UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended SEPTEMBER 30, 2007

 

Commission File Number:  1-3433

 

THE DOW CHEMICAL COMPANY

(Exact name of registrant as specified in its charter)

 

Delaware

 

38-1285128

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

 

 

2030 DOW CENTER, MIDLAND, MICHIGAN 48674

(Address of principal executive offices) (Zip Code)

 

 

 

989-636-1000

(Registrant’s telephone number, including area code)

 

 

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                    x Yes   o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes   x No

 

Class

 

Outstanding at September 30, 2007

Common Stock, par value $2.50 per share

 

944,397,632 shares

 

 



 

The Dow Chemical Company

 

QUARTERLY REPORT ON FORM 10-Q

For the quarterly period ended September 30, 2007

 

TABLE OF CONTENTS

 

 

 

PAGE

PART I – FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

Financial Statements.

 

3

 

 

 

 

 

Consolidated Statements of Income

 

3

 

 

 

 

 

Consolidated Balance Sheets

 

4

 

 

 

 

 

Consolidated Statements of Cash Flows

 

5

 

 

 

 

 

Consolidated Statements of Comprehensive Income

 

6

 

 

 

 

 

Notes to the Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

26

 

 

 

 

 

Disclosure Regarding Forward-Looking Information

 

26

 

 

 

 

 

Results of Operations

 

26

 

 

 

 

 

Changes in Financial Condition

 

34

 

 

 

 

 

Other Matters

 

35

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

 

39

 

 

 

 

Item 4.

Controls and Procedures.

 

40

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

 

Item 1.

Legal Proceedings.

 

41

 

 

 

 

Item 1A.

Risk Factors.

 

41

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

 

41

 

 

 

 

Item 6.

Exhibits.

 

41

 

 

 

 

SIGNATURE

 

43

 

 

 

EXHIBIT INDEX

 

44

 

2



 

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

 

The Dow Chemical Company and Subsidiaries

Consolidated Statements of Income

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 30,

 

Sept. 30,

 

Sept. 30,

 

Sept. 30,

 

In millions, except per share amounts (Unaudited)

 

2007

 

2006

 

2007

 

2006

 

Net Sales

 

$

13,589

 

$

12,359

 

$

39,286

 

$

36,888

 

Cost of sales

 

11,864

 

10,600

 

33,867

 

31,027

 

Research and development expenses

 

329

 

291

 

951

 

856

 

Selling, general and administrative expenses

 

476

 

420

 

1,371

 

1,210

 

Amortization of intangibles

 

22

 

13

 

51

 

37

 

Restructuring charges (credit)

 

 

579

 

(4

)

579

 

Purchased in-process research and development charges

 

59

 

 

59

 

 

Equity in earnings of nonconsolidated affiliates

 

296

 

317

 

828

 

717

 

Sundry income - net

 

70

 

4

 

262

 

87

 

Interest income

 

28

 

48

 

101

 

128

 

Interest expense and amortization of debt discount

 

148

 

155

 

423

 

462

 

Income before Income Taxes and Minority Interests

 

1,085

 

670

 

3,759

 

3,649

 

Provision for income taxes

 

659

 

137

 

1,271

 

831

 

Minority interests’ share in income

 

23

 

21

 

73

 

69

 

Net Income Available for Common Stockholders

 

$

403

 

$

512

 

$

2,415

 

$

2,749

 

Share Data

 

 

 

 

 

 

 

 

 

Earnings per common share - basic

 

$

0.42

 

$

0.53

 

$

2.53

 

$

2.85

 

Earnings per common share - diluted

 

$

0.42

 

$

0.53

 

$

2.49

 

$

2.82

 

Common stock dividends declared per share of common stock

 

$

0.42

 

$

0.375

 

$

1.215

 

$

1.125

 

Weighted-average common shares outstanding - basic

 

948.9

 

959.1

 

955.6

 

963.5

 

Weighted-average common shares outstanding - diluted

 

961.5

 

969.9

 

968.3

 

975.5

 

Depreciation

 

$

499

 

$

492

 

$

1,439

 

$

1,418

 

Capital Expenditures

 

$

519

 

$

420

 

$

1,311

 

$

1,118

 

 

See Notes to the Consolidated Financial Statements.

 

3



 

The Dow Chemical Company and Subsidiaries

Consolidated Balance Sheets

 

 

 

Sept. 30,

 

Dec. 31,

 

In millions (Unaudited)

 

2007

 

2006

 

Assets

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,945

 

$

2,757

 

Marketable securities and interest-bearing deposits

 

1

 

153

 

Accounts and notes receivable:

 

 

 

 

 

Trade (net of allowance for doubtful receivables - 2007: $115; 2006: $122)

 

6,007

 

4,988

 

Other

 

3,420

 

3,060

 

Inventories

 

6,772

 

6,058

 

Deferred income tax assets - current

 

108

 

193

 

Total current assets

 

18,253

 

17,209

 

Investments

 

 

 

 

 

Investment in nonconsolidated affiliates

 

3,190

 

2,735

 

Other investments

 

2,417

 

2,143

 

Noncurrent receivables

 

412

 

288

 

Total investments

 

6,019

 

5,166

 

Property

 

 

 

 

 

Property

 

46,607

 

44,381

 

Less accumulated depreciation

 

32,397

 

30,659

 

Net property

 

14,210

 

13,722

 

Other Assets

 

 

 

 

 

Goodwill

 

3,519

 

3,242

 

Other intangible assets (net of accumulated amortization - 2007: $697; 2006: $620)

 

752

 

457

 

Deferred income tax assets - noncurrent

 

3,062

 

4,006

 

Asbestos-related insurance receivables - noncurrent

 

687

 

725

 

Deferred charges and other assets

 

1,167

 

1,054

 

Total other assets

 

9,187

 

9,484

 

Total Assets

 

$

47,669

 

$

45,581

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Notes payable

 

$

306

 

$

219

 

Long-term debt due within one year

 

1,372

 

1,291

 

Accounts payable:

 

 

 

 

 

Trade

 

4,233

 

3,825

 

Other

 

2,006

 

1,849

 

Income taxes payable

 

753

 

569

 

Deferred income tax liabilities - current

 

187

 

251

 

Dividends payable

 

400

 

382

 

Accrued and other current liabilities

 

2,277

 

2,215

 

Total current liabilities

 

11,534

 

10,601

 

Long-Term Debt

 

8,019

 

8,036

 

Other Noncurrent Liabilities

 

 

 

 

 

Deferred income tax liabilities - noncurrent

 

903

 

999

 

Pension and other postretirement benefits - noncurrent

 

3,306

 

3,094

 

Asbestos-related liabilities - noncurrent

 

1,061

 

1,079

 

Other noncurrent obligations

 

3,378

 

3,342

 

Total other noncurrent liabilities

 

8,648

 

8,514

 

Minority Interest in Subsidiaries

 

400

 

365

 

Preferred Securities of Subsidiaries

 

1,000

 

1,000

 

Stockholders’ Equity

 

 

 

 

 

Common stock

 

2,453

 

2,453

 

Additional paid-in capital

 

858

 

830

 

Retained earnings (includes cumulative effect of adopting FIN No. 48 of $(290))

 

17,941

 

16,987

 

Accumulated other comprehensive loss

 

(1,560

)

(2,235

)

Treasury stock at cost

 

(1,624

)

(970

)

Net stockholders’ equity

 

18,068

 

17,065

 

Total Liabilities and Stockholders’ Equity

 

$

47,669

 

$

45,581

 

 

See Notes to the Consolidated Financial Statements.

 

4



 

The Dow Chemical Company and Subsidiaries

Consolidated Statements of Cash Flows

 

 

 

Nine Months Ended

 

 

 

Sept. 30,

 

Sept. 30,

 

In millions (Unaudited)

 

2007

 

2006

 

Operating Activities

 

 

 

 

 

Net Income Available for Common Stockholders

 

$

2,415

 

$

2,749

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,601

 

1,544

 

Purchased in-process research and development charges

 

59

 

 

Provision for deferred income tax

 

712

 

246

 

Earnings of nonconsolidated affiliates in excess of dividends received

 

(310

)

(239

)

Minority interests’ share in income

 

73

 

69

 

Pension contributions

 

(137

)

(395

)

Net (gain) loss on sales of investments

 

(120

)

2

 

Net gain on sales of property and businesses

 

(71

)

(48

)

Other net gain

 

(88

)

 

Restructuring (credit) charges

 

(4

)

579

 

Excess tax benefits from share-based payment arrangements

 

(14

)

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts and notes receivable

 

(857

)

(304

)

Inventories

 

(614

)

(811

)

Accounts payable

 

469

 

(435

)

Other assets and liabilities

 

140

 

(53

)

Cash provided by operating activities

 

3,254

 

2,904

 

Investing Activities

 

 

 

 

 

Capital expenditures

 

(1,311

)

(1,118

)

Proceeds from sales of property and businesses

 

110

 

69

 

Acquisitions of businesses

 

(143

)

 

Purchase of previously leased assets

 

(12

)

(205

)

Investments in consolidated companies, net of cash acquired

 

(742

)

(109

)

Investments in nonconsolidated affiliates

 

(60

)

(56

)

Distributions from nonconsolidated affiliates

 

5

 

4

 

Proceeds from sale of nonconsolidated affiliate

 

30

 

 

Purchases of investments

 

(1,367

)

(1,079

)

Proceeds from sales and maturities of investments

 

1,404

 

1,172

 

Cash used in investing activities

 

(2,086

)

(1,322

)

Financing Activities

 

 

 

 

 

Changes in short-term notes payable

 

38

 

9

 

Payments on long-term debt

 

(71

)

(598

)

Proceeds from issuance of long-term debt

 

13

 

 

Purchases of treasury stock

 

(1,144

)

(650

)

Proceeds from sales of common stock

 

291

 

97

 

Excess tax benefits from share-based payment arrangements

 

14

 

 

Distributions to minority interests

 

(48

)

(54

)

Dividends paid to stockholders

 

(1,115

)

(1,044

)

Cash used in financing activities

 

(2,022

)

(2,240

)

Effect of Exchange Rate Changes on Cash

 

42

 

(14

)

Summary

 

 

 

 

 

Decrease in cash and cash equivalents

 

(812

)

(672

)

Cash and cash equivalents at beginning of year

 

2,757

 

3,806

 

Cash and cash equivalents at end of period

 

$

1,945

 

$

3,134

 

 

See Notes to the Consolidated Financial Statements.

 

5



 

The Dow Chemical Company and Subsidiaries

Consolidated Statements of Comprehensive Income

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 30,

 

Sept. 30,

 

Sept. 30,

 

Sept. 30,

 

In millions (Unaudited)

 

2007

 

2006

 

2007

 

2006

 

Net Income Available for Common Stockholders

 

$

403

 

$

512

 

$

2,415

 

$

2,749

 

Other Comprehensive Income (Loss), Net of Tax

 

 

 

 

 

 

 

 

 

Net unrealized gains on investments

 

15

 

42

 

24

 

17

 

Translation adjustments

 

353

 

(39

)

487

 

325

 

Minimum pension liability adjustments

 

 

 

 

(2

)

Adjustments to pension and other postretirement benefit plans

 

32

 

 

108

 

 

Net gains (losses) on cash flow hedging derivative instruments

 

26

 

(89

)

56

 

(129

)

Total other comprehensive income (loss)

 

426

 

(86

)

675

 

211

 

Comprehensive Income

 

$

829

 

$

426

 

$

3,090

 

$

2,960

 

 

See Notes to the Consolidated Financial Statements.

 

6



 

The Dow Chemical Company and Subsidiaries

PART I – FINANCIAL INFORMATION, Item 1. Financial Statements.

(Unaudited)

Notes to the Consolidated Financial Statements

 

NOTE A – CONSOLIDATED FINANCIAL STATEMENTS

 

The unaudited interim consolidated financial statements of The Dow Chemical Company and its subsidiaries (“Dow” or the “Company”) were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and reflect all adjustments (including normal recurring accruals) which, in the opinion of management, are considered necessary for the fair presentation of the results for the periods presented. These statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

Certain reclassifications of prior year amounts have been made to conform to current year presentation.

 

NOTE B – RECENT ACCOUNTING PRONOUNCEMENTS

 

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 Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” This 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. This 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. At January 1, 2007, the total amount of unrecognized tax benefits was $865 million, of which $704 million would impact the effective tax rate, if recognized.

 

Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The Company’s accrual for interest and penalties was $123 million upon adoption of FIN No. 48.

 

The tax years 1998-2003 are currently under audit by the U.S. Internal Revenue Service, and the review of these years is expected to be completed during 2007. It is reasonably possible that a reduction in the unrecognized tax benefits may occur; however, quantification of an estimated range cannot be made at this time.

 

The tax years that remain subject to examination for the Company’s major tax jurisdictions are shown below:

 

Tax Years Subject to Examination for Major Tax
Jurisdictions at January 1, 2007

1998 – 2006

 

United States – federal income tax

2001 – 2006

 

Argentina

 

 

Brazil

2002 – 2006

 

Germany

 

 

Italy

 

 

United States – state and local income tax

2003 – 2006

 

Spain

2004 – 2006

 

Canada

 

 

France

 

 

Switzerland

2005 – 2006

 

United Kingdom

2006

 

The Netherlands

 

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).” This 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 G for the Company’s disclosures related to pension and other postretirement benefits.

 

7



 

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 GAAP, and expands disclosures about fair value measurements. This 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 is currently evaluating the impact of adopting this Statement.

 

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. The Company is currently evaluating if it will elect the fair value option for any of its eligible financial instruments and other items.

 

In April 2007, the FASB issued FASB Staff Position (“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 is currently evaluating the impact of applying the guidance in this FSP.

 

NOTE C – INVENTORIES

 

The following table provides a breakdown of inventories:

 

Inventories
In millions

 

Sept. 30,
2007

 

Dec. 31,
2006

 

Finished goods

 

$

3,928

 

$

3,498

 

Work in process

 

1,545

 

1,319

 

Raw materials

 

667

 

672

 

Supplies

 

632

 

569

 

Total inventories

 

$

6,772

 

$

6,058

 

 

The reserves reducing inventories from the first-in, first-out (“FIFO”) basis to the last-in, first-out (“LIFO”) basis amounted to $1,272 million at September 30, 2007 and $1,092 million at December 31, 2006.

 

NOTE D – 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 combines 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 initial third-party valuations. Allocation of the purchase price is subject to additional third-party valuation and has not been completed for this acquisition. Final determination of the values to be assigned may result in further adjustments to the preliminary values presented below.

 

8



 

Assets Acquired and Liabilities Assumed
In millions

 

At June 30,
2007

 

Purchase Price
Adjustments 
(1)

 

At Sept. 30,
2007

 

Current assets

 

$

188

 

$

15

 

$

203

 

Property

 

233

 

68

 

301

 

Goodwill (2)

 

364

 

(167

)

197

 

Other intangible assets (2)

 

8

 

174

 

182

 

Other assets

 

11

 

(5

)

6

 

Total assets acquired

 

$

804

 

$

85

 

$

889

 

Accounts payable

 

$

27

 

 

$

27

 

Long-term debt

 

10

 

 

10

 

Accrued and other liabilities

 

47

 

 

47

 

Pension benefits

 

117

 

(11

)

106

 

Deferred tax liabilities - noncurrent

 

 

98

 

98

 

Total liabilities assumed

 

$

201

 

$

87

 

$

288

 

Net assets acquired

 

$

603

 

$

(2

)

$

601

 

 


(1) Includes a $9 million write-off of purchased in-process research and development and the addition of
transaction costs of $7 million in the third quarter of 2007.

(2) See Note E for additional information.

 

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

 

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

 

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. In accordance with GAAP, 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 $59 million in the third quarter of 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:

 

 

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

 

9

 

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

 

 

 

$

59

 

 

The third quarter charges were shown as “Purchased in-process research and development charges” in the consolidated statements of income. $50 million of the charges was related to projects within the Agricultural Sciences segment. The $9 million charge related to IPR&D acquired from Wolff Walsrode impacted the results for the Performance Chemicals segment.

 

9



 

NOTE E – GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following table shows the carrying amount of goodwill by operating segment:

 

Goodwill
In millions

 

Performance
Plastics

 

Performance
Chemicals

 

Agricultural
Sciences

 

Basic
Plastics

 

Hydrocarbons
and Energy

 

Total

 

Balance at December 31, 2006

 

$

915

 

$

850

 

$

1,320

 

$

94

 

$

63

 

$

3,242

 

Increase related to acquisition of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional 50% interest in Styron Asia Limited

 

 

 

 

6

 

 

6

 

Hyperlast Limited

 

126

 

 

 

 

 

126

 

Wolff Walsrode

 

 

364

 

 

 

 

364

 

Purchase price adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Zhejiang Omex Environmental Engineering Co. LTD

 

 

(52

)

 

 

 

(52

)

Wolff Walsrode

 

 

(167

)

 

 

 

(167

)

Balance at September 30, 2007

 

$

1,041

 

$

995

 

$

1,320

 

$

100

 

$

63

 

$

3,519

 

 

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 initial recording of the acquisition resulted in goodwill of $126 million, none of which is expected to be deductible for tax purposes. Final determination of the values to be assigned to the assets acquired and liabilities assumed may result in adjustments to the preliminary values assigned at the date of acquisition.

 

In the second quarter of 2007, the Company completed the purchase price allocation related to the acquisition of Zhejiang Omex Environmental Engineering Co. LTD (“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 June 30, 2007, the Company completed the acquisition of Wolff Walsrode. The initial recording of the acquisition at June 30, 2007 resulted in goodwill of $364 million. In the third quarter of 2007, based on initial third-party valuations, the Company adjusted the estimated values of certain assets and liabilities, resulting in a reduction in goodwill of $167 million and the recording of an estimated $174 million of additional intangible assets. Approximately $22 million of the goodwill is expected to be deductible for tax purposes. Final determination of the values to be assigned to the assets acquired and liabilities assumed may result in further adjustments to the preliminary values. See Note D for additional information related to the purchase price adjustments.

 

Wolff Walsrode Intangible Assets

In millions

 

Estimated
Gross Carrying
Amount

 

Weighted-average
Amortization
Period

 

Intangible assets with finite lives:

 

 

 

 

 

Intellectual property

 

$

63

 

10 years

 

Trademarks

 

9

 

10 years

 

Software

 

5

 

5 years

 

Other (customer-related)

 

105

 

5 years

 

Total

 

$

182

 

7 years

 

 

10



 

On August 1 2007, Dow AgroSciences acquired the corn seed business of Agromen Tecnologia Ltda for $116 million. Allocation of the purchase price resulted in the recording of an estimated $72 million of intellectual property with a weighted-average amortization period of seven years. Final determination of the values to be assigned to the assets acquired and liabilities assumed may result in further adjustments to the preliminary values.

 

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

 

Other Intangible Assets

 

At September 30, 2007

 

At December 31, 2006

 

In millions

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Intangible assets with finite lives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Licenses and intellectual property

 

$

382

 

$

(162

)

$

220

 

$

234

 

$

(142

)

$

92

 

Patents

 

153

 

(111

)

42

 

148

 

(117

)

31

 

Software

 

519

 

(305

)

214

 

452

 

(269

)

183

 

Trademarks

 

166

 

(49

)

117

 

133

 

(40

)

93

 

Other

 

229

 

(70

)

159

 

110

 

(52

)

58

 

Total

 

$

1,449

 

$

(697

)

$

752

 

$

1,077

 

$

(620

)

$

457

 

 

The following table provides information regarding amortization expense:

 

Amortization Expense

 

Three Months Ended

 

Nine Months Ended

 

In millions

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Other intangible assets, excluding software

 

$

22

 

$

13

 

$

51

 

$

37

 

Software, included in “Cost of sales”

 

$

11

 

$

12

 

$

32

 

$

33

 

 

Total estimated amortization expense for 2007 and the five succeeding fiscal years is as follows:

 

Estimated Amortization Expense
In millions

 

 

 

2007

 

$

121

 

2008

 

$

132

 

2009

 

$

122

 

2010

 

$

118

 

2011

 

$

108

 

2012

 

$

74

 

 

NOTE F – COMMITMENTS AND CONTINGENT LIABILITIES

 

Litigation

 

Breast Implant Matters

 

On May 15, 1995, Dow Corning Corporation (“Dow Corning”), in which the Company is a 50 percent shareholder, voluntarily filed for protection under Chapter 11 of the Bankruptcy Code to resolve litigation related to Dow Corning’s breast implant and other silicone medical products. On June 1, 2004, Dow Corning’s Joint Plan of Reorganization (the “Joint Plan”) became effective and Dow Corning emerged from bankruptcy. The Joint Plan contains release and injunction provisions resolving all tort claims brought against various entities, including the Company, involving Dow Corning’s breast implant and other silicone medical products.

 

To the extent not previously resolved in state court actions, cases involving Dow Corning’s breast implant and other silicone medical products filed against the Company were transferred to the U.S. District Court for the Eastern District of Michigan (the “District Court”) for resolution in the context of the Joint Plan. On October 6, 2005, all such cases then pending in the District Court against the Company were dismissed. Should cases involving Dow Corning’s breast implant and other silicone medical products be filed against the Company in the future, they will be accorded similar treatment. It is the opinion of the Company’s management that the possibility is remote that a resolution of all future cases will have a material adverse impact on the Company’s consolidated financial statements.

 

11



 

As part of the Joint Plan, Dow and Corning Incorporated have agreed to provide a credit facility to Dow Corning in an aggregate amount of $300 million. The Company’s share of the credit facility is $150 million and is subject to the terms and conditions stated in the Joint Plan. At September 30, 2007, no draws had been taken against the credit facility.

 

DBCP Matters

 

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

 

Environmental Matters

 

Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. At September 30, 2007, the Company had accrued obligations of $352 million for environmental remediation and restoration costs, including $27 million for the remediation of Superfund sites. This is management’s best estimate of the costs for remediation and restoration with respect to environmental matters for which the Company has accrued liabilities, although the ultimate cost with respect to these particular matters could range up to twice that amount. Inherent uncertainties exist in these estimates primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies for handling site remediation and restoration. At December 31, 2006, the Company had accrued obligations of $347 million for environmental remediation and restoration costs, including $31 million for the remediation of Superfund sites.

 

Midland Site Environmental Matters

 

On June 12, 2003, the Michigan Department of Environmental Quality (“MDEQ”) issued a Hazardous Waste Operating License (the “License”) to the Company’s Midland, Michigan manufacturing site (the “Midland site”), which included provisions requiring the Company to conduct an investigation to determine the nature and extent of off-site contamination in Midland area soils; Tittabawassee and Saginaw River sediment and floodplain soils; and Saginaw Bay. The License required the Company, by August 11, 2003, to propose a detailed Scope of Work for the off-site investigation for the City of Midland and the Tittabawassee River and floodplain for review and approval by the MDEQ. Revised Scopes of Work were approved by the MDEQ on October 18, 2005. The Company was required to submit a Scope of Work for the investigation of the Saginaw River and Saginaw Bay by August 11, 2007. The Company submitted the Scope of Work for the Saginaw River and Saginaw Bay on July 13, 2007. The Company received a Notice of Deficiency dated August 29, 2007, from the MDEQ with respect to the Scope of Work for the Saginaw River and Saginaw Bay. The Company submitted a revised Scope of Work for the Saginaw River and Saginaw Bay to the MDEQ on October 15, 2007.

 

Discussions between the Company and the MDEQ that occurred in 2004 and early 2005 regarding how to proceed with off-site corrective action under the License resulted in the execution of the Framework for an Agreement Between the State of Michigan and The Dow Chemical Company (the “Framework”) on January 20, 2005. The Framework committed the Company to propose a remedial investigation work plan by the end of 2005, conduct certain studies, and take certain immediate interim remedial actions in the City of Midland and along the Tittabawassee River.

 

Remedial Investigation Work Plans

 

The Company submitted Remedial Investigation Work Plans for the City of Midland and for the Tittabawassee River on December 29, 2005. By letters dated March 2, 2006 and April 13, 2006, the MDEQ provided two Notices of Deficiency (“Notices”) to the Company regarding the Remedial Investigation Work Plans. The Company responded, as required, to some of the items in the Notices on May 1, 2006, and as required responded to the balance of the items and submitted revised Remedial Investigation Work Plans on December 1, 2006. In response to subsequent discussions with the MDEQ, the Company submitted further revised Remedial Investigation Work Plans on September 17, 2007, for the Tittabawassee River and on October 15, 2007, for the City of Midland.

 

Studies Conducted

 

On July 12, 2006, the MDEQ approved the sampling for the first six miles of the Tittabawassee River. On December 1, 2006, the MDEQ approved the Sampling and Analysis Plan in Support of Bioavailability Study for Midland (the “Plan”). The results of the Plan were provided to the MDEQ on March 22, 2007. On May 3, 2007, the MDEQ approved the GeoMorph® Pilot Site Characterization Report for the first six miles and approved this approach for the balance of the Tittabawassee River with some qualifications. On July 12, 2007, the MDEQ approved, with qualifications, the sampling for the next 11 miles of the Tittabawassee River.

 

12



 

Interim Remedial Actions

 

The Company has been working with the MDEQ to implement Interim Response Activities and Pilot Corrective Action Plans in specific areas in and along the Tittabawassee River, where elevated levels of dioxins and furans were found during the investigation of the first six miles of the river.

 

Removal Actions

 

On June 27, 2007, the U.S. Environmental Protection Agency (“EPA”) sent a letter to the Company demanding that the Company enter into consent orders under Section 106 of the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) for three areas identified during investigation of the first six miles of the Tittabawassee River as areas for interim remedial actions under MDEQ oversight. The EPA sought a commitment that the Company immediately engage in remedial actions to remove soils and sediments. Three removal orders were negotiated and were signed on July 12, 2007, and the work has commenced under EPA oversight.

 

The Framework also contemplates that the Company, the State of Michigan and other federal and tribal governmental entities will negotiate the terms of an agreement or agreements to resolve potential governmental claims against the Company related to historical off-site contamination associated with the Midland site. The Company and the governmental parties began to meet in the fall of 2005 and entered into a Confidentiality Agreement in December 2005. The Company continues to conduct negotiations with the governmental parties under the Federal Alternative Dispute Resolution Act.

 

On September 12, 2007, the EPA issued a press release reporting that they were withdrawing from the alternative dispute resolution process. On September 28, 2007, the Company entered into a Funding and Participation Agreement with the natural resource damage trustees that addressed the Company’s payment of past costs incurred by the trustees, payment of the costs of a trustee coordinator and a process to review additional cooperative studies that the Company might agree to fund or conduct with the natural resource damage trustees.

 

On October 10, 2007, the EPA presented a Special Notice letter to the Company offering to enter into negotiations for an administrative order on consent for the Company to conduct or fund a remedial investigation, a feasibility study, interim remedial actions and a remedial design for what the EPA has called the Tittabawassee River Dioxin Spill Site. The Company has agreed to enter into negotiations. The negotiations are subject to a 60-day period ending on December 10, 2007, which can be extended another 30 days at the discretion of the EPA.

 

At the end of 2006, the Company had an accrual for off-site corrective action of $7 million (included in the total accrued obligation of $347 million at December 31, 2006) based on the range of activities that the Company proposed and discussed implementing with the MDEQ and which is set forth in the Framework. At September 30, 2007, the accrual for off-site corrective action was $26 million (included in the total accrued obligation of $352 million at September 30, 2007).

 

Environmental Matters Summary

 

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.

 

Asbestos-Related Matters of Union Carbide Corporation

 

Union Carbide Corporation (“Union Carbide”), a wholly owned subsidiary of the Company, is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. These suits principally allege personal injury resulting from exposure to asbestos-containing products and frequently seek both actual and punitive damages. 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.

 

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.

 

13



 

In November 2004, Union Carbide requested ARPC to review Union Carbide’s historical asbestos claim and resolution activity and determine the appropriateness of updating its January 2003 study. In January 2005, ARPC provided Union Carbide with a report summarizing the results of its study. At December 31, 2004, Union Carbide’s recorded asbestos-related liability for pending and future claims was $1.6 billion. Based on the low end of the range in the January 2005 study, Union Carbide’s recorded asbestos-related liability for pending and future claims at December 31, 2004 would be sufficient to resolve asbestos-related claims against Union Carbide and Amchem into 2019. As in its January 2003 study, ARPC did provide estimates for a longer period of time in its January 2005 study, but also reaffirmed its prior advice that forecasts for shorter periods of time are more accurate than those for longer periods of time.

 

In November 2005, Union Carbide requested ARPC to review Union Carbide’s 2005 asbestos claim and resolution activity and determine the appropriateness of updating its January 2005 study. In response to that request, ARPC reviewed and analyzed data through October 31, 2005. In January 2006, 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, 2005, Union Carbide’s asbestos-related liability for pending and future claims was $1.5 billion.

 

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 January 2005 study. 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 its 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 2005 study, 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 covers 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 for 2006. At December 31, 2006, approximately 25 percent of the recorded liability related to pending claims and approximately 75 percent related to future claims.

 

Based on Union Carbide’s review of 2007 activity, Union Carbide determined that no adjustment to the accrual was required at September 30, 2007. Union Carbide’s asbestos-related liability for pending and future claims was $1.2 billion at September 30, 2007. Approximately 28 percent of the recorded liability related to pending claims and approximately 72 percent related to future claims.

 

At December 31, 2002, Union Carbide increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion, substantially exhausting its asbestos product liability coverage. 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 the third quarter of 2007, Union Carbide had reached settlements with several of the carriers involved in this litigation.

 

Union Carbide’s receivable for insurance recoveries related to its asbestos liability was $476 million at September 30, 2007 and $495 million at December 31, 2006. At September 30, 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.

 

14



 

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

In millions

 

Sept. 30,
2007

 

Dec. 31,
2006

 

Receivables for defense costs

 

$

29

 

$

34

 

Receivables for resolution costs

 

254

 

266

 

Total

 

$

283

 

$

300

 

 

Union Carbide expenses defense costs as incurred. The pretax impact for defense and resolution costs, net of insurance, was $16 million in the third quarter of 2007 ($1 million in the third quarter of 2006) and $58 million in the first nine months of 2007 ($29 million in the first nine months of 2006), and was reflected in “Cost of sales.”

 

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.

 

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.

 

Synthetic Rubber Industry Matters

 

In 2003, the U.S., Canadian and European competition authorities initiated separate investigations into alleged anticompetitive behavior by certain participants in the synthetic rubber industry. Certain subsidiaries of the Company (but as to the investigation in Europe only) have responded to requests for documents and are otherwise cooperating in the investigations.

 

On June 10, 2005, the Company received a Statement of Objections from the European Commission (the “EC”) stating that it believed that the Company and certain subsidiaries of the Company (the “Dow Entities”), together with other participants in the synthetic rubber industry, engaged in conduct in violation of European competition laws with respect to the butadiene rubber and emulsion styrene butadiene rubber businesses. In connection therewith, on November 29, 2006, the EC issued its decision alleging infringement of Article 81 of the Treaty of Rome and imposed a fine of Euro 64.575 million (approximately $85 million) on the Dow Entities. Several other companies were also named and fined. Subsequently, the Company has been named in various related U.S. civil actions. In the fourth quarter of 2006, the Company recognized a loss contingency of $85 million related to the fine. The Company has appealed the EC’s decision.

 

Additionally, on March 10, 2007, the Company received a Statement of Objections from the EC stating that it believed that DuPont Dow Elastomers L.L.C. (“DDE”), a former 50:50 joint venture with E.I. du Pont de Nemours and Company (“DuPont”), together with other participants in the synthetic rubber industry, engaged in conduct in violation of European competition laws with respect to the polychloroprene business. This Statement of Objections specifically names the Company, but only in its capacity as a former joint venture owner of DDE. The Company transferred its joint venture ownership interest in DDE to DuPont in 2005, and DDE then changed its name to DuPont Performance Elastomers L.L.C. (“DPE”). Based on agreements reached between the Company and DuPont in 2004, DuPont will manage DPE’s response to this Statement of Objections. Further, based on the Company’s allocation agreement with DuPont, it is the opinion of the Company’s management that the possibility is remote that its financial responsibility with respect to any potential DDE liabilities will have a material adverse impact on the Company’s consolidated financial statements.

 

15



 

Polyurethane Subpoena Matter

 

On February 16, 2006, the Company, among others, received a subpoena from the U.S. Department of Justice as part of an antitrust investigation of polyurethane chemicals, including methylene diphenyl diisocyanate, toluene diisocyanate and polyols. The Company is fully cooperating with the investigation.

 

Other Litigation Matters

 

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

 

Summary

 

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

 

Purchase Commitments

 

The Company has numerous agreements for the purchase of ethylene-related products globally. The purchase prices are determined on a cost-of-service basis, which, in addition to covering all operating expenses and debt service costs, provides the owners of the manufacturing plants with a specified return on capital. Total purchases under these agreements were $1,356 million in 2006, $1,175 million in 2005 and $1,063 million in 2004. The Company’s commitments at December 31, 2006 associated with these agreements are included in the table below.

 

The Company also has various commitments for take or pay and throughput agreements. Such commitments are at prices not in excess of current market prices. The terms of all but one of these agreements extend from one to 25 years. One agreement has terms extending to 80 years. The determinable future commitment for this agreement is included for 10 years in the following table which presents the fixed and determinable portion of obligations under the Company’s purchase commitments at December 31, 2006:

 

Fixed and Determinable Portion of Take or Pay and
Throughput Obligations at December 31, 2006

In millions

 

 

 

2007

 

$

2,107

 

2008

 

1,802

 

2009

 

1,579

 

2010

 

1,339

 

2011

 

889

 

2012 and beyond

 

5,281

 

Total

 

$

12,997

 

 

In addition to the take or pay obligations at December 31, 2006, the Company had outstanding commitments which ranged from one to six years for steam, electrical power, materials, property and other items used in the normal course of business of approximately $459 million. Such commitments were at prices not in excess of current market prices.

 

Guarantees

 

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

 

Guarantees

 

Guarantees arise during the ordinary course of business from relationships with customers and nonconsolidated affiliates when the Company undertakes an obligation to guarantee the performance of others (via delivery of cash or other assets) if specified triggering events occur. With guarantees, such as commercial or financial contracts, non-performance by the guaranteed party triggers the obligation of the Company to make payments to the beneficiary of the guarantee. The majority of the Company’s guarantees relate to debt of nonconsolidated affiliates, which have expiration dates ranging from less than one year to eight years, and trade financing transactions in Latin America and Asia Pacific, which typically expire within one year of their inception.

 

16



 

Residual Value Guarantees

 

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

 

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

 

Guarantees at September 30, 2007
In millions

 

Final
Expiration

 

Maximum Future
Payments

 

Recorded
Liability

 

Guarantees

 

2014

 

$

303

 

$

14

 

Residual value guarantees

 

2015

 

1,035

 

5

 

Total guarantees

 

 

 

$

1,338

 

$

19

 

 

 

 

 

 

 

 

 

Guarantees at December 31, 2006
In millions

 

Final
Expiration

 

Maximum Future
Payments

 

Recorded
Liability

 

Guarantees

 

2014

 

$

340

 

$

20

 

Residual value guarantees

 

2015

 

1,044

 

6

 

Total guarantees

 

 

 

$

1,384

 

$

26

 

 

Asset Retirement Obligations

 

In accordance with SFAS No. 143, as interpreted by FIN No. 47, the Company has recognized asset retirement obligations for the following activities:  demolition and remediation activities at manufacturing sites in the United States and Europe; capping activities at landfill sites in the United States, Canada, Italy and Brazil; and asbestos encapsulation as a result of planned demolition and remediation activities at manufacturing and administrative sites in the United States, Canada and Europe.

 

The aggregate carrying amount of asset retirement obligations recognized by the Company was $110 million at September 30, 2007 and $106 million at December 31, 2006. The discount rate used to calculate the Company’s asset retirement obligation was 4.6 percent. These obligations were included in the consolidated balance sheets as “Other noncurrent obligations.”

 

The Company has not recognized conditional asset retirement obligations for which a fair value cannot be reasonably estimated in its consolidated financial statements. It is the opinion of the Company’s management that the possibility is remote that such conditional asset retirement obligations, when estimable, will have a material adverse impact on the Company’s consolidated financial statements based on current costs.

 

NOTE G – PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS

 

Net Periodic Benefit Cost for All Significant Plans

 

Three Months Ended

 

Nine Months Ended

 

In millions

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Defined Benefit Pension Plans:

 

 

 

 

 

 

 

 

 

Service cost

 

$

72

 

$

71

 

$

215

 

$

212

 

Interest cost

 

218

 

208

 

652

 

619

 

Expected return on plan assets

 

(294

)

(276

)

(877

)

(824

)

Amortization of prior service cost

 

6

 

5

 

18

 

15

 

Amortization of net loss

 

48

 

56

 

147

 

166

 

Termination benefits/curtailment costs

 

 

33

 

1

 

33

 

Net periodic benefit cost

 

$

50

 

$

97

 

$

156

 

$

221

 

Other Postretirement Benefits:

 

 

 

 

 

 

 

 

 

Service cost

 

$

5

 

$

6

 

$

15

 

$

18

 

Interest cost

 

29

 

29

 

86

 

87

 

Expected return on plan assets

 

(9

)

(7

)

(27

)

(21

)

Amortization of prior service credit

 

(1

)

(2

)

(3

)

(6

)

Amortization of net loss

 

1

 

2

 

3

 

6

 

Net periodic benefit cost

 

$

25

 

$

28

 

$

74

 

$

84

 

 

17



 

NOTE H – STOCK-BASED COMPENSATION

 

The Company grants stock-based compensation to employees under the Employees’ Stock Purchase Plans (“ESPP”) and the 1988 Award and Option Plan (the “1988 Plan”), and to non-employee directors under the 2003 Non-Employee Directors’ Stock Incentive Plan. Most of the Company’s stock-based compensation awards are granted in the first quarter of each year. There was minimal grant activity in the second and third quarters of 2007. Details for awards granted in the first quarter of 2007 are included below.

 

During the first quarter of 2007, employees subscribed to the right to purchase 5.3 million shares with a weighted-average exercise price of $30.81 per share and a weighted-average fair value of $10.62 per share under the ESPP.

 

During the first quarter of 2007, the Company granted the following stock-based compensation awards to employees under the 1988 Plan:

 

                  7.6 million stock options with a weighted-average exercise price of $43.59 per share and a weighted-average fair value of $9.81 per share.

 

                  1.8 million shares of deferred stock with a weighted-average fair value of $43.58 per share.

 

                  1.0 million shares of performance deferred stock with a weighted-average fair value of $43.59 per share.

 

During the first quarter of 2007, the Company granted the following stock-based compensation awards to non-employee directors under the 2003 Non-Employee Directors’ Stock Incentive Plan:

 

                  48,400 stock options with a weighted-average fair value of $9.83 per share.

 

                  9,200 shares of restricted stock with a weighted-average fair value of $41.97 per share.

 

Total unrecognized compensation cost at March 31, 2007, including unrecognized cost related to first quarter 2007 activity, is provided in the following table:

 

Total Unrecognized Compensation Cost at March 31, 2007

In millions

 

Unrecognized
Compensation
Cost

 

Weighted-average
Recognition
Period

 

ESPP purchase rights

 

$

45

 

4.6 months

 

Unvested stock options

 

$

106

 

1.00 year

 

Deferred stock awards

 

$

163

 

1.94 years

 

Performance deferred stock awards

 

$

75

 

1.02 years

 

 

NOTE I – 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 continues its drive to improve the competitiveness of its global operations. As a consequence of these shutdowns, which are scheduled to be completed by the end of 2008, and other optimization activities, the Company recorded pretax restructuring charges totaling $591 million in the third and fourth quarters of 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 was shown as “Restructuring charges (credit)” in the consolidated statements of income.

 

The following table summarizes 2007 activities related to the Company’s restructuring reserve:

 

Activities Related to 2006 Restructuring

In millions

 

Costs associated
with Exit or
Disposal Activities

 

Severance
Costs

 

Total

 

Reserve balance at December 31, 2006

 

$

171

 

$

69

 

$

240

 

Cash payments

 

(1

)

(8

)

(9

)

Reserve balance at March 31, 2007

 

$

170

 

$

61

 

$

231

 

Adjustments to reserve

 

(4

)

 

(4

)

Cash payments

 

(40

)

(9

)

(49

)

Reserve balance at June 30, 2007

 

$

126

 

$

52

 

$

178

 

Cash payments

 

(5

)

(4

)

(9

)

Reserve balance at September 30, 2007

 

$

121

 

$

48

 

$

169

 

 

18



 

In the second quarter of 2007, the Company reached agreements with certain suppliers regarding the early cancellation of supply agreements related to the shutdown of manufacturing assets, resulting in a $4 million reduction of the restructuring reserve for contract termination fees. The adjustment was credited against the Performance Plastics segment.

 

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 the next two years. As of September 30, 2007, severance of $25 million had been paid to 310 employees, and a liability of $48 million remained for approximately 500 employees.

 

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.

 

NOTE J – EARNINGS PER SHARE CALCULATIONS

 

Earnings Per Share Calculations

 

Three Months Ended
Sept. 30, 2007

 

Three Months Ended
Sept. 30, 2006

 

In millions, except per share amounts

 

Basic

 

Diluted

 

Basic

 

Diluted

 

Net income available for common stockholders

 

$

403

 

$

403

 

$

512

 

$

512

 

Weighted-average common shares outstanding

 

948.9

 

948.9

 

959.1

 

959.1

 

Add dilutive effect of stock options and awards

 

 

12.6

 

 

10.8

 

Weighted-average common shares for EPS calculations

 

948.9

 

961.5

 

959.1

 

969.9

 

Earnings per common share

 

$

0.42

 

$

0.42

 

$

0.53

 

$

0.53

 

Stock options and deferred stock awards excluded from
EPS calculations
(1)

 

 

 

25.7

 

 

 

20.6

 

 

Earnings Per Share Calculations

 

Nine Months Ended
Sept. 30, 2007

 

Nine Months Ended
Sept. 30, 2006

 

In millions, except per share amounts

 

Basic

 

Diluted

 

Basic

 

Diluted

 

Net income available for common stockholders

 

$

2,415

 

$

2,415

 

$

2,749

 

$

2,749

 

Weighted-average common shares outstanding

 

955.6

 

955.6

 

963.5

 

963.5

 

Add dilutive effect of stock options and awards

 

 

12.7

 

 

12.0

 

Weighted-average common shares for EPS calculations

 

955.6

 

968.3

 

963.5

 

975.5

 

Earnings per common share

 

$

2.53

 

$

2.49

 

$

2.85

 

$

2.82

 

Stock options and deferred stock awards excluded from
EPS calculations
(1)

 

 

 

20.4

 

 

 

17.5

 

 


(1)         Outstanding options to purchase shares of common stock and deferred stock awards that were not included in the calculation of diluted earnings per share because the effect of including them would have been anti-dilutive.

 

NOTE K – INCOME TAXES

 

The tax rate for the third quarter of 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, which is effective January 1, 2008. 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 (equivalent to $0.38 per share) against the provision for income taxes in the third quarter of 2007.

 

19



 

NOTE L – OPERATING SEGMENTS AND GEOGRAPHIC AREAS

 

Corporate Profile

 

Dow is a diversified chemical company that offers a broad range of innovative chemical, plastic and agricultural products and services to customers in more than 175 countries, helping them to provide everything from fresh water, food and pharmaceuticals to paints, packaging and personal care. In 2006, Dow had annual sales of $49 billion and employed approximately 42,600 people worldwide. The Company has 150 manufacturing sites in 37 countries and produces more than 3,100 products. The following descriptions of the Company’s operating segments include a representative listing of products for each business.

 

PERFORMANCE PLASTICS

 

Applications: automotive interiors, exteriors, under-the-hood and body engineered systems building and construction, thermal and acoustic insulation, roofing communications technology, telecommunication cables, electrical and electronic connectors  footwear home and office furnishings:  kitchen appliances, power tools, floor care products, mattresses, carpeting, flooring, furniture padding, office furniture information technology equipment and consumer electronics packaging, food and beverage containers, protective packaging sports and recreation equipment wire and cable insulation and jacketing materials for power utility and telecommunications

 

Dow Automotive serves the global automotive market and is a leading supplier of plastics, adhesives, sealants and other plastics-enhanced products for interior, exterior, under-the-hood, vehicle body structure and acoustical management technology solutions. With offices and application development centers around the world, Dow Automotive provides materials science expertise and comprehensive technical capabilities to its customers worldwide.

 

                  Products: AFFINITY™ polyolefin plastomers; AMPLIFY™ functional polymers; BETABRACE™ reinforcing composites; BETADAMP™ acoustical damping systems; BETAFOAM™ NVH and structural foams; BETAGUARD™ sealants; BETAMATE™ structural adhesives; BETASEAL™ glass bonding systems; CALIBRE™ polycarbonate resins; DOW™ polyethylene resins; DOW™ polypropylene resins and automotive components made with DOW™ polypropylene; IMPAXX™ energy management foam; INSPIRE™ performance polymers; INTEGRAL™ adhesive film; ISONATE™ pure and modified methylene diphenyl diisocyanate (MDI) products; ISOPLAST™ engineering thermoplastic polyurethane resins; MAGNUM™ ABS resins; PAPI™ polymeric MDI; PELLETHANE™ thermoplastic polyurethane elastomers; Premium brake fluids and lubricants; PULSE™ engineering resins; SPECFLEX™ semi-flexible polyurethane foam systems; SPECTRIM™ reaction moldable polymers; STRANDFOAM™ polypropylene foam; VERSIFY™ plastomers and elastomers; VORANATE™ specialty isocyanates; VORANOL™ polyether polyols

 

Dow Building Solutions manufactures and markets an extensive line of insulation, weather barrier, and oriented composite building solutions, as well as a line of cushion packaging foam solutions. The business is the recognized leader in extruded polystyrene (XPS) insulation, known industry-wide by its distinctive Blue color and the Dow STYROFOAM™ brand for more than 50 years. The business also manufactures foam solutions for a wide range of applications including cushion packaging, electronics protection and material handling.

 

                  Products: EQUIFOAM™ comfort products; ETHAFOAM™ polyethylene foam; FROTH-PAK™ polyurethane spray foam; GREAT STUFF™ polyurethane foam sealant; IMMOTUS™ acoustic panels; INSTA-STIK™ roof insulation adhesive; QUASH™ sound management foam; SARAN™ vapor retarder film and tape; STYROFOAM™ brand insulation products (including XPS and polyisocyanurate rigid foam sheathing products); SYMMATRIX™ oriented composites; SYNERGY™ soft touch foam; TILE BOND™ roof tile adhesive; TRYMER™ polyisocyanurate foam pipe insulation; WEATHERMATE™ weather barrier solutions (housewraps, sill pans, flashings and tapes)

 

Dow Epoxy is a leading global producer of epoxy resins, intermediates and specialty resins for a wide range of industries and applications such as coatings, electrical laminates, civil engineering, adhesives and composites. With plants strategically located across four continents, the business is focused on providing customers around the world with differentiated solution-based epoxy products and innovative technologies and services.

 

                  Products: D.E.H.™ epoxy curing agents or hardeners; D.E.N.™ epoxy novolac resins; D.E.R.™ epoxy resins (liquids, solids and solutions); Epoxy intermediates (Acetone, Allyl chloride, Bisphenol-A, Epichlorohydrin, OPTIM™ synthetic glycerine and Phenol); Peroxymeric chemicals (CYRACURE™ cycloaliphatic epoxides, FLEXOL™ plasticizers; and TONE™ monomers, polyols and polymers); Specialty acrylic monomers (Glycidyl methacrylate, Hydroxyethyl acrylate and Hydroxypropyl acrylate); UCAR™ solution vinyl resins

 

20



 

The Polyurethanes and Polyurethane Systems business is a leading global producer of polyurethane raw materials and polyurethane systems. Differentiated by its ability to globally supply a high-quality, consistent and complete product range, this business emphasizes both existing and new business developments while facilitating customer success with a global market and technology network.

 

                  Products: ENFORCER™ Technology and ENHANCER™ Technology for polyurethane carpet and turf backing; ISONATE™ MDI; PAPI™ polymeric MDI; Propylene glycol; Propylene oxide; SPECFLEX™ copolymer polyols; SYNTEGRA™ waterborne polyurethane dispersions; VORACOR™, VORALAST™, VORALUX™ and VORASTAR™ polyurethane systems; VORANATE™ isocyanate; VORANOL™ and VORANOL™ VORACTIV™ polyether and copolymer polyols

 

Specialty Plastics and Elastomers is a business portfolio of specialty products including a broad range of engineering plastics and compounds, performance elastomers and plastomers, specialty copolymers, synthetic rubber, polyvinylidene chloride resins and films (PVDC), and specialty film substrates. The business serves such industries as automotive, civil construction, wire and cable, building and construction, consumer electronics and appliances, food and specialty packaging, and footwear.

 

                  Products: AFFINITY™ polyolefin plastomers (POPs); AMPLIFY™ functional polymers; CALIBRE™ polycarbonate resins; DOW XLA™ elastic fiber; EMERGE™ advanced resins; ENGAGE™ polyolefin elastomers; FLEXOMER™ very low density polyethylene (VLDPE) resins; INTEGRAL™ adhesive films; ISOPLAST™ engineering thermoplastic polyurethane resins; MAGNUM™ ABS resins; NORDEL™ hydrocarbon rubber; PELLETHANE™ thermoplastic polyurethane elastomers; PRIMACOR™ copolymers; PROCITE™ window envelope films; PULSE™ engineering resins; REDI-LINK™ polyethylene-based wire & cable insulation compounds; SARAN™ PVDC resin and SARAN™ PVDC film ; SARANEX™ barrier films; SI-LINK™ polyethylene-based low voltage insulation compounds; TRENCHCOAT™ protective films; TYRIL™ SAN resins; TYRIN™ chlorinated polyethylene; UNIGARD™ HP high-performance flame-retardant compounds; UNIGARD™ RE reduced emissions flame-retardant compounds; UNIPURGE™ purging compound; VERSIFY™ plastomers and elastomers; ZETABON™ coated metal cable armor

 

The Technology Licensing and Catalyst business includes licensing and supply of related catalysts, process control software and services for the UNIPOL™ polypropylene process, the METEOR™ process for ethylene oxide (EO) and ethylene glycol (EG), the LP OXO™ process for oxo alcohols, the QBIS™ bisphenol A process, and Dow’s proprietary technology for production of purified terephthalic acid (PTA). Licensing of the UNIPOL™ polyethylene process and sale of related catalysts, including metallocene catalysts, are handled through Univation Technologies, LLC, a 50:50 joint venture of Union Carbide.

 

                  Products: LP OXO™ process technology and NORMAX™ catalysts; METEOR™ EO/EG process technology and catalysts; PTA process technology; QBIS™ bisphenol A process technology and DOWEX™ QCAT™ catalyst; UNIPOL™ PP process technology and SHAC™ catalyst systems

 

The Performance Plastics segment also includes a portion of the results of the Siam Group, a group of Thailand-based joint ventures.

 

PERFORMANCE CHEMICALS

 

Applications: agricultural and pharmaceutical products and processing building materials chemical processing and intermediates electronics food processing and ingredients gas treating solvents household products metal degreasing and dry cleaning oil and gas treatment paints, coatings, inks, adhesives, lubricants personal care products pulp and paper manufacturing, coated paper and paperboard textiles and carpet water purification

 

Designed Polymers is a business portfolio of products and systems characterized by unique chemistry, specialty functionalities, and people with deep expertise in regulated industries. Within Designed Polymers, Dow Water Solutions offers world-class brands and enabling component technologies designed to advance the science of desalination, water purification, trace contaminant removal and water recycling. Also in Designed Polymers, businesses such as Dow Wolff Cellulosics, Dow Biocides and ANGUS Chemical Company (a wholly owned subsidiary of Dow), develop and market a range of products that enhance or enable key physical and sensory properties of end-use products in applications such as food, pharmaceuticals, oil and gas, paints and coatings, personal care, and building and construction.

 

21



 

                  Products and Services: Acrolein derivatives; Basic nitroparaffins and nitroparaffin-based specialty chemicals; CANGUARD™ BIT preservatives; CELLOSIZE™ hydroxyethyl cellulose; Chiral compounds and biocatalysts; CYCLOTENE™ advanced electronics resins; DOW™ latex powders; DOWEX™ ion exchange resins; DOWICIDE™ antimicrobial bactericides and fungicides; ETHOCEL™ ethylcellulose resins; FILMTEC™ membranes; FORTEFIBER™ soluble dietary fiber; Hydrocarbon resins; Industrial biocides; METHOCEL™ cellulose ethers; OMEXELL™ ultrafiltration; OMEXELL™ electrodeionization; Pfēnex Expression Technology™; POLYOX™ water-soluble resins; Quaternaries; SILK™ semiconductor dielectric resins; WALOCEL™ cellulose polymers

 

The Dow Latex business is a major global supplier of latexes, for a wide range of industries and applications. It provides the broadest line of styrene/butadiene (S/B) products supporting customers in paper and paperboard (for magazines, catalogues and food packaging) applications, and the carpet and floor covering industry. UCAR Emulsion Systems (UES) manufactures and sells acrylic, vinyl acrylic, vinyl acetate ethylene (VAE), and S/B and styrene acrylic latexes and NEOCAR™ branched vinyl ester latexes for use in the architectural and industrial coatings, adhesives, construction products such as caulks and sealants, textile, and traffic paint. It also offers the broadest product range in the dispersion area and produces and markets UCAR™ POLYPHOBE™ rheology modifiers.

 

                  Products: Acrylic latex; EVOCAR™ specialty latex; FOUNDATIONS™ latex; NEOCAR™ branched vinyl ester latexes; Styrene-acrylate latex; Styrene-butadiene latex; Styrene-butadiene vinyl acetate ethylene (VAE); UCAR™ all-acrylic, styrene-acrylic and vinyl-acrylic latexes; UCAR™ POLYPHOBE™ rheology modifiers; UCARHIDE™ opacifier

 

The Specialty Chemicals business provides products and services used as functional ingredients or processing aids in the manufacture of a diverse range of products. Applications include agricultural and pharmaceutical products and processing, building and construction, chemical processing and intermediates, electronics, food processing and ingredients, gas treating solvents, fuels and lubricants, oil and gas, household and institutional cleaners, coatings and paints, pulp and paper manufacturing, metal degreasing and dry cleaning, and transportation. Dow Haltermann Custom Processing provides contract and custom manufacturing services to other specialty chemical, agricultural chemical and biodiesel producers.

 

                  Products: Acrylic acid/Acrylic esters; AMBITROL™ and NORKOOL™ industrial coolants; Butyl CARBITOL™ and Butyl CELLOSOLVE™ ethylene oxide; CARBOWAX™ and CARBOWAX™ SENTRY™ polyethylene glycols and methoxypolyethylene glycols; Diphenyloxide; DOW™ polypropylene glycols; DOWCAL™, DOWFROST™, DOWTHERM™, SYLTHERM and UCARTHERM™ heat transfer fluids; DOWFAX™, TERGITOL™ and TRITON™ surfactants; Ethanolamines; Ethyleneamines; Isopropanolamines; MAXIBOOST™ cleaning boosters; MAXICHECK™ solvent analysis test kits; MAXISTAB™ stabilizers; Propylene oxide-based glycol ethers; SAFE-TAINER™ closed-loop delivery system; SYNALOX™ lubricants; UCAR™ deicing fluids; UCARKLEAN™ amine management; UCARSOL™ formulated solvents; UCON™ fluids; VERSENE™ chelating agents; Fine and specialty chemicals from the Dow Haltermann Custom Processing business; Test and reference fuels, printing ink distillates, pure hydrocarbons and esters, and derivatives from Haltermann Products, a wholly owned subsidiary of Dow

 

The Performance Chemicals segment also includes the results of Dow Corning Corporation, and a portion of the results of the OPTIMAL Group and the Siam Group, all joint ventures of the Company.

 

AGRICULTURAL SCIENCES

 

Applications: control of weeds, insects and plant diseases for agriculture and pest management agricultural seeds and traits (genes)

 

Dow AgroSciences is a global leader in providing pest management, agricultural and crop biotechnology products and solutions. The business develops, manufactures and markets products for crop production; weed, insect and plant disease management; and industrial and commercial pest management. Dow AgroSciences is building a leading plant genetics and biotechnology business in agricultural seeds, traits, healthy oils, and animal health.

 

22



 

                  Products: CLINCHER™ herbicide; DITHANE™ fungicide; FORTRESS™ fungicide; GARLON™ herbicide; GLYPHOMAX™ herbicide; GRANITE™ herbicide, HERCULEX™ I insect protection; HERCULEX™RW insect protection; HERCULEX™ XTRA insect protection; KEYSTONE™ herbicides; LAREDO™ fungicide; LONTREL™ herbicide; LORSBAN™ insecticides; MILESTONE™ herbicide; MUSTANG™ herbicide; MYCOGEN™ seeds; NEXERA™ canola and sunflower seeds; PHYTOGEN™ brand cottonseeds; PROFUME™ gas fumigant; SENTRICON™ termite colony elimination system; STARANE™ herbicide; STINGER™ herbicide; SURPASS™ herbicide; TELONE™ soil fumigant; TORDON™ herbicide; TRACER™ NATURALYTE™ insect control; VIKANE™ structural fumigant; WIDESTRIKE™ insect protection

 

BASIC PLASTICS

 

Applications: adhesives appliances and appliance housings agricultural films automotive parts and trim beverage bottles bins, crates, pails and pallets building and construction coatings consumer and durable goods consumer electronics disposable diaper liners fibers and nonwovens films, bags and packaging for food and consumer products hoses and tubing household and industrial bottles housewares hygiene and medical films industrial and consumer films and foams information technology oil tanks and road equipment plastic pipe textiles toys, playground equipment and recreational products wire and cable compounds

 

The Polyethylene business is the world’s leading supplier of polyethylene-based solutions through sustainable product differentiation. Through the use of multiple catalyst and process technologies, the business offers customers one of the industry’s broadest ranges of polyethylene resins via a strong global network of local experts focused on partnering for long-term success.

 

                  Products: ASPUN™ fiber grade resins; ATTANE™ ultra low density polyethylene (ULDPE) resins; CONTINUUM™ bimodal polyethylene resins; DOW™ high density polyethylene (HDPE) resins; DOW™ low density polyethylene (LDPE) resins; DOWLEX™ polyethylene resins; ELITE™ enhanced polyethylene (EPE) resins; TUFLIN™ linear low density polyethylene (LLDPE) resins; UNIVAL™ HDPE resins

 

The Polypropylene business, a major global polypropylene supplier, provides a broad range of products and solutions tailored to customer needs by leveraging Dow’s leading manufacturing and application technology, research and product development expertise, extensive market knowledge and strong customer relationships.

 

                  Products: DOW™ homopolymer polypropylene resins; DOW™ impact copolymer polypropylene resins; DOW™ random copolymer polypropylene resins; INSPIRE™ performance polymers

 

The Polystyrene business, the global leader in the production of polystyrene resins, is uniquely positioned with geographic breadth and participation in a diversified portfolio of applications. Through market and technical leadership and low cost capability, the business continues to improve product performance and meet customer needs.

 

                  Products: STYRON A-TECH™ and C-TECH™ advanced technology polystyrene resins and a full line of STYRON™ general purpose polystyrene resins; STYRON™ high-impact polystyrene resins

 

The Basic Plastics segment also includes the results of Equipolymers and a portion of the results of EQUATE Petrochemical Company K.S.C. and the Siam Group, all joint ventures of the Company.

 

BASIC CHEMICALS

 

Applications: agricultural products alumina automotive antifreeze and coolant systems carpet and textiles chemical processing dry cleaning dust control household cleaners and plastic products inks metal cleaning packaging, food and beverage containers, protective packaging paints, coatings and adhesives personal care products petroleum refining  pharmaceuticals plastic pipe pulp and paper manufacturing snow and ice control soaps and detergents water treatment

 

The Core Chemicals business is a leading global producer of each of its basic chemical products, which are sold to many industries worldwide, and also serve as key raw materials in the production of a variety of Dow’s performance and plastics products.

 

23



 

                  Products: Acids; Alcohols; Aldehydes; Caustic soda; Chlorine; Chloroform; COMBOTHERM™ blended deicer; DOWFLAKE™ calcium chloride; DOWPER™ dry cleaning solvent; Esters; Ethylene dichloride (EDC); LIQUIDOW™ liquid calcium chloride; MAXICHECK™ procedure for testing the strength of reagents; MAXISTAB™ stabilizers for chlorinated solvents; Methyl chloride; Methylene chloride; Monochloroacetic acid (MCAA); Oxo products; PELADOW™ calcium chloride pellets; Perchloroethylene; Trichloroethylene; Vinyl acetate monomer (VAM); Vinyl chloride monomer (VCM); Vinylidene chloride (VDC)

 

The Ethylene Oxide/Ethylene Glycol business is a key supplier of ethylene glycol to MEGlobal, a 50:50 joint venture and a world leader in the manufacture and marketing of merchant monoethylene glycol and diethylene glycol. Dow also supplies ethylene oxide to internal derivatives businesses. Ethylene glycol is used in polyester fiber, polyethylene terephthalate (PET) for food and beverage container applications, polyester film and antifreeze.

 

                  Products: Ethylene glycol (EG); Ethylene oxide (EO)

 

The Basic Chemicals segment also includes the results of MEGlobal and a portion of the results of EQUATE Petrochemical Company K.S.C. and the OPTIMAL Group, all joint ventures of the Company.

 

HYDROCARBONS AND ENERGY

 

Applications: polymer and chemical production power

 

The Hydrocarbons and Energy business encompasses the procurement of fuels, natural gas liquids and crude oil-based raw materials, as well as the supply of monomers, power and steam principally for use in Dow’s global operations. The business regularly sells its byproducts; the business also buys and sells products in order to balance regional production capabilities and derivative requirements. The business also sells products to certain Dow joint ventures. Dow is the world leader in the production of olefins and aromatics.

 

                  Products: Benzene; Butadiene; Butylene; Cumene; Ethylene; Propylene; Styrene; Power, steam and other utilities

 

The Hydrocarbons and Energy segment also includes the results of Compañía Mega S.A. and a portion of the results of the Siam Group, both joint ventures of the Company.

 

Unallocated and Other includes the results of New Ventures (which includes new business incubation platforms focused on identifying and pursuing new commercial opportunities); Venture Capital; the Company’s insurance operations and environmental operations; and overhead and other cost recovery variances not allocated to the operating segments.

 

Transfers of products between operating segments are generally valued at cost. However, transfers of products to Agricultural Sciences from other segments are generally valued at market-based prices; the revenues generated by these transfers in the first nine months of 2007 and 2006 were immaterial and eliminated in consolidation.

 

24



 

Operating Segments

 

Three Months Ended

 

Nine Months Ended

 

In millions

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sales by operating segment

 

 

 

 

 

 

 

 

 

Performance Plastics

 

$

3,877

 

$

3,463

 

$

11,148

 

$

10,398

 

Performance Chemicals

 

2,152

 

2,014

 

6,225

 

5,868

 

Agricultural Sciences

 

788

 

662

 

2,915

 

2,585

 

Basic Plastics

 

3,316

 

3,106

 

9,390

 

8,889

 

Basic Chemicals

 

1,507

 

1,461

 

4,233

 

4,245

 

Hydrocarbons and Energy

 

1,828

 

1,569

 

5,063

 

4,643

 

Unallocated and Other

 

121

 

84

 

312

 

260

 

Total

 

$

13,589

 

$

12,359

 

$

39,286

 

$

36,888

 

EBIT(1) by operating segment

 

 

 

 

 

 

 

 

 

Performance Plastics

 

$

409

 

$

144

 

$

1,232

 

$

1,282

 

Performance Chemicals

 

219

 

286

 

825

 

949

 

Agricultural Sciences

 

15

 

 

505

 

377

 

Basic Plastics

 

556

 

592

 

1,612

 

1,561

 

Basic Chemicals

 

205

 

122

 

504

 

495

 

Hydrocarbons and Energy

 

 

 

(1

)

 

Unallocated and Other

 

(199

)

(367

)

(596

)

(681

)

Total

 

$

1,205

 

$

777

 

$

4,081

 

$

3,983

 

Equity in earnings of nonconsolidated affiliates by operating segment (included in EBIT)

 

 

 

 

 

 

 

 

 

Performance Plastics

 

$

15

 

$

34

 

$

55

 

$

81

 

Performance Chemicals

 

90

 

91

 

299

 

275

 

Agricultural Sciences

 

1

 

1

 

1

 

1

 

Basic Plastics

 

39

 

65

 

141

 

127

 

Basic Chemicals

 

115

 

100

 

270

 

163

 

Hydrocarbons and Energy

 

35

 

26

 

62

 

68

 

Unallocated and Other

 

1

 

 

 

2

 

Total

 

$

296

 

$

317

 

$

828

 

$

717

 

 


(1)             The Company uses EBIT (which Dow defines as earnings before interest, income taxes and minority interests) as its measure of profit/loss for segment reporting purposes. EBIT by operating segment includes all operating items relating to the businesses; items that principally apply to the Company as a whole are assigned to Unallocated and Other. A reconciliation of EBIT to “Net Income Available for Common Stockholders” is provided below:

 

 

 

Three Months Ended

 

Nine Months Ended

 

In millions

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

EBIT

 

$

1,205

 

$

777

 

$

4,081

 

$

3,983

 

+ Interest income

 

28

 

48

 

101

 

128

 

- Interest expense and amortization of debt discount

 

148

 

155

 

423

 

462

 

- Provision for income taxes

 

659

 

137

 

1,271

 

831

 

- Minority interests’ share in income

 

23

 

21

 

73

 

69

 

Net Income Available for Common Stockholders

 

$

403

 

$

512

 

$

2,415

 

$

2,749

 

 

Geographic Areas

 

Three Months Ended

 

Nine Months Ended

 

In millions

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sales by geographic area

 

 

 

 

 

 

 

 

 

United States

 

$

4,700

 

$

4,514

 

$

13,613

 

$

13,903

 

Europe(1)

 

4,872

 

4,211

 

14,347

 

12,536

 

Rest of World(1)

 

4,017

 

3,634

 

11,326

 

10,449

 

Total

 

$

13,589

 

$

12,359

 

$

39,286

 

$

36,888

 

 


(1)          Sales to customers in the Middle East and Africa, previously reported with Europe, are now aligned with Rest of World; prior period sales have been adjusted to reflect this realignment.

 

25



 

The Dow Chemical Company and Subsidiaries

PART I – FINANCIAL INFORMATION, Item 2.  Management’s Discussion and

Analysis of Financial Condition and Results of Operations.

 

DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION

 

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

 

OVERVIEW

 

                  The Company delivered solid results in the third quarter of 2007 with record quarterly sales of $13.6 billion due to healthy increases in both volume and price.

 

                  Reflecting the increased level of demand, Dow’s plants ran at an operating rate of 90 percent of capacity in the quarter. This represents the highest quarterly operating rate since the third quarter of 2004.

 

                  Feedstock and energy costs rose steeply in the quarter, up approximately $380 million (6 percent) from the third quarter of 2006.

 

                  Operating expenses rose during the third quarter of 2007, but remained low as a percent of total sales as Dow continued the disciplined implementation of its growth strategy.

 

                  Dow’s nonconsolidated affiliates continued to contribute significantly to the overall results of the Company.

 

                  In line with the Company’s strategy to invest in the Performance businesses, the Company completed the acquisition of several agricultural businesses in the third quarter. Dow recognized pretax charges of $59 million for purchased in-process research and development in the third quarter, $50 million of which was related to these acquisitions. The remaining $9 million was related to the acquisition of Wolff Walsrode.

 

                  The tax rate for the third quarter of 2007 was negatively impacted by a charge of $362 million related to a change in German tax law that was enacted in August.

 

                  Capital spending remained on target; debt as a percent of total capitalization declined almost 1 percent from year-end 2006; and the Company continued to purchase shares under its share repurchase program.

 

Selected Financial Data

 

Three Months Ended

 

Nine Months Ended

 

In millions, except per share amounts

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Net sales

 

$

13,589

 

$

12,359

 

$

39,286

 

$

36,888

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

$

11,864

 

$

10,600

 

$

33,867

 

$

31,027

 

Percent of net sales

 

87.3

%

85.8

%

86.2

%

84.1

%

 

 

 

 

 

 

 

 

 

 

Research and development, and selling, general and administrative expenses

 

$

805

 

$

711

 

$

2,322

 

$

2,066

 

Percent of net sales

 

5.9

%

5.8

%

5.9

%

5.6

%

 

 

 

 

 

 

 

 

 

 

Effective tax rate (1)

 

60.7

%

20.4

%

33.8

%

22.8

%

 

 

 

 

 

 

 

 

 

 

Net income available for common stockholders

 

$

403

 

$

512

 

$

2,415

 

$

2,749

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share – basic

 

$

0.42

 

$

0.53

 

$

2.53

 

$

2.85

 

Earnings per common share – diluted

 

$

0.42

 

$

0.53

 

$

2.49

 

$

2.82

 

 

 

 

 

 

 

 

 

 

 

Operating rate percentage

 

90

%

87

%

87

%

85

%

 


(1) The effective tax rates for 2007 reflect a charge of $362 million related to a change in German tax law enacted in the third quarter of 2007.

 

RESULTS OF OPERATIONS

 

Net sales for the third quarter of 2007 were $13.6 billion, up 10 percent from $12.4 billion in the third quarter of last year. Compared with last year, prices rose 5 percent (with currency accounting for approximately 2 percent of the increase); volume was also up 5 percent. Prices improved in all operating segments, with increases ranging from 3 percent to 6 percent. From a geographic standpoint, prices were up significantly in all geographic areas outside of the United States, where prices were unchanged from last year. Prices were up 9 percent in Europe, 8 percent in Latin America and 5 percent in Asia Pacific.

 

26



 

Compared with the third quarter of last year, volume improved in all operating segments except Basic Chemicals, which reported a 2 percent decline. Volume growth was particularly strong in Agricultural Sciences (up 16 percent), Hydrocarbons and Energy (up 11 percent) and Performance Plastics (up 7 percent), while both Performance Chemicals (up 3 percent) and Basic Plastics (up 2 percent) reported steady growth.

 

Net sales for the first nine months of 2007 were $39.3 billion, up 7 percent from $36.9 billion in the same period last year. Compared with the first nine months of 2006, prices were up 5 percent, with approximately half of the increase related to currency, while volume was up 2 percent. Prices were up across all operating segments and all geographic areas except the United States, where prices declined 1 percent compared with the same period last year. Volume growth was especially strong in Agricultural Sciences (up 11 percent), while Performance Plastics, Performance Chemicals, Basic Plastics, and Hydrocarbons and Energy each reported modest growth. Volume declined 2 percent in Basic Chemicals. For additional details regarding the change in net sales, see the Sales Volume and Price table at the end of the section entitled “Segment Results.”

 

Gross margin was $1,725 million for the third quarter of 2007, down slightly from $1,759 million in the third quarter of last year. Despite higher sales, gross margin declined versus the third quarter of last year due to significantly higher hydrocarbon and energy (“H&E”) costs (up approximately $380 million), higher non-H&E raw material costs, the unfavorable impact of currency on cost, and increased freight costs. Year to date, gross margin was $5.4 billion, compared with $5.9 billion in the first nine months of 2006.

 

The Company’s global plant operating rate (for its chemicals and plastics businesses) was 90 percent in the third quarter of 2007, up from 87 percent in the third quarter of 2006. This represents the highest quarterly operating rate since the third quarter of 2004, reflecting a high level of demand. For the first nine months of 2007, Dow’s global plant operating rate was 87 percent, up from 85 percent in the same period of 2006. Operating rates in 2006 reflected a higher level of planned maintenance turnarounds at Dow’s manufacturing facilities.

 

Personnel count was 45,315 at September 30, 2007, up from 42,578 at December 31, 2006 and 42,910 at September 30, 2006. The increase in headcount was due to 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.

 

Operating expenses (research and development, and selling, general and administrative expenses) totaled $805 million in the third quarter of 2007, up $94 million or 13 percent, from $711 million in the third quarter of last year. Compared with last year, research and development (“R&D”) expenses increased $38 million; and selling, general and administrative expenses increased $56 million. For the first nine months of 2007, operating expenses totaled $2,322 million, up $256 million (12 percent) from $2,066 million in the first nine months of 2006. Year to date, approximately 60 percent of the increase in operating expenses was related to planned spending for growth initiatives and product development in the Performance businesses, including expenses related to the second quarter acquisitions of Wolff Walsrode and Hyperlast Limited, consistent with the Company’s strategy; and approximately 20 percent of the increase was related to the global expansion of the Company’s corporate branding campaign and other promotion and advertising expenses. Despite these increases, operating expenses remained low as a percentage of net sales.

 

Amortization of intangibles was $22 million in the third quarter of 2007, compared with $13 million in the third quarter of last year. For the first nine months of 2007, amortization of intangibles was $51 million, compared with $37 million for the same period last year. See Note E to the Consolidated Financial Statements for additional information on intangible assets.

 

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 continues its drive to improve the competitiveness of its global operations. As a consequence of these shutdowns, which are scheduled to be completed by the end of 2008, and other optimization activities, the Company recorded pretax restructuring charges totaling $579 million in the third quarter of 2006. The charges included asset write-downs and write-offs of $327 million, costs associated with exit or disposal activities of $171 million and severance costs of $81 million. The impact of the charges was shown as “Restructuring charges (credit)” in the consolidated statements of income and was reflected in the Company’s segment results as follows: Performance Plastics $242 million, Performance Chemicals $11 million, Basic Plastics $16 million, Basic Chemicals $165 million, and Unallocated and Other $145 million. When the restructuring plans have been fully implemented, the Company expects to realize ongoing annual savings of approximately $160 million. See Note I to the Consolidated Financial Statements for additional information on the restructuring charges.

 

During the third quarter of 2007, pretax charges totaling $59 million were recorded for purchased in-process research and development (“IPR&D”). See Note D 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.

 

27



 

Dow’s share of the earnings of nonconsolidated affiliates was $296 million in the third quarter of 2007, down from $317 million in the third quarter of last year. Compared with last year, improved earnings at EQUATE Petrochemical Company K.S.C. (“EQUATE”), Total Raffinaderij Nederland NV and MEGlobal were more than offset by lower earnings from the OPTIMAL Group (“OPTIMAL”), Equipolymers, Siam Polyethylene Company Limited (“Siam Polyethylene”) and Univation Technologies, LLC (“Univation”). For the first nine months of 2007, equity earnings were $828 million, up from $717 million for the same period last year principally due to improved earnings from EQUATE, OPTIMAL and MEGlobal.

 

Sundry income – net includes a variety of income and expense items such as the gain or loss on hedging foreign currency exchange, dividends from investments, and gains and losses on sales of investments and assets. Net sundry income for the third quarter of 2007 was $70 million, up from $4 million in the same quarter of 2006. Year to date, net sundry income was $262 million, compared with $87 million in the first nine months of 2006. The increase in net sundry income for the quarter and year to date reflected the impact of favorable foreign exchange hedging results and gains on the sale of assets.

 

Net interest expense (interest expense less capitalized interest and interest income) was $120 million in the third quarter of 2007, compared with $107 million in the third quarter of last year. Compared with the third quarter of last year, net interest expense was up principally due to lower interest income. Year to date, net interest expense was $322 million, down from $334 million in the first nine months of 2006.

 

The Company’s effective tax rate fluctuates based on, among other factors, where income is earned, the level of income relative to tax credits available, and events that occur in a certain period. The effective tax rate for the third quarter of 2007 was 60.7 percent, versus 20.4 percent for the third quarter of 2006. The tax rate for the third quarter of 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 is effective January 1, 2008, is expected to have an immaterial impact on the Company’s effective tax rate in the future.

 

The tax rate for the third quarter of 2006 was favorably impacted by: a reduction in the estimated annual tax rate for 2006, caused by a revised forecast of earnings in lower tax jurisdictions relative to total earnings; a higher level of equity earnings, which are mostly taxed at the joint venture level; and the adjustment of current and deferred tax balances based on positions taken on tax returns filed in multiple jurisdictions in the third quarter. Additionally, based on tax planning strategies that were implemented in Brazil, 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 $73 million. Offsetting this impact was the recognition of a valuation allowance of $61 million in the third quarter of 2006 resulting from enacted tax law changes in Italy, which limited the time frame during which tax loss carryforwards may be utilized. The Company determined that it was more likely than not that certain tax loss carryforwards would expire unused.

 

The effective tax rate for the first nine months of 2007 was 33.8 percent, compared with 22.8 percent for the same period last year. In addition to the items noted above for the third quarter of last year, the effective tax rate for 2006 was favorably impacted by the closure of tax audit issues in the United States in the first quarter and an enacted reduction in the Canadian tax rate in the second quarter.

 

Net income available for common stockholders was $403 million or $0.42 per share for the third quarter of 2007, compared with $512 million or $0.53 per share for the third quarter of 2006. Net income for the first nine months of 2007 was $2,415 million or $2.49 per share, compared with $2,749 million or $2.82 per share for the same period of 2006.

 

The following table summarizes the impact of certain items recorded in the three-month periods ended September 30, 2007 and 2006, and previously described in this section:

 

 

 

Pretax
Impact 
(1)

 

Impact on
Net Income 
(2)

 

Impact on
EPS 
(3)

 

 

 

Three Months Ended

 

Three Months Ended

 

Three Months Ended

 

In millions, except per share amounts

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Sept. 30,
2007

 

Sept. 30,
2006

 

Restructuring charges

 

 

$

(579

)

 

$

(438

)

 

$

(0.45

)

Purchased in-process research and development charges

 

$

(59

)

 

$

(39

)

 

$

(0.04

)

 

German tax law change