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 (the Company).

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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 has no obligation to provide revisions to any forward-looking statements should circumstances change.

THIRD QUARTER EARNINGS ANNOUNCEMENT (OCTOBER 26, 2000)

DOW REPORTS EARNINGS OF $0.48 PER SHARE ON RECORD THIRD QUARTER SALES

Third Quarter of 2000 Highlights

•

EBIT increased 8 percent over last year—from $584 million to $630 million—despite a 46 percent rise in feedstock and energy costs that totaled nearly $600 million.



•

Dow achieved record third quarter sales of $5.5 billion, up 17 percent from a year ago, reflecting increases in all businesses and geographies.



•

Volume rose 9 percent and price rose 8 percent. The performance segments achieved double-digit gains in volume and the basics segments posted strong improvements in price, demonstrating the value of Dow's balanced portfolio.

		3 Months Ended September 30						9 Months Ended September 30
(In millions, except for per share amounts)
		2000			1999			2000			1999
Net Sales		$	5,514		$	4,693		$	16,525		$	13,729
Earnings Before Interest, Income Taxes and Minority Interests (EBIT)			630			584			2,319			1,981
Earnings Per Common Share		$	0.48		$	0.48		$	1.86		$	1.58

     Note: Earnings per share amounts for prior periods have been restated to reflect Dow's three-for-one stock split, which was effective June 16, 2000.

Review of Third Quarter Results

    Reporting record third quarter sales of $5.5 billion, The Dow Chemical Company announced an 8 percent rise in earnings before interest, income taxes and minority interests (EBIT), compared with the same period a year ago, despite a 46 percent increase in feedstock and energy costs. The Company posted EBIT of $630 million, net income of $328 million and earnings per share of $0.48.

    "We are pleased with these results which demonstrate Dow's inherent strengths in the face of surging raw material and energy costs," said J. Pedro Reinhard, executive vice president and chief financial officer. He noted that Dow overcame nearly $600 million in higher feedstock and energy costs, which outpaced the Company's $400 million increase in sales prices. "Our diversified business and geographic mix, combined with our leading business positions, enabled us to capitalize on strong volume growth around the world. Improved results from joint ventures and a continued focus on cost controls further strengthened our performance."

    The 17 percent rise in sales, compared with third quarter 1999, reflected double-digit gains in all geographic areas and solid increases in all businesses.

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    Volume grew 9 percent, compared with the same period a year ago, led by a 13 percent increase in the performance segments. Substantial volume growth was recorded in all geographic areas, with double-digit gains in Europe and Latin America.

    Price rose 8 percent compared with the same quarter in 1999. Increases in Chemicals, Plastics and Performance Plastics more than offset modest price declines in Performance Chemicals and Agricultural Products.

    The performance segments achieved strong year-over-year volume growth, and price began to improve from second quarter 2000. Combined EBIT for these segments declined from a year ago, however, reflecting the escalating raw material costs.

    In the basics segments, EBIT increased 22 percent from the same quarter in 1999. Plastics EBIT grew 31 percent on a 23 percent rise in sales, with gains in both volume and price. Chemicals also posted higher sales and EBIT, due largely to price improvements that offset a modest decline in volume.

    "We remain confident that we will achieve measurably higher year-over-year earnings in 2000, though we continue to see challenging industry conditions, including volatile feedstock costs, some currency fluctuations and the potential for slower economic growth around the world," said Reinhard. "Our strategy continues to cushion Dow from the full impact of these challenges while positioning us to achieve our goal of growing earnings by 10 percent per year across the cycle."

ACQUISITIONS AND DIVESTITURES

    In April 1995, the Company signed an agreement with Bundesanstalt für vereinigungsbedingte Sonderaufgaben (BvS) for the privatization of three state-owned chemical companies in eastern Germany, Buna Sow Leuna Olefinverbund (BSL). Economic transfer of business operations to the Company, through the privatization agreement and various service agreements, occurred in June 1995, and the Company began a reconstruction program of the sites. In September 1997, the Company acquired 80 percent ownership in BSL for an investment of $174 million; BvS maintained 20 percent ownership. The Company had a call option and BvS a put option for the remaining 20 percent of BSL after the reconstruction period. In May 2000, the Company announced the completion of the reconstruction program and, for an additional investment of $156 million, acquired the remaining 20 percent of BSL. On June 1, 2000, BSL became a wholly owned subsidiary of the Company and, beginning on that date, the financial results of BSL are fully consolidated.

    BvS provided certain incentives during the reconstruction period to cover portions of the reconstruction program and has retained environmental cleanup obligations for existing facilities. Incentives related to property construction reduced the basis of such property. Incentives related to expenses during the reconstruction period were recognized as such expenses were incurred. During the reconstruction period, the Company included the financial results of BSL as a nonconsolidated affiliate.

    In January 1998, the Company completed the sale of the DowBrands consumer products business to S.C. Johnson & Son, Inc. for $1.2 billion. This transaction resulted in a pretax gain of $816 million.

    In February 1998, the Company entered into an agreement with Pronor Petroquimica S.A. (Pronor) to purchase a portion of its business. The new company, named Isopol, was acquired for the production and commercialization of toluene diisocyanate (TDI), used to manufacture durable goods such as cushioned furniture and mattresses, to supply the markets of the Mercosur countries of Latin America. The Company's total investment was $137 million.

    In January 1996, the Company and The Hartford Steam Boiler Inspection and Insurance Company (HSB) formed, through the transfer of net assets and existing businesses, a 60:40 joint venture named Radian International LLC to provide environmental services. In January 1998, HSB exercised a put

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option requiring the Company to purchase HSB's interest for $136 million. In July 1998, as part of the Company's ongoing efforts to restructure its business portfolio, Radian was sold to Dames & Moore Group for $117 million.

    In January 1996, DowElanco entered into agreements with Mycogen Corporation and the Lubrizol Corporation for transactions through which DowElanco, for a cash investment of $158 million, acquired a 47 percent equity stake in Mycogen and Mycogen acquired DowElanco's United Agriseeds subsidiary. In December 1996, DowElanco increased its equity stake in Mycogen to more than 50 percent. During the first quarter of 1998, Dow AgroSciences (formerly named DowElanco) invested an additional $121 million in Mycogen, increasing its ownership to 69 percent. In November 1998, following the expiration of a tender offer, the Company completed the acquisition of all remaining shares for $418 million. Mycogen is a diversified agribusiness and biotechnology company that develops and markets seeds and value-added traits for genetically enhanced crops.

    In December 1998, the Company and United Technologies Corporation sold the business and certain assets of their 50:50 joint venture, Dow-United Technologies Composite Products, Inc., to GKN Westland Aerospace, Inc., a unit of GKN plc, of the United Kingdom.

    On August 4, 1999, the Company and Union Carbide Corporation announced a definitive merger agreement for a tax-free, stock-for-stock transaction. Under the agreement, Union Carbide stockholders will receive 1.611 shares of Dow stock (on a post-split basis) for each share of Union Carbide stock they own. Based upon Dow's closing price of $124 ¹¹ / 16 (pre-split) on August 3, 1999, the transaction was valued at $66.96 per Union Carbide share, or $11.6 billion in aggregate including the assumption of $2.3 billion of net debt. According to the agreement, the merger is subject to certain conditions including approval by Union Carbide stockholders and review by antitrust regulatory authorities in the United States, Europe and Canada. Union Carbide stockholders approved the merger on December 1, 1999. On May 3, 2000, the European Commission approved the merger subject to certain conditions. Antitrust reviews in the United States and Canada are in progress, and the Company expects to complete the merger in the near future. The transaction is expected to be accounted for as a pooling-of-interests.

    In October 1999, the Company acquired CanStates Holdings, Inc. and its subsidiary, ANGUS Chemical, from TransCanada PipeLines Limited for approximately $350 million. ANGUS Chemical is a global leader in the manufacture and marketing of specialty nitroparaffins and their derivatives which are sold into over 40 industries. Allocation of the purchase price to the assets acquired and liabilities assumed has not been completed for this acquisition. Final determination of the fair values to be assigned may result in adjustments to the preliminary values assigned at the date of acquisition.

    In February 2000, the Company acquired Flexible Products Company of Marietta, Georgia, for approximately $160 million. Flexible Products Company is one of the largest polyurethane systems suppliers in North America and a leader in custom polyurethane foam formulations and dispensing technology. This acquisition is consistent with Dow's growth goals in polyurethanes and its commitment to the global formulated products and systems business. Allocation of the purchase price to the assets acquired and liabilities assumed has not been completed for this acquisition. Final determination of the fair values to be assigned may result in adjustments to the preliminary values assigned at the date of acquisition.

    On August 2, 2000, the Company announced it had signed an agreement to sell its 32.5 percent ownership interest in the Cochin pipeline system to a unit of Williams' energy services business. On October 23, 2000, NOVA Chemicals Corp., as one of the owners of Cochin, announced that it exercised its right of first refusal as provided in the contractual agreements among the Cochin owners. NOVA plans to purchase the Company's 32.5 percent interest in the pipeline under the same terms and conditions that had been negotiated with Williams with respect to the pipeline. The transaction is anticipated to close in the fourth quarter of 2000.

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    At September 30, 2000, the Company had unused and available credit facilities with various U.S. and foreign banks totaling $3.1 billion in support of its working capital requirements and commercial paper borrowings. Additional unused credit facilities totaling approximately $1.1 billion are available for use by foreign subsidiaries.

    Operating activities provided cash of $763 million for the nine months ended September 30, 2000. Additional cash of $1.5 billion was generated by sales of available-for-sale securities in excess of purchases of similar securities. Cash was used primarily for acquisitions (Flexible Products Company, General Latex and BSL), to reduce long-term debt, to pay dividends and for capital expenditures. See the Consolidated Statements of Cash Flows and the Acquisitions and Divestitures section (above) for more detail.

    At December 31, 1999, the balance of preferred stock issued to the employee stock ownership plan (ESOP) by the Company was 1.3 million shares. The preferred stock was redeemable in whole or in part at the Company's option any time after January 1, 2000 at $86.125 per share plus an amount equal to all accrued and unpaid dividends. On February 9, 2000, the Company exercised its option to redeem the preferred stock. On that same date, the trustee of the ESOP elected to convert the preferred stock into common stock at a ratio of 1:1.

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    During the past three years, the Company repurchased 31.4 million shares of its common stock as part of its overall stock repurchase program, and at year-end 1999, net shares outstanding had been reduced by 19 percent since the beginning of 1995. Due to the pending merger with Union Carbide Corporation, the Company's 1997 authorization to repurchase Dow stock was terminated by the Board of Directors on August 3, 1999. In December 1999, the Company sold 3.5 million shares of common stock held in treasury in the open market for $431 million to facilitate the accounting treatment of the merger with Union Carbide as a pooling-of-interests, which is a condition to the completion of the merger.

    On May 11, 2000, stockholders approved a measure to increase the number of authorized common shares from 500 million to 1.5 billion at the Company's 103rd Annual Meeting, and Dow's Board of Directors approved a three-for-one split of the Company's common stock. On June 16, 2000, Dow stockholders received two additional shares of stock for each share they owned on the record date of May 23, 2000. On a post-split basis, average shares outstanding for the first nine months of 2000 were 677 million, an increase of 3 percent compared with the average shares outstanding for the first nine months of 1999. The par value of $2.50 per common share remains unchanged.

    On October 30, 2000, the Company paid a quarterly dividend of 29 cents per share (equivalent to 87 cents per share on a pre-split basis) to shareholders of record on September 29, 2000. This was the 355th consecutive quarterly dividend since 1912 and in each instance Dow has maintained or increased the dividend.

    Net sales for the third quarter of 2000 were $5.5 billion, a new all-time record for third quarter sales. Compared with $4.7 billion in the third quarter of 1999, net sales were up $821 million, or 17 percent, with volume growth of 9 percent and increased prices of 8 percent. Volume was particularly strong in the performance segments, with Performance Plastics, Performance Chemicals and Agricultural Products all reporting double-digit volume growth. Substantial volume growth was recorded in all geographic areas, led by Latin America, up 15 percent, and Europe, up 10 percent. Sales prices improved approximately $400 million in total for the Company, driven by significant increases in the basics segments, reflecting a steep rise in feedstock and energy costs. Prices rose in all geographic

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areas, with increases ranging from 7 to 10 percent. Year to date, net sales of $16.5 billion were up 20 percent from $13.7 billion last year due to price increases of 11 percent and volume growth of 9 percent.

    Operating expenses (research and development, and selling, general and administrative expenses) were $614 million for the third quarter, up $30 million from $584 million for the same quarter last year. Compared with last year, operating expenses for the first nine months of the year were up $64 million, or 4 percent, reflecting the Company's planned support of new business growth initiatives and recent acquisitions. Excluding growth initiatives and acquisitions, operating expenses were down 4 percent for the quarter and 3 percent for the year, compared with 1999.

    Net income for the third quarter was $328 million or $0.48 per share (diluted), compared with $320 million or $0.48 per share (diluted) for the third quarter of 1999, despite a 46 percent increase in feedstock and energy costs that amounted to nearly $600 million. Net income for the first nine months of 2000 was $1.3 billion, up 20 percent from $1.1 billion for the same period last year. Year to date, feedstock and energy costs were up sharply, $1.9 billion (almost 60 percent) over last year. Overcoming the increase in raw material costs, net income improved for the quarter and the year through increased selling prices, strong volume gains, the Company's diverse business portfolio and geographic presence, and improved contributions from joint ventures around the world.

    PERFORMANCE PLASTICS

    Performance Plastics sales of $1,492 million for the third quarter were up 15 percent from $1,302 million in the third quarter of 1999, on a 12 percent increase in volume and a 3 percent increase in price. Excluding acquisitions, volume was up 7 percent. EBIT for the segment was $196 million, down from $248 million last year, primarily due to a significant increase in raw material costs.

    Dow Automotive, the Company's first industry-focused global business unit, reported good results for the third quarter of 2000, with sales up 15 percent from a year ago. The increase in sales was driven by volume growth, up significantly on the strength of the global automotive industry and Dow's increased participation in this industry. Prices were down slightly due to the negative impact of currency on sales in Europe. Third quarter EBIT for the business was relatively flat with last year as increased raw material costs offset volume growth.

    Engineering Plastics sales for the quarter were up 15 percent from the same quarter last year, with volume growth of 7 percent and price improvement of 8 percent. Volume was particularly strong for nylon and polycarbonate in North America and Asia Pacific. EBIT for the quarter improved significantly from the third quarter of 1999 as increases in sales volume and price exceeded higher raw material costs.

    Sales of Epoxy Products and Intermediates were up 18 percent from last year, with volume growth of 10 percent and price improvement of 8 percent. Demand was particularly strong for allylics, phenolics and converted resins in North America. Prices, up in all geographic areas except Europe, improved 10 percent in Latin America and 9 percent in North America. EBIT for the quarter was up compared with the same quarter last year due to increased volume and prices.

    Fabricated Products sales for the third quarter of 2000 were up 5 percent compared with last year. While volume was up 6 percent, demand growth moderated with year-to-date housing starts in the United States down 5 percent. Volume in Europe improved with the consolidation of BSL. While there was some improvement in local prices, price was down 1 percent in total, due to the negative impact of currency on sales in Europe. EBIT for the third quarter was down versus the third quarter of last year, impacted by higher raw material costs and the cost of converting blowing agent equipment.

    Polyurethanes sales for the third quarter were up 17 percent compared with the third quarter of 1999, driven by volume growth of 16 percent. Excluding acquisitions (Flexible Products Company and

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General Latex), volume was up 4 percent. Overall, volume was particularly strong in North America (due to acquisitions) and Asia Pacific. Product demand was led by methylene diphenyl diisocyanate (MDI), up 10 percent. Local prices were up 5 percent overall compared with last year, but offset by the negative impact of currency on sales in Europe. Raw material costs for the business increased significantly year over year, with propylene up 65 percent over last year's cost and benzene up more than 50 percent. Margins continued to be squeezed by the hydrocarbon cost increases, resulting in a substantial decrease in EBIT for the business versus last year.

    For the first nine months of the year, Performance Plastics sales were $4,342 million, up 12 percent from $3,862 million for the same period last year, due entirely to volume growth. Prices overall were flat with last year. Excluding acquisitions, volume was up 10 percent. Year to date, EBIT was $593 million compared with $815 million last year, reflecting the impact of increased raw material costs.

    PERFORMANCE CHEMICALS

    Performance Chemicals sales for the third quarter were $759 million, up significantly from $674 million for the third quarter of 1999, as volume grew 14 percent and prices declined 1 percent. Roughly one-third of the increase in volume came from acquisitions. Third quarter EBIT for the segment was down from $108 million last year to $82 million this year, as the combination of lower selling prices and higher raw material costs more than offset volume growth.

    Specialty Chemicals sales for the quarter were up 14 percent, with a 17 percent increase in volume and a 3 percent decline in prices versus the same quarter last year. Net of the acquisition of ANGUS Chemical, volume was up 11 percent. Volume improved in all geographic areas, led by strong growth in Europe and Asia Pacific. From a product standpoint, demand was particularly strong for biocides, alkanolamines and FilmTec membranes. Volume for Methocel cellulose ethers was down slightly from last year. Overall, local prices were relatively flat due to competitive pressure, but declined, in total, due to the negative impact of currency on sales in Europe. EBIT for the third quarter was down versus last year as higher raw material costs, increased operating expenses due to acquisitions and lower selling prices more than offset volume growth.

    Emulsion Polymers sales increased 9 percent versus the third quarter of 1999 on an 8 percent increase in volume. Volume increased significantly for SB latex sales into the coated paper industry around the world. Local prices improved 6 percent, but were offset by a 5 percent negative currency impact. EBIT for the quarter was down from last year due to higher styrene monomer and butadiene costs, both up over 50 percent from third quarter 1999.

    Performance Chemicals sales for the first nine months of 2000 were $2,265 million, up 15 percent from $1,971 million, on an 18 percent increase in volume partially offset by a 3 percent decline in prices. Year to date, EBIT for the segment was $283 million, down from $381 million last year due to lower selling prices and higher raw material costs.

    AGRICULTURAL PRODUCTS

    Sales of Agricultural Products for third quarter 2000 were $430 million, up 8 percent from $399 million last year. Volume for the segment grew 13 percent, while prices declined 5 percent. Demand was especially strong in Brazil for weed management products, up more than 50 percent from the third quarter of 1999. Demand was also strong for seeds and new products, including spinosad insect control products and glyphosate. Prices were down versus last year due to competitive pressure and the negative impact of currency on sales in Europe. EBIT for the quarter was a loss of $23 million, compared with a loss of $35 million in the third quarter of 1999. Growth in new products and continued improvement from Dow AgroSciences' cost reduction and business restructuring program announced last November mitigated the impact of lower prices and supported continued research investment in biotechnology. See the section entitled "1999 Special Charge" on page 18 for further details on Dow AgroSciences' restructuring program.

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    In June 2000, Dow AgroSciences reached agreement with the U.S. Environmental Protection Agency on changes in the use of insecticides containing chlorpyrifos. These changes are not expected to have a material impact on the Company's results.

    Sales for the segment were $1,722 million for the first nine months of this year, down slightly from $1,732 million in 1999. While volume improved 3 percent, prices declined 4 percent. Year to date, EBIT was $225 million, up 10 percent compared $205 million for the same period last year, reflecting the business' restructuring efforts.

    PLASTICS

    Plastics sales in the third quarter of 2000 were $1,435 million, up 23 percent from $1,170 million a year ago. Volume grew 8 percent; prices rose 15 percent. EBIT for the quarter was $271 million, up significantly from $207 million in the third quarter of 1999, due to increases in selling prices that outpaced the significant rise in hydrocarbon and energy costs.

    Polyethylene sales were up 14 percent versus the same quarter last year, with volume growth of 10 percent and price increases of 4 percent. Volume was up significantly in all geographic areas except North America, where volume was basically flat in the United States and down slightly in Canada. Demand was particularly strong for Affinity polyolefin plastomers, low density polyethylene and solution polyethylene. Year-over-year price increases moderated following four quarters of year-over-year price increases that ranged from 12 to 28 percent. EBIT for the business was down slightly, reflecting a decrease in margins as increases in selling prices moderated against a continued increase in feedstock costs.

    Sales of polyethylene terephthalate (PET) and purified terephthalic acid (PTA) for the third quarter were up 26 percent over the third quarter of last year, due to an increase in selling prices in Europe. Volume compared with last year was relatively flat. EBIT improved versus last year, reflecting the significant increase in selling prices.

    Polypropylene sales for the third quarter of 2000 continued a strong upward trend due to improved pricing and volume versus the same quarter last year. Volume was particularly strong in Europe, up 60 percent from last year. EBIT improved versus last year due to higher selling prices and improved customer/product mix.

    Polystyrene sales increased 44 percent in the third quarter versus the same quarter of 1999, entirely on increased prices. Volume during the quarter was flat. Selling prices increased sharply compared with last year, driven by styrene monomer pricing. EBIT for the business was up significantly compared with the third quarter of 1999, as price increases outpaced feedstock costs.

    Plastics sales for the first nine months of 2000 were $4,163 million compared with $3,110 million last year, an increase of 34 percent. Year to date, volume grew 8 percent and prices increased 26 percent. EBIT for the period was $827 million, up significantly from $437 million for the first nine months of 1999, as volume growth and increased prices outpaced a sharp rise in hydrocarbon and energy costs.

    CHEMICALS

    Third quarter sales for the Chemicals segment were $640 million, up 5 percent from $607 million in the third quarter of 1999. Prices rose 9 percent compared with last year, with increases reported in all geographic areas except Asia Pacific. Volume, down 4 percent overall, was strong in Europe, up 12 percent, but down in the rest of the world. Vinyl chloride monomer (VCM) sales were up significantly year over year due to price increases. Caustic sales were up versus last year on strong demand and price increases. Ethylene glycol (EG) sales were down for the quarter, with volume down roughly 20 percent due to delayed antifreeze demand. Volume for propylene glycol (PG) was strong during the quarter, but prices remained under pressure, especially in North America. EBIT for the

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segment was $105 million, up slightly from $101 million in the third quarter of 1999. EBIT improved as higher selling prices offset the increase in feedstock and energy costs.

    For the first nine months of 2000, sales for the Chemicals segment were $2,008 million, up from $1,660 million last year due to a 21 percent improvement in selling prices. EBIT for the period was $444 million compared with $290 million for 1999. While this segment was significantly impacted by higher feedstock and energy costs, EBIT improved due to increased selling prices.

    HYDROCARBONS AND ENERGY

    Hydrocarbons and Energy sales were up $191 million from $469 million in the third quarter of 1999 to $660 million, an increase of 41 percent driven by higher prices. Refinery sales prices were up in the quarter, reflecting significantly higher crude oil costs and tight supply conditions. Hydrocarbon feedstock costs continued to rise during the quarter, negatively impacting the results of several of the Company's businesses. EBIT for the quarter was a loss of $1 million compared with a loss of $17 million in the third quarter of 1999.

    Sales for the first nine months of 2000 were $1,769 million, up sharply from $1,141 million last year, largely due to a 50 percent rise in selling prices. Volume was up 5 percent. EBIT for the first nine months was $14 million compared with a loss of $7 million for the same period last year.

    UNALLOCATED AND OTHER

    Unallocated and Other includes research and development expenses in the Company's growth platforms, overhead cost recovery variances that are not allocated to the operating segments, results of Dow's insurance and finance company operations, gains and losses on sales of financial investments, and foreign exchange hedging results.

    EBIT for the quarter was at breakeven compared with a loss of $28 million for the third quarter of 1999. This improvement was due in part to favorable results in the Company's economic hedging program, positive recovery variances for overhead expenses and gains on sales of financial instruments. Year to date, EBIT was a loss of $67 million compared with a loss of $140 million for the nine months of 1999.

    COMPANY SUMMARY

Operating Rate

    The Company's global plant operating rate for its chemicals and plastics businesses was 85 percent, compared with 91 percent in the third quarter of 1999, primarily due to outages for maintenance in several of the Company's hydrocarbons and energy facilities. Year to date, the Company's operating rate was 87 percent, down slightly from 88 percent for the first nine months of last year.

Equity in Earnings of Nonconsolidated Affiliates

    Equity in earnings of nonconsolidated affiliates was $78 million in the third quarter, up from $15 million in the same quarter last year due to improved earnings by several of the Company's joint ventures around the world. These improvements included strong performance by several plastics joint ventures in Asia Pacific and Latin America, and improved results from several hydrocarbons joint ventures in North America. Third quarter results also included final resolution of BSL matters relating to the reconstruction period. Year to date, equity earnings were $244 million compared with $62 million in 1999.

    During the reconstruction period, the Company included the financial results of BSL as a nonconsolidated affiliate. On June 1, 2000, BSL became a wholly owned subsidiary of the Company and, beginning on that date, the financial results of BSL are fully consolidated.

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Sundry Income—Net

    Sundry income includes a variety of income and expense items such as the gain or loss on foreign currency exchange, dividends from investments, and gains and losses on sales of investments and assets. Sundry income for the third quarter of 2000 was $58 million compared with $53 million in the third quarter of 1999. Sundry income for the quarter included positive economic hedging results, which helped offset some of the negative impact of currency on reported net sales, and gains on sales of available-for-sale securities. Year to date, sundry income was $230 million compared with $210 million last year.

Interest Income and Expense

    The net total of interest expense (net of capitalized interest) and interest income was $112 million for the third quarter compared with $64 million for the third quarter of 1999. Generally consistent with previous quarters of this year, net interest expense was up compared with last year due to an increase in total debt, an increase in short-term interest rates and a decrease in short-term investments.

Provision for Taxes on Income

    The effective tax rate for the third quarter was 34.2 percent compared with 35.0 percent for the same quarter of 1999. Year to date, the effective tax rate was 34.7 percent compared with 35.5 percent last year.

1999 Special Charge

    In the fourth quarter of 1999, a special charge of $94 million was recorded for a cost reduction and business restructuring program in the Agricultural Products segment. The program, which was announced in November 1999, impacts operations in the United States, Europe, Middle East/Africa and Latin America, and is expected to be completed in 2000. The fourth quarter charge included severance of $51 million for approximately 700 employees, inventory write-offs of $17 million, and asset write-offs of $26 million. During the first nine months of 2000, $38 million of the severance reserve was used to reduce headcount by 492 individuals, leaving a balance of $13 million for an estimated additional headcount reduction of approximately 235. Seeds inventory was written off during the first quarter, fully utilizing the inventory reserve. The quarter-end balance for additional asset write-offs related to the plan was $20 million.

Outlook

    The macroeconomic environment for the fourth quarter of 2000 is quite different from that of a year ago. Energy prices are significantly higher and much more volatile. Last year, U.S. growth was strong and growth in Asia Pacific and Latin America was accelerating. The economic outlook for the fourth quarter is less certain. While Dow's businesses did not experience a general reduction in growth in the third quarter of 2000, global growth is expected to be a bit lower in 2001 than in 2000, and the impact of this slower growth may begin in the fourth quarter of 2000.

    The strength of the global economy should continue to help the chemical industry, although continued margin pressure from high hydrocarbon and energy costs is anticipated, along with some short-term weakening in certain industry fundamentals. The impact of capacity additions in the ethylene chain may result in price pressure for polyethylene and other ethylene derivatives for the next few quarters, although higher demand driven by continued economic strength should reduce this pressure somewhat. Supply/demand is relatively balanced in the chlor-alkali and styrene business chains.

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    Stabilizing hydrocarbon and energy prices are anticipated in the fourth quarter of 2000, with average oil and gas prices below current levels but somewhat higher than the third quarter averages. Strong product demand is also expected to continue.

    Year to date, most Dow products have experienced very strong volume growth, with double-digit increases in Performance Plastics and Performance Chemicals. Margin on increased volume has helped offset hydrocarbon and energy cost increases, which have outstripped sales price increases by over $300 million so far this year. Price momentum has turned modestly positive for the performance businesses, but has slowed or turned negative for some ethylene derivatives.

    Given an expectation of modest sequential increases in raw material costs and year-over-year volume growth in the 5 to10 percent range, the performance businesses should generally show improvement versus third quarter results, but may fall short of last year's fourth quarter levels. Results in the basics businesses may also be below fourth quarter 1999, with higher caustic prices and stronger ethylene glycol demand mitigating somewhat weaker supply/demand fundamentals in vinyl and certain ethylene derivatives.

    It is very difficult to forecast results in such an uncertain environment of volatile feedstock pricing, currency fluctuations and the potential for slower economic growth. Published analysts' estimates for Dow's fourth quarter results currently range from $0.34 to $0.46 per share. Given the dates of the estimates, some of those numbers may include expectations of declining feedstock pricing. While that range may be reasonable, if oil and gas prices do not decline somewhat, the upper end of that range will be difficult to achieve.

SUBSEQUENT EVENT

    On October 12, 2000, the Company announced it had reached an agreement with Gurit-Heberlein AG to acquire the 50 percent interest in Gurit-Essex AG that it does not currently own. Dow became a 50:50 partner with Gurit-Heberlein in 1988 when the Company purchased Essex Chemical. Gurit-Essex is the largest European supplier of automotive adhesives, sealants and body engineered systems for the automotive OEM and aftermarket. The acquisition will globalize Dow Automotive's product availability and double the Company's adhesives, sealants and body engineered systems business. Pending regulatory approvals, the transaction is expected to close by the end of the first quarter of 2001.

ACCOUNTING POLICIES

    In 1999, the Company adopted the following new accounting pronouncements:

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The American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," requires capitalization of certain internal-use computer software costs. SOP 98-1 was adopted by the Company on January 1, 1999. The Company's previous accounting policy was to expense such costs as incurred; therefore, adoption of this statement resulted in a favorable, though immaterial, initial impact on earnings.



•

SOP 98-5, "Reporting on the Costs of Start-Up Activities," provides guidance on the financial reporting of start-up costs and organization costs, requiring those costs to be expensed as incurred. The Company's previous policy regarding the treatment of these costs was substantially consistent with SOP 98-5; therefore, adoption of this standard on January 1, 1999 resulted in an immaterial impact on the Company's consolidated financial statements.

    In December 1999, the SEC issued Staff Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements," which summarizes the SEC's views in applying generally accepted accounting principles to revenue recognition. Implementation of SAB 101 is required no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. The Company has completed its assessment

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of SAB 101 and has determined that the bulletin's revenue recognition guidelines are consistent with the Company's existing revenue recognition policies; therefore, SAB 101 will not have a material impact on its consolidated financial statements.

    In May 2000, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus with respect to EITF Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." EITF 00-10 recognizes the inconsistencies in practice of the recording of shipping and handling costs incurred by most companies that sell goods. The Company currently treats freight and any directly related associated cost of transporting finished product to market as a reduction of net sales. Following the guidance of EITF 00-10, the Company will reclassify freight on sales in its Form 10-K for 2000, including the restatement of prior periods. As a result, reported net sales will increase approximately 5 percent, with a corresponding increase in cost of sales.

    The FASB issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," in June 1998. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133." In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," an amendment of SFAS No. 133. Based on the revised effective date, the Company will adopt SFAS No. 133, as amended by SFAS No. 138, on January 1, 2001. Upon adoption, the Company expects to increase other assets and current liabilities for the fair value of its financial derivatives that qualify for hedge accounting treatment, with an offsetting increase to accumulated other comprehensive income. The use of the short-cut method under SFAS No. 133, where applicable, will result in an immaterial net impact on assets, liabilities, and the income statement. If the Company had adopted SFAS No. 133 on October 1, 2000, based on its ending third quarter balances, the impact on other assets and current liabilities would have been immaterial. The accumulated other comprehensive income component of equity would have increased approximately $200 million. The Company does not believe that the transition adjustments upon adoption of SFAS No. 133 will have a material impact on the income statement, although the impact could be material in future periods due to market volatility. The Company anticipates volatility in accumulated other comprehensive income from its cash flow hedges; the amount of volatility will vary with the level of derivative activities during any period. A global team, formed to assess the impact of adopting the new standard, is executing its implementation plan.

    In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement, which replaces FASB Statement No. 125, revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of Statement 125's provisions without reconsideration. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. It is effective for recognition and reclassifications of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company will comply with the disclosure requirements of SFAS No. 140 in its Form 10-K for 2000, and believes the statement will not have a material impact on its consolidated financial statements.

EURO CONVERSION

    On January 1, 1999, the Euro was adopted as the national currency of 11 European Union member nations. During a three-year transition period, the Euro will be used as a non-cash transactional currency. The Company began conducting business in the Euro on January 1, 1999, and will change its functional currencies during the three-year transition period. The conversion to the Euro is not expected to have a significant operational impact or a material impact on the results of operations, financial position, or liquidity of its European businesses.

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