View the Presentation (101KB PDF)

 

Third Quarter 2008 Earnings
The Dow Chemical Company

October 23, 2008

Quarterly Earnings Conference Call/Webcast
With Investors, Financial Analysts and the Media

Remarks by:
Geoffery E. Merszei, Executive Vice President and Chief Financial Officer Howard Ungerleider, Vice President, Investor Relations

The following is a summary of prepared remarks made during Dow’s conference call/Webcast concerning its quarterly earnings on October 23, 2008. The news release and financial statements are also available on www.dow.com.

H. Ungerleider:

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. 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, Director in Investor Relations.

Around 6:30 this morning, October 23^rd, our earnings release went out on PR Newswire and was posted on the Internet on Dow’s website, dow.com. We have prepared some slides to supplement our comments on this conference call. 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 forecasts 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, 8-Ks and annual reports are available on the Internet at dow.com in the Financial Reports page of the Investor Relations section.

Starting with the agenda on Slide 3, Geoffery will begin today’s call with a high level review of our third quarter results.

He will turn the call back to me for some additional detail at the operating segment level.

Geoffery will then address several critical issues that are on the minds of many of our investors.

Such as what we are doing to address the global economic crisis, and he’ll give you an update on two of the larger transformational actions we have underway - the formation of K-Dow Petrochemicals and our planned acquisition of Rohm and Haas, as well as our outlook.

Finally, after our prepared remarks, we’ll move to your questions for Andrew and Geoffery.

Turning to Slide 4, you’ll see a summary of the financial highlights for the quarter. Now let me hand it over to Geoffery.

G.E. Merszei:

Thank you Howard.

The third quarter was characterized by three major events – record high feedstock and energy costs, weakening global demand, and finally the two large hurricanes that hit the U.S. Gulf Coast.

I believe Dow performed well in the quarter despite these challenges, delivering significant price increases, tight cost controls, and once again strong and consistent equity earnings.

So let’s get into the details on slide 5.

Sales for the third quarter increased 13 percent from the same period last year to $15.4 billion.

Price increased 22 percent, with double-digit price gains in all operating segments and all geographic areas.

In fact, this was the largest year-over-year percentage increase in price since the first quarter of 2005.

Volume was down 9 percent globally, reduced 2 percent by the impact of Hurricanes Gustav and Ike, further weakening of demand, and our focus on implementing price increases in the quarter.

Excluding the impact of acquisitions, divestitures and the hurricanes, volume was down 5 percent.

I’m pleased to report that the outstanding performance in Agricultural Sciences continued, setting a new third quarter sales and EBIT⁽¹⁾ record.

And equity earnings were $266 million for the quarter, marking the seventh consecutive quarter that earnings from joint ventures exceeded $250 million.

In spite of the recent significant declines in energy prices, which occurred near the end of the quarter,   purchased feedstock and energy costs surged 48 percent, representing an increase of $2.6 billion over the same quarter last year and actually we were up more than $350 million, or 27 cents per share, sequentially.

This was the largest year-over-year increase in the Company’s history and the third consecutive quarter in which these costs reached new highs.

So as a result, margin expansion in the quarter was not achieved by either our Basic or Performance segments, as the hurricanes idled approximately 80 percent of our North American capacity in September, just as feedstock costs were declining.

All of this led to reported earnings for the quarter of 46 cents per share.

Now turning to slide 6, please keep in mind that this number reflects the unfavorable impact from the hurricanes, composed of 9 cents per share in costs and 3 cents per share in margin on lost sales. In addition, there was a 3 cent per share impact for purchased in-process research and development charges, and 2 cents per share for expenses related to our announced acquisition of Rohm and Haas.

Now, if you add this to the reported earnings of 46 cents you get to an adjusted earnings of 63 cents. And this does not take into account that we had an unusually high tax rate of 29 percent in the quarter, which would add another 3 cents per share.

As I said earlier, I believe this was a good quarter for Dow, despite the numerous challenges we faced.

Another way to look at our earnings, is to start with our second quarter earnings of 81 cents, then subtract the earnings difference in Ag of 18 cents due to the normal seasonality of this business.

Next, factor in the substantial increase in our hydrocarbon and energy costs of 27 cents per share on a sequential basis.

Adding these two items together could have dropped our earnings to as low as 36 cents per share.

But due to the success of our price increases and our aggressive cost controls, I hope you agree that we delivered significantly better results.

And this does not even take into account that the third quarter is traditionally Dow’s weakest quarter or that we incurred various hurricane related impacts.

Now, before I turn the call back to Howard, I would like briefly highlight the strong contributions from our joint ventures as seen on slide 7.

Dow Corning reported record third quarter sales and earnings due in part to excellent results at its Hemlock Semiconductor unit.

OPTIMAL had a solid quarter as well, with margin expansion driven by higher prices and cost-advantaged feedstocks.

And EQUATE reported strong polyethylene results driven by higher prices and their advantaged feedstock position, however these strong results were offset by lower ethylene glycol earnings.

Now, I would like to turn the call back to Howard for a review of our performance by operating segment in the quarter.

H. Ungerleider:

Thanks, Geoffery.

Starting with slide 8, in Performance Plastics, the majority of the businesses in this segment posted double-digit price gains, with price up 14 percent overall. Volume was down 4 percent, on further declines in the North American automotive and housing industries. Demand also softened in these same industries in Europe, particularly in residential and commercial construction in Spain and the U.K.

In Dow Polyurethanes, volumes declined due to softening demand for furniture, bedding and appliance applications, as well as our aggressive efforts to raise prices, and the impact of the hurricanes, which limited supply.

Polyurethane Systems, however, reported strong demand for insulation materials used in oil and gas exploration applications. In fact, the business broke ground on an expansion at its Izolan Systems House in Russia during the quarter to capitalize on growth in this area.

In Dow Epoxy, there was significant margin squeeze in intermediates because of industry oversupply, which limited our ability to raise prices enough to offset higher costs. In Dow Epoxy Systems, growth in wind energy and infrastructure applications, however, remained strong.

Despite robust price gains across the segment, selling prices continued to lag significant increases in raw material costs.  And with the impact of the hurricanes, EBIT in the Performance Plastics segment was down vs. the same period last year.

Moving to Slide 9 … for the ninth consecutive quarter Performance Chemicals posted year-over-year price gains, up 21 percent. In North America, Asia Pacific and Latin America, price improved in each of these regions by more than 20 percent.

Designed Polymers reported strong demand in food, pharmaceutical and personal care applications in Dow Wolff Cellulosics, which partially offset weakness in construction polymers.

Dow Water Solutions reported growth for FILMTEC™ reverse osmosis membranes and ion exchange resins, as global water industry fundamentals remained strong due to growing demand for clean water. Outstanding results were reported in Biocides, driven by growth in oil and gas applications.

Specialty Chemicals prices were higher in all geographic areas, and strong demand was reported in industrial and household cleaning applications, as well as in the ag industry.

Margins for Dow Latex expanded in the quarter, due to our strong focus on price which was aided by a limited supply of a key raw material.

Equity earnings were strong in the quarter, based on results from OPTIMAL and Dow Corning.  Sales and earnings accelerated during the quarter at Dow Corning, due to continued strong demand in the solar industry, as well as new capacity at their Hemlock Semiconductor unit, which was operational for the full quarter.

For the Performance Chemicals segment overall, EBIT increased as improvement in sales and higher equity earnings offset an increase in raw material costs.

Slide 10 highlights our continued strong performer … Dow AgroSciences. Following a stellar performance in the first half of the year, and despite this being a seasonally slow quarter, Dow AgroSciences delivered a third quarter sales and EBIT record.

Price was up 16 percent, while volume increased 8 percent, reflecting organic growth and growth from recent acquisitions.

Our broad portfolio of both agricultural chemicals and seeds continued to benefit from robust global demand for agricultural output.
Sales in seeds and traits increased in the quarter, led by higher demand for sunflower oil and seed in Latin America. Corn sales in Brazil also rose in the quarter, due to an improved farm economy and a solid performance from our Agromen acquisition.

Strong demand was reported for cereal and broadleaf crop herbicides in North America and northern Europe, due to high cereal prices, an increase in planted acres, and the very successful launch of Pyroxsulam in Canada, which exceeded customer expectations.

Glyphosate sales were up in the quarter, driven by higher prices due to tight industry supply conditions. Strong volume growth continued for new products Penoxsulam rice herbicide and Aminopyralid herbicide for range and pasture.

Spinetoram insecticide sales continued to ramp-up from product launches in the United States.

The business announced two new bolt-on acquisitions in the quarter – Dairyland Seed and Renze Hybrids.

These represent the fifth and sixth acquisitions Dow AgroSciences has completed since May 2007.

Earnings were unfavorably impacted by pretax charges totaling $27 million for purchased in-process research and development related to these recent acquisitions.

Shifting to the Basics side on Slide 11 … Sales in Basic Plastics rose 7 percent to $3.5 billion, up from $3.3 billion in the same period last year.

Price increased a robust 25 percent, and was up in all businesses and in all geographic areas.

Volume, however, decreased 18 percent, due in part to several portfolio management actions Dow has taken over the past year, namely the shutdown of capacity in Louisiana and Brazil, and the formation of our Americas Styrenics joint venture in May of this year. Volumes were also unfavorably impacted by the hurricanes.

Strong price gains in Polyethylene more than offset increases in purchased feedstock and energy costs.

Demand for Polypropylene was down again this quarter, due to lower consumer spending and slowdowns in the housing and automotive sectors.

Equity earnings were up versus the same period last year on improved earnings from EQUATE. EBIT for Basic Plastics was down compared with the same period last year due to price increases not being sufficient to offset significantly higher raw material costs as well as the impact of the hurricanes.

Finally, in Basic Chemicals on slide 12, sales of $1.5 billion for the quarter were flat with the same period last year. The segment recorded a 20 percent gain in price, and a 20 percent decline in volume.

Compared with last year, volumes were lower due to the sale of the caustic soda business in Western Canada in December 2007. Pricing for caustic soda continued to be strong, benefiting from ongoing favorable industry supply/demand fundamentals.

Demand for vinyl chloride monomer used in PVC production, however, continued to decline as end-use applications for PVC in residential building and construction applications remained extremely weak.

Results for the Chlor-Vinyls business were also impacted by the hurricanes, which extended an earlier unplanned outage at our manufacturing facility in Freeport, Texas.

Volume was down in the Ethylene Oxide/Ethylene Glycol business, due to weak industry fundamentals and further declines in polyester fiber demand in Asia Pacific.

The EO/EG business was also negatively impacted by the two hurricanes in the quarter. Despite higher selling prices and higher equity earnings from OPTIMAL, EBIT was significantly lower compared with the third quarter of 2007.

One final data point … our operating rate for the quarter was 76 percent, down from 83 percent last quarter primarily because of the hurricanes. Excluding the hurricane impact, our operating rate would have been slightly higher sequentially at 84 percent.

Now I’d like to turn the call back to Geoffery who will address several critical issues that are on the minds of many of our investors.

G.E. Merszei:

Thank you Howard.

Turning now to slide 13 and the topic of risk management, I would like to share with you what we have done to preserve our financial flexibility and further strengthen our financial discipline.

As we all know, these are clearly challenging times, but I want to assure you that Dow remains financially strong, our balance sheet is in good shape and the Company has sufficient liquidity and financial flexibility to meet all of its business obligations.

When we saw that credit markets were beginning to tighten in the summer of 2007, we proactively focused our risk management activities in two key areas – liquidity and counterparty risk.

Today, in the area of liquidity, we have committed credit lines of approximately $5 billion of which half remains unused. In addition, we have other sources of funding available to us throughout the world.  For example, we regularly issue medium term retail bonds.

Regarding counterparty risk, we diversified our financial exposures, and by this I am referring to investments as well as derivatives.  We have also limited the maximum amount we would have to each counterparty as well as being very selective in the type of investments we make.

In addition to preserving our financial flexibility, our financial discipline also remains intact. We have taken a number of actions to preserve cash, defer or eliminate capital spending and cut costs.

First, we’re re-examining all capital projects in light of the new economic environment, and plan to reduce our capital spending by $100 million by year-end.

This will lower our capital spending goal from $2.2 billion to $2.1 billion.

Next, we are delaying all discretionary spending. In fact, in the third quarter, we successfully reduced our SG&A expenses by almost $20 million sequentially. And in light of the current economic environment, we have put in place new plans to reduce spending by an additional $100 to $150 million by year end.

We also have a goal to reduce our working capital by several hundred million dollars by the end of the year. Specifically, we plan to reduce DSI by three days, to 59 days by year end. And we are very actively managing our credit policies. In fact, our DSO tied a yearly-low of 38 days in the third quarter.

We believe that these are prudent measures given the economic slowdown and the uncertain times ahead.

I would also like to mention that Dow has been actively managing its business portfolio and taking action on underperforming, underutilized or non-competitive assets for quite some time.

For example, in the last two years, we have announced 43 plant shutdowns, exited 17 sites and we’ve divested 18 businesses.

And we will continue to trim spending on businesses that cannot hold their ground during tough economic conditions.

In fact, year to date we have divested nine businesses with revenues of approximately $1.5 billion and more than $40 million of negative EBIT.

We are also actively realigning existing businesses for growth and profitability.

The recent realignment in Dow Emulsion Polymers is a prime example.

The outcome of this effort will be a more focused, lean and agile business model. By the end of 2008, Dow Emulsion Polymers will have reduced its production capacity by about 20 percent in North America and 10 percent in Europe.  The business will also have reduced its workforce by 22 percent.

This strong financial discipline is part of our culture. This provides Dow with the strength and stability needed to navigate even in these challenging times.

And speaking of strength and stability, nothing communicates this more than our cash dividend.

As you can see on slide 14, Dow has a long and distinguished dividend history.

And according to my research, Dow is the only company in the Fortune 200 that has either maintained or increased its regular quarterly dividend since 1912.

This includes paying our dividend through two world wars, the Great Depression, the oil shock of the 70’s, the savings and loan collapse of the 80’s, the Asian financial crisis in the 90’s, as well as numerous industry cycles.

That’s 388 consecutive quarters of remunerating our shareholders without reduction or interruption.

I would like to reassure our investors that we have every intention to continue this long standing tradition.

And at today’s stock price, our dividend yields over 7 percent, making Dow a very appealing investment choice.

In the time that remains, I would like to update you on the two large transformational actions we have underway.

First, on slide 15, I would like to discuss the formation of K-Dow Petrochemicals, our joint venture with our Kuwaiti partners.

Over the past 10 months, we have been hard at work on this extremely exciting new joint venture.

We are still on track to close this transaction by the end of the year, which was the expected timing that we communicated when we announced this new JV last December.

When this transaction is complete, we will have created a global petrochemical leader, with sales of approximately $14 billion. In fact, if it were a public company, it would rank in the Fortune 200.

Now, as you can imagine, creating a Fortune 200 company from scratch is extremely complex.

This carve out includes over 60 plants at 15 manufacturing sites and 11 joint ventures in 11 countries. Given the size and geographic reach of this joint venture, K-Dow is establishing more than 60 new legal entities.

To facilitate the negotiations, a data room containing more than 12,000 documents and over 150,000 pages was established.

More than 1,000 Dow employees have been actively engaged in this project throughout the year.

And because Dow and K-Dow will be both customer and supplier to one another at many sites, we have created approximately 250 supply, service and technology agreements.

It’s important to note that these agreements will preserve the value of Dow’s integration, and our ability to supply our Performance businesses with key raw materials.

Recently, we named the K-Dow leadership team and announced that its corporate headquarters will be located in southeast Michigan.

The management team at K-Dow will consist of both Dow and Kuwaiti leaders who have many years of experience with the businesses being contributed to the JV, and in operating successfully through numerous petrochemical industry cycles.

This management team has already been working diligently to obtain financing for K-Dow. As a result of this effort, K-Dow will have the funds necessary to successfully operate and grow on Day One.

This is clear recognition that these are high quality businesses and are strong cash generators throughout the ethylene cycle.

Needless to say, this also speaks to the reputation and financial strength of both parent companies.

Kuwait Petroleum Corporation is one of the world’s top ten energy companies.

So, where are we in the closing process?

Well, regarding regulatory approvals, the transaction has received clearance from the FTC here in the U.S., and the European Commission.

And the project has been cleared by the Committee on Foreign Investment in the U.S., also known as CFIUS, due to it being deemed outside of their scope.

This transaction has also been approved in Kuwait by the Boards of Directors of both PIC and its parent, Kuwait Petroleum Corporation.

We are currently awaiting final approval from the Kuwaiti government via their Supreme Petroleum Council.

As I said earlier, we remain on-track to close this transaction by the end of the year.

Next, on slide 16, I would like to talk about our announced acquisition of Rohm and Haas.

We remain on track to close this transaction in the early part of 2009, pending regulatory approvals.

In order to complete the transaction, we have secured a $13 billion bridge loan. This facility has been fully committed and successfully syndicated amongst 19 banks with very favorable terms and conditions.

We have also secured $4 billion in convertible preferred securities for this acquisition – $1 billion from the Kuwaiti Investment Authority and $3 billion from Berkshire Hathaway.

These two facilities are contingent upon the close of the Rohm and Haas acquisition and are also committed.

As you’ll recall, these securities carry a coupon of 8.5%.

Now I believe Warren Buffet chose to invest in Dow because we have a good brand, an excellent management team, and a sound strategy and business position in our industry.

I also believe his involvement in this transaction is a sound endorsement of our transformational strategy, and the long-term value it will create.

After utilizing these funding sources, and the proceeds from the formation of K-Dow, we expect to draw approximately $4 to $6 billion from the $13 billion bridge facility in order to complete the acquisition.

As we said in July, Rohm and Haas is a strong operational fit for Dow, and this combination brings together best in class products and technologies, broad geographic reach and leading industry positions in coatings, electronics and adhesives to create an outstanding business portfolio with significant growth opportunities.

We are also making great progress on identifying synergies between the two companies.

We remain confident we will achieve the $800 million in cost synergies we announced back in July.

And I’d like to remind you that this $800 million we committed is in addition to the $110 million announced restructuring program that Rohm and Haas already has underway.

And, given the current economic climate, we are already identifying new ways to accelerate the implementation of the $800 million synergy commitment. As a part of this acceleration effort, we have set a goal to be at a $100 million annual run rate by Day One of the New Dow – an achievement rare in acquisitions.

Here are just a few examples of the work that has begun to get us to this run rate commitment.

First is an example in the IT space, where we will be able to immediately rationalize similar capabilities and stop redundant project work. In fact, just looking at Dow’s current IT activity, we have already identified 100,000 hours of active project work that could possibly be eliminated.

This is especially true in SAP development and implementation.

Another example is in the purchased services area, where we expect to have reductions in spending on IT from critical vendors based on the increased scale of the new company.

We’ve set an aggressive timeline to implement these cost reductions, where we fully expect to achieve a run rate in the range of $40 to $50 million in savings immediately following the close of the transaction.

Next is an example in marketing and sales.

We believe Rohm and Haas has a best-in-class marketing organization in our sector and knows how to drive profitable growth from customer driven technologies and products.

It is our intention to integrate this capability throughout Dow. Doing so will achieve marketing and sales cost synergies with an estimated run rate of $30 million dollars on Day One as well.

So as you can see, the majority of the $100 million Day One run rate has already been identified.

Finally, in order to accelerate the capture of synergies post-closing and be ready to implement on Day One, we have launched a number of “Clean Teams” to focus on both cost and growth synergies.

This is similar to what we have done on many successful acquisitions in the past.

Clean Teams are typically comprised of third parties such as Dow retirees or independent consultants who do much of the pre-work in advance of closing.

These teams gather and analyze the data, as well as formulate recommendations which will be shared with the implementation teams immediately after closing.

Clean Teams have been established in the functional areas of Purchasing, Supply Chain, Tax, Controllers and Manufacturing.

All of these efforts are aimed at jump starting synergy capture on Day One.

As you can see on slide 17, here is a summary of the major categories of savings we have identified in our $800 million dollar commitment.

In summary, we remain very confident in our ability to deliver total savings of at least $910 million, and to do it quickly after close.

I’d like to share with you a few more updates on important milestones regarding this transaction.

We are currently responding to a second request for information which we received from the FTC in the U.S. and we are cooperating.

In an effort to mitigate potential anti-trust issues, we proactively announced that we are exploring divestiture options for our Clear Lake, Texas acrylic acid and esters business, as well as our UCAR Emulsion Systems specialty latex business in North America.

We are also cooperating in the European Commission’s review of this transaction and are on-track to file regulatory documents in that process.

And finally, there is a Rohm and Haas shareholder vote on the proposed acquisition, which is scheduled for October 29.

At this point, we are not aware of issues that would prevent us from achieving any of the milestones I just outlined, and we reconfirm our intent to close this transaction in the early part of 2009.

Our acquisition of Rohm and Haas is very consistent with our strategy – increase the percentage of specialty businesses in our portfolio so that we are better able to withstand the ups and downs of the economic and industry cycles, and most importantly - create shareholder value in the long term.

Turning now to slide 18, I would like to make a few comments about our outlook and what to expect from Dow in the fourth quarter.

The global economy is now clearly feeling the effects of the same economic issues that have plagued the U.S. for the past several quarters.

These issues have been magnified by a lack of consumer confidence resulting in a drop in demand not only in the U.S., but around the world.

While feedstock and energy costs have significantly declined from the all-time highs we experienced recently, we believe margin expansion in the fourth quarter will likely be muted by weakening demand.

As I mentioned earlier, Dow is well positioned to weather this increasingly difficult economic downturn.

We have a strong balance sheet, we have a track record of strong financial discipline and we are accelerating our focus on what we can control, namely price/volume management as well as cutting costs, deferring or canceling capital spending and continued business portfolio management.

In addition, we will continue to implement actions that are aligned with our transformational strategy, such as completing our petrochemicals joint venture with our Kuwaiti partners and closing our announced acquisition of Rohm and Haas.

Thank you very much, and at this time, I will hand the call back to Howard for the Q&A portion of the call.

⁽¹⁾ Earnings before interest, income taxes and minority interests (“EBIT”). A reconciliation of EBIT to “Net Income Available for Common Stockholders” is provided in Dow’s 1st Quarter 2008 Earnings Release.