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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 March 31, 2004

Commission file number 1-3433

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

Delaware
(State or other jurisdiction of
incorporation or organization)
      38-1285128
(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 March 31, 2004
Common Stock, par value $2.50 per share       936,175,652 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

 

23
   
Disclosure Regarding Forward-Looking Information

 

23
   
Results of Operations

 

23
   
Changes in Financial Condition

 

29
   
Other Matters

 

31
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

37
 
Item 4. Controls and Procedures

 

38

PART II—OTHER INFORMATION

 

 
 
Item 1. Legal Proceedings

 

39
 
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

39
 
Item 6. Exhibits and Reports on Form 8-K

 

39

SIGNATURE

 

42

EXHIBIT INDEX

 

43

2



PART I—FINANCIAL INFORMATION
ITEM 1.    Financial Statements

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

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

  March 31,
2004

  March 31,
2003

 
Net Sales   $ 9,309   $ 8,081  
   
 
 
  Cost of sales     7,907     7,163  
  Research and development expenses     251     237  
  Selling, general and administrative expenses     363     355  
  Amortization of intangibles     29     15  
  Equity in earnings of nonconsolidated affiliates     140     39  
  Sundry income (expense)—net     (28 )   (6 )
  Interest income     18     20  
  Interest expense and amortization of debt discount     186     215  
   
 
 
Income before Income Taxes and Minority Interests     703     149  
   
 
 
  Provision for income taxes     204     47  
  Minority interests' share in income     30     17  
   
 
 
Income before Cumulative Effect of Change in Accounting Principle     469     85  
   
 
 
  Cumulative effect of change in accounting principle         (9 )
   
 
 
Net Income Available for Common Stockholders   $ 469   $ 76  
   
 
 
Share Data              
  Earnings before cumulative effect of change in accounting principle per common
        share—basic
  $ 0.50   $ 0.09  
  Earnings per common share—basic   $ 0.50   $ 0.08  
  Earnings before cumulative effect of change in accounting principle per common
        share—diluted
  $ 0.50   $ 0.09  
  Earnings per common share—diluted   $ 0.50   $ 0.08  
  Common stock dividends declared per share of common stock   $ 0.335   $ 0.335  
  Weighted-average common shares outstanding—basic     931.7     914.6  
  Weighted-average common shares outstanding—diluted     943.2     917.7  
   
 
 
Depreciation   $ 462   $ 433  
   
 
 
Capital Expenditures   $ 201   $ 223  
   
 
 

See Notes to the Consolidated Financial Statements.

3


The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  March 31,
2004

  Dec. 31,
2003

 
Assets              
Current Assets              
  Cash and cash equivalents   $ 1,926   $ 2,392  
  Marketable securities and interest-bearing deposits     47     42  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables—2004: $124; 2003: $118)     4,200     3,574  
    Other     2,180     2,246  
  Inventories     4,325     4,050  
  Deferred income tax assets—current     554     698  
   
 
 
  Total current assets     13,232     13,002  
   
 
 
Investments              
  Investment in nonconsolidated affiliates     1,906     1,878  
  Other investments     2,013     1,971  
  Noncurrent receivables     195     230  
   
 
 
  Total investments     4,114     4,079  
   
 
 
Property              
  Property     40,783     40,812  
  Less accumulated depreciation     26,847     26,595  
   
 
 
  Net property     13,936     14,217  
   
 
 
Other Assets              
  Goodwill     3,213     3,226  
  Other intangible assets (net of accumulated amortization—2004: $424; 2003: $406)     585     579  
  Deferred income tax assets—noncurrent     4,200     4,113  
  Asbestos-related insurance receivables—noncurrent     1,117     1,176  
  Deferred charges and other assets     1,485     1,499  
   
 
 
  Total other assets     10,600     10,593  
   
 
 
Total Assets   $ 41,882   $ 41,891  
   
 
 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 
Current Liabilities              
  Notes payable   $ 221   $ 258  
  Long-term debt due within one year     1,084     1,088  
  Accounts payable:              
    Trade     3,112     2,843  
    Other     2,112     2,041  
  Income taxes payable     249     212  
  Deferred income tax liabilities—current     252     241  
  Dividends payable     317     331  
  Accrued and other current liabilities     2,200     2,520  
   
 
 
  Total current liabilities     9,547     9,534  
   
 
 
Long-Term Debt     11,799     11,763  
   
 
 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     1,135     1,124  
  Pension and other postretirement benefits—noncurrent     3,545     3,572  
  Asbestos-related liabilities—noncurrent     1,739     1,791  
  Other noncurrent obligations     3,245     3,556  
   
 
 
  Total other noncurrent liabilities     9,664     10,043  
   
 
 
Minority Interest in Subsidiaries     393     376  
   
 
 
Preferred Securities of Subsidiaries     1,000     1,000  
   
 
 
Stockholders' Equity              
  Common stock     2,453     2,453  
  Additional paid-in capital     33     8  
  Unearned ESOP shares     (30 )   (30 )
  Retained earnings     10,149     9,994  
  Accumulated other comprehensive loss     (1,629 )   (1,491 )
  Treasury stock at cost     (1,497 )   (1,759 )
   
 
 
  Net stockholders' equity     9,479     9,175  
   
 
 
Total Liabilities and Stockholders' Equity   $ 41,882   $ 41,891  
   
 
 

See Notes to the Consolidated Financial Statements.

4


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
   
  Three Months Ended
 
In millions (Unaudited)

  March 31,
2004

  March 31,
2003

 
Operating Activities   Income before cumulative effect of change in accounting principles   $ 469   $ 85  
    Adjustments to reconcile net income to net cash provided
    by operating activities:
             
        Depreciation and amortization     514     470  
        Provision (Credit) for deferred income tax     47     (36 )
        Earnings/losses of nonconsolidated affiliates less than
        (in excess of) dividends received
    (14 )   15  
        Minority interests' share in income     30     17  
        Net gain on sales of investments     (6 )   (2 )
        Net (gain) loss on sales of property and businesses     (5 )   7  
        Other net (gain) loss     52     (42 )
        Tax benefit—nonqualified stock option exercises     33     7  
    Changes in assets and liabilities that provided (used) cash:              
        Accounts and notes receivable     (667 )   (116 )
        Inventories     (239 )   (24 )
        Accounts payable     391     131  
        Noncurrent receivables     35     11  
        Other assets and liabilities     (545 )   298  
       
 
 
    Cash provided by operating activities     95     821  
       
 
 
Investing Activities   Capital expenditures     (201 )   (223 )
    Proceeds from sales of property and businesses     9     14  
    Acquisition of business     (149 )    
    Investments in consolidated companies         (65 )
    Investments in nonconsolidated affiliates     (24 )   (29 )
    Purchases of investments     (469 )   (408 )
    Proceeds from sales and maturities of investments     436     379  
       
 
 
    Cash used in investing activities     (398 )   (332 )
       
 
 
Financing Activities   Changes in short-term notes payable     (49 )   131  
    Payments on long-term debt     (10 )   (156 )
    Proceeds from issuance of long-term debt         280  
    Purchases of treasury stock     (7 )   (3 )
    Proceeds from sales of common stock     235     28  
    Distributions to minority interests     (22 )   (27 )
    Dividends paid to stockholders     (310 )   (306 )
       
 
 
    Cash used in financing activities     (163 )   (53 )
       
 
 
Effect of Exchange Rate Changes on Cash         11  
       
 
 
Summary   Increase (Decrease) in cash and cash equivalents     (466 )   447  
    Cash and cash equivalents at beginning of year     2,392     1,484  
       
 
 
    Cash and cash equivalents at end of period   $ 1,926   $ 1,931  
       
 
 

See Notes to the Consolidated Financial Statements.

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

 
  Three Months Ended
 
In millions (Unaudited)

  March 31,
2004

  March 31,
2003

 
Net Income Available for Common Stockholders   $ 469   $ 76  
   
 
 
Other Comprehensive Income (Loss), Net of Tax              
  Net unrealized gains (losses) on investments     10     (7 )
  Translation adjustments     (142 )   105  
  Minimum pension liability adjustments     1     (3 )
  Net losses on cash flow hedging derivative instruments     (7 )   (16 )
   
 
 
  Total other comprehensive income (loss)     (138 )   79  
   
 
 
Comprehensive Income   $ 331   $ 155  
   
 
 

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 of The Dow Chemical Company and its subsidiaries ("Dow" or the "Company") were prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and 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, 2003.

NOTE B—ACCOUNTING CHANGES

        In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("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."

        In accordance with SFAS No. 143, 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, Italy and Brazil. The aggregate carrying amount of asset retirement obligations recognized by the Company was $48 million at March 31, 2004 and $46 million at December 31, 2003. These obligations are included in the consolidated balance sheets as "Other noncurrent obligations."

        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. As required by SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure," the following table provides pro forma results as if the fair value based method had been applied to all outstanding and unvested awards in each period presented:

 
  Three Months Ended
 
In millions

  March 31,
2004

  March 31,
2003

 
Net income, as reported   $ 469   $ 76  
Add: Stock-based compensation expense included in
    reported net income, net of tax
    23     3  
Deduct: Total stock-based compensation expense
    determined using fair value based method for all
    awards, net of tax
    (27 )   (19 )
   
 
 
Pro forma net income   $ 465   $ 60  
   
 
 
Earnings per share (in dollars):              
  Basic—as reported   $ 0.50   $ 0.08  
  Basic—pro forma     0.50     0.07  
  Diluted—as reported     0.50     0.08  
  Diluted—pro forma     0.49     0.07  
   
 
 

6


        In December 2003, the FASB issued revised FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities," which replaced FIN No. 46 issued in January 2003. Revised 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 do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The Company adopted the original FIN No. 46 during 2003. The application of revised FIN No. 46 did not have an impact on the Company's consolidated financial statements. The Company's disclosures related to variable interest entities can be found in Note M to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

        In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The revised standard requires new disclosures in addition to those required by the original standard about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. As revised, SFAS No. 132 is effective for financial statements with fiscal years ending after December 15, 2003. The interim-period disclosures required by this standard are effective for interim periods beginning after December 15, 2003. See Note G for the Company's interim disclosures regarding pension plans and other postretirement benefits.

        In January 2004, the FASB issued FASB Staff Position ("FSP") No. 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." The FSP permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Regardless of whether a sponsor elects that deferral, the FSP requires certain disclosures pending further consideration of the underlying accounting issues. The Company has elected to defer financial recognition of this legislation. See Note G for additional information.

        In March 2004, the FASB ratified consensuses reached by the Emerging Issues Task Force ("EITF") with respect to EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." EITF Issue No. 03-1 addresses recognition, measurement and disclosure of other-than-temporary impairment evaluations for securities within the scope of SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," and equity securities that are not subject to the scope of SFAS No. 115 and are not accounted for under the equity method according to Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock." The recognition and measurement guidance is effective for reporting periods beginning after June 15, 2004. Certain qualitative and quantitative disclosures for SFAS 115 securities were effective for fiscal years ending after December 15, 2003. Disclosures for cost method investments are required to be included in annual financial statements prepared for fiscal years ending after June 15, 2004. The Company has determined that its practices are substantially consistent with the application guidance of EITF Issue No. 03-1; therefore, adoption of EITF Issue No. 03-1 is expected to have an immaterial impact on the Company's consolidated financial statements.

        In March 2004, the FASB ratified the consensus reached by the EITF with respect to EITF Issue No. 03-16, "Accounting for Investments in Limited Liability Companies." According to EITF Issue No. 03-16, a limited liability company ("LLC") that maintains a "specific ownership account" for each investor should be viewed similar to a limited partnership for determining whether a noncontrolling investment in an LLC should be accounted for using the cost or equity method. The consensus applies to all investment in LLCs (except those required to be accounted for as debt securities) and is effective for reporting periods beginning after June 15, 2004. The Company is currently assessing the impact of adopting EITF Issue No. 03-16.

NOTE C—IMPAIRMENT OF LONG-LIVED ASSETS

        In the first quarter of 2003, certain studies to determine potential actions relative to non-strategic and under-performing assets were completed and management made decisions regarding the disposition of certain assets. These decisions resulted in the write-off of the net book value of several manufacturing facilities totaling $37 million (the largest of which was $16 million recorded in "Cost of sales" in the Hydrocarbons and Energy segment associated with the impairment of Union Carbide Corporation's ("Union Carbide") Seadrift, Texas, ethylene cracker, which was shut down 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 recorded in "Sundry income (expense)—net" in Unallocated and Other, and the write-off of cancelled capital projects totaling $12 million recorded in "Cost of sales" and reflected in Unallocated and Other.

7


        In the first quarter of 2004, Dow continued to evaluate non-strategic and under-performing assets, and management made decisions regarding the disposition of certain of the Company's assets. These decisions resulted in charges totaling $39 million. The two largest items were: a manufacturing facility for the production of polyols and propylene glycol in Priolo, Italy, and a manufacturing facility for the production of HAMPOSYL surfactants in Nashua, New Hampshire. On April 1, 2004, the Company announced the permanent closure of the Priolo plant; therefore, in the first quarter of 2004, the net book value of $22 million was written down, with a charge to "Cost of sales" in the Performance Plastics segment. In the first quarter of 2004, the Company made the decision to discontinue production of HAMPOSYL surfactants (manufactured by Hampshire Chemical Corp., a wholly owned subsidiary of the Company). The manufacturing facility for this line of business is expected to be closed in the third quarter of 2004; the plant will subsequently be demolished. As a result, in the first quarter of 2004, the Company wrote down the net book value of $9 million against "Cost of sales" in the Performance Chemicals segment. See Note E regarding the write-off of goodwill associated with this line of business.

NOTE D—INVENTORIES

        The following table provides a breakdown of inventories at March 31, 2004 and December 31, 2003:

Inventories
In millions

  March 31,
2004

  Dec. 31,
2003

Finished goods   $ 2,546   $ 2,396
Work in process     898     837
Raw materials     432     373
Supplies     449     444
   
 
Total inventories   $ 4,325   $ 4,050
   
 

        The reserves reducing inventories from the first-in, first-out ("FIFO") basis to the last-in, first-out ("LIFO") basis amounted to $393 million at March 31, 2004 and $330 million at December 31, 2003.

NOTE E—GOODWILL AND OTHER INTANGIBLE ASSETS

        The following table shows changes in the carrying amount of goodwill for the three months ended March 31, 2004, by operating segment:

In millions

  Performance
Plastics

  Performance
Chemicals

  Agricultural
Sciences

  Plastics
  Hydrocarbons
and Energy

  Total
 
Goodwill at December 31, 2003   $ 913   $ 781   $ 1,320   $ 149   $ 63   $ 3,226  
   
 
 
 
 
 
 
Goodwill write-off:                                      
  Hampshire surfactants business         (13 )               (13 )
   
 
 
 
 
 
 
Goodwill at March 31, 2004   $ 913   $ 768   $ 1,320   $ 149   $ 63   $ 3,213  
   
 
 
 
 
 
 

        The Specialty Chemicals business has experienced a significant decline in sales of HAMPOSYL surfactants (manufactured by Hampshire Chemical Corp., a wholly owned subsidiary of the Company). The Company's efforts to reach an acceptable agreement to sell this line of business were unsuccessful. In the first quarter of 2004, the Company made the decision to discontinue production of HAMPOSYL surfactants. The production site for this line of business is expected to be closed in the third quarter of 2004; the plant will subsequently be demolished. As a result, in the first quarter of 2004, the Company wrote off goodwill of $13 million associated with this line of business in the Performance Chemicals segment.

8


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

Other Intangible Assets

 
  At March 31, 2004
  At December 31, 2003
In millions

  Gross
Carrying
Amount

  Accumulated
Amortization

  Net
  Gross
Carrying
Amount

  Accumulated
Amortization

  Net
Intangible assets with finite lives:                                    
  Licenses and intellectual property   $ 287   $ (114 ) $ 173   $ 264   $ (107 ) $ 157
  Patents     153     (84 )   69     153     (81 )   72
  Software     321     (161 )   160     315     (153 )   162
  Trademarks     141     (28 )   113     142     (27 )   115
  Other     107     (37 )   70     111     (38 )   73
   
 
 
 
 
 
  Total   $ 1,009   $ (424 ) $ 585   $ 985   $ (406 ) $ 579
   
 
 
 
 
 

        The following table provides a summary of acquisitions of intangible assets during the quarter ended March 31, 2004:

Acquisitions of Intangible Assets in 2004

In millions

  Acquisition
Cost

  Weighted-average
Amortization Period

Intangible assets with finite lives:          
  Licenses and intellectual property   $ 26   5.2 years
  Software     4   5.0 years
   
 
  Total   $ 30   5.1 years
   
 

        Amortization expense for other intangible assets (not including software) was $16 million in the first quarter of 2004, compared with $15 million in the same period last year. Amortization expense for software, which is included in "Cost of sales," totaled $8 million in the first quarter of 2004 and $6 million in the first quarter of 2003. Total estimated amortization expense for 2004 and the five succeeding fiscal years is as follows:

In millions

  Estimated
Amortization
Expense

2004   $ 94
2005     86
2006     81
2007     72
2008     60
2009     35
   

9


NOTE F—COMMITMENTS AND CONTINGENT LIABILITIES

Litigation

Breast Implant Matters

        The following disclosure should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

        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 (see Note G to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2003).

        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 (consisting of approximately 33,000 claimants), 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.

        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 November 30, 1999, the Bankruptcy Court issued an Order confirming the Joint Plan. On November 13, 2000, U.S. District Court Judge Denise Page Hood affirmed the Bankruptcy Court's November 30, 1999 Order confirming the Joint Plan. On January 29, 2002, the United States Court of Appeals for the Sixth Circuit issued its opinion which, among other things, affirmed Judge Hood's previous 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. On March 24, 2004, the Sixth Circuit dismissed all remaining appeals related to the confirmation of the Joint Plan. On April 2, 2004, Judge Hood set June 1, 2004 as the effective date of the Joint Plan.

        As part of the Joint Plan, the Shareholders have agreed to provide a credit facility to Dow Corning in an aggregate amount of $300 million. The Company's share of the credit facility is $150 million and is subject to the terms and conditions stated in the Joint Plan.

        To the extent not previously resolved in state court actions, cases filed against the Company are currently pending in the U. S. District Court for the Eastern District of Michigan as a result of being transferred to that court for resolution in the context of the Joint Plan. Should cases be filed in the future, they will be accorded similar treatment. It is the opinion of the Company's management that the possibility is remote that a resolution of plaintiffs' claims would have a material adverse impact on the Company's consolidated financial statements.

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.

10


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 $381 million at December 31, 2003, for environmental remediation and restoration costs, including $40 million for the remediation of Superfund sites. At March 31, 2004, the Company had accrued obligations of $381 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.

        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 required the Company, by August 11, 2003, to propose a detailed Scope of Work for the off-site investigation, for review and approval by the MDEQ. Scope of Work documents were submitted to the MDEQ and were the subject of public comment. On December 12, 2003, MDEQ provided its formal response to the Company's August 11, 2003 Scope of Work documents in the form a Notice of Deficiency ("Notice") that required the Company respond to the Notice by February 17, 2004. The Company submitted revised Scope of Work documents on February 17, 2004. The Company has accrued an obligation of $7 million (included in the total accrued obligation of $381 million at March 31, 2004) with respect to off-site investigation, based on the investigative work that the Company has proposed and has discussed with MDEQ since the submission of the Scope of Work documents.

        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

        The following disclosure should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

        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. 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.

        Influenced by the bankruptcy filings of numerous defendants in asbestos-related litigation and the prospects of various forms of state and national legislative reform, the rate at which plaintiffs filed asbestos-related suits against various companies, including Union Carbide and Amchem, increased in 2001, 2002 and the first half of 2003. The rate of filing significantly abated in the second half of 2003 and the first quarter of 2004. Union Carbide expects more asbestos-related suits to be filed against Union Carbide and Amchem in the future, and will aggressively defend or reasonably resolve, as appropriate, both pending and future claims.

        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. 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. 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. 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

11


asbestos-related claims likely to face Union Carbide and Amchem if the following assumptions were made:


        Based on the resulting study completed by ARPC in January 2003, Union Carbide increased its December 31, 2002 asbestos-related liability for pending and future claims for the 15-year period ending in 2017 to $2.2 billion, excluding future defense and processing costs. Approximately 28 percent of the recorded liability related to pending claims and approximately 72 percent related to future claims.

        At each balance sheet date, Union Carbide compares current asbestos claim and resolution activity to the assumptions in the ARPC study to determine whether the accrual continues to be appropriate. In addition, in November 2003, Union Carbide requested ARPC to review the asbestos claim and resolution activity during 2003 and determine the appropriateness of updating its study. In its response to that request, ARPC reviewed and analyzed data through November 25, 2003 to determine the number of asbestos-related filings and costs associated with 2003 activity. In January 2004, ARPC stated that an update at that time would not provide a more likely estimate of future events than that reflected in its study of the previous year and, therefore, the estimate in that study remained applicable. Based on Union Carbide's own review of the asbestos claim and resolution activity and ARPC's response, Union Carbide determined that no change to the accrual was required at that time. Management noted, however, that the total number of claims filed in 2003 did exceed the number of claims assumed to be filed in the ARPC study. After consultation with outside counsel and other consultants, management believes this fact was strongly influenced by the pending national legislation and tort reform initiatives in key states. The total number of claims filed in the first quarter of 2004 also exceeded the number of claims assumed to be filed in the ARPC study. However, based on Union Carbide's review of 2004 activity, Union Carbide determined that no change to the accrual was required at March 31, 2004.

        Union Carbide's asbestos-related liability for pending and future claims was $1.8 billion at March 31, 2004 and $1.9 billion at December 31, 2003. At March 31, 2004, approximately 34 percent of the recorded liability related to pending claims and approximately 66 percent related to future claims. At December 31, 2003, approximately 33 percent of the recorded liability related to pending claims and approximately 67 percent related to future claims.

        At December 31, 2002, Union Carbide increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion, substantially exhausting its asbestos product liability coverage. Combined with the previously mentioned increase in the asbestos-related liability at December 31, 2002, 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. 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. Union Carbide's receivable for insurance recoveries related to its asbestos liability was $957 million at March 31, 2004 and $1.0 billion at December 31, 2003.

        In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement as follows:

Receivables for Costs Submitted to Insurance Carriers

In millions

  March 31,
2004

  December 31,
2003

Receivables for defense costs   $ 93   $ 94
Receivables for resolution costs     292     255
   
 
Total   $ 385   $ 349
   
 

12


        Union Carbide's insurance policies generally provide coverage for asbestos liability costs, including coverage for both resolution and defense costs. As previously noted, Union Carbide increased its receivable for insurance recoveries related to its asbestos liability at December 31, 2002, thereby recording the full favorable income statement impact of its insurance coverage in 2002. Accordingly, defense and resolution costs recovered from insurers reduce Union Carbide's insurance receivable. Prior to increasing the insurance receivable related to the asbestos liability at December 31, 2002, the impact on Union Carbide's results of operations for defense costs was the amount of those costs not covered by insurance. Since Union Carbide expenses defense costs as incurred, defense costs for asbestos-related litigation (net of insurance) have impacted, and will continue to impact, results of operations. The pretax impact for defense and resolution costs, net of insurance, was $25 million in the first quarter of 2004 and $30 million in the first quarter of 2003, and was reflected in "Cost of sales."

        In September 2003, Union Carbide filed a comprehensive insurance coverage case in the Circuit Court for Kanawha County in Charleston, West Virginia, seeking to confirm its rights to insurance for various asbestos claims. Although Union Carbide already has settlements in place concerning coverage for asbestos claims with many of its insurers, including those covered by the 1985 Wellington Agreement, this lawsuit was filed against insurers that are not signatories to the Wellington Agreement and/or do not otherwise have agreements in place with Union Carbide regarding their asbestos-related insurance coverage. Union Carbide continues to believe that its recorded receivable for insurance recoveries from all insurance carriers is collectible. Union Carbide reached this conclusion after a further review of its insurance policies, with due consideration given to applicable deductibles, retentions and policy limits, after taking into account the solvency and historical payment experience of various insurance carriers; existing insurance settlements; and the advice of outside counsel with respect to the applicable insurance coverage law relating to the terms and conditions of its insurance policies.

        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.

        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 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 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

        The U.S., Canadian and European competition authorities have initiated separate investigations into alleged anticompetitive behavior by certain participants in the synthetic rubber industry. DuPont Dow Elastomers L.L.C. ("DDE"), a 50:50 joint venture with E.I. du Pont de Nemours and Company ("DuPont"), and certain subsidiaries of the Company (but as to the investigation in Europe only) have responded, or are in the process of responding, to requests for documents and are otherwise cooperating in the investigations. Separately, related civil actions have been filed in various U.S. federal and state courts. Certain of these actions have named the Company. Although these investigations and related litigation are still at an early stage, based on the current status, DDE is expected to record a pre-tax charge of approximately $150 million. In that regard, on April 8, 2004, DuPont issued a press release stating that DuPont and the Company had entered into a series of agreements that, among other things: enables DuPont to direct DDE's response to these investigations and related litigation; results in DuPont funding 100 percent of any potential DDE liabilities and costs up to $150 million, with DuPont also funding more than 75 percent of the excess, if any; and grants the Company the option to acquire certain DDE assets in a cashless transaction which, if exercised, would obligate DuPont to acquire the Company's remaining equity interest in DDE.

        In addition to the breast implant, DBCP and environmental remediation matters, and as disclosed in the preceding paragraph, 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.

13


Summary

        Except for the possible effect of Union Carbide's asbestos-related liability 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.

Purchase Commitments

        At December 31, 2003, the Company had five major agreements for the purchase of ethylene-related products in North America. 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 $580 million in 2003. On January 1, 2004, seven additional agreements for the purchase of ethylene-related products in North America became effective. On January 1, 2005, another agreement for the purchase of ethylene-related products in North America will become effective. The Company's commitments associated with all of these agreements are included in the table below.

        At December 31, 2003, 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 20 years. 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, 2003 is presented in the table below.

Fixed and Determinable Portion of Take or Pay and
Throughput Obligations at December 31, 2003
In millions

2004   $ 1,358
2005     1,222
2006     1,110
2007     993
2008     903
2009 through expiration of contracts     3,713
   
Total   $ 9,299
   

        In addition to the take or pay obligations at December 31, 2003, the Company had outstanding purchase commitments which ranged from one to 20 years for steam, electrical power, materials, property and other items used in the normal course of business of approximately $302 million. In general, such commitments were at prices not in excess of current market prices.

        At December 31, 2003, the Company was also committed to lease PET manufacturing facilities under construction in Germany.

        In the first quarter of 2004, the Company entered into a throughput agreement for the right to use a liquefied natural gas terminal in North America. The fixed and determinable portion of the obligation requires payments of $70 million per year for 20 years beginning in 2007. In addition, in the first quarter of 2004, the Company entered into an agreement for the purchase of power in North America which requires payments of $56 million in 2006, $54 million in 2007 and $35 million in 2008.

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.

14


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

Guarantees at March 31, 2004

In millions

  Final
Expiration

  Maximum Future
Payments

  Recorded
Liability

Guarantees   2009   $ 808   $ 45
Residual value guarantees   2015     1,444    
   
 
 
Total       $ 2,252   $ 45
   
 
 

Guarantees at December 31, 2003

In millions

  Final
Expiration

  Maximum Future
Payments

  Recorded
Liability

Guarantees   2009   $ 888   $ 48
Residual value guarantees   2015     1,431    
   
 
 
Total       $ 2,319   $ 48
   
 
 

15


NOTE G—PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS

Net Periodic Benefit Cost for All Significant Plans

 
  Defined Benefit Pension Plans
Three Months Ended

  Other Postretirement Benefits
Three Months Ended

 
In millions

  March 31,
2004

  March 31,
2003

  March 31,
2004

  March 31,
2003

 
Service cost   $ 66   $ 61   $ 6   $ 8  
Interest cost     200     193     33     34  
Expected return on plan assets     (269 )   (271 )   (6 )   (5 )
Amortization of prior service cost (credit)     6     5     (3 )   (2 )
Amortization of net loss     7     3     2     2  
Special termination/curtailment cost         1          
   
 
 
 
 
Net periodic benefit cost (credit)   $ 10   $ (8 ) $ 32   $ 37  
   
 
 
 
 

Employer Contributions

Pension Plans

        The Company has defined benefit pension plans which cover employees in the United States and a number of other countries. The U.S. funded plan covering the parent company is the largest plan. Benefits are based on length of service and the employee's three highest consecutive years of compensation.

        The Company's funding policy is to contribute to those plans when pension laws and economics either require or encourage funding. As previously disclosed in the Company's financial statements for the year ended December 31, 2003, Dow expects to contribute $37 million to its U.S. qualified pension plan trust in 2004. No contributions were made in the first quarter of 2004. The Company also has non-qualified supplemental pension plans. As previously disclosed, benefit payments to retirees under these plans are expected to be $24 million in 2004. In the first quarter of 2004, benefit payments of $4 million were made.

Other Postretirement Benefits

        The Company provides certain health care and life insurance benefits to retired employees. The U.S. plan covering the parent company is the largest plan. The plan provides health care benefits, including hospital, physicians' services, drug and major medical expense coverage, and life insurance benefits. For employees hired before January 1, 1993, the plan provides benefits supplemental to Medicare when retirees are eligible for these benefits. The Company and the retiree share the cost of these benefits, with the Company portion increasing as the retiree has increased years of credited service. There is a cap on the Company portion. These benefits are subject to change at any time.

        The Company funds most of the cost of these health care and life insurance benefits as incurred. Dow previously disclosed in its financial statements for the year ended December 31, 2003, that it does not expect to contribute assets to its U.S. other postretirement benefits plan trust in 2004. Consistent with that expectation, no contributions were made in the first quarter of 2004. As previously disclosed, benefit payments to retirees under these plans are expected to be $165 million in 2004. In the first quarter of 2004, benefit payments of $62 million were made.

        On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") was signed into law. The Act expanded Medicare to include, for the first time, coverage for prescription drugs. Dow and its subsidiaries sponsor retiree medical programs. The Company expects that this legislation will eventually reduce its costs for some of these programs.

        At this point, the Company's analysis regarding the impact of the legislation is preliminary, as it awaits guidance from various governmental and regulatory agencies concerning the requirements that must be met to obtain these cost reductions, as well as the manner in which such savings should be measured. Based on this preliminary analysis, it appears that some of the Company's retiree medical plans may need to be modified in order to qualify for beneficial treatment under the Act.

        Because of various uncertainties related to Dow's response to this legislation and the appropriate accounting methodology for this event, the Company has elected to defer financial recognition of this legislation until the FASB issues final accounting guidance. When issued, the final guidance could require the Company to change previously reported information. This deferral election is permitted under FSP No. 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003."

16


NOTE H—OPERATING SEGMENTS AND GEOGRAPHIC AREAS

 
  Three Months Ended
 
In millions

  March 31,
2004

  March 31,
2003

 
Operating segment sales              
  Performance Plastics   $ 2,164   $ 1,847  
  Performance Chemicals     1,576     1,371  
  Agricultural Sciences     924     768  
  Plastics     2,234     1,974  
  Chemicals     1,276     1,049  
  Hydrocarbons and Energy     1,059     959  
  Unallocated and Other     76     113  
   
 
 
  Total   $ 9,309   $ 8,081  
   
 
 
Operating segment EBIT (1)              
  Performance Plastics   $ 191   $ 136  
  Performance Chemicals     142     122  
  Agricultural Sciences     231     130  
  Plastics     307     137  
  Chemicals     173     34  
  Hydrocarbons and Energy     (1 )   (21 )
  Unallocated and Other     (172 )   (194 )
   
 
 
  Total   $ 871   $ 344  
   
 
 
Geographic area sales              
  United States   $ 3,471   $ 3,103  
  Europe     3,448     2,997  
  Rest of World     2,390     1,981  
   
 
 
  Total   $ 9,309   $ 8,081  
   
 
 
(1)
The Company uses EBIT (which Dow defines as earnings before interest, income taxes and minority interests) 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
 
In millions

  March 31,
2004

  March 31,
2003

 
  EBIT   $ 871   $ 344  
  Interest income     18     20  
  Interest expense and amortization of debt discount     186     215  
  Provision for income taxes     204     47  
  Minority interests' share in income     30     17  
  Cumulative effect of change in accounting principle         (9 )
   
 
 
  Net Income Available for Common Stockholders   $ 469   $ 76  
   
 
 

        Transfers of products between operating segments are generally valued at cost. Transfers of products to the Agricultural Sciences segment from the other segments, however, are generally valued at market-based prices. The revenues generated by these transfers were immaterial in the first quarters of 2004 and 2003.

        In the first quarter of 2004, the Company made changes in its internal organizational structure. While this reorganization did not result in a change to Dow's operating segments, several of the businesses within the operating segments were renamed. The Corporate Profile included below reflects these changes:

17


Corporate Profile

Dow is a leading science and technology company that provides innovative chemical, plastic and agricultural products and services to many essential consumer markets. In 2003, Dow had annual sales of approximately $33 billion and employed approximately 46,000 people. The Company serves customers in 183 countries and a wide range of markets that are vital to human progress, including food, transportation, health and medicine, personal and home care, and building and construction, among others. The Company has 180 manufacturing sites in 37 countries and supplies more than 3,500 products grouped within the operating segments listed on the following pages.

18


19



20


21


22



The Dow Chemical Company and Subsidiaries
PART I, 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

OVERVIEW

        In the first quarter of 2004, feedstock and energy costs remained high and volatile. In an effort to further improve Dow's earnings and financial position, the Company's management and employees continued to focus on the steps outlined in Dow's 2003 Action Plan (announced in January 2003). For 2004, a new action plan was adopted that is specifically focused on: price/volume management; building on productivity improvements achieved in 2003; continued discipline in capital spending, targeting total spending of $1.3 billion in 2004; additional shutdown of non-competitive assets; and further divestitures of non-strategic assets. Progress was made in these areas in the first quarter. Dow's results showed broad-based improvements across all business segments and geographic areas. The results for the quarter included increased sales—with strong volume and favorable price momentum—good control on expenses and higher operating rates, which combined to more than offset historically high feedstock and energy costs, resulting in significantly improved earnings for the quarter. In addition, capital spending was lower in the first quarter and remains on track to achieve the Company's 2004 goal, and the Company took action on non-competitive, under-performing assets. Dow's results for the first quarter of 2004 are discussed further in this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Selected Financial Data

 
  Three Months Ended
 
In millions, except per share amounts

  March 31,
2004

  March 31,
2003

 
Sales   $ 9,309   $ 8,081  

Cost of sales

 

 

7,907

 

 

7,163

 
% of sales     85 %   89 %

Research and development, and selling, general
    and administrative expenses

 

 

614

 

 

592

 
% of sales     7 %   7 %

Effective tax rate

 

 

29.0

%

 

31.5

%

Net income available for common stockholders

 

$

469

 

$

76

 

Earnings per common share—basic

 

$

0.50

 

$

0.08

 
Earnings per common share—diluted   $ 0.50   $ 0.08  

Operating rate percentage

 

 

89

%

 

79

%
   
 
 

        Net sales for the first quarter of 2004 were $9.3 billion, up 15 percent from $8.1 billion in the first quarter of last year. Prices improved 8 percent, due to the continuing increase in feedstock and energy costs and the favorable impact of currency on sales in Europe, while volume grew 7 percent (see Sales Volume and Price table on page 28). Compared with last year, prices were up in all geographic areas and all operating segments, with the most significant increases in the basics businesses. Volume growth was also broad-based, with improvement in all operating segments and across all geographic areas. Volume was especially strong in Asia Pacific and Latin America, and in the performance segments.

23


        Gross margin for the first quarter of 2004 was $1.4 billion, compared with $918 million in the first quarter of last year. Gross margin improved as higher selling prices of approximately $650 million (including the favorable impact of currency in Europe), as well as volume growth and the impact of improved operating rates, more than offset an increase of approximately $100 million in feedstock and energy costs and the negative impact of currency on costs.

        The Company's global plant operating rate for its chemicals and plastics businesses was 89 percent in the first quarter of 2004, compared with 79 percent in the first quarter of 2003. Operating rates continued to improve as the Company increased run rates to support growing demand, a reflection of improved economic conditions around the world.

        Personnel count was 46,021 at March 31, 2004, compared with 46,372 at December 31, 2003 and 48,912 at March 31, 2003. Headcount continued to decline as the Company remained focused on the steps outlined in the action plan.

        Operating expenses (research and development, and selling, general and administrative expenses) were $614 million in the first quarter of 2004, up $22 million or 4 percent, from $592 million in the first quarter of last year. Research and development expenses were up $14 million due to spending on growth initiatives and the start-up of two pilot plants. Selling, general and administrative expenses were up $8 million. Compared with last year, an increase in selling, promotional and advertising expenses was partially offset by a decline in administrative expenses. The unfavorable impact of currency on expenses in Europe contributed to the increase in operating expenses in the first quarter of this year.

        Amortization of intangibles was $29 million in the first quarter of 2004, up from $15 million in the first quarter of last year, due to the write-off of goodwill associated with the Company's manufacturing facility in Nashua, New Hampshire, that produces HAMPOSYL surfactants. In the first quarter of 2004, the Company made the decision to discontinue production of HAMPOSYL surfactants. The production site for this line of business is expected to be closed in the third quarter of 2004; the plant will subsequently be demolished. As a result, in the first quarter of 2004, the Company wrote off goodwill of $13 million associated with this line of business in the Performance Chemicals segment. See Notes C and E to the Consolidated Financial Statements for additional information.

        Dow's share of the earnings of nonconsolidated affiliates was $140 million in the first quarter of 2004, compared with $39 million in the same quarter last year. Equity earnings increased primarily due to stronger results from the OPTIMAL Group ("OPTIMAL"), EQUATE Petrochemical Company K.S.C. ("EQUATE"), and UOP LLC. Dow Corning Corporation ("Dow Corning"), DuPont Dow Elastomers L.L.C. and Compania Mega S.A. also reported improved results.

        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 first quarter of 2004 was net expense of $28 million compared with net expense of $6 million in the first quarter of 2003. Net expense was higher than last year principally due to a loss of approximately $30 million on the sale of assets recorded in the first quarter of 2004.

        Net interest expense (interest expense less capitalized interest and interest income) was $168 million in the first quarter of 2004, down from $195 million in the first quarter of last year. Compared with last year, net interest expense declined primarily due to lower interest rates and a reduction in total debt.

        The effective tax rate for the first quarter was 29.0 percent, versus 31.5 percent for the first quarter of 2003. The effective tax rate fluctuates based on, among other factors, where income is earned and the level of income relative to tax credits available. In 2004, stronger earnings were reported by a number of the Company's joint ventures, and since most of the earnings from these companies are taxed at the joint venture level, the impact of higher equity earnings reduced Dow's overall effective tax rate for the first quarter.

        Net income for the first quarter of 2004 was $469 million or $0.50 per share, compared with $76 million or $0.08 per share for the first quarter of 2003. Last year, net income for the first quarter 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 change in accounting principle").

SEGMENT RESULTS

        The Company uses EBIT (which Dow defines as earnings before interest, income taxes and minority interests) as its measure of profit/loss for segment reporting purposes. EBIT includes all operating items relating to the business and excludes items that principally apply to the Company as a whole.

        In the first quarter of 2004, the Company made changes in its internal organizational structure. While this reorganization did not result in a change to Dow's operating segments, several of the businesses within the operating segments were renamed. The Corporate Profile included in Note H to the Consolidated Financial Statements reflects these changes. See Note H for additional information regarding the Company's operating segments.

24


PERFORMANCE PLASTICS

        Performance Plastics sales were $2,164 million for the first quarter of 2004, up 17 percent from $1,847 million in the first quarter of 2003. Volume grew 11 percent from last year, with improvement in all of the segment's businesses, while prices increased 6 percent, principally due to the favorable impact of currency in Europe. EBIT for the segment was $191 million in the first quarter, up from $136 million in the same period of last year, as the impact of higher selling prices and increased volume more than offset higher raw material costs.

        Building and Construction sales for the first quarter of 2004 were up 19 percent from a year ago as the global building industry showed continued resilience with strong off-season demand in North America, Japan and parts of Europe. Volume improved 10 percent, driven by high OSB (oriented strand board) pricing in North America, which caused builders to consider foam alternatives in residential construction. Prices were up 9 percent, primarily due to the strengthening of the Euro. EBIT improved versus the same quarter of 2003 as a result of price improvement and increased sales volume.

        Dow Automotive sales for the first quarter of 2004 were up 14 percent from the same quarter of last year. Prices rose 7 percent, favorably impacted by the strengthening Euro. In addition, price increases were successfully implemented to offset increases in feedstock costs. Compared with the first quarter of last year, volume improved 7 percent as sales to Dow's existing customer base grew due to continued solid product performance from glass and plastic bonding and body engineered systems. EBIT for the business improved from last year due to higher selling prices and volume growth.

        Engineering Plastics sales for the quarter were up 5 percent versus the first quarter of 2003, due to a 3 percent increase in prices and a 2 percent improvement in volume. While prices were favorably impacted by the strengthening Euro, local prices were under intense competitive pressure. Volume increased due to higher demand within the appliance and construction industries. EBIT for the first quarter of 2004 improved due to higher selling prices, volume growth and improved operating rates.

        Sales of Epoxy Products and Intermediates for the first quarter were up 18 percent from last year, as volume grew 12 percent and prices rose 6 percent. Demand was strong in all geographic areas, reflecting improvement in economic conditions. Demand was especially strong for epoxy coatings, with double-digit growth in Europe versus the first quarter of 2003. Price increases were broad-based, with increases reported in all geographic areas, except Latin America. Compared with last year, EBIT improved due to higher prices and increased volume.

        Polyurethanes and Thermoset Systems sales for the quarter were up 21 percent from the first quarter of 2003. Volume increased 14 percent, with strong demand in the appliance and construction industries for polyols and methylene diphenyl diisocyanate ("MDI"). Demand for propylene glycol ("PG") was also strong across a number of applications. Price increases for PG, polyols and MDI, coupled with the favorable impact of currency, drove prices up 7 percent. Operating rates for toluene diisocyanate ("TDI") declined in the first quarter due to excess industry capacity, dampening any price momentum within this product line. EBIT improved as increased volume and price more than offset the impact of increased raw material costs. EBIT in the first quarter of 2004 was negatively impacted by the write-down of the net book value ($22 million) of the Company's polyols production facility in Priolo, Italy, following Dow's decision to shut the facility down.

        Wire and Cable sales for the first quarter were up 13 percent from last year, due to volume growth of 7 percent and an increase in prices of 6 percent. Volume continued to improve due to increased demand within the telecommunication cable industry.

PERFORMANCE CHEMICALS

        Performance Chemicals sales for the first quarter of 2004 were $1,576 million, up 15 percent from $1,371 million last year, due to volume growth of 8 percent and increased prices of 7 percent, including the favorable impact of currency in Europe. EBIT for the first quarter was $142 million, up from $122 million in the first quarter of 2003. Compared with last year, EBIT improved due to higher selling prices, higher volume, improved equity earnings, lower feedstock costs, improved operating rates and a continued focus on productivity improvements.

        Acrylics and Oxide Derivatives sales for the quarter were up 38 percent from the first quarter of 2003, due to volume growth of 26 percent and a 12 percent increase in prices, including the favorable impact of currency in Europe. Volume increased primarily due to the acquisition of the acrylates business of Celanese AG on February 2, 2004. Volume of oxide derivatives improved due to increased demand for coatings (glycol ethers) and wet strength resin (amines). Due to a tight supply/demand balance in P-Series glycol ethers, ethanolamines, and ethyleneamines, customers have become more concerned with availability than price, resulting in some margin restoration. EBIT for the first quarter improved significantly due to strong volume growth, higher selling prices and improved equity earnings from OPTIMAL compared with the first quarter of 2003.

25


        Dow Latex sales for the quarter improved 13 percent compared with the first quarter of 2003. Prices rose 9 percent, largely due to the favorable impact of currency in Europe, while volume increased 4 percent. Prices for styrene-butadiene latex sold into the coated paper and carpet industries were up in most geographic areas, driven by increased styrene monomer costs. EBIT for the quarter increased significantly from last year as higher selling prices and volume growth offset increases in raw material costs.

        Specialty Chemicals sales were up 6 percent versus the first quarter of 2003 with a 5 percent increase in price, principally due to the favorable impact of currency in Europe, and a 1 percent increase in volume. Both price and volume improved for functional solutions and surfactants in the quarter. EBIT declined from last year due to charges related to the shutdown of Hampshire Chemical Corp.'s Nashua, New Hampshire, manufacturing site. The charges included a $9 million write-down of the net book value of the facility and a $13 million write-off of goodwill. The site is expected to be closed in the third quarter of 2004; the plant will subsequently be demolished. See Note E to the Consolidated Financial Statements for additional information.

        Specialty Polymers sales in the first quarter of 2004 were up 9 percent from the same period of last year. Volume increased 7 percent, while prices rose 2 percent. Volume was strong in all geographic areas. Sales in the first quarter were especially strong for ANGUS Chemical Company's products, biocides, CELLOSIZE cellulose ethers, liquid separations and METHOCEL cellulose ethers. EBIT for the business improved versus the first quarter of last year due to volume growth, higher selling prices and improved operating rates.

AGRICULTURAL SCIENCES

        Sales for the Agricultural Sciences segment for the first quarter of 2004 were $924 million, up 20 percent from $768 million last year. Volume, which was up in all geographic areas, grew 14 percent, while prices rose 6 percent, principally due to the favorable impact of currency in Europe. Volume improved in part due to the impact of higher farm commodity prices on farmers' buying patterns. In some geographic areas, this resulted in increased buying for higher acreage to be planted, while in others, it resulted in increased buyng for a more intensive use of crop protection chemicals to improve yield. Demand was strong for phenoxy herbicides, the result of an early spring in the United States and some volume shift from the second quarter, and for florasulam herbicides and spinosad insect control products. EBIT for the first quarter of 2004 was $231 million, up significantly from $130 million in the first quarter of 2003. Strong volume growth, higher selling prices, favorable product mix, improved operating rates and lower operating expenses all contributed to the strong EBIT improvement in 2004.

PLASTICS

        Plastics sales for the first quarter of 2004 were $2,234 million, up 13 percent from $1,974 million a year ago, as prices increased 12 percent and volume increased 1 percent. Price increases, driven by escalating feedstock costs, benefited from the strengthening of the Euro and improving supply/demand balances. Volume improved in North America and Latin America as economic recovery continued to gather momentum; however, much of this improvement was negated by volume reductions in Europe and Asia Pacific. EBIT for the first quarter was $307 million, up significantly from $137 million in the first quarter of 2003, as higher selling prices and improved equity earnings from EQUATE and DuPont Dow Elastomers L.L.C. offset the unfavorable impact of higher feedstock costs.

        Polyethylene sales were up significantly from the first quarter of 2003 as prices, including the favorable impact of currency in Europe, increased 14 percent and volume increased 3 percent. Prices were up in all geographic areas, with double-digit increases in Europe, Asia Pacific and Latin America; price improvement in North America was also strong. Volume growth was also reported in all geographic areas, as the continuing global economic recovery resulted in higher polyethylene demand overall. EBIT for the quarter improved significantly from the first quarter of 2003 primarily due to higher selling prices and improved equity earnings from EQUATE.

        Polypropylene sales were up 8 percent from the first quarter of 2003 as prices increased 9 percent, including the favorable impact of currency in Europe, and volume declined 1 percent. In response to high feedstock costs, prices were up in all geographic areas, with double-digit increases in North America and Asia Pacific. Improving economic conditions in North America resulted in an increase in volume; however, in Europe, limited availability of propylene had a negative impact on the Company's production volumes. EBIT improved over the same quarter of last year as higher selling prices more than offset the impact of increased feedstock costs.

26


        Polystyrene sales for the first quarter of 2004 were up 11 percent as prices rose 8 percent, including the favorable impact of currency in Europe, and volume grew 3 percent. Price improvement was reported across all geographic areas as the business raised prices in response to higher styrene monomer costs. Volume growth was also broad-based, with higher volume reported in all geographic areas except Asia Pacific. In Asia Pacific, volume decreased as customers reduced inventories. In addition, demand in The People's Republic of China declined in response to a recent ruling announced by the U.S. Department of Commerce that Chinese manufacturers of television receivers have been dumping products into the U.S. marketplace. Revised tariffs have been proposed to address the issue. Compared with the first quarter of 2003, EBIT declined as higher styrene monomer costs negated increases in selling prices.

CHEMICALS

        First quarter sales for the Chemicals segment were $1,276 million, up 22 percent from $1,049 million for the first quarter of last year, due to a 14 percent increase in prices and an 8 percent increase in volume. Price increases were driven by improving supply/demand balances, while volume improved primarily due to increasing demand for ethylene glycol ("EG"). Volume for vinyl chloride monomer ("VCM") was solid in the first quarter, reflecting good demand for polyvinyl chloride ("PVC") in North America and Europe. With relatively low inventories throughout the vinyl chain and solid demand, VCM prices increased during the quarter. EBIT for the quarter was $173 million, up significantly from $34 million in the first quarter of 2003, primarily due to the increased profitability of EG and vinyl chloride monomer. The results for the quarter reflect higher selling prices, increased volume and higher equity earnings from EQUATE and OPTIMAL.

HYDROCARBONS AND ENERGY

        Hydrocarbons and Energy sales for the first quarter of 2004 were $1,059 million, up 10 percent from $959 million in the first quarter of 2003 due to a 7 percent increase in volume and a 3 percent increase in selling prices, including the favorable impact of currency in Europe. Volume improved in part due to an increase in sales of cumene and benzene.

        The Hydrocarbons and Energy business transfers materials to Dow's derivative businesses at cost. Hydrocarbons and Energy EBIT for the quarter was a loss of $1 million, compared with a loss of $21 million in the first quarter of last year. EBIT in the first quarter of 2003 was impacted by a $16 million impairment charge associated with Union Carbide's ethylene production facility in Seadrift, Texas, which was shut down in the third quarter of 2003.

UNALLOCATED AND OTHER

        Included in the results for Unallocated and Other are:

        EBIT for the first quarter of 2004 was a loss of $172 million compared with a loss of $194 million in the first quarter of 2003. EBIT for the first quarter of 2004 was negatively impacted by a loss on the sale of assets of approximately $30 million and asbestos-related defense and resolution costs, net of insurance, of $25 million. In the first quarter of last year, EBIT was unfavorably impacted by asbestos-related defense and resolution costs, net of insurance, of $30 million and costs associated with decisions made in the first quarter relative to under-performing and non-strategic assets (which resulted in the $11 million write-down of Union Carbide's chemical transport vessel, which was sold in the second quarter of 2003, and the write-off of cancelled capital projects totaling $12 million).

27


Sales Volume and Price by Operating Segment and Geographic Area

 
  Three Months Ended
March 31, 2004

 
Percentage change from prior year

 
  Volume
  Price
  Total
 
Operating segments              
  Performance Plastics   11 % 6 % 17 %
  Performance Chemicals   8 % 7 % 15 %
  Agricultural Sciences   14 % 6 % 20 %
  Plastics   1 % 12 % 13 %
  Chemicals   8 % 14 % 22 %
  Hydrocarbons and Energy   7 % 3 % 10 %
   
 
 
 
  Total   7 % 8 % 15 %
   
 
 
 
Geographic area sales              
  United States   6 % 6 % 12 %
  Europe   5 % 10 % 15 %
  Rest of World   11 % 10 % 21 %
   
 
 
 
  Total   7 % 8 % 15 %
   
 
 
 

OUTLOOK

        For the chemical industry, improvements in global GDP and industrial production are expected going forward and should drive an increase in demand. With limited capacity additions expected, supply/demand balances should continue to tighten in 2004. Ethylene glycol supply is relatively tight and is expected to remain so for the balance of the year. Some signs of tightening are already visible in chlor-alkali products; the ethylene chain is expected to show continued improvement through 2004.

        Oil and natural gas prices are expected to remain high and volatile, and add uncertainty to the profit outlook. While U.S. natural gas prices may soften somewhat in the coming months, a significant decline during 2004 is not anticipated. Dow's purchased feedstock and energy costs are expected to increase slightly in the second quarter from the historically high levels of the first quarter. The year-over-year increase is expected to be substantial, continuing to put pressure on margins. During the second quarter, selling prices are expected to increase slightly. Compared with last year, volume is expected to improve with strengthening economic conditions. Dow's typical seasonal increase in agricultural products in the second quarter may be somewhat muted by the strong first quarter performance. Costs related to scheduled shutdowns for plant maintenance are expected to be up in the second quarter, compared with the first quarter of 2004, but not significantly different from the level of spending on such activities in the second quarter of last year. Structural costs are expected to be relatively flat with the first quarter, retaining the substantial gains achieved in 2003.

        During 2004, the Company expects to reduce personnel levels by approximately 3,000 compared with December 31, 2003, through a combination of business restructuring, attrition, plant shutdowns and divestitures. Severance costs of approximately $300 million, including $30 million in the first quarter, are anticipated in 2004. Annual savings associated with this reduction in personnel are expected to be approximately $350 million, with about one-half of that amount realized in 2004.

        The Company continues to focus on its financial improvement program—institutionalizing the savings of 2003 and continuing to focus on price volume management—to make 2004 a better year for Dow.

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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:

 
  Three Months Ended
 
In millions

  March 31,
2004

  March 31,
2003

 
Cash provided by (used in):              
  Operating activities   $ 95   $ 821  
  Investing activities     (398 )   (332 )
  Financing activities     (163 )   (53 )
  Effect of exchange rate changes on cash         11  
   
 
 
Net change in cash and cash equivalents   $ (466 ) $ 447  
   
 
 

        Despite a significant improvement in earnings in the first quarter of 2004, cash provided by operating activities declined versus the same period of last year due to an increase in working capital requirements and the payment of performance awards to employees of $390 million in the first quarter of this year. Accounts receivable increased significantly, consistent with the increase in sales in the first quarter. Last year, cash provided by operating activities included the receipt of a $275 million income tax refund due to U.S. net operating losses.

        Cash used in investing activities in the first quarter of 2004 compared with the first quarter last year increased primarily due to acquisition activity, partially offset by a reduction in capital expenditures and investments in consolidated companies. In the first quarter of 2004, cash was used to acquire the acrylates business of Celanese AG.

        Cash used in financing activities increased in the first quarter of 2004 compared with the first quarter last year. Although there were higher proceeds from sales of common stock (related to the exercise of stock options and the employee stock purchase plan) in the first quarter of 2004, cash used in the first quarter of last year was reduced by proceeds from the issuance of long-term debt.

        The following tables present working capital, total debt and certain balance sheet ratios at March 31, 2004 versus December 31, 2003:

Working Capital
In millions

  March 31,
2004

  Dec. 31,
2003

 
Current assets   $ 13,232   $ 13,002  
Current liabilities     9,547     9,534  
   
 
 
Working capital   $ 3,685   $ 3,468  
   
 
 
Current ratio     1.39:1     1.36:1  
Days-sales-outstanding-in-receivables     42     42  
Days-sales-in-inventory     55     56  
   
 
 

Total Debt
In millions


 

March 31,
2004


 

Dec. 31,
2003


 
Notes payable   $ 221   $ 258  
Long-term debt due within one year     1,084     1,088  
Long-term debt     11,799     11,763  
   
 
 
  Gross debt   $ 13,104   $ 13,109  
   
 
 
Cash and cash equivalents   $ 1,926   $ 2,392  
Marketable securities and interest-bearing deposits     47     42  
   
 
 
  Net debt   $ 11,131   $ 10,675  
   
 
 
Gross debt as a percent of total capitalization     54.7 %   55.4 %
Net debt as a percent of total capitalization     50.6 %   50.3 %
   
 
 

29


        As part of its ongoing financing activities, Dow routinely issues promissory notes under its U.S. and Euromarket commercial paper programs. At March 31, 2004, 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 $1.25 billion 364-day revolving credit facility, which matures in April 2005, and a $1.75 billion 5-year revolving credit facility, which matures in April 2009. Additional unused credit facilities totaling $916 million were available for use by foreign subsidiaries.

        At March 31, 2004, the Company had $1,955 million of SEC-registered securities available for issuance under a shelf registration, as well as Euro 2 billion (approximately $2.4 billion) available for issuance under the Company's Euro Medium Term Note Program. 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.

        The following table summarizes the Company's contractual obligations and commercial commitments at December 31, 2003. Additional information related to these obligations can be found in Notes J, K, L, M and S to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

Contractual Obligations at December 31, 2003

  Payments Due by Year
   
In millions

  2004
  2005
  2006
  2007
  2008
  2009 and
beyond

  Total
Long-term debt (1)   $ 1,088   $ 625   $ 1,434   $ 1,340   $ 612   $ 7,752   $ 12,851
Deferred income tax liabilities—noncurrent (2)                         1,124     1,124
Pension and other postretirement benefits     225     280     350     464     545     1,871     3,735
Other noncurrent obligations (3)     194     413     114     116     51     4,459     5,347
Other contractual obligations:                                          
  Minimum operating lease commitments     233     212     162     96     79     523     1,305
  Purchase commitments—take or pay and
    throughput obligations
    1,358     1,222     1,110     993     903     3,713     9,299
  Purchase commitments—other (4)     176     22     18     18     16     52     302
   
 
 
 
 
 
 
Total contractual obligations   $ 3,274   $ 2,774   $ 3,188   $ 3,027   $ 2,206   $ 19,494   $ 33,963
   
 
 
 
 
 
 

(1)
Includes "Long-term debt due within one year" of $1,088 million and capital lease obligations of $89 million.

(2)
Deferred tax liabilities may vary according to changes in tax laws, tax rates and the operating results of the Company. As a result, it is impractical to determine whether there will be a cash impact to an individual year. Therefore, all noncurrent deferred income tax liabilities have been reflected in "2009 and beyond."

(3)
Annual payments to resolve asbestos litigation will vary based on changes in defense strategies, changes in state and national law, and claims filing and resolution rates. As a result, it is impractical to determine the anticipated payments in any given year. Therefore, the noncurrent asbestos-related liability of $1,791 million has been reflected in "2009 and beyond."

(4)
Includes outstanding purchase orders and other commitments, obtained through a survey of the Company, greater than $1 million.

        In the first quarter of 2004, the Company entered into a throughput agreement for the right to use a liquefied natural gas terminal in North America. The fixed and determinable portion of the obligation requires payments of $70 million per year for 20 years beginning in 2007. Additionally in the first quarter of 2004, the Company entered into an agreement for the purchase of power in North America with required payments of $56 million in 2006, $54 million in 2007 and $35 million in 2008.

        The Company also had outstanding guarantees at March 31, 2004. Additional information related to these guarantees can be found in the "Guarantees" table provided in Note F to the Consolidated Financial Statements.

        On April 30, 2004, the Company paid a quarterly dividend of $0.335 per share to shareholders of record on March 31, 2004. Since 1912, the Company has paid a dividend every quarter and, in each instance, Dow has maintained or increased the amount of the dividend, adjusted for stock splits. During that 92-year period, Dow has increased the amount of the quarterly dividend 45 times (approximately 12 percent of the time) and maintained the amount of the quarterly dividend approximately 88 percent of the time.

30


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, 2003 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:

31


Increase (Decrease) in Market-Related Asset Value
Due to Recognition of Prior Asset Gains and Losses
In millions

   
 
2004   $ (696 )
2005     (589 )
2006     (270 )
2007     128  
   
 
Total   $ (1,427 )
   
 

32


Asbestos-Related Matters of Union Carbide Corporation

        The following disclosure should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

        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. 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.

        Influenced by the bankruptcy filings of numerous defendants in asbestos-related litigation and the prospects of various forms of state and national legislative reform, the rate at which plaintiffs filed asbestos-related suits against various companies, including Union Carbide and Amchem, increased in 2001, 2002 and the first half of 2003. The rate of filing significantly abated in the second half of 2003 and the first quarter of 2004. Union Carbide expects more asbestos-related suits to be filed against Union Carbide and Amchem in the future, and will aggressively defend or reasonably resolve, as appropriate, both pending and future claims.

33


        The table below provides information regarding asbestos-related claims filed against Union Carbide and Amchem:

 
  Three Months Ended
March 31, 2004

  Twelve Months Ended
December 31, 2003

 
Claims unresolved at beginning of period   193,891   200,882  
Claims filed   12,034   122,586  
Claims settled, dismissed or otherwise resolved   (7,688 ) (129,577 )
   
 
 
Claims unresolved at end of period   198,237   193,891  
   
 
 
Claimants with claims against both Union
    Carbide and Amchem
  68,198   66,656  
   
 
 
Individual claimants at end of period   130,039   127,235  
   
 
 

        In more than 98 percent of the cases filed against Union Carbide and Amchem, no specific amount of damages is alleged or, if an amount is alleged, it merely represents jurisdictional amounts or amounts to be proven at trial. This percentage has been increasing with more recently filed cases. Even in those situations where specific damages are alleged, the claims frequently seek the same amount of damages, irrespective of the disease or injury. Plaintiffs' lawyers often sue dozens or even hundreds of defendants in individual lawsuits on behalf of hundreds or even thousands of claimants. As a result, even when specific damages are alleged with respect to a specific disease or injury, those damages are not expressly identified as to Union Carbide, Amchem or any other particular defendant. In fact, there are no personal injury cases in which only Union Carbide and/or Amchem are the sole named defendants. For these reasons and based upon Union Carbide's litigation and settlement experience, Union Carbide does not consider the damages alleged against Union Carbide and Amchem to be a meaningful factor in its determination of any potential asbestos liability.

        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. 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. 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. 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 the following assumptions were made:

        Based on the resulting study completed by ARPC in January 2003, Union Carbide increased its December 31, 2002 asbestos-related liability for pending and future claims for the 15-year period ending in 2017 to $2.2 billion, excluding future defense and processing costs. Approximately 28 percent of the recorded liability related to pending claims and approximately 72 percent related to future claims.

        At each balance sheet date, Union Carbide compares current asbestos claim and resolution activity to the assumptions in the ARPC study to determine whether the accrual continues to be appropriate. In addition, in November 2003, Union Carbide requested ARPC to review the asbestos claim and resolution activity during 2003 and determine the appropriateness of updating its study. In its response to that request, ARPC reviewed and analyzed data through November 25, 2003 to determine the number of asbestos-related filings and costs associated with 2003 activity. In January 2004, ARPC stated that an update at that time would not provide a more likely estimate of future events than that reflected in its study of the previous year and, therefore, the estimate in that study remained applicable. Based on Union Carbide's own review of the asbestos claim and resolution activity and ARPC's response, Union Carbide determined that no change to the accrual was required at

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that time. Management noted, however, that the total number of claims filed in 2003 did exceed the number of claims assumed to be filed in the ARPC study. After consultation with outside counsel and other consultants, management believes this fact was strongly influenced by the pending national legislation and tort reform initiatives in key states. The total number of claims filed in the first quarter of 2004 also exceeded the number of claims assumed to be filed in the ARPC study. However, based on Union Carbide's review of 2004 activity, Union Carbide determined that no change to the accrual was required at March 31, 2004.

        The annual average resolution payment per asbestos claimant and the rate of new claim filings has fluctuated both up and down since the beginning of 2001. Union Carbide's management expects such fluctuations to continue in the future based upon the number and type of claims settled in a particular period, the jurisdictions in which such claims arose, and the extent to which any proposed legislative reform related to asbestos litigation is being considered.

        Union Carbide's asbestos-related liability for pending and future claims was $1.8 billion at March 31, 2004 and $1.9 billion at December 31, 2003. At March 31, 2004, approximately 34 percent of the recorded liability related to pending claims and approximately 66 percent related to future claims. At December 31, 2003, approximately 33 percent of the recorded liability related to pending claims and approximately 67 percent related to future claims.

        At December 31, 2002, Union Carbide increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion, substantially exhausting its asbestos product liability coverage. Combined with the previously mentioned increase in the asbestos-related liability at December 31, 2002, 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. 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. Union Carbide's receivable for insurance recoveries related to its asbestos liability was $957 million at March 31, 2004 and $1.0 billion at December 31, 2003.

        In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement as follows:

Receivables for Costs Submitted to Insurance Carriers

In millions

  March 31,
2004

  December 31,
2003

Receivables for defense costs   $ 93   $ 94
Receivables for resolution costs     292     255
   
 
Total   $ 385   $ 349
   
 

        The following table provides information regarding defense and resolution costs related to asbestos-related claims filed against Union Carbide and Amchem:

Defense and Resolution Costs

In millions

  Three Months Ended
March 31, 2004

  Twelve Months Ended
December 31, 2003

Defense costs for the period   $ 24   $ 110
Aggregate defense costs to date     282     258
Resolution costs for the period     59     293
Aggregate resolution costs to date     685     626
   
 

        Union Carbide's insurance policies generally provide coverage for asbestos liability costs, including coverage for both resolution and defense costs. As previously noted, Union Carbide increased its receivable for insurance recoveries related to its asbestos liability at December 31, 2002, thereby recording the full favorable income statement impact of its insurance coverage in 2002. Accordingly, defense and resolution costs recovered from insurers reduce Union Carbide's insurance receivable. Prior to increasing the insurance receivable related to the asbestos liability at December 31, 2002, the impact on Union Carbide's results of operations for defense costs was the amount of those costs not covered by insurance. Since Union Carbide expenses defense costs as incurred, defense costs for asbestos-related litigation (net of insurance) have impacted, and will continue to impact, results of operations. The pretax impact for defense and resolution costs, net of insurance, was $25 million in the first quarter of 2004 and $30 million in the first quarter of 2003, and was reflected in "Cost of sales."

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        In September 2003, Union Carbide filed a comprehensive insurance coverage case in the Circuit Court for Kanawha County in Charleston, West Virginia, seeking to confirm its rights to insurance for various asbestos claims. Although Union Carbide already has settlements in place concerning coverage for asbestos claims with many of its insurers, including those covered by the 1985 Wellington Agreement, this lawsuit was filed against insurers that are not signatories to the Wellington Agreement and/or do not otherwise have agreements in place with Union Carbide regarding their asbestos-related insurance coverage. Union Carbide continues to believe that its recorded receivable for insurance recoveries from all insurance carriers is collectible. Union Carbide reached this conclusion after a further review of its insurance policies, with due consideration given to applicable deductibles, retentions and policy limits, after taking into account the solvency and historical payment experience of various insurance carriers; existing insurance settlements; and the advice of outside counsel with respect to the applicable insurance coverage law relating to the terms and conditions of its insurance policies.

        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.

        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 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 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.

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The Dow Chemical Company and Subsidiaries
PART I, 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 2003 and 2002 are shown below:

 
  2003
  2002
Total Daily VAR at December 31*
In millions

  Year-end
  Average
  Year-end
  Average
Foreign exchange   $ 1   $ 2   $ 7   $ 10
Interest rate     109     108     94     83
Equity exposures, net of hedges     2     2     3     4
Commodities     12     14     17     11
   
 
 
 

*
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, 2003.

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The Dow Chemical Company and Subsidiaries
PART I, 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.

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The Dow Chemical Company and Subsidiaries
PART II—OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

Asbestos-Related Matters of Union Carbide Corporation

        No material developments regarding this matter occurred during the first quarter of 2004. 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 July 7, 2003, the New Hampshire Department of Environmental Services 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. On March 4, 2004, this matter was settled for a total civil penalty of $475,000, allocated as follows: $423,800 to the State of New Hampshire; $37,000 to the Nashua Regional Planning Commission to develop a Lower Merrimack River Corridor Management Plan; and $14,200 to the Nashua Fire Department for the purchase of a portable air monitoring station.

        On September 16, 2003, the Texas Commission on Environmental Quality issued a Notice of Enforcement alleging that the Company violated certain provisions of the Clean Air Act at its LaPorte, Texas, site. On February 18, 2004, the Company paid a civil penalty of $12,535 to settle this matter.


ITEM 2.    CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES

        On August 3, 1999, the Board of Directors terminated its 1997 authorization which allowed the Company to repurchase shares of Dow common stock. Since that time, the only shares purchased by the Company are those shares received from employees and non-employee directors to pay taxes owed to the Company as a result of the exercise of stock options or the delivery of stock grants. For information regarding the Company's stock option plans, see Note N to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year-ended December 31, 2003.


ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a)
Exhibits.
 
  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 first quarter of 2004:

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        The following Current Reports on Form 8-K were filed by the Company subsequent to the first quarter of 2004:

40



The Dow Chemical Company and Subsidiaries
Trademark Listing

The following trademarks or service marks of The Dow Chemical Company appear in this report:

The following trademarks or service marks of Dow AgroSciences LLC appear in this report:

The following trademark of Dow BioProducts Ltd. appears in this report: WOODSTALK

The following trademark of Dow Corning Corporation appears in this report: SYLTHERM

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

The following trademarks of Flexible Products Company appear in this report:

The following trademark of Hampshire Chemical Corp. appears in this report: HAMPOSYL

The following trademark of Mycogen Corporation appears in this report: MYCOGEN

The following trademark of PhytoGen Seed Company, LLC appears in this report: PHYTOGEN

The following trademarks or service marks of Union Carbide Corporation or its subsidiaries appear in this report:

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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: May 4, 2004

 

 

        

 

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

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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.

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QuickLinks

The Dow Chemical Company Table of Contents
The Dow Chemical Company and Subsidiaries Notes to the Consolidated Financial Statements
The Dow Chemical Company and Subsidiaries PART I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Dow Chemical Company and Subsidiaries PART I, Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Dow Chemical Company and Subsidiaries PART I, Item 4. Controls and Procedures
The Dow Chemical Company and Subsidiaries PART II—OTHER INFORMATION
The Dow Chemical Company and Subsidiaries Trademark Listing
The Dow Chemical Company and Subsidiaries Signature
The Dow Chemical Company and Subsidiaries Exhibit Index