Dow CEO & CFO Analyze 3rd Quarter Earnings

Third Quarter 2015 Earnings
The Dow Chemical Company

October 22, 2015

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

Remarks By:

Andrew N. Liveris, Chairman and CEO
Howard Ungerleider, Executive Vice President and CFO
Jack Broodo, Vice President, Investor Relations

J. Broodo

Good morning and welcome. I am Jack Broodo, Vice President of Investor Relations.

As usual, we are 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 Chief Executive Officer and Howard Ungerleider, Executive Vice Chairman and Chief Financial Officer.

Around 7:00 a.m. this morning, October 22, our earnings release went out on BusinessWire and was posted on the Internet on We have prepared slides to supplement our comments in this conference call. These slides are posted on our website, and through the link to our webcast.

Some of our comments today include statements about our expectations for the future. Those expectations involve risks and uncertainties. We cannot guarantee the accuracy of any forecasts or estimates, and we don't plan to update any forward-looking statements during the quarter. If you would like more information on the risks involved in forward-looking statements, please see our SEC filings.

In addition, some of our comments 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 and on our website.

Unless otherwise specified, all comparisons presented today will be on a year-over-year basis. Sales comparisons exclude divestitures and acquisitions. EBITDA, EBITDA margins, return on capital and earnings comparisons exclude certain items.

The agenda for today's call is on slide 3. I will now turn the call over to Howard.

H. Ungerleider

Thank you, Jack, and good morning, everyone.

Turning to slide 4.

Our results this quarter demonstrate once again the value of Dow’s integrated, structurally hedged portfolio, our focus on execution, and the strong financial position the company has built: Operating EPS rose to $0.82 – an increase of 14 percent year over year. Operating EBITDA rose to $2.4 billion versus the same quarter last year on continued demand growth, margin expansion and self-help actions. Volume grew in nearly all geographic areas – reflecting stable underlying demand for Dow’s innovative solutions. And operating EBITDA margins expanded in nearly all operating segments – reaching 20 percent, up 370 basis points year over year the highest quarterly result since 2005.

Our disciplined approach to price/volume management enabled us to deliver these results even in the midst of ongoing topline headwinds – with year-over-year price declines in oil of 50 percent and currency headwinds of 17 percent for the EURO and 51 percent for the Brazilian Real.

The consistent earnings growth, margin expansion and strong cash flow results we delivered in Q3 continue the steady drumbeat over the last 12 quarters, and underpin our ability to return increasing value to our owners, as illustrated on slide 5.

As we have covered in past quarters, we benchmark our quarterly results against key financial goals that provide a clear view on our performance. Quarterly EPS has grown at 21 percent CAGR over the last 3 years, on an operating basis. And I think it is important to note that the one-time gains resulting from portfolio actions has resulted in an additional $0.71 of as-reported EPS above the year-to-date operating EPS of $2.58. Operating ROC is now 11.9 percent, up more than 170 basis points versus the same quarter last year and we expect ongoing improvement as our growth levers – particularly on the U.S. Gulf Coast and in Saudi Arabia – continue to produce and as we complete our portfolio management actions. Cash from operations reached $2.5 billion in the quarter – up $700 million – or 41 percent versus the year-ago period and has now reached $8 billion over the last twelve months. And we continue to return this cash to shareholders – year to date, Dow has returned $1.9 billion to shareholders through declared dividends and share repurchases.

Additionally, our recent completion of the Dow Chlorine Products divestment, which successfully closed on October 5th had a tax-efficient value of $5 billion, or taxable equivalent value in excess of $7.5 billion.

This is an unprecedented value for a commodity business and created a win/win/win for Dow, for Olin and for shareholders of both companies. Overall, as a result of the transaction, our net debt went down by $3 billion, and $1.5 billion in Olin common stock was distributed to Dow shareholders in exchange for 34.1 million shares of Dow stock. A slide is available in the appendix for additional details.

Let’s please now turn to segment operating results, on slide 8.

In Ag. Sciences, operating EBITDA for the segment was down from the year-ago period, reflecting declines in price, the sale of AgroFresh, and a gain of $44 million from the one-time sale of a joint venture.

The business saw continued strong demand for new crop protection molecules, with a 40 percent increase in new product sales versus the same quarter last year and an 8 percent increase year to date, led by strong growth in spinetoram insecticide. Results in the quarter also reflected significant improvement in year-over-year cost reduction actions.

Overall, the Ag market continues to be challenged with high inventory levels and currency pressures more than offsetting higher volume gains in Europe, Middle East, Africa, India as well as North America. We expect ongoing weakness to continue over the next 12 to 24 months. While conditions in Brazil Ag were weak in the quarter, Dow continues to gain share and, in fact, has now moved up to second place in corn seed market share. Dow also achieved a significant regulatory milestone with the approval of ENLISTTM cotton.

Moving to slide 9, Consumer Solutions reported record operating EBITDA, despite a year-over-year decline in equity earnings.

Dow Automotive Solutions achieved a quarterly operating EBITDA record reflecting growth in both OEMs, as we see continued adoption of aluminum, high-strength steel and composites, as well as in our aftermarket segments. Our business continues to outpace industry growth, driven by Dow’s innovative structural adhesives solutions, and there is significant upside potential as we expand into adjacent applications.

Consumer Care volume grew in Pharma and Personal Care sectors offset by sales declines in the lower margin Home Care and Industrial markets, as well as by ongoing currency headwinds. We continued to see demand strength in the high-value portions of our cellulosics chain.

In Dow Electronic Materials, EBITDA growth in Semiconductor and Display was offset by declines in Interconnect technologies. Display profitability was improved this quarter by self-help actions, including the intentional exit of low-margin business and our focus on upgrading the portfolio.

Turning now to Infrastructure Solutions on slide 10, overall operating EBITDA for the segment decreased as growth within several businesses was offset by declines in equity earnings, reflecting a one-time tax credit Dow Corning received in the third quarter of 2014.

Dow Building & Construction reported record quarterly operating EBITDA as well as volume growth in most regions – particularly in cellulosics and sprayfoam technologies. Our innovative product lines are driving growth that is outpacing that of global construction markets, and our proprietary flame retardant technology is capturing attractive licensing income.

Dow Coating Materials reported volume gains in most regions led by double-digit growth in EMEAI. The business has expanded its market participation with a robust innovation pipeline in new vinyl acrylic binders and rheology modifiers across a broad range of customers.

On a global scale, Performance Monomers continues to remain in industry-wide, trough-like conditions.

Energy & Water Solutions reported double-digit volume growth in emerging markets for reverse osmosis solutions, partially offsetting declines in energy sales in North America.

Turning to slide 11, Performance Materials & Chemicals reported a decline in EBITDA, reflecting the impact of divestitures and lower MEG pricing. Strong volume in Asia Pacific as well as in a majority of businesses, was more than offset by global pricing pressures and ongoing currency headwinds.

Industrial Solutions reported earnings declines due to compressed glycol margins and weakness in North America oil and gas drilling demand.

Polyurethanes once again continued to deliver strong volume growth, with share gains due to broader market participation, expanding system house sales, the startup of our Thailand polyols plant, as well as underlying fundamental demand growth in EMEAI and Asia Pacific.

On slide 12, Performance Plastics EBITDA achieved record levels due to robust demand in all businesses.

Dow Packaging and Specialty Plastics reported a record quarterly operating EBITDA as the business captured gains from demand growth in emerging markets, high operating rates, strong asset reliability and tight inventory across the chain.

Dow Elastomers delivered a second consecutive quarterly operating EBITDA record due to demand in key markets such as transportation, high-end footwear and infrastructure.

And Dow Electrical and Telecommunications also reported volume growth in North America and EMEAI as new home sales and construction spending rates trended higher.

Turning to slide 13, we want to illustrate the importance over time of owning the full polyolefin value chain. As you can see, the source of income has shifted over time. It is hard to predict which bucket the value will come from in any given period. In the 2002 trough for example, the ethylene-to-naphtha spread was high in very weak markets with some contribution from the oil-to-gas spread. Our differentiation in 2002 was much lower than it is today. In the strong markets of 2005, there was virtually no oil-to-gas spread. In 2009, Dow retained market share and decent trough margins due to product differentiation, while competitors that didn’t own the differentiation or feedstock flexibility struggled to the brink of insolvency.

In 2014, the oil-to-gas spread was the main driver of margins but full chain integration and differentiation played an important role. This differentiation for Dow is based on unique resins and polymers, process, and co-founder monomer combinations. In 2015, the margin has been shifting to both the polymer and to differentiation as supply/demand tightness – especially across the integrated chain – continues to progress, even in a climate of soft GDP.

The Dow strategy has been to continue to be a leader in all three of the margin opportunity buckets, leveraging the Dow material science backbone to provide differentiation that amplifies that performance.

I also want to take a minute and share our latest outlook on supply/demand for the ethylene/polyethylene value chains on slide 14. This outlook utilizes the most recent GDP forecasts, assumes historical growth multiples to GDP, a gradually recovering China, as well as the latest data on capacity additions.

Integrated polyethylene and elastomer balances are tight today and the outlook indicates these balances will stay tight for at least the next several years. Additional tightness is likely to come from industry operating reliability issues, both at the monomer and polymer stages of the value chain. As we have discussed many times, much of these assets are old, and unplanned outages have been and likely will continue to happen at relatively higher frequencies. With these tight industry balances, any significant unexpected “operating event” will be met by shortages and a pricing response – which has certainly had an impact on conditions in the U.S., Europe and Asia in the last two years.

The bottom line in our view is that Dow is well positioned for favorable ethylene and polyethylene industry conditions through at least 2020 based on current announcements and timing to complete the projects.

Before I turn it over to Andrew, let me provide modeling guidance heading into the fourth quarter on slide 15.

I’ll just cover some highlights.

On a year-over-year basis, the fourth quarter will be impacted by divestitures, mainly AgroFresh, Angus, SBH and Dow Chlorine Products, in three material ways: first, on the revenue line, please remember revenue will be lower by $1.3-$1.8 billion, we also expect to realize a negative impact on EBITDA of between $150-$225 million. And, depreciation and amortization will be lower by $35-$50 million.

The other item I would like to point out is the tax rate for the fourth quarter will likely be between 24 and 27 percent on an operating basis. If Congress enacts the extenders R&D benefit before year-end, we will settle at the low-end of the range.

As you all know, we closed the Dow Chlorine Products transaction October 5th, which will have a tax impact on the as-reported earnings in the fourth quarter. As a result, we expect our as-reported tax rate will be between 10 to 13 percent.

Once again we provided the popular macroeconomic heat map in the appendix of this presentation.

And now I will turn it over to Andrew, who will provide an update on our outlook as well as strategic drivers for the next twenty four months.


Thank you, Howard.

In slide 15 you will see in just a few moments, I will share more details on the next series of goals we are driving in our portfolio transformation over the next two to three years.

At our Investor Day in 2014, you can see on slide 16, we summarized what you could expect from Dow for the next 12 months. This series of commitments was a continuum from our 2013 strategy reviews undertaken by our Board, which culminated in a series of choices in our growth engines and our self-help actions. What underpinned those reviews in 2013, and was reinforced by our statements at the Investor Forum in 2014 is that: We are an emergent and are a cash flow story. That our portfolio fine tuning would continue with an acute focus on carving out our chlorine chain and cleaning up our joint ventures. That we would raise our divestment target to $7 to $8.5 billion. We would continue to fund innovation and organic growth with no big M&A. And that we would return cash to our shareholders through dividend increases and share buybacks.

Slide 18 is a read-out of how we did versus what we said. We have over achieved our targets and there is no gap between what we said and what we did. We have built a portfolio that has as its foundation both integration and innovation, and is structurally hedged to handle all economic conditions, and as I’ve already referenced is a cash flow machine.

Let’s go to slide 19. As a result of these achievements, the Dow Board and management have deliberated on our focus for the next 24 – 36 months and have built a simple roadmap for this period.

And the goals on this page are clear. Our execution focus over these last three years has been granular and laser-like. This will continue. First, our productivity goal of $1 billion of cost reductions over three years starting in 2015 will be delivered through Dow’s previously announced change management program, Dow 10.0.

Second, our large assets in Sadara and on the U.S. Gulf Coast are commencing their commissioning phases. These huge new assets will change from being investment headwinds to cash and earnings tailwinds. Our CapEx will be ranged down to near depreciation levels over the next two years. We anticipate no new mega-projects during these next five years.

Third, we will conclude our joint venture portfolio work by providing full clarity on our large JVs and their future in Dow. And turning to slide 20 – On Kuwait, these large, highly profitable JVs will pivot through equity restructuring and move to a growth focus. Our partners in Kuwait are excited at the opportunity to consolidate all of their JVs under one ownership umbrella, retain Dow as a minority partner and move forward to a growth path, while extracting synergies in their consolidation.

The deal structure on this slide will yield over $3 billion of pre-tax proceeds to Dow by mid-2016, with $1.5 billion by the end of 2015. On slide 21, our joint venture of 72 years, Dow Corning, is a tremendous asset with a focus on specialty materials and specialty chemicals and polysilicon via the Hemlock JV.

Dow and Corning are in discussions around a potential transaction involving Corning’s ownership in Dow Corning. We will have more to say on this in the not-too-distant future.

Slide 22 – Dow’s portfolio work over these last five years has been to methodically exit commodity, cyclical value chains such as styrene, butadiene, chlorine and all their derivatives.

And as you can see on slide 23, these commodities exhibit no predictability, either on their input price (mostly oil), or their output price (which have been commoditized and generic) and have no technology advantage. We have been successful in repositioning the portfolio to growth markets, with clear integration and technology differentiation. Slide 23 shows how we have divested $15 billion of primarily high-beta business over these last six years.

And what is clear to us is that owners are continually looking at ways enterprises like Dow, with all of our attendant complexity, can not only create value, but actually release value.

We are very proud of what Dow has built in the agricultural market via Dow AgroSciences. This business has doubled EBITDA over the last five years and has the most envied technology pipeline in chemistry and in traits. By all accounts, this is a successful business, with a bright future.

So, despite Dow AgroSciences being a low-beta business, there is a rationale, in our opinion, that given the potential synergies in a newly consolidating agricultural market, an attractive opportunity to release value may be upon us. As a result, the Company is only considering those prospects that will extract further value from this business while comparing it to the value of retaining the business.

Slide 24 and 25, the final point on our emphasis goals for the next 24 to 36 months is captured by the notion that we are generating a lot of cash, have more in our imminent future and as slide 23 shows, have been a consistent returner of that cash to you, our shareholders.

This will continue.

We are pleased to announce our dividend increase up to $1.84 per share, representing a new historic dividend level. And we are going to continue to accelerate our share buybacks. And we will continue to return cash to you. We have no plans for any big new CapEx or large M&A in this time frame.

We have built a structurally hedged portfolio with tremendous organic growth drivers.

And slide 26 gives you a sense of these growth drivers.

In fact, Dow’s growth drivers are unique. We have built three strong, integrated pillars of value that uniquely define our enterprise.

We start with cost-advantaged monomers in geographies with attractive markets. In the second pillar, we select into industry-leading science and engineering, enabling us to create value differentiation with our customers, and in the third pillar, we select into attractive growth segments of key markets to lower volatility and drive reliability of earnings and cash flow.

The first and second pillars? Well they define our integration. The second and third pillars? They define and leverage our innovation.

The key is that no one else in this sector brings both operational and commercial excellence across all three pillars.

And If you look at slide 27, our broad scope of scientific capabilities creates a very high competitive hurdle not easily replicated or imitated, creating a benefit for both Dow and more importantly, Dow’s customers.

Just look at the examples of product launched as you can see on that slide. All unique. All highly valuable to Dow and to our customers.

Looking ahead, we believe the market outlook favors the products, technologies and geographic position of the Dow portfolio.

If you look at the market outlook on slide 29, and we expect ongoing expansion of growth opportunities that will enable Dow to continue to capture that growth in markets such as China, the U.S. and Europe, despite challenges in soft pockets around the world, such as Brazil.

We anticipate strength in construction, packaging, and transportation markets as well as in electronics, as the interconnectivity of the world continues to increase, and Dow is well-positioned to manage and, in fact, win from the weakness in agriculture.

Our forecasts indicate that there will be a gradual recovery in the oil markets and gas-based cracking will continue to be advantaged. And in the midst of all of this, our new investments – on the U.S. Gulf Coast and in Saudi Arabia – are coming online at exactly the right time – further boosting Dow’s ability to capture and expand margins.

The bottom line is this: Today’s macroeconomic realities mean the importance of driving differentiation into the portfolio will only increase, and companies that aim to win will need to invest in innovative solutions and work closely with customers.

Overall, Dow’s strategy, our integrated portfolio, our innovation engine, and our proven track record of execution are delivering results.

And going forward. And as always, capturing growth where growth exists is not the only way to demonstrate consistent earnings growth and strong cash flow. Our self-help and productivity actions underpin all of our operational and execution tactics.

Our third quarter results highlight this intense focus on delivering the potential of Dow: 12 consecutive quarters of EPS, EBITDA and margin growth. 8 consecutive quarters of volume growth. The highest EBITDA margin result since 2005.

The Dow machine is generating strong cash flows and returning that cash to its owners.

And today’s announcements outline for you the next 24 to 36 months of actions that will drive continued results and demonstrate our commitment to being exceptional stewards of the opportunities at hand – by combining exceptional capital utilization with our drive to return cash to Dow’s owners across the immediate-, mid- and long-term horizons.

Our team has distinguished itself by its performance.

And it will continue to do so.

With that, Jack, let’s turn to Q&A.

J. Broodo

Thank you, Andrew.

Now we will move on to your questions.

First, however, I would like to remind you that my comments regarding forward-looking statements and non-GAAP financial measures apply to both our prepared remarks and the following Q&A.

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

Thank you everyone for your questions.

As always, we appreciate your interest in The Dow Chemical Company.

For your reference, a copy of our prepared comments will be posted on Dow's website later today.

This concludes our call for today. We look forward to speaking with you again soon.

Use of non-GAAP measures: Dow’s management believes that measures of income excluding certain items (“non-GAAP” measures) provide relevant and meaningful information to investors about the ongoing operating results of the Company. Such measurements are not recognized in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and should not be viewed as an alternative to GAAP measures of performance. Reconciliations of non-GAAP measures to GAAP measures are provided in the Supplemental Information tables.

Note: The forward looking statements contained in this document involve risks and uncertainties that may affect Dow’s operations, markets, products, services, prices and other factors as discussed in filings with the Securities and Exchange Commission (“SEC”). These risks and uncertainties include, but are not limited to, economic, competitive, legal, governmental and technological factors. Accordingly, there is no assurance that Dow’s expectations will be realized. The Company assumes no obligation to provide revisions to any forward looking statements should circumstances change, except as otherwise required by securities and other applicable laws.