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, 2006
|
|
|
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
|
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 a large accelerated filer,
an
accelerated filer, or a non-accelerated filer. See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the
Exchange Act. (check one);
Large
accelerated filer [X] Accelerated filer [ ] Non-accelerated filer
[
]
|
|
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, 2006
|
|
|
Common
Stock, par value $0.01 per share
|
82,285,145
|
|
|
(including
rights to purchase shares of Common Stock or Participating Preferred
Stock)
|
||
--------------------------------------------------------------------------------------------------------------------------------
PAGE
1 OF 52 TOTAL SEQUENTIALLY NUMBERED PAGES
EXHIBIT
INDEX ON PAGE 51
TABLE
OF CONTENTS
|
ITEM
|
PAGE
|
PART
I. FINANCIAL INFORMATION
|
1.
|
Financial
Statements
|
|
|
3
|
||
|
|
4
|
|
|
|
5
|
|
|
|
6
|
|
|
2.
|
|
27
|
|
3.
|
|
46
|
|
4.
|
|
47
|
PART
II. OTHER INFORMATION
|
1.
|
|
48
|
|
1A.
|
48
|
|
|
2.
|
|
49
|
|
6.
|
|
49
|
SIGNATURES
|
|
5001
|
2
|
Third
Quarter
|
First
Nine Months
|
|||||||
|
(Dollars
in millions, except per share amounts)
|
2006
|
2005
|
2006
|
2005
|
||||
|
Sales
|
$
|
1,966
|
$
|
1,816
|
$
|
5,698
|
$
|
5,330
|
|
Cost
of sales
|
1,650
|
1,464
|
4,701
|
4,205
|
||||
|
Gross
profit
|
316
|
352
|
997
|
1,125
|
||||
|
Selling,
general and administrative expenses
|
105
|
108
|
316
|
339
|
||||
|
Research
and development expenses
|
40
|
42
|
126
|
120
|
||||
|
Asset
impairments and restructuring charges, net
|
13
|
4
|
23
|
23
|
||||
|
Other
operating income
|
--
|
--
|
--
|
(2)
|
||||
|
Operating
earnings
|
158
|
198
|
532
|
645
|
||||
|
Interest
expense, net
|
21
|
23
|
62
|
77
|
||||
|
Income
from equity investment in Genencor
|
--
|
--
|
--
|
(173)
|
||||
|
Early
debt extinguishment costs
|
--
|
--
|
--
|
46
|
||||
|
Other
(income) charges, net
|
1
|
(2)
|
(2)
|
(3)
|
||||
|
Earnings
before income taxes
|
136
|
177
|
472
|
698
|
||||
|
Provision
for income taxes
|
41
|
54
|
158
|
207
|
||||
|
Net
earnings
|
$
|
95
|
$
|
123
|
$
|
314
|
$
|
491
|
|
Earnings
per share
|
||||||||
|
Basic
|
$
|
1.16
|
$
|
1.51
|
$
|
3.84
|
$
|
6.10
|
|
Diluted
|
$
|
1.15
|
$
|
1.50
|
$
|
3.79
|
$
|
6.01
|
|
Comprehensive
Income
|
||||||||
|
Net
earnings
|
$
|
95
|
$
|
123
|
$
|
314
|
$
|
491
|
|
Other
comprehensive income (loss)
|
||||||||
|
Change
in cumulative translation adjustment
|
(8)
|
(5)
|
32
|
(84)
|
||||
|
Change
in unrealized gains (losses) on investments, net of tax
|
--
|
5
|
(1)
|
18
|
||||
|
Change
in unrealized gains (losses) on derivative instruments, net of
tax
|
(6)
|
--
|
5
|
1
|
||||
|
Total
other comprehensive income (loss)
|
(14)
|
--
|
36
|
(65)
|
||||
|
Comprehensive
income
|
$
|
81
|
$
|
123
|
$
|
350
|
$
|
426
|
|
Retained
Earnings
|
||||||||
|
Retained
earnings at beginning of period
|
$
|
2,070
|
$
|
1,806
|
$
|
1,923
|
$
|
1,509
|
|
Net
earnings
|
95
|
123
|
314
|
491
|
||||
|
Cash
dividends declared
|
(36)
|
(36)
|
(108)
|
(107)
|
||||
|
Retained
earnings at end of period
|
$
|
2,129
|
$
|
1,893
|
$
|
2,129
|
$
|
1,893
|
The
accompanying notes are an integral part of these consolidated financial
statements.
3
|
September
30,
|
December
31,
|
|||
|
(Dollars
in millions, except per share amounts)
|
2006
|
2005
|
||
|
(Unaudited)
|
||||
|
Assets
|
|
|||
|
Current
assets
|
||||
|
Cash
and cash equivalents
|
$
|
430
|
$
|
524
|
|
Trade
receivables, net of allowance of $16 and $20
|
758
|
575
|
||
|
Miscellaneous
receivables
|
81
|
81
|
||
|
Inventories
|
702
|
671
|
||
|
Other
current assets
|
56
|
73
|
||
|
Current
assets held for sale
|
132
|
--
|
||
|
Total
current assets
|
2,159
|
1,924
|
||
|
Properties
|
||||
|
Properties
and equipment at cost
|
8,763
|
9,597
|
||
|
Less:
Accumulated depreciation
|
5,707
|
6,435
|
||
|
Net
properties
|
3,056
|
3,162
|
||
|
Goodwill
|
313
|
312
|
||
|
Other
noncurrent assets
|
358
|
375
|
||
|
Noncurrent
assets held for sale
|
180
|
--
|
||
|
Total
assets
|
$
|
6,066
|
$
|
5,773
|
|
Liabilities
and Stockholders’ Equity
|
||||
|
Current
liabilities
|
||||
|
Payables
and other current liabilities
|
$
|
1,041
|
$
|
1,047
|
|
Borrowings
due within one year
|
3
|
4
|
||
|
Current
liabilities related to assets held for sale
|
15
|
--
|
||
|
Total
current liabilities
|
1,059
|
1,051
|
||
|
Long-term
borrowings
|
1,586
|
1,621
|
||
|
Deferred
income tax liabilities
|
264
|
317
|
||
|
Post-employment
obligations
|
1,058
|
1,017
|
||
|
Other
long-term liabilities
|
151
|
155
|
||
|
Long-term
liabilities related to assets held for sale
|
46
|
--
|
||
|
Total
liabilities
|
4,164
|
4,161
|
||
|
Stockholders’
equity
|
||||
|
Common
stock ($0.01 par value - 350,000,000 shares authorized;
shares
issued
- 90,214,704 and 89,566,115 for 2006 and 2005,
respectively)
|
1
|
1
|
||
|
Additional
paid-in capital
|
368
|
320
|
||
|
Retained
earnings
|
2,129
|
1,923
|
||
|
Accumulated
other comprehensive loss
|
(164)
|
(200)
|
||
|
2,334
|
2,044
|
|||
|
Less:
Treasury stock at cost (8,036,330 shares for 2006 and 8,034,901 shares
for
2005)
|
432
|
432
|
||
|
Total
stockholders’ equity
|
1,902
|
1,612
|
||
|
Total
liabilities and stockholders’ equity
|
$
|
6,066
|
$
|
5,773
|
The
accompanying notes are an integral part of these consolidated financial
statements.
4
|
First
Nine Months
|
||||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Cash
flows from operating activities
|
||||
|
Net
earnings
|
$
|
314
|
$
|
491
|
|
|
||||
|
Adjustments
to reconcile net earnings to net cash provided by operating
activities:
|
||||
|
Income
from equity investment in Genencor
|
--
|
(173)
|
||
|
Depreciation
and amortization
|
226
|
229
|
||
|
Gain
on sale of assets
|
(5)
|
--
|
||
|
Early
debt extinguishment costs
|
--
|
46
|
||
|
Asset
impairments
|
20
|
1
|
||
|
Provision
for deferred income taxes
|
49
|
130
|
||
|
Changes
in operating assets and liabilities:
|
||||
|
(Increase)
decrease in receivables
|
(189)
|
(35)
|
||
|
(Increase)
decrease in inventories
|
(134)
|
(141)
|
||
|
Increase
(decrease) in trade payables
|
50
|
(5)
|
||
|
Increase
(decrease) in liabilities for employee benefits and incentive
pay
|
(60)
|
(108)
|
||
|
Other
items, net
|
(38)
|
(58)
|
||
|
Net
cash provided by operating activities
|
233
|
377
|
||
|
Cash
flows from investing activities
|
||||
|
Proceeds
from sale of equity investment in Genencor, net
|
--
|
417
|
||
|
Additions
to properties and equipment
|
(279)
|
(224)
|
||
|
Proceeds
from sale of assets and investments
|
12
|
50
|
||
|
Additions
to capitalized software
|
(12)
|
(8)
|
||
|
Other
items, net
|
--
|
(5)
|
||
|
Net
cash provided by (used in) investing activities
|
(279)
|
230
|
||
|
Cash
flows from financing activities
|
||||
|
Net
increase (decrease) in commercial paper, credit facility and other
borrowings
|
33
|
(84)
|
||
|
Repayment
of borrowings
|
--
|
(544)
|
||
|
Dividends
paid to stockholders
|
(108)
|
(106)
|
||
|
Proceeds
from stock option exercises and other items
|
25
|
91
|
||
|
Net
cash provided by (used in) financing activities
|
(50)
|
(643)
|
||
|
Effect
of exchange rate changes on cash and cash equivalents
|
2
|
(3)
|
||
|
Net
change in cash and cash equivalents
|
(94)
|
(39)
|
||
|
Cash
and cash equivalents at beginning of period
|
524
|
325
|
||
|
Cash
and cash equivalents at end of period
|
$
|
430
|
$
|
286
|
The
accompanying notes are an integral part of these consolidated financial
statements.
5
|
ITEM
|
Page
|
|
7
|
|
|
7
|
|
|
7
|
|
|
8
|
|
|
8
|
|
|
9
|
|
|
9
|
|
|
10
|
|
|
11
|
|
|
11
|
|
|
12
|
|
|
14
|
|
|
14
|
|
|
15
|
|
|
16
|
|
|
16
|
|
|
17
|
|
|
21
|
|
|
23
|
|
|
24
|
|
|
26
|
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 2005 Annual
Report on Form 10-K, except as described in Note 17 to the Company's unaudited
financial statements in this Form 10-Q, and should be read in conjunction with
the consolidated financial statements in Part II, Item 8 of the Company’s 2005
Annual Report on 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 ("GAAP") in the United States 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 on the equity basis. Intercompany transactions and
balances are eliminated in consolidation. The Company has reclassified certain
2005 amounts to conform to the 2006 presentation including the reclassification
of segment sales and operating earnings. For additional information, see Note
18
to the Company's unaudited consolidated financial statements.
| 2. |
|
September
30,
|
December
31,
|
|||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
At
FIFO or average cost (approximates current cost)
|
||||
|
Finished
goods
|
$
|
672
|
$
|
664
|
|
Work
in process
|
227
|
207
|
||
|
Raw
materials and supplies
|
378
|
247
|
||
|
Total
inventories
|
1,277
|
1,118
|
||
|
LIFO
Reserve
|
(466)
|
(447)
|
||
|
Inventories
before assets held for sale
|
811
|
671
|
||
|
Assets
held for sale (1)
|
(109)
|
--
|
||
|
Total
inventories
|
$
|
702
|
$
|
671
|
| (1) |
For
more information regarding assets held for sale, see Note 5 to the
Company's unaudited consolidated financial statements.
|
Inventories
valued on the LIFO method were approximately 60% as of September 30, 2006 and
65% as of December 31, 2005 of total inventories.
The
Company has a 50 percent interest in and serves as the operating partner in
Primester, a joint venture which manufactures cellulose acetate at Eastman's
Kingsport, Tennessee plant. This investment is accounted for under the equity
method. During
fourth quarter 2005, the
Company provided a line of credit to the joint venture of up to $125 million,
which Primester fully utilized to repay the principal amount of the joint
venture's third-party borrowings, previously guaranteed by Eastman. The Company
holds an interest-bearing note receivable. Eastman's investment in the joint
venture was approximately $87 million and $86 million at September 30, 2006
and
December 31, 2005, respectively, which was comprised of the recognized portion
of the venture's accumulated deficits and the line of credit of $125 million.
Such amount was included in other noncurrent assets.
7
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
Eastman
also owns a 50 percent interest in Nanjing Yangzi Eastman Chemical Ltd.
("Nanjing"), a company which manufactures Eastotac
hydrocarbon tackifying resins for the adhesives market. This joint venture
is
accounted for under the equity method and is included in other noncurrent
assets. At September 30, 2006 and December 31, 2005, the Company’s investment in
Nanjing was approximately $5 million.
On
April
21, 2005, the Company completed the sale of its preferred and common stock
of
Genencor International, Inc. ("Genencor") for cash proceeds of approximately
$417 million, net of $2 million in fees. The book value of the investment prior
to sale was $246 million, and the Company recorded a
pre-tax
gain on the sale of $171 million.
|
September
30,
|
||
|
(Dollars
in millions)
|
2006
|
|
|
Current
assets
|
||
|
Trade
receivables, net
|
$
|
23
|
|
Inventories
|
109
|
|
|
Total
current assets
|
132
|
|
|
Non-current
assets
|
||
|
Properties
and Equipment, net
|
174
|
|
|
Other
non-current assets
|
6
|
|
|
Total
non-current assets
|
180
|
|
|
Total
assets
|
$
|
312
|
|
Current
liabilities
|
||
|
Payables
and other current liabilities, net
|
$
|
15
|
|
Total
current liabilities
|
15
|
|
|
Long-term
liabilities
|
||
|
Deferred
income tax liabilities
|
40
|
|
|
Other
long term liabilities
|
6
|
|
|
Total
long-term liabilities
|
46
|
|
|
Total
liabilities
|
$
|
61
|
For
the
third quarter 2006, the Company reclassified certain businesses and product
lines and related assets as held for sale based on entry into two definitive
agreements for the sale of those assets and recorded an impairment charge of
$11
million to adjust the asset values to the sales amounts less cost to sell.
These
businesses and product lines are (i) the specialty organic chemicals product
lines of the Performance Chemicals and Intermediates ("PCI") segment at the
Batesville, Arkansas manufacturing facility and (ii) the Polyethylene and
Epolene
polymer
businesses, related assets and the Company's ethylene pipeline in the Coatings,
Adhesives, Specialty Polymers and Inks ("CASPI") and Performance Polymers
segments.
The
Company has concluded that the assets, businesses and product lines being sold
should not be reported as discontinued operations per Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," due to supply agreements between the Company
and
the buyers that will continue beyond the date of sale.
8
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
|
September
30,
|
December
31,
|
|||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Trade
creditors
|
$
|
590
|
$
|
534
|
|
Accrued
payrolls, vacation, and variable-incentive compensation
|
120
|
154
|
||
|
Accrued
taxes
|
--
|
49
|
||
|
Post-employment
obligations
|
65
|
134
|
||
|
Interest
payable
|
26
|
31
|
||
|
Bank
overdrafts
|
89
|
10
|
||
|
Other
|
166
|
135
|
||
|
Payables
and other current liabilities before assets held for sale
|
1,056
|
1,047
|
||
|
Assets
held for sale (1)
|
(15)
|
--
|
||
|
Total
payables and other current liabilities
|
$
|
1,041
|
$
|
1,047
|
(1)
For
more
information regarding assets held for sale, see Note 5 to the Company's
unaudited consolidated financial statements.
|
Third
Quarter
|
First
Nine Months
|
|||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
2006
|
2005
|
Change
|
||||||
|
Provision
for income
taxes
|
$
|
41
|
$
|
54
|
(24)%
|
$
|
158
|
$
|
207
|
(24)%
|
||
|
Effective
tax rate
|
30
%
|
31
%
|
34
%
|
30
%
|
||||||||
The
third
quarter and first nine months 2006 effective tax rate reflects the Company's
expected annual tax rate on reported operating earnings before income tax,
excluding discrete items, of approximately 34 percent. The third quarter 2006
effective tax rate was impacted by the reversal of foreign loss valuation
allowances. The implementation of SFAS No. 123 Revised December 2004 ("SFAS
No.
123 (R)"), "Share Based Payment", effective January 1, 2006, did not have a
material effect on the Company's effective income tax rate in the third quarter
and first nine months 2006. For additional information regarding SFAS No. 123
(R), see Note 17 to the Company's unaudited consolidated financial statements.
The
third
quarter 2005 effective tax rate reflects the Company's then expected annual
tax
rate on reported operating earnings before income tax, excluding discrete items,
of approximately 30 percent and higher applicable tax rates related to the
early
extinguishment of debt costs and the gain on the sale of Genencor stock. The
first nine months 2005 effective tax rate also reflects a net deferred tax
benefit adjustment related to the expected utilization of capital loss
carryforwards.
As
described in Note 19 to the consolidated financial statements in Part II, Item
8
of the Company’s 2005 Annual Report on Form 10-K, the Company has significant
foreign 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 carryforwards is greater or less than anticipated.
9
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
| 8. |
|
September
30,
|
December
31,
|
|||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Borrowings
consisted of:
|
||||
|
3
1/4% notes due 2008
|
$
|
72
|
$
|
72
|
|
7%
notes due 2012
|
141
|
142
|
||
|
6.30%
notes due 2018
|
182
|
185
|
||
|
7
1/4% debentures due 2024
|
497
|
497
|
||
|
7
5/8% debentures due 2024
|
200
|
200
|
||
|
7.60%
debentures due 2027
|
297
|
297
|
||
|
Credit
facility borrowings
|
182
|
214
|
||
|
Other
|
18
|
18
|
||
|
Total
borrowings
|
1,589
|
1,625
|
||
|
Borrowings
due within one year
|
(3)
|
(4)
|
||
|
Long-term
borrowings
|
$
|
1,586
|
$
|
1,621
|
At
September 30, 2006, the Company has credit facilities with various U.S. and
non-U.S. banks totaling approximately $880 million as disclosed in Note 7 to
the
consolidated financial statements in Part II, Item 8 of the Company's 2005
Annual Report on Form 10-K. These credit facilities consist of a $700 million
revolving credit facility (the "Credit Facility"), which was amended in April
2006 to extend the expiration date to April 2011, and a 144 million euro credit
facility ("Euro Facility") which expires in December 2010. Borrowings under
these credit facilities are subject to interest at varying spreads above quoted
market rates. These credit facilities require facility fees on the total
commitment that are based on Eastman's credit rating. In addition, these credit
facilities contain a number of covenants and events of default, including the
maintenance of certain financial ratios. The Company's combined credit facility
borrowings at September 30, 2006 and December 31, 2005 were $182 million and
$214 million at weighted average interest rates of 3.49 percent and 3.01
percent, respectively.
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. Since the
Credit Facility expires in April 2011, any 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
September 30, 2006 and December 31, 2005, the Company had outstanding interest
rate swaps associated with the entire outstanding principle of the 7% notes
due
in 2012 and $150 million of the outstanding principle of the 6.30% notes due
in
2018. The average variable interest rate on the 7% notes was 7.89 percent and
7.22 percent for September 30, 2006 and December 31, 2005, respectively. The
average variable interest rate on the 6.30% notes was 6.30 percent and 5.63
percent for September 30, 2006 and December 31, 2005, respectively.
10
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
In
the
second quarter 2005, the Company completed the early repayment of $500 million
of its outstanding long-term debt for $544 million in cash, which resulted
in a
charge of $46 million for early debt extinguishment costs including $2 million
in unamortized bond issuance costs. The book value of the repaid debt was $500
million, as follows:
|
(dollars
in millions)
|
Book
Value
|
|
|
3
1/4% notes due 2008
|
$
|
178
|
|
6.30%
notes due 2018
|
68
|
|
|
7%
notes due 2012
|
254
|
|
|
Total
|
$
|
500
|
In
the
third quarter and first nine months 2006, asset impairments and restructuring
charges totaled $13 million and $23 million, respectively. During the third
quarter 2006, the Company classified the Batesville, Arkansas manufacturing
facility as an asset group held for sale and recorded a related $11 million
impairment charge to reduce the recorded book value of the assets to the
contracted sales price. Other charges for the year relate primarily to
previously closed manufacturing facilities.
During
the third quarter 2005, the Company recognized pre-tax restructuring charges
of
approximately $4 million, related primarily to
Cendian Corporation's ("Cendian") shutdown of its business activities.
For
the
first nine months 2005, pre-tax restructuring charges totaled $23 million,
primarily related to Cendian's shutdown of its business activities as well
as
the closure of other manufacturing facilities. Included in the $23 million
are
approximately $4 million in severance charges recognized within the PCI segment
related to the severance of approximately 90 employees at the Company's
Batesville, Arkansas manufacturing facility.
11
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 the full year 2005 and the
first nine
months 2006:
|
(Dollars
in millions)
|
Balance
at
January
1, 2005
|
Provision/
Adjustments
|
Non-cash
Reductions
|
Cash
Reductions
|
Balance
at
December
31, 2005
|
|||||
|
Non-cash
charges
|
$
|
--
|
$
|
12
|
$
|
(12)
|
$
|
--
|
$
|
--
|
|
Severance
costs
|
26
|
3
|
--
|
(26)
|
3
|
|||||
|
Site
closure and other restructuring costs
|
9
|
18
|
(1)
|
(19)
|
7
|
|||||
|
Total
|
$
|
35
|
$
|
33
|
$
|
(13)
|
$
|
(45)
|
$
|
10
|
|
Balance
at
January
1, 2006
|
Provision/
Adjustments
|
Non-cash
Reductions
|
Cash
Reductions
|
Balance
at
September
30, 2006
|
||||||
|
Non-cash
charges
|
$
|
--
|
$
|
21
|
$
|
(21)
|
$
|
--
|
$
|
--
|
|
Severance
costs
|
3
|
--
|
--
|
(1)
|
2
|
|||||
|
Site
closure and other restructuring costs
|
7
|
2
|
--
|
--
|
9
|
|||||
|
Total
|
$
|
10
|
$
|
23
|
$
|
(21)
|
$
|
(1)
|
$
|
11
|
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 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)
|
2006
|
2005
|
2006
|
2005
|
||||
|
Service
cost
|
$
|
11
|
$
|
11
|
$
|
33
|
$
|
32
|
|
Interest
cost
|
21
|
20
|
61
|
59
|
||||
|
Expected
return on assets
|
(21)
|
(21)
|
(65)
|
(59)
|
||||
|
Amortization
of:
|
||||||||
|
Prior
service credit
|
(3)
|
(2)
|
(7)
|
(8)
|
||||
|
Actuarial
loss
|
9
|
9
|
28
|
27
|
||||
|
Net
periodic benefit cost
|
$
|
17
|
$
|
17
|
$
|
50
|
$
|
51
|
In
July
2006, the Company announced plans to change the U.S. defined benefit plans
such
that employees hired on or after January 1, 2007 will not be eligible for those
plans. This change will not impact net periodic benefit cost in 2006 and will
begin to impact the financial statements in first quarter 2007.
12
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
As
of
September 30, 2006, the Company has contributed $75 million to its U.S. defined
benefit plans during 2006.
DEFINED
CONTRIBUTION PLANS
The
Company sponsors a defined contribution employee stock ownership plan (the
"ESOP"), a qualified plan under Section 401(a) of the Internal Revenue Code,
which is a component of the Eastman Investment Plan and Employee Stock Ownership
Plan ("EIP/ESOP"). Eastman anticipates that it will make annual contributions
for substantially all U.S. employees equal to five percent of eligible
compensation to the ESOP, or for employees who have five or more prior ESOP
contributions, to either the Eastman Stock Fund or other investment funds within
the EIP. Employees may diversify to other investment funds within the EIP from
the ESOP at any time without restrictions.
In
July
2006, the Company amended its EIP/ESOP to provide a company match of 50 percent
of the first 7 percent of an employee's compensation contributed to the plan
for
employees who are hired on or after January 1, 2007. Employees who are hired
on
or after January 1, 2007, will also be eligible for the 5 percent contribution
to the ESOP as described above.
POSTRETIREMENT
WELFARE PLANS
Eastman
provides life insurance and health care benefits for eligible retirees, and
health care benefits for retirees' eligible survivors. 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 ammunition plant. HDC’s contract with the Department of the
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 did not
contribute further to these costs. The Company continues to accrue and pay
for
the costs related to HDC retirees, and has pursued extraordinary relief from
the
DOA for reimbursement of these and other previously expensed employee benefit
costs. In October 2006, HDC received notification that the request for
extraordinary contractual relief to provide funding for post-retirement benefits
had been approved by the DOA, and HDC expects the decision to be effective
during the fourth quarter 2006. The Company will begin recognizing the impact
of
any reimbursement in the period settled by recording an unrecognized gain which
will be amortized into earnings over a period of time.
In
general, Eastman provides those benefits to retirees eligible under the
Company's U.S. pension plans. 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 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 the Company’s U.S. plans:
|
Summary
of Components of Net Periodic Benefit Costs
|
||||||||
|
Third
Quarter
|
First
Nine Months
|
|||||||
|
(Dollars
in millions)
|
2006
|
2005
|
2006
|
2005
|
||||
|
Service
cost
|
$
|
2
|
$
|
2
|
$
|
6
|
$
|
6
|
|
Interest
cost
|
10
|
11
|
31
|
32
|
||||
|
Amortization
of:
|
||||||||
|
Prior
service credit
|
(5)
|
(6)
|
(17)
|
(17)
|
||||
|
Actuarial
loss
|
3
|
5
|
11
|
15
|
||||
|
Net
periodic benefit cost
|
$
|
10
|
$
|
12
|
$
|
31
|
$
|
36
|
In
July
2006, the Company announced plans to change its U.S. life insurance and health
care benefit plans such that employees hired on or after January 1, 2007 will
have access to post-retirement health care benefits only, while Eastman will
not
provide a company contribution toward the premium cost of post-retirement
benefits for those employees. This change will begin to impact the financial
statements in first quarter 2007.
13
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
Certain
Eastman manufacturing sites generate hazardous and nonhazardous wastes, the
treatment, storage, transportation, and disposal of which are regulated by
various governmental agencies. In connection with the cleanup of various
hazardous waste sites, the Company, along with many other entities, has been
designated a potentially responsible party ("PRP") by the U.S. Environmental
Protection Agency under the Comprehensive Environmental Response, Compensation
and Liability Act, which potentially subjects PRPs to joint and several
liability for such cleanup costs. In addition, the Company will 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 to the consolidated financial statements in Part II, Item
8
of the Company's 2005 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 $51 million at September 30, 2006 and December 31, 2005,
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 $21 million to
the
maximum of $42 million at September 30, 2006 and at December 31,
2005.
| 13. |
Purchasing
Obligations and Lease Commitments
At
September 30, 2006, the Company had various purchase obligations totaling
approximately $2.1 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, non-cancelable, and month-to-month operating leases totaling
approximately $200 million over a period of several years. Of the total lease
commitments, approximately 15 percent relate to machinery and equipment,
including computer and communications equipment and production equipment;
approximately 45 percent relate to real property, including office space,
storage facilities and land; and approximately 40 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
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
September 30, 2006 and December 31, 2005. 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 $334
million and $314 million in the third quarter 2006 and 2005, respectively,
and
$323 million and $283 million for the first nine months of 2006 and 2005,
respectively.
Guarantees
Interpretation
No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("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. 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 September 30, 2006 totaled $98 million and consisted
primarily of leases for railcars, aircraft, and other equipment. The Company
believes, based on current facts and circumstances, that a material payment
pursuant to such guarantees is remote. Leases with guarantee amounts totaling
$3
million, $27 million, and $68 million will expire in 2006, 2008, and 2012,
respectively.
14
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
Variable
Interest Entities
The
Company has evaluated material relationships and has concluded that the legal
entities involved with these material relationships are not Variable Interest
Entities ("VIEs") or, in the case of Primester, a joint venture that
manufactures cellulose acetate at its Kingsport, Tennessee plant, the Company
is
not the primary beneficiary of the VIE. As such, in accordance with
Interpretation No. 46R "Consolidation of Variable Interest Entities" ("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 at September 30, 2006. These potential VIEs are joint ventures
from
which the Company has purchased raw materials and utilities for several years
and purchases approximately $70 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 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.
Hedging
Programs
Financial
instruments held as part of the hedging programs discussed below are recorded
at
fair value based upon comparable market transactions as quoted by
brokers.
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 9 to the consolidated financial statements in Part II,
Item 8 of the Company's 2005 Annual Report on Form 10-K.
At
September 30, 2006, mark-to-market gains from raw material, currency and certain
interest rate hedges that were included in accumulated other comprehensive
loss
totaled approximately $2 million. If realized, approximately $1 million in
losses will be reclassified into earnings during the next 12 months. The
mark-to-market gains or losses on non-qualifying, excluded and ineffective
portions of hedges are immediately recognized in cost of sales or other income
and charges. Such amounts did not have a material impact on earnings during
the
third quarter and first nine months 2006.
15
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
A
reconciliation of the changes in stockholders’ equity for the first nine months
2006 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, 2005
|
1
|
320
|
1,923
|
(200)
|
(432)
|
1,612
|
|
Net
Earnings
|
--
|
--
|
314
|
--
|
--
|
314
|
|
Cash
Dividends Declared
|
--
|
--
|
(108)
|
--
|
--
|
(108)
|
|
Other
Comprehensive Income
|
--
|
--
|
--
|
36
|
--
|
36
|
|
Stock
Option Exercises and Other Items (1)
|
--
|
48
|
--
|
--
|
--
|
48
|
|
Balance
at September 30, 2006
|
1
|
368
|
2,129
|
(164)
|
(432)
|
1,902
|
(1)
The tax
benefits relating to the difference between the amounts deductible for federal
income taxes over the amounts charged to income for book purposes have been
credited to paid-in capital.
|
(Dollars
in millions)
|
Cumulative
Translation Adjustment
|
Unfunded
Minimum Pension Liability
|
Unrealized
Gains (Losses) on Derivative Instruments
|
Unrealized
Gains (Losses) on Investments
|
Accumulated
Other Comprehensive Income (Loss)
|
|||||
|
Balance
at December 31, 2004
|
$
|
155
|
$
|
(248)
|
$
|
(8)
|
$
|
(2)
|
$
|
(103)
|
|
Period
change
|
(94)
|
(7)
|
3
|
1
|
(97)
|
|||||
|
Balance
at December 31, 2005
|
61
|
(255)
|
(5)
|
(1)
|
(200)
|
|||||
|
Period
change
|
32
|
--
|
5
|
(1)
|
36
|
|||||
|
Balance
at September 30, 2006
|
$
|
93
|
$
|
(255)
|
$
|
--
|
$
|
(2)
|
$
|
(164)
|
Except
for cumulative translation adjustment, amounts of other comprehensive 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.
|
Third
Quarter
|
First
Nine Months
|
||||||
|
2006
|
2005
|
2006
|
2005
|
||||
|
Shares
used for earnings per share calculation:
|
|||||||
|
Basic
|
82.1
|
81.3
|
81.8
|
80.5
|
|||
|
Diluted
|
83.1
|
82.0
|
82.8
|
81.7
|
|||
In
the
third quarter and first nine months 2005, common shares underlying options
to
purchase 1,210,088 shares of common stock at a range of prices from $52.19
to
$67.50 and 854,187 shares of common stock at a range of prices from $56.50
to
$67.50, respectively, were excluded from the computation of diluted earnings
per
share because the option exercise prices were greater than the average market
price of the common shares during those periods.
16
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
The
Company declared cash dividends of $0.44 per share in the third quarters 2006
and 2005 and $1.32 per share in the first nine months 2006 and
2005.
On
January 1, 2006, the Company adopted SFAS
No.
123
(R). SFAS No. 123 (R) replaces SFAS No. 123, "Accounting for Stock-Based
Compensation" and supersedes Accounting Principles Board Opinion ("APB") No.
25,
"Accounting for Stock Issued to Employees" and amends SFAS No. 95, "Statement
of
Cash Flows". Prior to adoption, the Company implemented the disclosure-only
requirements of SFAS No. 123 and continued to implement the requirements of
APB
No. 25 for financial statement reporting. Additional information regarding
SFAS
No. 123 (R), SFAS No. 123 and APB No. 25 may be found in Note 23 to the
consolidated financial statements in Part II, Item 8 of the Company's 2005
Annual Report on Form 10-K.
The
Company adopted SFAS No. 123 (R) using the "modified prospective" method that
requires compensation expense of all employee and non-employee director
share-based compensation awards be recognized in the financial statements based
upon their fair value over the requisite service or vesting period: a) based
upon the requirements of SFAS No. 123 (R) for all new awards granted after
the
effective date and b) based upon the requirements of SFAS No. 123 for all awards
granted prior to the effective date of SFAS No. 123 (R) that remain unvested
on
the effective date. Under the requirements of APB No. 25, the Company was
required to recognize compensation cost for such awards unless the employee
or
non-employee director paid an amount to acquire the awarded shares at least
equal to the quoted market price of the stock at the measurement date (typically
the date of grant). This requirement resulted in compensation expense
recognition and reporting in the financial statements for most share-based
awards (unrestricted stock awards, restricted stock awards, long-term
performance stock awards and stock appreciation rights) except for stock
options, substantially all of which were awarded at the closing market price
of
the Company's common stock on the date of grant. Effective with adoption of
SFAS
No. 123 (R), compensation expense related to stock option awards are recognized
in the financial statements at their fair value.
The
Company is authorized by the Board of Directors under the 2002 Omnibus Long-Term
Compensation Plan and 2002 Director Long-Term Compensation Plan to provide
grants to employees and non-employee members of the Board of Directors.
Additional information regarding compensation plans may be found in Note 15
to
the consolidated financial statements in Part II, Item 8 of the Company's 2005
Annual Report on Form 10-K. It has been the Company's practice to issue new
shares rather than treasury shares for equity awards that require payment by
the
issuance of common stock and to withhold or accept back shares awarded necessary
to cover the income taxes of employee participants. Shares of non-employee
directors are not withheld or acquired for the withholding of their income
taxes. Shares of unrestricted common stock owned by specified senior management
level employees are accepted by the Company to pay for the exercise price of
stock option exercises in accordance with the terms and conditions of the
awards.
17
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
In
accordance with implementation requirements of SFAS No. 123 (R) under the
modified prospective method, the Company did not restate prior fiscal periods
and is required to continue the same disclosure-only requirements of SFAS No.
123 for comparative purposes until all periods reported are comparable on the
same basis. The following table illustrates the effect on net earnings and
earnings per share as formerly provided under SFAS No. 123:
|
Third
Quarter
|
First
Nine Months
|
||||||||
|
(Dollars
and shares in millions, except per share amounts)
|
2006
|
Proforma
2005
|
2006
|
Proforma
2005
|
|||||
|
Net
earnings, as reported
|
$
|
95
|
$
|
123
|
$
|
314
|
$
|
491
|
|
|
Add:
Stock-based employee compensation expense
|
|||||||||
|
included
in net earnings, as reported
|
2
|
--
|
9
|
7
|
|||||
|
Deduct:
Total additional stock-based employee compensation cost, net of tax,
that
would have been included in net earnings under fair value
method
|
2
|
1
|
9
|
10
|
|||||
|
Pro
forma net earnings
|
$
|
95
|
$
|
122
|
$
|
314
|
$
|
488
|
|
|
Basic
earnings per share
|
As
reported
|
$
|
1.16
|
$
|
1.51
|
$
|
3.84
|
$
|
6.10
|
|
Pro
forma
|
$
|
N.A.
|
$
|
1.50
|
$
|
N.A.
|
$
|
6.06
|
|
|
Diluted
earnings per share
|
As
reported
|
$
|
1.15
|
$
|
1.50
|
$
|
3.79
|
$
|
6.01
|
|
Pro
forma
|
$
|
N.A.
|
$
|
1.49
|
$
|
N.A.
|
$
|
5.99
|
|
In
the
third quarter and first nine months 2006, approximately $4 million and $15
million, respectively, of compensation expense before tax was recognized in
selling, general and administrative expense in the earnings statement for all
share-based awards of which approximately $2 million and $6 million related
to
stock options in the third quarter and the first nine months 2006, respectively.
The impact on third quarter 2006 net earnings of $2 million is net of a $2
million credit to deferred tax expense for recognition of deferred tax assets.
The impact on the first nine months 2006 net earnings of $9 million is net
of a
$6 million credit to deferred tax expense for recognition of deferred tax
assets.
The
impact on the financial statements of implementing SFAS No. 123 (R) is the
recognition of compensation expense for all stock options granted.
18
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
Stock
Option Awards
Option
awards are granted to non-employee directors on an annual basis and to employees
who meet certain eligibility requirements. A single large volume option grant
is
usually awarded to eligible employees in the fourth quarter of each year, if
and
when granted by the Compensation and Management Development Committee of the
Board of Directors, and occasional individual grants are awarded to eligible
employees throughout the year. Option awards have an exercise price equal to
the
closing price of the Company's stock on the date of grant. The term of options
is ten years with vesting periods that vary up to three years. Vesting usually
occurs ratably or at the end of the vesting period. The fair value of options
cannot be determined by market value as they are not traded in an open market.
Accordingly, a financial pricing model is utilized to determine fair value.
The
Company utilizes the Black Scholes Merton ("BSM") model which relies on certain
assumptions to estimate an option's fair value. These weighted average
assumptions relevant to options granted in the third quarter and first nine
months 2006 and the same periods for 2005 are identified in the table
below:
|
Assumptions
|
Third
Quarter 2006
|
Third
Quarter 2005
|
First
Nine Months 2006
|
First
Nine Months 2005
|
|||
|
Exercise
Price
|
$52.18
|
--
|
$56.25
|
$56.52
|
|||
|
Expected
term years
|
5.00
|
--
|
4.41
|
6.00
|
|||
|
Expected
volatility rate
|
22.58%
|
--
|
22.51%
|
27.90%
|
|||
|
Expected
dividend yield
|
3.37%
|
--
|
3.13%
|
3.70%
|
|||
|
Average
risk-free interest rate
|
4.99%
|
--
|
5.02%
|
3.50%
|
|||
|
Expected
forfeiture rate
|
0.75%
|
--
|
0.75%
|
Actual
|
In
the
third quarter and first nine months 2006, the Company granted 3,200 and 110,838
options, respectively. The Company did not grant any options during the third
quarter 2005 and granted 64,788 options during the first nine months 2005.
Prior
to
adoption of SFAS No. 123 (R), the Company calculated the expected term of stock
options using a standard formula prescribed in accounting literature which
indicated a six year expected term. Effective with the fourth quarter 2005
large
annual option award, the Company analyzed historical pre-vesting and
post-vesting cancellations, forfeitures, expirations and exercise transactions
of large annual grants to determine the expected term. The Company expects
to
analyze historical transactions preceding the large annual option grant to
ensure that all assumptions based upon internal data reflect the most reasonable
expectations for fair value analysis.
The
volatility rate is derived from actual Company common stock volatility over
the
same time period as the expected term. The Company uses a weekly high closing
stock price based upon daily closing prices in the week. The volatility rate
is
derived by mathematical formula utilizing the weekly high closing price
data.
The
expected dividend yield is derived by mathematical formula which uses the
expected Company annual dividends over the expected term divided by the fair
market value of the Company's common stock at the grant date.
The
average risk-free interest rate is derived from United States Department of
Treasury published interest rates of daily yield curves for the same time period
as the expected term.
19
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
Prior
to
adoption of SFAS No. 123 (R), the Company did not estimate forfeitures and
recognized them as they occurred for proforma disclosure of share-based
compensation expense. With adoption of SFAS No. 123 (R), estimated forfeitures
must be considered in recording share-based compensation expense. While not
actually utilized by the BSM model to determine the fair value amount of a
share-based payment award, it is a factor that must be estimated, monitored
and
reviewed over the life of share-based compensation awards to record the most
probable expected compensation expense related to the award. Estimated
forfeiture rates vary with each type of award affected by several factors,
one
of which is the varying composition and characteristics of the award
participants. Estimated forfeitures for the Company's share-based awards range
from 0.75 percent to 10.0 percent with the estimated forfeitures for options
at
0.75 percent.
The
following tables provide a reconciliation of option activity for the first
nine
months 2006 and 2005:
|
Stock
Options
|
Number
of Shares
|
Weighted
Average Exercise Price
|
Weighted
Average Remaining Contractual Life (years)
|
Aggregate
Intrinsic Value(1)
|
||
|
Outstanding
at 12/31/2005
|
6,616,803
|
$
|
48.26
|
|||
|
Grants
|
110,838
|
$
|
56.25
|
|||
|
Exercises
|
(542,506)
|
$
|
44.82
|
$
|
5,938,424
|
|
|
Cancelled/Forfeited/Expired
|
(228,226)
|
$
|
55.65
|
|||
|
Outstanding
at 9/30/2006
|
5,956,909
|
$
|
48.44
|
5.6
|
$
|
37,167,411
|
|
Exercisable
at 9/30/2006
|
4,173,751
|
$
|
47.12
|
4.3
|
$
|
32,447,135
|
|
Outstanding
at 12/31/2004
|
8,155,148
|
$
|
46.86
|
|||
|
Grants
|
64,788
|
$
|
56.52
|
|||
|
Exercises
|
(2,159,797)
|
$
|
43.27
|
$
|
32,982,186
|
|
|
Cancelled/Forfeited/Expired
|
(469,135)
|
$
|
63.65
|
|||
|
Outstanding
at 9/30/2005
|
5,591,004
|
$
|
46.93
|
5.4
|
$
|
15,808,530
|
|
Exercisable
at 9/30/2005
|
4,628,774
|
$
|
47.24
|
4.8
|
$
|
13,758,499
|
(1)
Intrinsic value is the amount by which the market price of the stock or the
market price at the exercise date underlying the option exceeds the exercise
price of the option.
A
total
of 1,783,158 options are unvested at September 30, 2006 for which $12 million
in
compensation expense will be recognized over 3 years. A total of 962,230 options
were unvested at September 30, 2005. Cash proceeds from the exercise of options
in the first nine months 2006 total approximately $23 million with a related
tax
benefit of approximately $2 million.
Other
Share-Based Compensation Awards
In
addition to stock option awards, the Company has long-term performance stock
awards, restricted stock awards and stock appreciation rights. The long-term
performance awards are based upon return on capital and total shareholder
return. The recognized compensation cost before tax for these other share-based
awards in the third quarter and first nine months 2006, is approximately $2
million and $9 million, respectively. The unrecognized compensation cost before
tax for these same awards total approximately $18 million at September 30,
2006
and will be recognized through 2009.
20
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
The
Company's products and operations are managed and reported in five reportable
operating segments, consisting of the CASPI segment, the Fibers segment, the
PCI
segment, the Performance Polymers segment and the Specialty
Plastics
("SP")
segment.
The
Company's segments were previously aligned in a divisional structure that
provided for goods and services to be transferred between divisions at
predetermined prices that may have been in excess of cost, which resulted in
the
recognition of intersegment sales revenue and operating earnings. Such
interdivisional transactions were eliminated in the Company's consolidated
financial statements. In first quarter 2006, the Company realigned its
organizational structure to support its growth strategy and to better reflect
the integrated nature of the Company's assets. A result of the realigned
organizational structure is that goods and services are transferred among the
segments at cost. As part of this change, the Company's segment results have
been restated to eliminate the impact of interdivisional sales revenue and
operating earnings. For additional information concerning the
Company's segments' businesses and products, refer to Note 21 to the
consolidated financial statements in Part II, Item 8 of the Company's 2005
Annual Report on Form 10-K and the Form 8-K filed on April 20,
2006.
In
the
first quarter of 2006, management determined that the Developing Businesses
("DB") segment is not of continuing significance for financial reporting
purposes. As a result, revenues and costs previously included in the DB segment
and research and development 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" revenues and operating
losses.
|
Third
Quarter
|
||||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Sales
by Segment
|
||||
|
CASPI
|
$
|
367
|
$
|
333
|
|
Fibers
|
228
|
228
|
||
|
PCI
|
457
|
428
|
||
|
Performance
Polymers
|
707
|
646
|
||
|
SP
|
207
|
179
|
||
|
Total
Sales by Segment
|
1,966
|
1,814
|
||
|
Other
|
--
|
2
|
||
|
Total
Sales
|
$
|
1,966
|
$
|
1,816
|
|
First
Nine Months
|
||||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Sales
by Segment
|
||||
|
CASPI
|
$
|
1,078
|
$
|
977
|
|
Fibers
|
696
|
633
|
||
|
PCI
|
1,321
|
1,214
|
||
|
Performance
Polymers
|
2,007
|
1,944
|
||
|
SP
|
596
|
536
|
||
|
Total
Sales by Segment
|
5,698
|
5,304
|
||
|
Other
|
--
|
26
|
||
|
Total
Sales
|
$
|
5,698
|
$
|
5,330
|
21
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
|
Third
Quarter
|
||||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Operating
Earnings (Loss) (1)
|
||||
|
CASPI
(1)
|
$
|
53
|
$
|
63
|
|
Fibers
|
55
|
60
|
||
|
PCI
(1)
|
25
|
40
|
||
|
Performance
Polymers
|
17
|
32
|
||
|
SP
|
18
|
17
|
||
|
Total
Operating Earnings by Segment
|
168
|
212
|
||
|
Other
(1)
|
(10)
|
(14)
|
||
|
Total
Operating Earnings
|
$
|
158
|
$
|
198
|
| (1) |
Operating
earnings (loss) for the following segments include asset impairments
and
restructuring charges: CASPI includes $1 million in third quarter
2005 for
previously closed manufacturing facilities; PCI includes $11 million
in
third quarter 2006 for the expected divestiture of the Arkansas facility
and Other includes $4 million for Cendian's shutdown of its business
activities.
|
|
First
Nine Months
|
||||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Operating
Earnings (Loss) (1)
|
||||
|
CASPI
(2)
|
$
|
176
|
$
|
194
|
|
Fibers
|
182
|
155
|
||
|
PCI
(2)
|
113
|
128
|
||
|
Performance
Polymers
|
46
|
166
|
||
|
SP
|
50
|
59
|
||
|
Total
Operating Earnings by Segment
|
567
|
702
|
||
|
Other
(2)
|
(35)
|
(57)
|
||
|
Total
Operating Earnings
|
$
|
532
|
$
|
645
|
| (2) |
Operating
earnings (loss) for the following segments include asset impairments
and
restructuring charges: CASPI includes $8 million and $3 million in
the
first nine months 2006 and 2005, respectively, for previously closed
manufacturing facilities; PCI includes $11 million and $4 million
in the
first nine months 2006 and 2005, respectively, for the expected
divestiture of the Arkansas facility and Other includes $4 million
and $16
million for the first nine months 2006 and 2005, respectively for
Cendian's shutdown of its business activities.
|
22
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
|
September
30,
|
December
31,
|
|||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Assets
by Segment
|
||||
|
CASPI
|
$
|
1,509
|
$
|
1,393
|
|
Fibers
|
612
|
675
|
||
|
PCI
|
1,541
|
1,589
|
||
|
Performance
Polymers
|
1,318
|
1,416
|
||
|
SP
|
772
|
689
|
||
|
Total
Assets by Segment Before Assets Held for Sale
|
5,752
|
5,762
|
||
|
Other
|
2
|
11
|
||
|
Assets
Held for Sale (3)
|
312
|
--
|
||
|
Total
Assets
|
$
|
6,066
|
$
|
5,773
|
| (3) |
For
more information regarding assets held for sale, see Note 5 to the
Company's unaudited consolidated financial statements.
|
| 19. |
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 below), 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.
Sorbates
Litigation
Two
civil
cases relating to sorbates remain. In each case, the Company prevailed at the
trial court, and in each case, the plaintiff has appealed the trial court's
decision. The Company intends to vigorously defend its position at the appellate
court level in both cases.
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 have alleged
injury due to exposure to asbestos at Eastman’s manufacturing sites and sought
unspecified monetary damages and other relief. Historically, these cases have
been dismissed or settled without a material effect on Eastman’s financial
condition, results of operations, or cash flows.
In
certain 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 all such claims or to settle
them on acceptable terms.
The
Company has finalized an agreement with an insurer that issued primary general
liability insurance to certain predecessors of the Company prior to the
mid-1970's, pursuant to which that insurer will provide coverage for a portion
of certain of the Company's defense costs and payments of settlements or
judgments in connection with asbestos-related lawsuits.
23
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
Evaluation
of the allegations and claims made in recent asbestos-related lawsuits continue
to be reviewed by the Company. Based on such evaluation to date, the Company
continues to believe that the ultimate resolution of the approximately 1,000
pending asbestos claims 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.
In
February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
No.
155, “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," and
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." SFAS No. 155 simplifies accounting for certain
hybrid instruments under SFAS No. 133 by permitting fair value remeasurement
for
financial instruments containing an embedded derivative that otherwise would
require bifurcation. SFAS No. 155 eliminates both the previous restriction
under
SFAS No. 140 on passive derivative instruments that a qualifying special-purpose
entity may hold and SFAS No. 133 Implementation Issue No. D1, “Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets,” which
provides that beneficial interests are not subject to the provisions of SFAS
No.
133. SFAS No. 155 also establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation, and clarifies that concentrations of credit
risk in the form of subordination are not imbedded derivatives. SFAS No. 155
is
effective for all financial instruments acquired, issued, or subject to a
remeasurement event occurring after the beginning of an entity’s fiscal year
that begins after September 15, 2006. The Company has evaluated the effect
of
SFAS No. 155 and determined that it does not expect a material impact from
the
adoption to its consolidated financial position, liquidity, or results from
operations.
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets,” an amendment of SFAS No. 140. SFAS No. 156 permits entities to choose
to either subsequently measure servicing rights at fair value and report changes
in fair value in earnings or amortize servicing rights in proportion to and
over
the estimated net servicing income or loss and assess to rights for impairment
or the need for an increased obligation. SFAS No. 156 also clarifies when a
servicer should separately recognize servicing assets and liabilities; requires
all separately recognized assets and liabilities to be initially measured at
fair value, if practicable; permits a one-time reclassification of
available-for-sales securities to trading securities by an entity with
recognized servicing rights and requires additional disclosures for all
separately recognized servicing assets and liabilities. SFAS No. 156 is
effective as of the beginning of an entity’s fiscal year that begins after
September 15, 2006. The Company has evaluated the effect of SFAS No. 156 and
determined that it does not expect a material impact from the adoption to its
consolidated financial position, liquidity, or results from operations.
In
July
2006, the FASB issued Interpretation No. 48 ("FIN 48"), "Accounting for
Uncertainty in Income Taxes—an Interpretation of SFAS 109 "Accounting for Income
Taxes". FIN 48 prescribes a comprehensive model for how a company should
recognize, measure, present, and disclose in its financial statements uncertain
tax positions that a company has taken or expects to take on a tax return.
Under
FIN 48, the financial statements will reflect expected future tax consequences
of such positions presuming the taxing authorities' full knowledge of the
position and all relevant facts, but without considering time values. FIN 48
also revises disclosure requirements and introduces a prescriptive, annual,
tabular roll-forward of the unrecognized tax benefits. FIN 48 is effective
for
fiscal years beginning after December 15, 2006. The Company is currently
evaluating the effect FIN 48 will have on its consolidated financial position,
liquidity, or results of operations.
24
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
In
September 2006, the FASB issued SFAS
No.
157, "Fair Value Measurements," which
addresses the measurement of fair value by companies when they are required
to
use a fair value measure for recognition or disclosure purposes under GAAP.
SFAS
No. 157 provides a common definition of fair value to be used throughout GAAP
which is intended to make the measurement of fair value more consistent and
comparable and improve disclosures about those measures. SFAS No. 157 will
be
effective for an entity's financial statements issued for fiscal years beginning
after November 15, 2007. The Company is currently evaluating the effect SFAS
No.
157 will have on its consolidated financial position, liquidity, or results
of
operations.
In
September 2006, the FASB issued SFAS
No.
158, "Employers’ Accounting for Defined Benefit Pension and Other Postretirement
Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)". One
objective of this standard is to make it easier for investors, employees,
retirees and other parties to understand and assess an employer’s financial
position and its ability to fulfill the obligations under its benefit plans.
SFAS No. 158 requires employers to fully recognize in their financial statements
the obligations associated with single-employer defined benefit pension plans,
retiree healthcare plans, and other postretirement plans. SFAS No. 158 requires
an employer to fully recognize in its statement of financial position the
overfunded or underfunded status of a defined benefit postretirement plan (other
than a multiemployer plan) as an asset or liability and to recognize changes
in
that funded status in the year in which the changes occur through comprehensive
income. This Statement also requires an employer to measure the funded status
of
a plan as of the date of its year-end statement of financial position, with
limited exceptions. SFAS No. 158 requires an entity to recognize as a component
of other comprehensive income, net of tax, the gains or losses and prior service
costs or credits that arise during the period but are not recognized as
components of net periodic benefit cost pursuant to SFAS No. 87. This Statement
requires an entity to disclose in the notes to financial statements additional
information about certain effects on net periodic benefit cost for the next
fiscal year that arise from delayed recognition of the gains or losses, prior
service costs or credits, and transition asset or obligation. The Company is
required to initially recognize the funded status of a defined benefit
postretirement plan and to provide the required disclosures for fiscal years
ending after December 15, 2006. Based on the funded status of Eastman's pension
and postretirement benefit plans in the December 31, 2005 Annual Report on
Form
10-K, the adoption of SFAS No. 158 will result in a $128 million reduction
to
stockholders' equity.
In
September 2006, the Securities and Exchange Commission ("SEC") published Staff
Accounting Bulletin No. 108 ("SAB 108") which expresses the SEC staff's views
regarding the process to be applied in considering the effects of prior years'
misstatements when quantifying misstatements in the current year's financial
statements. Registrants must quantify the impact on the current year's financial
statements of correcting all misstatements, including the carryover and
reversing effects of prior years' misstatements, as well as the effects of
errors arising in the current year. If material to the current year's income
statement, correction of existing accumulated balance sheet misstatements (i.e.,
from immaterial errors in prior years) should be accomplished by correcting
the
financial statements of affected previous years. However, in such case,
previously filed reports would not require amendment; rather, corrections should
be made the next time such prior years' statements are filed with the SEC.
The
Company does not expect to change its current practice regarding accounting
for
misstatements and does not expect the need for restatement of prior periods
as a
result of SAB 108.
In
September 2006, the FASB issued Staff Position No. AUG AIR-1 ("FSP No. AUG
AIR-1") which addresses the accounting for planned major maintenance activities.
FSP No. AUG AIR-1 amends certain provisions in the American Institute of
Certified Public Accountants ("AICPA") Industry Audit Guide and APB Opinion
No.
28, "Interim Financial Reporting". Four alternative methods of accounting for
planned major maintenance activities were permitted: direct expense, built-in
overhaul, deferral, and accrual ("accrue-in-advance"). This FSP prohibits the
use of the accrue-in-advance method of accounting for planned major maintenance
activities because it results in the recognition of a liability in a period
prior to the occurrence of the transaction or event obligating the entity.
FSP
No. AUG AIR-1 is effective for an entity's financial statements issued for
fiscal years beginning after December 15, 2006. The Company does not utilize
the
accrue-in-advance method of accounting and therefore expects this FSP to have
no
impact on its consolidated financial position, liquidity, or results of
operations.
25
NOTES
TO THE UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
In
October 2006, the Company announced a definitive agreement for the sale of
its
polyethylene businesses for a purchase price of $255 million in cash at closing.
The sale will include Eastman's polyethylene and Epolene
polymer
businesses, related assets, and the Company's ethylene pipeline. Subject to
regulatory approval and satisfaction of customary conditions, the sale is
expected to be completed in fourth quarter 2006. Results from the polyethylene
product lines are reported in the Performance Polymers segment and results
from
the Epolene
polymer
businesses are reported in the CASPI Segment.
In
October 2006, the Company decided to cease production of cyclohexane dimethanol
("CHDM") modified polymers, intermediate products primarily used internally,
in
San Roque, Spain to gain operational efficiencies at other facilities, which
will result in asset impairment and restructuring charges in the fourth quarter
2006 of approximately $25 million.
26
|
ITEM
|
Page
|
|
27
|
|
|
28
|
|
|
29
|
|
|
32
|
|
|
37
|
|
|
38
|
|
|
41
|
|
|
43
|
|
|
44
|
|
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
Company's 2005 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.
In
preparing the consolidated financial statements in conformity with accounting
principles generally accepted ("GAAP") in the United States, Eastman
Chemical Company's (the "Company" or "Eastman")
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
ongoing basis, the Company evaluates its estimates, including those related
to
allowances for doubtful accounts, impaired assets, environmental costs, U.S.
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 policies listed
and described in Part II, Item 7 of the Company's 2005 Annual Report on Form
10-K
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 consolidated financial
statements.
27
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Sales
revenue in third quarter 2006 was $2.0 billion, an 8 percent increase over
third
quarter 2005. Sales revenue in the first nine months 2006 was $5.7 billion,
a 7
percent increase over the first nine months 2005. Operating
earnings were $158 million in third quarter 2006, a $40 million decrease from
third quarter 2005. Operating
earnings were $532 million in the first nine months 2006, a $113 million
decrease from first nine months 2005. Despite higher raw material and energy
costs, especially for paraxylene in the Performance Polymers and Specialty
Plastics ("SP") segments and for propane in all segments except Fibers, these
results reflect strong earnings from a broad base of businesses.
Third
quarter
and first nine months 2006 results were negatively impacted by $13 million
and
$23 million, respectively, in asset impairments and restructuring charges
compared to $4 million and $23 million for the comparable periods in 2005.
First
nine months 2006 results were negatively impacted by approximately $15 million
of costs, net of insurance, associated with operational disruptions at the
Company's Longview, Texas, manufacturing facility, primarily in the first
quarter 2006. The Company expects no further impact on results in the fourth
quarter 2006 from these events.
Net
earnings for the third quarter 2006 and first nine months 2006 were $95 million
and $314 million, respectively, versus the third quarter and first nine months
2005 net earnings of $123 million and $491 million, respectively. Included
in
2005
results were a $171 million gain on the sale of the Company's equity investment
in Genencor International, Inc. ("Genencor") and early debt retirement costs
of
$46 million.
The
Company generated $233 million in cash from operating activities in the first
nine months 2006, a decrease of $144 million compared to the first nine months
2005 due to the prior year's higher net earnings and the current year's increase
in working capital, partially offset by lower pension contributions in the
current year.
The
Company continues to evaluate its portfolio, which could lead to further
restructuring, divestiture, or consolidation of product lines. As
previously announced, the Company has entered into definitive agreements for
the
sale of its Batesville, Arkansas manufacturing facility and related assets
and
the specialty organic chemicals product lines in the Performance Chemicals
and
Intermediates ("PCI") segment and for the sale of its polyethylene and
Epolene
polymer
businesses and related assets of the Performance Polymers and Coatings,
Adhesives, Specialty Polymers, and Inks ("CASPI") segments located at the
Longview, Texas site, and the Company's ethylene pipeline. These sales are
for a
cash purchase price of $330 million at closing. Subject to regulatory approval
and satisfaction of customary conditions, both divestitures are expected to
be
completed in fourth quarter 2006. For the first nine months of 2006, sales
revenue of $667 million and operating earnings of $50 million were attributed
to
the product lines being divested.
With
the
continuing successful implementation of the Company's turnaround strategy,
as
evidenced by strong operating results and a strengthened financial profile,
the
Company believes that it is positioned for profitable growth. This growth will
be focused in markets in which the Company has expertise and deep understanding,
and where it can leverage the technological innovation it has built over the
past 85 years.
28
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
|
Third
Quarter
|
Volume
Effect
|
Price
Effect
|
Product
Mix
Effect
|
Exchange
Rate
Effect
|
||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
|||||||||||
|
Sales
|
$
|
1,966
|
$
|
1,816
|
8
%
|
--
%
|
9
%
|
(1)
%
|
--
%
|
|||||
|
First
Nine Months
|
Volume
Effect
|
Price
Effect
|
Product
Mix
Effect
|
Exchange
Rate
Effect
|
||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
|||||||||||
|
Sales
|
$
|
5,698
|
$
|
5,330
|
7
%
|
1
%
|
7
%
|
(1)
%
|
--
%
|
|||||
Sales
revenue for the third quarter and the first nine months 2006 increased $150
million and $368 million over the third quarter and the first nine months 2005,
respectively. The increase was primarily due to higher selling prices in
response to both higher raw material and energy costs and continued strong
economic conditions.
|
Third
Quarter
|
First
Nine Months
|
|||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
2006
|
2005
|
Change
|
||||||
|
Gross
Profit
|
$
|
316
|
$
|
352
|
(10)
%
|
$
|
997
|
$
|
1,125
|
(11)
%
|
||
|
As
a percentage of sales
|
16%
|
19
%
|
17
%
|
21
%
|
||||||||
Gross
profit and gross profit as a percentage of sales for third quarter 2006
decreased compared to the third quarter 2005 due to increased raw material
and
energy costs and operational disruptions that were partially offset by higher
selling prices.
Gross
profit and gross profit as a percentage of sales for first nine months 2006
decreased compared to the first nine months 2005 primarily due to reduced gross
margins in the Performance Polymers segment.
|
Third
Quarter
|
First
Nine Months
|
|||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
2006
|
2005
|
Change
|
||||||
|
Selling,
General and
|
||||||||||||
|
Administrative
Expenses
|
$
|
105
|
$
|
108
|
(3)
%
|
$
|
316
|
$
|
339
|
(7)
%
|
||
|
Research
and Development
|
||||||||||||
|
Expenses
|
40
|
42
|
(5)
%
|
126
|
120
|
5
%
|
||||||
|
$
|
145
|
$
|
150
|
(3)
%
|
$
|
442
|
$
|
459
|
(4)
%
|
|||
|
As
a percentage of sales
|
7
%
|
8
%
|
8
%
|
9
%
|
||||||||
Selling,
general and administrative ("SG&A") expenses for third quarter 2006
decreased compared to third quarter 2005 primarily due to lower incentive
compensation expense. SG&A expenses in the first nine months 2006 decreased
compared to the first nine months 2005 due to lower incentive compensation
expense in the first nine months 2006 and to Cendian Corporation's ("Cendian")
shutdown of its business activities in the first quarter of 2005. SG&A
expenses include compensation expense under Statement of Financial Accounting
Standards ("SFAS") No. 123 Revised December 2004 ("SFAS No. 123 (R)"),
"Share-Based Payment". For more information concerning SFAS No. 123 (R), see
Note 17 to the Company's unaudited consolidated financial statements.
29
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Research
and development ("R&D") expenses decreased $2 million in third quarter 2006
compared to third quarter 2005 primarily due to lower expenses in the
Performance Polymers segment. R&D expenses increased $6 million in the first
nine months 2006 compared to the first nine months 2005 primarily due to
increased spending on growth initiatives, particularly in the SP segment. The
Company expects that R&D expenses will be approximately 3 percent of revenue
in 2006.
Asset
Impairments and Restructuring Charges, Net
Asset
impairments and restructuring charges totaled $13 million and $23 million for
the third quarter and first nine months 2006 compared to $4 million and $23
million in third quarter and first nine months 2005, respectively. The Company
continues to review its portfolio of products and businesses, which could result
in further restructuring, divestiture, and consolidation. For more information
regarding asset impairments and restructuring charges, see Note 10 to the
Company's unaudited consolidated financial statements.
Other
Operating Income
Other
operating income for the first nine months 2005 reflects a gain of $2 million
related to the 2004 divestiture of certain businesses and product
lines
within
the CASPI segment.
Interest
Expense, Net
|
Third
Quarter
|
First
Nine Months
|
|||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
2006
|
2005
|
Change
|
||||||
|
Gross
interest costs
|
$
|
28
|
$
|
27
|
$
|
84
|
$
|
91
|
||||
|
Less:
Capitalized interest
|
2
|
1
|
5
|
3
|
||||||||
|
Interest
expense
|
26
|
26
|
--
%
|
79
|
88
|
(10)
%
|
||||||
|
Interest
income
|
5
|
3
|
17
|
11
|
||||||||
|
Interest
expense, net
|
$
|
21
|
$
|
23
|
(9)
%
|
$
|
62
|
$
|
77
|
(19)
%
|
||
Gross
interest costs for the third quarter 2006 were higher compared to the third
quarter 2005 due to higher average borrowings and higher average interest
rates.
Gross
interest costs for the first nine months 2006 were lower compared to the first
nine months 2005 due to lower average borrowings that more than offset higher
average interest rates.
For
2006,
the Company expects net interest expense to decrease compared to 2005 due to
anticipated lower average borrowings, increased capitalized interest and higher
interest income.
Income
from Equity Investment in Genencor
Income
from equity investment in Genencor includes the
Company's portion of earnings from its equity investment in Genencor for the
first six months 2005. In the second quarter 2005,
the
Company completed the sale of its equity interest in Genencor for net cash
proceeds of approximately $417 million. The book value of the investment prior
to sale was $246 million resulting
in a pre-tax gain on the sale of $171 million.
30
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Early
Debt Extinguishment Costs
In
the
second quarter 2005, the Company completed the early repayment of $500 million
of its outstanding long-term debt for $544 million in cash and recorded a charge
of $46 million for early debt extinguishment costs including $2 million in
unamortized bond issuance costs. The book value of the repaid debt was $500
million.
Other
(Income) Charges, Net
|
Third
Quarter
|
First
Nine Months
|
|||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
2006
|
2005
|
Change
|
||||||
|
Other
(income)
|
$
|
(3)
|
$
|
(2)
|
$
|
(1)
|
$
|
(10)
|
$
|
(8)
|
$
|
(2)
|
|
Other
charges
|
4
|
--
|
4
|
8
|
5
|
3
|
||||||
|
Other
(income) charges, net
|
$
|
1
|
$
|
(2)
|
$
|
3
|
$
|
(2)
|
$
|
(3)
|
$
|
1
|
Included
in other income are the Company’s portion of earnings from its equity
investments, gains on the sale of certain technology business venture
investments, royalty income, and net gains on foreign exchange transactions.
Included in other charges are net losses on foreign exchange transactions,
the
Company’s portion of losses from its equity investments, write-downs to fair
value of certain technology business venture investments due to other than
temporary declines in value, and fees on securitized receivables.
Provision
for Income Taxes
|
Third
Quarter
|
First
Nine Months
|
|||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
2006
|
2005
|
Change
|
||||||
|
Provision
for income taxes
|
$
|
41
|
$
|
54
|
(24)%
|
$
|
158
|
$
|
207
|
(24)%
|
||
|
Effective
tax rate
|
30%
|
31%
|
34%
|
30%
|
||||||||
The
third
quarter and first nine months 2006 effective tax rate reflects the Company's
expected annual tax rate on reported operating earnings before income tax,
excluding discrete items, of approximately 34 percent. The third quarter 2006
effective tax rate was impacted by the reversal of foreign loss valuation
allowances. The
increase in the effective tax rate for the first nine months 2006 over the
first
nine months 2005 is primarily attributable to lower foreign earnings in
favorable tax jurisdictions and to a decrease in tax deductions for charitable
donations. The
implementation of SFAS No. 123 (R), effective January 1, 2006, did not have
a
material effect on the Company's effective income tax rate in the third quarter
and first nine months 2006. For additional information regarding SFAS No. 123
(R), see Note 17 to the Company's unaudited consolidated financial statements.
The
third
quarter 2005 effective tax rate reflects the Company's then expected annual
tax
rate on reported operating earnings before income tax, excluding discrete items,
of approximately 30 percent and higher applicable tax rates related to the
early
extinguishment of debt costs and the gain on the sale of Genencor stock. The
first nine months 2005 effective tax rate also reflects a net deferred tax
benefit adjustment related to the expected utilization of capital loss
carryforwards.
As
described in Note 19 to the consolidated financial statements in Part II, Item
8
of the Company’s 2005 Annual Report on Form 10-K, the Company has significant
foreign 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 carryforwards is greater or less than anticipated.
31
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
In
the
first quarter of 2006, management determined that the Developing Businesses
("DB") segment is not of continuing significance for financial reporting
purposes. As a result, revenues and costs previously included in the DB segment
and research and development expenditures not identifiable to an operating
segment are not included in segment operating results for either of the periods
presented and are shown in Note 18 to the Company's unaudited consolidated
financial statements as "other" revenues and operating losses.
During
third quarter 2006, the Company entered into a definitive agreement for the
sale
of its Batesville, Arkansas manufacturing facility and related assets and
specialty organic chemicals product lines in the PCI segment. In October 2006,
the Company announced a definitive agreement for the sale of its polyethylene
and Epolene
polymer
businesses and related assets located at the Longview, Texas site and the
Company's ethylene pipeline. The polyethylene assets and product lines are
in
the Performance Polymers segment, while the Epolene
assets
and product lines are in the CASPI segment. Subject to regulatory approval
and
satisfaction of customary conditions, both divestitures are expected to be
completed in fourth quarter 2006.
|
CASPI
Segment
|
|||||||||||||||||
|
Third
Quarter
|
First
Nine Months
|
||||||||||||||||
|
Change
|
Change
|
||||||||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
$
|
%
|
2006
|
2005
|
$
|
%
|
|||||||||
|
Sales
|
$
|
367
|
$
|
333
|
$
|
34
|
10
%
|
$
|
1,078
|
$
|
977
|
$
|
101
|
10
%
|
|||
|
Volume
effect
|
(2)
|
(1)%
|
5
|
--
%
|
|||||||||||||
|
Price
effect
|
34
|
10
%
|
96
|
10
%
|
|||||||||||||
|
Product
mix effect
|
--
|
--
%
|
6
|
1
%
|
|||||||||||||
|
Exchange
rate effect
|
2
|
1
%
|
(6)
|
(1)%
|
|||||||||||||
|
Operating
earnings
|
53
|
63
|
(10)
|
(16)%
|
176
|
194
|
(18)
|
(9)%
|
|||||||||
|
Asset
impairments and
|
|||||||||||||||||
|
restructuring
charges, net
|
--
|
1
|
(1)
|
8
|
3
|
5
|
|||||||||||
|
Other
operating income
|
--
|
--
|
--
|
--
|
(2)
|
2
|
|||||||||||
32
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
For the third quarter and first nine months 2006 compared to the third quarter and first nine months 2005, sales revenue increased $34 million and $101 million, respectively, due to an increase in selling prices in response to higher raw material and energy costs.
Operating
earnings decreased $10 million, particularly for cyclical commodity and for
adhesives product lines, for the third quarter 2006 compared to the third
quarter 2005 due to an increase in raw materials and energy costs which was
partially offset by an increase in selling prices.
Operating
earnings decreased $18 million for the first nine months 2006 compared to the
first nine months 2005, primarily due to increased raw material and energy
costs
and increased asset impairments and restructuring charges which more than offset
an increase in selling prices. Asset impairments and restructuring charges
of $8
million for the first nine months 2006 and $3 million for the first nine months
2005, related primarily to previously closed manufacturing facilities.
In
October 2006, the Company announced a definitive agreement for the sale of
the
CASPI segment's Epolene
polymer
businesses and related assets. Subject to regulatory approval and satisfaction
of customary conditions, the divestiture is expected to be completed in fourth
quarter 2006. CASPI sales revenue and operating earnings attributed to the
assets held for sale were $53 million and $1 million, respectively, for the
first nine months of 2006.
|
Fibers
Segment
|
|||||||||||||||||
|
Third
Quarter
|
First
Nine Months
|
||||||||||||||||
|
Change
|
Change
|
||||||||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
$
|
%
|
2006
|
2005
|
$
|
%
|
|||||||||
|
Sales
|
$
|
228
|
$
|
228
|
$
|
--
|
--
%
|
$
|
696
|
$
|
633
|
$
|
63
|
10
%
|
|||
|
Volume
effect
|
(6)
|
(3)
%
|
37
|
6
%
|
|||||||||||||
|
Price
effect
|
12
|
6
%
|
51
|
8
%
|
|||||||||||||
|
Product
mix effect
|
(6)
|
(3)
%
|
(24)
|
(4)
%
|
|||||||||||||
|
Exchange
rate effect
|
--
|
--
%
|
(1)
|
--
%
|
|||||||||||||
|
Operating
earnings
|
55
|
60
|
(5)
|
(8)
%
|
182
|
155
|
27
|
17
%
|
|||||||||
Sales
revenue remained constant for the third quarter 2006 compared to the third
quarter 2005 primarily due to higher selling prices which were offset by lower
sales volume and an unfavorable shift in product mix. The higher selling prices
were in response to higher raw material and energy costs as well as continued
strong demand for and limited supply of acetate yarn and acetyl chemical
products. The lower sales volume was primarily a result of reduced operating
rates due to operational
disruptions.
Sales
revenue increased $63 million for the first nine months 2006 compared to the
first nine months 2005 primarily due to higher selling prices and higher sales
volume that were partially offset by an unfavorable shift in product mix. The
higher selling prices were in response to higher raw material and energy costs
as well as continued strong demand for and limited supply of acetate yarn and
acetyl chemical products. The increased sales volume was due to strong demand
for acetyl chemical products attributed to strengthened global acetate tow
demand.
Operating
earnings for the third quarter 2006 compared to the third quarter 2005 decreased
$5 million due to lower sales volume and higher raw materials and energy costs
more than offsetting higher selling prices.
Operating
earnings for the first nine months 2006 compared to the first nine months 2005
increased $27 million as higher selling prices and increased sales volume more
than offset higher raw material and energy costs.
33
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
The
Company believes that acetate tow has modest growth potential in future years
and has been evaluating growth options in Europe and Asia. In the third quarter
2006, the Company announced plans to add capacity and expand production of
Estron
acetate
tow in Europe at its Workington, England facility to ensure continued supply
of
customers' acetate tow needs. The Company continues to evaluate options for
growth in Asia.
|
PCI
Segment
|
|||||||||||||||||
|
Third
Quarter
|
First
Nine Months
|
||||||||||||||||
|
Change
|
Change
|
||||||||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
$
|
%
|
2006
|
2005
|
$
|
%
|
|||||||||
|
Sales
|
$
|
457
|
$
|
428
|
$
|
29
|
7
%
|
$
|
1,321
|
$
|
1,214
|
$
|
107
|
9
%
|
|||
|
Volume
effect
|
(1)
|
--
%
|
(5)
|
--
%
|
|||||||||||||
|
Price
effect
|
32
|
8
%
|
113
|
9
%
|
|||||||||||||
|
Product
mix effect
|
(3)
|
(1)%
|
1
|
--
%
|
|||||||||||||
|
Exchange
rate effect
|
1
|
--
%
|
(2)
|
--
%
|
|||||||||||||
|
Operating
earnings
|
25
|
40
|
(15)
|
(38)%
|
113
|
128
|
(15)
|
(12)%
|
|||||||||
|
Asset
impairments and
|
|||||||||||||||||
|
restructuring
charges, net
|
11
|
--
|
11
|
11
|
4
|
7
|
|||||||||||
Sales
revenue for the third quarter and first nine months 2006 compared to the third
quarter and first nine months 2005 increased $29 million and $107 million,
respectively, primarily due to higher selling prices, particularly in the
intermediates product lines, in response to increases in raw material and energy
costs.
Operating
earnings decreased $15 million for the third quarter and first nine months
2006
compared to the third quarter and first nine months 2005, respectively. The
third quarter 2006 operating earnings included asset impairments and
restructuring charges of $11 million related to the expected divestiture of
the
PCI segment's Arkansas facility, assets and product lines. The third quarter
2005 operating earnings included $10 million of operating earnings from the
achievement of certain milestones under an acetyls technology licensing
agreement.
In
third
quarter 2006, the Company announced a definitive agreement for the sale of
the
PCI segment's Batesville, Arkansas manufacturing facility and related assets
and
specialty organic chemicals product lines. Subject to regulatory approval and
satisfaction of customary conditions, this divestiture is expected to be
completed in fourth quarter 2006. PCI sales revenue and operating results
attributed to the assets held for sale were $97 million and $3 million,
respectively, for the first nine months of 2006.
34
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
|
Performance
Polymers Segment
|
|||||||||
|
Third
Quarter
|
|||||||||
|
Change
|
|||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
$
|
%
|
|||||
|
Total
sales
|
$
|
707
|
$
|
646
|
$
|
61
|
10
%
|
||
|
Sales
- assets held for sale
|
169
|
164
|
5
|
3
%
|
|||||
|
Sales
- continuing product lines
|
538
|
482
|
56
|
12
%
|
|||||
|
Volume
effect
|
(22)
|
(3)
%
|
|||||||
|
Price
effect
|
77
|
12
%
|
|||||||
|
Product
mix effect
|
(2)
|
--
%
|
|||||||
|
Exchange
rate effect
|
8
|
1
%
|
|||||||
|
Total
operating earnings
|
17
|
32
|
(15)
|
(47)
%
|
|||||
|
Operating
earnings - assets held for sale (1)
|
15
|
11
|
4
|
36
%
|
|||||
|
Operating
earnings - continuing product lines
|
2
|
21
|
(19)
|
(90)
%
|
|||||
|
First
Nine Months
|
|||||||||
|
Change
|
|||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
$
|
%
|
|||||
|
Total
sales
|
$
|
2,007
|
$
|
1,944
|
$
|
63
|
3
%
|
||
|
Sales
- assets held for sale
|
517
|
442
|
75
|
17
%
|
|||||
|
Sales
- continuing product lines
|
1,490
|
1,502
|
(12)
|
(1)
%
|
|||||
|
Volume
effect
|
--
|
--
%
|
|||||||
|
Price
effect
|
58
|
3
%
|
|||||||
|
Product
mix effect
|
11
|
--
%
|
|||||||
|
Exchange
rate effect
|
(6)
|
--
%
|
|||||||
|
Total
operating earnings
|
46
|
166
|
(120)
|
(72)
%
|
|||||
|
Operating
earnings - assets held for sale (1)
|
52
|
56
|
(4)
|
(7)
%
|
|||||
|
Operating
earnings - continuing product lines
|
(6)
|
110
|
(116)
|
>(100)
%
|
|||||
(1)
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.
In
October 2006, the Company announced a definitive agreement for the sale of
the
Performance Polymer segment's polyethylene businesses and related assets located
at the Longview, Texas site and the Company's ethylene pipeline. Subject to
regulatory approval and satisfaction of customary conditions, the divestiture
is
expected to be completed in fourth quarter 2006.
Sales
revenue increased $61 million in third quarter 2006 compared to third quarter
2005 primarily due to higher selling prices in all product lines in response
to
higher raw material and energy costs, partially offset by lower sales volume,
particularly for PET polymers in North America due to sustained levels of Asian
imports and for polyethylene due to operational disruptions. Excluding
the product lines being divested, sales revenue increased $56
million.
Sales
revenue increased $63 million in first nine months 2006 compared to first nine
months 2005 primarily due to higher selling prices in polyethylene.
Excluding
the product lines being divested, sales revenue decreased $12 million.
35
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Operating
earnings decreased $15 million in third quarter 2006 compared to third quarter
2005 primarily due to higher raw material costs and lower sales volume,
particularly for PET polymers in North America, more than offsetting higher
selling prices. Excluding product lines expected to be divested in fourth
quarter, operating earnings decreased $19 million.
Operating
earnings decreased $120 million in the first nine months 2006 compared to the
first nine months 2005 primarily due to higher raw material and energy costs
and
lower selling prices for PET polymers globally. Excluding the product lines
being divested, operating earnings decreased $116 million.
In
early
March, 2005, the Company broke ground on the first commercial scale PET polymers
plant based upon Eastman's IntegRex
technology. The plant will be a 350,000 metric ton facility and the Company
continues to expect to begin production in fourth quarter 2006. Research and
development efforts continue to enhance IntegRex
technology in parallel with construction of the first IntegRex
manufacturing facility. The Company is evaluating the possible construction
of a
full IntegRex
facility
in North America utilizing these further refinements to IntegRex
technology.
The
Company is continuing to evaluate its strategic and operational options related
to certain PET assets to improve profitability of the segment.
|
SP
Segment
|
|||||||||||||||||
|
Third
Quarter
|
First
Nine Months
|
||||||||||||||||
|
Change
|
Change
|
||||||||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
$
|
%
|
2006
|
2005
|
$
|
%
|
|||||||||
|
Sales
|
$
|
207
|
$
|
179
|
$
|
28
|
16
%
|
$
|
596
|
$
|
536
|
$
|
60
|
11
%
|
|||
|
Volume
effect
|
26
|
15
%
|
47
|
9
%
|
|||||||||||||
|
Price
effect
|
7
|
4
%
|
27
|
5
%
|
|||||||||||||
|
Product
mix effect
|
(5)
|
(3)
%
|
(9)
|
(2)
%
|
|||||||||||||
|
Exchange
rate effect
|
--
|
--
%
|
(5)
|
(1)
%
|
|||||||||||||
|
Operating
earnings
|
18
|
17
|
1
|
6
%
|
50
|
59
|
(9)
|
(15)%
|
|||||||||
Sales
revenue for the third quarter and first nine months 2006 compared to the third
quarter and first nine months 2005 increased $28 million and $60 million,
respectively, due to increased sales volume. The higher sales volume was
primarily attributed to continued market development efforts, particularly in
copolyester product lines. Selling prices increased to offset higher raw
material and energy costs with increases limited by competitive industry
dynamics.
Operating
earnings for third quarter 2006 increased $1 million compared with third quarter
2005 due to increased sales volume and higher selling prices which more than
offset higher raw material and energy costs.
Operating
earnings for the first nine months 2006 declined $9 million compared with the
first nine months 2005 primarily due to higher raw material and energy costs
and
increased expenditures related to growth initiatives more than offsetting
increased sales volume and higher selling prices.
Eastman
continues to be a market leading supplier of cyclohexane dimethanol ("CHDM")
modified polymers. In October 2006, the Company decided to cease production
of
CHDM, an intermediate product primarily used internally, in San Roque, Spain
to
gain operational efficiencies at other facilities, which will result in asset
impairment and restructuring charges in the fourth quarter 2006.
36
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Sales
Revenue
|
Third
Quarter
|
||||||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
Volume
Effect
|
Price
Effect
|
Product
Mix
Effect
|
Exchange
Rate
Effect
|
|||||||
|
United
States and Canada
|
$
|
1,111
|
$
|
1,052
|
6
%
|
(3)
%
|
9
%
|
--
%
|
--
%
|
|||||
|
Europe,
Middle East, and Africa
|
371
|
332
|
12
%
|
2
%
|
9
%
|
(3)
%
|
4
%
|
|||||||
|
Asia
Pacific
|
243
|
235
|
3
%
|
(3)
%
|
9
%
|
(3)
%
|
--
%
|
|||||||
|
Latin
America
|
241
|
197
|
22
%
|
14
%
|
6
%
|
2
%
|
--
%
|
|||||||
|
$
|
1,966
|
$
|
1,816
|
8
%
|
--
%
|
9
%
|
(1)
%
|
--
%
|
||||||
Sales
revenue in the United States and Canada increased for third quarter 2006
compared to third quarter 2005 primarily due to higher selling prices,
particularly in the Performance Polymers segment, which had a $47 million
positive impact on sales revenue. The higher selling prices were primarily
in
response to increases in raw material and energy costs.
Sales
revenue in Europe, Middle East and Africa increased for third quarter 2006
compared to third quarter 2005 primarily due to higher selling prices,
particularly in the Performance Polymers segment. The higher selling prices
were
primarily in response to increases in raw material and energy costs.
Sales
revenue in Asia Pacific increased for third quarter 2006 compared to third
quarter 2005 primarily due to higher selling prices, particularly in the PCI
segment.
Sales
revenue in Latin America increased for third quarter 2006 compared to third
quarter 2005 primarily due to higher sales volume, particularly in the
Performance Polymers segment.
|
First
Nine Months
|
||||||||||||||
|
(Dollars
in millions)
|
2006
|
2005
|
Change
|
Volume
Effect
|
Price
Effect
|
Product
Mix
Effect
|
Exchange
Rate
Effect
|
|||||||
|
United
States and Canada
|
$
|
3,278
|
$
|
3,068
|
7
%
|
--
%
|
8
%
|
(1)
%
|
--
%
|
|||||
|
Europe,
Middle East, and Africa
|
1,080
|
1,051
|
3
%
|
--
%
|
4
%
|
--
%
|
(1)
%
|
|||||||
|
Asia
Pacific
|
702
|
685
|
2
%
|
(4)
%
|
8
%
|
(1)
%
|
(1)
%
|
|||||||
|
Latin
America
|
638
|
526
|
21
%
|
21
%
|
(2)
%
|
2
%
|
--
%
|
|||||||
|
$
|
5,698
|
$
|
5,330
|
7
%
|
1
%
|
7
%
|
(1)
%
|
--
%
|
||||||
Sales
revenue in the United States and Canada increased for the first nine months
2006
compared to the first nine months 2005 primarily due to higher selling prices,
particularly in the PCI segment, which had an $87 million positive impact on
sales revenue. The higher selling prices were primarily in response to increases
in raw material and energy costs.
37
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Sales revenue in Europe, Middle East and Africa increased for the first nine months 2006 compared to the first nine months 2005 primarily due to higher selling prices.
Sales
revenue in Asia Pacific increased for the
first
nine months 2006 compared to the first nine months 2005
primarily due to increased selling prices, particularly in the Fibers and PCI
segments, which were partially offset by lower sales volume, particularly in
the
Fibers and Performance Polymers segments.
Sales
revenue in Latin America increased for the first nine months 2006 compared
to
the first nine months 2005 primarily due to higher sales volume, particularly
in
the Performance Polymers segment.
With
a
substantial portion of sales to customers outside the United States, 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, see Note 9 to the consolidated financial statements
in
Part II, Item 8 and Part
II,
Item 7A
of the
Company’s 2005 Annual Report on Form 10-K and Forward-Looking Statements and
Risk Factors of this Quarterly Report on Form 10-Q.
Cash
Flows
|
First
Nine Months
|
||||
|
(Dollars
in millions)
|
2006
|
2005
|
||
|
Net
cash provided by (used in)
|
||||
|
Operating
activities
|
$
|
233
|
$
|
377
|
|
Investing
activities
|
(279)
|
230
|
||
|
Financing
activities
|
(50)
|
(643)
|
||
|
Effect
of exchange rate changes on cash and cash equivalents
|
2
|
(3)
|
||
|
Net
change in cash and cash equivalents
|
(94)
|
(39)
|
||
|
|
||||
|
Cash
and cash equivalents at beginning of period
|
524
|
325
|
||
|
Cash
and cash equivalents at end of period
|
$
|
430
|
$
|
286
|
Cash
provided by operating activities decreased $144 million in the first nine months
2006 compared to the first nine months 2005 due to the prior year's higher
net
earnings and the current year's increase in working capital, partially offset
by
lower pension contributions in the current year. In the first nine months 2006,
the Company's working capital increased, consistent with a more normal level,
following a reduction of working capital requirements in the fourth quarter
2005
due to the impact of the Gulf Coast hurricanes on sales volume, especially
in
the Performance Polymers segment. The Company contributed $75 million and $165
million to its U.S. defined benefit pension plans in the first nine months
2006
and 2005, respectively.
Cash
used
in investing activities totaled $279 million in the first nine months 2006
and
cash provided by investing activities totaled $230 million in the first nine
months 2005. In the first nine months 2005, the Company received $417 million
in
net cash proceeds from the sale of its equity investment in Genencor. Capital
spending was higher in the first nine months 2006 and included expenditures
related to the construction of the IntegRex
facility.
38
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Cash
used
in financing activities in the first nine months 2006 totaled $50 million
compared to $643 million in the first nine months 2005. Cash used in financing
activities in the first nine months 2005 includes the Company's early repayment
of $500 million of its outstanding long-term debt and a decrease in commercial
paper, credit facility, and other borrowings including bank overdrafts of $84
million, offset by cash received from stock option exercises of $91 million.
The
payment of dividends is also reflected in financing activities in all
periods.
Liquidity
At
September 30, 2006, the Company had credit facilities with various U.S. and
non-U.S. banks totaling approximately $880 million as disclosed in Note 7 to
the
consolidated financial statements in Part II, Item 8 of the Company's 2005
Annual Report on Form 10-K. These credit facilities consist of a $700 million
revolving credit facility (the "Credit Facility"), which was amended in April
2006 to extend the expiration date to April 2011, and a 144 million euro credit
facility ("Euro Facility") which expires in December 2010. Borrowings under
these credit facilities are subject to interest at varying spreads above quoted
market rates. These credit facilities require facility fees on the total
commitment that are based on Eastman's credit rating. In addition, these credit
facilities contain 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. The Company's combined credit facility
borrowings at September 30, 2006 and December 31, 2005 were $182 million and
$214 million at weighted average interest rates of 3.49 percent and 3.01
percent, respectively.
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. Since the
Credit Facility expires in April 2011, any 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.
For
more
information regarding interest rates, refer to Note 8 to the Company's unaudited
consolidated financial statements.
The
Company has effective shelf registration statements filed with the Securities
and Exchange Commission ("SEC") to issue a combined $1.1 billion of debt or
equity securities.
The
Company contributed $75 million to its U.S. defined benefit pension plan in
the
first nine months 2006 and expects no further contributions during 2006.
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 material 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. The Company believes maintaining a financial profile consistent with
an
investment grade company is important to its long term strategic and financial
flexibility.
Capital
Expenditures
Capital
expenditures were $279 million and $224 million for the first nine months 2006
and 2005, respectively. The Company expects capital spending in 2006 will be
approximately $400 million which includes the expected
completion of the new PET facility in South Carolina utilizing IntegRex
technology and a copolyester intermediates expansion and to other targeted
growth initiatives.
39
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Commitments
At
September 30, 2006, the Company’s obligations related to notes and debentures
totaled approximately $1.4 billion to be paid over a period of up to 21 years.
Other borrowings, related primarily to credit facility borrowings, totaled
approximately $200 million.
The
Company had various purchase obligations at September 30, 2006 totaling
approximately $2.1 billion over a period of approximately 15 years for
materials, supplies and energy incident to the ordinary conduct of business.
For
information regarding the
Company's lease commitments, refer to Note 13 to the Company's unaudited
consolidated financial statements.
In
addition, the Company had other liabilities at September 30, 2006 totaling
approximately $1.1 billion primarily related to pension, retiree medical, and
other post-employment obligations.
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. For information on the
Company's residual value guarantees, refer to Note 13 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. For information on the
Company's accounts receivable securitization program, refer to Note 13 to the
Company's unaudited consolidated financial statements.
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.
The
Company has evaluated material relationships and has concluded that the legal
entities involved with these material relationships are not Variable Interest
Entities ("VIEs") or, in the case of Primester, a joint venture that
manufactures cellulose acetate at its Kingsport, Tennessee plant, the Company
is
not the primary beneficiary of the VIE. As such, in accordance with
Interpretation No. 46R ("FIN 46R"), "Consolidation of Variable Interest
Entities" 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 at September 30, 2006. These potential VIEs are joint
ventures from which the Company has purchased raw materials and utilities for
several years and purchases approximately $70 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
consolidates 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 entities are VIEs, and if one or both are VIEs, whether
or
not the Company is the primary beneficiary.
Guarantees
and claims also arise during the ordinary course of business from relationships
with suppliers, customers, and non-consolidated affiliates when the Company
undertakes an obligation to guarantee the performance of others if specified
triggering events occur. Non-performance under a contract could trigger an
obligation of the Company. These potential claims include actions based upon
alleged exposures to products, intellectual property and environmental matters,
and other indemnifications. The ultimate effect on future financial results
is
not subject to reasonable estimation because considerable uncertainty exists
as
to the final outcome of these claims. However, while the ultimate liabilities
resulting from such claims may be significant to results of operations in the
period recognized, management does not anticipate they will have a material
adverse effect on the Company's consolidated financial position or
liquidity.
40
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Dividends
The
Company declared cash dividends of $0.44 per share in the third quarter 2006
and
2005 and $1.32 per share in the first nine months 2006 and 2005.
In
February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
No.
155, “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," and
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." SFAS No. 155 simplifies accounting for certain
hybrid instruments under SFAS No. 133 by permitting fair value remeasurement
for
financial instruments containing an embedded derivative that otherwise would
require bifurcation. SFAS No. 155 eliminates both the previous restriction
under
SFAS No. 140 on passive derivative instruments that a qualifying special-purpose
entity may hold and SFAS No. 133 Implementation Issue No. D1, “Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets,” which
provides that beneficial interests are not subject to the provisions of SFAS
No.
133. SFAS No. 155 also establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation, and clarifies that concentrations of credit
risk in the form of subordination are not imbedded derivatives. SFAS No. 155
is
effective for all financial instruments acquired, issued, or subject to a
remeasurement event occurring after the beginning of an entity’s fiscal year
that begins after September 15, 2006. The Company has evaluated the effect
of
SFAS No. 155 and determined that it does not expect a material impact from
the
adoption to its consolidated financial position, liquidity, or results from
operations.
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets,” an amendment of SFAS No. 140. SFAS No. 156 permits entities to choose
to either subsequently measure servicing rights at fair value and report changes
in fair value in earnings or amortize servicing rights in proportion to and
over
the estimated net servicing income or loss and assess to rights for impairment
or the need for an increased obligation. SFAS No. 156 also clarifies when a
servicer should separately recognize servicing assets and liabilities; requires
all separately recognized assets and liabilities to be initially measured at
fair value, if practicable; permits a one-time reclassification of
available-for-sales securities to trading securities by an entity with
recognized servicing rights and requires additional disclosures for all
separately recognized servicing assets and liabilities. SFAS No. 156 is
effective as of the beginning of an entity’s fiscal year that begins after
September 15, 2006. The Company has evaluated the effect of SFAS No. 156 and
determined that it does not expect a material impact from the adoption to its
consolidated financial position, liquidity, or results from operations.
In
July
2006, the FASB issued Interpretation No. 48 ("FIN 48"), "Accounting for
Uncertainty in Income Taxes—an Interpretation of SFAS 109 "Accounting for Income
Taxes". FIN 48 prescribes a comprehensive model for how a company should
recognize, measure, present, and disclose in its financial statements uncertain
tax positions that a company has taken or expects to take on a tax return.
Under
FIN 48, the financial statements will reflect expected future tax consequences
of such positions presuming the taxing authorities' full knowledge of the
position and all relevant facts, but without considering time values. FIN 48
also revises disclosure requirements and introduces a prescriptive, annual,
tabular roll-forward of the unrecognized tax benefits. FIN 48 is effective
for
fiscal years beginning after December 15, 2006. The Company is currently
evaluating the effect FIN 48 will have on its consolidated financial position,
liquidity, or results of operations.
In
September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which
addresses the measurement of fair value by companies when they are required
to
use a fair value measure for recognition or disclosure purposes under GAAP.
SFAS
No. 157 provides a common definition of fair value to be used throughout GAAP
which is intended to make the measurement of fair value more consistent and
comparable and improve disclosures about those measures. SFAS No. 157 will
be
effective for an entity's financial statements issued for fiscal years beginning
after November 15, 2007. The Company is currently evaluating the effect SFAS
No.
157 will have on its consolidated financial position, liquidity, or results
of
operations.
41
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
In September 2006, the FASB issued SFAS No. 158, "Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)". One objective of this new standard is to make it easier for investors, employees, retirees and other parties to understand and assess an employer’s financial position and its ability to fulfill the obligations under its benefit plans. SFAS No. 158 requires employers to fully recognize in their financial statements the obligations associated with single-employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans. SFAS No. 158 requires an employer to fully recognize in its statement of financial position the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. SFAS No. 158 requires an entity to recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to SFAS No. 87. This Statement requires an entity to disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. The Company is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures for fiscal years ending after December 15, 2006. Based on the funded status of Eastman's pension and postretirement benefit plans in the December 31, 2005 Annual Report on Form 10-K, the adoption of SFAS No. 158 will result in a $128 million reduction to stockholders' equity.
In
September 2006, the SEC published Staff Accounting Bulletin No. 108 ("SAB 108")
which expresses the SEC staff's views regarding the process to be applied in
considering the effects of prior years' misstatements when quantifying
misstatements in the current year's financial statements. Registrants must
quantify the impact on the current year's financial statements of correcting
all
misstatements, including the carryover and reversing effects of prior years'
misstatements, as well as the effects of errors arising in the current year.
If
material to the current year's income statement, correction of existing
accumulated balance sheet misstatements (i.e., from immaterial errors in prior
years) should be accomplished by correcting the financial statements of affected
previous years. However, in such case, previously filed reports would not
require amendment; rather, corrections should be made the next time such prior
years' statements are filed with the SEC. The Company does not expect to change
its current practice regarding accounting for misstatements and does not expect
the need for restatement of prior periods as a result of SAB 108.
In
September 2006, the FASB issued Staff Position No. AUG AIR-1 ("FSP No. AUG
AIR-1") which addresses the accounting for planned major maintenance activities.
FSP No. AUG AIR-1 amends certain provisions in the American Institute of
Certified Public Accountants ("AICPA") Industry Audit Guide and Accounting
Principles Board ("APB") Opinion No. 28, "Interim Financial Reporting". Four
alternative methods of accounting for planned major maintenance activities
were
permitted: direct expense, built-in overhaul, deferral, and accrual
("accrue-in-advance"). This FSP prohibits the use of the accrue-in-advance
method of accounting for planned major maintenance activities because it results
in the recognition of a liability in a period prior to the occurrence of the
transaction or event obligating the entity. FSP No. AUG AIR-1 is effective
for
an entity's financial statements issued for fiscal years beginning after
December 15, 2006. The Company does not utilize the accrue-in-advance method
of
accounting and therefore expects this FSP to have no impact on its consolidated
financial position, liquidity, or results of operations.
42
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
For
2006,
the Company expects:
| · |
the
volatility of raw material and energy costs will continue and the
Company
will continue to pursue pricing strategies and ongoing cost control
initiatives to offset the effects on gross
profit;
|
| · |
strong
volume will be maintained due to continued economic strength, continued
substitution of Eastman products for other materials, and new applications
for existing products;
|
| · |
pension
and other post-employment benefit expenses will be similar to 2005
levels;
|
| · |
to
make no further contributions to the Company’s U.S. defined benefit
pension plan during 2006; $75 million has been contributed for the
nine
months ending September 30, 2006;
|
| · |
net
interest expense to decrease compared with 2005 primarily as a result
of
anticipated lower average borrowings, increased capitalized interest
and
higher interest income;
|
| · |
R&D
expenses will be approximately 3 percent of
revenue;
|
| · |
the
effective tax rate to be approximately 34
percent;
|
| · |
to
complete the sale of its Batesville, Arkansas manufacturing facility
and
related assets and specialty organic chemicals product lines and
of its
polyethylene and Epolene
polymer businesses and the ethylene pipeline;
|
| · |
to
continue to evaluate its portfolio, which could lead to further
restructuring, divestiture, or consolidation of assets and product
lines;
|
| · |
capital
expenditures to be approximately $400 million and exceed estimated
depreciation and amortization of approximately $300 million;
|
| · |
to
complete construction of the new PET facility in South Carolina utilizing
IntegRex
technology and a copolyester intermediates expansion, and to pursue
other
targeted growth initiatives; and
|
| · |
priorities
for use of available cash will be to pay the quarterly cash dividends,
fund targeted growth initiatives and fund the defined benefit pension
plans.
|
The
Company expects normal seasonality will reduce demand in some of its businesses
and product lines during the fourth quarter and; therefore, expects fourth
quarter 2006 earnings per share excluding gains and charges related to ongoing
strategic decisions to be at or above fourth quarter 2005 earnings per share
excluding asset impairments and restructuring charges.
See
“Forward-Looking Statements and Risk Factors below.”
43
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
The
expectations under "Outlook" and certain other statements in this Quarterly
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, foreign currencies and interest
rates; 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 expected financial
conditions; expectations, strategies, and plans for individual assets and
products, businesses and segments as well as for the whole of Eastman Chemical
Company; cash requirements and uses of available cash; financing plans; pension
expenses and funding; credit ratings; anticipated restructuring, divestiture,
and consolidation activities; 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 rates and net
interest costs.
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 cause the Company's actual results to differ materially
from
those in any such forward-looking statements:
| · |
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,
natural disasters, 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.
|
| · |
While
temporary shortages of raw materials and energy may occasionally
occur,
these items have historically been sufficiently available to cover
current
and projected requirements. However, their continuous availability
and
price are impacted by natural disasters, plant interruptions occurring
during periods of high demand, domestic and world market and political
conditions, changes in government regulation, and 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 in addition to those that the
Company
can impact. Natural disasters, 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 negatively impact the Company’s competitive position and its ability
to maintain market share. 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.
|
44
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
| · |
Limitation
of the Company's available manufacturing capacity due to significant
disruption in its manufacturing operations, including natural disasters,
could have a material adverse affect on sales revenue, costs and
results
of operations and financial condition.
|
| · |
The
Company has an extensive customer base; however, loss of, or material
financial weakness of, certain of the largest 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.
|
| · |
The
Company's competitive position has recently been adversely impacted
by low
cost competitors in certain regions and customers developing internal
or
alternative sources of supply.
|
| · |
The
Company has efforts underway to exploit growth opportunities in certain
core businesses by developing new products, expanding into new markets,
and tailoring product offerings to customer needs. There can be no
assurance that such efforts will result in financially successful
commercialization of such products or acceptance by existing or new
customers or new markets.
|
| · |
The
Company has made, and intends to continue making, strategic investments,
including IntegRex
technology, and has entered, and expects to continue to enter, into
strategic alliances in technology, services businesses, and other
ventures
in order to build, diversify, and strengthen certain Eastman capabilities
and to maintain high utilization of manufacturing assets. There can
be no
assurance that such investments and alliances will achieve their
underlying strategic business objectives or that they will be beneficial
to the Company's results of
operations.
|
| · |
In
addition to productivity and 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
price increases will be realized or will be realized within the Company’s
anticipated timeframe.
|
| · |
The
Company has undertaken and expects to 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.
|
| · |
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 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, chemical control regulations and testing requirements
could
result in higher or lower costs.
|
| · |
The
Company and its 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.
|
45
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
| · |
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 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.
|
| · |
Due
to the Company's global sales, earnings, and asset profile, it is
exposed
to volatility in foreign currency exchange rates and interest rates.
The
Company may use derivative financial instruments, including swaps,
options
and forwards, to mitigate the impact of changes in exchange rates
and
interest rates on its financial results. However, there can be no
assurance that these efforts will be successful and operating results
could be affected by significant adverse changes in currency exchange
rates and/or interest rates.
|
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
Quarterly 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.
There
are
no material changes to the Company's market risks since December 31, 2005.
For
more information regarding the Company's disclosure about market risks, see
Part
II, Item 7A of the Company's 2005 Annual Report on Form 10-K.
46
ITEM
4. CONTROLS
AND PROCEDURES
Disclosure
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. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Securities and Exchange Act of 1934 is
accumulated and communicated to the issuer's management, including its principal
executive and principal financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure. 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 September 30, 2006.
Changes
in Internal Control Over Financial Reporting
There
has
been no change in the Company’s internal control over financial reporting that
occurred during the third quarter of 2006 that has materially affected, or
is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.
47
PART
II. OTHER INFORMATION
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, 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. For additional information
about the sorbates and asbestos litigation, refer to Note 19 to the Company's
unaudited consolidated financial statements.
In
June
2005, Eastman Chemical Middelburg, B.V., a wholly owned subsidiary of the
Company, (the "Subsidiary") received a summons from the Middelburg (Netherlands)
District Court Office to appear before the economic magistrate of that District
and respond to allegations that the Subsidiary's manufacturing facility in
Middelburg has exceeded certain conditions in the permit that allows the
facility to discharge wastewater into the municipal wastewater treatment system.
The summons proposed penalties in excess of $100,000 (USD) as a result of the
alleged violations. A hearing in this matter took place on July 28, 2005, at
which time the magistrate bifurcated the proceeding into two phases: a
compliance phase and an economic benefit phase. With respect to the compliance
phase, the magistrate levied a fine of less than $100,000. With respect to
the
economic benefit phase, where the prosecutor's proposed penalty in excess of
$100,000 remains pending, the parties have submitted their respective written
positions to the magistrate. On October 27, 2006, the parties appeared before
the district court to present their positions. At this hearing, the Subsidiary
vigorously contested the assessment of an economic benefit penalty. The district
court will likely render its decision in this matter before the end of this
year. This disclosure is made pursuant to SEC Regulation S-K, Item 103,
Instruction 5.C., which requires disclosure of administrative proceedings
commenced under environmental laws that involve governmental authorities as
parties and potential monetary sanctions in excess of $100,000. The
Company believes that the ultimate resolution of this proceeding
will not have a material impact on the Company’s financial condition, results of
operations, or cash flows.
For
identification and discussion of the most significant risks applicable to the
Company and its business, see Part I - Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of Operations - Forward-Looking
Statements and Risk Factors of this Quarterly Report on Form
10-Q.
48
(c)
Purchases of Equity Securities by the Issuer
|
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)
|
|||
|
July
1- 31, 2006
|
102
|
$
|
52.18
|
0
|
$
|
288
|
|
|
August
1-31, 2006
|
137
|
$
|
51.02
|
0
|
$
|
288
|
|
|
September
1-30, 2006
|
265
|
$
|
52.42
|
0
|
$
|
288
|
|
|
Total
|
504
|
$
|
51.99
|
0
|
| (1) |
Shares
surrendered to the Company by employees to satisfy individual tax
withholding obligations upon vesting of previously issued shares
of
restricted common stock. Shares are not part of any Company repurchase
plan.
|
| (2) |
Average
price paid per share reflects the weighted average closing price
of
Eastman stock on the business date the shares were surrendered by
the
employee stockholder.
|
| (3) |
The
Company was authorized by the Board of Directors on February 4, 1999
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 after 2001.
For
additional information see Note 14 to the Company's consolidated
financial
statements in Part II, Item 8 of the 2005 Annual Report on Form
10-K.
|
Exhibits
filed as part of this report are listed in the Exhibit Index appearing on page
51.
49
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:
October 31,
2006
|
By:
|
/S/
Richard A. Lorraine
|
|
|
Richard
A. Lorraine
|
|||
|
Senior
Vice President and Chief Financial
Officer
|
50
|
Sequential
|
||||
|
Exhibit
|
Page
|
|||
|
Number
|
Description
|
Number
|
||
|
3.01
|
Amended
and Restated Certificate of Incorporation of Eastman Chemical Company,
(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
|
53
|
|||
|
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)
|
|||
|
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 (incorporated herein by reference to Exhibit 4.4 to Eastman
Chemical
Company's Registration Statement on Form S-8 relating to the Eastman
Investment Plan, File No. 33-73810)
|
|||
|
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 7 1/4% Debentures due January 15, 2024 (incorporated herein by
reference to Exhibit 4(d) to the 8-K)
|
|||
|
4.05
|
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"))
|
|||
|
4.06
|
Form
of 7 5/8% Debentures due June 15, 2024 (incorporated herein by reference
to Exhibit 4(b) to the June 8-K)
|
|||
|
4.07
|
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"))
|
|||
|
4.08
|
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)
|
|||
|
4.09
|
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)
|
|||
|
4.10
|
$200,000,000
Accounts Receivable Securitization agreement dated April 13, 1999
(amended
April 11, 2000), between the Company and Bank One, N.A., 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
|
|||
|
4.11
|
Amended
and Restated Credit Agreement, dated as of April 3, 2006 (the "Credit
Agreement") among Eastman Chemical Company, the Lenders named therein,
and
Citigroup Global Markets Inc. and J.P. Morgan Securities Inc., as
joint
lead arrangers (incorporated herein by reference to Exhibit 4.11
to
Eastman Chemical Company's Quarterly Report on Form 10-Q for the
quarter
ended June 30, 2006)
|
51
|
EXHIBIT
INDEX
|
Sequential
|
|||
|
Exhibit
|
Page
|
|||
|
Number
|
Description
|
Number
|
||
|
4.12
|
Form
of 3 ¼% 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 ended June 30, 2003)
|
|||
|
4.13
|
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)
|
|||
|
4.14
|
Amendments
to Stockholder Protection Rights Agreement (incorporated herein by
reference to Exhibits 4.1 and 4.2 to Eastman Chemical Company’s Current
Report on Form 8-K dated December 4, 2003)
|
|||
|
10.01
|
54
|
|||
|
10.02
|
55
|
|||
|
10.03
|
56
|
|||
|
10.04
|
57
|
|||
|
|
||||
|
12.01
|
Statement re: Computation of Ratios of Earnings to Fixed Charges |
58
|
||
|
31.01
|
Rule 13a - 14(a) Certification by J. Brian Ferguson, Chairman of the Board and Chief Executive Officer, for the quarter ended September 30, 2006 |
59
|
||
|
31.02
|
Rule 13a - 14(a) Certification by Richard A. Lorraine, Senior Vice President and Chief Financial Officer, for the quarter ended September 30, 2006 |
60
|
||
|
32.01
|
Section 1350 Certification by J. Brian Ferguson, Chairman of the Board and Chief Executive Officer, for the quarter ended September 30, 2006 |
61
|
||
|
32.02
|
Section 1350 Certification by Richard A. Lorraine, Senior Vice President and Chief Financial Officer, for the quarter ended September 30, 2006 |
62
|
||
|
99.01
|
63
|
52