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EASTMAN CHEMICAL CO - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

July 30, 2014

ITEM Page Critical Accounting Estimates 29 Non-GAAP Financial Measures 30 Overview 31 Results of Operations 33 Summary by Operating Segment 37 Summary by Customer Location 43 Liquidity, Capital Resources, and Other Financial Information 44 Recently Issued Accounting Standards 47 2014 Outlook 48 Forward-Looking Statements and Risk Factors 48 This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is based upon the consolidated financial statements for Eastman Chemical Company ("Eastman" or the "Company"), which have been prepared in accordance with accounting principles generally accepted ("GAAP") in the United States, and 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 2013 Annual Report on Form 10-K, and the Company's unaudited consolidated financial statements, including related notes, included elsewhere in this Quarterly Report on Form 10-Q. All references to earnings per share ("EPS") contained in this report are diluted earnings from continuing operations per share unless otherwise noted.



CRITICAL ACCOUNTING ESTIMATES

In preparing the consolidated financial statements in conformity with GAAP, 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, sales revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to allowances for doubtful accounts, impairment of long-lived assets, environmental costs, pension and other postretirement benefits, litigation and contingent liabilities, income taxes, and purchase accounting. 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 estimates described in Part II, Item 7 of the Company's 2013 Annual Report on Form 10-K are the most important to the fair presentation of the Company's financial condition and results. These estimates require management's most significant judgments in the preparation of the Company's consolidated financial statements. 29 --------------------------------------------------------------------------------

[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



NON-GAAP FINANCIAL MEASURES

In addition to evaluating the Company's financial condition, results of operations, liquidity and cash flows as reported in accordance with GAAP, Eastman management also evaluates Company and operating segment performance, and makes resource allocation and performance evaluation decisions, excluding the effect of transactions, costs, and losses or gains that do not directly arise from Eastman's normal, or "core", business and operations, or are otherwise of an unusual or non-recurring nature. These transactions, costs, and losses or gains relate to, among other things, cost reduction, growth and profitability improvement initiatives, and other events outside of core business operations (such as mark-to-market losses or gains for pension and other postretirement benefit plans, typically in the fourth quarter of each year and any other quarters in which an interim remeasurement is triggered). Because non-core or non-recurring transactions, costs, and losses or gains may materially affect the Company's, or any particular operating segment's, financial condition or results in a specific period in which they are recognized, Eastman believes it is appropriate to evaluate both the financial measures prepared and calculated in accordance with GAAP and the related non-GAAP financial measures excluding the effect on our results of these non-core or non-recurring items. In addition to using such measures to evaluate results in a specific period, management evaluates such non-GAAP measures, and believes that investors may also evaluate such measures, because such measures may provide more complete and consistent comparisons of the Company's, and its segments', operational performance on a period-over-period historical basis and, as a result, provide a better indication of expected future trends. Management discloses these non-GAAP measures, and the related reconciliations to the most comparable GAAP financial measures, because it believes investors use these metrics in evaluating longer term period-over-period performance, and to allow investors to better understand and evaluate the information used by management to assess the Company's, and its operating segments', performance, make resource allocation decisions and evaluate organizational and individual performance in determining certain performance-based compensation. Non-GAAP measures do not have definitions under GAAP, and may be defined differently by, and not be comparable to, similarly titled measures used by other companies. As a result, management cautions investors not to place undue reliance on any non-GAAP measure, but to consider such measures with the most directly comparable GAAP measure.



The non-core or non-recurring items excluded by management in its evaluation of certain results in this Quarterly Report are:

• Costs resulting from the sale of acquired BP plc global aviation turbine

engine oil business (the "aviation turbine oil business") inventories at fair

value (as required by purchase accounting, these inventories were marked to

fair value and a portion sold in second quarter 2014);

• Transaction and integration costs from the Solutia and aviation turbine oil

business acquisitions which are non-core costs; and

• Asset impairments and restructuring charges and gains, net, which, other than

severance costs, are not cash transactions impacting profitability,

in each case for the periods and in the amounts in the table below.

Non - GAAP Financial Measures -- Excluded Non-Core or Non-Recurring Items

Second Quarter First Six Months (Dollars in millions) 2014 2013 2014 2013 Additional costs of acquired inventories $ 2 $ - $ 2 $ - Acquisition transaction costs 3 - 3 - Acquisition integration costs 7 8 16 15 Asset impairments and restructuring charges (gains), net (7 ) 18 6 21



This MD&A includes the effect of the foregoing on the following financial measures:

• Gross profit,



• Selling, general, and administrative ("SG&A") expenses,

• Operating earnings,

• Earnings from continuing operations, and

• Diluted earnings per share.

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[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS These non-GAAP financial measures, and the accompanying reconciliations of the non-GAAP financial measures to the most comparable GAAP measures, are presented in "Overview", "Results of Operations", and "Summary by Operating Segment" in this MD&A. In addition to the non-GAAP measures presented in this Quarterly Report and other periodic reports, from time to time management evaluates and discloses to investors and securities analysts the non-GAAP measure cash provided by operating activities excluding certain non-core or non-recurring items ("cash provided by operating activities, as adjusted") when analyzing, among other things, business performance, liquidity and financial position, and performance-based compensation. Eastman management uses this non-GAAP measure in conjunction with the GAAP measure cash provided by operating activities because it believes it is a more appropriate metric to evaluate the cash flows from Eastman's core operations that are available to grow the business and create stockholder value, and because it allows for a more consistent period-over-period presentation of such amounts. In its evaluation, Eastman management generally excludes the impact of certain non-core activities and decisions of management because such activities and decisions are not considered core, ongoing components of operations and the decisions to undertake or not to undertake such activities may be made irrespective of the cash generated from operations. From time to time, management discloses this non-GAAP measure and the related reconciliation to investors and securities analysts to allow them to better understand and evaluate the information used by management in its decision making processes and because management believes investors and securities analysts use similar measures to assess Company performance, liquidity, and financial position over multiple periods and to compare these with other companies. Similarly, from time to time, Eastman may disclose to investors and securities analysts one or both of alternative non-GAAP measures of "free cash flow", which management defines as (i) cash provided by operating activities, as adjusted, described above, less the amounts of capital expenditures and dividends, and (ii) cash provided by operating activities, as adjusted, described above, less the amount of capital expenditures. Management believes such items are generally funded from available cash and, as such, should be considered in determining free cash flow. Eastman management believes these are appropriate metrics to use to evaluate the Company's overall ability to generate cash to fund future operations, inorganic growth opportunities, and to meet the Company's debt repayment obligations. Management believes these metrics are useful to investors and securities analysts in order to provide them with information similar to that used by management in evaluating potential future cash available for various initiatives and because management believes investors and securities analysts often use a similar measure of free cash flow to compare the results, and value, of comparable companies.



OVERVIEW

Eastman's portfolio of specialty businesses holds leading market positions and manufactures products that enhance performance in a variety of end markets such as transportation, building and construction, and consumables. Management believes that despite ongoing economic uncertainty, the Company's key end markets generally benefited from modest global economic growth. Eastman management believes that the Company's global market and manufacturing presence, and vertically integrated manufacturing streams, combined with global trends such as energy efficiency, a rising middle class in emerging economies, and increased health and wellness will continue to support the Company's achievement of its growth objectives in the long term. The Company generated sales revenue of $2.5 billion and $2.4 billion in second quarter 2014 and 2013, respectively, and sales revenue of $4.8 billion and $4.7 billion in first six months 2014 and 2013, respectively. Operating earnings were $436 million in second quarter 2014 compared with $428 million in second quarter 2013. Excluding the non-core or non-recurring items referenced in "Non-GAAP Financial Measures", operating earnings in second quarter 2014 and 2013 were $441 million and $454 million, respectively. The decline was primarily due to lower Specialty Fluids & Intermediates ("SFI") segment operating earnings of $22 million, including the negative impact of higher raw material and energy costs, particularly for propane. The previously announced unplanned shutdown at the Kingsport, Tennessee facility negatively impacted second quarter 2014 operating earnings by approximately $10 million, primarily due to resulting costs, in the Advanced Materials ("AM"), Fibers, and SFI segments. Operating earnings were $797 million in first six months 2014 compared with $821 million in first six months 2013. Excluding the non-core or non-recurring items referenced in "Non-GAAP Financial Measures", operating earnings in first six months 2014 and 2013 were $824 million and $857 million, respectively. The decline was primarily due to lower SFI segment operating earnings of $53 million, including the negative impact of higher raw material and energy costs, particularly for propane. 31 --------------------------------------------------------------------------------

[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



As described in more detail in "Results of Operations", earnings from continuing operations and diluted earnings per share attributable to Eastman are as follows:

Second Quarter 2014



2013

(Dollars in millions, except diluted EPS) $ EPS $ EPS Earnings from continuing operations, net of tax $ 290$ 1.92$ 264$ 1.69 Earnings from continuing operations excluding non-core or non-recurring items, net of tax (1) $ 291$ 1.92$ 282$ 1.80 First Six Months 2014 2013 (Dollars in millions, except diluted EPS) $ EPS $ EPS Earnings from continuing operations, net of tax $ 523$ 3.43$ 511$ 3.26 Earnings from continuing operations excluding non-core or non-recurring items, net of tax (1) $ 538$ 3.54$ 535$ 3.41 (1) Excludes the non-core or non-recurring items referenced in "Non-GAAP Financial Measures". The Company generated $389 million in cash from operating activities in first six months 2014 compared with cash provided by operating activities of $367 million in first six months 2013. The increase in cash from operating activities was primarily due to lower tax payments partially offset by higher variable compensation. Variable compensation increased primarily due to changes in design of certain variable compensation programs.



In 2014, the Company made progress on both organic (internal growth) and inorganic (external growth through joint venture and acquisition) growth initiatives including:

• In the Adhesives & Plasticizers ("A&P") segment:

• completing the capacity expansion of its Eastman 168™



non-phthalate

plasticizers at its manufacturing facility in Texas City, Texas in second quarter 2014.



• in the AM segment:

• continuing the expansion of Eastman TritanTM copolyester capacity at the Kingsport, Tennessee manufacturing facility which is expected to be operational in the second half of 2014 to meet demand for Eastman TritanTM copolyester; and • entering into a definitive agreement to acquire Commonwealth Laminating & Coating, Inc., a specialty films business. The acquisition is expected to be completed in the second half of 2014. • in the SFI segment: • continuing a Therminol® heat transfer fluid capacity



expansion in

Newport, Wales, which is expected to be operational in the first half of 2015 to support expected demand in the industrial chemicals and processing market; and • completing the acquisition of the aviation turbine oil



business from

BP plc. Added to the segment's Skydrol® aviation hydraulic fluids, the acquired aviation turbine oil business enables Eastman to better supply the global aviation industry. 32

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[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



RESULTS OF OPERATIONS

Second Quarter First Six Months (Dollars in millions) 2014 2013 Change 2014 2013 Change Sales $ 2,460$ 2,440 1 % $ 4,765$ 4,747 - % Volume effect - % (1 )% Price effect - % 1 % Exchange rate effect 1 % - %



Sales revenue was slightly higher in second quarter 2014 compared to second quarter 2013. Sales revenue was relatively unchanged in first six months 2014 compared to first six months 2013.

Second Quarter First Six Months (Dollars in millions) 2014 2013 Change 2014 2013 Change Gross Profit $ 657$ 677 (3 )% $ 1,252$ 1,293 (3 )% Additional costs of acquired inventories 2 - 2 - Gross Profit excluding non-core or non-recurring items $ 659$ 677 (3 )% $ 1,254$ 1,293 (3 )% Gross profit decreased in second quarter and first six months 2014 compared with second quarter and first six months 2013 by $20 million and $41 million, respectively. Gross profit decreased primarily in the SFI segment due to lower sales volume of $13 million and $22 million, respectively, and higher raw material and energy costs, particularly for propane, exceeding higher selling prices by $5 million and $24 million, respectively. The previously announced unplanned shutdown at the Kingsport facility negatively impacted second quarter and first six months 2014 gross profit by approximately $10 million, primarily costs, in the AM, Fibers, and SFI segments. Gross profit in second quarter and first six months 2014 was negatively impacted by $2 million for the sale of the acquired aviation turbine oil business inventories, which were marked to fair value as required by purchase accounting. For more information see Note 2, "Acquisitions", to the Company's unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Second Quarter First Six Months (Dollars in millions) 2014 2013 Change 2014 2013 Change Selling, General and Administrative Expenses $ 172$ 180 (4 )% $ 340$ 351 (3 )% Acquisition transaction costs (3 ) - (3 ) - Acquisition integration costs (7 ) (8 ) (16 ) (15 ) Selling, General, and Administrative Expenses excluding non-core or non-recurring items $ 162$ 172 (6 )% $ 321$ 336 (4 )% SG&A expenses in second quarter and first six months 2014 were lower compared to second quarter and first six months 2013 primarily due to Solutia acquisition cost reduction synergies. 33

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[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Second Quarter First Six Months (Dollars in millions) 2014 2013 Change 2014 2013 Change Research and Development Expenses $ 56$ 51 10 % $ 109



$ 100 9 %

Research and development ("R&D") expenses were higher in second quarter and first six months 2014 compared to second quarter and first six months 2013 primarily due to increased R&D for growth initiatives in the AM and Additives & Functional Products ("AFP") segments.

Asset Impairments and Restructuring (Gains) Charges, Net

In second quarter and first six months 2014, there were net asset impairments and restructuring gains of $7 million and charges of $6 million, respectively.

During second quarter 2014, the Company recognized gains from the sale of previously impaired assets at the former Photovoltaics production facility in Germany and a former polymers production facility in China of $5 million and $2 million, respectively. In first six months 2014, charges consisted of $8 million of asset impairments, including intangible assets, and $2 million of restructuring charges in the AM segment primarily due to the closure of a production facility in Taiwan for the Flexvue® product line. First six months 2014 also included $3 million of restructuring charges for severance associated with the continued integration of Solutia.



In second quarter and first six months 2013, there were net asset impairments and restructuring charges of $18 million and $21 million, respectively.

During second quarter 2013, management decided to shut-down the Photovoltaics product line, including the primary production facility in Germany. This resulted in the Company recognizing asset impairments of $7 million and restructuring charges of $5 million including charges for severance. During second quarter 2013, management also approved and recorded severance charges of $6 million primarily for a voluntary separation plan for certain employees. During second quarter 2013, a change in estimate for certain costs associated with the fourth quarter 2012 termination of the operating agreement for the Sao Jose dos Campos, Brazil site resulted in a reduction of $4 million to previously recorded asset impairments and restructuring charges.



In second quarter and first six months 2013, there were $3 million and $6 million, respectively, of restructuring charges primarily for severance associated with the continued integration of Solutia.

For more information regarding asset impairments and restructuring charges and gains see Note 14, "Asset Impairments and Restructuring Charges (Gains), Net", to the Company's unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. 34 -------------------------------------------------------------------------------- [[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating Earnings Second Quarter First Six Months (Dollars in millions) 2014 2013 Change 2014 2013 Change Operating earnings $ 436$ 428 2 % $ 797$ 821 (3 )% Additional costs of acquired inventories 2 - 2 - Acquisition transaction costs 3 - 3 - Acquisition integration costs 7 8 16 15 Asset impairments and restructuring charges (gains), net (7 ) 18 6 21 Operating earnings excluding non-core or non-recurring items $ 441$ 454 (3 )% $ 824$ 857 (4 )% Net Interest Expense Second Quarter First Six Months (Dollars in millions) 2014 2013 Change 2014 2013 Change Gross interest costs $ 50$ 47$ 97$ 96 Less: Capitalized interest 2 - 4 1 Interest expense 48 47 2 % 93 95 (2 )% Interest income 3 1 6 2 Net interest expense $ 45$ 46 (2 )% $ 87$ 93 (6 )% Net interest expense decreased $1 million in second quarter 2014 compared to second quarter 2013. The decrease was primarily due to repayment in 2013 of the five-year term loan (the "Term Loan") used to finance part of the Solutia acquisition and increased capitalized interest partially offset by interest expense for the new $500 million principal amount notes issued in May 2014. Net interest expense decreased $6 million in first six months 2014 compared to first six months 2013. The decrease was primarily due to repayment in 2013 of the Term Loan.



Other Charges (Income), Net

Second Quarter First Six Months (Dollars in millions) 2014 2013 2014 2013 Foreign exchange transaction (gains) losses $ - $ (1 ) $ - $ 4 (Income) loss from equity investments and other investment (gains) losses, net (2 ) (1 ) (5 ) (3 ) Other, net (6 ) 2 (6 ) - Other charges (income), net $ (8 ) $ - $ (11 )$ 1 Included in other charges (income), net are gains or losses on foreign exchange transactions, equity investments, business venture investments, non-operating assets, and certain litigation costs and earnings. 35 -------------------------------------------------------------------------------- [[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Provision for Income Taxes Second Quarter First Six Months (Dollars in millions) 2014 2013 2014 2013 Provision for income taxes $ 107$ 116$ 195$ 213 Effective tax rate 27 % - 30 % 27 % 29 % Excluding non-core or non-recurring items, the second quarter and first six months 2014 effective tax rate, and the expected full year tax rate on reported earnings from continuing operations before income tax of approximately 28 percent, reflects benefit from the integration of Eastman and Solutia business operations and legal entity structures. The first six months 2013 effective tax rate was impacted by enactment of the American Taxpayer Relief Act of 2012 in January 2013, which resulted in a $10 million benefit primarily related to an R&D tax credit.



Earnings from Continuing Operations and Diluted Earnings per Share

Second Quarter 2014



2013

(Dollars in millions, except diluted EPS) $ EPS $ EPS Earnings from continuing operations, net of tax $ 290$ 1.92$ 264$ 1.69 Additional costs of acquired inventories, net of tax 1 - - - Acquisition transaction and integration costs, net of tax 6 0.04 6 0.03 Asset impairments and restructuring charges (gains), net of tax (6 ) (0.04 ) 12 0.08 Earnings from continuing operations excluding non-core or non-recurring items, net of tax $ 291$ 1.92$ 282$ 1.80 First Six Months 2014 2013 (Dollars in millions, except diluted EPS) $ EPS $ EPS Earnings from continuing operations, net of tax $ 523$ 3.43$ 511$ 3.26 Additional costs of acquired inventories, net of tax 1 0.01 - - Acquisition transaction and integration costs, net of tax 11 0.08 10 0.06 Asset impairments and restructuring charges (gains), net of tax 3 0.02 14 0.09 Earnings from continuing operations excluding non-core or non-recurring items, net of tax $ 538$ 3.54$ 535$ 3.41



Second quarter and first six months 2014 diluted shares outstanding were less than second quarter and first six months 2013 primarily due to an increased number of shares repurchased in the first six months of 2014.

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[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Net Earnings and Diluted Earnings per Share

Second Quarter 2014



2013

(Dollars in millions, except diluted EPS) $ EPS $



EPS

Earnings from continuing operations, net of tax $ 290$ 1.92$ 264

$ 1.69 Earnings from discontinued operations, net of tax 2 0.01 - - Net earnings $ 292$ 1.93$ 264$ 1.69 First Six Months 2014 2013 (Dollars in millions, except diluted EPS) $ EPS $



EPS

Earnings from continuing operations, net of tax $ 523$ 3.43$ 511

$ 3.26 Earnings from discontinued operations, net of tax 2 0.02 - - Net earnings $ 525$ 3.45$ 511$ 3.26



In second quarter 2014, the Company recognized $2 million, net of tax, in earnings from discontinued operations from final settlement of commercial litigation related to the previously discontinued polyethylene terephthalate ("PET") business.

SUMMARY BY OPERATING SEGMENT Eastman has five reporting segments: Additives & Functional Products ("AFP"), Adhesives & Plasticizers ("A&P"), Advanced Materials ("AM"), Fibers, and Specialty Fluids & Intermediates ("SFI"). For additional information concerning the Company's segments' businesses and products, see Note 21, "Segment Information" to the consolidated financial statements in Part II, Item 8 of the Company's 2013 Annual Report on Form 10-K.



Additives & Functional Products Segment

Second Quarter First Six Months Change Change (Dollars in millions) 2014 2013 $ % 2014 2013 $ % Sales $ 452$ 430$ 22 5 % $ 875$ 849$ 26 3 % Volume effect 17 4 % 16 2 % Price effect 2 - % 6 1 % Exchange rate effect 3 1 % 4 - % Operating earnings 105 104 1 1 % 199 202 (3 ) (1 )% Asset impairments and restructuring charges (gains), net (2 ) 1 (2 ) 1 Operating earnings excluding non-core or non-recurring items 103 105 (2 ) (2 )% 197 203 (6 ) (3 )% Sales revenue in second quarter and first six months 2014 increased compared to second quarter and first six months 2013 primarily due to higher sales volume for coatings product lines attributed to strengthened demand, particularly for architectural coatings in the building and construction end market. 37 --------------------------------------------------------------------------------

[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating earnings in second quarter 2014 were relatively unchanged compared to second quarter 2013. Operating earnings in second quarter 2014 included a gain of approximately $2 million for previously impaired assets at a former polymers production facility in China. Excluding non-core or non-recurring items, operating earnings decreased slightly in second quarter 2014 compared to second quarter 2013. The decrease was primarily due to higher raw material and energy costs, particularly for propane, offsetting slightly higher selling prices for polymer product lines by $9 million and $3 million costs of refinement and enhancement of Crystex® insoluble sulfur rubber additive technology. The decrease was mostly offset by $9 million of higher sales volume. Operating earnings in first six months 2014 decreased compared to first six months 2013. Excluding non-core or non-recurring items, operating earnings decreased in first six months 2014 compared to first six months 2013. The decrease was primarily due to higher raw material and energy costs, particularly for propane, offsetting slightly higher selling prices for polymer product lines by $14 million and $5 million costs of refinement and enhancement of Crystex® insoluble sulfur rubber additive technology. The decrease was partially offset by $11 million of higher sales volume. The Company continues to make progress in the refinement and enhancement of its technology for the manufacture of Crystex® insoluble sulfur rubber additive in order to improve its cost position and introduce a higher performance product into the tires industry market. The Company continues to evaluate timing of incorporating this technology into a capacity expansion at the Kuantan, Malaysia manufacturing facility to capitalize on expected high industrial growth rates in the Asia Pacific region.



Adhesives & Plasticizers Segment

Second Quarter First Six Months Change Change (Dollars in millions) 2014 2013 $ % 2014 2013 $ % Sales $ 358$ 339$ 19 6 % $ 703$ 684$ 19 3 % Volume effect 29 9 % 38 6 % Price effect (13 ) (4 )% (24 ) (4 )% Exchange rate effect 3 1 % 5 1 % Operating earnings 56 49 7 14 % 103 98 5 5 % Asset impairments and restructuring charges (gains), net - 1 - 1 Operating earnings excluding non-core or non-recurring item 56 50 6 12 % 103 99 4 4 % Sales revenue in second quarter and first six months 2014 increased compared to second quarter and first six months 2013 primarily due to higher sales volume more than offsetting lower selling prices. Higher sales volume for adhesives resins product lines, primarily in Europe, was mostly attributed to stronger end-market demand, particularly for hygiene and packaging, and customer inventory destocking that negatively impacted second quarter and first six months 2013. Higher sales volume for plasticizers product lines was primarily attributed to the timing of substitution of phthalate plasticizers with Eastman non-phthalate plasticizers. Lower selling prices for adhesives resins product lines were primarily due to continued competitive pressure resulting from greater industry supply attributed to increased availability of key raw materials and additional competitor capacity. Lower selling prices for plasticizers product lines were primarily attributed to continued competitive pressures resulting from weakened demand in Asia Pacific and Europe. Excluding non-core or non-recurring items, operating earnings increased in second quarter and first six months 2014 primarily due to higher sales volume of $10 million and $14 million, respectively, and lower operating costs including the benefit of higher capacity utilization that resulted in lower unit costs and targeted cost reductions of $7 million and $14 million, respectively, more than offsetting lower selling prices and slightly higher raw material and energy costs of $14 million and $27 million, respectively. 38 --------------------------------------------------------------------------------

[[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Expansion of Eastman 168™ non-phthalate plasticizers' capacity at the manufacturing facility in Texas City, Texas was completed in second quarter 2014.

In 2012, the Company announced a joint venture to build a hydrogenated hydrocarbon resin plant in Nanjing, China. The venture will be equally owned by Eastman and Sinopec Yangzi Petrochemical Company Limited. The Company and Sinopec Yangzi Petrochemical Company Limited continue to evaluate the timing depending upon market conditions for hydrogenated hydrocarbon resins. The facility is expected to produce 50,000 metric tons of the A&P segment's Regalite™ hydrogenated hydrocarbon resins upon completion, increasing Eastman's total capacity for hydrogenated resins by 50 percent, making Eastman the largest global supplier of hydrogenated hydrocarbon resins, and supporting expected demand growth for its products in hygiene and packaging applications. Advanced Materials Segment Second Quarter First Six Months Change Change (Dollars in millions) 2014 2013 $ % 2014 2013 $ % Sales $ 631$ 625$ 6 1 % $ 1,212$ 1,209$ 3 - % Volume effect 3 - % 5 - % Price effect (2 ) - % (8 ) (1 )% Exchange rate effect 5 1 % 6 1 % Operating earnings 80 82 (2 ) (2 )% 141 147 (6 ) (4 )% Asset impairments and restructuring charges (gains), net - (1 ) 10 (1 ) Operating earnings excluding non-core or non-recurring items 80 81 (1 ) (1 )% 151 146 5 3 % Sales revenue in second quarter and first six months 2014 increased slightly compared to second quarter and first six months 2013 as higher sales volume for interlayers with acoustic properties and Eastman Tritan™ copolyester was mostly offset by lower sales volume for Flexure® coated films. Excluding non-core or non-recurring items, operating earnings in second quarter 2014 were relatively unchanged compared to second quarter 2013. Second quarter 2014 operating earnings were negatively impacted by $3 million, primarily costs, for the unplanned shutdown at the Kingsport site. Operating earnings in first six months 2014 decreased slightly compared to first six months 2013. Operating earnings in first six months 2014 included asset impairments and restructuring charges of $10 million primarily for the closure of a production facility in Taiwan for the Flexvue® product line. Excluding non-core or non-recurring items, operating earnings increased in first six months 2014 compared to first six months 2013 primarily due to lower unit costs for specialty plastics. The lower unit costs were due to higher capacity utilization resulting from previous inventory management decisions.



In 2013, the Company began the expansion of Eastman TritanTM copolyester capacity at its Kingsport, Tennessee manufacturing facility. This expansion is expected to be operational in the second half of 2014.

The Company is also progressing on enhancements and innovations to improve its cost position in its polyvinyl butyral ("PVB") resin technology supporting growth in the transportation and building and construction markets in the Asia Pacific region. The Company continues to evaluate timing of a capacity expansion at the Kuantan, Malaysia PVB manufacturing facility.



In March 2014, the Company entered into a definitive agreement to acquire Commonwealth Laminating & Coating, Inc., a specialty films business. The acquisition is expected to be completed in the second half of 2014.

39 -------------------------------------------------------------------------------- [[Image Removed]] MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Fibers Segment Second Quarter First Six Months Change Change (Dollars in millions) 2014 2013 $ % 2014 2013 $ % Sales $ 386$ 363$ 23 6 % $ 740$ 709$ 31 4 % Volume effect 9 2 % (2 ) - % Price effect 13 4 % 31 4 % Exchange rate effect 1 - % 2 - % Operating earnings 123 116 7 6 % 240 230 10 4 % Sales revenue in second quarter 2014 increased compared to second quarter 2013 primarily due to higher selling prices and sales of acetate flake to Eastman's China acetate tow joint venture more than offsetting lower acetate tow sales volume. The lower acetate tow sales volume was primarily attributed to additional industry capacity including Eastman's China acetate tow joint venture. Sales revenue in first six months 2014 increased compared to first six months 2013 primarily due to higher selling prices more than offsetting slightly lower sales volume. Lower sales volume for acetate tow, primarily attributed to additional industry capacity including Eastman's China acetate tow joint venture, was mostly offset by higher acetate flake sales volume to Eastman's China acetate tow joint venture. Operating earnings in second quarter and first six months 2014 increased compared to second quarter and first six months 2013 primarily due to $17 million and $34 million, respectively, of higher selling prices and slightly lower raw material and energy costs, mostly offset by $11 million and $30 million, respectively, in lower sales volume for acetate tow and related lower capacity utilization resulting in higher unit costs. In addition, operating earnings increased by $4 million and $12 million, respectively, due to higher acetate flake sales to Eastman's China acetate tow joint venture. Second quarter and first six months 2014 operating earnings were negatively impacted by $3 million, primarily costs, for the unplanned shutdown at the Kingsport site. Income or loss from the China acetate tow joint venture is reported as an equity investment in "Other (income) charges, net" within the Unaudited Consolidated Statements of Earnings. 40

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