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

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended DECEMBER 31, 2007

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)

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

Securities registered pursuant to Section 12(b) of the Act:

Title of each class   Name of each exchange on which registered

Common Stock, par value $2.50 per shares

 

Common Stock registered on the
New York and Chicago Stock Exchanges

Debentures, 6.85%, final maturity 2013

 

Debentures registered on the
New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

ý  Yes    o  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

o  Yes    ý  No

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.

ý  Yes    o  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

ý       

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

       Large accelerated filer  ý    Accelerated filer  o    Non-accelerated filer  o    Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

o  Yes    ý  No

The aggregate market value of voting stock held by non-affiliates as of June 30, 2007 (based upon the closing price of $44.22 per common share as quoted on the New York Stock Exchange), was approximately $42.0 billion. For purposes of this computation, it is assumed that the shares of voting stock held by Directors, Officers and the Dow Employees' Pension Plan Trust would be deemed to be stock held by affiliates. Non-affiliated common stock outstanding at June 30, 2007 was 949,152,650 shares.

Total common stock outstanding at January 31, 2008 was 939,605,806 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Part III: Proxy Statement for the Annual Meeting of Stockholders to be held on May 15, 2008.


The Dow Chemical Company

ANNUAL REPORT ON FORM 10-K
For the fiscal year ended December 31, 2007

TABLE OF CONTENTS

 
   
  PAGE

PART I        

Item 1.

 

Business.

 

3

Item 1A.

 

Risk Factors.

 

11

Item 1B.

 

Unresolved Staff Comments.

 

13

Item 2.

 

Properties.

 

14

Item 3.

 

Legal Proceedings.

 

15

Item 4.

 

Submission of Matters to a Vote of Security Holders.

 

18

PART II

 

 

 

 

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

21

Item 6.

 

Selected Financial Data.

 

22

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operation.

 

24

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk.

 

54

Item 8.

 

Financial Statements and Supplementary Data.

 

55

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

114

Item 9A.

 

Controls and Procedures.

 

114

Item 9B.

 

Other Information.

 

116

PART III

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance.

 

117

Item 11.

 

Executive Compensation.

 

117

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

117

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence.

 

117

Item 14.

 

Principal Accounting Fees and Services.

 

117

PART IV

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules.

 

118

SIGNATURES

 

120

2


The Dow Chemical Company and Subsidiaries
PART I, Item 1. Business.


THE COMPANY

The Dow Chemical Company was incorporated in 1947 under Delaware law and is the successor to a Michigan corporation, of the same name, organized in 1897. Except as otherwise indicated by the context, the terms "Company" or "Dow" as used herein mean The Dow Chemical Company and its consolidated subsidiaries. On February 6, 2001, the merger of Union Carbide Corporation ("Union Carbide") with a subsidiary of The Dow Chemical Company was completed, and Union Carbide became a wholly owned subsidiary of Dow.

       The Company is engaged in the manufacture and sale of chemicals, plastic materials, agricultural and other specialized products and services.

       The Company's principal executive offices are located at 2030 Dow Center, Midland, Michigan 48674, telephone 989-636-1000. Its Internet website address is www.dow.com. All of the Company's filings with the U.S. Securities and Exchange Commission are available free of charge through the Investor Relations page on this website, immediately upon filing.

BUSINESS AND PRODUCTS

Corporate Profile

Dow is a diversified chemical company that combines the power of science and technology with the "Human Element" to constantly improve what is essential to human progress. The Company delivers a broad range of products and services to customers in approximately 160 countries, connecting chemistry and innovation with the principles of sustainability to help provide everything from fresh water, food and pharmaceuticals to paints, packaging and personal care products. In 2007, Dow had annual sales of $53.5 billion and employed approximately 45,900 people worldwide. The Company has 150 manufacturing sites in 35 countries and produces approximately 3,100 products. The following descriptions of the Company's operating segments include a representative listing of products for each business.

3


4



5


6


Industry Segments and Geographic Area Results

See Note S to the Consolidated Financial Statements for disclosure of information by operating segment and geographic area.

7


Number of Products

Dow manufactures and supplies approximately 3,100 products and services. No single product accounted for more than 5 percent of the Company's consolidated net sales in 2007.

Competition

Historically, the chemical industry has operated in a competitive environment, and that environment is expected to continue. The Company experiences substantial competition in each of its operating segments and in each of the geographic areas in which it operates. In addition to other chemical companies, the chemical divisions of major international oil companies provide substantial competition in the United States and abroad. Dow competes worldwide on the basis of quality, price and customer service, and for 2007, continued to be the largest U.S. producer of chemicals and plastics, in terms of sales.

Raw Materials

The Company operates in an integrated manufacturing environment. Basic raw materials are processed through many stages to produce a number of products that are sold as finished goods at various points in those processes.

       The two major raw material streams that feed the integrated production of the Company's finished goods are chlorine-based and hydrocarbon-based raw materials.

       Salt, limestone and natural brine are the base raw materials used in the production of chlor-alkali products and derivatives. The Company owns salt deposits in Louisiana, Michigan and Texas; Alberta, Canada; Brazil; and Germany. The Company also owns natural brine deposits in Michigan and limestone deposits in Texas.

       The Company purchases hydrocarbon raw materials including liquefied petroleum gases, crude oil, naphtha, natural gas and condensate. These raw materials are used in the production of both saleable products and energy. The Company also purchases electric power, benzene, ethylene, propylene and styrene to supplement internal production. Expenditures for hydrocarbon feedstocks and energy accounted for 49 percent of the Company's production costs and operating expenses for the year ended December 31, 2007. The Company purchases these raw materials on both short- and long-term contracts.

       Other significant raw materials include acrylonitrile, aniline, bisphenol, co-monomers (for linear low density polyethylene), methanol, rubber, carbon black, ammonia, formaldehyde and toluene diamine. The Company purchases these raw materials on both short- and long-term contracts.

       The Company had adequate supplies of raw materials during 2007, and expects to continue to have adequate supplies of raw materials in 2008.

Method of Distribution

All products and services are marketed primarily through the Company's sales force, although in some instances more emphasis is placed on sales through distributors.

       Twenty-one percent of the sales of the Basic Chemicals segment in 2007 were to one customer. The Company has a supply contract with this customer on an ongoing basis. In addition, sales to MEGlobal, a 50:50 joint venture with Petrochemical Industries Company of the State of Kuwait, represented approximately 16 percent of the sales in the Basic Chemicals segment. Excess ethylene glycol produced in Dow's plants in the United States and Europe is sold to MEGlobal. Other than the sales to these customers, no significant portion of the business of any operating segment is dependent upon a single customer.

Research and Development

The Company is engaged in a continuous program of basic and applied research to develop new products and processes, to improve and refine existing products and processes, and to develop new applications for existing products. Research and development expenses were $1,305 million in 2007, $1,164 million in 2006 and $1,073 million in 2005. At December 31, 2007, the Company employed approximately 6,100 people in various research and development activities.

Patents, Licenses and Trademarks

The Company continually applies for and obtains U.S. and foreign patents. At December 31, 2007, the Company owned 2,424 active U.S. patents and 9,502 active foreign patents as follows:

8



Patents Owned at December 31, 2007
  U.S.   Foreign

Performance Plastics 1,203   5,094
Performance Chemicals 362   1,329
Agricultural Sciences 537   1,715
Basic Plastics 149   817
Basic Chemicals 64   163
Hydrocarbons and Energy 30   229
Other 79   155

Total 2,424   9,502

       Dow's primary purpose in obtaining patents is to protect the results of its research for use in operations and licensing. Dow is also party to a substantial number of patent licenses and other technology agreements. The Company had revenue related to patent and technology royalties totaling $247 million in 2007, $512 million in 2006 and $195 million in 2005. Revenue related to licensing was higher in 2006 due to lump sum licensing revenue that was earned in the first quarter of 2006. The Company incurred royalties to others of $57 million in 2007, $64 million in 2006 and $62 million in 2005. Dow also has a substantial number of trademarks and trademark registrations in the United States and in other countries, including the "Dow in Diamond" trademark. Although the Company considers that its patents, licenses and trademarks in the aggregate constitute a valuable asset, it does not regard its business as being materially dependent upon any single patent, license or trademark.

Principal Partly Owned Companies

Dow's principal nonconsolidated affiliates at December 31, 2007, including direct or indirect ownership interest for each, are listed below:

       See Note F to the Consolidated Financial Statements for additional information.

9


Financial Information About Foreign and Domestic Operations and Export Sales

In 2007, the Company derived 66 percent of its sales and had 47 percent of its property investment outside the United States. While the Company's international operations may be subject to a number of additional risks, such as changes in currency exchange rates, the Company does not regard its foreign operations, on the whole, as carrying any greater risk than its operations in the United States. Information on sales and long-lived assets by geographic area for each of the last three years appears in Note S to the Consolidated Financial Statements, and discussions of the Company's risk management program for foreign exchange and interest rate risk management appear in Item 1A. Risk Factors, Item 7A. Quantitative and Qualitative Disclosures About Market Risk, and Note H to the Consolidated Financial Statements.

Protection of the Environment

Matters pertaining to the environment are discussed in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation, and Notes A and J to the Consolidated Financial Statements.

Employees

Personnel count was 45,856 at December 31, 2007; 42,578 at December 31, 2006; and 42,413 at December 31, 2005. During 2007, headcount was impacted by the addition of research and development employees in India and China in support of the Company's growth initiatives; the addition of approximately 110 employees with the second quarter acquisition of Hyperlast Limited; and the addition of approximately 1,700 employees with the second quarter acquisition of Wolff Walsrode AG. During 2006, headcount was impacted by the addition of approximately 550 employees associated with the acquisition of Zhejiang Omex Environmental Engineering Co. LTD by FilmTec Corporation, a wholly owned subsidiary of the Company, and a reduction of approximately 260 employees due to the sale of the plastics division of Sentrachem Limited.

Other Activities

Dow engages in the property and casualty insurance and reinsurance business primarily through its Liana Limited subsidiaries.

10


The Dow Chemical Company and Subsidiaries
PART I, Item 1A. Risk Factors.


The factors described below represent the Company's principal risks. Except as otherwise indicated, these factors may or may not occur and the Company is not in a position to express a view on the likelihood of any such factor occurring. Other factors may exist that the Company does not consider to be significant based on information that is currently available or that the Company is not currently able to anticipate.

Volatility in purchased feedstock and energy costs impact Dow's operating costs and add variability to earnings.

During 2007, purchased feedstock and energy costs continued to rise, adding an additional $2.5 billion of costs compared with 2006 and accounting for 49 percent of the Company's total production costs and operating expenses in 2007, unchanged from 2006 and up from 47 percent in 2005. Purchased feedstock and energy costs are expected to remain high and volatile throughout 2008. The Company uses its feedstock flexibility and financial and physical hedging programs to lower overall feedstock costs. However, when these costs increase, the Company is not always able to immediately raise selling prices and, ultimately, its ability to pass on underlying cost increases is greatly dependent on market conditions. As a result, increases in these costs could negatively impact the Company's results of operations.

The earnings generated by the Company's basic chemical and basic plastic products will vary from period to period based in part on the balance of supply relative to demand within the industry.

The balance of supply relative to demand within the industry may be significantly impacted by the addition of new capacity. For basic commodities, capacity is generally added in large increments as world-scale facilities are built. This may disrupt industry balances and result in downward pressure on prices due to the increase in supply, which could negatively impact the Company's results of operations.

The businesses of many of Dow's customers are cyclical in nature and sensitive to changes in general economic conditions.

An economic downturn in the businesses or geographic areas in which Dow sells its products could reduce demand for these products and result in a decrease in sales volume that could have a negative impact on Dow's results of operations.

If key suppliers are unable to provide the raw materials required for production, Dow may not be able to obtain the raw materials from other sources on as favorable terms.

The Company purchases hydrocarbon raw materials including liquefied petroleum gases, crude oil, naphtha, natural gas and condensate. The Company also purchases electric power, benzene, ethylene, propylene and styrene to supplement internal production, and other raw materials. If the Company's key suppliers are unable to provide the raw materials required for production, it could have a negative impact on Dow's results of operations. For example, during 2005, the Company experienced temporary supply disruptions related to two major hurricanes on the U.S. Gulf Coast.

The Company experiences substantial competition in each of the operating segments and geographic areas in which it operates.

Historically, the chemical industry has operated in a competitive environment, and that environment is expected to continue. In addition to other chemical companies, the chemical divisions of major international oil companies provide substantial competition. Dow competes worldwide on the basis of quality, price and customer service. Increased levels of competition could result in lower prices or lower sales volume, which would have a negative impact on the Company's results of operations.

Actual or alleged violations of environmental laws or permit requirements could result in restrictions or prohibitions on plant operations, substantial civil or criminal sanctions, as well as the assessment of strict liability and/or joint and several liability.

The Company is subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, protection of the environment and the generation, storage, handling, transportation, treatment, disposal and remediation of hazardous substances and waste materials. At December 31, 2007, the Company had accrued obligations of $322 million for environmental remediation and restoration costs, including $28 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. Costs and capital expenditures relating to environmental, health or safety matters are subject to evolving regulatory requirements and will depend on the timing of the promulgation and enforcement of specific standards which impose the requirements. Moreover, changes in environmental regulations could inhibit or interrupt the Company's operations, or require modifications to its facilities. Accordingly, environmental, health or safety regulatory matters may result in significant unanticipated costs or liabilities.

11


The Company is party to a number of 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 the claims and lawsuits facing the Company purport to be class actions and seek damages in very large amounts. All such claims are being contested. With the exception of the possible effect of the asbestos-related liability of Union Carbide Corporation ("Union Carbide"), described below, it is the opinion of the Company's management that the possibility is remote that the aggregate of all such claims and lawsuits will have a material adverse impact on the Company's consolidated financial statements.

       Union Carbide is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. At December 31, 2007, Union Carbide's asbestos-related liability for pending and future claims was $1.1 billion and its receivable for insurance recoveries related to its asbestos liability was $467 million. At December 31, 2007, Union Carbide also had receivables of $271 million for insurance recoveries for defense and resolution costs. It is the opinion of the Company'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.

Local, state and federal governments have begun a regulatory process that could lead to new regulations impacting the security of chemical plant locations and the transportation of hazardous chemicals.

Growing public and political attention has been placed on protecting critical infrastructure, including the chemical industry, from security threats. Terrorist attacks and natural disasters have increased concern regarding the security of chemical production and distribution. In addition, local, state and federal governments have begun a regulatory process that could lead to new regulations impacting the security of chemical plant locations and the transportation of hazardous chemicals, which could result in higher operating costs and interruptions in normal business operations.

Failure to develop new products could make the Company less competitive.

The Company is engaged in a continuous program of basic and applied research to develop new products and processes, to improve and refine existing products and processes, and to develop new applications for existing products. Failure to develop new products could make the Company less competitive.

Failure to protect the Company's intellectual property could negatively affect its future performance and growth.

The Company continually applies for and obtains U.S. and foreign patents to protect the results of its research for use in operations and licensing. Dow is also party to a substantial number of patent licenses and other technology agreements. The Company relies on patents, confidentiality agreements and internal security measures to protect its intellectual property. Failure to protect this intellectual property could negatively affect the Company's future performance and growth.

Weather-related matters could impact the Company's results of operations.

In 2005, two major hurricanes caused significant disruption in Dow's operations on the U.S. Gulf Coast, logistics across the region and the supply of certain raw materials, which had an adverse impact on volume and cost for some of Dow's products. If similar weather-related matters occur in the future, it could negatively affect Dow's results of operations, due to the Company's substantial presence on the U.S. Gulf Coast.

The Company's global business operations give rise to market risk exposure.

The Company's global business operations give rise to market risk exposure related to changes in foreign exchange rates, interest rates, commodity prices and other market factors such as equity prices. To manage such risks, Dow enters into hedging transactions, pursuant to established guidelines and policies. If Dow fails to effectively manage such risks, it could have a negative impact on the Company's consolidated financial statements.

12


The Dow Chemical Company and Subsidiaries
PART I, Item 1B. Unresolved Staff Comments.


UNRESOLVED STAFF COMMENTS

None.

13


The Dow Chemical Company and Subsidiaries
PART I, Item 2. Properties.


PROPERTIES

The Company operates 150 manufacturing sites in 35 countries. Properties of Dow include facilities which, in the opinion of management, are suitable and adequate for the manufacture and distribution of Dow's products. During 2007, the Company's chemicals and plastics production facilities and plants operated at approximately 87 percent of capacity. The Company's major production sites are as follows:

United States:   Plaquemine, Louisiana; Hahnville, Louisiana; Midland, Michigan; Freeport, Texas; Seadrift, Texas; Texas City, Texas; South Charleston, West Virginia.
Canada:   Fort Saskatchewan, Alberta; Prentiss, Alberta.
Germany:   Boehlen; Leuna; Rheinmuenster; Schkopau; Stade.
France:   Drusenheim.
The Netherlands:   Terneuzen.
Spain:   Tarragona.
Argentina:   Bahia Blanca.
Brazil:   Aratu.

    Including the major production sites, the Company has plants and holdings in the following geographic areas:

United States:

 

42 manufacturing locations in 16 states.
Canada:     6 manufacturing locations in 3 provinces.
Europe:   49 manufacturing locations in 16 countries.
Latin America:   26 manufacturing locations in 5 countries.
Asia Pacific:   22 manufacturing locations in 8 countries.
India, Middle East and Africa:     5 manufacturing locations in 4 countries.

       All of Dow's plants are owned or leased, subject to certain easements of other persons which, in the opinion of management, do not substantially interfere with the continued use of such properties or materially affect their value. Dow leases ethylene plants in Fort Saskatchewan, Alberta, Canada, and Terneuzen, The Netherlands.

       A summary of properties, classified by type, is provided in Note E to the Consolidated Financial Statements. Additional information regarding leased properties can be found in Note M to the Consolidated Financial Statements.

14


The Dow Chemical Company and Subsidiaries
PART I, Item 3. Legal Proceedings.


LEGAL PROCEEDINGS

Asbestos-Related Matters of Union Carbide Corporation

Introduction

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. Since then, the rate of filing has significantly abated. 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.

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


 
    2007   2006   2005  

 
Claims unresolved at January 1   111,887   146,325   203,416  
Claims filed   10,157   16,386   34,394  
Claims settled, dismissed or otherwise resolved   (31,722 ) (50,824 ) (91,485 )

 
Claims unresolved at December 31   90,322   111,887   146,325  
Claimants with claims against both UCC and Amchem   28,937   38,529   48,647  

 
Individual claimants at December 31   61,385   73,358   97,678  

 

       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, the damages alleged are not expressly identified as to Union Carbide, Amchem or any other particular defendant, even when specific damages are alleged with respect to a specific disease or injury. 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.

Estimating the Liability

Based on a study completed by Analysis, Research & Planning Corporation ("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. Since then, Union Carbide has compared current asbestos claim and resolution activity to the results of the most recent ARPC study at each balance sheet date to determine whether the accrual continues to be appropriate. In addition, Union Carbide has requested ARPC to review Union Carbide's historical asbestos claim and resolution activity each November since 2004 to determine the appropriateness of updating the most recent ARPC study.

       In November 2006, Union Carbide requested ARPC to review Union Carbide's historical asbestos claim and resolution activity and determine the appropriateness of updating its most recent study from January 2005. In response to that request, ARPC reviewed and analyzed data through October 31, 2006 and concluded that the experience from 2004 through 2006 was sufficient for the purpose of forecasting future filings and values of asbestos claims filed against Union Carbide and Amchem, and could be used in place of previous assumptions to update the January study. The resulting study, completed by ARPC in December 2006, stated that the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, through 2021 was estimated to be between approximately $1.2 billion and $1.5 billion. As in its January 2003 and January 2005 studies, ARPC provided estimates for a longer period of time in its December 2006 study, but also reaffirmed its prior advice that forecasts for shorter periods of time are more accurate than those for longer periods of time.

15


       Based on ARPC's December 2006 study and Union Carbide's own review of the asbestos claim and resolution activity, Union Carbide decreased its asbestos-related liability for pending and future claims to $1.2 billion at December 31, 2006 which covered the 15-year period ending in 2021 (excluding future defense and processing costs). The reduction was $177 million and was shown as "Asbestos-related credit" in the consolidated statements of income.

       In November 2007, Union Carbide requested ARPC to review Union Carbide's 2007 asbestos claim and resolution activity and determine the appropriateness of updating its December 2006 study. In response to that request, ARPC reviewed and analyzed data through October 31, 2007. In December 2007, ARPC stated that an update of its study would not provide a more likely estimate of future events than the estimate 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 December 31, 2007, Union Carbide's asbestos-related liability for pending and future claims was $1.1 billion.

       At December 31, 2007, approximately 31 percent of the recorded liability related to pending claims and approximately 69 percent related to future claims. At December 31, 2006, approximately 25 percent of the recorded liability related to pending claims and approximately 75 percent related to future claims.

Defense and Resolution Costs

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   Aggregate Costs

In millions
 
2007
 
2006
 
2005
  to Date as of Dec. 31, 2007

 
Defense costs   $84   $62   $75   $565
Resolution costs   $88   $117   $139   $1,270

       The 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 a number of factors, including 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 expenses defense costs as incurred. The pretax impact for defense and resolution costs, net of insurance, was $84 million in 2007, $45 million in 2006 and $75 million in 2005, and was reflected in "Cost of sales."

Insurance Receivables

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. 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. The Wellington Agreement and other agreements with insurers are designed to facilitate an orderly resolution and collection of Union Carbide's insurance policies and to resolve issues that the insurance carriers may raise.

       In September 2003, Union Carbide filed a comprehensive insurance coverage case, now proceeding in the Supreme Court of the State of New York, County of New York, seeking to confirm its rights to insurance for various asbestos claims and to facilitate an orderly and timely collection of insurance proceeds. 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, in order to facilitate an orderly resolution and collection of such insurance policies and to resolve issues that the insurance carriers may raise. Although the lawsuit is continuing, through the end of 2007, Union Carbide has reached settlements with several of the carriers involved in this litigation.

       Union Carbide's receivable for insurance recoveries related to its asbestos liability was $467 million at December 31, 2007 and $495 million at December 31, 2006. At December 31, 2007 and December 31, 2006, all of the receivable for insurance recoveries was related to insurers that are not signatories to the Wellington Agreement and/or do not otherwise have agreements in place regarding their asbestos-related insurance coverage.

       In addition to the receivable for insurance recoveries related to its asbestos liability, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement as follows:

16



Receivables for Costs Submitted to Insurance Carriers
at December 31
In millions     2007     2006

Receivables for defense costs   $ 18   $ 34
Receivables for resolution costs     253     266

Total   $ 271   $ 300

       After a 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, Union Carbide continues to believe that its recorded receivable for insurance recoveries from all insurance carriers is probable of collection.

Summary

The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon current, known facts. However, future events, such as the number of new claims to be filed and/or received 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.

Environmental Matters

The Company and the Texas Commission on Environmental Quality (the "TCEQ") are in the process of combining 12 Notices of Enforcement ("NOEs") issued by the TCEQ in relation to the Company's Freeport, Texas, site into a single enforcement matter for resolution. Nine of the 12 initial penalty assessments associated with the NOEs were received by the Company in the second quarter of 2006. The 12 NOEs primarily relate to alleged fugitive air emissions, air emission events and environmental recordkeeping violations; and seek a combined civil penalty of $858,738. The TCEQ Staff and the Company have tentatively agreed to settle these and several additional, similar matters for a combined civil penalty of $648,904, half of which will be paid to the TCEQ, with the balance to be used to purchase low emission school buses for use near the Company's Freeport, Texas site. This settlement remains subject to final approval by the TCEQ Commissioners.

       On October 1, 2007, the Company received a separate NOE from the TCEQ related to alleged air emission events at the Company's Freeport, Texas site. The NOE seeks a total civil penalty of $354,000. While the Company expects that the penalty will ultimately be reduced, resolution of the NOE may result in a civil penalty in excess of $100,000.

17


The Dow Chemical Company and Subsidiaries
PART I, Item 4. Submission of Matters to a Vote of Security Holders.


SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of 2007.

EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below is information related to the Company's executive officers as of January 31, 2008.

WILLIAM F. BANHOLZER, 51. DOW CORPORATE VICE PRESIDENT AND CHIEF TECHNOLOGY OFFICER. Employee of Dow since 2005. General Electric Company, Chemical Engineer 1983-1989. Laboratory Manager and Leader R&D Center 1989-1992. Engineering Manager of Superabrasives Business 1992-1997. Vice President of Global Engineering, GE Lighting 1997-1999. Vice President of Global Technology, GE Advanced Materials 1999-2005. Dow Corporate Vice President and Chief Technology Officer 2005 to date. Director of Dow Corning Corporation* and Mycogen Corporation*. Member of Dow Corning Corporation Corporate Responsibility Committee. Elected to the U.S. National Academy of Engineering in 2002. Elected NAE Councilor 2005. Member of American Chemical Society and American Institute of Chemical Engineers. Advisory Board member for chemistry and chemical engineering at University of Illinois and University of California, Berkeley.

JULIE FASONE HOLDER, 55. DOW CORPORATE VICE PRESIDENT, CHIEF MARKETING & SALES AND REPUTATION OFFICER. Employee of Dow since 1975. Marketing Manager, Polyurethanes Business 1981-1984. District Sales Manager, Dow Latex 1984-1989. Group Marketing Manager for Formulation Products 1989-1994. Group Marketing Manager & Global Business Director, Performance Chemicals 1994-1997. Director of Sales and Marketing, Performance Chemicals 1997-2000. Business Vice President of Industrial Chemicals 2000-2004. Business Vice President, Specialty Plastics and Elastomers 2004-2005. Corporate Vice President, Human Resources, Diversity & Inclusion and Public Affairs 2005-2007. Dow Corporate Vice President, Chief Marketing & Sales and Reputation Officer January 2008 to date. Recipient of Dow Genesis Award in 1999 and The National Association for Female Executives Woman of Achievement Award in 2007. Director of Wolverine Bank and The Dow Chemical Company Foundation.

GREGORY M. FREIWALD, 54. DOW CORPORATE VICE PRESIDENT, HUMAN RESOURCES, CORPORATE AFFAIRS AND AVIATION. Employee of Dow since 1979. Human Resources Manager, Chemical & Performance Business-U.S. Region 1992-1993. Human Resources Director for Executive, Finance, Law and Corporate 1993-1994. Latin America Human Resources and Quality Performance Director 1994-1996. Latin America Human Resources Leader and PBBPolisur Human Resources Integration Leader 1996-1997. Global Human Resources, Resources Center Director 1997-2001. Senior Human Resources Director for Global Human Resources, Resource Center and Human Resources Director for Geographic Council 2001-2004. Human Resources Vice President, Operations 2004-2005. Human Resources Vice President 2005-2006. Vice President, Corporate Affairs, Aviation and Executive Compensation 2006-2007. Corporate Vice President, Human Resources, Corporate Affairs and Aviation January 2008 to date.

MICHAEL R. GAMBRELL, 54. DOW EXECUTIVE VICE PRESIDENT, BASIC PLASTICS AND CHEMICALS, AND MANUFACTURING AND ENGINEERING. Employee of Dow since 1976. Business Director for the North America Chlor- Alkali Assets Business 1989-1992. General Manager for the Plastic Lined Pipe Business 1992-1994. Vice President of Operations for Latin America 1994-1996. Corporate Director, Technology Centers and Global Process Engineering 1996-1998. Global Business Director of the Chlor-Alkali Assets Business 1998-2000. Business Vice President for EDC/VCM & ECU Management 2000-2003. Business Vice President for the Chlor-Vinyl Business 2003. Senior Vice President, Chemicals and Intermediates 2003-2005. Executive Vice President, Basic Plastics and Chemicals Portfolio 2005-2007. Executive Vice President, Basic Plastics and Chemicals, and Manufacturing and Engineering March 2007 to date. Board member of Oman Petrochemical Industries Company LLC*. Director of the National Association of Manufacturers. Board member and past chairman of World Chlorine Council. Member of U.S.-India Business Council. Recipient of the President's Distinguished Alumnus Award from Rose-Hulman Institute of Technology 1996.

18


HEINZ HALLER, 52. DOW EXECUTIVE VICE PRESIDENT, PERFORMANCE PLASTICS AND CHEMICALS. Employee of Dow 1980-1994 and since 2006. Dow sales representative, Emulsion Polymers, Specialty Chemicals and Chlorinated Solvents 1980-1994. Managing Director, Plüss-Staufer Ag 1994-1999. Chief Executive Officer, Red Bull Sauber AG and Sauber Petronas Engineering AG 2000-2002. Managing Director, Allianz Capital Partners GmbH 2002-2006. Dow Corporate Vice President, Strategic Development and New Ventures 2006-2007. Dow Executive Vice President May 2007 to date. Director of Mycogen Corporation* and Dow Corning Corporation*. Member of the Dow AgroSciences LLC* Members Committee. Director of the Michigan Molecular Institute.

CHARLES J. KALIL, 56. DOW SENIOR VICE PRESIDENT, GENERAL COUNSEL AND CORPORATE SECRETARY. Employee of Dow since 1980. U.S. Department of Justice – Assistant U.S. Attorney, Eastern District of Michigan 1977-1980. General Counsel of Petrokemya (a former 50:50 joint venture of the Company) 1982-1983. Regional Counsel to Middle East/Africa 1983-1986. Senior Environmental Attorney 1986-1987. Litigation Staff Counsel and Group Leader 1987-1990. Senior Financial Law Counsel, Mergers and Acquisitions 1990-1992. General Counsel and Area Director of Government and Public Affairs for Dow Latin America 1992-1997. Special Counsel and Manager of INSITE™ legal issues 1997-2000. Assistant General Counsel for Corporate and Financial Law 2000-2003. Associate General Counsel for Corporate Legal Affairs 2003-2004. Dow Corporate Vice President and General Counsel November 2004-2007. Dow Senior Vice President and General Counsel March 2007 to date. Corporate Secretary 2005 to date. Board member of Dow Corning Corporation*, Dorinco Reinsurance Company*, Liana Limited* and Oman Petrochemical Industries Company LLC*. Member of the Conference Board's Council of Chief Legal Officers. Member of the American Bar Association, District of Columbia Bar and the State Bar of Michigan.

DAVID E. KEPLER, 55. DOW SENIOR VICE PRESIDENT, CHIEF SUSTAINABILITY OFFICER, CHIEF INFORMATION OFFICER AND CORPORATE DIRECTOR OF SHARED SERVICES. Employee of Dow since 1975. Computer Services Manager of Dow U.S.A. Eastern Division 1984-1988. Commercial Director of Dow Canada Performance Products 1989-1991. Director of Pacific Area Information Systems 1991-1993. Manager of Information Technology for Chemicals and Plastics 1993-1994. Director of Global Information Systems Services 1994-1995. Director of Global Information Application 1995-1998. Vice President 1998-2000. Chief Information Officer 1998 to date. Corporate Vice President with responsibility for eBusiness 2000 to date. Responsibility for Advanced Electronic Materials 2002-2003. Responsibility for Shared Services – Customer Service, Information Systems, Purchasing, Six Sigma, Supply Chain, and Work Process Improvement 2004 to date. Senior Vice President with responsibility for EH&S 2006 to date. Responsibility as Chief Sustainability Officer May 2007 to date. Director of Dorinco Reinsurance Company* and Liana Limited*. Director of Teradata Corporation. Member of U.S. Chamber of Commerce Board of Directors and Vice Chairman of the Great Lakes Region. Member of the American Chemical Society and the American Institute of Chemical Engineers. Chairman of the Chemical IT Council and Cyber Security Program.

ANDREW N. LIVERIS, 53. DOW PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN. DIRECTOR SINCE 2004. Employee of Dow since 1976. General manager of Dow's Thailand operations 1989-1992. Group business director for Emulsion Polymers and New Ventures 1992-1993. General manager of Dow's start-up businesses in Environmental Services 1993-1994. Vice President of Dow's start-up businesses in Environmental Services 1994-1995. President of Dow Chemical Pacific Limited* 1995-1998. Vice President of Specialty Chemicals 1998-2000. Business Group President for Performance Chemicals 2000-2003. President and Chief Operating Officer 2003-2004. President and Chief Executive Officer 2004 to date and Chairman 2006 to date. Director of Citigroup, Inc. and the United States Climate Action Partnership. Chairman Emeritus of the Board of the American Chemistry Council. Chairman of the Board of the International Council of Chemical Associations. Member of the American Australian Association, The Business Council, the Business Roundtable, the Detroit Economic Club, the New York Economic Club, the International Business Council, the National Petroleum Council, the Société de Chimie Industrielle, the U.S.-China Business Council and the World Business Council for Sustainable Development. Member of the Board of Trustees of Tufts University and the Herbert H. and Grace A. Dow Foundation.

19


GEOFFERY E. MERSZEI, 56. DOW EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER. DIRECTOR SINCE 2005. Employee of Dow 1977-2001 and since 2005. Dow Middle East/Africa Credit Manager 1977-1980. Dow Asia Pacific Credit Manager 1980-1982. Dow Asia Pacific Finance and Credit Manager 1982-1983. Dow Germany and Eastern Europe Treasurer 1983-1986. Dow Foreign Exchange Manager 1986-1988. Director of Finance for Dow Asia Pacific 1988-1991. Director of Finance/Treasurer for Dow Europe 1991-1996. Dow Vice President and Treasurer 1996-2001. Alcan, Inc., Executive Vice President and Chief Financial Officer 2001-2005. Dow Executive Vice President and Chief Financial Officer 2005 to date. Board member of Dow Corning Corporation*, Dow Credit Corporation*, Dow Financial Services Inc.*, Mycogen Corporation*, and Oman Petrochemical Industries Company LLC*. Chairman of Dorinco Reinsurance Company*, Dow International Holdings, S.A.* and Liana Limited*. Board member of Chemical Financial Corporation. Chairman of the Conference Board's Council of Financial Executives. Trustee and Executive Committee Member of the United States Council for International Business.

FERNANDO RUIZ, 52. DOW CORPORATE VICE PRESIDENT AND TREASURER. Employee of Dow since 1980. Treasurer, Ecuador Region 1982-1984. Treasurer, Mexico Region 1984-1988. Financial Operations Manager, Corporate Treasury 1988-1991. Assistant Treasurer, USA Area 1991-1992. Senior Finance Manager, Corporate Treasury 1992-1996. Assistant Treasurer 1996-2001. Corporate Director of Insurance and Risk Management 2001. Corporate Vice President and Treasurer 2001 to date. President and Chief Executive Officer, Liana Limited* and Dorinco Reinsurance Company* 2001 to date. President of Dow Credit Corporation* 2001 to date. Director of Dow Financial Services Inc.* Member of Financial Executives International and Michigan State University (Eli Broad College of Business) Advisory Board. Member of DeVry, Inc. Board of Directors.

WILLIAM H. WEIDEMAN, 53. DOW VICE PRESIDENT AND CONTROLLER. Employee of Dow since 1976. Controller of Texas Operations 1994-1996. Global Business Controller for Specialty Chemicals 1996-1998. Global Finance Director for Specialty Chemicals 1998-2000. Global Finance Director for Performance Chemicals 2000-2004. Finance Vice President, Chemicals and Intermediates and Dow Ventures 2004-2006. Group Finance Vice President for Basic Chemicals and Plastics Portfolio 2006. Vice President and Controller 2006 to date. Director of Diamond Capital Management, Inc.*, Dorinco Reinsurance Company* and Liana Limited*. Director of the Dow Chemical Employees' Credit Union and Family and Children's Services of Midland. Board and finance committee member of Mid Michigan Medical Center. Member of Financial Executives International Committee on Corporate Reporting, Member of Central Michigan University Accounting Advisory Committee and Central Michigan University Development Board.

* A number of Company entities are referenced in the biographies and are defined as follows. Some of these entities have had various names over the years. The names and relationships to the Company, unless otherwise indicated, are stated in this footnote as they existed as of January 31, 2008. Dow Corning Corporation and Oman Petrochemical Industries Company LLC – companies ultimately 50 percent owned by Dow. Diamond Capital Management, Inc.; Dorinco Reinsurance Company; Dow AgroSciences LLC; Dow Chemical Pacific Limited; Dow Credit Corporation; Dow Financial Services Inc.; Dow International Holdings, S.A.; Liana Limited; and Mycogen Corporation – all ultimately wholly owned subsidiaries of Dow. Ownership by Dow described above may be either direct or indirect.

20


The Dow Chemical Company and Subsidiaries
PART II, Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities.


MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The principal market for the Company's common stock is the New York Stock Exchange.

       Quarterly market and dividend information can be found in Quarterly Statistics at the end of Part II, Item 8. Financial Statements and Supplementary Data, following the Notes to the Consolidated Financial Statements.

       At December 31, 2007, there were 98,699 registered common stockholders. The Company estimates that there were an additional 615,000 stockholders whose shares were held in nominee names at December 31, 2007. At January 31, 2008, there were 99,096 registered common stockholders.

       On February 14, 2008, the Board of Directors announced a quarterly dividend of $0.42 per share, payable April 30, 2008, to stockholders of record on March 31, 2008. Since 1912, the Company has paid a cash dividend every quarter and, in each instance, Dow has maintained or increased the amount of the dividend, adjusted for stock splits. During that 95-year period, Dow has increased the amount of the quarterly dividend 47 times (approximately 12 percent of the time) and maintained the amount of the quarterly dividend approximately 88 percent of the time. The Company declared dividends of $1.635 per share in 2007, $1.50 per share in 2006 and $1.34 per share in 2005.

       See Part III, Item 11. Executive Compensation for information relating to the Company's equity compensation plans.

       The following table provides information regarding purchases of the Company's common stock by the Company during the three months ended December 31, 2007:


Issuer Purchases of Equity Securities   Approximate dollar value
Period   Total number of shares purchased (1)   Average price paid per share   Total number of shares purchased as part of the Company's publicly announced share repurchase program (2)   of shares that may yet be purchased under the Company's publicly announced share repurchase program (2)

October 2007   510,505   $44.86   449,500   $1,132,017,073
November 2007   4,295,600   $41.79   4,295,600   952,483,295
December 2007   2,425,752   $41.20   2,425,600   852,540,131

Fourth quarter 2007   7,231,857   $41.81   7,170,700   $852,540,131

(1)
Includes 61,157 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 deferred stock. For information regarding the Company's stock option plans, see Note N to the Consolidated Financial Statements.
(2)
On October 26, 2006, the Company announced that the Board of Directors had approved a new share buy-back program, authorizing up to $2 billion to be spent on the repurchase of the Company's common stock. Purchases under this program began in March 2007, following the completion of the Company's previous repurchase program.

21


The Dow Chemical Company and Subsidiaries
PART II, Item 6. Selected Financial Data

In millions, except as noted        (Unaudited)     2007     2006     2005     2004     2003  

 
Summary of Operations                                
  Net sales (1)   $ 53,513   $ 49,124   $ 46,307   $ 40,161   $ 32,632  
  Cost of sales (1)     46,400     41,526     38,276     34,244     28,177  
  Research and development expenses     1,305     1,164     1,073     1,022     981  
  Selling, general and administrative expenses     1,864     1,663     1,545     1,436     1,392  
  Amortization of intangibles     72     50     55     81     63  
  Purchased in-process research and development charges     57                  
  Special charges, merger-related expenses, and restructuring     578     591     114     543      
  Asbestos-related charge (credit)         (177 )            
  Other income     1,446     1,096     1,719     1,622     468  
  Interest expense – net     454     431     564     661     736  

 
  Income (Loss) before income taxes and minority interests     4,229     4,972     6,399     3,796     1,751  
  Provision (Credit) for income taxes     1,244     1,155     1,782     877     (82 )
  Minority interests' share in income     98     93     82     122     94  
  Preferred stock dividends                      

 
  Income (Loss) before cumulative effect of changes in accounting principles     2,887     3,724     4,535     2,797     1,739  
  Cumulative effect of changes in accounting principles             (20 )       (9 )

 
  Net income (loss) available for common stockholders   $ 2,887   $ 3,724   $ 4,515   $ 2,797   $ 1,730  

 
  Per share of common stock (in dollars): (2)                                
    Earnings (Loss) before cumulative effect of changes in accounting principles per common share – basic   $ 3.03   $ 3.87   $ 4.71   $ 2.98   $ 1.89  
    Earnings (Loss) per common share – basic     3.03     3.87     4.69     2.98     1.88  
    Earnings (Loss) before cumulative effect of changes in accounting principles per common share – diluted     2.99     3.82     4.64     2.93     1.88  
    Earnings (Loss) per common share – diluted     2.99     3.82     4.62     2.93     1.87  
    Cash dividends declared per share of common stock     1.635     1.50     1.34     1.34     1.34  
    Cash dividends paid per share of common stock     1.59     1.46     1.34     1.34     1.34  
    Book value per share of common stock     20.62     17.81     15.84     12.88     9.89  
  Weighted-average common shares outstanding – basic (2)     953.1     962.3     963.2     940.1     918.8  
  Weighted-average common shares outstanding – diluted (2)     965.6     974.4     976.8     953.8     926.1  
  Convertible preferred shares outstanding                      

 
Year-end Financial Position                                
  Total assets   $ 48,801   $ 45,581   $ 45,934   $ 45,885   $ 41,891  
  Working capital     6,209     6,608     6,741     5,384     3,578  
  Property – gross     47,708     44,381     41,934     41,898     40,812  
  Property – net     14,388     13,722     13,537     13,828     14,217  
  Long-term debt and redeemable preferred stock     7,581     8,036     9,186     11,629     11,763  
  Total debt     9,715     9,546     10,706     12,594     13,109  
  Net stockholders' equity     19,389     17,065     15,324     12,270     9,175  

 
Financial Ratios                                
  Research and development expenses as percent of net sales (1)     2.4%     2.4%     2.3%     2.5%     3.0%  
  Income (Loss) before income taxes and minority interests as percent of net
sales (1)
    7.9%     10.1%     13.8%     9.5%     5.4%  
  Return on stockholders' equity (3)     14.9%     21.8%     29.5%     22.8%     18.9%  
  Debt as a percent of total capitalization     31.8%     34.1%     39.1%     47.9%     55.4%  

 
General                                
  Capital expenditures   $ 2,075   $ 1,775   $ 1,597   $ 1,333   $ 1,100  
  Depreciation     1,959     1,904     1,904     1,904     1,753  
  Salaries and wages paid     4,404     3,935     4,309     3,993     3,608  
  Cost of employee benefits     1,130     1,125     988     885     783  
  Number of employees at year-end (thousands)     45.9     42.6     42.4     43.2     46.4  
  Number of Dow stockholders of record at year-end (thousands) (4)     98.7     103.1     105.6     108.3     113.1  

 
(1) Adjusted for reclassification of freight on sales in 2000 and   (4) Stockholders of record as reported by the transfer agent. The
  reclassification of insurance operations in 2002.     Company estimates that there were an additional 615,000
(2) Adjusted for 3-for-1 stock split in 2000.     stockholders whose shares were held in nominee names at
(3) Included Temporary Equity in 1997-1999.     December 31, 2007.

22


In millions, except as noted        (Unaudited)     2002     2001     2000     1999     1998     1997  

 
Summary of Operations                                      
  Net sales (1)   $ 27,609   $ 28,075   $ 29,798   $ 26,131   $ 25,396   $ 27,814  
  Cost of sales (1)     23,780     23,892     24,310     20,422     19,566     20,961  
  Research and development expenses     1,066     1,072     1,119     1,075     1,026     990  
  Selling, general and administrative expenses     1,598     1,765     1,825     1,776     1,964     2,168  
  Amortization of intangibles     65     178     139     160     106     80  
  Purchased in-process research and development charges         69     6     6     349      
  Special charges, merger-related expenses, and restructuring     280     1,487         94     458      
  Asbestos-related charge (credit)     828                      
  Other income     94     423     706     424     1,166     657  
  Interest expense – net     708     648     519     432     458     355  

 
  Income (Loss) before income taxes and minority interests     (622 )   (613 )   2,586     2,590     2,635     3,917  
  Provision (Credit) for income taxes     (280 )   (228 )   839     874     902     1,320  
  Minority interests' share in income     63     32     72     74     20     113  
  Preferred stock dividends                 5     6     13  

 
  Income (Loss) before cumulative effect of changes in accounting principles     (405 )   (417 )   1,675     1,637     1,707     2,471  
  Cumulative effect of changes in accounting principles     67     32         (20 )       (17 )

 
  Net income (loss) available for common stockholders   $ (338 ) $ (385 ) $ 1,675   $ 1,617   $ 1,707   $ 2,454  

 
  Per share of common stock (in dollars): (2)                                      
    Earnings (Loss) before cumulative effect of changes in accounting principles per common share – basic   $ (0.44 ) $ (0.46 ) $ 1.88   $ 1.87   $ 1.92   $ 2.72  
    Earnings (Loss) per common share – basic     (0.37 )   (0.43 )   1.88     1.85     1.92     2.71  
    Earnings (Loss) before cumulative effect of changes in accounting principles per common share – diluted     (0.44 )   (0.46 )   1.85     1.84     1.89     2.63  
    Earnings (Loss) per common share – diluted     (0.37 )   (0.43 )   1.85     1.82     1.89     2.61  
    Cash dividends declared per share of common stock     1.34     1.295     1.16     1.16     1.16     1.12  
    Cash dividends paid per share of common stock     1.34     1.25     1.16     1.16     1.16     1.08  
    Book value per share of common stock     8.36     11.04     13.22     12.40     11.34     11.17  
  Weighted-average common shares outstanding – basic (2)     910.5     901.8     893.2     874.9     888.1     898.4  
  Weighted-average common shares outstanding – diluted (2)     910.5     901.8     904.5     893.5     904.8     936.2  
  Convertible preferred shares outstanding                 1.3     1.4     1.4  

 
Year-end Financial Position                                      
  Total assets   $ 39,562   $ 35,515   $ 35,991   $ 33,456   $ 31,121   $ 31,004  
  Working capital     2,519     2,183     1,150     2,848     1,570     1,925  
  Property – gross     37,934     35,890     34,852     33,333     32,844     31,052  
  Property – net     13,797     13,579     13,711     13,011     12,628     11,832  
  Long-term debt and redeemable preferred stock     11,659     9,266     6,613     6,941     5,890     5,703  
  Total debt     13,036     10,883     9,450     8,708     8,099     8,145  
  Net stockholders' equity     7,626     9,993     11,840     10,940     9,878     9,974  

 
Financial Ratios                                      
  Research and development expenses as percent of net sales (1)     3.9 %     3.8 %     3.8%     4.1%     4.0%     3.6%  
  Income (Loss) before income taxes and minority interests as percent of net
sales (1)
    (2.3)%     (2.2)%     8.7%     9.9%     10.4%     14.1%  
  Return on stockholders' equity (3)     (4.4)%     (3.9)%     14.1%     14.7%     17.2%     24.5%  
  Debt as a percent of total capitalization     59.2 %     48.9 %     42.5%     42.2%     43.6%     43.1%  

 
General                                      
  Capital expenditures   $ 1,623   $ 1,587   $ 1,808   $ 2,176   $ 2,328   $ 1,953  
  Depreciation     1,680     1,595     1,554     1,516     1,559     1,529  
  Salaries and wages paid     3,202     3,215     3,395     3,536     3,579     3,640  
  Cost of employee benefits     611     540     486     653     798     839  
  Number of employees at year-end (thousands)     50.0     52.7     53.3     51.0     50.7     55.9  
  Number of Dow stockholders of record at year-end (thousands) (4)     122.5     125.1     87.9     87.7     93.0     97.2  

 
(1) Adjusted for reclassification of freight on sales in 2000 and   (4) Stockholders of record as reported by the transfer agent. The
  reclassification of insurance operations in 2002.     Company estimates that there were an additional 615,000
(2) Adjusted for 3-for-1 stock split in 2000.     stockholders whose shares were held in nominee names at
(3) Included Temporary Equity in 1997-1999.     December 31, 2007.

23


The Dow Chemical Company and Subsidiaries
PART II, Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation.


Management's Discussion and Analysis of Financial Condition and Results of Operation Page
  2007 Overview 25
  Results of Operation 26
  Segment Results 31
    Performance Plastics 31
    Performance Chemicals 34
    Agricultural Sciences 35
    Basic Plastics 36
    Basic Chemicals 37
    Hydrocarbons and Energy 38
    Sales Price and Volume Chart (Percent change from prior year) 40
  Liquidity and Capital Resources 40
    Cash Flow 40
    Working Capital 41
    Debt 42
    Capital Expenditures 42
    Contractual Obligations 43
    Off-Balance Sheet Arrangements 44
    Dividends 44
  Critical Accounting Policies 45
  Environmental Matters 48
  Asbestos-Related Matters of Union Carbide Corporation 51

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.

ABOUT DOW

Dow is a diversified chemical company that combines the power of science and technology with the "Human Element" to constantly improve what is essential to human progress. The Company offers a broad range of products and services, connecting chemistry and innovation with the principles of sustainability to help provide everything from fresh water, food, and pharmaceuticals to paints, packaging and personal care products. Dow is the largest U.S. producer of chemicals and plastics, in terms of sales, with total sales of $53.5 billion in 2007. The Company conducts its worldwide operations through global businesses, which are reported in six operating segments: Performance Plastics, Performance Chemicals, Agricultural Sciences, Basic Plastics, Basic Chemicals, and Hydrocarbons and Energy.

       In 2007, the Company sold its approximately 3,100 products and its services to customers in approximately 160 countries throughout the world. Thirty-eight percent of the Company's sales were to customers in North America; 37 percent were in Europe; while the remaining 25 percent were to customers in Asia Pacific and Latin America. The Company employs approximately 45,900 people and has a broad, global reach with 150 manufacturing sites in 35 countries.

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2007 OVERVIEW

The Company reported solid financial performance in 2007, including record sales and earnings per share that were among the Company's highest. Dow's results demonstrated the value of its balanced business and geographic portfolio with a solid 3 percent volume growth in the combined Performance businesses (Performance Plastics, Performance Chemicals and Agricultural Sciences) outpacing a more modest gain of 1 percent in the combined Basics businesses (Basic Plastics, Basic Chemicals, and Hydrocarbons and Energy). A healthy increase in demand in Europe, Asia Pacific and Latin America compensated for a 2 percent decline in volume in North America. Despite the fifth consecutive year of double-digit percentage increases in feedstock and energy costs, the Company's focus on price and volume management, control of discretionary spending and capital expenditures, and active portfolio management delivered solid results.

       With continued global economic growth, industry conditions remained sound with supply and demand roughly balanced for most of the Company's products. Sales increased 9 percent from 2006 to $53.5 billion, establishing a new sales record for the Company. Continued volatility in feedstock and energy costs presented a challenge, impacting both costs and the ability of the Company to raise prices in a timely fashion. Despite these challenges, gains in price and volume helped to offset an increase of $2.5 billion in purchased feedstock and energy costs. The Company continued to exercise spending discipline, partially offsetting increased spending in targeted growth areas, such as the Performance businesses and emerging geographies, with decreases in other businesses or regions. The benefits of Dow's strategic decision to invest for growth through joint ventures were again apparent in this year's results, with Dow's share of the earnings from nonconsolidated affiliates exceeding $1 billion for the first time in the Company's history.

       The Company balanced its investment in new facilities with decisions to shut down a number of less efficient assets around the world in its drive to improve the competitiveness of its global operations. Capital expenditures were held below $2.1 billion, slightly above the level of depreciation, without sacrificing the efficiency, safety and environmental performance of Dow's manufacturing facilities. In addition, the Company's performance against key environmental and safety metrics continued to improve in 2007.

       With solid earnings and cash flow, the Company maintained its strong financial position in 2007, lowering its debt-to-capital ratio to 32 percent from 34 percent at the end of 2006 and 39 percent at the end of 2005. In April 2007, Dow's Board of Directors increased the quarterly dividend by 12 percent, to an annual rate of $1.68 per share. Since January 2006, the Company has raised its dividend by 25 percent. In the first quarter of 2007, Dow completed the share repurchase program authorized in July 2005, and commenced purchases under a new $2 billion share buyback program announced in October 2006. For the year, the Company invested over $1.4 billion to repurchase 32 million shares, an increase of more than 75 percent over the 18 million shares repurchased in 2006.

       During 2007, the Company continued to implement its strategy, which is designed to reduce earnings cyclicality and improve earnings growth by increasing investment in the Performance businesses, maintaining integration with the Basics businesses, and growing the Basics businesses through cost-advantaged joint ventures. Some of the actions taken during 2007 include:

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       For 2008, there is some uncertainty in the economic outlook for the United States. With approximately two-thirds of Dow's sales outside the United States, the Company's global footprint is expected to allow it to continue to capture growth in key regions of the world, such as Brazil, Eastern Europe/Russia, India and China. In addition, as the Company continues to implement its strategy, its focus will be on financial discipline and price/volume management which, coupled with the strong performance of the Company's joint ventures, is expected to produce another solid year of earnings for Dow.

       Dow's results of operations and financial condition for the year ended December 31, 2007 are described in further detail in the following discussion and analysis.

RESULTS OF OPERATION

Dow reported record sales of $53.5 billion in 2007, up 9 percent from $49.1 billion in 2006 and up 16 percent from $46.3 billion in 2005. Compared with last year, prices rose 7 percent (with currency accounting for approximately 3 percent of the increase), with increases in all operating segments and in all geographic areas. In 2007, the most significant price increases were reported in Basic Plastics and Hydrocarbons and Energy, driven by continuing increases in feedstock and energy costs. In 2007, volume improved 2 percent from last year, with growth in all segments with the exception of a slight decline in Basic Chemicals. From a geographic standpoint, 2007 volume in the United States was down slightly, due in part to weakness in the housing and automotive industries, while Europe and the rest of the world reported significant volume growth. Growth was strong in Asia Pacific, up 8 percent from 2006, and Latin America, up 7 percent.

       In 2006, sales rose 6 percent from 2005, as prices rose 5 percent, with increases in all operating segments except Agricultural Sciences, which was down 2 percent, and in all geographic areas. Volume increased 1 percent. Prices continued to be driven primarily by escalating feedstock and energy costs.

       Sales in the United States accounted for 34 percent of total sales in 2007, compared with 37 percent in 2006 and 38 percent in 2005.

       See the Sales Price and Volume table at the end of the section entitled "Segment Results" for details regarding the change in sales by operating segment and geographic area. In addition, sales and other information by operating segment and geographic area are provided in Note S to the Consolidated Financial Statements.

GRAPHIC   GRAPHIC

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       Gross margin for 2007 was $7.1 billion, compared with $7.6 billion in 2006 and $8.0 billion in 2005. Despite higher selling prices of nearly $3.3 billion, gross margin declined in 2007 compared with 2006, principally due to an increase of $2.5 billion in feedstock and energy costs, higher costs of other raw materials, the unfavorable impact of currency on costs, and increased freight costs. Gross margin for 2006 declined $433 million from 2005, principally due to an increase of $2.0 billion in feedstock and energy costs and increases of more than $400 million in the cost of other raw materials.

       Dow's global plant operating rate (for its chemicals and plastics businesses) was 87 percent of capacity in 2007, up from 85 percent of capacity in 2006 and 84 percent of capacity in 2005. Operating rates improved in 2007 for most of the Company's businesses, reflecting a higher level of demand and the closure of some of the Company's manufacturing facilities. In 2006, Dow's operating rates improved for many of the Company's Basics businesses. Overall, Dow's operating rate for 2006 reflected the impact of planned maintenance turnarounds at several of Dow's manufacturing facilities. Depreciation expense was $1,959 in 2007 and $1,904 million in 2006 and 2005.

GRAPHIC    

       Personnel count was 45,856 at December 31, 2007; 42,578 at December 31, 2006; and 42,413 at December 31, 2005. During 2007, headcount was impacted by the addition of research and development employees in India and China in support of the Company's growth initiatives; the addition of approximately 110 employees with the second quarter acquisition of Hyperlast Limited; and the addition of approximately 1,700 employees with the second quarter acquisition of Wolff Walsrode. During 2006, headcount was impacted by the addition of approximately 550 employees associated with the acquisition of Zhejiang Omex Environmental Engineering Co. LTD by FilmTec Corporation, a wholly owned subsidiary of the Company, and a reduction of approximately 260 employees due to the sale of the plastics division of Sentrachem Limited.

       Operating expenses (research and development, and selling, general and administrative expenses) totaled $3,169 million in 2007, up 12 percent from $2,827 million in 2006. Operating expenses were $2,618 million in 2005. Research and development ("R&D") expenses were $1,305 million in 2007, compared with $1,164 million in 2006 and $1,073 million in 2005. Selling, general and administrative expenses were $1,864 million in 2007, compared with $1,663 million in 2006 and $1,545 million in 2005. Consistent with the Company's strategy, approximately 75 percent of the increase in operating expenses in 2007 was related to spending for growth initiatives and product development in the Performance businesses, including expenses related to the 2007 acquisition of Wolff Walsrode and Hyperlast Limited, and for early stage research into new growth opportunities. The balance of the increase was related to the global expansion of the Company's corporate branding campaign and other corporate expenses. Approximately 60 percent of the increase in operating expenses in 2006 was related to spending for growth initiatives in the Performance businesses, consistent with the Company's strategy. The balance of the increase was principally due to the allocation of a portion of stock-based compensation expense to operating expenses in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123R. Prior to the adoption of SFAS No. 123R on January 1, 2006, all stock-based compensation expense was reflected in "Cost of sales." (See Notes A and N to the Consolidated Financial Statements for additional information on this accounting standard.) Operating expenses were 5.9 percent of sales in 2007, 5.8 percent of sales in 2006 and 5.7 percent of sales in 2005.

GRAPHIC   GRAPHIC

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       The following table illustrates the relative size of the primary components of total production costs and operating expenses of Dow. More information about each of these components can be found in other sections of Management's Discussion and Analysis of Financial Condition and Results of Operation, Notes to the Consolidated Financial Statements, and Part II, Item 6. Selected Financial Data.


 
Production Costs and Operating Expenses      
Cost components as a percent of total   2007   2006   2005  

 
Hydrocarbon feedstocks and energy   49 % 49 % 47 %
Salaries, wages and employee benefits   11   11   13  
Maintenance   3   3   3  
Depreciation   4   4   5  
Restructuring charges   1   1    
Supplies, services and other raw materials   32   32   32  

 
Total   100 % 100 % 100 %

 

       Amortization of intangibles was $72 million in 2007, $50 million in 2006 and $55 million in 2005. Amortization of intangibles was up in 2007 due to acquisitions. During 2007, the Company performed impairment tests for goodwill in conjunction with its annual long-term financial planning process. As a result of this review, it was determined that no goodwill impairments existed. See Note G to the Consolidated Financial Statements for additional information regarding goodwill and other intangible assets.

       On December 3, 2007, the Company's Board of Directors approved a restructuring plan that includes the shutdown of a number of assets and organizational changes within targeted support functions to improve the efficiency and cost effectiveness of the Company's global operations. As a result of these shutdowns and organizational changes, which are scheduled to be completed by the end of 2009, the Company recorded pretax restructuring charges totaling $590 million in 2007. The charges consisted of asset write-downs and write-offs of $422 million, costs associated with exit or disposal activities of $82 million and severance costs of $86 million. The impact of the charges is shown as "Restructuring charges" in the consolidated statements of income and was reflected in the Company's segment results as follows: Performance Plastics $184 million, Performance Chemicals $85 million, Agricultural Sciences $77 million, Basic Plastics $88 million, Basic Chemicals $7 million, Hydrocarbons and Energy $44 million, and Unallocated and Other $105 million. When the restructuring plans have been fully implemented, the Company expects to realize ongoing annual savings of approximately $180 million. See Note B to the Consolidated Financial Statements for details on the restructuring charges.

       On August 29, 2006, the Company's Board of Directors approved a plan to shut down a number of assets around the world as the Company continued its drive to improve the competitiveness of its global operations. As a consequence of these shutdowns, which are scheduled to be completed in the first quarter of 2009, and other optimization activities, the Company recorded pretax restructuring charges totaling $591 million in 2006. The charges included asset write-downs and write-offs of $346 million, costs associated with exit or disposal activities of $172 million and severance costs of $73 million.. The charges are shown as "Restructuring charges" in the consolidated statements of income and are reflected in the Company's segment results as follows: Performance Plastics $242 million, Performance Chemicals $12 million, Basic Plastics $16 million, Basic Chemicals $184 million, and Unallocated and Other $137 million. In 2007, the Company recorded a $12 million reduction of the 2006 restructuring charges, which included an $8 million reduction of the estimated severance costs and a $4 million reduction of the reserve for contract termination fees. These reductions impacted the Performance Plastics segment by $4 million and the Unallocated and Other segment by $8 million. When the restructuring plans have been fully implemented, the Company expects to realize ongoing annual savings of approximately $160 million. See Note B to the Consolidated Financial Statements for details on the restructuring charges.

       In the fourth quarter of 2005, the Company recorded pretax charges totaling $114 million related to restructuring activities, as the Company continued to focus on financial discipline and made additional decisions regarding noncompetitive and underperforming assets, as well as decisions regarding the consolidation of manufacturing capabilities. The charges included costs of $67 million related to the closure of approximately 20 small plants around the world, losses of $12 million on asset sales, the write-off of an intangible asset of $10 million and employee-related expenses of $25 million (which was paid to 197 employees in the fourth quarter of 2005). The total of these charges is shown as "Restructuring charges" in the consolidated statements of income. The charges were recorded against the Company's operating segments as follows: $28 million against Performance Plastics, $14 million against Performance Chemicals, $9 million against Agricultural Sciences, $12 million against Basic Plastics and $3 million against Basic Chemicals. Charges to Unallocated and Other amounted to $48 million. For additional information, see Note B to the Consolidated Financial Statements.

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       During 2007, pretax charges totaling $57 million were recorded for purchased in-process research and development ("IPR&D"). See Note C to the Consolidated Financial Statements for information regarding these charges. Future costs required to bring the purchased IPR&D projects to technological feasibility are expected to be immaterial.

       Following the December 2006 completion of a study to review Union Carbide's asbestos claim and resolution activity, Union Carbide decreased its asbestos-related liability for pending and future claims (excluding future defense and processing costs) by $177 million. The reduction was shown as "Asbestos-related credit" in the 2006 consolidated statements of income and reflected in the results of Unallocated and Other. See Note J to the Consolidated Financial Statements for additional information regarding asbestos-related matters of Union Carbide.

       Dow's share of the earnings of nonconsolidated affiliates in 2007 was $1,122 million, compared with $959 million in 2006 and $964 million in 2005. Equity earnings in 2007 exceeded $1 billion for the first time in the Company's history, reflecting increased earnings from EQUATE Petrochemical Company K.S.C. ("EQUATE"), MEGlobal and the OPTIMAL Group of Companies ("OPTIMAL"). Equity earnings in 2006 declined slightly from 2005 despite improved results from Dow Corning Corporation ("Dow Corning"), which was due in part to a favorable tax settlement reached in the second quarter of 2006; MEGlobal; Compañía Mega S.A.; and Univation Technologies, LLC. These improvements were offset by lower results from Equipolymers and Siam Polyethylene Company Limited ("Siam Polyethylene" which is part of the SCG-Dow Group), and the absence of equity earnings from UOP LLC ("UOP") and DuPont Dow Elastomers L.L.C., both of which the Company exited in 2005. See Note F to the Consolidated Financial Statements for additional information on nonconsolidated affiliates.

GRAPHIC    

       On December 13, 2007, the Company and PIC announced plans to form a 50:50 joint venture that will be a market-leading, global petrochemicals company. The joint venture, to be headquartered in the United States, will manufacture and market polyethylene, ethyleneamines, ethanolamines, polypropylene, and polycarbonate. To form the new joint venture, Dow will sell a 50 percent interest in the business assets included in the transaction to PIC. In turn, PIC and Dow will each contribute their assets into the joint venture. The resulting joint venture is expected to have revenues of more than $11 billion and employ more than 5,000 people worldwide. The transaction is subject to the completion of definitive agreements, customary conditions and regulatory approvals, and is anticipated to close in late 2008.

       Sundry income – net 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 for 2007 was $324 million, up from $137 million in 2006 and down from $755 million in 2005. In 2007, the increase in net sundry income reflected the impact of favorable foreign exchange hedging results and gains on the sale of miscellaneous assets. In 2006, sundry income was reduced by the recognition of a loss contingency of $85 million (reflected in the Performance Plastics segment) related to a fine imposed by the European Commission ("EC") associated with synthetic rubber industry matters (see Note J to the Consolidated Financial Statements for additional information). Sundry income for 2005 included a gain of $637 million on the sale of Union Carbide's indirect 50 percent interest in UOP (reflected in the Performance Plastics segment) and a $70 million gain ($41 million reflected in the Basic Chemicals segment; $29 million reflected in the Basic Plastics segment) on the sale of a portion of Union Carbide's interest in EQUATE in the first quarter of 2005. In November 2004, Union Carbide sold a 2.5 percent interest in EQUATE to National Bank of Kuwait for $104 million. In March 2005, these shares were sold to private Kuwaiti investors thereby completing the restricted transfer, which resulted in the first quarter gain and reduced Union Carbide's ownership interest from 45 percent to 42.5 percent. Sundry income for 2005 was reduced by a cash donation of $100 million to The Dow Chemical Company Foundation for aid to education and community development and a loss of $31 million associated with the early extinguishment of $845 million of debt (both reflected in Unallocated and Other).

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       Net interest expense (interest expense less capitalized interest and interest income) was $454 million in 2007, up slightly from $431 million in 2006 and down significantly from $564 million in 2005. Interest income was $130 million in 2007, down from $185 million in 2006 principally due to lower levels of cash and cash equivalents. Interest income was $138 million in 2005. Interest expense (net of capitalized interest) and amortization of debt discount totaled $584 million in 2007, $616 million in 2006 and $702 million in 2005. Interest expense declined in 2007 due to a lower level of debt throughout the year versus 2006.

       The provision for income taxes was $1,244 million in 2007, compared with $1,155 million in 2006 and $1,782 million in 2005. The Company's effective tax rate fluctuates based on, among other factors, where income is earned and the level of income relative to tax credits available. For example, as the percentage of foreign sourced income increases, the Company's effective tax rate declines. The Company's tax rate is also influenced by equity earnings, since most of the earnings from the Company's equity companies are taxed at the joint venture level. In 2007, the effective tax rate was 29.4 percent, compared with 23.2 percent in 2006 and 27.8 percent in 2005. The tax rate for 2007 was negatively impacted by a change in German tax law that was enacted in August and included a reduction in the German income tax rate. As a result of the change, the Company adjusted the value of its net deferred tax assets in Germany (using the lower tax rate) and recorded a charge of $362 million against the "Provision for income taxes" in the third quarter of 2007. The reduction in the German income tax rate, which was effective January 1, 2008, is expected to have a small incremental benefit to the Company's effective tax rate in the future. Also in 2007, the Company changed the legal ownership structure of its investment in EQUATE, resulting in a favorable impact to the "Provision for income taxes" of $113 million in the fourth quarter of 2007. Excluding these items, the effective tax rate was 23.5 percent in 2007.

       Based on tax strategies developed in Brazil during 2006, as well as projections of future earnings, it was determined that it was more likely than not that tax loss carryforwards would be utilized, resulting in a reversal of existing valuation allowances of $63 million. This impact, combined with strong financial results in jurisdictions with lower tax rates than the United States, enacted reductions in the tax rates in Canada and The Netherlands, and improved earnings from a number of the Company's joint ventures, resulted in an effective tax rate for 2006 that was lower than the U.S. statutory rate. In the second quarter of 2005, the Company finalized its plan for the repatriation of foreign earnings subject to the requirements of the American Jobs Creation Act of 2004 ("AJCA"), resulting in a credit to the provision for income taxes of $113 million (see Notes A and R to the Consolidated Financial Statements). On January 23, 2006, the Company received an unfavorable tax ruling from the United States Court of Appeals for the Sixth Circuit reversing a prior decision by the United States District Court relative to corporate owned life insurance, resulting in a charge to the provision for income taxes of $137 million in the fourth quarter of 2005. Excluding these items, the effective tax rate was 24.5 percent in 2006 and 27.5 percent in 2005. The underlying factors affecting Dow's overall effective tax rates are summarized in Note R to the Consolidated Financial Statements.

       Minority interests' share in income was $98 million in 2007, $93 million in 2006 and $82 million in 2005.

       Cumulative effect of change in accounting principle reflected an after-tax charge of $20 million in 2005 related to the adoption of FASB Interpretation ("FIN") No. 47, "Accounting for Conditional Asset Retirement Obligations," on December 31, 2005. See Note A to the Consolidated Financial Statements for additional information regarding this change in accounting principle.

       Net income available for common stockholders was $2,887 million in 2007 ($2.99 per share) compared with $3,724 million in 2006 ($3.82 per share) and $4,515 million in 2005 ($4.62 per share).

GRAPHIC    

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       The following table summarizes the impact of certain items recorded in 2007, 2006 and 2005:


 
  Pretax
Impact
(1)
  Impact on
Net Income
(2)
  Impact on
EPS
(3)
 
 
 
 
 
In millions, except per share amounts 2007   2006   2005   2007   2006   2005   2007   2006   2005  

 
Restructuring charges $(578 ) $(591 ) $(114 ) $(436 ) $(445 ) $(77 ) $(0.46 ) $(0.46 ) $(0.08 )
Purchased in-process research and development charges (57 )     (50 )     (0.05 )    
Asbestos-related credit   177       112       0.12    
Sundry income – net:                                    
  Loss contingency related to EC fine   (85 )     (84 )     (0.09 )  
  Gain on sale of EQUATE shares     70       46       0.05  
  Gain on sale of interest in UOP     637       402       0.41  
  Loss on early extinguishment of debt     (31 )     (20 )     (0.02 )
  Cash donation for aid to education and community development     (100 )     (65 )     (0.07 )
Provision for income taxes:                                    
  AJCA repatriation of foreign earnings           113       0.12  
  Unfavorable tax ruling           (137 )     (0.14 )
  German tax law change       (362 )     (0.38 )    
  Change in EQUATE legal ownership structure       113       0.12      
Cumulative effect of change in accounting principle           (20 )     (0.02 )

 
Total $(635 ) $(499 ) $462   $(735 ) $(417 ) $242   $(0.77 ) $(0.43 ) $0.25  

 
(1) Impact on "Income before Income Taxes and Minority Interests"          
(2) Impact on "Net Income Available for Common Stockholders"          
(3) Impact on "Earnings per common share – diluted"          

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 businesses and excludes items that principally apply to the Company as a whole. Additional information regarding the Company's operating segments and a reconciliation of EBIT to "Net Income Available for Common Stockholders" can be found in Note S to the Consolidated Financial Statements.

PERFORMANCE PLASTICS

Performance Plastics sales were $15,116 million in 2007, up from $13,944 million in 2006 and $12,405 million in 2005. Compared with 2006, sales increased 8 percent, as prices, including the favorable impact of currency (which accounted for about half of the increase in prices), rose 6 percent and volume improved 2 percent. Prices improved in all geographic areas with particular strength in Europe and Latin America as improved industry supply/demand fundamentals in certain businesses and increasing raw material costs drove prices higher. The overall improvement in volume was limited by weakness in North America and the impact of significant lump sum technology licensing revenue that was realized in the first quarter of 2006 and did not recur in 2007. Outside North America, volume increased 8 percent, with solid gains across most businesses in Europe, Latin America and Asia Pacific. In 2006, volume improved 7 percent and prices increased 5 percent over 2005. Volume in 2006 benefited from the full-year impact of the addition of ENGAGE™, NORDEL™ and TYRIN™ elastomers, acquired by the Company when it divested its interest in DuPont Dow Elastomers L.L.C. ("DDE") in 2005 (see Note F to the Consolidated Financial Statements) and from significant lump sum licensing revenue earned in the first quarter of 2006.

GRAPHIC   GRAPHIC

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       EBIT for 2007 was $1,390 million, compared with $1,629 million in 2006 and $2,507 million in 2005. Results for 2007 were negatively impacted by net restructuring charges of $180 million, which included $184 million related to the fourth quarter announced closure or impairment of a number of manufacturing facilities, offset by a $4 million reduction of the 2006 restructuring reserve for contract termination fees (see Note B to the Consolidated Financial Statements). The restructuring charges included the write-down of manufacturing assets, the write-off of obsolete capital spending and the accrual of contract termination fees associated with plant shutdown decisions. The most significant charges included impairment charges related to a rubber plant in Berre, France, and associated contract cancellation fees totaling $61 million; the write-down of the automotive sealants business in North America, Latin America and Asia Pacific which totaled $58 million; and the $29 million write-down of assets related to a fiber solution manufacturing plant in Tarragona, Spain. Results for 2006 were reduced by the recognition of a loss contingency of $85 million related to a fine imposed by the EC associated with synthetic rubber industry matters (see Note J to the Consolidated Financial Statements) and $242 million in asset restructuring costs as part of the plan announced by the Company in the third quarter of 2006, which included the permanent shutdown of the Company's toluene diisocyanate ("TDI") plant in Porto Marghera, Italy. Excluding the impact of these items, EBIT declined in 2007 primarily due to the lump sum technology licensing revenue that was earned in 2006 and that did not recur in 2007, and an increase in operating expenses related to the Company's efforts to expand geographic markets and develop new technologies and product applications within the Performance Plastics segment. EBIT for 2005 included a gain of $637 million related to the sale of Union Carbide's indirect 50 percent interest in UOP to a wholly owned subsidiary of Honeywell International, Inc. and charges totaling $28 million associated with the closure of six small manufacturing sites as part of the restructuring activities completed in the fourth quarter of 2005. Excluding the impact of these items, EBIT in 2006 improved over 2005 as higher selling prices and improved volumes more than offset the impact of increased raw material costs and lower equity earnings.

       Dow Automotive sales for 2007 were up 11 percent from 2006 driven by a 7 percent increase in volume and a 4 percent increase in price, principally due to the favorable impact of currency. The business benefited from its broad geographic reach in 2007 as strong volume gains in Asia Pacific, Latin America and Europe more than compensated for weakness in the North American automotive industry. The ability to raise prices was limited by the weakness in North America and customer efforts to establish dual sourcing positions. EBIT for 2007 was reduced by $64 million of restructuring charges primarily associated with the Company's decision in the fourth quarter of 2007 to exit the automotive sealants business in North America, Latin America and Asia Pacific. Excluding these charges, EBIT for the business declined in 2007 due to higher raw material costs, increased spending on product development and business growth initiatives, and higher costs associated with the consolidation of manufacturing operations in North America and Europe. When completed in 2009, this consolidation is expected to result in lower costs for the business.

       Dow Building Solutions sales in 2007 established a new record for the business, up 6 percent from the previous sales record set in 2006, despite a 15-year low in new housing starts in North America. The improvement was driven by higher prices of 7 percent, including the favorable impact of currency, which more than offset a 1 percent decline in volume. Price improvement was widespread with increases noted in all geographic areas. The decline in volume, which was driven by weakness in U.S. residential construction, was mitigated in large part by solid demand in Europe and efforts by the business to shift focus in the United States to commercial construction. EBIT in 2007 was negatively impacted by restructuring charges of $21 million related to the closure of five small manufacturing plants. Excluding the impact of the restructuring charges, EBIT in 2007 was down from 2006 as higher raw material costs and increased spending on market expansion activities in emerging geographies and development work on new products and technology exceeded the benefit of higher selling prices.

       Dow Epoxy sales in 2007 increased 7 percent compared with last year, reflecting a 10 percent increase in price and a 3 percent decline in volume. Prices improved in all geographic areas and across most businesses. Volume declined due to lower sales of intermediate products and the Company's 2006 exit of the peroxymeric chemicals business, more than offsetting volume gains in the rest of the world. Results for 2007 included a restructuring charge of $2 million related to the Company's fourth quarter of 2007 decision to exit the hydroxyalkyl acrylate business. Results for 2006 included a restructuring charge of $9 million related to the Company's third quarter of 2006 decision to exit the peroxymeric chemicals business in North America, Europe and Asia Pacific. EBIT in 2007 declined versus 2006 as the favorable impact of higher selling prices was more than offset by lost margin on lower sales volume, higher operating expenses and margin compression from higher raw material costs.

       Polyurethanes and Polyurethane Systems sales for 2007 increased 11 percent versus the prior year with price, including the favorable impact of currency, up 6 percent and volume up 5 percent. The increase in price was driven by tight industry supply/demand fundamentals for TDI. Volume improved significantly in 2007 for Polyurethane Systems due to the formation of the majority owned Dow Izolan joint venture in Russia and the acquisitions of Hyperlast Limited and Edulan A/S. EBIT for 2006 included significant restructuring charges associated with the Company's decision to shut down the TDI facility in Porto

32


Marghera, Italy. Excluding this impact, EBIT in 2007 increased from 2006 as higher selling prices and increased margin on volume gains more than offset the impact of higher raw material costs and operating expenses.

       Specialty Plastics and Elastomers established a new sales record in 2007, up 13 percent versus 2006, due to a 7 percent increase in volume and a 6 percent improvement in price. The increases in both volume and price were broad-based with improvement in all geographic areas and most businesses. EBIT for 2007 included restructuring charges of $97 million, including impairment charges related to a rubber plant in Berre, France, and a fiber solution plant in Tarragona, Spain. EBIT for 2006 included a restructuring charge of $11 million related to the shutdown of the polyethylene wax plant in Sarnia, Ontario, Canada, and a loss contingency of $85 million related to the EC fine. Excluding these items, EBIT declined for the business as higher raw material costs, coupled with increased spending on plant maintenance and operations, more than offset the benefit of higher selling prices and increased sales volume.

       Technology Licensing and Catalyst sales and EBIT were down significantly in 2007 due to lump sum licensing revenue earned in 2006 that did not recur in 2007.

Performance Plastics Outlook for 2008

Performance Plastics sales are expected to increase in 2008 as the Company continues to invest in Performance businesses and pursue growth opportunities in developing geographic areas. Additional industry capacity for some products may result in downward pressure on pricing. Raw material costs are expected to remain challenging as higher feedstock and energy costs continue to drive prices higher.

       Dow Automotive expects sales growth in line with automotive industry trends. Conditions in the North American automotive industry are expected to deteriorate further. To mitigate the impact of declining demand in North America, the business will focus on growth opportunities in Latin America and Eastern Europe, as well as expanding its position in Asia Pacific. Prices are expected to improve slightly in 2008 as producers attempt to recover some of the margin lost in 2007. New plants in Midland, Michigan and Schkopau, Germany are expected to start up in 2008. These facilities will replace older, less efficient plants, which are expected to close when the new facilities become fully operational.

       Dow Building Solutions expects moderate volume improvement in 2008, led by continued growth in Europe and solid commercial construction demand in the United States. The business expects the U.S. residential construction industry to continue to struggle in 2008, potentially reaching the bottom in the second half of the year. Conditions in the U.S. credit market will be a key factor in how U.S. residential construction develops in 2008. Pricing is expected to rise slightly on a global basis in line with the outlook for feedstock and other raw material costs. Continued low pricing on oriented strand board is expected to keep pressure on polyisocyanurate rigid foam and extruded polystyrene sheathing in North America. Pricing pressure is also expected in Europe where additional industry capacity will come on line in 2008. The Company will continue to invest in the Dow Building Solutions business during 2008 as new foaming agent formulations, compliant with the Montreal Protocol, are implemented in North American manufacturing sites for the production of STYROFOAM™ XPS insulation.

       Dow Epoxy volume is expected to increase in 2008 with three recent acquisitions – UPPC AG, POLY-CARB Inc. and GNS Technologies – driving growth in new systems applications; and continued strength in the key existing applications for electrical laminates, coatings and civil engineering. Margins are expected to come under some pressure from rising feedstock and energy costs as the addition of new industry capacity starting up in Asia Pacific in 2008 is expected to limit the ability of the business to raise prices.

       Polyurethanes and Polyurethane Systems expect volume to grow in 2008, benefiting from the full-year integration of recent acquisitions (including Hyperlast Limited), as well as continued growth in insulation and other applications. Industry fundamentals are expected to be less tight in 2008 as industry production volume increases for key products. Prices are expected to increase in response to increasing feedstock and other raw material costs, although price increases may not fully offset these higher costs.

       Specialty Plastics and Elastomers expect continued sales growth in 2008 driven primarily by higher volumes. Continued weakness in North America is expected to be offset by strength in Latin America, Europe and Asia Pacific. The infrastructure building industry remains strong, which should benefit the Wire & Cable business, and demand for packaging is expected to continue growing with food related applications, providing an opportunity for additional growth. While polycarbonate industry fundamentals remain challenging, demand is expected to continue to grow and should improve the industry supply/demand balance going forward.

       Technology Licensing and Catalyst revenue is expected to remain solid in 2008 with volume remaining firm.

33


PERFORMANCE CHEMICALS

Performance Chemicals sales increased 6 percent to $8,351 million in 2007, compared with $7,867 million in 2006; sales were $7,521 million in 2005. Compared with 2006, volume increased 2 percent, while prices rose 4 percent, largely due to the favorable impact of currency. The volume increase in 2007 was due in large part to the second quarter acquisition of Wolff Walsrode. In 2006, volume rose 4 percent from 2005 across most businesses in Europe, Latin America and Asia Pacific, while prices rose 1 percent.

GRAPHIC   GRAPHIC

       EBIT for 2007 was $949 million, compared with $1,242 million in 2006 and $1,435 million in 2005. Despite higher equity earnings from Dow Corning, EBIT declined in 2007 due to increases in raw material costs and higher operating expenses, as the businesses invested in new product development and growth initiatives, including integration costs associated with the acquisition of Wolff Walsrode. In addition, EBIT in 2007 was reduced by restructuring charges totaling $85 million and a $7 million charge for IPR&D related to the Wolff Walsrode acquisition. The restructuring charges included the write-down of manufacturing assets (due to plant closures in Aratu, Brazil; Freeport, Texas; and Midland, Michigan) totaling $43 million and the $42 million impairment write-down of the Company's indirect 50 percent interest in Dow Reichhold Specialty Latex LLC. In 2006, EBIT declined as higher raw material and energy costs more than offset higher selling prices. In addition, EBIT in 2006 was reduced by restructuring charges totaling $12 million. In 2005, EBIT was negatively impacted by charges of $14 million related to the closure of five small manufacturing facilities. See Notes B and C to the Consolidated Financial Statements for additional information regarding restructuring charges and IPR&D.

       Designed Polymers sales increased 23 percent versus 2006, with volume growth of 20 percent and price increases of 3 percent. The improvement in volume was primarily due to the second quarter acquisition of Wolff Walsrode. Excluding these sales, volume for the business was up 7 percent, driven by higher sales in biocides, methyl cellulosics, and Dow Water Solutions. The improvement in volume was across all geographic areas, with double-digit growth in Europe, Latin America and Asia Pacific. Compared with 2006, EBIT declined significantly due to higher operating expenses, including expenses related to the acquisition of Wolff Walsrode, and higher raw material costs. In addition, EBIT for 2007 was reduced by restructuring charges totaling $27 million related to the permanent closure of the cellulosics plant in Aratu, Brazil, and the shutdown of a small pharmaceutical plant in Midland, Michigan, as well as a $7 million IPR&D charge.

       Dow Latex sales for 2007 were flat with 2006, as a 5 percent increase in price was offset by a 5 percent decline in volume. Compared with 2006, paper and carpet latex prices were higher in all geographic areas. Volume was down, however, primarily due to challenging conditions in both the paper and carpet industries. Carpet latex was down due to the slow housing industry in North America, while paper latex continued to be impacted by changes in the advertising industry as spending moves toward alternative media versus print and coated paper. Prices were slightly higher for specialty latex, however, volume declined due to sluggish demand for architectural coatings in North America. Despite higher selling prices, EBIT declined significantly in 2007 due to lower volumes and higher feedstock and energy costs. In addition, EBIT in 2007 was reduced by a charge of $42 million related to the write-down of the Company's indirect 50 percent interest in Dow Reichhold Specialty Latex LLC.

       Specialty Chemicals sales were up 2 percent versus 2006, with a 3 percent increase in price and a 1 percent decrease in volume. Compared with 2006, prices were up across all geographic areas except North America, principally driven by higher raw material costs. Volume declined slightly versus 2006 primarily due to planned and unplanned outages at OPTIMAL, which manufactures products that are sold by Dow in Asia Pacific. EBIT in 2007 declined as higher raw material and energy costs and lower operating rates more than offset improvements in price. In addition, EBIT in 2007 was reduced by restructuring charges totaling $16 million related to the write-down of two manufacturing facilities.

34


Performance Chemicals Outlook for 2008

Performance Chemicals sales for 2008 are expected to increase as the Company benefits from growth opportunities related to the acquisition of Wolff Walsrode. Prices are expected to be higher across most major product lines reflecting good industry fundamentals, although excess industry supply and volatility of feedstock and energy costs will continue to put pressure on margins in Dow Latex.

       Designed Polymers sales are expected to increase significantly with higher prices for methyl cellulosics and CELLOSIZE™ hydroxyethyl cellulose used in food ingredients, pharmaceuticals and personal care products. Price and volume improvements are also expected in Specialty Polymers, Dow Water Solutions, biocides, and the specialty chemical products of ANGUS Chemical Company.

       Dow Latex sales are expected to decrease due to the slowdown in residential housing construction in North America, which will impact demand for specialty latex. In addition, some customers may seek lower cost alternatives to styrene-butadiene latex products in coated paper applications.

       Specialty Chemicals prices are expected to decrease slightly due to declining monoethylene glycol prices, which will put pricing pressure on ethylene oxide derivative products, including amines and glycol ethers.

AGRICULTURAL SCIENCES

Sales for Agricultural Sciences were $3,779 million in 2007, compared with $3,399 million in 2006 and $3,364 million in 2005. Volume increased 9 percent, compared with 2006, while prices increased 2 percent. The increase in price was primarily driven by the favorable impact of currency which offset local currency price decreases associated with generic competition. Volume was up significantly across several product lines in 2007. Strong volume growth continued for new products including penoxsulam rice herbicide and aminopyralid herbicide for range and pasture, which reported sales almost double the levels of 2006. Demand in cereals applications drove fluroxypyr mixtures and florasulam sales higher, while glyphosate and its mixtures grew in conjunction with the global increase in corn acreage. Spinosad and chlorpyrifos sales both benefited from a mild winter and early spring in Europe, while low termite pressure and the slow housing construction in the United States adversely impacted sales of SENTRICON™ Termite Colony Elimination System and sulfuryl fluoride. Demand creation efforts continued to progress as several additional large restaurant chains chose to use Omega-9 oils, heart-healthy canola and sunflower oils derived from NEXERA™ seed, in their establishments. In 2006, volume increased 3 percent from 2005, while prices declined 2 percent, primarily due to highly competitive industry conditions in Brazil and the unfavorable impact of currency in Europe and Asia Pacific. Volume increased as sales of insecticides rebounded from the competitive pressures of 2005. In 2006, commodity herbicides also benefited from the adoption of herbicide-tolerant soybeans in Brazil and herbicide-tolerant corn in the United States, while increased sales of cotton, sunflower and canola seed more than offset lower sales of corn seed in the United States.

GRAPHIC   GRAPHIC

       EBIT in 2007 was $467 million versus $415 million in 2006 and $543 million in 2005. The increase in EBIT in 2007 was primarily the result of strong demand related to high farm commodity prices and increased acres planted, economic stability across Latin America, and marked improvement in seeds operations. EBIT in 2007 was negatively impacted by $77 million of restructuring charges primarily related to the impairment of the Company's manufacturing site in Lauterbourg, France, and by IPR&D charges totaling $50 million related to recent acquisitions. See Notes B and C to the Consolidated Financial Statements for additional information regarding restructuring charges and IPR&D. In 2006, EBIT declined from 2005 due to downward pricing pressure in highly competitive industry conditions, product mix and an increase in raw material costs.

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Agricultural Sciences Outlook for 2008

Agricultural Sciences sales for 2008 are expected to grow above the levels achieved in 2007. Volume is expected to increase in key regions as farm commodity prices and grower confidence remain high. Price is anticipated to be relatively flat despite pricing pressure from generic competition in agricultural chemicals. Growth is anticipated in Brazil, but at a lesser rate than experienced with the economic rebound in 2007. The launch of pyroxsulam (cereal herbicide) and continued ramp-up of newer products, such as spinetoram, penoxsulam, aminopyralid, and WIDESTRIKE™ and HERCULEX™ insect protection, are expected to continue to increase sales. In addition, demand for Omega-9 oils should continue to build momentum in the healthy oils market segment. Consistent with the Company's strategy, the business expects to increase spending for the discovery and development of new products.

BASIC PLASTICS

Sales for the Basic Plastics segment were $12,878 million in 2007, up 9 percent from $11,833 million in 2006. Sales were $11,007 million in 2005. Prices, including the favorable impact of currency, increased 8 percent in 2007, while volume increased 1 percent. Price increases were reported in all geographic areas, reflecting significantly higher feedstock and energy costs. While volume was significantly higher in Asia Pacific and Europe, higher prices, a very competitive industry environment, and growing concerns about the strength of the U.S. economy resulted in lower volume in North America which was also impacted by the shutdown of two production facilities at the end of 2006. In 2006, prices increased 7 percent over 2005, while volume increased 1 percent. The increase in selling prices reflected significantly higher feedstock and energy costs in 2006. While volume was up significantly in Asia Pacific and Latin America, volume declined in North America as customers reduced inventories.

GRAPHIC   GRAPHIC

       EBIT for 2007 was $2,006 million, down from $2,022 million in 2006 and $2,398 million in 2005. EBIT declined in 2007 as price increases were not sufficient to offset the significant increases in feedstock and other raw material costs. Compared with last year, equity earnings increased due to significantly higher earnings from EQUATE (due to planned maintenance turnarounds in 2006), partially offset by lower equity earnings from Siam Polyethylene and Equipolymers. EBIT in 2007 was reduced by restructuring charges totaling $88 million related to the announced shutdown of the polypropylene production facility at St. Charles Operations in Hahnville, Louisiana; the write-down of the Company's 50 percent interest in Pétromont and Company, Limited Partnership; and the write-off of abandoned engineering costs. In 2006, EBIT declined from 2005 as price increases were not sufficient to offset the significant increases in feedstock and other raw material costs. Equity earnings from EQUATE and Siam Polyethylene in 2006 were also lower due to planned maintenance turnarounds. In addition, EBIT in 2006 was negatively impacted by restructuring charges totaling $16 million related to the shutdown of the polystyrene and polyethylene production facilities in Sarnia, Ontario, Canada.

       Polyethylene sales increased 8 percent in 2007 as prices increased 6 percent and volume increased 2 percent. Prices rose in all geographic areas, except North America, in response to significantly higher feedstock and energy costs. In North America, prices declined slightly as highly competitive industry conditions and soft demand made it difficult to implement price increases. Substantial volume growth in Asia Pacific and Europe, combined with modest increases in North America and Latin America, more than offset a notable decline in South Africa due to the sale of the Company's polyethylene manufacturing plant in that country in 2006. EBIT decreased slightly in 2007 as higher selling prices, lower operational costs, and higher equity earnings were more than offset by higher feedstock costs. EBIT in 2007 was reduced by a restructuring charge of $46 million related to the impairment write-down of the Company's 50 percent interest in Pétromont and Company, Limited Partnership and the write-down of abandoned engineering costs of $16 million. EBIT in 2007 was favorably impacted by a gain on the sale of the low density polyethylene plant in Cubatao, Brazil, in the second quarter of 2007.

36


       Polypropylene sales increased 5 percent in 2007 as prices improved 10 percent and volume declined 5 percent. Polypropylene prices increased in 2007 in response to significantly higher propylene costs. Volume improved significantly in Europe where a tight supply/demand balance resulted in customers pre-buying product in anticipation of future price increases. Volume declined significantly in South Africa, resulting from the sale of the Company's polypropylene manufacturing plant in 2006. Despite higher prices, EBIT declined from 2006 due to higher propylene costs, higher operating costs and a restructuring charge of $26 million related to the announced shutdown of the Company's polypropylene manufacturing facility at St. Charles Operations in Hahnville, Louisiana.

       Polystyrene sales increased 15 percent in 2007 as prices improved 13 percent and volume increased 2 percent. Prices improved in all geographic areas, driven by significantly higher feedstock and energy costs. Volume declined significantly in North America reflecting lower demand due to high polystyrene prices and the closure of the Company's polystyrene manufacturing facility at Sarnia, Ontario, Canada in the fourth quarter of 2006. Volume was significantly higher in Asia Pacific due to the consolidation of the SAL Petrochemical (Zhangjiagang) Company Limited, after the Company acquired the remaining 50 percent interest in the joint venture in the first quarter of 2007. EBIT improved significantly from 2006 as higher prices and lower operating costs more than offset the increase in feedstock and energy costs. EBIT for 2006 was negatively impacted by a restructuring charge related to the shutdown of the polystyrene plant in Sarnia, Ontario, Canada.

Basic Plastics Outlook for 2008

Feedstock and energy costs are expected to remain high during 2008, providing support for the maintenance of prices although some margin deterioration is expected. Demand for all products within the segment is expected to remain solid during the first half of the year; however, additional global production capacity scheduled for the second half of the year will likely result in increased industry competition.

       While feedstock costs are expected to be higher in 2008, polyethylene margins are expected to remain near 2007 levels during the first half of the year. Industry supply/demand balances are expected to remain consistent with 2007, but may be impacted by new industry production capacity in late 2008. Equity earnings are expected to be lower in 2008, due to slightly higher raw material and operating costs at EQUATE and higher feedstock costs at Siam Polyethylene. In addition, equity losses are expected from a new joint venture announced in the third quarter of 2007 by Dow and Crystalsev, to design and build a world-scale facility to manufacture polyethylene from sugar cane, as that joint venture incurs costs associated with the initial feasibility study.

       Polypropylene demand is expected to be comparable to 2007 and remain strong during the first half of the year. Margins should improve in North America as the shutdown of the production facility at St. Charles Operations results in a shift in product mix to higher margin products. North America volumes are expected to be negatively impacted by reduced export demand and planned maintenance shutdowns at the Company's Seadrift and Oyster Creek facilities in Texas. In Europe, margins are expected to decline as significant new industry production capacity comes on-line in Europe and the Middle East during the second half of the year.

       Within the polystyrene industry, demand growth is expected to remain low due to high prices and the volatility of raw materials costs, resulting in continued pressure on margins. The industry is expected to be highly competitive and industry restructuring will continue in 2008. The Company and Chevron Phillips Chemical Company LP signed a non-binding Memorandum of Understanding in the second quarter of 2007 relating to the formation of a joint venture involving assets from their respective polystyrene and styrene monomer businesses in the Americas. The new joint venture, subject to completion of definitive agreements and corporate and other approvals, is expected to begin operations in 2008.

       In addition, in the fourth quarter of 2007, Dow and PIC announced plans to form a 50:50 joint venture to create a market-leading petrochemicals company. The global joint venture will include the manufacturing and marketing of polyethylene and polypropylene, among other products. The transaction is subject to the completion of definitive agreements, customary conditions and regulatory approvals, and is anticipated to close in late 2008.

BASIC CHEMICALS

Sales for Basic Chemicals were $5,863 million in 2007, compared with $5,560 million in 2006 and $5,643 million in 2005. Overall, sales increased 5 percent as prices rose 6 percent, including the favorable impact of currency which accounted for about one-third of the price increase. The increase in price was primarily due to price improvements in ethylene oxide/ethylene glycol ("EO/EG") and solvents and intermediates, mainly driven by increases in feedstock and energy costs. Volume was down 1 percent in 2007 as volume growth in solvents and intermediates was more than offset by declines in EG and ethylene dichloride ("EDC"). Volume for EDC was down, principally in North America, due to the shutdown of the Company's EDC production facility in Fort Saskatchewan, Alberta, Canada in the fourth quarter of 2006. In 2006, volume was down 2 percent from 2005, due to plant closures in the chlor-vinyl business and the expiration of a customer contract for vinyl acetate monomer at the end of 2005; prices increased 1 percent versus 2005.

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       Caustic soda sales were slightly higher in 2007 mainly due to increased volume. Vinyl chloride monomer ("VCM") sales were essentially flat, as an increase in price was offset by a decrease in volume. The decline in volume was primarily due to maintenance outages.

       EO/EG sales increased 6 percent in 2007, as a 16 percent increase in prices, principally due to higher feedstock and energy costs, more than offset a 10 percent decrease in volume. EG volume declined in 2007 due to lack of supply related to planned and unplanned outages on the U.S. Gulf Coast and the restructuring of certain supply agreements.

       Solvents and intermediates sales were up 24 percent in 2007, with a 13 percent increase in volume and an 11 percent increase in price. The significant improvement in volume was related to solid demand for oxo products for coatings applications. Price improvement was driven by increases in feedstock and energy costs and other raw material cost increases.

GRAPHIC   GRAPHIC

       EBIT for Basic Chemicals was $813 million in 2007, compared with $689 million in 2006 and $1,129 million in 2005. Results for the segment in 2007 included restructuring charges of $7 million related to the write-off of capital project spending. In 2006, results included restructuring charges totaling $184 million related to the closure of the chlor-alkali plant at Fort Saskatchewan, Alberta, Canada, as well as a number of other small manufacturing facilities. Excluding these items from both periods, EBIT in 2007 declined from 2006 as sharply higher feedstock and energy costs and increases in other raw material costs more than offset the improvement in sales and higher equity earnings from EQUATE and MEGlobal. EBIT in 2006 declined from 2005 as significantly higher feedstock and energy costs and lower volume exceeded the benefits of improved plant operations and an increase in selling prices. Results for 2005 included a gain of $41 million associated with the sale of EQUATE shares, as well as a restructuring charge of $3 million related to the closure of a small manufacturing facility.

Basic Chemicals Outlook for 2008

Caustic soda prices are expected to remain flat in 2008, while volume is expected to decline due to three significant maintenance turnarounds planned for 2008.

       VCM sales are expected to increase in 2008 due to an anticipated increase in volume in Europe and Latin America, and expected increased prices driven by higher hydrocarbon and energy costs. Average industry operating rates for EG in 2008 are expected to be consistent with the average operating rate for 2007. However, 2008 supply/demand balance is expected to be tight early in the year, and then weaken slowly as a result of new industry capacity scheduled to come on-line late in the year, compressing margins. Equity earnings are expected to remain strong in 2008. The EG joint venture with PIC is expected to start production in the second half of 2008, adding to equity earnings.

       Solvents and intermediates' diversity of applications and increased geographic growth beyond North America and Asia Pacific will enable sustained demand for 2008. Sales volume is expected to grow slightly and margins should remain favorable despite continued high feedstock and energy costs, as no new industry capacity is scheduled to come on-line in 2008 in Asia Pacific and supply/demand is expected to remain balanced.

HYDROCARBONS AND ENERGY

Hydrocarbons and Energy sales were $7,105 million in 2007, compared with $6,205 million in 2006 and $6,061 million in 2005. In 2007, prices were up 12 percent and volume increased 3 percent from 2006. Prices increased in 2007 due to the continued rise in crude oil and feedstock costs, and tight supply/demand balances for certain hydrocarbon products. Volume increased in 2007 primarily due to additional U.S. power sales resulting from the fourth quarter 2006 acquisition of the Plaquemine Cogeneration Facility in Louisiana. In 2006, prices increased 11 percent and volume decreased 9 percent from 2005. Compared with 2005, prices rose following the rise in crude oil and feedstock costs; volume declined due to outages, both scheduled and unscheduled, at a number of the Company's facilities.

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GRAPHIC    

       The Hydrocarbons and Energy business transfers materials to Dow's derivative businesses at cost, which results in EBIT that is at or near breakeven. In 2007, EBIT was a loss of $45 million due to restructuring charges of $44 million recorded in the fourth quarter principally due to the shutdown of the Company's styrene monomer plant in Camaçari, Brazil, and the closure of storage wells in Fort Saskatchewan, Alberta, Canada (see Note B to the Consolidated Financial Statements). EBIT for the segment was at or near breakeven in 2006 and 2005.

       The Company uses derivatives of crude oil and natural gas as feedstocks in its ethylene facilities, while natural gas is used as a fuel. The Company's cost of purchased feedstocks and energy rose approximately $2.5 billion (11 percent) in 2007 due to increased prices. Crude oil prices increased for much of the year, and on average, 2007 prices were $7 per barrel higher than 2006 levels. Conversely, on average, North American natural gas prices continued the downward trend, and were approximately $0.13 per million Btu lower than in 2006, a decrease of approximately 2 percent.

GRAPHIC    

Hydrocarbons and Energy Outlook for 2008

Crude oil and natural gas prices are expected to remain volatile and sensitive to external factors such as weather, economic growth/sub-prime credit effects and geopolitical tensions. The Company expects crude oil prices, on average, to be higher than 2007. Ethylene margins are expected to be somewhat lower in 2008 due to global capacity growth, particularly in the Middle East, exceeding global demand growth. Ethylene margins could improve compared to these expectations, with stronger than anticipated demand and delayed startups of new capacity within the industry. The economic outlook is uncertain, and a faltering economy and/or major spike in crude oil prices may contribute to a decline in margins and volume.

UNALLOCATED AND OTHER

Sales for Unallocated and Other, which primarily relate to the Company's insurance operations, were $421 million in 2007, compared with $316 million in 2006 and $306 million in 2005. Included in the results for Unallocated and Other are:

       EBIT was a loss of $897 million in 2007 compared with a loss of $594 million in 2006 and a loss of $1,048 million in 2005. EBIT for 2007 was reduced by 2007 restructuring charges totaling $105 million, including employee-related severance

39


expenses of $86 million, pension curtailment costs and termination benefits of $15 million and asset write-offs of $4 million; franchise taxes of approximately $80 million; and higher performance-based compensation expenses (including stock-based compensation) of approximately $230 million. EBIT for 2007 was favorably impacted by improved results from insurance company operations, foreign exchange hedging results, and an $8 million favorable adjustment to the restructuring charge recorded in the third quarter of 2006 for employee-related severance.

       EBIT for 2006 was negatively impacted by restructuring charges of $137 million (including employee-related severance expenses of $73 million, pension curtailment costs and termination benefits of $33 million, asset write-offs of $18 million related to the shutdown of several small facilities around the world, and asbestos abatement of $10 million and environmental remediation of $3 million related to the shutdown of all production facilities at the Company's site in Sarnia, Ontario, Canada); performance-based stock compensation expenses of $86 million; other severance costs of $52 million; asbestos-related defense and resolution costs (net of insurance) of $45 million; and expenses of $59 million related to the Company's corporate branding program. EBIT for 2006 was favorably impacted by a $177 million reduction in Union Carbide's asbestos-related liability for pending and future claims (excluding future defense and processing costs). EBIT for 2005 was negatively impacted by charges totaling $48 million for restructuring activities in the fourth quarter of 2005 (including employee-related expenses of $25 million, the write-off of an intangible asset of $10 million and costs of $13 million related to the closure of three small plants), severance costs of $68 million, a cash donation of $100 million to The Dow Chemical Company Foundation, performance-based stock compensation expenses of $276 million, asbestos-related defense and resolution costs (net of insurance) of $75 million, and a loss of $31 million associated with the early extinguishment of debt.

       See Note B to the Consolidated Financial Statements for information regarding the restructuring charges.


 
Sales Price and Volume                                    
  2007   2006   2005  
 
 
 
 
Percent change from prior year Volume   Price   Total   Volume   Price   Total   Volume   Price   Total  

 
Operating Segments:                                    
  Performance Plastics 2 % 6 % 8 % 7 % 5 % 12 % 1 % 18 % 19 %
  Performance Chemicals 2   4   6   4   1   5   (2 ) 18   16  
  Agricultural Sciences 9   2   11   3   (2 ) 1   (3 ) 3    
  Basic Plastics 1   8   9   1   7   8     19   19  
  Basic Chemicals (1 ) 6   5   (2 ) 1   (1 ) (13 ) 17   4  
  Hydrocarbons and Energy 3   12   15   (9 ) 11   2   2   22   24  

 
Total 2 % 7 % 9 % 1 % 5 % 6 % (2 )% 17 % 15 %

 
Geographic Areas:                                    
  United States (1 )% 2 % 1 %   4 % 4 % (3 )% 19 % 16 %
  Europe 5   12   17   1 % 6   7   1   15   16  
  Rest of World 5   5   10   5   3   8   (5 ) 17   12  

 
Total 2 % 7 % 9 % 1 % 5 % 6 % (2 )% 17 % 15 %

 
Price includes the impact of currency. Volume includes the impact of acquisitions and divestitures.          
                                     

LIQUIDITY AND CAPITAL RESOURCES

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:


 
Cash Flow Summary                  
In millions   2007     2006     2005  

 
Cash provided by (used in):                  
  Operating activities $ 4,484   $ 4,154   $ 4,474  
  Investing activities   (2,858 )   (1,907 )   (1,096 )
  Financing activities   (2,728 )   (3,302 )   (2,508 )
  Effect of exchange rate changes on cash   81     6     (172 )

 
Net increase (decrease) in cash and cash equivalents $ (1,021 ) $ (1,049 ) $ 698  

 

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       Despite lower earnings, cash provided by operating activities in 2007 increased versus 2006 principally due to a reduction in cash contributed to the Company's pension plans. Cash provided by operating activities decreased in 2006 versus 2005 primarily due to lower earnings, partially offset by lower pension contributions.

       Cash used in investing activities in 2007 increased significantly compared with 2006 due to investments in consolidated companies (including $603 million for Wolff Walsrode and $151 million for Hyperlast Limited; see Notes C and G to the Consolidated Financial Statements), a $300 million increase in capital expenditures, several acquisitions of agricultural businesses, partially offset by a lower usage of cash to purchase previously leased assets. Cash used in investing activities in 2006 increased significantly compared with 2005, as cash usage in 2005 was reduced by proceeds of $867 million from the sale of Union Carbide's 50 percent indirect interest in UOP.

       Cash used in financing activities in 2007 decreased compared with 2006 as the issuance of promissory notes under the Company's U.S. commercial paper program and higher proceeds from the sales of common stock (related to the exercise of stock options and the Employees' Stock Purchase Plan), more than offset increases in purchases of treasury stock (related to the Company's share repurchase programs) and dividends paid to shareholders. In May 2007, the quarterly dividend was increased 12 percent. Cash used in financing activities in 2006 increased compared with 2005 principally due to purchases of treasury stock (related to a share repurchase program authorized in July 2005) and an increase in dividends paid to stockholders. In February 2006, the quarterly dividend was increased 12 percent.

       On August 29, 2006, the Board of Directors approved a plan (the "2006 Plan") to shut down a number of the Company's manufacturing facilities. These shutdowns are scheduled to be completed by the end of the first quarter of 2009. On December 3, 2007, the Board of Directors approved a restructuring plan (the "2007 Plan") that includes the shutdown of a number of assets and organizational changes within targeted functions. These restructuring activities are expected to be completed by the end of 2009. The restructuring activities related to both the 2006 Plan and the 2007 Plan are expected to result in additional cash expenditures of approximately $338 million over the next few years related to severance costs, contract termination fees, asbestos abatement and environmental remediation (see Note B to the Consolidated Financial Statements). Dow expects to incur future costs related to its restructuring activities, as the Company continually looks for ways to enhance the efficiency and cost effectiveness of its operations, to ensure competitiveness across its businesses and across geographic areas. Future costs are expected to include demolition costs related to the closed facilities, which will be recognized as incurred. The Company also expects to incur additional employee-related costs, including involuntary termination benefits, related to its other optimization activities, and pension plan settlement costs. These costs cannot be reasonably estimated at this time.


Working Capital at December 31      
In millions 2007   2006

Current assets $18,654   $17,209
Current liabilities 12,445   10,601

Working capital $6,209   $6,608

Current ratio 1.50:1   1.62:1

GRAPHIC

       At December 31, 2007, trade receivables were $5.9 billion, up from $5.0 billion at December 31, 2006, consistent with the significant increase in sales. Days-sales-outstanding-in-receivables (excluding the impact of sales of receivables) was 38 days at December 31, 2007 compared with 39 days at December 31, 2006. At December 31, 2007, total inventories were $6.9 billion, up from $6.1 billion at December 31, 2006, principally due to the increase in feedstock and energy costs and higher plant operating rates. Days-sales-in-inventory at December 31, 2007 was 61 days versus 63 days at December 31, 2006.

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Total Debt at December 31      
In millions 2007   2006

Notes payable $1,548   $219
Long-term debt due within one year 586   1,291
Long-term debt 7,581   8,036

Total debt $9,715   $9,546

Debt as a percent of total capitalization 31.8%   34.1%

GRAPHIC

       As part of its ongoing financing activities, Dow has the ability to issue promissory notes under its U.S. and Euromarket commercial paper programs. At December 31, 2007, there was $1.2 billion of commercial paper outstanding. In the event Dow has short-term liquidity needs and is unable to access these short-term markets for any reason, Dow has the ability to access liquidity through its committed and available $3 billion 5-year revolving credit facility with various U.S. and foreign banks. This credit facility matures in April 2011.

       At December 31, 2007, the Company had $500 million of SEC-registered securities available for issuance under U.S. shelf registrations, Euro 5.0 billion (approximately $7.4 billion) available for issuance under the Company's Euro Medium Term Note Program, as well as Japanese yen 50 billion (approximately $447 million) of securities available for issuance under a shelf registration filed with the Tokyo Stock Exchange on July 31, 2006. In addition, as a well-known seasoned issuer, the Company filed an automatic shelf registration for an unspecified amount of mixed securities with the SEC on February 23, 2007. Under this shelf registration, the Company may offer common stock, preferred stock, depositary shares, debt securities, warrants, stock purchase contracts and stock purchase units.

       Dow's public debt instruments and documents for its private funding transactions contain, among other provisions, certain covenants and default provisions. At December 31, 2007, the Company was in compliance with all of these covenants and default provisions. For information on Dow's covenants and default provisions, see Note K to the Consolidated Financial Statements.

       On July 14, 2005, the Board of Directors authorized the repurchase of up to 25 million shares of Dow common stock over the period ended on December 31, 2007 (the "2005 Program"). In 2005 and 2006, the Company purchased 18,798,407 shares of the Company's common stock under the 2005 Program. During the first quarter of 2007, the Company purchased the remaining 6,201,593 shares under the 2005 Program, bringing the program to a close.

       On October 26, 2006, the Company announced that its Board of Directors had approved a new share buy-back program, authorizing up to $2 billion to be spent on the repurchase of the Company's common stock (the "2006 Program"). Purchases under the 2006 Program began in March 2007, following completion of the 2005 Program. In 2007, the Company purchased 26,225,207 shares of the Company's common stock under the 2006 Program. For additional information, see PART II, Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Capital Expenditures

Capital spending for the year was $2,075 million, up 17 percent from $1,775 million in 2006. Capital spending was $1,597 million in 2005. In 2007, approximately 31 percent of the Company's capital expenditures were directed toward additional capacity for new and existing products, compared with 33 percent in 2006. In 2007, approximately 23 percent was committed to projects related to environmental protection, safety, loss prevention and industrial hygiene compared with 24 percent in 2006. The remaining capital was utilized to maintain the Company's existing asset base, including projects related to productivity improvements, energy conservation and facilities support.

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GRAPHIC

       Major projects underway during 2007 included the construction of a regional headquarters facility in Shanghai, China; Dow Automotive production facilities in Midland, Michigan, and Schkopau, Germany, for glass bonding and primer products; a facility for the production of octene in Tarragona, Spain; a multi-product facility for the production of isopropanolamines in Plaquemine, Louisiana; a new train for the production of METHOCEL™ cellulose ethers in Midland, Michigan; a new polyols plant in Terneuzen, The Netherlands; and the expansion of ethyleneamines and ethanolamines production facilities in Hahnville, Louisiana. Additional major projects included upgrades to isopropanol production facilities in Texas City, Texas; and the replacement of furnaces used in the production of ethylene and several projects to upgrade chlor-alkali production facilities in Freeport, Texas. Because the Company designs and builds most of its capital projects in-house, it had no material capital commitments other than for the purchase of materials from fabricators and construction labor.

Contractual Obligations

The following tables summarize the Company's contractual obligations, commercial commitments and expected cash requirements for interest at December 31, 2007. Additional information related to these obligations can be found in Notes J, K, L, M and R to the Consolidated Financial Statements.


Contractual Obligations at December 31, 2007   Payments Due by Year
   
                        2013 and    
In millions   2008   2009   2010   2011   2012   beyond   Total

Long-term debt – current and noncurrent   $586   $777   $1,065   $1,548   $1,006   $3,185   $8,167
Deferred income tax liabilities – noncurrent (1)             854   854
Pension and other postretirement benefits   279   236   240   240   242   1,777   3,014
Other noncurrent obligations (2)   294   250   172   110   60   2,988   3,874
FIN No. 48 obligations, including interest and penalties (3)   383           661   1,044
Other contractual obligations:                            
  Minimum operating lease commitments   231   200   171   117   93   441   1,253
  Purchase commitments – take or pay and throughput obligations   2,136   1,845   1,578   1,117   941   5,212   12,829
  Purchase commitments – other (4)   152   26   6   3   3   44   234
Expected cash requirements for interest   504   472   421   359   276   4,223   6,255

Total   $4,565   $3,806   $3,653   $3,494   $2,621   $19,385   $37,524

(1)
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. All noncurrent deferred income tax liabilities have been reflected in "2013 and beyond."
(2)
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 majority of the noncurrent asbestos-related liability of $1,001 million has been reflected in "2013 and beyond."
(3)
Due to uncertainties in the timing of the effective settlement of tax positions with the respective taxing authorities, the Company is unable to determine the timing of payments related to its FIN No. 48 noncurrent obligations, including interest and penalties. These amounts are therefore reflected in "2013 and beyond."
(4)
Includes outstanding purchase orders and other commitments greater than $1 million, obtained through a survey of the Company.

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Off-Balance Sheet Arrangements

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 if specific triggering events occur. Information regarding the Company's outstanding guarantees at December 31, 2007 is disclosed in Note J to the Consolidated Financial Statements.

       The Company leases an ethylene facility in The Netherlands from an owner trust that is a variable interest entity ("VIE"). Dow is not the primary beneficiary of the owner trust and, therefore, is not required to consolidate the owner trust. Additional information regarding this VIE can be found in Note M to the Consolidated Financial Statements.

Dividends

On February 14, 2008 the Board of Directors announced a quarterly dividend of $0.42 per share, payable April 30, 2008, to stockholders of record on March 31, 2008. Since 1912, the Company has paid a cash dividend every quarter and, in each instance, Dow has maintained or increased the amount of the dividend, adjusted for stock splits. During that 95-year period, Dow has increased the amount of the quarterly dividend 47 times (approximately 12 percent of the time) and maintained the amount of the quarterly dividend approximately 88 percent of the time. The Company declared dividends of $1.635 per share in 2007, $1.50 per share in 2006 and $1.34 per share in 2005.

Outlook for 2008

In 2007, the Company continued to strengthen its financial position. Despite the fifth consecutive year of double-digit percentage increases in feedstock and energy costs, coupled with softening economic conditions in the United States, the diversity of Dow's business and geographic portfolio, as well as record financial performance by its joint ventures, resulted in solid net income for the Company. Working capital was reduced by $399 million, despite higher sales levels, as the Company reduced its working capital ratios. Capital expenditures were $2.1 billion, slightly higher than depreciation. These actions enabled the Company to further reduce its ratio of debt to total capitalization to 31.8 percent, down from 59.2 percent at the end of 2002. The Company does not intend to reduce this ratio further in 2008.

       In 2008, the Company will continue to implement its strategy to improve long-term earnings growth and earnings consistency. While the economic outlook is unclear, primarily in the United States, the Company expects continued economic growth in the rest of the world, particularly in emerging geographies. Volatility in feedstock and energy costs is expected to continue, adding uncertainty to the outlook. The Company will maintain its financial discipline while increasing its investment in targeted growth opportunities, principally in its Performance businesses and in emerging geographies. Capital expenditures are expected to increase in 2008, but should remain close to the level of depreciation. These expenditures are planned at a level sufficient to maintain the safety and reliability of the Company's facilities while modestly increasing capacity in selected high-value businesses.

       Approximately $1.7 billion in debt will become due in 2008, including approximately $1.2 billion of commercial paper. While the Company expects to have sufficient cash to meet its scheduled debt obligations in 2008, the Company intends to repay this debt with the issuance of new debt.

       Dow and PIC announced plans in December 2007 to form a 50:50 petrochemicals joint venture. To form the new joint venture, Dow will sell to PIC a 50 percent interest in the business assets included in the transaction for approximately $9.5 billion (pretax). In turn, PIC and Dow will each contribute their assets into the joint venture. The transaction is subject to the completion of definitive agreements, customary conditions and regulatory approvals, and is anticipated to close in late 2008.

OTHER MATTERS

Recent Accounting Pronouncements

See Note A to the Consolidated Financial Statements for a summary of significant accounting policies and recent accounting pronouncements.

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Critical Accounting Policies

The preparation of financial statements and related disclosures in accordance with accounting principles generally accepted in the United States of America ("U.S. 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 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:

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46


 
  Net Increase in Market-Related Asset Value Due to
Recognition of Prior Asset Gains and Losses
  In millions      
 
  2008   $ 174
  2009     154
  2010     142
  2011     52
 
  Total   $ 522
 

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Environmental Matters

Environmental Policies

Dow is committed to world-class environmental, health and safety ("EH&S") performance, as demonstrated by a long-standing commitment to Responsible Care®, as well as a strong commitment to achieve the Company's 2015 Sustainability Goals – goals that set the standard for sustainability in the chemical industry by focusing on improvements in Dow's local corporate citizenship and product stewardship, and by actively pursuing methods to reduce the Company's environmental impact.

       To meet the Company's public commitments, as well as the stringent laws and government regulations related to environmental protection and remediation to which its global operations are subject, Dow has well-defined policies, requirements and management systems. Dow's EH&S Management System ("EMS") defines the "who, what, when and how" needed for the businesses to achieve the Company's policies, requirements, performance objectives, leadership expectations and public commitments. EMS is designed to minimize the long-term cost of environmental protection and to comply with these laws and regulations. To ensure effective utilization, the EMS is integrated into a company-wide management system for EH&S, Operations, Quality and Human Resources.

       It is Dow's policy to adhere to a waste management hierarchy that minimizes the impact of wastes and emissions on the environment. First, Dow works to eliminate or minimize the generation of waste and emissions at the source through research, process design, plant operations and maintenance. Second, Dow finds ways to reuse and recycle materials. Finally, unusable or non-recyclable hazardous waste is treated before disposal to eliminate or reduce the hazardous nature and volume of the waste. Treatment may include destruction by chemical, physical, biological or thermal means. Disposal of waste materials in landfills is considered only after all other options have been thoroughly evaluated. Dow has specific requirements for waste that is transferred to non-Dow facilities, including the periodic auditing of these facilities. Dow believes third-party verification is a cornerstone of world-class EH&S performance and building public trust. As such, numerous Dow sites in Europe, Latin America, Australia and North America have received third-party verification of Dow's compliance with Responsible Care® and with outside specifications such as ISO-14001. During 2007, five U.S. sites were audited by Lloyd's Register Quality Assurance, and found to be in conformance with Responsible Care® Management System requirements.

       Dow's EH&S policies helped the Company achieve excellent safety performance in 2007. Dow's personal injury and illness OSHA (Occupational Safety and Health Administration) rate and Injury and Illness Severity rate were both on target with the reductions necessary to achieve the 2015 goals, and the lowest in the Company's history. Tragically, one fatality occurred in 2007, when a Dow employee, traveling on behalf of the Company, was a passenger on a commercial airliner that crashed upon landing in Sao Paulo, Brazil.

       Reductions in leaks, breaks and spills in 2007 also exceeded the improvements necessary to reach the 2015 goals, and were the lowest recorded in the Company's history. Improvement in environmental compliance remains a top management priority, with initiatives underway to further improve compliance in 2008.

       Detailed information on Dow's performance regarding environmental matters and goals can be found online on Dow's Environment, Health and Safety webpage at www.dow.com.

Chemical Security

Growing public and political attention has been placed on protecting critical infrastructure, including the chemical industry, from security threats. Terrorist attacks and natural disasters have increased concern about the security of chemical production and distribution. In response to the increasing call by many, including Dow and the American Chemistry Council, for uniform performance-based national standards for securing the U.S. chemical industry, U.S. Chemical Plant Security legislation was passed in 2006, and the Department of Homeland Security ("DHS") is now implementing the regulations known as the Chemical Facility Anti-Terrorism Standards. Further, the U.S. Transportation Security Administration ("TSA") and the U.S. Department of Transportation are expected to finalize regulations covering the rail transportation of chemicals in the early part of 2008 as required by the 9/11 Commission Act of 2007.

       The focus on security is not new to Dow. A comprehensive, multi-level security plan for the Company has been maintained since 1988. This plan was activated in response to the events of 9/11. Dow continues to improve its security plans, placing emphasis on the safety of Dow communities and people by being prepared to meet risks at any level and to address both internal and external identifiable risks. Dow's security plans also are developed to avert interruptions of normal business

48


work operations which could materially and adversely affect the Company's results of operations, liquidity and financial condition.

       Dow played a key role in the development and implementation of the American Chemistry Council's Responsible Care® Security Code that requires all aspects of security – including facility, transportation, and cyberspace – be assessed and gaps addressed. Through the Company's global implementation of the Security Code, Dow has permanently heightened the level of security – not just in the United States, but worldwide. Dow employs approximately 500 employees and contractors in its Emergency Services and Security department worldwide. Dow committed over $100 million in capital over a ten-year period for plant security, supply chain and cyberspace security enhancements, regulatory compliance and response capabilities as well as other components of Dow's security program. These costs are not considered material to the Company's consolidated financial statements.

       Through the implementation of the Responsible Care® Security Code, including voluntary security enhancements and upgrades made since 2002, Dow is well positioned to comply with the new U.S. chemical facility regulations and other regulatory frameworks. In addition, Dow was the first chemical company to receive SAFETY Act coverage in 2007 from the DHS for the Company's Coast Guard covered sites (under the Maritime Transportation Security Act of 2002). This unprecedented certification helps validate Dow's efforts and provides additional liability coverage in the event of a terrorist attack.

       Dow continues to work collaboratively across the supply chain on Responsible Care®, Supply Chain Design, Emergency Preparedness, Shipment Visibility and Hazmat Routing. Dow is a leader in the implementation of advanced track and trace technologies. The breakthrough Next Generation Rail Tank Car project with Union Pacific Railroad and Union Tank Car Company continues to make progress with cooperation agreements signed with Transport Canada, The Federal Railroad Administration, and the TSA. Further, Dow's Distribution Risk Review process that has been in place for decades was expanded to address potential threats in all modes of transportation across the Company's supply chain. To reduce vulnerabilities, Dow maintains security measures that meet or exceed regulatory and industry security standards in all areas in which the Company operates.

       Dow continually works to strengthen partnerships with local responders, law enforcement, and security agencies, and to enhance confidence in the integrity of the Company's security and risk management program, as well as strengthen its preparedness and response capabilities. Dow also works closely with its supply chain partners and strives to educate lawmakers, regulators and communities about the Company's resolve and actions to date which are mitigating security and crisis threats.

Climate Change

There is a growing political and scientific consensus that emissions of greenhouse gases ("GHG") due to human activities continue to alter the composition of the global atmosphere in ways that are affecting the climate. Political debates continue about how to implement fair and effective GHG mitigation efforts. Dow takes global climate change very seriously and is not waiting for the resolution of the debate. Dow is committed to reducing its GHG intensity (pounds of GHG per pound of product), developing climate-friendly products and processes and, over the longer term, implementing technology solutions to achieve even greater climate change improvements. Since 1990, Dow has reduced its absolute GHG emissions by more than 20 percent, a more rapid reduction than required by Kyoto Protocol targets, and has achieved a 22 percent improvement in energy intensity (the amount of energy required to produce one pound of product). In doing so, it has avoided consuming more than 900 trillion Btus, a savings that when converted to electricity would be more than sufficient to supply the electricity consumed by residential users in the State of California for one year. This trend could reverse, however, depending on business growth, capacity utilization and the pace of new technology development.

       Dow also contributes to the climate change solution by producing products that help others reduce GHG emissions, such as lightweight plastics for automobiles and insulation for energy efficient homes and appliances. Dow has demonstrated its commitment to technological innovation and conservation though its exploration of renewable energy sources. For example, in 2007, Dow and Crystalsev, one of Brazil's largest ethanol companies, signed a Memorandum of Understanding which calls for plans to design and build a world-scale facility to manufacture polyethylene from sugar cane. In the United States, Dow Building Solutions announced plans to build a 505 kilowatt solar farm at Dow's Pittsburg, California site. This project will be the largest solar installation in Dow and the first commercial pilot for the Company, providing the energy equivalent to power 400 homes.

       Gains made toward Dow's Energy Efficiency goal will directly impact progress in meeting its 2015 Climate Change goal, which is to reduce GHG intensity by 2.5 percent a year per pound of product, from a 2005 baseline. Dow is studying the lifecycle impact of its products on climate change and additional global projects that could offset the Company's overall GHG emissions through carbon dioxide reduction.

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       A new Energy & Climate Change Policy and Issue Management Team was formed in 2007 to help establish Dow as a leader in providing energy and climate change solutions. The team is also tasked with developing and implementing a comprehensive climate change strategy and to advocate for an international framework that establishes clear pathways to help slow, stop and reverse the rate of GHG emissions.

Environmental Remediation

Dow accrues the costs of remediation of its facilities and formerly owned facilities based on current law and existing technologies. The nature of such remediation includes, for example, the management of soil and groundwater contamination and the closure of contaminated landfills and other waste management facilities. In the case of landfills and other active waste management facilities, Dow recognizes the costs over the useful life of the facility. The accounting policies adopted to properly reflect the monetary impacts of environmental matters are discussed in Note A to the Consolidated Financial Statements. To assess the impact on the financial statements, environmental experts review currently available facts to evaluate the probability and scope of potential liabilities. Inherent uncertainties exist in such evaluations primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies. These liabilities are adjusted periodically as remediation efforts progress or as additional technical or legal information become available. Dow had an accrued liability of $294 million at December 31, 2007, related to the remediation of current or former Dow-owned sites. The liability related to remediation at December 31, 2006 was $316 million.

       In addition to current and former Dow-owned sites, under the Federal Comprehensive Environmental Response, Compensation and Liability Act and equivalent state laws (hereafter referred to collectively as "Superfund Law"), Dow is liable for remediation of other hazardous waste sites where Dow allegedly disposed of, or arranged for the treatment or disposal of, hazardous substances. Dow readily cooperates in the remediation of these sites where the Company's liability is clear, thereby minimizing legal and administrative costs. Because Superfund Law imposes joint and several liability upon each party at a site, Dow has evaluated its potential liability in light of the number of other companies that also have been named potentially responsible parties ("PRPs") at each site, the estimated apportionment of costs among all PRPs, and the financial ability and commitment of each to pay its expected share. The Company's remaining liability for the remediation of Superfund sites at December 31, 2007 was $28 million ($31 million at December 31, 2006). The Company has not recorded any third-party recovery related to these sites as a receivable.

       Information regarding environmental sites is provided below:


 
Environmental Sites Dow-owned Sites (1)   Superfund Sites (2)  
  2007   2006   2007   2006  

 
Number of sites at January 1 251   245   64   72  
Sites added during year 3   8   31   8  
Sites closed during year (3 ) (2 ) (1 ) (16 )

 
Number of sites at December 31 251   251   94   64  

 
(1)   Dow-owned sites are sites currently or formerly owned by Dow, where remediation obligations are imposed (in the United States) by the Resource Conservation Recovery Act or analogous state law. 153 of these sites were formerly owned by Dowell Schlumberger, Inc., a group of companies in which the Company previously owned a 50 percent interest. Dow sold its interest in Dowell Schlumberger in 1992.
(2)   Superfund sites are sites, including sites not owned by Dow, where remediation obligations are imposed by Superfund Law.

       The Company's manufacturing sites in Freeport, Texas, and Midland, Michigan, are the sites for which the Company has the largest environmental remediation accruals. From the start of operations at the Freeport site in the 1940s until the mid-1970s, manufacturing wastes were typically placed in on-site pits and landfills. The resulting soil and groundwater contamination is being assessed and remediated under the provisions of the Resource Conservation Recovery Act ("RCRA"), in concert with the state of Texas. At December 31, 2007, the Company had an accrual of $37 million ($47 million at December 31, 2006) related to environmental remediation at the Freeport manufacturing site. In 2007, $6 million ($8 million in 2006) was spent on environmental remediation at the Freeport site.

       Similar to the Freeport site, in the early days of operations at the Midland site, manufacturing wastes were usually disposed of on-site, resulting in soil and groundwater contamination, which has been contained and managed on-site under a series of RCRA permits and regulatory agreements. The most recent Hazardous Waste Operating License for the Midland site, issued in 2003, also included provisions for the Company to conduct an investigation to determine the nature and extent of off-site contamination from historic Midland site operations. The scope of the investigation includes Midland area soils;

50


Tittabawassee and Saginaw River sediment and floodplain soils; and Saginaw Bay, and requires the Company to conduct interim response actions. See Note J to the Consolidated Financial Statements for additional information. At December 31, 2007, the Company had an accrual of $36 million ($41 million at December 31, 2006) for environmental remediation and investigation associated with the Midland site. In 2007, the Company spent $52 million ($20 million in 2006) on environmental remediation at the Midland site.

       In total, the Company's accrued liability for probable environmental remediation and restoration costs was $322 million at December 31, 2007, compared with $347 million at the end of 2006. 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. It is the opinion of the Company's management that the possibility is remote that costs in excess of those disclosed will have a material adverse impact on the Company's consolidated financial statements.

       The amounts charged to income on a pretax basis related to environmental remediation totaled $92 million in 2007, $125 million in 2006 and $79 million in 2005. Capital expenditures for environmental protection were $189 million in 2007, $193 million in 2006 and $150 million in 2005.

Asbestos-Related Matters of Union Carbide Corporation

Introduction

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. Since then, the rate of filing has significantly abated. 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.

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


 
  2007   2006   2005  

 
Claims unresolved at January 1 111,887   146,325   203,416  
Claims filed 10,157   16,386   34,394  
Claims settled, dismissed or otherwise resolved (31,722 ) (50,824 ) (91,485 )

 
Claims unresolved at December 31 90,322   111,887   146,325  
Claimants with claims against both UCC and Amchem 28,937   38,529   48,647  

 
Individual claimants at December 31 61,385   73,358   97,678  

 

       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, the damages alleged are not expressly identified as to Union Carbide, Amchem or any other particular defendant, even when specific damages are alleged with respect to a specific disease or injury. 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.

Estimating the Liability

Based on a study completed by Analysis, Research & Planning Corporation ("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. Since then, Union Carbide has compared current asbestos claim and resolution activity to the results of the most recent ARPC study at each balance sheet date to determine whether the accrual continues to be appropriate. In addition, Union Carbide has requested ARPC to review Union Carbide's historical asbestos claim and resolution activity each November since 2004 to determine the appropriateness of updating the most recent ARPC study.

51


       In November 2006, Union Carbide requested ARPC to review Union Carbide's historical asbestos claim and resolution activity and determine the appropriateness of updating its most recent study from January 2005. In response to that request, ARPC reviewed and analyzed data through October 31, 2006 and concluded that the experience from 2004 through 2006 was sufficient for the purpose of forecasting future filings and values of asbestos claims filed against Union Carbide and Amchem, and could be used in place of previous assumptions to update the January 2005 study. The resulting study, completed by ARPC in December 2006, stated that the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, through 2021 was estimated to be between approximately $1.2 billion and $1.5 billion. As in its January 2003 and January 2005 studies, ARPC provided estimates for a longer period of time in its December 2006 study, but also reaffirmed its prior advice that forecasts for shorter periods of time are more accurate than those for longer periods of time.

       Based on ARPC's December 2006 study and Union Carbide's own review of the asbestos claim and resolution activity, Union Carbide decreased its asbestos-related liability for pending and future claims to $1.2 billion at December 31, 2006 which covered the 15-year period ending in 2021 (excluding future defense and processing costs). The reduction was $177 million and was shown as "Asbestos-related credit" in the consolidated statements of income.

       In November 2007, Union Carbide requested ARPC to review Union Carbide's 2007 asbestos claim and resolution activity and determine the appropriateness of updating its 2006 study. In response to that request, ARPC reviewed and analyzed data through October 31, 2007. In December 2007, ARPC stated that an update of its study would not provide a more likely estimate of future events than the estimate 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 December 31, 2007, Union Carbide's asbestos-related liability for pending and future claims was $1.1 billion.

       At December 31, 2007, approximately 31 percent of the recorded liability related to pending claims and approximately 69 percent related to future claims. At December 31, 2006, approximately 25 percent of the recorded liability related to pending claims and approximately 75 percent related to future claims.

Defense and Resolution Costs

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             Aggregate Costs
              to Date as of
In millions 2007   2006   2005   Dec. 31, 2007

 
Defense costs $84   $62   $75   $565
Resolution costs $88   $117   $139   $1,270

       The 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 a number of factors, including 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 expenses defense costs as incurred. The pretax impact for defense and resolution costs, net of insurance, was $84 million in 2007, $45 million in 2006 and $75 million in 2005, and was reflected in "Cost of sales."

Insurance Receivables

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. 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. The Wellington Agreement and other agreements with insurers are designed to facilitate an orderly resolution and collection of Union Carbide's insurance policies and to resolve issues that the insurance carriers may raise.

52


       In September 2003, Union Carbide filed a comprehensive insurance coverage case, now proceeding in the Supreme Court of the State of New York, County of New York, seeking to confirm its rights to insurance for various asbestos claims and to facilitate an orderly and timely collection of insurance proceeds. 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, in order to facilitate an orderly resolution and collection of such insurance policies and to resolve issues that the insurance carriers may raise. Although the lawsuit is continuing, through the end of 2007, Union Carbide has reached settlements with several of the carriers involved in this litigation.

       Union Carbide's receivable for insurance recoveries related to its asbestos liability was $467 million at December 31, 2007 and $495 million at December 31, 2006. At December 31, 2007 and December 31, 2006, all of the receivable for insurance recoveries was related to insurers that are not signatories to the Wellington Agreement and/or do not otherwise have agreements in place regarding their asbestos-related insurance coverage.

       In addition to the receivable for insurance recoveries related to its asbestos liability, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement as follows:


Receivables for Costs Submitted to Insurance Carriers
at December 31
In millions 2007   2006

Receivables for defense costs $18   $34
Receivables for resolution costs 253   266

Total $271   $300

       After a 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, Union Carbide continues to believe that its recorded receivable for insurance recoveries from all insurance carriers is probable of collection.

Summary

The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon current, known facts. However, future events, such as the number of new claims to be filed and/or received 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.

53


The Dow Chemical Company and Subsidiaries
PART II, Item 7A. 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 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.

       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.

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

       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 movement in the respective price levels. These amounts are immaterial in comparison to the size of the equity of the Company. The VAR methodology used by Dow is based primarily on a variance/covariance statistical model. The year-end VAR and average daily VAR for the aggregate of non-trading and trading positions for 2007 and 2006 are shown below:


Total Daily VAR at December 31* 2007   2006
In millions Year-end   Average   Year-end   Average

Foreign exchange $7   $5   $3   $4
Interest rate $57   $44   $34   $43
Equity exposures, net of hedges $15   $16   $9   $3
Commodities $17   $11   $14   $19

* Using a 95 percent confidence level

       See Note H to the Consolidated Financial Statements for further disclosure regarding market risk.

54


The Dow Chemical Company and Subsidiaries
PART II, Item 8. Financial Statements and Supplementary Data.


Management's Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control framework and processes are designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of financial reporting and the preparation of the Company's consolidated financial statements in accordance with accounting principles generally accepted in the United States of America.

       The Company's internal control over financial reporting includes those policies and procedures that:

       Because of its inherent limitations, any system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements.

       Management assessed the effectiveness of the Company's internal control over financial reporting and concluded that, as of December 31, 2007, such internal control is effective. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control – Integrated Framework.

       The Company's independent auditors, Deloitte & Touche LLP, with direct access to the Company's Board of Directors through its Audit Committee, have audited the consolidated financial statements prepared by the Company. Their report on the consolidated financial statements is included herein. Deloitte & Touche LLP's report on the Company's internal control over financial reporting is included in Part II, Item 9A. Controls and Procedures.

/s/  ANDREW N. LIVERIS      
Andrew N. Liveris
President, Chief Executive Officer and
Chairman of the Board
  /s/  GEOFFERY E. MERSZEI      
Geoffery E. Merszei
Executive Vice President and Chief Financial Officer

/s/  
WILLIAM H. WEIDEMAN      
William H. Weideman
Vice President and Controller

 

 

February 13, 2008

55


Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
The Dow Chemical Company:

We have audited the accompanying consolidated balance sheets of The Dow Chemical Company and subsidiaries (the "Company") as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15 (a) 2. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

       We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

       In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Dow Chemical Company and subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

       As discussed in Notes A and L to the consolidated financial statements, effective December 31, 2006, the Company changed its method of accounting for defined benefit pension and other postretirement plans to conform to Statement of Financial Accounting Standards No. 158.

       We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 14, 2008 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/  DELOITTE & TOUCHE LLP          

Deloitte & Touche LLP
Midland, Michigan
February 14, 2008
   

56


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

(In millions, except per share amounts) For the years ended December 31     2007     2006     2005  

 
Net Sales   $ 53,513   $ 49,124   $ 46,307  

 
  Cost of sales     46,400     41,526     38,276  
  Research and development expenses     1,305     1,164     1,073  
  Selling, general and administrative expenses     1,864     1,663     1,545  
  Amortization of intangibles     72     50     55  
  Restructuring charges     578     591     114  
  Purchased in-process research and development charges     57          
  Asbestos-related credit         177      
  Equity in earnings of nonconsolidated affiliates     1,122     959     964  
  Sundry income – net     324     137     755  
  Interest income     130     185     138  
  Interest expense and amortization of debt discount     584     616     702  

 
Income before Income Taxes and Minority Interests     4,229     4,972     6,399  

 
  Provision for income taxes     1,244     1,155     1,782  
  Minority interests' share in income     98     93     82  

 
Income before Cumulative Effect of Change in Accounting Principle     2,887     3,724     4,535  

 
  Cumulative effect of change in accounting principle             (20 )

 
Net Income Available for Common Stockholders   $ 2,887   $ 3,724   $ 4,515  

 
Share Data                    
  Earnings before cumulative effect of change in accounting principle per common share – basic   $ 3.03   $ 3.87   $ 4.71  
  Earnings per common share – basic   $ 3.03   $ 3.87   $ 4.69  
  Earnings before cumulative effect of change in accounting principle per common share – diluted   $ 2.99   $ 3.82   $ 4.64  
  Earnings per common share – diluted   $ 2.99   $ 3.82   $ 4.62  
  Common stock dividends declared per share of common stock   $ 1.635   $ 1.50   $ 1.34  
  Weighted-average common shares outstanding – basic     953.1     962.3     963.2  
  Weighted-average common shares outstanding – diluted     965.6     974.4     976.8  

 

See Notes to the Consolidated Financial Statements.

57


The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

(In millions, except share amounts) At December 31   2007     2006  

 
Assets  

 
Current Assets            
  Cash and cash equivalents $ 1,736   $ 2,757  
  Marketable securities and interest-bearing deposits   1     153  
  Accounts and notes receivable:            
    Trade (net of allowance for doubtful receivables – 2007: $118; 2006: $122)   5,944     4,988  
    Other   3,740     3,060  
  Inventories   6,885     6,058  
  Deferred income tax assets – current   348     193  

 
  Total current assets   18,654     17,209  

 
Investments            
  Investment in nonconsolidated affiliates   3,089     2,735  
  Other investments   2,489     2,143  
  Noncurrent receivables   385     288  

 
  Total investments   5,963     5,166  

 
Property            
  Property   47,708     44,381  
  Less accumulated depreciation   33,320     30,659  

 
  Net property   14,388     13,722  

 
Other Assets            
  Goodwill   3,572     3,242  
  Other intangible assets (net of accumulated amortization – 2007: $721; 2006: $620)   781     457  
  Deferred income tax assets – noncurrent   2,126     4,006  
  Asbestos-related insurance receivables – noncurrent   696     725  
  Deferred charges and other assets   2,621     1,054  

 
  Total other assets   9,796     9,484  

 
Total Assets $ 48,801   $ 45,581  

 
Liabilities and Stockholders' Equity  

 
Current Liabilities            
  Notes payable $ 1,548   $ 219  
  Long-term debt due within one year   586     1,291  
  Accounts payable:            
    Trade   4,555     3,825  
    Other   1,981     1,849  
  Income taxes payable   728     569  
  Deferred income tax liabilities – current   117     251  
  Dividends payable   418     382  
  Accrued and other current liabilities   2,512     2,215  

 
  Total current liabilities   12,445     10,601  

 
Long-Term Debt   7,581     8,036  

 
Other Noncurrent Liabilities            
  Deferred income tax liabilities – noncurrent   854     999  
  Pension and other postretirement benefits – noncurrent   3,014     3,094  
  Asbestos-related liabilities – noncurrent   1,001     1,079  
  Other noncurrent obligations   3,103     3,342  

 
  Total other noncurrent liabilities   7,972     8,514  

 
Minority Interest in Subsidiaries   414     365  

 
Preferred Securities of Subsidiaries   1,000     1,000  

 
Stockholders' Equity            
  Common stock (authorized 1,500,000,000 shares of $2.50 par value each;            
    issued 981,377,562 shares)   2,453     2,453  
  Additional paid-in capital   902     830  
  Retained earnings (includes cummulative effect of adopting FIN No. 48 of $(290))   18,004     16,987  
  Accumulated other comprehensive loss   (170 )   (2,235 )
  Treasury stock at cost (2007: 41,011,018 shares; 2006: 23,326,570 shares)   (1,800 )   (970 )

 
  Net stockholders' equity   19,389     17,065  

 
Total Liabilities and Stockholders' Equity $ 48,801   $ 45,581  

 

See Notes to the Consolidated Financial Statements.

58


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

(In millions) For the years ended December 31   2007     2006     2005  

 
Operating Activities                  
  Net Income Available for Common Stockholders $ 2,887   $ 3,724   $ 4,515  
  Adjustments to reconcile net income to net cash provided by operating activities:                  
      Cumulative effect of change in accounting principle           20  
      Depreciation and amortization   2,190     2,074     2,079  
      Purchased in-process research and development charges   57          
      Provision for deferred income tax   494     104     740  
      Earnings of nonconsolidated affiliates in excess of dividends received   (348 )   (343 )   (469 )
      Minority interests' share in income   98     93     82  
      Pension contributions   (183 )   (575 )   (1,031 )
      Net gain on sales of ownership interests in nonconsolidated affiliates           (732 )
      Net gain on sales of investments   (143 )   (19 )   (33 )
      Net gain on sales of property, businesses and consolidated companies   (108 )   (130 )   (56 )
      Other net gain   (75 )   (12 )   (29 )
      Restructuring charges   577     586     41  
      Asbestos-related credit       (177 )    
      Tax benefit – nonqualified stock option exercises           85  
      Excess tax benefits from share-based payment arrangements   (31 )   (11 )    
  Changes in assets and liabilities:                  
    Accounts and notes receivable   (1,002 )   242     (469 )
    Inventories   (712 )   (758 )   (240 )
    Accounts payable   799     (129 )   106  
    Other assets and liabilities   (16 )   (515 )   (135 )

 
  Cash provided by operating activities   4,484     4,154     4,474  

 
Investing Activities                  
  Capital expenditures   (2,075 )   (1,775 )   (1,597 )
  Proceeds from sales of property, businesses and consolidated companies   211     296     105  
  Acquisitions of businesses   (143 )        
  Purchase of previously leased assets   (30 )   (208 )   (263 )
  Investments in consolidated companies   (867 )   (111 )   (109 )
  Investments in nonconsolidated affiliates   (78 )   (103 )   (208 )
  Distributions from nonconsolidated affiliates   63     6     41  
  Proceeds from sales of ownership interests in nonconsolidated affiliates   30     10     956  
  Purchases of investments   (1,952 )   (1,405 )   (1,400 )
  Proceeds from sales and maturities of investments   1,983     1,383     1,379  

 
  Cash used in investing activities   (2,858 )   (1,907 )   (1,096 )

 
Financing Activities                  
  Changes in short-term notes payable   1,220     23     74  
  Payments on long-term debt   (1,354 )   (1,359 )   (1,559 )
  Proceeds from issuance of long-term debt   21         4  
  Purchases of treasury stock   (1,462 )   (739 )   (68 )
  Proceeds from sales of common stock   379     223     398  
  Excess tax benefits from share-based payment arrangements   31     11      
  Distributions to minority interests   (51 )   (57 )   (70 )
  Dividends paid to stockholders   (1,512 )   (1,404 )   (1,287 )

 
  Cash used in financing activities   (2,728 )   (3,302 )   (2,508 )

 
Effect of Exchange Rate Changes on Cash   81     6     (172 )

 
Summary                  
  Increase (Decrease) in cash and cash equivalents   (1,021 )   (1,049 )   698  
  Cash and cash equivalents at beginning of year   2,757     3,806     3,108  

 
  Cash and cash equivalents at end of year $ 1,736   $ 2,757   $ 3,806  

 

See Notes to the Consolidated Financial Statements.

59


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Stockholders' Equity

(In millions) For the years ended December 31     2007     2006     2005  

 
Common Stock                    
  Balance at beginning and end of year   $ 2,453   $ 2,453   $ 2,453  

 
Additional Paid-in Capital                    
  Balance at beginning of year     830     661     274  
  Stock-based compensation     72     169     387  

 
  Balance at end of year     902     830     661  

 
Unearned ESOP Shares                    
  Balance at beginning of year         (1 )   (12 )
  Shares allocated to ESOP participants         1     11  

 
  Balance at end of year             (1 )

 
Retained Earnings                    
  Balance at beginning of year     16,987     14,719     11,527  
  Net income     2,887     3,724     4,515  
  Dividends declared on common stock     (1,548 )   (1,438 )   (1,292 )
  Other     (32 )   (18 )   (31 )
  Impact of the adoption of FIN No. 48     (290 )        

 
  Balance at end of year     18,004     16,987     14,719  

 
Accumulated Other Comprehensive Loss                    
  Unrealized Gains on Investments at beginning of year     42     11     41  
    Unrealized gains (losses)     29     31     (30 )

 
    Balance at end of year     71     42     11  

 
  Cumulative Translation Adjustments at beginning of year     (12 )   (663 )   301  
    Translation adjustments     735     651     (964 )

 
    Balance at end of year     723     (12 )   (663 )

 
  Minimum Pension Liability at beginning of year         (1,312 )   (1,357 )
    Adjustments         1,147     45  

 
    Balance at end of year, prior to Dec. 31, 2006 adoption of SFAS No. 158         (165 )   (1,312 )

 
    Reversal of Minimum Pension Liability under SFAS No. 158         165      
    Recognition of prior service cost and net loss under SFAS No. 158         (2,192 )    
  Pension and Other Postretirement Benefit Plans at beginning of year     (2,192 )        
    Net prior service cost     (74 )        
    Net gain     1,277          

 
    Pension and Other Postretirement Benefit Plans at end of year     (989 )   (2,192 )    

 
  Accumulated Derivative Gain (Loss) at beginning of year     (73 )   15     38  
    Net hedging results     20     (127 )   227  
    Reclassification to earnings     78     39     (250 )

 
    Balance at end of year     25     (73 )   15  

 
  Total accumulated other comprehensive loss     (170 )   (2,235 )   (1,949 )

 
Treasury Stock                    
  Balance at beginning of year     (970 )   (559 )   (995 )
  Purchases     (1,455 )   (746 )   (68 )
  Issuance to employees and employee plans     625     335     504  

 
  Balance at end of year     (1,800 )   (970 )   (559 )

 
Net Stockholders' Equity   $ 19,389   $ 17,065   $ 15,324  

 

See Notes to the Consolidated Financial Statements.

60


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

(In millions) For the years ended December 31     2007     2006     2005  

 
Net Income Available for Common Stockholders   $ 2,887   $ 3,724   $ 4,515  

 
Other Comprehensive Income (Loss), Net of Tax (tax amounts shown below
    for 2007, 2006, 2005)
                   
  Unrealized gains (losses) on investments:                    
    Unrealized holding gains (losses) during the period
    (net of tax of $42, $30, $(7))
    70     61     (21 )
    Less: Reclassification adjustments for net amounts included in
    net income (net of tax of $(22), $(16), $(6))
    (41 )   (30 )   (9 )
  Cumulative translation adjustments (net of tax of $5, $(39), $(29))     735     651     (964 )
  Minimum pension liability adjustments (net of tax of $–, $657, $26)         1,147     45  
  Defined benefit pension plans:                    
    Prior service cost arising during period (net of tax of $(53))     (88 )        
    Net gain arising during period (net of tax of $630)     1,150          
    Less: Amortization of prior service cost included in net periodic
    pension costs (net of tax of $5)
    14          
    Less: Amortization of net loss included in net periodic pension
    costs (net of tax of $67)
    127          
  Net gains (losses) on cash flow hedging derivative instruments
    (net of tax of $14, $(39), $8)
    98     (88 )   (23 )

 
  Total other comprehensive income (loss)     2,065     1,741     (972 )

 
Comprehensive Income   $ 4,952   $ 5,465   $ 3,543  

 

See Notes to the Consolidated Financial Statements.

61


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


Table of Contents

Note     Page
  A   Summary of Significant Accounting Policies and Recent Accounting Pronouncements 62
  B   Restructuring 67
  C   Acquisitions 72
  D   Inventories 73
  E   Property 73
  F   Nonconsolidated Affiliates and Related Company Transactions 74
  G   Goodwill and Other Intangible Assets 76
  H   Financial Instruments 78
  I   Supplementary Information 82
  J   Commitments and Contingent Liabilities 83
  K   Notes Payable, Long-Term Debt and Available Credit Facilities 90
  L   Pension Plans and Other Postretirement Benefits 92
  M   Leased Property and Variable Interest Entities 97
  N   Stock-Based Compensation 97
  O   Limited Partnership 102
  P   Preferred Securities of Subsidiaries 102
  Q   Stockholders' Equity 102
  R   Income Taxes 103
  S   Operating Segments and Geographic Areas 106


NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Presentation

The accompanying 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 ("U.S. GAAP") and include the assets, liabilities, revenues and expenses of all majority-owned subsidiaries over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest or is the primary beneficiary. Intercompany transactions and balances are eliminated in consolidation. Investments in nonconsolidated affiliates (20-50 percent owned companies, joint ventures and partnerships) are accounted for on the equity basis.

       Certain reclassifications of prior years' amounts have been made to conform to the presentation adopted for 2007.

Use of Estimates in Financial Statement Preparation

The preparation of financial statements in accordance with U.S. GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The Company's consolidated financial statements include amounts that are based on management's best estimates and judgments. Actual results could differ from those estimates.

Foreign Currency Translation

The local currency has been primarily used as the functional currency throughout the world. Translation gains and losses of those operations that use local currency as the functional currency are included in the consolidated balance sheets as "Accumulated other comprehensive income (loss)" ("AOCI"). Where the U.S. dollar is used as the functional currency, foreign currency gains and losses are reflected in income.

62


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. These accruals are adjusted periodically as assessment and remediation efforts progress or as additional technical or legal information becomes available. Accruals for environmental liabilities are included in the consolidated balance sheets as "Other noncurrent obligations" at undiscounted amounts. Accruals for related insurance or other third-party recoveries for environmental liabilities are recorded when it is probable that a recovery will be realized and are included in the consolidated balance sheets as "Accounts and notes receivable – Other."

       Environmental costs are capitalized if the costs extend the life of the property, increase its capacity, and/or mitigate or prevent contamination from future operations. Environmental costs are also capitalized in recognition of legal asset retirement obligations resulting from the acquisition, construction and/or normal operation of a long-lived asset. Costs related to environmental contamination treatment and cleanup are charged to expense. Estimated future incremental operations, maintenance and management costs directly related to remediation are accrued when such costs are probable and reasonably estimable.

Cash and Cash Equivalents

Cash and cash equivalents include time deposits and readily marketable securities with original maturities of three months or less.

Financial Instruments

The Company calculates the fair value of financial instruments using quoted market prices whenever available. When quoted market prices are not available for various types of financial instruments (such as forwards, options and swaps), the Company uses standard pricing models with market-based inputs, which take into account the present value of estimated future cash flows.

       The Company utilizes derivative instruments to manage exposures to currency exchange rates, commodity prices and interest rate risk. The fair values of all derivative instruments are recognized as assets or liabilities at the balance sheet date. Changes in the fair value of these instruments are reported in income or AOCI, depending on the use of the derivative and whether it qualifies for hedge accounting treatment under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended and interpreted.

       Gains and losses on derivative instruments that qualify as cash flow hedges are recorded in AOCI, to the extent the hedges are effective, until the underlying transactions are recognized in income. To the extent effective, gains and losses on derivative and nonderivative instruments used as hedges of the Company's net investment in foreign operations are recorded in AOCI as part of the cumulative translation adjustment. The ineffective portions of cash flow hedges and hedges of net investment in foreign operations, if any, are recognized in income immediately.

       Gains and losses on derivative instruments designated and qualifying as fair value hedging instruments, as well as the offsetting losses and gains on the hedged items, are reported in income in the same accounting period. Derivative instruments not designated as hedges are marked-to-market at the end of each accounting period with the results included in income.

Inventories

Inventories are stated at the lower of cost or market. On January 1, 2006, the Company began using normal capacity of production facilities (as defined by SFAS No. 151, "Inventory Costs – an amendment of ARB No. 43, Chapter 4") to calculate per unit costs of inventories. Prior to 2006, the Company used nameplate capacity. By subsidiary, the method of determining cost varies among last-in, first-out ("LIFO"); first-in, first-out ("FIFO"); and average cost, and is used consistently from year to year.

Property

Land, buildings and equipment, including property under capital lease agreements, are carried at cost less accumulated depreciation. Depreciation is based on the estimated service lives of depreciable assets and is calculated using the straight-line method. For most assets capitalized through 1996, the declining balance method was used. Fully depreciated assets are retained in property and depreciation accounts until they are removed from service. In the case of disposals, assets and related depreciation are removed from the accounts, and the net amounts, less proceeds from disposal, are included in income.

Impairment and Disposal of Long-Lived Assets

The Company evaluates long-lived assets and certain identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When undiscounted future cash flows are not expected to be sufficient to recover an asset's carrying amount, the asset is written down to its fair value.

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       Long-lived assets to be disposed of other than by sale are classified as held and used until they are disposed of. Long-lived assets to be disposed of by sale are classified as held for sale and are reported at the lower of carrying amount or fair value less cost to sell, and depreciation is ceased.

Investments

Investments in debt and marketable equity securities, including warrants, are classified as trading, available-for-sale, or held-to-maturity. Investments classified as trading are reported at fair value with unrealized gains and losses included in income. Those classified as available-for-sale are reported at fair value with unrealized gains and losses recorded in AOCI. Those classified as held-to-maturity are recorded at amortized cost. The cost of investments sold is determined by specific identification.

       The excess of the cost of investments in subsidiaries over the values assigned to assets and liabilities is shown as goodwill and is subject to the impairment provisions of SFAS No. 142, "Goodwill and Other Intangible Assets." Absent any impairment indicators, recorded goodwill is tested for impairment in conjunction with the annual planning and budgeting process by comparing the fair value of each reporting unit, determined using a discounted cash flow method, with its carrying value.

Revenue

Sales are recognized when the revenue is realized or realizable, and has been earned, in accordance with the U.S. Securities and Exchange Commission's Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition in Financial Statements." Approximately 98 percent of the Company's sales are related to sales of product. The remaining 2 percent is related to the Company's service offerings, insurance operations, and licensing of patents and technology. Revenue for product sales is recognized as risk and title to the product transfer to the customer, which usually occurs at the time shipment is made. Substantially all of the Company's products are sold FOB (free on board) shipping point or, with respect to countries other than the United States, an equivalent basis. As such, title to the product passes when the product is delivered to the freight carrier. Dow's standard terms of delivery are included in its contracts of sale, order confirmation documents and invoices. Freight costs and any directly related associated costs of transporting finished product to customers are recorded as "Cost of sales."

       The Company's primary service offerings are in the form of contract manufacturing services and services associated with Dow AgroSciences' termite solution, SENTRICON™ Termite Colony Elimination System. Revenue associated with these service offerings is recognized when services are rendered, according to contractual agreements.

       Revenue related to the Company's insurance operations includes third-party insurance premiums, which are earned over the terms of the related insurance policies and reinsurance contracts. Revenue related to the initial licensing of patents and technology is recognized when earned; revenue related to running royalties is recognized according to licensee production levels.

Legal Costs

The Company expenses legal costs, including those legal costs expected to be incurred in connection with a loss contingency, as incurred.

Severance Costs

The Company routinely reviews its operations around the world in an effort to ensure competitiveness across its businesses and geographic areas. When the reviews result in a workforce reduction related to the shutdown of facilities or other optimization activities, severance benefits are provided to employees primarily under Dow's ongoing benefit arrangements. These severance costs are accrued (under SFAS No. 112, "Employers' Accounting for Postemployment Benefits – an amendment of FASB Statements No. 5 and 43") once management commits to a plan of termination including the number of employees to be terminated, their job classifications or functions, their location(s) and the expected completion date.

Income Taxes

The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities using enacted rates.

       Annual tax provisions include amounts considered sufficient to pay assessments that may result from examinations of prior year tax returns; however, the amount ultimately paid upon resolution of issues raised may differ from the amounts accrued.

       The Company recognizes the financial statement effects of an uncertain income tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. The Company accrues for other tax contingencies when it is probable that a liability to a taxing authority has been incurred and the amount of the contingency

64


can be reasonably estimated. The current portion of uncertain income tax positions is included in "Income taxes payable" and the long-term portion is included in "Other noncurrent obligations" in the consolidated balance sheets.

       Provision is made for taxes on undistributed earnings of foreign subsidiaries and related companies to the extent that such earnings are not deemed to be permanently invested.

Earnings per Common Share

The calculation of earnings per common share is based on the weighted-average number of the Company's common shares outstanding for the applicable period. The calculation for diluted earnings per common share reflects the effect of all potential dilutive common shares that were outstanding during the respective periods.

RECENT ACCOUNTING PRONOUNCEMENTS

Accounting for Uncertainty in Income Taxes

In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes," which clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 was effective for fiscal years beginning after December 15, 2006.

       On January 1, 2007, the Company adopted the provisions of FIN No. 48. The cumulative effect of adoption was a $290 million reduction of retained earnings. See Note R for further information on income taxes.

Accounting for Stock-Based Compensation

On January 1, 2006, the Company adopted revised SFAS No. 123 ("SFAS No. 123R"), "Share-Based Payment." The fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," and SFAS No. 123R were materially consistent under the Company's equity plans; therefore, adoption of this standard had an immaterial impact on the Company's consolidated financial statements.

       In November 2005, the FASB issued FASB Staff Position ("FSP") No. 123R-3, "Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards." The FSP, which became effective in November 2005, required an entity to follow either the transition guidance for the additional-paid-in-capital pool as prescribed in SFAS No. 123R or the alternative transition method described in the FSP. An entity that adopted SFAS No. 123R using the modified prospective application may make a one-time election to adopt the transition method described in the FSP, and may take up to one year from the latter of its initial adoption of SFAS No. 123R or the effective date of the FSP to evaluate the available transition alternatives and make its one-time election. The Company adopted the alternative transition method provided in the FSP for calculating the tax effects of stock-based compensation under SFAS No. 123R.

       See Note N for disclosures related to stock-based compensation.

Accounting for Asset Retirement Obligations

In March 2005, the FASB issued FIN No. 47, "Accounting for Conditional Asset Retirement Obligations," which clarifies the term conditional asset retirement obligation as used in SFAS No. 143, "Accounting for Asset Retirement Obligations," as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the Company. FIN No. 47 was effective for the Company on December 31, 2005.

       Dow has 150 manufacturing sites in 35 countries. Most of these sites contain numerous individual manufacturing operations, particularly at the Company's larger sites. Asset retirement obligations are recorded in the period in which they are incurred and reasonably estimable, including those obligations for which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the Company. Retirement of assets may involve such efforts as remediation and treatment of asbestos, contractually required demolition, and other related activities, depending on the nature and location of the assets, and are typically realized only upon demolition of those facilities. In identifying asset retirement obligations, the Company considers identification of legally enforceable obligations, changes in existing law, estimates of potential settlement dates and the calculation of an appropriate discount rate to be used in calculating the fair value of the obligations. Dow has a well-established global process to identify, approve and track the demolition of retired or to-be-retired facilities; no assets are retired from service until this process has been followed. Dow typically forecasts demolition projects based on the usefulness of the assets; environmental, health and safety concerns; and other similar considerations. Under this process, as demolition projects are identified and approved, reasonable estimates may

65


then be determined for the time frames during which any related asset retirement obligations are expected to be settled. For those assets where a range of potential settlement dates may be reasonably estimated, obligations are recorded.

       Assets that have not been submitted/reviewed for potential demolition activities are considered to have continued usefulness and are generally still operating "normally." Therefore, without a plan to demolish the assets or the expectation of a plan, such as shortening the useful life of assets for depreciation purposes under the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," Dow is unable to reasonably forecast a time frame to use for present value calculations. As such, Dow has not recognized obligations for individual plants/buildings at its 150 manufacturing sites where estimates of potential settlement dates cannot be reasonably made. In addition, the Company has not recognized conditional asset retirement obligations for the capping of its approximately 45 underground storage wells at Dow-owned sites when there are no plans or expectations of plans to exit the sites. Dow routinely reviews all changes to the list of items under consideration for demolition to determine if an adjustment to the value of the asset retirement obligation is required.

       Adoption of FIN No. 47 on December 31, 2005 resulted in the recognition of an asset retirement obligation of $34 million and a charge of $20 million (net of tax of $12 million), which was included in "Cumulative effect of change in accounting principle" in the fourth quarter of 2005. The discount rate used to calculate the Company's asset retirement obligations was 4.6 percent.

       If the amortization of asset retirement cost and accretion of asset retirement obligation provisions of FIN No. 47 had been in effect during 2005, the impact on "Income before Cumulative Effect of Change in Accounting Principle" and "Net Income Available for Common Stockholders" would have been immaterial. Further, the impact on earnings per common share (both basic and diluted) would have been less than $0.01.

       See Note J for the Company's disclosures related to asset retirement obligations.

Other Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs – an amendment of ARB No. 43, Chapter 4," which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and also requires that the allocation of fixed production overhead be based on the normal capacity of the production facilities. SFAS No. 151 was effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Because the Company previously used nameplate capacity to calculate product costs, the adoption of SFAS No. 151 on January 1, 2006 had an immaterial favorable impact on the Company's consolidated financial statements.

       In December 2004, the FASB issued FSP No. FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004," which provides a practical exception to the SFAS No. 109 requirement to reflect the effect of a new tax law in the period of enactment by allowing additional time beyond the financial reporting period to evaluate the effects on plans for reinvestment or repatriation of unremitted foreign earnings. The American Jobs Creation Act of 2004 (the "AJCA") introduced a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. In May 2005, tax authorities released the clarifying language necessary to enable the Company to finalize its plan for the repatriation and reinvestment of foreign earnings subject to the requirements of the AJCA, resulting in a credit of $113 million to "Provision for income taxes" in the second quarter of 2005.

       In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)." The Statement, which was effective December 31, 2006 for the Company, required employers to recognize the funded status of defined benefit postretirement plans as an asset or liability on the balance sheet and to recognize changes in that funded status through comprehensive income. See Note L for the impact of adopting the Statement.

SAB No. 74 Disclosures for Accounting Standards Issued But Not Yet Adopted

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures about fair value measurements. The Statement applies under other accounting pronouncements that require or permit fair value measurements and is effective for fiscal years beginning after November 15, 2007. The Company's existing fair value measurements are consistent with the guidance of the Statement. Therefore, adoption of the Statement on January 1, 2008, is not expected to have a material impact on the Company's consolidated financial statements in the first quarter of 2008. Since the Company uses a December 31 measurement date for its pension and other postretirement plans, the Company is still evaluating the impact of adopting the Statement for its plan assets.

       In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115," which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007, which was January 1, 2008 for the Company. The Company did not elect the fair value

66


option for existing eligible items under SFAS No. 159; therefore, the Statement had no impact on the Company's consolidated financial statements at January 1, 2008.

       In April 2007, the FASB issued FSP No. FIN 39-1, "Amendment of FASB Interpretation No. 39." This FSP replaces certain terms in FIN No. 39 with "derivative instruments" (as defined in SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities") and permits the offsetting of fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. The FSP is effective for fiscal years beginning after November 15, 2007. The Company evaluated the guidance in the FSP and determined that it will have no impact on the Company's consolidated financial statements at January 1, 2008.

       In December 2007, the FASB issued SFAS No. 141R, "Business Combinations". The Statement establishes revised principles and requirements for how the Company will recognize and measure assets and liabilities acquired in a business combination. The Statement is effective for business combinations completed on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which begins January 1, 2009 for the Company.

       In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51". The Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The Statement is effective on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which begins January 1, 2009 for the Company. The Company is currently evaluating the impact of adopting the Statement.


NOTE B – RESTRUCTURING

2007 Restructuring

On December 3, 2007, the Company's Board of Directors approved a restructuring plan that includes the shutdown of a number of assets and organizational changes within targeted support functions to improve the efficiency and cost effectiveness of the Company's global operations. As a result of these shutdowns and organizational changes, which are scheduled to be completed by the end of 2009, the Company recorded pretax restructuring charges totaling $590 million in the fourth quarter of 2007. The charges consisted of asset write-downs and write-offs of $422 million, costs associated with exit or disposal activities of $82 million and severance costs of $86 million. The impact of the charges is shown as "Restructuring charges" in the consolidated statements of income and was reflected in the Company's segment results as shown in the following table, which also reflects adjustments made in 2007 to the 2006 restructuring charges, as discussed in the section titled "2006 Restructuring":


 
2007 Restructuring Charges by Operating Segment  




In millions
  Impairment of
Long-Lived Assets,
Other Intangible
Assets and Equity
Investments
 

Costs associated
with Exit or
Disposal Activities
 


Severance
Costs
 



Total
 

 
Performance Plastics   $153   $31     $184  
Performance Chemicals   81   4     85  
Agricultural Sciences   58   19     77  
Basic Plastics   88       88  
Basic Chemicals   7       7  
Hydrocarbons and Energy   31   13     44  
Unallocated and Other   4   15   $86   105  

 
Total restructuring charges related to 2007 plan   $422   $82   $86   $590  

 
Adjustments to 2006 restructuring charges:                  
  Performance Plastics     (4)     (4 )
  Unallocated and Other       (8 ) (8 )

 
Net 2007 Restructuring Charges   $422   $78   $78   $578  

 

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Details regarding the components of the 2007 restructuring charges are discussed below:

Impairment of Long-Lived Assets, Other Intangible Assets and Equity Investments

The restructuring charges related to the write-down or write-off of assets and equity investments in 2007 totaled $422 million and included the impact of plant closures and impairments of $273 million. The most significant plant write-downs affected Dow's facilities located in Lauterbourg, France; Camaçari, Brazil; Aratu, Brazil; Tarragona, Spain; Hahnville, Louisiana; and Berre, France; and assets related to the exit of the automotive sealants business in North America, Latin America and Asia Pacific. Details regarding these write-downs are as follows:

       In addition to the write-downs described above, the restructuring charges for plant closures included $66 million related to the shutdown of several small production facilities and the closure of certain storage wells in Canada.

       The restructuring charges in the fourth quarter of 2007 also included the write-down of investments in nonconsolidated affiliates of $99 million. The most significant write-downs were related to the Company's investment in Pétromont and Company, Limited Partnership ("Pétromont") and Dow Reichhold Specialty Latex LLC. Details regarding these write-downs are as follows:

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       In addition to the write-downs described above, the restructuring charges for investments in nonconsolidated affiliates included $11 million related to the dissolution of two smaller joint ventures.

       The restructuring charges in the fourth quarter of 2007 also included the write-off of capital project spending ($37 million), and trademarks and patents ($2 million) which the Company determined to be of no further value; as well as spare parts and catalysts ($11 million) associated with the plant closures. These write-offs were principally related to the businesses involved in the shutdown of assets and were therefore reflected in the results of various operating segments.

Costs Associated with Exit or Disposal Activities

The restructuring charges for costs associated with exit or disposal activities totaled $82 million in 2007 and included contract termination fees of $53 million, pension curtailment costs and termination benefits of $15 million, environmental remediation of $7 million and $7 million of other related costs.

       Contract termination fees of $53 million represent the Company's best estimate of the fair value to negotiate the settlement of the early cancellation of several service and supply agreements principally related to the shutdown of manufacturing assets within the Performance Plastics and Agricultural Sciences segments.

Severance Costs

As a result of the Company's decision to shut down assets around the world, and complete other workforce optimization activities, the restructuring charges recorded in 2007 included severance of $86 million for the separation of approximately 978 employees under the terms of Dow's ongoing benefit arrangements, primarily over the next two years. These costs were charged against Unallocated and Other. At December 31, 2007, severance of approximately $1 million had been paid to 12 employees and a liability of $85 million remained for approximately 966 employees.

       The following table summarizes the activities related to the Company's restructuring reserve:


 
2007 Restructuring Activities




In millions
Impairment of
Long-Lived
Assets,
Other Intangible
Assets and Equity
Investments
  Costs associated
with
Exit or Disposal
Activities
  Severance
Costs
  Total  

 
Restructuring charges incurred in
the fourth quarter of 2007
$ 422   $82   $86   $ 590  
Cash payments     (1 ) (1 )
Charges against reserve (422 ) (3 )   (425 )

 
Reserve balance at December 31, 2007   $79   $85   $ 164  

 

       Dow expects to incur future costs related to its restructuring activities, as the Company continually looks for ways to enhance the efficiency and cost effectiveness of its operations, and to ensure competitiveness across its businesses and across geographic areas. Future costs are expected to include demolition costs related to the closed facilities, which will be recognized as incurred. The Company also expects to incur additional employee-related costs, including involuntary termination benefits, related to its other optimization activities, and pension plan settlement costs. These costs cannot be reasonably estimated at this time.

2006 Restructuring

On August 29, 2006, the Company's Board of Directors approved a plan to shut down a number of assets around the world as the Company continued its drive to improve the competitiveness of its global operations. As a consequence of these shutdowns, which are scheduled to be completed by the first quarter of 2009, and other optimization activities, the Company recorded pretax restructuring charges totaling $591 million in 2006. The charges consisted of asset write-downs and write-offs of $346 million, costs associated with exit or disposal activities of $172 million and severance costs of $73 million. The impact of the charges is shown as "Restructuring charges" in the consolidated statements of income and was reflected in the Company's segment results as follows:

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2006 Restructuring Charges by Operating Segment


In millions
Impairment of
Long-Lived Assets
and Other
Intangible Assets
  Costs associated
with
Exit or Disposal
Activities
  Severance
Costs
  Total

Performance Plastics $174   $68     $242
Performance Chemicals 10   2     12
Basic Plastics 15   1     16
Basic Chemicals 129   55     184
Unallocated and Other 18   46   $73   137

Total $346   $172   $73   $591

       Details regarding the components of the restructuring charges are discussed below:

Impairment of Long-Lived Assets and Other Intangible Assets

The restructuring charges related to the write-down or write-off of assets in 2006 totaled $346 million and included the impact of plant closures of $269 million. The most significant plant closures affected Dow's facilities in Porto Marghera, Italy, and Fort Saskatchewan, Alberta, and Sarnia, Ontario, Canada. Details regarding these shutdowns are as follows:

       In addition to the larger shutdowns described above, the restructuring charges for plant closures included $56 million related to the shutdown of several small production facilities, a terminal, and a research and development facility.

       The restructuring charges in the third quarter of 2006 also included the write-off of capital project spending ($47 million) and technology assets ($18 million) which the Company determined to be of no further value, as well as spare parts and catalysts ($12 million) associated with the plant closures. These write-offs were principally related to the businesses involved in the shutdown of assets and were therefore reflected in the results of various operating segments.

Costs Associated with Exit or Disposal Activities

The restructuring charges for costs associated with exit or disposal activities totaled $172 million in 2006 and included contract termination fees of $65 million, environmental remediation of $60 million, pension curtailment costs and termination benefits of $33 million, and asbestos abatement of $14 million.

       Contract termination fees of $65 million represented the Company's best estimate of the fair value to negotiate the settlement of the early cancellation of several supply agreements principally related to the shutdown of manufacturing assets primarily within the Performance Plastics segment. In the second quarter of 2007, the Company reached agreements with

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certain suppliers regarding the early cancellation of supply agreements, resulting in a $4 million reduction of the restructuring reserve for contract termination fees. The adjustment was credited against the Performance Plastics segment.

       The restructuring charges for environmental remediation of $60 million and asbestos abatement of $14 million principally related to the shutdown of the Company's facilities in Canada. The charges were therefore reflected in various operating segments.

       According to the restructuring plan for Canada, the chlor-alkali and direct chlorination ethylene dichloride plants in Fort Saskatchewan were shut down at the end of October 2006; the Sarnia site will cease all production by the end of the first quarter of 2009. As such, for purposes of calculating the Company's obligation associated with Dow's defined benefit plans in Canada, the expected years of future service of active employees has been significantly reduced. In addition, the Company is obligated to provide certain termination benefits. As a result, the restructuring charge included pension curtailment costs and termination benefits of $33 million in 2006. These costs were reflected in Unallocated and Other.

Severance Costs

As a result of the Company's plans to shut down assets around the world, and conduct other optimization activities principally in Europe, the restructuring charges recorded in 2006 included severance of $73 million for the separation of approximately 810 employees under the terms of Dow's ongoing benefit arrangements, primarily over two years. These costs were charged against Unallocated and Other. At December 31, 2006, severance of $4 million had been paid to 115 employees and a liability of $69 million remained for approximately 695 employees. During 2007, severance of $25 million was paid to 245 employees, bringing the total payments against the program to $29 million paid to 360 employees. In the fourth quarter of 2007, a reduction of $8 million was recorded against the estimated program costs. At December 31, 2007, a liability of $39 million (including foreign currency impact) remained for approximately 410 employees.

       The following table summarizes the activities related to the Company's restructuring reserve:


 
2006 Restructuring Activities


In millions
Impairment of
Long-Lived Assets
and Other
Intangible Assets
  Costs associated
with
Exit or Disposal
Activities
  Severance
Costs
  Total  

 
Restructuring charges incurred in
the third quarter of 2006
$ 327   $171   $ 81   $ 579  
Adjustments to reserve 19   1   (8 ) 12  
Cash payments   (1 ) (4 ) (5 )
Charges against reserve (346 )     (346 )

 
Reserve balance at December 31, 2006   $171   $ 69   $ 240  
Adjustments to reserve   (4 ) (8 ) (12 )
Cash payments   (53 ) (25 ) (78 )
Foreign currency impact   21   3   24  

 
Reserve balance at December 31, 2007   $135   $ 39   $ 174  

 

2005 Restructuring

In the fourth quarter of 2005, the Company recorded pretax charges totaling $114 million related to restructuring activities, as the Company continued to focus on financial discipline and made additional decisions regarding noncompetitive and underperforming assets, as well as decisions regarding the consolidation of manufacturing capabilities. The charges included costs of $67 million related to the closure of approximately 20 small plants around the world, losses of $12 million on asset sales, the write-off of an intangible asset of $10 million and employee-related expenses of $25 million (paid to 197 employees in the fourth quarter of 2005). The total of these charges is shown as "Restructuring charges" in the consolidated statements of income. The charges were recorded against the Company's operating segments as follows: $28 million against Performance Plastics, $14 million against Performance Chemicals, $9 million against Agricultural Sciences, $12 million against Basic Plastics and $3 million against Basic Chemicals. Charges to Unallocated and Other amounted to $48 million.

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NOTE C – ACQUISITIONS

Acquisition of Wolff Walsrode

Consistent with the Company's strategy to invest in its Performance businesses, the Company announced on December 18, 2006, that it had reached an agreement with the Bayer Group to acquire Wolff Walsrode AG and certain related affiliates and assets ("Wolff Walsrode"), subject to regulatory approval. Wolff Walsrode, headquartered in Bomlitz, Germany, specializes in cellulose derivatives, food casings and site services. Following approval from the European Commission on June 20, 2007, Dow acquired Wolff Walsrode on June 30, 2007 for a cash purchase price of approximately $603 million.

       On July 2, 2007, the Company announced the creation of a new specialty business unit, Dow Wolff Cellulosics, which combined the newly acquired Wolff Walsrode with Dow's Water Soluble Polymers business. Dow Wolff Cellulosics will encompass cellulosics and related chemistries, providing application formulation expertise and other technical services to a broad range of strategic industry sectors, including construction, paint, personal care, pharmaceuticals, food and a number of specialty industrial applications.

       The following table summarizes the values of the assets acquired and liabilities assumed at the date of the acquisition, as well as adjustments that have been made primarily as a result of final valuations.


Assets Acquired and Liabilities Assumed
In millions
  At June 30,
2007
  Purchase Price
Adjustments 
(1)
  At Dec. 31,
2007

Current assets   $188   $15   $203
Property   233   89   322
Goodwill (2)   364   (163 ) 201
Other intangible assets (2)   8   148   156
Other assets   11   (5 ) 6

Total assets acquired   $804   $84   $888

Accounts payable   $27     $27
Long-term debt   10     10
Accrued and other liabilities   47   $(5 ) 42
Pension benefits   117   (11 ) 106
Deferred tax liabilities – noncurrent     88   88

Total liabilities assumed   $201   $72   $273

Net assets acquired   $603   $12   $615

(1)
Includes a $7 million write-off of purchased in-process research and development, the addition of transaction costs of $7 million in the second half of 2007 and $12 million of working capital adjustments.
(2)
See Note G for additional information.

       The Company evaluated the materiality of assets acquired, liabilities assumed and results of operations, individually and in the aggregate, and concluded that such assets, liabilities and results of operations were not material to the consolidated financial statements.

       Beginning in the third quarter of 2007, the results of Wolff Walsrode's operations were reflected in the Company's consolidated income statement.

Purchased In-Process Research and Development

Purchased in-process research and development ("IPR&D") represents the value assigned in a business combination to acquired research and development projects that, as of the date of the acquisition, had not established technological feasibility and had no alternative future use. Amounts assigned to IPR&D meeting these criteria must be charged to expense as part of the allocation of the purchase price of the business combination.

       The Company recorded pretax charges totaling $57 million in 2007 for IPR&D projects associated with several recent acquisitions. The estimated values assigned to the IPR&D projects were determined primarily based on a discounted cash flow model and are shown below:

72



In-Process Research and Development Projects Acquired

In millions
  Date of Acquisition   Estimated
Value Assigned
to IPR&D

Germplasm from Maize Technologies International   May 1, 2007   $2
Manufacturing process R&D from Wolff Walsrode   June 30, 2007   7
Germplasm from Agromen Tecnologia Ltda.   August 1, 2007   26
Germplasm from Duo Maize   August 30, 2007   3
Intellectual property for crop trait discovery from Exelixis
    Plant Sciences
  September 4, 2007   19

Total       $57

       The 2007 charges were shown as "Purchased in-process research and development charges" in the consolidated statements of income. IPR&D of $50 million related to projects within the Agricultural Sciences segment. The $7 million charge related to IPR&D acquired from Wolff Walsrode impacted the results of the Performance Chemicals segment.


NOTE D – INVENTORIES

The following table provides a breakdown of inventories:


Inventories at December 31        
In millions   2007   2006

Finished goods   $4,085   $3,498
Work in process   1,595   1,319
Raw materials   566   672
Supplies   639   569

Total inventories   $6,885   $6,058

       The reserves reducing inventories from a FIFO basis to a LIFO basis amounted to $1,511 million at December 31, 2007 and $1,092 million at December 31, 2006. Inventories valued on a LIFO basis, principally hydrocarbon and U.S. chemicals and plastics product inventories, represented 34 percent of the total inventories at December 31, 2007 and 38 percent of total inventories at December 31, 2006.

       A reduction of certain inventories resulted in the liquidation of some of the Company's LIFO inventory layers, increasing pretax income $321 million in 2007, $97 million in 2006 and $110 million in 2005.


NOTE E – PROPERTY


Property at December 31   Estimated        
  
In millions
  Useful Lives
(Years)
   
2007
   
2006

Land     $602   $582
Land and waterway improvements   15-25   1,286   1,206
Buildings   5-55   3,717   3,376
Machinery and equipment   3-20   36,266   33,457
Utility and supply lines   5-20   2,253   2,133
Other property   3-30   1,770   1,982
Construction in progress     1,814   1,645

Total property       $47,708   $44,381


 

 

 

 

 

 

 

In millions   2007   2006   2005

Depreciation expense   $1,959   $1,904   $1,904
Manufacturing maintenance and repair costs   $1,482   $1,376   $1,289
Capitalized interest   $85   $73   $56

73



NOTE F – NONCONSOLIDATED AFFILIATES AND RELATED COMPANY TRANSACTIONS

The Company's investments in related companies accounted for by the equity method ("nonconsolidated affiliates") were $3,089 million at December 31, 2007 and $2,735 million at December 31, 2006. At December 31, 2007, the carrying amount of the Company's investments in nonconsolidated affiliates was $64 million more than its share of the investees' net assets, exclusive of Dow Corning Corporation ("Dow Corning"), MEGlobal, Equipolymers and EQUATE Petrochemical Company K.S.C. ("EQUATE"), which are discussed separately below. This difference was $65 million at December 31, 2006. Dividends received from the Company's nonconsolidated affiliates were $774 million in 2007, $616 million in 2006 and $495 million in 2005.

       On May 15, 1995, Dow Corning, in which the Company is a 50 percent shareholder, voluntarily filed for protection under Chapter 11 of the U.S. Bankruptcy Code (see Note J). As a result, the Company fully reserved its investment in Dow Corning and reserved its 50 percent share of equity earnings from that time through the third quarter of 2000. A difference between the Company's 50 percent share of the underlying equity of Dow Corning and the carrying value of this investment has existed since May 1995. In November 2000, following affirmation of the Bankruptcy Court's order confirming the Joint Plan of Reorganization (the "Joint Plan"), the Company reviewed the value of its investment in Dow Corning, revised its assessment of the recoverability of its investment, and determined that it had adequately provided for the other-than-temporary decline associated with the bankruptcy. On June 1, 2004, Dow Corning's Joint Plan became effective and Dow Corning emerged from bankruptcy. The Company considers the difference between the carrying value of its investment in Dow Corning and its 50 percent share of Dow Corning's equity to be permanent. The difference was $227 million at December 31, 2007 and December 31, 2006.

       At December 31, 2007, the Company's investment in MEGlobal was $274 million less than the Company's proportionate share of MEGlobal's underlying net assets ($281 million less at December 31, 2006). This amount represents the difference between the value of certain assets of the joint venture and the Company's related valuation on a U.S. GAAP basis, of which $84 million is being amortized over the remaining useful lives of the assets and $190 million represents the Company's share of the joint venture's goodwill.

       At December 31, 2007, the Company's investment in Equipolymers was $48 million less than the Company's proportionate share of Equipolymers' underlying net assets ($49 million less at December 31, 2006). This amount represents the difference between the value of certain assets of the joint venture and the Company's related valuation on a U.S. GAAP basis, of which $11 million is being amortized over the remaining useful lives of the assets and $37 million represents the Company's share of the joint venture's goodwill.

       At December 31, 2007, the Company's investment in EQUATE equaled its proportionate share of the underlying net assets (and was $17 million less at December 31, 2006). The $17 million difference at December 31, 2006 represented the difference between EQUATE's value of certain assets and the Company's related valuation on a U.S. GAAP basis and was fully amortized in 2007.

       In November 2004, Union Carbide Corporation ("Union Carbide") sold a 2.5 percent interest in EQUATE to National Bank of Kuwait for $104 million. In March 2005, these shares were sold to private Kuwaiti investors thereby completing the restricted transfer and reducing Union Carbide's ownership interest from 45 percent to 42.5 percent. A pretax gain of $70 million was recorded in the first quarter of 2005 related to the sale of these shares.

       On January 3, 2005, the Company and E.I. du Pont de Nemours and Company ("DuPont") announced that the Company had exercised its option to acquire certain assets relating to ethylene elastomers and chlorinated elastomers from DuPont Dow Elastomers L.L.C. ("DDE"), including ENGAGE™, NORDEL™ and TYRIN™ elastomers, through an equity redemption transaction involving the Company's equity interest in DDE. As a result of this option exercise, DuPont purchased the Company's remaining equity interest in DDE for $87 million; the dissolution of the joint venture, which was completed on June 30, 2005, resulted in a pretax gain of $31 million in the second quarter of 2005. The Company decreased its investment in nonconsolidated affiliates and recorded $324 million in net property, $122 million in inventories, and $48 million in other net assets.

       On November 30, 2005, Union Carbide completed the sale of its indirect 50 percent interest in UOP LLC ("UOP") to a wholly owned subsidiary of Honeywell International, Inc. for a purchase price of $867 million, resulting in a pretax gain of $637 million in the fourth quarter of 2005.

       All of the nonconsolidated affiliates in which the Company has investments are privately held companies; therefore, quoted market prices are not available.

74


Principal Nonconsolidated Affiliates

Dow's principal nonconsolidated affiliates and the Company's direct or indirect ownership interest for each at December 31, 2007, 2006 and 2005 are shown below:


Principal Nonconsolidated Affiliates at December 31   Ownership Interest
    2007   2006   2005

Compañía Mega S.A.   28%   28%   28%
Dow Corning Corporation   50%   50%   50%
EQUATE Petrochemical Company K.S.C.   42.5%   42.5%   42.5%
Equipolymers   50%   50%   50%
MEGlobal   50%   50%   50%
The OPTIMAL Group of Companies:            
  OPTIMAL Chemicals (Malaysia) Sdn Bhd   50%   50%   50%
  OPTIMAL Glycols (Malaysia) Sdn Bhd   50%   50%   50%
  OPTIMAL Olefins (Malaysia) Sdn Bhd   23.75%   23.75%   23.75%
The SCG-Dow Group:            
  Pacific Plastics (Thailand) Limited   49%   49%   49%
  Siam Polyethylene Company Limited   49%   49%   49%
  Siam Polystyrene Company Limited   49%   49%   49%
  Siam Styrene Monomer Co., Ltd.   49%   49%   49%
  Siam Synthetic Latex Company Limited   49%   49%   49%
Univation Technologies, LLC   50%   50%   50%

       The Company's investment in its principal nonconsolidated affiliates was $2,488 million at December 31, 2007 and $2,107 million at December 31, 2006. Equity earnings from these companies were $1,072 million in 2007, $883 million in 2006 and $893 million in 2005. The summarized financial information presented below represents the combined accounts (at 100 percent) of the principal nonconsolidated affiliates.


 
Summarized Balance Sheet Information at December 31  
In millions   2007   2006  

 
Current assets       $6,943   $5,795  
Noncurrent assets       9,669   7,574  

 
Total assets       $16,612   $13,369  

 
Current liabilities       $3,165   $2,505  
Noncurrent liabilities       6,700   4,858  

 
Total liabilities       $9,865   $7,363  

 

 

 

 

 

 

 

 

 

 
Summarized Income Statement Information  
In millions   2007   2006   2005 (1)

 
Sales   $13,884   $11,916   $12,834  
Gross profit   $3,492   $3,168   $3,129  
Net income   $2,464   $1,960   $1,993  

 
(1)   The summarized income statement information for 2005 includes the results for DDE from January 1, 2005 through June 30, 2005, and the results for UOP from January 1, 2005 through November 30, 2005.

       The Company has service agreements with some of these entities, including contracts to manage the operations of manufacturing sites and the construction of new facilities; licensing and technology agreements; and marketing, sales, purchase and lease agreements.

       Excess ethylene glycol produced in Dow's plants in the United States and Europe is sold to MEGlobal and represented 2 percent of total net sales in 2007, 2006 and 2005. In addition, the Company sells ethylene to MEGlobal as a raw material for its ethylene glycol plants in Canada. The impact of these sales to MEGlobal by operating segment is summarized below:

75



Impact of Sales to MEGlobal by Operating Segment
Percent of segment sales   2007   2006   2005

Basic Chemicals   16%   15%   15%
Hydrocarbons and Energy   4%   4%   4%

       Overall, transactions with other nonconsolidated affiliates and balances due to and due from these entities were not material to the consolidated financial statements.


NOTE G – GOODWILL AND OTHER INTANGIBLE ASSETS

The following table shows changes in the carrying amount of goodwill for the year ended December 31, 2007, by operating segment:


 
Goodwill
In millions
  Performance
Plastics
  Performance
Chemicals
  Agricultural
Sciences
  Basic
Plastics
  Hydrocarbons
and Energy
 
Total
 

 
Balance at January 1, 2007   $915   $850   $1,320   $94   $63   $3,242  
Goodwill related to 2007
    acquisitions of:
                         
  Additional 50% interest in
Styron Asia Limited
        6     6  
  Hyperlast Limited   71           71  
  Wolff Walsrode     201         201  
  Agromen Tecnologia Ltda       59       59  
  GNS Technologies, LLC   8           8  
  Poly-Carb, Inc.   7           7  
  Edulan A/S   17           17  
  UPPC AG   21           21  
  Other   (5 ) (4 ) 1       (8 )
Adjustments to goodwill related to 2006 acquisition of Zhejiang Omex Environmental Engineering Co. LTD     (52 )       (52 )

 
Balance at December 31, 2007   $1,034   $995   $1,380   $100   $63   $3,572  

 

       On May 1, 2007, Dow Chemical Company Limited, a wholly owned subsidiary of the Company, acquired Hyperlast Limited, British Vita's polyurethane systems business, for $151 million. The recording of the acquisition resulted in goodwill of $71 million and intangible assets of $62 million as shown below. None of the goodwill is expected to be deductible for tax purposes.


Hyperlast Limited Intangible Assets
  
In millions
  Gross Carrying
Amount
  Weighted-average
Amortization
Period

Intangible assets with finite lives:        
  Trademarks   $10   15 years
  Other (customer-related)   52   14 years

  Total   $62   14 years

       On June 30, 2007, the Company completed the acquisition of Wolff Walsrode. The recording of the acquisition resulted in goodwill of $201 million and intangible assets of $156 million as shown below. None of the goodwill is expected to be deductible for tax purposes. See Note C for additional information related to purchase price adjustments.

76



Wolff Walsrode Intangible Assets

In millions
  Estimated
Gross Carrying
Amount
  Weighted-average
Amortization
Period

Intangible assets with finite lives:        
  Intellectual property   $46   10 years
  Trademarks   6   10 years
  Software   7   5 years
  Other (customer-related)   97   5 years

  Total   $156   7 years

       On July 11, 2006, FilmTec Corporation, a wholly owned subsidiary of the Company, completed the acquisition of Zhejiang Omex Environmental Engineering Co. LTD ("Omex"). The initial recording of the acquisition resulted in goodwill of $100 million, none of which is expected to be deductible for tax purposes. In the second quarter of 2007, the Company completed the purchase price allocation related to the acquisition of Omex, resulting in the recording of $51 million of intangible assets as follows:


Omex Intangible Assets

In millions
  Gross Carrying
Amount
  Weighted-average
Amortization
Period

Intangible assets with finite lives:        
  Trademarks   $23   10 years
  Patents   19   17 years
  Other   9   2-5 years

  Total   $51   11 years

       On August 1, 2007, Dow AgroSciences acquired the corn seed business of Agromen Tecnologia Ltda for $116 million. The recording of the acquisition resulted in goodwill of $59 million and intellectual property of $14 million with a weighted-average amortization period of six years. All of the goodwill is expected to be deductible for tax purposes.

Goodwill Impairments

During the fourth quarter of 2007, the Company performed impairment tests for goodwill in conjunction with its annual long-term financial planning process. As a result of this review, it was determined that no goodwill impairments existed.

Other Intangible Assets

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


Other Intangible Assets at December 31   2007
  2006
  
  
In millions
  Gross
Carrying
Amount
   
Accumulated
Amortization
   
  
Net
  Gross
Carrying
Amount
    
Accumulated
Amortization
   
 
Net

Intangible assets with finite lives:                        
  Licenses and intellectual property   $302   $(165 ) $137   $234   $(142 ) $92
  Patents   145   (104 ) 41   148   (117 ) 31
  Software   575   (318 ) 257   452   (269 ) 183
  Trademarks   173   (51 ) 122   133   (40 ) 93
  Other   307   (83 ) 224   110   (52 ) 58

  Total other intangible assets   $1,502   $(721 ) $781   $1,077   $(620 ) $457

       During 2007, the Company acquired software for $31 million. The weighted-average amortization period for the acquired software is five years.

       In 2006, the Company wrote off obsolete technology assets (from "Licenses and intellectual property" in the above table) with a net book value of $18 million in conjunction with other restructuring activities (see Note B). The write-off was included in "Restructuring charges" in the consolidated statements of income and reflected in the Performance Plastics segment ($15 million) and Unallocated and Other ($3 million).

77


       In 2005, following a review of non-strategic and underperforming assets, the Company wrote off the $10 million net book value of other intangible assets received in a 1992 acquisition. The charge was included in "Restructuring charges" in Unallocated and Other.

       The following table provides information regarding amortization expense:


Amortization Expense            
In millions   2007   2006   2005

Other intangible assets, excluding software   $72   $50   $55
Software, included in "Cost of sales"   $47   $45   $45

       Total estimated amortization expense for the next five fiscal years is as follows:


Estimated Amortization Expense
for Next Five Years
In millions

2008   $130
2009   $121
2010   $118
2011   $107
2012   $77


NOTE H – FINANCIAL INSTRUMENTS

Investments

The Company's investments in marketable securities are primarily classified as available-for-sale.


 
Investing Results              
In millions   2007   2006   2005  

 
Proceeds from sales of available-for-sale securities   $1,994   $1,305   $1,180  
Gross realized gains   $137   $55   $52  
Gross realized losses   $(23 ) $(42 ) $(19 )

 

       The following table summarizes the contractual maturities of the Company's investments in debt securities:


Contractual Maturities of Debt Securities
at December 31, 2007
In millions   Amortized Cost   Fair Value

Within one year   $168   $168
One to five years   415   424
Six to ten years   655   681
After ten years   262   280

Total   $1,500   $1,553

78



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Fair Value of Financial Instruments at December 31                  
    2007
  2006
 
In millions   Cost   Gain   Loss   Fair Value   Cost   Gain   Loss   Fair Value