Dow Chemical Q3 2007 Earnings Call Transcript

Oct.26.07 | About: Dow Chemical (DOW)

Dow Chemical (NYSE:DOW)

Q3 2007 Earnings Call

October 25, 200710:00 am ET

Executives

Andrew Liveris - Chairman and CEO

Geoffery Merszei – EVP and CFO

Kathleen Fothergill - Corporate Director IR

Jeff Tate – Manager, IR

Analysts

Don Carson - Merrill Lynch

David Begleiter - Deutsche Bank

Sergey Vasnetsov - Lehman Brothers

Jeff Zekauskas – JP Morgan

Frank Mitsch - BB&T

Prashant Juvekar -Citi

Mark Connelly - Credit Suisse

Peter Butler - Glen Hill Investments

Robert Koort - Goldman Sachs

Kevin McCarthy - Banc of AmericaSecurities

Gregg Goodnight - UBS

Operator

Good day and welcome to The Dow Chemical Company’s thirdquarter results conference call. Today’scall is being recorded. At this time, Iwould like to turn the call over to the Corporate Director of InvestorRelations, Ms. Kathy Fothergill. Pleasego ahead, Ma’am.

Kathleen Fothergill

Good morning, everyone and welcome. As usual, we’re making this call available toinvestors and the media via webcast. This call is the property of The Dow Chemical Company and anyredistribution, retransmission or rebroadcast of this call in any form withoutDow’s express written consent is strictly prohibited.

On the call with me today are Andrew Liveris, Dow’s Chairmanand CEO; Geoffery Merszei, Dow’s Executive Vice President and Chief FinancialOfficer; and Jeff Tate, Manager in Investor Relations.

Around 6:30 thismorning, October 25th, our earnings release went out on PR Newswire and wasposted on the Internet on Dow’s website, Dow.com. We’ve prepared some slides to supplement ourcomments on this conference call and the slides are posted on our websiteavailable on the presentations page of the Investor Relations section orthrough the link to our webcast.

As you know, some of our comments today may includestatements about our expectations for the future. Those expectations involve risks anduncertainties. We can’t guarantee theaccuracy of any forecast or estimates, and we don’t plan to update anyforward-looking statements during the quarter. If you’d like more information on the risks involved in forward-lookingstatements, please see our SEC filings.

In addition, some of our comments may reference non-GAAPfinancial measures. A reconciliation to the most directly comparable GAAPfinancial measure and other associated disclosures are contained in ourearnings release or on our website. Our earnings release as well as recent10-Qs, 10-Ks and annual reports are available on the Internet at Dow.com in thefinancial reports page of the Investor Relations section.

Now starting with the agenda on slide 3, Geoffery will leadoff with an overview of the third quarter. I’ll discuss the results of ouroperating segments, then Geoffery will update you on actions we’ve taken toadvance our strategy and describe Dow’s outlook for the months ahead. Afterthat, we’ll move to your questions for Andrew and Geoffery.

Now Geoffery, let’s move to slide 4 and your comments.

Geoffery Merszei

Thank you, Kathy and good morning, everyone. This was another strong quarter for Dow.Adjusted for the non-tax items highlighted in our press release, pre-tax incomewas $1.1 billion, down slightly from $1.2 billion in the same period last year.

Now year over year, volume was up 5%, the strongest growthin three years, led by Europe, Asia Pacific and Latin America. Price was also up 5%, with solid gains in all operatingsegments. Now these higher prices, combined with the benefit of volumeincreases, meant we were able to overcome the impact of ever-rising feedstockand energy costs. Our joint ventures continue to deliver outstanding results. Inshort, our business fundamentals for the quarter were solid.

So given the underlying strength, why was pre-tax incomelower? Well, there were two factors. First, as expected, we saw higheroperating expenses as we moved forward with our strategy to invest for growthin our performance portfolio. We supported newly acquired businesses, weincreased investments in innovation, and we enhanced our market capabilitiesfor long-term growth. Second and to a lesser extent, we had the negative impactof some plant outages.

Let me provide a few highlights from the quarter, which youwill find detail on slide 4. Sales increased 10% from the same period lastyear, the largest year-over-year percentage gain for two years, setting a newquarterly record of $13.6 billion.

Geographically, we saw double-digit sales growth in Europe,Asia Pacific and Latin America. With such strong growth,the regions outside the U.S.now account for more than 65% of Dow’s global revenues. Including our share of sales from jointventures that number in fact is now more than 70%, and we saw a major increasein feedstock and energy costs, up almost $400 million year over year.

This quarter, Dow’s feedstock and energy bill topped $6billion for the first time in the company’s history. Consider this: in 1999, we paid just $6.1billion for the entire year and this includes purchases for both Dow and Union Carbide.Now looked at another way, the cost of feedstock and energy has climbed fromconsuming 23% of our net sales to the current 44% year-to-date.

Now our strategy addresses this significant challenge on twofronts. In the long term, we’re buildingour portfolio of joint ventures with access to low-cost feedstocks. Shorter term,we are focused on controlling the things that we can control best: aggressiveaction to maintain our margins, tight expense management, and a sharp focus onfinancial discipline across every aspect of our operations. In this regard,capital spending in the third quarter was $519 million, higher than the sameperiod a year ago but fully in line with expectations. It brings our year-to-date total to $1.3billion, keeping us within our full-year $2 billion target.

Turning to earnings, there are some items this quarter whichmay distract a little from our ongoing performance. Let me offer some clarity on slide 5. Our reported earnings for the third quarterwere $0.42 per share, an amount that includes a few key items I believe worth highlighting.

First, a pre-tax charge of $59 million, or $0.04 a share,for purchase, process, research and development related to recent acquisitions,primarily on the ag side. But moresignificantly, the third quarter earnings also included a charge to theprovisions for income taxes of $362 million, equivalent to $0.38 per share,arising from a change in German tax law that will lower Germany’s corporate taxrate from around 37% to 28%. Now on an ongoing basis, this reduced tax rate in Germanyis clearly good news, but for the third quarter, its impact has been to reducetax loss carryforwards.

Now these NOLs relate to the operating losses incurred in Germanyduring the remediation and reconstruction of our assets at BSL in the former East Germany, which we acquired back in 1995, sothis dates back over 12 years. Theseassets now provide the platform for growth throughout the dynamic markets of Eastern Europe. Now the new German tax rate takes effect in January of2008, but since the law was adopted during the third quarter, we recognized anadjustment to the tax loss carryforward which was in accordance with U.S. GAAPin the quarter.

So as I said earlier, the good news is that starting next yearin 2008, we expect the underlying tax rate for the company as a whole to bereduced by around 0.5 percentage point. Even excluding the impact of the Germantax law change, our underlying tax rate for the third quarter was somewhathigher than we’ve seen for quite a while. We’ve said many times that rates can vary significantly from quarter toquarter, depending on where our income is earned and events that may occurduring the quarter, so you should expect some degree of variability over time.

Nevertheless, at 28% -- or fairly close to 28% -- this quarter has the highest underlying taxrate that we’ve seen in two years. So ona year-to-date basis, the underlying rate is just a shade below 25%, which wasin fact the rate we suggested you use for modeling purposes. So using that 25% rate, earnings would be$0.87 per share, the second highest third quarter earnings in Dow’s history.

Let me now turn to the contribution from our joint ventureactivities during the quarter. Slide 6provides some of these highlights. Equity earnings for the quarter were down 7% from last year’s quarterlyrecord to $296 million, while year-to-date they have climbed 14% to over $800million; $828 million to be exact. Theseresults reflect healthy quarters for both EQUATE and MEGlobal, and continuedstrong performance at Dow Corning, which reported its seventh consecutivequarter of record sales. Together,improvements at these businesses helped mitigate declines elsewhere, most notablyat OPTIMAL, which was hit by some operational issues during the quarter.

So as you can see from this slide, cash distributions fromjoint ventures were also up year-to-date, while our cash contributions to theseventures so far this year remained minimal, as their activities are in fact largelyself-funded.

During the quarter, we issued a white paper on our jointventures, which I hope helped provide greater clarity to Dow’s joint venturestrategy and more insight to the dynamics that shape equity earnings. By the way, this paper is available on Dow’swebsite.

In summary, another sound quarter for Dow. Record quarterlysales with substantial growth in Europe, Asia Pacificand Latin America. Solid price increases across everybusiness and in every geographic region. Strong volume improvements in mostoperating segments and a robust and consistent stream of equity earnings.

I have no doubt that our strategy is the right one and thatthe opportunities that are now being pursued across the company will deliversignificant value to our shareholders going forward.

Kathleen Fothergill

Thanks Geoffrey. Nowstarting with slide 7, Performance Plastics had a very good quarter with recordsales on gains in both price and volume. There is continuing strength in the polyurethanes group, with year-over-yearimprovements in price, volume, and EBIT, just as it had last quarter. We saw strong volume gains across the boardin components and in systems. WhileNorth American demand was down, all other regions reported solid volumegains. Strong organic growth wassupplemented by recent acquisitions: Hyperlast in Europeand Dow Izolan, our majority-owned subsidiary in Russia.

Specialty Plastics and Elastomers also showed very strongvolume growth with double-digit gains in Europe, Latin America and Asia Pacific more than offsetting a decline in North America. Wire and cable forfiber optic applications worldwide and performance elastomers for thosebrightly colored plastic clogs you see everywhere, are just two examples ofspecialty applications showing strong demand growth. This higher volume,combined with price increases, allowed the business to more than offset asignificant increase in raw material cost.

On the other hand, recent industry capacity additions in theepoxy chain limited our ability to maintain margins in the face of risingcosts, and the slowdown in U.S.housing and automotive sectors dampened results for Dow Automotive and DowBuilding Solutions.

Moving to slide 8, frankly the bottom line for PerformanceChemicals was disappointing, but it was the result of a few negative factorsoutweighing some good underlying performance.

Within Designed Polymers, the combination of Wolff Walsrodeand Dow’s Water Soluble Polymers business -- now Dow Wolff Cellulosics -- hasgone extremely well. We are seeing verygood growth in high-value pharmaceutical applications where Dow’s experiencewith regulated applications is critical, and in construction applications in Europe,which is one of Wolff’s strengths. In this first quarter of operations,however, the business had about $20 million of one-time costs associated withthe integration of Wolff, in addition to the IPR&D charge noted in ourrelease.

Dow Water Solutions is showing strong growth across itsportfolio; ion exchange resins, FILMTEC membranes and the recently acquiredOmex business in China.

Results for the Specialty Chemicals portfolio sufferedbecause of a number of plant outages -- some planned, some unplanned -- whichresulted in both lower volume and higher costs during the quarter. These included upstream outages at Seadrift, Texas and St. Charlesoperations in Louisiana, as wellas outages at OPTIMAL.

Within Dow Latex, aggressive price volume management forpaper and carpet latex has improved margins, but results for specialty latexfor paints were impacted by slower industry demand.

As you can see on slide 9, while third quarter is usually aseasonal low point for the ag business, Agricultural Sciences had anoutstanding quarter, consistent with what we’ve seen all year. The business posted double-digit volume gainsboth in Ag Chem and in Seeds and Traits, and volume improved around theworld. While Latin Americawas the clear growth leader in this quarter, we also saw volume growth in allother regions. Growth was driven by a combination of healthy industryconditions and Dow AgroSciences’ strong portfolio including spinosadinsecticide and aminopyralid herbicide. We also saw some shifting seasonal patterns with some customers in North America filling tanks earlier than in past years.

Slide 10 for Basic Plastics tells a familiar story. Goodgrowth in price and volume, but some margin squeeze from significantly higherraw material costs, particularly for polyethylene. You may remember that in the third quarter of2006, we had several things going strongly in our favor: solid price momentum moving into that quarterwith declining feedstock prices during the quarter, which allowed us to realizesignificant margin expansion. Thisquarter paints a different picture.

With higher feedstock costs but relatively stable coalproduct values, ethylene bore the brunt of the feedstock cost increase. We hadsome price momentum early in the third quarter, but it faded in September,particularly in North America, and margins came downsignificantly versus a year ago. However, our strong global position helped offset some of that U.S.weakness. For example, European industryconditions are much tighter, and our new train in Tarragonawas sold out less than a year after startup. Of course, the polyethylenebusiness also benefited from outstanding results at EQUATE, which isessentially protected from the global fluctuations in feedstock prices.

Polypropylene results improved from last year due in part tothe absence of turnaround costs. Additionally, our polypropylene plants are essentially sold out whichallows us to be selective in seeking out higher margin business.

In polystyrene, our bottom line improved as we aggressivelymanaged margins and realized some benefit from lower benzene costs.

Basic Chemicals, slide 11, showed a significant EBITdecline, excluding last year’s restructuring charge. The decline was almost evenly split betweenChlorVinyls and EO/EG. Within ChlorVinyls, industry conditions for caustic sodaare strong. We saw higher price in allregions although volume growth was limited by product availability. Unfortunately, the other half of thebusiness, VCM, was not as robust.

While overall, GDP growth is an important determinant of PVCdemand, the very weak housing market in the U.S.kept a lid on prices which compresses margins when the business has to contentwith higher feedstock costs for ethylene.

Industry conditionsfor EO/EG have improved significantly over the past few months due in largepart to supply constraints resulting from unplanned industry outages. Our own volume was limited in the quarterbecause an extended planned outage at St. Charlesand a shorter unplanned outage at Seadrift. OPTIMAL also experienced an unplanned outage which reduced equityearnings for the glycol business.

One final highlight, our operating rate for the quarter was90%, up 3 percentage points from the third quarter last year and the highestoperating rate in three years.

That wraps up the financial review of the quarter. Now, I’dlike Geoffery to take the microphone back for his update on strategy andoutlook.

Geoffery Merszei

Thank you, Kathy. AsI mentioned at the start of this call, our performance in the third quarterprovides solid testimony to the fact that our strategy is squarely ontarget. Slide 12 recaps the key facetsof our strategic agenda, which I know you are quite familiar with. So let me pick out a few highlights from thepast three months that illustrate how we are putting those words into actions. Startingwith recent investments that will accelerate geographic and businessgrowth.

As you can see from slide 13, 33% of sales in the thirdquarter came from products that have been introduced by Dow in the past five years. Of course, product sales are not the only wayin which Dow is able to capture value from its past investments in technologyand innovation, as witnessed by the cross-licensing agreement that we announcedwith Monsanto during the third quarter.

Monsanto, the unquestioned leader in agriculturalbiotechnology, is partnering with Dow for the licensing of SmartStax, afirst-ever eight-gene stack combination in corn. This tells us that ourresearch efforts are paying off. The ground-breaking gene technology is theresult of our steady investment in Dow AgroSciences, including investments inour in-house R&D capabilities, as well as our ability to acquire promisingtechnology very early on and at the right price. SmartStax will generate newroyalty revenues for Dow and provide an important platform for future businessgrowth as the company incorporates it into new, higher-yielding hybrid seedscombinations and stacks it with the other cutting-edge trait technologies.

We’re building a solid platform in the agriculturalbiotechnology space. We’re doing it through acquisitions, through jointresearch agreements, by securing exclusive rights to intellectual property andthrough our own research and development efforts. In that regard, the companyonce again raised the bar during the third quarter, unveiling a new family ofHerbicide Tolerance Traits that will provide resistance to multiple classes ofherbicide in many different crop species.

So let me give you two other examples of how Dow is aligningits R&D efforts to support the growth of its performance businesses. Firstin September, a Polyurethane business launched RENUVA Renewable ResourceTechnology, a process that produces bio-based polyols with high renewablecontent. These polyols have met with considerable interest from manufacturersacross a wide variety of industries.

The same is true of SAFETOUCH Fiberglass-Free insulation, aPET polyester fiber batting with insulating properties of fiberglass-basedmaterials, but with one important difference -- it does not irritate skin, northroat nor eyes; in fact, it can be transported and installed without gloves,dust masks or goggles. Since being launched during the third quarter inselected DIY stores here across the United States, the material has received hugeapproval from homeowners and the building trade.

Now turning to investment for growth, slide 14. During thequarter, our Agricultural Sciences’ business successfully completed a number ofsmall, but strategically significant acquisitions. None of these are large butstep-by-step, we are expanding our toolkit, our know-how and our capabilitiesin plant biotechnology,- building on our strong position in this arena and, atthe same time, strengthening our channel to market.

Our epoxy business also had an active quarter, signingagreements to acquire three leading epoxy systems formulators: one in Germanyand two right here in the United States.The acquisitions follow the launch of Dow Epoxy Systems earlier in the year andare designed to accelerate the growth and geographic expansion of this newbusiness.

Our polyurethanes systems business also announced plans toextend its geographic reach, by acquiring Danish company Edulan, an independentpolyurethane systems house specializing in rigid foam and elastomertechnologies. The deal will enhance the business’s activities in northern Europeand bring a range of exciting new technologies to Dow’s PU systems businessworldwide.

Investment activities through the quarter were not confinedto the acquisition of new businesses. We also announced expansions in polyolcapacity, driven by downstream demand, particularly for specialty polyols andpolyurethane system products.

Now moving on to a topic which is close to my heart,financial discipline, which you will find on slide 15. Our cash flow remainedhealthy during the quarter, supporting investment activity on several fronts. Weinvested $300 million to repurchase 7.1 million shares as part of our buybackprogram, bringing the total so far this year to $1.1 billion for around 25million shares.

While on the topic of shareholder remuneration, I shouldalso mention that the dividend we paid in July reflected a 12% increase weannounced back in April. We continued to invest in targeted acquisitions,bringing our year-to-date total close to $900 million, which includes ourinvestments in Wolff Walsrode and Hyperlast. Going forward, we will continue tobalance our use of cash, on one hand investing in growth through capitalexpenditures and acquisitions; on the other remunerating shareholders throughdividends and continued share repurchase.

Turning to portfolio management, in addition to theacquisitions I spoke about previously, we also announced the divestment of twobusinesses: our ETHAFOAM performance foam business to Sealed Air Corporation,and our Western Canada Caustic Soda business to Univar Canada.Now both transactions are subject to regulatory approval.

Finally, working capital management: Days sales outstandingin the receivables was down one day from the end of the second quarter, from alow level already to a new low of 39 days, while days sales in inventory endedthe quarter at 62 days, unchanged from the prior quarter. Working capitalmanagement, and in particular inventory management, remain an importantpriority for this organization.

Now in terms of our performance against financial metrics,Dow’s underlying return on capital and return on equity through the first ninemonths of this year were 15% and 21% respectively, both ahead of our long-termtargets.

Finally, let’s turn to Dow’s outlook. The global economy isbecoming increasingly bi-polar. We are seeing very strong economies in Europe,Asia Pacific, and Latin America, and this strength isexpected to extend into 2008. However, the U.S. GDP growth rate is forecast tobe at 2% or less in 2008 with early signs that weakening domestic demand isextending beyond automotive and residential housing.

Sound macroeconomic conditions, particularly in the emergingeconomies, will continue to support increasing demand for chemical and plasticproducts. In the fourth quarter, we expect healthy year-over-year demand growthto continue outside North America, although historicalseasonal patterns would point to slightly lower volume sequentially,particularly in the businesses with ties to the construction industry.

Our most pressing challenge, of course, remains high andvolatile feedstock and energy costs. Oil and its derivatives are trading nearrecord levels. In fact, WTI this morning was quoted at $88.60, and we thereforeexpect the fourth quarter to bring substantial year-over-year increase inhydrocarbons costs. Now we will mitigate these headwinds, as we have forseveral years, through aggressive actions to maintain margins, by keeping tightcontrol over the costs we can control and through our joint ventures, whichhave competitive feedstock positions.

2007 is turning out to be another good year for Dow, and weexpect that 2008 will be yet another year of solid earnings performance.

Thank you very much and Kathy, over to you.

Kathleen Fothergill

Thanks, Geoffery. Nowthat wraps up our prepared remarks. Foryour reference, a copy of these remarks will be posted on Dow’s website latertoday. Now we’ll move on to yourquestions.

Before we do though, I’d like to remind you that my commentson forward-looking statements and non-GAAP financial measures apply to both ourprepared remarks and to anything that may come up during the Q&A.

Jimmy, would you please explain the Q&A procedure?

Question-and-AnswerSession

Operator

Your first question comes from Don Carson - Merrill Lynch.

Don Carson - MerrillLynch

A question on ag, very strong South American results. I’mjust wondering, to what extent do you think that you might have pulled forwardfrom the fourth quarter? TraditionallyDow has its weakest quarter in Q3 and does somewhat better in Q4.

Geoffery, just a question on FX. With 70% of your salesoverseas, how much of that 5% price improvement was due to currency?

Geoffery Merszei

Don, let me first respond on the currency side. Just to remind everyone, on a sequentialbasis, forex, the euro, as a proxy, the dollar was about 1% down on theaverage. In fact, it’s a very minimalamount. When you do it on ayear-over-year basis, then it’s a little higher. The dollar on the average depreciated about6%. But frankly, Don, I wouldn’t put alot of value to looking at the currency impact on pricing if you compare year overyear because prices, in many cases, adjust over a longer period. Certainly, over a one-year basis, based ondemand and supply which is quite strong in Europe,particularly in Europe, these prices actuallyadjust. So trying to separate currencyfrom the underlying price, frankly, I don’t think adds a lot of value.

In terms of your first question on ag, certainly the strongdemand in Brazilwas driven very much and continues to be driven very much by the underlyingvalues on the ag commodity side, as well as the added liquidity in Brazil. It’s a very healthy environment, not just forag, but in particular for ag. There wasperhaps a little benefit of some of the sales that were booked in the thirdquarter which would have normally been booked in North America,but not a very large amount.

Don Carson - MerrillLynch

So would you expect a normal pattern where Q4 is strongerthan Q3 in ag?

Geoffery Merszei

No, I wouldn’t say that. I would say that it will be probably pretty much in line with a typicaltrend in the fourth quarter.

Operator

We’ll take our next question from David Begleiter - DeutscheBank.

David Begleiter -Deutsche Bank

I’m not sure if Andrew is there, but a question onstrategy. In terms of a transformationaltransaction, can you highlight again the criteria that you’re looking for in apartner, i.e. either capital or low-cost feedstocks? How important is it tocontrol a joint venture if it were to encompass your core ethylene chainassets?

Andrew Liveris

Great question, Dave, I am on the call. Those questions are near and dear to ourheart here and have been for two or three years, as we’ve described our needand desire and our platform around higher hydrocarbon energy costs. Clearly, these ethylene joint ventures,whether they be a single business, whether they be a project or whether theybe, indeed, an Ethylene envelope like you just described, they have to bringseveral things.

Number one is their ability for the new entity, whateverthat new entity looks like -- let’s call it a joint venture -- to be a growthcompany. In essence, not just aconsolidation play, not just an exit strategy, not a leverage play, butabsolutely a growth company.

Secondly, it has to preserve Dow’s integration, particularlyto our performance businesses, to the extent that a cracker has many outputsinclusive, of course, of the biggest of them all, ethylene, if it’s a liquidscracker. The other products become verysuper-critical to create competitive advantage, not just in things liketransfer prices, but also on leveraged infrastructure, leveraged services. A freeportdoesn’t get built overnight. So thesesorts of things are important in our transition to our marketplace businessunits which, of course, is the other key part of our strategy.

Now having put those two conditions in place, a strategicpartner that creates that is almost certainly going to have access to feedstocksomewhere in the world, notably, of course, regions like the Middle East, butnot just there. They’re going to be ableto provide us those feedstocks on an ongoing basis, not just on one project.

Beyond that, as we do these sorts of deals, our whole notionhere is to create what I would call a company that doesn’t necessarily have Dowcontrol, but has access to Dow expertise. So operations capability, market franchise around the world, technology,this new enterprise, MEGlobal is a good example of one we have in place. Itoperates pretty much at the governance level as a true joint venture and withinthe company, it is its own company, like Dow Corning.

So hopefully that has answered your question. If you have any other aspect of it, let meknow.

David Begleiter -Deutsche Bank

It does. You’re on this more consistent, less cyclicalearnings profile, as you’ve had discussions with these partners, I assume your confidencein trough earnings being $3 or more, maybe even $3.50, has increased over thecycle. Is that true?

Andrew Liveris

Yes, it is true. Look, we made our bold statements earlier this year. We’re sticking by them. We’ve demonstrated them through our dividendincrease. We’ve demonstrated themthrough what we’re doing with financial discipline. $2 to $3 is what everyone wrote after what wesaid. We don’t have any new announcementto make, but we would definitely tell you that we’ve always said and I’ve saidit in countless occasions, that our confidence in delivering the higher end ofthat is increasing. Why? Because of all the things you referenced,some of them; and some of the things I just referenced in answering the otherpart of your question.

Operator

Our next question will come from Sergey Vasnetsov - LehmanBrothers.

Sergey Vasnetsov -Lehman Brothers

90% operating rate is an excellent result, indeed, and it isjust shy of 91%, which was the highest ever in the past ten years. So I was just curious, what would this numberbe without outages that you’ve seen this quarter? Also, are you close to the effective sold-outcondition? If so, in which product?

Andrew Liveris

Sergey, yes. Firstly,the outages were not very big so not a lot different. We don’t have an exact number top of mindhere, but we did have some lost production in OPTIMAL, which is in our equityline, of course, and so that doesn’t factor into the operating rate. But EO/EG was the biggest impactor in the Dowline, and that was, as Kathy said, Seadrift and St. Charles. Therefore, to answer that question, not a lotdifferent.

In terms of maximum utilization, you know across a companythis diverse, it’s an incredibly difficult question to answer, which is why youasked the third question. But if youtake a generic statement of around 93% to 94% as your maximum utilization, youwouldn’t be far wrong.

Therefore now, to the last part of your question, which isreally which products are we seeing maxing out? Clearly, we’re seeing it in our ethylene chain in particular our polyethyleneethylene chain. We’re sold out in Europe;we’re sold out Asia. We’re running hard in North America, but the North American assets are running because ofexports. That will change, that’s not aconstant thing. There’s a big arbitragebetween the U.S.and the rest of the world right now in polyethylene pricing. I think you know that.

But look, I think the generic point you make -- and thankyou for the statistic on ten years, that’s a good Dow historian there, Sergey --I would tell you that we’re quite encouraged by the volume performance in thequarter despite this weakness in the U.S.

Operator

We’ll go ahead and take our next question from JeffZekauskas – JP Morgan.

Jeff Zekauskas – JPMorgan

Shouldn’t you have windfall profits in Ethylene Glycol inthe fourth quarter? In that if you’ve got 4 billion pounds of capacity, itlooks like prices are up on average at least $0.20 a pound. Shouldn’t that be about $0.15 a share benefitin the fourth quarter, or is my math off?

Andrew Liveris

Let me take a crack, and by the way, I’d be the first towant windfall profits in any chain right now given what we’ve been facing thelast x years. You’re right, EO/EG isfirming, so everything that’s out there in the press, we support yourstatement. But we do have some issues inour operations, Jeff, in that to be perfectly frank, OPTIMAL is still down,maybe it’ll be down all of the fourth quarter. St. Charles operations is still down now, itshould restart soon. So as much as wewould love to use the word windfall, we’re tempered by operational issues. This was a feature of our miss in the quarter;not a huge feature, but it’ll remain a feature of the fourth.

Jeff Zekauskas – JPMorgan

So maybe “tempered windfall” might be the rightcharacterization? In basic plastics, there’s been obviously so much rawmaterial price inflation and prices have been going up to try to catch up tothe inflation and there have been propylene outages. Do you think that the cash margins in thatbusiness for the fourth quarter are going up or down? That is, with all the raw material and priceintensity, can you sort it out, or can’t you tell?

Andrew Liveris

I think that you’ve got a couple of good statements in yourquestions, and the one I like in this question is can we tell? Look, it’sbecoming very difficult with all the moving parts you just defined. Of course, there’s no question that we’ve gotthe arbitrage in the United StatesI referred to earlier suppressing polyethylene somewhat in the U.S.and it’s very export driven.

Of course, the high ethane price here makes that crackreally difficult so here we are to liquids cracking. Propane is at all-time highs here in the U.S.,so we have commodity compression in the United States. We have the demand picture in the U.S.,which on the media this morning I made reference to how the industrial sectoris showing some weakness. What did Imean by that? I said wire and cable, Isaid industrial packaging. So there issome softness there which will again hurt the U.S.

Now, our price increases on polyethylene are sound, theOctober one and the November one is sticking right now. Well it isn’t sticking; it’s out there and noone seems to be blinking on it, which is great. So the moving parts here are quite significant.

If the price sticks like we’ve got it out there, which willbe significant, if this arbitrage in the U.S.the rest of the world catches, and then the cracking slate becomescompetitive. If you can forecast naphtha,please tell me, I’d love to have an input from you. This crude oil thing -- which is liftingnaphtha by the way -- so, it’s hard to tell.

Operator

We’ll go ahead and take our next question from Frank Mitsch -BB&T.

Frank Mitsch -BB&T

Good morning. Kathy, congratulations on last night.

Kathleen Fothergill

Thank you, Frank.

Frank Mitsch -BB&T

Now Andrew, a couple of weeks ago we saw major volatility inthe share price surrounding the decision to postpone your analyst meeting. Could you expand upon the reasons why youdecided to do that?

Andrew Liveris

Well, just like the Red Sox are in the World Series againFrank -- I assume that’s why you’re congratulating Kathy -- we’re playing ourown World Series here and lots of people are wondering what inning we’rein. I would tell you that the Dow Chemical Companyhas got lots of opportunities out there.

To Dave’s question, we just don’t want to have a prematureevent. We don’t want to have a meetingfor the sake of having a meeting. Whenwe have a meeting, we want to be able to tell you a lot about where we are oncertain of our transactions. Thatdoesn’t mean it’s an imminent one, it just means that with a lot of thingsgoing on, it just says that we didn’t think the timing was right.

We gave some notice when we first put the data out there, wesaid tentative. Then we were pretty muchtoying with the idea of December and we said, well, let’s just wait a littlebit. I would tell you that we are very active andwill stay very active. But when we havea meeting, you’ll hear a lot from us.

Frank Mitsch -BB&T

It almost begs the question on how imminent the transactionswill be because it does appear that you are targeting early next year. So I think some of the speculation isprobably not all that off base in terms of an imminent transaction. With that said, assuming that you’re thebuyer, how much dilution and for how long would you tolerate any significanttransformational transaction?

Andrew Liveris

I guess I’ll give you two quick answers. One, no comment on accretion or dilutionother than our whole M&A discipline is around accretion and doing the rightdeals for the right reasons, and we’ve been very consistent on that. Maybe the other answer, if I can be so bold,talk to me when the Red Sox win the World Series.

Frank Mitsch -BB&T

So we’re going to have to wait another 84 years?

Geoffery Merszei

Frank, let me just add on to what Andrew just said. We have been having regular dialogue with thesell side, as well as with the buy side analysts, and we’ve been listening toall of you. The bottom line is thateveryone basically agrees that when we have a meeting like this, we shouldn’thave a meeting just because it’s on the calendar every three years, but weshould have it at a time when it makes a lot of sense in terms of having afruitful dialogue and to make sure that it’s an efficient use of everyone’stime. So we have been listening, andthat is really truly the driver for having it at the right time.

Frank Mitsch -BB&T

Are we looking at some time in the latter part of the first quarter?

Andrew Liveris

In terms of the meeting? Is that the question?

Frank Mitsch -BB&T

Yes.

Andrew Liveris

Probably. I would sayit that way, but we will not give you a firm date. But trust us, we’re listening, as Geofferysaid. Our buy side, our sell side, allof you matter to us and we’re going to really time it so it’s the righttime. I don’t want to be waiting a yearfor it, how’s that? I’ll give you an outof bound.

Operator

Your next question comes from Prashant Juvekar - Citi.

Prashant Juvekar - Citi

On Performance Chemicals profits dropped theresignificantly. If you exclude all theoutages, how much of that drop was a raw material issue, and how much of thatwas weak demand?

Andrew Liveris

Let me try, P.J. A couple of points, and Geoffrey mayadd. Look, it was what you said, theoutages. We had one-time costsassociated with Wolff, that’s a biggie. Also, it’s a little bit, there are two sorts of businesses thatinfluence chemicals right now; two groups of businesses that are doingsensationally well -- the water soluble polymer business and generically, theirdesign polymers business, which includes the Water Solutions business.

And then, on the other side of the shop, we have Specialty Chemicalswhich includes these EO derivatives, ethanolamines which are affected by theoutages, and then we have latex which we’re trying to restore latex back towhere it was a few years ago. Paper andcarpet have always been challenged now for a while because of the housing thingand, of course, with the issues in the paper industry. But, actually, they didn’t do that bad, itwas really the acrylic latex side of the house that did poorly in the quarter.

That’s a sign, by the way, that the housing thing,especially remodeling and if you study the coatings guides, all thearchitectural coatings guides, there’s definite weakness, P.J., here in theUnited States on that side of the business; up to 10% down, actually,year-on-year.

So it’s two types of answers; one, some businesses that aretroubled, because of the economy, and outages. And then another group ofbusinesses that are doing quite well.

Geoffery Merszei

I would probably summarize it as one-third of it is relatedto some of the acquisitions, i.e., Wolff. One third of it is the cost-related and then the other third is thevolume, roughly.

Prashant Juvekar - Citi

On the acquisition side, you’ve chosen to make some smallbut interesting acquisitions. Now, isthat a deliberate strategy given your Union Carbide experience?

Andrew Liveris

Firstly the acknowledgement of interesting, I mean we 1,000%agree. We have said all along that wewill do bolt-ons. Bolt-ons, let’s callthem little, interesting that round out product lines, improve market positions,especially in our market-based businesses. We’ve been very rigorous in identifying those. Patrick Ho in the epoxy business is a goodexample of that. Jerome in the agbusiness, Pat Dawson in the urethanes business, and I can give you moreexamples. Peter Davies in the water soluble polymers and water business. So you should see more of those.

Over time as already you can see, they will make asignificant difference to our consistent and earnings growth story that we’rearticulating. Carbide yay or nay, did welearn a lot from Carbide, and the experience there? We certainly did and maybe in a differentenvironment, I can give you a lot more of the learnings.

We are much, much more cautious on what I call these bigbang acquisitions because as I’ve said a few times, they bring you some jewelsand they bring you some not so sparkly things.

Operator

Your next question comes from Mark Connelly - Credit Suisse.

Mark Connelly -Credit Suisse

I was just hoping to get a little more color on the VCMcomments, trying to understand the sequential improvement. We tend to think of VCM as a formula-drivenbusiness so I wouldn’t have expected that to have been a key driver there. Can you just give us a little bit more color?

Kathleen Fothergill

On sequential improvement in chemicals?

Mark Connelly -Credit Suisse

In basic chemicals.

Kathleen Fothergill

It wasn’t much improvement in vinyl. I would say caustic is better in this quarterthan last quarter and glycol is also better. As someone mentioned, Geoff mentioned, the glycol business is doingwell. We suffered because of someoutages but those things are better, the vinyl is not a source of strength inthe basic chemicals section.

Andrew Liveris

In fact we’d go also a little step further. We think theU.S. PVC market remains weak and demand remains a major concern. Vinyl siding producers are in trouble. I think there are other people out there whoare having trouble with the whole vinyl chain because of housing here in the U.S. So we wouldn’t say that vinyl did a goodquarter.

Mark Connelly -Credit Suisse

Maybe I misunderstood the earlier comment. Going back to Performance Materials for asecond, am I over-estimating the tailwind that you would have gotten from rawmaterials in Dow Corning? I mean clearlyyou had a lot of other stuff going on but were those two significant tailwindsfor this quarter?

Andrew Liveris

You’re talking about Dow Corning input costs?

Mark Connelly -Credit Suisse

Yes.

Andrew Liveris

You know why there’s no tailwind there, I mean as you know,Dow Corning is today of course it’s donewell now, as Kathy said in her remarks, for the last about seven straight quarters. The key for them is the top line is explodingwith growth because of solar and Hemlock Semiconductor, their majority-ownedjoint venture, which is doing spectacular and which of course, leveraging offtheir current infrastructure and their expansions are doing very well. But no tailwind on raw material there.

Geoffery Merszei

In fact Dow Corning continues to do exceedingly well. Yes, they may have some softening here in North America as many of us do, but again with their very balancedgeographic exposure, including on the silicon side particularly with gooddemand coming out of the Pacific, they continue to do very well. And then of course, they have the advantageof their polysilicon, which is going gangbusters.

Operator

Your next question comes from Peter Butler - Glen HillInvestments.

Peter Butler - GlenHill Investments

On the question of the timing of a possible bigjoint-venture deal. Once upon a time Iworked for Exxon and you knew a big restructuring was coming when all of asudden an organization chart appeared in your internal mail. An analogy to this, is it possible that yourwhite paper on joint ventures signals that you think a deal is pretty imminent?

Geoffery Merszei

Peter, if you take MEGlobal as a proxy, it took us quitesome time to put together MEGlobal. Allthese type of transactions are not a short-term fix, they’re a long-term fix,and so it’s got to be done right. You’vegot to select the right partner, you’ve got to make sure that the partner isfinancially sound, that he has access to new markets, that he has access to lowcost feedstock, that all the various supply contracts are in place, et cetera,et cetera. So this takes a long time inorder to execute these types of transactions.

Andrew Liveris

Peter, I will chime in. I wouldn’t correlate the issuing ofthe white paper to an imminent deal, of course. We promised it back I think in the second quarter and delivered in thethird.

I will tell you what I think was Dave’s question again. The strategic aspect of a transformationaldeal of that size and what we’re looking for and how it will be achieved hasbeen on our radar screen actually for about four straight years and hasaccelerated through the last 12 to 18 months. Whenever it comes, it’ll come for the right reasons, Peter.

Geoffery Merszei

By the way, the white paper was really driven by guys likeyourself, by the wholesale side and buy side analysts in order to add someclarity, some transparency to a growing portion of our income coming fromJVs. That’s really the purpose. This is not the end. We’re going to continue to provide more andmore information as we go forward.

Peter Butler - GlenHill Investments

On a different subject, Geoffrey, when you referred to thethird quarter, you said it was another strong quarter. On your guidance for ‘08, you said thatyou’re looking for another year of solid earnings performance. Does this mean that you guys see ‘08 earningsplus and minus ‘07? Or are the odds asyou see it now that the total is going to be down for sure? Or is it too close to call?

Geoffery Merszei

I think it’s very, very difficult to make these types offorecasts. As you know, we do not giveguidance. I can repeat what I saidearlier in terms of the bipolar economic situation that we’re facing withweakening tendencies in the U.S. clearly being compensated by a very, verystrong growth scenario in the emerging markets. Then, of course, the wild card is hydrocarbon and energy. We have been very effective in mitigatingthat certainly on an annual basis beyond just looking at it on a quarterlybasis. But that’s really the environmentthat I think we’re going to be facing.

Operator

Your next question comes from Robert Koort - Goldman Sachs.

Robert Koort -Goldman Sachs

Thanks very much. Andrew, I’m a little confused on the value of joint venturing yourwestern assets with somebody who might have access to raw materials. I guess I don’t really get how they can plugthose raw materials into western plants. Maybe MEGlobal is an example you use as a way to joint ventures some assets. How does PIC provide you with an advantagefor instance for your ethylene costs in Canada? And how is that a benchmark for what we mightexpect in your ethylene or chlorine chain?

Andrew Liveris

I think generically you are absolutely correct. But again, remember how I answered thequestion, I said a growth company. Agrowth company, when you put all assets, that’s existing assets as in developedeconomies but not just hard assets, intellectual property assets and technologydevelopment assets which in the main reside in the western economies, and yousay this company now looks at its global footprint and it’s a global company.It has got marketing all over the world, MEGlobal is exactly that.

If we did anything on polyethylene it will be exactly that.It would have scale, it would have customers all over the world who areleveraging off. We have customers’ linein the Dow Central Germany facilities that we brought in from Spain,and those same customers are looking at going to our complex in Ras Tanura thatwe’re going to build with Saudi Aramco. So it’s leveraging your customer base.

If you want a specific as a possible, and I’m not sayingthis is on the table, but for example, if you do partner with somebody who hasaccess to crude oil and refining streams and they are looking at locating arefinery whether it be in the U.S. or Europe, for that matter emerging Asia,then you can do it in an integrated context. In other words, you can look at refining, petrochemicals and plastics asone integrator approach.

The independent oil companies have done that fordecades. Of course, Exxon and others aremore successful maybe than some others but that play is very sensible. It brings liquid streams into the mix justlike our project with Saudi Aramco on the Persian Gulfin Ras Tanura, not just gas. Frankly,wet gas is a limited resource. In otherwords, there’s not a lot of it out there that can be brought to the market overtime to make straight polyethylene from ethane, so you do need to get access toliquids, and these liquids could be in fact part of the solution in the westernhemisphere.

So that’s just a specific to answer you, Bob, on maybe whata PIC or its equivalent could bring us in the western hemisphere context.

Robert Koort -Goldman Sachs

But in terms of what you guys offer, obviously yourintellectual capital is powerful and your marketing and brand equity isimportant, but why would a partner want to have access to your developedcountry assets? It would seem like all of this the growth opportunity is morein the emerging markets and you’ve already struck those sorts of deals withAramco and PIC, so what would your partners see in getting bigger in thedeveloped countries?

Andrew Liveris

Maybe the best short answer I can give you, I could spendmore time with you later, is just go ask SABIC. Why has SABIC bought DSM Petrochemicals’ business in Europeand now lately GE Plastics? I think you are discounting significantly the valueof being in market in an established market for an emerging regional.

I think an emerging region in global businesses, there aresome regional businesses where the comment doesn’t apply: building insulations,styrene-butadiene latex, even potentially polystyrene is more regional thanglobal. But I will tell you that in certain businesses like in our ethyleneglycol and specifically polyethylene, it matters to be present in theestablished geographies.

Robert Koort -Goldman Sachs

That’s helpful. Is this a discrete that what you do on thecommodity side, is that a discrete event from what you do in performance? Or doyou need the capital that you would get out of that kind of transaction to dosomething in performance?

Andrew Liveris

Well as you know, certainly in the last 12 to 18 months thecompany’s financial shape is topnotch and we’re demonstrating in all sorts ofways: dividend increases, share buybacks, disciplined acquisitions, rigorousexpense controls, everything Geoffrey said in his remarks. So they can bediscrete. We can organically grow and with selected acquisitions, our performancebusinesses.

But clearly if we did do something of significance thatmaterialized partly like we did with MEGlobal. And it made sense for ourPerformance businesses. It would even accelerate our ability to do even more.But we’re not counting on one to beget the other.

Operator

Your next question comes from Kevin McCarthy - Banc ofAmerica Securities.

Kevin McCarthy - Bancof America Securities

Andrew, you’ve been quite clear with regard to the value ofintegration with Dow’s portfolio and I don’t disagree with that notion. Howeverone could argue that integration is marginally less relevant to biotech foragriculture as well as higher value-added crop protection chemicals. Andmeanwhile the value of Ag assets has soared as you know in recent years. Do youthink the market gives you credit for the value of Dow AgroSciences and if not,are there any circumstances under which you’d consider separation of thoseassets to unlock value?

Andrew Liveris

Kevin, again this is a consistent question we get and Ithink we have been consistent in ouranswers. I will tell you that the market is beginning to awake to the notionthat the Dow AgroScience vehicle is a very productive research machine. Just asa little side point, we took our board there for the first time in ten yearslast month and we basically reviewed with our Board what the Dow AgroScienceR&D machine is doing down there.

It’s spectacular and SmartStax is a good example of therecent output. Geoffrey covered the others, I won’t go over it. But I will tellyou that what’s happening is, it’s becoming a partner of choice. Dow AgroSciences is becoming a partner ofchoice whether it be with small research R&D companies like Sangamo orwhether it be with the number one leader, Monsanto. And that just tells us thatwe’ve got capability to, (a) be very much a player in this space, and (b) wecan leverage it into the other part of the enterprise and biomaterials.

No, we’re not doing a DuPont-like play, but we’re being veryselective in how we take that leveragability and soy-based polyols is a goodexample. Geoffrey talked about RENUVA as a recent launch. We have more of thatto come. Under the right circumstances would we joint venture that business andretain that leveragability? Absolutely, we’ve always said that -- under theright circumstances.

Kevin McCarthy - Bancof America Securities

Understood, shifting gears a little bit to your Gulf Coast feedstock situation thatethane is dislocated versus natural gas once again, and I think we and othershave pointed out that it’s more correlated with crude now. Is there anythingthat Dow can do structurally or strategically to deal with that issue thatseems to rob you of some of your feedstock flexibility?

Andrew Liveris

I mean there is a long-term answer which if you read therecent issue of Chemical Engineering News, Bill Banholzer, CTO, gives a verythorough description of what we’re doing to solve and break the hold of liquidgas extraction, the situation with ethane on the U.S. Gulf Coast. Fundamentallythe answer there is C1. C1 research, C1 chemistry, Dow is very big and activein the space, we’ve got all sorts of programs going that link it to coal, thatlink it to biomass.

I won’t take you through it all because we don’t have thetime. So that’s a long-term answer. Short-term, fundamentally it’s a physicalhedge. We have to keep finding physical hedges, we have them; we have them in Canada,we have them in Argentina,our LNG facility, but frankly no one is going to give us a break. We understandthat. So it’s price management on the output side.

Kevin McCarthy - Bancof America Securities

Very briefly, Andrew, is there a next joint venture, anyupdate there?

Andrew Liveris

Still very much in motion, good dialogue with our partner, FTCapproved Chevron Phillips and Dow and we’re working very hard on getting ourselvesout there and announcing the launch of the player in styrenics in North America.

Kathleen Fothergill

We have actually gone past our time but we have time for onemore question.

Operator

Our final question will come from Gregg Goodnight - UBS.

Gregg Goodnight - UBS

Have you quantified the composite effect of the St. Charles, OPTIMAL, and Seadrift outages and theireffect in the third quarter? If you have, what is the breakdown between basicchemicals, performance chemicals?

Kathleen Fothergill

We haven’t quantified it, Gregg. I know that in performancechemicals the impact on results from outages generally, which there were a fewmore small ones besides those two, was probably a little bit greater than the$20 million that we talked about for the Wolffe integration cost. I would thinkthere’s probably a similar impact in basic chemicals too.

Gregg Goodnight - UBS

Andrew, you typified this quarter as a miss, just a qualitativequestion: If you wouldn’t have had these outages, do you think you would havehit the consensus number?

Andrew Liveris

I said it on CNBC’s Squawk Box this morning and I’ll say itagain, we’re not going to hide, it is a miss. Having said that, $100 million isthe miss on the before tax line, which of course, with the tax being so noisy,that’s the way to look at it.

We’ve said that about half of that is related to eitheracquisitions we have in the picture today we didn’t have a year ago, as well asorganic growth programs that we’re funding in our market-based business units.And then the rest of it, you can start adding these little one time things,including the outages.

Gregg Goodnight - UBS

Your tax rate, you mentioned, would be helped by 0.5% nextyear, have you given guidance to your 2008 tax rate yet?

Geoffery Merszei

No, we have not. But for the time being, I would stick tothe rate of about 25%.

Gregg Goodnight - UBS

If I can slip in one last question, you mentioned in thepast several times that you’re focusing on bolt-on acquisitions of nominally around$1 billion, would you consider a bigger deal, maybe not bolt-on, but that wouldextend your specialties portfolio even if that deal was, say, $2 billion to $3billion?

Andrew Liveris

Gregg, the answer is yes.

Gregg Goodnight - UBS

Would you do it in the immediate future?

Kathleen Fothergill

Gregg, by my count, I think you’ve got about five questionsin there.

Gregg Goodnight - UBS

I’m doing a very good job then, Kathy.

Kathleen Fothergill

Yes, you are.

Gregg Goodnight - UBS

Thank you, everyone.

Kathleen Fothergill

We’d like to thank all of you for joining us on this calland we do look forward to talking with you on our next conference call inJanuary. Good bye.

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