**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly periodended****  JUNE 30, 2006**

 

**Commission file number:****1-1463**

 

**UNION CARBIDE CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **New  York**                                                                                                                                  | ** ** | **13-1421730**                       |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                                                                                |       | (I.R.S. Employer Identification No.) |
| ** **                                                                                                                                     | ** ** | ** **                           |
| **400  West Sam Houston Parkway South, Houston, Texas 77042**                                                                                  |
| (Address of  principal executive offices)               (Zip  Code) |
|                                                                                                                                           |       |                                 |
| Registrant’s  telephone number, including area code: **713-978-2016**                                                                     |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. ýYes    o No

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):
| Large accelerated filer  o | Accelerated  filer o | Non-accelerated  filer ý |
|----------------------------|----------------------|-------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of the Act).o Yes   ý No

 

At June 30, 2006, 1,000shares of common stock were outstanding, all of which were held by theregistrant’s parent, The Dow Chemical Company.

 

The registrant meets the conditions set forth in General InstructionsH(1)(a) and (b) for Form 10-Q and is therefore filing this form with a reduceddisclosure format.

 

 

----

 

**UnionCarbide Corporation**

 

**TABLE OFCONTENTS**

 
| ** **                                                                                           | **PAGE**   |
|------------------------------------------------------------------------------------------------------|------------|
|                                                                                                 |       |
| **PART  I - FINANCIAL INFORMATION**                                                                  | ** ** |
|                                                                                                 |       |
| Item 1. Financial Statements.                                                                        | 3          |
|                                                                                                 |       |
| Consolidated Statements of  Income                                                                   | 3          |
|                                                                                                 |       |
| Consolidated Balance Sheets                                                                          | 4          |
|                                                                                                 |       |
| Consolidated Statements of  Cash Flows                                                               | 6          |
|                                                                                                 |       |
| Consolidated Statements of  Comprehensive Income                                                     | 6          |
|                                                                                                 |       |
| Notes to the Consolidated  Financial Statements                                                      | 7          |
|                                                                                                 |       |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations. | 15         |
|                                                                                                 |       |
| Disclosure Regarding  Forward-Looking Information                                                    | 15         |
|                                                                                                 |       |
| Results of Operations                                                                                | 15         |
|                                                                                                 |       |
| Other Matters                                                                                        | 16         |
|                                                                                                 |       |
| Item 3. Quantitative and  Qualitative Disclosures About Market Risk.                                 | 19         |
|                                                                                                 |       |
| Item 4. Controls and Procedures.                                                                     | 19         |
|                                                                                                 |       |
| **PART II  - OTHER INFORMATION**                                                                     | ** ** |
|                                                                                                 |       |
| Item 1. Legal Proceedings.                                                                           | 19         |
|                                                                                                 |       |
| Item 1A. Risk Factors.                                                                               | 19         |
|                                                                                                 |       |
| Item 6. Exhibits.                                                                                    | 19         |
|                                                                                                 |       |
| **SIGNATURES**                                                                                       | 20         |
|                                                                                                 |       |
| **EXHIBIT INDEX**                                                                                    | 21         |

 

2

----

 

**PART I.FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIALSTATEMENTS.**

 

**Union CarbideCorporation and Subsidiaries**

**Consolidated Statements of Income**

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **In millions (Unaudited)**              | ** ** | **June 30,  2006**          | ** ** | **June 30,  2005**        | ** ** | **June 30,  2006** | ** ** | **June 30,  2005** | ** ** |
| Net trade sales                                    |       | $                                | 56         |                           | $          | 73 |   | $ | 374 |   | $ | 145 |   |
| Net sales to related companies                     |       | 1,720                            |       | 1,511                          |       | 3,455 |   | 3,123 |   |
| Total Net Sales                                    |       | 1,776                            |       | 1,584                          |       | 3,829 |   | 3,268 |   |
| Cost of sales                                      |       | 1,603                            |       | 1,383                          |       | 3,239 |   | 2,824 |   |
| Research and development expenses                  |       | 19                               |       | 18                             |       | 40 |   | 39 |   |
| Selling, general and administrative expenses       |       | 1                                |       | 5                              |       | 12 |   | 10 |   |
| Equity in earnings of nonconsolidated affiliates   |       | 83                               |       | 98                             |       | 144 |   | 251 |   |
| Sundry income (expense) - net                      |       | (23                              | )          | 1                              |       | (44 | ) | 53 |   |
| Interest income                                    |       | 35                               |       | 6                              |       | 58 |   | 10 |   |
| Interest expense and amortization of debt discount |       | 13                               |       | 19                             |       | 26 |   | 42 |   |
| Income before Income Taxes                         |       | 235                              |       | 264                            |       | 670 |   | 667 |   |
| Provision for income taxes                         |       | 80                               |       | 74                             |       | 232 |   | 197 |   |
| Net Income Available for Common Stockholder        |       | $                                | 155        |                           | $          | 190 |   | $ | 438 |   | $ | 470 |   |
| Depreciation                                       |       | $                                | 71         |                           | $          | 68 |   | $ | 139 |   | $ | 135 |   |
| Capital Expenditures                               |       | $                                | 54         |                           | $          | 51 |   | $ | 95 |   | $ | 94 |   |

 

*See Notes to the Consolidated FinancialStatements.*

 

3

----

 

**Union Carbide Corporation and Subsidiaries**

**Consolidated Balance Sheets**

 
| ** **                                                                          | ** ** | **June 30,** | ** ** | **Dec. 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| **In millions (Unaudited)**                                               | ** ** | **2006**          | ** ** | **2005**          | ** ** |
| **Assets**                                                                          | ** ** | ** **        | ** ** | ** **        | ** ** |
| Current Assets                                                                      |       |              |       |              |       |
| Cash and cash equivalents                                                           |       | $                 | 69         |              | $          | 73 |   |
| Accounts receivable:                                                                |       |              |       |              |       |
| Trade (net of allowance for doubtful receivables - 2006: $2; 2005: $3)              |       | 36                |       | 53                |       |
| Related companies                                                                   |       | 361               |       | 508               |       |
| Other                                                                               |       | 97                |       | 96                |       |
| Notes receivable from related companies                                             |       | 2,180             |       | 1,631             |       |
| Inventories                                                                         |       | 208               |       | 181               |       |
| Deferred income tax assets - current                                                |       | 46                |       | 58                |       |
| Asbestos-related insurance receivables - current                                    |       | 76                |       | 117               |       |
| Total current assets                                                                |       | 3,073             |       | 2,717             |       |
| Investments                                                                         |       |              |       |              |       |
| Investments in related companies                                                    |       | 297               |       | 287               |       |
| Investments in nonconsolidated affiliates                                           |       | 744               |       | 887               |       |
| Other investments                                                                   |       | 21                |       | 13                |       |
| Noncurrent receivables                                                              |       | 60                |       | 62                |       |
| Noncurrent receivable from related company                                          |       | 199               |       | 197               |       |
| Total investments                                                                   |       | 1,321             |       | 1,446             |       |
| Property                                                                            |       |              |       |              |       |
| Property                                                                            |       | 7,414             |       | 7,415             |       |
| Less accumulated depreciation                                                       |       | 5,422             |       | 5,378             |       |
| Net property                                                                        |       | 1,992             |       | 2,037             |       |
| Other Assets                                                                        |       |              |       |              |       |
| Goodwill                                                                            |       | 26                |       | 26                |       |
| Other intangible assets (net of accumulated amortization - 2006: $122;  2005: $120) |       | 24                |       | 22                |       |
| Asbestos-related insurance receivables - noncurrent                                 |       | 763               |       | 818               |       |
| Prepaid pension expense                                                             |       | 840               |       | 806               |       |
| Deferred charges and other assets                                                   |       | 54                |       | 62                |       |
| Total other assets                                                                  |       | 1,707             |       | 1,734             |       |
| Total Assets                                                                        |       | $                 | 8,093      |              | $          | 7,934 |   |

 

*See Notes to the Consolidated Financial Statements.*

 

4

----

 

**Union Carbide Corporation and Subsidiaries**

**Consolidated Balance Sheets**

 
| ** **                                             | ** ** | **June 30,** | ** ** | **Dec. 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| **In millions (Unaudited)**                  | ** ** | **2006**          | ** ** | **2005**          | ** ** |
| **Liabilities and Stockholder’s  Equity**         | ** ** | ** **        | ** ** | ** **        | ** ** |
| Current Liabilities                                    |       |              |       |              |       |
| Notes payable:                                         |       |              |       |              |       |
| Related companies                                      |       | $                 | 10         |              | $          | 4 |   |
| Other                                                  |       | 3                 |       | 4                 |       |
| Long-term debt due within one year                     |       | 2                 |       | 2                 |       |
| Accounts payable:                                      |       |              |       |              |       |
| Trade                                                  |       | 216               |       | 292               |       |
| Related companies                                      |       | 174               |       | 317               |       |
| Other                                                  |       | 36                |       | 29                |       |
| Income taxes payable                                   |       | 115               |       | 41                |       |
| Asbestos-related liabilities - current                 |       | 87                |       | 121               |       |
| Accrued and other current liabilities                  |       | 229               |       | 235               |       |
| Total current liabilities                              |       | 872               |       | 1,045             |       |
| Long-Term Debt                                         |       | 820               |       | 822               |       |
| Other Noncurrent Liabilities                           |       |              |       |              |       |
| Deferred income taxes payable - noncurrent             |       | 55                |       | 89                |       |
| Pension and other postretirement benefits - noncurrent |       | 447               |       | 455               |       |
| Asbestos-related liabilities - noncurrent              |       | 1,346             |       | 1,384             |       |
| Other noncurrent obligations                           |       | 335               |       | 361               |       |
| Total other noncurrent liabilities                     |       | 2,183             |       | 2,289             |       |
| Minority Interest in Subsidiaries                      |       | 4                 |       | 4                 |       |
| Stockholder’s Equity                              |       |              |       |              |       |
| Common stock (1,000 shares authorized and issued)      |       | —            |       | —            |       |
| Additional paid-in capital                             |       | 121               |       | 121               |       |
| Retained earnings                                      |       | 4,174             |       | 3,736             |       |
| Accumulated other comprehensive loss                   |       | (81               | )          | (83               | )          |
| Net stockholder’s equity                          |       | 4,214             |       | 3,774             |       |
| Total Liabilities and Stockholder’s Equity        |       | $                 | 8,093      |              | $          | 7,934 |   |

 

*See Notes to the Consolidated FinancialStatements.*

 

5

----

 

**Union Carbide Corporation and Subsidiaries**

**Consolidated Statements of CashFlows**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**              | ** ** | **June 30,** | ** ** |
| **In millions (Unaudited)**                                              | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Operating Activities                                                               | * *   | * *                       | * *   | * * | * * |
| Net Income Available for Common Stockholder                                        |       | $                              | 438        |   | $ | 470 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 153                            |       | 148 |   |
| Provision (Credit) for deferred income tax                                         |       | (26                            | )          | 186 |   |
| Earnings/losses of nonconsolidated affiliates less than dividends  received        |       | 131                            |       | 25 |   |
| Other gain, net                                                                    |       | —                         |       | (1 | ) |
| Gain on sale of ownership interest in nonconsolidated affiliate                    |       | —                         |       | (70 | ) |
| Changes in assets and liabilities that provided (used) cash:                       |       |                           |       |   |   |
| Accounts and notes receivable                                                      |       | 12                             |       | 27 |   |
| Related company receivables                                                        |       | (402                           | )          | (117 | ) |
| Inventories                                                                        |       | (27                            | )          | (9 | ) |
| Accounts payable                                                                   |       | (50                            | )          | 2 |   |
| Related company payables                                                           |       | (137                           | )          | (203 | ) |
| Other assets and liabilities                                                       |       | —                         |       | (68 | ) |
| Cash provided by operating activities                                              |       | 92                             |       | 390 |   |
| Investing Activities                                                               |       |                           |       |   |   |
| Capital expenditures                                                               |       | (95                            | )          | (94 | ) |
| Distributions from nonconsolidated affiliates                                      |       | 4                              |       | 41 |   |
| Changes in noncurrent receivable from related company                              |       | (2                             | )          | 13 |   |
| Purchases of investments                                                           |       | (2                             | )          | (1 | ) |
| Proceeds from sales of investments                                                 |       | 2                              |       | — |   |
| Cash used in investing activities                                                  |       | (93                            | )          | (41 | ) |
| Financing Activities                                                               |       |                           |       |   |   |
| Changes in short-term notes payable                                                |       | (1                             | )          | — |   |
| Payments on long-term debt                                                         |       | (2                             | )          | (345 | ) |
| Cash used in financing activities                                                  |       | (3                             | )          | (345 | ) |
| Summary                                                                            |       |                           |       |   |   |
| Increase (Decrease) in cash and cash equivalents                                   |       | (4                             | )          | 4 |   |
| Cash and cash equivalents at beginning of year                                     |       | 73                             |       | 22 |   |
| Cash and cash equivalents at end of period                                         |       | $                              | 69         |   | $ | 26 |   |

 

*See Notes to the Consolidated Financial Statements.*

 

**Union Carbide Corporation and Subsidiaries**

**Consolidated Statements ofComprehensive Income**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| **In millions (Unaudited)**                       | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net Income Available for Common Stockholder                 |       | $                                | 155        |                           | $          | 190 |   | $ | 438 |   | $ | 470 |   |
| Other Comprehensive Income (Loss), Net of Tax               |       |                             |       |                           |       |   |   |   |   |
| Unrealized gains on investments                             |       | 1                                |       | —                         |       | — |   | — |   |
| Translation adjustments                                     |       | 1                                |       | (6                             | )          | 1 |   | (10 | ) |
| Minimum pension liability adjustment                        |       | —                           |       | (1                             | )          | — |   | 6 |   |
| Net gain (loss) on cash flow hedging derivative instruments |       | —                           |       | (2                             | )          | 1 |   | — |   |
| Total other comprehensive income (loss)                     |       | 2                                |       | (9                             | )          | 2 |   | (4 | ) |
| Comprehensive Income                                        |       | $                                | 157        |                           | $          | 181 |   | $ | 440 |   | $ | 466 |   |

 

*See Notes to the Consolidated FinancialStatements.*

 

6

----

 

**UnionCarbide Corporation and Subsidiaries**

**Notes to the Consolidated Financial Statements**

 

(Unaudited)

 

**NOTE A     CONSOLIDATED FINANCIAL STATEMENTS**

 

The unaudited interim consolidated financial statements of UnionCarbide Corporation and its subsidiaries (the “Corporation” or “UCC”) wereprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) and reflect all adjustments (including normalrecurring accruals) which, in the opinion of management, are considerednecessary for the fair presentation of the results for the periods presented.

 

The Corporation isa wholly owned subsidiary of The Dow Chemical Company (“Dow”). In accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 128, “EarningsPer Share,” the presentation of earnings per share is not required in financialstatements of wholly owned subsidiaries.

 

The Corporation’sbusiness activities comprise components of Dow’s global operations rather thanstand-alone operations. Dow conducts its worldwide operations through globalbusinesses. Because there are no separable reportable business segments for UCCunder SFAS No. 131, “Disclosures about Segments of an Enterprise and RelatedInformation,” and no detailed business information is provided to a chiefoperating decision maker regarding the Corporation’s stand-alone operations,the Corporation’s results are reported as a single operating segment.

 

Intercompanytransactions and balances are eliminated in consolidation. Transactions withthe Corporation’s parent company, Dow, or other Dow subsidiaries have beenreflected as related company transactions in the consolidated financialstatements. See Note G for further discussion.

 

These statementsshould be read in conjunction with the audited consolidated financialstatements and notes thereto included in the Corporation’s Annual Report onForm 10-K for the year ended December 31, 2005.

 

**NOTE B     ACCOUNTING CHANGES**

 

**Accounting for Conditional AssetRetirement Obligations**

 

In March 2005, the FinancialAccounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 47, “Accountingfor Conditional Asset Retirement Obligations,” which clarifies the term *conditional asset retirement obligation* asused in SFAS No. 143, “Accounting for Asset Retirement Obligations,” as a legalobligation to perform an asset retirement activity in which the timing and/ormethod of settlement are conditional on a future event that may or may not bewithin the control of the Corporation. FIN No. 47 was effective nolater than the end of fiscal years ending after December 15, 2005.

 

The Corporation has 17manufacturing sites in six countries. Most of these sites contain numerousindividual manufacturing operations, particularly at the Corporation’s largersites. Asset retirement obligations are recorded in the period in which theyare incurred and reasonably estimable, including those obligations for whichthe timing and/or method of settlement are conditional on a future event thatmay or may not be within the control of the Corporation. Retirement of assetsmay involve such efforts as remediation and treatment of asbestos,contractually required demolition, and other related activities, depending onthe nature and location of the assets, and are typically realized only upondemolition of those facilities. In identifying asset retirement obligations,the Corporation considers identification of legally enforceable obligations,changes in existing law, estimates of potential settlement dates and thecalculation of an appropriate discount rate to be used in calculating the fairvalue of the obligations. The Corporation has a well-established global processto identify, approve and track the demolition of retired or to-be-retiredfacilities; no assets are retired from service until this process has beenfollowed. The Corporation typically forecasts demolition projects based on theusefulness of the assets; environmental, health and safety concerns; and othersimilar considerations. Under this process, as demolition projects are identifiedand approved, reasonable estimates may then be determined for the time framesduring which any related asset retirement obligations are expected to besettled. For those assets where a range of potential settlement dates may bereasonably estimated, obligations are recorded.

 

Assets that have not beensubmitted/reviewed for potential demolition activities are considered to havecontinued usefulness and are generally still operating “normally.” Therefore,without a plan to demolish the assets or the expectation of a plan, such asshortening the useful life of assets for depreciation purposes under therequirements of SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” the Corporation is unable to reasonably forecast a timeframe to use for present value calculations. As such, the Corporation has notrecognized obligations for individual plants/buildings at its 17 manufacturingsites where estimates of potential settlement dates cannot be reasonably made.The Corporation routinely reviews all changes to the list of items underconsideration for demolition to determine if an adjustment to the value of theasset retirement obligation is required.

 

Adoption of FIN No. 47 onDecember 31, 2005 resulted in the recognition of an asset retirement obligationof $12 million and a charge of $8 million (net of tax of$4 million), which was included in “Cumulative effect of changes inaccounting principles” in the fourth quarter of 2005. The discount rate used tocalculate the Corporation’s asset retirement obligations was 4.6 percent.

 

7

----

 

If the conditional assetretirement obligation measurement and recognition provisions of FIN No. 47 hadbeen in effect on January 1, 2005, the aggregate carrying amount of thoseobligations on that date would have been $12 million. If the amortization ofasset retirement cost and accretion of asset retirement obligation provisionsof FIN No. 47 had been in effect during 2005, the impact on “Net IncomeAvailable to Common Stockholder” would have been immaterial.

 

In accordance with FINNo. 47, the Corporation has recognized conditional asset retirement obligationsrelated to asbestos encapsulation as a result of planned demolition andremediation activities at manufacturing and administrative sites in the UnitedStates. At December 31, 2005, the aggregate carrying amount of conditionalasset retirement obligations recognized by the Corporation was $12 million. Theaggregate carrying amount of conditional asset retirement obligations was $13million at June 30, 2006.

 

As described above, theCorporation has not recognized conditional asset retirement obligations forwhich a fair value cannot be reasonably estimated in its consolidated financialstatements. It is the opinion of management that the possibility is remote thatsuch conditional asset retirement obligations, when estimable, will have amaterial adverse impact on the Corporation’s consolidated financial statementsbased on current costs.

 

**Other Accounting Changes**

 

In November 2004, theFASB issued SFAS No. 151, “Inventory Costs – an amendment of ARB No. 43,Chapter 4,” which clarifies the accounting for abnormal amounts of idlefacility expense, freight, handling costs, and wasted material (spoilage) andalso requires that the allocation of fixed production overhead be based on thenormal capacity of the production facilities. SFAS No. 151 was effective forinventory costs incurred during fiscal years beginning after June 15, 2005.Because the Corporation previously used nameplate capacity to calculate productcosts, adoption of SFAS No. 151 on January 1, 2006 had an immaterial favorableimpact on the Corporation’s consolidated financial statements.

 

On January 1, 2006, Dowadopted revised SFAS No. 123 (“SFAS No. 123R”), “Share-Based Payment.” TheCorporation will continue to be allocated the portion of expense relating toits employees who receive stock-based compensation, which was immaterial in thefirst six months of 2006.

 

In September 2005, the FASB ratified the consensusreached by the Emerging Issues Task Force (“EITF”) with respect to EITF IssueNo. 04-13, “Accounting for Purchases and Sales of Inventory with the SameCounterparty.” EITF Issue No. 04-13 is effective for new arrangementsentered into, and modifications or renewals of existing arrangements, in thefirst interim or annual period beginning after March 15, 2006. TheCorporation has determined that its current accounting treatment for purchasesand sales of inventory with the same counterparty is consistent with theguidance in EITF Issue No. 04-13; therefore, the issue had no impact onthe Corporation’s consolidated financial statements.

 

In June 2006, the FASB issued FIN No. 48, “Accountingfor Uncertainty in Income Taxes,” which clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “Accountingfor Income Taxes.” This interpretationprescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. This interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. FIN No. 48 is effectivefor fiscal years beginning after December 15, 2006. The Corporation is includedin Dow’s consolidated federal income tax group and consolidated tax return andDow is currently evaluating the impact of adopting this interpretation.

 

**NOTE C     INVENTORIES**

 

The following tableprovides a breakdown of inventories:

 

**Inventories**
| **In millions** | ** ** | **June 30,  2006** | ** ** | **Dec. 31,  2005** | ** ** |
|----------------------|------------|-------------------------|------------|-------------------------|------------|
| Finished goods       |       | $                       | 45         |                    | $          | 30 |   |
| Work in process      |       | 30                      |       | 26                      |       |
| Raw materials        |       | 50                      |       | 41                      |       |
| Supplies             |       | 83                      |       | 84                      |       |
| Total  inventories   |       | $                       | 208        |                    | $          | 181 |   |

 

Thereserves reducing inventories from the first-in, first-out (“FIFO”) basis tothe last-in, first-out (“LIFO”) basis amounted to $158 million at June 30, 2006and $164 million at December 31, 2005.

 

8

----

 

**NOTE D     OTHER INTANGIBLE ASSETS**

 

The following table provides information regarding the Corporation’sother intangible assets:

 

**Other Intangible Assets**
| ** **                            | ** ** | **At June 30, 2006** | ** ** | **At December 31, 2005** | ** ** |
|---------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| **In millions**                  | ** ** | **Gross  Carrying  Amount**         | ** ** | **Accumulated  Amortization**           | ** ** | **Net** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Intangible  assets with finite lives: |       |                                |       |                                    |       |   |   |   |   |   |   |   |   |
| Licenses and  intellectual property   |       | $                                   | 33         |                                    | $          | (32 | ) | $ | 1 |   | $ | 33 |   | $ | (32 | ) | $ | 1 |   |
| Patents                               |       | 4                                   |       | (2                                      | )          | 2 |   | 4 |   | (2 | ) | 2 |   |
| Software                              |       | 108                                 |       | (87                                     | )          | 21 |   | 104 |   | (85 | ) | 19 |   |
| Other                                 |       | 1                                   |       | (1                                      | )          | — |   | 1 |   | (1 | ) | — |   |
| Total                                 |       | $                                   | 146        |                                    | $          | (122 | ) | $ | 24 |   | $ | 142 |   | $ | (120 | ) | $ | 22 |   |

 

Total estimatedamortization expense for 2006 and the next five fiscal years is as follows:

 

**Estimated Amortization Expensefor Next Five Years**
| **In millions** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|
| 2006                 |       | $          | 4          |   |
| 2007                 |       | $          | 4          |   |
| 2008                 |       | $          | 4          |   |
| 2009                 |       | $          | 4          |   |
| 2010                 |       | $          | 4          |   |
| 2011                 |       | $          | 3          |   |

 

**NOTE E     COMMITMENTS AND CONTINGENT LIABILITIES**

 

**EnvironmentalMatters**

 

Accruals for environmental matters are recorded when it is probablethat a liability has been incurred and the amount of the liability can bereasonably estimated, based on current law and existing technologies. TheCorporation had accrued obligations of $87 million at December 31, 2005 forenvironmental remediation and restoration costs, including $34 million for theremediation of Superfund sites. At June 30, 2006, the Corporation had accruedobligations of $74 million for environmental remediation and restoration costs,including $27 million for the remediation of Superfund sites. This is management’sbest estimate of the costs for remediation and restoration with respect toenvironmental matters for which the Corporation has accrued liabilities,although the ultimate cost with respect to these particular matters could rangeup to twice that amount. Inherent uncertainties exist in these estimatesprimarily due to unknown conditions, changing governmental****regulationsand legal standards regarding liability, and evolving technologies for handlingsite remediation and restoration. It is the opinion of the Corporation’smanagement that the possibility is remote that costs in excess of thosedisclosed will have a material adverse impact on the Corporation’s consolidatedfinancial statements.

 

**Litigation**

 

The Corporation and itssubsidiaries are involved in a number of legal proceedings and claims with bothprivate and governmental parties. These cover a wide range of matters,including, but not limited to: product liability; trade regulation;governmental regulatory proceedings; health, safety and environmental matters;employment; patents; contracts; taxes; and commercial disputes.

 

Separately, theCorporation is and has been involved in a large number of asbestos-relatedsuits filed primarily in state courts during the past three decades. Thesesuits principally allege personal injury resulting from exposure toasbestos-containing products and frequently seek both actual and punitivedamages. The alleged claims primarily relate to products that UCC sold in thepast, alleged exposure to asbestos-containing products located on UCC’spremises, and UCC’s responsibility for asbestos suits filed against a formersubsidiary, Amchem Products, Inc. (“Amchem”). In many cases, plaintiffs areunable to demonstrate that they have suffered any compensable loss as a resultof such exposure, or that injuries incurred in fact resulted from exposure tothe Corporation’s products.

 

9

----

 

Influenced by thebankruptcy filings of numerous defendants in asbestos-related litigation and theprospects of various forms of state and national legislative reform, the rateat which plaintiffs filed asbestos-related suits against various companies,including the Corporation and Amchem, increased in 2001, 2002 and the firsthalf of 2003. Since then, the rate of filing has significantly abated. TheCorporation expects more asbestos-related suits to be filed against it andAmchem in the future, and will aggressively defend or reasonably resolve, asappropriate, both pending and future claims.

 

Based on a studycompleted by Analysis, Research & Planning Corporation (“ARPC”) in January2003, the Corporation increased its December 31, 2002 asbestos-relatedliability for pending and future claims for the 15-year period ending in 2017to $2.2 billion, excluding future defense and processing costs. At each balancesheet date, the Corporation compares current asbestos claim and resolutionactivity to the assumptions in the most recent ARPC study to determine whetherthe accrual continues to be appropriate.

 

In November 2004,the Corporation requested ARPC to review the Corporation’s historical asbestosclaim and resolution activity and determine the appropriateness of updating itsJanuary 2003 study. In response to that request, ARPC reviewed and analyzed datathrough November 14, 2004, and again concluded that it was not possible toestimate the full range of the cost of resolving future asbestos-related claimsagainst UCC and Amchem because of various uncertainties associated with thelitigation of those claims. ARPC did advise, however, that it was reasonableand feasible to construct a new estimate of the cost of resolving current andfuture asbestos-related claims using the same two widely used forecastingmethodologies used by ARPC in its January 2003 study, if certain assumptionswere made. As a result, the following assumptions were made and then used byARPC:

 

•                  Thenumber of future claims to be filed annually against UCC and Amchem is unlikelyto exceed the level of claims experienced during 2004.

 

•                  Thenumber of claims filed against UCC and Amchem annually from 2001 to 2003 isconsidered anomalous for the purpose of estimating future filings.

 

•                  Thenumber of future claims to be filed against UCC and Amchem will decline at afairly constant rate each year from 2005.

 

•                  Theaverage resolution value for pending and future claims will be equivalent tothose experienced during 2003 and 2004 (excluding settlements from closedclaims filed in Madison County, Illinois with respect to future claims, aschanges in the judicial environment in Madison County caused the historicalexperience of claims in that jurisdiction to not be predictive of results forfuture claims).

 

The resulting studycompleted by ARPC in January 2005 stated that the undiscounted cost of resolvingpending and future asbestos-related claims against UCC and Amchem, excludingfuture defense and processing costs, through 2017 was estimated to be betweenapproximately $1.5 billion and $2.0 billion, depending on which of two acceptedmethodologies was used. At December 31, 2004, the recorded asbestos-relatedliability for pending and future claims was $1.6 billion. Based on the low endof the range in the January 2005 study, the recorded asbestos-related liabilityfor pending and future claims at December 31, 2004 would be sufficient toresolve asbestos-related claims against UCC and Amchem into 2019. As in itsJanuary 2003 study, ARPC provided estimates for a longer period of time in itsJanuary 2005 study, but also reaffirmed its prior advice that forecasts forshorter periods of time are more accurate than those for longer periods oftime. Based on ARPC’s studies, the Corporation’s asbestos litigationexperience, and the uncertainties surrounding asbestos litigation andlegislative reform efforts, management determined that no change to the accrualwas required at December 31, 2004.

 

In November 2005,the Corporation requested ARPC to review the Corporation’s 2005 asbestos claimand resolution activity and determine the appropriateness of updating theJanuary 2005 study. In response to that request, ARPC reviewed and analyzeddata through October 31, 2005. In January 2006, ARPC stated that an update ofthe study would not provide a more likely estimate of future events than theestimate reflected in its study of the previous year and, therefore, theestimate in that study remained applicable.

 

Based on the Corporation’sown review of the asbestos claim and resolution activity and ARPC’s response,the Corporation determined that no change to the accrual was required atDecember 31, 2005. The asbestos-related liability for pending and future claimswas $1.5 billion at December 31, 2005. Approximately 39 percent of the recordedliability related to pending claims and approximately 61 percent relatedto future claims.

 

Based on the Corporation’sreview of 2006 activity, the Corporation determined that no change to theaccrual was required at June 30, 2006. The asbestos-related liability forpending and future claims was $1.4 billion at June 30, 2006. Approximately 36percent of the recorded liability related to pending claims and approximately 64 percentrelated to future claims.

 

At December 31,2002, the Corporation increased the receivable for insurance recoveries relatedto its asbestos liability to $1.35 billion, substantially exhausting itsasbestos product liability coverage. The insurance receivable related to theasbestos liability was determined after a thorough review of applicableinsurance policies and the 1985 Wellington

 

10

----

 

Agreement, to which the Corporation and many of its liability insurersare signatory parties, as well as other insurance settlements, with dueconsideration given to applicable deductibles, retentions and policy limits,and taking into account the solvency and historical payment experience ofvarious insurance carriers. The Wellington Agreement and other agreements withinsurers are designed to facilitate an orderly resolution and collection of theCorporation’s insurance policies and to resolve issues that the insurancecarriers may raise.

 

The Corporation’sreceivable for insurance recoveries related to its asbestos liability was $485 millionat June 30, 2006 and $535 million at December 31, 2005. At June 30, 2006 $391million ($398 million at December 31, 2005) of the receivable for insurancerecoveries was related to insurers that are not signatories to the WellingtonAgreement and/or do not otherwise have agreements in place regarding theirasbestos-related insurance coverage.

 

In addition, theCorporation had receivables for defense and resolution costs submitted toinsurance carriers for reimbursement as follows:

 
| **Receivables for Costs Submitted to Insurance Carriers** |
|-----------------------------------------------------------------------------------------|
| **In millions**                                                                    | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
| Receivables for  defense costs                                                          |   | $ | 21 |   | $ | 73 |   |
| Receivables for  resolution costs                                                       |   | 333 |   | 327 |   |
| Total                                                                                   |   | $ | 354 |   | $ | 400 |   |

 

The Corporationexpenses defense costs as incurred. The pretax impact for defense andresolution costs, net of insurance, was $14 million in the second quarter of2006 and in the second quarter of 2005, and $28 million in the first six monthsof 2006 ($32 million in the first six months of 2005), and was reflected in “Costof sales.”

 

In September 2003, theCorporation filed a comprehensive insurance coverage case, now proceeding inthe Supreme Court of the State of New York, County of New York, seeking toconfirm its rights to insurance for various asbestos claims and to facilitatean orderly and timely collection of insurance proceeds. Although theCorporation already has settlements in place concerning coverage for asbestosclaims with many of its insurers, including those covered by the 1985Wellington Agreement, this lawsuit was filed against insurers that are notsignatories to the Wellington Agreement and/or do not otherwise have agreementsin place with the Corporation regarding their asbestos-related insurancecoverage, in order to facilitate an orderly resolution and collection of suchinsurance policies and to resolve issues that the insurance carriers may raise.The insurance carriers are contesting this litigation. Through the secondquarter of 2006, the Corporation reached settlements with several of thecarriers involved in this litigation. After a further review of its insurancepolicies, with due consideration given to applicable deductibles, retentionsand policy limits, after taking into account the solvency and historicalpayment experience of various insurance carriers; existing insurancesettlements; and the advice of outside counsel with respect to the applicableinsurance coverage law relating to the terms and conditions of its insurancepolicies, the Corporation continues to believe that its recorded receivable forinsurance recoveries from all insurance carriers is probable of collection.

 

The amounts recorded forthe asbestos-related liability and related insurance receivable described abovewere based upon current, known facts. However, future events, such as thenumber of new claims to be filed and/or received each year, the average cost ofdisposing of each such claim, coverage issues among insurers, and thecontinuing solvency of various insurance companies, as well as the numerousuncertainties surrounding asbestos litigation in the United States, could causethe actual costs and insurance recoveries to be higher or lower than thoseprojected or those recorded.

 

Because of theuncertainties described above, management cannot estimate the full range of thecost of resolving pending and future asbestos-related claims facing theCorporation and Amchem. Management believes that it is reasonably possible thatthe cost of disposing of the Corporation’s asbestos-related claims, includingfuture defense costs, could have a material adverse impact on the results ofoperations and cash flows for a particular period and on the consolidatedfinancial position of the Corporation.

 

While it is notpossible at this time to determine with certainty the ultimate outcome of anyof the legal proceedings and claims referred to in this filing, managementbelieves that adequate provisions have been made for probable losses withrespect to pending claims and proceedings, and that, except for theasbestos-related matters described above, the ultimate outcome of all known andfuture claims, after provisions for insurance, will not have a material adverseimpact on the results of operations, cash flows and consolidated financialposition of the Corporation. Should any losses be sustained in connection withany of such legal proceedings and claims in excess of provisions provided andavailable insurance, they will be charged to income when determinable.

 

11

----

 

**PurchaseCommitments**

 

At December 31, 2005, theCorporation had various outstanding commitments for take or pay agreements,with terms extending from one to five years. Such commitments were not inexcess of current market prices. The Corporation had an agreement for thepurchase of ethylene-related products in Canada; the Corporation assigned itsrights and obligations under this purchase agreement to a wholly ownedsubsidiary of Dow in December 2003. Total purchases under the ethylene-relatedagreement were $93 million in 2003.

 

The fixed anddeterminable portion of obligations under purchase commitments at December 31,2005 is presented in the following table:

 

**Fixed and Determinable Portion of Take or Pay Obligationsat December 31, 2005**
| **In millions** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|
| 2006                 |       | $          | 10         |   |
| 2007                 |       | 10         |       |
| 2008                 |       | 8          |       |
| 2009                 |       | 8          |       |
| 2010                 |       | 5          |       |
| Total                |       | $          | 41         |   |

 

**Guarantees**

 

The Corporation hasundertaken obligations to guarantee the performance of certain nonconsolidatedaffiliates (including the OPTIMAL Group and Nippon Unicar Company Limited) anda former subsidiary of the Corporation (via delivery of cash or other assets)if specified triggering events occur. Non-performance under a contract forcommercial and/or financial obligations by the guaranteed party would triggerthe obligation of the Corporation to make payments to the beneficiary of theguarantees. Financial obligations include debt and lease arrangements.

 

The followingtable provides a summary of the final expiration, maximum future payments, andrecorded liability reflected in the consolidated balance sheets for theseguarantees.

 

**Guarantees**
| **In millions**             | ** ** | **Final  Expiration** | ** ** | **Maximum Future  Payments** | ** ** | **Recorded  Liability** | ** ** |
|----------------------------------|------------|-----------------------|------------|-----------------------------------|------------|-------------------------|------------|
| Guarantees at  June 30, 2006     |       | 2014                  |       | $                                 | 93         |                    | $          | 1 |   |
| Guarantees at  December 31, 2005 |       | 2014                  |       | $                                 | 92         |                    | $          | 2 |   |

 

**NOTE F     PENSION AND OTHER POSTRETIREMENT BENEFITS**

 

**NetPeriodic Benefit Cost (Credit) for All Significant Plans**
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **In millions**                  | ** ** | **June 30,  2006**          | ** ** | **June 30,  2005**        | ** ** | **June 30,  2006** | ** ** | **June 30,  2005** | ** ** |
| *Defined  Benefit Pension Plans:*     |       |                             |       |                           |       |   |   |   |   |
| Service cost                          |       | $                                | 6          |                           | $          | 6 |   | $ | 12 |   | $ | 13 |   |
| Interest cost                         |       | 53                               |       | 55                             |       | 106 |   | 109 |   |
| Expected return  on plan assets       |       | (83                              | )          | (86                            | )          | (166 | ) | (171 | ) |
| Amortization of  prior service cost   |       | —                           |       | 1                              |       | — |   | 1 |   |
| Amortization of  net loss             |       | 8                                |       | —                         |       | 16 |   | 1 |   |
| Net periodic  benefit credit          |       | $                                | (16        | )                              | $          | (24 | ) | $ | (32 | ) | $ | (47 | ) |
|                                  |       |                             |       |                           |       |   |   |   |   |
| *Other  Postretirement Benefits:*     |       |                             |       |                           |       |   |   |   |   |
| Service cost                          |       | $                                | 1          |                           | $          | 1 |   | $ | 2 |   | $ | 2 |   |
| Interest cost                         |       | 8                                |       | 8                              |       | 16 |   | 17 |   |
| Amortization of  prior service credit |       | (1                               | )          | —                         |       | (2 | ) | (1 | ) |
| Amortization of  net loss             |       | 1                                |       | 2                              |       | 2 |   | 3 |   |
| Net periodic  benefit cost            |       | $                                | 9          |                           | $          | 11 |   | $ | 18 |   | $ | 21 |   |

 

12

----

 

**Employer Contributions**

 

*Pension Plans*

 

The Corporation has adefined benefit pension plan that covers substantially all employees in theUnited States. Benefits are based on length of service and the employee’s threehighest consecutive years of compensation.

 

The Corporation’s fundingpolicy is to contribute to the plans when pension laws and economics eitherrequire or encourage funding. As previously disclosed in the Corporation’s AnnualReport on Form 10-K for the year ended December 31, 2005, UCC does notexpect to contribute assets to its qualified pension plan in 2006. Consistentwith that expectation, no contributions were made in the first six months of2006. The Corporation also has a non-qualified supplemental pension plan. Benefitpayments to retirees under this plan are expected to be $2 million in 2006. Inthe first six months of 2006, benefit payments of $1 million were made.

 

*Other Postretirement Benefits*

 

The Corporation providescertain health care and life insurance benefits to retired U.S. employees. Theplan provides health care benefits, including hospital, physicians’ services,drug and major medical expense coverage, and life insurance benefits. TheCorporation and the retiree share the cost of these benefits, with theCorporation portion increasing as the retiree has increased years of creditedservice. There is a cap on the Corporation portion. The Corporation has theability to change these benefits at any time.

 

The Corporation fundsmost of the cost of these health care and life insurance benefits as incurred.As previously disclosed in the Corporation’s Annual Report on Form 10-K for theyear ended December 31, 2005, UCC does not expect to contribute assets to itsother postretirement benefit plans in 2006. Consistent with that expectation,no contributions were made in the first six months of 2006. Benefit payments toretirees under these plans are expected to be $60 million in 2006. In the firstsix months of 2006, benefit payments of $26 million were made.

 

**NOTE G     RELATED PARTY TRANSACTIONS**

 

The Corporation sells products to Dow to simplify the customerinterface process. Products are sold to and purchased from Dow in accordancewith the terms of Dow’s long-standing intercompany pricing policies. Theapplication of these policies results in products being sold to and purchasedfrom Dow at market-based prices. The Corporation also procures certaincommodities and raw materials through a Dow subsidiary and pays a commission tothat Dow subsidiary based on the volume and type of commodities and rawmaterials purchased. The commission expense is included in “Sundry income(expense) – net” in the consolidated statements of income. Purchases from thatDow subsidiary were approximately $725 million in the second quarter of2006 ($572 million in the second quarter of 2005) and $1,530 million in thefirst half of 2006 ($1,175 million in the first half of 2005).

 

The Corporationhas a master services agreement with Dow whereby Dow provides services, including,but not limited to, accounting, legal, treasury (investments, cash management,risk management, insurance), procurement, human resources, environmental,health and safety, and business management for UCC. Under the master servicesagreement with Dow, for general administrative and overhead type services thatDow routinely allocates to various businesses, UCC is charged the cost of thoseservices based on the Corporation’s and Dow’s relative manufacturing conversioncosts. This arrangement results in a quarterly charge of approximately $5million (included in “Sundry income (expense) – net”).

 

For services thatDow routinely charges based on effort, UCC is charged the cost of such serviceson a fully absorbed basis, which includes direct and indirect costs.Additionally, certain Dow employees are contracted to UCC and Dow is reimbursedfor all direct employment costs of such employees. Management believes themethod used for determining expenses charged by Dow is reasonable. Dow providesthese services by leveraging its centralized functional service centers toprovide services at a cost that management believes provides an advantage tothe Corporation.

 

The monitoring andexecution of risk management policies related to interest rate and foreigncurrency risks, which are based on Dow’s risk management philosophy, areprovided as a service to UCC.

 

As part of Dow’scash management process, UCC is a party to revolving loans with Dow that haveLIBOR-based interest rates with varying maturities. At June 30, 2006, theCorporation had a note receivable of $2,143 million from Dow under a revolvingloan agreement. The Corporation may draw from this note receivable in supportof its daily working capital requirements and as such, the net effect of cashinflows and outflows under this revolving loan agreement is presented in theconsolidated statements of cash flows as an operating activity.

 

13

----

 

The Corporationalso has a separate revolving credit agreement with Dow that allows theCorporation to borrow or obtain credit enhancements up to an aggregate of $1billion that matures December 30, 2006; however, Dow may demand repayment witha 30-day written notice to the Corporation, subject to certain restrictions. Arelated collateral agreement provides for the replacement of certain existingpledged assets, primarily equity interests in various subsidiaries and jointventures, with cash collateral. At June 30, 2006, $813 million wasavailable under the revolving credit agreement. The cash collateral wasreported as “Noncurrent receivable from related company” in the consolidatedbalance sheets.

 

The losses and additionalcosts incurred by the Corporation in 2005 due to hurricane Katrina were coveredby the Corporation’s insurance program. The Corporation has an insurancereceivable for losses incurred of $105 million at June 30, 2006 from itsinsurer (an affiliate of Dow). Additionally, the Corporation has insurancecoverage for lost sales and margins caused by hurricane Katrina. No amount ofrecovery for lost sales and margins has been recognized at June 30, 2006, andwill only be recognized when the amount of recovery is realized throughagreement amongst the insurers.

 

The Corporation recordedequity earnings of approximately $10 million from Dow Canada Holding LP (“DCHLP”)for the first two months of 2006 which increased the investment balance to $10million. On March 1, 2006, the Corporation transferred its 11.2 percentpartnership interest in DCHLP to a newly formed corporation, GWN Holding, Inc.(“GWN”), in exchange for 11.2 percent of GWN’s common stock. The Corporationaccounts for its 11.2 percent ownership interest in GWN using the cost method.

 

In accordance with theAmended and Restated Tax Sharing Agreement between the Corporation and Dow, theCorporation made a payment of $184 million to Dow in June 2006 to cover theCorporation’s estimated federal tax liability for the first six months of 2006.

 

14

----

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

** **

Pursuant to General Instruction H of Form 10-Q “Omission of Informationby Certain Wholly-Owned Subsidiaries,” this section includes only management’snarrative analysis of the results of operations for the three- and six-monthperiods ended June 30, 2006, the most recent periods, compared with the threeand six-month periods ended June 30, 2005, the corresponding periods in thepreceding fiscal year.

 

References below to “Dow”refer to The Dow Chemical Company and its consolidated subsidiaries, except asthe context otherwise requires.

 

The Corporation’sbusiness activities comprise components of Dow’s global operations rather thanstand-alone operations. Dow conducts its worldwide operations through globalbusinesses. Because there are no separable reportable business segments for UCCunder Statement of Financial Accounting Standards No. 131, “Disclosures aboutSegments of an Enterprise and Related Information,” and no detailed businessinformation is provided to a chief operating decision maker regarding theCorporation’s stand-alone operations, the Corporation’s results are reported asa single operating segment.

 

##### **DISCLOSURE REGARDINGFORWARD-LOOKING INFORMATION**

##### ** **

The Private Securities Litigation Reform Act of 1995 provides a “safeharbor” for forward-looking statements made by or on behalf of Union CarbideCorporation (the “Corporation” or “UCC”). This section covers the currentperformance and outlook of the Corporation. The forward-looking statementscontained in this section and in other parts of this document involve risks anduncertainties that may affect the Corporation’s operations, markets, products,services, prices and other factors as more fully discussed elsewhere and infilings with the U.S. Securities and Exchange Commission (SEC). These risks anduncertainties include, but are not limited to, economic, competitive, legal,governmental and technological factors. Accordingly, there is no assurance thatthe Corporation’s expectations will be realized. The Corporation assumes noobligation to provide revisions to any forward-looking statements shouldcircumstances change, except as otherwise required by securities and otherapplicable laws.

 

**RESULTSOF OPERATIONS**

 

Total net sales for the second quarter of 2006 were $1,776 millioncompared with $1,584 million for the second quarter of 2005, an increase of 12 percent.Selling prices to Dow are based on market prices for the related products. Averageselling prices for most products were higher in the second quarter of 2006,reflecting significantly higher raw material and energy costs. Overall volumefor the second quarter of 2006 was up slightly compared with the same period lastyear. Strong volume gains for polyethylene, oxo products and EG were largely offsetby lower demand for the Corporation’s other products, including vinyl acetatemonomer and isopropanol. Total net sales were $3,829 million for the firsthalf of 2006 compared with $3,268 million for the first half of 2005, anincrease of 17 percent. On a year-to-date basis, total net sales were favorablyimpacted by lump sum technology licensing revenue earned in the first quarterof 2006. Average selling prices for most of the Corporation’s products werehigher for the first six months of 2006 compared with the same period lastyear. On a year-to-date basis, volume was up slightly as gains in polyethylene,oxo products, EG and ethylene oxide were largely offset by lower demand forother products.

 

Cost of sales forthe second quarter of 2006 increased 16 percent compared with the secondquarter of 2005, and cost of sales for the first half of 2006 increased 15percent compared with the same period last year, principally due to higher rawmaterial costs.

 

Equity in earningsof nonconsolidated affiliates was $83 million in the second quarter of 2006 comparedwith $98 million in the same quarter last year. The absence of equity earningsfrom UOP LLC (which the Corporation exited in the fourth quarter of 2005) andlower earnings from EQUATE Petrochemical Co. K.S.C. (“EQUATE”) were partiallyoffset by improved earnings from the OPTIMAL Group (“OPTIMAL”) and UnivationTechnologies, LLC (“Univation”). Year to date, equity in earnings ofnonconsolidated affiliates was $144 million compared with $251 million lastyear. In addition to the items previously mentioned, results for EQUATE andOPTIMAL for the first half of 2006 were lower due to planned maintenanceturnarounds in the first quarter of 2006. EQUATE’s maintenance turnaround wascompleted during the second quarter of 2006.

 

Interest income was$35 million in the second quarter of 2006 compared with $6 million in the secondquarter of 2005. Year to date, interest income was $58 million, up from $10million in the first six months of 2005 due to higher interest rates and asignificantly higher level of interest-bearing assets.

 

15

----

 

Interest expenseand amortization of debt discount was $13 million in the second quarter of 2006compared with $19 million in the second quarter of 2005. Year to date,interest expense and amortization of debt discount was $26 million, down from$42 million for the first six months of 2005, due to the reduction of long-termdebt which resulted from the early extinguishment of approximately $436 millionof debt, primarily in the second quarter of 2005.

 

Sundry income(expense) – net includes a variety of income and expense items such as the gainor loss on foreign currency exchange, dividends from investments, commissions,charges for management services provided by Dow, and gains and losses on salesof investments and assets. Sundry income (expense) – net for the second quarterof 2006 was net expense of $23 million compared with net income of $1million for the second quarter last year. Net sundry income for the secondquarter of 2005 included dividend income of $29 million from Dow ChemicalCanada Inc. (“Dow Canada”) and a loss of $8 million associated with theearly extinguishment of $345 million of debt. Year to date, Sundry income(expense) – net was net expense of $44 million compared with net income of $53million for the first six months of last year. Sundry income in the first sixmonths of 2005 also benefited from a $70 million pretax gain on the saleof a portion of the Corporation’s interest in EQUATE.

 

The effective taxrate fluctuates based on, among other factors, where income is earned, thelevel of after-tax income from joint ventures, and the level of income relativeto tax credits available. The effective tax rate for the second quarter of 2006was 34 percent compared with 28 percent for the same quarter last year. Year todate, the effective tax rate was 34.6 percent versus 29.5 percent lastyear. The effective tax rates for the second quarter and first six months of2006 were higher than the same periods last year principally due to lowerearnings from the Corporation’s joint ventures. Since most of the earnings fromnonconsolidated affiliates are taxed at the joint venture level, the impact oflower equity earnings increased the Corporation’s overall effective tax rate.In addition, the effective tax rate for 2005 reflects the favorable impact of$29 million of dividend income from Dow Canada in the second quarter of 2005,which was based on previously taxed income.

 

The Corporationreported net income of $155 million for the second quarter of 2006, comparedwith $190 million for the second quarter of 2005. The results for the secondquarter of 2006 were negatively impacted by a decline in gross margin and lowerequity earnings. Net income for the first half of 2006 declined to $438 millionfrom $470 million for the first half of 2005.

 

**OTHERMATTERS**

 

**Accounting Changes**

 

See Note B to theConsolidated Financial Statements for a discussion of accounting changes andrecently issued accounting pronouncements.

 

**Critical Accounting Policies**

 

The preparation offinancial statements and related disclosures in conformity with GAAP requiresmanagement to make judgments, assumptions and estimates that affect the amountsreported in the Consolidated Financial Statements and accompanying notes. NoteA to the Consolidated Financial Statements in the Corporation’s Annual Reporton Form 10-K for the year ended December 31, 2005 (“2005 10-K”) describes thesignificant accounting policies and methods used in the preparation of theConsolidated Financial Statements. The Corporation’s critical accountingpolicies that are impacted by judgments, assumptions and estimates aredescribed in Management’s Discussion and Analysis of Financial Condition andResults of Operations in the Corporation’s 2005 10-K. Since December 31, 2005,there have been no material changes in the Corporation’s critical accountingpolicies.

 

**Asbestos-Related Matters**

 

*Introduction*

 

The Corporation is andhas been involved in a large number of asbestos-related suits filed primarilyin state courts during the past three decades. These suits principally allegepersonal injury resulting from exposure to asbestos-containing products andfrequently seek both actual and punitive damages. The alleged claims primarilyrelate to products that UCC sold in the past, alleged exposure toasbestos-containing products located on UCC’s premises, and UCC’sresponsibility for asbestos suits filed against a former subsidiary, AmchemProducts, Inc. (“Amchem”). In many cases, plaintiffs are unable to demonstratethat they have suffered any compensable loss as a result of such exposure, orthat injuries incurred in fact resulted from exposure to the Corporation’sproducts.

 

Influenced by thebankruptcy filings of numerous defendants in asbestos-related litigation andthe prospects of various forms of state and national legislative reform, therate at which plaintiffs filed asbestos-related suits against various companies,including the Corporation and Amchem, increased in 2001, 2002 and the firsthalf of 2003. Since then, the rate of filing has significantly abated. TheCorporation expects more asbestos-related suits to be filed against it andAmchem in the future, and will aggressively defend or reasonably resolve, asappropriate, both pending and future claims.

 

16

----

 

The table below providesinformation regarding asbestos-related claims filed against the Corporation andAmchem:

 
| ** **                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Claims  unresolved at January 1                    |       | 146,325  |       | 203,416  |       |
| Claims filed                                       |       | 9,130    |       | 20,456   |       |
| Claims settled,  dismissed or otherwise resolved   |       | (34,327  | )          | (25,402  | )          |
| Claims  unresolved at June 30                      |       | 121,128  |       | 198,470  |       |
| Claimants with  claims against both UCC and Amchem |       | 42,096   |       | 64,682   |       |
| Individual  claimants at June 30                   |       | 79,032   |       | 133,788  |       |

 

Plaintiffs’ lawyers oftensue dozens or even hundreds of defendants in individual lawsuits on behalf ofhundreds or even thousands of claimants. As a result, the damages alleged arenot expressly identified as to UCC, Amchem or any other particular defendant,even when specific damages are alleged with respect to a specific disease orinjury. In fact, there are no personal injury cases in which only the Corporationand/or Amchem are the sole named defendants. For these reasons and based uponthe Corporation’s litigation and settlement experience, the Corporation doesnot consider the damages alleged against it and Amchem to be a meaningfulfactor in its determination of any potential asbestos liability.

 

*Estimatingthe Liability*

 

Based on a studycompleted by Analysis, Research & Planning Corporation (“ARPC”) in January2003, the Corporation increased its December 31, 2002 asbestos-relatedliability for pending and future claims for the 15-year period ending in 2017to $2.2 billion, excluding future defense and processing costs. At each balancesheet date, the Corporation compares current asbestos claim and resolutionactivity to the assumptions in the most recent ARPC study to determine whetherthe accrual continues to be appropriate.

 

In November 2004, theCorporation requested ARPC to review the Corporation’s historical asbestosclaim and resolution activity and determine the appropriateness of updating itsJanuary 2003 study. In January 2005, ARPC provided the Corporation with areport summarizing the results of its study. At December 31, 2004, the recordedasbestos-related liability for pending and future claims was $1.6 billion.Based on the low end of the range in the January 2005 study, the recordedasbestos-related liability for pending and future claims at December 31, 2004would be sufficient to resolve asbestos-related claims against UCC and Amcheminto 2019. As in its January 2003 study, ARPC provided estimates for a longerperiod of time in its January 2005 study, but also reaffirmed its prior advicethat forecasts for shorter periods of time are more accurate than those forlonger periods of time. Based on ARPC’s studies, the Corporation’s asbestoslitigation experience, and the uncertainties surrounding asbestos litigationand legislative reform efforts, management determined that no change to theaccrual was required at December 31, 2004.

 

In November 2005, theCorporation requested ARPC to review the Corporation’s 2005 asbestos claim andresolution activity and determine the appropriateness of updating the January2005 study. In response to that request, ARPC reviewed and analyzed datathrough October 31, 2005. In January 2006, ARPC stated that an update of thestudy would not provide a more likely estimate of future events than theestimate reflected in its study of the previous year and, therefore, theestimate in that study remained applicable.

 

Based on the Corporation’sown review of the asbestos claim and resolution activity and ARPC’s response,the Corporation determined that no change to the accrual was required atDecember 31, 2005. The asbestos-related liability for pending and future claimswas $1.5 billion at December 31, 2005. Approximately 39 percent of the recordedliability related to pending claims and approximately 61 percent relatedto future claims.

 

Based on the Corporation’sreview of 2006 activity, the Corporation determined that no change to theaccrual was required at June 30, 2006. The asbestos-related liability forpending and future claims was $1.4 billion at June 30, 2006. Approximately 36percent of the recorded liability related to pending claims and approximately 64 percentrelated to future claims.

 

*Defenseand Resolution Costs*

 

The following tableprovides information regarding defense and resolution costs related toasbestos-related claims filed against the Corporation and Amchem:

 

**Defense and Resolution Costs**
| ** **           | ** ** | **Six Months Ended** | ** ** | **Aggregate Costs** | ** ** |
|----------------------|------------|--------------------------------|------------|--------------------------|------------|
| **In millions** | ** ** | **June 30,  2006**        | ** ** | **June 30,  2005**  | ** ** | **to Date as of  June 30, 2006** | ** ** |
| Defense costs        |       | $                              | 28         |                     | $          | 32 |   | $ | 447 |   |
| Resolution costs     |       | $                              | 73         |                     | $          | 98 |   | $ | 1,138 |   |

 

17

----

 

The average resolutionpayment per asbestos claimant and the rate of new claim filings has fluctuatedboth up and down since the beginning of 2001. Union Carbide’s managementexpects such fluctuations to continue in the future based upon the number andtype of claims settled in a particular period, the jurisdictions in which suchclaims arose, and the extent to which any proposed legislative reform relatedto asbestos litigation is being considered.

 

*Insurance Receivables*

 

At December 31, 2002, theCorporation increased the receivable for insurance recoveries related to itsasbestos liability to $1.35 billion, substantially exhausting its asbestosproduct liability coverage. The insurance receivable related to the asbestosliability was determined after a thorough review of applicable insurancepolicies and the 1985 Wellington Agreement, to which the Corporation and manyof its liability insurers are signatory parties, as well as other insurancesettlements, with due consideration given to applicable deductibles, retentionsand policy limits, and taking into account the solvency and historical paymentexperience of various insurance carriers. The Wellington Agreement and otheragreements with insurers are designed to facilitate an orderly resolution andcollection of the Corporation’s insurance policies and to resolve issues thatthe insurance carriers may raise.

 

The Corporation’sreceivable for insurance recoveries related to its asbestos liability was $485million at June 30, 2006 and $535 million at December 31, 2005. At June 30, 2006$391 million ($398 million at December 31, 2005) of the receivable forinsurance recoveries was related to insurers that are not signatories to theWellington Agreement and/or do not otherwise have agreements in place regardingtheir asbestos-related insurance coverage.

 

In addition, theCorporation had receivables for defense and resolution costs submitted toinsurance carriers for reimbursement as follows:

 

**Receivables for Costs Submitted to Insurance Carriers**
| **In millions**              | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Receivables for  defense costs    |       | $                       | 21         |                        | $          | 73 |   |
| Receivables for  resolution costs |       | 333                     |       | 327                         |       |
| Total                             |       | $                       | 354        |                        | $          | 400 |   |

 

The Corporation expensesdefense costs as incurred. The pretax impact for defense and resolution costs,net of insurance, was $14 million in the second quarter of 2006 and in the secondquarter of 2005, and $28 million in the first six months of 2006 ($32 millionin the first six months of 2005), and was reflected in “Cost of sales.”

 

In September 2003, theCorporation filed a comprehensive insurance coverage case, now proceeding in theSupreme Court of the State of New York, County of New York, seeking to confirmits rights to insurance for various asbestos claims and to facilitate anorderly and timely collection of insurance proceeds. Although the Corporationalready has settlements in place concerning coverage for asbestos claims withmany of its insurers, including those covered by the 1985 Wellington Agreement,this lawsuit was filed against insurers that are not signatories to theWellington Agreement and/or do not otherwise have agreements in place with theCorporation regarding their asbestos-related insurance coverage, in order tofacilitate an orderly resolution and collection of such insurance policies andto resolve issues that the insurance carriers may raise. The insurance carriersare contesting this litigation. Through the second quarter of 2006, theCorporation reached settlements with several of the carriers involved in thislitigation. After a further review of its insurance policies, with dueconsideration given to applicable deductibles, retentions and policy limits,after taking into account the solvency and historical payment experience ofvarious insurance carriers; existing insurance settlements; and the advice ofoutside counsel with respect to the applicable insurance coverage law relatingto the terms and conditions of its insurance policies, the Corporationcontinues to believe that its recorded receivable for insurance recoveries fromall insurance carriers is probable of collection.

 

*Summary*

 

The amounts recorded forthe asbestos-related liability and related insurance receivable described abovewere based upon current, known facts. However, future events, such as thenumber of new claims to be filed and/or received each year, the average cost ofdisposing of each such claim, coverage issues among insurers, and thecontinuing solvency of various insurance companies, as well as the numerousuncertainties surrounding asbestos litigation in the United States, could causethe actual costs and insurance recoveries to be higher or lower than thoseprojected or those recorded.

 

Because of theuncertainties described above, management cannot estimate the full range of thecost of resolving pending and future asbestos-related claims facing theCorporation and Amchem. Management believes that it is reasonably possible thatthe cost of disposing of the Corporation’s asbestos-related claims, includingfuture defense costs, could have a material adverse impact on the results ofoperations and cash flows for a particular period and on the consolidatedfinancial position of the Corporation.

 

18

----

 

**ITEM 3. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

Omitted pursuant toGeneral Instruction H of Form 10-Q.

 

**ITEM 4. CONTROLSAND PROCEDURES.**

 

As of the end of theperiod covered by this Quarterly Report on Form 10-Q, the Corporation carriedout an evaluation, under the supervision and with the participation of theCorporation’s Disclosure Committee and the Corporation’s management, includingthe Chief Executive Officer and the Chief Financial Officer, of theeffectiveness of the design and operation of the Corporation’s disclosurecontrols and procedures pursuant to Exchange Act Rule 15d-15(b); and whetherany change has occurred in the Corporation’s internal control over financialreporting pursuant to Exchange Act Rule 15d-15(d). Based upon that evaluation,the Chief Executive Officer and the Chief Financial Officer concluded that theCorporation’s disclosure controls and procedures are effective and that nochange in the Corporation’s internal control over financial reporting occurredduring the Corporation’s most recent fiscal quarter that materially affected,or is reasonably likely to materially affect, the Corporation’s internalcontrol over financial reporting.

 

**PART II –OTHER INFORMATION**

 

**ITEM 1. LEGALPROCEEDINGS.**

 

No material developments in asbestos-related matters occurred during thesecond quarter of 2006. For a summary of the history and current status ofasbestos-related matters, see Management’s Discussion and Analysis of FinancialCondition and Results of Operations, Asbestos-Related Matters; and Note E tothe Consolidated Financial Statements.

 

**ITEM 1A. RISKFACTORS.**

 

There were no materialchanges in the Corporation’s risk factors in the second quarter of 2006.

 

**ITEM 6. EXHIBITS.**

 

See the Exhibit Index onpage 21 of this Quarterly Report on Form 10-Q for exhibits filed with thisreport.

 

19

----

 

**UnionCarbide Corporation and Subsidiaries**

**Signatures**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
|                 |   | UNION CARBIDE  CORPORATION     |   |   |
|----------------------|--------|--------------------------------|--------|--------|
|                 |   | Registrant                     |   |   |
|                 |   |
|                 |   |
| Date: August 1, 2006 |   |
|                 |   |
|                 |   |
|                 | By:    | /s/ WILLIAM H.  WEIDEMAN       |   |
|                 |   | William  H. Weideman           |
|                 |   | Vice  President and Controller |
|                 |   | The  Dow Chemical Company      |
|                 |   | Authorized  Representative of  |
|                 |   | Union  Carbide Corporation     |
|                 |   |                           |
|                 |   |                           |
|                 | By:    | /s/ EDWARD W.  RICH            |   |
|                 |   | Edward W. Rich                 |
|                 |   | Vice President, Treasurer and  |
|                 |   | Chief Financial Officer        |
|                      |        |                                |        |        |  |  |

 

20

----

 

**Union Carbide Corporation and Subsidiaries**

**ExhibitIndex**

 
| **EXHIBIT NO.** | ** ** | **DESCRIPTION**                                                           |
|-----------------|------------|---------------------------------------------------------------------------|
|            |       |                                                                      |
| 23              |       | Analysis, Research  & Planning Corporation’s Consent.            |
|            |       |                                                                      |
| 31.1            |       | Certification Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                      |
| 31.2            |       | Certification Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                      |
| 32.1            |       | Certification Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                      |
| 32.2            |       | Certification Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

21

----