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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 September 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
September 30, 2002

Common Stock, $2.50 par value   911,107,535 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

 

20
   
Disclosure Regarding Forward-Looking Information

 

20
   
Results of Operations

 

20
   
Changes in Financial Condition

 

29
   
Other Matters

 

30
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

35
 
Item 4.    Controls and Procedures

 

36

PART II—OTHER INFORMATION

 

 
 
Item 1.    Legal Proceedings

 

37
 
Item 6.    Exhibits and Reports on Form 8-K

 

37

SIGNATURE

 

38

CERTIFICATIONS

 

39

EXHIBIT INDEX

 

41

2



PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Income

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

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Net Sales   $ 7,041   $ 6,729   $ 20,520   $ 21,459  
   
 
 
 
 
  Cost of sales     6,008     5,639     17,319     18,232  
  Research and development expenses     262     261     784     804  
  Selling, general and administrative expenses     389     433     1,185     1,341  
  Amortization of intangibles     16     50     49     118  
  Purchased in-process research and development charges         69         69  
  Merger-related expenses and restructuring     32     46     55     1,454  
  Insurance company operations, pretax income (loss)     2     (5 )   12     20  
  Equity in earnings of nonconsolidated affiliates     47     11     42     84  
  Sundry income—net     18     16     1     384  
  Interest income     13     21     43     61  
  Interest expense and amortization of debt discount     194     194     571     555  
   
 
 
 
 
Income (Loss) before Income Taxes and Minority Interests     220     80     655     (565 )
   
 
 
 
 
  Provision (Credit) for income taxes     67     20     202     (200 )
  Minority interests' share in income     25     3     49     15  
   
 
 
 
 
Income (Loss) before Cumulative Effect of Changes in Accounting Principles     128     57     404     (380 )
   
 
 
 
 
  Cumulative effect of changes in accounting principles             67     32  
   
 
 
 
 
Net Income (Loss) Available for Common Stockholders   $ 128   $ 57   $ 471   $ (348 )
   
 
 
 
 
Share Data                          
  Earnings (Loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.14   $ 0.06   $ 0.44   $ (0.42 )
  Earnings (Loss) per common share—basic   $ 0.14   $ 0.06   $ 0.52   $ (0.39 )
  Earnings (Loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.14   $ 0.06   $ 0.44   $ (0.42 )
  Earnings (Loss) per common share—diluted   $ 0.14   $ 0.06   $ 0.51   $ (0.39 )
  Common stock dividends declared per share of common stock   $ 0.335   $ 0.335   $ 1.005   $ 0.96  
  Weighted-average common shares outstanding—basic     911.7     902.8     909.9     900.6  
  Weighted-average common shares outstanding—diluted     917.9     913.6     917.3     900.6  
   
 
 
 
 
Depreciation   $ 417   $ 402   $ 1,207   $ 1,174  
   
 
 
 
 
Capital Expenditures   $ 398   $ 349   $ 1,086   $ 998  
   
 
 
 
 

See Notes to the Consolidated Financial Statements.

3


The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)

  Sept. 30,
2002

  Dec. 31,
2001

 
Assets              
Current Assets              
  Cash and cash equivalents   $ 500   $ 220  
  Marketable securities and interest-bearing deposits     48     44  
  Accounts and notes receivable:              
    Trade (net of allowance for doubtful receivables—2002: $106; 2001: $123)     3,161     2,868  
    Other     2,050     2,230  
  Inventories     4,480     4,440  
  Deferred income tax assets—current     522     506  
   
 
 
  Total current assets     10,761     10,308  
   
 
 
Investments              
  Investment in nonconsolidated affiliates     1,649     1,581  
  Other investments     1,632     1,663  
  Noncurrent receivables     1,010     802  
   
 
 
  Total investments     4,291     4,046  
   
 
 
Property              
  Property     37,394     35,890  
  Less accumulated depreciation     23,706     22,311  
   
 
 
  Net property     13,688     13,579  
   
 
 
Other Assets              
  Goodwill     3,188     3,130  
  Other intangible assets (net of accumulated amortization—2002: $410; 2001: $346)     602     607  
  Deferred income tax assets—noncurrent     2,336     2,248  
  Deferred charges and other assets     1,922     1,597  
   
 
 
  Total other assets     8,048     7,582  
   
 
 
Total Assets   $ 36,788   $ 35,515  
   
 
 
Liabilities and Stockholders' Equity              
Current Liabilities              
  Notes payable   $ 903   $ 1,209  
  Long-term debt due within one year     725     408  
  Accounts payable:              
    Trade     2,438     2,713  
    Other     1,388     926  
  Income taxes payable     182     190  
  Deferred income tax liabilities—current     206     236  
  Dividends payable     305     323  
  Accrued and other current liabilities     2,294     2,120  
   
 
 
  Total current liabilities     8,441     8,125  
   
 
 
Long-Term Debt     10,360     9,266  
   
 
 
Other Noncurrent Liabilities              
  Deferred income tax liabilities—noncurrent     922     760  
  Pension and other postretirement benefits—noncurrent     2,413     2,475  
  Other noncurrent obligations     3,514     3,539  
   
 
 
  Total other noncurrent liabilities     6,849     6,774  
   
 
 
Minority Interest in Subsidiaries     366     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     10,654     11,112  
  Accumulated other comprehensive loss     (1,016 )   (1,070 )
  Treasury stock at cost     (2,233 )   (2,412 )
   
 
 
  Net stockholders' equity     9,772     9,993  
   
 
 
Total Liabilities and Stockholders' Equity   $ 36,788   $ 35,515  
   
 
 

See Notes to the Consolidated Financial Statements.

4



The Dow Chemical Company and Subsidiaries
Consolidated Statements of Cash Flows

 
  Nine Months Ended
 
In millions (Unaudited)

  Sept. 30,
2002

  Sept. 30,
2001

 
Operating Activities              
  Income (Loss) before cumulative effect of changes in accounting principles   $ 404   $ (380 )
  Adjustments to reconcile net income (loss) to net cash provided by operating activities:              
    Depreciation and amortization     1,305     1,316  
    Purchased in-process research and development         69  
    Provision for deferred income tax     15     5  
    Earnings/losses of nonconsolidated affiliates less than (in excess of) dividends received     19     (50 )
    Minority interests' share in income     49     15  
    Net gain on sales of consolidated companies     (4 )    
    Net gain on sales of property and businesses     (11 )   (28 )
    Other net gain     (28 )   (266 )
    Merger-related expenses and restructuring         953  
    Tax benefit—nonqualified stock option exercises     18     25  
  Changes in assets and liabilities that provided (used) cash:              
    Accounts and notes receivable     (505 )   365  
    Inventories     (49 )   (241 )
    Accounts payable     100     (490 )
    Other assets and liabilities     30     (845 )
   
 
 
  Cash provided by operating activities     1,343     448  
   
 
 
Investing Activities              
  Capital expenditures     (1,086 )   (998 )
  Proceeds from sales of property and businesses     52     123  
  Acquisitions of businesses, net of cash received         (2,297 )
  Proceeds from sale of consolidated companies     39      
  Investments in nonconsolidated affiliates     (74 )   (64 )
  Advances to nonconsolidated affiliates, net of cash received         (106 )
  Proceeds from sale of nonconsolidated affiliates         180  
  Purchases of investments     (1,362 )   (1,956 )
  Proceeds from sales of investments     1,338     2,753  
   
 
 
  Cash used in investing activities     (1,093 )   (2,365 )
   
 
 
Financing Activities              
  Changes in short-term notes payable     (274 )   473  
  Payments on long-term debt     (424 )   (238 )
  Proceeds from issuance of long-term debt     1,596     2,105  
  Purchases of treasury stock     (3 )   (5 )
  Proceeds from sales of common stock     118     110  
  Proceeds from issuance of preferred securities of subsidiary         500  
  Distributions to minority interests     (67 )   (63 )
  Dividends paid to stockholders     (912 )   (759 )
   
 
 
  Cash provided by financing activities     34     2,123  
   
 
 
Effect of Exchange Rate Changes on Cash     (4 )   (4 )
   
 
 
Summary              
  Increase in cash and cash equivalents     280     202  
  Cash and cash equivalents at beginning of year     220     278  
   
 
 
  Cash and cash equivalents at end of period   $ 500   $ 480  
   
 
 

See Notes to the Consolidated Financial Statements.

5


The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

 
  Three Months Ended
  Nine Months Ended
 
In millions (Unaudited)

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Net Income (Loss) Available for Common Stockholders   $ 128   $ 57   $ 471   $ (348 )
   
 
 
 
 
Other Comprehensive Income (Loss), Net of Tax                          
  Net unrealized losses on investments     (41 )   (31 )   (64 )   (329 )
  Translation adjustments     (47 )   49     137     (100 )
  Net losses on cash flow hedging derivative instruments     (23 )   (30 )   (19 )   (13 )
   
 
 
 
 
  Total other comprehensive income (loss)     (111 )   (12 )   54     (442 )
   
 
 
 
 
Comprehensive Income (Loss)   $ 17   $ 45   $ 525   $ (790 )
   
 
 
 
 

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 December 15, 2001. Under this statement, goodwill and intangible assets that are deemed to have indefinite useful lives are not amortized, but are subject to impairment testing. Impairment testing is required to be performed at adoption and at least annually thereafter. On an ongoing basis (absent any impairment indicators), Dow plans to perform impairment tests during the fourth quarter of each year, in conjunction with the Company's annual budgeting process. Effective January 1, 2002, Dow ceased all amortization of goodwill, which is its only intangible asset with an indefinite useful life, and tested recorded goodwill for impairment by comparing the fair value of each reporting unit, determined using a discounted cash flow method, with its carrying value. As a result of the Company's impairment testing, goodwill

7



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

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

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

        In August 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.

        In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." This statement, which is effective for exit or disposal activities initiated after December 31, 2002, will change the measurement and timing of costs associated with exit and disposal activities undertaken by the Company in the future.

        On August 26, 2002, the Company announced that in the first quarter of 2003, it would begin expensing stock options issued to employees in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." Dow currently uses the accounting method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," as allowed by SFAS No. 123; however, expensing stock options is considered the preferable method of accounting for stock-based compensation. In the announcement, Dow stated it expected the expense associated with stock options to be approximately $0.02 per share in 2003, growing to approximately $0.06 per share in 2005. The estimates were based on the current guidance of SFAS No. 123, the terms of Dow's stock option plans and current assumptions for stock option grants and valuation, which may change in the future.

Note C—Merger-Related Expenses and Restructuring

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

        The special charge included $643 million for employee-related costs, which consisted predominantly of provisions for employee severance, change of control obligations, medical and retirement benefits, and outplacement services. The Company's integration plans included a workforce reduction of approximately 4,500

8



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. 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 three quarters of 2002, severance of $132 million was paid to approximately 1,750 former employees, bringing the program-to-date amount to $465 million paid to approximately 4,850 former employees. The planned merger-related program for workforce reductions was substantially completed in the third quarter of 2002, although additional reductions may continue as the Company continues its restructuring efforts. The Company will account for future workforce reductions as they occur.

        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. Included in the write-down were charges of $299 million for assets and facilities that were rendered redundant as a result of the merger, $81 million for lease abandonment reserves, $138 million for asset impairments and $101 million for losses on divestitures required for regulatory approval of the merger. 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 of 2001. At December 31, 2001, $77 million of the reserve remained for the abandonment of leased facilities and demolition costs; at September 30, 2002, $65 million of the reserve remained. The leased facilities will remain open until at least 2005.

        In addition to the special charge, one-time merger and integration costs, exclusively related to the Union Carbide merger, of $115 million were recorded in 2001. For the first three quarters of 2002, one-time merger and integration costs totaled $29 million, compared with $83 million for the same period of 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  
   
 
 
 
 
 
Adjustments to reserve   $ 21           $ 6   $ 27  
Charges against reserve     (21 )     $ (4 )   (6 )   (31 )
Completion of program (1)     (242 )       (65 )       (307 )
   
 
 
 
 
 
Balance at Sept. 30, 2002                      
   
 
 
 
 
 

(1)
Upon completion of the program, the outstanding merger-related reserve for employee-related costs associated with pension and postretirement benefit plans is considered part of the Company's regular pension and other postretirement obligations. The reserve related to the abandonment of leased facilities is included in "Other noncurrent obligations."

        In the third quarter of 2002, the Company also recorded severance of $5 million related to a workforce reduction program at Dow AgroSciences.

Note D—Acquisitions and Divestitures

Union Carbide Corporation Merger

        In August 1999, The Dow Chemical Company and Union Carbide Corporation announced a definitive merger agreement for a tax-free, stock-for-stock transaction. Under the agreement, Union Carbide stockholders received 1.611 shares of Dow stock (on a post-split basis) for each share of Union Carbide stock they owned, for a total of approximately 219 million shares. Based upon Dow's closing price of $12411/16 (pre-split) on August 3, 1999, the transaction was valued at $66.96 per Union Carbide share, or $11.6 billion in aggregate including $2.3 billion of net debt. According to the agreement, the merger was subject to certain conditions, including approval by Union Carbide stockholders and review by antitrust regulatory authorities in the United States, Europe and Canada. Union Carbide stockholders approved the merger on December 1, 1999. On May 3, 2000, the European Commission approved the merger subject to certain conditions. On February 6, 2001, after receiving clearance from the U.S. Federal Trade Commission, the Canadian Competition Bureau and other jurisdictions around the world, Union Carbide merged with a subsidiary of The Dow Chemical Company, and Union Carbide became a wholly owned subsidiary of Dow. As part of the regulatory approval process, the Company agreed to:

10


        The Union Carbide merger was accounted for as a pooling of interests. Accordingly, the Company's consolidated financial statements include the combined results of Dow and Union Carbide for all periods presented. See Note C regarding a special charge for merger-related expenses and restructuring recorded in 2001.

Other Significant Acquisitions and Divestitures

        The following acquisitions were accounted for using the purchase method of accounting.

        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, and began fully consolidating the results of Gurit-Essex AG. 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. In the second quarter of 2001, the Company began including the results of this business in its consolidated financial statements. 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, and began including the results of this business in its consolidated financial statements. In the second quarter of 2002, the Company finalized its allocation of the purchase price to the assets acquired and liabilities assumed, principally resulting in adjustments to the values assigned 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, and began including the results of Ascot in its consolidated financial statements. 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 resulting in adjustments to the values assigned 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 nine months ended September 30, 2001,

11



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

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

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Reported income (loss) before cumulative effect of changes in accounting principles   $ 128   $ 57   $ 404   $ (380 )
Reported net income (loss)   $ 128   $ 57   $ 471   $ (348 )
   
 
 
 
 
Adjustments:                          
  Goodwill amortization, net of tax       $ 42       $ 90  
  Negative goodwill amortization, net of tax         (2 )       (8 )
  Equity method goodwill amortization, net of tax         2         8  
   
 
 
 
 
    Total adjustments       $ 42       $ 90  
   
 
 
 
 
Adjusted income (loss) before cumulative effect of changes in accounting principles   $ 128   $ 99   $ 404   $ (290 )
Adjusted net income (loss)   $ 128   $ 99   $ 471   $ (258 )
   
 
 
 
 
Reported earnings (loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.14   $ 0.06   $ 0.44   $ (0.42 )
Reported earnings (loss) per common share—basic   $ 0.14   $ 0.06   $ 0.52   $ (0.39 )
   
 
 
 
 
Adjustments:                          
  Goodwill amortization, net of tax       $ 0.05       $ 0.10  
  Negative goodwill amortization, net of tax                 (0.01 )
  Equity method goodwill amortization, net of tax                 0.01  
   
 
 
 
 
    Total adjustments       $ 0.05       $ 0.10  
   
 
 
 
 
Adjusted earnings (loss) before cumulative effect of changes in accounting principles per common share—basic   $ 0.14   $ 0.11   $ 0.44   $ (0.32 )
Adjusted earnings (loss) per common share—basic   $ 0.14   $ 0.11   $ 0.52   $ (0.29 )
   
 
 
 
 
Reported earnings (loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.14   $ 0.06   $ 0.44   $ (0.42 )
Reported earnings (loss) per common share—diluted   $ 0.14   $ 0.06   $ 0.51   $ (0.39 )
   
 
 
 
 
Adjustments:                          
  Goodwill amortization, net of tax       $ 0.05       $ 0.10  
  Negative goodwill amortization, net of tax                 (0.01 )
  Equity method goodwill amortization, net of tax                 0.01  
   
 
 
 
 
    Total adjustments       $ 0.05       $ 0.10  
   
 
 
 
 
Adjusted earnings (loss) before cumulative effect of changes in accounting principles per common share—diluted   $ 0.14   $ 0.11   $ 0.44   $ (0.32 )
Adjusted earnings (loss) per common share—diluted   $ 0.14   $ 0.11   $ 0.51   $ (0.29 )
   
 
 
 
 

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 nine months ended September 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 )
   
 
 
 
 
 
 
Goodwill write-off related to sale of Chlorchem         (3 )               (3 )
   
 
 
 
 
 
 
Purchase price allocation adjustments:                                      
  Ascot         27                 27  
  Buildscape     11                     11  
  Gurit-Essex     3                     3  
  Rohm and Haas             17             17  
  Reichhold Specialty Latex         25                 25  
   
 
 
 
 
 
 
    Total adjustments     14     52     17             83  
   
 
 
 
 
 
 
Goodwill at September 30, 2002   $ 903   $ 788   $ 1,320   $ 114   $ 63   $ 3,188  
   
 
 
 
 
 
 

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

 
  At September 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   $ 297   $ (111 ) $ 186   $ 278   $ (87 ) $ 191
  Patents     156     (60 )   96     161     (54 )   107
  Software     323     (206 )   117     291     (188 )   103
  Trademarks     137     (12 )   125     126     (6 )   120
  Other     99     (21 )   78     97     (11 )   86
   
 
 
 
 
 
  Total   $ 1,012   $ (410 ) $ 602   $ 953   $ (346 ) $ 607
   
 
 
 
 
 

        Amortization expense for other intangible assets (not including software) was $16 million in the third quarter of 2002, compared with $7 million in the same period last year. Year to date, amortization expense for other intangible assets (not including software) was $49 million, compared with $27 million for the first nine months of 2001. Amortization expense for software, which is included in cost of sales, totaled $7 million in the third quarter, compared with $4 million last year. For the first nine months of this year, amortization expense for software was $18 million, up from $12 million for the same period last year. Total estimated amortization expense for 2002 and the five succeeding fiscal years is as follows:

In millions

  Estimated
Amortization
Expense

2002   $ 90
2003     82
2004     78
2005     70
2006     65
2007     56

13


Note F—Commitments and Contingent Liabilities

Litigation

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

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

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

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

        On July 7, 1998, Dow Corning, the Company and Corning Incorporated ("Corning"), on the one hand, and the Tort Claimants' Committee in Dow Corning's bankruptcy on the other, agreed on a binding Term Sheet to resolve all tort claims involving Dow Corning's silicone medical products, including the claims against Corning and the Company (collectively, the "Shareholders"). The agreement set forth in the Term Sheet was memorialized in a Joint Plan of Reorganization (the "Joint Plan") filed by Dow Corning and the Tort Claimants' Committee (collectively, the "Proponents") on November 9, 1998. On February 4, 1999, the Bankruptcy Court approved the disclosure statement describing the Joint Plan. Before the Joint Plan could become effective, however, it was subject to a vote by the claimants, a confirmation hearing and all relevant provisions of the Bankruptcy Code. Voting was completed on May 14, 1999, and the confirmation hearing concluded on July 30, 1999.

        On November 30, 1999, the Bankruptcy Court issued an Order confirming the Joint Plan, but then issued an Opinion on December 21, 1999, that, in the view of the Proponents and the Shareholders, improperly interpreted or attempted to modify certain provisions of the Joint Plan affecting the resolution of tort claims involving Dow Corning's silicone medical products against various entities, including the Shareholders. Many of the parties in interest, including the Shareholders, filed various motions and appeals seeking, among other things, a clarification of the December 21, 1999 Opinion. These motions and appeals were heard by U.S. District Court Judge Denise Page Hood on April 12 and 13, 2000, and on November 13, 2000, Judge Hood affirmed the Bankruptcy Court's November 30, 1999 Order confirming the Joint Plan and reversed, in part, the Bankruptcy Court's December 21, 1999 Opinion, including that portion of the Opinion the Shareholders had appealed. In turn, various parties in interest appealed Judge Hood's decision to the United States Court of Appeals for the Sixth Circuit, which heard oral arguments in the matter on October 23, 2001. On January 29, 2002, the Sixth Circuit issued its opinion which, among other things, affirmed Judge Hood's determination that claims against various entities, including the Shareholders, may be enjoined where "unusual circumstances" exist, and remanded the case to the District Court for certain factual determinations. The effectiveness of the Joint Plan remains subject to the District Court making such factual determinations and any subsequent appellate action. Accordingly, there can be no assurance at this time that the Joint Plan will become effective.

        It is the opinion of the Company's management that the possibility is remote that plaintiffs will prevail on the theory that the Company should be liable in the breast implant litigation because of its shareholder relationship

14



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, both inside and outside of the United States, alleging that the manufacture, distribution or use of pesticides containing dibromochloropropane ("DBCP") has caused personal injury and property damage, including contamination of groundwater. 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 $413 million as of September 30, 2002, for environmental matters, including $37 million for the remediation of Superfund sites. This is management's best estimate of the costs for remediation and restoration with respect to environmental matters for which the Company has accrued liabilities, although the ultimate cost with respect to these particular matters could range up to twice that amount. Inherent uncertainties exist in these estimates primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies for handling site remediation and restoration. It is the opinion of the Company's management that the possibility is remote that costs in excess of those accrued or disclosed will have a material adverse impact on the Company's consolidated financial statements.

        Union Carbide Corporation, a wholly owned subsidiary of the Company, has filed its quarterly report on Form 10-Q for the quarter ended September 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.

15



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

        At December 31, 2001, the Company had various outstanding commitments for take or pay and throughput agreements, including the purchase agreements referred to above, for terms extending from one to 20 years. In general, such commitments were at prices not in excess of current market prices.

Fixed and Determinable Portion of Take or Pay and
Throughput Obligations at December 31, 2001    (in millions)

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

        In addition to the take or pay obligations at December 31, 2001, the Company had outstanding purchase commitments which ranged from one to 20 years for steam, electrical power, materials, property and other items used in the normal course of business of approximately $152 million. In general, such commitments were at prices not in excess of current market prices. The Company also had outstanding commitments for construction performance and lease payment guarantees and other obligations of $860 million. The Company was also

16



committed to lease manufacturing facilities under construction in The Netherlands. At September 30, 2002, the Company was also committed to lease a pipeline under construction in Germany.

Company Guarantee of Registered Debt Securities of Finance Subsidiary

        The Company fully and unconditionally guarantees the registered debt securities originally issued by its finance subsidiary, Dow Capital B.V. These debt securities have been assumed by Dow Capital Plc, a wholly owned and fully consolidated subsidiary of the Company. Dow Capital B.V. was subsequently dissolved. At December 31, 2001, there was principal outstanding of $857 million with respect to these debt securities. There are no significant restrictions on the ability of the Company to obtain funds from Dow Capital Plc.

Note G—Inventories

        The following table provides a breakdown of inventories at September 30, 2002 and December 31, 2001:

Inventories

In millions

  Sept. 30,
2002

  Dec. 31,
2001

Finished goods   $ 2,669   $ 2,675
Work in process     936     894
Raw materials     490     509
Supplies     385     362
   
 
Total inventories   $ 4,480   $ 4,440
   
 

        The reserves required to adjust inventories from the first-in, first-out ("FIFO") basis to the last-in, first-out ("LIFO") basis amounted to a decrease of $179 million at September 30, 2002, and a decrease of $146 million at December 31, 2001.

17



Note H—Operating Segments and Geographic Areas

 
  Three Months Ended
  Nine Months Ended
 
In millions

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Operating segment sales                          
  Performance Plastics   $ 1,815   $ 1,829   $ 5,369   $ 5,614  
  Performance Chemicals     1,316     1,306     3,877     3,856  
  Agricultural Sciences     551     477     2,082     1,891  
  Plastics     1,667     1,606     4,783     5,072  
  Chemicals     917     857     2,463     2,798  
  Hydrocarbons and Energy     711     578     1,779     2,005  
  Unallocated and Other     64     76     167     223  
   
 
 
 
 
  Total   $ 7,041   $ 6,729   $ 20,520   $ 21,459  
   
 
 
 
 
Operating segment EBIT (1,2)                          
  Performance Plastics   $ 140   $ 214   $ 532   $ 571  
  Performance Chemicals     172     218     535     476  
  Agricultural Sciences     (25 )   (150 )   190     69  
  Plastics     170     83     214     158  
  Chemicals     38     57     (30 )   95  
  Hydrocarbons and Energy     9     (11 )   50     (14 )
  Unallocated and Other     (103 )   (158 )   (308 )   (1,426 )
   
 
 
 
 
  Total   $ 401   $ 253   $ 1,183   $ (71 )
   
 
 
 
 
Geographic area sales                          
  United States   $ 2,800   $ 2,741   $ 8,339   $ 9,149  
  Europe     2,384     2,190     6,898     6,825  
  Rest of World     1,857     1,798     5,283     5,485  
   
 
 
 
 
  Total   $ 7,041   $ 6,729   $ 20,520   $ 21,459  
   
 
 
 
 

(1)
The reconciliation between "Earnings (Loss) before interest, income taxes and minority interests ("EBIT")" and "Income (Loss) before income taxes and minority interests" is shown below:

 
  Three Months Ended
  Nine Months Ended
 
In millions

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
EBIT   $ 401   $ 253   $ 1,183   $ (71 )
Interest income     13     21     43     61  
Interest expense and amortization of debt discount     194     194     571     555  
   
 
 
 
 
Income (Loss) before income taxes and minority interests   $ 220   $ 80   $ 655   $ (565 )
   
 
 
 
 

18


(2)
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 nine months ended September 30, 2001 was as follows:

In millions

  Three Months
Ended
Sept. 30, 2001

  Nine Months
Ended
Sept. 30, 2001

 
Performance Plastics   $ 8   $ 21  
Performance Chemicals     10     18  
Agricultural Sciences     24     54  
Plastics     5     10  
Chemicals          
Hydrocarbons and Energy         2  
Unallocated and Other     (2 )   (6 )
   
 
 
Total   $ 45   $ 99  
   
 
 

19



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 nine months ended September 30, 2002 and 2001:

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

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Sales   $ 7,041   $ 6,729   $ 20,520   $ 21,459  

Cost of sales

 

 

6,008

 

 

5,639

 

 

17,319

 

 

18,232

 
% of sales     85  %   84  %   84  %   85  %

Research and development, and selling, general and administrative expenses

 

 

651

 

 

694

 

 

1,969

 

 

2,145

 
% of sales     9  %   10  %   10  %   10  %

Earnings (Loss) before interest, income taxes and minority interests ("EBIT") (1)

 

 

401

 

 

253

 

 

1,183

 

 

(71

)
% of sales     6  %   4  %   6  %    

Effective tax rate

 

 

30.5

 %

 

25.0

 %

 

30.8

 %

 

35.4

 %

Net income (loss) available for common stockholders

 

$

128

 

$

57

 

$

471

 

$

(348

)

Earnings (Loss) per common share—basic

 

$

0.14

 

$

0.06

 

$

0.52

 

$

(0.39

)
Earnings (Loss) per common share—diluted   $ 0.14   $ 0.06   $ 0.51   $ (0.39 )

Operating rate percentage

 

 

80

 %

 

77

 %

 

79

 %

 

77

 %
   
 
 
 
 

(1)
The reconciliation between "Earnings (Loss) before interest, income taxes and minority interests ("EBIT")" and "Income (Loss) before income taxes and minority interests" is shown below:

 
  Three Months Ended
  Nine Months Ended
 
In millions

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
EBIT   $ 401   $ 253   $ 1,183   $ (71 )
Interest income     13     21     43     61  
Interest expense and amortization of debt discount     194     194     571     555  
   
 
 
 
 
Income (Loss) before income taxes and minority interests   $ 220   $ 80   $ 655   $ (565 )
   
 
 
 
 

        Net sales for the third quarter of 2002 were $7.0 billion, up 5 percent from $6.7 billion in the third quarter of last year, as volume grew 3 percent and prices improved 2 percent (see Sales Volume and Price table on page 26). Compared with last year, volume improved significantly in Agricultural Sciences, Hydrocarbons and Energy, and Chemicals, and was up slightly in Performance Chemicals. Volume was flat in Performance Plastics and Plastics.

20



Prices rose 2 percent from the third quarter of last year, primarily due to the favorable impact of currency in Europe. Compared with last year, prices improved in the basic segments, but declined slightly in the Company's performance segments. From a geographic standpoint, significant volume growth was reported outside of the United States, particularly in Latin America and Asia Pacific, while volume was relatively flat in the United States. Prices improved in the United States and Europe, more than offsetting price declines in the rest of the world. Year to date, net sales of $20.5 billion were down 4 percent from $21.5 billion last year, as a 9 percent decline in selling prices overshadowed a 5 percent improvement in volume.

        Operating expenses (research and development, and selling, general and administrative expenses) were $651 million for the third quarter of 2002, down $43 million, or 6 percent, from $694 million last year due to cost control efforts and the realization of merger-related cost synergies. For the first nine months of the year, operating expenses totaled $1,969 million, down 8 percent from $2,145 million last year.

        Net income for the third quarter of 2002 was $128 million or $0.14 per share, compared with $57 million or $0.06 per share for the third quarter of 2001. Net income improved from last year as higher selling prices and volume growth more than offset the unfavorable impact of higher feedstock and energy costs of more than $120 million. Net income for the third quarter of 2002 was reduced by the following unusual items (reflected in "Merger-related expenses and restructuring"): additional pretax integration costs of $6 million related to the Union Carbide merger (see Note C to the Consolidated Financial Statements); additional pretax merger-related severance of $21 million; and pretax severance related to a workforce reduction program at Dow AgroSciences of $5 million. Net income for the third quarter of last year was reduced by the following unusual items: pretax merger-related integration costs of $46 million; a pretax charge of $69 million for purchased in-process research and development costs ("IPR&D") associated with the acquisition of Rohm and Haas' agricultural chemicals business (see Note D to Consolidated Financial Statements); a pretax $6 million reinsurance loss on the World Trade Center (reflected in "Insurance company operations"); and Dow's $11 million share of a restructuring charge recorded by Dow Corning (reflected in "Equity in earnings of nonconsolidated affiliates").

        Net income for the first nine months of 2002 was $471 million compared with a net loss of $348 million for the same period last year. Year to date, lower feedstock and energy costs of $1.4 billion were more than offset by lower selling prices of $2.0 billion, negatively impacting net income. Net income for the first three quarters of 2002 was reduced by the net impact of several unusual items: year-to-date pretax integration costs of $29 million related to the Union Carbide merger; pretax merger-related severance of $21 million; pretax severance of $5 million related to a workforce reduction program at Dow AgroSciences; a $10 million pretax restructuring charge (Dow's share) recorded by UOP (reflected in "Equity in earnings of nonconsolidated affiliates" in the Performance Plastics segment); 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 nine months of 2001 was negatively impacted by the net result of several unusual items: pretax merger-related costs and restructuring of $1.5 billion, a pretax charge of $69 million for IPR&D associated with the acquisition of Rohm and Haas' agricultural chemicals business (see Note D to Consolidated Financial Statements); a pretax $6 million reinsurance loss on the World Trade Center (reflected in "Insurance company operations"); Dow's $11 million share of a restructuring charge recorded by Dow Corning (reflected in "Equity in earnings of nonconsolidated affiliates"); 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.

21



        The following tables show the impact of the unusual items recorded in the three-month and nine-month periods ended September 30, 2002 and 2001 on 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

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Unusual items:                                      
  Merger-related expenses and restructuring   $ (32 ) $ (46 ) $ (20 ) $ (34 ) $ (0.02 ) $ (0.03 )
  Purchased in-process R&D         (69 )       (43 )       (0.05 )
  Reinsurance company loss on WTC         (6 )       (5 )       (0.01 )
  Dow Corning restructuring         (11 )       (11 )       (0.01 )
   
 
 
 
 
 
 
    Total unusual items   $ (32 ) $ (132 ) $ (20 ) $ (93 ) $ (0.02 ) $ (0.10 )
   
 
 
 
 
 
 
As reported   $ 401   $ 253   $ 128   $ 57   $ 0.14   $ 0.06  

Excluding unusual items

 

$

433

 

$

385

 

$

148

 

$

150

 

$

0.16

 

$

0.16

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

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

  Sept. 30,
2002

  Sept. 30,
2001

 
Unusual items:                                      
  Merger-related expenses and restructuring   $ (55 ) $ (1,454 ) $ (35 ) $ (970 ) $ (0.04 ) $ (1.07 )
  Purchased in-process R&D         (69 )       (43 )       (0.05 )
  Reinsurance company loss on WTC         (6 )       (5 )       (0.01 )
  Dow Corning restructuring         (11 )       (11 )       (0.01 )
  UOP restructuring     (10 )       (7 )       (0.01 )    
  Goodwill impairment losses in nonconsolidated affiliates     (16 )       (16 )       (0.02 )    
  Gain on sale of Schlumberger stock         266         168         0.18  
  Cumulative effect of changes in accounting principles             67     32     0.07     0.04  
   
 
 
 
 
 
 
    Total unusual items   $ (81 ) $ (1,274 ) $ 9   $ (829 )     $ (0.92 )
   
 
 
 
 
 
 
As reported   $ 1,183   $ (71 ) $ 471   $ (348 ) $ 0.51   $ (0.39 )

Excluding unusual items

 

$

1,264

 

$

1,203

 

$

462

 

$

481

 

$

0.51

 

$

0.53

 
   
 
 
 
 
 
 

PERFORMANCE PLASTICS

        Performance Plastics sales of $1,815 million for the third quarter of 2002 were down 1 percent from $1,829 million in the third quarter of 2001. Prices fell 1 percent; volume was unchanged. Third quarter EBIT for the segment was $140 million, down from $214 million in the same period of last year, as the impact of lower selling prices, flat volume and increased raw material costs more than offset the benefit of cost synergies realized through the Union Carbide merger and other 2001 acquisitions, and the impact of cost control initiatives.

        Dow Automotive sales for the third quarter of 2002 were up slightly from a year ago, as volume growth of 3 percent was partially offset by a 2 percent decline in selling prices. An increase in demand for new applications of products fueled the increase in volume as Dow continues to leverage its technological strengths and offer added capabilities to the automotive industry. The decline in selling prices reflects the competitive environment that domestic producers are facing within the global automotive industry. EBIT improved significantly compared with last year due to lower operating expenses.

        Engineering Plastics sales for the quarter were down 14 percent from the third quarter of 2001, due to a 9 percent decline in volume and a 5 percent decline in selling prices. Price continued to be negatively impacted by excess industry capacity in an intensely competitive environment and by slow demand in the information technology sector. EBIT for the quarter declined versus last year due to the declines in price and volume.

22


        Sales of Epoxy Products and Intermediates for the quarter were down 4 percent from last year, due to a decline in prices. Intense competitive pressure in all geographic areas continued to negatively impact price. EBIT for the quarter declined versus the third quarter of 2001 due to lower selling prices and higher raw material costs.

        Fabricated Products sales for the third quarter of 2002 were up 7 percent versus last year due to higher volume, particularly in the United States and Europe. Demand for new products such as isocyanurate foams, which were acquired from Celotex Corporation in the third quarter of last year, and WEATHERMATE insulation contributed significantly to the increase in volume. Excluding the products purchased from Celotex, volume was relatively flat versus last year. EBIT for the third quarter of 2002 improved from the same quarter of 2001 as volume growth and the realization of acquisition-related cost synergies more than offset higher raw material costs.

        Polyurethanes sales for the third quarter were up 2 percent compared with the third quarter of 2001, as volume growth of 3 percent exceeded a price decline of 1 percent. Volume continued to be strong, but prices for polyols and isocyanates declined due to competitive pressure and oversupply of product within the industry. EBIT for the third quarter declined versus the same quarter of last year due to increased raw material costs.

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

        For the first nine months of the year, Performance Plastics sales were $5,369 million, down 4 percent from $5,614 million in the same period last year. Prices declined 6 percent, exceeding a 2 percent improvement in volume. Year-to-date EBIT for the segment was $532 million, down from $571 million for the first three quarters of last year. Despite improved volume, EBIT declined as the impact of lower selling prices exceeded the benefit of lower raw material costs.

PERFORMANCE CHEMICALS

        Performance Chemicals sales for the third quarter of 2002 were $1,316 million, up 1 percent from $1,306 million in the third quarter of last year. Volume improved 1 percent while prices remained flat. Third quarter EBIT for the segment was $172 million, down from $218 million last year as higher raw material costs exceeded the benefit of merger-related cost synergies.

        Custom and Fine Chemicals sales for the third quarter of 2002 were down from last year due to a decline in volume. EBIT for the quarter, however, improved due to the realization of cost synergies related to the 2001 acquisition of Ascot Plc.

        Emulsion Polymers sales for the quarter improved 11 percent compared with the third quarter of 2001, on volume growth of 9 percent and higher prices of 2 percent. Approximately half of the improvement in volume was due to Dow's acquisition of Reichhold's carpet latex business in the fourth quarter of 2001, while the other half was due to strong demand for Dow's products. Despite higher sales, EBIT for the third quarter declined compared with last year due to higher monomer costs.

        Industrial Chemicals sales were down 7 percent from the third quarter of 2001, due to declines in both volume and price. Sales declined primarily due to competitive pressures in polyglycols and surfactants. EBIT for the business declined versus last year due to the decline in sales and an increase in feedstock costs.

        Oxide Derivatives sales for the third quarter of 2002 were up slightly from the same period of last year, on modest improvements in both volume and price. EBIT for the third quarter was essentially flat with last year, as higher raw material costs offset the impact of higher sales.

        Specialty Polymers sales in the third quarter were up 2 percent from the same period of 2001, as volume growth of 3 percent exceeded a price decline of 1 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 up 6 percent versus the third quarter of 2001, on 4 percent volume growth and a 2 percent improvement in price. Volume was up due to strong demand in the construction market driven by lower interest rates. EBIT for the third quarter improved versus last year due to higher sales and the realization of merger-related cost synergies.

        Performance Chemicals sales for the first nine months of 2002 were $3,877 million, up 1 percent from $3,856 million in the same period of 2001. Volume improved 4 percent, but was partially offset by a 3 percent decline in prices. Year to date, EBIT for the segment was $535 million, up significantly from $476 million in the first three quarters of 2001, as higher volume, lower raw material costs and the realization of cost synergies more than offset the impact of lower selling prices.

23


AGRICULTURAL SCIENCES

        Sales for the Agricultural Sciences segment for the third quarter of 2002 were $551 million, up 16 percent from $477 million last year. Volume was up 18 percent, while prices declined 2 percent. Demand was especially strong in the quarter for herbicides, as wet weather this past spring in North America delayed the use of herbicides until this quarter. Insecticide sales were also up. EBIT for the quarter was a loss of $25 million, compared with a loss of $150 million in the third quarter of 2001. EBIT was reduced in the third quarter by severance of $5 million related to a workforce reduction program. Last year, EBIT was reduced by a $69 million charge in the third quarter for IPR&D costs associated with the acquisition of Rohm and Haas' agricultural chemicals business (see Note D to Consolidated Financial Statements). Excluding this charge, EBIT for the third quarter of 2001 was a loss of $81 million. EBIT for the third quarter of 2002 improved from last year due to strong volume growth and lower operating expenses.

        Sales for the Agricultural Sciences segment were $2,082 million in the first nine months of the year, up 10 percent from $1,891 million in 2001. While volume improved 12 percent, prices fell 2 percent. Excluding the Rohm and Haas acquisition, volume was up approximately 2 percent from last year. EBIT for the first nine months of 2002 was $190 million compared with $69 million last year. As previously mentioned, results for 2001 were reduced by a $69 million charge for IPR&D. Excluding this charge, year-to-date EBIT improved from last year due to volume growth and lower operating expenses.

PLASTICS

        Plastics sales in the third quarter of 2002 were $1,667 million, up 4 percent from $1,606 million a year ago. Compared with last year, prices improved 4 percent, while volume remained flat. EBIT for the quarter was $170 million, up substantially from $83 million in the third quarter of 2001, as the segment benefited from higher selling prices and the realization of merger-related cost synergies that more than offset higher feedstock and energy costs.

        Polyethylene sales were up slightly from the third quarter of last year, as prices rose 4 percent and volume declined 3 percent. Prices in the United States increased during the quarter consistent with previously announced price increases. In Europe, prices were up 13 percent, due to the strengthening of the Euro. In Latin America, however, prices declined 13 percent. Volume declined in most geographic areas. The combined effect of the uncertain economic environment, a premium on the price of oil related to unrest in the Middle East, and ample supply of product in the market caused the margin improvement momentum of the second quarter to stall in the latter half of the third quarter. EBIT for the quarter improved significantly compared with the third quarter of last year due to increased selling prices, lower ethylene costs and the realization of merger-related cost synergies.

        Polypropylene sales for the third quarter of 2002 continued an upward trend, as prices increased more than 20 percent and volume grew 6 percent compared with the same quarter last year. The business continued to operate its plants at full capacity during the quarter to meet demand. Despite significantly higher propylene costs, EBIT improved substantially versus last year due to improved pricing and volume growth.

        Polystyrene sales for the third quarter of 2002 were up 20 percent compared with the same quarter last year, with significant improvement in both volume and price. Volume grew 12 percent from the low levels of 2001, as prices rose 8 percent. While strong growth was reported in all geographic areas, demand was particularly strong in Asia Pacific, up 25 percent from the third quarter of last year. Prices were up in all geographic areas, except Latin America. Compared with the third quarter of 2001, EBIT for the business improved as the impact of lower operating expenses and increased volume and prices offset higher styrene monomer costs.

        Plastics sales for the first nine months of 2002 were $4,783 million, down 6 percent from $5,072 million last year. Volume improved 8 percent compared with last year, but was more than offset by a sharp decline in prices of 14 percent. EBIT for the period was $214 million, up from $158 million in the first three quarters of 2001 as the favorable impact of higher demand, lower feedstock and energy costs, lower operating expenses, and the realization of cost synergies, offset the negative impact of the significantly lower selling prices.

CHEMICALS

        Third quarter sales for the Chemicals segment were $917 million, up 7 percent from $857 million in the third quarter of 2001, due to a 6 percent increase in volume and a 1 percent improvement in price. Volume increased due to improved demand for ethylene glycol ("EG"), caustic soda, vinyl chloride monomer ("VCM"), and organic intermediates, solvents and monomers ("OISM"). Prices for VCM were up, but were offset by price declines for chlorinated organics and caustic soda. EBIT for the quarter was $38 million versus $57 million in the third quarter

24



of last year. While results for the segment were favorably impacted in the third quarter by higher volume and price, EBIT declined due to increased feedstock and energy costs and higher operating costs.

        For the first nine months of 2002, sales for the Chemicals segment were $2,463 million, down 12 percent from $2,798 million for the same period of last year due to a 16 percent decline in prices and a 4 percent improvement in volume. EBIT for the first nine months of the year was a loss of $30 million compared with income of $95 million in 2001. EBIT was lower as significant declines in selling prices more than offset a favorable year-to-date impact of lower feedstock and energy costs and the realization of merger-related cost synergies.

HYDROCARBONS AND ENERGY

        Hydrocarbons and Energy sales for the quarter were $711 million, up 23 percent from $578 million in the third quarter of 2001, due to a 14 percent increase in volume and a 9 percent increase in selling prices.

        The Hydrocarbons and Energy business transfers materials to Dow's derivative businesses at cost. While selling prices for the Company in total were up approximately $100 million from the third quarter of last year, Dow's total energy and hydrocarbon feedstock costs for the third quarter were $120 million higher than last year, negatively impacting margins in some of the Company's businesses. Hydrocarbons and Energy EBIT for the quarter was $9 million compared with a loss of $11 million last year.

        Sales for the first nine months of 2002 were $1,779 million, down 11 percent from $2,005 million for the same period of 2001, due to a sharp decline in selling prices in the first half of the year. EBIT for the first nine months of 2002 was $50 million compared with a loss of $14 million last year.

UNALLOCATED AND OTHER

        EBIT for the third quarter was a loss of $103 million compared with a loss of $158 million in the third 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 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. This year, third quarter results included the unfavorable impact of additional merger-related integration costs of $6 million, bringing the year-to-date total to $29 million, and additional merger-related severance of $21 million. EBIT for the third quarter of 2001 was negatively impacted by additional merger-related expenses of $46 million, a $6 million reinsurance loss on the World Trade Center (reflected in "Insurance company operations"), and Dow's $11 million share of a restructuring charge recorded by Dow Corning, which reduced equity earnings. Compared with last year, EBIT for the third quarter improved primarily due to lower merger-related expenses, improved earnings from Dow Corning and less unfavorable foreign exchange results.

        For the first nine months of this year, EBIT for Unallocated and Other was a loss of $308 million compared with a loss of $1,426 million for the same period last year. In addition to the unusual items described above for the third quarter of 2001, last year's results were reduced by a $1,454 million 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.

25



Sales Volume and Price by Operating Segment and Geographic Area

 
  Three Months Ended
Sept. 30, 2002

  Nine Months Ended
Sept. 30, 2002

 
Percentage change from prior year

 
  Volume
  Price
  Total
  Volume
  Price
  Total
 
Operating segments                          
  Performance Plastics     (1 )% (1 )% 2  % (6 )% (4 )%
  Performance Chemicals   1  %   1  % 4  % (3 )% 1  %
  Agricultural Sciences   18  % (2 )% 16  % 12  % (2 )% 10  %
  Plastics     4  % 4  % 8  % (14 )% (6 )%
  Chemicals   6  % 1  % 7  % 4  % (16 )% (12 )%
  Hydrocarbons and Energy   14  % 9  % 23  % 5  % (16 )% (11 )%
   
 
 
 
 
 
 
  Total   3  % 2  % 5  % 5  % (9 )% (4 )%
   
 
 
 
 
 
 
Geographic area sales                          
  United States     2  % 2  % (1 )% (8 )% (9 )%
  Europe   2  % 7  % 9  % 9  % (8 )% 1  %
  Rest of World   9  % (6 )% 3  % 10  % (14 )% (4 )%
   
 
 
 
 
 
 
  Total   3  % 2  % 5  % 5  % (9 )% (4 )%
   
 
 
 
 
 
 

COMPANY SUMMARY

Operating Rate

        The Company's global plant operating rate for its chemicals and plastics businesses was 80 percent in the third quarter of 2002, up from 77 percent in the third quarter of 2001.

Amortization of Intangibles

        Amortization of intangibles (not including software, which is amortized to cost of sales) was $16 million in the third quarter of 2002, down from $50 million in the third 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 $49 million, compared with $118 million for the first nine months of 2001. Goodwill amortization expense, reported as "Amortization of intangibles," was $43 million in the third quarter of 2001 and $91 million for the first nine 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 third quarter of 2002, the Company recorded one-time merger and integration costs of $6 million, bringing the year-to-date total to $29 million. In the third quarter of 2002, the Company also recorded additional merger-related severance of $21 million and severance related to a workforce reduction program at Dow AgroSciences of $5 million. During the first nine months of 2001, costs totaling $1,454 million were recorded for merger-related expenses and restructuring. These costs included transaction costs, employee severance, the write-down of duplicate assets and facilities, and other merger-related expenses. For details regarding the charges related to the Union Carbide merger, 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 third quarter of 2002, the Company had taken actions that will result in annual cost savings of more than $1.0 billion. The cost reductions will affect cost of sales, research and development expenses, and selling, general and administrative expenses. These actions are not expected to have an impact on future revenues.

Equity in Earnings of Nonconsolidated Affiliates

        Dow's share of the earnings of nonconsolidated affiliates was $47 million in the third quarter of 2002, compared with $11 million in the same quarter last year. Equity earnings increased primarily due to strong results at Dow Corning. Year to date, equity earnings were $42 million versus $84 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.

26



Sundry Income—Net

        Sundry income includes a variety of income and expense items such as the gain or loss on foreign currency exchange, dividends from investments, and gains and losses on sales of investments and assets. Sundry income for the third quarter of 2002 was $18 million compared with $16 million in the third quarter of 2001. Year to date, Sundry income was $1 million compared with $384 million for the same period of last year. Sundry income for 2002 declined in part due to higher cost associated with foreign exchange hedging, primarily related to the Argentine peso. Also, given the current environment within the financial markets, Dow has not been as active in selling financial assets as it was in past quarters. In 2001, year-to-date Sundry income included a $266 million pretax gain on the sale of stock in Schlumberger Ltd.

Net Interest Expense

        Net interest expense (interest expense less capitalized interest and interest income) was $181 million in the third quarter of 2002 compared with $173 million in the third quarter of last year. Year to date, net interest expense was $528 million, up from $494 million in the first three quarters of 2001. The year-to-date increase is related to an increase in interest expense.

Provision for Taxes on Income

        The effective tax rate for the third quarter was 30.5 percent, versus 25.0 percent for the third quarter of 2001. The lower rate in the third quarter of 2001 reflected the impact of tax credits on a lower level of earnings. Year to date, the effective tax rate was 30.8 percent versus 35.4 percent last year. The effective tax rate fluctuates based on, among other factors, where income is earned and the level of income relative to tax credits available. Steps have been taken by the Company to lower the effective tax rate below Dow's historical average of around 35 percent.

Outlook

        Macroeconomic indicators provided mixed signals in the third quarter. After rising for seven consecutive months, U.S. industrial production fell slightly in August and September. Consumer confidence declined in recent months and the ISM (Institute of Supply Management, formerly National Association of Purchasing Management) survey dropped below 50 for the first time since January of this year. Auto production and housing starts, however, remain strong. Overall, Dow continues to believe that the U.S. industrial economy is improving, although somewhat more slowly than previously expected. There are no signs of a double dip recession in the United States. The European economy also posted mixed results during the third quarter and is expected to lag the U.S. recovery by one or two quarters. Growth in China continues to be strong, and much of the rest of Asia Pacific is expected to show improved economic growth compared with 2001. Latin America presents some economic challenges, with the current economic conditions in Argentina and elections in Brazil. Overall global GDP growth for 2002 is expected to be higher than in 2001 by about 0.5 percent, with an additional increase of between 0.5 percent and 1.0 percent in 2003.

        The improvement in industry demand that began late in the first quarter of 2002 slowed somewhat during the third quarter. As anticipated, demand in the chemical industry was lower in July and August, consistent with seasonal patterns in North America and Europe. However, the typical September pickup was less robust than expected. Demand in the electronics and telecommunications industries remains at very low levels, although there are some signs of improvement for electronics in certain regions. While there is little capacity being added for most products, chemical industry operating rates remain low, and it will take a number of quarters of solid volume growth to balance supply and demand. During the third quarter, prices for crude oil and its derivatives increased by about 10 percent, largely because of the uncertain geopolitical situation. Oil and gas prices remain volatile and cannot be forecasted based on normal supply/demand fundamentals while these uncertainties exist.

        Because of volatility in feedstock and energy costs, the outlook for the fourth quarter is uncertain. If these costs increase, despite some hedging, margins will be squeezed, particularly in the basics businesses where some price softness is anticipated. Underlying demand growth appears to be more muted than earlier anticipated. While some businesses experience seasonally lower demand in the fourth quarter, particularly those related to building and construction, Dow's businesses generally anticipate that overall volume should improve compared to last year. Even if feedstock and energy costs increase somewhat from average third quarter levels, results for Performance Plastics and Performance Chemicals are expected to show improvement from the fourth quarter of 2001 because of higher volume and prices compared with a year ago. Agricultural Sciences expects improved results compared with last year, with cost improvements from its restructuring program and due to the full integration of the Rohm

27



and Haas agricultural chemicals business. Margins in basic plastics are expected to decline from third quarter levels, with potential price softening in some products and regions. In the Chemicals segment, ethylene glycol pricing is expected to improve, but margins for the chlor-alkali business are expected to decline because of higher energy costs and somewhat lower prices for vinyl chloride monomer. Overall, the fourth quarter will be challenging because of the current geopolitical uncertainty and its impact on the volatility of feedstock and energy costs. Results will depend on whether improved volumes can offset anticipated margin contraction, primarily in the basics. Dow expects that earnings in the fourth quarter of 2002 will be better than the fourth quarter of last year.

28


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:

 
  Nine Months Ended
 
In millions

  Sept. 30,
2002

  Sept. 30,
2001

 
Cash provided by (used in):              
  Operating activities   $ 1,343   $ 448  
  Investing activities     (1,093 )   (2,365 )
  Financing activities     34     2,123  
  Effect of exchange rate changes on cash     (4 )   (4 )
   
 
 
Net change in cash and cash equivalents   $ 280   $ 202  
   
 
 

        Cash provided by operating activities increased in the nine months ended September 30, 2002, compared with the nine months ended September 30, 2001, primarily due to improved earnings and changes in certain working capital requirements.

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

        Cash provided by financing activities was lower in the nine months ended September 30, 2002 compared with the nine months ended September 30, 2001, due to the issuance of less new long-term debt, an increase in payments made on existing short-term and long-term debt, and the impact of the issuance of preferred securities in 2001.

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

Working Capital

In millions

  Sept. 30,
2002

  Dec. 31,
2001

Current assets   $ 10,761   $ 10,308
Current liabilities     8,441     8,125
   
 
Working capital   $ 2,320   $ 2,183
   
 
Current ratio     1.27:1     1.27:1
Days-sales-outstanding-in-receivables     46     50
Days-sales-in-inventory     70     77
Total Debt

In millions

  Sept. 30,
2002

  Dec. 31,
2001

 
Notes payable   $ 903   $ 1,209  
Long-term debt due within one year     725     408  
Long-term debt     10,360     9,266  
   
 
 
  Total debt   $ 11,988   $ 10,883  
   
 
 
Debt as a percent of total capitalization     51.8 %   48.9 %

        At September 30, 2002, the Company had unused and committed credit facilities with various U.S. and foreign banks totaling $3.0 billion in support of its working capital requirements and commercial paper borrowings. Additional unused credit facilities totaling $872 million were available for use by foreign subsidiaries. On September 12, 2002, the Company's new $1.5 billion registration for the issuance of SEC registered securities became effective. At September 30, 2002, there was a total of $1.6 billion available in SEC registered securities, as well as Japanese yen 70 billion (approximately $576 million) available in yen-denominated securities through the Japanese Ministry of Finance and Euro 900 million (approximately $885 million) available under the Company's Euro Medium-Term Note Program.

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        On June 21, 2002, the Company launched a retail Medium-Term Note Program. As of September 30, 2002, $156 million of notes had been issued under this program. At October 30, 2002, the Company had issued additional notes under this program, bringing the cumulative balance of notes issued to $205 million, with maturity dates ranging from 2005 through 2012.

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

OTHER MATTERS

Accounting Changes

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

Critical Accounting Policies

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

30


31


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 September 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.

32


        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.

October 2002 Announcement of Plan to Improve Earnings and Cash Flow

        On October 24, 2002, the Company announced in its third quarter earnings release significant steps to improve Dow's earnings and cash flow. Effectively immediately, Dow intends to implement the following steps:

33


        Through these measures, Dow expects to improve cash flow by more than $1 billion as the Company continues to focus on ways to enhance its competitive position and maximize long-term shareholder value.

34




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. Derivatives used for this purpose are designated as hedges per SFAS No. 133, where appropriate. A secondary objective is to add value by creating additional non-specific 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 year-end VAR and average quarterly VAR for the aggregate of non-trading and trading positions for 2001 and 2000 are shown below:

Total Daily VAR at December 31*

 
  2001
  2000
In millions

  Year-end
  Average
  Year-end
  Average
Foreign exchange   $ 21   $ 17   $ 8   $ 8
Interest rate     106     70     17     32
Equity exposures, net of hedges     7     9     45     26
Commodities     4     5     23     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.

35



The Dow Chemical Company and Subsidiaries
Item 4.    Control and Procedures

        Within the 90 days prior to the date of filing this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company's Disclosure Committee and the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. Subsequent to the date of that evaluation, there have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls, nor were any corrective actions required with regard to significant deficiencies and material weaknesses.

36



The Dow Chemical Company and Subsidiaries
Part II—Other Information


ITEM 1.    LEGAL PROCEEDINGS

Breast Implant Matters

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

Environmental Matters

        On September 27, 2002, the United States Environmental Protection Agency, Region 6 (the "EPA"), filed an administrative complaint against Union Carbide, a wholly owned subsidiary of the Company, charging civil fines of $185,458 for certain alleged violations of the Clean Air Act and the Resource Conservation and Recovery Act at Union Carbide's Texas City Operations. The EPA has proposed to settle these civil fines for $129,818 plus an additional civil fine of $130,753 for other alleged Clean Air Act violations at Texas City Operations that were voluntarily disclosed by Union Carbide.


ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a)
Exhibits.
Exhibit No.
  Description of Exhibit

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

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

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Signature

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


Date:    October 30, 2002

 

 

 

THE DOW CHEMICAL COMPANY

Registrant

 

 

 

 

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

38



The Dow Chemical Company and Subsidiaries
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

        I, Michael D. Parker, President and Chief Executive Officer of The Dow Chemical Company, certify that:


Date: October 30, 2002

 

 

 

 

/s/  
MICHAEL D. PARKER      
Michael D. Parker
President & Chief Executive Officer

39


The Dow Chemical Company and Subsidiaries
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

        I, J. Pedro Reinhard, Executive Vice President and Chief Financial Officer of The Dow Chemical Company, certify that:


Date:    October 30, 2002

 

 

 

 

/s/  
J. PEDRO REINHARD      
J. Pedro Reinhard
Executive Vice President & Chief Financial Officer

40



The Dow Chemical Company and Subsidiaries
Exhibit Index

EXHIBIT NO.
  DESCRIPTION
4       Agreement and Plan of Merger dated as of August 3, 1999 among Union Carbide Corporation, The Dow Chemical Company and Transition Sub Inc., incorporated by reference to Annex A to the proxy statement/prospectus included in The Dow Chemical Company's Registration Statement on Form S-4, File No. 333-88443, filed October 5, 1999.

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.

41




QuickLinks

The Dow Chemical Company and Subsidiaries Notes to the Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Control and Procedures
Part II—Other information
Signature
The Dow Chemical Company and Subsidiaries Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit Index