throughout the year.

Earnings from continuing operations were $101 million in third quarter 2009 compared to $100 million in third quarter 2008.  Excluding accelerated depreciation costs, asset impairments and restructuring charges, and net deferred tax benefits, earnings from continuing operations were $102 million in third quarter 2008.  Earnings from continuing operations were $168 million in first nine months 2009 compared to $330 million in first nine months 2008.  Excluding accelerated depreciation costs, asset impairments and restructuring charges, and net deferred tax benefits, earnings from continuing operations were $182 million and $338 million in first nine months 2009 and 2008, respectively.

 
22

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


The Company generated $668 million in cash from operating activities during first nine months 2009 compared to $293 million in first nine months 2008.  The improvement was primarily due to a decrease in working capital in 2009 compared to an increase in working capital in 2008, as well as a change in tax accounting method reflected as a provision for deferred income taxes.  The Company expects to generate positive free cash flow (operating cash flow less capital expenditures and dividends) in excess of $300 million in 2009, assuming continued difficult economic conditions and raw material and energy costs similar to current levels.
 
During third quarter 2009, the Company completed front-end engineering and design for its industrial gasification project in Beaumont, Texas, which resulted in a higher than anticipated capital cost estimate and a later estimated project completion date.  The Company continues to believe that the long-term business fundamentals of the project are favorable, and is evaluating alternatives to lower the overall project cost.  The Company is also pursuing government financing and incentives, and evaluating the possible impact of pending and proposed environmental legislation.  Given the uncertainty of the timing of the project, obtaining government financing and incentives, and possible environmental legislation, the Company has reduced spending for this project.

RESULTS OF OPERATIONS

 
Third Quarter
 
Volume Effect
 
Price Effect
 
Product
Mix Effect
 
Exchange
Rate
Effect
(Dollars in millions)
2009
 
2008
 
Change
 
                           
Sales
$
1,337
$
1,819
 
(27) %
 
(10) %
 
(17) %
 
-- %
 
-- %
                             
Sales - contract polymer intermediates sales (1)
 
--
 
35
                   
Sales - contract ethylene sales (2)
 
--
 
89
                   
Sales – excluding listed items
 
1,337
 
1,695
 
(21) %
 
(4) %
 
(18) %
 
1 %
 
-- %
                             

 
First Nine Months
 
Volume Effect
 
Price Effect
 
Product
Mix Effect
 
Exchange
Rate
Effect
(Dollars in millions)
2009
 
2008
 
Change
 
                           
Sales
$
3,719
$
5,380
 
(31) %
 
(18) %
 
(13) %
 
-- %
 
-- %
                             
Sales - contract polymer intermediates sales (1)
 
--
 
117
                   
Sales - contract ethylene sales (2)
 
18
 
283
                   
Sales – excluding listed items
 
3,701
 
4,980
 
(26) %
 
(12) %
 
(13) %
 
(1) %
 
-- %
                             
  (1) 
Included in 2008 sales revenue are contract polymer intermediates sales under the transition supply agreement related to the divestiture of the PET manufacturing facilities and related businesses in Mexico and Argentina in fourth quarter 2007.
(2) 
 Included in 2009 and 2008 sales revenue are contract ethylene sales under the transition supply agreement related to the divestiture of the PE businesses.

Sales revenue in third quarter 2009 compared to third quarter 2008 decreased $482 million.  Excluding revenue from the contract ethylene and polymer intermediates sales, sales revenue decreased $358 million in third quarter 2009 compared to third quarter 2008.  The decrease was primarily due to lower selling prices in response to lower raw material and energy costs, particularly in the PCI and Performance Polymers segments, and lower sales volume primarily attributed to weakened demand due to the global recession.

 
23

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


Sales revenue in first nine months 2009 compared to first nine months 2008 decreased $1.7 billion.  Excluding revenue from the contract ethylene and polymer intermediates sales, sales revenue decreased $1.3 billion in first nine months 2009 compared to first nine months 2008.  The decrease was due to lower selling prices in response to lower raw material and energy costs, particularly in the PCI and Performance Polymers segments, and lower sales volume primarily attributed to weakened demand due to the global recession.

 
Third Quarter
 
First Nine Months
(Dollars in millions)
2009
 
2008
 
Change
 
2009
 
2008
 
Change
                       
Gross Profit
$
328
$
322
 
2 %
$
767
$
980
 
(22) %
As a percentage of sales
 
25 %
 
18 %
     
21 %
 
18 %
   
                         
Accelerated depreciation costs included in cost of goods sold
 
--
 
3
     
--
 
8
   
                         
Gross profit excluding accelerated depreciation costs
 
328
 
325
 
1 %
 
767
 
988
 
(22) %
As a percentage of sales
 
25 %
 
18 %
     
21 %
 
18 %
   

Gross profit in third quarter 2009 increased slightly compared to third quarter 2008 with increases in the CASPI, Fibers, and SP segments offset by decreases in the PCI and Performance Polymers segments.  Gross profit as a percentage of sales in third quarter 2009 increased compared to third quarter 2008 due to lower raw material and energy costs and cost reduction actions more than offsetting lower selling prices and lower sales volume.  The increase was attributed to a favorable shift in company product mix due to a higher percentage of overall sales revenue from the Fibers, CASPI, and SP segments compared to the PCI and Performance Polymers segments.  Third quarter 2008 included accelerated depreciation costs of $3 million resulting from the previously reported shutdown of the cracking units in Longview, Texas and of higher cost PET polymer assets in Columbia, South Carolina.  The Company's third quarter raw material and energy costs decreased by approximately $350 million compared with third quarter 2008.

Gross profit in first nine months 2009 decreased compared to first nine months 2008 in all segments except the Fibers segment due to continued weakness in demand for the Company's products attributed to the global recession.  This weak demand caused lower sales volume and lower capacity utilization which resulted in higher unit costs.  In addition, first nine months 2009 included approximately $20 million in costs related to the reconfiguration of the Longview, Texas facility.  The reconfiguration costs impacted the PCI and CASPI segments.  First nine months 2009 also benefited from cost reduction actions.  First nine months 2008 included accelerated depreciation costs of $8 million resulting from the previously reported shutdown of the cracking units in Longview, Texas and of higher cost PET polymer assets in Columbia, South Carolina.  The Company's first nine months 2009 raw material and energy costs decreased by approximately $725 million compared with first nine months 2008.

 
Third Quarter
 
First Nine Months
(Dollars in millions)
2009
 
2008
 
Change
 
2009
 
2008
 
Change
                       
Selling, General and Administrative Expenses
$
104
$
107
 
(3) %
$
296
$
324
 
(9) %
Research and Development Expenses
 
33
 
39
 
(15) %
 
101
 
120
 
(16) %
 
$
137
$
146
 
(6) %
$
397
$
444
 
(11) %
As a percentage of sales
 
10 %
 
8 %
     
11 %
 
8 %
   

Selling, general and administrative expenses decreased in third quarter and first nine months 2009 compared to third quarter and first nine months 2008 primarily due to lower discretionary spending and compensation expense resulting from cost reduction actions partially offset by increased compensation expense linked to the Company's stock price.

 
24

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS


Research and development ("R&D") expenses decreased $6 million and $19 million in third quarter 2009 compared to third quarter 2008 and first nine months 2009 compared to first nine months 2008, respectively.  The decrease is primarily due to lower R&D expenses for corporate growth initiatives and lower discretionary spending resulting from cost reduction actions.

Asset Impairments and Restructuring Charges, Net

In first nine months 2009, restructuring charges were $23 million, net.  The charges, primarily for severance, resulted from a reduction in force.

In third quarter and first nine months 2008, asset impairments and restructuring charges, net totaled $2 million and $22 million, respectively, primarily for severance, pension charges, and site closure costs in the PCI segment resulting from the decision to close a previously impaired site in the United Kingdom.

For more information regarding asset impairments and restructuring charges, net see the segment discussions and Note 7, "Asset Impairments and Restructuring Charges, Net", to the Company's unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.
 
Operating Earnings
 
     
 
Third Quarter
 
First Nine Months
(Dollars in millions)
2009
 
2008
 
Change
 
2009
 
2008
 
Change
                         
Operating earnings
$
191
$
174
 
10 %
$
347
$
514
 
(32) %
Accelerated depreciation costs included in cost of goods sold
 
--
 
3
     
--
 
8
   
Asset impairments and restructuring charges, net
 
--
 
2
     
23
 
22
   
Operating earnings excluding accelerated depreciation costs and asset impairments and restructuring charges, net
$
 191
$
 179
 
7 %
$
 370
$
 544
 
(32) %
 
Operating earnings increased in third quarter 2009 compared to third quarter 2008 despite lower sales revenue as a result of a favorable shift in company product mix and cost reduction actions.  Operating earnings decreased in first nine months 2009 compared to first nine months 2008 reflecting continued weakness in demand for the Company's products.  This weakness in demand, which is attributed to the global recession, has been moderating throughout 2009 resulting in sequential sales volume and operating earnings increases each quarter.

Net Interest Expense

 
Third Quarter
 
First Nine Months
(Dollars in millions)
2009
 
2008
 
Change
 
2009
 
2008
 
Change
                       
Gross interest costs
$
23
$
26
   
$
73
$
80
   
Less:  Capitalized interest
 
3
 
3
     
10
 
7
   
Interest expense
 
20
 
23
 
(13) %
 
63
 
73
 
(14) %
Interest income
 
1
 
4
     
5
 
20
   
Net interest expense
$
19
$
19
 
-- %
$
58
$
53
 
9 %
                       
Net interest expense was unchanged in third quarter 2009 compared to third quarter 2008 as lower gross interest costs were offset by lower interest income due to lower average interest rates.

 
25

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

 
Net interest expense increased $5 million in first nine months 2009 compared to first nine months 2008.  Gross interest costs in first nine months 2009 were lower compared to first nine months 2008 due to lower average borrowings and lower average interest rates.  Interest income in first nine months 2009 was lower compared to first nine months 2008 due to lower average interest rates and lower average cash balances.

For 2009, the Company expects net interest expense to increase compared with 2008 primarily due to lower interest income, driven by lower average interest rates and lower average cash balances.

Other Charges (Income), Net

   
Third Quarter
 
First Nine Months
(Dollars in millions)
 
2009
 
2008
 
2009
 
2008
                 
Foreign exchange transaction losses
$
--
$
6
$
2
$
8
Investment losses (gains)
 
(1)
 
1
 
4
 
2
Other, net
 
3
 
--
 
5
 
(3)
Other charges (income), net
$
 2
$
 7
$
  11
$
   7

Included in net other charges (income) are gains or losses on foreign exchange transactions, results from equity investments, gains or losses on business venture investments, other non-operating income or charges related to Holston Defense Corporation, gains from the sale of non-operating assets, royalty income, certain litigation costs, fees on securitized receivables, other non-operating income, and other miscellaneous items.

Provision for Income Taxes

 
Third Quarter
 
First Nine Months
(Dollars in millions)
2009
 
2008
 
2009
 
2008
               
Provision for income taxes
$
69
$
48
$
110
$
124
Effective tax rate
 
40 %
 
33 %
 
39 %
 
27 %

Third quarter 2009 effective tax rate reflects a $12 million tax charge associated with the recapture of gasification investment tax credits as the Company no longer anticipates meeting the timeline agreed to with the Internal Revenue Service.  Third quarter 2008 effective tax rate reflected an $8 million benefit from the reversal of a U.S. capital loss valuation allowance associated with the sale of businesses, and a $6 million benefit from the settlement of a non-U.S. income tax audit.

First nine months 2009 effective tax rate reflects a $12 million tax charge associated with the recapture of gasification investment tax credits and a $7 million tax charge associated with a change in accounting method for tax purposes to accelerate timing of deductions for manufacturing repairs expense.  First nine months 2008 effective tax rate reflected the estimated benefit resulting from the gasification investment tax credit, an $8 million benefit from the reversal of a U.S. capital loss valuation allowance associated with the sale of businesses, and a $6 million benefit from the settlement of a non-U.S. income tax audit.  Including the above items, first nine months 2009 and 2008 effective tax rates reflect the Company's expected full year tax rate on reported earnings from continuing operations before income tax, of approximately 38 and 28 percent, respectively.

 
26

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS



Earnings from Continuing Operations
           
   
Third Quarter
 
First Nine Months
(Dollars in millions)
 
2009
 
2008
 
2009
 
2008
                 
Earnings from continuing operations
$
101
$
100
$
168
$
330
Accelerated depreciation costs included in cost of goods sold, net of tax
 
--
 
2
 
--
 
5
Asset impairments and restructuring charges, net of tax
 
--
 
3
 
14
 
17
Net deferred tax benefits related to the previous divestiture of  businesses
 
--
 
(3)
 
--
 
(14)
Earnings from continuing operations excluding accelerated depreciation costs, net of tax, asset impairments and restructuring charges, net of tax, and net deferred tax benefits related to the previous divestiture of businesses
$
 101
$
 102
$
 182
$
 338

Net Earnings
           
   
Third Quarter
 
First Nine Months
(Dollars in millions)
 
2009
 
2008
 
2009
 
2008
                 
Earnings from continuing operations
$
101
$
100
$
168
$
330
Earnings from disposal of discontinued operations, net of tax
 
--
 
--
 
--
 
18
Net earnings
$
 101
$
 100
$
 168
$
 348

The earnings on disposal of discontinued operations, net of tax of $18 million in first nine months 2008 was from the sale of the Company's PET polymers and PTA production facilities in the Netherlands and its PET production facility in the United Kingdom and related businesses for approximately $329 million in first quarter 2008.  For additional information, see Note 2, "Discontinued Operations", to the Company's unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.



R&D and other expenses not identifiable to an operating segment, including industrial gasification project expenses, are not included in segment operating results for either of the periods presented and are shown in Note 15, "Segment Information", to the Company's unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q, as "other" operating losses.  As discussed in Note 15, these "other" operating losses are $8 million and $29 million in third quarter and first nine months 2009, respectively, and $13 million and $39 million in third quarter and first nine months 2008, respectively.  The total corporate assets of $1.3 billion include approximately $230 million and $200 million at September 30, 2009 and December 31, 2008, respectively, related to the Beaumont, Texas gasification project.

 
27

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

 

CASPI Segment
 
Third Quarter
 
First Nine Months
         
Change
         
Change
(Dollars in millions)
2009
 
2008
 
$
 
%
 
2009
 
2008
 
$
 
%
                               
Sales
$
338
$
410
$
(72)
 
(18) %
$
890
$
1,213
$
(323)
 
(27) %
 
Volume effect
       
(27)
 
(7) %
         
(227)
 
(19) %
 
Price effect
       
(44)
 
(11) %
         
(64)
 
(5) %
 
Product mix effect
       
(1)
 
-- %
         
(29)
 
(3) %
 
Exchange rate effect
       
--
 
-- %
         
(3)
 
-- %
                               
                               
Operating earnings
84
 
55
 
29
 
53 %
 
148
 
167
 
(19)
 
(11) %
                               
Asset impairments and restructuring charges, net
--
 
--
 
--
     
5
 
(2)
 
7
   
                               
Operating earnings excluding asset impairments and restructuring charges, net
84
 
55
 
29
 
53 %
 
153
 
165
 
(12)
 
(7) %

Sales revenue decreased $72 million in third quarter 2009 compared to third quarter 2008 primarily due to lower selling prices and lower sales volume.  The lower selling prices were due to lower raw material and energy costs.  The lower sales volume was due to weak customer demand, attributed to the global recession, particularly for products sold into the automotive, building and construction, and packaging markets.

Sales revenue decreased $323 million in first nine months 2009 compared to first nine months 2008 primarily due to lower sales volume and lower selling prices.  The lower sales volume was due to weak customer demand, in all regions except Asia Pacific, attributed to the global recession, particularly for products sold into the automotive, building and construction, and packaging markets.  The lower selling prices were due to lower raw material and energy costs.

Excluding asset impairments and restructuring charges, net, operating earnings increased $29 million in third quarter 2009 compared to third quarter 2008 due primarily to lower raw material and energy costs and cost reduction actions, which more than offset lower selling prices and lower sales volume.

Excluding asset impairments and restructuring charges, net, operating earnings decreased $12 million in first nine months 2009 compared to first nine months 2008 due primarily to lower sales volume, partially offset by lower raw material and energy costs and cost reduction actions.  The asset impairments and restructuring charges, net for 2009 reflect the segment's portion of the severance charge for a reduction in force in first quarter 2009 and 2008 reflects an adjustment to a reserve for first quarter 2008 divestiture of certain product lines.

 
28

 
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS



Fibers Segment
 
Third Quarter
 
First Nine Months
         
Change
         
Change
(Dollars in millions)
2009
 
2008
 
$
 
%
 
2009
 
2008
 
$
 
%
                               
Sales
$
257
$
269
$
(12)
 
(5) %
$
779
$
783
$
(4)
 
-- %
 
Volume effect
       
(33)
 
(12) %
         
(79)
 
(10) %
 
Price effect
       
20
 
7 %
         
69
 
9 %
 
Product mix effect