**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For the quarterly period ended****  SEPTEMBER 30, 2006**

 

**Commissionfile number:****1-1463**

 

**UNIONCARBIDE CORPORATION**

(Exact name ofregistrant 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 reports required to be filed by  Section 13 or 15(d) of the Securities Exchange Act of 1934 during the  preceding 12 months (or for such shorter period that the registrant was |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| required to file such  reports), and (2) has been subject to such filing requirements for the past  90 days.                                                                                                                                     | ý  Yes | o  No |

 

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

 
| Indicate by  check mark whether the registrant is a shell company (as defined in Rule  12b-2 of the Act). | oYes | ý  No |
|-----------------------------------------------------------------------------------------------------------|------|------------|

 

At September 30, 2006,1,000 shares 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.

 

 

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** **

**Union Carbide 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

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**PART I - FINANCIALINFORMATION**

**ITEM 1. FINANCIALSTATEMENTS.**

**Union CarbideCorporation and SubsidiariesConsolidated Statements of Income**
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **Sept. 30,**               | ** ** | **Sept. 30,**              | ** ** | **Sept. 30,** | ** ** | **Sept. 30,** | ** ** |
| **In millions  (Unaudited)**                   | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net trade sales                                     |       | $                                | 55         |                            | $          | 73 |   | $ | 429 |   | $ | 218 |   |
| Net sales to  related companies                     |       | 1,845                            |       | 1,392                           |       | 5,300 |   | 4,515 |   |
| Total Net Sales                                     |       | 1,900                            |       | 1,465                           |       | 5,729 |   | 4,733 |   |
| Cost of sales                                       |       | 1,727                            |       | 1,321                           |       | 4,966 |   | 4,145 |   |
| Research and  development expenses                  |       | 17                               |       | 19                              |       | 57 |   | 58 |   |
| Selling, general  and administrative expenses       |       | 4                                |       | 4                               |       | 16 |   | 14 |   |
| Restructuring  charges                              |       | 13                               |       | —                          |       | 13 |   | — |   |
| Equity in  earnings of nonconsolidated affiliates   |       | 144                              |       | 105                             |       | 288 |   | 356 |   |
| Sundry income  (expense) - net                      |       | (16                              | )          | (2                              | )          | (60 | ) | 51 |   |
| Interest income                                     |       | 34                               |       | 6                               |       | 92 |   | 16 |   |
| Interest expense  and amortization of debt discount |       | 14                               |       | 15                              |       | 40 |   | 57 |   |
| Income before Income  Taxes                         |       | 287                              |       | 215                             |       | 957 |   | 882 |   |
| Provision for  income taxes                         |       | 69                               |       | 31                              |       | 301 |   | 228 |   |
| Net Income Available  for Common Stockholder        |       | $                                | 218        |                            | $          | 184 |   | $ | 656 |   | $ | 654 |   |
| Depreciation                                        |       | $                                | 67         |                            | $          | 66 |   | $ | 206 |   | $ | 201 |   |
| Capital Expenditures                                |       | $                                | 51         |                            | $          | 45 |   | $ | 146 |   | $ | 139 |   |

 

*See Notes to the Consolidated Financial Statements.*

3

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**UnionCarbide Corporation and Subsidiaries**

**Consolidated Balance Sheets**
| **In millions (Unaudited)**                                               | ** ** | **Sept. 30,  2006** | ** ** | **Dec. 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Assets**                                                                          | * *   | * *                 | * *   | * *                | * *   |
| Current Assets                                                                      |       |                     |       |                    |       |
| Cash and cash  equivalents                                                          |       | $                        | 73         |                    | $          | 73 |   |
| Accounts  receivable:                                                               |       |                     |       |                    |       |
| Trade (net of  allowance for doubtful receivables - 2006: $2; 2005: $3)             |       | 45                       |       | 53                      |       |
| Related  companies                                                                  |       | 463                      |       | 508                     |       |
| Other                                                                               |       | 78                       |       | 96                      |       |
| Notes receivable  from related companies                                            |       | 2,264                    |       | 1,631                   |       |
| Inventories                                                                         |       | 204                      |       | 181                     |       |
| Deferred income  tax assets - current                                               |       | 14                       |       | 58                      |       |
| Asbestos-related  insurance receivables - current                                   |       | 79                       |       | 117                     |       |
| Total current  assets                                                               |       | 3,220                    |       | 2,717                   |       |
| Investments                                                                         |       |                     |       |                    |       |
| Investments in  related companies                                                   |       | 297                      |       | 287                     |       |
| Investments in  nonconsolidated affiliates                                          |       | 867                      |       | 887                     |       |
| Other  investments                                                                  |       | 21                       |       | 13                      |       |
| Noncurrent  receivables                                                             |       | 59                       |       | 62                      |       |
| Noncurrent lreceivable  from related company                                        |       | 198                      |       | 197                     |       |
| Total  investments                                                                  |       | 1,442                    |       | 1,446                   |       |
| Property                                                                            |       |                     |       |                    |       |
| Property                                                                            |       | 7,438                    |       | 7,415                   |       |
| Less accumulated  depreciation                                                      |       | 5,476                    |       | 5,378                   |       |
| Net property                                                                        |       | 1,962                    |       | 2,037                   |       |
| Other Assets                                                                        |       |                     |       |                    |       |
| Goodwill                                                                            |       | 26                       |       | 26                      |       |
| Other intangible  assets (net of accumulated amortization - 2006: $123; 2005: $120) |       | 24                       |       | 22                      |       |
| Asbestos-related  insurance receivables - noncurrent                                |       | 750                      |       | 818                     |       |
| Prepaid pension  expense                                                            |       | 856                      |       | 806                     |       |
| Deferred charges  and other assets                                                  |       | 48                       |       | 62                      |       |
| Total other  assets                                                                 |       | 1,704                    |       | 1,734                   |       |
| Total Assets                                                                        |       | $                        | 8,328      |                    | $          | 7,934 |   |

 

*See Notes to the Consolidated Financial Statements.*

4

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**UnionCarbide Corporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| **In millions (Unaudited)**                   | ** ** | **Sept. 30,  2006** | ** ** | **Dec. 31,  2005** | ** ** |
|---------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **Liabilities  and Stockholder’s Equity**          | * *   | * *                 | * *   | * *                | * *   |
| Current Liabilities                                     |       |                     |       |                    |       |
| Notes payable:                                          |       |                     |       |                    |       |
| Related  companies                                      |       | $                        | 8          |                    | $          | 4 |   |
| Other                                                   |       | 4                        |       | 4                       |       |
| Long-term debt  due within one year                     |       | 2                        |       | 2                       |       |
| Accounts  payable:                                      |       |                     |       |                    |       |
| Trade                                                   |       | 230                      |       | 292                     |       |
| Related  companies                                      |       | 249                      |       | 317                     |       |
| Other                                                   |       | 38                       |       | 29                      |       |
| Income taxes  payable                                   |       | 77                       |       | 41                      |       |
| Asbestos-related  liabilities - current                 |       | 136                      |       | 121                     |       |
| Accrued and  other current liabilities                  |       | 238                      |       | 235                     |       |
| Total current  liabilities                              |       | 982                      |       | 1,045                   |       |
| Long-Term Debt                                          |       | 820                      |       | 822                     |       |
| Other Noncurrent  Liabilities                           |       |                     |       |                    |       |
| Deferred income  taxes payable - noncurrent             |       | 30                       |       | 89                      |       |
| Pension and  other postretirement benefits - noncurrent |       | 444                      |       | 455                     |       |
| Asbestos-related  liabilities - noncurrent              |       | 1,273                    |       | 1,384                   |       |
| Other noncurrent  obligations                           |       | 347                      |       | 361                     |       |
| Total other  noncurrent liabilities                     |       | 2,094                    |       | 2,289                   |       |
| Minority Interest in  Subsidiaries                      |       | 3                        |       | 4                       |       |
| Stockholder’s Equity                               |       |                     |       |                    |       |
| Common stock  (1,000 shares authorized and issued)      |       | —                   |       | —                  |       |
| Additional  paid-in capital                             |       | 121                      |       | 121                     |       |
| Retained  earnings                                      |       | 4,392                    |       | 3,736                   |       |
| Accumulated  other comprehensive loss                   |       | (84                      | )          | (83                     | )          |
| Net  stockholder’s equity                          |       | 4,429                    |       | 3,774                   |       |
| Total Liabilities and Stockholder’s Equity         |       | $                        | 8,328      |                    | $          | 7,934 |   |

 

*See Notes to the Consolidated Financial Statements.*

5

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**UnionCarbide Corporation and Subsidiaries**

**Consolidated Statements of Cash Flows**
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| **In millions  (Unaudited)**                                                  | ** ** | **Sept. 30,  2006**        | ** ** | **Sept. 30,  2005** | ** ** |
| Operating Activities                                                               | * *   | * *                        | * *   | * * | * * |
| Net Income  Available for Common Stockholder                                       |       | $                               | 656        |   | $ | 654 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                            |       |   |   |
| Depreciation and  amortization                                                     |       | 227                             |       | 222 |   |
| Provision  (Credit) for deferred income tax                                        |       | (3                              | )          | 208 |   |
| Earnings of  nonconsolidated affiliates less than dividends received               |       | 4                               |       | 1 |   |
| Gain on sales of  investments, net                                                 |       | —                          |       | (9 | ) |
| Gain on sales of  property, net                                                    |       | —                          |       | (3 | ) |
| Other gain, net                                                                    |       | —                          |       | (1 | ) |
| Gain on sale of  ownership interest in nonconsolidated affiliate                   |       | —                          |       | (70 | ) |
| Restructuring  charges                                                             |       | 13                              |       | — |   |
| Changes in  assets and liabilities that provided (used) cash:                      |       |                            |       |   |   |
| Accounts and  notes receivable                                                     |       | 22                              |       | 29 |   |
| Related company  receivables                                                       |       | (588                            | )          | (234 | ) |
| Inventories                                                                        |       | (23                             | )          | (21 | ) |
| Accounts payable                                                                   |       | (33                             | )          | (9 | ) |
| Related company  payables                                                          |       | (64                             | )          | (205 | ) |
| Other assets and  liabilities                                                      |       | (59                             | )          | (24 | ) |
| Cash provided by  operating activities                                             |       | 152                             |       | 538 |   |
| Investing Activities                                                               |       |                            |       |   |   |
| Capital  expenditures                                                              |       | (146                            | )          | (139 | ) |
| Proceeds from  sales of property                                                   |       | 2                               |       | 7 |   |
| Distributions  from nonconsolidated affiliates                                     |       | 4                               |       | 41 |   |
| Changes in  noncurrent receivable from related company                             |       | (1                              | )          | 13 |   |
| Purchases of  investments                                                          |       | (11                             | )          | (1 | ) |
| Proceeds from  sales of investments                                                |       | 3                               |       | — |   |
| Cash used in  investing activities                                                 |       | (149                            | )          | (79 | ) |
| Financing Activities                                                               |       |                            |       |   |   |
| Changes in  short-term notes payable                                               |       | (1                              | )          | (1 | ) |
| Payments on  long-term debt                                                        |       | (2                              | )          | (436 | ) |
| Cash used in  financing activities                                                 |       | (3                              | )          | (437 | ) |
| Summary                                                                            |       |                            |       |   |   |
| Increase in cash  and cash equivalents                                             |       | —                          |       | 22 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 73                              |       | 22 |   |
| Cash and cash  equivalents at end of period                                        |       | $                               | 73         |   | $ | 44 |   |

 

*See Notesto the Consolidated Financial Statements.*

 

**UnionCarbide Corporation and Subsidiaries**

**Consolidated Statements ofComprehensive Income**
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **In millions  (Unaudited)**                            | ** ** | **Sept. 30,  2006**         | ** ** | **Sept. 30,  2005**        | ** ** | **Sept. 30,  2006** | ** ** | **Sept. 30,  2005** | ** ** |
| Net Income Available  for Common Stockholder                 |       | $                                | 218        |                            | $          | 184 |   | $ | 656 |   | $ | 654 |   |
| Other Comprehensive  Income (Loss), Net of Tax               |       |                             |       |                            |       |   |   |   |   |
| Translation  adjustments                                     |       | (1                               | )          | (2                              | )          | — |   | (12 | ) |
| Minimum pension  liability adjustment                        |       | —                           |       | —                          |       | — |   | 6 |   |
| Net gain (loss)  on cash flow hedging derivative instruments |       | (2                               | )          | 1                               |       | (1 | ) | 1 |   |
| Total other  comprehensive loss                              |       | (3                               | )          | (1                              | )          | (1 | ) | (5 | ) |
| Comprehensive Income                                         |       | $                                | 215        |                            | $          | 183 |   | $ | 655 |   | $ | 649 |   |

 

*See Notesto the Consolidated Financial Statements.*

6

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**Union Carbide Corporation and Subsidiaries**

**Notes tothe Consolidated Financial Statements**

(Unaudited)

**NOTE A   CONSOLIDATED FINANCIAL STATEMENTS**

The unauditedinterim consolidated financial statements of Union Carbide Corporation and itssubsidiaries (the “Corporation” or “UCC”) were prepared in accordance withaccounting principles generally accepted in the United States of America (“GAAP”)and reflect all adjustments (including normal recurring accruals) which, in theopinion of management, are considered necessary for the fair presentation ofthe results for the periods presented.

The Corporation is awholly owned subsidiary of The Dow Chemical Company (“Dow”). In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share,”the presentation of earnings per share is not required in financial statementsof 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.

Intercompany transactionsand balances are eliminated in consolidation. Transactions with the Corporation’sparent company, Dow, or other Dow subsidiaries have been reflected as relatedcompany transactions in the consolidated financial statements. See Note G forfurther discussion.

These statements shouldbe read in conjunction with the audited consolidated financial statements andnotes thereto included in the Corporation’s Annual Report on Form 10-K for theyear ended December 31, 2005.

**NOTE B   ACCOUNTING CHANGES**

**Accounting for Conditional AssetRetirement Obligations**

In March 2005, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”)No. 47, “Accounting for Conditional Asset Retirement Obligations,” whichclarifies the term *conditional assetretirement obligation* as used in SFAS No. 143, “Accounting for AssetRetirement Obligations,” as a legal obligation to perform an asset retirementactivity in which the timing and/or method of settlement are conditional on afuture event that may or may not be within the control of the Corporation.FIN No. 47 was effective no later than the end of fiscal years endingafter December 15, 2005.

The Corporation has 17 manufacturing sites in sixcountries. Most of these sites contain numerous individual manufacturingoperations, particularly at the Corporation’s larger sites. Asset retirementobligations are recorded in the period in which they are incurred andreasonably estimable, including those obligations for which the timing and/ormethod of settlement are conditional on a future event that may or may not bewithin the control of the Corporation. Retirement of assets may involve suchefforts as remediation and treatment of asbestos, contractually requireddemolition, and other related activities, depending on the nature and locationof the assets, and are typically realized only upon demolition of thosefacilities. In identifying asset retirement obligations, the Corporationconsiders identification of legally enforceable obligations, changes inexisting law, estimates of potential settlement dates and the calculation of anappropriate discount rate to be used in calculating the fair value of theobligations. The Corporation has a well-established global process to identify,approve and track the demolition of retired or to-be-retired facilities; noassets are retired from service until this process has been followed. TheCorporation typically forecasts demolition projects based on the usefulness ofthe assets; environmental, health and safety concerns; and other similarconsiderations. Under this process, as demolition projects are identified andapproved, 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 been submitted/reviewed forpotential demolition activities are considered to have continued usefulness andare generally still operating “normally.” Therefore, without a plan to demolishthe assets or the expectation of a plan, such as shortening the useful life ofassets for depreciation purposes under the requirements of SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” the Corporation is unableto reasonably forecast a time frame to use for present value calculations. Assuch, the Corporation has not recognized obligations for individualplants/buildings at its 17 manufacturing sites where estimates of potentialsettlement dates cannot be reasonably made. The Corporation routinely reviewsall changes to the list of items under consideration for demolition todetermine if an adjustment to the value of the asset retirement obligation isrequired.

Adoption of FIN No. 47 on December 31, 2005 resultedin the recognition of an asset retirement obligation of $12 million and acharge of $8 million (net of tax of $4 million), which was includedin “Cumulative effect of changes in accounting principles” in the fourthquarter of 2005. The discount rate used to calculate the Corporation’s asset retirementobligations was 4.6 percent.

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If the conditional asset retirement obligationmeasurement and recognition provisions of FIN No. 47 had been in effect onJanuary 1, 2005, the aggregate carrying amount of those obligations on thatdate would have been $12 million. If the amortization of asset retirement costand accretion of asset retirement obligation provisions of FIN No. 47 had beenin effect during 2005, the impact on “Net Income Available to CommonStockholder” would have been immaterial.

In accordance withFIN No. 47, the Corporation has recognized conditional asset retirementobligations related to asbestos encapsulation as a result of planned demolitionand remediation activities at manufacturing and administrative sites in theUnited States. At December 31, 2005, the aggregate carrying amount ofconditional asset retirement obligations recognized by the Corporation was $12million. The aggregate carrying amount of conditional asset retirementobligations was $13 million at September 30, 2006. These obligations areincluded in the consolidated balance sheets as “Other noncurrent obligations.”

As described above, the Corporation has not recognizedconditional asset retirement obligations for which a fair value cannot bereasonably estimated in its consolidated financial statements. It is theopinion of management that the possibility is remote that such conditionalasset retirement obligations, when estimable, will have a material adverseimpact on the Corporation’s consolidated financial statements based on currentcosts.

**Other Accounting Changes**

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts — an amendment of ARB No. 43, Chapter 4,” which clarifies the accountingfor abnormal amounts of idle facility expense, freight, handling costs, andwasted material (spoilage) and also requires that the allocation of fixedproduction overhead be based on the normal capacity of the productionfacilities. SFAS No. 151 was effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. Because the Corporation previouslyused nameplate capacity to calculate product costs, adoption of SFAS No. 151 onJanuary 1, 2006 had an immaterial favorable impact on the Corporation’sconsolidated financial statements.

On January 1, 2006,Dow adopted revised SFAS No. 123 (“SFAS No. 123R”), “Share-Based Payment.”The Corporation will continue to be allocated the portion of expense relatingto its employees who receive stock-based compensation, which was immaterial inthe first nine 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 for uncertainty in income taxes recognized inan enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” Thisinterpretation prescribes a recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. This interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. FIN No. 48 is effective for fiscal yearsbeginning after December 15, 2006. The Corporation is included in Dow’sconsolidated federal income tax group and consolidated tax return, and Dow iscurrently evaluating the impact of adopting this interpretation.

In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, which expresses theviews of the SEC staff regarding the process of quantifying financial statementmisstatements. SAB No. 108 provides guidance on the consideration of theeffects of prior year misstatements in quantifying current year misstatementsfor the purpose of a materiality assessment. The guidance of this SAB iseffective for annual financial statements covering the first fiscal year endingafter November 15, 2006, which is December 31, 2006 for the Corporation.  The Corporation is currently evaluating theimpact of applying this guidance.

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements,” which defines fair value, establishes a framework formeasuring fair value in GAAP, and expands disclosures about fair valuemeasurements. This Statement applies under other accounting pronouncements thatrequire or permit fair value measurements and is effective for fiscal yearsbeginning after November 15, 2007. The Corporation is currently evaluating theimpact of adopting this Statement.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans - an amendment of FASB Statements No.87, 88, 106, and 132(R).” This Statement, which is effective December 31, 2006for the Corporation, requires employers to recognize the funded status ofdefined benefit postretirement plans as an asset or liability on the balancesheet and to recognize changes in that funded status through comprehensiveincome. SFAS No. 158 also establishes the measurement date of plan assets andobligations as the date of the employer’s 

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fiscal year end, andprovides for additional annual disclosures. UCC currently uses a December 31measurement date for all of its plans, consistent with its fiscal year end. TheCorporation is currently evaluating the impact of adopting this Statement.

**NOTE C   INVENTORIES**

The following tableprovides a breakdown of inventories:

**Inventories**
| In millions  | ** ** | **Sept. 30,  2006** | ** ** | **Dec. 31,  2005** | ** ** |
|-------------------|------------|--------------------------|------------|-------------------------|------------|
| Finished goods    |       | $                        | 34         |                    | $          | 30 |   |
| Work in process   |       | 40                       |       | 26                      |       |
| Raw materials     |       | 45                       |       | 41                      |       |
| Supplies          |       | 85                       |       | 84                      |       |
| Total inventories |       | $                        | 204        |                    | $          | 181 |   |

 

The reserves reducing inventories from the first-in, first-out (“FIFO”)basis to the last-in, first-out (“LIFO”) basis amounted to $172 million atSeptember 30, 2006 and $164 million at December 31, 2005.

**NOTE D   OTHER INTANGIBLEASSETS**

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

**Other Intangible Assets**
| ** **                            | ** ** | **At September 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                               |       | 3                                        |       | (2                                      | )          | 1 |   | 4 |   | (2 | ) | 2 |   |
| Software                              |       | 110                                      |       | (88                                     | )          | 22 |   | 104 |   | (85 | ) | 19 |   |
| Other                                 |       | 1                                        |       | (1                                      | )          | — |   | 1 |   | (1 | ) | — |   |
| Total                                 |       | $                                        | 147        |                                    | $          | (123 | ) | $ | 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             |       | $          | 4          |   |

 

**NOTE E   COMMITMENTSAND CONTINGENT LIABILITIES**

**EnvironmentalMatters**

Accruals forenvironmental matters are recorded when it is probable that a liability hasbeen incurred and the amount of the liability can be reasonably estimated,based on current law and existing technologies. The Corporation had accruedobligations of $87 million at December 31, 2005 for environmental remediationand restoration costs, including $34 million for the remediation of Superfundsites. At September 30, 2006, the Corporation had accrued obligations of $74million for environmental remediation and restoration costs, including $24million for the remediation of Superfund sites. This is

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management’s bestestimate 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, the Corporation is and has been involvedin a large number of asbestos-related suits filed primarily in state courtsduring the past three decades. These suits principally allege personal injuryresulting from exposure to asbestos-containing products and frequently seekboth actual and punitive damages. The alleged claims primarily relate toproducts that UCC sold in the past, alleged exposure to asbestos-containingproducts located on UCC’s premises, and UCC’s responsibility for asbestos suitsfiled against a former subsidiary, Amchem Products, Inc. (“Amchem”). In manycases, plaintiffs are unable to demonstrate that they have suffered anycompensable loss as a result of such exposure, or that injuries incurred infact resulted from exposure to the Corporation’s products.

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 variouscompanies, including the Corporation and Amchem, increased in 2001, 2002 andthe first half of 2003. Since then, the rate of filing has significantly abated.The Corporation 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 toreview the Corporation’s historical asbestos claim and resolution activity anddetermine the appropriateness of updating its January 2003 study. In responseto that request, ARPC reviewed and analyzed data through November 14, 2004, andagain concluded that it was not possible to estimate the full range of the costof resolving future asbestos-related claims against UCC and Amchem because ofvarious uncertainties associated with the litigation of those claims. ARPC didadvise, however, that it was reasonable and feasible to construct a newestimate of the cost of resolving current and future asbestos-related claimsusing the same two widely used forecasting methodologies used by ARPC in itsJanuary 2003 study, if certain assumptions were made. As a result, thefollowing assumptions were made and then used by ARPC:

·                  The number offuture claims to be filed annually against UCC and Amchem is unlikely to exceedthe level of claims experienced during 2004.

·                  The number ofclaims filed against UCC and Amchem annually from 2001 to 2003 is consideredanomalous for the purpose of estimating future filings.

·                  The number offuture claims to be filed against UCC and Amchem will decline at a fairlyconstant rate each year from 2005.

·                  The averageresolution value for pending and future claims will be equivalent to thoseexperienced during 2003 and 2004 (excluding settlements from closed claimsfiled in Madison County, Illinois with respect to future claims, as changes inthe judicial environment in Madison County caused the historical experience ofclaims in that jurisdiction to not be predictive of results for future claims).

The resultingstudy completed by ARPC in January 2005 stated that the undiscounted cost ofresolving pending and future asbestos-related claims against UCC and Amchem,excluding future defense and processing costs, through 2017 was estimated to bebetween approximately $1.5 billion and $2.0 billion, depending on which of twoaccepted methodologies was used. 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

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prior advice thatforecasts for shorter periods of time are more accurate than those for longerperiods of time. 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 toreview the Corporation’s 2005 asbestos claim and resolution activity anddetermine the appropriateness of updating the January 2005 study. In responseto that request, ARPC reviewed and analyzed data through October 31, 2005. In January2006, ARPC stated that an update of the study would not provide a more likelyestimate of future events than the estimate reflected in its study of theprevious year and, therefore, the estimate 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 theCorporation’s review of 2006 activity, the Corporation determined that nochange to the accrual was required at September 30, 2006. The asbestos-relatedliability for pending and future claims was $1.4 billion at September 30, 2006.Approximately 35 percent of the recorded liability related to pending claimsand approximately 65 percent related to future claims.

At December 31, 2002, the Corporation increased thereceivable for insurance recoveries related to its asbestos liability to $1.35billion, substantially exhausting its asbestos product liability coverage. Theinsurance receivable related to the asbestos liability was determined after athorough review of applicable insurance policies and the 1985 WellingtonAgreement, to which the Corporation and many of its liability insurers aresignatory 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’s receivable for insurance recoveriesrelated to its asbestos liability was $478 million at September 30, 2006 and$535 million at December 31, 2005. At September 30, 2006, $477 million ($398million at December 31, 2005) of the receivable for insurance recoveries wasrelated to insurers that are not signatories to the Wellington Agreement and/ordo not otherwise have agreements in place regarding their asbestos-relatedinsurance coverage.

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

**Receivables for CostsSubmitted to Insurance Carriers**
| In millions                  | *** *** | **September 30,  2006** | ** ** | **December 31,  2005** | *** *** |
|-----------------------------------|--------------|------------------------------|------------|-----------------------------|--------------|
| Receivables for  defense costs    |         | $                            | 9          |                        | $            | 73 |   |
| Receivables for  resolution costs |         | 342                          |       | 327                         |         |
| Total                             |         | $                            | 351        |                        | $            | 400 |   |

 

The Corporation expenses defense costs as incurred.The pretax impact for defense and resolution costs, net of insurance, was $1million in the third quarter of 2006 ($24 million in the third quarter of2005), and $29 million in the first nine months of 2006 ($56 million in thefirst nine months of 2005), and was reflected in “Cost of 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 insurance coverage,in order to facilitate an orderly resolution and collection of such insurancepolicies and to resolve issues that the insurance carriers may raise. Theinsurance carriers are contesting this litigation. Through the third quarter of 2006, the Corporation reached settlementswith several of the carriers involved in this litigation. After a furtherreview of its insurance policies, with due consideration given to applicabledeductibles, retentions and policy limits, after taking into account the solvencyand historical payment experience of various insurance carriers; existinginsurance settlements; and the advice of outside counsel with respect to theapplicable insurance coverage law relating to the terms and conditions of itsinsurance policies, the

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Corporationcontinues to believe that its recorded receivable for insurance recoveries fromall insurance carriers is probable of collection.

The amountsrecorded for the asbestos-related liability and related insurance receivabledescribed above were based upon current, known facts. However, future events,such as the number of new claims to be filed and/or received each year, theaverage cost of disposing of each such claim, coverage issues among insurers,and the continuing solvency of various insurance companies, as well as thenumerous uncertainties surrounding asbestos litigation in the United States,could cause the actual costs and insurance recoveries to be higher or lowerthan those projected 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 not possible at this time to determinewith certainty the ultimate outcome of any of the legal proceedings and claimsreferred to in this filing, management believes that adequate provisions havebeen made for probable losses with respect to pending claims and proceedings, andthat, except for the asbestos-related matters described above, the ultimateoutcome of all known and future claims, after provisions for insurance, willnot have a material adverse impact on the results of operations, cash flows andconsolidated financial position of the Corporation. Should any losses besustained in connection with any of such legal proceedings and claims in excessof provisions provided and available insurance, they will be charged to incomewhen determinable.

**Purchase Commitments**

At December 31, 2005, the Corporation had variousoutstanding commitments for take or pay agreements, with terms extending fromone to five years. Such commitments were not in excess of current marketprices. The Corporation had an agreement for the purchase of ethylene-relatedproducts in Canada; the Corporation assigned its rights and obligations underthis purchase agreement to a wholly owned subsidiary of Dow in December 2003.Total purchases under the ethylene-related agreement 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 Obligations at 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 following tableprovides 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  September 30, 2006 |       | 2014                  |       | $                                 | 83         |                    | $          | 1 |   |
| Guarantees at December  31, 2005  |       | 2014                  |       | $                                 | 92         |                    | $          | 2 |   |

 

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**NOTE F     PENSION AND OTHER POSTRETIREMENT BENEFITS**

**Net Periodic Benefit Cost (Credit)for All Significant Plans**

** **
| ** **                           | *** *** | **Three Months Ended** | ** ** | **Nine Months Ended** | *** *** |
|--------------------------------------|--------------|----------------------------------|------------|---------------------------------|--------------|
| **In millions**                 | *** *** | **September 30,  2006**     | ** ** | **September 30,  2005**    | ** **   | **September 30,  2006** | ** ** | **September 30,  2005** | *** *** |
| *Defined  Benefit Pension Plans:*    |         |                             |       |                            |         |   |   |   |   |
| Service cost                         |         | $                                | 6          |                            | $            | 7 |   | $ | 18 |   | $ | 20 |   |
| Interest cost                        |         | 53                               |       | 54                              |         | 159 |   | 163 |   |
| Expected return on plan assets       |         | (83                              | )          | (85                             | )            | (249 | ) | (256 | ) |
| Amortization of prior service cost   |         | 1                                |       | —                          |         | 1 |   | 1 |   |
| Amortization of net loss             |         | 7                                |       | 1                               |         | 23 |   | 2 |   |
| Net periodic benefit credit          |         | $                                | (16        | )                               | $            | (23 | ) | $ | (48 | ) | $ | (70 | ) |
| * *                             |         |                             |       |                            |         |   |   |   |   |
| *Other  Postretirement Benefits:*    |         |                             |       |                            |         |   |   |   |   |
| Service cost                         |         | $                                | 1          |                            | $            | 1 |   | $ | 3 |   | $ | 3 |   |
| Interest cost                        |         | 8                                |       | 9                               |         | 24 |   | 26 |   |
| Amortization of prior service credit |         | (1                               | )          | —                          |         | (3 | ) | (1 | ) |
| Amortization of net loss             |         | 1                                |       | 1                               |         | 3 |   | 4 |   |
| Net periodic benefit cost            |         | $                                | 9          |                            | $            | 11 |   | $ | 27 |   | $ | 32 |   |

 

**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’sfunding policy is to contribute to the plans when pension laws and economicseither require or encourage funding. As previously disclosed in the Corporation’sAnnual Report on Form 10-K for the year ended December 31, 2005, UCC doesnot expect to contribute assets to its qualified pension plan in 2006.Consistent with that expectation, no contributions were made in the first ninemonths of 2006. The Corporation also has a non-qualified supplemental pensionplan. Benefit payments to retirees under this plan are expected to be $3million in 2006. In the first nine months of 2006, benefit payments of $2million 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 Corporationfunds most of the cost of these health care and life insurance benefits asincurred. As previously disclosed in the Corporation’s Annual Report on Form10-K for the year ended December 31, 2005, UCC does not expect to contributeassets to its other postretirement benefit plans in 2006. Consistent with thatexpectation, no contributions were made in the first nine months of 2006.Benefit payments to retirees under these plans are expected to be $60 millionin 2006. In the first nine months of 2006, benefit payments of $37 million weremade.

**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 $847 million in the third quarter of2006 ($550 million in the third quarter of 2005) and $2,377 million in thefirst nine months of 2006 ($1,725 million in the first nine months of 2005).

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The Corporationhas a master services agreement with Dow whereby Dow provides services,including, but not limited to, accounting, legal, treasury (investments, cashmanagement, risk management, insurance), procurement, human resources,environmental, health and safety, and business management for UCC. Under themaster services agreement with Dow, for general administrative and overheadtype services that Dow routinely allocates to various businesses, UCC ischarged the cost of those services based on the Corporation’s and Dow’srelative manufacturing conversion costs. This arrangement results in aquarterly charge of approximately $5 million (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 September 30, 2006, theCorporation had a note receivable of $2,226 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.

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, 2007 pursuant to an amendment effective as ofSeptember 30, 2006; however, Dow may demand repayment with a 30-day writtennotice to the Corporation, subject to certain restrictions. A relatedcollateral agreement provides for the replacement of certain existing pledgedassets, primarily equity interests in various subsidiaries and joint ventures,with cash collateral. At September 30, 2006, $815 million was availableunder the revolving credit agreement. The cash collateral was reported as “Noncurrentreceivable from related company” in the consolidated balance sheets.

The losses andadditional costs incurred by the Corporation in 2005 due to hurricane Katrinawere covered by the Corporation’s insurance program. The Corporation has aninsurance receivable for losses incurred of $105 million at September 30,2006 from its insurer (an affiliate of Dow). Additionally, the Corporation hasinsurance coverage for lost sales and margins caused by hurricane Katrina. Noamount of recovery for lost sales and margins has been recognized throughSeptember 30, 2006, and will only be recognized when the amount of recovery isrealized through agreement amongst the insurers.

The Corporationrecorded equity earnings of approximately $10 million from Dow Canada HoldingLP (“DCHLP”) for the first two months of 2006 which increased the investmentbalance to $10 million. On March 1, 2006, the Corporation transferred its 11.2percent partnership interest in DCHLP to a newly formed corporation, GWNHolding, Inc. (“GWN”), in exchange for 11.2 percent of GWN’s common stock. TheCorporation accounts for its 11.2 percent ownership interest in GWN using thecost method.

In accordance withthe Amended and Restated Tax Sharing Agreement between the Corporation and Dow,the Corporation made a payment of $84 million to Dow in September 2006 to coverthe Corporation’s estimated federal tax liability for the third quarter of 2006($268 million for the first nine months of 2006).

**NOTE H     RESTRUCTURING**

Inthe third quarter of 2006, the Corporation recorded restructuring chargestotaling $13 million resulting from decisions made by management in the thirdquarter to improve the competitiveness of its global operations. The decisionresulted in the write-off of the net book value of three manufacturingfacilities totaling $10 million (the largest of which was $8 million associatedwith the shutdown of the peroxymeric chemicals production facility in St.Charles, Louisiana, in October 2006), and the write-off of the net book valueof fixed assets related to the dissolution of a consolidated joint venture inChina (ceasing operations in October 2006) totaling $3 million. The charges areshown as “Restructuring charges” in the consolidated statements of income.

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** **

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

Pursuant toGeneral Instruction H of Form 10-Q “Omission of Information by CertainWholly-Owned Subsidiaries,” this section includes only management’s narrativeanalysis of the results of operations for the three- and nine-month periodsended September 30, 2006, the most recent periods, compared with the three- andnine-month periods ended September 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 indicates.

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.

##### **DISCLOSUREREGARDING FORWARD-LOOKING INFORMATION**

The PrivateSecurities Litigation Reform Act of 1995 provides a “safe harbor” forforward-looking statements made by or on behalf of Union Carbide Corporation(the “Corporation” or “UCC”). This section covers the current performance andoutlook of the Corporation. The forward-looking statements contained in thissection and in other parts of this document involve risks and uncertaintiesthat may affect the Corporation’s operations, markets, products, services,prices and other factors as more fully discussed elsewhere and in filings withthe 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 salesfor the third quarter of 2006 were $1,900 million compared with $1,465 millionfor the third quarter of 2005, an increase of 30 percent. Selling prices to Doware based on market prices for the related products. Average selling prices formost products were higher in the third quarter of 2006, led by polyethylene,polypropylene and ethylene glycol (“EG”), reflecting significantly higher rawmaterial costs. Overall volume for the third quarter of 2006 was up solidlycompared with the low levels of the third quarter last year, which had beennegatively impacted by disruptions in production and distribution caused by twohurricanes affecting the U.S. Gulf Coast. Total net sales were$5,729 million for the first nine months of 2006 compared with $4,733million for the first nine months of 2005, an increase of 21 percent. On ayear-to-date basis, total net sales were favorably impacted by lump sumtechnology licensing revenue earned in the first quarter of 2006. Averageselling prices for most products were higher for the first nine months of 2006compared with the same period last year, led by polyethylene and polypropylene.On a year-to-date basis, overall volume showed solid improvement with gains inpolyethylene, EG and ethylene oxide.

Cost of sales for thethird quarter of 2006 increased 31 percent compared with the third quarter of2005, and cost of sales for the first nine months of 2006 increased 20 percentcompared with the same period last year, principally due to higher raw materialcosts.

Restructuring charges of $13 million included the write-off of the netbook value of three manufacturing facilities totaling $10 million (the largestof which was $8 million associated with the shutdown of the peroxymericchemicals production facility in St. Charles, Louisiana, in October 2006) andthe write-off of the net book value of fixed assets related to the dissolutionof a consolidated joint venture in China (ceasing operations in October 2006)totaling $3 million.

Equity in earnings ofnonconsolidated affiliates was $144 million in the third quarter of 2006compared with $105 million in the same quarter last year. Improvedearnings from the OPTIMAL Group, EQUATE Petrochemical Co. K.S.C. (“EQUATE”) andUnivation Technologies, LLC more than offset the absence of equity earningsfrom UOP LLC (which the Corporation exited in the fourth quarter of 2005). Yearto date, equity in earnings of nonconsolidated affiliates was $288 million,down from $356 million last year principally due to the absence of equityearnings from UOP LLC.

Sundry income (expense) —net includes a variety of income and expense items such as the gain or loss onforeign currency exchange, dividends from investments, commissions, charges formanagement services provided by Dow, and gains and losses on sales ofinvestments and assets. Sundry income (expense) — net for the third quarter of2006 was net expense of $16 million compared with net expense of $2million for the third quarter last year. Net sundry expense for the thirdquarter

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**Resultsof Operations - Continued**

of 2005 included again of $9 million associated with the sale of investments. Year to date,Sundry income (expense) — net was net expense of $60 million compared with netincome of $51 million for the first nine months of last year. Net sundry incomefor the first nine months of 2005 benefited from a $70 million pretax gainon the sale of a portion of the Corporation’s interest in EQUATE and dividendincome of $29 million from Dow Chemical Canada Inc.

Interest income was $34million in the third quarter of 2006 compared with $6 million in the thirdquarter of 2005. Year to date, interest income was $92 million, up from $16million in the first nine months of 2005 due to higher interest rates and asignificantly higher level of interest-bearing assets.

Interest expense andamortization of debt discount was $14 million in the third quarter of 2006compared with $15 million in the third quarter of 2005. Year to date,interest expense and amortization of debt discount was $40 million, down from$57 million for the first nine months of 2005, due to the reduction oflong-term debt which resulted from the early extinguishment of approximately$436 million of debt, primarily in the second quarter of 2005.

The effective tax ratefluctuates based on, among other factors, where income is earned, the level ofafter-tax income from joint ventures, and the level of income relative to taxcredits available. The effective tax rate for the third quarter of 2006 was24.0 percent compared with 14.4 percent for the same quarter last year. Theeffective tax rate for the third quarter of 2005 reflects the favorable impactof $21 million for adjustments resulting from the finalization of calculationsfollowing the closure of prior tax years. Year to date, the effective tax ratewas 31.5 percent versus 25.9 percent last year. The effective tax rate forthe first nine months of 2006 was higher than the same period last yearprincipally due to lower earnings from the Corporation’s joint ventures. Sincemost of the earnings from nonconsolidated affiliates are taxed at the jointventure level, the impact of lower equity earnings increased the Corporation’soverall effective tax rate. In addition, the year-to-date effective tax ratefor 2005 reflects the favorable impact of $29 million of dividend income fromDow Canada in the second quarter of 2005, which was based on previously taxedincome.

The Corporation reportednet income of $218 million for the third quarter of 2006, compared with $184million for the third quarter of 2005. The results for the third quarter of2006 were favorably impacted by an increase in gross margin and higher equityearnings. Net income for the first nine months of 2006 of $656 million wasessentially unchanged from $654 million for the first nine months of 2005.

**OTHERMATTERS**

**Accounting Changes**

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

**CriticalAccounting 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 isand has been involved in a large number of asbestos-related suits filedprimarily in state courts during the past three decades. These suitsprincipally 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.

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 variouscompanies, including the Corporation and Amchem, increased in 2001, 2002 andthe first half of 2003. Since then, the rate of filing has significantlyabated. The Corporation expects more asbestos-related suits to be filed againstit and Amchem in the future, and will aggressively defend or reasonablyresolve, as appropriate, both pending and future claims.

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The table belowprovides information regarding asbestos-related claims filed against theCorporation and Amchem:
|                                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Claims  unresolved at January 1                    |       | 146,325  |       | 203,416  |       |
| Claims filed                                       |       | 12,388   |       | 27,715   |       |
| Claims settled,  dismissed or otherwise resolved   |       | (45,006  | )          | (51,928  | )          |
| Claims  unresolved at September 30                 |       | 113,707  |       | 179,203  |       |
| Claimants with  claims against both UCC and Amchem |       | 39,432   |       | 61,524   |       |
| Individual claimants at  September 30              |       | 74,275   |       | 117,679  |       |

 

Plaintiffs’ lawyers often sue dozens or even hundreds of defendants inindividual lawsuits on behalf of hundreds or even thousands of claimants. As aresult, the damages alleged are not expressly identified as to UCC, Amchem orany other particular defendant, even when specific damages are alleged withrespect to a specific disease or injury. In fact, there are no personal injurycases in which only the Corporation and/or Amchem are the sole nameddefendants. For these reasons and based upon the Corporation’slitigation and settlement experience, the Corporation does not consider thedamages alleged against it and Amchem to be a meaningful factor in itsdetermination 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,the Corporation 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.

InNovember 2005, the Corporation requested ARPC to review the Corporation’s 2005asbestos claim and resolution activity and determine the appropriateness ofupdating the January 2005 study. In response to that request, ARPC reviewed andanalyzed data through October 31, 2005. In January 2006, ARPC stated that anupdate of the study would not provide a more likely estimate of future eventsthan the estimate reflected in its study of the previous year and, therefore,the estimate in that study remained applicable.

Based onthe Corporation’s own review of the asbestos claim and resolution activity andARPC’s response, the Corporation determined that no change to the accrual wasrequired at December 31, 2005. The asbestos-related liability for pending andfuture claims was $1.5 billion at December 31, 2005. Approximately 39 percentof the recorded liability related to pending claims and approximately61 percent related to future claims.

Based on theCorporation’s review of 2006 activity, the Corporation determined that nochange to the accrual was required at September 30, 2006. The asbestos-relatedliability for pending and future claims was $1.4 billion at September 30, 2006.Approximately 35 percent of the recorded liability related to pending claimsand approximately 65 percent related to future claims.

*Defense and 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**
|                      | ** ** | **Nine Months Ended** | ** ** | **Aggregate Costs** | ** ** |
|----------------------|------------|---------------------------------|------------|--------------------------|------------|
| **In millions** | ** ** | **Sept. 30,  2006**        | ** ** | **Sept. 30,  2005** | ** ** | **to Date as of  Sept. 30, 2006** | ** ** |
| Defense costs        |       | $                               | 45         |                     | $          | 55 |   | $ | 464 |   |
| Resolution costs     |       | $                               | 95         |                     | $          | 122 |   | $ | 1,160 |   |

 

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**Asbestos-RelatedMatters — Continued**

Theaverage resolution payment per asbestos claimant and the rate of new claimfilings has fluctuated both up and down since the beginning of 2001. UnionCarbide’s management expects such fluctuations to continue in the future basedupon the number and type of claims settled in a particular period, thejurisdictions in which such claims arose, and the extent to which any proposedlegislative reform related to 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 $478million at September 30, 2006 and $535 million at December 31, 2005. AtSeptember 30, 2006, $477 million ($398 million at December 31, 2005) of thereceivable for insurance recoveries was related to insurers that are notsignatories to the Wellington Agreement and/or do not otherwise have agreementsin place regarding their asbestos-related insurance coverage.

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

**Receivablesfor Costs Submitted to Insurance Carriers**
| In millions                  | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Receivables for  defense costs    |       | $                            | 9          |                        | $          | 73 |   |
| Receivables for  resolution costs |       | 342                          |       | 327                         |       |
| Total                             |       | $                            | 351        |                        | $          | 400 |   |

 

The Corporationexpenses defense costs as incurred. The pretax impact for defense andresolution costs, net of insurance, was $1 million in the third quarter of 2006($24 million in the third quarter of 2005), and $29 million in the first ninemonths of 2006 ($56 million in the first nine months of 2005), and wasreflected in “Cost of sales.”

In September 2003, the Corporation filed a comprehensiveinsurance coverage case, now proceeding in the Supreme Court of the State ofNew York, County of New York, seeking to confirm its rights to insurance forvarious asbestos claims and to facilitate an orderly and timely collection ofinsurance proceeds. Although the Corporation already has settlements in placeconcerning coverage for asbestos claims with many of its insurers, includingthose covered by the 1985 Wellington Agreement, this lawsuit was filed againstinsurers that are not signatories to the Wellington Agreement and/or do nototherwise have agreements in place with the Corporation regarding theirasbestos-related insurance coverage, in order to facilitate an orderlyresolution and collection of such insurance policies and to resolve issues thatthe insurance carriers may raise.  Theinsurance carriers are contesting this litigation. Through the third quarter of2006, the Corporation reached settlements with several of the carriers involvedin this litigation. 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.

Becauseof the uncertainties described above, management cannot estimate the full rangeof the cost 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.

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**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

Omitted pursuant toGeneral Instruction H of Form 10-Q.

**ITEM4.  CONTROLS AND 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**

**ITEM1.  LEGAL PROCEEDINGS.**

No materialdevelopments in asbestos-related matters occurred during the third quarter of2006. For a summary of the history and current status of asbestos-relatedmatters, see Management’s Discussion and Analysis of Financial Condition andResults of Operations, Asbestos-Related Matters; and Note E to the ConsolidatedFinancial Statements.

**ITEM1A.  RISK FACTORS.**

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

**ITEM6.  EXHIBITS.**

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

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**Union Carbide 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: October  31, 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       |   |

 

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**Union Carbide Corporation andSubsidiaries**

**Exhibit Index**

 
| EXHIBIT NO. | ** ** | **DESCRIPTION**                                                                                                                                                                               |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                          |
| 10.5.4      |       | Fourth Amendment to the Amended and Restated  Revolving Credit Agreement, dated as of September 30, 2006, among the  Corporation, The Dow Chemical Company and certain Subsidiary Guarantors. |
|        |       |                                                                                                                                                                                          |
| 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.                                                                                                                     |

 

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