Edgar Filing: EASTMAN CHEMICAL CO

form10qthirdquarter.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2007
	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, 2007
Common Stock, par value $0.01 per share		81,027,677

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EXHIBIT INDEX ON PAGE 52

TABLE OF CONTENTS

ITEM

PAGE

PART I. FINANCIAL INFORMATION

1.	Financial Statements

	Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings	3
	Consolidated Statements of Financial Position	4
	Unaudited Consolidated Statements of Cash Flows	5
	Notes to the Unaudited Consolidated Financial Statements	6

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

3.	Quantitative and Qualitative Disclosures About Market Risk	48

4.	Controls and Procedures	48

PART II. OTHER INFORMATION

1.	Legal Proceedings	49

1A.	Risk Factors	50

2.	Unregistered Sales of Equity Securities and Use of Proceeds	50

6.	Exhibits	50

SIGNATURES

Signatures

UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS,

COMPREHENSIVE INCOME AND RETAINED EARNINGS

		Third Quarter				First Nine Months
(Dollars in millions, except per share amounts)		2007		2006		2007		2006

Sales	$	1,813	$	1,966	$	5,503	$	5,698
Cost of sales		1,503		1,650		4,580		4,701
Gross profit		310		316		923		997

Selling, general and administrative expenses		107		105		321		316
Research and development expenses		43		40		116		126
Asset impairments and restructuring charges, net		120		13		143		23
Operating earnings		40		158		343		532

Interest expense, net		17		21		50		62
Other (income) charges, net		(9)		1		(15)		(2)
Earnings before income taxes		32		136		308		472
Provision for income taxes		12		41		106		158
Net earnings	$	20	$	95	$	202	$	314

Earnings per share
Basic	$	0.24	$	1.16	$	2.41	$	3.84
Diluted	$	0.24	$	1.15	$	2.38	$	3.79

Comprehensive Income
Net earnings	$	20	$	95	$	202	$	314
Other comprehensive income (loss)
Change in cumulative translation adjustment		21		(8)		31		32
Change in pension and other post employment benefits due to amortization, net of tax		22		--		18		--
Change in unrealized gains (losses) on investments, net of tax		--		--		1		(1)
Change in unrealized gains (losses) on derivative instruments, net of tax		(8)		(6)		(5)		5
Total other comprehensive income (loss)		35		(14)		45		36
Comprehensive income	$	55	$	81	$	247	$	350

Retained Earnings
Retained earnings at beginning of period	$	2,302	$	2,070	$	2,186	$	1,923
Net earnings		20		95		202		314
Adoption of accounting standards		--		--		8		--
Cash dividends declared		(36)		(36)		(110)		(108)
Retained earnings at end of period	$	2,286	$	2,129	$	2,286	$	2,129

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

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

		September 30,		December 31,
(Dollars in millions, except per share amounts)		2007		2006
		(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	781	$	939
Trade receivables, net of allowance of $6 and $16		596		682
Miscellaneous receivables		69		72
Inventories		646		682
Other current assets		75		47
Current assets held for sale		130		--
Total current assets		2,297		2,422

Properties
Properties and equipment at cost		8,679		8,844
Less: Accumulated depreciation		5,716		5,775
Net properties		2,963		3,069

Goodwill		321		314
Other noncurrent assets		309		368
Noncurrent assets held for sale		55		--
Total assets	$	5,945	$	6,173

Liabilities and Stockholders’ Equity
Current liabilities
Payables and other current liabilities	$	975	$	1,056
Borrowings due within one year		72		3
Current liabilities related to assets held for sale		27		--
Total current liabilities		1,074		1,059

Long-term borrowings		1,522		1,589
Deferred income tax liabilities		234		269
Post-employment obligations		985		1,084
Other long-term liabilities		133		143
Other long-term liabilities related to assets held for sale		6		--
Total liabilities		3,954		4,144

Stockholders’ equity
Common stock ($0.01 par value – 350,000,000 shares authorized; shares issued – 93,576,549 and 91,579,294 for 2007 and 2006, respectively)		1		1
Additional paid-in capital		564		448
Retained earnings		2,286		2,186
Accumulated other comprehensive loss		(129)		(174)
		2,722		2,461
Less: Treasury stock at cost (12,631,546 shares for 2007 and 8,048,442 shares for 2006)		731		432

Total stockholders’ equity		1,991		2,029

Total liabilities and stockholders’ equity	$	5,945	$	6,173

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

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

		First Nine Months
(Dollars in millions)		2007		2006

Cash flows from operating activities
Net earnings	$	202	$	314

Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		247		226
Gain on sale of assets		(3)		(5)
Asset impairments		138		20
Provision (benefits) for deferred income taxes		(23)		49
Changes in operating assets and liabilities:
(Increase) decrease in receivables		22		(189)
(Increase) decrease in inventories		1		(134)
Increase (decrease) in trade payables		(63)		50
(Decrease) in liabilities for employee benefits and incentive pay		(88)		(60)
Other items, net		(22)		(38)

Net cash provided by operating activities		411		233

Cash flows from investing activities
Additions to properties and equipment		(346)		(279)
Proceeds from sale of assets and investments		43		12
Additions to capitalized software		(8)		(12)
Other items, net		12		--

Net cash (used in) investing activities		(299)		(279)

Cash flows from financing activities
Net increase in commercial paper, credit facility and other borrowings		42		33
Dividends paid to stockholders		(112)		(108)
Treasury stock purchases		(300)		--
Proceeds from stock option exercises and other items		100		25

Net cash (used in) financing activities		(270)		(50)

Effect of exchange rate changes on cash and cash equivalents		--		2

Net change in cash and cash equivalents		(158)		(94)

Cash and cash equivalents at beginning of period		939		524

Cash and cash equivalents at end of period	$	781	$	430

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

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

ITEM	Page

Note 1. Basis of Presentation	7
Note 2. Assets Held for Sale	8
Note 3. Inventories	9
Note 4. Payables and Other Current Liabilities	9
Note 5. Provision for Income Taxes	10
Note 6. Borrowings	11
Note 7. Asset Impairments and Restructuring Charges, Net	11
Note 8. Pension and Other Post-Employment Benefits	13
Note 9. Environmental Matters	14
Note 10. Commitments	15
Note 11. Derivative Financial Instruments Held or Issued for Purposes Other Than Trading	16
Note 12. Stockholders' Equity	16
Note 13. Earnings and Dividends per Share	17
Note 14. Share-Based Compensation Awards	18
Note 15. Segment Information	18
Note 16. Legal Matters	21
Note 17. Recently Issued Accounting Standards	21
Note 18. Divestiture	22

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.	BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared by Eastman Chemical Company (the "Company" or "Eastman") in accordance and consistent with the accounting policies stated in the Company's 2006 Annual Report on Form 10-K, except as described below. The Company adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), on January 1, 2007. 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 generally accepted accounting principles ("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 2006 amounts to conform to the 2007 presentation including the reclassification of segment sales and operating earnings. For additional information, see Note 15 to the Company's unaudited consolidated financial statements.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2.	ASSETS HELD FOR SALE

During the third quarter 2007, Eastman entered into definitive agreements to sell its polyethylene terephthalate ("PET") polymers production facilities in Mexico and Argentina and the related businesses. The sale, which is subject to customary approvals, includes Eastman's PET manufacturing facilities in Cosoleacaque, Mexico, and Zarate, Argentina. Their production capacity is 150,000 and 185,000 metric tons per year, respectively. The Company also recorded an impairment charge of $117 million to adjust the asset values to the expected sales price less cost to sell, resulting from the expected fourth quarter 2007 sale. See Note 7 for additional information.

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 continuing involvement in the PET businesses in the region.

		September 30,
(Dollars in millions)		2007
Current assets
Miscellaneous receivables	$	8
Trade receivables		81
Inventories		41
Total current assets held for sale		130

Non-current assets
Properties and Equipment, net		35
Other non-current assets		20
Total non-current assets held for sale		55
Total assets	$	185

Current liabilities
Payables and other current liabilities, net	$	27
Total current liabilities held for sale		27

Non-current liabilities
Deferred tax liability		6
Total non-current liabilities held for sale		6
Total liabilities	$	33

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

3.	INVENTORIES

		September 30,		December 31,
(Dollars in millions)		2007		2006

At FIFO or average cost (approximates current cost)
Finished goods	$	632	$	660
Work in process		191		206
Raw materials and supplies		304		280
Total inventories		1,127		1,146
LIFO Reserve		(481)		(464)
Inventories before assets held for sale		646		682
Inventories related to assets held for sale⁽¹⁾		41		--
Total inventories	$	687	$	682

⁽¹⁾	For more information regarding assets held for sale, see Note 2 to the Company's unaudited consolidated financial statements.

Inventories valued on the LIFO method were approximately 70% as of September 30, 2007 and 65% as of December 31, 2006 of total inventories.

4.	PAYABLES AND OTHER CURRENT LIABILITIES

		September 30,		December 31,
(Dollars in millions)		2007		2006

Trade creditors	$	510	$	581
Accrued payrolls, vacation, and variable-incentive compensation		125		126
Accrued taxes		26		59
Post-employment obligations		60		63
Interest payable		26		31
Bank overdrafts		64		11
Other		164		185
Payables and other current liabilities before assets held for sale		975		1,056
Current liabilities related to assets held for sale ⁽¹⁾		27		--
Total payables and other current liabilities	$	1,002	$	1,056

⁽¹⁾For more information regarding assets held for sale, see Note 2 to the Company's unaudited consolidated financial statements.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

5.	PROVISION FOR INCOME TAXES

		Third Quarter			First Nine Months
(Dollars in millions)		2007		2006		2007		2006

Provision for income taxes	$	12	$	41	$	106	$	158
Effective tax rate		40 %		30 %		35 %		34 %

The third quarter and first nine months 2007 effective tax rates reflect the Company's normal tax rate on reported operating earnings before income tax, excluding discrete items, of approximately 34 percent. The third quarter 2007 effective tax rate was negatively impacted by tax law changes in Europe due to German tax law changes resulting in a reduction in the value of deferred tax assets. The third quarter 2006 effective tax rate was positively impacted by the reversal of foreign loss valuation allowances.

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48 and reliance on the FASB Staff Position No. FIN 48-a, "Definition of Settlement in FASB Interpretation No. 48," the Company recognized a decrease of approximately $3 million in the liability for unrecognized tax benefits, which was accounted for as a $8 million increase to the January 1, 2007 balance of retained earnings and a $5 million decrease in long-term deferred tax liabilities. After the above decrease, the liability for unrecognized tax benefits was approximately $31 million, of which $26 million would, if recognized, impact the Company's effective tax rate.

Interest and penalties, net, related to unrecognized tax benefits are recorded as a component of income tax expense. As of January 1, 2007 the Company had accrued approximately $3 million for interest, net of tax benefit and had no accrual for tax penalties. During the third quarter and first nine months 2007, the Company recognized an immaterial amount of interest associated with unrecognized tax benefits.

The Company or one of its subsidiaries files tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2001. It is reasonably possible that within the next 12 months the Company will recognize approximately $2 million of unrecognized tax benefits as a result of the expiration of relevant statutes of limitations.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

6.	BORROWINGS

		September 30,		December 31,
(Dollars in millions)		2007		2006

Borrowings consisted of:
3 1/4% notes due 2008	$	72	$	72
7% notes due 2012		143		141
6.30% notes due 2018		182		182
7 1/4% debentures due 2024		497		497
7 5/8% debentures due 2024		200		200
7.60% debentures due 2027		298		297
Credit facility borrowings		187		185
Other		15		18
Total borrowings		1,594		1,592
Borrowings due within one year		(72)		(3)
Long-term borrowings	$	1,522	$	1,589

At September 30, 2007, the Company has credit facilities with various U.S. and non-U.S. banks totaling approximately $890 million. These credit facilities consist of a $700 million revolving credit facility (the "Credit Facility"), expiring in April 2012, and a 132 million euro credit facility which expires in December 2011. Both of these credit facilities have options for a one year extension. 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, 2007 and December 31, 2006 were $187 million and $185 million at weighted average interest rates of 4.76 percent and 4.00 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 2012, 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, 2007 and December 31, 2006, the Company had outstanding interest rate swaps associated with the entire outstanding principal of the 7% notes due in 2012 and $150 million of the outstanding principal of the 6.30% notes due in 2018. The average variable interest rate on the 7% notes was 7.66 percent and 7.89 percent for September 30, 2007 and December 31, 2006, respectively. The average variable interest rate on the 6.30% notes was 6.06 percent and 6.30 percent for September 30, 2007 and December 31, 2006, respectively.

7.	ASSET IMPAIRMENTS AND RESTRUCTURING CHARGES, NET

In the third quarter 2007 and first nine months 2007, asset impairments and restructuring charges totaled $120 million and $143 million, respectively, related primarily to the impairment of assets of Eastman's PET manufacturing facilities in Cosoleacaque, Mexico, and Zarate, Argentina which were classified as held for sale in the third quarter 2007. The Company impaired the assets of these facilities in third quarter 2007 to adjust the asset values to the expected sales price less cost to sell. These charges were reflected in the Performance Polymers segment. Also in third quarter 2007, the Company adjusted the severance accrual recorded in fourth quarter 2006 which resulted in a reversal which was reflected in all segments.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

In first quarter 2007, the Company impaired the assets of the San Roque, Spain PET manufacturing facility which was sold in second quarter 2007 to adjust the asset values to the sales price less cost to sell and also recorded a charge to shut down the facility. The impairment was partially offset by the reversal of the $5 million severance accrual related to the fourth quarter 2006 shut down of the cyclohexane dimethanol ("CHDM") manufacturing facility, located adjacent to the PET manufacturing facility. The employees included in the CHDM severance accrual were employed by the purchaser of the San Roque, Spain PET manufacturing facility, relieving the Company of the severance obligation. These charges were reflected in the Performance Polymers and the Specialty Plastics ("SP") segments.

In the third quarter and first nine months 2006, asset impairments and restructuring charges totaled $13 million and $23 million, respectively, relating primarily to previously closed manufacturing facilities.

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 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 2006 and the first nine months 2007:

(Dollars in millions)		Balance at January 1, 2006		Provision/ Adjustments		Non-cash Reductions		Cash Reductions		Balance at December 31, 2006

Non-cash charges	$	--	$	62	$	(62)	$	--	$	--
Severance costs		3		32		--		(1)		34
Site closure and other restructuring costs		7		7		--		--		14
Total	$	10	$	101	$	(62)	$	(1)	$	48

		Balance at January 1, 2007		Provision/ Adjustments		Non-cash Reductions		Cash Reductions		Balance at September 30, 2007

Non-cash charges	$	--	$	143	$	(143)	$	--	$	--
Severance costs		34		(7)		--		(12)		15
Site closure and other restructuring costs		14		7		--		(6)		15
Total	$	48	$	143	$	(143)	$	(18)	$	30

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

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

8.	PENSION AND OTHER POST-EMPLOYMENT BENEFITS

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)		2007		2006		2007		2006

Service cost	$	12	$	11	$	36	$	33
Interest cost		23		21		68		61
Expected return on assets		(26)		(21)		(78)		(65)
Amortization of:
Prior service credit		(2)		(3)		(6)		(7)
Actuarial loss		8		9		25		28
Other loss		4		--		4		--
Net periodic benefit cost	$	19	$	17	$	49	$	50

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 did not impact net periodic benefit cost in 2006 and had minimal impact on the financial statements in the first nine months 2007.

The Company contributed $100 million and $75 million to its U.S. defined benefit plans during first nine months 2007 and 2006, respectively.

POSTRETIREMENT WELFARE PLANS

Eastman provides life insurance and health care benefits for eligible retirees, and health care benefits for retirees' eligible survivors. In general, Eastman provides those benefits to retirees eligible under the Company's U.S. defined benefit 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. postretirement welfare plans:

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Summary of Components of Net Periodic Benefit Costs
		Third Quarter				First Nine Months
		2007		2006		2007		2006

Service cost	$	1	$	2	$	5	$	6
Interest cost		11		10		32		31
Expected return on assets		(1)		--		(2)		--
Amortization of:
Prior service credit		(6)		(5)		(17)		(17)
Actuarial loss		3		3		9		11
Net periodic benefit cost	$	8	$	10	$	27	$	31

Similar benefits are also provided to retirees of Holston Defense Corporation (“HDC”), a wholly-owned subsidiary of the Company that, prior to January 1, 1999, operated a government-owned ammunitions plant. HDC’s contract with the Department of Army (“DOA”) provided for reimbursement of allowable costs incurred by HDC including certain postretirement welfare costs, for as long as HDC operated the plant. After the contract was terminated at the end of 1998, the DOA did not contribute further to these costs. The Company pursued extraordinary relief from the DOA and was granted an award in the amount of $95 million effective in the fourth quarter 2006. This award was for reimbursement of the described costs and other previously expensed post-retirement benefit costs. The Company began recognizing the impact of the reimbursement in fourth quarter 2006 by recording an unrecognized gain and amortizing the gain into earnings over a period of time.

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 had minimal impact on the financial statements in the first nine months 2007.

9.	ENVIRONMENTAL MATTERS

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 responsible for costs for environmental remediation and closure and postclosure under the federal Resource Conservation and Recovery Act. Reserves for environmental contingencies have been established in accordance with Eastman’s policies described in Note 1, "Significant Accounting Policies" in the Company's 2006 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 $43 million and $47 million at September 30, 2007 and December 31, 2006, respectively, representing the minimum or best estimate for remediation costs and the best estimate accrued to date over the facilities' estimated useful lives for asset retirement obligation costs. Estimated future environmental expenditures for remediation costs range from the minimum or best estimate of $14 million to the maximum of $20 million at September 30, 2007 and the minimum or best estimate of $18 million to the maximum of $32 million at December 31, 2006.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

10.

COMMITMENTS

Purchase Obligations and Lease Commitments

At September 30, 2007, the Company had various purchase obligations totaling approximately $2.2 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 10 percent relate to machinery and equipment, including computer and communications equipment and production equipment; approximately 55 percent relate to real property, including office space, storage facilities and land; and approximately 35 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, 2007 and December 31, 2006. 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 $320 million and $334 million in the third quarter 2007 and 2006, respectively, and $308 million and $323 million for the first nine months of 2007 and 2006, respectively.

Guarantees

FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), clarifies the requirements of Statement of Financial Accounting Standards 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, 2007 totaled $153 million and consisted primarily of leases for railcars, aircraft, and other equipment. Leases with guarantee amounts totaling $2 million, $27 million, $9 million and $115 million will expire in 2007, 2008, 2011 and 2012, respectively. The Company believes, based on current facts and circumstances, that the likelihood of a material payment pursuant to such guarantees is remote.

Variable Interest Entities

The Company has evaluated material relationships including the guarantees related to the third-party borrowings of joint ventures and has concluded that the entities are not Variable Interest Entities (“VIEs”) or, in the case of Primester, a joint venture that manufactures cellulose acetate at the Company's Kingsport, Tennessee plant, the Company is not the primary beneficiary of the VIE. As such, in accordance with FASB 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, 2007. 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.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

11.

DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING

Hedging Programs

Financial instruments held as part of the hedging programs described 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 2006 Annual Report on Form 10-K.

At September 30, 2007, mark-to-market gains from raw material and energy, currency and certain interest rate hedges that were included in accumulated other comprehensive loss totaled approximately $11 million, and if realized, the majority 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 of 2007.

12.

STOCKHOLDERS' EQUITY

A reconciliation of the changes in stockholders’ equity for the first nine months 2007 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, 2006	1	448	2,186	(174)	(432)	2,029

Net Earnings	--	--	202	--	--	202
Effect of FIN 48 Adoption	--	--	8	--	--	8
Cash Dividends Declared ⁽¹⁾	--	--	(110)	--	--	(110)
Other Comprehensive Income	--	--	--	45	--	45
Stock Option Exercises and Other Items ⁽²⁾⁽³⁾	--	116	--	--	1	117
Stock Repurchases	--	--	--	--	(300)	(300)
Balance at September 30, 2007	1	564	2,286	(129)	(731)	1,991

⁽¹⁾Includes cash dividends paid and dividends declared but unpaid.

⁽²⁾The tax benefits relating to the difference between the amounts deductible for federal income taxes over the amounts charged to income for financial reporting purposes have been credited to paid-in capital.

⁽³⁾Includes the fair value of equity share-based awards recognized under SFAS No. 123 Revised December 2004 ("SFAS No. 123(R)"), "Share-Based Payment".

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

(Dollars in millions)	Cumulative Translation Adjustment	Unfunded Additional Minimum Pension Liability	Unrecognized Loss and Prior Service Cost, net of taxes	Unrealized Gains (Losses) on Cash Flow Hedges	Unrealized Losses on Investments	Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2005	61	(255)	--	(5)	(1)	(200)
Period change	60	48	--	(1)	--	107
Pre-SFAS No. 158 ⁽¹⁾ balance at December 31, 2006	121	(207)	--	(6)	(1)	(93)
Adjustments to apply SFAS No. 158	--	207	(288)	--	--	(81)
Balance at December 31, 2006	121	--	(288)	(6)	(1)	(174)
Period change	31	--	18	(5)	1	45
Balance at September 30, 2007	152	--	(270)	(11)	--	(129)

⁽¹⁾SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" ("SFAS No. 158").

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.

13.

EARNINGS AND DIVIDENDS PER SHARE

	Third Quarter		First Nine Months
	2007	2006	2007	2006

Shares used for earnings per share calculation:
Basic	82.6	82.1	83.6	81.8
Diluted	83.6	83.1	84.6	82.8

In the third quarter and first nine months 2007, common shares underlying options to purchase 20,000 shares of common stock and 591,233 shares of common stock, respectively, were excluded from the computation of diluted earnings per share, because the total market value of option exercises for these awards was less than the total proceeds that would be received for these awards. Additionally, the basic and diluted shares were reduced in third quarter and first nine months 2007 as a result of the share repurchase program completed in third quarter 2007. For third quarter and first nine months 2007, a total of 3,231,348 shares and 4,601,448 shares, respectively, were repurchased.

In the third quarter and first nine months 2006, common shares underlying options to purchase 2,193,779 shares of common stock for both periods were excluded from the computation of diluted earnings per share because, the total market value of option exercises for these awards was less than the total proceeds that would be received for these awards.

The Company declared cash dividends of $0.44 per share in the third quarters 2007 and 2006 and $1.32 per share in the first nine months 2007 and 2006.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

14.

SHARE-BASED COMPENSATION AWARDS

In the third quarter and first nine months 2007, approximately $5 million and $18 million, respectively, of compensation expense before tax was recognized in selling, general and administrative expense in the earnings statement for all share-based awards. The impact on third quarter 2007 net earnings of $3 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 2007 net earnings of $11 million is net of a $7 million credit to deferred tax expense for recognition of deferred tax assets.

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.

Additional information regarding share-based compensation may be found in Note 15 to the consolidated financial statements in Part II, Item 8 of the Company's 2006 Annual Report on Form 10-K.

Stockholders approved the 2007 Omnibus Long-Term Compensation Plan at the annual stockholders' meeting held on May 3, 2007. This new plan, effective with the date of approval, replaces the 2002 Omnibus Long-Term Compensation Plan.

15.

SEGMENT INFORMATION

The Company's products and operations are managed and reported in five reportable operating segments, consisting of the Coatings, Adhesives, Specialty Polymers and Inks ("CASPI") segment, the Fibers segment, the Performance Chemicals and Intermediates ("PCI") segment, the Performance Polymers segment and the SP segment. 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 2006 Annual Report on Form 10-K.

Revenues, research and development, other expenses and assets 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, operating losses and assets.

In fourth quarter 2006, certain product lines were transferred from the PCI segment to the Performance Polymers segment. Accordingly, the 2006 amounts for sales and operating earnings have been adjusted to retrospectively apply these changes to all periods presented.

		Third Quarter
(Dollars in millions)		2007		2006
Sales by Segment
CASPI	$	368	$	367
Fibers		258		228
PCI		509		437
Performance Polymers		461		727
SP		217		207
Total Sales by Segment		1,813		1,966
Other		--		--

Total Sales	$	1,813	$	1,966

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

		First Nine Months
(Dollars in millions)		2007		2006
Sales by Segment
CASPI	$	1,089	$	1,078
Fibers		731		696
PCI		1,559		1,260
Performance Polymers		1,480		2,068
SP		644		596
Total Sales by Segment		5,503		5,698
Other		--		--

Total Sales	$	5,503	$	5,698

		Third quarter
(Dollars in millions)		2007		2006

Operating Earnings (Loss)
CASPI ⁽¹⁾	$	59	$	53
Fibers		66		55
PCI ⁽¹⁾		50		22
Performance Polymers ⁽¹⁾		(134)		20
SP⁽¹⁾		13		18
Total Operating Earnings (Loss) by Segment		54		168
Other		(14)		(10)

Total Operating Earnings (Loss)	$	40	$	158

⁽¹⁾Operating earnings (loss) for the following segments include asset impairments and restructuring charges: CASPI includes $(1) million in the third quarter 2007 related primarily to an adjustment to severance charges recorded in fourth quarter 2006; PCI includes $(1) million in the third quarter 2007 related primarily to an adjustment to severance charges recorded in fourth quarter 2006 and $11 million in the third quarter 2006 for the expected divestiture of the Arkansas facility; Performance Polymers includes $120 million in the third quarter of 2007 relating primarily to the divestiture of PET assets in Latin America; and Other includes $2 million in the third quarter 2007 related to an intangible asset impairment and $2 million in third quarter 2006 for Cendian's shutdown of its business activities. Operating earnings (loss) for the third quarter 2007 in the PCI and Performance Polymers segments also include $2 million and $7 million, respectively, in accelerated depreciation costs related to cracking units at the Company's Longview, Texas facility and polymer assets in Columbia, South Carolina.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

		First Nine Months
(Dollars in millions)		2007		2006

Operating Earnings (Loss)
CASPI ⁽¹⁾	$	190	$	176
Fibers		176		182
PCI ⁽¹⁾		161		108
Performance Polymers ⁽¹⁾		(198)		51
SP⁽¹⁾		49		50
Total Operating Earnings (Loss) by Segment		378		567
Other		(35)		(35)

Total Operating Earnings (Loss)	$	343	$	532

⁽¹⁾

Operating earnings (loss) for the following segments include asset impairments and restructuring charges: CASPI includes $(1) million in the first nine months 2007 related primarily to an adjustment to severance charges recorded in fourth quarter 2006 and $8 million in first nine months 2006 relating primarily to the divestiture of previously closed manufacturing facilities; PCI includes $(1) million in the first nine months 2007 related primarily to an adjustment to severance charges recorded in fourth quarter 2006 and $11 million in the first nine months 2006 for the expected divestiture of the Arkansas facility; Performance Polymers includes $142 million in the first nine months 2007 related to the divestiture of PET assets in Latin America and Europe; SP includes $1 million in the first nine months 2007 relating primarily to the San Roque, Spain CHDM facility; and Other includes $2 million in first nine months 2007 related to an intangible asset impairment and $4 million in the first nine months 2006 for Cendian's shutdown of its business activities. Operating earnings (loss) for the first nine months 2007 in the PCI, Performance Polymers and SP segments also include $16 million, $20 million and $1 million, respectively, in accelerated depreciation costs related to cracking units at the Company's Longview, Texas facility and polymer assets in Columbia, South Carolina.

		September 30,		December 31,
(Dollars in millions)		2007		2006

Assets by Segment ⁽¹⁾
CASPI	$	1,118	$	1,078
Fibers		680		651
PCI		1,080		926
Performance Polymers⁽²⁾		972		1,480
SP		622		599
Total Assets by Segment		4,472		4,734
Other		25		13
Corporate Assets		1,263		1,426
Total Assets Before Assets Held for Sale		5,760		6,173
Assets Held for Sale ⁽³⁾		185		--
Total Assets	$	5,945	$	6,173

⁽¹⁾	Assets managed by segments include accounts receivable, inventory, fixed assets and goodwill.

⁽²⁾	The Performance Polymers assets have decreased as a result of asset impairments, divestitures in Europe and assets held for sale in Latin America.

⁽³⁾	For more information regarding assets held for sale, see Note 2 to the Company's unaudited consolidated financial statements.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

16.

LEGAL MATTERS

General

From time to time, the Company and its operations are parties to, or targets of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, asbestos, patent and intellectual property, commercial, contract, environmental, antitrust, health and safety, and employment matters, which are being handled and defended in the ordinary course of business. While the Company is unable to predict the outcome of these matters, it does not believe, based upon currently available facts, that the ultimate resolution of any such pending matters, including the sorbates litigation and the asbestos litigation (described 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

Over time, the Company has been named in several putative class action lawsuits filed on behalf of purchasers of sorbates and products containing sorbates, claiming those purchasers paid more for sorbates and for products containing sorbates than they would have paid in the absence of the defendants’ price-fixing. Two civil cases relating to sorbates remain. In each case, the Company prevailed at the trial court, and in each case, the plaintiff appealed the trial court's decision. In one case, the appellate court affirmed the trial court's dismissal of all claims, except the plaintiff's claim for civil penalties. In the other case, the court of appeals overturned the trial court's decision and ruled that the plaintiff could amend and re-file its complaint with the trial court. The Company appealed this decision to the state supreme court, which declined to review the decision. Accordingly, the plaintiff filed its Second Amended Complaint on July 9, 2007. In each case the Company intends to continue to vigorously defend its position.

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. More recently, certain plaintiffs have claimed exposure to an asbestos-containing plastic, which Eastman manufactured in limited amounts between the mid-1960’s and the early 1970’s.

To date, the Company has obtained dismissals or settlements of its asbestos-related lawsuits with no material effect on its financial condition, results of operations or cash flows, and over the past several years, has substantially reduced its number of pending asbestos-related claims. The Company has also confirmed insurance coverage that applies to a portion of certain of the Company’s defense costs and payments of settlements or judgments in connection with asbestos-related lawsuits.

Based on an ongoing evaluation, the Company believes that the resolution of its 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.

17.

RECENTLY ISSUED ACCOUNTING STANDARDS

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," ("SFAS No. 157") 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.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

In February, 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115" ("SFAS No. 159"). SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value at specified election dates. Upon adoption, an entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," applies to all entities with available for sale and trading securities. SFAS No. 159 will be effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. The Company is currently evaluating the effect SFAS No. 159 will have on its consolidated financial position, liquidity, or results of operations.

18.

DIVESTITURE

Certain Businesses and Product Lines and Related Assets in Performance Polymers Segments

On April 30, 2007, the Company sold its San Roque, Spain PET manufacturing facility in the Performance Polymer's segment for net proceeds of approximately $43 million. The Company also retained approximately $12 million of accounts receivable related to this manufacturing site. The Company will continue to produce certain intermediate products for the buyer under ongoing supply agreements with indefinite terms. In addition, the Company indemnified the buyer against certain liabilities primarily related to taxes, legal matters, environmental matters, and other representations and warranties. During the first nine months 2007, the Company has recorded an impairment charge and site closure costs of $21 million related to the San Roque PET site.

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

ITEM	Page

Critical Accounting Policies	21

Strategic Actions and Related Presentation of Non-GAAP Financial Measures	22

Overview	22

Results of Operations	24

Summary by Operating Segment	28

Summary by Customer Location	36

Liquidity, Capital Resources, and Other Financial Information	38

Recently Issued Accounting Standards	41

Outlook	41

Forward-Looking Statements and Risk Factors	42

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 2006 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.

CRITICAL ACCOUNTING POLICIES

In preparing the consolidated financial statements in conformity with generally accepted accounting principles ("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, impairment of 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 2006 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.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

STRATEGIC ACTIONS AND RELATED PRESENTATION OF NON-GAAP FINANCIAL MEASURES

During the second and third quarters 2007, the Company undertook strategic actions in its Performance Polymers segment for its underperforming polyethylene terephthalate ("PET") manufacturing facilities outside the United States. In second quarter 2007, the Company completed the sale of its San Roque, Spain PET manufacturing facility. During the third quarter 2007, the Company entered into definitive agreements to sell its PET polymers production facilities in Mexico and Argentina and the related businesses. Asset impairments and restructuring charges resulting from these actions were $21 million for the Spain divestiture in the first nine months 2007 and $117 million in the third quarter and first nine months 2007 for the Latin American manufacturing sites.

In fourth quarter 2006, the Company sold its Batesville, Arkansas manufacturing facility and related assets in the Performance Chemicals and Intermediates ("PCI") segment and its polyethylene ("PE") and Epolene polymer businesses and related assets of the Performance Polymers and Coatings, Adhesives, Specialty Polymers, and Inks ("CASPI") segments. For the third quarter and first nine months of 2006, sales revenue of $225 million and $667 million, respectively and operating earnings of $4 million and $47 million, respectively, were attributed to these divested product lines. Asset impairments and restructuring charges resulting from the divested Arkansas manufacturing facility were $11 million for the third quarter and first nine months 2006. As part of the PE divestiture, the Company entered into a transition agreement for contract ethylene sales, for which revenues and operating earnings are reflected in the PCI segment results in third quarter and first nine months 2007. Third quarter and first nine months 2007 included accelerated depreciation costs of $9 million and $37 million, respectively, resulting from the scheduled shutdown of cracking units in Longview, Texas related to the divestiture and a planned shutdown of higher cost PET assets in Columbia, South Carolina.

This Management's Discussion and Analysis includes the following non-GAAP financial measures and accompanying reconciliations to the most directly comparable GAAP financial measures:

·	Company and segment sales excluding contract ethylene sales under a transition agreement related to the PE product lines divested in fourth quarter 2006;

·	Company sales and segment sales and operating results excluding sales revenue and operating results from the fourth quarter 2006 divested product lines;

·	Company gross profit, operating earnings and net earnings excluding accelerated depreciation costs and asset impairments and restructuring charges; and

·	Segment operating earnings excluding accelerated depreciation costs and asset impairments and restructuring charges.

Eastman's management believes that sales from contract ethylene sales under the transition agreement related to the previous divestiture of the PE product lines do not reflect the continuing and expected future business of the PCI segment. In addition, management believes that corporate and segment earnings should be considered both with and without accelerated depreciation costs and asset impairments and restructuring charges for evaluation and analysis of ongoing business results. However, management believes that these items are indicative of results of continuous efforts to reduce costs and of actions to improve the profitability of the Company. Management believes that investors can better evaluate and analyze historical and future business trends if they also consider the reported corporate and segment results, respectively, without the identified items. Management utilizes corporate and segment results including and excluding the identified items in the measures it uses to evaluate business performance and in determining certain performance-based compensation. These measures, excluding the identified items, are not recognized in accordance with GAAP and should not be viewed as alternatives to the GAAP measures of performance.

In addition, the Company has chosen to present in this Management's Discussion and Analysis certain financial measures for the Company and certain segments with and without sales and operating results attributable to sales revenue and operating results in Latin America from PET manufactured at non-U.S. sites. This additional information is provided to assist the reader in understanding the impact on the Company and the Performance Polymers segment of the announced Latin American PET divestitures. Following the completion of the divestitures, subject to certain product-specific agreements associated with the sale of the manufacturing facilities in Mexico and Argentina, the Company plans to continue to sell a limited set of PET products manufactured in the U.S. in certain Latin American markets.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The Company generated sales revenue of $1.8 billion and $2.0 billion for the third quarter 2007 and third quarter 2006, respectively, and $5.5 billion and $5.7 billion for the first nine months 2007 and first nine months 2006, respectively. Excluding the sales from divested product lines and contract ethylene sales, sales revenue decreased 1 percent in the third quarter 2007 and increased 5 percent in the first nine months 2007.

As a result of strategic decisions related to the Performance Polymers and PCI segments discussed above, operating earnings in third quarter and first nine months 2007 were negatively impacted by accelerated depreciation costs of $9 million and $37 million, respectively, as well as asset impairments and restructuring charges of $120 million and $143 million for the respective periods. Operating earnings in third quarter and first nine months 2006 were negatively impacted by asset impairments and restructuring charges of $13 million and $23 million, respectively. Operating earnings were $40 million in third quarter 2007, a $118 million decrease compared with third quarter 2006, and $343 million in the first nine months 2007, a $189 million decrease compared with the first nine months 2006. Excluding accelerated depreciation costs and asset impairments and restructuring charges, operating earnings were $169 million in third quarter 2007 compared with $171 million in third quarter 2006, and $523 million in first nine months 2007 compared with $555 million in first nine months 2006. Net earnings were $20 million for third quarter 2007 compared to $95 million for third quarter 2006. Net earnings were $202 million for first nine months 2007 compared to $314 million for first nine months 2006. Excluding accelerated depreciation costs and asset impairments and restructuring charges, net earnings were $106 million and $103 million, for third quarter 2007 and 2006, respectively and $322 million and $331 million for first nine months 2007 and 2006, respectively. The Company's broad base of businesses continues to have strong results, with the declines primarily due to operating results in the Performance Polymers segment.

The Company generated $411 million in cash from operating activities during the first nine months 2007 compared to $233 million from operating activities in the first nine months 2006. The difference was due primarily to the significant increases in working capital in the first nine months 2006. The Company contributed $100 million and $75 million to its U.S. defined benefit pension plans in the first nine months 2007 and 2006, respectively. The Company does not plan to make additional contributions to its U.S. defined benefit pension plans in 2007. Priorities for use of available cash include paying the quarterly cash dividend, funding targeted growth initiatives and repurchasing shares. In the third quarter and first nine months 2007, the Company repurchased shares totaling $214 million and $300 million, respectively, completing the share repurchases authorized by the board in February 2007. In October 2007, the Board of Directors authorized an additional $700 million in share repurchases.

In addition to achieving the above results, Eastman continued to progress on its overall growth objectives including the announcement in July 2007 of two industrial gasification projects in the U.S. Gulf Coast and actions to improve the performance of its Performance Polymers segment.

The gasification projects announcement is an important milestone in the Company's continuing efforts to leverage its technology and operational expertise for future growth. The Beaumont, Texas project is expected to be operational in 2011 and will produce low-cost intermediate chemicals, such as hydrogen, methanol, and ammonia. The Company will be an investor, developer, service provider and customer for this project. In October 2007, the Company announced it has entered into an agreement with Green Rock Energy, L.L.C., a company formed by the D. E. Shaw group and Goldman, Sachs & Co., to jointly develop the approximately $1.6 billion industrial gasification facility in Beaumont, Texas with expects to obtain non-recourse project financing for the development, design, engineering, construction, start-up, and testing of the facility. The Faustina project is expected to be operational in 2010 and will produce anhydrous ammonia for agriculture, methanol, sulfur and industrial-grade carbon dioxide. The Company will be an investor, service provider and customer for this project.

During the second and third quarters 2007, the Company undertook strategic actions in its Performance Polymers segment for its underperforming PET manufacturing facilities outside the United States. In second quarter 2007, the Company completed the sale of its Spain PET manufacturing facility. During the third quarter 2007, the Company entered into definitive agreements to sell its PET polymers production facilities in Mexico and Argentina and the related businesses.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Additional actions in the Performance Polymers segment include the start-up of the Company's new 350 thousand metric tons PET facility using IntegRex technology in Columbia, South Carolina, which was fully operational in the first quarter of 2007 and continuing qualifications of the ParaStar PET product with customers.

The Company continues to pursue strategic actions for the remaining PET manufacturing facilities located in Rotterdam, the Netherlands and Workington, United Kingdom. The Company does not expect material asset impairments and restructuring charges related to these actions.

RESULTS OF OPERATIONS

		Third Quarter				Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect
(Dollars in millions)		2007		2006	Change	Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect

Sales	$	1,813	$	1,966	(8) %	(10) %	1 %	1 %	-- %

Sales - contract ethylene sales		84		--
Sales - divested product lines ⁽¹⁾		--		225
Sales – continuing product lines		1,729		1,741	(1) %	(5) %	2 %	1 %	1 %

Sales - PET sales in Latin America from non-U.S. sites ⁽²⁾		91		136

Sales – continuing product lines excluding PET sales in Latin America from non-U.S. sites⁽²⁾		1,638		1,605

⁽¹⁾

Divested product lines are Polyethylene and Epolene polymer businesses and related assets of the Performance Polymers and CASPI segments located at the Longview, Texas site and the Company's ethylene pipeline and the Company's Batesville, Arkansas manufacturing facility and related assets and the specialty organic chemicals product lines in the PCI segment.

⁽²⁾

Sales revenue in Latin America from PET manufactured at non-U.S. sites, including the Mexico and Argentina PET manufacturing facilities held for sale at September 30, 2007. During the third quarter 2007, Eastman entered into definitive agreements to sell its PET manufacturing facilities in Mexico and Argentina and the related businesses. Subject to certain product-specific agreements associated with the sale of the manufacturing facilities in Mexico and Argentina, the Company plans to continue to sell a limited set of PET products manufactured in the U.S. in certain Latin American markets. For more information, refer to Note 2 to the unaudited consolidated financial statements.

Sales revenue in third quarter 2007 compared to the third quarter 2006 decreased $153 million. Sales revenue in the third quarter 2007 included $84 million of revenue from contract ethylene sales under the transition agreement resulting from the divestiture of the Performance Polymers segment's PE business in the fourth quarter 2006. Sales revenue in third quarter 2006 included $225 million of revenue from divested product lines. Excluding contract ethylene sales and divested product lines, revenues decreased 1 percent primarily due to lower volume in the Performance Polymers segment.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

		First Nine Months				Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect
(Dollars in millions)		2007		2006	Change	Volume Effect	Price Effect	Product Mix Effect	Exchange Rate Effect

Sales	$	5,503	$	5,698	(3) %	(6) %	1 %	1 %	1 %

Sales - contract ethylene sales		228		--
Sales - divested product lines ⁽¹⁾		--		667
Sales – continuing product lines		5,275		5,031	5 %	-- %	3 %	1 %	1 %

Sales - PET sales in Latin America from non-U.S. sites⁽²⁾		328		364

Sales – continuing product lines excluding PET sales in Latin America from non-U.S. sites⁽²⁾		4,947		4,667

⁽¹⁾

⁽²⁾

Sales revenue in the first nine months 2007 compared to the first nine months 2006 decreased $195 million. Sales revenue in the first nine months 2007 included $228 million of revenue from contract ethylene sales under the transition agreement. Sales revenue in first nine months 2006 included $667 million of revenue from divested product lines. Excluding contract ethylene sales and divested product lines, revenues increased 5 percent primarily due to higher selling prices, particularly in the PCI and Specialty Plastics ("SP") segments.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

		Third Quarter					First Nine Months
(Dollars in millions)		2007		2006	Change		2007		2006	Change

Gross Profit	$	310	$	316	(2) %	$	923	$	997	(7) %
As a percentage of sales		17 %		16 %			17 %		17 %

Accelerated depreciation included in cost of goods sold		9		--			37		--

Gross Profit excluding accelerated depreciation		319		316	1 %		960		997	(4) %
As a percentage of sales		18 %		16 %			17 %		17 %

Gross profit for third quarter and first nine months 2007 decreased compared to the third quarter and first nine months 2006 due primarily to accelerated depreciation costs of $9 million and $37 million, respectively, resulting from the scheduled shutdown of cracking units in Longview, Texas and of higher cost PET polymer assets in Columbia, South Carolina. The Company's first nine months 2007 raw material and energy costs increased by approximately $100 million.

		Third Quarter					First Nine Months
(Dollars in millions)		2007		2006	Change		2007		2006	Change

Selling, General and
Administrative Expenses	$	107	$	105	3 %	$	321	$	316	2 %
Research and Development
Expenses		43		40	7 %		116		126	(8) %
	$	150	$	145	4 %	$	437	$	442	(1) %
As a percentage of sales		8 %		7 %			8 %		8 %

Selling, general and administrative ("SG&A") expenses for the third quarter and first nine months 2007 increased compared to the comparable periods in 2006 due to higher compensation expense.

Research and development ("R&D") expenses increased $3 million in third quarter 2007 compared to third quarter 2006 primarily due to higher expenses for growth initiatives in the SP segment. R&D expenses decreased $10 million in the first nine months 2007 compared to first nine months 2006 primarily due to decreases in the Performance Polymers segment resulting from the commercialization of ParaStar next generation PET resins using IntegRex technology in the fourth quarter 2006.

Asset Impairments and Restructuring Charges, Net

Asset impairments and restructuring charges, net, totaled $120 million and $143 million for the third quarter and first nine months 2007, respectively, primarily associated with the held for sale PET manufacturing facilities in Mexico and Argentina and the sale of the San Roque, Spain PET manufacturing facility. Asset impairments and restructuring charges, net, totaled $13 million and $23 million in the third quarter and first nine months 2006. The Company continues to make progress on strategic actions for the remaining PET manufacturing facilities outside the United States and does not expect material asset impairments and restructuring charges related to these actions. For more information regarding asset impairments and restructuring charges, primarily related to recent and pending divestitures, see the Performance Polymers segment discussion and Note 7 to the Company's unaudited consolidated financial statements.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Operating Earnings		Third Quarter					First Nine Months
		2007		2006	Change		2007		2006	Change
(Dollars in millions)

Operating earnings	$	40	$	158	(75) %	$	343	$	532	(36)%
Accelerated depreciation included in cost of goods sold		9		--			37		--
Asset impairments and restructuring charges		120		13			143		23
Operating earnings excluding accelerated depreciation and asset impairment and restructuring charges	$	169	$	171	(1) %	$	523	$	555	(6) %

Interest Expense, Net

		Third Quarter					First Nine Months
(Dollars in millions)		2007		2006	Change		2007		2006	Change

Gross interest costs	$	31	$	28	10 %	$	89	$	84	6 %
Less: Capitalized interest		3		2			8		5
Interest expense		28		26	7 %		81		79	3 %
Interest income		11		5			31		17
Interest expense, net	$	17	$	21	(19)%	$	50	$	62	(19)%

Gross interest costs for the third quarter and first nine months 2007 were higher compared to the third quarter and first nine months 2006 due to higher average interest rates. Capitalized interest for the third quarter and first nine months 2007 were higher compared to the third quarter and first nine months 2006 due to increased spending on capital projects during those periods. Interest income for the third quarter and first nine months 2007 was higher compared to the third quarter and first nine months 2006 due to higher average cash balances and higher average interest rates.

For 2007, the Company expects net interest expense to decrease compared to 2006 due to higher interest income driven by higher invested cash balances.

Other (Income) Charges, Net

		Third Quarter					First Nine Months
(Dollars in millions)		2007		2006	Change		2007		2006	Change

Other (income)	$	(12)	$	(3)	>100 %	$	(18)	$	(10)	80 %
Other charges		3		4	(25) %		3		8	(63) %
Other (income) charges, net	$	(9)	$	1	>100 %	$	(15)	$	(2)	>100 %

Included in other income are the Company’s portion of earnings from its investments, net gains on foreign exchange transactions, and other non-operating income related to the funding of Holston Defense Corporation's post-retirement benefits. Included in other charges are net losses on foreign exchange transactions and fees on securitized receivables.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Provision for Income Taxes

		Third Quarter			First Nine Months
(Dollars in millions)		2007		2006		2007		2006

Provision for income taxes	$	12	$	41	$	106	$	158
Effective tax rate		40 %		30 %		35 %		34 %

The third quarter and first nine months 2006 effective tax rates reflect the Company's expected normal tax rate on reported operating earnings before income tax, excluding discrete items, of approximately 35 percent. The third quarter and first nine months 2006 effective tax rates were positively impacted by lower foreign earnings in favorable tax jurisdictions and 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.

Net Earnings
		Third Quarter				First Nine Months
(Dollars in millions)		2007		2006		2007		2006

Net earnings	$	20	$	95	$	202	$	314
Accelerated depreciation included in cost of goods sold, net of tax		6		--		24		--
Asset impairments and restructuring charges, net of tax		80		8		96		17
Net earnings excluding accelerated depreciation and asset impairment and restructuring charges, net of tax	$	106	$	103	$	322	$	331

SUMMARY BY OPERATING SEGMENT

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 SP segment. For additional information concerning the Company’s operating businesses and products, refer to Note 21, "Segment Information", to the consolidated financial statements in Part II, Item 8 of the Company's 2006 Annual Report on Form 10-K.

Revenues and expenses not identifiable to an operating segment are not included in segment operating results for either of the periods presented and are shown in Note 15, "Segment Information", as "other" revenues and operating losses in this Form 10-Q.

In fourth quarter 2006, certain product lines were transferred from the PCI segment to the Performance Polymers segment. Accordingly, the prior year's amounts for sales and operating earnings have been adjusted to retrospectively apply these changes to all periods presented.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

CASPI Segment
			Third Quarter							First Nine Months
							Change							Change
(Dollars in millions)			2007		2006		$	%		2007		2006		$	%

Sales		$	368	$	367	$	1	-- %	$	1,089	$	1,078	$	11	1 %
	Volume effect						(22)	(6)%						(64)	(6)%
	Price effect						8	2 %						40	4 %
	Product mix effect						11	3 %						19	2 %
	Exchange rate effect						4	1 %						16	1 %

Operating earnings			59		53		6	11 %		190		176		14	8 %

Asset impairments and
restructuring charges, net			(1)		--		(1)			(1)		8		(9)

Operating earnings excluding asset impairments and restructuring charges, net			58		53		5	9 %		189		184		5	3 %

Sales revenue increased $1 million in third quarter 2007 compared to third quarter 2006 and $11 million in the first nine months 2007 compared to first nine months 2006 as a favorable shift in product mix and higher selling prices were offset by lower sales volume. The lower sales volume was primarily attributed to the divestiture of the Company's Epolene product lines in fourth quarter 2006. Excluding Epolene product lines divested in fourth quarter 2006, sales revenue increased due to an increase in selling prices in response to higher raw material and energy costs.

Operating earnings increased $6 million for third quarter 2007 compared to third quarter 2006 and $14 million for first nine months 2007 compared to first nine months 2006. Excluding asset impairments and restructuring charges of $(1) million in third quarter 2007 and $(1) million and $8 million for the first nine months 2007 and 2006, respectively, operating earnings increased $5 million for both comparable periods. Increases in operating earnings are primarily due to higher selling prices and an improved product mix that more than offset higher raw material and energy costs. Asset impairments and restructuring charges in 2006 were related to previously closed manufacturing facilities.

Fibers Segment
			Third Quarter							First Nine Months
							Change							Change
(Dollars in millions)			2007		2006		$	%		2007		2006		$	%

Sales		$	258	$	228	$	30	14 %	$	731	$	696	$	35	5 %
	Volume effect						6	3 %						(14)	(2)%
	Price effect						21	9 %						39	6 %
	Product mix effect						2	2 %						8	1 %
	Exchange rate effect						1	-- %						2	-- %

Operating earnings			66		55		11	20 %		176		182		(6)	(3) %

Sales revenue increased $30 million in third quarter 2007 compared to third quarter 2006 and increased $35 million in the first nine months 2007 compared to first nine months 2006 due primarily to higher selling prices. Selling prices increased primarily due to efforts to offset higher raw material and energy costs, particularly for wood pulp, and favorable market conditions for acetate tow and acetyl chemical product lines related to competitor outages.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Operating earnings increased $11 million for third quarter 2007 compared to third quarter 2006 reflecting improved results particularly for acetyl chemical and acetate tow product lines. Operating earnings decreased $6 million for first nine months 2007 compared to first nine months 2006.

PCI Segment
			Third Quarter							First Nine Months
							Change							Change
(Dollars in millions)			2007		2006		$	%		2007		2006		$	%

Sales		$	509	$	437	$	72	17 %	$	1,559	$	1,260	$	299	24 %
	Volume effect						68	16 %						341	27 %
	Price effect						9	2 %						(36)	(3) %
	Product mix effect						(6)	(1) %						(12)	(1) %
	Exchange rate effect						1	-- %						6	1 %

Sales – contract ethylene sales			84		--		84			228		--		228
Sales – divested product lines			--		38		(38)			--		97		(97)

Sales – excluding listed items			425		399		26	6 %		1,331		1,163		168	14 %
Volume effect							(6)	(1) %						101	8 %
Price effect							29	7 %						66	6 %
Product mix effect							2	-- %						(5)	-- %
Exchange rate effect							1	-- %						6	-- %

Operating earnings			50		22		28	>100 %		161		108		53	49 %
Operating earnings (loss) – divested product lines ⁽¹⁾			--		(11)		11	100 %		--		(8)		8	100 %
Operating earnings – excluding divested product lines			50		33		17	52 %		161		116		45	39 %

Accelerated depreciation included in cost of goods sold			2		--		2			16		--		16

Asset impairment and restructuring charges			(1)		11		(12)			(1)		11		(12)
Asset impairment and restructuring charges -divested product lines ⁽¹⁾			--		11		(11)			--		11		(11)
Asset impairment and restructuring charges - excluding divested product lines			(1)		--		(1)			(1)		--		(1)

Operating earnings excluding certain items ⁽²⁾			51		33		18	55 %		176		119		57	48 %
Operating earnings excluding certain items ⁽²⁾– divested product lines ⁽¹⁾			--<