Dow Chemical 10-Q 2003 Q3 Quarterly report

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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 QUARTERLY PERIOD ENDED September 30, 2003

Commission file number1-3433

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

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

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

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes ý    No o

Class	Outstanding at September 30, 2003
Common Stock, par value $2.50 per share	920,534,758 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	5
		Notes to the Consolidated Financial Statements	6
	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		19
		Disclosure Regarding Forward-Looking Information	19
		Results of Operations	19
		Changes in Financial Condition	26
		Other Matters	28
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		33
	Item 4. Controls and Procedures		34
PART II—OTHER INFORMATION
	Item 1. Legal Proceedings		35
	Item 6. Exhibits and Reports on Form 8-K		35
SIGNATURE			36
EXHIBIT INDEX			37

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, 2003		Sept. 30, 2002		Sept. 30, 2003			Sept. 30, 2002
Net Sales		$	7,977	$	7,084	$	24,300		$	20,648
	Cost of sales		6,861		6,049		20,994			17,435
	Research and development expenses		247		262		730			784
	Selling, general and administrative expenses		334		389		1,043			1,185
	Amortization of intangibles		14		16		44			49
	Merger-related expenses and restructuring		—		32		—			55
	Equity in earnings of nonconsolidated affiliates		74		47		203			42
	Sundry income (expense)—net		69		18		115			1
	Interest income		22		13		60			43
	Interest expense and amortization of debt discount		204		194		626			571
Income before Income Taxes and Minority Interests			482		220		1,241			655
	Provision for income taxes		127		67		360			202
	Minority interests' share in income		23		25		71			49
Income before Cumulative Effect of Changes in Accounting         Principles			332		128		810			404
	Cumulative effect of changes in accounting principles		—		—		(9	)		67
Net Income Available for Common Stockholders		$	332	$	128	$	801		$	471
Share Data
	Earnings before cumulative effect of changes in accounting         principles per common share—basic	$	0.36	$	0.14	$	0.88		$	0.44
	Earnings per common share—basic	$	0.36	$	0.14	$	0.87		$	0.52
	Earnings before cumulative effect of changes in accounting         principles per common share—diluted	$	0.36	$	0.14	$	0.88		$	0.44
	Earnings per common share—diluted	$	0.36	$	0.14	$	0.87		$	0.51
	Common stock dividends declared per share of common stock	$	0.335	$	0.335	$	1.005		$	1.005
	Weighted-average common shares outstanding—basic		919.8		911.7		917.3			909.9
	Weighted-average common shares outstanding—diluted		926.5		917.9		922.9			917.3
Depreciation		$	434	$	417	$	1,293		$	1,207
Capital Expenditures		$	256	$	398	$	751		$	1,086

See Notes to the Consolidated Financial Statements.

3

The Dow Chemical Company and Subsidiaries
Consolidated Balance Sheets

In millions (Unaudited)				Sept. 30, 2003			Dec. 31, 2002
Assets
Current Assets
	Cash and cash equivalents			$	2,566		$	1,484
	Marketable securities and interest-bearing deposits				47			89
	Accounts and notes receivable:
		Trade (net of allowance for doubtful receivables—2003: $124; 2002: $127)			3,144			3,116
		Other			2,184			2,369
	Inventories				4,167			4,208
	Deferred income tax assets—current				133			109
	Total current assets				12,241			11,375
			��
Investments
	Investment in nonconsolidated affiliates				1,800			1,565
	Other investments				1,924			1,689
	Noncurrent receivables				308			577
	Total investments				4,032			3,831
Property
	Property				39,307			37,934
	Less accumulated depreciation				25,797			24,137
	Net property				13,510			13,797
Other Assets
	Goodwill				3,226			3,189
	Other intangible assets (net of accumulated amortization—2003: $380; 2002: $349)				590			613
	Deferred income tax assets—noncurrent				3,850			3,776
	Asbestos-related insurance receivables—noncurrent				1,300			1,489
	Deferred charges and other assets				1,556			1,492
	Total other assets				10,522			10,559
Total Assets				$	40,305		$	39,562
Liabilities and Stockholders' Equity
Current Liabilities
	Notes payable			$	371		$	580
	Long-term debt due within one year				1,086			797
	Accounts payable:
		Trade			2,601			2,834
		Other			1,987			1,789
	Income taxes payable				217			202
	Deferred income tax liabilities—current				32			30
	Dividends payable				308			326
	Accrued and other current liabilities				2,551			2,298
	Total current liabilities				9,153			8,856
Long-Term Debt					11,695			11,659
Other Noncurrent Liabilities
	Deferred income tax liabilities—noncurrent				1,117			994
	Pension and other postretirement benefits—noncurrent				3,834			3,775
	Asbestos-related liabilities—noncurrent				1,923			2,072
	Other noncurrent obligations				3,255			3,214
	Total other noncurrent liabilities				10,129			10,055
Minority Interest in Subsidiaries					368			366
Preferred Securities of Subsidiaries					1,000			1,000
Stockholders' Equity
	Common stock				2,453			2,453
	Additional paid-in capital				1			—
	Unearned ESOP shares				(52	)		(61	)
	Retained earnings				9,376			9,520
	Accumulated other comprehensive loss				(1,857	)		(2,097	)
	Treasury stock at cost				(1,961	)		(2,189	)
	Net stockholders' equity				7,960			7,626
Total Liabilities and Stockholders' Equity				$	40,305		$	39,562

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, 2003			Sept. 30, 2002
Operating Activities	Income before cumulative effect of changes in accounting     principles	$	810		$	404
	Adjustments to reconcile net income to net cash provided     by operating activities:
	Depreciation and amortization		1,401			1,305
	Provision for deferred income tax		122			15
	Earnings/losses of nonconsolidated affiliates less than         (in excess of) dividends received		(88	)		27
	Minority interests' share in income		71			49
	Net (gain) loss on sales of consolidated companies		3			(4	)
	Net gain on sales of property and businesses		(93	)		(11	)
	Other net gain		(17	)		(28	)
	Net gain on sales of nonconsolidated affiliates		(21	)		—
	Tax benefit—nonqualified stock option exercises		23			18
	Changes in assets and liabilities that provided (used) cash:
	Accounts and notes receivable		(288	)		(505	)
	Inventories		(22	)		(49	)
	Accounts payable		(48	)		100
	Noncurrent receivables		269			136
	Other assets and liabilities		608			(114	)
	Cash provided by operating activities		2,730			1,343
Investing Activities	Capital expenditures		(751	)		(1,086	)
	Proceeds from sales of property and businesses		202			52
	Acquisitions of businesses, net of cash received		(8	)		—
	Investments in consolidated companies		(69	)		—
	Proceeds from sales of consolidated companies		—			39
	Investments in nonconsolidated affiliates		(70	)		(74	)
	Proceeds from sales of nonconsolidated affiliates		51			—
	Purchases of investments		(1,283	)		(1,362	)
	Proceeds from sales and maturities of investments		1,136			1,338
	Cash used in investing activities		(792	)		(1,093	)
Financing Activities	Changes in short-term notes payable		(195	)		(274	)
	Payments on long-term debt		(797	)		(424	)
	Proceeds from issuance of long-term debt		901			1,596
	Purchases of treasury stock		(5	)		(3	)
	Proceeds from sales of common stock		138			118
	Distributions to minority interests		(53	)		(67	)
	Dividends paid to stockholders		(920	)		(912	)
	Cash provided by (used in) financing activities		(931	)		34
Effect of Exchange Rate Changes on Cash			75			(4	)
Summary	Increase in cash and cash equivalents		1,082			280
	Cash and cash equivalents at beginning of year		1,484			220
	Cash and cash equivalents at end of period	$	2,566		$	500

See Notes to the Consolidated Financial Statements.

The Dow Chemical Company and Subsidiaries
Consolidated Statements of Comprehensive Income

		Three Months Ended						Nine Months Ended
In millions (Unaudited)		Sept. 30, 2003			Sept. 30, 2002			Sept. 30, 2003			Sept. 30, 2002
Net Income Available for Common Stockholders		$	332		$	128		$	801		$	471
Other Comprehensive Income (Loss), Net of Tax
	Net unrealized gains (losses) on investments		3			(41	)		35			(64	)
	Translation adjustments		51			(47	)		236			137
	Minimum pension liability adjustments		—			—			(3	)		—
	Net losses on cash flow hedging derivative instruments		(30	)		(23	)		(28	)		(19	)
	Total other comprehensive income (loss)		24			(111	)		240			54
Comprehensive Income		$	356		$	17		$	1,041		$	525

See Notes to the Consolidated Financial Statements.

5

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 for the year ended December 31, 2002. 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

        In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," which replaced 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 "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 June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which replaced APB Opinion No. 17, "Intangible Assets," and established 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 deemed to have indefinite useful lives are not amortized, but are subject to impairment testing. Impairment testing was required at adoption and at least annually thereafter. On an ongoing basis (absent any impairment indicators), Dow performs impairment tests during the fourth quarter of each year, in conjunction with the Company's annual budgeting process. Effective January 1, 2002, Dow ceased all amortization of goodwill, which is its only intangible asset with an indefinite useful life, and tested recorded goodwill for impairment by comparing the fair value of each reporting unit, determined using a discounted cash flow method, with its carrying value.

        As a result of the Company's impairment testing, goodwill impairment losses totaling $22 million were recorded in the first quarter of 2002 and included in "Cumulative effect of changes in accounting principles." Summaries of the impairment losses are as follows:

•

The Hampshire Fine Chemicals reporting unit has experienced increased competition and the loss of several large customers. The reporting unit has revised its 10-year earnings forecast to reflect the decreased profitability outlook, and, as a result, the Company recognized a goodwill impairment loss of $18 million in the first quarter of 2002 in the Performance Chemicals segment.



•

The Rubber reporting unit has faced increased competition and rapidly rising hydrocarbon costs with a significant oversupply of natural rubber, resulting in steadily declining margins. Revisions were made to the 10-year earnings forecast to reflect these negative trends and, as a result, a goodwill impairment loss of $4 million was recognized in the first quarter of 2002 in the Plastics segment.

        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 disclosures related to goodwill and other intangible assets.

        In June 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 was effective for fiscal years beginning after June 15, 2002. Adoption of SFAS No. 143 on January 1, 2003 resulted in the recognition of an asset retirement obligation of $45 million and a charge of $9 million (net of tax of $5 million), which was included in "Cumulative effect of changes in accounting principles." See Note H for disclosures related to asset retirement obligations.

        In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." This statement, which was 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.

6

        In the first quarter of 2003, Dow adopted the fair value provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," for new grants of equity instruments (which include stock options, deferred stock grants, and subscriptions to purchase shares under the Company's Employees' Stock Purchase Plan) to employees. Dow expects the incremental after-tax expense associated with awards of stock options to be approximately $0.02 per share in 2003, growing to approximately $0.06 per share in 2005. These estimates were based on the terms of Dow's stock option plans and current assumptions for stock option grants and valuation, which may change when stock options are granted in the future. See Note I for disclosures required by SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure."

        In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies," relating to the guarantor's accounting for and disclosures of certain guarantees issued. The initial recognition and measurement provisions of the interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements of the interpretation were effective for financial statements of interim or annual periods ending after December 15, 2002. The Company's disclosures related to guarantees can be found in Note F.

        In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or in which equity investors do not bear the residual economic risks. The interpretation was immediately applicable to variable interest entities ("VIEs") created after January 31, 2003, and to VIEs in which an enterprise obtains an interest after that date. As originally issued, it applied in the fiscal year or interim period beginning after June 15, 2003, to VIEs in which an enterprise holds a variable interest that was acquired before February 1, 2003. In October 2003, the FASB issued FASB Staff Position No. 46-6, which defers the effective date for FIN No. 46 to the first interim or annual period ending after December 15, 2003 for VIEs created before February 1, 2003. See Note G for disclosures regarding the Company's VIEs, and the expected impact of adoption in the fourth quarter of 2003.

        In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires the classification of certain financial instruments that embody obligations for the issuer as liabilities (or assets in some circumstances). SFAS No. 150 was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. The Company evaluated the preferred securities previously issued by two consolidated subsidiaries and concluded that the $500 million of preferred securities issued by Hobbes Capital S.A. is outside of the scope of the standard and will continue to be classified as "Preferred Securities of Subsidiaries." The $500 million of preferred partnership units issued by Tornado Finance V.O.F. ("Tornado") is within the scope of the standard and was classified as a liability of the Company upon adoption of SFAS No. 150 on July 1, 2003. The rights of the holders of Tornado's preferred partnership units were subsequently modified to eliminate the unconditional mandatory redemption feature; therefore, the preferred partnership units were classified as "Preferred Securities of Subsidiaries" in the consolidated balance sheet at September 30, 2003. See Note P to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 for additional information.

NOTE C—MERGER-RELATED EXPENSES AND RESTRUCTURING

Merger-Related Expenses and Restructuring

        On February 6, 2001, the merger of Union Carbide Corporation ("Union Carbide") with a subsidiary of The Dow Chemical Company was completed, and Union Carbide became a wholly owned subsidiary of Dow. Following the completion of the Union Carbide merger, Dow's management made certain decisions relative to employment levels, duplicate assets and facilities and excess capacity resulting from the merger. These decisions resulted in a pretax special charge in the first quarter of 2001 of $1.4 billion. The planned merger-related program was substantially completed in the third quarter of 2002. Complete disclosures relative to the program and the activity in the merger-related special charge reserve can be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

        In conjunction with this program, merger-related expenses of $50 million (including $21 million of severance), exclusively related to the merger, were recorded in the first nine months of 2002. In the third quarter of 2002, the Company also recorded severance of $5 million related to a workforce reduction program at Dow AgroSciences.

        During the fourth quarter of 2002, an additional charge of $34 million was recorded for merger-related severance. Under this revised severance program, $62 million was paid to 746 former employees in the first quarter of 2003.

7

Other Restructuring

        In late 2002, immediately following the appointment of a new President and CEO, management began a series of studies to determine potential actions relative to under-performing assets and employment levels. Prior to the end of 2002, certain studies were completed and management made decisions relative to certain assets. The economic effects of these decisions resulted in a pretax charge in the fourth quarter of 2002 of $168 million, which included $37 million for severance for 624 employees (included in Unallocated and Other for segment reporting purposes). The charge for severance was based on severance plans communicated to employees. In the first nine months of 2003, severance of $16 million was paid to approximately 260 former employees, leaving an accrual balance of $21 million to be paid to approximately 375 employees. The program is expected to be completed in the fourth quarter of 2003.

        In the first quarter of 2003, additional studies regarding non-strategic and under-performing assets were completed and management made decisions relative to certain assets. These decisions resulted in the write-down of the net book value of several manufacturing facilities totaling $37 million (the largest of which was $16 million associated with the impairment of Union Carbide's Seadrift, Texas, ethylene cracker, which was shut down in the third quarter of 2003), the impairment of Union Carbide's chemical transport vessel (sold in the second quarter of 2003) of $11 million, and the write-off of cancelled capital projects totaling $12 million.

NOTE D—INVENTORIES

        The following table provides a breakdown of inventories at September 30, 2003 and December 31, 2002:

Inventories In millions	Sept. 30, 2003		Dec. 31, 2002
Finished goods	$	2,366	$	2,523
Work in process		917		843
Raw materials		450		452
Supplies		434		390
Total inventories	$	4,167	$	4,208

        The reserves reducing inventories from the first-in, first-out ("FIFO") basis to the last-in, first-out ("LIFO") basis amounted to $342 million at September 30, 2003 and $209 million at December 31, 2002.

NOTE E—GOODWILL AND OTHER INTANGIBLE ASSETS

        The following table shows changes in the carrying amount of goodwill for the nine months ended September 30, 2003, by operating segment:

In millions		Performance Plastics		Performance Chemicals			Agricultural Sciences		Plastics			Hydrocarbons and Energy		Total
Goodwill at December 31, 2002		$	905	$	784		$	1,320	$	117		$	63	$	3,189
Increase related to acquisitions:
	Remaining 20% interest in     INCA International SPA		—		—			—		25			—		25
	Remaining 26.7% interest in     Union Carbide do Brasil S.A.		—		—			—		11			—		11
	Remaining 50% interest in Epoxital     S.R.L.		8		—			—		—			—		8
	Total increase related to acquisitions		8		—			—		36			—		44
Goodwill write-off related to sale of     Sentrachem businesses: Karbochem,         Chemical Intermediates, and         Calcium Carbide			—		(3	)		—		(4	)		—		(7	)
	Total adjustments		8		(3	)		—		32			—		37
Goodwill at September 30, 2003		$	913	$	781		$	1,320	$	149		$	63	$	3,226

8

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

Other Intangible Assets

		At September 30, 2003							At December 31, 2002
In millions		Gross Carrying Amount		Accumulated Amortization			Net		Gross Carrying Amount		Accumulated Amortization			Net
Intangible assets with finite lives:
	Licenses and intellectual property	$	267	$	(105	)	$	162	$	288	$	(117	)	$	171
	Patents		152		(76	)		76		153		(64	)		89
	Software		306		(144	)		162		271		(126	)		145
	Trademarks		140		(24	)		116		140		(18	)		122
	Other		105		(31	)		74		110		(24	)		86
	Total	$	970	$	(380	)	$	590	$	962	$	(349	)	$	613

        The following table provides a summary of acquisitions of intangible assets for the nine months ended September 30, 2003:

Acquisitions of Intangible Assets in 2003

In millions		Acquisition Cost		Weighted-average Amortization Period
Intangible assets with finite lives:
	Licenses and intellectual property	$	8	13.3 years
	Software		14	5.0 years
	Total	$	22	8.0 years

        Amortization expense for other intangible assets (not including software) was $14 million in the third quarter of 2003, compared with $16 million in the same period last year. Year to date, amortization expense for other intangible assets (not including software) was $44 million, compared with $49 million for the first nine months of 2002. Amortization expense for software, which is included in cost of sales, totaled $7 million in the third quarter of 2003 and the third quarter of 2002. For the first nine months of this year, amortization expense for software was $21 million, up from $18 million in the same period last year. Total estimated amortization expense for 2003 and the five succeeding fiscal years is as follows:

In millions	Estimated Amortization Expense
2003	$	84
2004		80
2005		72
2006		67
2007		57
2008		48

9

NOTE F—COMMITMENTS AND CONTINGENT LIABILITIES

Litigation

Breast Implant Matters

        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 would not have a material adverse impact on the Company's consolidated financial statements.

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

        Judge 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. On December 11, 2002, Judge Hood found that the release and injunction provisions of the Plan were appropriate based on the factual determination that "unusual circumstances" do exist in this case. The effectiveness of the Joint Plan remains subject to any subsequent appellate action. Accordingly, there can be no assurance at this time that the Joint Plan will become effective.

10

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

DBCP Matters

        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. 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.

Environmental Matters

        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 $394 million at December 31, 2002, for environmental remediation and restoration costs, including $43 million for the remediation of Superfund sites. At September 30, 2003, the Company had accrued obligations of $378 million for environmental remediation and restoration costs, including $35 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.

        Separately, on June 12, 2003, the Michigan Department of Environmental Quality ("MDEQ") issued a Hazardous Waste Operating License to the Company's Midland, Michigan manufacturing site, which included provisions requiring the Company to conduct an investigation to determine the nature and extent of off-site contamination in Midland area soils; Tittabawasee and Saginaw River sediment and floodplain soils; and Saginaw Bay. The operating license required the Company, by August 11, 2003, to propose a detailed Statement of Work for the off-site investigation, for review and approval by the MDEQ. Statements of Work have been submitted to the MDEQ and have been disseminated for public comment.

        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.

Asbestos-Related Matters of Union Carbide Corporation

        Union Carbide Corporation ("Union Carbide"), a wholly owned subsidiary of the Company, is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. These suits principally allege personal injury resulting from exposure to asbestos-containing products and frequently seek both actual and punitive damages, often in very large amounts. The alleged claims primarily relate to products that Union Carbide sold in the past, alleged exposure to asbestos-containing products located on Union Carbide's premises, and Union Carbide's responsibility for asbestos suits filed against a former Union Carbide subsidiary, Amchem Products, Inc. ("Amchem"). In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable loss as a result of such exposure, or that injuries incurred in fact resulted from exposure to Union Carbide's products.

        The rate at which plaintiffs filed asbestos-related suits against various companies, including Union Carbide and Amchem, increased in both 2001 and 2002, influenced by the bankruptcy filings of numerous defendants in asbestos-related litigation. Union Carbide expects more asbestos-related suits to be filed against Union Carbide and Amchem in the future. Union Carbide will aggressively defend or reasonably resolve, as appropriate, both pending and future claims.

11

        Typically, Union Carbide is only one of many named defendants, many of which, including Union Carbide and Amchem, were members of the Center for Claims Resolution ("CCR"), an entity that defended and resolved asbestos cases on behalf of its members. As members of the CCR, Union Carbide's and Amchem's strategy was to resolve the claims against them at the relatively small percentage allocated to them pursuant to the CCR's collective defense. The CCR ceased operating in February 2001, except to administer certain settlements. Union Carbide then began using Peterson Asbestos Claims Enterprise, but only for claims processing and insurance invoicing.

        Certain members of Dow's legal department and certain Dow management personnel have been retained to provide their experience in mass tort litigation to assist Union Carbide in responding to asbestos-related matters. In early 2002, Union Carbide hired new outside counsel to serve as national trial counsel. In connection with these actions, aggressive defense strategies were designed to reduce the cost of resolving all asbestos-related claims, including the elimination of claims that lack demonstrated illness or causality.

        At the end of 2001 and through the third quarter of 2002, Union Carbide had concluded it was not possible to estimate its cost of disposing of asbestos-related claims that might be filed against Union Carbide and Amchem in the future due to a number of reasons, including its lack of sufficient comparable loss history from which to assess either the number or value of future asbestos-related claims. During the third and fourth quarters of 2002, Union Carbide worked with Analysis, Research & Planning Corporation ("ARPC"), a consulting firm with broad experience in estimating resolution costs associated with mass tort litigation, including asbestos, to explore whether it would be possible to estimate the cost of disposing of pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Union Carbide and Amchem.

        Union Carbide provided ARPC with all relevant data regarding asbestos-related claims filed against Union Carbide and Amchem through November 6, 2002. ARPC concluded that it was not possible to estimate the full range of the cost of resolving future asbestos-related claims against Union Carbide and Amchem, because of various uncertainties associated with the litigation of those claims. These uncertainties, which hindered Union Carbide's ability to project future claim volumes and resolution costs, included the following:

•

Until a series of bankruptcies led to the CCR ceasing operations in early 2001, Union Carbide and Amchem generally settled claims filed against CCR members according to a sharing formula that would not necessarily reflect the cost of resolving those claims had they been separately litigated against Union Carbide or Amchem.



•

The bankruptcies in the years 2000 to 2002 of other companies facing large asbestos liability were a likely contributing cause of a sharp increase in filings against many defendants, including Union Carbide and Amchem.



•

It was not until the CCR ceased operating in early 2001 that Union Carbide took direct responsibility for the defense of claims against itself and Amchem.



•

New defense counsel for Union Carbide and Amchem implemented more aggressive defense strategies in mid-2002.

        Despite its inability to estimate the full range of the cost of resolving future asbestos-related claims, ARPC advised Union Carbide that it would be possible to determine an estimate of a reasonable forecast of the cost of resolving pending and future asbestos-related claims likely to face Union Carbide and Amchem, if certain assumptions were made. Specifically, ARPC advised Union Carbide that for purposes of determining an estimate it is reasonable to assume that in the near term asbestos-related claims filed against Union Carbide and Amchem are unlikely to return to levels below those experienced prior to 2001—when the recent spike in filings commenced—and that average claim values are unlikely to return to levels below those experienced in 2001-2002, the years immediately following CCR's cessation of operations. ARPC advised Union Carbide that, by assuming that future filings were unlikely to exceed the levels experienced prior to 2001 and extrapolating from 2001 and 2002 average claim values, ARPC could make a reasonable forecast of the cost of resolving asbestos-related claims facing Union Carbide and Amchem. ARPC also advised Union Carbide that forecasts of resolution costs for a 10 to 15 year period from the date of the forecast are likely to be more accurate than forecasts for longer periods of time.

        In projecting Union Carbide's resolution costs for future asbestos-related claims, ARPC applied two methodologies that have been widely used for forecasting purposes. Applying these methodologies, ARPC forecast the number and allocation by disease category of those potential future claims on a year-by-year basis through 2049. ARPC then calculated the percentage of claims in each disease category that had been closed with payments in 2001 and 2002. Using those percentages, ARPC calculated the number of future claims by disease category that would likely require payment by Union Carbide and Amchem and multiplied the number of such claims by the mean values paid by Union Carbide and Amchem, respectively, to dispose of such claims in 2001 and 2002. In estimating Union Carbide's cost of resolving pending claims, ARPC used a process similar to that used for calculating the cost of resolving future claims.

12

        As of December 31, 2002, ARPC estimated the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, for the 15-year period from the present through 2017 to be between approximately $2.2 billion and $2.4 billion, depending on which of the two accepted methodologies was used.

        Although ARPC provided estimates for a longer period of time, based on ARPC's advice that forecasts for shorter periods of time are more accurate and in light of the uncertainties inherent in making long-term projections, Union Carbide determined that the 15-year period through 2017 is the reasonable time period for projecting the cost of disposing of its future asbestos-related claims. Union Carbide concluded that it is probable that the undiscounted cost of disposing of asbestos-related pending and future claims ranges from $2.2 billion to $2.4 billion, which is the range for the 15-year period ending in 2017 as estimated by ARPC using both methodologies. Accordingly, Union Carbide increased its asbestos-related liability for pending and future claims at December 31, 2002 to $2.2 billion, excluding future defense and processing costs. At September 30, 2003, Union Carbide's asbestos-related liability for pending and future claims was $2.0 billion.

        Union Carbide also increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion at December 31, 2002, substantially exhausting its asbestos product liability coverage. This resulted in a net income statement impact to Union Carbide of $828 million, $522 million on an after-tax basis, in the fourth quarter of 2002. At September 30, 2003, Union Carbide's receivable for insurance recoveries related to its asbestos liability was $1.2 billion. The insurance receivable related to the asbestos liability was determined by Union Carbide after a thorough review of applicable insurance policies and the 1985 Wellington Agreement, to which Union Carbide and many of its liability insurers are signatory parties, as well as other insurance settlements, with due consideration given to applicable deductibles, retentions and policy limits, and taking into account the solvency and historical payment experience of various insurance carriers. In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement of $219 million at December 31, 2002 and $267 million at September 30, 2003.

        The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon currently known facts. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, coverage issues among insurers, and the continuing solvency of various insurance companies, as well as the numerous uncertainties surrounding asbestos litigation in the United States, could cause the actual costs and insurance recoveries for Union Carbide to be higher or lower than those projected or those recorded.

        In September 2003, Union Carbide filed a comprehensive insurance coverage case in the Circuit Court for Kanawha County in Charleston, West Virginia, seeking to confirm its rights to insurance for various asbestos claims. Although Union Carbide already has settlements in place concerning coverage for asbestos claims with many of its insurers, including those covered by the 1985 Wellington Agreement, this lawsuit was filed against insurers that are not signatories to the Wellington Agreement and/or do not otherwise have agreements in place with Union Carbide regarding their asbestos-related insurance coverage. Union Carbide continues to believe that its recorded receivable for insurance recoveries from all insurance carriers is collectible. Union Carbide reached this conclusion after a further review of its insurance policies, with due consideration given to applicable deductibles, retentions and policy limits, after taking into account the solvency and historical payment experience of various insurance carriers; existing insurance settlements; and the advice of outside counsel with respect to the applicable insurance coverage law relating to the terms and conditions of its insurance policies.

        Union Carbide expenses defense and processing costs as incurred. Accordingly, defense and processing costs incurred by Union Carbide in the future for asbestos-related litigation, net of insurance, will impact Union Carbide's results of operations in future periods.

        Because of the uncertainties described above, Union Carbide's management cannot estimate the full range of the cost of resolving pending and future asbestos-related claims facing Union Carbide and Amchem. Union Carbide's management believes that it is reasonably possible that the cost of disposing of Union Carbide's asbestos-related claims, including future defense and processing costs, could have a material adverse impact on Union Carbide's results of operations and cash flows for a particular period and on the consolidated financial position of Union Carbide.

        It is the opinion of Dow's management that it is reasonably possible that the cost of Union Carbide disposing of its asbestos-related claims, including future defense and processing costs, could have a material adverse impact on the Company's results of operations and cash flows for a particular period and on the consolidated financial position of the Company.

13

Other Litigation Matters

        The U.S., Canadian and European competition authorities have initiated separate investigations into alleged anticompetitive behavior by certain participants in the synthetic rubber industry. DuPont Dow Elastomers L.L.C. ("DDE"), a 50:50 joint venture, and certain Company subsidiaries (but as to the investigation in Europe only) have responded, or are in the process of responding, to requests for documents and are otherwise cooperating in the investigations. Separately, related civil actions have been filed in various U.S. federal and state courts. Certain of these actions have named the Company. Although these investigations and related litigation are still at an early stage, it is probable that a loss will be incurred at DDE, but it is impossible at this time to estimate the range or amount.

        In addition to the breast implant, DBCP and environmental remediation matters, and as disclosed in the preceding paragraph, 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.

Summary

        Except for the possible effect of Union Carbide's asbestos-related liability described above and the possible effect on the Company's net income for breast implant litigation, also 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 $293 million in 2002, $221 million in 2001 and $178 million in 2000.

        At December 31, 2002, the Company had various outstanding commitments for take or pay and throughput agreements, including the purchase agreements referred to above, with terms extending from one to 25 years. In general, such commitments were at prices not in excess of current market prices. The fixed and determinable portion of obligations under these purchase commitments at December 31, 2002 are presented in the following table:

        Fixed and Determinable Portion of Take or Pay and
        Throughput Obligations at December 31, 2002

In millions
2003	$	556
2004		511
2005		472
2006		408
2007		407
2008 through expiration of contracts		2,041
Total	$	4,395

        In addition to the take or pay obligations at December 31, 2002, the Company had outstanding purchase commitments which ranged from one to 23 years for steam, electrical power, materials, property and other items used in the normal course of business of approximately $158 million. In general, such commitments were at prices not in excess of current market prices. At December 31, 2002, the Company was also committed to lease manufacturing facilities under construction in The Netherlands and a pipeline under construction in Germany. At September 30, 2003, the Company was also committed to lease manufacturing facilities under construction in Germany.

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Guarantees

        The Company provides a variety of guarantees, as described more fully in the following sections.

Guarantees

        Guarantees arise during the ordinary course of business from relationships with customers and nonconsolidated affiliates when the Company undertakes an obligation to guarantee the performance of others (via delivery of cash or other assets) if specified triggering events occur. Non-performance under a contract by the guaranteed party triggers the obligation of the Company. Such non-performance usually relates to commercial obligations or loans.

Residual Value Guarantees

        The Company provides guarantees related to leased assets specifying the residual value that will be available to the lessor at lease termination through sale of the assets to the lessee or third parties.

        The following tables provide a summary of the aggregate terms, maximum future payments and associated liability reflected in the consolidated balance sheets for each type of guarantee:

Guarantees at September 30, 2003

In millions	Final Expiration	Maximum Future Payments		Recorded Liability
Guarantees	2009	$	783	—
Residual value guarantees	2017		1,861	—
Total		$	2,644	—

Guarantees at December 31, 2002

In millions	Final Expiration	Maximum Future Payments		Recorded Liability
Guarantees	2009	$	928	—
Residual value guarantees	2017		1,694	—
Total		$	2,622	—

15

NOTE G—VARIABLE INTEREST ENTITIES

        At the beginning of 2003, Dow had operating leases with nine special purpose entities that qualified as variable interest entities ("VIEs") under FIN No. 46, "Consolidation of Variable Interest Entities." Seven of the VIEs were dissolved during the second quarter of 2003, and the rights and obligations of the dissolved VIEs under the existing lease agreements were assumed by lessors that do not qualify as VIEs.

        During the second quarter of 2003, Dow terminated its lease of an ethylene facility in The Netherlands with a VIE and entered into a lease with a new owner trust, which qualifies as a VIE. Dow is not the primary beneficiary of the owner trust and is, therefore, not required to consolidate the owner trust. At September 30, 2003, the facility was valued at $394 million. Upon expiration of the lease, which matures in 2014, Dow may purchase the facility for an amount based upon a fair market value determination. At September 30, 2003, Dow had provided to the owner trust a residual value guarantee of $363 million, which represents Dow's maximum exposure to loss under the lease. Given the productive nature of the facility, it is probable that the facility will have continuing value to Dow or the owner trust in excess of the residual value guarantee.

        Dow has an operating lease with an entity that qualifies as a VIE under FIN No. 46. The VIE, which was established in 1998, is a foreign company that leases ethylene and polyethylene manufacturing facilities in Argentina. Based on the terms of the lease agreement, which matures in 2017, and the residual value guarantee Dow provides to the lessor, the Company will be the primary beneficiary of the VIE, as defined in FIN No. 46. As a result, if the facts and circumstances remain the same, Dow will be required to consolidate the assets of $495 million and liabilities of $523 million held by the VIE at December 31, 2003. Upon adoption of FIN No. 46, accumulated depreciation expense of $28 million (after tax and minority interest) will be included in "Cumulative effect of changes in accounting principles." Upon termination or expiration of the lease, Dow may return the assets to the lessor, renew the lease, or purchase the assets for an amount based on a fair market value determination. Dow had provided a residual value guarantee to the lessor of $455 million at September 30, 2003 and December 31, 2002, which represents Dow's maximum exposure to loss under the lease. Given the productive nature of the assets, it is probable they will have continuing value to Dow or another company in excess of the residual value guarantee.

        In September 2001, Hobbes Capital S.A. ("Hobbes"), a consolidated foreign subsidiary of the Company, issued $500 million of preferred securities in the form of equity certificates. The certificates provide a floating rate return (which may be reinvested) based on London Interbank Offered Rate ("LIBOR"), and may be redeemed in 2008 and at seven-year intervals thereafter. The equity certificates have been classified as "Preferred Securities of Subsidiaries" in the consolidated balance sheets. The preferred return is included in "Minority interests' share in income" in the consolidated statements of income. Reinvested preferred returns are included in "Minority Interest in Subsidiaries" in the consolidated balance sheets. Hobbes qualifies as a VIE under FIN No. 46 and the Company will be the primary beneficiary of the VIE. Accordingly, upon adoption of FIN No. 46, Hobbes will continue to be a consolidated subsidiary.

NOTE H—ASSET RETIREMENT OBLIGATIONS

        In accordance with SFAS No. 143, "Accounting for Asset Retirement Obligations," the Company has recognized asset retirement obligations related to demolition and remediation activities at manufacturing sites in the United States, Germany, France and The Netherlands. In addition, the Company has recognized obligations related to capping activities at landfill sites in the United States, Canada and Brazil. At September 30, 2003, the aggregate carrying amount of asset retirement obligations recognized by the Company was $41 million. These obligations are included in the consolidated balance sheets as "Other noncurrent obligations."

        If the asset retirement obligation measurement and recognition provisions of SFAS No. 143 had been in effect on January 1, 2002, the aggregate carrying amount of those obligations on that date would have been $46 million. If the amortization of asset retirement cost and accretion of asset retirement obligation provisions of SFAS No. 143 had been in effect during 2001 and 2002, the impact on "Income before Cumulative Effect of Changes in Accounting Principles" and "Net Income Available for Common Stockholders" each year would have been immaterial. Further, the impact on earnings per common share (both basic and diluted) would have been less than $0.01 per share each year.

16

NOTE I—STOCK-BASED COMPENSATION

Prior to 2003, the Company accounted for its stock-based compensation plans (which include stock options, deferred stock grants, and subscriptions to purchase shares under the Company's Employees' Stock Purchase Plan ("ESPP")) using the intrinsic value method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Given the terms of the Company's plans, no compensation cost was recognized for its stock option plans or the ESPP in prior periods.

        Effective January 1, 2003, the Company began expensing stock-based compensation newly issued in 2003 to employees in accordance with the fair value based method of accounting set forth in SFAS No. 123, "Accounting for Stock-Based Compensation." The fair value of equity instruments issued to employees is measured on the date of grant and recognized as compensation expense over the applicable vesting period. The Company estimates the fair value of stock options and subscriptions to purchase shares under the ESPP using a binomial option-pricing model. The weighted-average assumptions used to calculate total stock-based compensation expense for 2003 and the pro forma results provided below for 2002 were as follows:

	Three Months Ended				Nine Months Ended
	Sept. 30, 2003		Sept. 30, 2002		Sept. 30, 2003		Sept. 30, 2002
Dividend yield	2.19	%	4.48	%	3.89	%	4.40	%
Expected volatility	38.99	%	38.11	%	41.09	%	42.75	%
Risk-free interest rate	0.98	%	3.14	%	2.28	%	4.18	%
Expected life of stock option plans	5 years		7 years		5 years		7 years
Expected life of stock purchase plan	0.67 years		0.83 years		0.67 years		0.83 years

        The following table provides pro forma results as if the fair value based method had been applied to all outstanding and unvested awards, including stock options, deferred stock grants, and subscriptions to purchase shares under the ESPP, in each period:

		Three Months Ended						Nine Months Ended
In millions, except per share amounts		Sept. 30, 2003			Sept. 30, 2002			Sept. 30, 2003			Sept. 30, 2002
Net income, as reported		$	332		$	128		$	801		$	471
Add: Stock-based compensation expense         included in reported net income,         net of tax			10			3			21			10
Deduct: Total stock-based compensation         expense determined using fair         value based method for         all awards, net of tax			(19	)		(26	)		(57	)		(81	)
Pro forma net income		$	323		$	105		$	765		$	400
Earnings per share:
	Basic—as reported	$	0.36		$	0.14		$	0.87		$	0.52
	Basic—pro forma		0.35			0.12			0.83			0.44
	Diluted—as reported		0.36			0.14			0.87			0.51
	Diluted—pro forma		0.35			0.11			0.83			0.44

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NOTE J—OPERATING SEGMENTS AND GEOGRAPHIC AREAS

		Three Months Ended						Nine Months Ended
In millions		Sept. 30, 2003			Sept. 30, 2002			Sept. 30, 2003			Sept. 30, 2002
Operating segment sales
	Performance Plastics	$	1,966		$	1,815		$	5,721		$	5,369
	Performance Chemicals		1,399			1,316			4,174			3,877
	Agricultural Sciences		623			551			2,318			2,082
	Plastics		1,890			1,667			5,741			4,783
	Chemicals		1,098			917			3,195			2,463
	Hydrocarbons and Energy		939			711			2,883			1,779
	Unallocated and Other		62			107			268			295
	Total	$	7,977		$	7,084		$	24,300		$	20,648
Operating segment EBIT (1)
	Performance Plastics	$	199		$	140		$	498		$	532
	Performance Chemicals		233			172			540			535
	Agricultural Sciences		42			(25	)		405			190
	Plastics		155			170			451			214
	Chemicals		82			38			217			(30	)
	Hydrocarbons and Energy		19			9			6			50
	Unallocated and Other		(66	)		(103	)		(310	)		(308	)
	Total	$	664		$	401		$	1,807		$	1,183
Geographic area sales
	United States	$	3,124		$	2,843		$	9,622		$	8,467
	Europe		2,649			2,384			8,519			6,898
	Rest of World		2,204			1,857			6,159			5,283
	Total	$	7,977		$	7,084		$	24,300		$	20,648

(1)

Dow uses "Earnings before Interest, Income Taxes and Minority Interests" ("EBIT") as its measure of profit/loss for segment reporting purposes. EBIT includes all operating items relating to the businesses and excludes items that principally apply to the Company as a whole. A reconciliation of EBIT to "Net Income Available for Common Stockholders" is provided below:

	Three Months Ended				Nine Months Ended
In millions	Sept. 30, 2003		Sept. 30, 2002		Sept. 30, 2003			Sept. 30, 2002
EBIT	$	664	$	401	$	1,807		$	1,183
Interest income		22		13		60			43
Interest expense and amortization of     debt discount		204		194		626			571
Provision for income taxes		127		67		360			202
Minority interests' share in income		23		25		71			49
Cumulative effect of changes in accounting     principles		—		—		(9	)		67
Net Income Available for Common Stockholders	$	332	$	128	$	801		$	471

18

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, 2003 and 2002:

	Three Months Ended						Nine Months Ended
In millions, except per share amounts	Sept. 30, 2003			Sept. 30, 2002			Sept. 30, 2003			Sept. 30, 2002
Sales	$	7,977		$	7,084		$	24,300		$	20,648
Cost of sales		6,861			6,049			20,994			17,435
% of sales		86	%		85	%		86	%		84	%
Research and development, and selling, general     and administrative expenses		581			651			1,773			1,969
% of sales		7	%		9	%		7	%		10	%
Effective tax rate		26.3	%		30.5	%		29.0	%		30.8	%
Net income available for common stockholders	$	332		$	128		$	801		$	471
Earnings per common share—basic	$	0.36		$	0.14		$	0.87		$	0.52
Earnings per common share—diluted	$	0.36		$	0.14		$	0.87		$	0.51
Operating rate percentage		84	%		80	%		81	%		79	%

        Net sales for the third quarter of 2003 were $8.0 billion, up 13 percent from $7.1 billion in the third quarter of last year. Prices improved 8 percent, due to increasing feedstock and energy costs, and the favorable impact of currency on sales in Europe, while volume grew 5 percent, reflecting some improvement in economic conditions (see Sales Volume and Price table on page 24). Compared with last year, prices were up in all geographic areas and all businesses. Volume, up in all geographic areas, improved in all segments except Performance Chemicals, which was flat versus the third quarter of last year. Volume was especially strong in Asia Pacific, where demand has recovered in China. Year to date, net sales were $24.3 billion, up 18 percent from $20.6 billion in the first nine months of 2002 on a 15 percent increase in selling prices and 3 percent volume growth.

        Operating expenses (research and development, and selling, general and administrative expenses) were $581 million in the third quarter of 2003, down $70 million or 11 percent, from $651 million in the third quarter of last year. Expenses declined as the Company continued its cost control efforts and as spending for growth initiatives was focused on those opportunities with the greatest potential for value creation. For the first nine months of the year, operating expenses totaled $1,773 million, down 10 percent from $1,969 million for the same period last year.

19

        Net income for the third quarter of 2003 was $332 million or $0.36 per share, compared with $128 million or $0.14 per share for the third quarter of 2002. Compared with the same period last year, net income for the quarter improved as higher selling prices, increased volume, lower operating expenses, improved equity earnings and several small gains on sales of non-strategic assets more than offset higher feedstock and energy costs of approximately $465 million and the negative impact of currency on cost. Net income in the third quarter of last year was negatively impacted by the following items, reflected in "Merger-related expenses and restructuring:" additional pretax expenses of $27 million related to the Union Carbide merger (reflected in Unallocated and Other); and pretax severance of $5 million related to a workforce reduction program at Dow AgroSciences (reflected in the Agricultural Sciences segment).

        Net income for the first nine months of 2003 was $801 million or $0.87 per share, compared with $471 million or $0.51 per share for the same period of 2002. Year-to-date net income for 2003 was reduced by an after-tax charge of $9 million related to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations" (reflected in "Cumulative effect of changes in accounting principles"). Despite a $2.4 billion increase in feedstock and energy costs, the negative impact of currency on cost, and asset impairments of approximately $60 million in the first quarter of this year, net income improved significantly from last year due to higher selling prices, volume growth, continued cost control efforts, improved equity earnings and several small gains on sales of non-strategic assets.

        Last year, net income for the first nine months of the year was impacted by several items: additional pretax expenses of $50 million related to the Union Carbide merger (reflected in "Merger-related expenses and restructuring" in Unallocated and Other); pretax severance of $5 million related to a workforce reduction program at Dow AgroSciences (reflected in "Merger-related expenses and restructuring" in the Agricultural Sciences segment); pretax goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates (reflected in "Equity in earnings of nonconsolidated affiliates" in Unallocated and Other); a $10 million pretax restructuring charge (Dow's share) recorded by UOP LLC in the second quarter (reflected in "Equity in earnings of nonconsolidated affiliates" in the Performance Plastics segment); and a net after-tax gain of $67 million related to the adoption of two new accounting standards (SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets").

        The following tables show the impact of certain items recorded in the three-month and nine-month periods ended September 30, 2003 and 2002:

	Pretax Impact(1)				Impact on Net Income(2)
	Three Months Ended				Three Months Ended
In millions	Sept. 30, 2003	Sept. 30, 2002			Sept. 30, 2003	Sept. 30, 2002
Merger-related expenses and restructuring	—	$	(32	)	—	$	(20	)
Total	—	$	(32	)	—	$	(20	)

	Pretax Impact(1)				Impact on Net Income(2)
	Nine Months Ended				Nine Months Ended
In millions	Sept. 30, 2003	Sept. 30, 2002			Sept. 30, 2003			Sept. 30, 2002
Merger-related expenses and restructuring	—	$	(55	)		—		$	(35	)
Goodwill impairment losses in nonconsolidated affiliates	—		(16	)		—			(16	)
UOP restructuring	—		(10	)		—			(7	)
Cumulative effect of changes in accounting principles	—		—		$	(9	)		67
Total	—	$	(81	)	$	(9	)	$	9

(1)

Impact on "Income before Income Taxes and Minority Interests"

(2)

Impact on "Net Income Available for Common Stockholders"

20

SEGMENT RESULTS

        Dow uses "Earnings before Interest, Income Taxes and Minority Interests" ("EBIT") as its measure of profit/loss for segment reporting purposes. EBIT includes all operating items relating to the businesses and excludes items that principally apply to the Company as a whole. A reconciliation of EBIT to "Net Income Available for Common Stockholders" is provided below:

	Three Months Ended				Nine Months Ended
In millions	Sept. 30, 2003		Sept. 30, 2002		Sept. 30, 2003			Sept. 30, 2002
EBIT	$	664	$	401	$	1,807		$	1,183
Interest income		22		13		60			43
Interest expense and amortization of debt discount		204		194		626			571
Provision for income taxes		127		67		360			202
Minority interests' share in income		23		25		71			49
Cumulative effect of changes in accounting principles		—		—		(9	)		67
Net Income Available for Common Stockholders	$	332	$	128	$	801		$	471

PERFORMANCE PLASTICS

        Performance Plastics sales were $1,966 million for the third quarter of 2003, up 8 percent from $1,815 million in the third quarter of 2002. Prices increased 6 percent, including the favorable impact of currency in Europe, and volume was up 2 percent. EBIT for the segment was $199 million in the third quarter, up from $140 million in the same period of last year, as the impact of higher selling prices more than offset higher raw material costs.

        Dow Automotive sales for the third quarter of 2003 were up 7 percent from the same quarter of 2002. Prices rose 5 percent, favorably impacted by the strengthening Euro, while volume increased 2 percent. Volume growth, especially strong in Asia Pacific and Europe, was aided by continued solid product performance from structural adhesives and STRANDFOAM plastic foam. EBIT for the business was down from last year as higher raw material costs offset the benefit of higher selling prices and improved volume.

        Engineering Plastics sales for the quarter were up 24 percent versus the third quarter of 2002, due to a 20 percent improvement in volume and a 4 percent increase in prices. Volume was particularly strong for ABS resins in Europe and Asia Pacific, due to strong demand in the appliance, information technology and automotive industries. Prices were favorably impacted by the strengthening of the Euro. Compared with last year, EBIT for the quarter improved as higher volumes and lower operating costs offset the impact of higher raw material costs.

        Sales of Epoxy Products and Intermediates for the third quarter were up 10 percent from last year, as prices rose 6 percent and volume grew 4 percent. Contributing to the overall improvement in prices were increases for epichlorohydrin. The increase in volume was driven by phenolics, while demand within the industrial coatings industry showed signs of improvement. EBIT improved slightly versus the third quarter of 2002 as higher selling prices offset increased raw material costs.

        Fabricated Product sales for the third quarter of 2003 were up 9 percent from a year ago. Prices were up 5 percent, primarily due to the favorable impact of currency in Europe. Volume grew 4 percent, led by an increase in demand for extruded polystyrene foam in North America and Europe. EBIT improved significantly versus the same quarter of 2002 due to higher selling prices, improved volume and a reduction in operating expenses.

        Polyurethanes sales for the quarter were up 6 percent from the third quarter of 2002. Price increases for polyols and methylene diphenyl diisocyanate ("MDI"), driven by increasing feedstock costs, coupled with the favorable impact from currency in Europe, resulted in an 8 percent increase in prices for the business. Compared with last year, volume was down 2 percent, as declines due to operating problems at the Company's toluene diisocyanate ("TDI") plant in Porto Marghera, Italy, and fewer shipments of propylene oxide offset the gains from increased demand for MDI. EBIT improved significantly versus the third quarter of 2002 as higher selling prices offset the impact of increased raw material costs.

        Wire and Cable sales for the quarter were up 12 percent from last year, due to price increases of 7 percent, driven by increasing feedstock costs, and volume growth of 5 percent. Volume improved as demand began to recover within the telecommunication cable industry. Compared with last year, EBIT improved significantly as higher prices and expense reduction initiatives offset higher raw material costs.

21

        For the first nine months of the year, Performance Plastics sales were $5,721 million, up 7 percent from $5,369 million for the same period of last year. Prices increased 10 percent, including the favorable impact of currency in Europe, while volume declined 3 percent. Year to date, EBIT for the segment was $498 million, down from $532 million for the first nine months of 2002 as the impact of higher raw material costs and lower volumes more than offset higher selling prices.

PERFORMANCE CHEMICALS

Performance Chemicals sales for the third quarter of 2003 were $1,399 million, up 6 percent from $1,316 million last year, as prices improved 6 percent, including the impact of currency in Europe. EBIT for the third quarter was $233 million compared with $172 million in the third quarter of 2002. Compared with last year, EBIT improved as higher selling prices, improved equity earnings, and a gain of $47 million on the sale of several product lines of Amerchol Corporation ("Amerchol"), a wholly owned subsidiary, more than offset the impact of higher raw material costs.

        Emulsion Polymers sales for the quarter improved 12 percent compared with the third quarter of 2002 primarily due to increased prices, including the impact of currency in Europe; volume was down 2 percent. For styrene-butadiene latex sold to the coated paper industry, prices improved significantly compared with the third quarter of last year. EBIT for the quarter increased significantly from last year as higher selling prices offset increases in raw material costs.

        Industrial Chemicals sales for the quarter improved 7 percent from the third quarter of last year with a 4 percent increase in price and a 3 percent increase in volume. Both price and volume improved for functional solutions and surfactants in the quarter. Despite higher sales in the quarter, EBIT declined from last year due to an increase in feedstock costs.

        Oxide Derivatives sales for the quarter improved 12 percent compared with the third quarter of 2002. Prices improved 5 percent, including the favorable impact of currency in Europe, as volume increased 7 percent. Price and volume increases were led by improvements in alkanolamines and gylcol ethers. EBIT for the quarter was essentially flat compared with last year as higher raw material costs offset the benefit of higher selling prices, increased volume and improved equity earnings from the OPTIMAL Group.

        Specialty Polymers sales for the quarter improved 5 percent versus the third quarter of 2002. Prices were up 3 percent, primarily due to the favorable impact of currency in Europe. Volume, up 2 percent, remained strong for acrylate and acrylic esters, which set a quarterly volume record. EBIT for the third quarter increased from the same period of last year primarily due to higher selling prices and improved volume.

        Water Soluble Polymers sales for the quarter improved 4 percent compared with the same period of 2002. Prices increased 3 percent versus last year, including the favorable impact of currency in Europe; volume grew 1 percent. Broad-based volume improvement in the United States offset some of the weakness in Europe. While volume was down in the third quarter for hair and skin care products from Amerchol, volume improved for ETHOCEL ethylcellulose resins, METHOCEL cellulose ethers and POLYOX water soluble resins. EBIT for the quarter improved significantly from the third quarter of last year due to the gain of $47 million on the sale of several product lines of Amerchol.

        Performance Chemicals sales were $4,174 million in the first nine months of the year, up 8 percent from $3,877 million in 2002. Prices improved 7 percent, including the impact of currency in Europe, while volume increased 1 percent. EBIT for the first nine months of 2003 was $540 million compared with $535 million last year. Year to date, higher selling prices, volume growth, improved equity earnings and the gain on the sale of several Amerchol products were offset by higher raw material costs.

AGRICULTURAL SCIENCES

        Sales for the Agricultural Sciences segment for the third quarter of 2003 were $623 million, up 13 percent from $551 million last year. Volume was up 6 percent, while prices were up 7 percent, including the favorable impact of currency in Europe. Demand was strong in the quarter for herbicides, led by sulfonamides and haloxyfop, with additional soybean acres planted in Brazil, as well as a delay in the use of herbicides until this quarter. Sales for insecticides were also up, with strong growth from spinosad; sales of LORSBAN insecticides grew due to a grasshopper and aphid outbreak in the United States. In Europe, volume improved due to the strength of the portfolio of products acquired from Rohm and Haas Company in 2001. EBIT for the quarter was $42 million, up from a loss of $25 million in the third quarter of 2002. Higher selling prices, increased volumes and improved plant utilization contributed to the improvement in EBIT. Last year, EBIT was reduced in the third quarter by severance of $5 million related to a workforce reduction program.

        Sales for the Agricultural Sciences segment were $2,318 million in the first nine months of the year, up 11 percent from $2,082 million in 2002. Volume improved 6 percent versus last year, while prices increased 5 percent principally due to the favorable impact of currency in Europe. EBIT for the first nine months of 2003 was $405 million compared with

22

$190 million last year. The year-over-year improvement in EBIT was principally the result of higher selling prices, volume growth and lower operating expenses. EBIT in 2002 was impacted by severance related to a workforce reduction program, an accounts receivable write-down in Argentina and a write-down related to the closure of seed production facilities.

PLASTICS

        Plastics sales for the third quarter of 2003 were $1,890 million, up 13 percent from $1,667 million a year ago, as prices increased 7 percent and volume increased 6 percent. Price increases, driven by escalating feedstock and energy costs, benefited from the strengthening of the Euro. The increase in volume was led by double-digit volume gains in Europe and Latin America, while volume in North America and Asia Pacific was flat. EBIT for the third quarter was $155 million, down from $170 million in the third quarter of 2002, as higher feedstock and energy costs and lower equity earnings from DuPont Dow Elastomers L.L.C. more than offset the favorable impact of higher selling prices, continued cost control efforts and improved volume.

        Polyethylene sales were up significantly from the third quarter of 2002, as prices rose 7 percent and volume grew 9 percent. Price increases, driven by higher feedstock and energy costs, were reported in all geographic areas, except Europe, where prices declined. Volume improved in all geographic areas, with particularly strong growth in Europe and Latin America. EBIT for the quarter improved significantly as higher selling prices, volume growth, ongoing cost control efforts and improved equity earnings from EQUATE Petrochemical Company K.S.C ("EQUATE") more than offset the impact of higher ethylene costs.

        Polypropylene sales for the third quarter of 2003 were up 7 percent compared with the same quarter of last year, as volume increased 5 percent and prices increased 2 percent. Volume improved in all geographic areas, except Europe, where volume declined due to a government-mandated (every five years), six-week shutdown for a safety inspection and maintenance at the Company's German facility, Buna Sow Leuna Olefinverbund ("BSL"). The inspection was completed ahead of schedule with no major issues identified. Overall, prices rose during the quarter as pricing pressure due to declining propylene costs was offset by the favorable impact of currency in Europe. EBIT for the third quarter declined from last year, principally due to the shutdown at BSL.

        Polystyrene sales for the third quarter of 2003 were up slightly as prices improved 6 percent and volume fell 5 percent. Price increases, driven by higher feedstock and energy costs, were reported in all geographic areas, except Europe, where prices declined. Volume was down compared with last year in all geographic areas, except Europe, where demand remained strong. Contributing to the decline, volume was down in Asia Pacific compared with last year due to the October 2002 start-up of SAL Petrochemical (Zhangiagang) Co. Ltd., a 50:50 joint venture in The People's Republic of China, which now supplies local customers. EBIT for the third quarter declined from last year as the benefit of higher selling prices and ongoing cost reduction efforts were more than offset by higher styrene monomer costs.

        Plastics sales for the first nine months of 2003 were $5,741 million, up 20 percent from $4,783 million in 2002. Compared with last year, prices increased 22 percent and volume declined 2 percent. Year to date, EBIT was $451 million, up significantly from $214 million in the first nine months of 2002, as the benefit of higher selling prices and continued cost control efforts more than offset the impact of escalating feedstock and energy costs and lower equity earnings from DuPont Dow Elastomers L.L.C.

CHEMICALS

        Third quarter sales for the Chemicals segment were $1,098 million, up 20 percent from $917 million for the third quarter of last year due to a 12 percent increase in price and an 8 percent increase in volume. Price increases, which continued to be driven by significantly higher feedstock and energy costs, were reported for ethylene glycol ("EG"), caustic soda, and organic intermediates, solvents and monomers ("OISM"), partially offset by declining prices in vinyl chloride monomer ("VCM"). Volume, up for most products in the segment, increased most notably for EG. EBIT for the quarter was $82 million, up from $38 million in the third quarter of 2002. EBIT improved as higher selling prices, increased volume and higher equity earnings from EQUATE more than offset the impact of higher feedstock and energy costs.

        For the first nine months of 2003, sales for the Chemicals segment were $3,195 million, up 30 percent from $2,463 million last year, as prices rose 26 percent and volume grew 4 percent. EBIT for the first nine months of the year was $217 million compared with a loss of $30 million for the same period last year. Year to date, EBIT improved as significant increases in selling prices, higher volume, and improved equity earnings more than offset the sharp increase in feedstock and energy costs.

23

HYDROCARBONS AND ENERGY

        Hydrocarbons and Energy sales for the quarter were $939 million, up 32 percent from $711 million in the third quarter of 2002 due to a 22 percent increase in volume and a 10 percent increase in selling prices. Volume increased in part this quarter due to higher sales of byproducts, the result of a change in the mix of feedstocks in the Company's hydrocarbon crackers, and higher sales of monomers. Year to date, sales for the segment were $2,883 million, up significantly from $1,779 million in the same period of 2002 due to significant increases in both selling prices and volume. Increases in selling prices during the year were driven by rising feedstock costs.

        The Hydrocarbons and Energy business transfers materials to Dow's derivative businesses at cost. Hydrocarbon and Energy EBIT for the quarter was $19 million, compared with $9 million in the third quarter of last year. EBIT for the first nine months of 2003 was $6 million, compared with $50 million last year.

UNALLOCATED AND OTHER

        Included in the results for Unallocated and Other are:

•

expenses related to new business development activities,



•

overhead and other cost recovery variances not allocated to the operating segments,



•

results of insurance operations,



•

gains and losses on sales of financial assets,



•

foreign exchange hedging results,



•

Dow's share of the earnings/losses of Dow Corning Corporation ("Dow Corning") and Cargill Dow Polymers LLC ("Cargill Dow"), and



•

the results of several small diversified businesses acquired in Dow's acquisition of Sentrachem Limited.

        EBIT for the third quarter of 2003 was a loss of $66 million compared with a loss of $103 million in the third quarter of 2002. EBIT for the third quarter of last year was reduced by additional merger-related expenses of $27 million.

        For the first nine months of 2003, EBIT for Unallocated and Other was a loss of $310 million compared with a loss of $308 million for the same period of 2002. While EBIT for the first nine months of 2003 was favorably impacted by higher equity earnings from Dow Corning, results were unfavorably impacted by costs associated with decisions made in the first quarter relative to under-performing and non-strategic assets (the write-down of Union Carbide's chemical transport vessel, sold in the second quarter of 2003, of $11 million and the write-off of cancelled capital projects totaling $12 million), lower equity earnings from Cargill Dow, and higher asbestos-related litigation expenses at Union Carbide. Results for Unallocated and Other for the first nine months of 2002 included the unfavorable impact of merger-related expenses of $50 million, goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates, and the unfavorable impact of the devaluation of the Argentine peso.

Sales Volume and Price by Operating Segment and Geographic Area

		Three Months Ended Sept. 30, 2003					Nine Months Ended Sept. 30, 2003
Percentage change from prior year
		Volume		Price		Total	Volume		Price		Total
Operating segments
	Performance Plastics	2	%	6	%	8%	(3	)%	10	%	7	%
	Performance Chemicals	—		6	%	6%	1	%	7	%	8	%
	Agricultural Sciences	6	%	7	%	13%	6	%	5	%	11	%
	Plastics	6	%	7	%	13%	(2	)%	22	%	20	%
	Chemicals	8	%	12	%	20%	4	%	26	%	30	%
	Hydrocarbons and Energy	22	%	10	%	32%	31	%	31	%	62	%
	Total	5	%	8	%	13%	3	%	15	%	18	%
Geographic area sales
	United States	4	%	6	%	10%	3	%	11	%	14	%
	Europe	5	%	6	%	11%	2	%	21	%	23	%
	Rest of World	8	%	11	%	19%	4	%	13	%	17	%
	Total	5	%	8	%	13%	3	%	15	%	18	%

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COMPANY SUMMARY

Operating Rate

        The Company's global plant operating rate for its chemicals and plastics businesses was 84 percent in the third quarter of 2003, compared with 80 percent in the third quarter of 2002.

Equity in Earnings of Nonconsolidated Affiliates

        Dow's share of the earnings of nonconsolidated affiliates was $74 million in the third quarter of 2003, compared with $47 million in the same quarter last year. Equity earnings increased primarily due to stronger results from EQUATE, the OPTIMAL Group, and Compania Mega S.A., partially offset by a decline in results from DuPont Dow Elastomers L.L.C.

        For the first nine months of 2003, equity earnings were $203 million compared with $42 million in the first nine months of 2002. In addition to the joint ventures previously mentioned, improved results from Univation Technologies, LLC and Dow Corning contributed to the improvement in year-to-date equity earnings compared with the first nine months of 2002. Additionally, equity earnings in 2002 were negatively impacted by goodwill impairment losses of $16 million related to investments in nonconsolidated affiliates and a $10 million restructuring charge (Dow's share) recorded by UOP LLC.

Sundry Income (Expense)—Net

        Sundry income (expense) includes a variety of income and expense items such as the gain or loss on foreign currency exchange, dividends from investments, and gains and losses on sales of investments and assets. Sundry income (expense) for the third quarter of 2003 was net income of $69 million compared with $18 million in the third quarter of 2002. Sundry income (expense) in the third quarter increased from last year principally due to several small gains on sales of non-strategic assets, including a gain of $47 million on the sale of several product lines of Amerchol. Year-to-date, Sundry income (expense) was net income of $115 million compared with $1 million for the first nine months of 2002. Sundry income (expense) in 2003 was impacted by gains on sales of non-strategic assets and a favorable swing in foreign currency exchange from 2002, primarily due to the devaluation of the Argentine peso in the first quarter of last year.

Net Interest Expense

        Net interest expense (interest expense less capitalized interest and interest income) was $182 million in the third quarter of 2003 compared with $181 million in the third quarter of last year. Year to date, net interest expense was $566 million, up from $528 million for the first nine months of 2002. Net interest expense in 2003 increased due to an increase in total debt.

Provision for Taxes on Income

        The effective tax rate for the third quarter was 26.3 percent, versus 30.5 percent for the third quarter of 2002. The effective tax rate for the first nine months of the year was 29.0 percent, compared with 30.8 percent for the same period 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.

Outlook

        Feedstock and energy costs are expected to remain high and volatile during the fourth quarter and to increase compared with the third quarter, with increases in both crude oil and natural gas. Crude oil prices rose sharply in October and will continue to be impacted by geopolitical events. Natural gas inventories are expected to enter the winter season at average levels, but prices in the fourth quarter will be influenced by weather. Assuming normal weather patterns, natural gas prices are expected to move higher over the next quarter. The average price for crude oil in the fourth quarter is expected to be higher than in the third quarter. The current industry pricing environment continues to be challenging. Supply/demand balances should improve with the recovery of demand through stronger economic activity. Much tighter supply/demand balances are anticipated over the next few years.

        Moving into the fourth quarter, there is some positive momentum for plastics prices, but it remains to be seen whether these increases will be fully realized. Fourth quarter volumes are typically down from third quarter, with the slowdown in building and construction and the impact of year-end shutdowns at many of our customers. With the current challenging environment, the profit outlook for the fourth quarter is uncertain. With possible margin compression and a normal seasonal slowdown, it will be very challenging for Dow to match third quarter results in the fourth quarter. However, earnings are expected to be substantially better than the fourth quarter of last year as the Company continues to implement its financial improvement program.

25

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, 2003			Sept. 30, 2002
Cash provided by (used in):
	Operating activities	$	2,730		$	1,343
	Investing activities		(792	)		(1,093	)
	Financing activities		(931	)		34
	Effect of exchange rate changes on cash		75			(4	)
Net change in cash and cash equivalents		$	1,082		$	280

        Cash provided by operating activities increased in the first nine months of 2003 compared with the first nine months of 2002, primarily due to improved earnings, the securitization of European trade receivables, the collection of amounts due on noncurrent receivables and the collection of an income tax refund.

        Cash used in investing activities decreased in the first nine months of 2003 compared with the first nine months of 2002, primarily due to a reduction in capital expenditures. An increase in the proceeds from sales of businesses, primarily the sale of several product lines of Amerchol, contributed to the decrease in cash used in investing activities versus the first nine months of 2002.

        Cash used in financing activities increased in the first nine months of 2003 principally due to a reduction in the amount of proceeds from the issuance of long-term debt, combined with net higher payments to reduce short- and long-term debt.

        The following tables present working capital, total debt and certain balance sheet ratios at September 30, 2003 versus December 31, 2002:

Working Capital In millions		Sept. 30, 2003			Dec. 31, 2002
Current assets		$	12,241		$	11,375
Current liabilities			9,153			8,856
Working capital		$	3,088		$	2,519
Current ratio			1.34:1			1.28:1
Days-sales-outstanding-in-receivables			42			45
Days-sales-in-inventory			60			64
Total Debt In millions		Sept. 30, 2003			Dec. 31, 2002
Notes payable		$	371		$	580
Long-term debt due within one year			1,086			797
Long-term debt			11,695			11,659
	Total debt	$	13,152		$	13,036
Gross debt as a percent of total capitalization			58.5	%		59.2	%
Net debt* as a percent of total capitalization			53.0	%		56.0	%

*

Net debt equals total debt minus cash, cash equivalents, marketable
securities, and interest-bearing deposits.

        As part of its ongoing financing activities, Dow routinely issues promissory notes under its U.S. and Euromarket commercial paper programs. At September 30, 2003, there were no commercial paper borrowings outstanding. In the event Dow is unable to access these short-term markets, due to a systemic disruption or other extraordinary events, Dow has the ability to access liquidity through its committed and available credit facilities with various U.S. and foreign banks totaling $3.0 billion in support of its working capital requirements and commercial paper borrowings. These facilities include a $1.75 billion 364-day revolving credit facility and a $1.25 billion 5-year revolving credit facility that mature in June 2004. Additional unused credit facilities totaling $871 million were available for use by foreign subsidiaries.

26

        At September 30, 2003, the Company had $1,955 million of SEC-registered securities available for issuance under a shelf registration, as well as Euro 500 million (approximately $582 million) available for issuance under the Company's Euro Medium Term Note Program. On June 26, 2003, the Company filed a registration statement on Form S-3 with the SEC for an additional $1.5 billion of registered securities. This registration statement has not yet been declared effective by the SEC.

        On June 21, 2002, the Company launched a U.S. retail Medium-Term Note Program under which the Company has issued a total of $826 million in notes to date, including $366 million issued during the first nine months of 2003, with maturity dates ranging from 2005 through 2013.

        On January 31, 2003, Moody's Investor Services reaffirmed the Company's senior unsecured debt rating of "A3" and its short-term debt rating of "Prime-2," but changed its ratings outlook to "negative." On February 3, 2003, Fitch, Inc. lowered the Company's senior unsecured debt rating from "A" to "A-" and its short-term debt rating from "F1" to "F2" and maintained its rating outlook as negative. On March 14, 2003, Standard & Poor's lowered the Company's senior unsecured debt rating from "A" to "A-" and its short-term debt rating from "A1" to "A2" and maintained its rating outlook as "negative." The Company's ability to access credit facilities has not been affected as a result of these changes, although over time, the Company may incur marginally higher borrowing costs.

        Dow leases real property, railcars, and certain manufacturing facilities from various entities. These entities are not owned directly or indirectly by the Company or any of its directors, officers or employees. Those transactions that meet the requirements for operating lease treatment under SFAS No. 13, "Accounting for Leases," are recorded as such. For further discussion, including information regarding future minimum lease commitments, see Note M to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

        Dow has an operating lease with an entity that qualifies as a variable interest entity ("VIE") under FASB Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities." The VIE, which was established in 1998, is a foreign company that leases ethylene and polyethylene manufacturing facilities in Argentina. Based on the terms of the lease agreement, which matures in 2017, and the residual value guarantee Dow provides to the lessor, the Company will be the primary beneficiary of the VIE, as defined in FIN No. 46. As a result, if the facts and circumstances remain the same, Dow will be required to consolidate the assets of $495 million and liabilities of $523 million held by the VIE at December 31, 2003. Upon adoption of FIN No. 46, accumulated depreciation expense of $28 million (after tax and minority interest) will be included in "Cumulative effect of changes in accounting principles."

        Upon termination or expiration of the leases, Dow may return the assets to the lessors, renew the leases, or purchase the assets for an amount based on a fair market value determination. Dow had provided residual value guarantees totaling $1,861 million, which included $455 million related to the VIE, at September 30, 2003 and $1,694 million, which included $455 million related to the VIE, at December 31, 2002, to the various lessors. Given the productive nature of the assets, it is probable they will have continuing value to Dow or another company in excess of the residual value guarantees.

        The Company also had outstanding guarantees at September 30, 2003. Additional information related to these guarantees can be found in the "Guarantees" table provided in Note F to the Consolidated Financial Statements.

        Following the FASB's issuance of SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," in May 2003, the Company evaluated the preferred securities previously issued by two consolidated subsidiaries and concluded that the $500 million of preferred partnership units issued by Tornado Finance V.O.F. ("Tornado") is within the scope of the standard and was classified as a liability of the Company on July 1, 2003; however, the rights of the holders of Tornado's preferred partnership units were subsequently modified to eliminate the unconditional mandatory redemption feature. Therefore, the preferred partnership units were classified as "Preferred Securities of Subsidiaries in the consolidated balance sheet at September 30, 2003. See Note B for additional information regarding SFAS No. 150. See Note P to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 for additional information.

        On October 30, 2003, the Company paid a quarterly dividend of $0.335 per share to shareholders of record on September 30, 2003. Since 1912, the Company has paid a dividend every quarter and in each instance Dow has maintained or increased the dividend.

27

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 of America ("GAAP") 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, 2002 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Following are the Company's critical accounting policies impacted by judgments, assumptions and estimates:

Litigation

        The Company is subject to legal proceedings and claims arising out of the normal course of business. The Company routinely assesses the likelihood of any adverse judgments or outcomes to these matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an analysis of historical claims experience for incurred but not reported matters. Dow has an active risk management program consisting of numerous insurance policies secured from many carriers. These policies provide coverage that is utilized to minimize the impact, if any, of the legal proceedings. The required reserves may change in the future due to new developments in each matter. For further discussion, see Note F to the Consolidated Financial Statements.

Asbestos-Related Matters of Union Carbide Corporation

        Union Carbide Corporation ("Union Carbide"), a wholly owned subsidiary of the Company, is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. At the end of 2001 and through the third quarter of 2002, Union Carbide had concluded it was not possible to estimate its cost of disposing of asbestos-related claims that might be filed against Union Carbide and Amchem Products, Inc. ("Amchem") in the future due to a number of reasons, including its lack of sufficient comparable loss history from which to assess either the number or value of future asbestos-related claims. During the third and fourth quarters of 2002, Union Carbide worked with Analysis, Research & Planning Corporation ("ARPC"), a consulting firm with broad experience in estimating resolution costs associated with mass tort litigation including asbestos to explore whether it would be possible to estimate the cost of disposing of pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Union Carbide and Amchem.

        In projecting Union Carbide's resolution costs for future asbestos-related claims, ARPC applied two methodologies that have been widely used for forecasting purposes. As of December 31, 2002, ARPC estimated the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, for the 15-year period from the present through 2017 to be between approximately $2.2 billion and $2.4 billion, depending on which of the two accepted methodologies was used.

        Although ARPC provided estimates for a longer period of time, based on ARPC's advice that forecasts for shorter periods of time are more accurate and in light of the uncertainties inherent in making long-term projections, Union Carbide determined that the 15-year period through 2017 is the reasonable time period for projecting the cost of disposing of its future asbestos-related claims. Union Carbide concluded that it is probable that the undiscounted cost of disposing of asbestos-related pending and future claims ranges from $2.2 billion to $2.4 billion, which is the range for the 15-year period ending in 2017 as estimated by ARPC using both methodologies. Accordingly, Union Carbide increased its asbestos-related liability for pending and future claims at December 31, 2002 to $2.2 billion, excluding future defense and processing costs. At September 30, 2003, Union Carbide's asbestos-related liability for pending and future claims was $2.0 billion.

        Union Carbide also increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion at December 31, 2002. At September 30, 2003, Union Carbide's receivable for insurance recoveries related to its asbestos liability was $1.2 billion. In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement of $219 million at December 31, 2002 and $267 million at September 30, 2003. The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon currently known facts. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, coverage issues among insurers, and the continuing

28

solvency of various insurance companies, as well as the numerous uncertainties surrounding asbestos litigation in the United States, could cause the actual costs and insurance recoveries for Union Carbide to be higher or lower than those projected or those recorded. Union Carbide expenses defense and processing costs as incurred. Accordingly, defense and processing costs incurred by Union Carbide in the future for asbestos-related litigation, net of insurance, will impact Union Carbide's results of operations in future periods. For additional information, see Asbestos-Related Matters of Union Carbide Corporation in Management's Discussion and Analysis of Financial Condition and Results of Operations and Note F to the Consolidated Financial Statements.

Environmental Matters

        The Company determines the costs of environmental remediation of its facilities and formerly owned facilities based on evaluations of current law and existing technologies. Inherent uncertainties exist in such evaluations primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies. The recorded liabilities are adjusted periodically as remediation efforts progress or as additional technical or legal information becomes available. The Company had accrued obligations of $394 million at December 31, 2002, for environmental remediation and restoration costs, including $43 million for the remediation of Superfund sites. At September 30, 2003, the Company had accrued obligations of $378 million for environmental remediation and restoration costs, including $35 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. For further discussion, see Note F to the Consolidated Financial Statements in this filing and Environmental Matters in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

Pension and Other Postretirement Benefits

        The amounts recognized in the consolidated financial statements related to pension and other postretirement benefits are determined from actuarial valuations. Inherent in these valuations are assumptions including expected return on plan assets, discount rates at which the liabilities could be settled at December 31, 2002, rate of increase in future compensation levels, mortality rates and health care cost trend rates. These assumptions are updated annually and are disclosed in Note L to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. In accordance with GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, affect expense recognized and obligations recorded in future periods.

        The expected long-term rate of return on assets is developed with input from the Company's actuarial firm, which includes the actuary's review of the asset class return expectations of several respected consultants and economists, based on broad equity and bond indices. The Company's historical experience with the pension fund asset performance and comparisons to expected returns of peer companies with similar fund assets is also considered. The long-term rate of return assumption used for determining net periodic pension expense for 2002 was 9.25 percent. This assumption was reduced to 9 percent for determining 2003 net periodic pension expense. Lowering the expected long-term rate of return of the U.S. qualified plan assets by 0.25 percent (from 9.25 percent to 9 percent) would have reduced the pension income of the U.S. qualified plans for 2002 by approximately $25 million. The Company's historical actual return averaged 9.1 percent for the ten-year period ending December 31, 2002. Future actual pension expense will depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in the Company's pension plans.

        The Company bases the determination of pension expense or income on a market-related valuation of plan assets, which reduces year-to-year volatility. This market-related valuation recognizes investment gains or losses over a five-year period from the year in which they occur. Investment gains or losses for this purpose represent the difference between the expected return calculated using the market-related value of plan assets and the actual return based on the market value of plan assets. Since the market-related value of plan assets recognizes gains or losses over a five-year period, the future value of plan assets will be impacted when previously deferred gains or losses are recorded. Over the life of the plan, both gains and losses have been recognized and amortized. For the year ending December 31, 2002, $1.2 billion of losses remain to be recognized by the U.S. qualified plans in the calculation of the market-related value of plan assets. These losses will result in decreases in future pension income as they are recognized.

29

        The discount rate utilized for determining future pension obligations of the U.S. qualified plans is based on long-term bonds receiving an AA- or better rating by a recognized rating agency. The resulting discount rate decreased from 7 percent at December 31, 2001, to 6.75 percent at December 31, 2002.

        For 2003, the Company left its assumption for the long-term rate of increase in compensation levels for the U.S. qualified plans unchanged at 5 percent.

        Based on the revised pension assumptions and the actual investment performance of the plan assets in 2002, the Company expects to record approximately $100 million of incremental expense for all pension and other postretirement benefits in 2003.

        The value of the U.S. qualified plan assets decreased from $9.3 billion at December 31, 2001, to $7.7 billion at December 31, 2002. The investment performance and declining discount rates reduced the funded status of the U.S. qualified plans, net of benefit obligations, by $2.2 billion from December 31, 2001 to December 31, 2002. The Company does not expect significant cash contributions to be required for the U.S. qualified plans in 2003.

Income Taxes

        Deferred tax assets and liabilities are determined using enacted tax rates for the effects of net operating losses and temporary differences between the book and tax bases of assets and liabilities. The Company records a valuation allowance on deferred tax assets when appropriate to reflect the expected future tax benefits to be realized. In determining the appropriate valuation allowance, certain judgments are made relating to recoverability of deferred tax assets, use of tax loss carryforwards, level of expected future taxable income and available tax planning strategies. These judgments are routinely reviewed by management. At September 30, 2003, the Company had a net deferred tax asset balance of $2.9 billion, after valuation allowances of $701 million. For additional information, see Note S to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

Asbestos-Related Matters of Union Carbide Corporation

        Union Carbide Corporation ("Union Carbide"), a wholly owned subsidiary of the Company, is and has been involved in a large number of asbestos-related suits filed primarily in state courts during the past three decades. These suits principally allege personal injury resulting from exposure to asbestos-containing products and frequently seek both actual and punitive damages, often in very large amounts. The alleged claims primarily relate to products that Union Carbide sold in the past, alleged exposure to asbestos-containing products located on Union Carbide's premises, and Union Carbide's responsibility for asbestos suits filed against a former Union Carbide subsidiary, Amchem Products, Inc. ("Amchem"). In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable loss as a result of such exposure, or that injuries incurred in fact resulted from exposure to Union Carbide's products.

        The rate at which plaintiffs filed asbestos-related suits against various companies, including Union Carbide and Amchem, increased in both 2001 and 2002, influenced by the bankruptcy filings of numerous defendants in asbestos-related litigation. Union Carbide expects more asbestos-related suits to be filed against Union Carbide and Amchem in the future. Union Carbide will aggressively defend or reasonably resolve, as appropriate, both pending and future claims.

        Typically, Union Carbide is only one of many named defendants, many of which, including Union Carbide and Amchem, were members of the Center for Claims Resolution ("CCR"), an entity that defended and resolved asbestos cases on behalf of its members. As members of the CCR, Union Carbide's and Amchem's strategy was to resolve the claims against them at the relatively small percentage allocated to them pursuant to the CCR's collective defense. The CCR ceased operating in February 2001, except to administer certain settlements. Union Carbide then began using Peterson Asbestos Claims Enterprise, but only for claims processing and insurance invoicing.

        Certain members of Dow's legal department and certain Dow management personnel have been retained to provide their experience in mass tort litigation to assist Union Carbide in responding to asbestos-related matters. In early 2002, Union Carbide hired new outside counsel to serve as national trial counsel. In connection with these actions, aggressive defense strategies were designed to reduce the cost of resolving all asbestos-related claims, including the elimination of claims that lack demonstrated illness or causality.

30

        At the end of 2001 and through the third quarter of 2002, Union Carbide had concluded it was not possible to estimate its cost of disposing of asbestos-related claims that might be filed against Union Carbide and Amchem in the future due to a number of reasons, including its lack of sufficient comparable loss history from which to assess either the number or value of future asbestos-related claims. During the third and fourth quarters of 2002, Union Carbide worked with Analysis, Research & Planning Corporation ("ARPC"), a consulting firm with broad experience in estimating resolution costs associated with mass tort litigation, including asbestos, to explore whether it would be possible to estimate the cost of disposing of pending and future asbestos-related claims that have been, and could reasonably be expected to be, filed against Union Carbide and Amchem.

        Union Carbide provided ARPC with all relevant data regarding asbestos-related claims filed against Union Carbide and Amchem through November 6, 2002. ARPC concluded that it was not possible to estimate the full range of the cost of resolving future asbestos-related claims against Union Carbide and Amchem, because of various uncertainties associated with the litigation of those claims. These uncertainties, which hindered Union Carbide's ability to project future claim volumes and resolution costs, included the following:

•

Until a series of bankruptcies led to the CCR ceasing operations in early 2001, Union Carbide and Amchem generally settled claims filed against CCR members according to a sharing formula that would not necessarily reflect the cost of resolving those claims had they been separately litigated against Union Carbide or Amchem.



•

The bankruptcies in the years 2000 to 2002 of other companies facing large asbestos liability were a likely contributing cause of a sharp increase in filings against many defendants, including Union Carbide and Amchem.



•

It was not until the CCR ceased operating in early 2001 that Union Carbide took direct responsibility for the defense of claims against itself and Amchem.



•

New defense counsel for Union Carbide and Amchem implemented more aggressive defense strategies in mid-2002.

        Despite its inability to estimate the full range of the cost of resolving future asbestos-related claims, ARPC advised Union Carbide that it would be possible to determine an estimate of a reasonable forecast of the cost of resolving pending and future asbestos-related claims likely to face Union Carbide and Amchem, if certain assumptions were made. Specifically, ARPC advised Union Carbide that for purposes of determining an estimate it is reasonable to assume that in the near term asbestos-related claims filed against Union Carbide and Amchem are unlikely to return to levels below those experienced prior to 2001—when the recent spike in filings commenced—and that average claim values are unlikely to return to levels below those experienced in 2001-2002, the years immediately following CCR's cessation of operations. ARPC advised Union Carbide that, by assuming that future filings were unlikely to exceed the levels experienced prior to 2001 and extrapolating from 2001 and 2002 average claim values, ARPC could make a reasonable forecast of the cost of resolving asbestos-related claims facing Union Carbide and Amchem. ARPC also advised Union Carbide that forecasts of resolution costs for a 10 to 15 year period from the date of the forecast are likely to be more accurate than forecasts for longer periods of time.

        In projecting Union Carbide's resolution costs for future asbestos-related claims, ARPC applied two methodologies that have been widely used for forecasting purposes. Applying these methodologies, ARPC forecast the number and allocation by disease category of those potential future claims on a year-by-year basis through 2049. ARPC then calculated the percentage of claims in each disease category that had been closed with payments in 2001 and 2002. Using those percentages, ARPC calculated the number of future claims by disease category that would likely require payment by Union Carbide and Amchem and multiplied the number of such claims by the mean values paid by Union Carbide and Amchem, respectively, to dispose of such claims in 2001 and 2002. In estimating Union Carbide's cost of resolving pending claims, ARPC used a process similar to that used for calculating the cost of resolving future claims.

        As of December 31, 2002, ARPC estimated the undiscounted cost of resolving pending and future asbestos-related claims against Union Carbide and Amchem, excluding future defense and processing costs, for the 15-year period from the present through 2017 to be between approximately $2.2 billion and $2.4 billion, depending on which of the two accepted methodologies was used.

        Although ARPC provided estimates for a longer period of time, based on ARPC's advice that forecasts for shorter periods of time are more accurate and in light of the uncertainties inherent in making long-term projections, Union Carbide determined that the 15-year period through 2017 is the reasonable time period for projecting the cost of disposing of its future asbestos-related claims. Union Carbide concluded that it is probable that the undiscounted cost of disposing of asbestos-related pending and future claims ranges from $2.2 billion to $2.4 billion, which is the range for the 15-year period ending in 2017 as estimated by ARPC using both methodologies. Accordingly, Union Carbide increased its asbestos-related liability for pending and future claims at December 31, 2002 to $2.2 billion, excluding future defense and processing costs. At September 30, 2003, Union Carbide's asbestos-related liability for pending and future claims was $2.0 billion.

31

        Union Carbide also increased the receivable for insurance recoveries related to its asbestos liability to $1.35 billion at December 31, 2002, substantially exhausting its asbestos product liability coverage. This resulted in a net income statement impact to Union Carbide of $828 million, $522 million on an after-tax basis, in the fourth quarter of 2002. At September 30, 2003, Union Carbide's receivable for insurance recoveries related to its asbestos liability was $1.2 billion. The insurance receivable related to the asbestos liability was determined by Union Carbide after a thorough review of applicable insurance policies and the 1985 Wellington Agreement, to which Union Carbide and many of its liability insurers are signatory parties, as well as other insurance settlements, with due consideration given to applicable deductibles, retentions and policy limits, and taking into account the solvency and historical payment experience of various insurance carriers. In addition, Union Carbide had receivables for defense and resolution costs submitted to insurance carriers for reimbursement of $219 million at December 31, 2002 and $267 million at September 30, 2003.

        The amounts recorded by Union Carbide for the asbestos-related liability and related insurance receivable described above were based upon currently known facts. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, coverage issues among insurers, and the continuing solvency of various insurance companies, as well as the numerous uncertainties surrounding asbestos litigation in the United States, could cause the actual costs and insurance recoveries for Union Carbide to be higher or lower than those projected or those recorded.

        In September 2003, Union Carbide filed a comprehensive insurance coverage case in the Circuit Court for Kanawha County in Charleston, West Virginia, seeking to confirm its rights to insurance for various asbestos claims. Although Union Carbide already has settlements in place concerning coverage for asbestos claims with many of its insurers, including those covered by the 1985 Wellington Agreement, this lawsuit was filed against insurers that are not signatories to the Wellington Agreement and/or do not otherwise have agreements in place with Union Carbide regarding their asbestos-related insurance coverage. Union Carbide continues to believe that its recorded receivable for insurance recoveries from all insurance carriers is collectible. Union Carbide reached this conclusion after a further review of its insurance policies, with due consideration given to applicable deductibles, retentions and policy limits, after taking into account the solvency and historical payment experience of various insurance carriers; existing insurance settlements; and the advice of outside counsel with respect to the applicable insurance coverage law relating to the terms and conditions of its insurance policies.

        Union Carbide expenses defense and processing costs as incurred. Accordingly, defense and processing costs incurred by Union Carbide in the future for asbestos-related litigation, net of insurance, will impact Union Carbide's results of operations in future periods.

        Because of the uncertainties described above, Union Carbide's management cannot estimate the full range of the cost of resolving pending and future asbestos-related claims facing Union Carbide and Amchem. Union Carbide's management believes that it is reasonably possible that the cost of disposing of Union Carbide's asbestos-related claims, including future defense and processing costs, could have a material adverse impact on Union Carbide's results of operations and cash flows for a particular period and on the consolidated financial position of Union Carbide.

        It is the opinion of Dow's management that it is reasonably possible that the cost of Union Carbide disposing of its asbestos-related claims, including future defense and processing costs, could have a material adverse impact on the Company's results of operations and cash flows for a particular period and on the consolidated financial position of the Company.

32

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, "Accounting for Derivative Instruments and Hedging Activities," 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, cross-currency swaps, 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 2002 and 2001 are shown below:

	2002				2001
Total Daily VAR at December 31* In millions
	Year-end		Average		Year-end		Average
Foreign exchange	$	7	$	10	$	21	$	17
Interest rate		94		83		106		70
Equity exposures, net of hedges		3		4		7		9
Commodities		17		11		4		5

*

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, 2002.

33

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

        As of the end of the period covered by 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 Rules 13a-15(e) and 15d-15(e). 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. No change in the Company's internal control over financial reporting occurred during the Company's most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

34

The Dow Chemical Company and Subsidiaries
Part II—Other Information

ITEM 1.    LEGAL PROCEEDINGS

Breast Implant Matters

No material developments regarding this matter occurred during the third quarter of 2003. For a summary of the history and current status of this matter, see Note F to the Consolidated Financial Statements.

Asbestos-Related Matters of Union Carbide Corporation

        No material developments regarding this matter occurred during the third quarter of 2003. For a summary of the history and current status of this matter, see Management's Discussion and Analysis of Financial Condition and Results of Operations, Asbestos-Related Matters of Union Carbide Corporation; and Note F to the Consolidated Financial Statements.

Environmental Matters

        On July 8, 2003, the Michigan Department of Environmental Quality ("MDEQ") issued a Letter of Violation alleging that Dow AgroSciences LLC, an indirect wholly owned subsidiary of the Company, had violated certain provisions of its Renewable Operating Air Permit at its Harbor Beach, Michigan, facility. Although the Letter of Violation did not include a penalty for the alleged violations, it is possible that the MDEQ will assess a civil penalty in excess of $100,000 at a later date.

        On September 16, 2003, the Texas Commission on Environmental Quality issued a Notice of Enforcement ("NOE") alleging that the Company violated certain provisions of the Clean Air Act at its LaPorte, Texas site. Although the NOE did not include a penalty for the alleged violations, it is possible that the agency will assess a civil penalty in excess of $100,000 at a later date.

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits.

See the Exhibit Index on page 37 of this Quarterly Report on Form 10-Q for exhibits filed with this report and exhibits incorporated by reference. The following exhibits are filed with this report:

Exhibit No.	Description of Exhibit
23	Analysis, Research & Planning Corporation's Consent.
31(a)	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b)	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32(a)	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32(b)	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)

Reports on Form 8-K.

        The following Current Report on Form 8-K was filed by the Company during the third quarter of 2003:

On July 24, 2003, the Company filed a Current Report on Form 8-K that included a press release issued on July 24, 2003, announcing the second quarter of 2003 earnings for the Company.

        The following Current Report on Form 8-K was filed by the Company subsequent to the third quarter of 2003:

On October 23, 2003, the Company filed a Current Report on Form 8-K that included a press release issued on October 23, 2003, announcing the third quarter of 2003 earnings for the Company.

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

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

The following trademark of Union Carbide Chemicals & Plastics Technology Corporation appears in this report:    POLYOX

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The Dow Chemical Company and Subsidiaries
Signature

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

	THE DOW CHEMICAL COMPANYRegistrant
Date: October 30, 2003
	/s/ FRANK H. BRODFrank H. Brod Vice President & Controller

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The Dow Chemical Company and Subsidiaries
Exhibit Index

EXHIBIT NO.	DESCRIPTION
23	Analysis, Research & Planning Corporation's Consent.
31(a)	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b)	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32(a)	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32(b)	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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QuickLinks

The Dow Chemical Company Table of Contents

PART I—FINANCIAL INFORMATION ITEM 1. Financial Statements

The Dow Chemical Company and Subsidiaries Notes to the Consolidated Financial Statements
The Dow Chemical Company and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Dow Chemical Company and Subsidiaries Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Dow Chemical Company and Subsidiaries Item 4. Controls and Procedures
The Dow Chemical Company and Subsidiaries Part II—Other Information

ITEM 1. LEGAL PROCEEDINGS
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

The Dow Chemical Company and Subsidiaries Signature
The Dow Chemical Company and Subsidiaries Exhibit Index