Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

The Dow Chemical Company (NYSE:DOW)

Q4 2008 Earnings Call

February 03, 2009 10:00 AM ET

Executives

Howard Ungerleider - Vice President of Investor Relations

Andrew N. Liveris - Chief Executive Officer and Chairman

Geoffery E. Merszei - Executive Vice President and Chief Financial Officer

Analysts

David Begleiter - Deutsche Bank

Frank Mitsch - BB&T Capital Markets

Sergey Vasnetsov - Barclays Capital

Jeffrey Zekauskas - JPMorgan

Michael Judd - Greenwich Consultants

Kevin McCarthy - Bank of America

John Roberts - Buckingham Research

Operator

Good day everyone and welcome to The Dow Chemical Company's Fourth Quarter 2008 Earnings Results Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Howard Ungerleider, Vice President of Investor Relations. Please go ahead sir.

Howard Ungerleider

Thanks Jennifer. Good morning everyone and welcome. 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 expressed 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, Investor Relations.

Around 6:30 this morning, February 3rd, our earnings release went out on PR Newswire and was posted on the Internet on Dow's website, dow.com.

Also, earlier this morning, we filed our answer to the lawsuit filed by Rohm and Haas. This answer is also posted on our website. 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 could 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 SEC filings and annual reports are available on the Internet at dow.com in the Financial Reports page of the Investor Relations section.

On slide three, I would like to run through the agenda for today's call. As is our year-end practice, Andrew will lead us through a 2008 year-end review and provide an update on several specific actions we have taken to address the current global financial and economic crisis. He will then discuss the outlook for the first quarter of 2009 and beyond as well as the next steps related to our Basic Plastics joint venture and the Rohm and Haas transaction.

Before he does, I would like to very briefly cover the fourth quarter and the key drivers of our performance in the period beginning on slide four.

Sales for the quarter were $10.9 billion, down 23% from the same quarter last year. Declines were reported in all geographic areas and in all operating segments except Agricultural Sciences, which posted record fourth quarter sales of 885 million. Volume declined 17% with declines in all operating segments except Agricultural Sciences and Hydrocarbons and Energy and in all geographic areas. Price declined 6% as price increases in Performance Plastics, Performance Chemicals and Ag Sciences were more than offset by declines in the basics businesses. Purchased feedstock and energy costs fell by 23% or $1.2 billion versus the same quarter last year.

Now let's walk through each of our reporting segments. In Performance Plastics, on slide five, prices held in the quarter despite the drop in feedstock and energy costs. Further deterioration of the automotive and construction sectors, however, unfavorably impacted volumes in the quarter. And in response to the decline in demand we experienced, we reduced the operating rates to historically low levels, which resulted in increase in our unabsorbed fixed costs.

In Performance Chemicals on slide six, double-digit price increases were reported in nearly all geographies as strength in Dow Water Solutions as well as food and pharmaceutical applications served by Dow Wolff Cellulosics continued. However, this good news was more than offset by declines in volume, a result of demand destruction which negatively impacted profitability.

Turning now to slide seven, Agricultural Sciences set another fourth quarter sales record, driven by growth in Seeds & Traits. Dow AgroSciences continued to deploy its growth agenda with two more acquisitions in the quarter, bringing the total number of acquisitions to nine since May 2007. New products such as aminopyralid, penoxsulam, pyroxsulam and spinetoram also continued to ramp up successfully.

Results in Basic Plastics on slide eight were impacted by volume declines and inventory destocking brought about by the global economic environment as well as declines in price, due in large part to the drop in feedstock and energy costs.

In Basic Chemicals on slide nine, the story was similar. Strong caustic soda prices were more than offset by lower demand in vinyl chloride monomer used in PVC production for housing and construction applications. Further declines in EO/EG [Ethylene Oxide/Ethylene Glycol] demand for polyester fiber production in Asia also hurt overall operating results.

All of this led to a reported loss of $1.68 per share as you can see on slide 10. Excluding certain items, the loss was $0.62 per share.

Slide 11 shows an itemized list of these certain items and their EPS impact. In addition, earnings for the quarter reduced by a much higher effective tax rate than we have seen in prior quarters, which included an unfavorable impact of $295 million or the equivalent of $0.32 per share.

Now I'd like to turn the call over to Andrew for his comments.

Andrew N. Liveris

Thank you, Howard, and good morning everyone. Thanks for joining us as I review 2008 and give you a glimpse of what 2009 looks like. I promise you, I will cover every topic that's on the minds of everyone who follows our company. We have never shied away from the truth neither in good times or bad and we are not going to start now.

So as you turn to slide 13, there are five things I would like you to take away from my comments today.

First, the financial results are very disappointing and a reflection of the demand deterioration we saw in global markets and the turmoil in the financial world.

Second, we have a very good cash flow story to tell as the interventions and quick actions we committed to take as the crisis unfolded helped us create cash in a very difficult economy. The fact that we quickly and proactively started this work in the early fall helped us meet our cash goals.

Third, we have taken and will continue take actions to repair the company for both the current economic downturn and the continued implementation of our long-term strategy.

Fourth, considering today's economy, we remain a strong company with many options moving forward. Although we had a very significant setback in December to our long-term strategy, it was a temporary setback. I say again today, we are committed to our strategy and we will address the setback as creating a pause in our implementation.

And fifth, we are committed above all else to maintaining an investment grade rating and are prepared to take all necessarily steps to do so.

With that framework, let's begin by looking back at 2008.

As everyone on this call knows, 2008 proved to be a very tough year for everyone in our sector, or in any industry for that matter. What started out as the fear of inflation at the beginning of the middle of the year quickly morphed into a banking and credit crisis that ultimately caused the U.S. economy to totally disintegrate in the latter part of the year, which then affected the entire global economy in a heartbeat. The meltdown was swift and unprecedented in modern times. So in many ways, it was a tale of two years.

In the first half, we weathered a huge run-up in feedstock and energy costs, which net-net resulted in us recording the sixth consecutive year of double-digit percentage increases in feedstock and energy costs. And just when raw material costs seemed to moderate and thoughts of margin expansion began to reappear, however, we were hit with two major hurricanes on the U.S. Gulf Coast, which disrupted over 80% of our North American capacity.

Also in the second half of the year, financial markets unraveled and took with them consumer confidence. The rapid demand destruction and unprecedented destocking throughout almost every value chain is something none of us have ever experienced. The impact of this global economic correction in the fourth quarter was inescapable, and that is reflected in the financial results we recorded in 2008 with the fourth quarter being one of the worst quarters we have seen in more than two decades.

For the year, we once again posted record sales, a reflection of our ability early in the year to push through two unprecedented companywide price increases. The price increases helped offset the $5.9 billion year-over-year increase in purchased feedstock and energy costs but did little for margins.

Overall volume however was negatively impacted by the world's economic problems. What begins as luck less the demand in the United States spread through every geography, leading us to an overall volume drop of 5% year-over-year. The vast majority of that occurred in the fourth quarter.

Equity earnings, which were robust for the three quarters of 2008, fell for the year to $787 million. The combination of demand destruction, particularly in the EO/EG polyester chain, lower oil prices and naphtha disconnecting from oil in the quarter caused our Basics joint ventures, which are typically advantaged to also suffer, the reality is that demand destruction, which of course drives oil prices lower, will hurt even these cost advantaged joint ventures.

Excluding certain items, 2008 earnings per share were $1.82 versus $3.76 in 2007.

If you turn to slide 15. Given the speed of the deteriorating economy in the fourth quarter, we responded with two proactive interventions: one in October and one in December. The larger of the two interventions was December's where we announced a workforce reduction of 11%, the divestiture of non-strategic businesses, the shutdown of 20 facilities and the idling of 180 more.

We also exceeded our proactive cash preservation interventions by reducing DSI by four days, reducing discretionary spending by more than $225 million and reducing our volume of inventory by almost $900 million. In addition, we took aggressive steps to match our production to demand, leading to a fourth quarter operating rate of 64%. In fact, Dow's operating rate in December was a dismal 44%, levels we have not seen in over two decades.

Nevertheless, the actions we implemented helped us maintain good cash generation throughout the year. In the fourth quarter, management intervention substantially contributed to cash provided by operating activities of $2.2 billion and free cash flow of $1.2 billion in the quarter. Cash provided by operating activities was $4.7 billion in 2008, an improvement of more than $200 million versus 2007.

I would like to point out that those results came in the face of deteriorating economic conditions at the back end of the year. We ended the year in a good position with $2.8 billion of cash on hand and a net debt to total capital below 40%.

As for our outlook, I wish there was more positive news to share. As each day brings more and more negative news on the economy and job losses, we are assuming that late 2008 demand levels will continue for several quarters and possibly beyond.

There are a few bright spots in the markets, which suggest there may be some recovery in the second half of the year. In Agricultural Sciences, for example, farmers are coming out of 2008 in a relatively strong position and we expect growth in seeds and traits and a continued ramp up in new product sales. The long-term fundamentals in this segment have not changed.

In Europe, we're seeing the trends for higher energy efficiency standards are driving insulation sales and offsetting the declines in construction activity. In fact, insulation sales worldwide should increase as this trend continues to develop, perhaps aided by government stimuli and regulations. Increased government spending on infrastructure rehabilitation could also help stabilize demand in specific segments. If this in fact occurs, Dow would be in a strong position because of our unique and proven solutions for roads, highways, bridges and other infrastructure projects.

The fundamentals for the water industry remain strong as well. That's good news for Dow Water Solutions. Fourth quarter 2008 was actually the best quarter in the history of that business with sales up 33% year-over-year, driven by timing of some very large projects. For the full year, revenue was up 22%. There is also a good possibility for an uptick with polyethylene as well. A significant chunk of our polyethylene is sold into packaged goods and the underlying volume in that segment is resilient. There was a huge inventory drawdown in the latter part of the year, which negatively impacted 2008 results. We believe the possibility exists for restocking going forward.

Now let me point out that polyethylene going back many decades has had steady annualized growth and we have never seen two back-to-back down years in volume. With the underlying fundamentals of the segment and possibly restocking, we see the potential for an upswing for polyethylene and potentially an early except from this vicious demand-led trough, although the timing is unknown at this juncture.

So there are a few bright spots. Notice that many of those appear to be driven by government stimulus packages aimed directly consumer spending and improving energy efficiency. Some of the stimulus packages targets are in infrastructure, housing and energy efficiency. So they do hit sweet pots for Dow, and in that regard we would like to be cautiously optimistic. But many of the stimulus packages being rolled out are skewed towards the back end of 2009 and beyond, especially on infrastructure projects.

Our view is that until these various stimulus packages translate into real jobs, consumers will most likely favor saving over spending and the economy will continue to drag. We do expect to see slight increases in demand month to month as inventory levels throughout the value chain are replenished. Where that can be sustained and for how long is unknown at this point.

The bottom line is that we are preparing for the recession to persist through 2009 and are running our business accordingly. We are assuming that the late 2008 demand levels will continue for several quarters and possibly beyond.

If you turn to slide nine, please note since we can't control the economy or the markets, however, we are left to manage those things within our control. So expect us to retain an intense focus on generating cash and pushing productivity throughout 2009, just as we did in 2008. Protecting the balance sheet and maintaining financial flexibility will be the key drivers for Dow in 2009. The fallout from the historic economic meltdown we are currently experiencing would have been difficulty enough for any company to manage of course. We are seeing many companies in out sector and beyond simply succumb.

By itself, however, it would not have been enough to impact our strategy. After all, this company is 112-years old. We have survived two world wars, the Great Depression, numerous recessions in industrial cycles. We have an experienced management team steeped in financial discipline with an execution mindset. So we were confident that the interventions I mentioned earlier were the right steps that would allow us to manage this downturn.

But as you all aware, we were in for a more stunning and ill-timed surprise.

On December 28th, Dow was verbally informed that the Kuwait Supreme Petroleum Council, without justification, buckled under political pressure and reversed its prior commercial decision approval of the commercial binding and definitive agreement between Dow and the Petrochemical Industries Corporation of Kuwait on the formation of K-Dow. PIC then formally informed us in writing on December 31st that they were not going to go forward with the scheduled January 2 closing.

Of course, we were not just surprised; we were extremely disappointed by PIC's breach of the November 28th joint venture formation agreement. We had a signed, binding and definitive agreement and had dedicated significant resources for over a year to complete this transaction. Furthermore, we had at the request of the Supreme Petroleum Council renegotiated the deal in November with PIC and agreed to a lower price to reflect the marketplace realities.

As we have said publicly, we are pursuing legal options to enforce our rights and remedies as a result of PIC's failure to close the transaction and the improper actions of others in Kuwait, including the Supreme Petroleum Council. PIC has breached the K-Dow formation agreement and we are taking every action necessary to protect our interests.

I am not in a position to discuss all these actions today. But I can say this involves more than just arbitration with PIC. In addition to initiating the London-based arbitration process against PIC shortly after PIC failed to close the transaction, in early January, we filed a lawsuit against other Kuwaiti parties that I am not at liberty to discuss right now.

In the meantime, we are working to find an appropriate resolution. Make no mistake: between the arbitration and litigation, Dow will be seeking damages in excess of $2.5 billion.

This behavior of the Supreme Petroleum Council has clearly had a significant, but, in our view, temporary impact on the implementation of our strategy to change the portfolio mix up our company and establish Dow as a reliable and consistent earnings growth company.

Note that I used the word temporary. Let me stress that this management team remains committed to our strategy as does our Board of Directors. It is the right strategy, we remain a strong company and we will not let a temporary setback detour us from advancing towards our strategy in a very deliberate but prudent way. However, we are also realists. We know that this is major setback and we know we have to get our house in order before we resume implementation of our strategy.

A key part of that strategy was to go downstream through organic growth and acquisitions. And as you know, last July, we announced the acquisition of Rohm and Haas. We were firmly down that path that we would close the acquisition on time when the Kuwaiti deal fell apart.

We saw and still see the Rohm and Haas transaction as being consistent with our long-term strategy: Good markets, good assets and good people. But it's the collective job of this management team and the job of the Board of our company to protect the interest of the shareholders and protect this enterprise called Dow. Recent material developments have created unacceptable uncertainties on both the funding and the economics of the proposed combined Dow Rohm and Haas enterprise.

Proceeding with the deal at this time under these conditions would do irreparable harm to our mutual stakeholders and will jeopardize the future of both companies. It's important to remember that the world has shifted greatly since this deal originated. We are in the midst of a unique economic meltdown now full of economic uncertainties. This is the most difficult market in 75 years, dramatically reducing the availability and certainty of borrowing. We must consider this fact and realize that is in the best interest of both Dow and Rohm and Haas to delay closing until the economic uncertainties are resolved.

Rohm and Haas has filed suit in the Court of Chancery of Delaware seeking specific performance, which would essentially be an order forcing us to close the transaction now, regardless of all of the pending uncertainties. We are highly respectful of the litigation process. And it came as no surprise under the circumstances. At the end of the day the Chancery Court must render an equity-based order based on all the facts and circumstances.

We filed our response to that suit this morning. And this response sets out in detail our position that when all the facts and circumstances are balanced, it will do more harm than good to force this transaction to close now.

As this matter is in litigation and in deference to the process in the Delaware court, we will not have much more to say right now. And I will not answer questions about this topic in today's Q&A session.

But let me stress this. We have the highest respect for Rohm and Haas, its management and its employees. We are ready to sit down with Rohm and Haas immediately to discuss any options that could allow this transaction to close in such a way that the combined organizations will be successful going forward.

Now obvious question we get is this. How are our actions regarding the Rohm and Haas transaction different than PIC's actions concerning the K-Dow transaction?

Let me address that now by turning to slide 22 because here are some important differences. Let me be clear. Dow is not closing the Rohm and Haas acquisition at this time due to the impact of the combination of our very distinct items: One, PIC's wrongful failure to close the K-Dow transaction on January 2, 2009; two, the unprecedented uncertainty stemming for the rapidly deteriorating world economy.; three, the resulting negative impact on chemical industry demand and four, the historic meltdown in the financial and credit markets.

Taken together, these factors create too much uncertainty around the prospects of the proposed combined Dow and Rohm and Haas enterprise.

PIC on the other hand failed to close on its binding K-Dow commitment after the Kuwait Supreme Petroleum Council's commercial decision was improperly influenced by political pressure. This commercial decision was not based on the deteriorating economy as the deal had just been renegotiated to reflect the new economic realities and the new economic uncertainties.

Let me repeat that Dow renegotiated our deal with PIC in November to reflect the changed market realities. Dow agreed to reduce the price by almost 20% from the value agreed to in principle a year ago, and then the deal was breached in December. By contrast, we negotiated with Rohm and Haas in July when oil prices were high and before the unprecedented economic collapse around the world. The stunning failure by the Kuwaitis to adhere to the rule of law was unprecedented. And importantly, the Kuwaitis have failed to accept their responsibility for their actions.

As we have said, Dow will fully pursue its rights and remedies as a result of the K-Dow transaction failing to close.

By comparison, Dow understand that it will need to be accountable for its decision not to close the Rohm and Haas acquisition at this time. But we believe there are important mitigating factors which need to be considered which on balance should result in a decision not to force an untimely closing. Dow understands that if the litigation goes all the way to conclusion that this may result in a damages award against the company. For further details and explanation, I encourage you to read our formal answer which we filed in the Court of Chancery today and which is posted on our website.

The bottom line is this. We must do what is right for all the stakeholders and we don't see an appropriate path to closing of Rohm and Haas at this point in time. Dow stands ready to continue discussions with Rohm and Haas to see if together we can find a workable solution outside the litigation arena.

So what does this all mean going forward? As you turn to slide 23, it means first, that from a strategic standpoint, we are actually today where we were a couple of years ago, albeit with a very different world economy. We have every element of success in place, though our tactics going forward must change. We remain a strong, vibrant company with a laser-like focus on financial discipline and execution, and I expect us to continue delivering strong operating cash flow in 2009. We are taking the appropriate actions in response to the global economic crisis. We are accelerating our previously announced restructuring effort and now expect to realize a run rate savings of $500 million by the end of 2009 and $750 million by the end of 2010. And we are significantly reducing capital spending to an estimated $1.1 billion in 2009 with a commitment to maintaining safe and environmentally compliant operations.

We have a fantastic global footprint and expect to capture opportunities in emerging markets. And most of all, we have the right strategy to continue our transformation into an earnings growth company. Likewise, we are not abandoning our strongest term, innovation (ph). Moving our company into new and more profitable markets depends heavily on our ability to innovate and use our strengths as a science and research company.

When the economy turns, the commercial world will be clamoring for sustainable solutions, and that's what we will provide. We will not only see new business opportunities ahead, but new revenue streams as well. Additionally, we remain on path to transformation. Despite the events of December and the turmoil we are experiencing in the marketplace, we are as committed as ever to realizing this goal. We have already made great progress and nothing of the economy or even this recent setback can diminish the hard and substantial work this company has accomplished over the past five years in actively managing our portfolio towards this vision.

We are actively pursuing partners for our franchise Basics assets. These are great assets that include the number one global producer of polyethylene, which is the largest volume thermoplastic in the world. In fact, we've had significant interest concerning these businesses from more than a dozen companies. We are in the process now of narrowing that list and are currently in face-to-face negotiations with some of them.

If we don't find the right partner during this downcycle, we are certain we will in the next upcycle. And as I've said earlier, the Rohm and Haas acquisition is consistent with our strategy and we remain interested in discussing possible solutions with Rohm and Haas to complete this proposed transaction.

But we all have to realize that the world has shifted quite dramatically and we have to find a reasonable way to respond to those changes if we are to have a combined enterprise that can thrive moving forward.

Finally, at the end of the day, we must take the appropriate steps to ensure we retain our options, our financial flexibility and above all, protect our investment grade rating. The Board is committed to that, I am committed to that and our entire team at Dow is committed to that.

We are asking for your patience to allow us the time to do what we have always done best: Take our challenges head on, provide answers that work and implement them. We commit to you that we can do this over the next several months and get back on track. Judge us by our actions.

Thank you and now let me give the call back to Howard.

Howard Ungerleider

Thanks Andrew. That wraps up our prepared remarks. For your reference, a copy of these comments will be posted on Dow's website later today.

Now we'll move on your questions. Before we do, though, I would 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.

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

Question-and-Answer Session

Operator

Yes, sir. (Operator Instructions). And we will go ahead to our first question, which will come from David Begleiter with Deutsche Bank.

David Begleiter - Deutsche Bank

Good morning.

Andrew Liveris

Good morning David.

Howard Ungerleider

Hi Dave.

David Begleiter - Deutsche Bank

Andrew, do you foresee the need to raise or sell equity to help maintain your investment grade rating?

Andrew Liveris

David, as I said towards the end of my talk here, we are looking at everything we need to do to protect our investment grade rating. We don't preclude that. We understand the cost of raising equity. We understand that the operating environment we saw in the fourth quarter, as we are assuming, continues in all of 2009. Lots of companies are going to have to do lots of things. The equity markets aren't great as you know. It's not necessarily the top option; there are other options we are working with. And as I also said towards the end of my talk, we are working on all the flank fronts you can imagine to the financial ones as well as the asset ones to look at maintaining our investment grade rating. So the answer is yes, we would look at that, but it's not our top option.

David Begleiter - Deutsche Bank

And lastly on the JV, what's a reasonable timeframe to expect a decision on a new partner?

Andrew Liveris

Yes, as I said, there was dozen parties, some of them directly negotiating. The topic at hand is strategic partner versus financial partner. I think that there is a mixture of interest. This is very valuable assets, it fits the strategic partner model very well. I would tell you that the next several months would tell us the palatability of the answer. It's obviously part financial, part strategic. And we would have to decide whether this is the right moment to execute against just a financial answer. And that clearly is one of the weapons we are using. But you can be guaranteed, we are not going to fire sell that asset.

David Begleiter - Deutsche Bank

Thank you.

Operator

All right, we'll move to our next question which will come from Frank Mitsch with BB&T Capital Markets.

Frank Mitsch - BB&T Capital Markets

Good morning gentlemen.

Howard Ungerleider

Hi Frank.

Andrew Liveris

Good morning Frank.

Frank Mitsch - BB&T Capital Markets

I don't normally say this, but in terms of reading legal documents, yours was actually readable. So congratulations for dummying it down so that I could even understand it. And looking through it, it was interesting that just middle of December, December 10th, you guys actually thought that you were going to earn $0.30 a share in the fourth quarter and you wind up reporting a negative 62. That seems extremely dramatic. Can you talk about what specifically led to the $0.90 change in the expectation to the result?

Andrew Liveris

Thanks Frank. Firstly, you've got to adjust for the tax rate. So it's a $0.60 going, but that still doesn't take... takes your question down maybe a little notch, but not a very big notch. We were through November taking out assets very fast, but the number of assets we had to take down in December was dramatic, Frank. And 180 assets, for exampling in polyethylene 53 assets. We have 53 trains... or plants around the world, excuse me; 22 of those were down in December, which was way more than we were conjecturing late in November or early December. Demand basically stopped. I've read from others who had earnings before us where there was some days where they had no orders. We were close to that in December. Obviously, it's all the combined effects that we are reading about, but notably, I think December basically disappeared from a demand point of view for the chemical sector.

Some have told me that one of the possibilities here, and I don't dismiss this, is destocking was so rapid and rapid that as a consequence of that, we may end up having a 13-month year this year. We are not seeing that in January yet. But that was really the big swing, Frank.

Frank Mitsch - BB&T Capital Markets

Okay, great. And you specifically talked about suing for more than 2.5 billion with the Kuwaiti litigation, and obviously that was the figure that was in the JV agreement. Can talk about the justifications for a number north of 2.5 billion and what would be the case in terms of timing of a settlement there?

Andrew Liveris

None of our financial scenarios are incorporating any number that says that gets received any time soon. I think the three things we said concerning K-Dow is the rights in and around commercially binding agreement speak to arbitration, the (ph) $2.5 billion number. But they breached in many areas in terms of conditions meant for closing. And the consequence of that is litigation. We aren't saying anything about the litigation right now because of a third point, which in we are in dialogue with the Kuwaitis and where obliviously the best stands through in all told would be that we find our way back to doing the deal with Kuwait and find our way back outside of litigation and find our way back outside of even arbitration. But those two levers, legal litigation and arbitration are being paralleled and you will see a lot more about the litigation event towards the back half of February.

Frank Mitsch - BB&T Capital Markets

Great, thank you.

Operator

We will move to a question from Sergey Vasnetsov with Barclays Capital.

Sergey Vasnetsov - Barclays Capital

Good morning.

Andrew Liveris

Good morning, Sergey.

Howard Ungerleider

Good morning.

Sergey Vasnetsov - Barclays Capital

Andrew, you have taken significant steps to reduce your capacity in the fourth quarter. I know the answer might vary specific plan-by-plan, quarter-by-quarter, but how long would you need to wait for the demand to come back before you decide if some of those shutdowns will be permanent?

Andrew Liveris

Yes, it's a good question. Mike Gambrell has been appointed to head our entire restructuring effort and we has... we have weekly meetings on plants that are staying idle versus plants that come down permanently. Clearly, the restocking phenomenon, especially in the Basics, especially in polyethylene, Sergey, is saying that we are being quite conservative there and not looking at permanent shutdowns, especially in polyethylene right now. As I said on the pervious question, 22 trains... plants being down, that's a significant number in December and that pretty much is continuing in January.

On something like a polyethylene, frankly, we've been here before. We have seen these demand-led troughs go this vicious, and polyethylene, as I said in my prepared remarks, is a very resilient thermoplastic. And even with a emerging country GDP, or say a China of a 5 or 6% next year, that's still double-digit... this year... that's still double-digit demand for polyethylene. So something like polyethylene I'd expect very little permanent closure. So that speaks maybe to a big product for us.

But across the board, Sergey, I mean with 20 permanents announced in November, you can expect that number will climb in the next three to four months, which also speaks to another point. We made a major announcement in December on restructuring. We are implementing it fast like I said in my prepared remarks. But we are already working on another round to see if another is necessary based on your point, which is more permanent shutdowns from the idling. I would expect another two or three months before we have more to say on that, Sergey.

Sergey Vasnetsov - Barclays Capital

Okay. And another question on your Ras Tanura Project. You have said yourself that circumstances in the world could change significantly with oversupply, at the same time construction costs coming down. What's your current view for 2009-2010, how this project might proceed?

Andrew Liveris

Yeah, our partners in it (ph) and we are obviously looking at that very carefully; in fact, Saudi Aramco has been very public with some of their other projects that they deliberately paused some of their other projects to take advantage of rapidly declining EPC and materials costs as you've really said. And I think, well, you should know that that's something we are very much looking at with Saudi Aramco. This is the year where we are finalizing the FEED [Front-End Engineering and Design] study. Even the FEED study itself, which, as you know is detailed engineering, we have the flexibility to do what we need to do this year to attenuate the start up of the first facility so they go beyond the original dates and more critically, take advantage of the low construction costs, low EPC costs that you've referenced. We will have probably by the end of first quarter between the two partners a decision on when Ras Tanura as a complex should start up. But you should assume that it won't be when we originally said, so we can take advantage of this down cycle on EPC.

Sergey Vasnetsov - Barclays Capital

Thanks, that's helpful.

Andrew Liveris

Thank you, Sergey.

Operator

We'll now move to a question from Khan Ahmed with HSBC. Sir, your line is open. Mr. Ahmed, your line is open sir. Okay, hearing no response, we'll move to a question from Bill Young with Chemspeak (ph).

Unidentified Analyst

Bill Young: Good morning. A question on your dividend, Andrew. You said all options are on the table. A while back you said that the dividend won't be cut on your watch. Maybe you could reconcile these two statements.

Andrew Liveris

Well, firstly, Bill it's nice to hear your voice again, and thank you for your question. Obliviously, your question was loaded, and I also remember that very well. I would also tell you that December changed everything, Bill. I mean I'm a realist, the talked about realist. The Board of The Dow Chemical Company decides on dividend every quarter. I obliviously with my management team are looking at all options to retain investment grade. It will be foolhardy of us to go back to those pre-December words and say they must stay intact.

I also recognize we have been in very... a lot of conversations with our long-term owners. Many of our long-term owners rely on a dividend, and one of the reasons we have long-term owners is the dividend. This current equity market correction is pretty vicious. I know we have been overcorrected, but I would say to you there aren't many stocks out there, especially in the commodity chemical world that haven't been overcorrected of late because of what's happening in this demand-led trough.

We have been here before, '01-'02, when know we have paid dividends throughout that period of time at very high percentage payout ratios based on earnings inference, you might say. So we are very respectful of the need to look after the interest of all shareholders. And whether that means the dividend cut occurs or not, it would have to be a collection of things that we'd look at to ensure we stay strong investment grade. And right now, I would be the first to tell you that that is a different statement than what I said prior to December, and I acknowledge the reality of the moment.

Unidentified Analyst

Okay. Secondly, let's look at polyethylene for a second. You did paint a pretty bleak picture for volumes going ahead actually throughout the company in the new term. I believe one or two of your competitors said there were signs of the end of destocking in polyethylene and they have seen some significant improvement in demand. Maybe you could give us a little more color there on what you are seeing in one of your largest products.

Andrew Liveris

Yes, in my prepared remarks, I actually... interesting you should say I was bleak. I actually... I didn't think I was as bleak as that. Maybe I'm not as optimistic as what some of our competitors have said. But I would put us closer to their end of the scale than complete bleakness. Look, the realty is, as I said to a previous question, that polyethylene is very much an emerging market event plus a lot of our polyethylene is in things like packaging. And once the emerging market restocks, polyethylene, and we are already seeing it, we've got a price increase announcement of $0.07 a pound for the month of February; maybe we'll get $0.03 of that. But that's a price increase in what is a terrible volume correction. So restocking and price increase, low hydrocarbon values.

I don't want to paint too optimistic a scenario, maybe not as far as some of our competitors went. But we are seeing some signs of life. And right now, given what we've just gone through, I want to put that down as a bonus. We can't speak to the timing of recovery, certainly with this market as terrible as it is. But Bill, I would be a little more optimistic than what you suggested I was.

Unidentified Analyst

Okay, great. Thanks.

Andrew Liveris

Thank you Bill.

Operator

We'll move to our question from Jeff Zekauskas with JPMorgan.

Jeffrey Zekauskas - JPMorgan

Hi, good morning.

Andrew Liveris

Good morning Jeff.

Jeffrey Zekauskas - JPMorgan

I've got two questions. The first is really a question I guess for Geoffery Merszei. It looks to me like the working capital benefit in the quarter was about 3.3 billion in that your receivables are down almost 3 billion and your inventories are down 1.5, and that's made up a little bit by the payables. So if that's the case, and normally your accounts receivables are around 9.5 billion and you're running at around, I don't know, 6.8, your working capital next year should be something like negative 3 billion. And if your working capital is negative 3 billion, and normally, I don't know, for the last few years, you've generated something like 4.5 billion in cash flow annually, you are really not going to have very much free cash flow next year with your 1.1 billion in CapEx. Is that a correct analysis or an incorrect analysis?

Geoffery Merszei

No, I don't think so Jeff. I don't think the conclusion is correct. We will see obviously somewhat the benefit of this huge cash inflow in the beginning of the first quarter. As you know, with the accounts payables flowing out in the first quarter, I do expect some pressure on working capital in the first quarter. We are going to mitigate that with a continued very, very strong effort on controlling inventory in the pipeline. And on the accounts receivable side again with a very low DSO around 40 days on the accounts receivable side, we should be minimizing that.

So I think there is going to be a little pressure in the first quarter. But I think overall, I think we can still continue to improve our overall working capital management and reduced the overall investment in working capital.

And then of course from a cash flow from operations, as you, or Andrew pointed out, for 2008, we had a very strong cash flow from operations. Obviously, with this very uncertain economic environment and pressure on earnings, that's going to hurt. But the combination of our restructuring program, the acceleration of the run rate to 500 as well as the, as you pointed out, the reduction in CapEx from 2.1 to 1.1 billion, I expect a positive free cash flow for the year.

Jeffrey Zekauskas - JPMorgan

Okay. And then just to thank you, and then my second question. It's a question for Andrew, and it's really more of a conceptual question. When the Kuwait deal fell through, roughly, there was 7 billion that you were going to get in cash that you didn't get. And so the way I thought of the Rohm and Haas transaction and your investment grade rating is you have something like a $7 billion hole that you have to fill. And right now, commodity chemical assets... so the first part is that the hole you have to fill? Is that what you were trying to do in order to affect your Rohm and Haas transaction?

And then secondly, I mean we've seen the price of NOVA Chemical, we've seeing what's happen to Lyondell. Right now, petrochemical assets are really sort of trading at very distressed multiples. But it is the case that you have a very valuable agricultural business and there is a very valuable salt business that Rohm and Haas has. So in order to fill this $7 billion hole, as you say, all options are on the table, are some of those options the sale of the higher quality assets of Dow in order to fill that gap?

Andrew Liveris

Yes, Jeff, that's a great conceptual question. And I think the bandwidth you provided it is exactly right. I mean if you take... even if you read the legal brief we filed this morning, I Frank Mitsch was asking about and he said it was put in layman's terms. So I think it's pretty clear if you read that brief that throughout the month of the December, all the way up until the Kuwaiti event, we were closing the Rohm and Haas deal whenever regulatory approvals came through. Despite this massive correction, despite the pressure on paying too much in July, I think all these things, the reality was that the market was deteriorating, December was a terrible month, we started to see it in the back end of December and then the Kuwaitis withdrew from us.

So we've got two holes created to us. Hole number one was the Kuwait hole, if we can call it that, which is a $7 billion net hole. And the second hole was '09 started to look very differently at the back end of '08 than what we originally said as recent as, I think Frank pointed out, early in December. And so that hole was an operating hole that of course had the two events together with the downgrades that occurred the day after the Kuwaitis made their announcement, verbal notification to us, hit our ability to look at the financing of the whole transaction period. So the dominos that occurred all within a matter of weeks. Yes, simplistically, you could say it's a $7 billion hole, but it's a $7 billion hole net plus an operating environment that is horrible that is creating almost no money from income, basically as Geoff said earlier, plus this tenuousness on the financing side.

Those three things together with the economic uncertainty we are facing and maintaining investment grade rating to recover... to put a recovery plan in place that makes sense to your conceptual question to fill against all those uncertainties, you've got to do many things and put them all on the table.

And I think your point on divestments is not lost on us. We have 12 assets we are working on right now, including the K-Dow assets of varying sizes that we are working on with divestment teams and also banks, investment banks. So to help us work out which of these are realizable in the context of filling the hole that we just addressed together in your question and my answer and on top of that more specifically, where there is traction from a buyer universe. And I think your analysis on the commodity side is fair. I won't declare defeat yet. I think there is strong interest in a, let's call it, an asset that is number one in the world, polyethylene, that has proven demonstrated earnings capability through upcycles. So the clarity around cycle average earnings there is demonstrated over many, many cycles. But having said that, I think your point is very valid.

And so therefore, you have to go through the universe of specialty assets and say to yourself, which in the portfolio fit the Dow long-term strategy, which ones don't? And we've always said that AgroSciences needs a different act. It can't be just the current act. We are very proud of the business, it's a high earner. In the last five years we have invested in it. It's generated a great R&D pipeline and in fact generated a lot of great niches and in fact good positions around the world in various crops and in various chemical markets. But having said that, I would tell you that all options are on the table. And the mere fact that I've said that there are 12 assets that we are working on I think answers your question.

Jeffrey Zekauskas - JPMorgan

Thanks very much. That's a very clear answer.

Andrew Liveris

Thank you, Jeff.

Operator

Our next question will come from Michael Judd with Greenwich Consultants.

Michael Judd - Greenwich Consultants

Yes, good morning. A question on the financing with the banks. I know that you've been working hard on the strategic plans. But I am just wondering if you could give us an update in terms of the potentiality for more permanent financing of that $1 billion.... Sorry, not $1 billion, but for the one year bridge loan. And in addition to that, I have a follow-on question. Thank you.

Geoffery Merszei

Yes, Mike, this is Geoffery. I mean recognizing that we're in a very difficult banking environment, right, we are I think making pretty good progress in our discussions with the lead arrangers, i.e., Citi, Morgan Stanley and BofA, the combination of Merrill. If you recall, Merrill was one of the three lead arrangers. And so now we are talking to BofA. We haven't yet concluded the extension that you referred to of the term out for an additional one year. But like I said, we are making good progress and we hope sometime in the future, in the near term future, to conclude this transaction.

Michael Judd - Greenwich Consultants

Fair enough. And as a part of that, will there be something beyond just bridge financing? Could there be more permanent financing? And then just secondarily, on the preferreds, the Kuwaitis had made a commitment I believe for 1 billion. Is that still reasonable to anticipate that that would still occur?

Geoffery Merszei

Yes, Mike. Both the KI and Warren Buffet's 3 billion, the total of 4 billion convertibles, we expect those still to occur. And with regards to additional financing, the whole idea is to get a term out for our exiting bridge, which will allow us then to secure the right type of rating, a strong investment grade rating so that we can go and tap the public debt markets. So the intention is not to make full use of this bridge, but in fact this is an interim kind of a bridge in order to tap the public debt market. Did I answer your question?

Michael Judd - Greenwich Consultants

Yes, it does. Thanks for the help.

Geoffery Merszei

Okay, Mike.

Operator

We'll move to a question from Kevin McCarthy with Bank of America.

Kevin McCarthy - Bank of America

Yes, good morning. Andrew would you address the subject of asset rationalization in the chemical segment? And as destocking abates, would you expect that business to return to profitability at some point this year?

Andrew Liveris

And when you say chemical business, Kevin, just so I'm clear, you mean our Basic chemical business, right?

Kevin McCarthy - Bank of America

Your chemical segment, correct.

Andrew Liveris

Yes, right. Yes, look, it's no question that if you take EO/EG, it appears we are going through a cyclical trough. In other words, the compressed margins that are pretty much led by this demand destruction in the polyester textile change, which is basically China, has basically said that the EO/EG business for most of this year is the demand-led trough which should not therefore benefit from any restocking. I think that would be the first point we'd make. So we don't have much hope there for margin of any sort in the EO/EG business. That's part of Ghana (ph), the overwhelming stable we are making around how we see '09.

There is also of course in the basic chemical sector, there is the big ones for us is EDC vinyl and the PVC chain in general on the caustic side. Clearly, the housing, residential markets, the piping markets, all of that. Chlorine and it's associated exposure to that is really bad, I mean not just in the United States, but around the world. And on top of that, there are other chlorine derivates that Dow has over these many years moved our portfolio to value add chlorine derivates like those in the polyurethanes chain. The polyurethanes chain has also been hit. So whether it's the isocyanides or polyol in general for bedding and furniture, appliances, other durables, those markets have also had massive demand destruction. And there's no end in sight and that's also global. So you'd look at all that and say chlorine margin recovery, whether it's in the specialty side of the house or in the EDC vinyl side of the house, we're not assuming any of it this year. So very prolonged chlorine trough.

Of course, the flip is going on in caustic. I mean caustic is having the restrained supply issue, which of course is causing their prices to stay up. But that doesn't mitigate the negativity on chlorine at all. And of course the other issue on caustic is as metals, especially aluminum go through their massive correction, it will start to impact caustic as well.

So I hate to be the harbinger of doom,, but I will tell you, the basic chemical sector is going to have a terrible '09.

Kevin McCarthy - Bank of America

Okay. And then as a follow up on a different subject and perhaps one with some better outlook, Dow AgroSciences has hung in quite nicely. Looking ahead to '09, we do have lower commodity prices, some credit availability issues around the world among growers and some degree of pressure on farm income. So just filling that down, Andrew, would you expect Dow AgroSciences' operating income to rise, fall or stay about flat in '09 versus '08?

Andrew Liveris

Yes, I think '08 as Jerome Peribere liked to tell me, all the stars were aligned for a perfect year. And '09, where we're thinking that if it stays flat, that will be sensational because '08 was so good. There is uncertainty out there on what U.S. farmers are going to plant. And as you probably know, I mean many farmers are awaiting to see what commodity and fertilizer prices are going to do before deciding. And with high fertilizer prices relative to commodity prices, they probably will favor soybean planting over corn in the U.S. And there are drought issues in Argentina and California and Texas. There are some challenging financial situations in Latin America and Eastern Europe. So even though agriculture is somewhat protected from the economic meltdown, it's going to be hard to keep the agricultural economy at the same levels of '08. So flat would be great and maybe a little down.

Kevin McCarthy - Bank of America

Thanks very much.

Howard Ungerleider

Jennifer, we've time for one last question.

Operator

Okay, sir. We'll take our last question from John Roberts with Buckingham Research.

John Roberts - Buckingham Research

Good morning guys.

Andrew Liveris

Good morning, John.

John Roberts - Buckingham Research

I didn't read all of your legal filing this morning, but is the crux of your case that Rohm and Haas Board has responsibility on just the shareholders, they've got responsibility to the employees and community. And is there any precedent where a Board has been forced to put employees in community ahead of the shareholders?

Kevin McCarthy - Bank of America

So, John, I am sorry, I am going to... even though it's the last question, I am going have to defer given we've got litigation pending. I just... we don't want to be disruptive to the process. But I would encourage not only to read the briefing, but read actually my transcript here, my prepared remarks. I think I pretty much addressed the point you are making and I think you derive the answer you need from those two documents.

John Roberts - Buckingham Research

Okay. Maybe you take one more question then from someone then. Thanks.

Howard Ungerleider

That's all the time we have. Thanks John. Thanks to everybody for joining us on the call today. Our team looks forward to talking with you again soon. Bye bye.

Operator

Thank you, sir. This does conclude today's teleconference. We thank you all for your participation. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: The Dow Chemical Company Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts