January 25, 2007

Fourth Quarter 2006 Earnings
The Dow Chemical Company

Andrew N. Liveris, Chairman and Chief Executive Officer

A. N. Liveris:

We look upon the year 2006 as a significant milestone for our company, and we think 2007 will be even more significant. In fact, I think 2007 will one day be seen as a defining moment in the history of our company.

Well, let’s examine what we’ve done. 

We launched our new Dow Water Solutions business unit, which offers world-class brands and technologies to the water treatment industry.  With Dow’s technologies, and the acquisition in July of Zhejiang Omex Engineering in China, this platform advances our capabilities in desalination, water purification, contaminant removal and water recycling.

We also started up a new plant in the United States for the production of FILMTEC membranes, substantially increasing the production capacity of our reverse osmosis membranes used in water treatment.   

We strengthened our Performance portfolio with a number of other actions:
In Dow AgroSciences, we doubled our current production for canola and sunflower oils - which supports our growth strategy in the healthy oils sector.
In cellulosics, we launched a new line of dietary fiber products that helps combat the problems of excessive blood glucose, cholesterol, insulin and obesity.
In our Building Solutions businesses, we expanded our Styrofoam capacity, and we added a new composite product for decking that is superior to wood in durability and maintenance.  We also added our highly successful GREAT STUFF insulating foam sealants to take advantage of Dow Building Solution’s strong channel-to-market. 
In China - where, by the way, our sales increased from $2.3 billion to $2.7 billion - we committed to the construction of a new glycol ethers plant, as well as a $200 million investment in our Epoxy business for new manufacturing capacity and a new epoxy R&D center, and we began construction of our major new technology center in Shanghai. 
Finally, we announced the acquisition of Bayer’s cellulosics business, which will increase the sales of our Water Soluble Polymers business to roughly $1 billion a year.   

But as much as we accomplished in 2006, we are by no means pausing in the acceleration of our Performance strategy in 2007. 

Part of that acceleration is our announcement, by way of this conference call, that we are launching two new market-facing businesses, one in Coatings and the other in Footwear. 

Coatings is a $40 billion global industry.  This new unit will aggregate our coatings products into a market-facing business platform, enabling a strong channel-to-market, customer focus, cost and product synergies, and opportunities for us to further develop and apply competitive technology.We're already off to a great start with a number of technologies, based on amine and polyurethane chemistry, that support the launch of value-added advanced coatings.

The story is similar with the $20 billion footwear industry.  We already serve this industry by selling various products into component parts, but now we are consolidating our efforts into a coordinated channel.  This enables us to focus our dedicated technology; for example, in adhesives as well as in flexible, strong, light-weight materials derived from urethanes and specialty polymers.  It also enables us to dedicate commercial people to this industry who understand it and know how to serve it, bringing value both to our customers and to Dow. 

One more point:  we are far from finished.  We continue to evaluate 12 additional market-facing business opportunities.  Now not all of them will come to fruition, but many of them will.  In fact, we expect to launch some additional new ones this year, so stay tuned.  

Now let me turn to our Basics portfolio.

We said last March that we would strengthen our franchise Basics businesses and grow through joint ventures (JVs), not only building new plants with JV partners but, in some cases, placing our existing assets into JVs - similar to what we did with our Ethylene Glycol business in our MEGlobal joint venture.  We call it our “asset light” strategy, although some prefer the term, “equity light.”    

Well, let’s look at our track record in the Basics for the last 10 months.

We were selected by Saudi Aramco as its preferred partner for exclusive negotiations to form a joint venture to build a world-scale complex in Saudi Arabia.  This is an unambiguous affirmation that we are one of the world’s premier chemical companies.  Given their position as the largest oil and gas company in the world, Saudi Aramco could have chosen practically any chemical company as its partner for this project, and many chemical majors were in the running.  So we are particularly pleased to have been selected. 
We will provide more details on this mega-project in the coming months, but suffice to say that this site will become the Freeport, Texas of the emerging world. 

Incidentally, we have also made significant progress on many negotiations with other partners as well; in the Middle East, Asia, and other regions of the world.

We agreed to a joint venture in Thailand, with our current partner Siam Cement, to manufacture propylene and other building blocks that will drive the growth of the Company’s Performance businesses in Asia.  Among the projects we are considering is a hydrogen peroxide to propylene oxide (HPPO) plant, which is a new technology we developed with BASF, with whom we are also building a world-scale facility in Europe.

We established an off-take agreement with the Romanian company, Rompetrol, for the manufacture and marketing of low density and high density polyethylene resins in Eastern Europe.

We also continued our negotiations with Russia’s Gazprom for our two companies to work jointly on energy-related projects both inside Russia and elsewhere in Europe.

And in the Basics, as with our Performance portfolio, let me also assure you that we will continue to take aggressive action throughout 2007. 

Last month, we completed an extensive review of our Basics businesses, focusing on how to prepare these businesses for future success, including the use of new business models.  
As a result, you soon will be seeing some exciting new asset light announcements, but let me give you a sense of what we are planning.

First, we have decided to seek and implement a new model for our Polystyrene business and, second, we will do the same for our Polypropylene business. This decision underscores our seriousness to upgrade our portfolio and pursue our asset light strategy.

Our goal is to better compete in these dynamic businesses, and in each of these cases, we will work with partners who offer added strengths, such as further back integration in feedstocks or expanded geographic presence. 

So once again, stay tuned for some bold new moves in our Basics portfolio.
 
Now let me talk about what we are doing in the area of innovation.

As you know, Dow has a long history of strong innovation, and we are writing some new chapters to that history.

The current revitalization of our organic growth engine, led by Romeo Kreinberg, executive VP of our Performance portfolio, and Chief Technology Officer Bill Banholzer, has focused on building a very tight bond between our marketing and R&D organizations. 
 
Doing this, and doing it well, is key to re-establishing Dow as a growth company.

Well, let me give you a quick overview of how we are doing.

In just 18 months, we have identified and are funding over projects that vary from strengthening our incumbency in key franchises, such as our soybean-to-polyol project in Polyurethanes to capture new markets, and by taking advantage of technology discontinuities, such as our new commercially viable family of olefin block co-polymers, which could very well be our next INSITE technology platform in terms of its impact on revenue and earnings.

The point is, we are not talking about 10 or so rifle-shot projects or programs, but over 600 projects that could yield over $2 billion of new EBIT by 2011.

We will have a lot to say about our company’s innovation projects at upcoming conferences and investor meetings.  But let me give you a short preview of things to come.

Firstly, by the commonly used and accepted industry measure, Dow’s percentage of revenues from new products introduced in the last five years has been benchmarked using external data and puts our number at 35%  ?  well into the top tier of our industry.

Secondly, consistent with global macro-trends, we have chosen various thematics to direct our precious innovation investment dollars.

Let me describe three of these thematics that are of strong interest to us:
 
The first is Alternative Feedstocks.

The second is Healthcare and Nutrition.

And the third area I will mention is Building and Construction.

As I said, this science and technology company has a powerful history of innovation.  We will have a lot more to say about how these projects will create new value for our shareholders as we move through 2007.

So once again, stay tuned to our innovation story.

I think from all of what I’ve just outlined, it is fair to say that we have been vigorous in implementing the strategy we presented in March.

And let me assure you again, we will continue to move aggressively. 
 
So to wrap this up, I’ll address what all of this means to our short- and long-term financial results - and here I think a brief history lesson is in order.
 
Many of you who have followed our company for a number of years recall that the last cyclical peak of our industry was in 1995, when Dow earned $2.76 a share, excluding unusuals. 

Although for the five years after that, Dow’s earnings declined from the peak, they remained on what I call a ridge of solid earnings ? that is, until 2001 and 2002, when they fell off that ridge.

Everything we are now doing, from a strategy point of view, is to put together another ridge of earnings, except this time, the ridge is significantly higher.  Towards that end, we have made a good start ? with earnings, excluding unusuals, of $4.37 per share in 2005 and $4.25 per share in 2006, compared to pre-Union Carbide earnings of $2.76 in 1995 and $2.57 in 1996.        

Now our challenge is to extend the current ridge and, critically, to avoid the equivalent of the drop-off that occurred in 2001 and 2002.      

Probably the single greatest reason our earnings dropped so precipitously in 2001 and 2002 ? at least from the point of view of what we inside the Company could control ? is that we did not retain our discipline as we executed our growth strategy.    

The 2001-2002 trough was a confluence of many difficult factors, including a severe industrial recession in the United States, the addition of significant capacity in ethylene, and low industry operating rates.   For Dow, the picture was complicated further by the acquisition and subsequent integration of Union Carbide.

However, despite those conditions, our study showed that if we had been more disciplined in 2001, husbanding our resources, trimming and pruning our costs as we went along, being rigorous in evaluating and funding new business development and some of our acquisitions, we would have earned our cost of capital at the last trough. 

I mention this not as a criticism of the past, but in the context of learning from the past so that we can change the future. 

And I think we have learned.  So going forward, our strategy will be one of disciplined growth.

Yes, we will continue to invest in R&D, in bolt-on acquisitions, in launching new market-facing businesses, expanding in promising new geographies … all of the things I’ve described. But we will be disciplined in doing so.

Our goal, as you’ve heard me say many times, is to generate earnings growth AND earnings consistency over the short term and the long term. In other words, to change our earnings profile.

The only way to do that is to change the profile of our company, and that is exactly what we are doing. 

So going forward, you can expect more of what you saw in 2006:

And now I am going to put a public stake in the ground.

As we change the profile of this company ? so that our earnings are more heavily drawn from our Performance businesses ? and as we move our Basics businesses into joint ventures with partners who provide competitive advantages to those ventures, while still retaining the advantages of integration and the big cash generation of those businesses, we will have it in our power to earn our cost of capital at the next trough; which translated to earnings would put us in the mid-range of $2 to $3 a share.

We believe we can do that because we have hit the sweet spot of how to grow this very complex enterprise known as The Dow Chemical Company, and we have learned how to execute disciplined growth.

So we will continue to invest in the technologies, businesses, regions and markets that are the most promising, prune our portfolio of non-strategic businesses and non-competitive assets and keep ongoing costs under control, and we will keep our balance sheet very strong, so that we can capture value-creating opportunities when and where they arise.

And we will continue to balance our use of cash, both to reward our shareholders and to grow our businesses.

We have the right strategy; we are implementing it with discipline and speed ? and our initial results are showing great promise.

If we remain focused and disciplined  - and we will - we have every reason to believe that we will not only endure the downside of the cycle, but having learned the lessons of

the past, emerge from it as a much more resilient company; a company that generates both earnings growth and earnings consistency ? and delivers greater value to its owners. 

As I mentioned earlier, I believe we are at a defining moment in our company’s history, and I am very bullish about our long-term future, and committed to deliver against our goals.