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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 June 30, 2001

Commission file number 1-3433


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


Delaware

 

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

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

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
June 30, 2001

Common Stock, $2.50 par value   900,809,497 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

 

16
   
Disclosure Regarding Forward-Looking Information

 

16
   
Results of Operations

 

16
   
Changes in Financial Condition

 

24
   
Other Matters

 

25
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

26

PART II—OTHER INFORMATION

 

 
 
Item 1. Legal Proceedings

 

27
 
Item 4. Submission of Matters to a Vote of Security Holders

 

27
 
Item 6. Exhibits and Reports on Form 8-K

 

28

SIGNATURE

 

29

Exhibit 3(ii)

 

30

2



PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (Note A)

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

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

  June 30,
2001

  June 30,
2000

  June 30,
2001

  June 30,
2000

Net Sales   $ 7,344   $ 7,586   $ 14,730   $ 14,855
   
 
 
 
  Cost of sales     6,137     5,968     12,593     11,810
  Research and development expenses     271     277     543     547
  Selling, general and administrative expenses     456     431     908     905
  Amortization of intangibles     35     32     68     73
  Merger-related expenses and restructuring (Note B)     24         1,408    
  Insurance and finance company operations, pretax income     14     14     25     43
  Equity in earnings of nonconsolidated affiliates     38     130     73     260
  Sundry income—net     85     107     368     208
   
 
 
 
Earnings (Loss) before Interest, Income Taxes and Minority Interests     558     1,129     (324 )   2,031
   
 
 
 
  Interest income     16     29     40     74
  Interest expense and amortization of debt discount     179     169     361     324
   
 
 
 
Income (Loss) before Income Taxes and Minority Interests     395     989     (645 )   1,781
   
 
 
 
  Provision for income taxes     120     311     (220 )   573
  Minority interests' share in income (loss)     (5 )   21     12     39
   
 
 
 
Income (Loss) before Cumulative Effect of Change in Accounting Principle     280     657     (437 )   1,169
   
 
 
 
  Cumulative effect of change in accounting principle (Note C)             32    
   
 
 
 
Net Income (Loss) Available for Common Stockholders   $ 280   $ 657   $ (405 ) $ 1,169
   
 
 
 
Share Data                        
  Earnings (Loss) before cumulative effect of change in accounting principle per common share—basic   $ 0.31   $ 0.73   $ (0.49 ) $ 1.31
  Earnings (Loss) per common share—basic   $ 0.31   $ 0.73   $ (0.45 ) $ 1.31
  Earnings (Loss) before cumulative effect of change in accounting principle per common share—diluted   $ 0.31   $ 0.72   $ (0.49 ) $ 1.29
  Earnings (Loss) per common share—diluted   $ 0.31   $ 0.72   $ (0.45 ) $ 1.29
  Common stock dividends declared per share of Dow common stock   $ 0.335   $ 0.29   $ 0.625   $ 0.58
  Weighted-average common shares outstanding—basic     900.9     894.5     899.5     892.0
  Weighted-average common shares outstanding—diluted     912.7     906.1     899.5     905.0
   
 
 
 
Depreciation   $ 384   $ 389   $ 772   $ 757
   
 
 
 
Capital Expenditures   $ 376   $ 471   $ 649   $ 910
   
 
 
 

See Notes to Financial Statements.

3


The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  June 30,
2001

  Dec. 31,
2000

 
Assets              
Current Assets              
  Cash and cash equivalents   $ 203   $ 278  
  Marketable securities and interest-bearing deposits     100     163  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables—2001: $119; 2000: $103)     3,825     3,655  
    Other     2,580     2,764  
  Inventories:              
    Finished and work in process     3,763     3,396  
    Materials and supplies     813     817  
  Deferred income tax assets—current     675     250  
   
 
 
  Total current assets     11,959     11,323  
   
 
 
Investments              
  Investment in nonconsolidated affiliates     1,903     2,096  
  Other investments     1,755     2,528  
  Noncurrent receivables     647     674  
   
 
 
  Total investments     4,305     5,298  
   
 
 
Property              
  Property     35,101     34,852  
  Less accumulated depreciation     21,634     21,141  
   
 
 
  Net property     13,467     13,711  
   
 
 
Other Assets              
  Goodwill (net of accumulated amortization—2001: $498; 2000: $459)     3,363     1,928  
  Deferred income tax assets—noncurrent     2,015     1,968  
  Deferred charges and other assets     1,838     1,763  
   
 
 
  Total other assets     7,216     5,659  
   
 
 
Total Assets   $ 36,947   $ 35,991  
   
 
 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 
Current Liabilities              
  Notes payable   $ 3,700   $ 2,519  
  Long-term debt due within one year     38     318  
  Accounts payable:              
    Trade     2,487     2,975  
    Other     1,016     1,594  
  Income taxes payable     192     258  
  Deferred income tax liabilities—current     210     35  
  Dividends payable     323     217  
  Accrued and other current liabilities     2,186     2,257  
   
 
 
  Total current liabilities     10,152     10,173  
   
 
 
Long-Term Debt     8,379     6,613  
   
 
 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     1,358     1,165  
  Pension and other postretirement benefits—noncurrent     2,400     2,238  
  Other noncurrent obligations     3,177     3,012  
   
 
 
  Total other noncurrent liabilities     6,935     6,415  
   
 
 
Minority Interest in Subsidiaries     393     450  
   
 
 
Preferred Securities of Subsidiary     500     500  
   
 
 
Stockholders' Equity              
  Common stock     2,453     2,453  
  Additional paid-in capital     45      
  Unearned ESOP shares     (103 )   (103 )
  Retained earnings     11,707     12,675  
  Accumulated other comprehensive loss     (990 )   (560 )
  Treasury stock at cost     (2,524 )   (2,625 )
   
 
 
  Net stockholders' equity     10,588     11,840  
   
 
 
Total Liabilities and Stockholders' Equity   $ 36,947   $ 35,991  
   
 
 

See Notes to Financial Statements.

4


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
   
  Six Months Ended
 
In millions (Unaudited)

  June 30,
2001

  June 30,
2000

 
Operating Activities   Income (loss) before cumulative effect of change in accounting principle   $ (437 ) $ 1,169  
    Adjustments to reconcile net income to net cash provided by operating activities:              
      Depreciation and amortization     863     849  
      Credit for deferred income tax     (268 )   (67 )
      Undistributed earnings of nonconsolidated affiliates     (43 )   (214 )
      Minority interests' share in income     12     39  
      Net gain on sales of property and businesses     (10 )   (7 )
      Other net gain     (290 )   (82 )
      Merger-related expenses and restructuring     1,051      
      Tax benefit-nonqualified stock option exercises     22     20  
    Changes in assets and liabilities that provided (used) cash:              
      Accounts and notes receivable     134     (242 )
      Inventories     (113 )   (275 )
      Accounts payable     (594 )   (34 )
      Other assets and liabilities     (226 )   (22 )
       
 
 
    Cash provided by operating activities     101     1,134  
       
 
 
Investing Activities   Capital expenditures     (649 )   (910 )
    Proceeds from sales of property and businesses     102     22  
    Purchases of consolidated companies     (2,204 )   (416 )
    Investments in nonconsolidated affiliates     (111 )   (197 )
    Proceeds from sale of nonconsolidated affiliate     180      
    Purchases of investments     (1,364 )   (1,596 )
    Proceeds from sales of investments     2,002     2,420  
       
 
 
    Cash used in investing activities     (2,044 )   (677 )
       
 
 
Financing Activities   Changes in short-term notes payable     727     113  
    Payments on long-term debt     (234 )   (510 )
    Proceeds from issuance of long-term debt     1,799     8  
    Purchases of treasury stock     (5 )   (3 )
    Proceeds from sales of common stock     75     128  
    Distributions to minority interests     (32 )   (35 )
    Dividends paid to stockholders     (458 )   (450 )
       
 
 
    Cash provided by (used in) financing activities     1,872     (749 )
       
 
 
Effect of Exchange Rate Changes on Cash     (4 )   (6 )
       
 
 
Summary   Decrease in cash and cash equivalents     (75 )   (298 )
    Cash and cash equivalents at beginning of year     278     547  
       
 
 
    Cash and cash equivalents at end of period   $ 203   $ 249  
       
 
 

See Notes to Financial Statements.

5


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

 
   
  Three Months Ended
  Six Months Ended
 
In millions (Unaudited)

  June 30,
2001

  June 30,
2000

  June 30,
2001

  June 30,
2000

 
Net Income (Loss) Available for Common Stockholders   $ 280   $ 657   $ (405 ) $ 1,169  
Other Comprehensive Income (Loss), Net of Tax   Unrealized gains (losses) on investments     (11 )   (23 )   (298 )   70  
    Cumulative translation adjustments     (41 )   (69 )   (149 )   (104 )
    Minimum pension liability                 1  
    Net gains (losses) on cash flow hedging derivative instruments     (12 )       17      
       
 
 
 
 
    Total other comprehensive income (loss)     (64 )   (92 )   (430 )   (33 )
       
 
 
 
 
Comprehensive Income (Loss)   $ 216   $ 565   $ (835 ) $ 1,136  
       
 
 
 
 

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 half of 2001, pretax costs of $1,408 million were recorded for merger-related expenses and restructuring. These costs included transaction costs, employee severance, the write-down of duplicate assets and facilities, and other merger-related expenses. For further details, see Merger-related Expenses and Restructuring on page 21.

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.

7


Note D—Operating Segments and Geographic Areas

 
  Three Months Ended
  Six Months Ended
 
In millions

  June 30,
2001

  June 30,
2000

  June 30,
2001

  June 30,
2000

 
Operating segment sales                          
  Performance Plastics   $ 1,864   $ 1,941   $ 3,785   $ 3,768  
  Performance Chemicals     1,240     1,373     2,550     2,711  
  Agricultural Products     809     694     1,414     1,327  
  Plastics     1,697     1,761     3,466     3,540  
  Chemicals     945     1,079     1,941     2,117  
  Hydrocarbons and Energy     718     638     1,427     1,209  
  Unallocated and Other     71     100     147     183  
   
 
 
 
 
  Total   $ 7,344   $ 7,586   $ 14,730   $ 14,855  
   
 
 
 
 
Operating segment EBIT                          
  Performance Plastics   $ 140   $ 274   $ 357   $ 590  
  Performance Chemicals     158     182     258     334  
  Agricultural Products     176     158     219     248  
  Plastics     42     321     75     581  
  Chemicals     45     180     38     323  
  Hydrocarbons and Energy     (14 )   2     (3 )   20  
  Unallocated and Other     11     12     (1,268 )   (65 )
   
 
 
 
 
  Total   $ 558   $ 1,129   $ (324 ) $ 2,031  
   
 
 
 
 
Geographic area sales                          
  United States   $ 3,203   $ 3,394   $ 6,408   $ 6,531  
  Europe     2,265     2,189     4,635     4,453  
  Rest of World     1,876     2,003     3,687     3,871  
   
 
 
 
 
  Total   $ 7,344   $ 7,586   $ 14,730   $ 14,855  
   
 
 
 
 

    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

8


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.

    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,

9


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

    On November 30, 1999, the Bankruptcy Court issued an Order confirming the Joint Plan, but then issued an Opinion on December 21, 1999 that, in the view of the Proponents and the Shareholders, improperly interpreted or attempted to modify certain provisions of the Joint Plan affecting the resolution of tort claims involving Dow Corning's silicone medical products against various entities, including the Shareholders. Many of the parties in interest, including the Shareholders, filed various motions and appeals seeking, among other things, a clarification of the December 21, 1999 Opinion. These motions and appeals were heard by U.S. District Court Judge Denise Page Hood on April 12 and 13, 2000, and on November 13, 2000, Judge Hood affirmed the Bankruptcy Court's November 30, 1999 Order confirming the Joint Plan and reversed, in part, the Bankruptcy Court's December 21, 1999 Opinion, including that portion of the Opinion the Shareholders had appealed. In turn, various parties in interest 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 $486 million at June 30, 2001 for environmental matters, including $54 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

10


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.

    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 was also committed to lease manufacturing facilities under construction in Argentina and The Netherlands. The facilities in Argentina are now complete and have been leased to the Company.

    Union Carbide severally guaranteed up to $54 million at June 30, 2001 of EQUATE's debt and working capital financing needs. Union Carbide also severally guaranteed certain sales volume targets

11


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 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 21 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 was 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

12


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. In January 2001, the Company completed the acquisition for approximately $390 million. The acquisition has globalized Dow Automotive's product availability and doubled the Company's adhesives, sealants and body engineered systems business. Allocation of the purchase price to the assets acquired and liabilities assumed has not been completed for this acquisition. Final 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. to EniChem in order to satisfy the European Commission's conditions for approval of the merger. Final determination of the fair values to be assigned may result in adjustments to the preliminary values assigned at the date of acquisition.

    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. After receiving regulatory approval, the Company announced completion of the acquisition on June 1, 2001. Final determination of the fair values to be assigned may result in adjustments to the preliminary values assigned at the date of acquisition, and could principally impact goodwill, property and purchased in-process research and development.

    On March 29, 2001, Dow announced it was making a tender offer to acquire 100 percent of the outstanding shares of Ascot Plc, a publicly traded UK company. Subsequently, the European Commission granted regulatory approval of the acquisition on May 11, 2001, and the Company declared its offer to acquire Ascot wholly unconditional on June 1, 2001. The acquisition is valued at approximately $450 million. Dow plans to integrate the Fine Chemicals and Specialty Chemicals

13


businesses of Ascot into Dow's Performance Chemicals' business group. Ascot's annual chemical sales are approximately $335 million. Final determination of the fair values to be assigned may result in adjustments to the preliminary values assigned at the date of acquisition.

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 recognized 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 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.

    In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." These statements replace APB Opinion No. 16, "Business Combinations" and APB Opinion No. 17, "Intangible Assets", respectively. Under SFAS No. 141 all business combinations initiated after June 30, 2001 are accounted for using only the purchase method. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. Under this statement, goodwill will not be amortized, but will be subject to impairment testing. The Company is currently assessing the impact of adopting these 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,

14


on January 1, 2001. Refer to the first five paragraphs of "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) in 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.

15



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 and six months ended June 30, 2001 and 2000:

 
  Three Months Ended
  Six Months Ended
 
Dollars in millions, except for share amounts

  June 30,
2001

  June 30,
2000

  June 30,
2001

  June 30,
2000

 
Sales   $ 7,344   $ 7,586   $ 14,730   $ 14,855  
Cost of sales     6,137     5,968     12,593     11,810  
% of sales     84 %   79 %   85 %   80 %
Research and development, selling, general and administrative expenses     727     708     1,451     1,452  
Earnings (Loss) before interest, income taxes and minority interests (EBIT)     558     1,129     (324 )   2,031  
% of sales     8 %   15 %   (2) %   14 %
Effective tax rate     30.4 %   31.4 %   34.1 %   32.2 %
Net income (loss) available for common stockholders   $ 280   $ 657   $ (405 ) $ 1,169  
Earnings (Loss) per common share—basic   $ 0.31   $ 0.73   $ (0.45 ) $ 1.31  
Earnings (Loss) per common share—diluted   $ 0.31   $ 0.72   $ (0.45 ) $ 1.29  
Operating rate percentage     76 %   88 %   77 %   86 %
   
 
 
 
 

    Net sales for the second quarter of 2001 were $7.3 billion, down 3 percent from $7.6 billion in the second quarter of 2000 with no change in volume and a 3 percent decline in prices. Sales volume was particularly strong in Agricultural Products (due partially to the acquisition of Rohm and Haas' Agricultural Chemicals business), Plastics, and Hydrocarbons and Energy, but was down in Performance Chemicals and Chemicals. From a geographic standpoint, substantial volume growth was recorded in Europe and Latin America, offsetting the results of slowing demand in North America and Asia Pacific. Selling prices, down $275 million in total, declined in all segments except Performance Chemicals and in all geographic areas, reflecting the current economic environment. Year to date, net

16


sales of $14.7 billion were down 1 percent from $14.9 billion last year due to a 1 percent decline in prices.

    Operating expenses (research and development, and selling, general and administrative expenses) were $727 million for the second quarter, up $19 million from $708 million last year. Excluding the Company's growth initiatives and net acquisitions, operating expenses were up 1 percent from the same quarter last year. For the first half of the year, operating expenses totaled $1,451 million, essentially flat with operating expenses for the same period last year. Excluding growth initiatives and net acquisitions, year to date operating expenses were down 3 percent from the first half of 2000.

    Net income for the second quarter was $280 million or $0.31 per share, compared with $657 million or $.72 per share for the second quarter of 2000. Results for the quarter were negatively impacted by flat sales volume, lower selling prices of $275 million and increased feedstock and energy costs of $150 million. Net income was further reduced by $24 million ($0.02 per share) for expenses related to the Company's recent merger with Union Carbide (see Merger-related Expenses and restructuring on page 21). Net loss for the first half of 2001 was $(405) million versus net income of $1.2 billion for the same period last year. Year to date, net income was negatively impacted by merger-related costs and restructuring of $1.4 billion ($1.04 per share), increased feedstock and energy costs of $725 million, and lower selling prices of $175 million. First quarter earnings were favorably 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 half of 2001 proved to be one of the most challenging periods ever for the North American chemical industry and for Dow. Hydrocarbon and energy costs remained high, while selling prices declined. These factors, combined with current supply/demand imbalances in certain businesses, have had a significant negative impact on the Company's earnings this year.

PERFORMANCE PLASTICS

    Performance Plastics sales of $1,864 million for the second quarter were down 4 percent from $1,941 million in the second quarter of 2000, on 2 percent declines in both price and volume. EBIT for the segment was $140 million, down from $274 million last year as lower sales and increased costs from plant turnarounds negatively impacted results.

    Dow Automotive sales for the second quarter were up more than 20 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 volume was down approximately 6 percent from the second quarter of 2000, due to the general weakness of the global automotive industry. Second quarter EBIT for the business was down significantly due to lower volume in North America and increased manufacturing costs.

    Engineering Plastics sales for the quarter were up compared with the second quarter of 2000, as a 10 percent improvement in volume more than offset a slight decline in prices. Demand was particularly strong for polycarbonate compounds and blends, overcoming declines in several of the business' other product lines due to an overall weak demand environment. During the quarter, prices improved in Europe and stabilized in North America, but weakened in Latin America and Asia Pacific. Helped by a strong supply/demand environment for polycarbonate, EBIT for the quarter improved from last year due to increased volume.

    Sales of Epoxy Products and Intermediates were down 12 percent from last year primarily due to a decline in volume. Lower volumes were reported in all geographic areas, led by weak demand within the electronics industry in Asia Pacific. Overall, prices were flat compared with last year, although some improvement was seen in Europe and Latin America. EBIT for the quarter was down significantly from

17


the second quarter of last year as lower volumes and costs associated with plant outages negatively impacted results.

    Fabricated Products sales for the second quarter of 2001 were down 8 percent compared with last year, as prices declined 6 percent, including the negative impact of currency, and volume fell 2 percent. While sales into the construction industry in North America improved, sales were weak for all other products and in all other geographic areas. Further, price declines were reported in all geographic areas. EBIT for the second quarter of 2001 was down from the same period in 2000 due to lower sales and the cost of blowing agent conversions in Europe.

    Polyurethanes sales for the second quarter were down compared with the second quarter of 2000, due to a decline in prices of 3 percent. Excluding recent acquisitions, volume was down 4 percent, reflecting a very competitive environment within the industry. While selling prices for PO/PG were flat versus last year, prices were down for polyols, TDI, MDI and systems formulations. EBIT was substantially lower in the second quarter as the cost of plant turnarounds and lower prices more than offset reduced propylene costs.

    Wire and Cable sales for the second quarter of 2001 were down 9 percent from the second quarter of last year, as a decline in volume more than offset increased selling prices. EBIT for the second quarter improved versus last year due to lower costs and customer/product mix.

    For the first six months of the year, Performance Plastics sales were $3,785 million, essentially flat with $3,768 million for the same period last year. Both volume and price were unchanged versus a year ago. Year to date EBIT for the segment was $357 million compared with $590 million for the first half of 2000, reflecting the negative impact of the current competitive environment and higher costs.

PERFORMANCE CHEMICALS

    Performance Chemicals sales for the second quarter were $1,240 million, down 10 percent from $1,373 million in the second quarter of 2000. Price improvement of 2 percent was more than offset by a 12 percent decrease in volume. Volume declined due to the divestiture of businesses required for regulatory approval of the merger with Union Carbide (discussed in further detail below). Second quarter EBIT for the segment was down from $182 million last year to $158 million this year due to the decrease in sales.

    Emulsion Polymers sales for the quarter were down slightly, with an 8 percent increase in price offset by a 9 percent decline in volume versus the same quarter last year. Significant price improvements in North America and Europe were partially offset by declines in Latin America and Asia Pacific. Volume softened during the quarter due to slower demand for coated paper in North America and Europe, and reduced carpet production in North America. EBIT for the second quarter improved from last year due to higher prices and lower styrene monomer costs.

    Industrial Chemicals sales were down 6 percent from the second quarter of 2000 primarily due to decreased demand for polyglycols and chelants. EBIT for this business was down compared with last year due to lower volume.

    Oxide Derivatives sales for the second quarter were down 25 percent compared with last year due to a 29 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 low margin glycol ethers business. EBIT was down in the second quarter due to lower volume.

    Specialty Polymers sales in the second quarter were essentially flat compared with the second quarter of 2000, with a wide mix of results for the products within this business. Overall, both volume

18


and price were relatively flat. In a highly competitive environment, demand was strong for superabsorbants and membranes. For products sold into the electronics industry, the business continued to experience a softening in demand. EBIT was unchanged compared with last year.

    Water Soluble Polymers sales for the quarter were down 4 percent, with a slight decline in volume and a 3 percent decline in price primarily due to mix. Despite lower sales, EBIT for the second quarter was relatively flat versus last year.

    Performance Chemicals sales for the first half of 2001 were $2,550 million, down 6 percent from $2,711 million in the same period last year. Volume declined 8 percent, more than offsetting a 2 percent improvement in price. Year to date, EBIT for the segment was $258 million compared with $334 million last year. EBIT declined primarily due to lower volume.

AGRICULTURAL PRODUCTS

    Sales of Agricultural Products for the second quarter of 2001 were $809 million, up 17 percent from $694 million last year. Volume for the segment grew 21 percent, while prices declined 4 percent. Excluding the impact of recent acquisitions (Cargill Hybrid Seeds, Zeneca Limited's acetochlor herbicide product line, and Rohm and Haas' Agricultural Chemicals business), volume grew 8 percent. Demand was especially strong for seeds, spinosad insect control products, glyphosate and Sentricon TERMITE COLONY ELIMINATION SYSTEM. New product sales were up more than 30 percent. Prices were down versus last year, with agricultural commodity prices at their lowest levels in 20 years. EBIT for the quarter was $176 million, up from $158 million in the second quarter of 2000 due to increased sales of profitable new products.

    Sales for the segment were $1,414 million for the first six months of the year, up 7 percent from $1,327 million in 2000. While volume improved 12 percent, prices declined 5 percent. Year to date, EBIT was $219 million, down from $248 million for the first half of 2000, reflective of adverse conditions worldwide in the agricultural industry.

PLASTICS

    Plastics sales in the second quarter of 2001 were $1,697 million, down 4 percent versus $1,761 million a year ago. While volume grew 7 percent, prices overall declined 11 percent. EBIT for the quarter was $42 million, down substantially from $321 million in the second quarter of 2000 due to a rise in certain hydrocarbon and energy costs and decreased selling prices.

    Polyethylene sales were down versus the second quarter of last year, as volume growth of 5 percent was offset by price declines of 10 percent. While volume was off in North America, demand was strong in all other geographic areas. Demand was particularly strong for Affinity polyolefin plastomers and low density polyethylene. Due to excess supply in the industry, price declines were reported for most products and in most geographic areas. EBIT for the business was down significantly, reflecting the squeeze of lower selling prices and higher ethylene costs in Canada and Europe.

    Polypropylene sales for the second quarter of 2001 continued a strong upward trend due to increased volume, partially offset by lower prices, versus the same quarter last year. Volume growth was aided by the December 2000 start-up of a new polypropylene plant in Freeport, Texas, and the April 2001 acquisition of Basell's polypropylene plant in Cologne, Germany. Volume grew in all geographic areas, with the most notable increases reported in Europe and in the United States. EBIT declined versus last year due to continuing weak industry fundamentals.

    Polystyrene sales were down in the second quarter of 2001 compared with the same quarter last year, as a softening in demand negatively impacted prices. Volume was up slightly, while prices declined 19 percent. Prices weakened dramatically during the quarter due to excess product availability. EBIT

19


for the business declined compared with the second quarter of 2000 as selling prices fell faster than a decline in styrene monomer costs.

    Plastics sales for the first half of 2001 were $3,466 million, down 2 percent from $3,540 million last year. During the first six months of this year, volume improved 5 percent, but was more than offset by a 7 percent drop in prices. EBIT for the period was $75 million, down sharply from $581 million for the first half of 2000 as lower prices and higher feedstock and energy costs resulted in reduced margins.

CHEMICALS

    Second quarter sales for the Chemicals segment were $945 million, down 12 percent from $1,079 million in the second quarter of 2000. Volume was down 9 percent overall as declines in chlorinated organics; ethylene glycol (EG); and organic intermediates, solvents and monomers (OISM) more than offset volume improvements in vinyl chloride monomer (VCM) and ethanol. Production at the Company's EG facility in Prentiss, Alberta, Canada continued to be temporarily shut down due to weak volume. Prices were down 3 percent compared with last year, as price declines for VCM, EG and butanol more than offset increases for caustic and ethanol. EBIT for the segment was $45 million, down sharply from $180 million in the second quarter of 2000. Although there was some relief from lower ethylene costs in the United States, EBIT for the segment declined as lower volumes, lower prices and higher energy costs negatively impacted margins.

    For the first half of 2001, sales for the Chemicals segment were $1,941 million, down 8 percent from $2,117 million last year due to a decline in volume. EBIT for the period was $38 million compared with $323 million for the first six months of 2000. The sharp decline in EBIT resulted from weak supply/demand conditions and increased hydrocarbon and energy costs.

HYDROCARBONS AND ENERGY

    Hydrocarbons and Energy sales were $718 million, up 13 percent over $638 million in the second quarter of 2000 due to an increase in volume. Refinery and power sales were up significantly in the quarter. Energy and hydrocarbon feedstock costs were approximately $150 million higher than the second quarter of 2000, negatively impacting the results of several of the Company's businesses. EBIT for the quarter was a loss of $14 million compared with income of $2 million in the first quarter of 2000.

    Sales for the first half of 2001 were $1,427 million, up 18 percent from $1,209 million for the same period last year on a 12 percent improvement in volume and a 6 percent increase in prices. EBIT for the first six months was a loss of $3 million compared with income of $20 million last year.

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 $11 million compared with $12 million for the second quarter of 2000. Year to date, EBIT was a loss of $1,268 million versus a loss of $65 million for the first half of last year. First quarter results for Unallocated and Other this year 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. Second quarter results included an additional $24 million (pretax) of merger-related expenses.

20


Sales Volume and Price by Operating Segment and Geographic Area

 
  Three Months Ended
June 30, 2001

  Six Months Ended
June 30, 2001

 
Percentage change from prior year

 
  Volume
  Price
  Total
  Volume
  Price
  Total
 
Operating segments                          
  Performance Plastics   (2 )% (2 )% (4 )%      
  Performance Chemicals   (12 )% 2 % (10 )% (8 )% 2 % (6 )%
  Agricultural Products   21 % (4 )% 17 % 12 % (5 )% 7 %
  Plastics   7 % (11 )% (4 )% 5 % (7 )% (2 )%
  Chemicals   (9 )% (3 )% (12 )% (8 )%   (8 )%
  Hydrocarbons and Energy   13 %   13 % 12 % 6 % 18 %
   
 
 
 
 
 
 
  Total     (3 )% (3 )%   (1 )% (1 )%
   
 
 
 
 
 
 
Geographic area sales                          
  United States   (4 )% (2 )% (6 )% (3 )% 1 % (2 )%
  Europe   9 % (6 )% 3 % 8 % (4 )% 4 %
  Rest of World   (3 )% (3 )% (6 )% (3 )% (2 )% (5 )%
   
 
 
 
 
 
 
  Total     (3 )% (3 )%   (1 )% (1 )%
   
 
 
 
 
 
 

COMPANY SUMMARY

Operating Rate

    The Company's global plant operating rate for its chemicals and plastics businesses was 76 percent in the second quarter of 2001, down from 88 percent in the second quarter of 2000. The decrease in operating rate includes a temporary decrease in production in some of Dow's North American facilities in response to high feedstock and energy prices and low demand, in instances 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 $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

21


employees. Headcount reductions began in the second quarter of 2001. More than 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.

    As of June 30, 2001, severance of $270 million had been paid to 1,563 former employees. One-time merger and integration costs totaled $37 million for the second quarter.

    The following table summarizes the activity in the special charge reserve for the three-month periods ended March 31, 2001 and June 30, 2001:

In millions

   
   
   
Quarter
  Opening
Balance

  Additions to
Reserve

  Charges Against
Reserve

  Balance at
Period End

1Q01       $ 1,384   $ 740   $ 644
2Q01   $ 644   $ 24   $ 202   $ 466
   
 
 
 

    The Company 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.

Equity in Earnings of Nonconsolidated Affiliates

    Equity in earnings of nonconsolidated affiliates was $38 million in the second 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. Year to date, equity earnings were $73 million versus $260 million in 2000.

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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 second quarter of 2001 was $85 million compared with $107 million in the second quarter of 2000. Year to date, sundry income was $368 million compared with $208 million last year. 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 $163 million in the second quarter of 2001 compared with $140 million last year. Net interest expense was up primarily due to an increase in total debt partially offset by lower interest rates. Year to date, net interest expense was $321 million, up from $250 million in the first half of 2000. 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 second quarter was 30.4 percent compared with 31.4 percent for the same quarter of 2000. Year to date, the effective tax rate was 34.1 percent versus 32.2 percent last year.

Outlook

    Overall economic growth prospects remain fragile. While declining economic conditions in North America may have stabilized, there are few signs of improvement near term. During the second quarter it became apparent that the European economic outlook is deteriorating. The outlook for Asia Pacific is mixed. Healthy growth in China is expected to continue, while growth in the exporting countries, like Korea and Thailand, will most likely be affected by the North American slowdown. The Japanese economy shows no signs of substantial improvement. In Latin America, the outlook is clouded by the economic instability in Argentina and reduced growth in Brazil due to energy restrictions. Growth in Mexico is also limited because of its economic ties to a slower U.S. economy.

    The year 2001 will continue to be one of the most challenging years for the chemical industry. While hydrocarbon and energy prices are expected to moderate further in the third quarter, supply/demand balances in key industries are driving selling prices lower. Oil prices are expected to range between $24 and $26 per barrel in the third quarter, and U.S. natural gas prices are expected to average slightly above $3.00 per million Btu. Additionally, the third quarter is typically a seasonally slow quarter, especially in Europe. Automotive production is also generally down in the third quarter, and global vehicle production is estimated to be 10 percent lower in third quarter than in second quarter. Normal seasonal factors will also have a substantial negative impact on agricultural chemical producers.

    With lower hydrocarbon and energy costs expected in the third quarter, the ability to maintain current price levels will be a key factor in determining Dow's profitability. Businesses within the Performance Plastics segment anticipate some margin improvement versus the second quarter with stable prices and lower hydrocarbon and energy costs, while Performance Chemicals' businesses expect to maintain margins in spite of increased price pressure. Agricultural Products is expected to be at slightly better than breakeven performance for the rest of the year, somewhat improved from its typical seasonal pattern because of the contribution from recent acquisitions. Although Plastics expects continued downward pressure on price, most of these businesses anticipate some improvement from lower feedstock costs and moderate gains in volume. Results for the Chemicals segment are expected to benefit from seasonally higher demand for ethylene oxide/ ethylene glycol and lower energy costs for chlor-alkali. In addition, Dow's results will benefit from increased realization of cost synergies

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associated with the integration of Union Carbide and other recent acquisitions. Based on these factors, Dow estimates earnings of between $0.25 and $0.35 per share in the third quarter of 2001.

CHANGES IN FINANCIAL CONDITION

    The following tables present total debt and working capital at June 30, 2001 versus December 31, 2000:

In millions

  June 30,
2001

  Dec. 31,
2000

  Increase
(Decrease)

 
Notes payable   $ 3,700   $ 2,519   $ 1,181  
Long-term debt due within one year     38     318     (280 )
Long-term debt     8,379     6,613     1,766  
   
 
 
 
  Total debt   $ 12,117   $ 9,450   $ 2,667  
   
 
 
 

    At June 30, 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 June 30, 2001, there was a total of $2.0 billion in available SEC registered securities, as well as Japanese yen 70 billion (approximately $515 million) available in yen-denominated securities through the Japanese Ministry of Finance. On May 15, 2001, the Company closed the sale of $1 billion of three-year notes in a private offering with full SEC registration rights. It is expected that during the third quarter of 2001, these privately-placed notes will be exchanged for public notes registered with the SEC. On June 22, 2001, the Company closed the sale of Japanese yen 30 billion (approximately $220 million) five-year notes in Japan in a public offering.

In millions

  June 30,
2001

  Dec. 31,
2000

  Increase
(Decrease)

 
Cash and cash equivalents   $ 203   $ 278   $ (75 )
Marketable securities and interest-bearing deposits     100     163     (63 )
Accounts and notes receivable—net     6,405     6,419     (14 )
Inventories:                    
  Finished and work in process     3,763     3,396     367  
  Materials and supplies     813     817     (4 )
Deferred income tax assets—current     675     250     425  
   
 
 
 
    Total current assets     11,959     11,323     636  
   
 
 
 
    Total current liabilities     10,152     10,173     (21 )
   
 
 
 
    Working capital   $ 1,807   $ 1,150   $ 657  
   
 
 
 

    Cash provided by operating activities was $101 million for the six months ended June 30, 2001 compared with $1,134 million for the same period last year. The decline was primarily the result of lower net income. Net income for the first six months of the year was negatively impacted by higher hydrocarbon and feedstock costs, lower selling prices and a special charge for merger-related expenses and restructuring. Cash of $638 million was generated by sales of available-for-sale securities in excess of purchases of similar securities. Additional cash of $2.3 billion was generated from a combination of new short and long-term debt. Cash was used to fund acquisitions, for capital expenditures, and to pay

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dividends. See the Consolidated Statements of Cash Flows and Note F to Financial Statements for further details.

Balance Sheet Ratios

  June 30,
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   72   73  
Debt as a percent of total capitalization   51.3 % 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.

    On July 30, 2001, the Company paid a quarterly dividend of $0.335 per share, an increase of 15.5 percent, to shareholders of record on June 29, 2001. This was the 358th consecutive quarter in which the Company has issued a dividend since 1912 and in each instance Dow has maintained or increased the 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.

The following trademark of The Dow Chemical Company appears in this report: Affinity

The following trademark of Dow AgroSciences LLC appears in this report: Sentricon

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PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Breast Implant Matters

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

Environmental Matters

    On July 31, 2001, Hampshire Chemical Corp., a wholly owned subsidiary of the Company, agreed to pay a civil fine of U.S. $103,500 to the U.S. Department of Labor's Occupational Safety and Health Administration for alleged safety violations at its Deer Park facility in Texas.


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

    The annual meeting of stockholders of The Dow Chemical Company was held on May 10, 2001. At that meeting the following directors were elected to serve three-year terms to expire at the annual meeting in 2004: Arnold A. Allemang, John C. Danforth, Allan D. Gilmour, James M. Ringler and William S. Stavropoulos. In addition, the terms of the following directors continued after that meeting: Jacqueline K. Barton, Anthony J. Carbone, J. Michael Cook, Willie D. Davis, Barbara Hackman Franklin, Michael D. Parker, J. Pedro Reinhard, Harold T. Shapiro and Paul G. Stern.

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

Description of Matter

  For
  Against
  Withheld
  Abstentions
  Broker
Nonvotes

1.   Election of Directors:                    
    Class III                    
    Arnold A. Allemang   763,077,756   N/A   17,156,354   N/A   N/A
    John C. Danforth   768,824,680   N/A   11,409,431   N/A   N/A
    Allan D. Gilmour   770,792,658   N/A   9,441,452   N/A   N/A
    James M. Ringler   770,947,940   N/A   9,286,170   N/A   N/A
    William S. Stavropoulos   699,036,109   N/A   81,198,001   N/A   N/A
2.   Ratification of the selection of Deloitte & Touche LLP as the Company's independent auditors for 2001   771,547,620   4,935,262   N/A   3,751,228   0

N/A
—Not applicable

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)
Exhibits

 

 

 
Exhibit No.
  Description of Exhibit
3(ii)   A copy of the Bylaws of The Dow Chemical Company, as amended on July 12, 2001.
(b)
Reports on Form 8-K.

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

    The following Current Report on Form 8-K was filed by the Company subsequent to the second 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: August 10, 2001

 

 

 

 

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

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