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Dow Chemical Company (NYSE:DOW)

Transformational Strategy Call

December 8, 2008 9:00 am ET

Executives

Howard Ungerleider - Vice President of Investor Relations

Andrew N. Liveris - Chairman of the Board, President, Chief Executive Officer

Geoffery E. Merszei - Chief Financial Officer, Executive Vice President, Director

Analysts

Frank Mitsch - BB&T Capital Markets

Jeffrey Zekauskas - J.P. Morgan

Michael Judd - Greenwich Consultants

Mark Connelly - Credit Suisse

David Begleiter - Deutsche Bank Securities

Prashant Juvekar - Citigroup

Peter Butler - Glen Hill Investments

Robert Koort - Goldman Sachs

Operator

Welcome to Dow’s continued implementation of its transformation strategy. Today’s call is being recorded. At this time I would like to turn the call over to Mr. Howard Ungerleider, Vice President of Investor Relations.

Hoard Ungerleider

As usual we’re making this call available to investors and the media via webcast. This call is the property of the Dow Chemical Company. Any redistribution, retransmission or rebroadcast of this call in any form without Dow’s express written consent is strictly prohibited.

On the call with me today is Andrew Liveris, Dow’s Chairman and Chief Executive Officer, and Geoffery Merszei, Dow’s Chief Financial Officer.

Now turning to slide 2 in the presentation, as you know some of our comments today may include statements about our expectations for the future. Those expectations involve risks and uncertainties. We can’t guarantee the accuracy of any forecasts or estimates and we don’t plan to update any forward-looking statements if our expectations change. In addition some of our comments may reference non-GAAP financial measures. If you’d like more information on the risks involved in forward-looking statements or reconciliation of the most directly comparable GAAP financial measures and associated disclosures, please see our SEC filings.

Now let me hand it over to Dow’s Chairman and CEO Andrew Liveris.

Andrew N. Liveris

I’d like to share with you this morning the next steps in our transformational strategy here at Dow. We’ve been working on changing our portfolio for several years and as you can see on slide 3, in March 2006 we announced at an investor meeting in New York our priorities. I’m going to walk you through our business model shift as it’s shown on slides 4 through 6.

We have spent the last several years working intensely on forming asset light joint ventures with key partners such as PIC and KPC, Saudi Aramco, Siam Cement and many others as well as pruning our portfolio to create a leaner higher growth market centered group of businesses that could accelerate our transformation into an earnings growth company.

Clearly the two large transactions of the last 12 months were pivotal in that regard with the announcement last Monday of the signing of the K-Dow deal being a pivot point in our transformation. We are also on track to close the Rohm and Haas acquisition, and we’ll have more to say on that deal very soon.

Now throughout this strategy we’ve really been very intensely focused on creating a new way of working here at Dow, one that builds on our long history of operational excellence and integration but really creates a market driven technology centric company and a culture based on our deep scientific capabilities. We always were attenuated to the need to shed unproductive assets, divest non-value creating businesses and create agility and autonomy in how we react to the market place.

Today’s announcement marks the next phase in our transformation. Clearly we have the portfolio in hand to move to this new model and equally clearly we’re accelerating this move given the deterioration in the world economy and in most of our markets.

We will create a leaner corporate center, a shared business services group and three business operating models as shown on slide number 5. We will organize ourselves over the next several months to this design thereby affording ourselves the opportunity to shed costs and create the culture that accelerates our transformation. The three business operating models will be: Joint ventures and asset light, performance products and market facing businesses including health and agriculture and advanced materials.

Now the joint venture asset light model allows us to position these assets with a partner for growth while maintaining our integration but with obviously much less capital intensity and cyclicality as a result. All of our basics joint ventures will be in this model as will be some of our basics businesses.

Performance products on the other hand is comprised of high volume technology differentiated products and processes that place an emphasis on innovation. We have industry leading positions with these products such as in polyurethanes and epoxies, especially chemicals and many others like product driven businesses.

Finally health and agriculture, advanced materials and other market facing businesses are comprised of businesses with high margins and strong brands. The focus here is to use the full extent of Dow’s R&D engine to develop value-added customer solutions in fast-growing markets. This is of course where Rohm and Haas and Dow AgroSciences are two prime examples.

These new business models will become effective in the first quarter and we’ll provide more specific details early next year. These businesses will now be supported by the shared business services group as well as a lean and efficient corporate center that will serve the needs of their businesses in a cost-efficient and effective way as shown on slide number 6.

Now as a result of moving to this structure as shown on slide number 7 we can and we can proceed to eliminate approximately 5,000 full-time jobs which is about 11% of Dow’s current workforce. This will be in addition to the Rohm and Haas synergies which I and Geoffery will discuss in a few minutes.

We’re also closing 20 production plants in high cost areas and divesting several non-strategic businesses. The vast majority of these businesses were already part of Dow’s business portfolio optimization group and were targeted for action. Today’s announcement means we’ll pursue these closures and divestitures at an even more aggressive pace than we have in the past. I should point out that about 2,000 roles of the total jobs being eliminated are expected to go with these divested businesses.

We are also in the process of temporarily idling approximately 180 production plants. These represent approximately 30% of our plants worldwide and are mostly split evenly between North America and Europe. As a result we will also be reducing our contractor workforce by about 6,000.

Now I would like to turn it over to Geoffery who’s going to run you through the financial impact.

Geoffery E. Merszei

As you can see on slide 8 we estimate that today’s announcement will result in a pre-tax charge within our fourth quarter earnings of $700 million. The composition of this charge is approximately $350 million in anticipated severance payments and another $350 million in charges mainly related to the 20 plant shutdowns that Andrew referred to. All of this will lead to an EPS impact of between $0.50 and $0.60 per share in the fourth quarter.

Now regarding cash flow, the majority of this impact will occur next year in 2009 in the form of severance payments as positions are being eliminated. We expect operating cost savings of $700 million with a run rate of approximately $350 million by the end of next year and full implementation by the end of 2010.

Moving on to slide 9, these measures are in addition to the Rohm and Haas synergies of $800 million bringing our total cost reduction commitment to $1.5 billion by the end of 2010. I would also like to remind you that Rohm and Haas has a separate cost-reduction program already underway and that $110 million program would be additive to the $1.5 billion that I just mentioned.

Now moving on to slide 10, in addition to today’s announcement we are implementing several actions to preserve cash in 2009. First, we are committing to reducing working capital requirements by approximately $2 billion. This is a combination of tighter working capital management and a reflection of lower feedstock and energy costs. Second, we are reducing our capital spending target by $600 million versus the 2008 levels. These two commitments will lower our cash requirements by approximately $2.5 billion through 2009 and will deliver an additional $1 billion in free cash flow next year.

So now let me turn it back over to Andrew.

Andrew N. Liveris

Before I close out the presentation part of this phone call, I want to talk briefly about the dividend. On slide number 11 if you can turn there, I know that there are a lot of companies out there that are either cutting or eliminating their dividend. Dow is the only company in the Fortune 200 to have paid its regular quarterly cash dividend without reduction or interruption since 1912. That’s 388 consecutive quarters. I’ve said it before but I want to say it again. We will not break that string. Not Dow. Not on my watch.

So let me close this out if you can turn to slide 12. I know you have questions. Before I go there, let me summarize by pointing out the actions we’re taking today are an acceleration of our long-term strategy to transform Dow into an earnings growth company. This will strengthen our financial position as we respond to this rapidly-changing and deteriorating economy.

While we are making a number of reductions in our cost structure, let me assure you we will not cut spending at the expense of growth. We will continue to fund our growth projects like the ones in Saudi Arabia, Kuwait, Brazil and China. We will continue to fund R&D spending to drive innovation. And we will continue to support growth in performance and market facing businesses like in Dow AgroSciences and Rohm and Haas, and we will continue to pay; let me repeat, continue to pay; our dividend.

At this time we’d like to turn it over back to you and we’d be happy to take your questions.

Howard Ungerleider

That wraps up our prepared remarks. For your reference, a copy of these remarks will be posted on Dow’s website later today. Now we’ll move on to your questions. Before we do though, I’d like to remind you that my comments on forward-looking statements and non-GAAP financial measures apply to both our prepared remarks and to anything that may come up during the Q&A. Yolanda, would you please explain the Q&A procedure.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Frank Mitsch - BB&T Capital Markets.

Frank Mitsch - BB&T Capital Markets

You obviously are taking some aggressive steps here to preserve cash and put yourself in a better position for this downturn. Is there any thought that perhaps you might go back to Rohm and Haas and instead of making it an all-cash transaction use a component of cash as well as some equity?

Andrew N. Liveris

We get asked the question a lot about the Rohm and Haas transaction and I think even yourself. We have examined all sorts of ways to think at the Rohm and Haas transaction in the context of today’s economic circumstances including currency. Some of these things we’ve examined, we’re not at liberty to talk publicly about. I know you would respect that. But rest assured that we’re looking at every possible mechanism. At the same time we remain committed to closing the deal.

Today’s announcement, which you know really was centered on our transformation and acceleration of our transformation, is really an acceleration to accommodate not only the current market conditions but the nature of the transaction that we’re undertaking with Rohm and Haas. I’ve said it many times, if in today’s market conditions we’re paying a premium that is pretty high to say the least compared to current equity prices but even so back in July some of you said it was high in the context of those conditions, there is really only one real answer.

And that is to adjust ourselves and accelerate the ability to implement better and to deliver more savings to the bottom line. We believe we’ve come up with a way to do it through firstly our own acceleration of our restructuring and we’ll have a lot more to say about what we will do once we complete the acquisition.

But on the currency side you can rest assured we’ve looked at all sorts of ways and without getting into specific answers.

Operator

Our next question comes from Jeffrey Zekauskas - J.P. Morgan.

Jeffrey Zekauskas - J.P. Morgan

Can you discuss in more detail your 30% production cut? That is, is this relative to a product chain or weighted in a product chain or in an end market or in a geographic region? And what’s the timing of these production cuts?

Andrew N. Liveris

We’ve been in the last two months operating what we’ve been calling internally in the company Code Red. Geoffery and I and the entire executive team meet with the business leaders every week and we’ve been diving through the analysis of market conditions watching the operating rates, watching the end use markets, seeing where the biggest deteriorations were, and we actually are so diversified in end use that we’re not singularly exposed to just one set of geographic product combinations like housing US or auto US. That’s the beauty I guess of our diversification.

What we were seeing in September and October, and October was really precipitous and November was pretty bad but at the kind of October run rates, was a deterioration really pretty much across the board. So the 30% idling, the 180 plants, I would tell you is across the board. It’s not centered on one particular geographic area or one value chain.

Indicative to us therefore with maybe some exceptions such as food and agriculture and health products, those probably were definitely businesses that are still doing fine. For example our cellulosics business or Dow AgroSciences, but indicative to us really that the entire industrial supply chain all the way to whatever the consumer buys outside of food and health is in a recessionary mode.

So to kind of make it short and sweet, across the board everywhere.

Operator

Our next question comes from Michael Judd - Greenwich Consultants.

Michael Judd - Greenwich Consultants

You were very adamant about the dividend. I guess we’ve all seen you on TV also being very adamant about the dividend. But I have a couple questions for you about that. I mean, these are unprecedented times and changes and we’ve seen in past recessions that Dow has maintained the dividend. There were even periods when one could argue the free cash flow didn’t actually cover that. But what is your thought about how things are different this time as it relates to the dividend?

And also quite frankly you’re cutting back production; you’re making a lot of changes here to make sure that you have adequate cash flow. Why is it so unreasonable to potentially cut back the dividend even by some modest amount?

And lastly, in terms of the negotiations that are ongoing with the banks related to the funding of the potential debt for the Rohm and Haas transaction, what are they telling you in regards to the negotiations that you have to have with them in terms of interest rates, etc. in regard to the dividend?

Geoffery E. Merszei

Let me take a stab at it. In terms of the dividend and our expectations for our earnings and cash flow and free cash flow for next year, we are well well within the range. In other words, both our earnings expectations for next year as well as our cash flow expectations for next year will exceed the requirements for the dividend payment. So we really do not have based on all the data we have today concern about paying that dividend. First question.

Now the second question which you felt was related to the dividend, although I see it as a separate issue, is on the bank financing. We have committed facilities for the Rohm and Haas acquisition. We have within the next few days in writing the facility commitments for the K-Dow acquisition that is supposed to close no later than January 1. We have as we speak quite a few billion dollars of cash available with unused credit facilities amounting to $2 billion or $3 billion plus uncommitted facilities around the world. In other words, we have plenty of financing resources available to cover all of our liabilities that we envision as of today.

Andrew N. Liveris

If I could just add on the dividend point, you made a statement that I just wanted to make sure that it was well understood from my prepared remarks. Geoffery answered it from a financial viewpoint.

What we’re doing here of course is reacting to current market conditions but there’s nothing that we’re doing that cuts to bone on the quality of the company going forward. We are putting in place an acceleration of a restructuring we were going to do in a form that is exhibited on these slides that we put on the web so that you could see we’re moving to a lean active corporate center. We’re going to a shared business services structure and three different operating models. That is in fact our transformation.

So not only do we feel confident we can cover the dividend with these actions, we’re just accelerating our implementation of these actions so we can actually put in place our business model faster.

Michael Judd - Greenwich Consultants

One quick follow on to my previous question. Again it’s a cost-related item. When you shut down plants, isn’t there typically a pickup in environmental expense?

Andrew N. Liveris

No. We run a very central environmental group and they basically as we take out plants, these are normally part of systems and grids. No, we don’t normally see that.

Operator

Our next question comes from Mark Connelly - Credit Suisse.

Mark Connelly - Credit Suisse

Just a broad question Andrew. When you think about reorganizing the company into three very different kinds of businesses, getting beyond the short term cuts of 5,000 people and 6,000 contractors, how do you start to think about allocating capital and resources across three businesses that have so little to do with each other?

Andrew N. Liveris

Firstly for a period of time the connectivity between our joint ventures and hydrocarbons and feedstocks, performance products and their purchase of those inputs for integration purposes such as in the propylene chain, and then value-add in the market face businesses have a strong connectivity even on vertical integration which we’re preserving in this business model restructuring.

But when we think about capital allocation to make your point, clearly we now move to a different space in terms of our capital intensity and we will become much more oriented to R&D allocation and where do we put R&D money and marketing money. And you can start to see an inversion of what Dow normally would do, start talking about our big R&D budget, starting talking about how to allocate that to the market face businesses, start looking at R&D as a percent of gross margin rather than as a percent of sales which we’ve already started to do in these market face businesses. You’ll start to see different sorts of metrics that we will manage from the corporate center.

Cleary the JV boards will do it their own way and we will have less to say about that as 100% Dow which is part of our reduction of our capital intensity as well. We’ll operate the JVs making sure we preserve Dow’s integration to our performance businesses but at the same time let them operate as their own entity on allocation of capital.

It really is a transition for us. We’ll have a lot more transparency on the metrics and the reporting when we finalize the actual organizational structures and that’s what we’ll commit to deliver to you in the first quarter.

Operator

Our next question comes from David Begleiter - Deutsche Bank Securities.

David Begleiter - Deutsche Bank Securities

Andrew, of the 3,000 people being eliminated ex-the asset sales, are they related to the 20 plants or are they related to the lean corporate center? Can you add any more insight into those?

Andrew N. Liveris

There are some hundreds associated with the facilities but the majority is the business services lean efficient corporate center. Really honing in on my prepared remarks the way we will work.

The way you run a big integrated machine, horizontal integration which is where you share a lot of functionality is one set of cost structures. When you move to a machine that has more autonomy according to these three operating models, you can do different things in terms of those cost structures and that’s really what we’ve been working on frankly for over 18 months getting ready for these two big steps K-Dow and Rohm and Haas. So this is an acceleration of that point.

Operator

Our next question comes from Prashant Juvekar - Citigroup.

Prashant Juvekar - Citigroup

I have a comment and a question. My comment is that I’m surprised that you did not update us on fourth quarter earnings expectations given what companies like DuPont and 3M have done. That was my comment. You can comment on that if you want.

The question is related to the auto industry you and your direct and indirect exposure. If the Detroit 3 were to become the Detroit 2, what is the impact on Dow and what is your position with the Japanese transplants?

Geoffery E. Merszei

First of all, I think I made some comments on your first point when I made some comments last week at your conference about a tough economic environment and I think we all understand that. We haven’t changed our policy for providing guidance.

In terms of the automotive industry, actually our direct exposure whether it’s two or three is in fact not that great. It’s the overall exposure to the automotive industry that of course is a Dow exposure and overall relative to our total portfolio it’s approximately 10%, maybe even a little less of our total business.

Andrew N. Liveris

And not to lose the thought that if the Big 3 goes to the Big 2 doesn’t mean the other assets disappear. There will still be cars produced in the United States. There will be different types of cars. We believe the Obama stimuli will of course come forward not only in infrastructure and credit opportunities for companies like ours but also will eventually come around to alternative energy and alternative energy automobiles.

Dow is very front and center working with not only the Big 3 but also the State of Michigan on how to redeploy resources on alternative energy to re-establish the auto center. So with every valley of death there’s a resurrection and I believe that on the other side of the auto industry here there will be opportunities. There may be some short-term pain so we’ve accommodated that with our restructuring.

Operator

Our next question comes from Peter Butler - Glen Hill Investments.

Peter Butler - Glen Hill Investments

You indicated a couple of times now that you signed the Kuwait deal a week ago. When are we going to get the money and what do you think your balance sheet will look like after you do? If you have time for it, could you discuss a little bit more the parameters of what you’re calling you’re going to have an advantage feedstock position? What does that mean?

Geoffery E. Merszei

Just quickly let me respond to your first question on the financials. First of all, we do expect as we said the closing no later than January 1. In other words, we expect the money in the till on January 1 or January 2. I think there’s a holiday there, so the first working day after January 1.

The second question on the balance sheet, which is an important question of course in today’s environment. We are pretty much on track to have a balance sheet, a capital structure with a debt-to-total capital within that 40%. Remember our philosophy over the years has been around 40% give or take 5% up or down. So we will be within that range in the low to mid-40s after the Rohm and Haas acquisition, after we have consummated the Rohm and Haas transaction. We’re on track.

Andrew N. Liveris

On the feedstock question it enables me to make the statement from last week. The K-Dow formation and its growth opportunities in emerging countries with refinery integration using Kuwaiti crude will be the platform for growth. As I said last week, we will have an opportunity through the 50% participation there to make more money at the 50% level than we would if we had stayed with the legacy assets at the 100% level.

Not only will Kuwait bring gas within Kuwait to the joint venture in an advantage context for the ethylene chain with a majority of its businesses but also bring us refinery integration where gas is not available in places like China, Vietnam, India and elsewhere. We will be contributing several projects, I mentioned Libya as a good example, to K-Dow so that we will have growth opportunities to bring feedstock integration of the refinery kind and of the gas kind to its product slate immediately.

Last but not least this announcement we’re making today, we’ve been working on this knowing K-Dow would form. So there are two things we’re addressing as part of our restructuring here. One is to ensure we have no stranded costs left in the mother ship. So we’re back to the question I think that was asked by Dave Begleiter or someone about our functional costs and the lean and corporate center and how much of that is that.

A lot of that is geared to the launching of K-Dow so we don’t leave stranded costs in the company and critically then to the advantage of K-Dow is they will get lower cost services from the Dow Chemical Company so their functional structures will be very lean and mean, be very business driven and have no extra costs associated with overhead and governance. It’s a very important way that they can have a lean mean corporate structure really focused on their business while buying low-cost shared services from the Dow Chemical Company.

Howard Ungerleider

Yolanda, we have time for one more question.

Operator

Our last question comes from Robert Koort - Goldman Sachs.

Robert Koort - Goldman Sachs

Could you size the total contractor employer base that you have? Secondly Andrew, what will trigger you to turn back on those 180 plants that you’re idling? And I guess around that, is there not an option to run at reduced rates? Why go for a full shut-down of those plants?

Andrew N. Liveris

The 6,000 is roughly 30% of our total contractor base to answer that quickly.

That’s a terrific question and speaks to visibility. I’ve been and many other CEOs like me, I think I’m not alone, have been talking about how we have very little visibility going forward. So we’ve worked very hard in our manufacturing operations to where we have large integrated sites to turn them down but not turn them off because it takes a lot and a lot of cost to turn them back on later.

We’re turning down and we picked the facilities that have the least impact on the businesses that are doing well. We do have some of those. So we’re dialing down and in some cases of these 180 we can turn all the way off. But a lot of them are to minimize the cash burn during uncertain times.

We’re running weekly meetings here on product markets. Our businesses are reporting in constantly on where there is any sign of let’s call it red light going to yellow light going to green light. Once we get some visibility we’ll be able to turn back on quickly and I think that’s your major point. This isn’t a complete disruption.

Now remember also we’re entering holiday seasons and a lot of the pre-buying that’s going on in the US in terms of deep discounts at the retailers and all that, it’ll start running out of steam here real soon. Chinese New Year. So December and January is not a bad time to have factories dialed down or off.

Howard Ungerleider

That’s all the time we have for today. I’d like to thank you for joining us on the call and our team looks forward to speaking with you again soon. Thanks very much.

Operator

That does conclude today’s conference. Thank you all once again for your participation and have a wonderful day.

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