Edgar Filing: EASTMAN CHEMICAL CO

Eastman Chemical Company Form 10-Q - June 30, 2005

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, 2005
	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

	Yes	No
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.	[X]
	Yes	No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).	[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, 2005
Common Stock, par value $0.01 per share		81,477,900
(including rights to purchase shares of Common Stock or Participating Preferred Stock)

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EXHIBIT INDEX ON PAGE 51

TABLE OF CONTENTS

ITEM

PAGE

PART I. FINANCIAL INFORMATION

1.	Financial Statements	3
	Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings	3
	Consolidated Statements of Financial Position	4
	Unaudited Consolidated Statements of Cash Flows	5
	Notes to Unaudited Consolidated Financial Statements	6
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
4.	Controls and Procedures	46

PART II. OTHER INFORMATION

1.	Legal Proceedings	47
2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
4.	Submission of Matters to a Vote of Security Holders	49
6.	Exhibits	49

SIGNATURES

Signatures

UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS, COMPREHENSIVE

INCOME, AND RETAINED EARNINGS

		Second Quarter				First Six Months
(Dollars in millions, except per share amounts)		2005		2004		2005		2004

Sales	$	1,752	$	1,676	$	3,514	$	3,273
Cost of sales		1,378		1,406		2,741		2,768
Gross profit		374		270		773		505

Selling, general and administrative expenses		122		112		231		222
Research and development expenses		39		38		78		81
Asset impairments and restructuring charges, net		10		79		19		146
Other operating income		--		--		(2)		--
Operating earnings		203		41		447		56

Interest expense, net		24		30		54		59
Income from equity investment in Genencor		(171)		(5)		(173)		(9)
Early debt extinguishment costs		46		--		46		--
Other (income) charges, net		--		6		(1)		9
Earnings (loss) before income taxes		304		10		521		(3)
Provision (benefit) for income taxes		98		(74)		153		(81)
Net earnings	$	206	$	84	$	368	$	78

Earnings per share
Basic	$	2.55	$	1.08	$	4.59	$	1.01
Diluted	$	2.51	$	1.07	$	4.52	$	1.00

Comprehensive Income
Net earnings	$	206	$	84	$	368	$	78
Other comprehensive income (loss)
Change in cumulative translation adjustment		(56)		(10)		(79)		(18)
Change in minimum pension liability, net of tax		1		1		--		(1)
Change in unrealized gains (losses) on investments, net of tax		1		--		1		--
Change in unrealized gains (losses) on derivative instruments, net of tax		1		(1)		13		(2)
Total other comprehensive income (loss)		(53)		(10)		(65)		(21)
Comprehensive income	$	153	$	74	$	303	$	57

Retained Earnings
Retained earnings at beginning of period	$	1,636	$	1,436	$	1,509	$	1,476
Net earnings		206		84		368		78
Cash dividends declared		(36)		(34)		(71)		(68)
Retained earnings at end of period	$	1,806	$	1,486	$	1,806	$	1,486

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

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

		June 30,		December 31,
(Dollars in millions, except per share amounts)		2005		2004
		(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	241	$	325
Trade receivables, net of allowance of $20 and $15		679		675
Miscellaneous receivables		78		104
Inventories		740		582
Other current assets		99		82
Total current assets		1,837		1,768

Properties
Properties and equipment at cost		9,468		9,628
Less: Accumulated depreciation		6,358		6,436
Net properties		3,110		3,192

Goodwill		312		314
Other noncurrent assets		310		598
Total assets	$	5,569	$	5,872

Liabilities and Stockholders’ Equity
Current liabilities
Payables and other current liabilities	$	1,069	$	1,098
Borrowings due within one year		5		1
Total current liabilities		1,074		1,099

Long-term borrowings		1,449		2,061
Deferred income tax liabilities		286		210
Postemployment obligations		1,068		1,145
Other long-term liabilities		185		173
Total liabilities		4,062		4,688

Stockholders’ equity
Common stock ($0.01 par value - 350,000,000 shares authorized; shares issued - 89,236,721 and 87,125,532 for 2005 and 2004, respectively)		1		1
Additional paid-in capital		300		210
Retained earnings		1,806		1,509
Accumulated other comprehensive loss		(168)		(103)
		1,939		1,617
Less: Treasury stock at cost (7,895,592 and 7,911,546 shares for 2005 and 2004, respectively)		432		433

Total stockholders’ equity		1,507		1,184

Total liabilities and stockholders’ equity	$	5,569	$	5,872

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

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

		First Six Months
(Dollars in millions)		2005		2004

Cash flows from operating activities
Net earnings	$	368	$	78

Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		153		165
Asset impairments		1		103
Income from equity investment in Genencor		(173)		(9)
Early debt extinguishment costs		46		--
Provision (Benefit) for deferred income taxes		67		(84)
Changes in operating assets and liabilities:
(Increase) decrease in receivables		(38)		(152)
(Increase) decrease in inventories		(173)		(6)
Increase (decrease) in trade payables		22		70
Increase (decrease) in liabilities for employee benefits and incentive pay		(46)		14
Other items, net		(18)		3

Net cash provided by (used in) operating activities		209		182

Cash flows from investing activities
Additions to properties and equipment		(124)		(117)
Proceeds from sale of assets		50		--
Proceeds from sale of equity investment in Genencor, net		417		--
Additions to capitalized software		(6)		(7)
Other items, net		(2)		(3)

Net cash provided by (used in) investing activities		335		(127)

Cash flows from financing activities
Net increase (decrease) in commercial paper, credit facility and other short-term borrowings		(104)		89
Repayment of borrowings		(544)		(500)
Dividends paid to stockholders		(70)		(68)
Proceeds from stock option exercises and other items		90		13

Net cash provided by (used in) financing activities		(628)		(466)

Net change in cash and cash equivalents		(84)		(411)

Cash and cash equivalents at beginning of period		325		558

Cash and cash equivalents at end of period	$	241	$	147

The accompanying notes are an integral part of these 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 2004 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 2004 Annual Report on Form 10-K. In the opinion of the Company, all normal recurring adjustments necessary for a fair presentation have been included in the unaudited consolidated financial statements. The unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America 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. Eastman accounts for joint ventures and investments in minority-owned companies where it exercises significant influence on the equity basis. Intercompany transactions and balances are eliminated in consolidation. The Company has reclassified certain 2004 amounts to conform to the 2005 presentation.

2.	STOCK OPTIONS

In December 2004, the Financial Accounting Standards Board ("FASB") released Statement of Financial Accounting Standard ("SFAS") No. 123 (Revised) - Share Based Payment. SFAS No. 123 (Revised) required the Company to implement this Standard in the first interim period commencing after June 15, 2005. In April 2005, the implementation date was delayed to the first annual fiscal period commencing after June 15, 2005. For additional information regarding SFAS 123 (Revised), refer to Note 22 to the consolidated financial statements in Part II, Item 8 of the Company’s 2004 Annual Report on Form 10-K.

Until implementation of SFAS No. 123 (Revised) in 2006, the Company continues to apply the disclosure-only requirements of SFAS No. 123 - Accounting for Stock-Based Compensation and applies intrinsic value accounting for its employee stock options that defines compensation cost for stock options, if any, as the excess of the quoted market price of the stock at the date of grant over the amount an employee must pay to acquire the stock. The Company’s disclosure of pro forma net earnings and pro forma earnings per share, recognizing compensation expense based upon the fair value at the grant dates of these awards, is disclosed below:

			Second Quarter				First Six Months
(Dollars and shares in millions, except per share amounts)			2005		2004		2005		2004

Net earnings, as reported		$	206	$	84	$	368	$	78

Add: Stock-based employee compensation expense
included in net earnings, as reported			6		2		7		2

Deduct: Total additional stock-based employee
compensation cost, net of tax, that would have been
included in net earnings under fair value method			7		3		9		5

Pro forma net earnings		$	205	$	83	$	366	$	75

Basic earnings per share	As reported	$	2.55	$	1.08	$	4.59	$	1.01
	Pro forma	$	2.54	$	1.07	$	4.57	$	0.97

Diluted earnings per share	As reported	$	2.51	$	1.07	$	4.52	$	1.00
	Pro forma	$	2.51	$	1.07	$	4.51	$	0.97

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

3.	INVENTORIES

		June 30,		December 31,
(Dollars in millions)		2005		2004

At FIFO or average cost (approximates current cost)
Finished goods	$	633	$	550
Work in process		208		171
Raw materials and supplies		262		216
Total inventories		1,103		937
LIFO Reserve		(363)		(355)
Total inventories	$	740	$	582

Inventories valued on the LIFO method were approximately 70% of total inventories at each period end.

4.	EQUITY INVESTMENT IN GENENCOR

On April 21, 2005, the Company completed the sale of its preferred and common stock of Genencor International, Inc. ("Genencor") for cash proceeds of approximately $417 million, net of $2 million in fees. The book value of the investment prior to sale was $246 million, and the Company recorded a pre-tax gain on the sale of $171 million.

As of March 31, 2005, Eastman owned 25 million shares, or approximately 42%, of the outstanding common shares of Genencor. This investment was accounted for under the equity method and included in other noncurrent assets. At March 31, 2005 and December 31, 2004, the Company’s investment in Genencor, including preferred stock and accumulated dividends receivable, was $253 million and $242 million, respectively.

Summarized financial information for Genencor is shown on a 100 percent basis.

		First Quarter
(Dollars in millions)		2005 (unaudited)		2004 (unaudited)

Statement of Earnings (Loss) Data

Revenues	$	106	$	94
Costs of products sold		63		50
Net earnings (loss)		(4)		13


Statement of Financial Position Data		March 31,		December 31,
		2005		2004
		(unaudited)
Current assets	$	338	$	371
Noncurrent assets		364		381
Total assets		702		752
Current liabilities		98		114
Noncurrent liabilities		49		73
Total liabilities		147		187
Redeemable preferred stock		186		184

Also included in Income from Equity Investment in Genencor is the Company's portion of earnings from its equity investment in Genencor for the first six months 2005 and 2004.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

5.	PAYABLES AND OTHER CURRENT LIABILITIES

		June 30,		December 31,
(Dollars in millions)		2005		2004

Trade creditors	$	486	$	474
Accrued payrolls, vacation, and variable-incentive compensation		100		124
Accrued taxes		71		94
Post-employment obligations		160		117
Interest payable		30		34
Bank overdrafts		52		40
Other		170		215
Total	$	1,069	$	1,098

6.	BORROWINGS

		June 30,		December 31,
(Dollars in millions)		2005		2004

Borrowings consisted of:
3 1/4% notes due 2008	$	72	$	250
6.30% notes due 2018		193		253
7% notes due 2012		147		399
7 1/4% debentures due 2024		497		497
7 5/8% debentures due 2024		200		200
7.60% debentures due 2027		297		297
Commercial paper and credit facility borrowings		25		146
Other		23		20
Total borrowings		1,454		2,062
Borrowings due within one year		(5)		(1)
Long-term borrowings	$	1,449	$	2,061

Eastman has access to a $700 million revolving credit facility (the "Credit Facility") expiring in April 2009. Any borrowings under the Credit Facility are subject to interest at varying spreads above quoted market rates, principally LIBOR. The Credit Facility requires facility fees on the total commitment that vary based on Eastman's credit rating. The rate for such fees was 0.15% as of June 30, 2005 and December 31, 2004. The Credit Facility contains a number of covenants and events of default, including the maintenance of certain financial ratios. At June 30, 2005 and at December 31, 2004, the Company’s commercial paper and revolving credit facility borrowings were $25 million and $146 million at an effective interest rate of 3.98% and 2.98%, respectively.

In the second quarter 2005, the Company completed the early repayment of $500 million of its outstanding long-term debt. See Note 11 for further information regarding the early extinguishment of this debt.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

In the third quarter 2003, the Company entered into interest rate swaps that converted the effective interest rate of $250 million of the $400 million 7% notes due in 2012 to variable rates. In the second quarter of 2004, the Company entered into interest rate swaps that converted the effective interest rate of $100 million of the $400 million 7% notes due in 2012 to variable rates. The Company settled $50 million of these interest rate swaps during the first quarter 2005. Cash proceeds received and the gain resulting from the settlement were immaterial. During the second quarter 2005, the company received cash proceeds and recognized a gain of approximately $2 million resulting from the settlement of $155 million of these interest rate swaps in connection with the early extinguishment of debt. The average rate on the variable portion was 6.23% at June 30, 2005 and 5.18% at December 31, 2004. The recording of the fair value of the interest rate swaps and the corresponding debt resulted in a slight decrease in long-term borrowings and a slight increase in other noncurrent assets in the first six months of 2005. The fair values of the interest rate swaps were an asset of approximately $2 million at June 30, 2005 and at December 31, 2004.

In the fourth quarter 2003, the Company entered into interest rate swaps that converted the effective interest rate of $150 million of the $250 million 6.30% notes due in 2018 to variable rates. The average rate on the variable portion was 4.64% at June 30, 2005 and 3.71% at December 31, 2004. The recording of the fair value of the interest rate swaps and the corresponding debt resulted in an approximately $7 million increase in long-term borrowings and an approximately $7 million increase in other noncurrent assets in the first six months of 2005. The fair values of the interest rate swaps were an asset of approximately $12 million at June 30, 2005, and an asset of approximately $5 million at December 31, 2004.

7.	EARNINGS AND DIVIDENDS PER SHARE

	Second Quarter		First Six Months
	2005	2004	2005	2004

Shares used for earnings per share calculation:
Basic	80.7	77.4	80.1	77.3
Diluted	82.0	78.1	81.5	78.0

Certain shares underlying options outstanding during the second quarter and the first six months 2005 and 2004 were excluded from the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares during those periods. For the second quarter and first six months 2005, common shares underlying options to purchase 1,306,724 shares of common stock at a range of prices from $56.87 to $67.50 and 802,273 shares of common stock at a range of prices from $56.50 to $63.25, respectively, have been excluded from the calculation of diluted earnings per share. For the second quarter and first six months 2004, common shares underlying options to purchase 6,821,997 shares of common stock at a range of prices from $45.17 to $67.50 and 6,847,998 shares of common stock at a range of prices from $42.75 to $67.50, respectively, have been excluded from the calculation of diluted earnings per share.

The Company declared cash dividends of $0.44 per share in the second quarter 2005 and 2004 and $0.88 per share in the first six months 2005 and 2004.

8.	PENSION AND OTHER POSTEMPLOYMENT BENEFITS

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.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

PENSION PLANS

Below is a summary of the components of net periodic benefit cost recognized for Eastman's significant defined benefit pension plans:

Summary of Benefit Costs
		Second Quarter				First Six Months
(Dollars in millions)		2005		2004		2005		2004

Components of net periodic benefit cost:
Service cost	$	11	$	9	$	21	$	21
Interest cost		20		20		40		41
Expected return on assets		(20)		(21)		(39)		(41)
Amortization of:
Prior service credit		(3)		(2)		(5)		(5)
Actuarial loss		8		6		17		13
Curtailment		--		--		--		2
Net periodic benefit cost	$	16	$	12	$	34	$	31

As of June 30, 2005, the Company has contributed $62 million to its U.S. defined benefit plans during 2005 and expects to contribute up to $100 million in the second half of 2005.

POSTRETIREMENT WELFARE PLANS

Summary of Benefit Costs
		Second Quarter				First Six Months
(Dollars in millions)		2005		2004		2005		2004

Components of net periodic benefit cost:
Service cost	$	2	$	1	$	4	$	4
Interest cost		11		14		22		29
Amortization of:
Prior service credit		(6)		(3)		(12)		(4)
Actuarial loss		5		5		10		9
Net periodic benefit cost	$	12	$	17	$	24	$	38

In May, 2004, the FASB issued FASB Staff Position ("FSP") 106-2, providing final guidance on accounting for the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 ("the Act"). Under the provisions of FSP 106-2, the Company determined that its health care plans were not actuarially equivalent to Medicare Part D. In January, 2005, the Centers for Medicare and Medicaid Services released final regulations implementing the Act. The Company has determined that, although its plans are believed to be actuarially equivalent under the most recent regulations, implementation of these regulations will have an immaterial impact on its financial condition, liquidity, and results of operations and therefore are not reflected in the above amounts.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

9.	ASSET IMPAIRMENTS AND RESTRUCTURING CHARGES, NET

2005

Asset Impairments and Restructuring Charges, Net

During the second quarter 2005, the Company recognized pre-tax restructuring charges of $10 million, related to the previously announced shutdown of Cendian Corporation ("Cendian") as well as the closures of other previously announced manufacturing facilities. For the first six months 2005, pre-tax asset impairments and restructuring charges totaled $19 million, with non-cash restructuring charges and cash restructuring charges totaling $3 million and $16 million, respectively.

2004

Asset Impairments and Restructuring Charges, Net

In the second quarter 2004, the company recognized $62 million in asset impairment charges related to assets held for sale. The assets were part of the Company’s sale of certain businesses and product lines within the Coatings, Adhesives, Specialty Polymers, and Inks ("CASPI") segment, which was completed July 31, 2004. The charges reflect adjustment of the values of these assets to the expected sales proceeds. Also in second quarter 2004, the Company recognized approximately $13 million in severance related charges stemming from the Company's voluntary separation program announced in April, 2004, and $4 million of site closure costs related primarily to previously announced closures of the Company’s Hartlepool, Waterford, and Bury manufacturing facilities.

In the first six months 2004, the Company recorded asset impairments of $103 million, consisting of $62 million as described above as well as $40 million related to the closure of its copolyester manufacturing facility in Hartlepool, United Kingdom, and $1 million in additional impairments within the CASPI organization for changes in estimates to previously accrued amounts. The decision to close the Hartlepool site, which manufactures products that are within the Company’s Specialty Plastics (“SP”) segment’s product lines, was made in order to consolidate production at other sites to create a more integrated and efficient global manufacturing structure. Accordingly, the carrying value of the manufacturing fixed assets was written down to fair value, as established by appraisal and available market data. The Company further recognized $38 million in severance charges primarily as a result of ongoing cost reduction efforts throughout the Company and costs related to the Company’s employee separation programs announced in April 2004. Site closure costs of $5 million were also recorded during the first six months 2005 related primarily to previously announced closures of manufacturing facilities, as described above.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Asset impairment and restructuring charges reserve roll-forward

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

(Dollars in millions)		Balance at January 1, 2004		Provision/ Adjustments		Noncash Reductions		Cash Reductions		Balance at December 31, 2004

Non-cash charges	$	--	$	140	$	(140)	$	--	$	--
Severance costs		10		53		--		(37)		26
Site closure and other restructuring costs		5		13		--		(9)		9
Total	$	15	$	206	$	(140)	$	(46)	$	35

		Balance at January 1, 2005		Provision/ Adjustments		Noncash Reductions		Cash Reductions		Balance at June 30, 2005

Non-cash charges	$	--	$	1	$	(1)	$	--	$	--
Severance costs		26		4		--		(23)		7
Site closure and other restructuring costs		9		14		(5)		(7)		11
Total	$	35	$	19	$	(6)	$	(30)	$	18

As of the end of the second quarter 2005, out of approximately 90 employee separations that were identified and for which charges were recorded, all have been completed. The remaining severance and site closure costs are expected to be applied to the reserves within one year.

10.

DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING

Hedging Programs

Financial instruments held as part of the hedging programs discussed below are recorded at fair value based upon comparable market transactions as quoted by brokers.

The Company is exposed to market risk, such as changes in currency exchange rates, raw material and energy costs and interest rates. The Company uses various derivative financial instruments pursuant to the Company's hedging policies to mitigate these market risk factors and their effect on the cash flows of the underlying transactions. Designation is performed on a specific exposure basis to support hedge accounting. The changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the cash flows of the underlying exposures being hedged. The Company does not hold or issue derivative financial instruments for trading purposes. For further information, see Note 8 to the consolidated financial statements in Part II, Item 8 of the Company's 2004 Annual Report on Form 10-K.

At June 30, 2005, mark-to-market gains from raw material, currency and certain interest rate hedges that were included in accumulated other comprehensive income (loss) totaled approximately $5 million. If realized, approximately $3 million of this gain 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 second quarter and first six months 2005.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

11.

EARLY EXTINGUISHMENT OF DEBT

In the second quarter 2005, the Company completed the early repayment of $500 million of its outstanding long-term debt for $544 million in cash, which resulted in a charge of $46 million for early debt extinguishment costs including $2 million in unamortized bond issuance costs. The book value of the purchased debt was $500 million, as follows:

(dollars in millions)		Book Value

3 1/4% notes due 2008	$	178
6.30% notes due 2018		68
7% notes due 2012		254
Total	$	500

12.

STOCKHOLDER'S EQUITY

A reconciliation of the changes in stockholders’ equity for first six months 2005 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, 2004	1	210	1,509	(103)	(433)	1,184

Net Earnings	--	--	368	--	--	368
Cash Dividends	--	--	(71)	--	--	(71)
Other Comprehensive Income	--	--	--	(65)	--	(65)
Stock Option Exercises and Other Items ⁽¹⁾	--	90	--	--	1	91
Balance at June 30, 2005	1	300	1,806	(168)	(432)	1,507

⁽¹⁾ The tax benefits relating to the difference between the amounts deductible for federal income taxes over the amounts charged to income for book purposes have been credited to paid-in capital.

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

Balance at December 31, 2003	$	119	$	(242)	$	(2)	$	4	$	(121)
Period change		36		(6)		--		(12)		18
Balance at December 31, 2004		155		(248)		(2)		(8)		(103)
Period change		(79)		--		1		13		(65)
Balance at June 30, 2005	$	76	$	(248)	$	(1)	$	5	$	(168)

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

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

13.

SEGMENT INFORMATION

The Company’s products and operations are managed and reported in three divisions comprised of six operating segments. Eastman Division consists of the CASPI segment, the Performance Chemicals and Intermediates ("PCI") segment and the SP segment. Voridian Division contains the Polymers segment and the Fibers segment. The Developing Businesses Division consists of the Developing Businesses ("DB") segment. For additional information, refer to Note 20 to the consolidated financial statements in Part II, Item 8 of the Company's 2004 Annual Report on Form 10-K.

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

	Second Quarter, 2005
(Dollars in millions)		Gross Sales		Interdivisional Sales		External Sales
Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	326	$	1	$	325
Performance Chemicals and Intermediates		555		158		397
Specialty Plastics		191		11		180
Total Eastman Division		1,072		170		902

Voridian Division
Polymers		667		25		642
Fibers		226		21		205
Total Voridian Division		893		46		847

Developing Businesses Division
Developing Businesses		4		1		3
Total Developing Businesses Division		4		1		3

Total Eastman Chemical Company	$	1,969	$	217	$	1,752

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

	Second Quarter, 2004
(Dollars in millions)		Gross Sales		Interdivisional Sales		External Sales
Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	476	$	--	$	476
Performance Chemicals and Intermediates		453		140		313
Specialty Plastics		167		13		154
Total Eastman Division		1,096		153		943

Voridian Division
Polymers		530		15		515
Fibers		204		23		181
Total Voridian Division		734		38		696

Developing Businesses Division
Developing Businesses		148		111		37
Total Developing Businesses Division		148		111		37

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

	First Six Months, 2005
(Dollars in millions)		Gross Sales		Interdivisional Sales		External Sales
Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	645	$	1	$	644
Performance Chemicals and Intermediates		1,112		326		786
Specialty Plastics		382		25		357
Total Eastman Division		2,139		352		1,787

Voridian Division
Polymers		1,342		44		1,298
Fibers		453		48		405
Total Voridian Division		1,795		92		1,703

Developing Businesses Division
Developing Businesses		85		61		24
Total Developing Businesses Division		85		61		24

Total Eastman Chemical Company	$	4,019	$	505	$	3,514

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

	First Six Months, 2004
(Dollars in millions)		Gross Sales		Interdivisional Sales		External Sales
Sales by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	915	$	--	$	915
Performance Chemicals and Intermediates		884		281		603
Specialty Plastics		336		25		311
Total Eastman Division		2,135		306		1,829

Voridian Division
Polymers		1,063		33		1,030
Fibers		397		44		353
Total Voridian Division		1,460		77		1,383

Developing Businesses Division
Developing Businesses		281		220		61
Total Developing Businesses Division		281		220		61

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

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

		Second Quarter				First Six Months
(Dollars in millions)		2005		2004		2005		2004

Operating Earnings (Loss) by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty
Polymers, and Inks ^{(1) (2)}	$	64	$	(24)	$	131	$	6
Performance Chemicals and Intermediates ^{(1) (2)}		52		12		102		20
Specialty Plastics^{(1) (2)}		21		19		42		(4)
Total Eastman Division		137		7		275		22

Voridian Division
Polymers ^{(1) (2)}		48		20		119		8
Fibers		43		33		90		66
Total Voridian Division		91		53		209		74

Developing Businesses Division
Developing Businesses ^{(1) (2)}		(22)		(19)		(43)		(39)
Total Developing Businesses Division		(22)		(19)		(43)		(39)

Eliminations		(3)		--		6		(1)
Total Eastman Chemical Company	$	203	$	41	$	447	$	56

⁽¹⁾ Second quarter 2005 operating earnings for the CASPI segment included restructuring charges of approximately $1 million. Second quarter 2004 operating loss for the CASPI segment included asset impairments and restructuring charges of approximately $69 million. Second quarter 2004 operating earnings for the PCI segment included restructuring charges of approximately $4 million. Second quarter 2004 operating earnings for the SP segment included restructuring charges of approximately $4 million. Second quarter 2004 operating earnings for the Polymers segment included restructuring charges of approximately $1 million. Second quarter 2005 operating results for the Developing Businesses segment included restructuring charges of approximately $9 million. Second quarter 2004 operating results for the Developing Businesses segment included restructuring charges of approximately $1 million.

⁽²⁾First six months 2005 operating earnings for the CASPI segment included asset impairments and restructuring charges of approximately $2 million. First six months 2004 operating earnings for the CASPI segment included asset impairments and restructuring charges of approximately $75 million. First six months 2005 operating earnings for the PCI segment included restructuring charges of approximately $4 million. First six months 2004 operating earnings for the PCI segment included an asset impairment charge of approximately $7 million. First six months 2004 operating results for the SP segment included asset impairment and restructuring charges of approximately $50 million. First six months 2004 operating earnings for the Polymers segment included restructuring charges of approximately $12 million. First six months 2005 operating results for the Developing Businesses segment included restructuring charges of approximately $13 million. First six months 2004 operating results for the Developing Businesses segment included restructuring charges of approximately $2 million.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

		June 30,		December 31,
(Dollars in millions)		2005		2004

Assets by Division and Segment
Eastman Division
Coatings, Adhesives, Specialty Polymers, and Inks	$	1,366	$	1,495
Performance Chemicals and Intermediates		1,538		1,640
Specialty Plastics		679		709
Total Eastman Division		3,583		3,844

Voridian Division
Polymers		1,394		1,418
Fibers		573		580
Total Voridian Division		1,967		1,998

Developing Businesses Division
Developing Businesses		19		30
Total Developing Businesses Division		19		30

Total Eastman Chemical Company	$	5,569	$	5,872

14.

LEGAL MATTERS

General

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

Sorbates Litigation

As previously reported and as more fully described in Part I, Item 3 - Legal Proceedings of the Company's 2004 Annual Report on Form 10-K, only two civil cases relating to sorbates remain. The first is a case filed by a multi-state class of indirect purchasers seeking claimed damages, whose claims have been dismissed by Tennessee's trial court and that state's court of appeals. Arguments before the state's highest court were heard in May 2005. The second is a case that has been filed by New York's attorney general, also seeking claimed damages, which is now in the pretrial discovery phase of the case.

Asbestos Litigation

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

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

The Company has finalized an agreement with an insurer that issued primary general liability insurance to certain predecessors of the Company prior to the mid-1970s, pursuant to which that insurer will provide coverage for a portion of certain of the Company's defense costs and payments of settlements or judgments in connection with asbestos-related lawsuits.

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

15.

RECENTLY ISSUED ACCOUNTING STANDARDS

In March, 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"). FIN 47 is an interpretation of SFAS 143, "Asset Retirement Obligations", which was issued in June 2001. The Interpretation was issued to address diverse accounting practices that have developed with regard to the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. According to FIN 47, uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The provisions of this Interpretation will be effective for the Company as of December 31, 2005. The Company is currently evaluating the effect FIN 47 will have on its consolidated financial position, liquidity, or results from operations.

In December 2004, the FASB released SFAS No. 123 (Revised) - Share Based Payment. SFAS No. 123 (Revised) required the Company to implement this Standard in the first interim period commencing after June 15, 2005. In April 2005, the implementation date was delayed to the first annual fiscal period commencing after June 15, 2005. For additional information regarding SFAS 123 (Revised), refer to Note 22 to the consolidated financial statements in Part II, Item 8 of the Company's 2004 Annual Report on Form 10-K. Until implementation of SFAS No. 123 (Revised) in 2006, the Company continues to apply the disclosure-only requirements of SFAS No. 123 - Accounting for Stock-Based Compensation and applies intrinsic value accounting for its employee stock options that defines compensation cost for stock options, if any, as the excess of the quoted market price of the stock at the date of grant over the amount an employee must pay to acquire the stock.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

16.

COMMITMENTS

Purchase Obligations and Lease Commitments

At June 30, 2005, the Company had various purchase obligations totaling approximately $1.9 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 $168 million over a period of several years. Of the total lease commitments, approximately 15% relate to machinery and equipment, including computer and communications equipment and production equipment; approximately 55% relate to real property, including office space, storage facilities and land; and approximately 30% relate to 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 June 30, 2005 and December 31, 2004. 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 $243 million and $265 million in the second quarter 2005 and 2004, respectively.

Guarantees

Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. Disclosures about each group of similar guarantees are provided below and summarized in the following table:

(Dollars in millions)		June 30, 2005

Obligations of equity affiliates	$	125
Residual value guarantees		92
Total	$	217

Eastman has a 50% interest in and serves as the operating partner in Primester, a joint venture which manufactures cellulose acetate at its Kingsport, Tennessee plant. The joint venture is accounted for under the equity method. The Company guarantees up to $125 million of the principal amount of this joint-venture's third-party borrowings, but believes, based on current facts and circumstances and the structure of the venture, that the likelihood of a payment pursuant to such guarantee is remote. The guarantee will expire in 2006.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Variable Interest Entities

The Company has evaluated material relationships including the guarantees related to the third-party borrowings of joint ventures described above and has concluded that the entities are not Variable Interest Entities ("VIEs") or, in the case of Primester, the Company is not the primary beneficiary of the VIE. As such, in accordance with 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 June 30, 2005. These potential VIEs are joint ventures from which the Company has purchased raw materials and utilities for several years and purchases approximately $40 million of raw materials and utilities on an annual basis. The Company has no equity interest in these entities and has confirmed that one party to each of these joint ventures does consolidate the potential VIE. However, due to 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.

17.

PROVISION (BENEFIT) FOR INCOME TAXES

		Second Quarter					First Six Months
(Dollars in millions)		2005		2004	Change		2005		2004	Change

Provision (benefit) for income taxes	$	98	$	(74)	--	$	153	$	(81)	--
Effective tax rate		32.2 %		>100 %			29.3 %		>100 %

The second quarter 2005 effective tax rate reflects the Company's expected tax rate on reported normalized operating earnings before income tax of approximately 30 percent and higher applicable tax rates related to the early extinguishment of debt costs and the gain on the sale of Genencor stock. The first six months 2005 effective tax rate also reflects a net deferred tax benefit adjustment related to the expected utilization of capital loss carryforwards.

In fourth quarter 2004, the American Jobs Creation Act was signed into law. The Act includes a provision for a tax deduction to U.S. manufacturing companies whereby the effective tax rate is expected to be reduced. The Company expects 2005 tax benefits of this new deduction to be approximately $5 million, partially offset by the reduction of benefits from the elimination of the extraterritorial income exclusion. The Act also includes many other provisions which may impact the Company. These are currently being reviewed to determine the impact to the Company's effective tax rate for 2005 and beyond. For additional information, see Note 18 to the consolidated financial statements in Part II, Item 8 of the Company's 2004 Annual Report on Form 10-K.

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

Excluding the above items, the company’s effective tax rate through second quarter 2004 was approximately 28 percent. This tax rate reflects the impact of favorable foreign rate variances and extraterritorial income exclusion benefits on normal taxable earnings.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

18.

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. Adequate reserves for environmental contingencies have been established in accordance with Eastman’s policies described in Note 1 to the consolidated financial statements in Part II, Item 8 of the Company's 2004 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, it does not believe its 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 $53 million and $56 million at June 30, 2005 and December 31, 2004, respectively, representing the minimum or best estimate for remediation costs and, for asset retirement obligation costs, the amount accrued to date over the facilities’ estimated useful lives. Estimated future environmental expenditures for remediation costs range from the minimum or best estimate of $21 million to the maximum of $42 million at June 30, 2005 and the minimum or best estimate of $25 million to the maximum of $45 million at December 31, 2004.

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

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company's audited consolidated financial statements, including related notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's 2004 Annual Report on Form 10-K, and the unaudited interim consolidated financial statements included elsewhere in this report. All references to earnings per share contained in this report are to diluted earnings per share unless otherwise noted.

CRITICAL ACCOUNTING POLICIES

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, the Company’s management must make decisions which impact the reported amounts and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and assumptions on which to base estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to allowances for doubtful accounts, impaired assets, environmental costs, U.S. pension and other post-employment benefits, litigation and contingent liabilities, and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s management believes the critical accounting policies listed and described in Part II, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company's 2004 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.

OVERVIEW

In the first six months 2005, the Company had the best half-year earnings per share in its history, with earnings per share of $4.52. Second quarter 2005 earnings per share were $2.51 and included a gain of $171 million associated with the sale of the Company's equity investment in Genencor International, Inc. ("Genencor") and costs of $46 million associated with the early repayment of $500 million in long-term debt. Also included in second quarter and first six months 2005 operating earnings were asset impairments and restructuring charges of $10 million and $19 million, respectively, as well as other operating income of $2 million in first six months 2005. Included in second quarter and first six months 2004 operating earnings were asset impairments and restructuring charges of $79 million and $146 million, respectively. Revenues for second quarter and first six months 2005 were $1,752 million and $3,514 million, increases of approximately 5 percent and 7 percent, respectively. In the second quarter and first six months 2004, revenues included the divested businesses and product lines of the Coatings, Adhesives, Specialty Polymers, and Inks ("CASPI") segment.

Operating earnings for the second quarter and first six months 2005 were $203 million and $447 million, respectively, versus the second quarter and first six months 2004 operating earnings of $41 million and $56 million, respectively.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Key factors in the improved results were:

·	solid economic growth;

·	completion of previously announced restructuring, divestiture and consolidation efforts in 2004;

·	increased selling prices throughout the Company in response to increasing raw material and energy costs;

·	a continued focus on more profitable businesses and product lines, particularly in the Company’s Eastman Division;

·	increased sales volume in continuing product lines; and

·	improved capacity utilization and cost reduction efforts.

The Company's cash flow from operations increased by $27 million in the first six months 2005 compared with the first six months 2004 as a result of strong operating results. In second quarter 2005, the Company completed the sale of its investment in Genencor for approximately $417 million in net cash proceeds and completed the early repayment of $500 million of its outstanding long-term debt, further strengthening its financial position.

Beginning in 2002, the Company implemented a turnaround strategy to improve profitability, which included an evaluation of its portfolio and implementation of initiatives to reduce costs. In 2004, the evaluation led to restructuring, divestitures, and consolidation within the Company, as described in Part II, Item 7—Management’s

Discussion and Analysis of Financial Condition and Results of Operations of the Company's 2004 Annual Report on Form 10-K. The Company continues to implement several initiatives to improve margins in 2005, including the improvement of pricing processes and strategies, particularly in response to the volatility in the price of raw material and energy costs, the improvement of product mix, and cost reduction efforts. These actions, combined with a strengthened economy, have positioned the Company to pursue targeted growth initiatives while improving profitability and financial flexibility.

RESULTS OF OPERATIONS

Second Quarter

Volume Effect

Price Effect

Product

Mix Effect

Exchange

Rate

Effect

(Dollars in millions)

2005

2004

Change

Sales

1,752

1,676

5 %

(7)%

15 %

(4)%

1 %

First Six Months

Volume Effect

Price Effect

Product

Mix Effect

Exchange

Rate

Effect

(Dollars in millions)

2005

2004

Change

Sales

3,514

3,273

7 %

(9)%

16 %

(1)%

1 %

Sales revenue for the second quarter and first six months 2005 increased compared to the second quarter and first six months 2004 primarily due to higher selling prices of approximately $250 million and approximately $540 million, respectively, throughout the Company and higher sales volumes in continuing product lines that more than offset a decrease in volume resulting from divested businesses and product lines in 2004. Sales volume increased slightly for continuing businesses and product lines for first quarter 2005 over first quarter 2004.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

		Second Quarter					First Six Months
(Dollars in millions)		2005		2004	Change		2005		2004	Change

Gross Profit	$	374	$	270	39 %	$	773	$	505	53 %
As a percentage of sales		21 %		16 %			22 %		15 %

Gross profit and gross profit as a percentage of sales for second quarter and first six months 2005 increased compared to second quarter and first six months 2004 primarily due to the following factors:

·	increased selling prices across all segments, in response to higher raw material and energy costs which increased more than $100 million and $260 million in the second quarter and first six months 2005, respectively;

·	increased sales volumes from continuing product lines, particularly within the Performance Chemicals and Intermediates ("PCI") segment, and improved capacity utilization; and

·	improved cost structure through restructuring efforts and cost reduction programs.

		Second Quarter					First Six Months
(Dollars in millions)		2005		2004	Change		2005		2004	Change

Selling, General and
Administrative Expenses	$	122	$	112	10 %	$	231	$	222	4 %
Research and Development
Expenses		39		38	2 %		78		81	(3) %
	$	161	$	150	7 %	$	309	$	303	2 %
As a percentage of sales		9 %		9%			9 %		9 %

Selling, General and Administrative ("SG&A") costs for the second quarter and first six months 2005 compared to the same periods 2004 increased due to higher compensation and employee related costs, higher bad debt expense, and increased professional service fees, which more than offset decreases resulting from the previous divestiture of certain businesses and product lines within the CASPI segment and the restructuring of operations at Cendian Corporation ("Cendian").

For second quarter and first six months 2005, combined SG&A and Research and Development ("R&D") costs as a percentage of sales were flat. The Company expects that SG&A and R&D costs within the Developing Businesses ("DB") segment combined with corporate R&D costs will be approximately 3% of revenue in 2005.

Asset Impairments and Restructuring Charges, Net

Asset impairments and restructuring charges totaled $10 million and $19 million in second quarter and first six months 2005, and totaled $79 million and $146 million in second quarter and first six months 2004, respectively. The Company continues to review its portfolio of products and businesses, which could result in further restructuring, divestiture, and consolidation. For more information regarding asset impairments and restructuring charges, see Note 9 to the Company's unaudited consolidated financial statements.

Other Operating Income

Other operating income for first six months 2005 reflects a gain of $2 million related to the 2004 divestiture of certain businesses and product lines within the CASPI segment.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Interest Expense, Net

		Second Quarter					First Six Months
(Dollars in millions)		2005		2004	Change		2005		2004	Change

Gross interest costs	$	30	$	32		$	64	$	64
Less: Capitalized interest		1		1			2		2
Interest expense		29		31	(7)%		62		62	--
Interest income		5		1			8		3
Interest expense, net	$	24	$	30	(19)%	$	54	$	59	(8)%

Lower gross interest costs for the second quarter 2005 compared to the second quarter 2004 reflected higher average interest rates that were more than offset by lower average borrowings. Higher interest income reflected higher invested cash balances as well as higher average interest rates, resulting in lower net interest expense for the second quarter 2005.

For the first six months 2005 compared to the first six months 2004, gross interest costs remained consistent as higher average interest rates offset lower average borrowings. Higher interest income reflected higher invested

cash balances as well as higher average interest rates, resulting in lower net interest expense for first six months 2005 compared to first six months 2004.

For 2005, the Company expects net interest expense to decrease compared to 2004 due to lower average borrowings and higher average interest rates on higher invested cash balances.

Income from Equity Investment in Genencor

Income from equity investment in Genencor includes the Company's portion of earnings from its equity investment in Genencor for the first six months 2005 and 2004. Additionally, in second quarter 2005, the Company completed the sale of its equity interest in Genencor for net cash proceeds of approximately $417 million. The book value of the investment prior to sale was $246 million resulting in a pre-tax gain on the sale of $171 million.

Early Debt Extinguishment Costs

In the second quarter 2005, the Company completed the early repayment of $500 million of its outstanding long-term debt for $544 million in cash and recorded a charge of $46 million for early debt extinguishment costs including $2 million in unamortized bond issuance costs. The book value of the purchased debt was $500 million.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Other (Income) Charges, Net

		Second Quarter						First Six Months
(Dollars in millions)		2005		2004		Change		2005		2004		Change

Other income	$	(2)	$	(1)	$	(1)	$	(6)	$	(3)	$	(3)
Other charges		2		7		(5)		5		12		(7)
Other (income) charges, net	$	--	$	6	$	(6)	$	(1)	$	9	$	(10)

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

Provision (Benefit) for Income Taxes

		Second Quarter					First Six Months
(Dollars in millions)		2005		2004	Change		2005		2004	Change

Provision (benefit) for income taxes	$	98	$	(74)	--	$	153	$	(81)	--
Effective tax rate		32.2%		>100%			29.3%		>100%

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

SUMMARY BY OPERATING SEGMENT

The Company’s products and operations are managed and reported in three divisions comprised of six operating segments. Segments are determined by the customer markets in which the Company sells its products. Eastman Division consists of the CASPI segment, the PCI segment, and the Specialty Plastics ("SP") segment. Voridian Division contains the Polymers segment and the Fibers segment. The Developing Businesses Division consists of the DB Segment. For more detail, reference Part II, Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company’s 2004 Annual Report on Form 10-K.

CASPI Segment
		Second Quarter
					All Product Lines					Continuing Product Lines⁽¹⁾
							Change					Change
(Dollars in millions)			2005		2004		$	%		2004		$	%

External Sales		$	325	$	476	$	(151)	(32)%	$	283	$	42	15 %
	Volume effect						(199)	(42)%				(6)	(2)%
	Price effect						52	11 %				52	18 %
	Product mix effect						(7)	(2)%				(7)	(2)%
	Exchange rate effect						3	1 %				3	1 %

Operating earnings (loss)			64		(24)		88	--		48		16	33 %

Asset impairments and
restructuring charges, net			1		69		(68)			3		(2)

PCI Segment
			Second Quarter							First Six Months
							Change							Change
(Dollars in millions)			2005		2004		$	%		2005		2004		$	%

External sales		$	397	$	313	$	84	27 %	$	786	$	603	$	183	30 %
	Volume effect						34	11 %						84	14 %
	Price effect						59	19 %						117	19 %
	Product mix effect						(10)	(3)%						(21)	(3)%
	Exchange rate effect						1	-- %						3	-- %

Interdivisional sales			158		140		18	13 %		326		281		45	16 %

Operating earnings			52		12		40	>100 %		102		20		82	>100 %

Asset impairments and
restructuring charges, net			--		4		(4)			4		7		(3)

SP Segment
			Second Quarter							First Six Months
							Change							Change
(Dollars in millions)			2005		2004		$	%		2005		2004		$	%

External sales		$	180	$	154	$	26	17 %	$	357	$	311	$	46	15 %
	Volume effect						9	6 %						12	4 %
	Price effect						15	10 %						29	10 %
	Product mix effect						--	-- %						1	-- %
	Exchange rate effect						2	1 %						4	1 %

Interdivisional sales			11		13		(2)	(16)%		25		25		0	-- %

Operating earnings (loss)			21		19		2	11 %		42		(4)		46	-- %

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

Polymers Segment
			Second Quarter							First Six Months
							Change							Change
(Dollars in millions)			2005		2004		$	%		2005		2004		$	%

External sales		$	642	$	515	$	127	25 %	$	1,298	$	1,030	$	268	26 %
	Volume effect						13	3 %						(24)	(2)%
	Price effect						105	20 %						271	26 %
	Product mix effect						--	-- %						3	-- %
	Exchange rate effect						9	2 %						18	2 %

Interdivisional sales			25		15		10	64 %		44		33		11	33 %

Operating earnings			48		20		28	140 %		119		8		111	>100 %

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

Fibers Segment
			Second Quarter							First Six Months
							Change							Change
(Dollars in millions)			2005		2004		$	%		2005		2004		$	%

External sales		$	205	$	181	$	24	13 %	$	405	$	353	$	52	15 %
	Volume effect						21	11 %						16	5 %
	Price effect						15	8 %						26	7 %
	Product mix effect						(13)	(7)%						8	2 %
	Exchange rate effect						1	1 %						2	1 %

Interdivisional sales			21		23		(1)	(5)%		48		44		4	9 %

Operating earnings			43		33		10	30 %		90		66		24	36 %

Developing Businesses Segment
		Second Quarter							First Six Months
						Change							Change
(Dollars in millions)		2005		2004		$	%		2005		2004		$	%

External sales	$	3	$	37	$	(34)	(91)%	$	24	$	61	$	(37)	(60)%

Interdivisional sales		1		111		(110)	(99)%		61		220		(159)	(72)%

Operating loss		(22)		(19)		(3)	(16)%		(43)		(39)		(4)	(10)%

Asset impairments and restructuring charges		9		1		8			13		2		11

Period	Total Number of Shares Purchased (1)		Average Price Paid Per Share (2)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (3)		Approximate Dollar Value (in millions) that May Yet Be Purchased Under the Plans or Programs (3)
April 1- 30, 2005	14,755	$	52.66	--	$	288
May 1-31, 2005	19,250		58.60	--		288
June 1-30, 2005	40		57.86	--		288
Total	34,045	$	56.02	--	$

Nominee	Votes For	Votes Withheld	Abstentions	Broker Non-Votes
Michael P. Connors	69,400,147	1,519,332	-0-	-0-
J. Brian Ferguson	68,159,033	2,760,446	-0-	-0-
Donald W. Griffin	69,431,864	1,487,615	-0-	-0-

Votes For	Votes Against	Abstentions	Broker Non-Votes
68,393,712	2,061,650	464,117	-0-

		Eastman Chemical Company


Date: August 4, 2005	By:	/s/ Richard A. Lorraine
		Richard A. Lorraine
		Senior Vice President and Chief Financial Officer

	EXHIBIT INDEX	Sequential
Exhibit		Page
Number	Description	Number

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

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

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

4.02	Stockholder Protection Rights Agreement dated as of December 13, 1993, between Eastman Chemical Company and First Chicago Trust Company of New York, as Rights Agent (incorporated herein by reference to Exhibit 4.4 to Eastman Chemical Company's Registration Statement on Form S-8 relating to the Eastman Investment Plan, File No. 33-73810)

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

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

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

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

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

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

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

4.10	$200,000,000 Accounts Receivable Securitization agreement dated July 14, 2005, between the Company and The Bank of Tokyo-Mitsubishi, Ltd., New York Branch, and Wachovia Bank, N.A., as agents. Pursuant to Item 601(b)(4)(iii) of Regulation S-K, in lieu of filing a copy of such agreement, the Company agrees to furnish a copy of such agreement to the Commission upon request.