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


FORM 10-Q

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

FOR THE QUARTER ENDED March 31, 2001

Commission file number 1-3433


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

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

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

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

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


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

Class
  Outstanding at March 31, 2001
Common Stock, $2.50 par value   897,530,013 shares



THE DOW CHEMICAL COMPANY
TABLE OF CONTENTS

 
  PAGE
PART I—FINANCIAL INFORMATION    
 
Item 1. Financial Statements

 

3
   
Consolidated Statements of Income

 

3
   
Consolidated Balance Sheets

 

4
   
Consolidated Statements of Cash Flows

 

5
   
Consolidated Statements of Comprehensive Income

 

6
   
Notes to Financial Statements

 

7
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

15
   
Disclosure Regarding Forward-Looking Information

 

15
   
Results of Operations

 

15
   
Changes in Financial Condition

 

22
   
Other Matters

 

23
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

24

PART II—OTHER INFORMATION

 

 
 
Item 1. Legal Proceedings

 

25
 
Item 6. Exhibits and Reports on Form 8-K

 

25

SIGNATURE

 

27

2



PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (Note A)

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

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

  Mar. 31,
2001

  Mar. 31,
2000


Net Sales   $ 7,386   $ 7,269

  Cost of sales     6,456     5,842
  Research and development expenses     272     270
  Selling, general and administrative expenses     452     474
  Amortization of intangibles     33     41
  Merger-related expenses and restructuring (Note B)     1,384    
  Insurance and finance company operations, pretax income     11     29
  Equity in earnings of nonconsolidated affiliates     35     130
  Sundry income—net     283     101

Earnings (Loss) before Interest, Income Taxes and Minority Interests     (882 )   902

  Interest income     24     45
  Interest expense and amortization of debt discount     182     155

Income (Loss) before Income Taxes and Minority Interests     (1,040 )   792

  Provision for income taxes     (340 )   262
  Minority interests' share in income     17     18

Income (Loss) before Cumulative Effect of Change in Accounting Principle     (717 )   512

  Cumulative effect of change in accounting principle (Note C)     32    

Net Income (Loss) Available for Common Stockholders   ($ 685 ) $ 512

Share Data            
  Earnings (Loss) before cumulative effect of change in accounting principle per common share—basic   ($ 0.80 ) $ 0.58
  Earnings (Loss) per common share—basic   ($ 0.76 ) $ 0.58
  Earnings (Loss) before cumulative effect of change in accounting principle per common share—diluted   ($ 0.80 ) $ 0.57
  Earnings (Loss) per common share—diluted   ($ 0.76 ) $ 0.57
  Common stock dividends declared per share of Dow common stock   $ 0.29   $ 0.29
  Weighted-average common shares outstanding—basic     898.1     889.6
  Weighted-average common shares outstanding—diluted     898.1     903.8

Depreciation   $ 388   $ 368

Capital Expenditures   $ 273   $ 439

See Notes to Financial Statements.

3


The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  Mar. 31,
2001

  Dec. 31,
2000

 

 
Assets              

 
Current Assets              
  Cash and cash equivalents   $ 244   $ 278  
  Marketable securities and interest-bearing deposits     246     163  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables—2001: $121; 2000: $103)     3,594     3,655  
    Other     2,603     2,764  
  Inventories:              
    Finished and work in process     3,618     3,396  
    Materials and supplies     759     817  
  Deferred income tax assets—current     687     250  

 
  Total current assets     11,751     11,323  

 
Investments              
  Investment in nonconsolidated affiliates     1,954     2,096  
  Other investments     1,819     2,528  
  Noncurrent receivables     676     674  

 
  Total investments     4,449     5,298  

 
Property              
  Property     34,475     34,852  
  Less accumulated depreciation     21,495     21,141  

 
  Net property     12,980     13,711  

 
Other Assets              
  Goodwill (net of accumulated amortization—2001: $491; 2000: $459)     2,226     1,928  
  Deferred income tax assets—noncurrent     2,092     1,968  
  Deferred charges and other assets     1,932     1,763  

 
  Total other assets     6,250     5,659  

 
Total Assets   $ 35,430   $ 35,991  

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 
Current Liabilities              
  Notes payable   $ 3,086   $ 2,519  
  Long-term debt due within one year     307     318  
  Accounts payable:              
    Trade     2,540     2,975  
    Other     1,203     1,594  
  Income taxes payable     285     258  
  Deferred income tax liabilities—current     7     35  
  Dividends payable     152     217  
  Accrued and other current liabilities     2,182     2,257  

 
  Total current liabilities     9,762     10,173  

 
Long-Term Debt     7,139     6,613  

 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     1,384     1,165  
  Pension and other postretirement benefits—noncurrent     2,408     2,238  
  Other noncurrent obligations     3,241     3,012  

 
  Total other noncurrent liabilities     7,033     6,415  

 
Minority Interest in Subsidiaries     416     450  

 
Preferred Securities of Subsidiary     500     500  

 
Stockholders' Equity              
  Common stock     2,453     2,453  
  Additional paid-in capital     42      
  Unearned ESOP shares     (103 )   (103 )
  Retained earnings     11,729     12,675  
  Accumulated other comprehensive loss     (926 )   (560 )
  Treasury stock at cost     (2,615 )   (2,625 )

 
  Net stockholders' equity     10,580     11,840  

 
Total Liabilities and Stockholders' Equity   $ 35,430   $ 35,991  

 

See Notes to Financial Statements.

4


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
  Three Months Ended
 
In millions (Unaudited)

  Mar. 31,
2001

  Mar. 31,
2000

 

 
Operating Activities              
  Income (loss) before cumulative effect of change in accounting principle   ($ 717 ) $ 512  
  Adjustments to reconcile net income to net cash provided by operating activities:              
    Depreciation and amortization     434     418  
    Provision (credit) for deferred income tax     (461 )   6  
    Undistributed earnings of nonconsolidated affiliates     (17 )   (104 )
    Minority interests' share in income     17     18  
    Net (gain) loss on sales of property and businesses     10     (2 )
    Other net gain     (249 )   (40 )
    Merger-related expenses and restructuring     1,205      
    Tax benefit-nonqualified stock option exercises     4     14  
  Changes in assets and liabilities that provided (used) cash:              
    Accounts and notes receivable     (25 )   (475 )
    Inventories     (165 )   (13 )
    Accounts payable     (461 )   188  
    Other assets and liabilities     (159 )   (51 )

 
  Cash provided by (used in) operating activities     (584 )   471  

 
Investing Activities              
  Capital expenditures     (273 )   (439 )
  Proceeds from sales of property and businesses     74     15  
  Purchases of consolidated companies     (364 )   (197 )
  Investments in nonconsolidated affiliates     (65 )   (95 )
  Purchases of investments     (717 )   (875 )
  Proceeds from sales of investments     1,168     1,215  

 
  Cash used in investing activities     (177 )   (376 )

 
Financing Activities              
  Changes in short-term notes payable     548     204  
  Payments on long-term debt     (9 )   (364 )
  Proceeds from issuance of long-term debt     504     1  
  Purchases of treasury stock     (4 )   (1 )
  Proceeds from sales of common stock     23     59  
  Distributions to minority interests     (25 )   (23 )
  Dividends paid to stockholders     (307 )   (224 )

 
  Cash provided by (used in) financing activities     730     (348 )

 
Effect of Exchange Rate Changes on Cash     (3 )   (3 )

 
Summary              
  Decrease in cash and cash equivalents     (34 )   (256 )
  Cash and cash equivalents at beginning of year     278     547  

 
  Cash and cash equivalents at end of period   $ 244   $ 291  

 

See Notes to Financial Statements.

5


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

 
  Three Months Ended
 
In millions (Unaudited)

  Mar. 31,
2001

  Mar. 31,
2000

 

 
Net Income (Loss) Available for Common Stockholders   ($ 685 ) $ 512  

 
Other Comprehensive Income (Loss), Net of Tax              
  Unrealized gains (losses) on investments     (287 )   93  
  Cumulative translation adjustments     (108 )   (35 )
  Minimum pension liability         1  
  Net gains on cash flow hedging derivative instruments     29      

 
  Total other comprehensive income (loss)     (366 )   59  

 
Comprehensive Income (Loss)   ($ 1,051 ) $ 571  

 

See Notes to Financial Statements.

6


The Dow Chemical Company and Subsidiaries
Notes to Financial Statements

(Unaudited)


Note A—Consolidated Financial Statements

    On February 6, 2001, a wholly owned subsidiary of The Dow Chemical Company ("Dow" or the "Company") merged with Union Carbide Corporation ("Union Carbide") and, as a result, Union Carbide became a wholly owned subsidiary of the Company. The merger was accounted for as a pooling of interests. Accordingly, the consolidated financial statements have been prepared to give retroactive effect to the merger and include the combined accounts of Dow and Union Carbide for all periods presented.

    The unaudited interim financial statements reflect all adjustments (consisting of normal recurring accruals) which, in the opinion of management, are considered necessary for a fair presentation of the results for the periods covered. Certain reclassifications of prior year amounts have been made to conform to current year presentation. These statements should be read in conjunction with the audited supplemental consolidated financial statements and notes thereto included in a Form 8-K filed by the Company on April 4, 2001 for the year ended December 31, 2000.

Note B—Merger-related Expenses and Restructuring

    In the first quarter of 2001, pretax costs of $1,384 million were recorded for merger-related expenses and restructuring. These costs included transaction costs, employee severance, and the write-down of duplicate assets and facilities. For further details, see Merger-related Expenses and Restructuring on page 19.

Note C—Cumulative Effect of Change in Accounting Principle

    On January 1, 2001, the Company recorded a cumulative transition adjustment gain of $32 million (net of related income tax of $19 million) upon adoption of Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." For further details, see discussion of SFAS No. 133 in Note G.

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Note D—Operating Segments and Geographic Areas

 
  Three Months Ended

 
In millions

  Mar. 31,
2001

  Mar. 31,
2000

 

 
Operating segment sales              
  Performance Plastics   $ 1,921   $ 1,827  
  Performance Chemicals     1,310     1,338  
  Agricultural Products     605     633  
  Plastics     1,769     1,779  
  Chemicals     996     1,038  
  Hydrocarbons and Energy     709     571  
  Unallocated and Other     76     83  

 
  Total   $ 7,386   $ 7,269  

 
Operating segment EBIT              
  Performance Plastics   $ 217   $ 316  
  Performance Chemicals     100     152  
  Agricultural Products     43     90  
  Plastics     33     260  
  Chemicals     (7 )   143  
  Hydrocarbons and Energy     11     18  
  Unallocated and Other     (1,279 )   (77 )

 
  Total   $ (882 ) $ 902  

 
Geographic area sales              
  United States   $ 3,205   $ 3,137  
  Europe     2,370     2,264  
  Rest of World     1,811     1,868  

 
  Total   $ 7,386   $ 7,269  

 

    The reconciliation between "Earnings (Loss) before Interest, Income Taxes and Minority Interests (EBIT)" and "Income (Loss) before Income Taxes and Minority Interests" consists of "Interest income" and "Interest expense and amortization of debt discount," and can be found in the Consolidated Statements of Income. Intersegment revenues are not material in total or in any one operating segment.

Note E—Commitments and Contingent Liabilities

    In January 1994, Dow Corning Corporation (Dow Corning), in which the Company is a 50 percent shareholder, announced a pretax charge of $640 million ($415 million after tax) for the fourth quarter of 1993. In January 1995, Dow Corning announced a pretax charge of $241 million ($152 million after tax) for the fourth quarter of 1994. These charges included Dow Corning's best estimate of its potential liability for breast implant litigation based on a global Breast Implant Litigation Settlement Agreement (the Settlement Agreement); litigation and claims outside of the Settlement Agreement; and provisions for legal, administrative and research costs related to breast implants. The charges for 1993 and 1994 included pretax amounts of $1,240 million and $441 million less expected insurance recoveries of $600 million and $200 million, respectively. The 1993 amounts reported by Dow Corning were determined on a present value basis. On an undiscounted basis, the estimated liability noted above for 1993 was $2,300 million less expected insurance recoveries of $1,200 million.

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    As a result of the Dow Corning actions, the Company recorded its 50 percent share of the charges, net of tax benefits available to Dow. The impact on net income was a charge of $192 million for 1993 and $70 million for 1994.

    Dow Corning reported an after-tax net loss of $167 million for the second quarter of 1995 as a result of a $221 million after-tax charge taken to reflect a change in accounting method from the present value basis noted above to an undiscounted basis resulting from the uncertainties associated with its voluntary filing for protection under Chapter 11 of the U.S. Bankruptcy Code on May 15, 1995. As a result of such loss and Chapter 11 filing, the Company recognized a pretax charge against income of $330 million for the second quarter of 1995, fully reserved its investment in Dow Corning, and has reserved its 50 percent share of equity earnings through the third quarter of 2000.

    On September 1, 1994, Judge Sam C. Pointer, Jr. of the U.S. District Court for the Northern District of Alabama approved the Settlement Agreement, pursuant to which plaintiffs choosing to participate in the Settlement Agreement released the Company from liability. The Company was not a participant in the Settlement Agreement, nor was it required to contribute to the settlement. On October 7, 1995, Judge Pointer issued an order which concluded that the Settlement Agreement was not workable in its then-current form because the funds committed to it by industry participants were inadequate. The order provided that plaintiffs who had previously agreed to participate in the Settlement Agreement could opt out after November 30, 1995.

    The Company's financial statement exposure for breast implant product liability claims against Dow Corning is limited to its investment in Dow Corning which, after the second quarter of 1995 charge, the reserving of its share of equity earnings through the third quarter of 2000, and the resumption of recognizing of its share of Dow Corning's earnings in the fourth quarter of 2000, is negligible. As a result, any future charges by Dow Corning related to such claims or as a result of the Chapter 11 proceeding would not have a material adverse impact on the Company's consolidated financial statements.

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

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

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

9



claimants, a confirmation hearing and all relevant provisions of the Bankruptcy Code. Voting was completed on May 14, 1999, and the confirmation hearing concluded on July 30, 1999.

    On November 30, 1999, the Bankruptcy Court issued an Order confirming the Joint Plan, but then issued an Opinion on December 21, 1999 that, in the view of the Proponents and the Shareholders, improperly interpreted or attempted to modify certain provisions of the Joint Plan affecting the resolution of tort claims involving Dow Corning's silicone medical products against various entities, including the Shareholders. Many of the parties in interest, including the Shareholders, filed various motions and appeals seeking, among other things, a clarification of the December 21, 1999 Opinion. These motions and appeals were heard by U.S. District Court Judge Denise Page Hood on April 12 and 13, 2000, and on November 13, 2000, Judge Hood affirmed the Bankruptcy Court's November 30, 1999 Order confirming the Joint Plan and reversed, in part, the Bankruptcy Court's December 21, 1999 Opinion, including that portion of the Opinion the Shareholders had appealed. In turn, various parties in interest have appealed Judge Hood's decision to the United States Court of Appeals for the Sixth Circuit. The effectiveness of the Joint Plan remains subject to the resolution of those appeals. Accordingly, there can be no assurance at this time that the Joint Plan will become effective.

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

    Numerous lawsuits have been brought against the Company and other chemical companies alleging that the manufacture, distribution or use of pesticides containing dibromochloropropane (DBCP) has caused, among other things, property damage, including contamination of groundwater. To date, there have been no verdicts or judgments against the Company in connection with these allegations. 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.

    Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. The Company had accrued obligations of $495 million at March 31, 2001 for environmental matters, including $55 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. It is the opinion of the Company's management that the possibility is remote that costs in excess of those accrued or disclosed will have a material adverse impact on the Company's consolidated financial statements.

    In addition to the breast implant, DBCP and environmental remediation matters, the Company is party to a number of other claims and lawsuits arising out of the normal course of business with respect to commercial matters, including product liability, governmental regulation and other actions. Certain of these actions purport to be class actions and seek damages in very large amounts. All such claims are being contested.

10


    Dow has an active risk management program consisting of numerous insurance policies secured from many carriers at various times. These policies provide coverage that will be utilized to minimize the impact, if any, of the contingencies described above.

    Except for the possible effect on the Company's net income for breast implant litigation 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.

    The Company has two major agreements (two in 1999 and three in 1998) for the purchase of ethylene-related products in Canada. The purchase price is determined on a cost-of-service basis which, in addition to covering all operating expenses and debt service costs, provides the owner of the manufacturing plants with a specified return on capital. Total purchases under the agreements were $178 million in 2000, $144 million in 1999 and $266 million in 1998.

    At December 31, 2000, the Company had various outstanding commitments for take or pay and throughput agreements, including the two purchase agreements referred to above, for terms extending from one to 20 years. In general, such commitments were at prices not in excess of current market prices.

Fixed and Determinable Portion of Take or Pay and
Throughput Obligations at December 31, 2000 (in millions)

2001   $ 437
2002     419
2003     399
2004     352
2005     314
2006 through expiration of contracts     2,104

Total   $ 4,025

    In addition to the take or pay obligations at December 31, 2000, the Company had outstanding purchase commitments which ranged from one to 20 years for steam, electrical power, materials, property and other items used in the normal course of business of approximately $242 million. In general, such commitments were at prices not in excess of current market prices. The Company also had outstanding direct and indirect commitments for construction performance and lease payment guarantees and other obligations of $535 million. The Company is also committed to lease manufacturing facilities under construction in Argentina and The Netherlands.

    Union Carbide severally guaranteed up to $122 million at December 31, 2000 of EQUATE's debt and working capital financing needs. Union Carbide also severally guaranteed certain sales volume targets until EQUATE's sales capabilities are proved. In addition, Union Carbide has pledged its shares in EQUATE as security for EQUATE's debt. Union Carbide has political risk insurance coverage for its equity investment and a majority of its guarantee of EQUATE's debt.

Note F—Acquisitions and Divestitures

    In August 1999, The Dow Chemical Company and Union Carbide announced a definitive merger agreement for a tax-free, stock-for-stock transaction. Under the agreement, Union Carbide stockholders received 1.611 shares of Dow stock (on a post-split basis) for each share of Union Carbide stock they owned. Based upon Dow's closing price of $12411/16 (pre-split) on August 3, 1999, the transaction was valued at $66.96 per Union Carbide share, or $11.6 billion in aggregate including the assumption of $2.3 billion of net debt. The transaction has been accounted for as a pooling of interests. According to the agreement, the merger was subject to certain conditions, including approval by Union Carbide stockholders and review by antitrust regulatory authorities in the United States, Europe and Canada. Union Carbide stockholders approved the merger on December 1, 1999. On May 3, 2000, the

11



European Commission approved the merger subject to certain conditions. The Company completed the merger on February 6, 2001, after receiving clearance from the U.S. Federal Trade Commission, the Canadian Competition Bureau and other jurisdictions around the world. As part of the regulatory approval process, the Company agreed to:

    See Merger-related Expenses and Restructuring on page 19 regarding a special charge recorded in the first quarter of 2001 related to the merger with Union Carbide.

    In February 2000, the Company acquired Flexible Products Company of Marietta, Georgia, for approximately $160 million. Flexible Products Company is one of the largest polyurethane systems suppliers in North America and a leader in custom polyurethane foam formulations and dispensing technology.

    In April 1995, the Company signed an agreement with Bundesanstalt für vereinigungsbedingte Sonderaufgaben (BvS) for the privatization of three state-owned chemical companies in eastern Germany, Buna Sow Leuna Olefinverbund (BSL). Economic transfer of business operations to the Company, through the privatization agreement and various service agreements, occurred in June 1995, and the Company began a reconstruction program of the sites. In September 1997, the Company acquired 80 percent ownership in BSL for an investment of $174 million; BvS maintained 20 percent ownership. The Company had a call option and BvS a put option for the remaining 20 percent of BSL after the reconstruction period. In May 2000, the Company announced the completion of the reconstruction program and, for an additional investment of $156 million, acquired the remaining 20 percent of BSL. On June 1, 2000, BSL became a wholly owned subsidiary of the Company and, beginning on that date, the financial results of BSL are fully consolidated.

    BvS provided certain incentives during the reconstruction period to cover portions of the reconstruction program and has retained environmental cleanup obligations for existing facilities. Incentives related to property construction reduced the cost basis of such property. Incentives related to expenses during the reconstruction period were recognized as such expenses were incurred. During the reconstruction period, the Company included the financial results of BSL as a nonconsolidated affiliate.

    In October 2000, the Company announced it had reached an agreement with Gurit-Heberlein AG to acquire the 50 percent interest in Gurit-Essex AG that it did not own. Gurit-Essex AG is the largest European supplier of automotive adhesives, sealants and body engineered systems for the automotive OEM and aftermarket. The acquisition will globalize Dow Automotive's product availability and double the Company's adhesives, sealants and body engineered systems business. In January 2001, the Company completed the acquisition for approximately $390 million. Allocation of the purchase price to the assets acquired and liabilities assumed has not been completed for this acquisition. Final

12



determination of the fair values to be assigned may result in adjustments to the preliminary values assigned at the date of acquisition.

    In December 2000, the Company sold its 32.5 percent ownership interest in the Cochin pipeline system to NOVA Chemicals Corp. for $119 million, resulting in a pretax gain of $98 million. The Company initially announced its agreement to sell its interest in the pipeline to a unit of Williams' energy services business in August 2000. In October 2000, NOVA Chemicals Corp., one of the owners of Cochin, exercised its right of first refusal as provided in the contractual agreements among the Cochin owners.

    On February 9, 2001, Dow announced it had reached an agreement with EniChem to acquire its polyurethanes business. Annual sales for EniChem's polyurethanes and systems business are approximately $500 million. The acquisition, which strengthens Dow's polyurethanes portfolio by enhancing its European presence, was completed in April 2001 for a net cash cost of approximately $80 million. Under the terms of the agreement, Dow divested Union Carbide's 50-percent interest in Polimeri Europa S.r.l. in order to satisfy the European Commission's conditions for approval of the merger.

    On March 8, 2001, Dow announced it had reached an agreement to acquire Rohm and Haas' Agricultural Chemicals business, including working capital, for approximately $1 billion. The transaction is expected to close in the second quarter of 2001, subject to regulatory approvals.

    On March 29, 2001, Dow announced it is making a tender offer to acquire 100 percent of the outstanding shares of Ascot Plc, a publicly traded UK company. The acquisition, subject to various conditions including Ascot shareholder acceptance and applicable regulatory approvals, is valued at approximately $450 million. Dow plans to integrate the Fine Chemicals and Specialty Chemicals businesses of Ascot into Dow's Performance Chemicals' business group. The transaction is expected close during the second quarter of this year. Ascot's annual chemical sales are approximately $335 million.

Note G—Accounting Changes

    In December 1999, the U.S. Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements," which summarizes the SEC's views in applying generally accepted accounting principles to revenue recognition. The Company has determined that SAB 101's revenue recognition guidelines are consistent with the Company's existing revenue recognition policies; therefore, SAB 101 did not have a material impact on the Company's consolidated financial statements.

    In May 2000, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus with respect to EITF Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." EITF 00-10 recognizes the inconsistencies in practice with regard to the recording of shipping and handling costs incurred by most companies that sell goods. The Company, with the exception of Union Carbide, had historically recorded freight and any directly related associated cost of transporting finished product to customers as a reduction of net sales. At the end of 2000, following the guidance of EITF 00-10, the Company reclassifed these costs to cost of sales for all periods. As a result, reported net sales increased approximately 4 percent, with a corresponding increase in cost of sales. Beginning in 2001, these costs are recorded as cost of sales.

    In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement, which replaces FASB Statement No. 125, revises the standards for accounting for securitizations and other transfers of financial assets and collateral, and requires certain disclosures, but it carries over most of the provisions of Statement 125 without reconsideration. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. It is effective for recognition and reclassifications of collateral and for disclosures relating to securitization transactions and collateral for

13



fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material impact on the Company's consolidated financial statements.

SFAS No. 133

    The FASB issued SFAS No.133, "Accounting for Derivative Instruments and Hedging Activities," in June 1998. SFAS No.133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999, the FASB issued SFAS No.137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No.133." In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," an amendment of SFAS No. 133. Based on the revised effective date, the Company adopted SFAS No.133, as amended by SFAS No. 138, on January 1, 2001. Refer to the first five paragraphs of Item 3. Quantitative and Qualitative Disclosures about Market Risk for further discussion of the Company's use of derivative instruments and risk management objectives.

    The Company uses derivative instruments to manage exposures to currency exchange rates, commodity prices, and interest rate risks. The adoption of SFAS No. 133 resulted in a cumulative after-tax increase to net income of $32 million ($51 million pretax) and a cumulative after-tax increase to accumulated other comprehensive income (AOCI) of $65 million ($103 million pretax).

    At March 31, 2001, the Company had interest rate swaps in a net gain position of $2.3 million designated as fair value hedges of underlying fixed rate debt obligations and a net loss position of $10.8 million designated as cash flow hedges of underlying forecasted interest payments. The mark-to-market effects of both the fair value hedge instruments and the underlying debt obligations were recorded as offsetting unrealized gains and losses in interest expense. The effective portion of the mark-to-market effects of the cash flow hedge instrument is recorded in AOCI until the underlying interest payment affects earnings. All existing fair value and cash flow hedges are highly effective. As a result, there was no material impact on earnings due to hedge ineffectiveness.

    The Company has exposure to the prices of commodities in its procurement of certain raw materials. The primary purpose of commodity hedging activities is to manage the volatility associated with these forecasted inventory purchases. Swaps and futures contracts with maturities of not more than 36 months are utilized and qualify as cash flow hedges. Current open contracts hedge forecasted transactions until March 2002. Gains and losses on derivatives qualifying as cash flow hedges are recorded in AOCI, to the extent that hedges are effective, until the underlying transactions are recognized in earnings. Net gains included in AOCI as of March 31, 2001, including the transition adjustment, were $36.1 million after tax, all of which is expected to be reclassified to cost of sales within the next twelve months. The unrealized amounts in AOCI will fluctuate based on changes in the fair value of open contracts at the end of each reporting period.

    In addition, the Company utilizes option instruments that are effective as economic hedges of commodity price exposures, but do not meet the SFAS No. 133 effectiveness threshold. The $32 million decline in the fair value of these instruments was included in cost of sales during the first quarter of 2001.

    A net gain of $87.2 million resulting from hedges of the Company's net investment in foreign operations was included in the cumulative translation adjustment within AOCI during the first quarter of 2001.

    The Company also uses other derivative instruments that are not designated as hedging instruments, the impact of which is not material to the financial statements.

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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), which now includes Union Carbide Corporation (Union Carbide). 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.

INTRODUCTORY NOTE TO READERS

    The accompanying consolidated financial statements of The Dow Chemical Company and its subsidiaries have been prepared to give retroactive effect to the merger of Dow and Union Carbide on February 6, 2001, which has been accounted for as a pooling of interests. Accordingly, the financial statements include the combined accounts of the two companies for all periods presented.

RESULTS OF OPERATIONS

Selected data for the three months ended March 31, 2001 and 2000:

 
  Three Months Ended

 
Dollars in millions, except for share amounts

  March 31, 2001
  March 31, 2000
 

 
Sales   $ 7,386   $ 7,269  
Cost of sales     6,456     5,842  
% of sales     87 %   80 %
Research and development, selling, general and administrative expenses     724     744  
Earnings (Loss) before interest, income taxes and minority interests (EBIT)     (882 )   902  
% of sales     (12 )%   12 %
Effective tax rate     32.7 %   33.1 %
Net income (loss) available for common stockholders   $ (685 ) $ 512  
Earnings (Loss) per common share—basic   $ (0.76 ) $ 0.58  
Earnings (Loss) per common share—diluted   $ (0.76 ) $ 0.57  
Operating rate percentage     80 %   86 %

 

    Net sales for the first quarter of 2001 were $7.4 billion, a record for first quarter sales. Compared with $7.3 billion in the first quarter of 2000, net sales were up $117 million, or 2 percent, with 1 percent increases in both volume and price. Sales volume was particularly strong in the Plastics, Performance Plastics, and Hydrocarbons and Energy segments. Substantial volume growth was recorded in Europe and Latin America, compensating for slowing demand in North America and Asia Pacific. Selling prices improved in all segments except Agricultural Products and Plastics. From a geographic standpoint, prices improved in North America, with prices up 4 percent in the United States and 9 percent in Canada, but declined in all other geographic areas.

15



    Operating expenses (research and development, and selling, general and administrative expenses) were $724 million for the first quarter, down $20 million compared with $744 million last year. Excluding the Company's growth initiatives and acquisitions, operating expenses were down 6 percent from the same quarter of last year.

    Net income for the first quarter was $(685) million or $(0.76) per share, compared with $512 million or $0.57 per share for the first quarter of 2000. Net income was reduced by a pretax special charge of $1,384 million, or $1.02 per share, for costs related to Dow's recent merger with Union Carbide (see Merger-related Expenses and Restructuring on page 19). Net income was also negatively impacted by an increase of almost $600 million in feedstock and energy costs. Additionally, earnings were affected by an $0.18 per share gain on the sale of stock in Schlumberger Ltd. and a $0.04 per share transition adjustment gain from the adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."

    The first quarter proved to be one of the most challenging quarters ever for the North American chemical industry and for Dow. Oil prices have been persistently high, while natural gas prices have been volatile and reached unprecedented highs. These factors, combined with current supply/demand imbalances in certain businesses, had a negative impact on the Company's first quarter earnings.

PERFORMANCE PLASTICS

    Performance Plastics sales of $1,921 million for the first quarter were up 5 percent from $1,827 million in the first quarter of 2000, on a 3 percent increase in price and a 2 percent increase in volume. EBIT for the segment was $217 million, down from $316 million last year, primarily due to a significant increase in raw material costs.

    Dow Automotive sales for the first quarter were up 17 percent from a year ago, primarily due to the consolidation of Gurit-Essex AG following the completion of that acquisition in January 2001 (see Note F to Financial Statements). Excluding the impact of this acquisition, sales were down approximately 15 percent from the first quarter of 2000, due to the general weakness of the global automotive industry. First quarter EBIT for the business was down significantly due to lower sales and increased raw material and manufacturing costs.

    Engineering Plastics sales for the quarter were up slightly from the same quarter last year, as price increases of 11 percent offset a 9 percent decline in volume. Overall prices improved in all geographic areas except Latin America. Volume was off approximately 20 percent in North America due to slowing demand in the electronics industry. Helped by a strong supply/demand environment for polycarbonate, EBIT for the quarter improved from the first quarter of 2000 as increases in price exceeded higher raw material costs.

    Sales of Epoxy Products and Intermediates were up 4 percent from last year, with a 5 percent improvement in price. Prices improved in all geographic areas except Canada. Volume declined slightly due to softening market conditions. EBIT for the quarter was up compared with the same quarter last year due to increased prices and favorable plant operations that more than offset increases in raw material costs.

    Fabricated Products sales for the first quarter of 2001 were down 3 percent compared with last year. While volume improved 1 percent, prices declined 4 percent, including the negative impact of currency on sales in Europe. EBIT for the first quarter was down versus the first quarter of last year, impacted by higher raw material costs and the cost of blowing agent conversions.

    Polyurethanes sales for the first quarter were up 8 percent compared with the first quarter of 2000. Volume increased 5 percent, driven by Dow's acquisition of two North American system house formulators, Flexible Products Company and General Latex. Prices improved 3 percent, with increases

16



in polyols and toluene diisocyanate (TDI). Margins continued to be squeezed by the hydrocarbon cost increases, resulting in a decrease in EBIT for the business versus last year.

    Wire and Cable sales for the first quarter of 2001 were up 9 percent over the first quarter of last year. Volume improved 6 percent and prices rose 3 percent. While demand was strong in Latin America and Europe, the slowing U.S. economy and poor weather negatively impacted sales in the first quarter. EBIT for the first quarter was lower than last year due to increased hydrocarbon costs.

PERFORMANCE CHEMICALS

    Performance Chemicals sales for the first quarter were $1,310 million, down 2 percent from $1,338 million in the first quarter of 2000. Prices improved 3 percent compared with last year, as volume declined 5 percent, impacted by the divestiture of businesses required for regulatory approval of the merger with Union Carbide (discussed in further detail below). First quarter EBIT for the segment was down from $152 million last year to $100 million this year, as the combination of lower volume and higher raw material costs more than offset the increase in selling prices.

    Emulsion Polymers sales for the quarter were up 4 percent, with a 10 percent increase in price that more than offset a 6 percent decline in volume versus the same quarter last year. Prices were up significantly in North America and Europe, flat in Latin America and down slightly in Asia Pacific. Demand for styrene-butadiene latex for carpet and coated paper applications was down due to the economic slowdown in the United States. EBIT for the first quarter improved versus last year as higher prices overcame increased styrene monomer costs and the decline in volume.

    Industrial Chemicals sales were up slightly from the first quarter of 2000 on increased volume for polyglycols. EBIT for this business was down compared with last year due to higher feedstock and energy costs.

    Oxide Derivatives sales for the first quarter were down 11 percent compared with last year due to a 14 percent decline in volume, reflecting the impact of the divestiture of Dow's ethyleneamines, ethanolamines and North American Gas/Spec gas treating businesses in the first quarter. These divestitures were required for regulatory approval of the merger with Union Carbide. Volume was also reduced as the Company decided to forego certain low margin glycol ethers and alkanolamines business. EBIT was down in the first quarter as higher feedstock and energy costs exceeded a 3 percent increase in selling prices.

    Specialty Polymers sales were up slightly in the first quarter versus last year. Volume was flat with demand up in Europe and Asia Pacific, and down in North America primarily due to a softening in demand in the electronics industry. Prices were up slightly. EBIT for the first quarter was down modestly due to higher feedstock and energy costs.

    Water Soluble Polymers sales improved 2 percent on strong demand for Methocel cellulose ethers, Ethocel ethylcellulose resins, and POLYOX™ water soluble resins, which more than offset a 4 percent decline in prices. EBIT for this business was flat versus the first quarter of 2000.

AGRICULTURAL PRODUCTS

    Sales of Agricultural Products for first quarter 2001 were $605 million, down 4 percent from $633 million last year. Volume for the segment grew 2 percent, due primarily to the acquisition of Cargill Hybrid Seeds, but was more than offset by a 6 percent decline in prices. Demand was strong for seeds, spinosad insect control products and glyphosate. Volume overall was lower than expected in the quarter due to unfavorable weather conditions that caused a delay in planting in Midwestern United States and in Europe. Prices were down versus last year due to competitive pressure and the negative impact of currency on sales in Europe. EBIT for the quarter was $43 million, compared with

17



$90 million in the first quarter of 2000, reflecting adverse conditions worldwide in the agricultural industry and the effect of discontinued in and around the home applications of chlorpyrifos.

PLASTICS

    Plastics sales in the first quarter of 2001 were $1,769 million, down slightly compared with $1,779 million a year ago. Volume grew 3 percent, with increases in all geographic areas except Canada. Prices overall declined 4 percent, as price declines were reported in all geographic areas except North America. EBIT for the quarter was $33 million, down substantially from $260 million in the first quarter of 2000, due to a significant rise in hydrocarbon and energy costs and decreased selling prices.

    Polyethylene sales were relatively flat versus the first quarter of last year, with volume growth of 5 percent offset by price declines of 5 percent. Volume was strong in North America and Europe, but down marginally in Asia Pacific due to reduced exports from North America. Demand was particularly strong for Affinity polyolefin plastomers and low density polyethylene. While prices continued to fall from the second half of 2000 due to excess supply in the industry, some price increases were successful late in the quarter. During the quarter, Dow implemented temporary plant slowdowns in order to not operate at negative cash margins during the peak in ethane costs. EBIT for the business was down significantly, reflecting the squeeze of lower selling prices and a continued rise in feedstock costs.

    Polypropylene sales for the first quarter of 2001 continued a strong upward trend due to improved pricing and volume versus the same quarter last year. Volume was particularly strong in North America and Europe. EBIT was down, however, versus last year due to weak industry fundamentals, a plant shutdown at BSL, start-up costs associated with a new polypropylene plant in Freeport, Texas, and higher propylene costs.

    Polystyrene sales were down in the first quarter of 2001 compared with the same quarter last year, as a softening in demand negatively impacted prices. Volume fell 9 percent, while prices declined 4 percent. EBIT for the business was down compared with the first quarter of 2000 due to difficult market conditions.

CHEMICALS

    First quarter sales for the Chemicals segment were $996 million, down 4 percent from $1,038 million in the first quarter of 2000. Volume was down 7 percent overall, with declines in ethylene glycol (EG) and organic intermediates, solvents, and monomers (OISM). Weak volume and high ethylene costs led to the temporary shutdown of production at the Company's EG facility in Prentiss, Alberta, Canada, while a slowdown in the coatings and adhesives industry resulted in lower vinyl acetate monomer (VAM) volumes. Prices rose 3 percent compared with last year, as price increases in caustic, VAM and ethanol offset unfavorable vinyl chloride monomer (VCM) prices. EBIT for the segment was $(7) million, compared with $143 million in the first quarter of 2000. EBIT declined due to lower volumes and higher feedstock and energy costs that negatively impacted margins.

HYDROCARBONS AND ENERGY

    Hydrocarbons and Energy sales were $709 million, a 24 percent increase over $571 million in the first quarter of 2000. Volume was up 14 percent, while prices rose 10 percent. Refinery sales and sales of power and steam were up in the quarter. Hydrocarbon feedstock costs continued to rise during the quarter, negatively impacting the results of several of the Company's businesses. EBIT for the quarter was $11 million compared with $18 million in the first quarter of 2000.

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UNALLOCATED AND OTHER

    Unallocated and Other includes research and other expenses related to developmental activities in Growth Platforms, overhead and other cost recovery variances that are not allocated to the operating segments, results of Dow's insurance and finance company operations, gains and losses on sales of financial assets, and foreign exchange hedging results.

    EBIT for the quarter was a loss of $1.3 billion compared with a loss of $77 million for the first quarter of 2000. The first quarter results for Unallocated and Other included a pretax special charge of $1,384 million for costs related to Dow's recent merger with Union Carbide (see Merger-related Expenses and Restructuring below) and a $266 million gain on the sale of stock in Schlumberger Ltd.

Sales Volume and Price by Operating Segment and Geographic Area

 
  Three Months Ended
March 31, 2001

 
Percentage change from prior year

  Volume
  Price
  Total
 

 
Operating segments              
  Performance Plastics   2 % 3 % 5 %
  Performance Chemicals   (5 )% 3 % (2 )%
  Agricultural Products   2 % (6 )% (4 )%
  Plastics   3 % (4 )% (1 )%
  Chemicals   (7 )% 3 % (4 )%
  Hydrocarbons and Energy   14 % 10 % 24 %

 
  Total   1 % 1 % 2 %

 
Geographic area sales              
  United States   (2 )% 4 % 2 %
  Europe   7 % (2 )% 5 %
  Rest of World   (2 )% (1 )% (3 )%

 
  Total   1 % 1 % 2 %

 

COMPANY SUMMARY

Operating Rate

    The Company's global plant operating rate for its chemicals and plastics businesses was 80 percent compared with 86 percent in the first quarter of 2000. This decline reflects a temporary decrease in production in some of Dow's North American facilities, in response to high natural gas prices, where the Company would not have recovered its cash costs.

Merger-related Expenses and Restructuring

    On March 29, 2001 Dow's management made certain decisions relative to employment levels, duplicate assets and facilities and excess capacity resulting from the merger with Union Carbide. These decisions were based on management's assessment of the actions necessary to achieve synergies as the result of the merger. The economic effects of these decisions, combined with merger-related transaction costs and certain assets impairments, resulted in a pretax special charge in the first quarter of

19



$1,384 million. This charge was included in Unallocated and Other for segment reporting purposes. The following table shows the major components of the special charge:

In millions

   

Transaction costs   $ 122
Labor-related costs     643
Write-down of assets and facilities     619

Total   $ 1,384

    Transaction costs of $122 million consisted primarily of investment banking, legal and accounting fees, all of which had been paid at March 31, 2001.

    Employee-related costs consisted predominantly of provisions for employee severance, change of control obligations, medical and retirement benefits, and outplacement services. The Company's integration plans include a workforce reduction of approximately 4,500 people, primarily from Union Carbide's administrative, marketing, purchasing, research and development, and manufacturing workforce. The charge for severance was based upon the severance plan provisions communicated to employees. Headcount reductions began in the second quarter of 2001. Approximately one-half of the reductions will be completed by the end of September; approximately 80 percent will be completed by the end of the first 12 months following the merger. The Company expects that approximately 66 percent of the employee-related costs will be expended in cash within the next two years, though the timing of severance payments is dependent upon employee elections. Expenditures with respect to employee-related costs associated with pension and postretirement benefit plans will occur over a much more extended period that is not currently determinable.

    The special charge included $619 million for the write-down of duplicate assets and facilities directly related to the merger, the loss on divestitures required to obtain regulatory approval for the merger, asset impairments and lease abandonment reserves. Duplicate assets consist principally of capitalized software costs, information technology equipment, research and development facilities and equipment, all of which were written off during the first quarter. The fair values of the impaired assets, which include production facilities and transportation equipment, were determined based on discounted cash flows and an appraisal, respectively. These components of the special charge will require limited future cash outlays, and will result in a decrease in annual depreciation of approximately $65 million.

    The following table summarizes the activity in the special charge reserve for the three months ended March 31, 2001:

In millions

   
   
   

Opening
Balance

  Additions to
Reserve

  Charges Against
Reserve

  Balance at
Period End


  $ 1,384   (740 ) $ 644

    The Company's expects the foregoing actions, in combination with other synergy activities, to result in annual cost savings of $1.1 billion by the end of the first quarter of 2003. The cost reductions will affect cost of sales, research and development expenses, and selling, general and administrative expenses. These actions are not expected to have an impact on future revenues.

1999 Special Charge

    In the fourth quarter of 1999, a special charge of $94 million was recorded for a cost reduction and business restructuring program in the Agricultural Products segment. At March 31, 2001, the program was substantially complete.

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Equity in Earnings of Nonconsolidated Affiliates

    Equity in earnings of nonconsolidated affiliates was $35 million in the first quarter of 2001, compared with $130 million in the same quarter last year. Equity earnings declined primarily due to the consolidation of Gurit-Essex AG in the first quarter of 2001 and BSL beginning June 1, 2000, and the divestiture of Dow's interest in Polimeri Europa, which was required for regulatory approval of the merger with Union Carbide (see Note F to Financial Statements). Lower results in several of the Company's basics joint ventures, which corresponded with the decline in the results of Dow's basics businesses, also contributed to the decline.

Sundry Income—Net

    Sundry income includes a variety of income and expense items such as the gain or loss on foreign currency exchange, dividends from investments, and gains and losses on sales of investments and assets. Sundry income for the first quarter of 2001 was $283 million compared with $101 million in the first quarter of 2000. In the first quarter of 2001, sundry income included a $266 million pretax gain on the sale of stock in Schlumberger Ltd.

Net Interest Expense

    Net interest expense (interest expense less capitalized interest and interest income) was $158 million in the first quarter of 2001 compared with $110 million last year. Net interest expense was up primarily due to an increase in total debt. Additionally, interest income in the first quarter of last year included $15 million related to a tax refund.

Provision for Taxes on Income

    The effective tax rate for the first quarter was 32.7 percent compared with 33.1 percent for the same quarter of 2000.

Outlook

    While there was a noticeable slowdown in economic activity in North America and Asia Pacific in the first quarter, demand in Europe and Latin America held up well. While the U.S. automotive and electronics industries have been impacted more than other industries, the last few months may have represented the trough of economic activity in the United States. Though there has been a slight slowdown in Europe, demand remains strong. In Asia Pacific, despite weakness in Japan, the Chinese economy remains healthy. In Latin America, growth this year is expected to be approximately the same as it was in 2000. For the second quarter overall, global GDP is expected to be about even with the first quarter, perhaps slightly higher.

    This year will be a challenging one for the chemical industry. The prices of oil and oil-based feedstocks have remained high, despite expectations throughout 2000 that they would decline. North American natural gas prices reached unprecedented levels at the end of 2000, and in the first quarter of 2001 were nearly three times the level of the first quarter of 2000, severely impacting energy and gas-related feedstock costs in the region. While these costs are expected to be volatile and remain at historically high levels, the second quarter may bring some relief compared to the first quarter, and the year-over-year increase in costs may narrow somewhat. Oil prices are expected to range between $25 and $27 per barrel for most of the second quarter.

    Demand for chemicals and plastics in the quarter may be bolstered by a seasonal upswing in the construction industry and by an anticipated increase in North American auto production. Unless demand picks up significantly more than anticipated, some industry sectors will continue to be affected by recent capacity additions in the ethylene chain, limiting the ability of producers to recover increased costs through higher prices.

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    Demand in the second quarter is expected to be flat to slightly up compared with the first quarter for many of Dow's businesses. With price increases recently implemented or announced in several businesses, margins are expected to improve versus the cumulative increases in feedstock and energy costs. The anticipated moderation of these costs will also improve second quarter results. Agricultural Products should see a strong rebound in sales and profitability during the second quarter with the acceleration of fieldwork that was delayed due to poor weather in some of Dow AgroSciences' key regions. In addition to these improved business fundamentals, the Company will realize some of the cost synergies that have been identified from the merger with Union Carbide.

    Given the assumptions of a modest decline in hydrocarbon and energy costs from the first quarter average, the continuation of current exchange rates and a slight improvement in demand, Dow's earnings are expected to improve substantially from the first quarter of 2001, but not reach the level of the second quarter of last year. While it is difficult to forecast earnings in this uncertain environment, Dow's earnings for the second quarter are expected to be between $0.35 and $0.45 per share.

CHANGES IN FINANCIAL CONDITION

    The following tables present total debt and working capital at March 31, 2001 versus December 31, 2000:

In millions

  March 31,
2001

  Dec. 31,
2000

  Increase
(Decrease)

 

 
Notes payable   $ 3,086   $ 2,519   $ 567  
Long-term debt due within one year     307     318     (11 )
Long-term debt     7,139     6,613     526  

 
Total debt   $ 10,532   $ 9,450   $ 1,082  

 

    At March 31, 2001, the Company had unused and available credit facilities with various U.S. and foreign banks totaling $3.1 billion in support of its working capital requirements and commercial paper borrowings. Additional unused credit facilities totaling $1.0 billion were available for use by foreign subsidiaries. At March 31, 2001, there was a total of $1.3 billion in available SEC registered securities. On May 1, 2001, the Company filed a shelf registration statement on Form S-3 with the SEC to register $2 billion in securities, including $260 million that was rolled over from a prior shelf and included in the $1.3 billion that was available at March 31, 2001. This registration statement has not been declared effective as of the date of the filing of this Form 10-Q. Separately, on May 8, 2001, the Company agreed to sell $1 billion of three-year notes in a private offering expected to close on May 15, 2001.

In millions

  March 31,
2001

  Dec. 31,
2000

  Increase
(Decrease)

 

 
Cash and cash equivalents   $ 244   $ 278   $ (34 )
Marketable securities and interest-bearing deposits     246     163     83  
Accounts and notes receivable—net     6,197     6,419     (222 )
Inventories:                    
Finished and work in process     3,618     3,396     222  
Materials and supplies     759     817     (58 )
Deferred income tax assets—current     687     250     437  

 
Total current assets     11,751     11,323     428  

 
Total current liabilities     9,762     10,173     (411 )

 
Working capital   $ 1,989   $ 1,150   $ 839  

 

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    Cash used in operating activities was $584 million for the three months ended March 31, 2001, and was primarily the result of lower net income that included a special charge for merger-related expenses and restructuring. Cash of $451 million was generated by sales of available-for-sale securities in excess of purchases of similar securities. Additional cash of $1 billion was generated from a combination of new short and long-term debt. Cash was used to fund acquisitions, capital expenditures, and to pay dividends. See the Consolidated Statements of Cash Flows and Note F to Financial Statements for further details.

Balance Sheet Ratios

  March 31,
2001

  Dec. 31,
2000

 

 
Current assets over current liabilities   1.2:1   1.1:1  
Days-sales-outstanding-in-receivables   46   45  
Days-sales-in-inventory   87   84  
Debt as a percent of total capitalization   47.8 % 42.5 %

 

    On May 11, 2000, stockholders approved a measure to increase the number of authorized common shares from 500 million to 1.5 billion and Dow's Board of Directors approved a three-for-one split of the Company's common stock. On June 16, 2000, Dow stockholders received two additional shares of stock for each share they owned on the record date of May 23, 2000. All references in the consolidated financial statements to common shares, share prices, per share amounts and stock plans have been restated retroactively for the stock split, unless otherwise noted.

    The Company announced on January 31, 2001 that two pro rata dividends would be paid to Dow stockholders for the first quarter of 2001, in order to comply with the terms of the merger agreement with Union Carbide. Due to the closing of the merger on February 6, 2001, two pro rata dividends were paid as follows:

    The two pro rata dividends together equal Dow's current quarterly dividend rate of 29 cents per share. This was the 357th consecutive quarter in which the Company has issued a dividend. Since 1912, Dow has maintained or increased the quarterly dividend.

OTHER MATTERS

ACCOUNTING CHANGES

    See Note G to Financial Statements for a discussion of accounting changes.

EURO CONVERSION

    On January 1, 1999, the Euro was adopted as the national currency of 11 European Union member nations. During a three-year transition period, the Euro is being used as a non-cash transactional currency. The Company began conducting business in the Euro on January 1, 1999. Effective January 1, 2001, the Company has completed its change of functional currencies for its subsidiaries operating in the participating member nations from the national currency to the Euro. The conversion to the Euro has not had an operational impact on the Company or an impact on the results of operations, financial position, or liquidity of its European businesses.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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

    Inherent in Dow's business is exposure to price changes for several commodities. Some exposures can be hedged effectively through liquid tradable financial instruments. Cracker feedstocks and natural gas constitute the main commodity exposures. Over-the-counter and exchange traded instruments are used to hedge these risks when feasible. The risk of these hedging instruments was not material in 1999.

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

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

Average Daily VAR at December 31*
In millions

  2000
  1999

Foreign exchange   $ 7   $ 5
Interest rate     45     69
Equity exposures, net of hedges     26     14
Commodities     28    

*Using a 95 percent confidence level

    Management believes there have been no material changes in market risk or in risk management policies since December 31, 2000.

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The following trademarks of The Dow Chemical Company appear in this report: Affinity, Ethocel, Gas/Spec, Methocel


PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Breast Implant Matters

    No material developments regarding this matter occurred during the first quarter of 2001. For a summary of the history and current status of this matter, see Note E to Financial Statements.

Environmental Matters

    As initially reported in Union Carbide's Quarterly Report on Form 10-Q for the period ended September 30, 2000, Union Carbide was served with an administrative Complaint and Notice of Opportunity for Hearing ("Complaint") by the U.S. Environmental Protection Agency, Region 6, alleging violations of reporting requirements under section 112 of the Federal Clean Air Act at its Taft facility in Hahnville, Louisiana. The Complaint sought civil penalties of $159,840. On January 18, 2001, the Complaint was withdrawn.

    On March 27, 2001, the Texas Natural Resource Conservation Commission served a Notice of Enforcement Action on the Company, alleging the violation of various air pollution laws and regulations, for which it is seeking a civil penalty of $514,825.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)
Exhibits
(b)
Reports on Form 8-K.

    The following Current Reports on Form 8-K were filed by the Company during the first quarter of 2001:

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    The following Current Reports on Form 8-K were filed by the Company subsequent to the first quarter of 2001:

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SIGNATURE

    Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

THE DOW CHEMICAL COMPANY
Registrant

Date: May 9, 2001

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

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QuickLinks

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Note A)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PART II—OTHER INFORMATION