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Dow Chemical (NYSE:DOW)

Q3 2007 Earnings Call

October 25, 2007 10:00 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 America Securities

Gregg Goodnight - UBS

Operator

Good day and welcome to The Dow Chemical Company’s third quarter results conference call. Today’s call is being recorded. At this time, I would like to turn the call over to the Corporate Director of Investor Relations, Ms. Kathy Fothergill. Please go ahead, Ma’am.

Kathleen Fothergill

Good morning, everyone and welcome. 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 and 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 are Andrew Liveris, Dow’s Chairman and CEO; Geoffery Merszei, Dow’s Executive Vice President and Chief Financial Officer; and Jeff Tate, Manager in Investor Relations.

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

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 forecast or estimates, and we don’t plan to update any forward-looking statements during the quarter. If you’d like more information on the risks involved in forward-looking statements, please see our SEC filings.

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

Now starting with the agenda on slide 3, Geoffery will lead off with an overview of the third quarter. I’ll discuss the results of our operating segments, then Geoffery will update you on actions we’ve taken to advance our strategy and describe Dow’s outlook for the months ahead. After that, 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 income was $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 growth in three years, led by Europe, Asia Pacific and Latin America. Price was also up 5%, with solid gains in all operating segments. Now these higher prices, combined with the benefit of volume increases, meant we were able to overcome the impact of ever-rising feedstock and energy costs. Our joint ventures continue to deliver outstanding results. In short, our business fundamentals for the quarter were solid.

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

Let me provide a few highlights from the quarter, which you will find detail on slide 4. Sales increased 10% from the same period last year, the largest year-over-year percentage gain for two years, setting a new quarterly 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 joint ventures that number in fact is now more than 70%, and we saw a major increase in feedstock and energy costs, up almost $400 million year over year.

This quarter, Dow’s feedstock and energy bill topped $6 billion for the first time in the company’s history. Consider this: in 1999, we paid just $6.1 billion 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 from consuming 23% of our net sales to the current 44% year-to-date.

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

Turning to earnings, there are some items this quarter which may distract a little from our ongoing performance. Let me offer some clarity on slide 5. Our reported earnings for the third quarter were $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 more significantly, the third quarter earnings also included a charge to the provisions 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 tax rate from around 37% to 28%. Now on an ongoing basis, this reduced tax rate in Germany is clearly good news, but for the third quarter, its impact has been to reduce tax loss carryforwards.

Now these NOLs relate to the operating losses incurred in Germany during the remediation and reconstruction of our assets at BSL in the former East Germany, which we acquired back in 1995, so this dates back over 12 years. These assets now provide the platform for growth throughout the dynamic markets of Eastern Europe. Now the new German tax rate takes effect in January of 2008, but since the law was adopted during the third quarter, we recognized an adjustment to the tax loss carryforward which was in accordance with U.S. GAAP in the quarter.

So as I said earlier, the good news is that starting next year in 2008, we expect the underlying tax rate for the company as a whole to be reduced by around 0.5 percentage point. Even excluding the impact of the German tax law change, our underlying tax rate for the third quarter was somewhat higher than we’ve seen for quite a while. We’ve said many times that rates can vary significantly from quarter to quarter, depending on where our income is earned and events that may occur during 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 tax rate that we’ve seen in two years. So on a year-to-date basis, the underlying rate is just a shade below 25%, which was in 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 venture activities during the quarter. Slide 6 provides some of these highlights. Equity earnings for the quarter were down 7% from last year’s quarterly record to $296 million, while year-to-date they have climbed 14% to over $800 million; $828 million to be exact. These results reflect healthy quarters for both EQUATE and MEGlobal, and continued strong performance at Dow Corning, which reported its seventh consecutive quarter of record sales. Together, improvements at these businesses helped mitigate declines elsewhere, most notably at OPTIMAL, which was hit by some operational issues during the quarter.

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

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

In summary, another sound quarter for Dow. Record quarterly sales with substantial growth in Europe, Asia Pacific and Latin America. Solid price increases across every business and in every geographic region. Strong volume improvements in most operating segments and a robust and consistent stream of equity earnings.

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

Kathleen Fothergill

Thanks Geoffrey. Now starting with slide 7, Performance Plastics had a very good quarter with record sales on gains in both price and volume. There is continuing strength in the polyurethanes group, with year-over-year improvements in price, volume, and EBIT, just as it had last quarter. We saw strong volume gains across the board in components and in systems. While North American demand was down, all other regions reported solid volume gains. Strong organic growth was supplemented by recent acquisitions: Hyperlast in Europe and Dow Izolan, our majority-owned subsidiary in Russia.

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

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

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

Within Designed Polymers, the combination of Wolff Walsrode and Dow’s Water Soluble Polymers business -- now Dow Wolff Cellulosics -- has gone extremely well. We are seeing very good growth in high-value pharmaceutical applications where Dow’s experience with 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 with the integration of Wolff, in addition to the IPR&D charge noted in our release.

Dow Water Solutions is showing strong growth across its portfolio; ion exchange resins, FILMTEC membranes and the recently acquired Omex business in China.

Results for the Specialty Chemicals portfolio suffered because of a number of plant outages -- some planned, some unplanned -- which resulted in both lower volume and higher costs during the quarter. These included upstream outages at Seadrift, Texas and St. Charles operations in Louisiana, as well as outages at OPTIMAL.

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

As you can see on slide 9, while third quarter is usually a seasonal low point for the ag business, Agricultural Sciences had an outstanding quarter, consistent with what we’ve seen all year. The business posted double-digit volume gains both in Ag Chem and in Seeds and Traits, and volume improved around the world. While Latin America was the clear growth leader in this quarter, we also saw volume growth in all other regions. Growth was driven by a combination of healthy industry conditions and Dow AgroSciences’ strong portfolio including spinosad insecticide 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. Good growth in price and volume, but some margin squeeze from significantly higher raw material costs, particularly for polyethylene. You may remember that in the third quarter of 2006, we had several things going strongly in our favor: solid price momentum moving into that quarter with declining feedstock prices during the quarter, which allowed us to realize significant margin expansion. This quarter paints a different picture.

With higher feedstock costs but relatively stable coal product values, ethylene bore the brunt of the feedstock cost increase. We had some price momentum early in the third quarter, but it faded in September, particularly in North America, and margins came down significantly versus a year ago. However, our strong global position helped offset some of that U.S. weakness. For example, European industry conditions are much tighter, and our new train in Tarragona was sold out less than a year after startup. Of course, the polyethylene business also benefited from outstanding results at EQUATE, which is essentially protected from the global fluctuations in feedstock prices.

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

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

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

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

Industry conditions for EO/EG have improved significantly over the past few months due in large part to supply constraints resulting from unplanned industry outages. Our own volume was limited in the quarter because an extended planned outage at St. Charles and a shorter unplanned outage at Seadrift. OPTIMAL also experienced an unplanned outage which reduced equity earnings for the glycol business.

One final highlight, our operating rate for the quarter was 90%, up 3 percentage points from the third quarter last year and the highest operating rate in three years.

That wraps up the financial review of the quarter. Now, I’d like Geoffery to take the microphone back for his update on strategy and outlook.

Geoffery Merszei

Thank you, Kathy. As I mentioned at the start of this call, our performance in the third quarter provides solid testimony to the fact that our strategy is squarely on target. Slide 12 recaps the key facets of our strategic agenda, which I know you are quite familiar with. So let me pick out a few highlights from the past three months that illustrate how we are putting those words into actions. Starting with recent investments that will accelerate geographic and business growth.

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

Monsanto, the unquestioned leader in agricultural biotechnology, is partnering with Dow for the licensing of SmartStax, a first-ever eight-gene stack combination in corn. This tells us that our research efforts are paying off. The ground-breaking gene technology is the result of our steady investment in Dow AgroSciences, including investments in our in-house R&D capabilities, as well as our ability to acquire promising technology very early on and at the right price. SmartStax will generate new royalty revenues for Dow and provide an important platform for future business growth as the company incorporates it into new, higher-yielding hybrid seeds combinations and stacks it with the other cutting-edge trait technologies.

We’re building a solid platform in the agricultural biotechnology space. We’re doing it through acquisitions, through joint research agreements, by securing exclusive rights to intellectual property and through our own research and development efforts. In that regard, the company once again raised the bar during the third quarter, unveiling a new family of Herbicide Tolerance Traits that will provide resistance to multiple classes of herbicide in many different crop species.

So let me give you two other examples of how Dow is aligning its R&D efforts to support the growth of its performance businesses. First in September, a Polyurethane business launched RENUVA Renewable Resource Technology, a process that produces bio-based polyols with high renewable content. These polyols have met with considerable interest from manufacturers across a wide variety of industries.

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

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

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

Our polyurethanes systems business also announced plans to extend its geographic reach, by acquiring Danish company Edulan, an independent polyurethane systems house specializing in rigid foam and elastomer technologies. The deal will enhance the business’s activities in northern Europe and bring a range of exciting new technologies to Dow’s PU systems business worldwide.

Investment activities through the quarter were not confined to the acquisition of new businesses. We also announced expansions in polyol capacity, driven by downstream demand, particularly for specialty polyols and polyurethane 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 remained healthy during the quarter, supporting investment activity on several fronts. We invested $300 million to repurchase 7.1 million shares as part of our buyback program, bringing the total so far this year to $1.1 billion for around 25 million shares.

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

Turning to portfolio management, in addition to the acquisitions I spoke about previously, we also announced the divestment of two businesses: 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 outstanding in the receivables was down one day from the end of the second quarter, from a low level already to a new low of 39 days, while days sales in inventory ended the quarter at 62 days, unchanged from the prior quarter. Working capital management, and in particular inventory management, remain an important priority 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 nine months of this year were 15% and 21% respectively, both ahead of our long-term targets.

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

Sound macroeconomic conditions, particularly in the emerging economies, will continue to support increasing demand for chemical and plastic products. In the fourth quarter, we expect healthy year-over-year demand growth to continue outside North America, although historical seasonal 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 and volatile feedstock and energy costs. Oil and its derivatives are trading near record levels. In fact, WTI this morning was quoted at $88.60, and we therefore expect the fourth quarter to bring substantial year-over-year increase in hydrocarbons costs. Now we will mitigate these headwinds, as we have for several years, through aggressive actions to maintain margins, by keeping tight control over the costs we can control and through our joint ventures, which have competitive feedstock positions.

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

Thank you very much and Kathy, over to you.

Kathleen Fothergill

Thanks, Geoffery. Now 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.

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

Question-and-Answer Session

Operator

Your first question comes from Don Carson - Merrill Lynch.

Don Carson - Merrill Lynch

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

Geoffery, just a question on FX. With 70% of your sales overseas, 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 sequential basis, forex, the euro, as a proxy, the dollar was about 1% down on the average. In fact, it’s a very minimal amount. When you do it on a year-over-year basis, then it’s a little higher. The dollar on the average depreciated about 6%. But frankly, Don, I wouldn’t put a lot of value to looking at the currency impact on pricing if you compare year over year because prices, in many cases, adjust over a longer period. Certainly, over a one-year basis, based on demand and supply which is quite strong in Europe, particularly in Europe, these prices actually adjust. So trying to separate currency from the underlying price, frankly, I don’t think adds a lot of value.

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

Don Carson - Merrill Lynch

So would you expect a normal pattern where Q4 is stronger than 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 typical trend in the fourth quarter.

Operator

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

David Begleiter - Deutsche Bank

I’m not sure if Andrew is there, but a question on strategy. In terms of a transformational transaction, can you highlight again the criteria that you’re looking for in a partner, i.e. either capital or low-cost feedstocks? How important is it to control a joint venture if it were to encompass your core ethylene chain assets?

Andrew Liveris

Great question, Dave, I am on the call. Those questions are near and dear to our heart here and have been for two or three years, as we’ve described our need and 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 they be, indeed, an Ethylene envelope like you just described, they have to bring several things.

Number one is their ability for the new entity, whatever that new entity looks like -- let’s call it a joint venture -- to be a growth company. In essence, not just a consolidation play, not just an exit strategy, not a leverage play, but absolutely a growth company.

Secondly, it has to preserve Dow’s integration, particularly to our performance businesses, to the extent that a cracker has many outputs inclusive, of course, of the biggest of them all, ethylene, if it’s a liquids cracker. The other products become very super-critical to create competitive advantage, not just in things like transfer prices, but also on leveraged infrastructure, leveraged services. A freeport doesn’t get built overnight. So these sorts of things are important in our transition to our marketplace business units which, of course, is the other key part of our strategy.

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

Beyond that, as we do these sorts of deals, our whole notion here is to create what I would call a company that doesn’t necessarily have Dow control, 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. It operates pretty much at the governance level as a true joint venture and within the 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 me know.

David Begleiter - Deutsche Bank

It does. You’re on this more consistent, less cyclical earnings profile, as you’ve had discussions with these partners, I assume your confidence in trough earnings being $3 or more, maybe even $3.50, has increased over the cycle. 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 dividend increase. We’ve demonstrated them through what we’re doing with financial discipline. $2 to $3 is what everyone wrote after what we said. We don’t have any new announcement to make, but we would definitely tell you that we’ve always said and I’ve said it in countless occasions, that our confidence in delivering the higher end of that is increasing. Why? Because of all the things you referenced, some of them; and some of the things I just referenced in answering the other part of your question.

Operator

Our next question will come from Sergey Vasnetsov - Lehman Brothers.

Sergey Vasnetsov - Lehman Brothers

90% operating rate is an excellent result, indeed, and it is just shy of 91%, which was the highest ever in the past ten years. So I was just curious, what would this number be without outages that you’ve seen this quarter? Also, are you close to the effective sold-out condition? 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 mind here, but we did have some lost production in OPTIMAL, which is in our equity line, of course, and so that doesn’t factor into the operating rate. But EO/EG was the biggest impactor in the Dow line, and that was, as Kathy said, Seadrift and St. Charles. Therefore, to answer that question, not a lot different.

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

Therefore now, to the last part of your question, which is really which products are we seeing maxing out? Clearly, we’re seeing it in our ethylene chain in particular our polyethylene ethylene 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 of exports. That will change, that’s not a constant thing. There’s a big arbitrage between 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 thank you 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 the quarter despite this weakness in the U.S.

Operator

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

Jeff Zekauskas – JP Morgan

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

Andrew Liveris

Let me take a crack, and by the way, I’d be the first to want windfall profits in any chain right now given what we’ve been facing the last x years. You’re right, EO/EG is firming, so everything that’s out there in the press, we support your statement. But we do have some issues in our 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, it should restart soon. So as much as we would 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 – JP Morgan

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

Andrew Liveris

I think that you’ve got a couple of good statements in your questions, and the one I like in this question is can we tell? Look, it’s becoming very difficult with all the moving parts you just defined. Of course, there’s no question that we’ve got the arbitrage in the United States I 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 crack really 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 sector is showing some weakness. What did I mean by that? I said wire and cable, I said industrial packaging. So there is some softness there which will again hurt the U.S.

Now, our price increases on polyethylene are sound, the October one and the November one is sticking right now. Well it isn’t sticking; it’s out there and no one 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 will be significant, if this arbitrage in the U.S. the rest of the world catches, and then the cracking slate becomes competitive. If you can forecast naphtha, please tell me, I’d love to have an input from you. This crude oil thing -- which is lifting naphtha 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 in the share price surrounding the decision to postpone your analyst meeting. Could you expand upon the reasons why you decided to do that?

Andrew Liveris

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

To Dave’s question, we just don’t want to have a premature event. We don’t want to have a meeting for the sake of having a meeting. When we have a meeting, we want to be able to tell you a lot about where we are on certain of our transactions. That doesn’t mean it’s an imminent one, it just means that with a lot of things going 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, we said tentative. Then we were pretty much toying with the idea of December and we said, well, let’s just wait a little bit. I would tell you that we are very active and will stay very active. But when we have a meeting, you’ll hear a lot from us.

Frank Mitsch - BB&T

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

Andrew Liveris

I guess I’ll give you two quick answers. One, no comment on accretion or dilution other than our whole M&A discipline is around accretion and doing the right deals 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 the sell side, as well as with the buy side analysts, and we’ve been listening to all of you. The bottom line is that everyone basically agrees that when we have a meeting like this, we shouldn’t have a meeting just because it’s on the calendar every three years, but we should have it at a time when it makes a lot of sense in terms of having a fruitful dialogue and to make sure that it’s an efficient use of everyone’s time. So we have been listening, and that 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 say it that way, but we will not give you a firm date. But trust us, we’re listening, as Geoffery said. Our buy side, our sell side, all of you matter to us and we’re going to really time it so it’s the right time. I don’t want to be waiting a year for it, how’s that? I’ll give you an out of bound.

Operator

Your next question comes from Prashant Juvekar - Citi.

Prashant Juvekar - Citi

On Performance Chemicals profits dropped there significantly. If you exclude all the outages, how much of that drop was a raw material issue, and how much of that was weak demand?

Andrew Liveris

Let me try, P.J. A couple of points, and Geoffrey may add. Look, it was what you said, the outages. We had one-time costs associated with Wolff, that’s a biggie. Also, it’s a little bit, there are two sorts of businesses that influence chemicals right now; two groups of businesses that are doing sensationally well -- the water soluble polymer business and generically, their design polymers business, which includes the Water Solutions business.

And then, on the other side of the shop, we have Specialty Chemicals which includes these EO derivatives, ethanolamines which are affected by the outages, and then we have latex which we’re trying to restore latex back to where it was a few years ago. Paper and carpet have always been challenged now for a while because of the housing thing and, of course, with the issues in the paper industry. But, actually, they didn’t do that bad, it was 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 the architectural coatings guides, there’s definite weakness, P.J., here in the United 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 are troubled, because of the economy, and outages. And then another group of businesses that are doing quite well.

Geoffery Merszei

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

Prashant Juvekar - Citi

On the acquisition side, you’ve chosen to make some small but interesting acquisitions. Now, is that 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 we will do bolt-ons. Bolt-ons, let’s call them 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 good example of that. Jerome in the ag business, Pat Dawson in the urethanes business, and I can give you more examples. 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 a significant difference to our consistent and earnings growth story that we’re articulating. Carbide yay or nay, did we learn a lot from Carbide, and the experience there? We certainly did and maybe in a different environment, I can give you a lot more of the learnings.

We are much, much more cautious on what I call these big bang acquisitions because as I’ve said a few times, they bring you some jewels and 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 VCM comments, trying to understand the sequential improvement. We tend to think of VCM as a formula-driven business 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 quarter than last quarter and glycol is also better. As someone mentioned, Geoff mentioned, the glycol business is doing well. We suffered because of some outages but those things are better, the vinyl is not a source of strength in the basic chemicals section.

Andrew Liveris

In fact we’d go also a little step further. We think the U.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 who are having trouble with the whole vinyl chain because of housing here in the U.S. So we wouldn’t say that vinyl did a good quarter.

Mark Connelly - Credit Suisse

Maybe I misunderstood the earlier comment. Going back to Performance Materials for a second, am I over-estimating the tailwind that you would have gotten from raw materials in Dow Corning? I mean clearly you had a lot of other stuff going on but were those two significant tailwinds for 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 done well now, as Kathy said in her remarks, for the last about seven straight quarters. The key for them is the top line is exploding with growth because of solar and Hemlock Semiconductor, their majority-owned joint venture, which is doing spectacular and which of course, leveraging off their 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 balanced geographic exposure, including on the silicon side particularly with good demand coming out of the Pacific, they continue to do very well. And then of course, they have the advantage of their polysilicon, which is going gangbusters.

Operator

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

Peter Butler - Glen Hill Investments

On the question of the timing of a possible big joint-venture deal. Once upon a time I worked for Exxon and you knew a big restructuring was coming when all of a sudden an organization chart appeared in your internal mail. An analogy to this, is it possible that your white 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 quite some time to put together MEGlobal. All these 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’ve got to select the right partner, you’ve got to make sure that the partner is financially sound, that he has access to new markets, that he has access to low cost feedstock, that all the various supply contracts are in place, et cetera, et cetera. So this takes a long time in order to execute these types of transactions.

Andrew Liveris

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

I will tell you what I think was Dave’s question again. The strategic aspect of a transformational deal of that size and what we’re looking for and how it will be achieved has been on our radar screen actually for about four straight years and has accelerated 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 like yourself, by the wholesale side and buy side analysts in order to add some clarity, some transparency to a growing portion of our income coming from JVs. That’s really the purpose. This is not the end. We’re going to continue to provide more and more information as we go forward.

Peter Butler - Glen Hill Investments

On a different subject, Geoffrey, when you referred to the third quarter, you said it was another strong quarter. On your guidance for ‘08, you said that you’re looking for another year of solid earnings performance. Does this mean that you guys see ‘08 earnings plus and minus ‘07? Or are the odds as you 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 of forecasts. As you know, we do not give guidance. I can repeat what I said earlier in terms of the bipolar economic situation that we’re facing with weakening tendencies in the U.S. clearly being compensated by a very, very strong growth scenario in the emerging markets. Then, of course, the wild card is hydrocarbon and energy. We have been very effective in mitigating that certainly on an annual basis beyond just looking at it on a quarterly basis. But that’s really the environment that 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 your western assets with somebody who might have access to raw materials. I guess I don’t really get how they can plug those 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 advantage for instance for your ethylene costs in Canada? And how is that a benchmark for what we might expect in your ethylene or chlorine chain?

Andrew Liveris

I think generically you are absolutely correct. But again, remember how I answered the question, I said a growth company. A growth company, when you put all assets, that’s existing assets as in developed economies but not just hard assets, intellectual property assets and technology development assets which in the main reside in the western economies, and you say 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 are leveraging off. We have customers’ line in 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 that we’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 saying this is on the table, but for example, if you do partner with somebody who has access to crude oil and refining streams and they are looking at locating a refinery 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 as one integrator approach.

The independent oil companies have done that for decades. Of course, Exxon and others are more successful maybe than some others but that play is very sensible. It brings liquid streams into the mix just like our project with Saudi Aramco on the Persian Gulf in Ras Tanura, not just gas. Frankly, wet gas is a limited resource. In other words, there’s not a lot of it out there that can be brought to the market over time to make straight polyethylene from ethane, so you do need to get access to liquids, and these liquids could be in fact part of the solution in the western hemisphere.

So that’s just a specific to answer you, Bob, on maybe what a 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 your intellectual capital is powerful and your marketing and brand equity is important, but why would a partner want to have access to your developed country assets? It would seem like all of this the growth opportunity is more in the emerging markets and you’ve already struck those sorts of deals with Aramco and PIC, so what would your partners see in getting bigger in the developed countries?

Andrew Liveris

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

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

Robert Koort - Goldman Sachs

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

Andrew Liveris

Well as you know, certainly in the last 12 to 18 months the company’s financial shape is topnotch and we’re demonstrating in all sorts of ways: dividend increases, share buybacks, disciplined acquisitions, rigorous expense controls, everything Geoffrey said in his remarks. So they can be discrete. We can organically grow and with selected acquisitions, our performance businesses.

But clearly if we did do something of significance that materialized partly like we did with MEGlobal. And it made sense for our Performance 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 of America Securities.

Kevin McCarthy - Banc of America Securities

Andrew, you’ve been quite clear with regard to the value of integration with Dow’s portfolio and I don’t disagree with that notion. However one could argue that integration is marginally less relevant to biotech for agriculture as well as higher value-added crop protection chemicals. And meanwhile the value of Ag assets has soared as you know in recent years. Do you think 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 those assets to unlock value?

Andrew Liveris

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

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

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

Kevin McCarthy - Banc of America Securities

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

Andrew Liveris

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

I won’t take you through it all because we don’t have the time. So that’s a long-term answer. Short-term, fundamentally it’s a physical hedge. 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 understand that. So it’s price management on the output side.

Kevin McCarthy - Banc of America Securities

Very briefly, Andrew, is there a next joint venture, any update there?

Andrew Liveris

Still very much in motion, good dialogue with our partner, FTC approved Chevron Phillips and Dow and we’re working very hard on getting ourselves out 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 one more 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 their effect in the third quarter? If you have, what is the breakdown between basic chemicals, performance chemicals?

Kathleen Fothergill

We haven’t quantified it, Gregg. I know that in performance chemicals the impact on results from outages generally, which there were a few more 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 think there’s probably a similar impact in basic chemicals too.

Gregg Goodnight - UBS

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

Andrew Liveris

I said it on CNBC’s Squawk Box this morning and I’ll say it again, we’re not going to hide, it is a miss. Having said that, $100 million is the 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 either acquisitions we have in the picture today we didn’t have a year ago, as well as organic 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% next year, have you given guidance to your 2008 tax rate yet?

Geoffery Merszei

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

Gregg Goodnight - UBS

If I can slip in one last question, you mentioned in the past 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 would extend your specialties portfolio even if that deal was, say, $2 billion to $3 billion?

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 questions in 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 call and we do look forward to talking with you on our next conference call in January. Good bye.

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Source: Dow Chemical Q3 2007 Earnings Call Transcript
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