UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2006

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 1-815

E. I. du Pont de Nemours and Company
(Exact Name of Registrant as Specified in Its Charter)

 

1007 Market Street, Wilmington, Delaware       19898
(Address of Principal Executive Offices)

(302) 774-1000
(Registrant’s Telephone Number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x   No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act.  (Check one):

Indicate by check mark whether the Registrant is a shell company (as defined by Rule12b-2 of the Exchange Act).

Yes  o   No   x

 

921,791,134 shares (excludes 87,041,427 shares of treasury stock) of common stock, $0.30 par value, were outstanding at July 17, 2006.

E. I. DU PONT DE NEMOURS AND COMPANY

Table of Contents

The terms “DuPont” or the “company” as used herein refer to E. I. du Pont de Nemours and Company and its consolidated subsidiaries, or to E. I. du Pont de Nemours and Company, as the context may indicate.

 

 

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Part  I.  Financial Information

Item 1.    CONSOLIDATED FINANCIAL STATEMENTS

E. I. DU PONT DE NEMOURS AND COMPANY AND CONSOLIDATED SUBSIDIARIES

Consolidated Income Statements (Unaudited)
(Dollars in millions, except per share)

 

See pages 6-23 for Notes to Consolidated Financial Statements.

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E. I. du Pont de Nemours and Company

Consolidated Balance Sheets (Unaudited)
(Dollars in millions, except per share)

		June 30, 2006			December 31, 2005
Assets
Current assets
Cash and cash equivalents		$	820		$	1,736
Marketable debt securities		7			115
Accounts and notes receivable, net		6,875			4,801
Inventories		4,453			4,743
Prepaid expenses		204			199
Income taxes		843			828
Total current assets		13,202			12,422
Property, plant and equipment, net of accumulated depreciation(June 30, 2006 - $15,022; December 31, 2005 - $14,654)		10,379			10,309
Goodwill		2,115			2,087
Other intangible assets		2,675			2,684
Investment in affiliates		837			844
Other assets		5,149			4,904
Total		$	34,357		$	33,250
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable		$	2,342		$	2,819
Short-term borrowings and capital lease obligations		2,408			1,397
Income taxes		448			280
Other accrued liabilities		2,785			2,967
Total current liabilities		7,983			7,463
Long-term borrowings and capital lease obligations		6,123			6,783
Other liabilities		8,374			8,441
Deferred income taxes		1,197			1,166
Total liabilities		23,677			23,853
Minority interests		485			490
Commitments and contingent liabilities
Stockholders’ equity
Preferred stock		237			237
Common stock, $0.30 par value; 1,800,000,000 shares authorized; Issued and outstanding at June 30, 2006 - 1,008,832,537 December 31, 2005 - 1,006,651,566		303			302
Additional paid-in capital		7,832			7,678
Reinvested earnings		9,038			7,935
Accumulated other comprehensive loss		(488		)	(518		)
Common stock held in treasury, at cost (Shares: June 30, 2006 and December 31, 2005 - 87,041,427)		(6,727		)	(6,727		)
Total stockholders’ equity		10,195			8,907
Total		$	34,357		$	33,250

 

See pages 6-23 for Notes to Consolidated Financial Statements.

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E. I. du Pont de Nemours and Company

Consolidated Statements of Cash Flows (Unaudited)
(Dollars in millions)

 

 

See pages 6-23 for Notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share)

Note 1.  Summary of Significant Accounting Policies

Interim Financial Statements

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S.) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included.  Results for interim periods should not be considered indicative of results for a full year.  These interim consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto contained in the company’s Annual Report on Form 10-K for the year ended December 31, 2005.  The Consolidated Financial Statements include the accounts of the company and all of its subsidiaries in which a controlling interest is maintained, as well as variable interest entities in which DuPont is considered the primary beneficiary.  Certain reclassifications of prior year’s data have been made to conform to current year classifications.

Accounting Standards Issued Not Yet Adopted

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 ”Accounting for Uncertainty in Income Taxes” an interpretation of FASB Statement No. 109  “Accounting for Income Taxes”. The interpretation clarifies the accounting for uncertainty in income taxes recognized in financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This statement becomes effective for the company beginning in the first quarter of 2007. The company is currently evaluating the impact of its adoption on its consolidated financial statements.

Note 2.  Stock-Based Compensation

The DuPont Stock Performance Plan provides for long-term incentive grants of stock options, time-vested restricted stock units, and performance-based restricted stock units to key employees.

Effective January 1, 2006, the company adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” using the modified prospective application transition method.  Because the company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended, prospectively on January 1, 2003, the adoption of SFAS No. 123(R) did not have a material impact on the company’s financial position or results of operations.  Prior to adoption of SFAS No. 123(R), the nominal vesting approach was followed for all awards.  Upon adoption of SFAS No. 123(R) on January 1, 2006, the company began expensing new stock-based compensation awards using a non-substantive approach, under which compensation costs are recognized over at least six months for awards granted to employees who are retirement eligible at the date of the grant or would become retirement eligible during the vesting period of the grant.  Using the non-substantive vesting approach in lieu of the nominal vesting approach would not have had a material impact on the company’s results of operations. Prior to the adoption of SFAS No. 123(R), the company reported the tax benefit of stock option exercises as operating cash flows.  Upon the adoption of SFAS No. 123(R), tax benefits resulting from tax deductions in excess of compensation cost recognized for those options or restricted stock units are reported as financing cash flows rather than as a reduction of taxes paid.

The total stock-based compensation cost included in the Consolidated Income Statements was $46 and $89, respectively, and $14 and $29 of income tax benefits related to stock-based compensation arrangements in the three and six months ended June 30, 2006.  The total stock-based compensation cost included in the Consolidated Income Statements was $21 and $42, respectively, and $6 and $13 of income tax benefits related to stock-based compensation arrangements in the three and six months ended June 30, 2005.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 2.  Stock-Based Compensation (Continued)

The maximum number of shares that may be granted subject to option or in the form of time-vested and performance-based restricted stock units for any consecutive five-year period is 72 million shares.  Of the 72 million shares, 12 million may be in the form of time-vested and/or performance-based restricted stock units.  At December 31, 2005, approximately 42 million shares were authorized for future grant under the company’s plan.  The company’s Compensation Committee determines the long-term incentive mix, including stock options, time-vested and performance-based restricted stock units, and may authorize new grants annually.

The company issues new shares to satisfy stock compensation awards.  Management currently purchases stock under the company’s share repurchase plan as approved by the Board of Directors in June 2001 to offset dilution from shares issued under employee compensation plans.  Management has not established a timeline for completion of this repurchase plan.

Stock Options

The company grants stock option awards under the DuPont Stock Performance Plan.  The purchase price of shares subject to option is equal to the market price of the company’s stock on the date of grant.  Generally, options are exercisable from one to three years after date of grant.  Prior to 2004, options expired 10 years from date of grant; however, beginning in 2004, options serially vest over a three-year period and carry a six-year option term.  The plan allows retirement eligible employees to retain any granted awards upon retirement provided the employee has rendered at least six months of service following grant date.

For purposes of determining the fair value of stock options awards, the company uses the Black-Scholes option pricing model and the assumptions set forth in the table below.  The weighted-average grant-date fair value of options granted in the three and six months ended June 30, 2006 was $7.73 and $7.28 respectively. The weighted-average grant-date fair value of options granted in the three and six months ended June 30, 2005 was $7.78 and $8.79, respectively.

 

The company determines the dividend yield by dividing the current annual dividend on the company’s stock by the option exercise price.  A historical daily measurement of volatility is determined based on the expected life of the option granted.  The risk free interest rate is determined by reference to the yield on an outstanding U.S. Treasury note with a term equal to the expected life of the option granted.  Expected life is determined by reference to the company’s historical experience.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 2.  Stock-Based Compensation (Continued)

Stock Option awards as of June 30, 2006 and changes during the three and six month period then ended were as follows:

 

*                    Includes 12.5 million and 8.4 million options outstanding from the 2002 and 1997 grants of 200 shares to all eligible employees at an option price of $44.50 and $52.50, respectively.

The aggregate intrinsic values in the table above represent the total pretax intrinsic value (the difference between DuPont’s closing stock price on the last trading day of the quarter of fiscal 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options at quarter end.  The amount changes based on the fair market value of DuPont’s stock.  Total intrinsic value of options exercised for the three and six months ended June 30, 2006 was $3 and $5, respectively. For the three and six months ended June 30, 2005 the total intrinsic value of options exercised was $9 and $152, respectively.

As of June 30, 2006, $64 of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 1.6 years.

Time-vested and Performance-based Restricted Stock Units

In 2004, the company began issuing time-vested restricted stock units in addition to stock options.  These restricted stock units serially vest over a three-year period.  Concurrently, stock option terms were reduced from ten years to six years and the number of options granted was also reduced.  A retirement eligible employee retains any granted awards upon retirement provided the employee has rendered at least six months of service following grant date.  Additional restricted stock units are also granted from time to time to key senior management employees.  These restricted stock units generally vest over periods ranging from two to five years.

The company also grants performance-based restricted stock units to senior leadership.  Vesting occurs upon attainment of pre-established corporate revenue growth and return on investment objectives versus peer companies at the end of a three-year performance period.  The actual award, delivered as DuPont common stock, can range from zero percent to 200 percent of the original grant.  During the first half of 2006, 361,100 performance-based restricted stock units were granted at a weighted average grant date fair value of $39.31.

The fair value of time-vested and performance-based restricted stock units is based upon the market price of the underlying common stock as of the date of the grant.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 2.  Stock-Based Compensation (Continued)

Nonvested awards of time-vested and performance-based restricted stock units as of June 30, 2006 and changes during the period then ended were as follows:

 

The table above includes restricted stock units for the Board of Directors settled in cash.

As of June 30, 2006, there was $73 unrecognized stock-based compensation expense related to nonvested awards. That cost is expected to be recognized over a weighted-average period of 1.9 years.  The total fair value of shares vested during the three and six months ended June 30, 2006 was $0 and $22, respectively. For the three and six months ended June 30, 2005 the total fair value of shares vested was $0 and $10, respectively.

Note 3.  Other Income, Net

 

*                    The company routinely uses forward exchange contracts to hedge its net exposures, by currency, related to the foreign currency-denominated monetary assets and liabilities of its operations.  The objective of this program is to maintain an approximately balanced position in foreign currencies in order to minimize the effects of exchange rate changes on an after-tax basis.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 4.  Restructuring Charges

During the second quarter 2006, there were no changes in estimates related to reserves established for restructuring initiatives recorded in the first quarter 2006 or in prior years. A complete discussion of the prior years’ activities is included in the company’s Annual Report on Form 10-K for the year ended December 31, 2005, at Note 4, “Employee Separation Costs and Asset Impairment Charges.”

A transformation plan was instituted during the first quarter 2006 within the Coatings & Color Technologies segment in order to better serve the company’s customers and improve profitability.  The plan includes the elimination of 1,700 positions and encompasses redeployment of employees in excess positions to the extent possible.  Restructuring charges resulting from the plan totaled $135 and are included in Cost of goods sold and other operating charges.  These charges include $123 related to severance payments primarily in Europe and the U.S. for approximately 1,300 employees involved in manufacturing, marketing, administrative and technical activities.  In connection with this program, a $12 charge was also recorded related to exit costs of non-strategic assets. During the second quarter 2006, approximately 290 employees left the roles and approximately 235 were redeployed. As of June 30, 2006, cash payments related to these separations were $7.  All employees are expected to be off the roles by fourth quarter 2007.

Prior Year Corporate Programs

The account balance and activity for prior year programs are as follows:

 

The remaining liability balance at June 30, 2006 represents payments to be made over time to separated employees.

Note 5.  Separation Activities - Textiles & Interiors

In January 2006, the company completed the sale of its interest in the last equity affiliate to its equity partner for proceeds of $14 thereby completing the sale of all the net assets of Textiles & Interiors.

In the second quarter of 2005, the company recorded a net gain of $39 ($26 after-tax) related to the separation of Textiles & Interiors.  This net gain included the sale of its investment in an affiliated company to its equity partner for $110, and the completion of the previously delayed transfer of its interest in two equity affiliates to subsidiaries of Koch Industries, Inc. (Koch), partially offset by other costs associated with the separation of Textiles & Interiors.

Note 6.  Provision for Income Taxes

In the second quarter 2006, the company recorded a tax provision of $278, including $16 of tax expense associated with the company’s policy of hedging the foreign currency-denominated monetary assets and liabilities of its operations. Also included in the second quarter 2006 is a tax benefit of $31 associated with an increase in the deferred tax assets of a European subsidiary for a tax basis investment loss recognized on the local tax return. Year-to-date 2006 also includes a net tax benefit of $41 related to the reversal of certain prior year tax contingencies previously reserved and an additional $4 of tax expense associated with the company’s hedging policy.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 6.  Provision for Income Taxes (Continued)

In the second quarter 2005, the company recorded a tax provision of $517, including $193 of tax expense associated with the company’s policy of hedging the foreign currency-denominated monetary assets and liabilities of its operations. Also included in the second quarter of 2005 was a tax benefit of $24 related to the reversal of certain prior year tax contingencies previously reserved. Year-to-date 2005 includes an additional $149 of tax expense associated with the company’s hedging policy.

Note 7.  Earnings Per Share of Common Stock

Set forth below is a reconciliation of the numerator and denominator for basic and diluted earnings per share calculations for the periods indicated:

 

The following average stock options are antidilutive, and therefore, are not included in the diluted earnings per share calculations:

 

Note 8.  Inventories

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 9.  Goodwill and Other Intangible Assets

Changes in goodwill for the period ended June 30, 2006 are summarized in the table below.

 

1                     Includes purchase accounting refinements related to certain elastomer businesses.

2                     Includes goodwill resulting from the acquisition of environmental technology businesses.

 

The gross carrying amounts and accumulated amortization in total and by major class of other intangible assets are as follows:

 

The aggregate amortization expense for definite-lived intangible assets was $56 and $115 for the three-and six-month periods ended June 30, 2006, respectively, and $57 and $114 for the three- and six-month periods ended June 30, 2005.  The estimated aggregate pretax amortization expense for 2006 and each of the next five years is approximately $230, $210, $190, $165, $130, and $110.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 10.  Commitments and Contingent Liabilities

Guarantees

Product Warranty Liability

The company warrants to the original purchaser of its products that it will, at its option refund, repair or replace, without charge, such products if they fail due to a manufacturing defect.  The term of these warranties varies (30 days to 10 years) by product.  The company’s estimated product warranty liability as of June 30, 2006 is $32.  In the first quarter of 2006, the company increased its reserve for product warranty liability primarily in the Safety & Protection segment to reflect obligations related to certain product warranties.  The company has recourse provisions for certain products that would enable recovery from third parties for amounts paid under the warranties.  The company accrues for product warranties when, based on available information, it is probable that customers will make claims under warranties relating to products that have been sold, and a reasonable estimate of the costs (based on historical claims experience relative to sales) can be made.

Set forth below is a reconciliation of the company’s estimated product warranty liability from December 31, 2005 through June 30, 2006:

 

Indemnifications

In connection with acquisitions and divestitures, the company has indemnified respective parties against certain liabilities that may arise in connection with these transactions and business activities prior to the completion of the transaction.  The term of these indemnifications, which typically pertain to environmental, tax and product liabilities, is generally indefinite.  In addition, the company indemnifies its duly elected or appointed directors and officers to the fullest extent permitted by Delaware law, against liabilities incurred as a result of their activities for the company, such as adverse judgments relating to litigation matters.  If the indemnified party were to incur a liability or have a liability increase as a result of a successful claim, pursuant to the terms of the indemnification, the company would be required to reimburse the indemnified party.  The maximum amount of potential future payments is generally unlimited.  The carrying amounts recorded for all indemnifications as of June 30, 2006 and December 31, 2005 are $110 and $103, respectively.  Although it is reasonably possible that future payments may exceed amounts accrued, due to the nature of indemnified items, it is not possible to make a reasonable estimate of the maximum potential loss or range of loss.  No assets are held as collateral and no specific recourse provisions exist.

In connection with the sale of the majority of the net assets of Textiles & Interiors (INVISTA), the company indemnified the purchasers, subsidiaries of Koch, against certain liabilities primarily related to taxes, legal and environmental matters, and other representations and warranties.  The estimated fair value of these obligations of $70 is included in the indemnification balance of $110 stated above.  The fair value was based on management’s best estimate of the value expected to be required to issue the indemnifications in a stand alone, arm’s length transaction with an unrelated party and, where appropriate, by the utilization of probability-weighted discounted net cash flow models.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 10.  Commitments and Contingent Liabilities (Continued)

Obligations for Equity Affiliates & Others

The company has directly guaranteed various debt obligations under agreements with third parties related to equity affiliates, customers, suppliers and other unaffiliated companies.  At June 30, 2006, the company had directly guaranteed $576 of such obligations, plus $260 relating to guarantees of historical obligations for divested subsidiaries.  This represents the maximum potential amount of future (undiscounted) payments that the company could be required to make under the guarantees.

In certain cases, the company has recourse to assets held as collateral, as well as personal guarantees from customers and suppliers.  Assuming liquidation, these assets are estimated to cover approximately 39 percent of the $263 of guaranteed obligations of customers and suppliers.  Set forth below are the company’s guaranteed obligations at June 30, 2006:

 

 

1                     Existing guarantees for customers and suppliers arose as part of contractual agreements.

2                     Existing guarantees for equity affiliates arose for liquidity needs in normal operations.

3                     The company has guaranteed certain obligations and liabilities related to divested subsidiaries, including Conoco and its subsidiaries and affiliates, Consolidation Coal Sales Company, and INVISTA entities sold to Koch.  The Restructuring, Transfer and Separation Agreement between DuPont and Conoco requires Conoco to use its best efforts to have Conoco, or any of its subsidiaries, substitute for DuPont.  Conoco, Koch and Consolidation Coal Sales Company have indemnified the company for any liabilities the company may incur pursuant to these guarantees.

 

Residual Value Guarantees

As of June 30, 2006, the company had one synthetic lease program relating to short-lived equipment.  In connection with this synthetic lease program, the company had residual value guarantees in the amount of $97 at June 30, 2006.  The guarantee amounts are tied to the unamortized lease values of the assets under synthetic lease and are due should the company decide neither to renew these leases nor to exercise its purchase option.  At June 30, 2006, the company had no liabilities recorded for these obligations.  Any residual value guarantee amounts paid to the lessor may be recovered by the company from the sale of the assets to a third party.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 10.  Commitments and Contingent Liabilities (Continued)

Litigation

BenlateÒ

In 1991, DuPont began receiving claims by growers that use of BenlateÒ 50 DF fungicide had caused crop damage.  DuPont has since been served with several hundred lawsuits, most of which have been disposed of through trial, dismissal or settlement.  The status of BenlateÒ cases is indicated in the table below.

 

In March 2006, DuPont settled the only case pending in Australia alleging plant damage for $375 thousand. Nine cases are pending in Florida state court, involving allegations that BenlateÒ caused crop damage.  Two of these cases, involving twenty-seven Costa Rican fern growers, were tried during the second quarter of 2006 resulting in a $56 judgment against DuPont.  At trial, the plaintiffs sought damages in the range of $270 to $400.  The plaintiffs as well as DuPont have filed post trial motions and DuPont will appeal the verdict.  DuPont believes that the appeal will be resolved in its favor and, therefore, has not established a reserve relating to the judgment.

Twenty-four of the pending cases seek to reopen settlements with the company by alleging that the company committed fraud and misconduct, as well as violations of federal and state racketeering laws.  Plaintiffs are appealing the Florida federal court’s dismissal of 16 of the reopener cases.  One of the two cases pending in Florida state court is scheduled for trial in September 2006.  In December 2005, the Ninth Circuit Court of Appeals reversed the Hawaii federal court’s dismissal of the five reopener cases before it.  These five cases are scheduled for a common issues trial in November 2006.  The remaining case in Hawaii state court was settled in part for $1.2.  The remainder of this case was dismissed on DuPont’s motion.  Plaintiffs have appealed.

In one of the three cases involving allegations that BenlateÒ caused birth defects to children exposed in utero pending before it, the Delaware state court granted the company’s motion to dismiss due to insufficient scientific support for causation.  Plaintiffs have appealed and the court has stayed the other two cases pending the outcome of the appeal.

Twenty-six cases involving damage to shrimp are pending against the company in state court in Florida.  The company contends that the injuries alleged are attributable to a virus, Taura Syndrome Virus, and in no way involve BenlateÒ OD.  One case was tried in late 2000 and another in early 2001. Both trials resulted in adverse judgments of approximately $14 each.  The intermediate appellate court subsequently reversed the adverse verdicts and, in the first quarter of 2005, judgments were entered in the company’s favor in both cases.  Plaintiffs have filed a motion seeking sanctions for alleged discovery defaults in all of the cases, including the two cases in which judgment has been entered for the company.  Hearings regarding the motion for sanctions have concluded and a ruling is expected in the third quarter of 2006.

The company does not believe that BenlateÒ caused the damages alleged in each of these cases and denies the allegations of fraud and misconduct.  The company continues to defend itself in ongoing matters.  As of June 30, 2006, the company has incurred costs and expenses of approximately $1,900 associated with these matters.  The company has recovered approximately $275 of its costs and expenses through insurance and does not expect additional insurance recoveries, if any, to be significant. While management recognizes that it is reasonably possible that additional losses may be incurred, a range of such losses cannot be reasonably estimated at this time. At June 30, 2006, no reserves exist for Benlate® litigation matters.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

 

Note 10.  Commitments and Contingent Liabilities (Continued)

PFOA

EPA Complaints

In July and December 2004, the EPA filed administrative complaints against DuPont alleging that the company failed to comply with the technical reporting requirements of the Toxic Substances Control Act (TSCA) and the Resource Conservation and Recovery Act (RCRA) regarding PFOA, (collectively, perfluorooctanoic acids and its salts, including the ammonium salt).  The first complaint related to information about PFOA for a period beginning in June 1981 through March 2001; the second related to information about PFOA for a period beginning in late July 2004 to mid-October 2004.  In December 2005, the parties entered into a settlement agreement to resolve the original counts set forth in the complaints and the additional counts raised by the EPA in 2005. As a result in 2005, the company established reserves of $16.5 to fund its obligations under the settlement agreement.  The agreement requires the company to pay civil fines of $10.25 and fund two Supplemental Environmental Projects at a total cost of $6.25. The company paid the civil fines of $10.25 in January 2006 and expects that the projects will be completed, and the costs of $6.25 incurred, over a three year period ending December 31, 2009.

Department of Justice: Grand Jury Subpoena

On May 17, 2005, DuPont was served with a grand jury subpoena from the U.S. District Court for the District of Columbia.  The subpoena, which was served by the Environmental Crimes Section of the Environment and Natural Resources Division of the Department of Justice (DOJ), relates to PFOA, ammonium perfluorooctanoate (APFO), C-8 and FC-143.  The subpoena calls for the production of documents previously produced to the EPA and other documents related to those chemicals.  DuPont has been and will continue to be fully responsive to the DOJ in this matter and has begun the production of documents. It is expected that the collection, review and production of documents will continue at least through 2006.

Class Actions:  Drinking Water

In August 2001, a class action, captioned Leach v. DuPont, was filed in West Virginia state court against DuPont and the Lubeck Public Service District.  DuPont uses PFOA as a processing aid to manufacture fluoropolymer resins and dispersions at various sites around the world including its Washington Works plant in West Virginia.  The complaint alleged that residents living near the Washington Works facility had suffered, or may suffer, deleterious health effects from exposure to PFOA in drinking water.  The relief sought included damages for medical monitoring, diminution of property values, and punitive damages plus injunctive relief to stop releases of PFOA.  DuPont and attorneys for the class reached a settlement agreement in 2004 and as a result, the company established reserves of $108 million in 2004. The agreement was approved by the Wood County Circuit Court on February 28, 2005 after a fairness hearing.  The settlement binds a class of approximately 80,000 residents.  As defined by the court, the class includes those individuals who have consumed, for at least one year, water containing 0.05 parts per billion or greater of PFOA from any of six designated public water sources or from sole source private wells.

In July 2005, the company paid the plaintiffs’ attorneys’ fees and expenses of $23 and made a payment of $70, which class counsel has designated to fund a community health project. The company also is funding a health study by an independent science panel of experts in the communities exposed to PFOA to evaluate available scientific evidence on whether any probable link exists between exposure to PFOA and human disease. In the second quarter 2006, DuPont increased its estimate of the cost of the independent science panel health study from $5 to $15, of which $5 was originally placed in an interest-bearing escrow account. The increase of $10 is primarily due to an increase in the study’s scope which in turn lengthens the expected timeframe to complete the study by approximately two years, to between four and six years.  In addition, the company is providing state-of-the art water treatment systems designed to reduce the level of PFOA in water to six area water districts until the science panel completes its work. Due to the revised timeframe for the study, the estimated cost of constructing, operating and maintaining these systems has increased from $15 to $18, of which $10 was originally placed in an interest-bearing

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 10.  Commitments and Contingent Liabilities (Continued)

escrow account. The company is funding a bottled water program (estimated to cost about $3) for residents in one water district on an interim basis until the installation of the water treatment systems.  In the second quarter 2006, the company increased its reserves relating to this matter by $13 reflecting the increased cost projections for the independent health study and water treatment systems. As a result of this reserve addition, payments and activities undertaken pursuant to the settlement agreement during the period, the reserve balance at June 30, 2006 was $27, including $9 in interest bearing escrow accounts.

The settlement resulted in the dismissal of all claims asserted in the lawsuit except for personal injury claims.  If the independent science panel concludes that no probable link exists between exposure to PFOA and any diseases, then the settlement would also resolve personal injury claims.  If it concludes that a probable link does exist between exposure to PFOA and any diseases, then DuPont would also fund up to $235 for a medical monitoring program to pay for such medical testing.  In this event, plaintiffs would retain their right to pursue personal injury claims.  All other claims in the lawsuit would remain dismissed by the settlement. DuPont believes that it is remote that the panel will find a probable link.  Therefore, at June 30, 2006, the company had not established any reserves related to this matter.
However, there can be no assurance as to what the independent science panel will conclude.

The Little Hocking Water Association was one of the six area water districts for whom DuPont was to offer to design and construct a state of the art water treatment system under the settlement. Little Hocking opted out of the settlement and in May 2006 sued DuPont in Ohio state court claiming that perfluorinated compounds (including PFOA) allegedly released from the Washington Works plant contaminated its well fields and underlying aquifer.  Little Hocking’s complaint seeks a variety of relief including compensatory and punitive damages, and an injunction requiring the company to provide a new “pristine” well field and the infrastructure to deliver it. The court has not issued any rulings in this case.

In the second quarter of 2006, three purported class actions were filed alleging that drinking water had been contaminated by PFOA in excess of 0.05 parts per billion (ppb) due to alleged releases from certain DuPont plants. One of these cases was filed in West Virginia state court on behalf of customers of the Parkersburg City Water District, but was removed on DuPont’s motion to the U.S. District Court for the Southern District of West Virginia. The other two purported class actions were filed in New Jersey. One was filed in federal court on behalf of individuals who allegedly drank water contaminated by releases from DuPont’s Chambers Works plant in Deepwater, New Jersey. The second was filed in state court on behalf of customers serviced primarily by the Pennsville Township Water Department and was removed to New Jersey federal district court on DuPont’s motion.

The company intends to defend itself vigorously against these lawsuits alleging contamination of drinking water sources. While DuPont believes that it is reasonably possible that it will incur losses related to PFOA, a range of such loss, if any, cannot be reasonably estimated at this time.

Consumer Products Class Actions

 

As of June 30, 2006, 21 intrastate class actions have been filed on behalf of consumers that have purchased cookware with Teflon® non-stick coating in federal district courts against DuPont. The actions were filed on behalf of consumers in Colorado, Connecticut, Delaware, the District of Columbia, Florida, Illinois, Iowa, Kentucky, Massachusetts, Michigan, Missouri, New Jersey, New Mexico, New York, Ohio, Pennsylvania, South Carolina, Texas and West Virginia and two were filed in California. By order of the Judicial Panel on Multidistrict Litigation, all of these actions have been combined for coordinated and consolidated pretrial proceedings in federal district court for the Southern District of Iowa. The

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 10.  Commitments and Contingent Liabilities (Continued)

proceedings in this court will include the central question of whether these cases can proceed as class actions. A ruling on this issue is not expected before 2007.

The actions allege that DuPont violated state laws by engaging in deceptive and unfair trade practices by failing “to disclose to consumers that products containing Teflon® were or are potentially harmful to consumers” and that DuPont has liability based on state law theories of negligence and strict liability.  The actions allege that Teflon® contained or released harmful and dangerous substances, including a chemical (PFOA) alleged to have been determined to be “likely” to cause cancer in humans.  The actions seek unspecified monetary damages for consumers who purchased cooking products containing Teflon®, as well as the creation of funds for medical monitoring and independent scientific research, attorneys’ fees and other relief.

In December 2005, a motion was filed by a single named plaintiff in the Superior Court for the Province of Quebec, Canada seeking authorization to institute a class action on behalf of all Quebec consumers who have purchased or used kitchen items, household appliances or food-packaging containing Teflon® or Zonyl® non-stick coatings.  Damages are not quantified, but are alleged to include the cost of replacement products as well as one hundred dollars per class member as exemplary damages. In June 2006, plaintiffs filed an additional motion seeking authorization to expand the purported class to include all Canadian consumers of these products, not just Quebec residents. The Court is not expected to rule on this latest motion until late 2006.

The company believes that the 21 class actions and the motion filed in Quebec are without merit and, therefore, believes it is remote that it will incur losses related to these actions. At June 30, 2006, the company had not established any reserves related to these matters.

Elastomers Antitrust Matters

Investigations of the U.S., European Union and Canadian synthetic rubber markets for possible antitrust violations are ongoing. These investigations included DuPont Dow Elastomers, LLC, (DDE) as a result of its participation in the polychloroprene (PCP) and ethylene propylene diene monomer (EPDM) markets. DDE was a joint venture between The Dow Chemical Company (Dow) and DuPont.  DDE and DuPont were named in related civil litigation.

In April of 2004, DuPont and Dow entered into a series of agreements under which DuPont obtained complete control over directing DDE’s response to these investigations and the related litigation, and DuPont agreed to a disproportionate share of the venture’s liabilities and costs related to these matters.  Consequently, DuPont bears any potential liabilities and costs up to the initial $150.  Dow is obligated to indemnify DuPont for up to $72.5 by paying 15 to 30 percent toward liabilities and costs in excess of $150. On June 30, 2005, DDE became a wholly owned subsidiary of DuPont and was renamed DuPont Performance Elastomers LLC (DPE).

DDE resolved all criminal antitrust allegations against it related to PCP in the U.S. through a plea agreement with the Department of Justice (DOJ) in January 2005 which was approved by the court on March 29, 2005. The agreement requires the subsidiary to pay a fine of $84 which, at its election, may be paid in six equal, annual installments. The annual installment payments for 2005 and 2006 have been made.  The agreement also requires the subsidiary to provide ongoing cooperation with the DOJ’s investigation. DDE responded to investigations by European Union and Canadian antitrust authorities and DPE continues to cooperate with the authorities.

In November of 2004, the court approved the settlement reached by DDE and attorneys for the class, of federal antitrust litigation related to PCP for $42, including attorneys’ fees and costs.  DDE also reached a settlement with attorneys for the class, of federal antitrust litigation related to EPDM for $24.6, including attorneys’ fees and costs.  The court approved the EPDM settlement in May 2005. During the second quarter of 2006, the court-appointed fund administrators returned a portion of the class settlement paid in connection with the PCP class action related to individual claimants that opted out of the class. Including the PCP and EPDM class settlements, net of the PCP class action funds returned to the company,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 10.  Commitments and Contingent Liabilities (Continued)

related to civil lawsuits and claims alleging antitrust violations in certain synthetic rubber markets, the company has paid $88 through June 30, 2006. Certain claims are still pending.

As a result of its April 2004 agreements with Dow, DuPont established reserves in 2004 of $268, of which $18 will be reimbursed by Dow to reflect its share of anticipated losses.  At June 30, 2006, the balance of the reserves is $144, which reflects net adjustments made for claimants who opted out of the PCP settlement during the second quarter 2006, and includes $56 for the remaining four installment payments to be made under the plea agreement with the DOJ. Given the uncertainties inherent in predicting the outcome of these matters and the likelihood of additional future claims it is reasonably possible that actual losses may exceed the amount accrued. However, a range of such losses cannot be reasonably estimated at this time.

General

The company is subject to various lawsuits and claims arising out of the normal course of its business.  These lawsuits and claims include actions based on alleged exposures to products, intellectual property and environmental matters, and contract and antitrust claims.  The company accrues for contingencies when the information available indicates that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated.  While the ultimate liabilities resulting from such lawsuits and claims may be significant to results of operations in the period recognized, management does not anticipate they will have a material adverse effect on the company’s consolidated financial position or liquidity.

Environmental

The company is also subject to contingencies pursuant to environmental laws and regulations that in the future may require the company to take further action to correct the effects on the environment of prior disposal practices or releases of chemical or petroleum substances by the company or other parties.  Additional information relating to environmental remediation activity is contained in Notes 1 and 24 to the company’s Consolidated Financial Statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2005.  At June 30, 2006, the company’s Consolidated Balance Sheet includes a liability of $342 relating to these matters and, in management’s opinion, is appropriate based on existing facts and circumstances.  Considerable uncertainty exists with respect to these costs and, under adverse changes in circumstances, potential liability may range up to two to three times the amount accrued at June 30, 2006.

Note 11.  Comprehensive Income

The following sets forth the company’s total comprehensive income for the periods shown:

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 12. Derivatives and Other Hedging Instruments

The company’s objectives and strategies for holding derivative instruments are included in Note 29 to the company’s Consolidated Financial Statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2005.  In the second quarter 2006, the company entered into derivative contracts to hedge exposure to price fluctuations on natural gas with no ineffectiveness.  During the first half of 2006, hedge ineffectiveness of $(1) was reported in earnings. There were no hedge gains or losses excluded from the assessment of hedge effectiveness or reclassifications to earnings for forecasted transactions that did not occur related to cash flow hedges. The following table summarizes the effect of cash flow hedges on accumulated other comprehensive income (loss) for the period:

 

 

Note 13.  Employee Benefits

The following sets forth the components of the company’s net periodic pension benefit cost:

 

The company disclosed in its Consolidated Financial Statements for the year ended December 31, 2005, that it expected to contribute approximately $280 to its pension plans, other than to the principal U.S. pension plan in 2006.  As of June 30, 2006, contributions of $131 have been made to these pension plans and the company anticipates additional contributions of approximately $164 during the remainder of 2006.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 13.  Employee Benefits (Continued)

The following sets forth the components of the company’s net periodic cost for other postretirement benefits:

 

The company disclosed in its Consolidated Financial Statements for the year ended December 31, 2005, that it expected to make payments of approximately $350 to its other postretirement benefit plans in 2006.  Through June 30, 2006, the company has made benefit payments of $170 related to its postretirement benefit plans and anticipates additional payments of approximately $180 during the remainder of 2006.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 14.  Segment Information

Segment sales include transfers and a pro rata share of equity affiliates’ sales.  Segment pretax operating income (PTOI) is defined as operating income before income taxes, minority interests, exchange gains (losses), corporate expenses and interest.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share)

Note 14.  Segment Information (Continued)

1                      Includes the following results from Engage®, Nordel®, and Tyrin® businesses transferred to Dow on June 30, 2005.

 

2                       A reconciliation of the pretax operating income totals reported for the operating segments to the applicable line item on the Consolidated Financial Statements is as follows:

 

3                       Includes a gain of $48 resulting from the sale of the company’s equity interest in DuPont Photomasks Inc.

4                       Includes a gain of $23 from the disposition of certain assets of DDE to Dow and a charge of $34 related to the shutdown of an elastomers manufacturing facility in the U.S.

5                       Includes a net gain of $39 relating to the disposition of three equity affiliates associated with the ongoing separation of Textiles & Interiors, partly offset by other separation costs.

6                       Includes a $135 restructuring charge, which is discussed in more detail in Note 4.

Note 15.  Subsequent Event

On October 27, 2005, the company purchased and retired 75.7 million shares of DuPont’s outstanding common stock at a price per share of $39.62 from Goldman, Sachs & Co. (Goldman Sachs) under an accelerated share repurchase agreement. During the subsequent nine-month period, which ended July 27, 2006, Goldman Sachs purchased an equal number of shares in the open market with a volume weighted average price (VWAP) of $41.99 per share. Upon the conclusion of the agreement, the company was required to pay Goldman Sachs a settlement payment at the company’s option, in cash or shares of its common stock. The final settlement price was based upon the difference between the VWAP per share during the nine-month period and the purchase price of $39.62 per share. On August 1, 2006, the company made a cash settlement payment of $180 to Goldman Sachs. The amount paid to settle the contract will be recorded as a reduction to Additional paid-in capital.

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Item 2.           MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION AND RESULTS OF OPERATIONS

Cautionary Statements About Forward-Looking Statements

This report contains forward-looking statements which may be identified by their use of words like “plans,” “expects,” “will,” “anticipates,” “intends,” “projects,” “estimates” or other words of similar meaning.  All statements that address expectations or projections about the future, including statements about the company’s strategy for growth, product development, market position, expenditures and financial results, are forward-looking statements.

Forward-looking statements are based on certain assumptions and expectations of future events.  The company cannot guarantee that these assumptions and expectations are accurate or will be realized.  See the Risk Factors discussion set forth under Part II, Item 1A included on page 37.  In addition, the following are some of the important factors that could cause the company’s actual results to differ materially from those projected in any such forward-looking statements:

·                  As part of its strategy for growth, the company has made and may continue to make acquisitions and divestitures and form strategic alliances.  There can be no assurance that these will be completed or beneficial to the company.

·                  The company has undertaken and may continue to undertake productivity initiatives, including cost reduction programs, organizational restructurings and Six Sigma projects, to improve performance and generate cost savings.  There can be no assurance that these will be completed or beneficial to the company.  Also, there can be no assurance that any estimated cost savings from such activities will be realized.

Results of Operations

Overview

Second quarter results reflect the company’s execution of its growth strategies across all business segments.  Sustained pricing momentum continued in the second quarter, which coupled with volume growth and solid fixed cost control offset higher energy and ingredient costs. While the cost of natural gas and certain other materials have declined, oil and oil derivatives in general were considerably above last year’s level.  It is anticipated that raw material costs will remain higher in the second half of 2006 than last year.

Execution of the company’s cost and productivity initiatives resulted in savings that offset inflation and expenses related to ongoing growth investments.  The titanium dioxide (TiO2) plant in DeLisle Mississippi has been completely restored and is fully operational.  The transformation plan launched early this year in the coatings businesses to consolidate certain manufacturing and laboratory sites and focus on higher growth market segments is on track to save $135 million annually when complete in late 2007.

The company continues to invest in new products and emerging business opportunities in industrial biotechnology.  New licensing agreements were executed in the quarter related to advances in the company’s seed product pipeline with Syngenta Seeds, Inc. and Delta and Pineland Company.  The company also initiated a partnership with BP p.l.c. (BP) to develop, produce and market biofuels to help meet increasing global demand for renewable transportation fuels.  DuPont and BP plan to deliver advanced biofuels that will provide improved options for expanding energy supplies and accelerate the move to renewable transportation fuels, which lower overall greenhouse gas emissions.

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Net Sales

Consolidated net sales for the second quarter were $7.4 billion versus $7.5 billion in the second quarter 2005.  A 1 percent increase in U.S. dollar (USD) selling prices and 1 percent higher volume partly offset a 3 percent reduction in Net sales reflecting the absence of $213 million in prior-year sales from former DuPont Dow Elastomers LLC (DDE) businesses transferred to The Dow Chemical Company (Dow) on June 30, 2005. Local prices improved in all regions reflecting higher prices in all segments except Agriculture & Nutrition.   Worldwide volume growth was driven by increases in regions outside the United States of America (U.S.), principally Asia Pacific and Latin America, reflecting increased sales of engineering polymers, coatings, electronic materials, and aramids. Volumes in the U.S. and Europe were negatively affected by a significant decrease in sales of crop protection products.

The tables below show Net sales and an analysis of variances versus the prior year for each region:

		Three Months Ended June 30					Percent Change Versus 2005
		2006			Percent		After Adjusting For Portfolio Changes(a)
		Net Sales			Change				Local		Currency
		($ Billions)			Vs. 2005		Total		Price		Effect		Volume
Worldwide		$	7.4		(1	)%	2		2		(1	)	1
U.S.		3.3			(3	)	(1	)	2		—		(3	)
Europe		2.0			(2	)	—		1		(3	)	2
Asia Pacific		1.2			2		7		2		(2	)	7
Canada & Latin America		0.9			9		9		2		2		5

 

(a)             Excludes $213 million of second quarter 2005 sales attributable to the elastomers businesses that were transferred to Dow on June 30, 2005.

For the six months ended June 30, 2006, Consolidated net sales were $14.8 billion versus $14.9 billion in the prior year, down 1 percent, principally due to the absence of elastomers sales from businesses transferred to Dow and a negative currency effect. Local selling prices were higher across all regions and most businesses. Worldwide volume increased 1 percent reflecting 6 percent gains in the Asia Pacific and Latin America/ Canada regions, largely offset by a reduction in the U.S. Lower U.S. volume primarily reflects lower sales of crop protection products.

Six Months Ended

June 30

Percent Change Versus 2005

2006

Percent

After Adjusting For Portfolio Changes(a)

Net Sales

Change

Local

Currency