EMN 2013.06.30 10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC  20549
FORM 10-Q

(Mark
One)
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2013
 
OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______________ to ______________

Commission file number 1-12626

EASTMAN CHEMICAL COMPANY
(Exact name of registrant as specified in its charter)
Delaware
62-1539359
(State or other jurisdiction of
(I.R.S. employer
incorporation or organization)
identification no.)
 
 
200 South Wilcox Drive
 
Kingsport, Tennessee
37662
(Address of principal executive offices)
(Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X]  NO  [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES [X]  NO  [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[X]
Accelerated filer
[  ]
Non-accelerated filer
[  ]
Smaller reporting company
[  ]
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES [  ]  NO  [X]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
Number of Shares Outstanding at June 30, 2013
Common Stock, par value $0.01 per share
154,238,678
--------------------------------------------------------------------------------------------------------------------------------
PAGE 1 OF 62 TOTAL SEQUENTIALLY NUMBERED PAGES
EXHIBIT INDEX ON PAGE 61

1

TABLE OF CONTENTS
ITEM
 
PAGE

PART I.  FINANCIAL INFORMATION

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

PART II.  OTHER INFORMATION

 
 
 
 
 
 
 
 
 

SIGNATURES

 

EXHIBIT INDEX

 

2


  
UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS,
COMPREHENSIVE INCOME AND RETAINED EARNINGS
 
Second Quarter
 
First Six Months
(Dollars in millions, except per share amounts)
2013
 
2012
 
2013
 
2012
Sales
$
2,440

 
$
1,853

 
$
4,747

 
$
3,674

Cost of sales
1,763

 
1,372

 
3,454

 
2,762

Gross profit
677

 
481

 
1,293

 
912

Selling, general and administrative expenses
180

 
121

 
351

 
247

Research and development expenses
51

 
43

 
100

 
84

Asset impairments and restructuring charges, net
18

 
—

 
21

 
—

Operating earnings
428

 
317

 
821

 
581

Net interest expense
46

 
28

 
93

 
47

Other charges (income), net
—

 
20

 
1

 
20

Earnings from continuing operations before income taxes
382

 
269

 
727

 
514

Provision for income taxes from continuing operations
116

 
91

 
213

 
176

Earnings from continuing operations
266

 
178

 
514

 
338

Gain from disposal of discontinued operations, net of tax
—

 
2

 
—

 
1

Net earnings
$
266

 
$
180

 
$
514

 
$
339

Less: Net earnings attributable to noncontrolling interest
2

 
1

 
3

 
2

Net earnings attributable to Eastman
$
264

 
$
179

 
$
511

 
$
337

Amounts attributable to Eastman stockholders
 
 
 
 
 
 
 
Earnings from continuing operations, net of tax
$
264

 
$
177

 
$
511

 
$
336

Gain from discontinued operations, net of tax
—

 
2

 
—

 
1

Net earnings attributable to Eastman stockholders
$
264

 
$
179

 
$
511

 
$
337

Basic earnings per share attributable to Eastman
 
 
 
 
 
 
 
Earnings from continuing operations
$
1.71

 
$
1.28

 
$
3.31

 
$
2.43

Earnings from discontinued operations
—

 
0.02

 
—

 
0.01

Basic earnings per share attributable to Eastman
$
1.71

 
$
1.30

 
$
3.31

 
$
2.44

Diluted earnings per share attributable to Eastman
 

 
 

 
 

 
 

Earnings from continuing operations
$
1.69

 
$
1.26

 
$
3.26

 
$
2.38

Earnings from discontinued operations
—

 
0.01

 
—

 
0.01

Diluted earnings per share attributable to Eastman
$
1.69

 
$
1.27

 
$
3.26

 
$
2.39



3

UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS,
COMPREHENSIVE INCOME AND RETAINED EARNINGS (continued)

 
Second Quarter
 
First Six Months
(Dollars in millions, except per share amounts)
2013
 
2012
 
2013
 
2012
Comprehensive Income
 

 
 

 
 

 
 

Net earnings including noncontrolling interest
$
266

 
$
180

 
$
514

 
$
339

Other comprehensive income (loss), net of tax
 

 
 

 
 

 
 

Change in cumulative translation adjustment
15

 
(24
)
 
(35
)
 
(9
)
Defined benefit pension and other postretirement benefit plans:
 

 
 

 
 

 
 

Amortization of unrecognized prior service credits included in net periodic costs
(3
)
 
(3
)
 
(7
)
 
(8
)
Derivatives and hedging:
 

 
 

 
 

 
 

Unrealized (loss) gain during period
(10
)
 
(40
)
 
4

 
(30
)
Reclassification adjustment for (losses) gains included in net income
3

 
4

 
5

 
(1
)
Total other comprehensive income (loss), net of tax
5

 
(63
)
 
(33
)
 
(48
)
Comprehensive income including noncontrolling interest
271

 
117

 
481

 
291

Comprehensive income attributable to noncontrolling interest
2

 
1

 
3

 
2

Comprehensive income attributable to Eastman
$
269

 
$
116

 
$
478

 
$
289

Retained Earnings
 

 
 

 
 

 
 

Retained earnings at beginning of period
$
3,239

 
$
2,882

 
$
3,038

 
$
2,760

Net earnings attributable to Eastman
264

 
179

 
511

 
337

Cash dividends declared
(47
)
 
(37
)
 
(93
)
 
(73
)
Retained earnings at end of period
$
3,456

 
$
3,024

 
$
3,456

 
$
3,024


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

4

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
 
June 30,
 
December 31,
(Dollars in millions, except per share amounts)
2013
 
2012
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
234

 
$
249

Trade receivables, net
1,053

 
846

Miscellaneous receivables
173

 
151

Inventories
1,286

 
1,260

Other current assets
92

 
88

Total current assets
2,838

 
2,594

Properties
 

 
 

Properties and equipment at cost
9,747

 
9,681

Less:  Accumulated depreciation
5,570

 
5,500

Net properties
4,177

 
4,181

Goodwill
2,620

 
2,644

Intangible assets, net of accumulated amortization
1,820

 
1,849

Other noncurrent assets
307

 
351

Total assets
$
11,762

 
$
11,619

Liabilities and Stockholders' Equity
 

 
 

Current liabilities
 

 
 

Payables and other current liabilities
$
1,309

 
$
1,360

Borrowings due within one year
—

 
4

Total current liabilities
1,309

 
1,364

Long-term borrowings
4,679

 
4,779

Deferred income tax liabilities
97

 
91

Post-employment obligations
1,827

 
1,856

Other long-term liabilities
477

 
501

Total liabilities
8,389

 
8,591

Stockholders' equity
 

 
 

Common stock ($0.01 par value – 350,000,000 shares authorized; shares issued – 214,805,555 and 213,406,523 for 2013 and 2012, respectively)
2

 
2

Additional paid-in capital
1,749

 
1,709

Retained earnings
3,456

 
3,038

Accumulated other comprehensive income
90

 
123

 
5,297

 
4,872

Less: Treasury stock at cost (60,627,362 shares for 2013 and 59,511,662 shares for 2012)
2,007

 
1,929

Total Eastman stockholders' equity
3,290

 
2,943

Noncontrolling interest
83

 
85

Total equity
$
3,373

 
$
3,028

Total liabilities and stockholders' equity
$
11,762

 
$
11,619


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

5

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
First Six Months
(Dollars in millions)
2013
 
2012
Cash flows from operating activities
 
 
 
Net earnings including noncontrolling interest
$
514

 
$
339

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
 

 
 

Depreciation and amortization
218

 
140

Asset impairment charges
6

 
—

Provision for deferred income taxes
46

 
23

Pension and other postretirement contributions (in excess of) less than expenses
(42
)
 
(45
)
Variable compensation (in excess of) less than expenses
(9
)
 
(36
)
Changes in operating assets and liabilities, net of effect of acquisitions and divestitures:
 

 
 

(Increase) decrease in trade receivables
(214
)
 
(103
)
(Increase) decrease in inventories
(35
)
 
(2
)
Increase (decrease) in trade payables
(32
)
 
(31
)
Other items, net
(85
)
 
50

Net cash provided by operating activities
367

 
335

Cash flows from investing activities
 

 
 

Additions to properties and equipment
(187
)
 
(177
)
Proceeds from redemption of short-term time deposits
—

 
200

Proceeds from sale of assets and investments
5

 
6

Acquisitions and investments in joint ventures, net of cash acquired
—

 
(10
)
Additions to capitalized software
(1
)
 
(3
)
Other items, net
(8
)
 
(35
)
Net cash used in investing activities
(191
)
 
(19
)
Cash flows from financing activities
 

 
 

Net increase (decrease) in commercial paper, credit facility, and other borrowings
300

 
(1
)
Proceeds from borrowings
150

 
2,311

Repayment of borrowings
(555
)
 
(146
)
Dividends paid to stockholders
(47
)
 
(71
)
Treasury stock purchases
(78
)
 
—

Dividends paid to noncontrolling interest
(7
)
 
(1
)
Proceeds from stock option exercises and other items, net
47

 
15

Net cash provided by (used in) financing activities
(190
)
 
2,107

Effect of exchange rate changes on cash and cash equivalents
(1
)
 
—

Net change in cash and cash equivalents
(15
)
 
2,423

Cash and cash equivalents at beginning of period
249

 
577

Cash and cash equivalents at end of period
$
234

 
$
3,000


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

6

ITEM
 
Page
 
 
 

7

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 2012 Annual Report on Form 10-K and should be read in conjunction with the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K. The unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States ("GAAP") and of necessity include some amounts that are based upon management estimates and judgments.  Future actual results could differ from such current estimates.  The unaudited consolidated financial statements include assets, liabilities, sales revenue, and expenses of all majority-owned subsidiaries and joint ventures in which a controlling interest is maintained.  Eastman accounts for other joint ventures and investments where it exercises significant influence on the equity basis.  Intercompany transactions and balances are eliminated in consolidation.  Certain prior period data has been reclassified in the Consolidated Financial Statements and accompanying footnotes to conform to current period presentation.

Solutia acquisition
Information related to the Solutia Inc. ("Solutia") acquisition completed July 2, 2012 is in Note 2, "Acquisitions and Investments in Joint Ventures".  As of the date of acquisition, results of the acquired Solutia businesses are included in Eastman results. 

2.
ACQUISITIONS AND INVESTMENTS IN JOINT VENTURES

Solutia Inc.
On July 2, 2012, the Company completed its acquisition of Solutia, a global leader in performance materials and specialty chemicals.  In the acquisition, each outstanding share of Solutia common stock was cancelled and converted automatically into the right to receive $22.00 in cash and 0.12 shares of Eastman common stock.  In total, 14.7 million shares of Eastman common stock were issued in the transaction.  The fair value of total consideration transferred was $4.8 billion, consisting of cash of $2.6 billion, net of cash acquired; equity in the form of Eastman stock of approximately $700 million; and the assumption and subsequent repayment of Solutia's debt at fair value of $1.5 billion.  

The funding of the cash portion of the purchase price, repayment of Solutia's debt, and acquisition costs was provided primarily from borrowings, including the $2.3 billion net proceeds from the public offering of notes on June 5, 2012 and borrowings of $1.2 billion on July 2, 2012 under a five-year term loan agreement (the "Term Loan").  See Note 6, "Borrowings".

The purchase price allocation for the July 2, 2012 Solutia acquisition has been finalized as of June 30, 2013. Updates to the December 31, 2012 preliminary purchase price allocation of the Solutia acquisition during second quarter 2013 for finalization of current and deferred income taxes have been reflected in the Company's Consolidated Statements of Financial Position as of June 30, 2013 and are summarized in the table below. These adjustments are primarily for finalization of valuation allowances against Federal and state deferred tax assets in connection with the filing of the final Solutia consolidated federal tax return. These updates were not material to the Company's financial position or results of operations for 2012 or 2013.
(Dollars in millions)
Initial Valuation
 
2012 Net Adjustments to Fair Value
 
December 31, 2012
 
2013 Net Adjustments to Fair Value
 
June 30, 2013
Assets acquired and liabilities assumed on July 2, 2012
Current assets
$
901

 
$
19

 
$
920

 
$
2

 
$
922

Properties and equipment
940

 
7

 
947

 
—

 
947

Intangible assets
1,807

 
(16
)
 
1,791

 
—

 
1,791

Other noncurrent assets
612

 
2

 
614

 
67

 
681

Goodwill
1,965

 
265

 
2,230

 
(22
)
 
2,208

Current liabilities
(461
)
 
(1
)
 
(462
)
 
—

 
(462
)
Long-term liabilities
(2,389
)
 
(276
)
 
(2,665
)
 
(47
)
 
(2,712
)
Equity and cash consideration, net of $88 million cash acquired
$
3,375

 
$
—

 
$
3,375

 
$
—

 
$
3,375



8

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Company used the income, market, or cost approach (or a combination thereof) for the valuation as appropriate, and used valuation inputs in these models and analyses that were based on market participant assumptions.  Market participants are considered to be buyers and sellers unrelated to Eastman in the principal or most advantageous market for the asset or liability. For certain items, the carrying value was determined to be a reasonable approximation of fair value based on information available to Eastman management. The fair value of receivables acquired from Solutia on July 2, 2012 was $350 million, with gross contractual amounts receivable of $366 million. Acquired intangible assets are primarily customer relationships, trade names, and developed technologies.  Long-term liabilities are primarily Solutia's debt, which was repaid by Eastman at closing, deferred tax liabilities, environmental liabilities, and pension and other postretirement welfare plan obligations. The Company finalized the acquisition accounting related to the transaction during fourth quarter 2012 with the exception of income taxes which were completed during second quarter 2013 and did not have a material impact on the Company's financial position or results of operations.

The acquisition of Solutia broadens Eastman's global presence, facilitates growth opportunities through enhanced access to markets such as the automotive and architectural industries, and expands Eastman's portfolio of sustainable products.  In connection with the purchase, the Company recorded goodwill, which represents the excess of the purchase price over the estimated fair value of tangible and intangible assets acquired, net of liabilities assumed. The goodwill is attributed primarily to Solutia as a going concern and the fair value of expected cost synergies and revenue growth from combining the Eastman and Solutia businesses.  The going concern element represents the ability to earn a higher return on the combined assembled collection of assets and businesses of Solutia than if those assets and businesses were to be acquired and managed separately.  Other relevant elements of goodwill are the benefits of access to certain markets and work force. Goodwill from the Solutia acquisition has been allocated to certain of the Company's reportable segments. None of the goodwill is deductible for tax purposes. 
Goodwill
Goodwill by Segment
(Dollars in millions)
 
Additives & Functional Products
$
745
 
Advanced Materials
1,004
 
Specialty Fluids & Intermediates
459
 
Total
$
2,208
 

Properties acquired included a number of manufacturing, sales, and distribution sites and related facilities, land and leased sites that include leasehold improvements, and machinery and equipment for use in manufacturing operations.  Management valued properties using the cost approach supported where available by observable market data which includes consideration of obsolescence.

Intangible assets acquired included a number of trade names and trademarks that are both business-to-business and business-to-consumer in nature, including Crystex®, Saflex®, and Llumar®.  Also acquired was technology related to products protected by a number of existing patents, patent applications, and trade secrets.  In addition to these intangible assets, the Company acquired a number of customer relationships in industries such as automotive tires and aviation. Management valued intangible assets using the relief from royalty and multi-period excess earnings methods, both forms of the income approach supported by observable market data for peer chemical companies.
Intangible Assets
 
 
 
 
(Dollars in millions)
Fair Value
 
Weighted-Average Amortization Period (Years)
Amortizable intangible assets
 
 
 
Customer relationships
$
809

 
22
Developed technologies
440

 
13
Indefinite-lived intangible assets
 
 
 
Trade names
542

 
 
Total
$
1,791

 
 


9

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Management estimated the fair market value of fixed-rate debt based on the viewpoint that the exit price approximated the entry price given the lack of observable market prices. Additionally, acquired interest rate swaps and foreign exchange contracts were terminated and settled immediately following the acquisition. Because these derivatives were recorded at fair value in the opening balance sheet, there were no gains or losses associated with these settlements.

Management also evaluated probable loss contingencies, including those for legal and environmental matters, as prescribed under applicable GAAP. Due to the lack of observable market inputs, assumed liabilities for environmental loss contingencies that were both probable and estimable were recorded based upon estimates of future cash outflows for such contingencies as of the acquisition date. See Note 10, "Environmental Matters", for more information.

Related to the acquisition of Solutia, in second quarter and first six months 2013 the Company recognized $8 million and $15 million, respectively, in integration costs. In second quarter and first six months 2012, the Company recognized $4 million and $13 million, respectively, in transaction costs; and $27 million and $32 million, respectively, in financing costs; and $2 million in both periods in integration costs. Transaction costs and integration costs were expensed as incurred and are included in the "Selling, general and administrative expenses" line item, and financing costs are included in the "Net interest expense" and "Other charges (income), net" line items in the Unaudited Consolidated Statements of Earnings, Comprehensive Income, and Retained Earnings.  

Beginning third quarter 2012, the Company's consolidated results of operations include the results of the acquired Solutia businesses.  The unaudited pro forma financial results for three months and six months ended June 30, 2012 combine the consolidated results of Eastman and Solutia giving effect to the acquisition of Solutia as if it had been completed on January 1, 2011, the beginning of the comparable annual reporting period prior to the year of acquisition.  The unaudited pro forma financial results presented below do not include any anticipated synergies or other expected benefits of the acquisition.  This unaudited pro forma financial information is presented for informational purposes only and is not indicative of future operations or results had the acquisition been completed as of January 1, 2011.

The unaudited pro forma financial results include certain adjustments for additional depreciation and amortization expense based upon the fair value step-up and estimated useful lives of Solutia depreciable fixed assets and definite-life amortizable assets acquired in the transaction.  The unaudited pro forma results also include adjustments to net interest expense and elimination of early debt extinguishment costs historically recorded by Solutia based upon the retirement of Solutia's debt and issuance of additional debt related to the transaction.  The provision for income taxes from continuing operations has also been adjusted for all periods, based upon the foregoing adjustments to historical results, as well as the elimination of historical net changes in valuation allowances against certain deferred tax assets of Solutia.

Additionally, in the preparation of unaudited pro forma sales and earnings from continuing operations including noncontrolling interest, Solutia's historical consolidated results have been retrospectively adjusted for the change in accounting methodology for pension and other postretirement benefit ("OPEB") plans actuarial gains and losses adopted by Eastman during first quarter 2012.  For additional information, see Note 14, "Accounting Methodology Change for Pension and Other Postretirement Benefit Plans" in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K.

2012
(Dollars in millions)
Second Quarter
 
First Six Months
Pro forma sales
$
2,373

 
$
4,692

Pro forma earnings from continuing operations including noncontrolling interest
226

 
448


Non-recurring costs directly attributable to the acquisition, which will not have an ongoing impact, are excluded from unaudited pro forma earnings from continuing operations including noncontrolling interest for second quarter 2012. These items include transaction, integration, and financing costs incurred by Eastman during second quarter and first six months 2012 as well as transaction costs of $14 million and $25 million incurred by Solutia during second quarter and first six months 2012, respectively, prior to its acquisition by Eastman.


10

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

3.
INVENTORIES
 
June 30,
 
December 31,
(Dollars in millions)
2013
 
2012
At FIFO or average cost (approximates current cost)
 
 
 
Finished goods
$
977

 
$
941

Work in process
298

 
288

Raw materials and supplies
514

 
536

Total inventories
1,789

 
1,765

LIFO Reserve
(503
)
 
(505
)
Total inventories
$
1,286

 
$
1,260


Inventories valued on the LIFO method were approximately 60 percent of total inventories as of both June 30, 2013 and December 31, 2012.

4.
PAYABLES AND OTHER CURRENT LIABILITIES
 
June 30,
 
December 31,
(Dollars in millions)
2013
 
2012
Trade creditors
$
686

 
$
723

Accrued payrolls, vacation, and variable-incentive compensation
152

 
171

Accrued taxes
71

 
76

Post-employment obligations
61

 
62

Interest payable
47

 
59

Environmental contingent liabilities, current portion
35

 
35

Other
257

 
234

Total payables and other current liabilities
$
1,309

 
$
1,360


The current portion of post-employment obligations is an estimate of current year payments. Included in "Other" above are dividends payable, certain accruals for payroll deductions and employee benefits, the current portion of hedging liabilities, and other payables and accruals.

5.
PROVISION FOR INCOME TAXES
 
Second Quarter
 
First Six Months
(Dollars in millions)
2013
 
2012
 
2013
 
2012
Provision for income taxes
$
116

 
$
91

 
$
213

 
$
176

Effective tax rate
30
%
 
34
%
 
29
%
 
34
%
 
The first six months 2013 effective tax rate was impacted by enactment of the American Taxpayer Relief Act of 2012 in January 2013, which resulted in a $10 million benefit primarily related to a research and development ("R&D") tax credit. The second quarter and first six months 2012 effective tax rates were impacted by the non-deductibility of certain transaction costs related to the acquisition of Solutia.


11

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following table reflects a revision of a 2012 deferred tax liability line item reported in Note 9, "Provision for Income Taxes" to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K. The "Amortization" line item was mischaracterized as "Inventory reserves". There was no impact on net deferred tax liability reported in the Company's 2012 Annual Report on Form 10-K.
(Dollars in millions)
December 31, 2012
Deferred tax assets
 
Post-employment obligations
$
715

Net operating loss carryforwards
630

Tax credit carryforwards
230

Environmental reserves
145

Other
82

Total deferred tax assets
1,802

Less valuation allowance
(215
)
Deferred tax assets less valuation allowance
$
1,587

Deferred tax liabilities
 
Depreciation
$
(951
)
Amortization
(666
)
Total deferred tax liabilities
$
(1,617
)
Net deferred tax liabilities
$
(30
)
As recorded in the Consolidated Statements of Financial Position:
 
Other current assets
$
34

Other noncurrent assets
30

Payables and other current liabilities
(3
)
Deferred income tax liabilities
(91
)
Net deferred tax liabilities
$
(30
)



12

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

6.
BORROWINGS
 
June 30,
 
December 31,
(Dollars in millions)
2013
 
2012
Borrowings consisted of:
 
 
 
3% debentures due 2015
$
250

 
$
250

2.4% notes due 2017
997

 
997

6.30% notes due 2018
173

 
174

5.5% notes due 2019
250

 
250

4.5% debentures due 2021
250

 
250

3.6% notes due 2022
894

 
893

7 1/4% debentures due 2024
243

 
243

7 5/8% debentures due 2024
54

 
54

7.60% debentures due 2027
222

 
222

4.8% notes due 2042
496

 
496

Credit facility borrowings
850

 
950

Other
—

 
4

Total borrowings
4,679

 
4,783

Borrowings due within one year
—

 
4

Long-term borrowings
$
4,679

 
$
4,779


On June 5, 2012, the Company issued 2.4% notes due 2017 in the principal amount of $1.0 billion, 3.6% notes due 2022 in the principal amount of $900 million, and 4.8% notes due 2042 in the principal amount of $500 million.  Proceeds from the sale of the notes, net of original issue discounts, issuance costs, and the monetization of interest rate swaps, were $2.3 billion. 

Credit Facility Borrowings

On July 2, 2012, the Company borrowed the entire $1.2 billion available under the five-year Term Loan. Proceeds from these borrowings were used to pay, in part, the cash portion of the Solutia acquisition, repay Solutia debt, and pay acquisition costs. During the first six months of 2013, the Company repaid $550 million of its Term Loan using $300 million of commercial paper borrowings, $150 million of its accounts receivable securitization facility (the "A/R Facility"), and $100 million in cash. At June 30, 2013 and December 31, 2012, the Term Loan balances outstanding were $400 million and $950 million, respectively. The interest rate on the Term Loan as of June 30, 2013 was 1.75 percent.

The Company has a $750 million revolving credit agreement (the "Revolving Credit Facility") expiring December 2016.  Borrowings under the Revolving Credit Facility are subject to interest at varying spreads above quoted market rates and a commitment fee is paid on the total unused commitment. At June 30, 2013 and December 31, 2012, the Company had no outstanding borrowings under the Revolving Credit Facility.

The Revolving Credit Facility provides liquidity support for commercial paper borrowings and general corporate purposes.  Accordingly, any outstanding commercial paper borrowings reduce capacity for borrowings available under the Revolving Credit Facility.  Given the expiration date of the Revolving Credit Facility, any commercial paper borrowings supported by the Revolving Credit Facility are classified as long-term borrowings because the Company has the ability and intent to refinance such borrowings on a long-term basis. At June 30, 2013 the Company's commercial paper borrowings were $300 million with a weighted average interest rate of 0.34 percent, and the proceeds were used to repay a portion of the Term Loan. There were no commercial paper borrowings at December 31, 2012.


13

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Company also has a $250 million line of credit under the A/R Facility, expiring April 2016.  Borrowings under the A/R Facility are subject to interest rates based on a spread over the lender's borrowing costs, and the Company pays a fee to maintain availability of the A/R Facility.  At June 30, 2013, the Company's borrowings under the A/R Facility were $150 million with an interest rate of 0.94 percent, and the proceeds were used to repay a portion of the Term Loan. These borrowings are secured by $150 million of trade receivables. At December 31, 2012, the Company had no outstanding borrowings under the A/R Facility.

The Term Loan, Revolving Credit Facility, and the A/R Facility contain a number of customary covenants and events of default, including the maintenance of certain financial ratios. The Company was in compliance with all such covenants for all periods presented.  As of June 30, 2013, as a result of the $300 million in commercial paper borrowings, the amount available under the Revolving Credit Facility was $450 million. As of June 30, 2013, as a result of the $150 million borrowings under the A/R Facility, $100 million was available under this facility. As of December 31, 2012, substantially all of the amounts under these facilities were available for borrowing. The Company would not violate applicable covenants for these periods if the total available amounts of the facilities had been borrowed.

Fair Value of Borrowings

The Company has classified its long-term borrowings at June 30, 2013 and December 31, 2012 under the fair value hierarchy as defined in the accounting policies in Note 1, "Significant Accounting Policies" to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K.  The fair value for fixed-rate borrowings is based on current market prices and is classified in level 1.  The fair value for the Company's floating-rate borrowings, which relate to the Term Loan, the A/R Facility, and commercial paper, equals the carrying value and is classified within level 2.


 
 
 
Fair Value Measurements at June 30, 2013
(Dollars in millions)
 
Recorded Amount June 30, 2013
 
Total Fair Value
 
 Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Long-term borrowings
 
$
4,679

 
$
4,838

 
$
3,988

 
$
850

 
$
—

 
 
 
 
 
Fair Value Measurements at December 31, 2012
(Dollars in millions)
 
Recorded Amount December 31, 2012
 
Total Fair Value
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Long-term borrowings
 
$
4,779

 
$
5,165

 
$
4,215

 
$
950

 
$
—


7.
DERIVATIVES

Hedging Programs

The Company is exposed to market risk, such as changes in currency exchange rates, commodity prices, and interest rates.  The Company uses various derivative financial instruments when appropriate 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 12, "Derivatives", to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K.


14

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Fair Value Hedges

Fair value hedges are defined as derivative or non-derivative instruments designated as and used to hedge the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk.  For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings.  As of June 30, 2013 and December 31, 2012, the Company had no fair value hedges.

Cash Flow Hedges

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

As of June 30, 2013, the total notional amounts of the Company's foreign exchange forward and option contracts were €612 million (approximately $800 million equivalent) and ¥7.6 billion (approximately $78 million equivalent), respectively. The total notional volume for contract ethylene sales was approximately 52 thousand metric tons, and the total notional volume hedged for feedstock was approximately 4 million barrels.  The Company had no outstanding hedges for energy or interest rate swaps.

As of December 31, 2012, the total notional amounts of the Company's foreign exchange forward and option contracts were €480 million (approximately $635 million equivalent) and ¥3.2 billion (approximately $35 million equivalent), respectively. The total notional volume for contract ethylene sales was approximately 49 thousand metric tons, and the total notional volume hedged for feedstock was approximately 3 million barrels.  The Company had no outstanding hedges for energy or interest rate swaps.

Fair Value Measurements

For additional information on fair value measurement, see Note 1, "Significant Accounting Policies" to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K.

The following chart shows the financial assets and liabilities valued on a recurring basis.
(Dollars in millions)
 
 
 
Fair Value Measurements at June 30, 2013
Description
 
June 30, 2013
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Derivative Assets
 
$
45

 
$
—

 
$
45

 
$
—

Derivative Liabilities
 
(27
)
 
—

 
(20
)
 
(7
)
 
 
$
18

 
$
—

 
$
25

 
$
(7
)
 
(Dollars in millions)
 
 
 
Fair Value Measurements at December 31, 2012
Description
 
December 31, 2012
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
Derivative Assets
 
$
28

 
$
—

 
$
28

 
$
—

Derivative Liabilities
 
(24
)
 
—

 
(19
)
 
(5
)
 
 
$
4

 
$
—

 
$
9

 
$
(5
)


15

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The majority of the Company's derivative assets are classified as Level 2.  Level 2 fair value is based on estimates using standard pricing models.  These standard pricing models use inputs which are derived from or corroborated by observable market data such as interest rate yield curves and currency spot and forward rates.  The fair value of commodity contracts is derived using forward curves supplied by an industry recognized and unrelated third party.  In addition, on an ongoing basis, the Company tests a subset of its valuations against valuations received from the transaction's counterparty to validate the accuracy of its standard pricing models.  Counterparties to these derivative contracts are highly rated financial institutions which the Company believes carry only a minimal risk of nonperformance.

The Company holds Level 3 assets for commodity hedges.  The fair values of Level 3 instruments are determined using pricing data similar to that used in Level 2 financial instruments described above, and reflect adjustments for less liquid markets or longer contractual terms.  All Level 3 hedges will mature in the current year.  The Company determines the fair value of paraxylene derivative forward contracts based on related inputs that are either readily available in public markets or can be derived from information available in publicly quoted markets, and which influence the actual forward price of the commodity.  Due to the fact that the forward price of the commodity itself is considered unobservable, the Company has categorized these forward contracts as Level 3. The Company determines the fair value of ethylene derivative forward contracts using an average of unadjusted forward ethylene prices provided by industry recognized experts.

The table below presents a rollforward of activity for these assets (liabilities) for the period ended June 30, 2013:
Fair Value Measurements Using Level 3 Inputs
 
 
 
 
 
 
 
 
Commodity Contracts
 
Second Quarter
 
First Six Months
(Dollars in millions)
 
2013
 
2012
 
2013
 
2012
Balance at beginning of period
 
$
(12
)
 
$
—

 
$
(5
)
 
$
—

Realized gain (loss) in sales revenue
 
(3
)
 
—

 
(7
)
 
—

Change in unrealized gain (loss)
 
5

 
(9
)
 
(2
)
 
(9
)
Settlements
 
3

 
1

 
7

 
1

Transfers (out) in of Level 3
 
—

 
—

 
—

 
—

Balance at June 30
 
$
(7
)
 
$
(8
)
 
$
(7
)
 
$
(8
)

The following chart shows the financial assets and liabilities valued on a recurring basis and their location in the Unaudited Consolidated Statements of Financial Position.  The Company had no nonqualifying derivatives or derivatives that are not designated as hedges as of June 30, 2013 and December 31, 2012. All of the Company's derivative contracts are subject to master netting arrangements, or similar agreements, which provide for the option to settle contracts on a net basis when they settle on the same day and the same currency. In addition, these arrangements provide for a net settlement of all contracts with a given counterparty in the event that the arrangement is terminated due to the occurrence of default or a termination event. The Company has elected to present the derivative contracts on a gross basis in the Unaudited Consolidated Statements of Financial Position. Had it chosen to present the derivatives contracts on a net basis, it would have a derivative in a net asset position of $31 million and a derivative in a net liability position of $13 million as of June 30, 2013. The Company also does not have any cash collateral due under such agreements.

Fair Value of Derivatives Designated as Hedging Instruments
(Dollars in millions)
 
 
 
Fair Value Measurements Significant Other Observable Inputs
Derivative Assets
 
Statement of Financial Position Location
 
June 30, 2013
 
December 31, 2012
Cash Flow Hedges
 
 
 
 
 
 
Commodity contracts
 
Other current assets
 
$
1

 
$
7

Foreign exchange contracts
 
Other current assets
 
19

 
8

Foreign exchange contracts
 
Other noncurrent assets
 
25

 
13

 
 
 
 
$
45

 
$
28

 

16

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions)
 
 
 
Fair Value Measurements Significant Other Observable Inputs
Derivative Liabilities
 
Statement of Financial Position Location
 
June 30, 2013
 
December 31, 2012
Cash Flow Hedges
 
 
 
 
 
 
Commodity contracts
 
Payables and other current liabilities
 
$
13

 
$
13

Commodity contracts
 
Other long-term liabilities
 
1

 
—

Foreign exchange contracts
 
Payables and other current liabilities
 
5

 
8

Foreign exchange contracts
 
Other long-term liabilities
 
8

 
3

 
 
 
 
$
27

 
$
24


Derivatives' Hedging Relationships
 
 
Second Quarter
(Dollars in millions)
 
Change in amount after tax of gain/(loss) recognized in Other Comprehensive Income on derivatives (effective portion)
 
Location of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
 
Pre-tax amount of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
Derivatives' Cash Flow Hedging Relationships
 
June 30,
2013
 
June 30,
2012
 
June 30,
2013
 
June 30,
2012
Commodity contracts
 
$
(2
)
 
$
3

 
Sales
 
$
(3
)
 
$
—

 
 
 
 
 
 
Cost of Sales
 
(3
)
 
(18
)
Foreign exchange contracts
 
(6
)
 
4

 
Sales
 
4

 
9

Forward starting interest rate swap contracts
 
1

 
(43
)
 
Net interest expense
 
(2
)
 
(1
)
 
 
$
(7
)
 
$
(36
)
 
 
 
$
(4
)
 
$
(10
)
 
 
 
 
 
 
 
 
 
 
 
 
 
First Six Months
(Dollars in millions)
 
Change in amount after tax of gain/(loss) recognized in Other Comprehensive Income on derivatives (effective portion)
 
Location of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
 
Pre-tax amount of gain/(loss) reclassified from Accumulated Other Comprehensive Income into income (effective portion)
Derivatives' Cash Flow Hedging Relationships
 
June 30,
2013
 
June 30,
2012
 
June 30,
2013
 
June 30,
2012
Commodity contracts
 
$
(4
)
 
$
(4
)
 
Sales
 
$
(7
)
 
$
—

 
 
 
 
 
 
Cost of sales
 
(3
)
 
(18
)
Foreign exchange contracts
 
11

 
3

 
Sales
 
6

 
17

Forward starting interest rate swap contracts
 
2

 
(30
)
 
Net interest expense
 
(4
)
 
(1
)
 
 
$
9

 
$
(31
)
 
 
 
$
(8
)
 
$
(2
)

In second quarter 2012, forward starting interest rate swaps related to the issuance of debt for the Solutia acquisition were settled, resulting in an additional loss, net of tax of $44 million recorded in Other Comprehensive Income.

17

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Hedging Summary
 
Monetized positions and mark-to-market gains and losses from raw materials and energy, currency, and certain interest rate hedges that were included in accumulated other comprehensive income before taxes totaled losses of approximately $60 million at June 30, 2013 and $54 million at June 30, 2012.  If realized, approximately $5 million in losses in second quarter 2013 will be reclassified into earnings during the next 12 months.  Ineffective portions of hedges are immediately recognized in cost of sales or other charges (income), net.  There were no material gains or losses related to the ineffective portion of hedges recognized in second quarter and first six months 2013. For second quarter and first six months 2012, the ineffective portion of the Company's qualifying hedges was $2 million.

The gains or losses on nonqualifying derivatives or derivatives that are not designated as hedges are marked to market in the line item "Other charges (income), net" of the Statements of Earnings, and, in all periods presented, represent foreign exchange derivatives denominated in multiple currencies and are transacted and settled in the same quarter.  The Company recognized no net gains or losses during second quarter 2013 and approximately $2 million net gains during second quarter 2012 on nonqualifying derivatives.  The Company recognized approximately $2 million net losses and $1 million net gains on nonqualifying derivatives during first six months 2013 and 2012, respectively.

8.
RETIREMENT PLANS

As described in more detail below, Eastman offers various postretirement benefits to its employees.

DEFINED BENEFIT PENSION PLANS AND POSTRETIREMENT WELFARE PLANS

Pension Plans
 
Eastman maintains defined benefit pension plans that provide eligible employees with retirement benefits.  Costs recognized for these benefits are recorded using estimated amounts, which may change as actual costs derived for the year are determined.
 
In July 2012, as part of its acquisition of Solutia, the Company assumed Solutia's U.S. and non-U.S. defined benefit pension plans.  These U.S. plans were closed to new participants prior to the acquisition and were no longer accruing additional benefits.  For more information on the Solutia acquisition, see Note 2, "Acquisitions and Investments in Joint Ventures".

Postretirement Welfare Plans

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

Eligible employees hired on or after January 1, 2007 have access to postretirement health care benefits, but Eastman does not provide a subsidy toward the premium cost of postretirement benefits for those employees.  A few of the Company's non-U.S. operations have supplemental health benefit plans for certain retirees, the cost of which is not significant to the Company.

In July 2012, as part of its acquisition of Solutia, the Company assumed Solutia's postretirement welfare plans.  For more information on the Solutia acquisition, see Note 2, "Acquisitions and Investments in Joint Ventures".


18

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Costs recognized for benefits for eligible retirees hired prior to January 1, 2007 are recognized using estimated amounts which may change as actual costs for the year are determined.  Components of net periodic benefit cost were as follows:
 
Second Quarter
 
First Six Months
 
Pension Plans
 
Postretirement Welfare Plans
 
Pension Plans
 
Postretirement Welfare Plans
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
(Dollars in millions)
U.S.
 
Non-U.S.
 
U.S.
 
Non-U.S.
 
 
 
 
 
U.S.
 
Non-U.S.
 
U.S.
 
Non-U.S.
 
 
 
 
Components of net periodic benefit cost:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
11

 
$
3

 
$
10

 
$
1

 
$
3

 
$
3

 
$
21

 
$
7

 
$
20

 
$
3

 
$
6

 
$
5

Interest cost
22

 
7

 
19

 
3

 
11

 
10

 
44

 
14

 
37

 
6

 
22

 
21

Expected return on assets
(32
)
 
(8
)
 
(21
)
 
(4
)
 
(2
)
 
(1
)
 
(64
)
 
(17
)
 
(42
)
 
(8
)
 
(4
)
 
(1
)
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prior service cost/(credit)
(1
)
 
—

 
(1
)
 
—

 
(5
)
 
(5
)
 
(2
)
 
—

 
(2
)
 
—

 
(10
)
 
(10
)
Net periodic benefit cost
$
—

 
$
2

 
$
7

 
$
—

 
$
7

 
$
7

 
$
(1
)
 
$
4

 
$
13

 
$
1

 
$
14

 
$
15


Second quarter and first six months 2013 reflect the impact on the U.S. and non-U.S. defined benefit pension plans and the other postretirement welfare plans of the Solutia acquisition.

The Company contributed $24 million and $45 million to its U.S. defined benefit pension plans in first six months 2013 and 2012, respectively.

9.
COMMITMENTS

Purchase Obligations and Lease Commitments
 
The Company had various purchase obligations at June 30, 2013 totaling $2.9 billion over a period of approximately 15 years for materials, supplies, and energy incident to the ordinary conduct of business.  The Company also had various lease commitments for property and equipment under cancelable, noncancelable, and month-to-month operating leases totaling approximately $218 million over a period of several years.  Of the total lease commitments, approximately 5 percent relate to machinery and equipment, including computer and communications equipment and production equipment; approximately 60 percent relate to real property, including office space, storage facilities, and land; and approximately 35 percent relate to railcars.

Guarantees

The Company has operating leases with terms that require the Company to guarantee a portion of the residual value of the leased assets upon termination of the lease as well as other guarantees.  Disclosures about each group of similar guarantees are provided below.

Residual Value Guarantees

The Company has operating leases with terms that require the Company to guarantee a portion of the residual value of the leased assets upon termination of the lease.  These residual value guarantees at June 30, 2013 totaled $110 million and consisted primarily of leases for railcars and company aircraft and will expire beginning in 2016.  Management believes, based on current facts and circumstances, that the likelihood of material residual guarantee payments is remote.


19

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Other Guarantees

Guarantees and claims also arise during the ordinary course of business from relationships with joint venture partners, suppliers, customers, and other parties when the Company undertakes an obligation to guarantee the performance of others, if specified triggering events occur.  Non-performance under a contract could trigger an obligation of the Company.  The Company's current other guarantees include guarantees relating primarily to intellectual property, environmental matters, and other indemnifications and have arisen through the normal course of business.  The ultimate effect on future financial results is not subject to reasonable estimation because considerable uncertainty exists as to the final outcome of these claims, if they were to occur.  These other guarantees have terms of between 1 and 15 years with maximum potential future payments of approximately $55 million in the aggregate, with none of these guarantees individually significant to the Company's operating results, financial position, or liquidity.  The Company's current expectation is that future payment or performance related to non-performance under other guarantees is considered remote.

10.
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 required to incur costs for environmental remediation and closure and postclosure under the federal Resource Conservation and Recovery Act.  Reserves for environmental contingencies have been established in accordance with Eastman's policies described in Note 1, "Significant Accounting Policies" to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K. The Company's total reserve for environmental contingencies was $379 million and $394 million at June 30, 2013 and December 31, 2012, respectively.  At both June 30, 2013 and December 31, 2012, this reserve included $8 million related to sites previously closed and impaired by Eastman, as well as sites that have been divested by Eastman but for which the Company retains the environmental liability related to these sites.

Estimated future environmental expenditures for remediation costs ranged from the minimum or best estimate of $350 million to the maximum of $606 million and from the minimum or best estimate of $365 million to the maximum of $623 million at June 30, 2013 and December 31, 2012, respectively.  The maximum estimated future costs are considered to be reasonably possible and include the amounts accrued at both June 30, 2013 and December 31, 2012.  Although the resolution of uncertainties related to these environmental matters may have a material adverse effect on the Company's consolidated results of operations in the period recognized, because of 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 or cash flows.  

For facilities that have asset retirement obligations, the best estimate accrued to date over the facilities' estimated useful lives for these asset retirement obligation costs was $29 million at both June 30, 2013 and December 31, 2012. 

Reserves for environmental remediation that management believes to be probable and estimable are recorded as current and long-term liabilities in the Unaudited Consolidated Statements of Financial Position. These reserves include liabilities expected to be paid out within 30 years. Changes in the reserves for environmental remediation liabilities during first six months 2013 including net charges taken, which are included in cost of goods sold, and cash reductions are summarized below:
(Dollars in millions)
Environmental Remediation Liabilities
Balance at December 31, 2012
$
365

Net charges taken
—

Cash reductions
(15
)
Balance at June 30, 2013
$
350



20

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Company's total environmental reserve for environmental contingencies, including remediation costs and asset retirement obligations, is recorded in the Unaudited Consolidated Statements of Financial Position as follows:
(Dollars in millions)
June 30, 2013
 
December 31, 2012
Environmental contingent liabilities, current
$
35

 
$
35

Environmental contingent liabilities, long-term
344

 
359

Total
$
379

 
$
394


On July 2, 2012, as described in Note 2, "Acquisitions and Investments in Joint Ventures", the Company completed the acquisition of Solutia, resulting in a $368 million increase to the Company's reserve for remediation costs and $1 million in additional asset retirement obligation costs. Included in the additional remediation reserve are costs associated with damages to natural resources. The additional environmental remediation reserve includes costs of $149 million and $107 million related to the Anniston, Alabama and the Sauget, Illinois plant sites, respectively.

11.
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 will have a material adverse effect on its overall financial condition, results of operations, or cash flows.

12.
STOCKHOLDERS' EQUITY

A reconciliation of the changes in stockholders' equity for first six months 2013 is provided below:
(Dollars in millions)
Common Stock at Par Value
$
 
Paid-in Capital
$
 
Retained Earnings
$
 
Accumulated Other Comprehensive Income (Loss)
$
 
Treasury Stock at Cost
$
 
Total Stockholders' Equity Attributed to Eastman
$
 
Noncontrolling Interest $
 
Total Stockholders' Equity $
Balance at December 31, 2012
2

 
1,709

 
3,038

 
123

 
(1,929
)
 
2,943

 
85

 
3,028

Net Earnings
—

 
—

 
511

 
—

 
—

 
511

 
3

 
514

Cash Dividends Declared (1)
—

 
—

 
(93
)
 
—

 
—

 
(93
)
 
—

 
(93
)
Other Comprehensive Income
—

 
—

 
—

 
(33
)
 
—

 
(33
)
 
—

 
(33
)
Share-Based Compensation Expense (2)
—

 
19

 
—

 
—

 
—

 
19

 
—

 
19

Stock Option Exercises
—

 
6

 
—

 
—

 
—

 
6

 
—

 
6

Shares Issued for Business Combination (3)
—

 
16

 
—

 
—

 
—

 
16

 
—

 
16

Other (4)
—

 
(1
)
 
—

 
—

 
—

 
(1
)
 
1

 
—

Share Repurchase
—

 
—

 
—

 
—

 
(78
)
 
(78
)
 
—

 
(78
)
Distributions to Noncontrolling Interest
—

 
—

 
—

 
—

 
—

 
—

 
(6
)
 
(6
)
Balance at June 30, 2013
2

 
1,749

 
3,456

 
90

 
(2,007
)
 
3,290

 
83

 
3,373

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
Includes cash dividends declared, but unpaid.
(2) 
Includes the fair value of share-based awards recognized for share-based compensation.
(3) 
Proceeds of warrant exercises related to the Company's acquisition of Solutia.
(4) 
Primarily tax benefits relating to the difference between the amounts deductible for federal income taxes over the amounts charged to income for book value purposes credited to paid-in capital and other items.


21

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
 
 
 
 
(Dollars in millions)
Cumulative Translation Adjustment
 
Unrecognized Prior Service Credits for Benefit Plans
 
Unrealized Gains (Losses) on Derivative Instruments
 
Unrealized Losses on Investments
 
Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2011
$
64

 
$
78

 
$
(3
)
 
$
(1
)
 
$
138

Period change
41

 
(13
)
 
(43
)
 
—

 
(15
)
Balance at December 31, 2012
105

 
65

 
(46
)
 
(1
)
 
123

Period change
(35
)
 
(7
)
 
9

 
—

 
(33
)
Balance at June 30, 2013
$
70

 
$
58

 
$
(37
)
 
$
(1
)
 
$
90


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


22

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Components of other comprehensive income recorded in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings are presented below, before tax and net of tax effects:
 
Second Quarter
 
2013
 
2012
(Dollars in millions)
Before Tax
 
Net of Tax
 
Before Tax
 
Net of Tax
Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in cumulative translation adjustment
$
15

 
$
15

 
$
(25
)
 
$
(24
)
Defined benefit pension and other postretirement benefit plans:
 
 
 
 
 
 
 

Amortization of unrecognized prior service credits included in net periodic costs (1)
(6
)
 
(3
)
 
(6
)
 
(3
)
Derivatives and hedging:
 
 
 
 
 
 
 

Unrealized loss during period
(16
)
 
(10
)
 
(64
)
 
(40
)
Reclassification adjustment for losses included in net income (2)
5

 
3

 
6

 
4

Total other comprehensive income (loss)
$
(2
)
 
$
5

 
$
(89
)
 
$
(63
)
 
 
 
 
 
 
 
 
 
First Six Months
 
2013
 
2012
(Dollars in millions)
Before Tax
 
Net of Tax
 
Before Tax
 
Net of Tax
Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in cumulative translation adjustment
$
(35
)
 
$
(35
)
 
$
(9
)
 
$
(9
)
Defined benefit pension and other postretirement benefit plans:
 
 
 
 
 
 
 

Amortization of unrecognized prior service credits included in net periodic costs (1)
(12
)
 
(7
)
 
(12
)
 
(8
)
Derivatives and hedging:
 
 
 
 
 
 
 

Unrealized gain (loss) during period
7

 
4

 
(48
)
 
(30
)
Reclassification adjustment for gains (losses) included in net income (2)
8

 
5

 
(2
)
 
(1
)
Total other comprehensive income (loss)
$
(32
)
 
$
(33
)
 
$
(71
)
 
$
(48
)

(1) 
Included in the calculation of net periodic benefit costs for pension and OPEB. See Note 8, "Retirement Plans".
(2) 
Gains and losses from derivatives and hedging are included in sales, cost of sales, and net interest expense. See Note 7, "Derivatives".

13.
EARNINGS AND DIVIDENDS PER SHARE
 
Second Quarter
 
First Six Months
 
2013
 
2012
 
2013
 
2012
Shares used for earnings per share calculation (in millions):
 
 
 
 

 

Basic
154.4
 
138.1
 
154.4
 
137.7
Diluted
156.7
 
141.2
 
156.7
 
140.9


23

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

In July 2012, as part of the Company's acquisition of Solutia, the Company issued 14.7 million shares of Eastman common stock and 4,481,250 warrants to purchase 0.12 shares of Eastman common stock and $22.00 cash per warrant upon payment of the warrant exercise price of $29.70. Second quarter and first six months 2013 include the shares issued in the Solutia acquisition. First six months 2013 also reflects the impact of exercised Solutia acquisition warrants. Unexercised warrants expired on February 27, 2013. For more information on the Solutia acquisition, see Note 2, "Acquisitions and Investments in Joint Ventures".

In second quarter and first six months 2013, common shares underlying options to purchase 317,879 and 121,070 shares of common stock, respectively, were excluded from the shares treated as outstanding for computation of diluted earnings per share because the total market value of option exercises for these awards was less than the total cash proceeds that would be received for these exercises. Second quarter and first six months 2013 reflect the impact of share repurchases of 670,200 and 1,115,700 shares, respectively.

In second quarter and first six months 2012, there were no outstanding options to purchase shares of common stock excluded from shares treated as outstanding for the computation of diluted earnings per share and no share repurchases.

The Company declared cash dividends of $0.30 and $0.26 per share in second quarter 2013 and 2012, respectively, and $0.60 and $0.52 per share in first six months 2013 and 2012, respectively.

14.
ASSET IMPAIRMENTS AND RESTRUCTURING CHARGES, NET

In second quarter and first six months 2013, there were $18 million and $21 million, respectively, of net asset impairments and restructuring charges. During second quarter 2013, management announced its intent and finalized its decision to close a production facility in Germany for the Photovoltaics product line. This resulted in the Company recognizing asset impairments of $7 million and restructuring charges of $5 million including charges for severance. During second quarter 2013, management also approved and recorded severance charges of $6 million primarily for a voluntary separation plan for certain employees.

During second quarter 2013, a change in estimate for certain costs associated with the fourth quarter 2012 termination of the operating agreement for the Sao Jose dos Campos, Brazil site resulted in a reduction of $4 million to previously recorded asset impairments and restructuring charges. Analysis of total site shutdown costs is ongoing and is subject to the finalization of certain aspects of the operating agreement termination.

In second quarter and first six months 2013, there were $3 million and $6 million, respectively, of restructuring charges primarily for severance associated with the continued integration of Solutia. For additional information related to the acquisition of Solutia, see Note 2, "Acquisitions and Investments in Joint Ventures".

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

The following table summarizes the changes in other asset impairments and restructuring charges, the non-cash reductions attributable to asset impairments, and the cash reductions in shutdown reserves for severance costs and site closure costs paid for full year 2012 and first six months 2013:
 
(Dollars in millions)
Balance at January 1, 2012
 
Provision/ Adjustments
 
Non-cash Reductions/ Adjustments
 
Cash Reductions
 
Balance at December 31, 2012
Non-cash charges, net
$
—

 
$
43

 
$
(43
)
 
$
—

 
$
—

Severance costs
2

 
34

 
—

 
(32
)
 
4

Site closure and restructuring costs
—

 
43

 
(20
)
 
(2
)
 
21

Total
$
2

 
$
120

 
$
(63
)
 
$
(34
)
 
$
25


24

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 (Dollars in millions)
Balance at January 1, 2013
 
Provision/ Adjustments
 
Non-cash Reductions/ Adjustments
 
Cash Reductions
 
Balance at June 30, 2013
Non-cash charges, net
$
—

 
$
8

 
$
(8
)
 
$
—

 
$
—

Severance costs
4

 
13

 
2

 
(3
)
 
16

Site closure and restructuring costs
21

 
—

 
(1
)
 
(5
)
 
15

Total
$
25

 
$
21

 
$
(7
)
 
$
(8
)
 
$
31


The costs remaining for severance are expected to be applied to the reserves within one year.

15.
SHARE-BASED COMPENSATION AWARDS

The Company utilizes share-based awards under employee and non-employee director compensation programs.  These share-based awards may include restricted and unrestricted stock, restricted stock units, stock options, and performance shares.  In both second quarter 2013 and 2012, approximately $8 million of compensation expense before tax was recognized in selling, general and administrative expense in the Unaudited Consolidated Statements of Earnings for all share-based awards. The impact on both second quarter 2013 and 2012 net earnings of approximately $5 million is net of deferred tax expense related to share-based award compensation for each period.

In first six months 2013 and 2012, approximately $19 million and $17 million, respectively, of compensation expense before tax were recognized in selling, general and administrative expense in the Unaudited Consolidated Statements of Earnings for all share-based awards. The impact on first six months 2013 and 2012 net earnings of approximately $12 million and $10 million, respectively, is net of deferred tax expense related to share-based award compensation for each period.

For additional information regarding share-based compensation plans and awards, see Note 21, "Share-Based Compensation Plans and Awards", to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K.
 
 
 
16.
SUPPLEMENTAL CASH FLOW INFORMATION

Included in the line item "Other items, net" of the "Cash flows from operating activities" section of the Unaudited Consolidated Statements of Cash Flows are the following changes to balance sheet line items:
(Dollars in millions)
First Six Months
 
2013
 
2012
Current assets
$
22

 
$
(21
)
Other assets
19

 
32

Current liabilities
(60
)
 
74

Long-term liabilities and equity
(66
)
 
(35
)
Total
$
(85
)
 
$
50


These changes included transactions such as monetized positions from raw material and energy, currency, and certain interest rate hedges, prepaid insurance, miscellaneous deferrals, accrued taxes, interest accruals, environmental accruals, and other miscellaneous accruals.


25

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

17.
SEGMENT INFORMATION

The Company's products and operations are currently managed and reported in five operating segments -- Additives & Functional Products, Adhesives & Plasticizers, Advanced Materials, Fibers, and Specialty Fluids & Intermediates. Sales revenue for Perennial Wood™ and the Photovoltaics product line acquired from Solutia is shown in the tables below as "other" sales revenue. R&D, pension and OPEB, and other expenses not identifiable to an operating segment are not included in segment operating results for any of the periods presented and are shown in the tables below as "other" operating earnings (loss).  For additional information concerning the Company's segments' businesses and products, see Note 23, "Segment Information" to the consolidated financial statements in Part II, Item 8 of the Company's 2012 Annual Report on Form 10-K.

Included in second quarter and first six months 2013 "other" operating loss were integration costs of $8 million and $15 million, respectively, and restructuring charges of $3 million and $6 million, respectively, primarily for severance associated with the continued integration of Solutia. Included in second quarter and first six months 2012 "other" operating loss were transaction costs of $4 million and $13 million, respectively, and integration costs of $2 million in both periods for the acquisition of Solutia.
 
Second Quarter
(Dollars in millions)
2013
 
2012
Sales
 
 
 
Additives & Functional Products
$
430

 
$
279

Adhesives & Plasticizers
339

 
372

Advanced Materials
625

 
315

Fibers
363

 
318

Specialty Fluids & Intermediates
677

 
567

Total Sales by Segment
2,434

 
1,851

Other
6

 
2

Total Sales
$
2,440

 
$
1,853

 
 
 
 
 
First Six Months
(Dollars in millions)
2013
 
2012
Sales
 
 
 
Additives & Functional Products
$
849

 
$
542

Adhesives & Plasticizers
684

 
746