10-Q 1 emn2018093010q.htm THIRD QUARTER 2018 EASTMAN CHEMICAL COMPANY 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC  20549
FORM 10-Q
(Mark
One)
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2018
 
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, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[X]
 
Accelerated filer
[  ]
Non-accelerated filer
[   ]
(Do not check if a smaller reporting company)
Smaller reporting company
[  ]
 
 
 
Emerging growth company
[  ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
YES [  ]  NO  [  ]

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
Number of Shares Outstanding at September 30, 2018
Common Stock, par value $0.01 per share
140,042,105
--------------------------------------------------------------------------------------------------------------------------------

1


TABLE OF CONTENTS
ITEM
 
PAGE

PART I.  FINANCIAL INFORMATION


PART II.  OTHER INFORMATION


SIGNATURES



2


FORWARD-LOOKING STATEMENTS

Certain statements made or incorporated by reference in this Quarterly Report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act (Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities and Exchange Act of 1934, as amended). Forward-looking statements are all statements, other than statements of historical fact, that may be made by Eastman Chemical Company ("Eastman" or the "Company") from time to time. In some cases, you can identify forward-looking statements by terminology such as "anticipates", "believes", "estimates", "expects", "intends", "may", "plans", "projects", "will", "would", and similar expressions or expressions of the negative of these terms. Forward-looking statements may relate to, among other things, such matters as planned and expected capacity increases and utilization; anticipated capital spending; expected depreciation and amortization; environmental matters; exposure to, and effects of hedging of, raw material and energy prices and costs; foreign currencies and interest rates; disruption or interruption of operations and of raw material or energy supply; global and regional economic, political, and business conditions; competition; growth opportunities; supply and demand, volume, price, cost, margin and sales; pending and future legal proceedings; earnings, cash flow, dividends, stock repurchases and other expected financial results, events, and conditions; expectations, strategies, and plans for individual assets and products, businesses, and operating segments, as well as for the whole of Eastman; cash requirements and uses of available cash; financing plans and activities; pension expenses and funding; credit ratings; anticipated and other future restructuring, acquisition, divestiture, and consolidation activities; cost reduction and control efforts and targets; the timing and costs of, and benefits from, the integration of, and expected business and financial performance of, acquired businesses; strategic and technology and product innovation initiatives and development, production, commercialization and acceptance of new products, services and technologies and related costs; asset, business, and product portfolio changes; and expected tax rates and net interest costs.

Forward-looking statements are based upon certain underlying assumptions as of the date such statements were made. Such assumptions are based upon internal estimates and other analyses of current market conditions and trends, management expectations, plans, and strategies, economic conditions, and other factors. Forward-looking statements and the assumptions underlying them are necessarily subject to risks and uncertainties inherent in projecting future conditions and results. Actual results could differ materially from expectations expressed in the forward-looking statements if one or more of the underlying assumptions and expectations proves to be inaccurate or is unrealized. The most significant known factors, risks, and uncertainties that could cause actual results to differ materially from those in the forward-looking statements are identified and discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors" in Part I, Item 2 of this Quarterly Report. Other factors, risks or uncertainties of which management is not aware, or presently deems immaterial, could also cause actual results to differ materially from those in the forward-looking statements.

The Company cautions you not to place undue reliance on forward-looking statements, which speak only as of the date such statements are made. Except as may be required by law, the Company undertakes no obligation to update or alter these forward-looking statements, whether as a result of new information, future events, or otherwise. Investors are advised, however, to consult any further public Company disclosures (such as filings with the Securities and Exchange Commission or in Company press releases) on related subjects.


3


PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS,
COMPREHENSIVE INCOME AND RETAINED EARNINGS
 
Third Quarter
 
First Nine Months
(Dollars in millions, except per share amounts)
2018
 
2017
 
2018
 
2017
Sales
$
2,547

 
$
2,465

 
$
7,775

 
$
7,187

Cost of sales
1,819

 
1,794

 
5,762

 
5,281

Gross profit
728

 
671

 
2,013

 
1,906

Selling, general and administrative expenses
175

 
180

 
554

 
540

Research and development expenses
60

 
59

 
176

 
174

Asset impairments and restructuring charges, net

 

 
6

 

Other components of post-employment (benefit) cost, net
(30
)
 
(28
)
 
(90
)
 
(86
)
Other (income) charges, net
6

 
(4
)
 
(50
)
 
(7
)
Earnings before interest and taxes
517

 
464

 
1,417

 
1,285

Net interest expense
58

 
61

 
178

 
182

Earnings before income taxes
459

 
403

 
1,239

 
1,103

Provision for income taxes
46

 
79

 
190

 
206

Net earnings
413

 
324

 
1,049

 
897

Less: Net earnings attributable to noncontrolling interest
1

 
1

 
3

 
4

Net earnings attributable to Eastman
$
412

 
$
323

 
$
1,046

 
$
893

 
 
 
 
 
 
 
 
Basic earnings per share attributable to Eastman
$
2.93

 
$
2.24

 
$
7.38

 
$
6.15

Diluted earnings per share attributable to Eastman
$
2.89

 
$
2.22

 
$
7.28

 
$
6.10

Comprehensive Income
 
 
 
 
 

 
 

Net earnings including noncontrolling interest
$
413

 
$
324

 
$
1,049

 
$
897

Other comprehensive income (loss), net of tax:


 


 
 

 
 

Change in cumulative translation adjustment
(21
)
 
17

 
(28
)
 
60

Defined benefit pension and other postretirement benefit plans:
 
 
 
 
 

 
 

Amortization of unrecognized prior service credits
(7
)
 
(7
)
 
(22
)
 
(20
)
Derivatives and hedging:
 
 
 
 
 

 
 

Unrealized gain (loss) during period
37

 
31

 
78

 
(8
)
Reclassification adjustment for (gains) losses included in net income, net
(10
)
 
7

 
(13
)
 
11

Total other comprehensive income (loss), net of tax
(1
)
 
48

 
15

 
43

Comprehensive income including noncontrolling interest
412

 
372

 
1,064

 
940

Less: Comprehensive income attributable to noncontrolling interest
1

 
1

 
3

 
4

Comprehensive income attributable to Eastman
$
411

 
$
371

 
$
1,061

 
$
936

Retained Earnings
 

 
 

 
 

 
 

Retained earnings at beginning of period
$
7,292

 
$
6,142

 
$
6,802

 
$
5,721

Cumulative effect adjustment resulting from adoption of new accounting standards

 

 
16

 

Net earnings attributable to Eastman
412

 
323

 
1,046

 
893

Cash dividends declared
(78
)
 
(74
)
 
(238
)
 
(223
)
Retained earnings at end of period
$
7,626

 
$
6,391

 
$
7,626

 
$
6,391


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

4


UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
 
September 30,
 
December 31,
(Dollars in millions, except per share amounts)
2018
 
2017
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
193

 
$
191

Trade receivables, net of allowance for doubtful accounts
1,404

 
1,026

Miscellaneous receivables
368

 
360

Inventories
1,625

 
1,509

Other current assets
57

 
57

Total current assets
3,647

 
3,143

Properties
 
 
 
Properties and equipment at cost
12,604

 
12,370

Less: Accumulated depreciation
7,034

 
6,763

Net properties
5,570

 
5,607

Goodwill
4,509

 
4,527

Intangible assets, net of accumulated amortization
2,231

 
2,373

Other noncurrent assets
405

 
349

Total assets
$
16,362

 
$
15,999

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Current liabilities
 
 
 
Payables and other current liabilities
$
1,425

 
$
1,589

Borrowings due within one year
728

 
393

Total current liabilities
2,153

 
1,982

Long-term borrowings
5,898

 
6,147

Deferred income tax liabilities
944

 
893

Post-employment obligations
901

 
963

Other long-term liabilities
471

 
534

Total liabilities
10,367

 
10,519

Stockholders' equity
 
 
 
Common stock ($0.01 par value – 350,000,000 shares authorized; shares issued – 219,119,060 and 218,369,992 for 2018 and 2017, respectively)
2

 
2

Additional paid-in capital
2,036

 
1,983

Retained earnings
7,626

 
6,802

Accumulated other comprehensive income (loss)
(194
)
 
(209
)
 
9,470

 
8,578

Less: Treasury stock at cost (79,127,753 shares for 2018 and 75,454,111 shares for 2017)
3,550

 
3,175

Total Eastman stockholders' equity
5,920

 
5,403

Noncontrolling interest
75

 
77

Total equity
5,995

 
5,480

Total liabilities and stockholders' equity
$
16,362

 
$
15,999


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

5


UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
First Nine Months
(Dollars in millions)
2018
 
2017
Operating activities
 
 
 
Net earnings
$
1,049

 
$
897

Adjustments to reconcile net earnings to net cash provided by operating activities:


 


Depreciation and amortization
451

 
440

Gain from sale of business

 
(3
)
Gain from property insurance
(65
)
 

Provision for deferred income taxes
15

 
70

Changes in operating assets and liabilities, net of effect of acquisitions and divestitures:
 
 
 
(Increase) decrease in trade receivables
(229
)
 
(188
)
(Increase) decrease in inventories
(261
)
 
(143
)
Increase (decrease) in trade payables
7

 
(20
)
Pension and other postretirement contributions (in excess of) less than expenses
(112
)
 
(81
)
Variable compensation (in excess of) less than expenses
23

 
18

Other items, net
(75
)
 
21

Net cash provided by operating activities
803

 
1,011

Investing activities
 
 
 
Additions to properties and equipment
(381
)
 
(438
)
Proceeds from property insurance
65

 

Proceeds from sale of business and assets

 
14

Acquisitions, net of cash acquired

 
(4
)
Other items, net
1

 
(2
)
Net cash used in investing activities
(315
)
 
(430
)
Financing activities
 
 
 
Net increase (decrease) in commercial paper and other borrowings
339

 
71

Proceeds from borrowings
490

 
600

Repayment of borrowings
(693
)
 
(750
)
Dividends paid to stockholders
(240
)
 
(223
)
Treasury stock purchases
(375
)
 
(275
)
Dividends paid to noncontrolling interest
(3
)
 
(5
)
Other items, net

 
14

Net cash used in financing activities
(482
)
 
(568
)
Effect of exchange rate changes on cash and cash equivalents
(4
)
 
1

Net change in cash and cash equivalents
2

 
14

Cash and cash equivalents at beginning of period
191

 
181

Cash and cash equivalents at end of period
$
193

 
$
195


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

6


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



7


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.
SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared by Eastman Chemical Company ("Eastman" or the "Company") in accordance and consistent with the accounting policies stated in the Company's 2017 Annual Report on Form 10-K, and should be read in conjunction with the consolidated financial statements in Part II, Item 8 of that report, with the exception of the items noted below. The December 31, 2017 financial position data included herein was derived from the audited consolidated financial statements included in the 2017 Annual Report on Form 10-K but does not include all disclosures required by accounting principles generally accepted in the United States ("GAAP").

In the opinion of management, the unaudited consolidated financial statements include all normal recurring adjustments necessary for fair statement of the interim financial information in conformity with GAAP. These statements contain 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. As of January 1, 2018:
Eastman's primary measure of operating performance for all periods presented is earnings before interest and taxes ("EBIT") on a consolidated and segment basis. Previously, the Company's primary measure of performance was operating earnings.
As discussed below, the new accounting standard for the presentation of net periodic benefit costs requires the Company to present non-service cost components of net periodic benefit costs (interest cost, expected return on plan assets, curtailment gains or losses, amortization of prior service costs or credits, and mark-to-market gains or losses) separately from service cost. These non-service cost components were reclassified from "Cost of sales", "Selling, general and administrative expenses", and "Research and development expenses" line items and are now included in a new line item, "Other components of post-employment (benefit) cost, net" on the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings for all periods presented. This reclassification does not change prior period EBIT, earnings before income taxes, or net earnings and, accordingly, management does not consider this change to have a material impact on the Company's financial statements and related disclosures.

Recently Adopted Accounting Standards

Accounting Standards Update ("ASU") 2014-09 Revenue Recognition (Accounting Standards Codification "ASC" 606): On January 1, 2018, Eastman adopted this standard under the modified retrospective method, such that revenue for all periods prior to January 1, 2018 continue to be reported under the previous standard, which resulted in an increase to retained earnings of $53 million after tax for products shipped but not delivered as of December 31, 2017.

Under the new standard, the Company recognizes revenue when performance obligations of the sale are satisfied. The majority of the Company's terms of sale have a single performance obligation to transfer products. Accordingly, the Company recognizes revenue when control has been transferred to the customer, generally at the time of shipment of products. Under the previous revenue recognition accounting standard, the Company recognized revenue upon transfer of title and risk of loss, generally upon the delivery of goods.

Management does not expect that changes in its accounting required by this new standard will materially impact the Company's financial statements and related disclosures when comparing 2018 under the new revenue standard to previous years under the prior standard. However, the difference in timing of revenue recognition under the current and former accounting standards is expected to have some impact on seasonal revenue and EBIT trends during 2018 compared to previous years. For further information, see Note 18, "Revenue Recognition".


8


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

ASU 2016-01 Financial Instruments: On January 1, 2018, Eastman adopted this standard relating to the recognition and measurement of financial assets and financial liabilities. This standard requires equity investments (except equity method and consolidated investments) to be measured at fair value with changes in fair value recognized in net income. Management has concluded that changes in its accounting required by the new standard did not materially impact the Company's financial statements and related disclosures. In February 2018, the Financial Accounting Standards Board ("FASB") issued ASU 2018-03 as an update to the standard described above which was adopted on July 1, 2018. Management has concluded that changes in its accounting required by the update did not materially impact the Company's financial statements and related disclosures.

ASU 2016-16 Income Taxes - Intra-Entity Transfers: On January 1, 2018, Eastman adopted this standard under the modified retrospective method resulting in a beginning retained earnings decrease of $39 million. Under this standard, the Company is required to recognize the income tax consequence of an intra-entity transfer of an asset other than inventory when the transfer occurs.

ASU 2017-05 Other Income - Gains and Losses from Derecognition of Nonfinancial Assets: On January 1, 2018, Eastman adopted this standard in conjunction with the revenue recognition standard mentioned above. This standard clarifies the scope of nonfinancial asset derecognition and the accounting for partial sales of nonfinancial assets. This adoption had no impact on the Company's financial statements and related disclosures in the current period.

ASU 2017-07 Compensation - Retirement Benefits: On January 1, 2018, Eastman adopted this standard retrospectively for income statement effects and prospectively for balance sheet effects. This standard is intended to improve the presentation of net periodic pension and postretirement benefit costs by requiring the reporting of the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net periodic benefit costs (interest cost, expected return on plan assets, curtailment gains or losses, amortization of prior service costs or credits, and mark-to-market gains or losses) are to be presented in the income statement separately from the service cost component and outside the subtotal of income from operations, if presented. Management has concluded that changes in its accounting required by this new standard did not materially impact the Company's financial statements and related disclosures.

ASU 2017-12 Derivatives and Hedging: On January 1, 2018, Eastman adopted this standard on a modified retrospective basis for income statement impacts and prospectively for presentation and disclosure resulting in a beginning retained earnings increase of $2 million related to ineffectiveness recognized in "Accumulated other comprehensive income (loss)" ("AOCI") which was recognized in the Unaudited Consolidated Statements of Financial Position under the previous standard. This standard is intended to simplify the application of hedge accounting and improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in the financial statements. Management has included the additional disclosures required by this standard in Note 6, "Derivative and Non-Derivative Financial Instruments".

Accounting Standards Issued But Not Adopted as of September 30, 2018

ASU 2016-02 Leases: In February 2016, the FASB issued this standard on lease accounting. The new standard establishes two types of leases for lessees: finance and operating. Both finance and operating leases will have associated right-of-use assets and liabilities initially measured at the present value of the lease payments. This standard is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and early adoption is permitted. The new standard is to be applied under a modified retrospective approach wherein practical expedients have been allowed that will not require reassessment of current leases at the effective date. In January 2018, the FASB issued an update to the new standard above in ASU 2018-01 that sets forth the requirement to assess land easements to determine if the arrangement should be accounted for as a lease. In July 2018, the FASB issued update ASU 2018-10 that provides narrow-scope improvements to the leases standard above including clarification on reassessment, change in a reference index or rate, and periods included in the lease term. Also in July 2018, the FASB issued update ASU 2018-11 to the leases standard above. This update allows entities to initially apply the new leases standard prospectively at the adoption date with a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption as necessary. The effective date for these updates are the same as that of the leases standard above. In preparation for adoption, management continues accounting system testing, development of internal controls, and the evaluation of implementation options and impact on the Company's financial statements and related disclosures.


9


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

ASU 2016-13 Financial Instruments - Credit Losses: In June 2016, the FASB issued this standard relating to credit losses. The amendments require a financial asset (including trade receivables) to be presented at the net amount expected to be collected through the use of allowances for credit losses valuation account. The income statement will reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. This standard is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period and early adoption is permitted, including adoption in an interim period, beginning after December 15, 2018. The new standard application is mixed among the various elements that include modified retrospective and prospective transition methods. Management does not expect that changes in its accounting required by the new standard will materially impact the Company's financial statements and related disclosures.

ASU 2017-04 Intangibles - Goodwill and Other: In January 2017, the FASB issued this standard as a part of its simplification initiative that bases the impairment of goodwill on any difference for which the carrying value is greater than the fair value of the reporting unit. This standard is effective for annual reporting periods, or interim period testing performed, beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment testing performed after January 1, 2017. This standard is to be applied on a prospective basis for goodwill testing that occur after the effective date. Management does not expect that changes in its accounting required by the new standard will materially impact the Company's financial statements and related disclosures.

ASU 2018-02 Income Statement - Reporting Comprehensive Income: In February 2018, the FASB issued this standard that allows the reclassification from AOCI to retained earnings for stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act ("Tax Reform Act"). The amount of the reclassification is the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances related to items remaining in AOCI. This standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The new standard is to be applied either in the period of adoption or retrospectively to each period (or periods) in which the effects of the change in the income tax rate in the Tax Reform Act are recognized. Management is currently evaluating implementation options and impact on the Company's financial statements and related disclosures.

ASU 2018-13 Fair Value Measurement - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement: In August 2018, the FASB issued this update as a part of its disclosure framework project to improve the effectiveness of disclosures in the notes to financial statements. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption was permitted upon issuance of this update and an entity is permitted to early adopt any removed or modified disclosures upon issuance of this update and delay adoption of the additional disclosures until the effective date. Certain disclosure amendments are to be applied prospectively for only the most recent interim or annual period presented, while other amendments are to be applied retrospectively to all periods presented. Management is currently evaluating implementation options and impact on the Company's related disclosures.

ASU 2018-14 Retirement Benefits - Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans: In August 2018, the FASB issued this update as a part of its disclosure framework project to improve the effectiveness of disclosures in the notes to financial statements. This standard is effective for fiscal years ending after December 15, 2020 and early adoption is permitted. Upon adoption, this update is to be applied on a retrospective basis to all periods presented. Management is currently evaluating the impact on the Company's related disclosures.

ASU 2018-15 Internal-Use Software - Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract: In August 2018, the FASB issued this update. This standard is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. This standard is to be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Management is currently evaluating implementation options and impact on the Company's financial statements and related disclosures.


10


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2.
INVENTORIES
 
September 30,
 
December 31,
(Dollars in millions)
2018
 
2017
Finished goods
$
1,118

 
$
1,114

Work in process
271

 
213

Raw materials and supplies
554

 
470

Total inventories at FIFO or average cost
1,943

 
1,797

Less: LIFO reserve
318

 
288

Total inventories
$
1,625

 
$
1,509


Inventories valued on the last-in, first-out ("LIFO") method were approximately 55 percent and 60 percent of total inventories at September 30, 2018 and December 31, 2017, respectively.

3.
PAYABLES AND OTHER CURRENT LIABILITIES
 
September 30,
 
December 31,
(Dollars in millions)
2018
 
2017
Trade creditors
$
823

 
$
842

Accrued payrolls, vacation, and variable compensation
191

 
199

Accrued taxes
82

 
111

Other
329

 
437

Total payables and other current liabilities
$
1,425

 
$
1,589


"Other" consists primarily of accruals for dividends payable, post-employment obligations, interest payable, the current portion of environmental liabilities, and miscellaneous accruals.

4.
INCOME TAXES
 
Third Quarter
 
First Nine Months
(Dollars in millions)
2018
 
2017
 
2018
 
2017
 
$
 
%
 
$
 
%
 
$
 
%
 
$
 
%
Provision for income taxes and tax rate
$
46

 
10
%
 
$
79

 
20
%
 
$
190

 
15
%
 
$
206

 
19
%

The third quarter and first nine months 2018 effective tax rates include the impact of the U.S. corporate tax rate reduction resulting from the Tax Reform Act. In third quarter and first nine months 2018, the Company also recognized a decrease of $14 million and $4 million, respectively, to the provision for income taxes resulting from adjustments to the provisional net tax benefit recognized in fourth quarter 2017 resulting from the Tax Reform Act and tax impact of outside-U.S. entity reorganizations as part of the transition to an international treasury services center. Third quarter and first nine months 2018 adjustments resulting from the Tax Reform Act were due to a decrease to the provision for income taxes related to foreign income inclusion and associated foreign tax credits partially offset by an increase to the provision for income taxes for a remeasurement of the deferred tax assets as a result of additional guidance released in the third quarter 2018. Third quarter and first nine months 2018 effective tax rates also include a $14 million decrease to the provision for income taxes related to prior year income tax returns and a $17 million decrease to the provision for income taxes related to current year estimates of business tax credits. In addition, first nine months 2018, adjustment included a $10 million increase to the one-time transition tax on deferred foreign income resulting from the Tax Reform Act.

The first nine months 2017 effective tax rate included a $22 million tax decrease to reflect finalization of prior years' income tax returns and a $22 million tax decrease due to planned amendments to prior years' income tax returns.


11


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As previously reported, the Company recognized a provisional net tax benefit for the year ended December 31, 2017, primarily resulting from the Tax Reform Act. The provisional net tax benefit included a benefit from the one-time revaluation of deferred tax liabilities, partially offset by a one-time transition tax on deferred foreign income and changes in valuation of deferred tax assets. The provisional net tax benefit was updated in 2018, as described above. As of September 30, 2018, the Company continues to consider the accounting for the following impacts of the Tax Reform Act to be provisional and, accordingly, subject to adjustment in future periods: the transition tax on deferred foreign income (which consists of post-1986 accumulated earnings and profits of controlled foreign corporations and the determination of cash versus non-cash balances), the impact of the change in income tax rates on deferred tax assets and liabilities, and the evaluation of gross foreign tax credit carryforwards and related valuation allowances. In preparing the provisional estimates as of September 30, 2018, the Company considered notices and revenue procedures issued by the Internal Revenue Service and authoritative accounting guidance.

Certain of the provisional amounts will be finalized in the fourth quarter 2018 following the filing of the Company's U.S. federal income tax return for the year ended December 31, 2017. While historically differences between amounts reported in the Company's consolidated financial statements and the Company's U.S. federal income tax return have resulted in offsetting changes in estimates in current and deferred taxes for items which are timing related, the reduction of the U.S. tax rate will result in adjustments to the Company's income tax provision when recognized. The Company also considers it likely that further technical guidance regarding certain aspects of the new provisions included in the Tax Reform Act, as well as clarity regarding state income tax conformity to current federal tax code, may be issued which could result in changes to the provisional amounts reported as of September 30, 2018.

Additionally, the Company continues to consider the future impact of the Tax Reform Act for the year beginning January 1, 2018, including the new provisions known as the base erosion anti-abuse tax ("BEAT") and global intangible low-tax income ("GILTI") tax, as well as other provisions. Under U.S. GAAP, companies can make an accounting policy election to either treat taxes resulting from GILTI as a current-period expense when incurred or factor such amounts into the measurement of deferred taxes. The Company has not completed its analysis of the effects of the GILTI provisions and will further consider the accounting policy election within the measurement period as provided under Staff Accounting Bulletin No. 118, "Income Tax Accounting Implications of the Tax Cuts and Jobs Act".


12


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

5.
BORROWINGS
 
September 30,
 
December 31,
(Dollars in millions)
2018
 
2017
Borrowings consisted of:
 
 
 
5.5% notes due November 2019
$
250

 
$
250

2.7% notes due January 2020
798

 
797

4.5% notes due January 2021
185

 
185

3.6% notes due August 2022
739

 
738

1.50% notes due May 2023 (1)
865

 
895

7 1/4% debentures due January 2024
198

 
197

7 5/8% debentures due June 2024
43

 
43

3.8% notes due March 2025
688

 
690

1.875% notes due November 2026 (1)
572

 
592

7.60% debentures due February 2027
195

 
195

4.8% notes due September 2042
493

 
493

4.65% notes due October 2044
872

 
871

Commercial paper and short-term borrowings
727

 
389

Credit facilities borrowings

 
200

Capital leases and other
1

 
5

Total borrowings
6,626

 
6,540

Borrowings due within one year
728

 
393

Long-term borrowings
$
5,898

 
$
6,147

(1) 
The carrying value of the euro-denominated 1.50% notes due May 2023 and 1.875% notes due November 2026 will fluctuate with changes in the euro exchange rate. The carrying value of these euro-denominated borrowings have been designated as non-derivative net investment hedges of a portion of the Company's net investments in euro functional-currency denominated subsidiaries to offset foreign currency fluctuations.

Credit Facilities and Commercial Paper Borrowings

In December 2016, the Company borrowed $300 million under a five-year term loan agreement ("2021 Term Loan"). Borrowings under the 2021 Term Loan agreement are subject to interest at varying spreads above quoted market rates. As of December 31, 2017, the 2021 Term Loan outstanding balance was $200 million with an interest rate of 2.60 percent. In second quarter 2018, $100 million of the borrowings under the 2021 Term Loan were repaid using available cash. In third quarter 2018, the Company repaid the remaining balance of $100 million using available cash.

The Company has access to a $1.25 billion revolving credit agreement (the "Credit Facility") expiring October 2021. Borrowings under the Credit Facility are subject to interest at varying spreads above quoted market rates and a commitment fee is paid on the total unused commitment. The Credit Facility provides available liquidity for general corporate purposes and supports commercial paper borrowings. Commercial paper borrowings are classified as short-term. At September 30, 2018 and December 31, 2017, the Company had no outstanding borrowings under the Credit Facility. At September 30, 2018, the Company's commercial paper borrowings were $605 million with a weighted average interest rate of 2.36 percent. At December 31, 2017, the Company's commercial paper borrowings were $280 million with a weighted average interest rate of 1.61 percent. In October 2018, the Company amended the Credit Facility to increase the available borrowing amount to $1.50 billion and extend the maturity to October 2023.


13


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Company has access to a $250 million accounts receivable securitization agreement (the "A/R Facility") that expires April 2020. Eastman Chemical Financial Corporation ("ECFC"), a subsidiary of the Company, has an agreement to sell interests in trade receivables under the A/R Facility to a third party purchaser. Third party creditors of ECFC have first priority claims on the assets of ECFC before those assets would be available to satisfy the Company's general obligations. Borrowings under the A/R Facility are subject to interest rates based on a spread over the lender's borrowing costs, and ECFC pays a fee to maintain availability of the A/R Facility. In first quarter 2018, $100 million available under the A/R Facility was borrowed and repaid in second quarter 2018. In second quarter 2018, $25 million available under the A/R Facility was borrowed and remained outstanding at June 30, 2018. In third quarter 2018, the outstanding balance of $25 million under the A/R Facility was repaid. At September 30, 2018 and December 31, 2017, the Company had no borrowings outstanding under the A/R Facility.

The Company has access to borrowings of up to €150 million ($174 million) under a receivables facility based on the discounted value of selected customer accounts receivable. This facility expires December 2020 and renews for another one year period if not terminated with 90 days notice by either party. These arrangements include receivables in the United States, Belgium, and Finland, and are subject to various eligibility requirements. Borrowings under this facility are subject to interest at an agreed spread above EURIBOR for euro denominated drawings and the counterparty's cost of funds for drawings in any other currencies, plus administration and insurance fees and are classified as short-term. At September 30, 2018, the Company's amount of outstanding borrowings under this facility were $122 million with a weighted average interest rate of 1.50 percent. At December 31, 2017, the Company's amount of outstanding borrowings under this facility were $109 million with a weighted average interest rate of 1.31 percent.

The Credit and A/R Facilities and other borrowing agreements contain customary covenants and events of default, some of which require the Company to maintain certain financial ratios that determine the amounts available and terms of borrowings. The Company was in compliance with all covenants at both September 30, 2018 and December 31, 2017.

Fair Value of Borrowings

Eastman has classified its total borrowings at September 30, 2018 and December 31, 2017 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 2017 Annual Report on Form 10-K. The fair value for fixed-rate debt securities is based on current market prices and is classified as Level 1. The fair value for the Company's other borrowings primarily under commercial paper and a receivables facility equals the carrying value and is classified as Level 2. The Company had no borrowings classified as Level 3 as of September 30, 2018 and December 31, 2017.



 
 
 
Fair Value Measurements at September 30, 2018
(Dollars in millions)
 
Recorded Amount
 
Total Fair Value
 
 Quoted Prices in Active Markets for Identical Liabilities (Level 1)
 
Significant Other Observable Inputs (Level 2)
Total borrowings
 
$
6,626

 
$
6,791

 
$
6,062

 
$
729


 
 
 
 
Fair Value Measurements at December 31, 2017
(Dollars in millions)
 
Recorded Amount
 
Total Fair Value
 
 Quoted Prices in Active Markets for Identical Liabilities (Level 1)
 
Significant Other Observable Inputs (Level 2)
Total borrowings
 
$
6,540

 
$
6,980

 
$
6,386

 
$
594



14


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

6.
DERIVATIVE AND NON-DERIVATIVE FINANCIAL INSTRUMENTS

Overview of Hedging Programs

Eastman is exposed to market risks, such as changes in foreign currency exchange rates, commodity prices, and interest rates. To mitigate these market risks and their effects on the cash flows of the underlying transactions and investments in foreign subsidiaries, the Company uses various derivative and non-derivative financial instruments, when appropriate, in accordance with the Company's hedging strategy and policies. Designation is performed on a specific exposure basis to support hedge accounting. The Company does not enter into derivative transactions for speculative purposes.

For further information on hedging programs, see Note 9, "Derivative and Non-Derivative Financial Instruments", to the consolidated financial statements in Part II, Item 8 of the Company's 2017 Annual Report on Form 10-K.

Cash Flow Hedges

Cash flow hedges are derivative instruments designated and used to hedge the exposure to variability in expected future cash flows that are attributable to a particular risk. The derivative instruments that are designated and qualify as a cash flow hedge are reported on the balance sheet at fair value and the changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the anticipated cash flows of the underlying exposures being hedged. The net of the change in the hedge instrument and item being hedged for qualifying cash flow hedges is reported as a component of AOCI located in the Unaudited Consolidated Statements of Financial Position and recognized in earnings in the same period or periods during which the hedged transaction affects earnings.

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. The derivative instruments that are designated and qualify as fair value hedges are recognized on the balance sheet at fair value and the changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the anticipated fair value of the underlying exposures being hedged. The net of the change in the hedge instrument and item being hedged for qualifying fair value hedges is recognized in earnings in the same period or periods during which the hedged transaction affects earnings.

Net Investment Hedges

Net investment hedges are defined as derivative or non-derivative instruments designated as and used to hedge the foreign currency exposure of the net investments in certain foreign operations. The net of the change in the hedge instrument and item being hedged for qualifying net investment hedges is reported as a component of the "Cumulative Translation Adjustment" ("CTA") within AOCI located in the Unaudited Consolidated Statements of Financial Position. Recognition in earnings of amounts previously recognized in CTA is limited to circumstances such as complete or substantially complete liquidation of the net investment in the hedged foreign operation.

For derivative cross-currency interest rate swap net investment hedges, gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in CTA within AOCI and recognized in earnings through the periodic swap interest accruals. The cross-currency interest rate swaps designated as net investment hedges are included as part of "Other long-term liabilities" or "Other noncurrent assets" within the Unaudited Consolidated Statements of Financial Position.

In January 2018, Eastman entered into fixed-to-fixed cross-currency swaps and designated these swaps to hedge a portion of its net investment in a euro functional currency denominated subsidiary against foreign currency fluctuations. These contracts involve the exchange of fixed U.S. dollars with fixed euro interest payments periodically over the life of the contracts and an exchange of the notional amounts at maturity. The fixed-to-fixed cross-currency swaps include €150 million ($180 million) maturing January 2021 and €266 million ($320 million) maturing August 2022.


15


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Summary of Financial Position and Financial Performance of Hedging Instruments

The following table presents the notional amounts outstanding at September 30, 2018 and December 31, 2017 associated with Eastman's hedging programs.
Notional Outstanding
 
September 30, 2018
 
December 31, 2017
 
 
 
 
 
 
Derivatives designated as cash flow hedges:
 
 
 
 
Foreign Exchange Forward and Option Contracts (in millions)
 
 
 
 
 
EUR/USD (in EUR)
 
€338
 
€525
Commodity Forward and Collar Contracts
 
 
 
 
 
Feedstock (in million barrels)
 
7

 
7

 
Energy (in million million british thermal units)
 
31

 
23

 
 
 
 
 
Derivatives designated as fair value hedges:
 
 
 
 
Fixed-for-floating interest rate swaps (in millions)
 
$75
 
$75
 
 
 
 
 
Derivatives designated as net investment hedges:
 
 
 
 
Cross-currency interest rate swaps (in millions)
 
 
 
 
 
EUR/USD (in EUR)
 
€416
 

 
 
 
 
 
Non-derivatives designated as net investment hedges:
 
 
 
 
Foreign Currency Net Investment Hedges (in millions)
 
 
 
 
 
EUR/USD (in EUR)
 
€1,241
 
€1,240

Fair Value Measurements

All the Company's derivative assets and liabilities are currently classified as Level 2. Level 2 fair value is based on estimates using standard pricing models. These standard pricing models use inputs that 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 minimal risk of nonperformance, and the Company diversifies its positions among such counterparties to reduce its exposure to counterparty risk and credit losses. The Company monitors the creditworthiness of its counterparties on an on-going basis. The Company did not recognize a credit loss during third quarter 2018 and 2017.

All 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 in 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 does not have any cash collateral due under such agreements.

The Company has elected to present derivative contracts on a gross basis within the Unaudited Consolidated Statements of Financial Position. The following table presents the financial assets and liabilities valued on a recurring and gross basis and includes where the financial assets and liabilities are located within the Unaudited Consolidated Statements of Financial Position as of September 30, 2018 and December 31, 2017.

16


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Financial Position and Fair Value Measurements of Hedging Instruments on a Gross Basis
(Dollars in millions)
 
 
 
 
 
 
Derivative Type
 
Statements of Financial
Position Classification
 
September 30, 2018
Level 2
 
December 31, 2017
Level 2
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
Commodity contracts
 
Other current assets
 
$
46

 
$
9

Commodity contracts
 
Other noncurrent assets
 
16

 
4

Foreign exchange contracts
 
Other current assets
 
18

 
23

Foreign exchange contracts
 
Other noncurrent assets
 
3

 
2

 
 
 
 
 
 
 
Derivatives designated as fair value hedges:
 
 
 
 
 
 
Fixed-for-floating interest rate swap
 
Other current assets
 

 
1

 
 
 
 
 
 
 
Derivatives designated as net investment hedges:
 
 
 
 
 
 
Cross-currency interest rate swaps
 
Other noncurrent assets
 
6

 

Total Derivative Assets
 
 
 
$
89

 
$
39

 
 
 
 
 
 
 
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
Commodity contracts
 
Payables and other current liabilities
 
$
3

 
$
28

Commodity contracts
 
Other long-term liabilities
 
2

 
10

Foreign exchange contracts
 
Payables and other current liabilities
 

 
6

Foreign exchange contracts
 
Other long-term liabilities
 

 
4

 
 
 
 
 
 
 
Derivatives designated as fair value hedges:
 
 
 
 
 
 
Fixed-for-floating interest rate swap
 
Long-term borrowings
 
6

 
4

Total Derivative Liabilities
 
 
 
$
11

 
$
52

Total Net Derivative Assets (Liabilities)
 
 
 
$
78

 
$
(13
)

In addition to the fair value associated with derivative instruments designated as cash flow hedges, fair value hedges, and net investment hedges noted in the table above, the Company had a carrying value of $1.4 billion and $1.5 billion associated with non-derivative instruments designated as foreign currency net investment hedges at September 30, 2018 and December 31, 2017, respectively. The designated foreign currency-denominated borrowings are included in the "Long-term borrowings" line item of the Unaudited Consolidated Statements of Financial Position.

For additional fair value measurement information, see Note 1, "Significant Accounting Policies", and Note 9, "Derivative and Non-Derivative Financial Instruments", to the consolidated financial statements in Part II, Item 8 of the Company's 2017 Annual Report on Form 10-K.


17


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As of September 30, 2018 and December 31, 2017, the following amounts were included on the Unaudited Consolidated Statements of Financial Position related to cumulative basis adjustments for fair value hedges.
(Dollars in millions)
 
Carrying amount of the hedged liabilities
 
Cumulative amount of fair value hedging loss adjustment included in the carrying amount of the hedged liability
Line item in the Unaudited Consolidated Statements of Financial Position in which the hedged item is included
 
September 30, 2018
 
December 31, 2017
 
September 30, 2018
 
December 31, 2017
Long-term borrowings (1)
 
$
757

 
$
760

 
$
(14
)
 
$
(10
)

(1) 
At September 30, 2018 and December 31, 2017, the cumulative amount of fair value hedging loss adjustment remaining for hedged liabilities for which hedge accounting has been discontinued was $7 million and $6 million, respectively.

The following table presents the effect of cash flow and net investment hedge accounting on "Other comprehensive income (loss), net of tax" ("OCI") for third quarter and first nine months 2018 and 2017:
 
 
Change in amount of after tax gain (loss) recognized in OCI on derivatives
 
Pre-tax amount of gain (loss) reclassified from OCI into earnings
(Dollars in millions)
 
Third Quarter
 
First Nine Months
 
Third Quarter
 
First Nine Months
Hedging Relationships
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
 
$
28

 
$
49

 
$
57

 
$
42

 
$
8

 
$
(15
)
 
$
3

 
$
(42
)
Foreign exchange contracts
 
(2
)
 
(12
)
 
5

 
(42
)
 
7

 
6

 
18

 
28

Forward starting interest rate and treasury lock swap contracts
 
1

 

 
3

 
2

 
(2
)
 
(2
)
 
(4
)
 
(4
)
Non-derivatives in net investment hedging relationships (pre-tax):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net investment hedges
 
12

 
(49
)
 
51

 
(158
)
 

 

 

 

Derivatives in net investment hedging relationships (pre-tax):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cross-currency interest rate swaps
 
3

 

 
18

 

 

 

 

 

Cross-currency interest rate swaps excluded component
 
(1
)
 

 
(12
)
 

 

 

 

 



18


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the effect of fair value and cash flow hedge accounting on the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings for third quarter 2018 and 2017.
Location and Amount of Gain or (Loss) Recognized in Earnings on Fair Value and Cash Flow Hedging Relationships
 
 
Third quarter
 
 
2018
 
2017
(Dollars in millions)
 
Sales
 
Cost of Sales
 
Net Interest Expense
 
Sales
 
Cost of Sales
 
Net Interest Expense
Total amounts of income and expense line items presented in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings in which the effects of fair value or cash flow hedges are recognized
 
$
2,547

 
$
1,819

 
$
58

 
$
2,465

 
$
1,794

 
$
61

 
 
 
 
 
 
 
 
 
 
 
 
 
The effects of fair value and cash flow hedging:
 
 
 
 
 
 
 
 
 
 
 
 
Gain or (loss) on fair value hedging relationships:
 
 
 
 
 
 
 
 
 
 
 
 
Interest contracts (fixed-for-floating interest rate swaps):
 
 
 
 
 
 
 
 
 
 
 
 
Hedged items
 
 
 
 
 

 
 
 
 
 
(1
)
Derivatives designated as hedging instruments
 
 
 
 
 

 
 
 
 
 
1

Gain or (loss) on cash flow hedging relationships:
 
 
 
 
 
 
 
 
 
 
 
 
Interest contracts (forward starting interest rate and treasury lock swap contracts):
 
 
 
 
 
 
 
 
 
 
 
 
Amount reclassified from AOCI into earnings
 
 
 
 
 
(2
)
 
 
 
 
 
(2
)
Commodity Contracts:
 
 
 
 
 
 
 
 
 
 
 
 
Amount reclassified from AOCI into earnings
 
 
 
8

 
 
 
 
 
(15
)
 
 
Foreign Exchange Contracts:
 
 
 
 
 
 
 
 
 
 
 
 
Amount reclassified from AOCI into earnings
 
7

 
 
 
 
 
6

 
 
 
 




19


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the effect of fair value and cash flow hedge accounting on the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings for first nine months 2018 and 2017.
Location and Amount of Gain or (Loss) Recognized in Earnings on Fair Value and Cash Flow Hedging Relationships
 
 
First Nine Months
 
 
2018
 
2017
(Dollars in millions)
 
Sales
 
Cost of Sales
 
Net Interest Expense
 
Sales
 
Cost of Sales
 
Net Interest Expense
Total amounts of income and expense line items presented in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings in which the effects of fair value or cash flow hedges are recognized
 
$
7,775

 
$
5,762

 
$
178

 
$
7,187

 
$
5,281

 
$
182

 
 
 
 
 
 
 
 
 
 
 
 
 
The effects of fair value and cash flow hedging:
 
 
 
 
 
 
 
 
 
 
 
 
Gain or (loss) on fair value hedging relationships:
 
 
 
 
 
 
 
 
 
 
 
 
Interest contracts (fixed-for-floating interest rate swaps):
 
 
 
 
 
 
 
 
 
 
 
 
Hedged items
 
 
 
 
 

 
 
 
 
 
(3
)
Derivatives designated as hedging instruments
 
 
 
 
 

 
 
 
 
 
3

Gain or (loss) on cash flow hedging relationships:
 
 
 
 
 
 
 
 
 
 
 
 
Interest contracts (forward starting interest rate and treasury lock swap contracts):
 
 
 
 
 
 
 
 
 
 
 
 
Amount reclassified from AOCI into earnings
 
 
 
 
 
(4
)
 
 
 
 
 
(4
)
Commodity Contracts:
 
 
 
 
 
 
 
 
 
 
 
 
Amount reclassified from AOCI into earnings
 
 
 
3

 
 
 
 
 
(42
)
 
 
Foreign Exchange Contracts:
 
 
 
 
 
 
 
 
 
 
 
 
Amount reclassified from AOCI into earnings
 
18

 
 
 
 
 
28

 
 
 
 

The Company enters into foreign exchange derivatives denominated in multiple currencies which are transacted and settled in the same quarter. These derivatives are not designated as hedges due to the short-term nature and the gains or losses on these derivatives are marked-to-market in line item "Other (income) charges, net" of the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings. The Company recognized a net gain of $2 million and a net loss of $2 million during third quarter 2018 and 2017, respectively, and recognized a net loss of $4 million and net gain of $2 million during first nine months 2018 and 2017, respectively, on these derivatives.

Pre-tax monetized positions and mark-to-market gains and losses from raw materials and energy, currency, and certain interest rate hedges that were included in AOCI included net losses of $72 million and $214 million at September 30, 2018 and December 31, 2017, respectively. Losses in AOCI decreased September 30, 2018 compared to December 31, 2017 primarily as a result of an increase in commodity prices, particularly propane, and a decrease in foreign currency exchange rates associated with the euro. If realized, approximately $51 million in pre-tax gains, as of September 30, 2018, would be reclassified into earnings during the next 12 months.


20


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

7.
RETIREMENT PLANS

Defined Benefit Pension Plans and Other Postretirement Benefit Plans

Eastman maintains defined benefit pension plans that provide eligible employees with retirement benefits. In addition, Eastman provides life insurance for eligible retirees hired prior to January 1, 2007. Eastman provides a subsidy for pre-Medicare health care and dental benefits to eligible retirees hired prior to January 1, 2007 that will end on December 31, 2021. Company funding is also provided for eligible Medicare retirees hired prior to January 1, 2007 with a health reimbursement arrangement. Costs recognized for these benefits are estimated amounts, which may change as actual costs derived for the year are determined.

For additional information regarding retirement plans, see Note 10, "Retirement Plans", to the consolidated financial statements in Part II, Item 8 of the Company's 2017 Annual Report on Form 10-K.

Components of net periodic benefit (credit) cost were as follows:
 
Third Quarter
 
Pension Plans
 
Other Postretirement Benefit Plans
 
2018
 
2017
 
2018
 
2017
(Dollars in millions)
U.S.
 
Non-U.S.
 
U.S.
 
Non-U.S.
 
 
 
 
Service cost
$
9

 
$
3

 
$
10

 
$
3

 
$

 
$

Interest cost
16

 
5

 
16

 
5

 
6

 
6

Expected return on assets
(36
)
 
(9
)
 
(35
)
 
(8
)
 
(2
)
 
(1
)
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
Prior service credit, net

 

 
(1
)
 

 
(10
)
 
(10
)
Net periodic benefit (credit) cost
$
(11
)
 
$
(1
)
 
$
(10
)
 
$

 
$
(6
)
 
$
(5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
First Nine Months
 
Pension Plans
 
Other Postretirement Benefit Plans
 
2018
 
2017
 
2018
 
2017
(Dollars in millions)
U.S.
 
Non-U.S.
 
U.S.
 
Non-U.S.
 
 
 
 
Service cost
$
26

 
$
11

 
$
28

 
$
10

 
$

 
$
2

Interest cost
50

 
15

 
49

 
14

 
17

 
18

Expected return on assets
(110
)
 
(28
)
 
(105
)
 
(25
)
 
(4
)
 
(4
)
Amortization of:
 
 
 
 
 
 
 
 
 
 
 
Prior service credit, net

 

 
(3
)
 

 
(30
)
 
(30
)
Net periodic benefit (credit) cost
$
(34
)
 
$
(2
)
 
$
(31
)
 
$
(1
)
 
$
(17
)
 
$
(14
)

On January 1, 2018, the Company adopted ASU 2017-07 resulting in non-service cost components of the net periodic pension and other postretirement benefit plans being presented in the "Other components of post-employment (benefit) cost, net" line item of the Unaudited Consolidated Statement of Earnings, Comprehensive Income and Retained Earnings. See Note 1, "Significant Accounting Policies", for additional information.


21


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

8.
COMMITMENTS AND OFF BALANCE SHEET ARRANGEMENTS

Purchase Obligations and Lease Commitments
 
The Company had various purchase obligations at September 30, 2018, totaling approximately $2.8 billion over a period of approximately 30 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 noncancelable operating leases totaling $262 million over a period of approximately 40 years. Of the total lease commitments, approximately 50 percent relate to real property, including office space, storage facilities, and land; approximately 40 percent relate to railcars; and approximately 10 percent relate to machinery and equipment, including computer and communications equipment and production equipment.

Guarantees

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 totaled $68 million at September 30, 2018 and consist primarily of leases for railcars that will expire beginning in second quarter 2019. Residual guarantee payments that become probable and estimable are recognized as rent expense over the remaining life of the applicable lease. Management's current expectation is that the likelihood of material residual guarantee payments is remote.

Other Guarantees

Guarantees and claims also arise during the ordinary course of business from relationships with customers, suppliers, joint venture partners, 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 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 up to 30 years with maximum potential future payments of approximately $35 million in the aggregate, with none of these guarantees being individually significant to the Company's operating results, financial position, or liquidity. Management's current expectation is that future payment or performance related to non-performance under other guarantees is remote.

Other Off Balance Sheet Arrangements

The Company has off balance sheet uncommitted non-recourse factoring facilities that include customer specific receivables in the United States and Europe. The Company sells the receivables at face value, less a transaction fee, which substantially equals the carrying value and fair value with no gain or loss recognized. There is no continuing involvement with these receivables once sold and no credit loss exposure. The total amount of cumulative receivables sold in third quarter 2018 and 2017 were $38 million and $10 million, respectively. The total amount of cumulative receivables sold in first nine months 2018 and 2017 were $123 million and $15 million, respectively.


22


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

9.
ENVIRONMENTAL MATTERS AND ASSET RETIREMENT OBLIGATIONS

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 certain cleanup costs. In addition, the Company will incur costs for environmental remediation and closure and post-closure 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 2017 Annual Report on Form 10-K. 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 the availability of legal defenses, the Company's preliminary assessment of actions that may be required, and, if applicable, the expected sharing of costs, management does not believe that the Company's liability for these environmental matters, individually or in the aggregate, will be material to the Company's consolidated financial position, results of operations, or cash flows. The Company's total reserve for environmental loss contingencies was $297 million and $304 million at September 30, 2018 and December 31, 2017, respectively. The environmental reserve includes costs related to sites previously closed and impaired by Eastman and sites that have been divested by Eastman but for which the Company retains the environmental liability related to these sites of $7 million at both September 30, 2018 and December 31, 2017.

Environmental Remediation and Environmental Asset Retirement Obligations

The Company's total environmental reserve that management believes to be probable and reasonably estimable for environmental contingencies, including remediation costs and asset retirement obligations, is included as part of "Payables and other current liabilities" and "Other long-term liabilities" in the Unaudited Consolidated Statements of Financial Position as follows:
(Dollars in millions)
September 30, 2018
 
December 31, 2017
Environmental contingent liabilities, current
$
25

 
$
25

Environmental contingent liabilities, long-term
272

 
279

Total
$
297

 
$
304


Environmental Remediation

Estimated future environmental expenditures for undiscounted remediation costs ranged from the best estimate or minimum of $273 million to the maximum of $513 million at September 30, 2018 and from the best estimate or minimum of $280 million to the maximum of $483 million at December 31, 2017. The best estimate or minimum estimated future environmental expenditures are considered to be probable and reasonably estimable and include the amounts recognized at both September 30, 2018 and December 31, 2017.

Reserves for environmental remediation include liabilities expected to be paid within approximately 30 years. The amounts charged to pre-tax earnings for environmental remediation and related charges are included within "Cost of sales" in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings. Changes in the reserves for environmental remediation liabilities during first nine months 2018 are summarized below:
(Dollars in millions)
Environmental Remediation Liabilities
Balance at December 31, 2017
$
280

Changes in estimates recognized in earnings and other
6

Cash reductions
(13
)
Balance at September 30, 2018
$
273



23


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Environmental Asset Retirement Obligations

An asset retirement obligation is an obligation for the retirement of a tangible long-lived asset that is incurred upon the acquisition, construction, development, or normal operation of that long-lived asset. The Company recognizes asset retirement obligations in the period in which they are incurred if a reasonable estimate of fair value can be made. The asset retirement obligations are discounted to expected present value and subsequently adjusted for changes in fair value. The associated estimated asset retirement costs are capitalized as part of the carrying value of the long-lived assets and depreciated over their useful life. Environmental asset retirement obligations consist primarily of closure and post-closure costs. For sites that have environmental asset retirement obligations, the best estimate recognized to date for these environmental asset retirement obligation costs was $24 million at both September 30, 2018 and December 31, 2017

Non-Environmental Asset Retirement Obligations

The Company has contractual asset retirement obligations not associated with environmental liabilities. Eastman's non-environmental asset retirement obligations are primarily associated with the future closure of leased manufacturing assets at Pace, Florida and Oulu, Finland. These recognized non-environmental asset retirement obligations were $46 million and $49 million at September 30, 2018 and December 31, 2017, respectively, and is included as part of "Other long-term liabilities" in the Unaudited Consolidated Statements of Financial Position.

10.
LEGAL MATTERS

From time to time, Eastman 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 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.


24


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

11.
STOCKHOLDERS' EQUITY

A reconciliation of the changes in stockholders' equity for first nine months 2018 is provided below:
(Dollars in millions)
Common Stock at Par Value
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Treasury Stock at Cost
 
Total Eastman Stockholders' Equity
 
Noncontrolling Interest
 
Total Equity
Balance at December 31, 2017
$
2

 
$
1,983

 
$
6,802

 
$
(209
)
 
$
(3,175
)
 
$
5,403

 
$
77

 
$
5,480

Cumulative Effect of Adoption of New Accounting Standards (1)

 

 
16

 

 

 
16

 

 
16

Net Earnings

 

 
1,046

 

 

 
1,046

 
3

 
1,049

Cash Dividends Declared (2)
($1.68 per share)

 

 
(238
)
 

 

 
(238
)
 

 
(238
)
Other Comprehensive Income

 

 

 
15

 

 
15

 

 
15

Share-Based Compensation Expense (3)

 
53

 

 

 

 
53

 

 
53

Stock Option Exercises

 
17

 

 

 

 
17

 

 
17

Other (4)

 
(17
)
 

 

 

 
(17
)
 

 
(17
)
Share Repurchases

 

 

 

 
(375
)
 
(375
)
 

 
(375
)
Distributions to Noncontrolling Interest

 

 

 

 

 

 
(5
)
 
(5
)
Balance at September 30, 2018
$
2

 
$
2,036

 
$
7,626

 
$
(194
)
 
$
(3,550
)
 
$
5,920

 
$
75

 
$
5,995


(1) 
On January 1, 2018, the Company adopted new accounting standards for revenue recognition, income taxes, and derivatives and hedging, which resulted in adjustments to beginning retained earnings. See Note 1, "Significant Accounting Policies", for specific amounts related to each standard.
(2) 
Cash dividends declared includes cash dividends paid and dividends declared but unpaid.
(3) 
Share-based compensation expense is the fair value of share-based awards.
(4) 
Additional paid-in capital includes value of shares withheld for employees' taxes on vesting of share-based compensation awards.

Accumulated Other Comprehensive Income (Loss), Net of Tax
 
 
 
 
(Dollars in millions)
Cumulative Translation Adjustment
 
Benefit Plans Unrecognized Prior Service Credits
 
Unrealized Gains (Losses) on Derivative Instruments
 
Unrealized Losses on Investments
 
Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2016
$
(381
)
 
$
163

 
$
(62
)
 
$
(1
)
 
$
(281
)
Period change
85

 
(27
)
 
14

 

 
72

Balance at December 31, 2017
(296
)
 
136

 
(48
)
 
(1
)
 
(209
)
Period change
(28
)
 
(22
)
 
65

 

 
15

Balance at September 30, 2018
$
(324
)
 
$
114

 
$
17

 
$
(1
)
 
$
(194
)

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


25


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Components of other comprehensive income recognized in the Unaudited Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings are presented below, before tax and net of tax effects:
 
Third Quarter
 
2018
 
2017
(Dollars in millions)
Before Tax
 
Net of Tax
 
Before Tax
 
Net of Tax
Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in cumulative translation adjustment
$
(21
)
 
$
(21
)
 
$
17

 
$
17

Defined benefit pension and other postretirement benefit plans:
 
 
 
 
 
 
 
Amortization of unrecognized prior service credits
(10
)
 
(7
)
 
(11
)
 
(7
)
Derivatives and hedging:
 
 
 
 
 
 
 
Unrealized gain (loss) during period
50

 
37

 
49

 
31

Reclassification adjustment for (gains) losses included in net income, net
(14
)
 
(10
)
 
10

 
7

Total other comprehensive income (loss)
$
5

 
$
(1
)
 
$
65

 
$
48

 
First Nine Months
 
2018
 
2017
(Dollars in millions)
Before Tax
 
Net of Tax
 
Before Tax
 
Net of Tax
Other comprehensive income (loss)
 
 
 
 
 
 
 
Change in cumulative translation adjustment
$
(28
)
 
$
(28
)
 
$
60

 
$
60

Defined benefit pension and other postretirement benefit plans:
 
 
 
 
 
 
 
Amortization of unrecognized prior service credits
(30
)
 
(22
)
 
(33
)
 
(20
)
Derivatives and hedging:
 
 
 
 
 
 


Unrealized gain (loss) during period
103

 
78

 
(13
)
 
(8
)
Reclassification adjustment for (gains) losses included in net income, net
(17
)
 
(13
)
 
17

 
11

Total other comprehensive income (loss)
$
28

 
$
15

 
$
31

 
$
43



26


NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

12.
EARNINGS AND DIVIDENDS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share ("EPS"):
 
Third Quarter
 
First Nine Months
(In millions, except per share amounts)
2018
 
2017
 
2018
 
2017
Numerator
 
 
 
 
 
 
 
Earnings attributable to Eastman, net of tax
$
412

 
$
323

 
$
1,046

 
$
893

 
 
 
 
 
 
 
 
Denominator
 
 
 
 
 
 
 
Weighted average shares used for basic EPS
140.6

 
144.3

 
141.7

 
145.2

Dilutive effect of stock options and other awards
1.8

 
1.2

 
2.0

 
1.3

Weighted average shares used for diluted EPS
142.4

 
145.5

 
143.7

 
146.5

 
 
 
 
 
 
 
 
(Calculated using whole dollars and shares)
 
 
 
 
 
 
 
EPS
 
 
 
 
 
 
 
Basic
$
2.93

 
$
2.24

 
$
7.38

 
$
6.15

Diluted
$
2.89

 
$
2.22

 
$
7.28

 
$
6.10


In both third quarter and first nine months 2018, options to purchase 619,706 shares of common stock were excluded from the shares treated as outstanding for computation of diluted EPS because the market value of option exercises for these awards were less than the cash proceeds that would be received from these exercises. Third quarter and first nine months 2018 reflect the impact of share repurchases of 1,263,868 and 3,673,642, respectively.

In third quarter and first nine months 2017, options to purchase 727,111 and 781,011 shares of common stock, respectively, were excluded from the shares treated as outstanding for computation of diluted EPS because the market value of option exercises for these awards were less than the cash proceeds that would be received from these exercises. Third quarter and first nine months 2017 reflect the impact of share repurchases of 1,184,107 and 3,360,783, respectively.

The Company declared cash dividends of $0.56 and $0.51 per share in third quarter 2018 and 2017, respectively, and $1.68 and $1.53 per share in first nine months 2018 and 2017, respectively.

13.
ASSET IMPAIRMENTS AND RESTRUCTURING CHARGES, NET
 
 
 
 
There were no asset impairments and restructuring charges in third quarter 2018. In first nine months 2018, the Company recognized restructuring charges of $6 million for corporate severance costs. There were no asset impairments and restructuring charges in third quarter and first nine months 2017.

Changes in Reserves

The following table summarizes the changes in asset impairments and restructuring charges and gains, the non-cash reductions attributable to asset impairments, and the cash reductions in restructuring reserves for severance costs and site closure costs paid in first nine months 2018 and full year 2017:
(Dollars in millions)
Balance at January 1, 2018
 
Provision/ Adjustments