UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-K
(Mark One)
Commission file number 1-12626
EASTMAN CHEMICAL COMPANY
Registrant’s telephone number, including area code: (423) 229-2000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
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EASTMAN CHEMICAL COMPANY AND SUBSIDIARIES
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 o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes x No o
The aggregate market value (based upon the closing price on the New York Stock Exchange on June 30, 2002) of the 77,085,937 shares of common equity held by nonaffiliates as of December 31, 2002 was approximately $3,615,330,445, using beneficial ownership rules adopted pursuant to Section 13 of the Securities Exchange Act of 1934, as amended, to exclude common stock that may be deemed beneficially owned as of December 31, 2002 by the current directors and executive officers and Eastman Chemical Company’s (“Eastman” or the “Company”) charitable foundation, some of whom might not be held to be affiliates upon judicial determination. At December 31, 2002, 77,346,296 shares of common stock of the registrant were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement relating to the 2003 Annual Meeting of Stockholders (the “2003 Proxy Statement”), to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10 to 12 of this Annual Report on Form 10-K (the “Annual Report”) as indicated herein.
FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report are forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. These statements and other written and oral forward-looking statements made by the Company from time to time 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; legal proceedings; exposure to, and effects of hedging of, raw material and energy costs and foreign currencies; global and regional economic, political, and business conditions; competition; growth opportunities; supply and demand, volume, price, cost, margin, and sales; earnings, cash flow, dividends and other expected financial conditions; expectations, strategies, and plans for individual products, businesses, segments and divisions as well as for the whole of Eastman; cash requirements and uses of available cash; financing plans; pension expenses and funding; future expenses and insurance settlement associated with operational disruptions; credit rating; cost reduction and control efforts and targets; integration and rationalization of acquired businesses; development, production, commercialization, and acceptance of new products, services and technologies and related costs; and business, asset and product portfolio changes.
These plans and expectations are based upon certain underlying assumptions, including those mentioned with the specific statements. Such assumptions are in turn based upon internal estimates and analyses of current market conditions and trends, management plans and strategies, economic conditions and other factors. These plans and expectations 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. Certain important factors that could cause actual results to differ materially from those in the forward-looking statements are included with such forward-looking statements and in Part II—Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward-Looking Statements and Risk Factors.”
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TABLE OF CONTENTS
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PART I
ITEM 1. BUSINESS
CORPORATE PROFILE
Eastman Chemical Company (“Eastman” or the “Company”), a global chemical company engaged in the manufacture and sale of a broad portfolio of chemicals, plastics, and fibers, began business in 1920 for the purpose of producing chemicals for Eastman Kodak Company’s (“Kodak’s”) photographic business. The Company was incorporated in Delaware in 1993 and became an independent entity as of December 31, 1993, when Kodak spun off its chemicals business. The Company’s headquarters and largest manufacturing site are located in Kingsport, Tennessee.
Eastman is the largest producer of polyethylene terephthalate (“PET”) polymers for packaging based on capacity share and is a leading supplier of raw materials for paints and coatings, inks and graphic arts, adhesives, textile sizes, and other formulated products, and of cellulose acetate fibers. Eastman has 41 manufacturing sites in 17 countries that supply major chemicals, fibers, and plastics products to customers throughout the world. In 2002, the Company had sales revenue of $5.3 billion, operating earnings of $208 million, and net earnings of $61 million. Earnings per diluted share were $0.79.
The Company’s products and operations are managed and reported in five operating segments. Effective January 1, 2002, the Company implemented a divisional structure that separated the businesses into two divisions. Eastman Division consists of the Coatings, Adhesives, Specialty Polymers, and Inks (“CASPI”) segment, the Performance Chemicals and Intermediates (“PCI”) segment and the Specialty Plastics (“SP”) segment. Voridian Division contains the Polymers segment and the Fibers segment.
EASTMAN DIVISION
Business and Industry Overview
Operating in a variety of markets with varying growth prospects and competitive factors, the segments in Eastman Division manufacture a diverse portfolio of specialty chemicals and plastics that are used in a wide range of consumer and industrial markets. With 35 manufacturing sites in 15 countries, Eastman Division is focused on providing its customers with chemicals and plastics products that meet their evolving needs. Eastman Division is comprised of the following segments: CASPI, PCI, and SP, which are more fully discussed below.
The CASPI segment generally competes in the markets for raw materials for paints and coatings, inks and graphic arts and adhesives. Growth in these markets in North America and Europe typically coincides with economic growth in general, due to the wide variety of end uses for these applications and the particular dependence on the economic conditions of the market for durable goods. Higher growth sub-markets exist within North America and Europe, driven primarily by increasing governmental regulation. Industry participants are promoting, for example, products and technologies primarily designed to reduce air emissions. Growth outside of North America and Europe is substantially higher, driven primarily by the increasing requirements of industrializing economies. The adhesives raw materials market historical growth rate has been consistent with general economic growth. In addition to steady overall market growth, Eastman believes that greater growth opportunities exist for hot melt adhesives due to their superior performance characteristics and the resulting ability to displace other adhesives.
The PCI segment competes in diverse markets for its intermediates, specialty organic and custom manufacturing chemicals offerings. Specialty organic chemicals products are specifically developed based on product performance criteria, which make market quantification difficult. Instead, the focus in this market is on specific opportunities for value added products, and market size, growth opportunities and other industry characteristics are a function of the level and extent to which a producer chooses to participate in niche opportunities driven by these customer specifications. For other PCI products, the markets are varied, from durables to food products to pharmaceuticals and, although opportunities for differentiation on service and product offerings exist, these products compete primarily on price.
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The SP segment competes in the market for the development of plastics that meet specific performance criteria, typically determined on an application-by-application basis. Development is dependent upon a manufacturer’s ability to design products that achieve specific performance characteristics determined by the customer, while doing so either more effectively or more efficiently than alternative materials such as polycarbonate (“PC”) and acrylic. Increases in market share are gained through the development of new applications, substitution of plastic for other materials, and particularly, displacement by plastic resins in existing applications. The Company estimates that the market growth for copolyesters, which has historically been high due to the relatively small market size, will be substantially higher than general economic growth due to displacement opportunities. Eastman believes that growth of the cellulosic plastics markets will be flat or, at best, equal to the rate of growth of the economy in general.
Strategy
The Company’s objectives for Eastman Division are to improve gross margins, accelerate revenues and earnings growth through exploiting growth opportunities in its core businesses, and build capabilities for future growth. The key elements of this strategy include:
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The Company currently has in place and continues to pursue opportunities for joint ventures, equity investments and other alliances. These strategic initiatives are expected to diversify and strengthen businesses by providing access to new markets and high-growth areas as well as providing an efficient means of ensuring that Eastman is involved in and supportive of technological innovation in or related to the chemicals industry. The Company is committed to pursuing these initiatives in order to capitalize on new business concepts that differentiate it from other chemical manufacturers and that will provide incremental growth beyond that which is inherent in the chemicals industry and at lesser capital investment requirements.
The Company’s current initiatives include its approximate 42% equity interest in Genencor International, Inc. (“Genencor”), a publicly traded biotechnology company engaged in the discovery, development, manufacture, and marketing of biotechnology products for the industrial chemicals, agricultural, and health care markets, and a developer of integrated genomics technology. The Company, which was an early stage investor and held a 50% interest prior to Genencor’s initial public offering in 2000, believes this investment provides the opportunity for a financial return as well as access to complementary technologies that may result in expanded product offerings and additional market penetration. Genencor is accounted for by the equity method of accounting for investments in common stock. Genencor’s common stock is registered under the Securities Exchange Act of 1934 and is listed on the NASDAQ National Market System under the symbol GCOR. See the “Investments” section of Note 1 to the Company’s consolidated financial statements for a discussion of the equity method of accounting for the investment in Genencor.
CASPI SEGMENT
Through the CASPI segment, Eastman Division manufactures binders, liquid vehicles, pigment concentrates and additives, unsaturated polyester resins and polyester and acrylic emulsions, which are integral to the production of paints and coatings, inks and graphic arts, adhesives, textile sizes and other formulated products. The CASPI segment focuses on raw materials rather than finished products in order to develop long-term, strategic relationships and achieve preferred supplier status with its customers. In 2002, the CASPI segment had sales revenue of approximately $1.6 billion, which represented 29% of Eastman’s total sales and 43% of Eastman Division’s total sales.
Success in the CASPI segment is dependent upon Eastman Division’s ability to realize value from the optimization of returns from recently-acquired businesses and assets and to capitalize on organic growth opportunities by offering existing products and technologies to new markets and new products and technologies to customers in multiple markets. For these reasons, activities within the CASPI segment are focused on capitalizing on the higher growth rates in environmentally friendly products such as waterborne, powder and pigment dispersion technologies and on higher growth geographical markets, such as the Asia Pacific region. The CASPI segment has strong technology capabilities and an international presence that position it to take advantage of new product growth and international opportunities. Continued optimization will result in further operational efficiencies in areas such as manufacturing, supply chain and cost management. This optimization, coupled with further rationalization of businesses and products, is expected to improve overall gross margins.
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PCI SEGMENT
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In order to build on and maintain its status as a low–cost producer, Eastman continuously focuses on cost control, operational efficiency and capacity utilization in order to maximize earnings. The Company’s highly integrated and world-scale manufacturing facilities position it to achieve its strategic goals. For example, the Kingsport, Tennessee manufacturing facilities allow the PCI segment to produce acetic anhydride and other acetyl derivatives from coal rather than natural gas or other petroleum feedstocks. Similarly, at the Longview, Texas facility, the PCI segment utilizes local ethane and propane supplies along with Eastman’s proprietary oxo-technology in the world’s largest single-site oxo-aldehyde manufacturing facility to produce a wide range of alcohols, esters and other derivatives products. These integrated facilities, combined with large scale production processes and continuous focus on additional process improvements, allow the Company to remain cost competitive with, and for many products cost-advantaged over, its competitors.
Because of the niche applications of the PCI segment’s specialty organic chemical products, each individual product offering is tailored to specific end uses. Other performance chemicals and intermediates are more readily substitutable, and have a more identifiable potential customer base. In order to obtain a better understanding of its customers’ requirements, which in turn allows it to focus on developing application-specific products, the Company focuses on establishing long-term, partnership-oriented relationships with its customers. From time to time, customers decide to vertically integrate their own processes and internally develop products or diversify their sources of supply that had been provided by Eastman. Approximately 80% of the PCI segment’s sales revenue in 2002 was to 100 customers out of approximately 1,450 customers worldwide.
During 2001, the Company reported that a large customer of the PCI segment did not intend to renew its contract for a custom synthesis product beyond June 30, 2002. As a consequence, the related assets were impaired as expected cash flows over the remaining term of the contract were not sufficient to recover the carrying value of such assets. Nonrecurring charges related to the impacted assets were recorded during the second and third quarters 2001 as part of the $69 million in charges taken for restructuring of the fine chemicals product lines, as described in Note 15 to the Company’s consolidated financial statements. Subsequently, the customer initiated discussions with the Company, which resulted in an agreement being reached in June 2002, to extend the custom synthesis product contract one year based on renegotiated terms. Sales revenue related to the contract extension was approximately 3% of the PCI segment’s sales in 2002.
The PCI segment’s products are used in a variety of markets and end uses, including agrochemical, automotive, beverages, catalysts, nutrition, pharmaceuticals, coatings, flooring, medical devices, toys, photographic and imaging, household products, polymers, textiles and consumer and industrials. The markets for products with market-based pricing in the PCI segment are cyclical. This cyclicality is caused by periods of supply and demand imbalance, either when incremental capacity additions are not offset by corresponding increases in demand, or when demand exceeds existing supply. Demand, in turn, is based on general economic conditions, energy prices, consumer demand and other factors beyond the Company’s control. Eastman may be unable to increase or maintain its level of sales in periods of economic stagnation or downturn, and its future results of operations and financial condition may experience fluctuations from period to period due to these economic conditions. The Company believes many of these markets to be in the “trough” of the cycle. Cyclicality is expected to remain a significant factor in the PCI segment, particularly in the near term, as existing capacity becomes absorbed and utilization rates increase from current levels. The Company believes that, as excess capacity disappears, market conditions will improve.
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For specialty organic chemicals and other niche applications, there are typically few equivalent products, as the products and their applications are very specialized. For this reason, producers compete with others only to the extent they attempt to manufacture similar or enhanced products that share performance characteristics. Barriers to entry in this market have typically been cost, either due to raw material, integration, size or capacity issues, technology and customer service. On a general level, Eastman’s primary competitors for specialty organic chemicals are multinational specialty chemical manufacturers such as Ciba Specialty Chemicals Holding Inc., Clariant International Ltd. and Lonza Group Ltd. Recently, an increasing number of producers, primarily from China and India, have been entering the market primarily on price, benefiting from low-cost labor, less stringent environmental regulations and government support. These producers may later focus on improving their product quality and customer service. Although the entry of new competitors is impacting the pricing of existing products, Eastman believes it currently maintains a competitive advantage over these competitors due to the combination of its successful research and development applications, its low-cost manufacturing base due to vertical integration, its long-term customer relations and related customer service focus, as well as the fact that these suppliers are frequently unable to produce products of consistently high quality.
For the majority of the PCI segment’s products with market-based pricing, historically there have been significant barriers to entry, namely the fact that the relevant technology has been held by a small number of companies. As this technology has become more readily available, competition from multinational chemicals manufacturers has intensified. Eastman competes with these and other producers primarily based on price, as products are interchangeable, and, to a lesser extent, based on technology, marketing and other resources. While some of the Company’s competitors within the PCI segment have greater financial resources than Eastman does, which may better enable them to compete on price, the Company believes it maintains a strong position due to a combination of its scale of operations, breadth of product line, level of integration and technology leadership. For manufacturers of products with market-based pricing, there continues to be increasing consolidation, as evidenced by the combination of Dow and Union Carbide Corporation in 2001.
SP SEGMENT
The SP segment produces highly specialized copolyesters, cellulosic plastics and compounded polyethylene plastics that possess unique performance properties for value-added end uses such as appliances, store fixtures and displays, building and construction, electronics and electronic packaging, medical packaging, personal care and cosmetics, performance films, tape and labels, biodegradeables, cups and lids, fiber and strapping, photographic and optical, graphic arts and general packaging. In 2002, the SP segment had sales revenue of $595 million, which represented approximately 10% of Eastman’s total sales and 16% of Eastman Division’s total sales.
Specialty copolyester products within the SP segment, including modified specialty copolyesters such as Eastar™ and Spectar™, have higher than industry average growth rates. Eastman’s specialty copolyesters, which generally are based on Eastman’s market leading supply of CHDM modified polymers, typically fill a market position between polycarbonates and acrylics. While polycarbonates traditionally have had some superior performance characteristics, acrylics have been less expensive. Specialty copolyesters combine superior performance with competitive pricing and are taking market share from both polycarbonates and acrylics as their performance characteristics continue to improve and their pricing remains competitive.
The specialty copolyesters market also includes environmentally friendly specialty copolyesters and plastic sheeting that allow for flexibility in designing signs and displays. The SP segment includes cellulosic plastics, which has historically been a steady business with strong operating margins for the Company, and also includes what Eastman believes is a North American market-leading position in cellulose esters for tape and film products and cellulose plastics for molding applications.
Eastman has the ability within its SP segment to modify its polymers and plastics to control and customize their final properties, creating numerous opportunities for new application development, including the expertise to develop new materials and new applications starting from the molecular level in the research laboratory to the final designed application in the customer’s plant. In addition, the SP segment has a long history of manufacturing excellence with strong process improvement programs providing continuing cost reduction.
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Manufacturing process models and information technology systems support global manufacturing sites and provide monitoring and information transfer capability that speed up the innovation process.
The SP segment’s key products are:
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EASTMAN DIVISION GENERAL INFORMATION
Sales, Marketing and Distribution
The Company markets Eastman Division products primarily through a global sales organization, which has a presence in the United States as well as in over 35 other countries around the world. Eastman Division has a number of broad product lines which require a sales and marketing strategy that is tailored to specific customers in order to deliver high quality products and high levels of service to all of its customers worldwide. Judgment and process knowledge are critical in determining the application of Eastman Division’s products for a particular customer. Through a highly skilled and specialized sales force that is capable of providing customized business solutions for each of its three operating segments, Eastman Division is able to establish long-term customer relationships and strives to become the preferred supplier of specialty chemicals and plastics.
Eastman Division’s products are marketed through a variety of selling channels, with the majority of sales being direct and the balance sold primarily through indirect channels such as distributors. International sales tend to be made more frequently through distributors than domestic sales. Eastman Division’s customers throughout the world have the choice of obtaining products and services through Eastman’s website, www.eastman.com, through any of the global customer service centers, or through any of Eastman’s direct sales force or independent distributors. Customers who choose to use the Company’s website can conduct a wide range of business transactions such as ordering online, accessing account and order status and obtaining product and technical data.
Eastman is an industry leader in the implementation and utilization of e-business technology for marketing products to customers and was one of the first chemical companies to offer this capability. Eastman views this as an opportunity to increase supply chain efficiency by having an enterprise resource-planning platform with connectivity to customers. These sales and marketing capabilities combine to reduce costs and provide a platform for growth opportunities for the Company by providing potential customers new methods to access Eastman’s products.
Eastman Division’s products are shipped to customers directly from Eastman’s manufacturing plants as well as from distribution centers worldwide, with the method of shipment generally determined by the customer. In order to further capitalize on its expertise and minimize its costs, the Company completed the outsourcing of all of its North American logistics needs to Cendian in 2001 and substantially all of its international logistics requirements in 2002. Cendian also provides logistics outsourcing services to other chemicals manufacturers and companies.
Intellectual Property and Trademarks
The Company considers its Eastman Division-related intellectual property portfolio to be a valuable corporate asset which it expands and vigorously protects globally through a combination of patents that expire at various times, trademarks, copyrights and trade secrets. The Company’s primary strategy regarding its Eastman Division-related intellectual property portfolio is to protect all innovations that provide its segments with a significant competitive advantage. The Company also derives significant value from its intellectual property by actively licensing and selling patents and expertise worldwide. In addition, when appropriate, the Company licenses technology from third parties that complement Eastman Division’s strategic business objectives. Neither Eastman Division’s business as a whole nor any particular segment is materially dependent upon any one particular patent, trademark, copyright, or trade secret. As a producer of a broad and diverse portfolio of chemicals and plastics, Eastman Division’s intellectual property and trademarks relate to a wide variety of products and processes. As the laws of many foreign countries do not protect intellectual property to the same extent as the laws of the United States, Eastman Division cannot assure that it will be able to adequately protect all of its intellectual property assets.
Research and Development
Eastman Division devotes significant resources to its research and development programs, which are primarily targeted towards three objectives:
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In the last several years, research and development has developed a number of new copolyesters for specific market applications and has improved the Company’s specialty polyester manufacturing expertise. There has been a significant expansion in coatings and adhesives technologies, resulting in a number of new products in the waterborne and emulsion resins area. In addition, a new cellulose based water dispersible additive that has been commercialized provides the opportunity for more environmentally friendly automotive coatings while maintaining a smooth finish. Recently, Eastman Division has discovered and is developing Bophoz ™, a catalyst that has the potential to provide intermediates for medicinal drugs. This is a recent innovation for Eastman Division, and the Company believes it has large market potential in the pharmaceutical and other industries.
VORIDIAN DIVISION
The Voridian Division consists of the Polymers segment and the Fibers segment. The Polymers segment is the largest producer of PET polymers for packaging based on capacity share and the Fibers segment is one of the two largest producers of acetate tow worldwide. With eight manufacturing plants in six countries and two contract-manufacturing arrangements in Asia, Voridian is globally positioned to serve its growing markets.
PET polymers are clear, lightweight plastics used principally in packaging applications such as containers for beverages, edible oils and other foods. To a lesser extent, they are also used in films and sheet for packaging and consumer and industrial applications. Defining characteristics include high strength, light weight, durability, clarity, versatility, low cost, safety and recyclability.
In 2002, the worldwide market for PET polymers, including containers, film and sheet was over 8.9 million metric tons. Demand for PET polymers has grown briskly over the past several years, driven by its popularity as a substitute for glass in packaging and consumer applications. PET polymers have already made significant inroads in soft drink and water bottles, and producers are currently targeting markets such as hot-fill and barrier containers for beer, soups and sauces. Industry analysts report that PET polymers consumption grew worldwide from 1.0 million metric tons in 1989 to approximately 8 million in 2001, a compound annual growth rate of 17.3%. Global demand for PET polymers is expected to grow approximately 10% annually over the next several years. The strong growth in demand, coupled with ease of access to manufacturing technology, has resulted in the presence of approximately seventy suppliers in this market, up from fewer than twenty in 1995. Capacity utilization rates in Western Europe and the Americas could decline slightly in 2003 if expected additions to capacity materialize.
The Polymers segment’s polyethylene products consist of both low-density polyethylene, or LDPE, and linear low-density polyethylene, or LLDPE. According to industry analysts, demand growth in the combined LDPE and LLDPE markets in North America is expected to be 2% to 3% through 2005. Competitive advantages in this market are achieved through increased operating efficiencies and new product offerings.
The industries utilizing PET polymers and polyethylene products compete to a large extent on price and can be characterized as capital intensive. Success in these industries depends largely on attaining scale-related benefits by keeping manufacturing costs at a minimum through the use of efficient processes at high levels of capacity utilization and obtaining access to low-cost utilities, energy and raw materials.
The acetate tow market, which Voridian believes is approximately a $2 billion market annually, grew at a rate of 2.5% annually from 1998 to 2001. Voridian estimates that, for 2002, the acetate tow market grew by 1% to 2% as compared to 2001. Three trends are contributing to the current increase in demand and are expected to do so in future years:
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If polypropylene tow usage in China was totally replaced by acetate tow over the next five years, the world market for acetate tow could grow at a rate of approximately 2% per year. Increased filter lengths due to legislated lower tar deliveries in the European Union, Brazil and China could increase the expected growth rate to 2% to 3% per year for the next few years. After polypropylene tow is replaced in China, the expected growth rate for worldwide demand is approximately 0.5% to 1.0% per year. Included within these estimates are adjustments for the expected decrease in cigarette consumption in the United States, which is expected to be more than offset by a corresponding increase in consumption overseas.
Voridian estimates that the market for acetate yarn was approximately $300 million in 2002. The demand for acetate yarn has declined 50% since the mid-1990’s due to the impact of business casual fashions and the substitution of polyester yarn. This decrease in demand has led to associated decreases in price and profitability throughout the market. The market demand is expected to stabilize at these levels for the next 2 to 3 years.
Voridian focuses on strategic goals that are appropriate for a company operating in a price-sensitive industry. Voridian will continue to take advantage of its global position as one of the most efficient producers of PET polymers and acetate tow, while maintaining its reputation for market-leading quality products at competitive prices. To achieve these objectives, Voridian employs operational strategies on both a division-wide and segment-by-segment basis. The key elements of the division-wide strategy include:
Voridian is a global leader in market share in two of its major product markets and expects to leverage its product knowledge, experience and scale to further reduce production costs and increase output. As a highly integrated major PET polymers producer and one of only a few integrated acetate fiber producers, Voridian intends to develop further efficiencies to enhance its cost position.
Voridian is a leader in developing and implementing improved process technologies through efficient use of research and development. Voridian intends to develop increasingly efficient technologies to improve its cost position with the goal of improving operating margins.
Voridian’s product quality and innovation make it a recognized industry leader in the manufacture of PET polymers and acetate fibers products. Voridian will continue to commercialize new PET polymers products driven by customer needs and consumer preference.
Voridian intends to expand its production capabilities in a capital-efficient manner. Voridian intends to focus on utilizing excess capacity at existing manufacturing sites, adding capacity by reducing bottlenecks in its current production lines to increase productivity and participating in strategic manufacturing alliances.
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POLYMERS SEGMENT
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The Polymers segment has a diverse customer base consisting of more than 150 companies worldwide. The largest 75 customers within the Polymers segment accounted for 80% of the segment’s total sales revenue in 2002. These customers are primarily PET polymer container suppliers whose business is in the large volume beverage segments such as carbonated soft drinks, water and juice, with strong participation in custom areas such as food, liquor, sport and fruit beverages, health and beauty aids and household products.
PET polymers supply has significantly exceeded demand since 1997 as a result of excess capacity being introduced into the market. While the demand for PET polymers has steadily increased since then, some excess capacity still remains. As a result of this imbalance, the Polymers segment may continue to be unable to maintain sales volume at desired price levels.
Within the PET resin industry, competition varies by region. There are a substantial number of regional competitors worldwide, with no PET polymers competitors having any dominant role or any significant competitive advantage over Voridian. These competitors, such as KoSa, M&G and Wellman do not have Voridian’s level of integration or global operations. Competition is primarily on the basis of price, as well as product performance and quality, service and reliability. Industry pricing, in turn, is strongly affected by industry capacity utilization and raw material costs. For this reason, the Company believes that the combination of its size and scale of operations enables Voridian to be a low-cost PET polymers producer, providing a significant advantage.
In the marketing of PET resin, the Company believes it maintains a distinct competitive advantage due to its breadth of product line and formula capability. Voridian is considered to be a technology leader in PET polymers and strives to remain at the forefront of new product development.
Voridian is a niche polyethylene producer due to its size and ability to target specific markets. In the low-density polyethylene product line, Voridian is a significant producer of materials used in extrusion coatings applications and is one of only two North American producers of acrylate copolymers. In the linear low-density polyethylene market, Voridian employs its proprietary Energx™ technology, which offers ease of processability, to compete in higher strength film markets. Some polyethylene producers are substantially larger than Voridian, and have greater market presence and resources devoted to polyethylene than Voridian. This may allow them, or other competitors, to price competing products at lower levels, or devote substantial resources to product development, that Voridian is unable or unwilling to match, which may substantially impair Voridian’s polyethylene revenues.
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FIBERS SEGMENT
Voridian’s growth strategy in the Fibers segment is as follows:
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The customer base in the Fibers segment is relatively concentrated, consisting of about 150 companies, primarily those involved in the production of cigarettes and in the textiles industry. The largest 20 customers within the Fibers segment, multinational as well as regional cigarette producers and textile industry fabric manufacturers, accounted for greater than 80% of the segment’s total sales revenue in 2002.
Voridian is well known for its expert technical service. Voridian periodically reviews customers’ processes and provides process training to some of its customers’ employees to assist them in the efficient use of Voridian’s products. Voridian also engages in collaborative planning with its customers to maximize supply chain management. These customer-focused efforts, combined with Voridian’s long history and product quality reputation, have resulted in many long-term customer relationships, a key competitive advantage.
Competition in the fibers industry is based primarily on product quality, technical and customer service, reliability, long-term customer relationships and price. To be successful, Voridian is required to minimize costs and maximize production efficiency. Competitors in the fibers market include one global supplier, Celanese AG, in both the acetate tow and yarn markets, and several regional competitors in each market. The supply and demand balance at a given time affects pricing in the market. Currently, the acetate yarn market has an excess supply of products due to manufacturing capacity remaining high while demand declined, resulting in lower prices. Voridian management believes it is well positioned to respond to competitive price pressures due to its scale of operations and level of integration.
In the acetate tow market, Celanese AG has capacity in China and is considering additional capacity through joint ventures with the government-owned China National Tobacco Corporation. Increased local production in China may diminish Voridian’s access to this market.
Within the acetate yarn market, product quality, technical service and global distribution are key competitive factors. Particularly with respect to textile customers, a majority of the customer base and production capacity has moved to regions where Voridian does not have manufacturing sites. This shift in the worldwide customer base requires Voridian to capitalize upon its global product distribution capability and product quality.
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VORIDIAN DIVISION GENERAL INFORMATION
Voridian primarily markets its products through direct sales channels; however, it employs contract representatives and resellers where beneficial. As part of its commitment to customer and technical service which leads to increased repeat sales, Voridian periodically provides audits of customers’ processes, as well as process training to some of its customers’ employees. Voridian is committed to maintaining its high level of customer service by remaining current with customer needs, market trends and performance requirements.
Through the use of e-business platforms that improve connectivity and reduce costs, Voridian offers its customers an internet option, www.voridian.com, for placing and tracking orders, generating reports and bidding at online auctions. Voridian also provides integrated direct capabilities to customers, allowing enhanced collaborative planning to improve supply chain efficiencies.
The Company believes that significant advantages can be obtained through the continued focus on branding its products and, for this reason, protects its Voridian Division-related intellectual property through a combination of patents that expire at various times, trademarks and licenses. The Company expects to expand its portfolio of technologies licensed to other companies in the future. To date, the Company has selectively licensed a fairly extensive portfolio of patented Voridian polyester, intermediates, and polyethylene technologies. The Company has formed an alliance to license PTA technology, trademarked EPTA, to SK, a PET and EPTA producer headquartered in South Korea and to Lurgi Oel Gas Chemie, an EPC firm headquartered in Germany. Energx™ polyethylene technology has been licensed to Hanwha Chemical, headquartered in South Korea, and BP Amoco ("BP"), headquartered in the United Kingdom. BP is also licensed to market and sub-license the technology to other gas-phase LLDPE producers. Additionally, the Company has formed an alliance with W.R. Grace/Davison Catalysts to further exploit Energx™ globally. Voridian Division’s intellectual property portfolio is an important asset. However, neither its business as a whole nor any particular segment is materially dependent upon any one particular patent, trademark, copyright, or trade secret. As the laws of many foreign countries do not protect intellectual property to the same extent as the laws of the United States, Voridian Division cannot assure that it will be able to adequately protect all of its intellectual property assets.
Voridian directs its research and development programs for the Polymers segment toward five key objectives:
Voridian’s research and development efforts in the Polymers segment have resulted in new products that have met with wide acceptance in the marketplace. In the PET polymers business, Voridian has introduced sixteen new products since the beginning of 2000 including two Eastapak Aqua™ polymer formulas for the water market, two Elegante™ polymer formulas for the personal care/cosmetics market, AmberGuard™ polymer for the beer market, Heatwave™ polymer for hot-fill beverage applications that require ultra-violet (UV) protection, VersaTray™ polymer for food packaging and cooking, suitable for both conventional and microwave oven use, and new enhanced reheat resins for the European and Asian markets. In the polyethylene business, Voridian has commercialized a group of new, higher-value polyethylene products with increased tear strength and impact performance such as Mxsten™ and Voridian Hifor™.
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Research and development efforts for the Fibers segment are primarily focused on incremental process and product improvements, as well as cost reduction, with the goal of increasing sales and reducing costs. Achievements have included fiber product advancements that allow improved processability on customers’ equipment and improved packaging design.
EASTMAN CHEMICAL COMPANY GENERAL INFORMATION
Sources and Availability of Raw Materials and Energy
Eastman purchases a substantial portion, approximately 70%, of its key raw materials and energy through long-term contracts, generally of three to five years initial duration with renewal or cancellation options for each party. Most of those agreements do not require the Company to purchase materials or energy if its operations are reduced or idle. The cost of raw materials and energy is generally based on market price at the time of purchase, although derivative financial instruments, valued at quoted market prices, have been utilized to mitigate the impact of short-term market price fluctuations. Key raw materials and purchased energy include paraxylene, ethylene glycol, PTA, propane and ethane, cellulose, methanol, coal, natural gas, electricity, and a wide variety of precursors for specialty organic chemicals. The Company has multiple suppliers for most key raw materials and energy and uses quality management principles, such as the establishment of long-term relationships with suppliers and on-going performance assessment and benchmarking, as part of the supplier selection process. When appropriate, the Company purchases raw materials from a single source supplier to maximize quality and cost improvements, and has developed contingency plans that would minimize the impact of any supply disruptions from single source suppliers.
While temporary shortages of raw materials and energy may occasionally occur, these items are generally sufficiently available to cover current and projected requirements. However, their continuous availability and price are subject to unscheduled plant interruptions occurring during periods of high demand, or due to domestic or world market and political conditions, changes in government regulation, war or other outbreak of hostilities. Eastman’s operations or products may, at times, be adversely affected by these factors. The Company’s total cost of raw materials as a percent of total cost of operations was approximately 50% in 2002.
Capital Expenditures
The completion of several significant capital investment projects in the late 1990’s and Eastman’s strategy of growth through strategic acquisitions resulted in reduced capital expenditures in recent years. Capital expenditures were $427 million, $234 million and $226 million in 2002, 2001 and 2000, respectively. Capital expenditures for 2002 included $161 million related to the purchase of certain machinery and equipment previously utilized under an operating lease.
In 2003, Eastman expects that capital expenditures and other directed investments for small acquisitions and other ventures will be no more than depreciation and amortization. Efficiency of capital utilization is a key element of the Company’s strategy to improve gross margins and, where appropriate, alliances, joint ventures, acquisitions of existing businesses, and tolling arrangements are used to expand available capacity using less capital.
Employees
Eastman employs approximately 15,700 men and women worldwide. Approximately 12% of the total worldwide labor force is represented by unions, mostly outside the United States.
Customers
Eastman has an extensive customer base and, while it is not dependent on any one customer, loss of certain top customers could adversely affect the Company until such business is replaced. The top 100 customers accounted for approximately 55% of the Company’s 2002 sales revenue.
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While the Company’s intellectual property portfolio is an important Company asset which it expands and vigorously protects globally through a combination of patents that expire at various times, trademarks, copyrights, and trade secrets, neither its business as a whole nor any particular segment is materially dependent upon any one particular patent, trademark, copyright, or trade secret. As a producer of a broad and diverse portfolio of both specialty and commodity chemicals, plastics, and fibers, Eastman owns well over 1,000 active United States patents and more than 1,000 active foreign patents, expiring at various times over several years, and also owns over 3,000 active worldwide trademarks. The Company’s intellectual property relates to a wide variety of products and processes. As the laws of many foreign countries do not protect intellectual property to the same extent as the laws of the United States, Eastman cannot assure that it will be able to adequately protect all of its intellectual property assets.
For 2002, 2001 and 2000, Eastman’s research and development expense totaled $159 million, $160 million and $149 million, respectively. Research and development expenses are expected to increase in 2003, driven by Voridian’s efforts to develop operational efficiencies and as a result of the Company’s increased technology efforts associated with new business initiatives.
Seasonality
The Company typically experiences a seasonal decline in earnings in the fourth quarter. Demand in the CASPI segment is typically higher in the second and third quarters due to increased use of coatings products in the building and construction industries and weaker during the winter months and the holiday season because of seasonal construction downturns. The Polymers segment typically experiences stronger demand for PET polymers for beverage plastics during the second quarter due to higher consumption of beverages, while demand typically weakens during the third quarter. Seasonality in the SP segment is associated with certain segments of the photographic and adhesive tape market, coupled with the effect of a typical year-end inventory reduction by several customers.
Environmental
Eastman is subject to laws, regulations and legal requirements relating to the use, storage, handling, generation, transportation, emission, discharge, disposal and remediation of, and exposure to, hazardous and non-hazardous substances and wastes in all of the countries in which it does business. These health, safety and environmental considerations are a priority in the Company’s planning for all existing and new products and processes. The Health, Safety, and Environmental/Public Policy Committee of Eastman’s Board of Directors reviews the Company’s policies and practices concerning health, safety and the environment and its processes for complying with related laws and regulations, and monitors related matters.
The Company’s policy is to operate its plants and facilities in a manner that protects the environment and the health and safety of its employees and the public. The Company intends to continue to make expenditures for environmental protection and improvements in a timely manner consistent with its policies and with the technology available. In some cases, applicable environmental regulations such as those adopted under the U.S. Clean Air Act and Resource Conservation and Recovery Act, and related actions of regulatory agencies, determine the timing and amount of environmental costs incurred by the Company.
The Company accrues environmental costs when it is probable that the Company has incurred a liability and the amount can be reasonably estimated. The amount accrued reflects the Company’s assumptions about remedial requirements at the contaminated site, the nature of the remedy, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. Changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in health, safety, environmental, chemical control regulations and testing requirements could result in higher or lower costs.
Other matters pertaining to health, safety, and the environment are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 11 to the Company’s consolidated financial statements.
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Backlog
On January 1, 2003, Eastman’s backlog of firm sales orders was approximately $233 million compared with approximately $244 million at January 1, 2002. The Company adjusts its inventory policy to control the backlog of products depending on customers’ needs. In areas where the Company is the single source of supply, or competitive forces or customers’ needs dictate, the Company may carry additional inventory to meet customer requirements.
Available Information
The Company makes available free of charge, through the “Investors – SEC Filings” section of its Internet website (www.eastman.com), its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the Securities and Exchange Commission (the “SEC”). Once filed with the SEC, such documents may be read and/or copied at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including Eastman Chemical Company, that electronically file with the SEC at http://www.sec.gov.
Financial Information About Geographic Areas
For information about revenues and long-lived assets based on geographic areas, see Note 22 to the Company’s consolidated financial statements.
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EXECUTIVE OFFICERS OF THE COMPANY
Certain information about the Company’s executive officers is provided below:
J. Brian Ferguson, age 48, is Chairman of the Board and Chief Executive Officer. Mr. Ferguson joined the Company in 1977. He was named Vice President, Industry and Federal Affairs in 1994, became Managing Director, Greater China in 1997, was named President, Eastman Chemical Asia Pacific in 1998, became President, Polymers Group in 1999, became President, Chemicals Group in 2001, and was elected to his current position in January 2002.
Allan R. Rothwell, age 55, is Executive Vice President of the Company and President of Voridian Division. Mr. Rothwell joined the Company in 1969, became Vice President and General Manager, Container Plastics Business Organization in 1994, and was appointed Vice President, Corporate Development and Strategy in 1997. He was named Senior Vice President and Chief Financial Officer in 1998, became President, Chemicals Group in 1999, became President, Polymers Group in 2001, and was appointed to his current position in January 2002.
James P. Rogers, age 51, joined Eastman in 1999 as Senior Vice President and Chief Financial Officer and effective in January 2002, was also appointed Chief Operations Officer of Eastman Division. Mr. Rogers served previously as Executive Vice President and Chief Financial Officer of GAF Materials Corporation. He also served as Executive Vice President, Finance, of International Specialty Products, Inc., which was spun off from GAF in 1997. During 2003, Mr. Rogers will become President of Eastman Division upon the expected hiring by the Company of a new Chief Financial Officer.
Betty W. DeVinney, age 58, is Senior Vice President, Human Resources, Organizational Effectiveness, and Communications and Public Affairs. Mrs. DeVinney joined Eastman in 1973. She became Manager, Employment in 1991, Manager, Community Relations in 1995, Manager, Corporate Relations in 1997, Vice President, Communications and Public Affairs in 1998, and was appointed to her current position in January 2002.
Theresa K. Lee, age 50, is Senior Vice President, General Counsel and Secretary. Ms. Lee joined Eastman as a staff attorney in 1987, served as Assistant General Counsel for the health, safety, and environmental legal staff from 1993 to 1995, and served as Assistant General Counsel for the corporate legal staff from 1995 until her appointment as Vice President, Associate General Counsel and Secretary in 1997. She became Vice President, General Counsel, and Secretary of Eastman in 2000 and was appointed to her current position in January 2002.
Roger K. Mowen, Jr., age 57, is Senior Vice President, Global Developing Businesses and Corporate Strategy. Mr. Mowen joined Eastman in 1971. He was named Vice President and General Manager, Polymer Modifiers in 1991, Superintendent of the Polymers Division in 1994, President, Carolina Operations in 1996, Vice President, Customer Demand Chain in 1998, Vice President, CustomerFirst and Chief Information Officer in 1999, Vice President, Global Customer Services Group and Chief Information Officer in 2000, and appointed Senior Vice President, Global Customer Services Group and Chief Information Officer in 2001. He was appointed to his current position in March 2003.
Gregory O. Nelson, age 51, is Senior Vice President and Chief Technology Officer. Dr. Nelson joined Eastman in 1982 as a research chemist. He has held a number of positions in the research and development organization, and became Director, Polymers Research Division in 1995, was appointed Vice President, Polymers Technology in 1997, and appointed Vice President and Chief Technology Officer in 2001. He was appointed to his current position in January 2003.
Curtis E. Espeland, age 38, is Controller of the Company. Mr. Espeland joined Eastman in 1996. At Eastman, Mr. Espeland has served as Director of Internal Auditing and Director of Financial Services, Asia Pacific, was named Assistant Controller of the Company and Controller of Eastman Division in 2002, and was appointed to his current position in December 2002. Prior to joining Eastman, he was an audit and business advisory manager with Arthur Andersen LLP.
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ITEM 2. PROPERTIES
PROPERTIES
At December 31, 2002 Eastman operated 41 manufacturing sites in 17 countries. Utilization of these facilities may vary with product mix and economic, seasonal, and other business conditions, but none of the principal plants are substantially idle. The Company’s plants, including approved expansions, generally have sufficient capacity for existing needs and expected near-term growth. These plants are generally well maintained, in good operating condition, and suitable and adequate for their use. Unless otherwise indicated, all of the properties are owned. The locations and general character of the major manufacturing facilities are:
* indicates a location that Eastman leases from a third party.
** indicates a location that Eastman leases from a third party under a long-term ground lease.
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Eastman has a 50% interest in Primester, a joint venture that manufactures cellulose esters at its Kingsport, Tennessee plant. The production of cellulose esters is an intermediate step in the manufacture of acetate tow and other cellulose-based products. The Company also has a 50% interest in a manufacturing facility in Nanjing, People’s Republic of China. This joint venture produces Eastotac™ hydrocarbon tackifying resins for pressure-sensitive adhesives, caulks, and sealants. Eastotac™ hydrocarbon resins are also used to produce hot melt adhesives for packaging applications in addition to glue sticks, tapes, labels, and other adhesive applications.
Eastman has distribution facilities at all of its plant sites. In addition, the Company owns or leases over 120 stand-alone distribution facilities in the United States and 17 other countries. Corporate headquarters are in Kingsport, Tennessee. The Company’s regional headquarters are in Miami, Florida; the Hague, the Netherlands; Singapore; and Kingsport, Tennessee. Technical service is provided to the Company’s customers from technical service centers in Kallo, Belgium; Kingsport, Tennessee; Kirkby, England; Pleasant Prairie, Wisconsin; and Singapore. Customer service centers are located in Kingsport, Tennessee; Rotterdam, the Netherlands; Miami, Florida; and Singapore.
A summary of properties, classified by type, is contained in Note 3 to the Company’s consolidated financial statements.
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ITEM 3. LEGAL PROCEEDINGS
General
From time to time, the Company and its operations are parties to, or targets of, lawsuits, claims, investigations and proceedings, including product liability, personal injury, patent and intellectual property, commercial, contract, environmental, antitrust, health and safety and employment matters, which are being handled and defended in the ordinary course of business. While the Company is unable to predict the outcome of these matters, it does not believe, based upon currently available facts, that the ultimate resolution of any of such pending matters, including the sorbates litigation and the asbestos litigation described in the following paragraphs, will have a material adverse effect on its overall financial condition, results of operations or cash flows. However, adverse developments could negatively impact earnings in a particular future period.
Sorbates Litigation
As previously reported, on September 30, 1998, the Company entered into a voluntary plea agreement with the U.S. Department of Justice and agreed to pay an $11 million fine to resolve a charge brought against the Company for violation of Section One of the Sherman Act. Under the agreement, the Company entered a plea of guilty to one count of price-fixing for sorbates, a class of food preservatives, from January 1995 through June 1997. The plea agreement was approved by the United States District Court for the Northern District of California on October 21, 1998. The Company recognized the entire fine as a charge against earnings in the third quarter of 1998 and is paying the fine in installments over a period of five years. On October 26, 1999, the Company pleaded guilty in a Federal Court of Canada to a violation of the Competition Act of Canada and was fined $780,000 (Canadian). The plea in Canada admitted that the same conduct that was the subject of the United States guilty plea had occurred with respect to sorbates sold in Canada, and prohibited repetition of the conduct and provides for future monitoring. The Canadian fine has been paid and was recognized as a charge against earnings in the fourth quarter of 1999.
Following the September 30, 1998 plea agreement, the Company, along with other defendants, was sued in federal, state and Canadian courts in a number of putative class action lawsuits filed on behalf of purchasers of sorbates and products containing sorbates, claiming those purchasers paid more for sorbates and for products containing sorbates than they would have paid in the absence of the defendants’ price-fixing. All but three of these more than twenty lawsuits have been resolved via settlement. No class has been certified in any of the three unresolved private cases, and the trial court in one of them decided in October 2002 that the case would not proceed as a class action, though that decision has been appealed by the plaintiff. One of the other two remaining cases is dormant and the third was filed on February 7, 2003.
In addition, several states have recently sued the Company and other defendants in connection with the sorbates matter, seeking unspecified damages, restitution and civil penalties on behalf of consumers of sorbates in those respective states. Several other states have advised the Company that they intend to bring similar actions against the Company and others.
The Company has recognized charges to earnings in each of the past four years for estimated and actual costs, including legal fees and expenses, related to the sorbates fine and litigation. While the Company intends to continue to vigorously defend the remaining sorbates actions unless they can be settled on acceptable terms, the ultimate outcome of the matters still pending and of additional claims that could be made is not expected to have a material impact on the Company’s financial condition, results of operations, or cash flows, although these matters could result in the Company being subject to monetary damages, costs or expenses and charges against earnings in particular periods.
Asbestos Litigation
Over the years, Eastman was named as a defendant, along with numerous other defendants, in lawsuits in various state courts in which plaintiffs alleged injury due to exposure to asbestos at Eastman’s manufacturing sites and sought unspecified monetary damages and other relief. Historically, these cases were dismissed or settled without a material effect on Eastman’s results of operations or financial condition.
The Company has recently experienced an increase in the number of asbestos claims against it. Currently, there are approximately 7,000 claims asserted against the Company in about 17 cases that also involve hundreds of other defendants. By far, the majority of these claims are in Mississippi, with smaller numbers in Texas and Illinois. In the recently filed cases in Mississippi, plaintiffs allege exposure to asbestos-containing products allegedly made by Eastman. Based on its investigation to date, the Company has information that it manufactured limited amounts of an asbestos-containing plastic product between the mid-1960’s and the early 1970’s. The Company’s investigation has found no evidence that any of the Mississippi plaintiffs worked with or around any such product alleged to have been manufactured by the Company. The Company intends to defend vigorously all of these actions or to settle them on acceptable terms.
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The Company continues to evaluate the allegations and claims made in recent asbestos-related lawsuits and its insurance coverages. Based on such evaluation to date, the Company continues to believe that the ultimate resolution of asbestos cases will not have a material impact on the Company’s financial condition, results of operations, or cash flows, although these matters could result in the Company being subject to monetary damages, costs or expenses and charges against earnings in particular periods. To date, costs incurred by the Company related to the recent asbestos-related lawsuits have not been material, and in the case of the Mississippi claims have been limited to legal fees and expenses.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company’s stockholders during the fourth quarter of 2002.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company’s common stock is traded on the New York Stock Exchange (the “NYSE”) under the symbol EMN. The following table presents the high and low closing sales prices of the common stock on the NYSE and the cash dividends per share declared by the Company’s Board of Directors for each quarterly period of 2001 and 2002.
As of December 31, 2002, there were 77,346,296 shares of the Company’s common stock issued and outstanding, which shares were held by 39,066 stockholders of record. These shares include 144,825 shares held by the Company’s charitable foundation. The Company has declared a cash dividend of $0.44 per share during the first quarter of 2003. Quarterly dividends on common stock, if declared by the Company’s Board of Directors, are usually paid on or about the first business day of the month following the end of each quarter. The payment of dividends is a business decision to be made by the Board of Directors from time to time based on the Company’s earnings, financial position and prospects, and such other considerations as the Board considers relevant. Accordingly, while management currently expects that the Company will continue to pay the quarterly cash dividend, its dividend policy may change at any time.
For information concerning issuance of shares and option grants in 2002 under compensation and benefit plans and shares held by the Company’s charitable foundation, see Notes 13 and 14 to the Company’s consolidated financial statements.
Information require by Item 201(d) of Regulation S-K is set forth under Part III — Item 12 — “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” and is incorporated herein by reference.
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ITEM 6. SELECTED FINANCIAL DATA
In 2002 the Company adopted the non-amortization provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142. As a result of the adoption of SFAS No. 142, results for the year 2002 do not include certain amounts of amortization of goodwill and indefinite-lived intangible assets that are included in prior years’ financial results. See Note 4 to the Company’s consolidated financial statements for additional information.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 in the United States of America, and should be read in conjunction with the Company’s consolidated financial statements included elsewhere in this Annual Report. All references to earnings per share contained in this report are diluted earnings per share unless otherwise noted.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, the Company’s management must make decisions which impact the reported amounts and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and assumptions on which to base estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to customer programs and incentives, doubtful accounts, inventory valuation, impaired assets, restructuring of operations, environmental costs, pensions and other postemployment benefits, goodwill and intangible assets, and litigation and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s management believes the critical accounting policies described below are the most important to the fair presentation of the Company’s financial condition and results. The policies require management’s more significant judgments and estimates in the preparation of the Company’s consolidated financial statements.
Customer Programs and Incentives
The Company records estimated obligations for customer programs and incentive offerings, which consist primarily of revenue or volume-based amounts that a customer must achieve over a specified period of time, as a reduction of revenue to each underlying revenue transaction as the customer progresses toward reaching goals specified in incentive agreements. These estimates are based on a combination of forecast of customer sales and actual sales volumes and revenues against established goals, the customer’s current level of purchases, and Eastman’s knowledge of customer purchasing habits and industry pricing practice. The incentive payment rate may be variable, based upon the customer reaching higher sales volume or revenue levels over a specified period of time in order to receive an agreed upon incentive payment. The Company’s reserve for customer programs and incentives was $50 million, $44 million, and $49 million at December 31, 2002, 2001, and 2000, respectively, and was recorded as a reduction of trade receivables. If market conditions change, the Company may take actions to adjust customer incentive offerings to maintain market share and capacity utilization.
Allowances for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management continuously assesses the financial condition of the Company’s customers and the markets in which these customers participate and adjusts credit limits or the allowance for doubtful accounts based on this periodic review. Actual losses for uncollectible accounts have historically been consistent with the Company’s estimates. However, deteriorating financial conditions of certain key customers or a significant continued slow down in the economy could have a material negative impact on the Company’s ability to collect on accounts, in which case additional allowances may be required. The Company’s allowance for doubtful accounts was $32 million, $35 million, and $16 million at December 31, 2002, 2001, and 2000, respectively. Further information is provided in Schedule II, “Valuation and Qualifying Accounts.”
In response to economic developments in Argentina in late 2001, management established a reserve for credit risks related to devaluation of the peso. At December 31, 2001, the reserve was established at $18 million and at December 31, 2002, $3 million remained in the reserve. Management believes the reserve balance at December 31, 2002 adequately reflects the Company’s potential losses.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS
Inventory Reserves
Inventories are valued at the lower of cost or market. The Company determines the cost of most raw materials, work in process, and finished goods inventories in the United States of America by the last-in, first-out (“LIFO”) method. At December 31, 2002, 2001, and 2000 the Company had $273 million, $288 million, and $275 million, respectively, recorded in the LIFO reserve. The cost of all other inventories, including inventories outside the United States of America, is determined by the average cost method, which approximates the first-in, first-out method. The Company regularly compares inventory quantities on hand against anticipated future requirements to identify and evaluate inventory items for obsolescence and excessive quantities. Several factors, such as decisions to exit product lines, technological changes, changes in customer requirements, and new product development, could result in a change in the amount of obsolete or excess inventory quantities on hand. Additionally, estimates of future product demand may prove to be inaccurate, in which case excess and obsolete inventory provisions may be understated or overstated. The Company writes down its inventories for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. The Company’s reserve for excess and obsolete inventories was $5 million at December 31, 2002, and $2 million at December 31, 2001 and 2000.
Impaired Assets
The Company evaluates the carrying value of long-lived assets to be held and used, including definite-lived intangible assets, when events or changes in circumstances indicate that the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such asset are separately identifiable and are less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the projected cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for disposal costs. As the Company’s assumptions related to assets to be held and used are subject to change, additional write-downs may be required in the future. If estimates of fair value less costs to sell are revised, the carrying amount of the related asset is adjusted, resulting in recognition of a charge or benefit to earnings.
Restructuring of Operations
The Company records restructuring charges incurred in connection with consolidation or relocation of operations, exited business lines, or shutdowns of specific sites. These restructuring charges, which reflect management’s commitment to a termination or exit plan that generally will begin and will be substantially completed within 12 months, are based on estimates of the expected costs associated with site closure, legal and environmental matters, demolition, contract terminations, or other costs directly related to the restructuring. If the actual cost incurred exceeds the estimated cost, an additional charge to earnings will result. If the actual cost is less than the estimated cost, a credit to earnings will be recognized. At December 31, 2002, 2001, and 2000, the Company’s reserve for restructuring of operations, including severance and site closure costs, was $9 million, $23 million, and $10 million, respectively. For additional information see Note 15 to the Company’s consolidated financial statements.
Environmental Costs
The Company accrues environmental costs when it is probable that the Company has incurred a liability and the amount can be reasonably estimated. When a single amount cannot be reasonably estimated but the cost can be estimated within a range, the Company accrues the minimum amount. The amount accrued reflects the Company’s assumptions about remediation requirements at the contaminated site, the nature of the remedy, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. Changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in health, safety, environmental, and chemical control regulations and testing requirements could result in higher or lower costs. Estimated future environmental contingencies ranged from the minimum or best estimate of $97 million to the maximum of $111 million at December 31, 2002. The Company’s reserve for environmental contingencies was $60 million, $54 million, and $49 million at December 31, 2002, 2001, and 2000, respectively, representing the minimum or best estimate for remediation costs and, for closure/postclosure, costs accrued to date over the facilities’ estimated useful lives. For additional information see Note 11 to the Company’s consolidated financial statements and Schedule II, “Valuation and Qualifying Accounts.”
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Pension and Other Postemployment Benefits
The Company maintains defined benefit plans that provide eligible employees with retirement benefits. Additionally, Eastman provides life insurance and health care benefits for eligible retirees and health care benefits for retirees’ eligible survivors. The costs and obligations related to these benefits reflect the Company’s assumptions related to general economic conditions (particularly interest rates), expected return on plan assets, rate of compensation increase for employees and health care cost trends. At December 31, 2002, the Company assumed a discount rate of 6.75%; an expected return on assets of 9.0%; a rate of compensation increase of 4.0%; and an initial health care cost trend of 10%. The cost of providing plan benefits also depends on demographic assumptions including retirements, mortality, turnover and plan participation. If actual experience differs from these assumptions, the cost of providing these benefits could increase or decrease. For example, a 1% increase in health care cost trend would increase the 2002 service and interest costs by $3 million, and the 2002 benefit obligation by $40 million. A 1% decrease in health care cost trend would decrease the 2002 service and interest costs by $3 million, and the 2002 benefit obligation by $34 million. For additional information see Note 9 to the Company’s consolidated financial statements.
Goodwill and Other Intangibles
Prior to the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” the Company amortized certain intangible assets on a straight-line basis over the estimated useful lives of such assets. The Company adopted the provisions of SFAS No. 142, effective January 1, 2002. Under the provisions of SFAS No. 142, the Company performs the annual review for impairment at the reporting unit level, which Eastman has determined to be one level below its operating segment level and considers the criteria set forth in SFAS No. 142 in aggregating the reporting units. The tests are performed by determining the fair values of the reporting units using a discounted cash flow model and comparing those fair values to the carrying values of the reporting units, including goodwill. If the fair value of a reporting unit is less than its carrying value, the Company then allocates the fair value of the reporting unit to all the assets and liabilities of that reporting unit, including any unrecognized intangible assets, as if the reporting unit’s fair value was the price to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of the goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to such excess. Events or changes in circumstances could occur that may create underperformance relative to projected future cash flows which could create future impairments. At December 31, 2002, 2001, and 2000, the Company recorded approximately $344 million, $339 million, and $344 million, respectively, of goodwill and $229 million, $275 million, and $277 million, respectively, of other intangibles.
Litigation and Contingent Liabilities
From time to time, the Company and its operations are parties to or targets of lawsuits, claims, investigations and proceedings, including product liability, personal injury, 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. The Company accrues a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. The Company believes the amounts reserved are adequate for such pending matters; however, results of operations could be affected by significant litigation adverse to the Company.
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Nonrecurring Items
It is the Company’s policy to report as a “nonrecurring item” a material charge or gain that is not associated with on-going operations or that is caused by unique events not reflective of the Company’s normal business activities in the period if such items individually or in the aggregate have a material impact on a specific line item in the Consolidated Statements of Earnings (Loss) or have a material impact on results overall. The Company believes that separately reporting such charges or gains enhances transparency and comparability of results by removing distortion that would otherwise occur. Examples of such items that have been separately reported in the past under this policy include material charges or gains resulting from asset impairments and restructuring of operations, including employee terminations; litigation not related to on-going operations; discontinued businesses; and acquisition charges including those related to acquired in-process research and development. Nonrecurring items are appropriately identified in the Consolidated Statements of Earnings (Loss).
RESULTS OF OPERATIONS
SUMMARY OF CONSOLIDATED RESULTS — 2002 COMPARED WITH 2001
The Company’s results of operations as presented in the Company’s consolidated financial statements appearing in this Annual Report are described below:
Earnings (Loss)
Operating earnings for 2002 were significantly impacted by lower selling prices for all of the Company’s segments. Such selling prices decreased more than raw material costs, resulting in a reduction in gross margin in excess of $100 million. Higher sales volumes and lower unit costs resulting from increased capacity utilization had a positive impact on operating earnings for 2002.
In addition, operating earnings for 2002 were negatively impacted by:
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Operating results for 2001 were negatively impacted by:
Sales revenue for 2002 declined slightly compared to 2001 primarily due to lower selling prices for all of the Company’s segments which had a negative impact on revenues of $351 million. The decline in selling prices is indicative of the Company’s inability to increase its selling prices for some of its products, as discussed below, and also of a persistently sluggish global economy, particularly for manufacturers. Increased sales volumes for all of the Company’s segments had a positive impact on sales revenue of $359 million.
Decreased selling prices had a negative impact on gross profit for 2002 of $351 million, offset approximately two-thirds by decreased raw material costs. Operational disruptions at the Company’s plants in Rotterdam, the Netherlands and Columbia, South Carolina negatively impacted gross profit by approximately $39 million. Fourth quarter 2002 asset charges relating primarily to equipment dismantlements and other write-offs totaling approximately $17 million also had a negative impact on gross profit.
The following factors affect the Company’s ability to impact margins by increasing selling prices:
The Company expects that higher raw material costs and a sluggish global economy in 2003 will negatively impact operating results unless the Company is able to offset this impact in part through price increases for certain of its products and through various cost control measures. In addition, the Company has begun taking the following actions to improve its near-term and long-term profitability:
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Selling and general administrative expenses for 2002 were flat compared to 2001 even though costs related to the Company’s growth initiatives increased from $35 million in 2001 to approximately $50 million in 2002. This increase was offset by cost control efforts. For 2003, the Company expects to recognize increased selling and general administrative expenses related to Cendian Corporation (“Cendian”), the Company’s logistics subsidiary, as it adds capacity while continuing to add new customers and revenues. Research and development expenses for 2002 were flat compared to 2001. While the Company expects research and development expenses to increase in 2003, the combined costs related to selling and general administrative expenses and research and development expenses are expected to continue to be at or below 11% of sales revenue.
Asset Impairments and Restructuring Charges, Net
In 2002 and 2001, the Company recorded charges related to the write-down of underperforming polyethylene assets totaling approximately $1 million and $103 million, respectively. Also in 2001, the Company recorded a charge of $108 million for the write-off of a prepaid asset related to the termination of a raw material supply agreement. These charges were reflected in the Polymers segment.
Consolidation and restructuring of the operations of the Coatings, Adhesives, Specialty Polymers, and Inks (“CASPI”) segment resulted in restructuring charges, including related asset write-downs, of approximately $5 million in 2002 and $77 million in 2001. In the fourth quarter 2002, the Company recognized restructuring charges of approximately $4 million related to closure of plants in Duesseldorf, Germany; Rexdale, Canada; and LaVergne, Tennessee; and additionally recognized an asset impairment charge of approximately $2 million related to certain other European assets. A change in estimate for shutdown reserves for Philadelphia, Pennsylvania and Portland, Oregon resulted in a $1 million credit to earnings in the third quarter 2002.
In the fourth quarter 2002, a change in estimate related to the sale of operating assets resulted in a $2 million credit to earnings in the Performance Chemicals and Intermediates (“PCI”) segment. A charge of approximately $1 million related to impaired research and development assets was also recognized in the PCI segment. Both of these items were related to the Company’s fine chemicals product lines. In 2001, the Company recorded restructuring charges, including related asset write-downs, of approximately $70 million related to its restructuring of the fine chemicals product lines.
During 2001, the Company recorded asset impairment charges related to under-utilized assets including $10 million related to the discontinuation of the precolored-green PET product line in Kingsport, Tennessee; $10 million related to cessation of production at the Company’s solid-stating facility in Toronto, Ontario; $15 million related to deterioration of demand for certain specialty plastics products produced in Kingsport, Tennessee; and $3 million related to other impaired assets in Europe. Approximately $20 million of these charges were reflected in the Polymers segment, $15 million in the Specialty Plastics (“SP”) segment, and $3 million in the PCI segment.
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For additional information regarding these asset impairments and restructuring charges, see Note 15 to the Company’s consolidated financial statements.
Other Nonrecurring Operating Items
Other nonrecurring operating items totaling $50 million were recognized in 2001. These items consisted of approximately $20 million in charges associated with efforts to spin-off the specialty chemicals and plastics businesses; an $18 million write-down of accounts receivable for credit risks resulting from the economic crisis in Argentina; a $7 million pension settlement charge; and a $5 million write-off of acquired in-process research and development related to the May 2001 acquisition of certain businesses from Hercules Incorporated (“Hercules Businesses”). Approximately $26 million of these items were reflected in the Polymers segment, $11 million in the CASPI segment, $7 million in the PCI segment, $4 million in the SP segment, and $2 million in the Fibers segment.
Interest Expense, Net
Lower interest expense for 2002 compared to 2001 reflected a net reduction in borrowings and decreases in market interest rates, partially offset by a higher interest rate on the Company’s April 2002 10-year bond issue versus the interest rate on commercial paper that was outstanding during the prior period.
Other (Income) Charges, Net
Other income for 2002 primarily reflected the Company’s portion of earnings from its equity investments and a gain on foreign exchange transactions. The Company’s portion of earnings from its equity investments was net of a charge of $5 million related to the previously announced restructuring of Genencor International, Inc., (“Genencor”) in which the Company owns an approximate 42% equity interest. Other income for 2001 primarily reflected the Company’s portion of earnings from its equity investment in Genencor.
Other charges for 2002 primarily reflected a write-down to fair value of certain technology business venture investments due to other than temporary declines in value and fees on securitized receivables. Other charges for 2001 primarily reflected fees on securitized receivables.
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Other Nonrecurring Charges
Other nonrecurring charges for 2001 totaling $20 million consisted of a $12 million charge for currency losses resulting from the economic crisis in Argentina and $8 million of sorbates civil litigation settlement costs and other professional fees.
Provision (Benefit) for Income Taxes
The 2002 effective tax rate was reduced by a net credit of $17 million resulting from the favorable resolution of prior periods’ tax contingencies, by a reduction in international taxes related to the implementation of the Company’s divisional structure, and the elimination of nondeductible goodwill and indefinite-lived intangible asset amortization resulting from the implementation of SFAS No. 142.
The 2001 effective tax rate was impacted by the significant asset impairments and restructuring charges recorded during 2001 as described above.
In both years, the Company has recorded benefits from a foreign sales corporation or extraterritorial income exclusion, and management expects these benefits to continue into 2003. The Company also expects its effective tax rate in 2003 will return to a more normal historical level of 30% to 33%.
Cumulative Effect of Change in Accounting Principle, Net
In connection with the adoption of SFAS No. 142, the Company completed in the first quarter 2002 the impairment test for intangible assets with indefinite useful lives other than goodwill. As a result of this impairment test, it was determined that the fair value of certain trademarks related to the CASPI segment, as established by appraisal and based on discounted future cash flows, was less than the recorded value. Accordingly, the Company recognized an after-tax impairment charge of approximately $18 million in the first quarter 2002. This charge is reported in the Consolidated Statements of Earnings (Loss) as the cumulative effect of a change in accounting principle. Additionally, the Company reclassified $12 million of its intangible assets related to assembled workforce and the related deferred tax liabilities of approximately $5 million to goodwill. During the second quarter 2002, the Company performed the transitional impairment test on its goodwill as required upon adoption of this Statement, and determined that no impairment of goodwill existed as of January 1, 2002. The Company completed its annual testing of goodwill and indefinite-lived intangible assets for impairment in the third quarter 2002 and determined that no impairment existed as of September 30, 2002. The Company plans to continue its annual testing of goodwill and indefinite-lived intangible assets for impairment in the third quarter of each year, unless events warrant more frequent testing.
For additional information regarding the change in accounting principle, see Note 4 to the Company’s consolidated financial statements.
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SUMMARY BY OPERATING SEGMENT
The Company’s products and operations are managed and reported in five operating segments. Effective January 1, 2002, the Company implemented a divisional structure that separated the businesses into two divisions. Eastman Division consists of the CASPI segment, the PCI segment and the SP segment. Voridian Division contains the Polymers segment and the Fibers segment. The divisional structure has allowed the Company to align costs more directly with the activities and businesses that generate them. The divisional and segment results for 2002, but not for prior periods, reflect this new cost structure.
With the implementation of the divisional structure, goods and services are transferred between the two divisions at predetermined prices that may be in excess of cost. Accordingly, the divisional structure results in the recognition of interdivisional sales revenue and operating earnings. Such interdivisional transactions are eliminated in the Company’s consolidated financial statements. Prior to 2002, segment sales revenue reflected only actual sales to third parties and the intersegment transfer of goods and services, recorded at cost, had no impact on segment earnings.
All Eastman Chemical Company assets were allocated to the divisions as of January 1, 2002. Corporate, general purpose and other nonoperating assets were allocated to segments within each division based on process or product responsibility. Certain infrastructure assets at each site, primarily utilities that were previously allocated to all five segments, were allocated to the primary division at that site. The primary division invoices the other division for services provided by such infrastructure assets.
Effective January 1, 2002, sales and operating results for Cendian, the Company’s logistics subsidiary and an Eastman Division initiative, are included in amounts for the CASPI, PCI and SP segments, and have been allocated to these segments on the basis of sales revenues for each of these segments. Prior to 2002, sales and operating results for Cendian were allocated to all five segments.
Effective January 1, 2002, certain compounded polyethylene products were moved from the Polymers segment to the SP segment. Accordingly, amounts for 2001 and 2000 have been reclassified to reflect this change. Operating earnings for 2002 for the CASPI segment and the SP segment have been reclassified from those presented in the Company’s January 30, 2003 sales and earnings press release.
The CASPI segment manufactures raw materials, additives and specialty polymers, primarily for the paints and coatings, inks and graphic arts, adhesives and other markets. The CASPI segment’s products consist of binders and resins, liquid vehicles, pigment concentrates and additives, unsaturated polyester resins and polyester and acrylic emulsions. Binders and resins, such as alkyd and polyester resins, hydrocarbon resins and rosins and rosin esters, are used in adhesives as key components in paints and inks to form a protective coating or film, and bind color to the substrate. Liquid vehicles, such as ester, ketone and alcohol solvents, maintain the binders in liquid form for ease of application. Pigment concentrates and additives, such as cellulosic polymers, Texanol™ coalescing aid and chlorinated polyolefins, provide different properties or performance enhancements to the end product. Unsaturated polyester resins are used primarily in gel coats and fiberglass reinforced plastics. Polyester and acrylic emulsions are traditionally used as textile sizes to protect fibers during processing in textile manufacturing, and the technology is also used in water-based paints, coatings and inks. Additional products are developed in response to, or in anticipation of, new applications where the Company believes significant value can be achieved.
The Company’s PCI segment manufactures diversified products that are used in a variety of markets and industrial and consumer applications, including chemicals for agricultural intermediates, fibers, food and beverage ingredients, photographic chemicals, pharmaceutical intermediates, polymer compounding and chemical manufacturing intermediates.
The SP segment produces highly specialized copolyesters and cellulosic plastics that possess unique performance properties for value-added end uses such as appliances, in-store fixtures and displays, building and construction, electronics and electronic packaging, medical packaging, personal care and cosmetics, performance films, tape and labels, biodegradeables, cups and lids, fiber and strapping, photographic and optical, graphic arts and general packaging. The SP segment’s key products include engineering and specialty polymers, specialty film and sheet products, and packaging film and fiber products.
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The Polymers segment manufactures and supplies PET polymers for use in beverage and food packaging and other applications such as custom-care and cosmetics packaging, health care and pharmaceutical uses, household products and industrial. PET polymers serve as source products for packaging a wide variety of products including carbonated soft drinks, water, beer and personal care items and food containers that are suitable for both conventional and microwave oven use. The Polymers segment also manufactures low-density polyethylene and linear low-density polyethylene, which are used primarily for packaging and film applications and in extrusion coated containers such as milk and juice cartons.
The Fibers segment manufactures Estron™ acetate tow and Estrobond™ triacetin plasticizers for the cigarette filter market; Chromspun™ and Estron™ acetate yarns for use in apparel, home furnishings and industrial fabrics; and acetate flake and acetyl raw materials for other acetate fiber producers.
For additional information concerning an analysis of the results of the Company’s operating segments, see Note 22 to the Company’s consolidated financial statements and Exhibits 99.01 and 99.02 to this Annual Report.
CASPI Segment
2002 Compared With 2001
Sales revenue for 2002 increased moderately compared to 2001 mainly due to interdivisional sales and increased sales volumes, which had a positive impact on sales revenue of $61 million and $58 million, respectively. The increase in sales volumes for 2002 was primarily due to the Hercules Businesses. Lower selling prices had a negative impact on sales revenue of $49 million.
Operating earnings for 2002 were negatively impacted by asset impairments and restructuring charges totaling approximately $5 million as described above and in Note 15 to the Company’s consolidated financial statements. Operating results for 2001 were negatively impacted by asset impairments and restructuring charges and other nonrecurring operating items totaling approximately $88 million as more fully described above and in Notes 15 and 16 to the Company’s consolidated financial statements. Operating results for 2001 were also impacted by amortization of goodwill and indefinite-lived intangibles totaling approximately $20 million.
In addition to the items above, selling prices for 2002 declined more than raw material costs resulting in margin compression. Operating earnings for 2002 were also negatively impacted by fourth quarter asset charges relating primarily to equipment dismantlements and other write-offs totaling approximately $6 million.
For 2003, the Company expects the focus for the CASPI segment to be more on improved margins and profitability than on sales volume gains, except for the strong growth potential for CASPI products in the Asia Pacific and Latin America regions. Additionally, the Company expects further rationalization of businesses and products and consolidation of manufacturing facilities in the CASPI segment to improve overall gross margin.
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PCI Segment
Sales revenue for 2002 increased $383 million including interdivisional sales, but declined $38 million excluding interdivisional sales. Lower selling prices had a negative impact on revenues of $65 million. Increased sales volumes had a positive impact on sales revenue of $87 million, partially offset by an unfavorable shift in product mix, which had a negative impact on revenues of $65 million. The shift in product mix was primarily due to increased sales volumes of lower unit priced products, particularly glacial acetic acid in the acetyl and intermediates product group.
In 2002, a change in estimate resulting in a credit of approximately $2 million related to the sale of operating assets and a charge of approximately $1 million related to impaired research and development assets, as more fully described above and in Note 15 to the Company’s consolidated financial statements, were recognized in the PCI segment. Results for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $73 million and other nonrecurring operating items totaling approximately $7 million, as more fully described above and in Notes 15 and 16 to the Company’s consolidated financial statements.
In addition to the items above, selling prices for 2002 declined more than raw material costs resulting in margin compression. Operating results for 2002 were also negatively impacted by fourth quarter asset charges relating primarily to equipment dismantlements and other write-offs totaling approximately $3 million.
During 2001, the Company reported that a large customer of the PCI segment did not intend to renew its contract for a custom synthesis product beyond June 30, 2002. As a consequence, the related assets were impaired as expected cash flows over the remaining term of the contract were not sufficient to recover the carrying value of such assets. Nonrecurring charges totaling approximately $70 million related to the impacted assets were recorded during 2001 as part of the restructuring of the fine chemicals product lines, as described in Note 15 to the Company’s consolidated financial statements. Subsequently, the customer initiated discussions with the Company which resulted in an agreement being reached in June 2002 to extend the custom synthesis product contract one year based on renegotiated terms. Sales revenue related to the contract extension was approximately 3% of the PCI segment’s sales revenue for 2002.
Long-term, the Company expects that aggressive management of costs in the PCI segment will help improve margins and position it to take full advantage of the upturn expected in the 2005 through 2006 timeframe. The PCI segment is aggressively identifying and implementing six sigma projects to reduce costs and improve performance.
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SP Segment
Sales revenue for 2002 increased $60 million compared to 2001 including interdivisional sales, but decreased $6 million excluding interdivisional sales. The decline in sales revenue excluding interdivisional sales was attributed to a decline in selling prices, which had a negative impact on sales revenue of $19 million. The decline in selling prices was partially offset by increased sales volumes, which had a positive impact on sales revenue of $12 million.
Operating earnings for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $15 million and other nonrecurring operating items totaling approximately $4 million, as more fully described above and in Notes 15 and 16 to the Company’s consolidated financial statements.
In addition to the items above, operating earnings for 2002 were negatively impacted by lower selling prices, mainly for cellulosic plastics products. The decline in operating earnings for 2002 was also partially due to the recognition of technology licensing revenue of $6 million that was reflected in results for 2001. New competitors in Asia and Europe negatively impacted results for copolyesters during 2002. However, the Company is committed to maintaining its cost advantages obtained from its scale of operations and manufacturing experience and increasing its utilization of current capacity.
Polymers Segment
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The slight decrease in sales revenue for 2002 compared to 2001 was mainly due to lower selling prices, for both PET polymers and polyethylene, which had a negative impact on revenues of $207 million. Increased sales volumes, for both PET polymers and polyethylene, had a positive impact on revenues of $131 million. Interdivisional sales also had a positive impact on revenues of $55 million.
A nonrecurring charge of approximately $1 million related to impaired polyethylene assets was recognized in the fourth quarter 2002. Results for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $231 million and other nonrecurring operating items totaling approximately $26 million, as more fully described above and in Notes 15 and 16 to the Company’s consolidated financial statements.
In addition to the items above, operational disruptions at the Company’s plants in Rotterdam, the Netherlands and Columbia, South Carolina negatively impacted operating earnings for 2002 by approximately $39 million. The Company expects the insurance claims process associated with the operational disruptions to be settled in 2003, and that such settlement will positively impact operating earnings and cash flows when completed. Operating earnings for 2002 were also negatively impacted by fourth quarter asset charges relating primarily to equipment dismantlements and other write-offs totaling approximately $3 million. Operating earnings for 2002 were positively impacted by increased sales volumes for PET polymers, lower raw material costs, and better operation and utilization of polyethylene assets.
For 2003, the Company expects continued profitability from its PET polymers products as the Company maintains its focus on lowering costs and growing along with overall market demand growth. Longer term, the Company expects global demand for PET polymers to grow at an average rate of approximately 10% annually over the next several years. The Company also expects peaks and troughs in the Polymers segment created by supply and demand imbalances to be less pronounced in the future; capacity utilization in the Polymers segment to be lower in 2003 than in 2002 based on industry projections worldwide; and capacity utilization to vary by region.
Fibers Segment
The increase in sales revenue for 2002 compared to 2001 was mainly due to interdivisional sales and higher sales volumes. Interdivisional sales had a positive impact on revenues of $73 million. Increased sales volumes had a positive impact on revenues of $69 million, largely offset by an unfavorable shift in product mix, which had a negative impact on sales revenue of $47 million. The unfavorable shift in product mix was due to increased sales volumes of lower unit priced products, particularly acetyl raw materials. Lower selling prices, primarily for acetyl raw materials, had a negative impact on sales revenue of $11 million.
Operating earnings for 2001 were negatively impacted by other nonrecurring operating items totaling approximately $2 million related to costs associated with efforts to spin-off the specialty chemicals and plastics businesses as more fully described above and in Note 16 to the Company’s consolidated financial statements. Operating earnings for 2002 were negatively impacted by fourth quarter asset charges relating primarily to equipment dismantlements and other write-offs totaling approximately $3 million.
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For 2003, the Company expects the Fibers segment to experience flat to slightly lower revenues but consistent operating earnings and cash flows.
SUMMARY BY CUSTOMER LOCATION — 2002 COMPARED WITH 2001 Sales Revenue
Sales revenue in the United States and Canada for 2002 decreased $162 million compared to 2001 primarily due to lower selling prices. The decline in selling prices, which occurred in all segments, had a negative impact on revenues of $185 million. An unfavorable shift in product mix, primarily in the PCI and Fibers segments, had a negative impact on revenues of $107 million offset by increased sales volumes, which had a positive impact on revenues of $131 million.
Sales revenue in Europe, Middle East, and Africa for 2002 increased $22 million compared to 2001 due to increased sales volumes, which had a positive impact on revenues of $58 million, and the positive effect of foreign currency exchange rates, which had a positive impact on revenues of $43 million. These increases were mostly offset by decreased selling prices, primarily for the Polymers segment, which had a negative impact on revenues of $78 million.
Sales revenue in the Asia Pacific region for 2002 increased $81 million compared to 2001 due to higher sales volumes, primarily for acetyl and intermediates products, which had a positive impact on revenues of $113 million. Lower selling prices had a negative impact on revenues of $27 million.
Sales revenue in Latin America for 2002 decreased $11 million compared to 2001 primarily due to lower selling prices, which had a negative impact on revenues of $61 million. Increased sales volumes had a positive impact on revenues of $58 million. Both the decrease in selling prices and the increase in sales volumes were predominantly attributed to the Polymers segment. Foreign currency exchange rates had a negative impact on revenues of $8 million.
With a substantial portion of sales to customers outside the United States of America, Eastman is subject to the risks associated with operating in international markets. To mitigate its exchange rate risks, the Company frequently seeks to negotiate payment terms in U.S. dollars. In addition, where it deems such actions advisable, the Company engages in foreign currency hedging transactions and requires letters of credit and prepayment for shipments where its assessment of individual customer and country risks indicates their use is appropriate. See Note 8 to the Company’s consolidated financial statements and Part II—Item 7A—“Quantitative and Qualitative Disclosures About Market Risk.”
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SUMMARY OF CONSOLIDATED RESULTS — 2001 COMPARED WITH 2000
The operating loss of $120 million for 2001 was $682 million below the 2000 operating earnings of $562 million. Operating results for 2001 and 2000 included asset impairments and restructuring charges totaling approximately $396 million and $13 million, respectively, and other nonrecurring operating items totaling approximately $50 million and $8 million, respectively, as more fully described below and in Notes 15 and 16 to the Company’s consolidated financial statements. In 2001, lower sales volumes excluding acquisitions, higher unit costs driven by lower capacity utilization, and additional selling and general administrative expenses and research and development expenses from acquisitions also negatively impacted operating results. The decline in sales volumes in existing businesses was attributed to weaker economic demand worldwide.
Revenue from acquisitions contributed 8% or $411 million to the increase in sales revenue, partially offset by decreased sales volumes in existing businesses, which had a negative impact of 5% or $245 million on sales revenue. The decline in sales volumes in existing businesses was attributed to weaker economic demand worldwide. Foreign currency exchange rates had a negative impact on sales revenue of $56 million. Overall selling prices remained flat compared to 2000.
In 2001, gross profit was negatively impacted by lower sales volumes in existing businesses attributed to weaker economic demand worldwide. Higher unit costs driven by lower capacity utilization also had a negative impact on gross profit.
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Higher selling and general administrative expenses primarily reflected additional costs associated with recent acquisitions, including integration costs, and costs incurred by Cendian to develop its capacity to establish new customers in the chemicals logistics business. Research and development expenses increased for 2001 compared to 2000 mainly due to costs associated with the Hercules Businesses and McWhorter Technologies, Inc. (“McWhorter”).
Asset Impairments and Restructuring Charges
In 2001, nonrecurring charges totaling $396 million related to asset impairments and restructuring costs were recognized.
In 2001, approximately $231 million of asset impairment and restructuring charges were incurred in the Polymers segment. A charge of $108 million was recognized for the write-off of a prepaid asset related to the termination of a raw material supply agreement and a charge of $103 million was recognized for the write-down of underperforming polyethylene assets. A $10 million charge related to discontinuation of the precolored-green PET product line in Kingsport, Tennessee and a $10 million charge related to cessation of production at the Company’s solid-stating facility in Toronto, Ontario were also recognized.
The consolidation and restructuring of the operations of the CASPI segment resulted in restructuring charges, including related asset write-downs, totaling $77 million. Of these charges, $27 million related to the closure of an operating site in Duesseldorf, Germany that was obtained in the acquisition of Jager and $21 million related to the closure of a Moundville, Alabama plant that was obtained in the acquisition of Lawter International, Inc. The closure of plants in Philadelphia, Pennsylvania and Portland, Oregon that were obtained in the acquisition of McWhorter resulted in charges of $20 million being recognized. These restructuring charges included write-downs of the fixed assets at these facilities, severance accruals for employees impacted by the plant shutdowns, and other costs associated with closing the facilities. Charges of $6 million and $3 million were recorded for the write-down of impaired operating assets in North America and Europe, respectively.
The PCI segment incurred total nonrecurring charges of $73 million in 2001. Approximately $70 million of these charges resulted from the Company’s on-going restructuring of its fine chemicals product lines to reduce costs and to write down assets determined to be impaired. The restructuring initiative and related asset impairments included assets at the Company’s Tennessee and Arkansas sites within the United States, a plant in Wales, and a plant in Hong Kong. A charge of $63 million pertained primarily to write-downs of fixed assets associated with product lines that the Company will no longer pursue, net of the effect of a reversal of a customer deposit related to the impacted assets, and
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write-downs of other long-term deposits. A charge of $7 million pertained primarily to severance accruals for employees impacted by the plant shutdowns, closure costs, and write-downs of fixed assets. An additional charge of $3 million was recognized for other impaired assets in the European region.
The Company recorded asset impairment charges of approximately $15 million associated with under-utilized assets in the SP segment. These charges related to deterioration of demand for certain specialty plastics products produced in Kingsport, Tennessee.
Approximately $75 million of the charges discussed above were recognized in the fourth quarter 2001. Of this total, $36 million related to the consolidation and restructuring of the operations of the CASPI segment; $20 million related to asset impairment charges associated with under-utilized assets in the Polymers segment; $15 million related to under-utilized specialty plastics assets; $3 million related to impaired PCI European assets; and $1 million related to the Company’s on-going restructuring of its fine chemicals product lines.
In 2000, nonrecurring charges totaling $13 million were recognized, of which $8 million related to costs associated with exiting the sorbates manufacturing site at Chocolate Bayou, Texas, and $5 million related to the shutdown of facilities at Distillation Products Industries in Rochester, New York. These charges were reflected in the PCI segment.
Other nonrecurring operating items totaling $50 million were recognized in 2001. These items consisted of approximately $20 million in charges associated with efforts to spin-off the specialty chemicals and plastics businesses; an $18 million write-down of accounts receivable for credit risks resulting from the economic crisis in Argentina; a $7 million pension settlement charge; and a $5 million write-off of acquired in-process research and development related to the acquisition of the Hercules Businesses. Approximately $26 million of these items were reflected in the Polymers segment, $11 million in the CASPI segment, $7 million in the PCI segment, $4 million in the SP segment, and $2 million in the Fibers segment.
Other nonrecurring operating items totaling approximately $8 million were recorded in 2000. Reflected in the CASPI segment was a $9 million charge to write off in-process research and development related to the McWhorter acquisition, partially offset by a $1 million gain on the sale of certain assets, reflected in the Polymers segment.
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Higher interest expense reflected higher average commercial paper and other short-term borrowings used to finance the purchase of recent acquisitions and for general financing and investing activities, partially offset by lower average borrowing rates of approximately 6.5% for 2001 compared to approximately 7.25% for 2000.
Other income includes the Company’s portion of earnings from its equity investments, gains on sales of nonoperating assets, royalty income, gains on foreign exchange transactions, and other miscellaneous items. Other income for 2001 primarily reflected the Company’s portion of earnings from its equity investment in Genencor. Other income for 2000 primarily reflected gains on sales of nonoperating assets and the Company’s portion of earnings from its equity investments.
Other charges for 2001 included losses from foreign exchange transactions, certain litigation costs, losses from its equity investments, losses on sales of nonoperating assets, fees on securitized receivables, and other miscellaneous items. Other charges declined mainly due to a decrease in certain litigation costs and lower fees related to securitized receivables.
In 2000, a nonrecurring gain of approximately $38 million resulted from the initial public offering of common shares of Genencor.
Other Nonrecurring Items
Other nonrecurring items for 2001 totaling $20 million consisted of a $12 million charge for currency losses resulting from the economic crisis in Argentina and $8 million of sorbates civil litigation settlement costs and other professional fees.
Other nonrecurring items for 2000 totaling $10 million were recognized for costs related to sorbates civil litigation.
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2001 Compared With 2000
Sales revenue from acquisitions had a positive impact on sales revenue of $409 million, which was partially offset by a decrease in sales volumes for existing businesses of $77 million. The decline in sales volumes for existing businesses was attributed to weaker economic demand worldwide. Increased selling prices had a positive impact on sales revenue of 1% or $15 million, offset by the negative effect of foreign currency exchange rates of 1% or $16 million.
Operating results for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $77 million and by other nonrecurring operating items totaling approximately $11 million. Operating earnings for 2000 were negatively impacted by other nonrecurring operating items of approximately $9 million. For further information refer to Notes 15 and 16 to the Company’s consolidated financial statements.
In addition to the above items, operating results for 2001 were negatively impacted by lower sales volumes excluding acquisitions, higher unit costs driven by lower capacity utilization, and additional selling and general administrative expenses and research and development expenses from acquisitions.
Sales revenue declined 10% or $133 million due to lower sales volumes attributed to weaker economic demand worldwide. Decreased selling prices had a negative impact on sales revenue of approximately 1% or $11 million. An unfavorable shift in product mix had a negative impact on sales revenue of 1% or $15 million. The remaining decline in sales revenue was attributable to foreign currency exchange rates.
Operating results for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $73 million and other nonrecurring operating items totaling approximately $7 million. Operating earnings for 2000 were negatively impacted by asset impairments and restructuring charges totaling approximately $13 million. For further information see Notes 15 and 16 to the Company’s consolidated financial statements.
In addition to the items above, operating results for 2001 were negatively impacted by higher unit costs driven by lower capacity utilization and decreased sales volumes resulting from weaker economic demand worldwide.
Based upon indications from a large customer of this segment that it did not intend to renew its contract for a custom synthesis product beyond June 30, 2002, the Company did not expect to pursue that product in the future. Sales of that product represented approximately 2% of Eastman’s sales revenue for 2000 and approximately 5% of Eastman’s operating earnings for 2000. Financial results reported after June 30, 2001 reflect a minimal contribution to operating earnings from this contract.
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Sales revenue declined $38 million mainly due to lower sales volumes, which had a negative impact on sales revenue of 7% or $39 million. Foreign currency exchange rates also had a negative effect of 1% or $7 million on sales revenue while selling prices remained relatively flat compared to 2000. A favorable shift in product mix had a positive effect on sales revenue of 2% or $9 million.
Operating earnings for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $15 million and by other nonrecurring operating charges totaling approximately $4 million, as more fully described above and in Notes 15 and 16 to the Company’s consolidated financial statements.
In addition to the items above, operating earnings for 2001 were negatively impacted by higher unit costs driven by lower capacity utilization and decreased sales volumes resulting from weaker demand, primarily for cellulosic products.
Foreign currency exchange rates had a negative impact on sales revenue of 2% or $25 million. Decreased selling prices, primarily for polyethylene, also had a negative impact on sales revenue of 1% or $20 million, partially offset by an increase in sales volumes, primarily for PET polymers, which had a positive impact on sales revenue of 1% or $16 million.
Results for 2001 were negatively impacted by asset impairments and restructuring charges totaling approximately $231 million and by other nonrecurring operating items totaling approximately $26 million. Operating earnings for 2000 were positively impacted by a $1 million gain on the sale of certain assets. For further information, see Notes 15 and 16 to the Company’s consolidated financial statements.
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Decreased sales volumes had a negative impact on sales revenue of 2% or $11 million. The sales volume decrease was largely offset by increased selling prices, primarily related to acetate tow. Foreign currency exchange rates had a negative effect on sales revenue of 1% or $3 million.
Operating earnings for 2001 included nonrecurring items of approximately $2 million, as more fully described above and in Note 16 to the Company’s consolidated financial statements.
Operating earnings for 2001 remained relatively flat as a slight decline in sales volumes was offset by a slight increase in selling prices.
For additional information concerning the Company’s operating segments, see Exhibits 99.01 and 99.02 to this Annual Report and Note 22 to the Company’s consolidated financial statements.
SUMMARY BY CUSTOMER LOCATION — 2001 COMPARED WITH 2000
Sales Revenue
In the United States and Canada, sales revenue decreased slightly mainly due to lower sales volumes for existing businesses, attributed to weaker economic demand, which had a negative impact of 8% or $248 million on sales revenue. Lower selling prices, primarily for polyethylene, also had a negative impact on sales revenue of $50 million. These decreases were partially offset by revenue contributed by acquisitions, which had a positive impact on sales revenue of 9% or $285 million.
In Europe, Middle East, and Africa, sales revenue increased mainly due to revenue contributed by acquisitions, which had a positive impact on sales revenue of 11% or $118 million. Increased selling prices had a positive impact on sales revenue of $52 million, more than offset by decreased sales volumes for existing businesses. PET polymers were the primary reason for the change in selling prices and sales volumes. Foreign currency exchange rates had a negative impact of $36 million on sales revenue.
The slight increase in sales revenue in the Asia Pacific region was due to higher sales volumes, mainly for PET polymers, which had a positive impact on sales revenue of $38 million. This increase was partially offset by lower selling prices and foreign currency exchange rates, which had a negative impact on sales revenue of $20 million and $9 million, respectively.
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In Latin America, sales revenue increased primarily due to increased sales volumes, mainly for PET polymers, which had a positive impact on sales revenue of $31 million. Higher selling prices had a positive impact on sales revenue of $10 million, offset by the negative impact of foreign currency exchange rates.
LIQUIDITY, CAPITAL RESOURCES, AND OTHER FINANCIAL DATA
Cash Flows
Cash provided by operating activities in 2002 increased $404 million primarily due to the impact of changes in working capital; a change in liabilities for employee benefits and incentive compensation; and receipt of a federal income tax refund of approximately $40 million.
Changes in working capital increased operating cash flows by approximately $66 million in 2002 and decreased operating cash flows by approximately $46 million in 2001. Working capital decreased during 2002 as significant increases in trade accounts payable were partially offset by increases in inventory. In 2001, working capital increased as a result of a significant decrease in trade accounts payable and an increase in inventories, partially offset by a decrease in receivables. Changes in liabilities for employee benefits and incentive compensation increased operating cash flows $81 million in 2002 and decreased cash flows $8 million in 2001. Payments required under the Eastman Performance Plan and the Unit Performance Plan during 2002 were significantly lower than similar payments in 2001 due to the performance under these plans for 2001 and 2000.
In 2000, cash flows from operations were positively impacted by settlement of strategic foreign currency hedging transactions, partially offset by an increase in working capital. Cash provided by operating activities in 2000 also reflected $50 million provided by a continuous sale of accounts receivable program.
Cash used in investing activities reflected increased expenditures for capital additions in 2002 compared with 2001 primarily due to the $161 million related to the purchase of certain machinery and equipment previously utilized under an operating lease, while expenditures for acquisitions decreased in 2002 compared with 2001. In 2002, cash paid for Ariel Research Corporation was approximately $6 million; in 2001, cash paid for the Hercules Businesses was approximately $252 million; in 2000, cash paid for McWhorter was approximately $200 million and for Sokolov was approximately $46 million. Cash used in investing activities in 2002, 2001 and 2000 additionally reflects other small acquisitions. Cash used in investing activities in 2000 reflected higher proceeds from sales of assets.
Cash used in financing activities in 2002 reflected a significant decrease in commercial paper and short-term borrowings attributable to the use of proceeds from long-term debt issued during 2002 and the use of cash generated from operations to repay indebtedness. Cash provided by financing activities in 2001 included the effect of treasury stock purchases resulting from a reverse/forward stock split of the Company’s common stock approved by the stockholders in 2001. In 2000, cash used in financing activities reflected a repayment of borrowings associated with acquisitions and the effect of treasury stock purchases. The payment of dividends is also reflected in all periods.
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The Company expects to continue to pay the quarterly cash dividend. Priorities for use of available cash from operations will be to pay the dividend, reduce outstanding borrowings, fund targeted growth initiatives such as small acquisitions and other ventures, and repurchase shares.
Liquidity
Eastman has access to a $600 million revolving credit facility (the “Credit Facility”) expiring in July 2005. The Credit Facility was reduced from $800 million to $600 million in the second quarter 2002 following the issuance of $400 million in fixed rate debt described below. Any borrowings under the Credit Facility are subject to interest at varying spreads above quoted market rates, principally LIBOR. The Credit Facility requires facility fees on the total commitment that vary based on Eastman’s credit rating. The rate for such fees was 0.15% as of December 31, 2002 and 2001. The Credit Facility contains a number of covenants and events of default, including the maintenance of certain financial ratios.
Eastman typically utilizes commercial paper, generally with maturities of 90 days or less, to meet its liquidity needs. The Credit Facility provides liquidity support for commercial paper borrowings and general corporate purposes. Accordingly, outstanding commercial paper borrowings reduce borrowings available under the Credit Facility. Because the Credit Facility expires in July 2005, the commercial paper borrowings supported by the Credit Facility are classified as long-term borrowings because the Company has the ability to refinance such borrowings on a long-term basis. At December 31, 2002, the Company’s commercial paper borrowings were $143 million at an effective interest rate of 1.66%. At December 31, 2001, the Company’s outstanding Credit Facility and commercial paper borrowings were $637 million at an effective interest rate of 3.17%.
The Company has an effective registration statement on file with the Securities and Exchange Commission to issue up to $1 billion of debt or equity securities. On April 3, 2002, Eastman issued notes in the principal amount of $400 million due 2012 and bearing interest at 7% per annum. Net proceeds from the sale of the notes were $394 million and were used to repay portions of outstanding borrowings under the Credit Facility and commercial paper borrowings.
In the first quarter 2002, the Company entered into interest rate swaps that converted the effective interest rates of the notes due in January 2004 to variable rates. These original interest rate swaps were settled during the fourth quarter 2002 resulting in $13 million cash proceeds being received by the Company which were included in cash flows from 2002 operations in the Consolidated Statements of Cash Flows. The gain resulting from the settlement of the swaps is reflected as an increase in long-term debt and will be amortized into earnings as a reduction of interest expense through the maturity of the notes in January 2004. In conjunction with the settlement of the original interest rate swaps, new interest rate swaps were entered into in the fourth quarter 2002, converting the effective interest rates on the notes due in 2004 to variable rates that averaged 4.07% at December 31, 2002. The recording of the fair value of the interest rate swaps and the corresponding debt resulted in increases of $3 million in other noncurrent assets and long-term borrowings at December 31, 2002.
The Company expects to contribute approximately $220 million to its U.S. defined benefit pension plans during 2003 and that additional funding will be required in 2004, although the amount of such contribution is dependent upon interest rates, actual return on plan assets, retirement and attrition rates of employees, and other factors.
Cash flows from operations and the sources of capital described above are expected to be available and sufficient to meet foreseeable cash flow requirements. However, the Company’s cash flows from operations can be affected by numerous factors including risks associated with global operations, raw materials availability and cost, demand for and pricing of Eastman’s products, capacity utilization and other factors described under “Forward-Looking Statements and Risk Factors” below.
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Capital expenditures were $427 million, $234 million and $226 million for 2002, 2001 and 2000, respectively. Capital expenditures for 2002 include $161 million related to the purchase of certain machinery and equipment previously utilized under an operating lease. The Company continues its emphasis on cash flow management and, for 2003, expects that capital spending and other directed investments for small acquisitions and other ventures will be no more than depreciation and amortization. Long-term commitments related to planned capital expenditures are not material.
Other Commitments
At December 31, 2002, the Company’s obligations related to long-term notes and debentures totaled $1.9 billion to be paid over a period of 25 years. Other borrowings, related primarily to commercial paper borrowings, totaled approximately $154 million.
The Company had various purchase obligations at December 31, 2002 totaling approximately $1.3 billion over a period of approximately 15 years for materials, supplies and energy incident to the ordinary conduct of business. The Company also had various lease commitments for property and equipment under cancelable, noncancelable and month-to-month operating leases totaling approximately $257 million over a period of several years. Of the total lease commitments, approximately 40% relate to machinery and equipment, including computer and communications equipment and production equipment; approximately 34% relate to real property, including office space, storage facilities and land; and approximately 26% relate to railcars. The obligations described above are summarized in the following table:
If certain operating leases are terminated by the Company, it guarantees a portion of the residual value loss, if any, incurred by the lessors in disposing of the related assets. The Company believes, based on current facts and circumstances, that a material payment pursuant to such guarantees in excess of the payments included above is remote. Under these operating leases, the residual value guarantees at December 31, 2002 totaled $52 million.
The Company maintains defined benefit plans that provide eligible employees with retirement benefits. Benefits are paid to employees from trust funds. The Company contributes to the plans as permitted by laws and regulations. No contribution to the plans was made or required in 2002 and the Company anticipates funding approximately $220 million in 2003. As disclosed in Note 9 to the Company’s consolidated financial statements, during 2002 the Company’s additional minimum pension liability increased from $187 million to $417 million. While this amount does not correspond directly to cash funding requirements, it is an indication the Company will be required to contribute cash to the plans in future years. The amount and timing of such contributions is dependent upon interest rates, actual returns on plan assets, retirement and attrition rates of employees, and other factors. Such factors can significantly impact the amount and timing of any future contributions by the Company.
The Company has long-term commitments relating to joint ventures as described in Note 5 to the Company’s consolidated financial statements. The Company guarantees up to $137 million of the principal amount of the joint ventures’ third-party borrowings, but believes, based on current facts and circumstances and the structure of the ventures, that the likelihood of a payment pursuant to such guarantees is remote.
As described in Note 10 to the Company’s consolidated financial statements, Eastman entered into an agreement in 1999 that allows it to sell undivided interests in certain domestic trade accounts receivable under a planned continuous sale program to a third party. Under this agreement, receivables sold to the third party totaled $200 million at December 31, 2002 and 2001. Undivided interests in designated receivable pools were sold to the purchaser with recourse limited to the purchased interest in the receivable pools.
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The Company also had outstanding guarantees at December 31, 2002. Additional information related to these guarantees is included in Note 10 to the Company’s consolidated financial statements.
The Company did not have any other material relationships with unconsolidated entities or financial partnerships, often referred to as special purpose entities, for the purpose of facilitating off-balance sheet arrangements with contractually narrow or limited purposes. Thus, Eastman is not materially exposed to any financing, liquidity, market, or credit risk related to the above or any other such relationships.
Treasury Stock Transactions
The Company is currently authorized to repurchase up to $400 million of its common stock. No shares of Eastman common stock were repurchased by the Company during 2002. During 2001, 77,069 shares of common stock at a total cost of approximately $4 million, or an average price of $53 per share, were repurchased. A total of 2,746,869 shares of common stock at a cost of approximately $112 million, or an average price of approximately $41 per share, has been repurchased under the authorization. Repurchased shares may be used to meet common stock requirements for compensation and benefit plans and other corporate purposes. In the first quarter 2002, the Company issued 126,614 previously repurchased shares as the annual Company contribution to the Eastman Investment and Employee Stock Ownership Plan.
Dividends
The Company declared cash dividends of $0.44 per share in the fourth quarters 2002, 2001 and 2000 and a total of $1.76 per share in 2002, 2001 and 2000.
ENVIRONMENTAL
Certain Eastman manufacturing sites generate hazardous and nonhazardous wastes, the treatment, storage, transportation, and disposal of which are regulated by various governmental agencies. In connection with the cleanup of various hazardous waste sites, the Company, along with many other entities, has been designated a potentially responsible party (“PRP”) by the U.S. Environmental Protection Agency under the Comprehensive Environmental Response, Compensation and Liability Act, which potentially subjects PRPs to joint and several liability for such cleanup costs. In addition, the Company will be required to incur costs for environmental remediation and closure/postclosure under the federal Resource Conservation and Recovery Act. Adequate reserves for environmental contingencies have been established in accordance with Eastman’s policies as described in Note 1 to the Company’s consolidated financial statements. Because of expected sharing of costs, the availability of legal defenses, and the Company’s preliminary assessment of actions that may be required, it does not believe its liability for these environmental matters, individually or in the aggregate, will be material to the Company’s consolidated financial position, results of operations, or cash flows.
The Company accrues environmental costs when it is probable that the Company has incurred a liability and the amount can be reasonably estimated. The amount accrued reflects the Company’s assumptions about remedial requirements at the contaminated site, the nature of the remedy, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other PRPs. Changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in health, safety, environmental, chemical control regulations and testing requirements could result in higher or lower costs.
When a single amount cannot be reasonably estimated but the cost can be estimated within a range, the Company accrues the minimum amount. Estimated future environmental contingencies ranged from the minimum or best estimate of $97 million to the maximum of $111 million at December 31, 2002. At December 31, 2002 and 2001, the Company had recognized environmental contingencies of approximately $60 million and $54 million, respectively, representing the minimum or best estimate for remediation costs and, for closure/postclosure, costs accrued to date over the facilities’ estimated useful lives.
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The Company’s cash expenditures related to environmental protection and improvement were approximately $195 million, $216 million and $195 million in 2002, 2001 and 2000, respectively. These amounts pertain primarily to operating costs associated with environmental protection equipment and facilities, but also include expenditures for construction and development. The Company does not expect future environmental capital expenditures arising from requirements of recently promulgated environmental laws and regulations to materially increase the Company’s planned level of capital expenditures for environmental control facilities.
INFLATION
In recent years, inflation has not had a material adverse impact on Eastman’s costs. The cost of raw materials is generally based on market price, although derivative financial instruments may be utilized, as appropriate, to mitigate short-term market price fluctuations.
RECENTLY ISSUED ACCOUNTING STANDARDS
In August 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the asset.
The Company adopted the provisions of SFAS No. 143 on January 1, 2003. Upon initial application of the provisions of SFAS No. 143, entities are required to recognize a liability for any existing asset retirement obligations adjusted for cumulative accretion to the date of adoption of this Statement, an asset retirement cost capitalized as an increase to the carrying amount of the associated long-lived asset, and accumulated depreciation on that capitalized cost. The effect, if any, of initially applying this Statement will be reported in the Consolidated Statements of Earnings (Loss) as the cumulative effect of a change in accounting principle. The Company is evaluating the effect this Statement will have on its future financial statements.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This Statement, which updates, clarifies and simplifies existing accounting pronouncements, addresses the reporting of debt extinguishments and accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The provisions of this Statement are generally effective for the Company’s 2003 fiscal year, or in the case of specific provisions, for transactions occurring after May 15, 2002 or for financial statements issued on or after May 15, 2002. The provisions of this Statement have not had and are not expected to have a material impact on the Company’s financial condition or results of operations.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and concludes that an entity’s commitment to an exit plan does not by itself create a present obligation that meets the definition of a liability. This Statement also establishes that fair value is the objective of initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company adopted SFAS No. 146 on January 1, 2003. If adopted early, this Statement would not have had a material impact on the Company’s financial condition or results of operations.
In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company is currently evaluating the effect that the adoption of EITF Issue No. 00-21 will have on its results of operations and financial condition.
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In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The disclosure provisions of FIN 45 are effective for the current fiscal year, and the Company has included this information in Note 10 to the Company’s consolidated financial statements. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002, irrespective of a guarantor’s year-end. The Company has not assessed what impact, if any, the adoption of the initial recognition and measurement provisions of FIN 45 will have upon its financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, amendment of FASB Statement No. 123.” This Statement provides additional transition guidance for those entities that elect to voluntarily adopt the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” Furthermore, SFAS No. 148 mandates new disclosures in both interim and year-end financial statements within Note 1, “Significant Accounting Policies,” to the Company’s consolidated financial statements. The Company has elected not to adopt the recognition provisions of SFAS No. 123, as amended by SFAS No. 148. However, the Company has adopted the disclosure provisions for the current fiscal year and has included this information in Note 1 to the Company’s consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities (“VIE’s”) created after January 31, 2003, and to VIE’s in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to VIE’s in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period. See Note 10 to the Company’s consolidated financial statements for disclosures regarding the Company’s VIE’s. The adoption of FIN 46 is not expected to have a material impact on the Company’s consolidated financial position, liquidity, or results of operations.
OUTLOOK
For 2003, the Company expects:
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The Company is continuing to work towards achieving earnings in 2003 that are sufficient to return the cost of capital, which would result in earnings of approximately $2.70 to $2.85 per share; however, there are a number of factors that are negatively impacting earnings that make accomplishing this goal difficult, including:
In order to offset these and other challenging factors in 2003, the Company is: utilizing its marketing capabilities to recover raw material cost increases and improve margins wherever possible; implementing various organizational changes and cost control measures; and using all lines of the income statement to improve profitability. See “Forward-Looking Statements and Risk Factors.”
Longer term, the Company expects:
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FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The expectations under “Outlook” and certain other statements in this Annual Report may be forward-looking in nature as defined in the Private Securities Litigation Reform Act of 1995. These statements and other written and oral forward-looking statements made by the Company from time to time 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; legal proceedings; exposure to, and effects of hedging of, raw material and energy costs and foreign currencies; global and regional economic, political, and business conditions; competition; growth opportunities; supply and demand, volume, price, cost, margin, and sales; earnings, cash flow, dividends and other expected financial conditions; expectations, strategies, and plans for individual products, businesses, segments and divisions as well as for the whole of Eastman Chemical Company; cash requirements and uses of available cash; financing plans; pension expenses and funding; future expenses and insurance settlement associated with operational disruptions; credit rating; cost reduction and control efforts and targets; integration of acquired businesses; development, production, commercialization, and acceptance of new products, services and technologies and related costs; and asset and product portfolio changes.
These plans and expectations are based upon certain underlying assumptions, including those mentioned with the specific statements. Such assumptions are in turn based upon internal estimates and analyses of current market conditions and trends, management plans and strategies, economic conditions and other factors. These plans and expectations 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. In addition to the factors described in this report, the following are some of the important factors that could cause the Company’s actual results to differ materially from those in any such forward-looking statements:
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The foregoing list of important factors does not include all such factors nor necessarily present them in order of importance. This disclosure, including that under “Outlook” and “Forward-Looking Statements and Risk Factors,” and other forward-looking statements and related disclosures made by the Company in this filing and elsewhere from time to time, represent management’s best judgment as of the date the information is given. The Company does not undertake responsibility for updating any of such information, whether as a result of new information, future events, or otherwise, except as required by law. Investors are advised, however, to consult any further public Company disclosures (such as in filings with the Securities and Exchange Commission or in Company press releases) on related subjects.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to changes in financial market conditions in the normal course of its business due to its use of certain financial instruments as well as transacting in various foreign currencies and funding of foreign operations. To mitigate the Company’s exposure to these market risks, Eastman has established policies, procedures, and internal processes governing its management of financial market risks and the use of financial instruments to manage its exposure to such risks.
The Company is exposed to changes in interest rates primarily as a result of its borrowing activities, which include short-term commercial paper and long-term borrowings used to maintain liquidity and to fund its business operations and capital requirements. Currently, these borrowings are predominately U.S. dollar denominated. The nature and amount of the Company’s long-term and short-term debt may vary as a result of future business requirements, market conditions, and other factors.
The Company’s operating cash flows denominated in foreign currencies are exposed to changes in foreign currency exchange rates. The Company continually evaluates its foreign currency exposure based on current market conditions and the locations in which the Company conducts business. In order to mitigate the effect of foreign currency risk, the Company enters into forward exchange contracts to hedge certain firm commitments denominated in foreign currencies and currency options to hedge probable anticipated but not yet committed export sales and purchase transactions expected within no more than two years and denominated in foreign currencies. The gains and losses on these contracts offset changes in the value of related exposures. It is the Company’s policy to enter into foreign currency transactions only to the extent considered necessary to meet its objectives as stated above. The Company does not enter into foreign currency transactions for speculative purposes.
The Company is exposed to fluctuations in market prices for certain of its major raw materials. To mitigate short-term fluctuations in market prices for certain commodities, principally propane, ethane, and natural gas, the Company enters into forwards and options contracts.
The Company determines its market risk utilizing sensitivity analysis, which measures the potential losses in fair value resulting from one or more selected hypothetical changes in interest rates, foreign currency exchange rates, and/or commodity prices. For 2002 and 2001, the market risk associated with the fair value of interest-rate-sensitive instruments, assuming an instantaneous parallel shift in interest rates of 10% are approximately $100 million and $81 million, respectively, and an additional $10 million for each one percentage point change in interest rates thereafter. This exposure is primarily related to long-term debt with fixed interest rates. The market risk associated with foreign currency-sensitive instruments utilizing a modified Black-Scholes option pricing model and a 10% adverse move in the U.S. dollar relative to each foreign currency hedged by the Company is approximately $4 million and $2 million and an additional $0.4 million and $0.1 million for 2002 and 2001, respectively, for an additional one percentage point adverse change in foreign currency exchange rates. Further adverse movements in foreign currencies would create losses in fair value; however, such losses would not be linear to that disclosed above. This exposure, which is primarily related to foreign currency options purchased by the Company to manage fluctuations in foreign currencies, is limited to the dollar value of option premiums payable by the Company for the related financial instruments. In 2002, the market risk associated with foreign currency options utilizing a modified Black-Scholes option pricing model and a 10% adverse change in the U.S. dollar relative to each foreign currency results in a $2 million loss in fair value. Furthermore, since the Company utilizes currency-sensitive derivative instruments for hedging anticipated foreign currency transactions, a loss in fair value for those instruments is generally offset by increases in the value of the underlying anticipated transactions. The market risk associated with feedstock options and natural gas swaps assuming an instantaneous parallel shift in the underlying commodity price of 10% is approximately $2 million and an additional $0.1 million and $0.2 million for 2002 and 2001, respectively, for each one percentage point move in closing prices thereafter.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation and integrity of the accompanying consolidated financial statements of Eastman Chemical Company and subsidiaries appearing on pages 70 through 111. Eastman has prepared these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and the statements of necessity include some amounts that are based on management’s best estimates and judgments.
Eastman’s accounting systems include extensive internal controls designed to provide reasonable assurance of the reliability of its financial records and the proper safeguarding and use of its assets. Such controls are based on established policies and procedures, are implemented by trained, skilled personnel with an appropriate segregation of duties, and are monitored through a comprehensive internal audit program. The Company’s policies and procedures prescribe that the Company and all employees are to maintain the highest ethical standards and that its business practices throughout the world are to be conducted in a manner that is above reproach.
The consolidated financial statements have been audited by PricewaterhouseCoopers LLP, independent accountants, who were responsible for conducting their audits in accordance with auditing standards generally accepted in the United States of America. Their report is included herein.
The Board of Directors exercises its responsibility for these financial statements through its Audit Committee, which consists entirely of nonmanagement Board members. The independent accountants and internal auditors have full and free access to the Audit Committee. The Audit Committee meets periodically with PricewaterhouseCoopers LLP and Eastman’s director of internal auditing, both privately and with management present, to discuss accounting, auditing, policies and procedures, internal controls, and financial reporting matters.
February 21, 2003
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders ofEastman Chemical Company
In our opinion, the accompanying consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 116 present fairly, in all material respects, the financial position of Eastman Chemical Company and its subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 115 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Notes 1, 4, and 8 to the consolidated financial statements, on January 1, 2002 Eastman Chemical Company adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”, and on January 1, 2001, adopted Statement of Financial Accounting Standard No. 133, as amended by Statement of Financial Accounting Standard No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.”
/s/ PricewaterhouseCoopers LLP
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CONSOLIDATED STATEMENTS OF EARNINGS (LOSS),COMPREHENSIVE INCOME (LOSS) and RETAINED EARNINGS
The accompanying notes are an integral part of these financial statements.
70
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
71
CONSOLIDATED STATEMENTS OF CASH FLOWS
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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74
75
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77
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79
80
81
82
83
84
85
86
87
88
Purchase Obligations and Lease Commitments
Accounts Receivable Securitization Program
89
Guarantees
Obligations of Equity Affiliates
Residual Value Guarantees
Other Guarantees
Product Warranty Liability
Variable Interest Entities
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
Except for cumulative translation adjustment, amounts of other comprehensive income (loss) are presented net of applicable taxes. Because cumulative translation adjustment is considered a component of permanently invested unremitted earnings of subsidiaries outside the United States, no taxes are provided on such amounts.
Cash flows from operating activities include the Company’s portion of earnings from its equity investments of $11 million, $6 million, and $15 million for 2002, 2001 and 2000, respectively. Derivative financial instruments and related gains and losses are included in cash flows from operating activities. The effect on cash of foreign currency transactions and exchange rate changes for all years presented was insignificant.
With the implementation of the divisional structure, goods and services are transferred between the two divisions at predetermined prices which may be in excess of cost. Accordingly, the divisional structure results in the recognition of interdivisional sales revenue and operating earnings. Such interdivisional transactions are eliminated in the Company’s consolidated financial statements. Prior to 2002, segment sales revenue reflected only actual sales to third parties and the intersegment transfer of goods and services, recorded at cost, had no impact on segment earnings.
Effective January 1, 2002, sales and operating results for Cendian Corporation (“Cendian”), the Company’s logistics subsidiary and an Eastman Division initiative, are included in amounts for the CASPI, PCI and SP segments, and have been allocated to these segments on the basis of sales revenues for each of these segments. Prior to 2002, sales and operating results for Cendian were allocated to all five segments.
105
Effective January 1, 2002, certain compounded polyethylene products were moved from the Polymers segment to the SP segment. Accordingly, amounts for 2001 and 2000 have been reclassified to reflect this change.
106
107
Revenues are attributed to countries based on customer location. No individual foreign country is material with respect to revenues or long-lived assets.
109
In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the asset.
The Company adopted the provisions of SFAS No. 143 on January 1, 2003. Upon initial application of the provisions of SFAS No. 143, entities are required to recognize a liability for any existing asset retirement obligations adjusted for cumulative accretion to the date of adoption of this Statement, an asset retirement cost capitalized as an increase to the carrying amount of the associated long-lived asset, and accumulated depreciation on that capitalized cost. The cumulative effect, if any, of initially applying this Statement will be reported in the Consolidated Statements of Earnings (Loss) as the cumulative effect of a change in accounting principle. The Company is evaluating the effect this Statement will have on the Company’s future financial statements.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and concludes that an entity’s commitment to an exit plan does not by itself create a present obligation that meets the definition of a liability. This Statement also establishes that fair value is the objective of initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged.
110
The Company has not yet assessed the impact of this Statement on its financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. The disclosure provisions of FIN 45 are effective for the current fiscal year and the Company has included this information in Note 10 to the Company’s consolidated financial statements. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002, irrespective of a guarantor’s year-end. The Company has not assessed the impact, if any, of the adoption of FIN 45.
In the first quarter 2003, Eastman reached an agreement to sell certain of its high-performance crystalline plastics assets, including certain technology rights and other intellectual property. Under terms of the agreement, Eastman will continue to supply certain polymers used in the business. Other than a potential gain to be recognized related to the sale transaction, the sale of these assets should not have a significant impact on the Company’s future results of operations, financial position or cash flows.
111
None.
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PART III
The material under the heading “Proposals to be Voted Upon at the Annual Meeting—Item 1—Election of Directors,” (except for the material under the subheading “Board Committees—Audit Committee—Audit Committee Report”, which is not incorporated by reference herein) and in Note (10) to the Summary Compensation Table under the heading “Executive Compensation—Compensation Tables”, in the to be filed definitive 2003 Proxy Statement is incorporated by reference herein in response to this Item. Certain information concerning executive officers of the Company is set forth under the heading “Executive Officers of the Company” in Part I of this Annual Report.
The material under the headings “Proposals to be Voted Upon at the Annual Meeting—Item 1—Election of Directors—Director Compensation” in the to be filed definitive 2003 Proxy Statement is incorporated by reference herein in response to this Item. In addition, the material under the heading “Executive Compensation” in the to be filed definitive 2003 Proxy Statement is incorporated by reference herein in response to this Item, except for the material under the subheadings “ — Compensation and Management Development Committee Report on Executive Compensation” and “ — Performance Graph,” which are not incorporated by reference herein.
The material under the headings “Stock Ownership of Directors and Executive Officers—Common Stock” and “Stock Ownership of Certain Beneficial Owners” in the to be filed definitive 2003 Proxy Statement is incorporated by reference herein in response to this Item.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
Equity Compensation Plans Approved by Stockholders
Stockholders approved the Company’s 1994, 1997, and 2002 Omnibus Long-Term Compensation Plans; the 1994, 1999, and 2002 Director Long-Term Compensation Plans; and the 1996 Non-Employee Director Stock Option Plan. Although stock and stock-based based awards are still outstanding under the 1994 and 1997 Omnibus Long-Term Compensation Plans, as well as the 1994 and 1999 Director Long-Term Compensation Plans, no new shares are available under these plans for future grants.
Equity Compensation Plans Not Approved by Stockholders
Stockholders have approved all compensation plans under which shares of Eastman common stock may be issued.
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Summary Table
The following table sets forth certain information as of December 31, 2002 with respect to compensation plans under which shares of Eastman common stock may be issued.
There are no transactions or relationships since the beginning of the last completed fiscal year required to be reported in response to this Item.
The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Within the 90-day period prior to the filing of this Annual Report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective.
Subsequent to the date of their evaluation, there were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls.
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PART IV
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
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CERTIFICATIONS
I, J. Brian Ferguson, certify that:
Date: March 11, 2003
/s/ J. Brian Ferguson
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I, James P. Rogers, certify that:
1. I have reviewed this Annual Report on Form 10-K of Eastman Chemical Company;
/s/ James P. Rogers
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EXHIBIT INDEX
120
121
122
123