QuickLinks -- Click here to rapidly navigate through this document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

FOR THE QUARTERLY PERIOD ENDED June 30, 2003

Commission file number 1-3433

THE DOW CHEMICAL COMPANY
(Exact name of registrant as specified in its charter)

Delaware       38-1285128
(State or other jurisdiction of
incorporation or organization)
      (I.R.S. Employer Identification No.)

2030 DOW CENTER, MIDLAND, MICHIGAN 48674
(Address of principal executive offices) (Zip Code)

989-636-1000
(Registrant's telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

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 ý    No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o

Class
   
  Outstanding at June 30, 2003
Common Stock, par value $2.50 per share       918,396,819 shares




The Dow Chemical Company
Table of Contents

 
  PAGE
PART I—FINANCIAL INFORMATION    
 
Item 1. Financial Statements

 

3
   
Consolidated Statements of Income

 

3
   
Consolidated Balance Sheets

 

4
   
Consolidated Statements of Cash Flows

 

5
   
Consolidated Statements of Comprehensive Income

 

5
   
Notes to the Consolidated Financial Statements

 

6
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

18
   
Disclosure Regarding Forward-Looking Information

 

18
   
Results of Operations

 

18
   
Changes in Financial Condition

 

25
   
Other Matters

 

27
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

32
 
Item 4. Controls and Procedures

 

33

PART II—OTHER INFORMATION

 

 
 
Item 1. Legal Proceedings

 

34
 
Item 4. Submission of Matters to a Vote of Security Holders

 

35
 
Item 6. Exhibits and Reports on Form 8-K

 

36

SIGNATURE

 

37

EXHIBIT INDEX

 

38

2



PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

 
  Three Months Ended
  Six Months Ended
 
In millions, except per share amounts (Unaudited)

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Net Sales   $ 8,242   $ 7,259   $ 16,323   $ 13,564  
   
 
 
 
 
  Cost of sales     6,970     6,031     14,133     11,386  
  Research and development expenses     246     272     483     522  
  Selling, general and administrative expenses     354     405     709     796  
  Amortization of intangibles     15     19     30     33  
  Merger-related expenses and restructuring         10         23  
  Equity in earnings (losses) of nonconsolidated affiliates     90     21     129     (5 )
  Sundry income (expense)—net     52     (4 )   46     (17 )
  Interest income     18     14     38     30  
  Interest expense and amortization of debt discount     207     188     422     377  
   
 
 
 
 
Income before Income Taxes and Minority Interests     610     365     759     435  
   
 
 
 
 
  Provision for income taxes     186     111     233     135  
  Minority interests' share in income     31     16     48     24  
   
 
 
 
 
Income before Cumulative Effect of Changes in Accounting
    Principles
    393     238     478     276  
   
 
 
 
 
  Cumulative effect of changes in accounting principles             (9 )   67  
   
 
 
 
 
Net Income Available for Common Stockholders   $ 393   $ 238   $ 469   $ 343  
   
 
 
 
 
Share Data                          
  Earnings before cumulative effect of changes in accounting
    principles per common share—basic
  $ 0.43   $ 0.26   $ 0.52   $ 0.30  
  Earnings per common share—basic   $ 0.43   $ 0.26   $ 0.51   $ 0.38  
  Earnings before cumulative effect of changes in accounting
    principles per common share—diluted
  $ 0.43   $ 0.26   $ 0.52   $ 0.30  
  Earnings per common share—diluted   $ 0.43   $ 0.26   $ 0.51   $ 0.37  
  Common stock dividends declared per share of common stock   $ 0.335   $ 0.335   $ 0.67   $ 0.67  
  Weighted-average common shares outstanding—basic     917.3     910.7     916.0     909.0  
  Weighted-average common shares outstanding—diluted     921.9     919.3     921.8     917.2  
   
 
 
 
 
Depreciation   $ 426   $ 402   $ 859   $ 790  
   
 
 
 
 
Capital Expenditures   $ 272   $ 391   $ 495   $ 688  
   
 
 
 
 

See Notes to the Consolidated Financial Statements.

3



The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  June 30,
2003

  Dec. 31,
2002

 
Assets              
Current Assets              
  Cash and cash equivalents   $ 2,276   $ 1,484  
  Marketable securities and interest-bearing deposits     71     89  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables—2003: $125; 2002: $127)     3,260     3,116  
    Other     2,261     2,369  
  Inventories     4,235     4,208  
  Deferred income tax assets—current     147     109  
   
 
 
  Total current assets     12,250     11,375  
   
 
 
Investments              
  Investment in nonconsolidated affiliates     1,721     1,565  
  Other investments     1,823     1,689  
  Noncurrent receivables     306     577  
   
 
 
  Total investments     3,850     3,831  
   
 
 
Property              
  Property     39,101     37,934  
  Less accumulated depreciation     25,447     24,137  
   
 
 
  Net property     13,654     13,797  
   
 
 
Other Assets              
  Goodwill     3,219     3,189  
  Other intangible assets (net of accumulated amortization—2003: $383; 2002: $349)     594     613  
  Deferred income tax assets—noncurrent     3,903     3,776  
  Asbestos-related insurance receivables—noncurrent     1,350     1,489  
  Deferred charges and other assets     1,677     1,492  
   
 
 
  Total other assets     10,743     10,559  
   
 
 
Total Assets   $ 40,497   $ 39,562  
   
 
 
Liabilities and Stockholders' Equity              
Current Liabilities              
  Notes payable   $ 586   $ 580  
  Long-term debt due within one year     1,260     797  
  Accounts payable:              
    Trade     2,578     2,834  
    Other     2,050     1,789  
  Income taxes payable     220     202  
  Deferred income tax liabilities—current     101     30  
  Dividends payable     328     326  
  Accrued and other current liabilities     2,464     2,298  
   
 
 
  Total current liabilities     9,587     8,856  
   
 
 
Long-Term Debt     11,636     11,659  
   
 
 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     1,093     994  
  Pension and other postretirement benefits—noncurrent     3,818     3,775  
  Asbestos-related liabilities—noncurrent     1,913     2,072  
  Other noncurrent obligations     3,245     3,214  
   
 
 
  Total other noncurrent liabilities     10,069     10,055  
   
 
 
Minority Interest in Subsidiaries     355     366  
   
 
 
Preferred Securities of Subsidiaries     1,000     1,000  
   
 
 
Stockholders' Equity              
  Common stock     2,453     2,453  
  Additional paid-in capital          
  Unearned ESOP shares     (51 )   (61 )
  Retained earnings     9,352     9,520  
  Accumulated other comprehensive loss     (1,881 )   (2,097 )
  Treasury stock at cost     (2,023 )   (2,189 )
   
 
 
  Net stockholders' equity     7,850     7,626  
   
 
 
Total Liabilities and Stockholders' Equity   $ 40,497   $ 39,562  
   
 
 

See Notes to the Consolidated Financial Statements.

4


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
   
  Six Months Ended
 
In millions (Unaudited)

  June 30,
2003

  June 30,
2002

 
Operating Activities   Income before cumulative effect of changes in accounting
    principles
  $ 478   $ 276  
    Adjustments to reconcile net income to net cash provided by
    operating activities:
             
            Depreciation and amortization     935     853  
            Provision for deferred income tax     54     17  
            Earnings/losses of nonconsolidated affiliates less than
            (in excess of) dividends received
    (45 )   51  
            Minority interests' share in income     48     24  
            Net loss on sales of consolidated companies     3      
            Net gain on sales of property and businesses     (24 )   (9 )
            Other net gain     (40 )   (24 )
            Net loss on sale of nonconsolidated affiliate     1      
            Tax benefit—nonqualified stock option exercises     13     16  
    Changes in assets and liabilities that provided (used)
    cash:
             
            Accounts and notes receivable     (361 )   (862 )
            Inventories     (78 )   85  
            Accounts payable     (41 )   81  
            Noncurrent receivables     271     (201 )
            Other assets and liabilities     448     233  
       
 
 
    Cash provided by operating activities     1,662     540  
       
 
 
Investing Activities   Capital expenditures     (495 )   (688 )
    Proceeds from sales of property and businesses     83     39  
    Investments in consolidated companies     (69 )    
    Investments in nonconsolidated affiliates     (48 )   (71 )
    Proceeds from sale of nonconsolidated affiliate     8      
    Advances to nonconsolidated affiliates         (11 )
    Purchases of investments     (936 )   (1,106 )
    Proceeds from sales and maturities of investments     886     1,051  
       
 
 
    Cash used in investing activities     (571 )   (786 )
       
 
 
Financing Activities   Changes in short-term notes payable     (8 )   419  
    Payments on long-term debt     (594 )   (87 )
    Proceeds from issuance of long-term debt     833     532  
    Purchases of treasury stock     (4 )   (3 )
    Proceeds from sales of common stock     96     111  
    Distributions to minority interests     (38 )   (38 )
    Dividends paid to stockholders     (612 )   (607 )
       
 
 
    Cash provided by (used in) financing activities     (327 )   327  
       
 
 
Effect of Exchange Rate Changes on Cash     28     (2 )
       
 
 
Summary   Increase in cash and cash equivalents     792     79  
    Cash and cash equivalents at beginning of year     1,484     220  
       
 
 
    Cash and cash equivalents at end of period   $ 2,276   $ 299  
       
 
 

See Notes to the Consolidated Financial Statements.

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

 
  Three Months Ended
  Six Months Ended
 
In millions (Unaudited)

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Net Income Available for Common Stockholders   $ 393   $ 238   $ 469   $ 343  
   
 
 
 
 
Other Comprehensive Income, Net of Tax                          
  Net unrealized gains (losses) on investments     39     (16 )   32     (23 )
  Translation adjustments     80     217     185     184  
  Minimum pension liability adjustments             (3 )    
  Net gains (losses) on cash flow hedging derivative instruments     18     (16 )   2     4  
   
 
 
 
 
  Total other comprehensive income     137     185     216     165  
   
 
 
 
 
Comprehensive Income   $ 530   $ 423   $ 685   $ 508  
   
 
 
 
 

See Notes to the Consolidated Financial Statements.

5



The Dow Chemical Company and Subsidiaries
Notes to the Consolidated Financial Statements

(Unaudited)

NOTE A—CONSOLIDATED FINANCIAL STATEMENTS

        The unaudited interim consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) which, in the opinion of management, are considered necessary for a fair presentation of the results for the periods covered. Certain reclassifications of prior year amounts have been made to conform to current year presentation. These statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Except as otherwise indicated by the context, the terms "Company" or "Dow" as used herein mean The Dow Chemical Company and its consolidated subsidiaries.

NOTE B—ACCOUNTING CHANGES

        In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," which replaced Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations." Under SFAS No. 141, all business combinations initiated after June 30, 2001 are accounted for using the purchase method. As required by SFAS No. 141, negative goodwill of $89 million associated with the acquisition of Buna Sow Leuna Olefinverbund ("BSL") in 1997 was written off and included in "Cumulative effect of changes in accounting principles" in the first quarter of 2002. The application of SFAS No. 141 did not result in the reclassification of any amounts previously recorded as goodwill or other intangible assets.

        In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which replaced APB Opinion No. 17, "Intangible Assets," and established new accounting and reporting requirements for goodwill and other intangible assets, effective for fiscal years beginning after December 15, 2001. Under this statement, goodwill and intangible assets deemed to have indefinite useful lives are not amortized, but are subject to impairment testing. Impairment testing was required at adoption and at least annually thereafter. On an ongoing basis (absent any impairment indicators), Dow plans to perform impairment tests during the fourth quarter of each year, in conjunction with the Company's annual budgeting process. Effective January 1, 2002, Dow ceased all amortization of goodwill, which is its only intangible asset with an indefinite useful life, and tested recorded goodwill for impairment by comparing the fair value of each reporting unit, determined using a discounted cash flow method, with its carrying value.

        As a result of the Company's impairment testing, goodwill impairment losses totaling $22 million were recorded in the first quarter of 2002 and included in "Cumulative effect of changes in accounting principles." Summaries of the impairment losses are as follows:

        As required by SFAS No. 142, the Company also reassessed the useful lives and the classification of its identifiable intangible assets and determined them to be appropriate. See Note E for disclosures related to goodwill and other intangible assets.

        In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which requires an entity to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the related long-lived asset. The liability is adjusted to its present value each period and the asset is depreciated over its useful life. A gain or loss may be incurred upon settlement of the liability. SFAS No. 143 was effective for fiscal years beginning after June 15, 2002. Adoption of SFAS No. 143 on January 1, 2003 resulted in the recognition of an asset retirement obligation of $45 million and a charge of $9 million (net of tax of $5 million), which was included in "Cumulative effect of changes in accounting principles." See Note H for disclosures related to asset retirement obligations.

        In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." This statement, which was effective for exit or disposal activities initiated after December 31, 2002, will change the measurement and timing of costs associated with exit and disposal activities undertaken by the Company in the future.

6


        In the first quarter of 2003, Dow adopted the fair value provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," for new grants of equity instruments (which include stock options, deferred stock grants, and subscriptions to purchase shares under the Company's Employees' Stock Purchase Plan) to employees. Dow expects the incremental after-tax expense associated with awards of stock options to be approximately $0.02 per share in 2003, growing to approximately $0.06 per share in 2005. These estimates were based on the terms of Dow's stock option plans and current assumptions for stock option grants and valuation, which may change when stock options are granted in the future. See Note I for disclosures required by SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure."

        In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies," relating to the guarantor's accounting for and disclosures of certain guarantees issued. The initial recognition and measurement provisions of the interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements of the interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company's disclosures related to guarantees can be found in Note F.

        In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 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 in which equity investors do not bear the residual economic risks. The interpretation was immediately applicable to variable interest entities ("VIEs") created after January 31, 2003, and to VIEs in which an enterprise obtains an interest after that date. It applies in the fiscal year or interim period beginning after June 15, 2003, to VIEs in which an enterprise holds a variable interest that was acquired before February 1, 2003. See Note G for disclosures regarding the Company's VIEs, and the expected impact of adoption in the third quarter of 2003.

        In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires the classification of certain financial instruments that embody obligations for the issuer as liabilities (or assets in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company has evaluated the preferred securities previously issued by two consolidated subsidiaries and concluded that the $500 million of preferred securities issued by Hobbes Capital S.A. is outside of the scope of the standard and will continue to be classified as preferred securities of subsidiaries. The $500 million of preferred partnership units issued by Tornado Finance V.O.F. ("Tornado") is within the scope of the standard and must be classified as a liability of the Company upon adoption of SFAS No. 150 on July 1, 2003; however, the rights of the holders of Tornado's preferred partnership units were subsequently modified to eliminate the unconditional mandatory redemption feature. Therefore, the preferred partnership units will be classified as preferred securities of subsidiaries when the financial statements are issued for the third quarter of 2003. See Note P to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 for additional information regarding preferred securities of subsidiaries.

NOTE C—MERGER-RELATED EXPENSES AND RESTRUCTURING

Merger-Related Expenses and Restructuring

        On February 6, 2001, the merger of Union Carbide Corporation ("Union Carbide") with a subsidiary of The Dow Chemical Company was completed, and Union Carbide became a wholly owned subsidiary of Dow. Following the completion of the Union Carbide merger, Dow's management made certain decisions relative to employment levels, duplicate assets and facilities and excess capacity resulting from the merger. These decisions resulted in a pretax special charge in the first quarter of 2001 of $1.4 billion. The planned merger-related program was substantially completed in the third quarter of 2002. Complete disclosures relative to the program and the activity in the merger-related special charge reserve can be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. In conjunction with this program, one-time merger and integration costs of $23 million, exclusively related to the merger, were recorded in the second quarter of 2002.

        During the fourth quarter of 2002, an additional charge of $34 million was recorded for merger-related severance. Under this revised severance program, $62 million was paid to 746 former employees in the first quarter of 2003.

7


Other Restructuring

        In late 2002, immediately following the appointment of a new President and CEO, management began a series of studies to determine potential actions relative to under-performing assets and employment levels. Prior to the end of 2002, certain studies were completed and management made decisions relative to certain assets. The economic effects of these decisions resulted in a pretax charge in the fourth quarter of 2002 of $168 million, which included $37 million for severance for 624 employees (included in Unallocated and Other for segment reporting purposes). The charge for severance was based on severance plans communicated to employees. In the first half of 2003, severance of $13 million was paid to approximately 230 former employees, leaving an accrual balance of $24 million to be paid to approximately 415 employees. The program is expected to be completed in the third quarter of 2003.

        In the first quarter of 2003, additional studies regarding non-strategic and under-performing assets were completed and management made decisions relative to certain assets. These decisions resulted in the write-down of the net book value of several manufacturing facilities totaling $37 million (the largest of which was $16 million associated with the impairment and planned shutdown of Union Carbide's Seadrift, Texas, ethylene cracker in the third quarter of 2003), the impairment of Union Carbide's chemical transport vessel (sold in the second quarter of 2003) of $11 million, and the write-off of cancelled capital projects totaling $12 million.

NOTE D—INVENTORIES

        The following table provides a breakdown of inventories at June 30, 2003 and December 31, 2002:

Inventories
In millions

  June 30,
2003

  Dec. 31,
2002

Finished goods   $ 2,440   $ 2,523
Work in process     889     843
Raw materials     492     452
Supplies     414     390
   
 
Total inventories   $ 4,235   $ 4,208
   
 

        The reserves reducing inventories from the first-in, first-out ("FIFO") basis to the last-in, first-out ("LIFO") basis amounted to $365 million at June 30, 2003 and $209 million at December 31, 2002.

NOTE E—GOODWILL AND OTHER INTANGIBLE ASSETS

        The following table shows changes in the carrying amount of goodwill for the six months ended June 30, 2003, by operating segment:

In millions

  Performance
Plastics

  Performance
Chemicals

  Agricultural
Sciences

  Plastics
  Hydrocarbons
and Energy

  Total
 
Goodwill at December 31, 2002   $ 904   $ 785   $ 1,320   $ 117   $ 63   $ 3,189  
   
 
 
 
 
 
 
Increase related to acquisitions:                                      
  Remaining 20% interest in INCA
    International SPA
                25         25  
  Remaining 26.7% interest in Union
    Carbide do Brasil S.A.
                11         11  
   
 
 
 
 
 
 
  Total increase related to acquisitions                 36         36  
   
 
 
 
 
 
 
Goodwill write-off related to sale of
    Sentrachem businesses, Karbochem and
        Chemical Intermediates
        (3 )       (3 )       (6 )
   
 
 
 
 
 
 
  Total adjustments         (3 )       33         30  
   
 
 
 
 
 
 
Goodwill at June 30, 2003   $ 904   $ 782   $ 1,320   $ 150   $ 63   $ 3,219  
   
 
 
 
 
 
 

8


        The following table provides information regarding the Company's other intangible assets:

Other Intangible Assets

 
  At June 30, 2003
  At December 31, 2002
In millions

  Gross
Carrying
Amount

  Accumulated
Amortization

  Net
  Gross
Carrying
Amount

  Accumulated
Amortization

  Net
Intangible assets with finite lives:                                    
  Licenses and intellectual property   $ 307   $ (128 ) $ 179   $ 304   $ (121 ) $ 183
  Patents     156     (74 )   82     156     (66 )   90
  Software     273     (135 )   138     258     (124 )   134
  Trademarks     138     (18 )   120     137     (15 )   122
  Other     103     (28 )   75     107     (23 )   84
   
 
 
 
 
 
  Total   $ 977   $ (383 ) $ 594   $ 962   $ (349 ) $ 613
   
 
 
 
 
 

        The following table provides a summary of acquisitions of intangible assets for the six months ended June 30, 2003:

Acquisitions of Intangible Assets in 2003

   
In millions

  Acquisition Cost
  Weighted-average
Amortization Period

Intangible assets with finite lives:          
  Licenses and intellectual property   $ 8   13.3 years
  Software     10   5.0 years
   
 
  Total   $ 18   8.7 years
   
 

        Amortization expense for other intangible assets (not including software) was $15 million in the second quarter of 2003, compared with $19 million in the same period last year. Year to date, amortization expense for other intangible assets (not including software) was $30 million, compared with $33 million for the first six months of 2002. Amortization expense for software, which is included in cost of sales, totaled $7 million in the second quarter, compared with $6 million last year. For the first six months of this year, amortization expense for software was $14 million, up from $11 million in the same period last year. Total estimated amortization expense for 2003 and the five succeeding fiscal years is as follows:

In millions

  Estimated
Amortization
Expense

2003   $ 84
2004     80
2005     72
2006     67
2007     57
2008     48

9


NOTE F—COMMITMENTS AND CONTINGENT LIABILITIES

Litigation

Breast Implant Matters

        On May 15, 1995, Dow Corning Corporation ("Dow Corning"), in which the Company is a 50 percent shareholder, voluntarily filed for protection under Chapter 11 of the Bankruptcy Code to resolve litigation related to Dow Corning's breast implant and other silicone medical products. As a consequence of that action and prior charges taken by Dow Corning, the Company fully reserved its investment in Dow Corning and reserved its 50 percent share of equity earnings through the third quarter of 2000.

        The Company's financial statement exposure for breast implant product liability claims against Dow Corning is limited to its investment in Dow Corning, which, after fully reserving its investment in Dow Corning and reserving its share of equity earnings through the third quarter of 2000, is not material. As a result, any future charges by Dow Corning related to such claims or as a result of the Chapter 11 proceeding would not have a material adverse impact on the Company's consolidated financial statements.

        The Company is separately named as a defendant in more than 14,000 breast implant product liability cases, of which approximately 4,000 state cases are the subject of summary judgments in favor of the Company. In these situations, plaintiffs have alleged that the Company should be liable for Dow Corning's alleged torts based on the Company's 50 percent stock ownership in Dow Corning and that the Company should be liable by virtue of alleged "direct participation" by the Company or its agents in Dow Corning's breast implant business. These latter, direct participation claims include counts sounding in strict liability, fraud, aiding and abetting, conspiracy, concert of action and negligence.

        Judge Sam C. Pointer of the U.S. District Court for the Northern District of Alabama was appointed by the Federal Judicial Panel on Multidistrict Litigation to oversee all of the product liability cases involving silicone breast implants filed in the U.S. federal courts. Initially, in a ruling issued on December 1, 1993, Judge Pointer granted the Company's motion for summary judgment, finding that there was no basis on which a jury could conclude that the Company was liable for any claimed defects in the breast implants manufactured by Dow Corning. In an interlocutory opinion issued on April 25, 1995, Judge Pointer affirmed his earlier ruling as to plaintiffs' corporate control claims but vacated that ruling as to plaintiffs' direct participation claims.

        On July 7, 1998, Dow Corning, the Company and Corning Incorporated ("Corning"), on the one hand, and the Tort Claimants' Committee in Dow Corning's bankruptcy on the other, agreed on a binding Term Sheet to resolve all tort claims involving Dow Corning's silicone medical products, including the claims against Corning and the Company (collectively, the "Shareholders"). The agreement set forth in the Term Sheet was memorialized in a Joint Plan of Reorganization (the "Joint Plan") filed by Dow Corning and the Tort Claimants' Committee (collectively, the "Proponents") on November 9, 1998. On February 4, 1999, the Bankruptcy Court approved the disclosure statement describing the Joint Plan. Before the Joint Plan could become effective, however, it was subject to a vote by the claimants, a confirmation hearing and all relevant provisions of the Bankruptcy Code. Voting was completed on May 14, 1999, and the confirmation hearing concluded on July 30, 1999.

        On November 30, 1999, the Bankruptcy Court issued an Order confirming the Joint Plan, but then issued an Opinion on December 21, 1999, that, in the view of the Proponents and the Shareholders, improperly interpreted or attempted to modify certain provisions of the Joint Plan affecting the resolution of tort claims involving Dow Corning's silicone medical products against various entities, including the Shareholders. Many of the parties in interest, including the Shareholders, filed various motions and appeals seeking, among other things, a clarification of the December 21, 1999 Opinion. These motions and appeals were heard by U.S. District Court Judge Denise Page Hood on April 12 and 13, 2000, and on November 13, 2000, Judge Hood affirmed the Bankruptcy Court's November 30, 1999 Order confirming the Joint Plan and reversed, in part, the Bankruptcy Court's December 21, 1999 Opinion, including that portion of the Opinion the Shareholders had appealed. In turn, various parties in interest appealed Judge Hood's decision to the United States Court of Appeals for the Sixth Circuit, which heard oral arguments in the matter on October 23, 2001. On January 29, 2002, the Sixth Circuit issued its opinion which, among other things, affirmed Judge Hood's determination that claims against various entities, including the Shareholders, may be enjoined where "unusual circumstances" exist, and remanded the case to the District Court for certain factual determinations. On December 11, 2002, Judge Hood found that the release and injunction provisions of the Plan were appropriate based on the factual determination that "unusual circumstances" do exist in this case. The effectiveness of the Joint Plan remains subject to any subsequent appellate action. Accordingly, there can be no assurance at this time that the Joint Plan will become effective.

10


        It is the opinion of the Company's management that the possibility is remote that plaintiffs will prevail on the theory that the Company should be liable in the breast implant litigation because of its shareholder relationship with Dow Corning. The Company's management believes that there is no merit to plaintiffs' claims that the Company is liable for alleged defects in Dow Corning's silicone products because of the Company's alleged direct participation in the development of those products, and the Company intends to contest those claims vigorously. Management believes that the possibility is remote that a resolution of plaintiffs' direct participation claims, including the vigorous defense against those claims, would have a material adverse impact on the Company's financial position or cash flows. Nevertheless, in light of Judge Pointer's April 25, 1995 ruling, it is possible that a resolution of plaintiffs' direct participation claims, including the vigorous defense against those claims, could have a material adverse impact on the Company's results of operations for a particular period, although it is impossible at this time to estimate the range or amount of any such impact.

DBCP Matters

        Numerous lawsuits have been brought against the Company and other chemical companies, both inside and outside of the United States, alleging that the manufacture, distribution or use of pesticides containing dibromochloropropane ("DBCP") has caused personal injury and property damage, including contamination of groundwater. It is the opinion of the Company's management that the possibility is remote that the resolution of such lawsuits will have a material adverse impact on the Company's consolidated financial statements.

Environmental Matters

        Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. The Company had accrued obligations of $394 million at December 31, 2002, for environmental remediation and restoration costs, including $43 million for the remediation of Superfund sites. At June 30, 2003, the Company had accrued obligations of $388 million for environmental remediation and restoration costs, including $37 million for the remediation of Superfund sites. This is management's best estimate of the costs for remediation and restoration with respect to environmental matters for which the Company has accrued liabilities, although the ultimate cost with respect to these particular matters could range up to twice that amount. Inherent uncertainties exist in these estimates primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies for handling site remediation and restoration.

        Separately, on June 12, 2003, the Michigan Department of Environmental Quality ("MDEQ") issued a Hazardous Waste Operating License to the Company's Midland, Michigan manufacturing site, which included provisions requiring the Company to conduct an investigation to determine the nature and extent of off-site contamination in Midland area soils; Tittabawassee and Saginaw River sediment and floodplain soils; and Saginaw Bay. The operating license requires the Company, by August 11, 2003, to propose a detailed Statement of Work for the off-site investigation, for review and approval by the MDEQ.

        It is the opinion of the Company's management that the possibility is remote that costs in excess of those accrued or disclosed will have a material adverse impact on the Company's consolidated financial statements.

Asbestos-Related Matters of Union Carbide Corporation

        Union Carbide Corporation ("Union Carbide"), a wholly owned subsidiary of the Company, is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. These suits principally allege personal injury resulting from exposure to asbestos-containing products and frequently seek both actual and punitive damages, often in very large amounts. The alleged claims primarily relate to products that Union Carbide sold in the past, alleged exposure to asbestos-containing products located on Union Carbide's premises, and Union Carbide's responsibility for asbestos suits filed against a former Union Carbide subsidiary, Amchem Products, Inc. ("Amchem"). In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable loss as a result of such exposure, or that injuries incurred in fact resulted from exposure to Union Carbide's products.

        The rate at which plaintiffs filed asbestos-related suits against various companies, including Union Carbide and Amchem, increased in both 2001 and 2002, influenced by the bankruptcy filings of numerous defendants in asbestos-related litigation. Union Carbide expects more asbestos-related suits to be filed against Union Carbide and Amchem in the future. Union Carbide will aggressively defend or reasonably resolve, as appropriate, both pending and future claims.

11


        Typically, Union Carbide is only one of many named defendants, many of which, including Union Carbide and Amchem, were members of the Center for Claims Resolution ("CCR"), an entity that defended and resolved asbestos cases on behalf of its members. As members of the CCR, Union Carbide's and Amchem's strategy was to resolve the claims against them at the relatively small percentage allocated to them pursuant to the CCR's collective defense. The CCR ceased operating in February 2001, except to administer certain settlements. Union Carbide then began using Peterson Asbestos Claims Enterprise, but only for claims processing and insurance invoicing.

        Certain members of Dow's legal department and certain Dow management personnel have been retained to provide their experience in mass tort litigation to assist Union Carbide in responding to asbestos-related matters. In early 2002, Union Carbide hired new outside counsel to serve as national trial counsel. In connection with these actions, aggressive defense strategies were designed to reduce the cost of resolving all asbestos-related claims, including the elimination of claims that lack demonstrated illness or causality.

        At the end of 2001 and through the third quarter of 2002, Union Carbide had concluded it was not possible to estimate its cost of disposing of asbestos-related claims that might be filed against Union Carbide and Amchem in the future due to a number of reasons, including its lack of sufficient comparable loss history from which to assess either the number or value of future asbestos-related claims. During the third and fourth quarters of 2002, Union Carbide worked with Analysis, Research & Planning Corporation ("ARPC"), a consulting firm with broad experience in estimating resolution costs associated with mass tort litigation, including asbestos, to explore whether it would be possible to estimate the cost of disposing of pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Union Carbide and Amchem.

        Union Carbide provided ARPC with all relevant data regarding asbestos-related claims filed against Union Carbide and Amchem through November 6, 2002. ARPC concluded that it was not possible to estimate the full range of the cost of resolving future asbestos-related claims against Union Carbide and Amchem, because of various uncertainties associated with the litigation of those claims. These uncertainties, which hindered Union Carbide's ability to project future claim volumes and resolution costs, included the following:

        Despite its inability to estimate the full range of the cost of resolving future asbestos-related claims, ARPC advised Union Carbide that it would be possible to determine an estimate of a reasonable forecast of the cost of resolving pending and future asbestos-related claims likely to face Union Carbide and Amchem, if certain assumptions were made. Specifically, ARPC advised Union Carbide that for purposes of determining an estimate it is reasonable to assume that in the near term asbestos-related claims filed against Union Carbide and Amchem are unlikely to return to levels below those experienced prior to 2001—when the recent spike in filings commenced—and that average claim values are unlikely to return to levels below those experienced in 2001-2002, the years immediately following CCR's cessation of operations. ARPC advised Union Carbide that, by assuming that future filings were unlikely to exceed the levels experienced prior to 2001 and extrapolating from 2001 and 2002 average claim values, ARPC could make a reasonable forecast of the cost of resolving asbestos-related claims facing Union Carbide and Amchem. ARPC also advised Union Carbide that forecasts of resolution costs for a 10 to 15 year period from the date of the forecast are likely to be more accurate than forecasts for longer periods of time.

        In projecting Union Carbide's resolution costs for future asbestos-related claims, ARPC applied two methodologies that have been widely used for forecasting purposes. Applying these methodologies, ARPC forecast the number and allocation by disease category of those potential future claims on a year-by-year basis through 2049. ARPC then calculated the percentage of claims in each disease category that had been closed with payments in 2001 and 2002. Using those percentages, ARPC calculated the number of future claims by disease category that would likely require payment by Union Carbide and Amchem and multiplied the number of such claims by the mean values paid by Union Carbide and Amchem, respectively, to dispose of such claims in 2001 and 2002. In estimating Union Carbide's cost of resolving pending claims, ARPC used a process similar to that used for calculating the cost of resolving future claims.

12


        As of December 31, 2002, ARPC estimated the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, for the 15-year period from the present through 2017 to be between approximately $2.2 billion and $2.4 billion, depending on which of the two accepted methodologies was used.

        Although ARPC provided estimates for a longer period of time, based on ARPC's advice that forecasts for shorter periods of time are more accurate and in light of the uncertainties inherent in making long-term projections, Union Carbide determined that the 15-year period through 2017 is the reasonable time period for projecting the cost of disposing of its future asbestos-related claims. Union Carbide concluded that it is probable that the undiscounted cost of disposing of asbestos-related pending and future claims ranges from $2.2 billion to $2.4 billion, which is the range for the 15-year period ending in 2017 as estimated by ARPC using both methodologies. Accordingly, Union Carbide increased its asbestos-related liability for pending and future claims at December 31, 2002 to $2.2 billion, excluding future defense and processing costs. At June 30, 2003, Union Carbide's asbestos-related liability for pending and future claims was $2.1 billion.

        Union Carbide also increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion at December 31, 2002, substantially exhausting its asbestos product liability coverage. This resulted in a net income statement impact to Union Carbide of $828 million, $522 million on an after-tax basis, in the fourth quarter of 2002. At June 30, 2003, Union Carbide's receivable for insurance recoveries related to its asbestos liability was $1.2 billion. The insurance receivable related to the asbestos liability was determined by Union Carbide after a thorough review of applicable insurance policies and the 1985 Wellington Agreement, to which Union Carbide and many of its liability insurers are signatory parties, as well as other insurance settlements, with due consideration given to applicable deductibles, retentions and policy limits, and taking into account the solvency and historical payment experience of various insurance carriers. In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement of $219 million at December 31, 2002 and $254 million at June 30, 2003.

        The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon currently known facts. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, coverage issues among insurers, and the continuing solvency of various insurance companies, as well as the numerous uncertainties surrounding asbestos litigation in the United States, could cause the actual costs and insurance recoveries for Union Carbide to be higher or lower than those projected or those recorded. Union Carbide expenses defense and processing costs as incurred. Accordingly, defense and processing costs incurred by Union Carbide in the future for asbestos-related litigation, net of insurance, will impact Union Carbide's results of operations in future periods.

        Because of the uncertainties described above, Union Carbide's management cannot estimate the full range of the cost of resolving pending and future asbestos-related claims facing Union Carbide and Amchem. Union Carbide's management believes that it is reasonably possible that the cost of disposing of Union Carbide's asbestos-related claims, including future defense and processing costs, could have a material adverse impact on Union Carbide's results of operations and cash flows for a particular period and on the consolidated financial position of Union Carbide.

        It is the opinion of Dow's management that it is reasonably possible that the cost of Union Carbide disposing of its asbestos-related claims, including future defense and processing costs, could have a material adverse impact on the Company's results of operations and cash flows for a particular period and on the consolidated financial position of the Company.

Other Litigation Matters

        In addition to the breast implant, DBCP and environmental remediation matters, the Company is party to a number of other claims and lawsuits arising out of the normal course of business with respect to commercial matters, including product liability, governmental regulation and other actions. Certain of these actions purport to be class actions and seek damages in very large amounts. All such claims are being contested. Dow has an active risk management program consisting of numerous insurance policies secured from many carriers at various times. These policies provide coverage that will be utilized to minimize the impact, if any, of the contingencies described above.

        Except for the possible effect of Union Carbide's asbestos-related liability described above and the possible effect on the Company's net income for breast implant litigation, also described above, it is the opinion of the Company's management that the possibility is remote that the aggregate of all claims and lawsuits will have a material adverse impact on the Company's consolidated financial statements.

13


Purchase Commitments

        The Company has three major agreements for the purchase of ethylene-related products in Canada. The purchase prices are determined on a cost-of-service basis, which, in addition to covering all operating expenses and debt service costs, provides the owner of the manufacturing plants with a specified return on capital. Total purchases under the agreements were $293 million in 2002, $221 million in 2001 and $178 million in 2000.

        At December 31, 2002, the Company had various outstanding commitments for take or pay and throughput agreements, including the purchase agreements referred to above, with terms extending from one to 25 years. In general, such commitments were at prices not in excess of current market prices. The fixed and determinable portion of obligations under these purchase commitments at December 31, 2002 are presented in the following table:

Fixed and Determinable Portion of Take or Pay and
Throughput Obligations at December 31, 2002
In millions

2003   $ 556
2004     511
2005     472
2006     408
2007     407
2008 through expiration of contracts     2,041
   
Total   $ 4,395
   

        In addition to the take or pay obligations at December 31, 2002, the Company had outstanding purchase commitments which ranged from one to 23 years for steam, electrical power, materials, property and other items used in the normal course of business of approximately $158 million. In general, such commitments were at prices not in excess of current market prices. At December 31, 2002, the Company was also committed to lease manufacturing facilities under construction in The Netherlands and a pipeline under construction in Germany. At June 30, 2003, the Company was also committed to lease manufacturing facilities under construction in Germany.

Guarantees

        The Company provides a variety of guarantees, as described more fully in the following sections.

Guarantees

        Guarantees arise during the ordinary course of business from relationships with customers and nonconsolidated affiliates when the Company undertakes an obligation to guarantee the performance of others (via delivery of cash or other assets) if specified triggering events occur. Non-performance under a contract by the guaranteed party triggers the obligation of the Company. Such non-performance usually relates to commercial obligations or loans.

Residual Value Guarantees

        The Company provides guarantees related to leased assets specifying the residual value that will be available to the lessor at lease termination through sale of the assets to the lessee or third parties.

        The following tables provide a summary of the aggregate terms, maximum future payments and associated liability reflected in the consolidated balance sheet for each type of guarantee:

Guarantees at June 30, 2003
In millions

  Final
Expiration

  Maximum Future
Payments

  Recorded
Liability

Guarantees   2009   $ 807  
Residual value guarantees   2017     1,859  
       
 
Total       $ 2,666  
       
 

14


Guarantees at December 31, 2002
In millions

  Final
Expiration

  Maximum Future
Payments

  Recorded
Liability

Guarantees   2009   $ 928  
Residual value guarantees   2017     1,694  
       
 
Total       $ 2,622  
       
 

NOTE G—VARIABLE INTEREST ENTITIES

        At March 31, 2003, Dow had operating leases with nine special purpose entities that qualified as variable interest entities ("VIEs") under FIN No. 46, "Consolidation of Variable Interest Entities." Seven of the VIEs were dissolved during the second quarter of 2003, and the rights and obligations of the dissolved VIEs under the existing lease agreements were assumed by lessors that do not qualify as VIEs.

        During the second quarter of 2003, Dow terminated its lease of an ethylene facility in The Netherlands with a VIE and entered into a lease with a new owner trust, which qualifies as a VIE. Dow is not the primary beneficiary of the owner trust and is, therefore, not required to consolidate the owner trust. At June 30, 2003, the facility was valued at $394 million. Upon expiration of the lease, which matures in 2014, Dow may purchase the facility for an amount based upon a fair market value determination. At June 30, 2003, Dow had provided to the owner trust a residual value guarantee of $365 million, which represents Dow's maximum exposure to loss under the lease. Given the productive nature of the facility, it is probable that the facility will have continuing value to Dow or the owner trust in excess of the residual value guarantee.

        Dow has an operating lease with an entity that qualifies as a VIE under FIN No. 46. The VIE, which was established in 1998, is a foreign trust that leases ethylene and polyethylene manufacturing facilities in Argentina. Based on the terms of the lease agreement, which matures in 2017, and the residual value guarantee Dow provides to the lessor, the Company will be the primary beneficiary of the VIE, as defined in FIN No. 46. As a result, Dow will be required to consolidate the assets of $500 million and liabilities of $523 million held by the VIE in the third quarter of 2003. Upon adoption of FIN No. 46, accumulated depreciation expense of $23 million (after tax and minority interest) will be included in "Cumulative effect of changes in accounting principles." Upon termination or expiration of the lease, Dow may return the assets to the lessor, renew the lease, or purchase the assets for an amount based on a fair market value determination. Dow had provided a residual value guarantee to the lessor of $455 million at June 30, 2003 and December 31, 2002, which represents Dow's maximum exposure to loss under the lease. Given the productive nature of the assets, it is probable they will have continuing value to Dow or another company in excess of the residual value guarantee.

        In September 2001, Hobbes Capital S.A. ("Hobbes"), a consolidated foreign subsidiary of the Company, issued $500 million of preferred securities in the form of equity certificates. The certificates provide a floating rate return (which may be reinvested) based on London Interbank Offered Rate ("LIBOR"), and may be redeemed in 2008 and at seven-year intervals thereafter. The equity certificates have been classified as "Preferred Securities of Subsidiaries" in the consolidated balance sheets. The preferred return is included in "Minority interests' share in income" in the consolidated statements of income. Reinvested preferred returns are included in "Minority Interest in Subsidiaries" in the consolidated balance sheets. Hobbes qualifies as a VIE under FIN No. 46 and the Company will be the primary beneficiary of the VIE. Accordingly, upon adoption of FIN No. 46, Hobbes will continue to be a consolidated subsidiary.

NOTE H—ASSET RETIREMENT OBLIGATIONS

        In accordance with SFAS No. 143, "Accounting for Asset Retirement Obligations," the Company has recognized asset retirement obligations related to demolition and remediation activities at manufacturing sites in the United States, Germany, France and The Netherlands. In addition, the Company has recognized obligations related to capping activities at landfill sites in the United States, Canada and Brazil. At June 30, 2003, the aggregate carrying amount of asset retirement obligations recognized by the Company was $45 million. These obligations are included in the consolidated balance sheets as "Other noncurrent obligations."

15


        If the asset retirement obligation measurement and recognition provisions of SFAS No. 143 had been in effect on January 1, 2002, the aggregate carrying amount of those obligations on that date would have been $46 million. If the amortization of asset retirement cost and accretion of asset retirement obligation provisions of SFAS No. 143 had been in effect during 2001 and 2002, the impact on "Income before Cumulative Effect of Changes in Accounting Principles" and "Net Income Available for Common Stockholders" each year would have been immaterial. Further, the impact on earnings per common share (both basic and diluted) would have been less than $0.01 per share each year.

NOTE I—STOCK-BASED COMPENSATION

        Prior to 2003, the Company accounted for its stock-based compensation plans (which include stock options, deferred stock grants, and subscriptions to purchase shares under the Company's Employees' Stock Purchase Plan ("ESPP")) using the intrinsic value method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Given the terms of the Company's plans, no compensation cost was recognized for its stock option plans or the ESPP in prior periods.

        Effective January 1, 2003, the Company began expensing stock-based compensation newly issued in 2003 to employees in accordance with the fair value based method of accounting set forth in SFAS No. 123, "Accounting for Stock-Based Compensation." The fair value of equity instruments issued to employees is measured on the date of grant and recognized as compensation expense over the applicable vesting period. The Company estimates the fair value of stock options and subscriptions to purchase shares under the ESPP using a binomial option-pricing model. The weighted-average assumptions used to calculate total stock-based compensation expense for 2003 and the pro forma results provided below for 2002 were as follows:

 
  Three Months Ended
  Six Months Ended
 
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Dividend yield   4.89 % 4.11 % 4.89 % 4.40 %
Expected volatility   42.20 % 40.53 % 42.20 % 42.77 %
Risk-free interest rate   2.96 % 4.56 % 2.96 % 4.18 %
Expected life of stock option plans   5 years   7 years   5 years   7 years  
Expected life of stock purchase plan   0.83 years   0.83 years   0.83 years   0.83 years  

        The following table provides pro forma results as if the fair value based method had been applied to all outstanding and unvested awards, including stock options, deferred stock grants, and subscriptions to purchase shares under the ESPP, in each period:

 
  Three Months Ended
  Six Months Ended
 
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Net income, as reported   $ 393   $ 238   $ 469   $ 343  
Add: Stock-based compensation expense included in reported net
    income, net of tax
    8     3     11     7  
Deduct: Total stock-based compensation expense determined using
    fair value based method for all awards, net of tax
    (19 )   (23 )   (38 )   (55 )
   
 
 
 
 
Pro forma net income   $ 382   $ 218   $ 442   $ 295  
   
 
 
 
 
Earnings per share:                          
  Basic—as reported   $ 0.43   $ 0.26   $ 0.51   $ 0.38  
  Basic—pro forma     0.42     0.24     0.48     0.32  
  Diluted—as reported     0.43     0.26     0.51     0.37  
  Diluted—pro forma     0.41     0.24     0.48     0.32  

16


NOTE J—OPERATING SEGMENTS AND GEOGRAPHIC AREAS

 
  Three Months Ended
  Six Months Ended
 
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Operating segment sales                          
  Performance Plastics   $ 1,908   $ 1,835   $ 3,755   $ 3,554  
  Performance Chemicals     1,404     1,302     2,775     2,561  
  Agricultural Sciences     927     886     1,695     1,531  
  Plastics     1,877     1,688     3,851     3,116  
  Chemicals     1,048     861     2,097     1,546  
  Hydrocarbons and Energy     985     583     1,944     1,068  
  Unallocated and Other     93     104     206     188  
   
 
 
 
 
  Total   $ 8,242   $ 7,259   $ 16,323   $ 13,564  
   
 
 
 
 
Operating segment EBIT(1)                          
  Performance Plastics   $ 163   $ 145   $ 299   $ 392  
  Performance Chemicals     185     165     307     363  
  Agricultural Sciences     233     189     363     215  
  Plastics     159     106     296     44  
  Chemicals     101     (15 )   135     (68 )
  Hydrocarbons and Energy     8     10     (13 )   41  
  Unallocated and Other     (50 )   (61 )   (244 )   (205 )
   
 
 
 
 
  Total   $ 799   $ 539   $ 1,143   $ 782  
   
 
 
 
 
Geographic area sales                          
  United States   $ 3,395   $ 3,025   $ 6,498   $ 5,624  
  Europe     2,873     2,359     5,870     4,514  
  Rest of World     1,974     1,875     3,955     3,426  
   
 
 
 
 
  Total   $ 8,242   $ 7,259   $ 16,323   $ 13,564  
   
 
 
 
 

(1)
Dow uses "Earnings before Interest, Income Taxes and Minority Interests" ("EBIT") as its measure of profit/loss for segment reporting purposes. EBIT includes all operating items relating to the businesses and excludes items that principally apply to the Company as a whole. A reconciliation of EBIT to "Net Income Available for Common Stockholders" is provided below:

 
  Three Months Ended
  Six Months Ended
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

EBIT   $ 799   $ 539   $ 1,143   $ 782
Interest income     18     14     38     30
Interest expense and amortization of debt discount     207     188     422     377
Provision for income taxes     186     111     233     135
Minority interests' share in income     31     16     48     24
Cumulative effect of changes in accounting principles             (9 )   67
   
 
 
 
Net Income Available for Common Stockholders   $ 393   $ 238   $ 469   $ 343
   
 
 
 

17



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

DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION

        The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements made by or on behalf of The Dow Chemical Company and its subsidiaries ("Dow" or the "Company"). This section covers the current performance and outlook of the Company and each of its operating segments. The forward-looking statements contained in this section and in other parts of this document involve risks and uncertainties that may affect the Company's operations, markets, products, services, prices and other factors as more fully discussed elsewhere and in filings with the U.S. Securities and Exchange Commission ("SEC"). These risks and uncertainties include, but are not limited to, economic, competitive, legal, governmental and technological factors. Accordingly, there is no assurance that the Company's expectations will be realized. The Company assumes no obligation to provide revisions to any forward-looking statements should circumstances change, except as otherwise required by securities and other applicable laws.


RESULTS OF OPERATIONS

Selected data for the three months and six months ended June 30, 2003 and 2002:

 
  Three Months Ended
  Six Months Ended
 
In millions, except per share amounts

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Sales   $ 8,242   $ 7,259   $ 16,323   $ 13,564  

Cost of sales

 

 

6,970

 

 

6,031

 

 

14,133

 

 

11,386

 
% of sales     85 %   83 %   87 %   84 %

Research and development, and selling, general and administrative
    expenses

 

 

600

 

 

677

 

 

1,192

 

 

1,318

 
% of sales     7 %   9 %   7 %   10 %

Effective tax rate

 

 

30.5

%

 

30.4

%

 

30.7

%

 

31.0

%

Net income available for common stockholders

 

$

393

 

$

238

 

$

469

 

$

343

 

Earnings per common share—basic

 

$

0.43

 

$

0.26

 

$

0.51

 

$

0.38

 
Earnings per common share—diluted   $ 0.43   $ 0.26   $ 0.51   $ 0.37  

Operating rate percentage

 

 

79

%

 

80

%

 

79

%

 

78

%

 

        Net sales for the second quarter of 2003 were $8.2 billion, up 14 percent from $7.3 billion in the second quarter of last year. Prices improved 16 percent, driven by increases in feedstock and energy costs, while volume declined 2 percent (see Sales Volume and Price table on page 23). Compared with last year, prices were up in all geographic areas and all businesses. The strongest gains were reported in Europe, where the impact of currency accounted for more than half of the gain, and in the basic businesses. Volume, down in all geographic areas, was down in all segments except Agricultural Sciences, which was flat, and Hydrocarbons and Energy, which was up significantly versus the second quarter of last year. Volume was down in the second quarter due to a generally sluggish global economy and a high level of sales to customers in the first quarter in advance of announced price increases. Year to date, net sales were $16.3 billion, up 20 percent from $13.6 billion in the first six months of 2002 on an 18 percent increase in selling prices and 2 percent volume growth.

        Operating expenses (research and development, and selling, general and administrative expenses) were $600 million in the second quarter of 2003, down $77 million or 11 percent, from $677 million in the second quarter of last year. Expenses declined as the Company continued its cost control efforts and as spending for growth initiatives was focused on those opportunities with the greatest potential for value creation. For the first half of the year, operating expenses totaled $1,192 million, down 10 percent from $1,318 million for the same period last year.

18


        Net income for the second quarter of 2003 was $393 million or $0.43 per share, compared with $238 million or $0.26 per share for the second quarter of 2002. Compared with the same period last year, net income for the quarter improved as higher selling prices, lower operating expenses and improved equity earnings more than offset higher feedstock and energy costs of approximately $700 million, the negative impact of currency on cost and a decline in volume. Two items negatively impacted net income in the second quarter of last year: additional pretax expenses of $10 million related to the Union Carbide merger (reflected in Unallocated and Other) and a $10 million pretax restructuring charge (Dow's share) recorded by UOP LLC in the second quarter (reflected in "Equity in earnings of nonconsolidated affiliates" in the Performance Plastics segment).

        Net income for the first six months of 2003 was $469 million or $0.51 per share, compared with $343 million or $0.37 per share for the same period of 2002. Year-to-date net income for 2003 was reduced by an after-tax charge of $9 million related to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations" (reflected in "Cumulative effect of changes in accounting principles"). Last year, net income for the first half of the year was impacted by several items: additional pretax expenses of $23 million related to the Union Carbide merger (reflected in Unallocated and Other); pretax goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates (reflected in "Equity in earnings of nonconsolidated affiliates" in Unallocated and Other); a $10 million pretax restructuring charge (Dow's share) recorded by UOP LLC in the second quarter (reflected in "Equity in earnings of nonconsolidated affiliates" in the Performance Plastics segment); and a net after-tax gain of $67 million related to the adoption of two new accounting standards (SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets"). Despite an increase in feedstock and energy costs of $1.9 billion, the negative impact of currency on cost, and asset impairments of approximately $60 million in the first quarter, net income improved significantly from last year due to higher selling prices, volume growth, continued cost control efforts and improved earnings from the Company's joint ventures.

        The following tables show the impact of the certain items recorded in the three-month and six-month periods ended June 30, 2003 and 2002:

 
  Pretax
Impact(1)

  Impact on
Net Income(2)

 
 
  Three Months Ended
  Three Months Ended
 
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Merger-related expenses and restructuring     $ (10 )   $ (7 )
UOP restructuring       (10 )     (7 )
   
 
 
 
 
Total     $ (20 )   $ (14 )
   
 
 
 
 

 


 

Pretax
Impact(1)


 

Impact on
Net Income(2)


 
 
  Six Months Ended
  Six Months Ended
 
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

 
Merger-related expenses and restructuring     $ (23 )     $ (15 )
Goodwill impairment losses in non-consolidated affiliates       (16 )       (16 )
UOP restructuring       (10 )       (7 )
Cumulative effect of changes in accounting principles         $ (9 )   67  
   
 
 
 
 
Total     $ (49 ) $ (9 ) $ 29  

(1)
Impact on "Income before Income Taxes and Minority Interests"

(2)
Impact on "Net Income Available for Common Stockholders"

19


SEGMENT RESULTS

        Dow uses "Earnings before Interest, Income Taxes and Minority Interests" ("EBIT") as its measure of profit/loss for segment reporting purposes. EBIT includes all operating items relating to the businesses and excludes items that principally apply to the Company as a whole. A reconciliation of EBIT to "Net Income Available for Common Stockholders" is provided below:

 
  Three Months Ended
  Six Months Ended
In millions

  June 30,
2003

  June 30,
2002

  June 30,
2003

  June 30,
2002

EBIT   $ 799   $ 539   $ 1,143   $ 782
Interest income     18     14     38     30
Interest expense and amortization of debt discount     207     188     422     377
Provision for income taxes     186     111     233     135
Minority interests' share in income     31     16     48     24
Cumulative effect of changes in accounting principles             (9 )   67
   
 
 
 
Net Income Available for Common Stockholders   $ 393   $ 238   $ 469   $ 343
   
 
 
 

PERFORMANCE PLASTICS

        Performance Plastics sales were $1,908 million for the second quarter of 2003, up 4 percent from $1,835 million in the second quarter of 2002. Prices increased 12 percent, including the favorable impact of currency in Europe, while volume declined 8 percent. EBIT for the segment was $163 million in the second quarter, up from $145 million in the same period last year as the impact of higher selling prices and higher equity earnings more than offset the impact of higher raw material costs and reduced volume.

        Dow Automotive sales for the second quarter of 2003 were up 6 percent from a year ago, as prices rose 9 percent and more than offset a 3 percent decline in volume. Prices were favorably impacted by the strengthening Euro. The decline in volume was generally consistent with the decline in global auto production. EBIT for the business declined versus last year principally due to higher raw material costs.

        Engineering Plastics sales for the quarter were flat versus the second quarter of 2002, as an 11 percent increase in prices was offset by an 11 percent decline in volume. Prices were favorably impacted by the strengthening Euro and price increases for copolymers in Europe. Volume in the second quarter was down due to a high level of sales to customers in the first quarter of 2003, in advance of announced price increases. Compared with the second quarter of last year, volume for polycarbonate declined in Asia Pacific, as customers in that region are now supplied by LG Dow Polycarbonate Ltd., a 50:50 joint venture. Sales volume was also impacted by Dow's departure from its nylon alliance with Solutia Inc. in May 2002. Excluding the impact of these two structural changes, volume for Engineering Plastics increased slightly versus the second quarter of last year. EBIT for the quarter was down due to higher raw material costs.

        Sales of Epoxy Products and Intermediates for the quarter were up 5 percent from last year due to a 15 percent increase in price that was partially offset by a 10 percent decline in volume. Contributing to the overall improvement in prices were significant price increases for epichlorohydrin across all geographic areas and phenolics in North America. Epoxy volumes declined due to weak demand, particularly within the appliance and electronics industries. EBIT versus the second quarter of 2002 was down due to increased costs for raw materials.

        Fabricated Product sales for the second quarter of 2003 were up 9 percent versus last year primarily due to higher prices. Price increases for extruded polystyrene foam, including the favorable impact of currency in Europe, accounted for a large part of the increase in sales. Volume for the business was relatively flat versus last year. EBIT improved significantly versus the same quarter of 2002 as higher selling prices and reduced operating expenses more than offset the impact of higher raw material costs.

        Polyurethanes sales for the second quarter were up 4 percent from the second quarter of 2002, as a 15 percent increase in price was partially offset by an 11 percent decrease in volume. Driven by increasing feedstock costs, price increases for polyols and toluene diisocyanate ("TDI") that were implemented in the first quarter of 2003 continued to be supported in the second quarter. Volume for TDI declined as demand for flexible polyurethanes remained soft. Despite higher selling prices, EBIT was flat compared with the second quarter of 2002 due to increased raw materials costs and TDI production outages.

20


        Wire and Cable sales for the quarter were down 12 percent from last year. While prices increased 10 percent, volume declined 22 percent due to weak demand within the telecommunications cable industry. EBIT improved due to higher selling prices.

        For the first six months of the year, Performance Plastics sales were $3,755 million, up 6 percent from $3,554 million in the same period last year. Prices increased 10 percent, including the favorable impact of currency in Europe, while volume declined 4 percent. Year to date, EBIT for the segment was $299 million, down from $392 million for the first half of 2002, as the impact of higher raw material costs and the decline in volume more than offset the benefit of higher selling prices.

PERFORMANCE CHEMICALS

        Performance Chemicals sales for the second quarter of 2003 were $1,404 million, up 8 percent from $1,302 million last year. Prices improved 10 percent, including the impact of currency in Europe, as volume fell 2 percent. EBIT for the second quarter was $185 million compared with $165 million in the second quarter of 2002. EBIT improved as the benefit of higher selling prices and lower operating expenses more than offset the impact of higher raw material costs.

        Emulsion Polymers sales for the quarter improved 25 percent compared with the second quarter of 2002 primarily due to increased prices, including the impact of currency in Europe; volume was relatively flat. For styrene-butadiene latex sold to the coated paper industry, prices improved significantly and volume grew compared with the second quarter of last year. EBIT for the quarter increased significantly from last year as higher selling prices offset increases in raw material costs.

        Industrial Chemicals sales for the quarter improved 6 percent over the second quarter of last year with increases in price and volume. Both price and volume improved for functional solutions and surfactants in the quarter. Despite higher sales in the quarter, EBIT declined from last year due to an increase in feedstock costs.

        Oxide Derivatives sales for the quarter improved 9 percent compared with the second quarter of 2002 primarily due to increased prices, led by increases in glycol ether prices in the United States. Prices were also favorably impacted by the strengthening Euro. Volume for the business declined slightly versus last year. EBIT for the quarter increased compared with last year, primarily due to increased equity earnings from the OPTIMAL Group. Higher raw material costs offset the benefit of higher selling prices.

        Specialty Polymers sales for the quarter improved 9 percent versus the second quarter of 2002 primarily due to increased prices, including the impact of currency in Europe. Volume, up slightly overall, remained strong for FILMTEC membranes and ion exchange resins. EBIT for the quarter increased significantly from the second quarter of last year primarily due to higher selling prices.

        Water Soluble Polymers sales for the quarter improved 4 percent compared with the same period of 2002. Prices increased versus last year primarily due to the impact of currency in Europe; volume declined 3 percent. While volume was down in the second quarter for hair and skin care products from Amerchol Corporation and ETHOCEL ethylcellulose resins, volume improved for CELLOSIZE hydroxyethyl cellulose and METHOCEL cellulose ethers. EBIT for the quarter improved slightly from the second quarter of last year.

        Performance Chemicals sales were $2,775 million in the first six months of the year, up 8 percent from $2,561 million in 2002. Prices improved 7 percent, including the impact of currency in Europe, while volume grew 1 percent. EBIT for the first six months of 2003 was $307 million, down from $363 million last year, as significantly higher raw material costs more than offset the favorable impact of higher sales and lower operating expenses.

AGRICULTURAL SCIENCES

        Sales for the Agricultural Sciences segment were $927 million in the second quarter, setting a new quarterly record. Sales were up 5 percent from $886 million in the second quarter of 2002 due to price increases, driven principally by the favorable impact of currency in Europe. While volume was flat overall compared with second quarter of last year, demand remained strong in the quarter for spinosad insect control products and glyphosate and acetochlor herbicides. EBIT for the quarter was $233 million, up from $189 million in the second quarter of 2002 due to higher selling prices and lower operating expenses.

        Sales for the Agricultural Sciences segment were $1,695 million for the first six months of the year, up 11 percent from $1,531 million in 2002. While volume grew 6 percent, prices increased 5 percent primarily due to the favorable impact of currency in Europe. EBIT for the first half of 2003 was $363 million, up significantly from $215 million last year. The year-over-year improvement in EBIT was the result of volume growth, higher selling prices and lower operating expenses. Additionally, EBIT in 2002 was negatively impacted by an accounts receivable write-down in Argentina and a write-down related to the closure of seed production facilities.

21


PLASTICS

        Plastics sales for the second quarter of 2003 were $1,877 million, up 11 percent from $1,688 million a year ago, as price increases of 22 percent were partially offset by a decline in volume. Price increases were driven by escalating feedstock and energy costs and the strengthening of the Euro. Volume, down 11 percent overall, declined in all geographic areas as customers reduced inventories built in the first quarter in advance of higher prices. EBIT for the second quarter was $159 million, a substantial improvement from $106 million in the second quarter of 2002. EBIT improved versus last year as the benefit of higher selling prices and continued cost control efforts more than offset the impact of escalating feedstock and energy costs and lower volume.

        Polyethylene sales were up significantly from the second quarter of 2002, as prices increased 21 percent and volume declined 8 percent. Double-digit price increases, driven by significantly higher feedstock and energy costs, were reported in all geographic areas, except Asia Pacific, where prices increased slightly. Demand was consistently weak globally, as customers reduced inventories. Slight volume gains were reported in Europe and Asia Pacific. EBIT for the quarter improved substantially as the strong improvement in selling prices, improved equity earnings from EQUATE Petrochemical Company K.S.C ("EQUATE") and reduced costs more than offset significantly higher ethylene costs.

        Polypropylene sales for the second quarter of 2003 increased significantly versus the same quarter of last year. Prices increased 22 percent from last year as volume declined 7 percent. Price increases, driven by significantly higher feedstock and energy costs, were reported in all geographic areas except Asia Pacific, where prices were flat compared with last year. Volume declined in the quarter as significant volume growth in North America and Asia Pacific was offset by declines in the other geographic areas. The business continued to operate its plants near capacity during the quarter to meet demand. EBIT for the second quarter improved over the same period last year as higher selling prices offset the impact of higher propylene costs.

        Polystyrene sales declined slightly versus the same quarter of last year, as price increases were offset by a 19 percent decline in volume. Double-digit price increases, driven by significantly higher feedstock and energy costs, were reported in all geographic areas. As in the other Plastics businesses, volume was down as customers reduced inventories built in the first quarter. Also contributing to the decline, volume was down in Asia Pacific due to the recent start-up of SAL Petrochemical (Zhangiagang) Co. Ltd., a 50:50 joint venture in The People's Republic of China, which now supplies local customers. EBIT declined from the second quarter of 2002 as price increases and cost reduction initiatives were not sufficient to offset the decline in volume and the increase in styrene monomer costs.

        Plastics sales for the first half of 2002 were $3,851 million, up 24 percent from $3,116 million in 2002. Compared with last year, prices increased 30 percent and volume declined 6 percent. Year to date, EBIT was $296 million, up significantly from $44 million in the first six months of 2002, as the benefit of higher selling prices and continued cost control efforts more than offset the impact of escalating feedstock and energy costs and lower volume.

CHEMICALS

        Second quarter sales for the Chemicals segment were $1,048 million, up 22 percent from $861 million for the second quarter of last year due to a 28 percent increase in prices that was partially offset by a 6 percent decline in volume. Price increases, which continued to be driven by significantly higher feedstock and energy costs, were reported for ethylene glycol; caustic soda; vinyl chloride monomer; and organic intermediates, solvents and monomers ("OISM"). Compared with the second quarter of last year, volume was down for caustic soda, ethylene dichloride and OISM as a sluggish economy resulted in a decrease in demand. EBIT for the quarter was $101 million, up from a loss of $15 million in the second quarter of 2002. EBIT improved as higher selling prices and higher equity earnings from the OPTIMAL Group and EQUATE more than offset the impact of higher feedstock and energy costs and reduced volume.

        For the first half of 2003, sales for the Chemicals segment were $2,097 million, up 36 percent from $1,546 million last year, as prices rose 32 percent and volume grew 4 percent. EBIT for the first six months of the year was $135 million compared with a loss of $68 million last year. Year to date, EBIT improved as significant increases in selling prices and higher equity earnings more than offset sharp increases in feedstock and energy costs.

22


HYDROCARBONS AND ENERGY

        Hydrocarbons and Energy sales for the quarter were $985 million, up significantly from $583 million in the second quarter of 2002 due to a 42 percent increase in volume and a 27 percent increase in selling prices. Volume increased in part this quarter due to higher sales of byproducts, the result of a change in the mix of feedstocks in the Company's hydrocarbon crackers. Year to date, sales for the segment were $1,944 million, up from $1,068 million in the same period of 2002 due to significant increases in both selling prices and volume. Increases in selling prices during the year were driven by rising feedstock costs.

        The Hydrocarbons and Energy business transfers materials to Dow's derivative businesses at cost. Hydrocarbon and Energy EBIT for the quarter was $8 million, compared with $10 million in the second quarter of last year. EBIT for the first half of 2003 was a loss of $13 million, compared with income of $41 million last year. EBIT in 2003 was negatively impacted by a $16 million charge recorded in the first quarter for the impairment of Union Carbide's ethylene production facility in Seadrift, Texas, which is scheduled to be shut down in the third quarter of 2003.

UNALLOCATED AND OTHER

        EBIT for the second quarter of 2003 was a loss of $50 million compared with a loss of $61 million in the second quarter of 2002. Included in the results for Unallocated and Other are:

        For the first six months of 2003, EBIT for Unallocated and Other was a loss of $244 million compared with a loss of $205 million for the same period of 2002. Year-to-date results for 2003 included the following costs associated with decisions made in the first quarter relative to under-performing and non-strategic assets: the write-down of Union Carbide's chemical transport vessel (sold in the second quarter of 2003) of $11 million and the write-off of cancelled capital projects totaling $12 million. EBIT for the first half of 2003 was favorably impacted by higher equity earnings from Dow Corning. Results for Unallocated and Other for the first half of 2002 included the unfavorable impact of merger-related integration expenses of $23 million, goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates, and the unfavorable impact of the devaluation of the Argentine peso.

Sales Volume and Price by Operating Segment and Geographic Area

 
  Three Months Ended
June 30, 2003

  Six Months Ended
June 30, 2003

 
Percentage change from prior year

 
  Volume
  Price
  Total
  Volume
  Price
  Total
 
Operating segments                          
  Performance Plastics   (8 )% 12 % 4 % (4 )% 10 % 6 %
  Performance Chemicals   (2 )% 10 % 8 % 1 % 7 % 8 %
  Agricultural Sciences     5 % 5 % 6 % 5 % 11 %
  Plastics   (11 )% 22 % 11 % (6 )% 30 % 24 %
  Chemicals   (6 )% 28 % 22 % 4 % 32 % 36 %
  Hydrocarbons and Energy   42 % 27 % 69 % 39 % 43 % 82 %
   
 
 
 
 
 
 
  Total   (2 )% 16 % 14 % 2 % 18 % 20 %
   
 
 
 
 
 
 
Geographic area sales                          
  United States   (2 )% 14 % 12 % 2 % 14 % 16 %
  Europe   (1 )% 23 % 22 % 1 % 29 % 30 %
  Rest of World   (5 )% 10 % 5 % 2 % 13 % 15 %
   
 
 
 
 
 
 
  Total   (2 )% 16 % 14 % 2 % 18 % 20 %
   
 
 
 
 
 
 

23


COMPANY SUMMARY

Operating Rate

        The Company's global plant operating rate for its chemicals and plastics businesses was 79 percent in the second quarter of 2003, compared with 80 percent in the second quarter of 2002.

Equity in Earnings (Losses) of Nonconsolidated Affiliates

        Dow's share of the earnings of nonconsolidated affiliates was $90 million in the second quarter of 2003, compared with $21 million in the same quarter last year. Equity earnings increased primarily due to stronger results from the OPTIMAL Group, Compania Mega S.A, UOP LLC and Dow Corning Corporation, partially offset by a decline in results from DuPont Dow Elastomers L.L.C.

        For the first six months of 2003, equity earnings were $129 million compared with a loss of $5 million in the first half of 2002. In addition to the joint ventures previously mentioned, improved results from EQUATE and Univation Technologies, LLC contributed to the improvement in year-to-date equity earnings compared with the first half of 2002. Additionally, equity earnings in the first quarter of 2002 were negatively impacted by goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates.

Sundry Income (Expense)—Net

        Sundry income (expense) includes a variety of income and expense items such as the gain or loss on foreign currency exchange, dividends from investments, and gains and losses on sales of investments and assets. Sundry income (expense) for the second quarter of 2003 was net income of $52 million compared with net expense of $4 million in the second quarter of 2002. Sundry income (expense) in the second quarter increased from last year principally due to a swing in foreign exchange hedging results. Year-to-date, Sundry income (expense) was net income of $46 million compared with net expense of $17 million for the first half of 2002. Sundry income (expense) in 2003 included a charge of $11 million in the first quarter associated with the write-down of Union Carbide's chemical transport vessel (sold in the second quarter of 2003). Sundry income (expense) in 2002 included the unfavorable impact of the devaluation of the Argentine peso in the first quarter.

Net Interest Expense

        Net interest expense (interest expense less capitalized interest and interest income) was $189 million in the second quarter of 2003 compared with $174 million in the second quarter of last year. Year to date, net interest expense was $384 million, up from $347 million for the first six months of 2002. Net interest expense in 2003 increased due to an increase in total debt.

Provision for Taxes on Income

        The effective tax rate for the second quarter was 30.5 percent, versus 30.4 percent for the second quarter of 2002. The effective tax rate for the first six months of the year was 30.7 percent, compared with 31.0 percent for the same period last year. The effective tax rate fluctuates based on, among other factors, where income is earned and the level of income relative to tax credits available.

Outlook

        Global GDP growth for 2003 is expected to be around 2 percent. While growth in the first half of the year was dampened by geopolitical uncertainty as well as high oil and gas prices, the second half is expected to see improved growth. The United States is starting to see the first signs of improvement as a result of fiscal and monetary stimulus, although the recovery is very fragile. Some European central banks lowered interest rates in the second quarter, which should improve economic activity in that region. In Asia Pacific, the service sector was impacted by SARS in the second quarter, but Chinese export demand and industrial production have remained strong.

        Overall feedstock and energy costs are expected to remain stubbornly high, about flat in the third quarter compared with the second quarter, although there will likely be some shifts for specific products and geographies. With the expected rise in average prices for crude oil and naphtha, and moderate declines in natural gas, North American feedstock costs are expected to show relative improvement compared with those in Europe. Downward pressure on prices is expected in the third quarter. Third quarter sales are difficult to forecast due to the impact of the summer vacation season, especially in Europe. Several businesses, including Polystyrene and Ethylene Glycol saw volume increase late in the second quarter, which may signal improved demand for the third quarter. Based on normal seasonal patterns, Agricultural Sciences is expected to be about breakeven for the balance of the year. With a pickup in economic activity and no further increases in hydrocarbon costs, Dow's third quarter earnings are expected to show an improvement compared with the third quarter of last year through continued focus on implementation of Dow's financial improvement program.

24



CHANGES IN FINANCIAL CONDITION

        The Company's cash flows from operating, investing and financing activities, as reflected in the Consolidated Statements of Cash Flows, are summarized in the following table:

 
  Six Months Ended
 
In millions

  June 30,
2003

  June 30,
2002

 
Cash provided by (used in):              
  Operating activities   $ 1,662   $ 540  
  Investing activities     (571 )   (786 )
  Financing activities     (327 )   327  
  Effect of exchange rate changes on cash     28     (2 )
   
 
 
Net change in cash and cash equivalents   $ 792   $ 79  
   
 
 

        Cash provided by operating activities increased in the first six months of 2003 compared with the first six months of 2002, primarily due to improved earnings, the securitization of European trade receivables and the collection of amounts due on noncurrent receivables.

        Cash used in investing activities decreased in the first six months of 2003 compared with the first six months of 2002, primarily due to a reduction in capital expenditures.

        Cash used in financing activities increased in the first six months of 2003 principally due to higher payments to reduce long-term debt.

        The following tables present working capital, total debt and certain balance sheet ratios at June 30, 2003 versus December 31, 2002:

Working Capital
In millions

  June 30,
2003

  Dec. 31,
2002

Current assets   $ 12,250   $ 11,375
Current liabilities     9,587     8,856
   
 
Working capital   $ 2,663   $ 2,519
   
 
Current ratio     1.28:1     1.28:1
Days-sales-outstanding-in-receivables     44     45
Days-sales-in-inventory     60     64

Total Debt
In millions


 

June 30,
2003


 

Dec. 31,
2002

Notes payable   $ 586   $ 580
Long-term debt due within one year     1,260     797
Long-term debt     11,636     11,659
   
 
  Total debt   $ 13,482   $ 13,036
   
 
Gross debt as a percent of total capitalization     59.4%     59.2%
Net debt* as a percent of total capitalization     54.7%     56.0%

*
Net debt equals total debt minus cash, cash equivalents, marketable securities, and interest-bearing deposits.

        As part of its ongoing financing activities, Dow routinely issues promissory notes under its U.S. and Euromarket commercial paper programs. At June 30, 2003, there were no commercial paper borrowings outstanding. In the event Dow is unable to access these short-term markets, due to a systemic disruption or other extraordinary events, Dow has the ability to access liquidity through its committed and available credit facilities with various U.S. and foreign banks totaling $3.0 billion in support of its working capital requirements and commercial paper borrowings. These facilities include a $1.75 billion 364-day revolving credit facility agreement that matures in June 2004 (that was renewed during the second quarter on essentially the same terms and conditions as the previous agreement) and a $1.25 billion 5-year revolving credit facility agreement that matures in June 2004. Additional unused credit facilities totaling $836 million were available for use by foreign subsidiaries. At June 30, 2003, the Company also had Japanese yen 70 billion (approximately $584 million) available

25


in yen-denominated securities through the Japanese Ministry of Finance and Euro 500 million (approximately $572 million) available under the Company's Euro Medium-Term Note Program.

        On April 25, 2003, the Company filed a prospectus supplement registering $500 million of its existing $2 billion in SEC-registered securities for use in its retail Medium-Term Note Program. At June 30, 2003, $80 million had been issued, leaving a total of $1.9 billion available in SEC-registered securities. Under the Medium-Term Note Program, there was a total of $816 million in notes (with maturity dates ranging from 2005 through 2013) outstanding at June 30, 2003.

        On June 26, 2003, the Company filed a registration statement on Form S-3 with the SEC for an additional $1.5 billion of registered securities. This registration statement has not yet been declared effective by the SEC.

        On January 31, 2003, Moody's Investor Services reaffirmed the Company's senior unsecured debt rating of "A3" and its short-term debt rating of "Prime-2," but changed its ratings outlook to "negative." On February 3, 2003, Fitch, Inc. lowered the Company's senior unsecured debt rating from "A" to "A-" and its short-term debt rating from "F1" to "F2" and maintained its rating outlook as negative. On March 14, 2003, Standard & Poor's lowered the Company's senior unsecured debt rating from "A" to "A-" and its short-term debt rating from "A1" to "A2" and maintained its rating outlook as "negative." The Company's ability to access credit facilities has not been affected as a result of these changes, although over time, the Company may incur marginally higher borrowing costs.

        Dow leases real property, railcars, and certain manufacturing facilities from various entities. These entities are not owned directly or indirectly by the Company or any of its directors, officers or employees. Those transactions that meet the requirements for operating lease treatment under SFAS No. 13, "Accounting for Leases," are recorded as such. For further discussion, including information regarding future minimum lease commitments, see Note M to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

        Dow has an operating lease with an entity that qualifies as a variable interest entity ("VIE") under FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities." The VIE, which was established in 1998, is a foreign trust that leases ethylene and polyethylene manufacturing facilities in Argentina. Based on the terms of the lease agreement, which matures in 2017, and the residual value guarantee Dow provides to the lessor, the Company will be the primary beneficiary of the VIE, as defined in FIN No. 46. As a result, Dow will be required to consolidate the assets of $500 million and liabilities of $523 million held by the VIE in the third quarter of 2003. Upon adoption of FIN No. 46, accumulated depreciation expense of $23 million (after tax and minority interest) will be included in "Cumulative effect of changes in accounting principles."

        Upon termination or expiration of the leases, Dow may return the assets to the lessors, renew the leases, or purchase the assets for an amount based on a fair market value determination. Dow had provided residual value guarantees totaling $1,859 million, which included $455 million related to the VIE, at June 30, 2003 and $1,694 million, which included $455 million related to the VIE, at December 31, 2002, to the various lessors. Given the productive nature of the assets, it is probable they will have continuing value to Dow or another company in excess of the residual value guarantees.

        Following the FASB's issuance of SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," in May 2003, the Company evaluated the preferred securities previously issued by two consolidated subsidiaries and concluded that the $500 million of preferred partnership units issued by Tornado Finance V.O.F. ("Tornado") is within the scope of the standard and must be classified as a liability of the Company upon adoption of SFAS No. 150 on July 1, 2003; however, the rights of the holders of Tornado's preferred partnership units were subsequently modified to eliminate the unconditional mandatory redemption feature. Therefore, the preferred partnership units will be classified as preferred securities of subsidiaries when the financial statements are issued for the third quarter of 2003. See Note B for additional information regarding SFAS No. 150. See Note P to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 for additional information regarding preferred securities of subsidiaries.

        The Company also had outstanding guarantees at June 30, 2003. Additional information related to these guarantees can be found in the "Guarantees" table provided in Note F to the Consolidated Financial Statements.

        On July 30, 2003, the Company paid a quarterly dividend of $0.335 per share to shareholders of record on June 30, 2003. Since 1912, the Company has paid a dividend every quarter and in each instance Dow has maintained or increased the dividend.

26



OTHER MATTERS

Accounting Changes

        See Note B to the Consolidated Financial Statements for a discussion of accounting changes.

Critical Accounting Policies

        The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note A to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Following are the Company's critical accounting policies impacted by judgments, assumptions and estimates:

27


28


Asbestos-Related Matters of Union Carbide Corporation

        Union Carbide Corporation ("Union Carbide"), a wholly owned subsidiary of the Company, is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. These suits principally allege personal injury resulting from exposure to asbestos-containing products and frequently seek both actual and punitive damages, often in very large amounts. The alleged claims primarily relate to products that Union Carbide sold in the past, alleged exposure to asbestos-containing products located on Union Carbide's premises, and Union Carbide's responsibility for asbestos suits filed against a former Union Carbide subsidiary, Amchem Products, Inc. ("Amchem"). In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable loss as a result of such exposure, or that injuries incurred in fact resulted from exposure to Union Carbide's products.

        The rate at which plaintiffs filed asbestos-related suits against various companies, including Union Carbide and Amchem, increased in both 2001 and 2002, influenced by the bankruptcy filings of numerous defendants in asbestos-related litigation. Union Carbide expects more asbestos-related suits to be filed against Union Carbide and Amchem in the future. Union Carbide will aggressively defend or reasonably resolve, as appropriate, both pending and future claims.

        Typically, Union Carbide is only one of many named defendants, many of which, including Union Carbide and Amchem, were members of the Center for Claims Resolution ("CCR"), an entity that defended and resolved asbestos cases on behalf of its members. As members of the CCR, Union Carbide's and Amchem's strategy was to resolve the claims against them at the relatively small percentage allocated to them pursuant to the CCR's collective defense. The CCR ceased operating in February 2001, except to administer certain settlements. Union Carbide then began using Peterson Asbestos Claims Enterprise, but only for claims processing and insurance invoicing.

        Certain members of Dow's legal department and certain Dow management personnel have been retained to provide their experience in mass tort litigation to assist Union Carbide in responding to asbestos-related matters. In early 2002, Union Carbide hired new outside counsel to serve as national trial counsel. In connection with these actions, aggressive defense strategies were designed to reduce the cost of resolving all asbestos-related claims, including the elimination of claims that lack demonstrated illness or causality.

29


        At the end of 2001 and through the third quarter of 2002, Union Carbide had concluded it was not possible to estimate its cost of disposing of asbestos-related claims that might be filed against Union Carbide and Amchem in the future due to a number of reasons, including its lack of sufficient comparable loss history from which to assess either the number or value of future asbestos-related claims. During the third and fourth quarters of 2002, Union Carbide worked with Analysis, Research & Planning Corporation ("ARPC"), a consulting firm with broad experience in estimating resolution costs associated with mass tort litigation, including asbestos, to explore whether it would be possible to estimate the cost of disposing of pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Union Carbide and Amchem.

        Union Carbide provided ARPC with all relevant data regarding asbestos-related claims filed against Union Carbide and Amchem through November 6, 2002. ARPC concluded that it was not possible to estimate the full range of the cost of resolving future asbestos-related claims against Union Carbide and Amchem, because of various uncertainties associated with the litigation of those claims. These uncertainties, which hindered Union Carbide's ability to project future claim volumes and resolution costs, included the following:

        Despite its inability to estimate the full range of the cost of resolving future asbestos-related claims, ARPC advised Union Carbide that it would be possible to determine an estimate of a reasonable forecast of the cost of resolving pending and future asbestos-related claims likely to face Union Carbide and Amchem, if certain assumptions were made. Specifically, ARPC advised Union Carbide that for purposes of determining an estimate it is reasonable to assume that in the near term asbestos-related claims filed against Union Carbide and Amchem are unlikely to return to levels below those experienced prior to 2001—when the recent spike in filings commenced—and that average claim values are unlikely to return to levels below those experienced in 2001-2002, the years immediately following CCR's cessation of operations. ARPC advised Union Carbide that, by assuming that future filings were unlikely to exceed the levels experienced prior to 2001 and extrapolating from 2001 and 2002 average claim values, ARPC could make a reasonable forecast of the cost of resolving asbestos-related claims facing Union Carbide and Amchem. ARPC also advised Union Carbide that forecasts of resolution costs for a 10 to 15 year period from the date of the forecast are likely to be more accurate than forecasts for longer periods of time.

        In projecting Union Carbide's resolution costs for future asbestos-related claims, ARPC applied two methodologies that have been widely used for forecasting purposes. Applying these methodologies, ARPC forecast the number and allocation by disease category of those potential future claims on a year-by-year basis through 2049. ARPC then calculated the percentage of claims in each disease category that had been closed with payments in 2001 and 2002. Using those percentages, ARPC calculated the number of future claims by disease category that would likely require payment by Union Carbide and Amchem and multiplied the number of such claims by the mean values paid by Union Carbide and Amchem, respectively, to dispose of such claims in 2001 and 2002. In estimating Union Carbide's cost of resolving pending claims, ARPC used a process similar to that used for calculating the cost of resolving future claims.

        As of December 31, 2002, ARPC estimated the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, for the 15-year period from the present through 2017 to be between approximately $2.2 billion and $2.4 billion, depending on which of the two accepted methodologies was used.

        Although ARPC provided estimates for a longer period of time, based on ARPC's advice that forecasts for shorter periods of time are more accurate and in light of the uncertainties inherent in making long-term projections, Union Carbide determined that the 15-year period through 2017 is the reasonable time period for projecting the cost of disposing of its future asbestos-related claims. Union Carbide concluded that it is probable that the undiscounted cost of disposing of asbestos-related pending and future claims ranges from $2.2 billion to $2.4 billion, which is the range for the 15-year period ending in 2017 as estimated by ARPC using both methodologies. Accordingly, Union Carbide increased its asbestos-related liability for pending and future claims at December 31, 2002 to $2.2 billion, excluding future defense and processing costs. At June 30, 2003, Union Carbide's asbestos-related liability for pending and future claims was $2.1 billion.

30


        Union Carbide also increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion at December 31, 2002, substantially exhausting its asbestos product liability coverage. This resulted in a net income statement impact to Union Carbide of $828 million, $522 million on an after-tax basis, in the fourth quarter of 2002. At June 30, 2003, Union Carbide's receivable for insurance recoveries related to its asbestos liability was $1.2 billion. The insurance receivable related to the asbestos liability was determined by Union Carbide after a thorough review of applicable insurance policies and the 1985 Wellington Agreement, to which Union Carbide and many of its liability insurers are signatory parties, as well as other insurance settlements, with due consideration given to applicable deductibles, retentions and policy limits, and taking into account the solvency and historical payment experience of various insurance carriers. In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement of $219 million at December 31, 2002 and $254 million at June 30, 2003.

        The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon currently known facts. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, coverage issues among insurers, and the continuing solvency of various insurance companies, as well as the numerous uncertainties surrounding asbestos litigation in the United States, could cause the actual costs and insurance recoveries for Union Carbide to be higher or lower than those projected or those recorded. Union Carbide expenses defense and processing costs as incurred. Accordingly, defense and processing costs incurred by Union Carbide in the future for asbestos-related litigation, net of insurance, will impact Union Carbide's results of operations in future periods.

        Because of the uncertainties described above, Union Carbide's management cannot estimate the full range of the cost of resolving pending and future asbestos-related claims facing Union Carbide and Amchem. Union Carbide's management believes that it is reasonably possible that the cost of disposing of Union Carbide's asbestos-related claims, including future defense and processing costs, could have a material adverse impact on Union Carbide's results of operations and cash flows for a particular period and on the consolidated financial position of Union Carbide.

        It is the opinion of Dow's management that it is reasonably possible that the cost of Union Carbide disposing of its asbestos-related claims, including future defense and processing costs, could have a material adverse impact on the Company's results of operations and cash flows for a particular period and on the consolidated financial position of the Company.

31




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Dow's business operations give rise to market risk exposure due to changes in foreign exchange rates, interest rates, commodity prices and other market factors such as equity prices. To manage such risks effectively, the Company enters into hedging transactions, pursuant to established guidelines and policies, which enable it to mitigate the adverse effects of financial market risk. Derivatives used for this purpose are designated as hedges per SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," where appropriate. A secondary objective is to add value by creating additional non-specific exposure within established limits and policies; derivatives used for this purpose are not designated as hedges per SFAS No. 133. The potential impact of creating such additional exposures is not material to the Company's results.

        The global nature of Dow's business requires active participation in the foreign exchange markets. As a result of investments, production facilities and other operations on a global basis, the Company has assets, liabilities and cash flows in currencies other than the U.S. dollar. The primary objective of the Company's foreign exchange risk management is to optimize the U.S. dollar value of net assets and cash flows, keeping the adverse impact of currency movements to a minimum. To achieve this objective, the Company hedges on a net exposure basis using foreign currency forward contracts, over-the-counter option contracts, cross-currency swaps, and nonderivative instruments in foreign currencies. Main exposures are related to assets and liabilities denominated in the currencies of Europe, Asia Pacific and Canada; bonds denominated in foreign currencies—mainly the Euro and Japanese yen; and economic exposure derived from the risk that currency fluctuations could affect the U.S. dollar value of future cash flows. The majority of the foreign exchange exposure is related to European currencies and the Japanese yen.

        The main objective of interest rate risk management is to reduce the total funding cost to the Company and to alter the interest rate exposure to the desired risk profile. Dow uses interest rate swaps, "swaptions," and exchange-traded instruments to accomplish this objective. The Company's primary exposure is to the U.S. dollar yield curve.

        Inherent in Dow's business is exposure to price changes for several commodities. Some exposures can be hedged effectively through liquid tradable financial instruments. Cracker feedstocks and natural gas constitute the main commodity exposures. Over-the-counter and exchange traded instruments are used to hedge these risks when feasible.

        Dow has a portfolio of equity securities derived from its acquisition and divestiture activity. This exposure is managed in a manner consistent with the Company's market risk policies and procedures.

        Dow uses value at risk ("VAR"), stress testing and scenario analysis for risk measurement and control purposes. VAR estimates the potential gain or loss in fair market values, given a certain move in prices over a certain period of time, using specified confidence levels. On an ongoing basis, the Company estimates the maximum gain or loss that could arise in one day, given a two-standard-deviation move in the respective price levels. These amounts are relatively insignificant in comparison to the size of the equity of the Company. The VAR methodology used by Dow is based primarily on the variance/covariance statistical model. The year-end VAR and average quarterly VAR for the aggregate of non-trading and trading positions for 2002 and 2001 are shown below:

 
 
2002

 
2001

Total Daily VAR at December 31*
In millions

  Year-end
  Average
  Year-end
  Average
Foreign exchange   $ 7   $ 10   $ 21   $ 17
Interest rate     94     83     106     70
Equity exposures, net of hedges     3     4     7     9
Commodities     17     11     4     5

*
Using a 95 percent confidence level

        Management believes there have been no material changes in market risk or in risk management policies since December 31, 2002.

32



ITEM 4. CONTROLS AND PROCEDURES

        As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company's Disclosure Committee and the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. No change in the Company's internal control over financial reporting occurred during the Company's most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

33



PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Breast Implant Matters

        No material developments regarding this matter occurred during the second quarter of 2003. For a summary of the history and current status of this matter, see Note F to the Consolidated Financial Statements.

Asbestos-Related Matters of Union Carbide Corporation

        No material developments regarding this matter occurred during the second quarter of 2003. For a summary of the history and current status of this matter, see Management's Discussion and Analysis of Financial Condition and Results of Operations, Asbestos-Related Matters of Union Carbide Corporation; and Note F to the Consolidated Financial Statements.

Environmental Matters

        On September 27, 2002, the United States Environmental Protection Agency, Region 6, filed an administrative complaint against Union Carbide Corporation ("Union Carbide"), a wholly owned subsidiary of the Company, charging civil fines of $185,458 for certain alleged violations of the Clean Air Act and the Resource Conservation and Recovery Act at Union Carbide's Texas City Operations. A Consent Agreement and Final Order was entered into, effective April 15, 2003, resolving those issues as well as certain other alleged Clean Air Act violations at Texas City Operations that were voluntarily disclosed by Union Carbide. Pursuant to the Consent Agreement and Final Order, Union Carbide paid a civil penalty of $133,508 on May 15, 2003, and agreed to perform a supplemental environmental project valued at $127,063.

        On July 7, 2003, the New Hampshire Department of Environmental Services (the "NHDES") filed a Petition for Permanent Injunction, Cost Recovery and Civil Forfeiture in the Southern District of the Hillsborough County Superior Court, New Hampshire, alleging that Hampshire Chemical Corp., an indirect wholly owned subsidiary of the Company, had violated certain hazardous waste laws, rules and permits at its Nashua, New Hampshire facility. Among other remedies, the NHDES is seeking "civil forfeiture" (civil penalties) that may exceed $100,000.

        As most recently reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2002, the Louisiana Department of Environmental Quality (the "LDEQ") took certain actions on October 16, 2001, December 3, 2002 and December 20, 2002, with respect to alleged environmental violations at the Company's Louisiana facilities. On July 24, 2003, the Company and the State of Louisiana, through the LDEQ, entered into a written Settlement Agreement resolving these matters as well as certain alleged water permit violations from September 2002 through December 2002 and certain alleged air permit violations. Pursuant to the Settlement Agreement, the Company will pay a civil penalty to the State of Louisiana of $1 million and will spend an additional $1.4 million for various environmental projects.

34



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        The annual meeting of stockholders of The Dow Chemical Company was held on May 8, 2003. At that meeting the following directors were elected to serve three-year terms to expire at the annual meeting in 2006: J. Michael Cook, Willie D. Davis, Keith R. McKennon, J. Pedro Reinhard and Paul G. Stern. In addition, the terms of the following directors continued after that meeting: Arnold A. Allemang, Jacqueline K. Barton, Anthony J. Carbone, John C. Danforth, Barbara Hackman Franklin, James M. Ringler, Harold T. Shapiro and William S. Stavropoulos.

        The following table gives a brief description of each matter voted upon at the above referenced annual meeting and, as applicable, the number of votes cast for, against or withheld, as well as the number of abstentions and broker nonvotes.

Description of Matter

  For
  Against
  Withheld
  Abstentions
  Broker
Nonvotes

1.   Election of Directors:
    
Class I
                   
    J. Michael Cook   742,870,765   N/A   44,892,473   N/A   N/A
    Willie D. Davis   745,149,254   N/A   42,613,984   N/A   N/A
    Keith R. McKennon   775,638,645   N/A   12,124,593   N/A   N/A
    J. Pedro Reinhard   773,689,016   N/A   14,074,222   N/A   N/A
    Paul G. Stern   742,057,318   N/A   45,705,920   N/A   N/A
2.   Ratification of the appointment of Deloitte & Touche LLP as the Company's independent auditors for 2003   762,264,981   19,639,366   N/A   5,858,891   N/A
3.   Authorization of the 2003-2013 Employees' Stock Purchase Plan   603,364,546   76,028,096   N/A   6,664,888   101,705,709
4.   Authorization of the 2003 Non-Employee Directors' Stock Incentive Plan   563,207,824   114,394,053   N/A   8,455,646   101,705,716
5.   Stockholder Proposal, Persistent Bioaccumulative Toxins   43,089,014   582,922,737   N/A   60,045,768   101,705,719

N/A—Not applicable

35



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)
Exhibits.

        See the Exhibit Index on page 38 of this Quarterly Report on Form 10-Q for exhibits filed with this report and exhibits incorporated by reference. The following exhibits are filed with this report:

Exhibit No.

  Description of Exhibit
23   Analysis, Research & Planning Corporation's Consent.
31(a)   Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b)   Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32(a)   Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32(b)   Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b)
Reports on Form 8-K.

        The following Current Reports on Form 8-K were filed by the Company during the second quarter of 2003:

        The following Current Report on Form 8-K was filed by the Company subsequent to the second quarter of 2003:

The following trademarks of The Dow Chemical Company or its subsidiaries appear in this report: CELLOSIZE, ETHOCEL, METHOCEL

The following trademark of FilmTec Corporation appears in this report:    FILMTEC

36



The Dow Chemical Company and Subsidiaries
Signature

        Pursuant to the requirements 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.

    THE DOW CHEMICAL COMPANY
Registrant

Date: August 5, 2003

 

 

 

 

/s/  
FRANK H. BROD      
Frank H. Brod
Vice President & Controller

37



The Dow Chemical Company and Subsidiaries
Exhibit Index

EXHIBIT NO.

  DESCRIPTION
23   Analysis, Research & Planning Corporation's Consent.

31(a)

 

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31(b)

 

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32(a)

 

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32(b)

 

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

38




QuickLinks

The Dow Chemical Company Table of Contents
PART I—FINANCIAL INFORMATION
The Dow Chemical Company and Subsidiaries Consolidated Statements of Income
The Dow Chemical Company and Subsidiaries Consolidated Balance Sheets
The Dow Chemical Company and Subsidiaries Consolidated Statements of Cash Flows
The Dow Chemical Company and Subsidiaries Consolidated Statements of Comprehensive Income
The Dow Chemical Company and Subsidiaries Notes to the Consolidated Financial Statements
PART II—OTHER INFORMATION
The Dow Chemical Company and Subsidiaries Signature
The Dow Chemical Company and Subsidiaries Exhibit Index