Management Discussion and Analysis

Summary of Consolidated Results

An analysis of gross profit changes is summarized on a basic per-share basis on below.

Net Sales decreased 7% on a 1% volume increase. On a comparable business basis, sales decreased 3% while volume was flat. In addition to the divestiture of two businesses, resulting in the exclusion of AtoHaas' sales from 1998, the remaining 50% of NorsoHaas was acquired and operations in China were consolidated during the year. The sales decrease on higher volume is largely a result of weaker currencies, primarily in Asia-Pacific, and 2% lower selling prices. Volume was strong in Europe and Latin America while the unfavorable business environment hurt volume in the Asia-Pacific region. Volume in North America was flat. On a comparable business basis, Asia-Pacific region sales declined 19% and volume decreased 12%. Sales of $3,999 million in 1997 were essentially the same as in 1996, the net result of 6% volume gains, 1% lower selling prices, 9% weaker currencies in Europe, a 10% weaker Japanese yen and the absence of Petroleum Chemicals sales, which were part of the unconsolidated RohMax joint venture in 1997. Volume growth was strong in all regions, with all businesses contributing except Agricultural Chemicals.

Raw Material Prices declined throughout 1998 largely as a result of lower prices in North America for acetone, methanol, propylene and other monomer related raw materials primarily benefiting the Performance Polymers segment. Raw material prices were stable in 1997. They declined throughout the first three quarters of 1996, until natural gas and oil prices increased in the fourth quarter of that year. Prices for raw materials, including methanol, propylene, acetone and butanol, were down 10%, net, in 1998 compared to decreases of 1% and 7% in 1997 and 1996, respectively, excluding currency impacts.

Gross Profit of $1,464 million increased 1% from 1997, largely as a result of 10% lower raw material costs and efficient plant operations. Selling prices were 2% lower. Currency fluctuations in Europe and Asia-Pacific were unfavorable. Total gross profit increased to $1,455 million in 1997, up 4% from 1996. The gross profit margin was 39%, 36% and 35% in 1998, 1997 and 1996, respectively. Gross profit in 1998 increased largely as a result of lower raw material costs. The gross profit margin increased in 1997 because of higher volume but was negatively affected by 1% lower selling prices and unfavorable currency impacts.

Selling, Administrative and Research (SAR) Expenses for 1998 were essentially unchanged compared to the 1997 period, reflecting the net effect of higher research expense and lower selling and administrative expense due to the absence of AtoHaas costs. SAR expenses in 1997 were up 3% over 1996 due to higher selling expenses, higher bonus expense, insurance costs and the cost of new product introductions.

Interest Expense of $34 million in 1998 decreased 13% from 1997 due to 1998 debt retirements. Interest expense in 1997 was flat compared to 1996.

Share of Affiliate Net Earnings were $2 million in 1998, compared to earnings of $11 million in 1997 and losses of $12 million in 1996. Affiliate earnings decreased in 1998 due to the absence of the affiliate earnings of RohMax. In 1997, share of affiliate net earnings were a result of the RohMax joint venture, the contribution of Rodel and improved results from AtoHaas Europe. During 1996, AtoHaas Europe experienced operating losses because of weak market conditions characterized by lower volume, falling selling prices and increasing raw material prices. The 1996 losses of the AtoHaas Europe business also included $4 million of write-offs and costs related to the restructuring of its operations.

Analysis of Change in Basic Per-Common-Share Earnings Current Year Relative to Year Earlier

Other Income, Net was $110 million, compared to $22 million in 1997 and $4 million in 1996. Income in 1998 reflects the net before-tax gain on second quarter non-recurring items, including the divestiture of the AtoHaas and RohMax businesses. The 1997 amount includes $26 million related to remediation settlements with insurance carriers during the fourth quarter. In 1996, other income included a gain of $10 million on the sale of land in Japan and $6 million of royalty income, offset by $8 million of severance and early retirement costs and $5 million of minority interest expense.

The Effective Tax Rates were 35% in 1998, 33% in 1997 and 32% in 1996. The 1998 increase was largely a result of the tax effect of 1998 non-recurring items. The 1996 period included a $10 million retroactive tax credit on sales outside the United States.

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