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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, 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 June 30, 2002
Common Stock, $2.50 par value   910,718,107 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

 

21

 

 

Disclosure Regarding Forward-Looking Information

 

21

 

 

Results of Operations

 

21

 

 

Changes in Financial Condition

 

30

 

 

Other Matters

 

32
 
Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

37

PART II—OTHER INFORMATION

 

 
 
Item 1.

 

Legal Proceedings

 

38
 
Item 4.

 

Submission of Matters to a Vote of Security Holders

 

38
 
Item 6.

 

Exhibits and Reports on Form 8-K

 

39

SIGNATURE

 

40

2



PART I—FINANCIAL INFORMATION

Item 1. Financial Statements


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

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

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Net Sales   $ 7,217   $ 7,344   $ 13,479   $ 14,730  
   
 
 
 
 
  Cost of sales     5,990     6,137     11,311     12,593  
  Research and development expenses     272     271     522     543  
  Selling, general and administrative expenses     405     456     796     908  
  Amortization of intangibles     19     35     33     68  
  Merger-related expenses and restructuring     10     24     23     1,408  
  Insurance and finance company operations, pretax income     1     14     10     25  
  Equity in earnings (losses) of nonconsolidated affiliates     21     38     (5 )   73  
  Sundry income (expense)—net     (4 )   85     (17 )   368  
   
 
 
 
 
Earnings (Loss) before Interest, Income Taxes and Minority Interests     539     558     782     (324 )
   
 
 
 
 
  Interest income     14     16     30     40  
  Interest expense and amortization of debt discount     188     179     377     361  
   
 
 
 
 
Income (Loss) before Income Taxes and Minority Interests     365     395     435     (645 )
   
 
 
 
 
  Provision (Credit) for income taxes     111     120     135     (220 )
  Minority interests' share in income (loss)     16     (5 )   24     12  
   
 
 
 
 
Income (Loss) before Cumulative Effect of Changes in Accounting Principles     238     280     276     (437 )
   
 
 
 
 
  Cumulative effect of changes in accounting principles             67     32  
   
 
 
 
 
Net Income (Loss) Available for Common Stockholders   $ 238   $ 280   $ 343   $ (405 )
   
 
 
 
 
Share Data                          
  Earnings (Loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.26   $ 0.31   $ 0.30   $ (0.49 )
  Earnings (Loss) per common share—basic   $ 0.26   $ 0.31   $ 0.38   $ (0.45 )
  Earnings (Loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.26   $ 0.31   $ 0.30   $ (0.49 )
  Earnings (Loss) per common share—diluted   $ 0.26   $ 0.31   $ 0.37   $ (0.45 )
  Common stock dividends declared per share of common stock   $ 0.335   $ 0.335   $ 0.67   $ 0.625  
  Weighted-average common shares outstanding—basic     910.7     900.9     909.0     899.5  
  Weighted-average common shares outstanding—diluted     919.3     912.7     917.2     899.5  
   
 
 
 
 
Depreciation   $ 402   $ 384   $ 790   $ 772  
   
 
 
 
 
Capital Expenditures   $ 391   $ 376   $ 688   $ 649  
   
 
 
 
 

See Notes to the Consolidated Financial Statements.

3



The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  June 30,
2002

  Dec. 31,
2001

 
Assets              
Current Assets              
  Cash and cash equivalents   $ 299   $ 220  
  Marketable securities and interest-bearing deposits     64     44  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables —2002: $120; 2001: $123)     3,667     2,868  
    Other     2,047     2,230  
  Inventories:              
    Finished and work in process     3,440     3,569  
    Materials and supplies     915     871  
  Deferred income tax assets—current     518     506  
   
 
 
  Total current assets     10,950     10,308  
   
 
 
Investments              
  Investment in nonconsolidated affiliates     1,615     1,581  
  Other investments     1,703     1,663  
  Noncurrent receivables     1,003     802  
   
 
 
  Total investments     4,321     4,046  
   
 
 
Property              
  Property     37,206     35,890  
  Less accumulated depreciation     23,469     22,311  
   
 
 
  Net property     13,737     13,579  
   
 
 
Other Assets              
  Goodwill     3,180     3,130  
  Other intangible assets (net of accumulated amortization—2002: $388; 2001: $346)     609     607  
  Deferred income tax assets—noncurrent     2,550     2,248  
  Deferred charges and other assets     1,758     1,597  
   
 
 
  Total other assets     8,097     7,582  
   
 
 
Total Assets   $ 37,105   $ 35,515  
   
 
 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 
Current Liabilities              
  Notes payable   $ 1,645   $ 1,209  
  Long-term debt due within one year     921     408  
  Accounts payable:              
    Trade     2,505     2,713  
    Other     1,284     926  
  Income taxes payable     196     190  
  Deferred income tax liabilities—current     285     236  
  Dividends payable     327     323  
  Accrued and other current liabilities     2,257     2,120  
   
 
 
  Total current liabilities     9,420     8,125  
   
 
 
Long-Term Debt     9,336     9,266  
   
 
 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     1,063     760  
  Pension and other postretirement benefits—noncurrent     2,416     2,475  
  Other noncurrent obligations     3,464     3,539  
   
 
 
  Total other noncurrent liabilities     6,943     6,774  
   
 
 
Minority Interest in Subsidiaries     355     357  
   
 
 
Preferred Securities of Subsidiaries     1,000     1,000  
   
 
 
Stockholders' Equity              
  Common stock     2,453     2,453  
  Additional paid-in capital          
  Unearned ESOP shares     (86 )   (90 )
  Retained earnings     10,833     11,112  
  Accumulated other comprehensive loss     (905 )   (1,070 )
  Treasury stock at cost     (2,244 )   (2,412 )
   
 
 
  Net stockholders' equity     10,051     9,993  
   
 
 
Total Liabilities and Stockholders' Equity   $ 37,105   $ 35,515  
   
 
 

See Notes to the Consolidated Financial Statements.

4



The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
  Six Months Ended
 
In millions (Unaudited)

  June 30,
2002

  June 30,
2001

 
Operating Activities              
  Income (Loss) before cumulative effect of changes in accounting principles   $ 276   $ (437 )
  Adjustments to reconcile net income (loss) to net cash provided by operating activities:              
    Depreciation and amortization     853     863  
    Provision (Credit) for deferred income tax     17     (268 )
    Earnings/losses of nonconsolidated affiliates less than (in excess of) dividends received     46     (43 )
    Minority interests' share in income     24     12  
    Net gain on sales of property and businesses     (9 )   (10 )
    Other net gain     (24 )   (290 )
    Merger-related expenses and restructuring         1,051  
    Tax benefit—nonqualified stock option exercises     16     22  
  Changes in assets and liabilities that provided (used) cash:              
    Accounts and notes receivable     (862 )   134  
    Inventories     85     (113 )
    Accounts payable     81     (594 )
    Other assets and liabilities     37     (226 )
   
 
 
  Cash provided by operating activities     540     101  
   
 
 
Investing Activities              
  Capital expenditures     (688 )   (649 )
  Proceeds from sales of property and businesses     39     102  
  Acquisitions of businesses, net of cash received         (2,204 )
  Investments in nonconsolidated affiliates     (71 )   (54 )
  Advances to nonconsolidated affiliates     (11 )   (57 )
  Proceeds from sale of nonconsolidated affiliates         180  
  Purchases of investments     (1,106 )   (1,364 )
  Proceeds from sales of investments     1,051     2,002  
   
 
 
  Cash used in investing activities     (786 )   (2,044 )
   
 
 
Financing Activities              
  Changes in short-term notes payable     419     727  
  Payments on long-term debt     (87 )   (234 )
  Proceeds from issuance of long-term debt     532     1,799  
  Purchases of treasury stock     (3 )   (5 )
  Proceeds from sales of common stock     111     75  
  Distributions to minority interests     (38 )   (32 )
  Dividends paid to stockholders     (607 )   (458 )
   
 
 
  Cash provided by financing activities     327     1,872  
   
 
 
Effect of Exchange Rate Changes on Cash     (2 )   (4 )
   
 
 
Summary              
  Increase (Decrease) in cash and cash equivalents     79     (75 )
  Cash and cash equivalents at beginning of year     220     278  
   
 
 
  Cash and cash equivalents at end of period   $ 299   $ 203  
   
 
 

See Notes to the Consolidated 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,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Net Income (Loss) Available for Common Stockholders   $ 238   $ 280   $ 343   $ (405 )
   
 
 
 
 
Other Comprehensive Income (Loss), Net of Tax                          
  Net unrealized losses on investments     (16 )   (11 )   (23 )   (298 )
  Translation adjustments     217     (41 )   184     (149 )
  Net gains (losses) on cash flow hedging derivative instruments     (16 )   (12 )   4     17  
   
 
 
 
 
  Total other comprehensive income (loss)     185     (64 )   165     (430 )
   
 
 
 
 
Comprehensive Income (Loss)   $ 423   $ 216   $ 508   $ (835 )
   
 
 
 
 

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. The Company adopted SFAS No. 133, as amended and interpreted by the FASB and the Derivatives Implementation Group through "Statement 133 Implementation Issues," 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

7



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 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

8



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 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 half of 2002, severance of $111 million was paid to approximately 1,600 former employees, bringing the program-to-date amount to $444 million paid to approximately 4,700 former employees.

        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 June 30, 2002, $69 million of the reserve remained.

        In addition to the special charge, one-time merger and integration costs of $115 million were recorded in 2001. For the first half of 2002, one-time merger and integration costs totaled $23 million, compared with $24 million last year.

9



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

In millions

  Labor-related
Costs

  Transaction
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  
   
 
 
 
 
 
  Adjustments to reserve               $ 10   $ 10  
  Charges against reserve   $ (30 )     $ (4 )   (10 )   (44 )
   
 
 
 
 
 
Balance at June 30, 2002   $ 242       $ 69       $ 311  
   
 
 
 
 
 

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 $124 11/16 (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:

10


        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. In the second quarter of 2002, the Company finalized its allocation of the purchase price to the assets acquired and liabilities assumed, principally consisting of adjustments to goodwill, property, and accounts receivable.

        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. In the second quarter of 2002, the Company finalized its allocation of the purchase price to the assets acquired and liabilities assumed, principally consisting of adjustments to goodwill, property, and other intangible assets.

Note E—Goodwill and Other Intangible Assets

        The Company ceased amortizing goodwill upon adoption of SFAS No. 142 on January 1, 2002 (see Note B). The following table provides pro forma results for the three months and six months ended

11



June 30, 2001, compared with actual results for the three months and six months ended June 30, 2002, as if the non-amortization provisions of SFAS No. 142 had been applied:

 
  Three Months Ended
  Six Months Ended
 
In millions, except per share amounts

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Reported income (loss) before cumulative effect of changes in accounting principles   $ 238   $ 280   $ 276   $ (437 )
Reported net income (loss)   $ 238   $ 280   $ 343   $ (405 )
   
 
 
 
 
Adjustments:                          
  Goodwill amortization, net of tax       $ 25       $ 48  
  Negative goodwill amortization, net of tax         (3 )       (6 )
  Equity method goodwill amortization, net of tax         3         6  
   
 
 
 
 
    Total adjustments       $ 25       $ 48  
   
 
 
 
 
Adjusted income (loss) before cumulative effect of changes in accounting principles   $ 238   $ 305   $ 276   $ (389 )
Adjusted net income (loss)   $ 238   $ 305   $ 343   $ (357 )
   
 
 
 
 
Reported earnings (loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.26   $ 0.31   $ 0.30   $ (0.49 )
Reported earnings (loss) per common share—basic   $ 0.26   $ 0.31   $ 0.38   $ (0.45 )
   
 
 
 
 
Adjustments:                          
  Goodwill amortization, net of tax       $ 0.03       $ 0.05  
  Negative goodwill amortization, net of tax                 (0.01 )
  Equity method goodwill amortization, net of tax                 0.01  
   
 
 
 
 
    Total adjustments       $ 0.03       $ 0.05  
   
 
 
 
 
Adjusted earnings (loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.26   $ 0.34   $ 0.30   $ (0.44 )
Adjusted earnings (loss) per common share—basic   $ 0.26   $ 0.34   $ 0.38   $ (0.40 )
   
 
 
 
 
Reported earnings (loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.26   $ 0.31   $ 0.30   $ (0.49 )
Reported earnings (loss) per common share—diluted   $ 0.26   $ 0.31   $ 0.37   $ (0.45 )
   
 
 
 
 
Adjustments:                          
  Goodwill amortization, net of tax       $ 0.03       $ 0.05  
  Negative goodwill amortization, net of tax                 (0.01 )
  Equity method goodwill amortization, net of tax                 0.01  
   
 
 
 
 
    Total adjustments       $ 0.03       $ 0.05  
   
 
 
 
 
Adjusted earnings (loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.26   $ 0.34   $ 0.30   $ (0.44 )
Adjusted earnings (loss) per common share—diluted   $ 0.26   $ 0.34   $ 0.37   $ (0.40 )
   
 
 
 
 

12


        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 six months ended June 30, 2002, by operating segment:

In millions

  Performance
Plastics

  Performance
Chemicals

  Agricultural
Sciences

  Plastics
  Hydrocarbons
and Energy

  Total
 
Goodwill 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         27                 27  
  Gurit-Essex     3                     3  
  Rohm and Haas             17             17  
  Reichhold Specialty Latex         25                 25  
   
 
 
 
 
 
 
  Total adjustments     3     52     17             72  
   
 
 
 
 
 
 
Goodwill at June 30, 2002   $ 892   $ 791   $ 1,320   $ 114   $ 63   $ 3,180  
   
 
 
 
 
 
 

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

 
  At June 30, 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   $ 295   $ (104 ) $ 191   $ 278   $ (87 ) $ 191
  Patents     156     (56 )   100     161     (54 )   107
  Software     310     (200 )   110     291     (188 )   103
  Trademarks     137     (10 )   127     126     (6 )   120
  Other     99     (18 )   81     97     (11 )   86
   
 
 
 
 
 
  Total   $ 997   $ (388 ) $ 609   $ 953   $ (346 ) $ 607
   
 
 
 
 
 

        Amortization expense for other intangible assets (not including software) was $19 million in the second quarter of 2002, compared with $10 million in the same period last year. Year to date, amortization expense for other intangible assets (not including software) was $33 million, compared with $20 million for the first six months of 2001. Amortization expense for software, which is included in cost of sales, totaled $6 million in the second quarter, compared with $4 million last year. For the first six months of this year, amortization expense for software was $11 million, up from $8 million for

13



the same period last year. Total estimated amortization expense for 2002 and the five succeeding fiscal years is as follows:

 
  Estimated
Amortization
Expense

 
  In millions

2002   $ 96
2003     97
2004     94
2005     86
2006     81
2007     72

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

14



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 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 $425 million at June 30, 2002, for environmental matters, including $41 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

15



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 June 30, 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.

16



*
Union Carbide Corporation, Quarterly Report on Form 10-Q for the Quarter Ended June 30, 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.

17


        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

18



obligations of $860 million. The Company was also committed to lease manufacturing facilities under construction in The Netherlands.

Note G—Operating Segments and Geographic Areas

 
  Three Months Ended
  Six Months Ended
 
In millions

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Operating segment sales                          
  Performance Plastics   $ 1,835   $ 1,864   $ 3,554   $ 3,785  
  Performance Chemicals     1,302     1,240     2,561     2,550  
  Agricultural Sciences     886     809     1,531     1,414  
  Plastics     1,688     1,697     3,116     3,466  
  Chemicals     861     945     1,546     1,941  
  Hydrocarbons and Energy     583     718     1,068     1,427  
  Unallocated and Other     62     71     103     147  
   
 
 
 
 
  Total   $ 7,217   $ 7,344   $ 13,479   $ 14,730  
   
 
 
 
 
Operating segment EBIT(1)                          
  Performance Plastics   $ 145   $ 140   $ 392   $ 357  
  Performance Chemicals     165     158     363     258  
  Agricultural Sciences     189     176     215     219  
  Plastics     106     42     44     75  
  Chemicals     (15 )   45     (68 )   38  
  Hydrocarbons and Energy     10     (14 )   41     (3 )
  Unallocated and Other     (61 )   11     (205 )   (1,268 )
   
 
 
 
 
  Total   $ 539   $ 558   $ 782   $ (324 )
   
 
 
 
 
Geographic area sales                          
  United States   $ 2,983   $ 3,203   $ 5,539   $ 6,408  
  Europe     2,359     2,265     4,514     4,635  
  Rest of World     1,875     1,876     3,426     3,687  
   
 
 
 
 
  Total   $ 7,217   $ 7,344   $ 13,479   $ 14,730  
   
 
 
 
 

(1)
Financial results for 2002 do not include goodwill amortization due to the adoption of SFAS No. 142 (see Note E). Total goodwill amortization expense, including equity method goodwill, included in EBIT for the three and six months ended June 30, 2001 was as follows:

19


 
  Three Months
Ended
June 30, 2001

  Six Months
Ended
June 30, 2001

 
 
  In millions

 
Performance Plastics   $ 8   $ 13  
Performance Chemicals     4     8  
Agricultural Sciences     16     30  
Plastics     4     5  
Chemicals          
Hydrocarbons and Energy     1     2  
Unallocated and Other     (2 )   (4 )
   
 
 
Total   $ 31   $ 54  
   
 
 

        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.

20



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 and six months ended June 30, 2002 and 2001:

 
  Three Months Ended
  Six Months Ended
 
In millions, except per share amounts

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Sales   $ 7,217   $ 7,344   $ 13,479   $ 14,730  

Cost of sales

 

 

5,990

 

 

6,137

 

 

11,311

 

 

12,593

 
% of sales     83 %   84 %   84 %   85 %

Research and development, and selling, general and administrative expenses

 

 

677

 

 

727

 

 

1,318

 

 

1,451

 
% of sales     9 %   10 %   10 %   10 %

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

 

 

539

 

 

558

 

 

782

 

 

(324

)
% of sales     7 %   8 %   6 %   (2 )%

Effective tax rate

 

 

30.4

%

 

30.4

%

 

31.0

%

 

34.1

%

Net income (loss) available for common stockholders

 

$

238

 

$

280

 

$

343

 

$

(405

)

Earnings (Loss) per common share—basic

 

$

0.26

 

$

0.31

 

$

0.38

 

$

(0.45

)
Earnings (Loss) per common share—diluted   $ 0.26   $ 0.31   $ 0.37   $ (0.45 )

Operating rate percentage

 

 

80

%

 

76

%

 

78

%

 

77

%

        Net sales for the second quarter of 2002 were $7.2 billion, down from second quarter sales of $7.3 billion last year. Compared with last year, volume improved 8 percent, while prices fell 10 percent (see Sales Volume and Price table on page 21). Volume improved in all segments, except Hydrocarbons and Energy. Excluding the addition of sales from recently acquired businesses (primarily Rohm and Haas' agricultural chemicals business, EniChem's polyurethanes business and Ascot Plc), volume was up 5 percent. (Information regarding significant acquisitions and divestitures can be found in Note D to the Consolidated Financial Statements.) Prices in the second quarter were down $730 million in total compared with last year, with declines in all operating segments and across all geographies. The largest

21



price declines continued to be reported by the Company's basics businesses, although the chemical industry began to show signs of recovering from trough-level pricing during the second quarter. From a geographic standpoint, volume was up in all geographic areas with substantial volume growth reported outside of the United States. Year to date, net sales of $13.5 billion were down 8 percent from $14.7 billion last year as volume growth of 6 percent was more than offset by a 14 percent overall decline in prices.

        Operating expenses (research and development, and selling, general and administrative expenses) were $677 million for the second quarter of 2002, down $50 million, or 7 percent, from $727 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 12 percent from the same quarter last year. For the first half of the year, operating expenses totaled $1,318 million, down 9 percent from $1,451 million last year. Excluding growth initiatives, acquisitions and divestitures, year-to-date operating expenses were down 13 percent from the first half of last year.

        Net income for the second quarter of 2002 was $238 million or $0.26 per share, compared with $280 million or $0.31 per share for the second quarter of 2001. Net income declined versus last year as selling prices fell $730 million and more than offset the favorable impact of lower feedstock and energy costs of $450 million. Two unusual items also negatively impacted net income for the quarter: additional pretax expenses of $10 million related to the Union Carbide merger and a $10 million pretax restructuring charge (Dow's share) recorded by UOP LLC in the second quarter (reflected in "Equity in earnings of nonconsolidated affiliates" in the Performance Plastics segment). Net income last year was reduced by pretax merger-related expenses of $24 million.

        Net income for the first six months of 2002 was $343 million compared with a loss of $405 million for the same period last year. Year to date, lower feedstock and energy costs of $1.6 billion were more than offset by lower selling prices of $2.2 billion, thereby reducing net income. Net income for the first half of 2002 was increased by the net impact of several unusual items: year-to-date pretax expenses of $23 million related to the Union Carbide merger, the $10 million pretax restructuring charge (Dow's share) recorded by UOP, 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 [Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets."]. Net income for the first half of 2001 was negatively impacted by the net result of three unusual items: pretax merger-related costs and restructuring of $1.4 billion, 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.

22



        The following table shows the impact of the unusual items recorded in the three-month and six-month periods ended June 30, 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

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Unusual items:                                      
  Merger-related expenses and restructuring   $ (10 ) $ (24 ) $ (7 ) $ (17 ) $ (0.01 ) $ (0.02 )
  UOP restructuring     (10 )       (7 )       (0.01 )    
   
 
 
 
 
 
 
    Total unusual items   $ (20 ) $ (24 ) $ (14 ) $ (17 ) $ (0.02 ) $ (0.02 )
   
 
 
 
 
 
 
As reported   $ 539   $ 558   $ 238   $ 280   $ 0.26   $ 0.31  
Excluding unusual items   $ 559   $ 582   $ 252   $ 297   $ 0.28   $ 0.33  
 
  EBIT
  Net Income
  Earnings Per Share
 
 
  Six Months Ended
  Six Months Ended
  Six Months Ended
 
In millions, except per share amounts

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

  June 30,
2002

  June 30,
2001

 
Unusual items:                                      
  Merger-related expenses and restructuring   $ (23 )   $(1,408 ) $ (15 ) $ (936 ) $ (0.02 ) $ (1.04 )
  UOP restructuring     (10 )       (7 )       (0.01 )    
  Goodwill impairment losses in non-consolidated 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   $ (49 )   $(1,142 ) $ 29   $ (736 ) $ 0.02   $ (0.82 )
   
 
 
 
 
 
 
As reported   $ 782   $ (324 ) $ 343   $ (405 ) $ 0.37   $ (0.45 )
Excluding unusual items   $ 831   $ 818   $ 314   $ 331   $ 0.35   $ 0.37  

PERFORMANCE PLASTICS

        Performance Plastics sales of $1,835 million for the second quarter of 2002 were down 2 percent from $1,864 million in the second quarter of 2001, as prices fell 8 percent and volume improved 6 percent. Excluding acquisitions, volume was up 2 percent. Despite lower sales in the quarter, EBIT for the segment of $145 million was up 4 percent from $140 million in the same period of 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. EBIT for the segment also included the negative impact of a restructuring charge recorded by UOP in the second quarter. Dow's share of this charge was $10 million.

        Dow Automotive sales for the second quarter of 2002 were down slightly from a year ago, as lower selling prices more than offset a modest improvement in volume. The decline in selling prices reflects the competitive environment that domestic producers are facing within the global automotive industry. EBIT for the business improved significantly compared with last year as the business realized cost synergies related to the acquisition of the remaining 50 percent of Gurit-Essex AG in January 2001 (see

23



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 20 percent from the second quarter of 2001, due to a 14 percent decline in prices and a 6 percent decline in volume. Both price and volume were negatively impacted by new industry capacity, which intensified the competitive environment. Despite lower operating expenses, EBIT for the quarter declined versus last year due to the declines in price and volume.

        Sales of Epoxy Products and Intermediates for the quarter were down 7 percent from last year, as a decline in prices of 12 percent more than offset volume growth of 5 percent. The decline in prices was the result of intense competitive price pressure in all geographic areas. Demand was strong around the world, with the exception of the electronics industry. EBIT for the quarter improved versus the second quarter of last year as stronger volume and lower operating expenses offset the impact of lower selling prices.

        Fabricated Products sales for the second quarter of 2002 were up 7 percent versus last year, as volume growth of 9 percent exceeded a 2 percent decline in prices. Volume for building materials improved significantly from last year, reflecting the addition of sales related to the purchase of assets from Celotex Corporation in the third quarter of last year. Excluding this acquisition, volume was down 2 percent, primarily due to a decrease in demand for engineering films and laminates. EBIT for the second quarter of 2002 improved versus the same quarter of 2001 due to volume growth and the realization of acquisition-related cost synergies.

        Polyurethanes sales for the second quarter were up 8 percent compared with the second quarter of 2001, as volume growth of 17 percent exceeded price declines of 9 percent. Excluding last year's acquisition of EniChem's polyurethanes business, volume was up 11 percent. Volume continued to be strong for systems formulations, with increased volume across all geographies and applications, particularly in developing regions of the world. EBIT for the second quarter improved significantly over last year due to volume growth and improved plant operations, especially for toluene diisocyanate.

        Wire and Cable sales and EBIT for the second quarter of 2002 were down from the second quarter of last year, primarily due to weak demand within the telecommunications cable industry and lower prices.

        For the first six months of the year, Performance Plastics sales were $3,554 million, down 6 percent from $3,785 million in the same period last year. Prices declined 10 percent, exceeding a 4 percent improvement in volume. Excluding acquisitions, volume was flat versus last year. Year-to-date EBIT for the segment was $392 million, up from $357 million for the first half of last year. Despite lower sales, EBIT improved due to lower feedstock and energy costs, the realization of cost synergies related to the Union Carbide merger and 2001 acquisitions, the impact of cost control initiatives, and a favorable litigation settlement in the first quarter of 2002.

PERFORMANCE CHEMICALS

        Performance Chemicals sales for the second quarter of 2002 were $1,302 million, up 5 percent from $1,240 million in the second quarter of last year. Volume improved 9 percent as prices fell 4 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 improved 2 percent from the second quarter of 2001. Second quarter EBIT for the segment was $165 million, up from $158 million last year as higher volume, lower raw material costs and the realization of merger-related cost synergies offset lower selling prices.

        Custom and Fine Chemicals sales for the second quarter of 2002 increased significantly compared with last year due primarily to the acquisition of Ascot Plc in 2001. EBIT for the quarter, however,

24



declined due to lower sales in Hampshire Fine Chemicals and integration costs associated with the Ascot acquisition.

        Emulsion Polymers sales for the quarter were up 6 percent compared with 2001. Volume increased 17 percent due to strong demand for Dow's products and the acquisition of Reichhold's carpet latex business in the fourth quarter of 2001. Excluding this acquisition, volume was up 12 percent, reflecting increased customer preference for Dow's products. Prices were down 11 percent. Compared with last year, EBIT for the second quarter declined due to lower selling prices.

        Industrial Chemicals sales were down 9 percent from the second quarter of 2001, due to declines in both volume and price. EBIT for the business improved versus last year, however, due to lower raw material costs and the realization of cost synergies related to the Union Carbide merger.

        Oxide Derivatives sales for the second quarter of 2002 were up slightly from last year. Volume improved 5 percent, largely due to stronger demand for alkanolamines and glycol ethers in Latin America and Asia Pacific, while prices declined 4 percent. EBIT improved substantially in the second quarter versus last year, as margins improved due to lower raw material costs and the realization of merger-related cost synergies.

        Specialty Polymers sales in the second quarter were up 2 percent from the same period of 2001, as volume growth of 4 percent exceeded price declines of 2 percent. Despite higher sales, EBIT for the business declined versus last year due to higher propylene costs and competitive pressures in acrylic acid and acrylate derivatives.

        Water Soluble Polymers sales for the quarter were down slightly versus the second quarter of 2001, as a slight improvement in price was offset by a decline in volume. Volume was down slightly compared with last year for METHOCEL cellulose ethers, ETHOCEL ethylcellulose resins and CELLOSIZE hydroxyethyl cellulose. EBIT for the second quarter improved versus last year due to lower operating costs and the realization of merger-related cost synergies.

        Performance Chemicals sales for the first half of 2002 were $2,561 million, essentially flat with $2,550 million in the same period of 2001. Volume improved 5 percent, but was offset by a 5 percent decline in prices. Year to date, EBIT for the segment was $363 million, up significantly from $258 million in the first half of 2001, as higher volume, lower raw material costs and the realization of merger-related cost synergies more than offset the impact of lower selling prices.

AGRICULTURAL SCIENCES

        Sales for the Agricultural Sciences segment for the second quarter of 2002 were $886 million, up 10 percent from $809 million last year. The acquisition of Rohm and Haas' agricultural chemicals business in June of last year (see Note D to the Consolidated Financial Statements) contributed favorably to both sales and EBIT for the segment. Volume was up 11 percent, while prices declined 1 percent. Excluding the acquisition, volume was down 1 percent, as wet weather in North America delayed the planting season and the use of herbicides. Insecticide sales were up, driven by increased demand for chlorpyrifos and continued progress with SENTRICON Termite Colony Elimination System, although sales for spinosad insect control products were lower due to fewer cotton acres being planted. EBIT for the quarter was $189 million, up from $176 million in the second quarter of 2001, primarily the result of having a full quarter of Rohm and Haas activity and lower operating expenses.

        Sales for the Agricultural Sciences segment were $1,531 million in the first six months of the year, up 8 percent from $1,414 million in 2001. While volume improved 10 percent, prices fell 2 percent. Excluding the Rohm and Haas acquisition, volume was down 4 percent from last year. EBIT for the first six months of 2002 was $215 million compared with $219 million last year. Results for 2002 include a write-down of accounts receivable in Argentina and a write-down related to the closure of seed production facilities in the first quarter.

25



PLASTICS

        Plastics sales in the second quarter of 2002 were $1,688 million, down 1 percent from $1,697 million a year ago. Compared with last year, prices fell 14 percent, more than offsetting volume growth of 13 percent. EBIT for the quarter was $106 million, versus $42 million in the second quarter of 2001, as the segment benefited from lower feedstock and energy costs, improved volumes, the realization of merger-related cost synergies, and lower operating expenses, overcoming the impact of significantly lower selling prices.

        Polyethylene sales were down 4 percent compared with the second quarter of last year, as an 18 percent drop in prices exceeded volume growth of 14 percent. Prices increased during the quarter consistent with announced price increases, but remained significantly below 2001 levels. Demand improved in all geographic areas, due to increased end-use consumption and inventory restocking. Despite the sharp decline in selling prices, EBIT for the quarter improved significantly compared with the second quarter of last year due to increased volume, lower ethylene costs and the realization of merger-related cost synergies.

        Polypropylene sales for the second quarter of 2002 continued an upward trend, with a significant increase in volume and a slight improvement in prices versus the same quarter last year. Volume was strong, with all Dow plants running at capacity. EBIT improved significantly versus last year due to the increase in volume.

        Polystyrene sales were up 9 percent in the second quarter of 2002 compared with the same quarter last year, as volume growth of 15 percent was partially offset by 6 percent lower prices. Strong volume was reported by all geographic areas. Prices improved in Europe and Asia Pacific, but were more than offset by price declines in the other geographic areas. EBIT for the business was flat compared with the second quarter of 2001 as the impact of lower selling prices offset the increase in volume.

        Plastics sales for the first half of 2002 were $3,116 million, down 10 percent from $3,466 million last year. Compared with last year, volume improved 12 percent, but was more than offset by a sharp decline in prices of 22 percent. EBIT for the period was $44 million, down from $75 million in the first half of 2001 as margins were compressed by price declines that significantly exceeded the benefit of lower feedstock and energy costs.

CHEMICALS

        Second quarter sales for the Chemicals segment were $861 million compared with $945 million in the second quarter of 2001. Volume increased 12 percent due to improved demand for caustic soda, vinyl chloride monomer ("VCM"), ethylene glycol, and oxo products. Prices were down 21 percent from last year, with significant declines in caustic soda; and organic intermediates, solvents and monomers ("OISM"). Caustic soda pricing appears to have bottomed and showed signs of improving during the quarter. After three quarters of trough level pricing, VCM prices improved to the levels of a year ago. EBIT for the quarter was a loss of $15 million versus income of $45 million in 2001. While results for the segment were favorably impacted in the second quarter by higher volume, lower feedstock and energy costs, and the realization of merger-related cost synergies, EBIT declined due to lower overall selling prices.

        For the first half of 2002, sales for the Chemicals segment were $1,546 million, down 20 percent from $1,941 million last year on a 23 percent decline in prices and a 3 percent improvement in volume. EBIT for the first six months of this year was a loss of $68 million compared with income of $38 million in 2001. EBIT was lower as significant declines in selling prices more than offset the favorable impact of lower feedstock and energy costs and the realization of merger-related cost synergies.

26



HYDROCARBONS AND ENERGY

        Hydrocarbons and Energy sales for the quarter were $583 million, down 19 percent from $718 million in the second quarter of 2001, due to an 8 percent decline in volume and an 11 percent drop in selling prices, reflecting lower sales of energy and monomers and a decline in hydrocarbon and energy costs.

        The Hydrocarbons and Energy business transfers materials to Dow's derivative businesses at cost. While Dow's total energy and hydrocarbon feedstock costs for the second quarter were approximately $450 million lower than the second quarter of last year, selling prices for the Company in total fell $730 million, negatively impacting margins in many of the Company's businesses. EBIT for the quarter was $10 million compared with a loss of $14 million last year.

        Sales for the first half of 2002 were $1,068 million, down 25 percent from $1,427 million for the same period of 2001, due to a sharp decline in selling prices. EBIT for the first six months of 2002 was $41 million compared with a loss of $3 million last year.

UNALLOCATED AND OTHER

        EBIT for the second quarter was a loss of $61 million compared with income of $11 million for the second 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. Second quarter results included the unfavorable impact of additional merger-related expenses of $10 million, bringing the year-to-date total to $23 million. Compared with last year, EBIT for the second quarter declined primarily due to lower results from the Company's insurance and finance company operations, unfavorable foreign exchange results, lower sales of financial assets, and a loss reported by Cargill Dow as that joint venture incurred start-up expenses.

        For the first six months of this year, EBIT for Unallocated and Other was a loss of $205 million compared with a loss of $1.3 billion for the same period last year. Results for 2001 included the negative impact of a $1.4 billion special charge for costs related to the Union Carbide merger (see Note C to the Consolidated Financial Statements), partially offset by a $266 million gain on the sale of stock in Schlumberger Ltd.

27



Sales Volume and Price by Operating Segment and Geographic Area

 
  Three Months Ended
June 30, 2002

  Six Months Ended
June 30, 2002

 
Percentage change from prior year

 
  Volume
  Price
  Total
  Volume
  Price
  Total
 
Operating segments                          
  Performance Plastics   6 % (8 )% (2 )% 4 % (10 )% (6 )%
  Performance Chemicals   9 % (4 )% 5 % 5 % (5 )%  
  Agricultural Sciences   11 % (1 )% 10 % 10 % (2 )% 8 %
  Plastics   13 % (14 )% (1 )% 12 % (22 )% (10 )%
  Chemicals   12 % (21 )% (9 )% 3 % (23 )% (20 )%
  Hydrocarbons and Energy   (8 )% (11 )% (19 )% 1 % (26 )% (25 )%
   
 
 
 
 
 
 
  Total   8 % (10 )% (2 )% 6 % (14 )% (8 )%
   
 
 
 
 
 
 
Geographic area sales                          
  United States   3 % (10 )% (7 )% (1 )% (13 )% (14 )%
  Europe   11 % (7 )% 4 % 13 % (16 )% (3 )%
  Rest of World   14 % (14 )%   10 % (17 )% (7 )%
   
 
 
 
 
 
 
  Total   8 % (10 )% (2 )% 6 % (14 )% (8 )%
   
 
 
 
 
 
 

COMPANY SUMMARY

Operating Rate

        The Company's global plant operating rate for its chemicals and plastics businesses was 80 percent in the second quarter of 2002, up from 76 percent in the second quarter of 2001.

Amortization of Intangibles

        Amortization of intangibles (not including software, which is amortized to cost of sales) was $19 million in the second quarter of 2002, down from $35 million in the second quarter of last year due to the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," which required the discontinuation of amortization of goodwill. Year to date, amortization of intangibles was $33 million, compared with $68 million for the first six months of 2001. Goodwill amortization expense, reported as "Amortization of intangibles," in the second quarter of 2001 was $25 million and $48 million for the first six months of 2001. See Notes B and E to the Consolidated Financial Statements for additional information regarding SFAS No. 142 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 half of 2002, the Company recorded one-time merger and integration costs of $23 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 second quarter of 2002, the Company had taken actions that will result in annual cost savings of more than $950 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.

28



Equity in Earnings (Losses) of Nonconsolidated Affiliates

        Dow's share of the earnings (losses) of nonconsolidated affiliates was income of $21 million in the second quarter of 2002, compared with $38 million in the same quarter last year. Equity earnings declined primarily due to a restructuring charge recorded by UOP in the second quarter of 2002 and lower earnings at Cargill Dow. Year to date, equity earnings (losses) were a loss of $5 million versus income of $73 million in 2001. The decline in year-to-date results was attributable to goodwill impairment losses of $16 million recorded in the first quarter of 2002 related to investments in nonconsolidated affiliates and start-up costs recorded at Cargill Dow. Lower results in several of the Company's basic plastics and chemicals joint ventures, which corresponded with the decline in the results of Dow's basics businesses, also contributed to the decline in year-to-date results.

Sundry Income (Expense)—Net

        Sundry income (expense) 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 (expense) for the second quarter of 2002 was a net expense of $4 million compared with net income of $85 million in the second quarter of 2001. Sundry income for the second quarter of 2002 declined, in part due to higher costs associated with foreign exchange hedging, primarily related to the Argentine peso. Also, given the current environment within the financial markets, Dow was not as active in selling financial assets as it had been in past quarters. Year to date, sundry income (expense) was a net expense of $17 million compared with net income of $368 million last year. Sundry income for the first half of 2001 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 $174 million in the second quarter of 2002 compared with $163 million in the second quarter of last year. While total debt at the end of the second quarter was down compared with the balance at June 30, 2001, net interest expense was up due to a change in the makeup of total debt (from short-term to long-term) and lower capitalized interest. Year to date, net interest expense was $347 million, up from $321 million in the first half of 2001.

Provision for Taxes on Income

        The effective tax rate for the second quarter was 30.4 percent, the same effective tax rate as the second quarter of 2001. Year to date, the effective tax rate was 31.0 percent versus 34.1 percent last year.

Outlook

        Macroeconomic indicators continue to support Dow's view that the U.S. industrial economy is improving. U.S. industrial production has increased for six straight months (through June) and capacity utilization is also improving. GDP growth in the first quarter was better than expected, and auto production and housing starts, while down from the very high levels of recent years, are still strong. The European economy is expected to lag the U.S. recovery by one or two quarters, and has shown some signs of improvement. Growth in China continues to be strong, and much of the rest of Asia Pacific is expected to post improved economic growth compared with 2001. While there are still concerns about the Japanese economy, industrial production in Japan has been improving each month this year. Latin America presents some economic challenges, with the current conditions in Argentina and pending elections in Brazil. Overall global GDP growth for the year is expected to be higher than in 2001 by about 0.5 percent.

29



        It appears that industry conditions reached a trough in the fourth quarter of 2001 and the first quarter of 2002. The improvement that began late in the first quarter has continued through the second quarter, with stronger demand in many markets. While some of this improvement was tied to the rebuilding of very low customer inventories, the Company believes that end-user demand has also increased. While demand in the chemical industry typically slows down in July and August, Dow anticipates that the normal September pickup will result in higher year-over-year volumes for the quarter. There has been some improvement in industry operating rates, although it will take a number of quarters of solid volume growth to balance supply and demand. During the second quarter of 2002, oil and gas prices were relatively stable, following a rise in the first quarter. Average feedstock costs in the third quarter are expected to be close to second quarter levels.

        Aside from the influence of seasonal factors, the solid demand levels Dow experienced in the second quarter of 2002 are expected to continue into the third quarter. Continued volume growth is expected, with volume for the third quarter up 3 to 5 percent compared with last year. Results for the third quarter should benefit from price increases that were implemented over the past few months, resulting in further margin expansion, particularly in the Plastics and Chemicals businesses. Some additional price increases are anticipated in Performance Plastics and Performance Chemicals, reflecting initiatives to recover some of the margin lost due to recent hydrocarbon and energy cost increases. Although third quarter is typically the weakest quarter for Agricultural Sciences, the business expects to post improved results compared with last year, reflecting the full integration of the Rohm and Haas agricultural chemicals business. The seasonal decline in Agricultural Sciences is expected to be offset by margin improvements in the other segments. Overall, third quarter earnings are expected to be substantially higher than the third quarter of 2001, and may be better than the second quarter of 2002. With continued progress in economic and industry conditions, results in the second half of 2002 are expected to be better than in the first half of 2002, and earnings for the full year are expected to show substantial improvement compared with 2001.


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:

 
  Six Months Ended
 
In millions

  June 30,
2002

  June 30,
2001

 
Cash provided by (used in):              
  Operating activities   $ 540   $ 101  
  Investing activities     (786 )   (2,044 )
  Financing activities     327     1,872  
  Effect of exchange rate changes on cash     (2 )   (4 )
   
 
 
Net change in cash and cash equivalents   $ 79   $ (75 )
   
 
 

        Cash provided by operating activities increased in the six months ended June 30, 2002, compared with the six months ended June 30, 2001, due to improved earnings partially offset by an increase in certain working capital requirements.

        Cash used in investing activities decreased in the six months ended June 30, 2002 compared with the six months ended June 30, 2001, principally due to a decrease in cash used for acquisitions and a reduction in cash generated by sales of available-for-sale securities in excess of purchases of similar securities.

30



        Cash provided by financing activities was lower in the six months ended June 30, 2002 compared with the six months ended June 30, 2001, primarily due to a reduction in the level of issuance of new long-term debt in 2002.

        The following tables present working capital, total debt, and certain balance sheet ratios at June 30, 2002 versus December 31, 2001:

Working Capital
In millions

  June 30,
2002

  Dec. 31,
2001

Current assets   $ 10,950   $ 10,308
Current liabilities     9,420     8,125
   
 
Working capital   $ 1,530   $ 2,183
   
 
Current ratio     1.16:1     1.27:1
Days-sales-outstanding-in-receivables     48     50
Days-sales-in-inventory     68     77
Total Debt
In millions

  June 30,
2002

  Dec. 31,
2001

 
Notes payable   $ 1,645   $ 1,209  
Long-term debt due within one year     921     408  
Long-term debt     9,336     9,266  
   
 
 
  Total debt   $ 11,902   $ 10,883  
   
 
 
Debt as a percent of total capitalization     51.1 %   48.9 %

        At June 30, 2002, the Company had unused and committed 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 approximately $740 million were available for use by foreign subsidiaries. At June 30, 2002, there was a total of $1.2 billion available in SEC registered securities, as well as Japanese yen 70 billion (approximately $585 million) available in yen-denominated securities through the Japanese Ministry of Finance and Euro 900 million (approximately $892 million) available under the Company's Euro Medium-Term Note Program.

        On June 21, 2002, the Company launched a $500 million Medium-Term Note Program. The securities under this program will be issued under an existing $1.2 billion SEC shelf registration. The Company will periodically be issuing notes under this program, however, none were issued as of June 30, 2002. As of July 18, 2002, the Company had issued a cumulative $30 million in notes, with maturity dates ranging from 2005 through 2009, under this program.

        On June 26, 2002, the Company filed an S-3 registration statement for an additional $1.5 billion in capacity to issue SEC registered securities.

        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.

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

31




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.


*
Union Carbide Corporation, Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002, Management's Discussion and Analysis of Financial Condition and Results of Operations, Other Matters, Critical Accounting Policies, Litigation, Asbestos-Related Matters.

32


33


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 June 30, 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.

34


35



*
Union Carbide Corporation, Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002, Management's Discussion and Analysis of Financial Condition and Results of Operations, Asbestos-Related Matters.

        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.

36




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.

37



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.


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 9, 2002. At that meeting the following directors were elected to serve three-year terms to expire at the annual meeting in 2005: Jacqueline K. Barton, Anthony J. Carbone, Barbara Hackman Franklin and Harold T. Shapiro. In addition, the terms of the following directors continued after that meeting: Arnold A. Allemang, J. Michael Cook, John C. Danforth, Willie D. Davis, Allan D. Gilmour, Michael D. Parker, J. Pedro Reinhard, James M. Ringler, William S. Stavropoulos 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 I                    
    Jacqueline K. Barton   755,825,860   N/A   9,798,555   N/A   N/A
    Anthony J. Carbone   755,283,526   N/A   10,340,889   N/A   N/A
    Barbara Hackman Franklin   749,648,924   N/A   15,975,491   N/A   N/A
    Harold T. Shapiro   750,175,825   N/A   15,448,590   N/A   N/A

2.

 

Ratification of the appointment of Deloitte & Touche LLP as the Company's independent auditors for 2002

 

743,646,839

 

17,578,930

 

N/A

 

4,398,646

 

0

3.

 

Authorization of the amendment to the 1988 Award and Option Plan

 

707,574,060

 

47,931,774

 

N/A

 

10,118,581

 

0

N/A—Not applicable

38



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 11, 2002.

99(a

)

Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

99(b

)

Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
(b)
Reports on Form 8-K.

        The following Current Report on Form 8-K was filed by the Company during the second quarter of 2002:

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

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

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

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

39




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 13, 2002

 

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

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EXHIBIT INDEX

EXHIBIT NO.

  DESCRIPTION
3(ii ) A copy of the Bylaws of The Dow Chemical Company, as amended on July 11, 2002.

99(a

)

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

99(b

)

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

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Table of Contents
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Comprehensive Income
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
EXHIBIT INDEX