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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, 2002

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 ý    No o

.

Class
  Outstanding at
March 31, 2002

Common Stock, $2.50 par value   907,677,392 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 the Consolidated Financial Statements

 

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

 

17
   
Disclosure Regarding Forward-Looking Information

 

17
   
Results of Operations

 

17
   
Changes in Financial Condition

 

23
   
Other Matters

 

24
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

28

PART II—OTHER INFORMATION

 

 
 
Item 1. Legal Proceedings

 

29
 
Item 6. Exhibits and Reports on Form 8-K

 

29

SIGNATURE

 

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
 
In millions, except per share amounts (Unaudited)

  March 31, 2002
  March 31, 2001
 
Net Sales   $ 6,262   $ 7,386  
   
 
 
  Cost of sales     5,321     6,456  
  Research and development expenses     250     272  
  Selling, general and administrative expenses     391     452  
  Amortization of intangibles     14     33  
  Merger-related expenses and restructuring (Note C)     13     1,384  
  Insurance and finance company operations, pretax income     9     11  
  Equity in earnings (losses) of nonconsolidated affiliates     (26 )   35  
  Sundry income (expense)—net     (13 )   283  
   
 
 
Earnings (Loss) before Interest, Income Taxes and Minority Interests     243     (882 )
   
 
 
  Interest income     16     24  
  Interest expense and amortization of debt discount     189     182  
   
 
 
Income (Loss) before Income Taxes and Minority Interests     70     (1,040 )
   
 
 
  Provision (Credit) for income taxes     24     (340 )
  Minority interests' share in income     8     17  
   
 
 
Income (Loss) before Cumulative Effect of Changes in Accounting Principles     38     (717 )
   
 
 
  Cumulative effect of changes in accounting principles (Note B)     67     32  
   
 
 
Net Income (Loss) Available for Common Stockholders   $ 105   $ (685 )
   
 
 
Share Data              
  Earnings (Loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.04   $ (0.80 )
  Earnings (Loss) per common share—basic   $ 0.12   $ (0.76 )
  Earnings (Loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.04   $ (0.80 )
  Earnings (Loss) per common share—diluted   $ 0.11   $ (0.76 )
  Common stock dividends declared per share of common stock   $ 0.335   $ 0.29  
  Weighted-average common shares outstanding—basic     907.3     898.1  
  Weighted-average common shares outstanding—diluted     915.1     898.1  
   
 
 
Depreciation   $ 388   $ 388  
   
 
 
Capital Expenditures   $ 297   $ 273  
   
 
 

See Notes to the Consolidated Financial Statements.

3


The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  March 31,
2002

  Dec. 31,
2001

 
Assets              
Current Assets              
  Cash and cash equivalents   $ 234   $ 220  
  Marketable securities and interest-bearing deposits     63     44  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables—2002: $120; 2001: $123)     3,223     2,868  
    Other     2,004     2,230  
  Inventories:              
    Finished and work in process     3,446     3,569  
    Materials and supplies     859     871  
  Deferred income tax assets—current     438     506  
   
 
 
  Total current assets     10,267     10,308  
   
 
 
Investments              
  Investment in nonconsolidated affiliates     1,494     1,581  
  Other investments     1,714     1,663  
  Noncurrent receivables     963     802  
   
 
 
  Total investments     4,171     4,046  
   
 
 
Property              
  Property     36,007     35,890  
  Less accumulated depreciation     22,580     22,311  
   
 
 
  Net property     13,427     13,579  
   
 
 
Other Assets              
  Goodwill (Note E)     3,123     3,130  
  Other intangible assets (Note E)     560     607  
  Deferred income tax assets—noncurrent     2,136     2,248  
  Deferred charges and other assets     1,667     1,597  
   
 
 
  Total other assets     7,486     7,582  
   
 
 
Total Assets   $ 35,351   $ 35,515  
   
 
 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 
Current Liabilities              
  Notes payable   $ 1,719   $ 1,209  
  Long-term debt due within one year     559     408  
  Accounts payable:              
    Trade     2,368     2,713  
    Other     1,095     926  
  Income taxes payable     199     190  
  Deferred income tax liabilities—current     56     236  
  Dividends payable     304     323  
  Accrued and other current liabilities     2,095     2,120  
   
 
 
  Total current liabilities     8,395     8,125  
   
 
 
Long-Term Debt     9,099     9,266  
   
 
 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     765     760  
  Pension and other postretirement benefits—noncurrent     2,461     2,475  
  Other noncurrent obligations     3,434     3,539  
   
 
 
  Total other noncurrent liabilities     6,660     6,774  
   
 
 
Minority Interest in Subsidiaries     352     357  
   
 
 
Preferred Securities of Subsidiaries     1,000     1,000  
   
 
 
Stockholders' Equity              
  Common stock     2,453     2,453  
  Additional paid-in capital          
  Unearned ESOP shares     (89 )   (90 )
  Retained earnings     10,902     11,112  
  Accumulated other comprehensive loss     (1,090 )   (1,070 )
  Treasury stock at cost     (2,331 )   (2,412 )
   
 
 
  Net stockholders' equity     9,845     9,993  
   
 
 
Total Liabilities and Stockholders' Equity   $ 35,351   $ 35,515  
   
 
 

See Notes to the Consolidated Financial Statements.

4


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
  Three Months Ended
 
In millions (Unaudited)

  March 31, 2002
  March 31, 2001
 
Operating Activities              
  Income (Loss) before cumulative effect of changes in accounting principles   $ 38   $ (717 )
  Adjustments to reconcile net income (loss) to net cash provided by operating activities:              
    Depreciation and amortization     416     434  
    Credit for deferred income tax     (67 )   (461 )
    Earnings/losses of nonconsolidated affiliates less than (in excess of) dividends received     58     (17 )
    Minority interests' share in income     8     17  
    Net loss on sales of property and businesses         10  
    Other net gain     (31 )   (249 )
    Merger-related expenses and restructuring         1,205  
    Tax benefit—nonqualified stock option exercises     11     4  
  Changes in assets and liabilities that provided (used) cash:              
    Accounts and notes receivable     (365 )   (25 )
    Inventories     134     (165 )
    Accounts payable     (129 )   (461 )
    Other assets and liabilities     76     (159 )
   
 
 
  Cash provided by (used in) operating activities     149     (584 )
   
 
 
Investing Activities              
  Capital expenditures     (297 )   (273 )
  Proceeds from sales of property and businesses     3     74  
  Acquisitions of businesses, net of cash received         (364 )
  Investments in nonconsolidated affiliates     (8 )   (36 )
  Advances to nonconsolidated affiliates         (29 )
  Purchases of investments     (606 )   (717 )
  Proceeds from sales of investments     555     1,168  
   
 
 
  Cash used in investing activities     (353 )   (177 )
   
 
 
Financing Activities              
  Changes in short-term notes payable     532     548  
  Payments on long-term debt     (14 )   (9 )
  Proceeds from issuance of long-term debt     11     504  
  Purchases of treasury stock     (3 )   (4 )
  Proceeds from sales of common stock     33     23  
  Distributions to minority interests     (33 )   (25 )
  Dividends paid to stockholders     (303 )   (307 )
   
 
 
  Cash provided by financing activities     223     730  
   
 
 
Effect of Exchange Rate Changes on Cash     (5 )   (3 )
   
 
 
Summary              
  Increase (Decrease) in cash and cash equivalents     14     (34 )
  Cash and cash equivalents at beginning of year     220     278  
   
 
 
  Cash and cash equivalents at end of period   $ 234   $ 244  
   
 
 

See Notes to the Consolidated Financial Statements.

5


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

 
  Three Months Ended
 
In millions (Unaudited)

  March 31,
2002

  March 31,
2001

 
Net Income (Loss) Available for Common Stockholders   $ 105   $ (685 )
   
 
 
Other Comprehensive Income (Loss), Net of Tax              
  Net unrealized losses on investments     (7 )   (287 )
  Translation adjustments     (33 )   (108 )
  Net gains on cash flow hedging derivative instruments     20     29  
   
 
 
  Total other comprehensive loss     (20 )   (366 )
   
 
 
Comprehensive Income (Loss)   $ 85   $ (1,051 )
   
 
 

See Notes to the Consolidated Financial Statements.

6


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

(Unaudited)

Note A—Consolidated Financial Statements

        The unaudited interim consolidated 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 consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K filed on March 20, 2002 for the year ended December 31, 2001. Except as otherwise indicated by the context, the terms "Company" or "Dow" as used herein mean The Dow Chemical Company and its consolidated subsidiaries.

Note B—Accounting Changes

        The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("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. See 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 transition adjustment gain 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.

        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 SFAS 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 SFAS No. 125 without reconsideration. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. It was 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," which replaces Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations." Under SFAS No. 141, all business combinations initiated after June 30, 2001 are accounted for using the purchase method. As required by SFAS No. 141, negative goodwill of $89 million associated with the acquisition of Buna Sow Leuna Olefinverbund ("BSL") in 1997 was written off and included in the cumulative effect of changes in accounting principles in the first quarter of 2002. The application of SFAS No. 141 did not result in the reclassification of any amounts previously recorded as goodwill or other intangible assets.

        In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which replaces APB Opinion No. 17, "Intangible Assets," and establishes new accounting and reporting requirements for goodwill and other intangible assets, effective for fiscal years beginning after December 15, 2001. Under this statement, goodwill and intangible assets that are deemed to have indefinite useful lives are not amortized, but are subject to impairment testing. Impairment testing is required to be performed at adoption and at least annually thereafter. On an ongoing basis (absent any impairment indicators), Dow plans to perform impairment tests during the fourth quarter of each year, in conjunction with the Company's annual budgeting process. Effective January 1, 2002, Dow ceased all amortization of goodwill, which is its only intangible asset with an indefinite useful life, and tested recorded goodwill for impairment by comparing the fair value of each reporting unit, determined using a discounted cash flow method, with its carrying value. As a result of the Company's impairment testing, goodwill

7



impairment losses totaling $22 million were recorded in the first quarter of 2002 and included in the cumulative effect of changes in accounting principles. Summaries of the impairment losses are as follows:


        As required by SFAS No. 142, the Company also reassessed the useful lives and the classification of its identifiable intangible assets and determined them to be appropriate. See Note E for additional disclosures regarding the adoption of SFAS No. 142.

        In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which requires an entity to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the related long-lived asset. The liability is adjusted to its present value each period and the asset is depreciated over its useful life. A gain or loss may be incurred upon settlement of the liability. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently assessing the impact of adopting this statement.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement replaces SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and provisions of APB Opinion No. 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of segments of a business. The statement creates one accounting model, based on the framework established in SFAS No. 121, to be applied to all long-lived assets including discontinued operations. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company determined that its current accounting policy for the impairment of long-lived assets is consistent with SFAS No. 144.

Note C—Merger-Related Expenses and Restructuring

        On March 29, 2001, management made certain decisions relative to employment levels, duplicate assets and facilities and excess capacity resulting from the Union Carbide Corporation ("Union Carbide") merger (see Note D) on February 6, 2001. These decisions were based on management's assessment of the actions necessary to achieve synergies as a result of the merger. The economic effects of these decisions, combined with merger-related transaction costs and certain asset impairments, resulted in a pretax special charge in the first quarter of 2001 of $1,384 million, which was included in Unallocated and Other for segment reporting purposes.

        The special charge included $643 million for employee-related costs, which consisted predominantly of provisions for employee severance, change of control obligations, medical and retirement benefits, and outplacement services. The Company's integration plans included 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. According to the initial integration plans, the Company expected to expend approximately 66 percent of the employee-related costs within the first two years following the merger, 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. The Company is in the process of determining these costs and the period of time over which they will be expended. During the fourth quarter of 2001, a review of the Company's integration plans resulted in a revision to the estimated workforce reduction, as actual reductions had exceeded the original plans. Consequently, the severance provision was increased $56 million for an additional workforce reduction of approximately 600 people. As of December 31, 2001, severance of $333 million had been paid to approximately 3,100 former employees. In the first quarter of 2002, severance of $81 million was paid to approximately 1,150 former employees, bringing the program-to-date amount to $414 million paid to approximately 4,250 former employees.

8



        The special charge included $122 million for transaction costs, which consisted primarily of investment banking, legal and accounting fees. All of these costs had been paid at March 31, 2001.

        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 consisted principally of capitalized software costs, information technology equipment, and research and development facilities and equipment, all of which were written off during the first quarter of 2001. 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 $62 million. In November 2001, the decision to close a research and development facility in Bound Brook, New Jersey, was reversed in light of difficult economic conditions; the facility will now remain open until at least 2005. Consequently, $55 million of the special charge was reversed during the fourth quarter. At December 31, 2001, $77 million of the reserve remained for the abandonment of leased facilities and demolition costs; at March 31, 2002, $73 million of the reserve remained.

        In addition to the special charge, one-time merger and integration costs of $115 million were recorded in 2001. In the first quarter of 2002, one-time merger and integration costs were $13 million; there were no one-time merger and integration costs in the first quarter of 2001.

        The following table summarizes the activity in the special charge reserve:

In millions

  Labor-related
Costs

  Transactions
Costs

  Write-down of
Duplicate Assets
and Facilities

  One-time Merger
and Integration
Costs

  Total
 
2001:                                
Special charge   $ 643   $ 122   $ 619       $ 1,384  
Adjustments to reserve     43         (55 ) $ 115     103  
Charges against reserve     (333 )   (122 )   (487 )   (115 )   (1,057 )
   
 
 
 
 
 
Balance at Dec. 31, 2001   $ 353       $ 77       $ 430  
   
 
 
 
 
 
2002:                                
Adjustments to reserve               $ 13   $ 13  
Charges against reserve   $ (81 )     $ (4 )   (13 )   (98 )
   
 
 
 
 
 
Balance at March 31, 2002   $ 272       $ 73       $ 345  
   
 
 
 
 
 

Note D—Acquisitions and Divestitures

Union Carbide Corporation Merger

        In August 1999, The Dow Chemical Company and Union Carbide Corporation 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, for a total of approximately 219 million shares. 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 $2.3 billion of net debt. 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. On February 6, 2001, after receiving clearance from the U.S. Federal Trade Commission, the Canadian Competition Bureau and other jurisdictions around the world, Union Carbide merged with a subsidiary of The Dow Chemical Company, and Union Carbide became a wholly owned subsidiary of Dow. As part of the regulatory approval process, the Company agreed to:

9


        The Union Carbide merger was accounted for as a pooling of interests. See Note C regarding a special charge for merger-related expenses and restructuring recorded in 2001.

Other Significant Acquisitions and Divestitures

        In January 2001, the Company acquired the 50 percent interest in Gurit-Essex AG that it did not previously own from Gurit-Heberlein AG for approximately $390 million. Gurit-Essex AG is the largest European supplier of automotive adhesives, sealants and body engineered systems for the automotive OEM and aftermarket. The acquisition globalized Dow Automotive's product availability and doubled the Company's adhesives, sealants and body engineered systems business.

        On February 9, 2001, Dow announced it had reached an agreement with EniChem to acquire its polyurethanes business, which had annual sales of 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.

        On March 8, 2001, Dow announced it had reached an agreement to acquire Rohm and Haas Company's 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. 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, and could principally impact goodwill and property.

        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 U.K. company with annual chemical sales of approximately $335 million. 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 has integrated the Fine Chemicals and Specialty Chemicals businesses of Ascot into Dow's Performance Chemicals' business group. 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.

10



Note E—Goodwill and Other Intangible Assets

        The following table provides pro forma results for the three months ended March 31, 2001, compared with actual results for the three months ended March 31, 2002, as if the non-amortization provisions of SFAS No. 142 had been applied:

 
  Three Months Ended
 
In millions, except per share amounts

  March 31,
2002

  March 31,
2001

 
Reported income (loss) before cumulative effect of changes in accounting principles   $ 38   $ (717 )
Reported net income (loss)   $ 105   $ (685 )
   
 
 
Adjustments:              
  Goodwill amortization, net of tax       $ 23  
  Negative goodwill amortization, net of tax         (3 )
  Equity method goodwill amortization, net of tax         3  
   
 
 
    Total adjustments       $ 23  
   
 
 
Adjusted income (loss) before cumulative effect of changes in accounting principles   $ 38   $ (694 )
Adjusted net income (loss)   $ 105   $ (662 )

 
 
 
Reported earnings (loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.04   $ (0.80 )
Reported earnings (loss) per common share—basic   $ 0.12   $ (0.76 )
   
 
 
Adjustments:              
  Goodwill amortization, net of tax       $ 0.03  
  Negative goodwill amortization, net of tax          
  Equity method goodwill amortization, net of tax          
   
 
 
    Total adjustments       $ 0.03  
   
 
 
Adjusted earnings (loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.04   $ (0.77 )
Adjusted earnings (loss) per common share—basic   $ 0.12   $ (0.73 )

 
 
 
Reported earnings (loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.04   $ (0.80 )
Reported earnings (loss) per common share—diluted   $ 0.11   $ (0.76 )
   
 
 
Adjustments:              
  Goodwill amortization, net of tax       $ 0.03  
  Negative goodwill amortization, net of tax          
  Equity method goodwill amortization, net of tax          
   
 
 
    Total adjustments       $ 0.03  
   
 
 
Adjusted earnings (loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.04   $ (0.77 )
Adjusted earnings (loss) per common share—diluted   $ 0.11   $ (0.73 )
   
 
 

11


        Accumulated amortization for goodwill upon adoption of SFAS No. 142 was $569 million. The following table shows changes in the carrying amount of goodwill for the quarter ended March 31, 2002, by operating segment:

In millions

  Performance
Plastics

  Performance
Chemicals

  Agricultural
Sciences

  Plastics
  Hydrocarbons
and Energy

  Total
 
Balance at January 1, 2002   $ 889   $ 757   $ 1,303   $ 118   $ 63   $ 3,130  
   
 
 
 
 
 
 
Impairment losses:                                      
  Hampshire Fine Chemicals         (18 )               (18 )
  Rubber                 (4 )       (4 )
   
 
 
 
 
 
 
  Total impairment losses         (18 )       (4 )       (22 )
   
 
 
 
 
 
 
Purchase price allocation adjustments:                                      
  Ascot goodwill         (1 )               (1 )
  Rohm and Haas goodwill             (9 )           (9 )
  Reichhold Specialty Latex goodwill         25                 25  
   
 
 
 
 
 
 
  Total adjustments         24     (9 )           15  
   
 
 
 
 
 
 
Balance at March 31, 2002   $ 889   $ 763   $ 1,294   $ 114   $ 63   $ 3,123  
   
 
 
 
 
 
 

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

 
  At March 31, 2002
  At December 31, 2001
In millions

  Gross
Carrying
Amount

  Accumulated
Amortization

  Net
  Gross
Carrying
Amount

  Accumulated
Amortization

  Net
Intangible assets with finite lives:                                    
  Licenses and intellectual property   $ 278   $ (94 ) $ 184   $ 269   $ (88 ) $ 181
  Patents     153     (50 )   103     160     (52 )   108
  Software     312     (194 )   118     301     (181 )   120
  Trademarks     126     (7 )   119     126     (6 )   120
  Other     49     (13 )   36     97     (19 )   78
   
 
 
 
 
 
  Total   $ 918   $ (358 ) $ 560   $ 953   $ (346 ) $ 607
   
 
 
 
 
 

        Amortization expense for other intangible assets was $14 million for the three months ended March 31, 2002, compared with $10 million for the three months ended March 31, 2001. Estimated amortization expense for 2002 and the five succeeding fiscal years is as follows:

In millions

  Estimated
Amortization
Expense

2002   $ 82
2003     72
2004     66
2005     52
2006     42
2007     31

12


Note F—Commitments and Contingent Liabilities

Litigation

        On May 15, 1995, Dow Corning Corporation ("Dow Corning"), in which the Company is a 50 percent shareholder, voluntarily filed for protection under Chapter 11 of the Bankruptcy Code to resolve litigation related to Dow Corning's breast implant and other silicone medical products. As a consequence of that action and prior charges taken by Dow Corning, the Company fully reserved its investment in Dow Corning and reserved its 50 percent share of equity earnings through the third quarter of 2000.

        The Company's financial statement exposure for breast implant product liability claims against Dow Corning is limited to its investment in Dow Corning, which, after fully reserving its investment in Dow Corning and reserving its share of equity earnings through the third quarter of 2000, is not material. As a result, any future charges by Dow Corning related to such claims or as a result of the Chapter 11 proceeding are not expected to 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 Sam C. Pointer of the U.S. District Court for the Northern District of Alabama 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 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 appealed Judge Hood's decision to the United States Court of Appeals for the Sixth Circuit, which heard oral arguments in the matter on October 23, 2001. On January 29, 2002, the Sixth Circuit issued its opinion which, among other things, affirmed Judge Hood's determination that claims against various entities, including the Shareholders, may be enjoined where "unusual circumstances" exist, and remanded the case to the District Court for certain factual determinations. The effectiveness of the Joint Plan remains subject to the District Court making such factual determinations and any subsequent appellate action. 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

13



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 $441 million at March 31, 2002, for environmental matters, including $45 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.

        Union Carbide Corporation, a wholly owned subsidiary of the Company, has filed its quarterly report on Form 10-Q for the quarter ended March 31, 2002, and has provided the disclosure below concerning asbestos. The Company does not consider Union Carbide's asbestos-related liability to be material to Dow's consolidated financial statements. The disclosures contained in Union Carbide's Form 10-Q are provided in this filing to more broadly disclose information concerning Union Carbide's asbestos-related liability. References below to the "Corporation" or to "UCC" refer to Union Carbide Corporation.

14



*
Union Carbide Corporation, Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2002, Notes to the Consolidated Financial Statements, Note F—Commitments and Contingent Liabilities, Litigation.

        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.

Purchase Commitments

        The Company has three major agreements for the purchase of ethylene-related products in Canada. The purchase prices are determined on a cost-of-service basis, which, in addition to covering all operating expenses and debt service costs, provides the owner of the manufacturing plants with a specified return on capital. Total purchases under the agreements were $221 million in 2001, $178 million in 2000 and $144 million in 1999.

        At December 31, 2001, the Company had various outstanding commitments for take or pay and throughput agreements, including the 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, 2001    (in millions)

   
2002   $ 542
2003     512
2004     470
2005     431
2006     277
2007 through expiration of contracts     1,889
   
Total   $ 4,121
   

        In addition to the take or pay obligations at December 31, 2001, 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 $152 million. In general, such commitments were at prices not in excess of current market prices. The Company also had outstanding commitments for construction performance and lease payment guarantees and other obligations of $860 million. The Company was also committed to lease manufacturing facilities under construction in The Netherlands.

15



Note G—Operating Segments and Geographic Areas

 
  Three Months Ended
 
In millions

  March 31,
2002

  March 31,
2001

 
Operating segment sales              
  Performance Plastics   $ 1,719   $ 1,921  
  Performance Chemicals     1,259     1,310  
  Agricultural Sciences     645     605  
  Plastics     1,428     1,769  
  Chemicals     685     996  
  Hydrocarbons and Energy     485     709  
  Unallocated and Other     41     76  
   
 
 
  Total   $ 6,262   $ 7,386  
   
 
 
Operating segment EBIT (1)              
  Performance Plastics   $ 247   $ 217  
  Performance Chemicals     198     100  
  Agricultural Sciences     26     43  
  Plastics     (62 )   33  
  Chemicals     (53 )   (7 )
  Hydrocarbons and Energy     31     11  
  Unallocated and Other     (144 )   (1,279 )
   
 
 
  Total   $ 243   $ (882 )
   
 
 
Geographic area sales              
  United States   $ 2,556   $ 3,205  
  Europe     2,155     2,370  
  Rest of World     1,551     1,811  
   
 
 
  Total   $ 6,262   $ 7,386  
   
 
 

(1)
The financial results for March 31, 2002 do not include goodwill amortization as a result of adopting SFAS No. 142 (see Note E). Amortization expense included in EBIT for the three months ended March 31, 2001 was as follows:

Performance Plastics   $ 5  
Performance Chemicals     4  
Agricultural Sciences     14  
Plastics     1  
Chemicals      
Hydrocarbons and Energy     1  
Unallocated and Other     (2 )
   
 
Total   $ 23  
   
 

        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.

16




The Dow Chemical Company and Subsidiaries
Item 2.    Management's Discussion and Analysis of Financial Condition
and Results of Operations

DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION

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

RESULTS OF OPERATIONS

Selected data for the three months ended March 31, 2002 and 2001:

 
  Three Months Ended
 
In millions, except per share amounts

  March 31,
2002

  March 31,
2001

 
Sales   $ 6,262   $ 7,386  

Cost of sales

 

 

5,321

 

 

6,456

 
% of sales     85  %   87  %

Research and development, and selling, general and administrative expenses

 

 

641

 

 

724

 
% of sales     10  %   10  %

Earnings (Loss) before interest, income taxes and minority interests ("EBIT")

 

 

243

 

 

(882

)
% of sales     4  %   (12 )%

Effective tax rate

 

 

34.3

 %

 

32.7

 %

Net income (loss) available for common stockholders

 

$

105

 

$

(685

)

Earnings (Loss) per common share—basic

 

$

0.12

 

$

(0.76

)
Earnings (Loss) per common share—diluted   $ 0.11   $ (0.76 )

Operating rate percentage

 

 

76

 %

 

77

 %
   
 
 

        Net sales for the first quarter of 2002 were $6.3 billion, down from record first quarter sales of $7.4 billion last year. Compared with last year, prices fell sharply, by 19 percent, while volume improved 4 percent (see Sales Volume and Price table on page 21). Prices, down $1.4 billion in total, declined in all operating segments and across all geographies, with the most significant declines reported by the Company's basics businesses as the chemical industry continued to experience trough-level pricing. Volume improved in all segments, except Chemicals, substantially due to the addition of sales from recently acquired businesses (primarily Rohm and Haas' agricultural chemicals business, EniChem's polyurethanes business and Ascot Plc). Information regarding significant acquisitions and divestitures can be found in Note D to the Consolidated Financial Statements. Excluding net acquisitions, volume was flat versus the same quarter last year. From a geographic standpoint, substantial volume growth was reported in Europe and Asia Pacific, offsetting lower demand in the United States. In Latin America and Canada, volume was up slightly.

        Operating expenses (research and development, and selling, general and administrative expenses) were $641 million for the first quarter of 2002, down $83 million, or 11 percent, from $724 million last year due to cost control efforts and the realization of merger-related cost synergies. Excluding growth initiatives, acquisitions and divestitures, operating expenses were down 14 percent from the same quarter last year.

17



        Net income for the first quarter was $105 million or $0.11 per share, compared with a loss of $685 million or a loss of $0.76 per share for the first quarter of 2001. While feedstock and energy costs were down $1.1 billion versus last year, selling prices declined $1.4 billion, compressing margins. Net income for the quarter was impacted by three unusual items: additional pretax expenses of $13 million related to the Union Carbide merger, pretax goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates, and a net after-tax gain of $67 million related to the adoption of two new accounting standards (SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets.") Net income for the first quarter of 2001 was also impacted by three unusual items: a pretax special charge of $1.4 billion for costs related to the Union Carbide merger, a pretax gain of $266 million on the sale of stock in Schlumberger Ltd., and an after-tax transition adjustment gain of $32 million related to the adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." Notes B and C to the Consolidated Financial Statements provide additional information regarding accounting changes and merger-related expenses, respectively.

        The following table shows the impact of the unusual items recorded in the quarters ended March 31, 2002 and 2001 on earnings (loss) before interest, income taxes and minority interests ("EBIT"); net income (loss); and earnings (loss) per common share—diluted:

 
  EBIT
  Net Income
  Earnings Per Share
 
 
  Three Months Ended
  Three Months Ended
  Three Months Ended
 
In millions, except per share amounts

  March 31,
2002

  March 31,
2001

  March 31,
2002

  March 31,
2001

  March 31,
2002

  March 31,
2001

 
Unusual items:                                      
Merger-related expenses and restructuring   $ (13 ) $ (1,384 ) $ (8 ) $ (919 ) $ (0.01 ) $ (1.02 )
Goodwill impairment losses in nonconsolidated affiliates     (16 )       (16 )       (0.02 )    
Gain on sale of Schlumberger stock         266         168         0.18  
Cumulative effect of changes in accounting principles             67     32     0.07     0.04  
   
 
 
 
 
 
 
  Total unusual items   $ (29 ) $ (1,118 ) $ 43   $ (719 ) $ 0.04   $ (0.80 )
   
 
 
 
 
 
 
As reported   $ 243   $ (882 ) $ 105   $ (685 ) $ 0.11   $ (0.76 )

Excluding unusual items

 

$

272

 

$

236

 

$

62

 

$

34

 

$

0.07

 

$

0.04

 
   
 
 
 
 
 
 

PERFORMANCE PLASTICS

        Performance Plastics sales of $1,719 million for the first quarter were down 11 percent from $1,921 million in the first quarter of 2001, as prices fell 12 percent and volume improved slightly. Excluding acquisitions, volume was down 3 percent, reflecting weak industry demand in most of the segment's businesses. Despite lower sales in the quarter, EBIT for the segment was $247 million, up 14 percent from $217 million last year, reflecting the realization of cost synergies related to the Union Carbide merger and 2001 acquisitions, and the impact of cost control initiatives, including Six Sigma.

        Dow Automotive sales for the first quarter of 2002 were down slightly from a year ago, as lower selling prices more than offset an increase in volume. The decline in selling prices reflects the general weakness of the global automotive industry. First quarter EBIT for the business improved significantly as the business realized cost synergies related to the acquisition of the remaining 50 percent of Gurit-Essex AG in January 2001 (see Note D to the Consolidated Financial Statements). Lower operating expenses also contributed to the improvement in EBIT.

        Engineering Plastics sales for the quarter were down 10 percent from the first quarter of 2001, as improved volume was more than offset by a sharp decline in prices, across most geographic areas and most of the business' product lines. Despite lower operating expenses, EBIT for the quarter declined versus last year due to the decline in prices.

        Sales of Epoxy Products and Intermediates were down more than 20 percent from last year due to declines in both volume and price. The declines in prices were the result of intense competition during a period of soft demand. EBIT for the quarter improved versus the first quarter of last year as lower raw material costs and operating expenses offset the impact of lower sales. First quarter results were also impacted by a favorable litigation settlement.

18



        Fabricated Products sales for the first quarter of 2002 were down slightly versus last year, as price declines exceeded volume growth of 3 percent. Price declines were reported in most product lines, but were most significant for engineered films and laminates due to slow demand. EBIT for the first quarter of 2002 was up due to volume growth and lower raw material costs.

        Polyurethanes sales for the first quarter were down 7 percent compared with the first quarter of 2001, as price declines of 14 percent well exceeded a 7 percent improvement in volume. Excluding last year's acquisition of EniChem's polyurethanes business, volume was down 2 percent, reflecting soft global demand for durable goods. Volume continued to be strong, however, for toluene diisocyanate ("TDI") and systems formulations, both primarily due to the EniChem acquisition. Prices declined across most product lines and all geographic areas as economic conditions remained weak. Despite lower propylene costs, EBIT for the first quarter declined versus last year primarily due to lower selling prices.

        Wire and Cable sales for the first quarter of 2002 were down from the first quarter of last year primarily due to lower demand for telecommunications cable. EBIT for the first quarter improved versus last year due to lower ethylene costs, the realization of merger-related cost synergies, and some improvement in selling prices.

PERFORMANCE CHEMICALS

        Performance Chemicals sales for the first quarter of 2002 were $1,259 million, down 4 percent from $1,310 million in the first quarter of last year. Volume improved 1 percent as prices fell 5 percent. Excluding the divestiture of businesses required for regulatory approval of the Union Carbide merger and the recent acquisition of Ascot Plc (see Note D to the Consolidated Financial Statements), volume declined 3 percent, reflecting weak economic conditions. First quarter EBIT for the segment was $198 million, up significantly from $100 million last year due to lower raw material costs and the realization of merger-related cost synergies.

        Custom and Fine Chemicals sales for the first quarter of 2002 increased significantly compared with last year due primarily to the acquisition of Ascot Plc in 2001. EBIT for the quarter improved due to increased volume and the realization of cost synergies related to the Ascot acquisition.

        Emulsion Polymers sales for the quarter were down 6 percent, as volume growth of 6 percent was more than offset by an 12 percent decline in prices versus the same quarter last year. Volume was particularly strong in the United States for styrene-butadiene latex sold into the carpet industry. Prices declined significantly in Europe for styrene-butadiene latex sold into the paper industry. EBIT for the first quarter improved significantly from last year due to lower styrene monomer costs.

        Industrial Chemicals sales were down 9 percent from the first quarter of 2001 due primarily to lower demand, although selling prices also declined compared with last year. EBIT for the business improved significantly versus last year due to lower costs for ethylene oxide and the realization of cost synergies related to the Union Carbide merger.

        Oxide Derivatives sales for the first quarter of 2002 were down 21 percent compared with last year due to the divestiture of Dow's ethyleneamines, ethanolamines and North American GAS/SPEC gas treating businesses last year. These divestitures were required for regulatory approval of the Union Carbide merger. Excluding the divestitures, volume was down 7 percent, as the business decided to forego lower margin glycol ethers sales. Prices were relatively stable compared with the first quarter of 2001. EBIT improved substantially in the first quarter as margins improved due to lower raw material costs and the realization of merger-related cost synergies.

        Specialty Polymers sales in the first quarter were down 9 percent from the same period of 2001 due primarily to a decline in volume, although prices were also down slightly. EBIT for the business improved significantly compared with last year due to lower raw material costs and the realization of merger-related cost synergies.

        Water Soluble Polymers sales for the quarter were up slightly versus the first quarter of 2001, as an improvement in volume was partially offset by a decline in prices. Volume was particularly strong for POLYOX water soluble resins and continued to be strong for METHOCEL cellulose ethers used in the construction industry. EBIT for the first quarter improved versus last year due to the realization of merger-related cost synergies.

AGRICULTURAL SCIENCES

        Sales of Agricultural Sciences for the first quarter of 2002 were $645 million, up 7 percent from $605 million last year. Volume for the segment was up 9 percent, while prices declined 2 percent due to the negative impact of currency in Europe. Excluding the impact of the acquisition of Rohm and Haas' agricultural chemicals business in

19



June of last year (see Note D to the Consolidated Financial Statements), volume fell 9 percent. In the fourth quarter of 2001, the agricultural industry experienced some shift in seasonal business in North America, resulting in lower sales in the first quarter of this year compared with last year. Adding to the decline in volume were lower sales of seeds in the first quarter due to an intensely competitive environment. EBIT for the quarter was $26 million, down from $43 million in the first quarter of 2001, due in part to the write-down of accounts receivable in Argentina and a write-down related to the closure of seed production facilities.

PLASTICS

        Plastics sales in the first quarter of 2002 were $1,428 million, down 19 percent versus $1,769 million a year ago. Compared with last year, prices fell sharply, 30 percent, while volume grew 11 percent. EBIT for the quarter was a loss of $62 million, versus income of $33 million in the first quarter of 2001. While the segment benefited from lower hydrocarbon and energy costs versus last year, weak supply/demand balances resulted in a substantially larger decline in selling prices.

        Polyethylene sales were down substantially compared with the first quarter of last year, as volume growth of 6 percent was more than offset by a 31 percent drop in prices. Demand improved in all geographic areas versus the first quarter of 2001, except the United States, which was off significantly. Due to excess supply in the industry, significant price declines were reported for most products and in all geographic areas. The Company temporarily idled three polyethylene production trains in the first quarter of this year due to soft demand within the industry. Although the business received some benefit from lower ethylene costs and the realization of merger-related cost synergies, EBIT for the business was down significantly due to the sharp decline in selling prices.

        Polypropylene sales for the first quarter of 2002 continued an upward trend, as a significant increase in volume was partially offset by lower prices versus the same quarter last year. Volume growth was aided by the April 2001 acquisition of Basell's polypropylene plant in Cologne, Germany. Prices fell compared with last year due to low demand and weakening monomer prices. EBIT improved versus last year due to the increase in volume and lower propylene costs.

        Polystyrene sales were down significantly in the first quarter of 2002 compared with the same quarter last year. Prices fell 33 percent, as volume improved 12 percent. Prices weakened dramatically in all geographic areas during the quarter due to a sharp decline in industry demand. EBIT for the business declined compared with the first quarter of 2001 as selling prices fell more than the decline in styrene monomer costs.

CHEMICALS

        First quarter sales for the Chemicals segment were $685 million, down 31 percent from $996 million in the first quarter of 2001. Volume was down 5 percent due primarily to declines in caustic soda and vinyl chloride monomer ("VCM").The decline in VCM volume was related to the shutdown of VCM production facilities in Freeport, Texas, for most of the quarter, as the Company completed its capacity expansion for VCM. Volume improved during the quarter for ethylene oxide/EG and organic intermediates, solvents and monomers (OISM). Prices were down 26 percent compared with last year, with significant declines in VCM, caustic soda, EG and chloromethanes. EBIT for the segment was a loss of $53 million versus a loss of $7 million in the first quarter of 2001. Although there was some relief in the quarter from lower feedstock and energy costs and the realization of merger-related cost synergies, EBIT for the segment declined due to lower volume and selling prices.

HYDROCARBONS AND ENERGY

        Hydrocarbons and Energy sales for the quarter were $485 million, down 32 percent from $709 million in the first quarter of 2001. Volume improved 7 percent, while prices fell 39 percent, reflecting a sharp decline in hydrocarbon and energy costs. While Dow's total energy and hydrocarbon feedstock costs for the first quarter were approximately $1.1 billion lower than the first quarter of last year, selling prices for the Company in total fell $1.4 billion, negatively impacting margins in most of the Company's businesses. EBIT for the quarter was $31 million compared with $11 million last year.

UNALLOCATED AND OTHER

        EBIT for the quarter was a loss of $144 million compared with a loss of $1,279 million for the first quarter of 2001. Included in the results for Unallocated and Other are developmental expenses related to Growth Platforms, overhead and other cost recovery variances that are not allocated to the operating segments, results of insurance and finance company operations, gains and losses on sales of financial assets, foreign exchange hedging results, and Dow's share of the earnings/losses of Dow Corning Corporation and Cargill Dow LLC. First quarter results

20



also included the unfavorable impact of additional merger-related expenses of $13 million, goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates, and the unfavorable impact of the devaluation of the Argentine peso. First quarter results for Unallocated and Other last year included a special charge of $1,384 million for costs related to the Union Carbide merger (see Note C to the Consolidated Financial Statements) 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, 2002

 
Percentage change from prior year

 
  Volume
  Price
  Total
 
Operating segments              
  Performance Plastics   1  % (12 )% (11 )%
  Performance Chemicals   1  % (5 )% (4 )%
  Agricultural Sciences   9  % (2 )% 7  %
  Plastics   11  % (30 )% (19 )%
  Chemicals   (5 )% (26 )% (31 )%
  Hydrocarbons and Energy   7  % (39 )% (32 )%
   
 
 
 
  Total   4  % (19 )% (15 )%
   
 
 
 
Geographic area sales              
  United States   (6 )% (14 )% (20 )%
  Europe   14  % (23 )% (9 )%
  Rest of World   8  % (22 )% (14 )%
   
 
 
 
  Total   4  % (19 )% (15 )%
   
 
 
 

COMPANY SUMMARY

Operating Rate

        The Company's global plant operating rate for its chemicals and plastics businesses was 76 percent in the first quarter of 2002, down from 77 percent in the first quarter of 2001, but up from 73 percent in the fourth quarter of last year. The decline in operating rate from the first quarter of 2001 reflects a reduced run rate at several Dow plants as the Company manages inventory levels during a period of slower demand.

Amortization of Intangibles

        Amortization of intangibles was $14 million in the first quarter of 2002, down from $33 million in the first quarter of last year due to the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets." Goodwill amortization expense, reported as "Amortization of intangibles," in the first quarter of 2001 was $23 million. See Notes B and E to the Consolidated Financial Statements for additional information regarding this new accounting standard and the impact of adoption.

Merger-Related Expenses and Restructuring

        In the first quarter of 2001, a pretax special charge of $1,384 million was recorded for merger-related expenses and restructuring, which included transaction costs, employee severance, and the write-down of duplicate assets and facilities. In the first quarter of 2002, the Company recorded one-time merger and integration costs of $13 million. For details regarding these charges, see Note C to the Consolidated Financial Statements.

        The Company expects its integration plans and synergy activities related to the merger to result in annual cost savings of $1.1 billion by the end of the first quarter of 2003. By the end of the first quarter of 2002, the Company had taken actions that will result in annual cost savings of more than $850 million. 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.

Equity in Earnings (Losses) of Nonconsolidated Affiliates

        Dow's share of the earnings (losses) of nonconsolidated affiliates was a loss of $26 million in the first quarter of 2002, compared with income of $35 million in the same quarter last year. Equity earnings declined primarily

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due to start-up costs recorded at Cargill Dow and lower results from Dow Corning and UOP. Also contributing to the decline were goodwill impairment losses of $16 million recorded in the first quarter of 2002 related to investments in nonconsolidated affiliates.

Sundry Income (Expense)—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 2002 was a net expense of $13 million compared with net income of $283 million in the first quarter of 2001. Sundry income for the first quarter of 2002 included the unfavorable impact of the devaluation of the Argentine peso. Last year, sundry income for the first quarter 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 $173 million in the first quarter of 2002 compared with $158 million in the first quarter of last year. Net interest expense was up due to an increase in total debt partially offset by lower interest rates.

Provision for Taxes on Income

        The effective tax rate for the first quarter was 34.3 percent compared with 32.7 percent for the same quarter of 2001.

Outlook

        The challenging conditions experienced by the chemical industry in 2001 carried over to the beginning of 2002. It appears that industry fundamentals reached a trough level late in the fourth quarter of 2001 and early in the first quarter of 2002, and improved somewhat as the first quarter progressed. Volume improved with increased end-user demand in certain markets, and customers started to rebuild inventories from unusually low levels. Higher than anticipated U.S. auto production and increased demand in the construction industry, due to a relatively mild winter, added volume support for a variety of chemicals and plastics. Some industries, particularly those tied to ethylene, remain oversupplied and will require several quarters of increasing demand to become more balanced. The increases in oil and natural gas prices during the first quarter have raised concerns about the industry's ability to improve margins in the near term. There also continues to be a risk to the industry of adverse currency impacts, particularly in Argentina.

        2001 was one of the most challenging years Dow and the rest of the chemical industry faced since the early 1980s. In the face of the spike in natural gas costs, the U.S. manufacturing recession, and the global economic impact of the events of September 11, Dow completed the Union Carbide merger and several other acquisitions, which are designed to bring improved performance going forward. Following very weak demand in December, the broad-based volume improvement in the first quarter is encouraging, with sequential volume gains in most businesses and geographies. A number of price increases are planned to be implemented in the second quarter and should help offset rising feedstock and energy costs in the basics businesses. While Plastics margins should improve in the second quarter, it may be mid-year before favorable results are seen for Chemicals. Performance Plastics and Performance Chemicals margins may be squeezed by rising feedstock costs, but it is expected that prices will remain stable and volumes will improve. Agricultural Sciences anticipates a good second quarter, with contributions from the former Rohm and Haas business offsetting continued difficult conditions in the agricultural industry globally. Productivity gains from the realization of cost synergies related to the merger and other acquisitions, Six Sigma and other business restructuring efforts are expected to continue to add to the bottom line, particularly as industry conditions improve. Overall, second quarter earnings should be markedly better than first quarter of 2002, but may not exceed the level of second quarter 2001. With continued progress in economic and industry conditions, results for 2002 are expected to show improvement compared with 2001.

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CHANGES IN FINANCIAL CONDITION

        The Company's cash flows from operating, investing and financing activities, as reflected in the Consolidated Statements of Cash Flows, are summarized in the following table:

In millions

  March 31,
2002

  March 31,
2001

 
Cash provided by (used in):              
Operating activities   $ 149   $ (584 )
Investing activities     (353 )   (177 )
Financing activities     223     730  
Effect of exchange rate changes on cash     (5 )   (3 )
   
 
 
Net change in cash and cash equivalents   $ 14   $ (34 )
   
 
 

        Cash provided by operating activities increased $733 million in the first quarter of 2002 compared with the first quarter of 2001 due to improved earnings and a decrease in working capital requirements.

        Cash used in investing activities increased in the first quarter of 2002 compared with the first quarter of 2001, principally due to a $502 million reduction in cash generated by sales of available-for-sale securities in excess of purchases of similar securities partially offset by a decrease in cash used for acquisitions.

        Cash provided by financing activities was lower in the first quarter of 2002 compared with the first quarter of 2001 primarily due to the issuance of new long-term debt in the first quarter of 2001.

        The following tables present working capital, total debt, and certain balance sheet ratios at March 31, 2002 versus December 31, 2001:

Working Capital

In millions

  March 31,
2002

  Dec. 31,
2001

Current assets   $ 10,267   $ 10,308
Current liabilities     8,395     8,125
   
 
Working capital   $ 1,872   $ 2,183
   
 
Current ratio     1.22:1     1.27:1
Days-sales-outstanding-in-receivables     50     50
Days-sales-in-inventory     75     77
Total Debt

In millions

  March 31,
2002

  Dec. 31,
2001

  Increase
(Decrease)

 
Notes payable   $ 1,719   $ 1,209   $ 510  
Long-term debt due within one year     559     408     151  
Long-term debt     9,099     9,266     (167 )
   
 
 
 
  Total debt   $ 11,377   $ 10,883   $ 494  
   
 
 
 
Debt as a percent of total capitalization     50.4 %   48.9 %      

        At March 31, 2002, 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 $700 million were available for use by foreign subsidiaries. At March 31, 2002, there was a total of $1.2 billion available in SEC registered securities, as well as Japanese yen 70 billion (approximately $528 million) available in yen-denominated securities through the Japanese Ministry of Finance and Euro 1.4 billion (approximately $1.2 billion) available under the Company's Euro Medium-Term Note Program.

        On January 16, 2002, Fitch Inc. downgraded the Company's senior debt rating to "A", while affirming the Company's short term rating of "F1". On January 31, 2002, Standard & Poor's affirmed its longstanding "A" rating for the Company's long term debt and "A1" rating for the Company's short term debt. On April 9, 2002, Moody's Investors Services downgraded the Company's senior debt rating to "A3" and its short-term debt rating to "Prime-2." These changes have not resulted in any material impact on the Company's borrowing costs.

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        On April 30, 2002, the Company paid a quarterly dividend of $0.335 per share to shareholders of record on March 28, 2002. Since 1912, the Company has paid a dividend every quarter and in each instance Dow has maintained or increased the dividend.

OTHER MATTERS

Accounting Changes

        See Note B to the Consolidated Financial Statements for a discussion of accounting changes.

Critical Accounting Policies

        The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note A to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2001, describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Following are some of the Company's critical accounting policies impacted by judgments, assumptions and estimates.

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Asbestos-Related Matters of Union Carbide Corporation

        Union Carbide Corporation, a wholly owned subsidiary of the Company, has filed its quarterly report on Form 10-Q for the quarter ended March 31, 2002, and has provided the disclosure below concerning asbestos. Note F to Dow's Consolidated Financial Statements provides some additional information related to Union Carbide's asbestos-related liability. In view of the exposure of Union Carbide to asbestos-related liability noted below, the related insurance coverage available to Union Carbide, and its stated intention to aggressively defend or reasonably resolve, as appropriate, the pending asbestos cases and any additional asbestos cases as may be filed in the future, the Company does not consider Union Carbide's asbestos-related liability to be material to Dow's consolidated financial statements. The disclosures contained in Union Carbide's Form 10-Q are provided in this filing to more broadly disclose information concerning Union Carbide's asbestos-related liability. References below to the "Corporation" or to "UCC" refer to Union Carbide Corporation.

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        There are inherent uncertainties associated with asbestos litigation. Dow recognizes that future facts, events and legislation may alter estimates of probable outcomes. Dow assessed the known facts and circumstances of Union Carbide's asbestos-related litigation and believes that adequate provisions have been made for probable losses with respect to pending claims and proceedings.

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The Dow Chemical Company and Subsidiaries
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.

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

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

Average Daily VAR at December 31*

In millions

  2001
  2000
Foreign exchange   $ 13   $ 7
Interest rate     70     45
Equity exposures, net of hedges     9     26
Commodities     5     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, 2001.

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The Dow Chemical Company and Subsidiaries
Part II—Other Information


ITEM 1. LEGAL PROCEEDINGS

Breast Implant Matters

        Since the filing of the Company's Annual Report on Form 10-K on March 20, 2002, there have been no material developments regarding this matter. For a summary of the history and current status of this matter, see Note F to the Consolidated Financial Statements.

Environmental Matters

        On November 13, 1998, the Michigan Department of Environmental Quality ("MDEQ") commenced an investigation of alleged unpermitted release and improper storage of material containing dioxin and furans at Radian International LLC's ("Radian") waste treatment facility which is located within the Company's Michigan Operations manufacturing site. The Company and MDEQ entered into a consent order, effective April 11, 2002, to settle this and several unrelated matters. Any potential liabilities of Radian are outside the scope of this consent order. The consent order requires Dow to pay a settlement amount of $499,270; reimburse $10,377 in costs of surveillance and enforcement; and undertake Supplemental Environmental Projects worth $800,000. The Company may ultimately have indemnification rights against Radian.


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)
Exhibits.

        None

(b)
Reports on Form 8-K.

        The following Current Reports on Form 8-K were filed by the Company during the first quarter of 2002:

        The following Current Report on Form 8-K was filed by the Company subsequent to the first quarter of 2002:

        The following trademarks of The Dow Chemical Company or its subsidiaries appear in this report:    METHOCEL, POLYOX, UNIPOL

        The following trademark of INEOS plc appears in this report:    GAS/SPEC

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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.


Date: May 3, 2002

 

 

 

THE DOW CHEMICAL COMPANY

Registrant

 

 

By:

 

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

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QuickLinks

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