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Executives

Doug May - VP of Investor Relations

Andrew Liveris - CEO

Bill Weideman - CFO

Analysts

John Roberts - UBS

Robert Koort - Goldman Sachs

Hassan Ahmed - Alembic Capital

Frank Mitsch - Wells Fargo Securities

Duffy Fischer - Barclays

Chris Nocella - RBC Capital Markets

David Begleiter - Deutsche Bank

Kevin McCarthy - Bank of America Merrill Lynch

Jeff Zekauskas - JPMorgan

Don Carson - Susquehanna Financial

PJ Juvekar - Citi

The Dow Chemical Company (DOW) Q2 2013 Earnings Call July 25, 2013 9:00 AM ET

Operator

Good day, and welcome to The Dow Chemical Company's second quarter 2013 earnings results conference call. [Operator instructions.] I’d now like to turn the call over to Doug May, vice president of investor relations. Please go ahead, sir.

Doug May

Thank you, operator. 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 and any redistribution, retransmission or rebroadcast of this call in any form without Dow's express written consent is strictly prohibited.

On the call with me today are Andrew Liveris, Dow's chairman and chief executive officer, Bill Weideman; executive vice president and chief financial officer; and Dale Winger, associate director of investor relations.

Around 7 a.m. this morning, July 25, our earnings release went out on Business Wire and was posted on the internet on dow.com. 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.

Now, 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 forecast or estimates and we don’t plan to update on 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. EBITDA, EBITDA margins, and earnings comparisons exclude certain items. The agenda for today's call is on slide three.

And now I’ll hand the call over to Andrew.

Andrew Liveris

Thank you, Doug, and good morning everyone. Thank you for joining us. If you turn to slide four, this was a strong quarter for Dow, and our results reflect the deliberate actions we’ve taken and continue to take across our portfolio. We are pleased with our performance, despite ongoing macroeconomic headwinds in most parts of the world.

Notwithstanding this strong performance, we will continue to stay focused and keep taking proactive measures to maintain this strong trajectory and deliver earnings growth. Our action plans are working, and we are squarely aligned behind what we need to do in the next 12 to 24 months to maintain this earnings momentum.

So here are some highlights from the quarter: adjusted earnings per share of $0.64, representing a 16% increase year over year. The receipt of the K-Dow award cash payment was a critical accomplishment this quarter. In line with our stated cash priorities, we immediately applied these funds to pay down debt. Our cash flow from operations saw significant improvement, up $2.8 billion year over year, driving our net debt to total capital ratio down to 36.4%, achieving levels not seen since 2008.

These actions are immediately accretive in value and go right to our bottom line. In total, we expect to deliver interest expense reductions of approximately $150 million year over year in 2013. And, as you think about our strong balance sheet, we now have the flexibility to move forward and evaluate additional opportunities to remunerate our shareholders.

On the top line, our company delivered 7% growth in emerging geographies, which represented 34% of total company revenue in the quarter, and in the agricultural sciences segment, we achieved record second quarter sales with double-digit growth.

And of course, there is our performance plastics segment, which delivered $1 billion of EBITDA and expanded margins by 700 basis points, driven by our tremendous low-cost feedstock advantage on the United States Gulf Coast and our focus on higher-value markets. Here, as you know, we have significant investments in place in this region that will drive further EBITDA growth and margin expansion as we grow our packaging franchise and build on our competitive advantage.

All of this enabled us to deliver EBITDA growth and margin expansion at an enterprise level: strong results delivered by a very focused team. All of these accomplishments during the quarter, the strong operating discipline; the focus on cash, cost and capital; plus the K-Dow award cash payment, had delivered a balance sheet that is back to strength.

This fact, plus our ongoing $1.5 billion stock repurchase plan, have us poised to deliver increased shareholder remuneration in the next 12 to 24 months. I’ll have more to say on this later in the call, and in subsequent shareholder communications.

But now, let me turn it over to Bill for more detail on our financial and operating results in the quarter.

Bill Weideman

Thank you, Andrew. Let me begin by providing a financial overview on slide six. Dow reported earnings of $1.87 per share, or $0.64 per share excluding certain items. Certain items in the quarter included a charge for the early extinguishment of debt as well as a gain from the K-Dow arbitration award.

Adjusted EBITDA rose nearly 9% in the quarter, reflecting savings from our 2012 restructuring programs, and these savings will continue to ramp as we move forward. Our advantaged market and feedstock position continues to drive strong margin expansion in performance plastics, particularly in North America, and we saw improved performance in our joint ventures.

Now turning to price and volume trends on slide seven, volume gains were reported in most regions and most operating segments. Our agricultural sciences segment, once again, reported double digit sales growth this quarter, achieving a first half sales record of nearly $4 billion, reflecting the strong pipeline of new products that we have in place.

Emerging markets demonstrated ongoing strength this quarter, achieving a 9% increase in volume, led by strong performance in Latin America and Asia-Pacific. North America also saw increased volume. However, conditions in Europe continued to be weak, demonstrated by nearly 3% declines. However, excluding the impact of our asset rationalizations, volumes in Europe were actually flat.

Price declined 2%, driven by a declining raw material environment, primarily in feedstock and energy, and ongoing currency headwinds, which represented nearly one-third of the decline in price.

Moving to slide eight, overall we grew earnings and expanded margins due in large part to our ongoing strength in performance plastics. The company’s cash and cost improvement actions also continued to deliver benefits. I’ll speak more to this in a moment.

Another positive driver of results this quarter was equity earnings, which were up year over year due to improved performance at our MEGlobal joint venture, as well as improvements in [NAFTA based] margins in Asia

Now turning to our operating segments, starting with electronic and function materials on slide nine. Sales of electronic and function materials were flat as volume increases were offset by price declines. Electronic materials’ strong growth films and OLED contributed to sales increases in display technologies. However, this growth was offset by the sales declines of semiconductor technologies, which experienced softer demand.

In function materials, Dow microbial controls grew sales in all regions, achieving a new quarterly sales record. Coating infrastructure solutions sales were flat for the quarter. Dow coating materials sales increased as construction conditions in North America continued to strengthen. This was offset by lower sales in building construction due to ongoing weakness in the construction market in Europe.

Now turning to Dow Corning, we believe that market conditions in polysilicon have stabilized. We also expect the impact of the July 18 preliminary [unintelligible] ruling will have minimal impact on operating equity earnings going forward. We will continue to carefully monitor these dynamics in this value chain and if conditions worsen, Dow Corning will take further actions as appropriate.

Now turning to agricultural sciences, which reported a 10% year over year increase in sales. In crop protection, sales of new products grew 14% in the quarter. In seeds, traits, and oils, sales were up 4% versus the same period last year and year to date sales are up 23%, driven primarily by strong farmer demand for smart [stack] corn hybrids.

EBITDA for ag sciences was down slightly from last year’s record second quarter EBITDA due to a shift of seasonal buying patterns, increased growth investments, and unseasonably cool and wet weather across the northern hemisphere. Yet despite this, the segment still achieved a first half EBITDA record of $774 million.

In performance materials, volume increased, driven by gains in our polyurethanes chain. Prices declined 3% due to lower propylene costs and EBITDA was impacted by industry challenges in epoxy, chlorinated organics, propylene oxide, and propylene glycol.

Sales in performance plastics were $3.7 billion. Dow Packaging, especially plastics, demonstrated a strong performance during the quarter with improved sales in North America, Latin America, and Asia-Pacific, which more than offset lower sales in Europe, which reflect the previously announced shutdown of our high-density polyethylene plant in Tessenderlo, Belgium.

Performance plastics delivered $1 billion of EBITDA in the quarter, which is up 33% versus the same quarter last year and expanded EBITDA margins by 700 basis points. In feedstock and energy, [unintelligible] [monomer] costs let to price declines, while volumes remained flat.

Volume gains in EOEG were offset by decreases in hydrocarbons, which were driven by a lighter feed slate in Europe. Equity earnings increased due to improving NAFTA margins in Asia as well as improved performance by MEGlobal, reflecting lower turnaround costs year over year.

Moving to slide 12, we continue to drive targeted ROC improvement actions by tightly managing pricing and prioritizing R&D investments. Our cost and cash actions are on track, with the target we laid out at the end of 2012.

To date, we have shut down 18 of our committed 29 assets, and this quarter we idled another Dow-formulated systems asset in Europe. Our workforce reduction targets also remain ahead of schedule.

These actions have already delivered $170 million year over year EBITDA improvements and will continue to ramp in the second half of the year, placing us firmly on track to deliver a $500 million EBITDA improvement this year.

We also remain committed to our divestiture targets. In March, we increased our divestiture target to $1.5 billion over the next 18 months. We’re currently in the process of selling three businesses as we previously announced: Dow Plastic Additives, Dow Polypropylene Licensing Catalyst, and a small fumigants business in our agricultural sciences business. We’re making excellent progress, and we expect to close all three transactions by the end of the year.

Just as we remain on a solid path to deliver on our portfolio commitments, we have also remained focused on reducing our debt, and the second quarter represented a series of milestones in this regard. As you know, in May we reached a final resolution of our K-Dow arbitration award. This resulted in Dow receiving a direct payment of approximately $2.2 billion from PIC.

In the second quarter, we applied this award to debt reduction, which drove our net debt to total capitalization down to 36.4%. This action significantly enhanced our balance sheet. As our cash flow and earnings continue to ramp, we remain committed to rewarding our shareholders as we move forward.

Now looking forward to the second half of the year, we have a number of actions currently in motion that will further boost Dow’s 2013 performance. We expect healthy margins will continue in performance plastics. Here we expect to see the year over year improvement throughout the rest of 2013. We expect to see ongoing growth in agricultural sciences, as this segment remains on track to achieve its sales and EBITDA objectives for the year. And our restructuring actions will continue to ramp in the back half of the year.

From an operations perspective, the majority of our large planned maintenance activities have been completed in the first half, which means turnaround spending will continue to trend downward in the remainder of the year. And the contributions from the restart of our St. Charles operations cracker will increase in the second half of 2013.

And finally, as interest rates increase, we would expect to see a pension tailwind in 2014. For modeling purposes, the 100-basis point upward trend in interest rates is equal to approximately a $250 million decrease in pension expense.

And now I’d like to turn it back over to Andrew.

Andrew Liveris

Thank you, Bill. If you go to slide 16, as you can see, we delivered a strong second quarter and continue to make notable progress against the objectives we laid out for you last call, executing on targeted portfolio actions, growing our high return businesses, and focusing on improving our lower return businesses.

Now, we unveiled this concept last investor day in late 2012, so let me update you on where we are in upgrading our portfolio and indeed improving our returns. Slide 17, first our higher performers. Recent business reviews have shown us that these are clearly all located in high growth value pools, as you can see in the slide, where our share of profit can indeed grow because the market is growing.

These included the agricultural and food sectors. These include packaging, as well as electronic and personal care markets, and they represent more than $25 billion of high-margin revenues with strong IP technology fundamentals. We will continue to invest in and grow these businesses.

On slide 18, in the performance materials and coatings and infrastructure solutions segments, we have been analyzing vigorously on how to improve returns. The good news is that we have businesses such as Dow Water and Specialty Chemicals within these segments that are already high return and growing.

We also have businesses that are performing below our expectations, where we expect meaningful signs of improvement from our direct interventions and actions. Notably, our acrylics Dow [unintelligible] business, and our polyurethanes franchise, which will benefit from our Sadara and PDH investments, as well as improving global construction and coatings markets.

We also have areas in our portfolio where we see results below our expectations. For example, in our epoxy business, and in our European building and construction business, as well as our commodity chlorine derivatives. Here we see the need for more dramatic interventions. Therefore, these businesses are in the fix-take action mode, which includes exploring all possibilities, including joint venturing or divesting them.

These last two slides are illustrative of the six months of portfolio work that has resulted in clear outcomes and destinations for underperforming businesses. We have more specifics on these actions, and we will have more to say on these in the next several months.

Equally important to keep in mind in these portfolio management actions is ensuring we do not lose our previously discussed integration benefits. Dow is a fully integrated chemical, biological, and materials science company, with both physical and capability integration.

Carve-outs, therefore are not easy. Having said that, we have done them before, most recently with our Styron divestment. This was a highly complex carve-out on 20 Dow sites, with hundreds of residual service agreements to ensure that there were no stranded costs. Dow has the expertise and demonstrated track record to execute a highly complex, integrated carve-out successfully, with Styron as a recent, strong example.

The bottom line is this. We have divested over $8 billion of revenue of low-margin businesses over the last several years, and our analysis suggests that we will move formally on the path of doing more so as to release even more value for our shareholders.

So turning to slide 19, and turning to our balance sheet, which Bill has talked about, where we are clearly and aggressively delivering against the commitments we’ve made. First and foremost, our balance sheet is strong, and we are delivering solid cash flow gains.

Between 2012 and 2013 year to date, we’ve generated more than $8 billion in cash flow from operations. With the application of the K-Dow award, we’ve made substantial progress in further strengthening our balance sheet due to our aggressive debt reduction actions during the quarter.

Year to date, we’ve reduced net debt by more than $2.5 billion, and we’ve reduced net debt by nearly $6 billion since 2009. As a result of these actions, our net debt to total capital ratio is below 2008/2009 levels, and our annual interest expense has declined by nearly $350 million since that time period, with more than $60 million through the second quarter alone.

Let me summarize our balance sheet view and priorities. We have allocated funds for the growth we need for the next decade. We have paid down debt to pre-’08 levels. We have identified new ways to release more cash and value from the balance sheet and portfolio. We are generating strong cash flows and have a strong balance sheet that will get stronger. And, we do not need any M&A.

Said another way, we have not, and will not, waver from our relentless execution against our priorities for cash. We have reduced a significant amount of debt and still have plans to reduce more. And as we create and liberate additional cash, we will deploy the surplus cash to you, our shareholders, generating strong returns for, and rewarding, our shareholders remains our singular focus going forward.

Let me turn to the outlook on slide 21. As you know, heading into 2013 we held the view that, from a macroeconomic perspective, this year would largely be a replay of 2012, and calibrated our business plans accordingly. Looking at global market dynamics again this quarter, this continues to be the right view.

Having said that, there are promising signs out there. For one, the U.S. continues to be a bright spot, with the housing market recovering and signs of life with the consumer. Secondly, emerging markets are a surprising pillar of strength, and we expect there will be growth in the second half that was not seen in the first half, especially in Asia with China appearing to be stabilizing.

The leadership there is in place and very focused, and we are confident they will course correct, with positive signs beginning even in this recent quarter. However, we maintain the view that while growth continues in China, we all have to reset expectations below historical rates. And the downside continues to be in Europe, where our view remains unchanged, as the weakness continues with no material signs of improvement on the near term horizon.

Let me close on slide 22, with our priorities for the second half of the year, where we have singularly focused on the following: strongly managing our portfolio to drive further margin expansion and earnings growth, maintaining a laser-like focus on generating ongoing positive and strong cash flow and directing the significant portion of this cash toward increasing rewarding shareholders, and third, aggressively managing and continuing to evaluate every aspect of our enterprise to release and deliver even further value for our shareholders.

You saw additional granularity on the way we are releasing new value from our portfolio earlier in this call, and you can expect to hear more in the coming months. Taken on the whole, we continue to deliver against the commitments we have made, making calculated decisions and delivering strong results in the face of what remain uncertain market conditions. We will be focused on delivering strong earnings and cash flow and remunerating our shareholders. Nothing more, and nothing less.

And with that, I will turn things back over to Doug for Q&A.

Doug May

Thank you, Andrew. Now we’ll move to your questions. First, however, I’d 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.

Operator, would you please explain the Q&A process?

Question-and-Answer Session

Operator

[Operator instructions.] And we’ll take our first question from John Roberts with UBS.

John Roberts - UBS

Andrew, your comments on Styron as an example would appear to be directed towards the chlorine derivatives. I mean, looking at the chart, it’s the most complicated, integrated business that would be similar to the Styron situation you addressed. Am I reading that right?

Andrew Liveris

Firstly, as you can all tell from the chart that you’re referring to, slide 18, the six months of work I referred to is producing outcomes and we, as your observation has suggested, we provided this fresh granularity so you can see where we are heading from the point of view of improved and fixed. And when you marry that with the point you’re making in integration, these aren’t simple things to go get. The red bubble businesses, especially chlorine, are very integrated.

But we have done it before, and the red bubbles are indicative of where we’re prepared to do it again. This is not an announcement. We are in the business of moving those businesses to higher ROC territory, whatever it takes, and I’m just giving you the heads up that we have the expertise to do it, and I think that’s a good reason.

Operator

[Operator instructions.] We will go next to Robert Koort with Goldman Sachs.

Robert Koort - Goldman Sachs

Andrew, you mentioned that plastics might have even done better except you had a facility down as Lake Charles was ramping. How big a delta in a static world relative to other factors would that be in the second half?

Andrew Liveris

Well, that particular unit, the [Texas Seven], was a $30-40 million type hit, if you like, and it’s one-time. So yeah, to the extent that it could have even been a bigger result than the one you saw, as you well know, Bob, the balances going forward into 2014 all go very, very well for everyone exposed to the positive dynamics around ethylene, polyethylene, and the downstream value adds like we are.

So we believe this unit, this number that it’s achieved, we haven’t seen since ’05. 2005 was a commodity peak. We have changed the portfolio substantially since then to high value-add applications like packaging. If you take the high value applications like packaging, hygiene, and medical, and the feedstock dynamic, and a cyclical peak coming forward, this unit, to achieve this result during this period of time, not only was indicative of how strong it is, but how much more it can do as we enter 2014/2015.

Bill Weideman

And to that point, the other thing in my prepared comments, I’d highlighted St. Charles operations, as previously announced, would add $150 million of additional EBIT this year. And a significant portion of that will occur in the second half of the year. So that might help you also.

Robert Koort - Goldman Sachs

And Andrew, I think you were proud of the cost-cutting traction you gained and talked about it being evident, and I guess when I look outside of plastics, it looks like there was quite a bit of margin weakness across the portfolio. So should we be seeing that evidence at the corporate line? Or could some of those subsegments have been even worse without the cost cutting? How do we, from the outside, measure that success when it appears the margins across the performance businesses remain really impaired?

Andrew Liveris

Yes, the performance materials and [unintelligible] infrastructure, that’s why we gave you the graded granularity on slide 18, that was asked about in the first question. Not everything’s equal in there, and so the cost reduction programs are across the entire enterprise, not just in the corporate bucket you just referred to.

What you are seeing, though, is the epoxy business is getting tough competition out of China and Asia that is destroying margins, and going down below cash cost margins. We’re not the first to tell you that. Others in the game are telling you that.

So that’s why that business in particular is fairly troubled. The chlorine derivatives point that was made, the way we do chlorine, you know, frankly, we’re not in the PVC business, so as a consequence of that, lots of margin compression based on their commoditization.

And then last but not least, propylene and its volatility is hurting, for now, the acrylics envelope as well as the PO envelope. Those have got fixes in front of them, which is the 450 basis points coming from Sadara and PDH and all the things we’re doing. From here to there, we’re going to bridge over.

So the margin deterioration, we’ve taken out assets, we’ve got more assets. The run rate for those take outs will start to hit the second half. You can start to see improvement therefore in performance materials as a whole as that happens to take hold specifically inside of their reporting segment. The corporate stuff will appear across the entire enterprise, and you’ll start to see that as well.

We make no bones about it. There is work we need to do in parts of those two units, and that’s what you just heard us on the call. We will get it done, so we get that $500 million EBITDA saving to the bottom line this year as promised.

Operator

We’ll go next to Hassan Ahmed with Alembic Capital.

Hassan Ahmed - Alembic Capital

Good numbers on the performance plastics side of things. And obviously in line with some of the commentary you provided in your Q1 call about a relatively near term peak in the cycle. Now, since that period, a bunch of consultants and industry folks have come out and have been talking down the utilization rate side of things. And some have even come out and said, on the back of a slowdown in China, utilization rates may not even get to 90% if the next level of capacity comes online in 2017. So we’d love to hear your views about that.

Andrew Liveris

There are three ways we make money in performance plastics, and we believe two of the three you’ve seen the results and you’ll see more of. One is the value add. We have a unique plastics unit that is value add in the packaging, hygiene, and medical space that is different to 90% of the competitors you see out there, especially the guys who are very reliant on just the commodity cycle. So we are not reliant on the commodity cycle is number one.

Number two, our unique ethylene footprint being in low-cost jurisdictions. You know, the 70% post the expansion to low-cost jurisdictions which we’re investing against. And number three is the question you’ve asked.

Look, GDP forecasts, as you know, are all over the map. We have factored into our views a lower GDP scenario operating rate. And so that’s why we’re into the 2014 discussion in terms of the cycle coming into play. And you know, frankly, if you look at the run rates and the oil and gas arbitrage, if that indeed puts pressure on the guys who are in NAFTA, there will be capacity rationalization during this period of time, so that’s the one scenario.

Frankly, there’s about 9 million metric tons in Europe and Asia that’s under that type of pressure. So that will be capacity take out that will fulfill the operating rate number being in the 90, 91, 92 frame that will give us the evidence of a cycle.

Of course, the other scenario is the one where GDP is even better and then of course the discussion is over. The operating rate will lift. So under either scenario, firstly we have three ways to make money in this business, and the third way, when that operating rate hits, we believe the low GDP scenario is a 2014 event.

Hassan Ahmed - Alembic Capital

You talked about, in the press release, market share gains within polyurethane. Now, obviously on the Sadara side of things, you will be bringing online some NDI capacity, and there are others who are bringing on NDI as well. So do you see, even on the back of these capacity additions, the market relatively tight in the near to medium term?

Andrew Liveris

Yeah, the Sadara capacity 2015 and beyond, the balance would suggest that NDI should be fine under the weak GDP scenario. The market share gains you’re referring to for us for polyurethanes are particularly out of our Thai assets, which were the [unintelligible] and propylene glycol side of the conversation. But look, NDI and our forecast suggest it will be fine in the weak GDP scenario.

Remember one thing that’s going on, which is the consumer matters in polyurethanes. So furniture, bedding, construction, these are all very good things that are associated with [unintelligible] and as the U.S. is showing strong demand in the consumer side on housing and the renovations of all that, and China becomes more of a consumer society.

Very instructive in China for us this quarter was how much demand was coming out of west China. This is all new consumer demand. So look, again, we’re not declaring victory on China yet. China’s got a long way to go to recalibrate its economy. [unintelligible] recalibrate it around consumption, that’s more domestic consumption, consumer-driven, which will help polyurethanes and therefore help NDI.

Operator

We’ll go next to Frank Mitsch with Wells Fargo Securities.

Frank Mitsch - Wells Fargo Securities

How should we think about the pace of share buyback? And is there anything that could be done, you believe, in the near term, on the convertible preferred?

Bill Weideman

A couple of things. The K-Dow award winding up on the balance sheet, it gives us a lot more flexibility going forward. Specifically to the preferreds, that remains a high priority, and a top priority for us. And as you can imagine, as we’ve said all along, timing is important on this. And clearly as interest rates tend to go upward, the potential premium that we would need to pay to retire those decreases. So things are moving in the right direction from that standpoint. So you can rest assured that we’ll be looking at different opportunities there.

From a share repurchase standpoint, we’ve gone out at this point and said going forward that our plan is to cover dilution. Actually, this quarter we actually purchased $80 million of shares back second quarter, and we’ll continue to go forward. But clearly I don’t want to put a new target out there, but clearly with additional financial flexibility we have the ability to do more going forward.

Andrew Liveris

Frank, I want you to note, not that I speak to graphics often, but the graphic that we provided you in the deck, on slide 19, has an arrow within an arrow, which is, if you look at the debt reduction arrow, that’s pointed to shareholder remuneration. Bill’s good work on the balance sheet plus the preferreds as we address those releases value, releases cash, and as I said in my prepared remarks, totally oriented to shareholder. And that’s our mindset.

So whatever lens you put on it, the debt paydown lens, the preferred lens, the actual direct cash is geared to the shareholder. I said that in the remarks, and just reinforcing it with the graphic on slide 19, supporting Bill’s comments.

Frank Mitsch - Wells Fargo Securities

Congrats to your graphics department on that arrow within an arrow. On the ag side of things, you talk about a shift in buying patterns, but yet sales were a record in ag, and obviously earnings were off. So how should we think about growth spending? Can you kind of give us an order of magnitude of growth spending? Because obviously that impacted the results there and when do we think we start to see the benefits?

Bill Weideman

We are continuing very much in an invest mode in Dow Ag, and that’s paying huge benefits you’ve seen on the top line and will continue as we’ve got a lot of new product introductions coming forward, and Enlist is a large one coming forward.

And actually, as you analyze the results this quarter, you will see that R&D and SG&A are down versus prior quarter, and you should expect that trend to continue going forward. This is a company comparison. But up over a year ago, and most all of that increase is due to the investments we’re making in ag.

So we’ll continue to invest in ag, but what you’re seeing with our strong 23% increase in sales year to date on seeds, traits, and oil, you’ll see the sales and actually the EBIT there reflected going forward. But we are still in invest mode in ag.

Andrew Liveris

And not to forget Enlist. So this is the biggest launch that we’ve ever had. So, look, that [unintelligible] that you’re asking about, as Bill said that will improve with the quarters, but give yourself a 2014/2015 kind of anchor to see the target EBITDA margins will start to inflect the other way.

Operator

We’ll go next to Duffy Fischer with Barclays.

Duffy Fischer - Barclays

The equity affiliates seem to be doing better. You referenced MEGlobal, some of the NAFTA consumption in Asia. Can you talk about the next half year, and maybe into ’14, how you see the equity affiliates playing out, and what we can expect from them?

Bill Weideman

To your point, you saw a nice increase in our equity earnings this quarter. We would expect that trend to continue. A couple of drivers this quarter, as I highlighted in my prepared comments, MEGlobal was up quite a bit, but in comparison to the period a year ago, they had apparently sizable turnaround. But we expect to see continued improvement in our joint ventures as they go forward. And Dow Corning has stabilized, and so Dow Corning is down over a year ago, but it’s up versus prior quarter. So we expect that trend to also continue. So going forward, we expect an upward trend in joint venture income.

Duffy Fischer - Barclays

And then looking at coatings and performance materials, if you did a similar exercise with electronics and functional materials, what would that look like? How much stuff might be in that bottom third, the middle third, and the upper third?

Andrew Liveris

You’re asking for information that we’re not ready to release. Look, we are going to talk much, much more about this granularity going forward. That’s what we promised last year, and the slide is an indicator of our willingness to do it. But I would tell you that electronic materials is all green. So we are in good shape. And functional materials as a portfolio, lots of high tech, high margin businesses. Just roughly two-thirds good, and the rest kind of less than good, but no reds.

Operator

We’ll go next to Peter Butler with Glenn Hill Investments.

Peter Butler - Glenn Hill Investments

Dow’s new cash flow story, including this moratorium on acquisitions, has really been a nice plus for shareholders, but do we have to worry that your M&A folks may be getting a bit bored with divestments and they may want to have more fun with a big acquisition?

Andrew Liveris

No, I’m not worried about that at all. If they feel that way, I’m sure Bill could have a lot to say to them about it. But look, as you said, we’re reinventing some very key things, and very focused on the shareholder you led in with. There are going to be small bolt ons in ag and in water and electronics, but they aren’t worth the conversation. They’re very accretive and we explore them globally when we do them.

So the key mode of action is that slide 18, which is we’re going to be in the business of improving ROC by culling from the bottom. And we’re going to grow the growers, and we’re going to fix or eject the ones that aren’t growing, all with the single focus of cash. If I get a bored M&A department out of that, then so be it. That’s the least of my concerns.

Peter Butler - Glenn Hill Investments

One of the chemical stocks in history was the old Celanese story, where the management just threw in the towel on trying to grow their commodity business. You talked on CNBC this morning about you’re down to about a third of your sales are in the portion affected by country competition, etc. Why not split it off and run it? I know it’s a lot of work, but it could be hugely successful for shareholders.

Andrew Liveris

Look, the comments on CNBC are not new in the sense that I have been very clear that competing against countries that subsidize through their financial weapons, these competitions that we get from the commodity side, is a trend that won’t go away. It really started in the Middle East in the 80s as you well know, and has now gone around the world. And we’re seeing it from every country.

So there’s no question. Epoxy resin’s a good case in point right now. We’re getting competition out of China, you know, and it’s been commoditized. So look, I think all options are on the table. We will continue to move away from competing against people that really don’t have the same financial metrics as our shareholders demand.

And so I agree with you. This is the way you should think about our company going forward. And frankly, all options are on the table. The difficulty of disintegration has to be taken into account, but as I said in my prepared remarks, we are willing to attack that, as witnessed by our Styron divestment. So I think you’re spot on, Peter.

Operator

We’ll go next to Chris Nocella with RBC Capital Markets.

Chris Nocella - RBC Capital Markets

Andrew, you had price declines across most of the segments this quarter, and that’s been the case for the past few quarters now. My question is particularly for the specialty chemical businesses, can you still price there for value versus strategy now and use price to grow volumes and [unintelligible] share?

Andrew Liveris

The effective price was the 2%, one half of that was currency, of course, so it is different around the world. There’s no question was the deflationary actions out of China in the last year, where they’ve stopped spending, they’re a big buyer. And once you get a big buyer out of the market, no matter how specialty you are, you’re going to see some volatility on the price equation if they’re not buying anything.

So as a consequence of that, we’ve had mixed price performance across the segments. I will tell you that right now the pricing environment is on the cusp of changing momentum-wise. You know, we have charts we run here, green, yellow, red. There’s enough green on these charts where we’re value sellers not volume sellers, based on improving margins through lower cost but also higher prices, based on the functionality of our product. Two-thirds of the mix is now much more technology driven.

We’re just redirecting ourselves to more and more of that value sell, knowing that some of it’s going to be subject to deflationary issues such as hydrocarbons. But going forward, I think we’re not counting on market share gains as a way to run this enterprise. We’re basically counting on value share gains. And then those businesses that can’t do it, like the ones with the red dots on slide 18, frankly we’re going to run them with very, very low cost models and eventually eject.

Chris Nocella - RBC Capital Markets

And then just as a follow up on performance plastics, if we were to assume today’s margins, where they stand, plus the absence of any shutdowns you had in the second quarter, do you expect that business to be up sequentially in the third quarter?

Andrew Liveris

That’s a good assumption.

Bill Weideman

Yeah, that’s a good assumption.

Operator

We’ll go next to David Begleiter with Deutsche Bank.

David Begleiter - Deutsche Bank

Andrew, on your slide 18, the polyurethanes, that’s now yellow, what gives you the confidence it will migrate towards green as opposed to migrate towards red?

Andrew Liveris

There’s a few polyurethanes, and the way it’s written, polyurethane systems, that there’s quite an envelope in there. So I think it was Hassan who asked about the NDI piece. There’s no one answer to your question.

On the downstream side, the systems side, I’ve already made comments on U.S. construction and China consumer and all the things that are going on. We’re quite confident we can still be strongly green there in the system side, and frankly you might argue that if you peeled it out it might be green already.

The real issue is inside of the polyurethane [unintelligible] components, TDI, propylene oxide, and NDI. Look, we’ve got fixes in place for all three to not make them red, but obviously to improve the yellow.

But some of those fixes, given the asset sizes, are truly low-cost positions and removing the volatility of inputs, where Sadara and PDH are the best fixes. And that’s really 15-18 months from now. Between now and then, the pressure on the pieces of the businesses that are running in the yellow, if you like, not be red, is all about costs, costs, costs.

So in other words, we’re going to keep them pretty buttoned down until such time as the low cost capacity comes onboard. And frankly, as that comes onboard, we’ll look at rationalization as one of the outcomes.

David Begleiter - Deutsche Bank

And then just lastly, U.S. ethylene projects still waiting for permits from I guess the EPA and others. Timing on that, in your view?

Andrew Liveris

I think the one you’re asking about from a permit point of view is of course what we call the Texas Nine cracker, which is a large one, which is a 2017 startup. And at the moment, we are on track and frankly there’s nothing that’s going to delay that from 2017 from this point in time, including permits.

Operator

We’ll go next to Kevin McCarthy from Bank of America Merrill Lynch.

Kevin McCarthy - Bank of America Merrill Lynch

Just wanted to follow up on Dow Agrosciences. You referenced some increased investments that you’re making. And with regard to the margin pressure year over year, are there also any timing issues between Q2 and Q3, for example, that would have had a meaningful influence there? A number of your peers in the space have pointed to the delayed planning in North America, for example.

Andrew Liveris

Clearly the delayed planning in North America impacted the delay, and there’s no question that it impacted in particular the U.S. results, northern hemisphere in general. We see strong sales from a Q3/Q4 point of view in Latin America, just like some of our peers have reported, being, if you like, an unusual second half event compared to normal second half.

And just to remind you, we have corn share of 16% in Brazil and 13% in Argentina. So we are very well-positioned, especially the launch of PowerCore last year on the corn trait adoption cycle.

So, look, the soybean versus corn comparison is also a big deal. As you know, the first part of the Latin American season is normally soy. So we do expect to see acreage increase there for soy and corn economics will still stay good. So yeah, there will be some of that, delay out of North America, plus a strong back half for Latin America.

Bill Weideman

Also, there were actually strong seed sales in the first quarter, as farmers purchased live seeds early to make sure they had those. But if you look forward to the third quarter, our expectation is that Dow Ag comps will be favorable year over year comps for the third quarter.

Kevin McCarthy - Bank of America Merrill Lynch

And then a brief follow up on China. Andrew, you made a remark that you believe China appears to be stabilizing and then another comment about stronger consumer demand, I think in western China. Where do you see that showing up across Dow’s portfolio? Perhaps you can talk about specific product lines where you’re more encouraged.

Andrew Liveris

I think the notable increases in volumes, so polyurethanes, was what let me to that question in response to the west China point in particular. Packaging, that will show up in packaging, with strong, obviously, performance by our polymer business, polyethylene and [unintelligible] packaging enterprise. But not just that, the [unintelligible] as well.

Autos and Dow Automotive, in particular what they’re doing with respect to especially sealants and adhesives. [unintelligible] solvents, polyglycols, surfactants in general, which feed, if you like, the industries that feed the consumer. And then Dow Agroscience. I think Dow Agroscience is increasing, albeit off a small base. And then last but not least, functional materials and coatings and infrastructure, in particular Dow Coatings and Dow Water.

Operator

We’ll go next to Jeff Zekauskas from JPMorgan.

Jeff Zekauskas - JPMorgan

Can you tell us how much your pension expense went up this year, or how much you believe it will go up this year, and what your pension funding will be this year?

Bill Weideman

This year, ’13 versus ’12, our pension expense will be up approximately $275 million. And that’s embedded in our operating results, so we’re covering that in our operating results. As you know, we don’t call that out as a certain item. So up $275 million in ’13 versus ’12.

From a pension funding standpoint, our plan right now is to fund the pension plan about $900 million this year, which is similar to the funding that we had in 2012. But as I mentioned in my prepared comments, interest rates had a large impact on this, and dependent on your view on interest rates going forward, a small increase in interest rates could be a significant tailwind as we go into 2014.

Jeff Zekauskas - JPMorgan

And in terms of your electronic materials outlook, do you see the demand climate as strengthening or weakening, or relatively stable in the second half?

Andrew Liveris

We think electronics is one of those businesses that is moving in a positive direction in the second half, as an industry. We’ve seen that from the downstreams, from the space where we actually directly supply, whether it be Apple or Samsung or Intel. You’ve seen what they’re doing with increased capex for example.

There’s clearly a strong move on display technologies, where we’re increasing our presence in [unintelligible] technologies, so OLED and films, for example, from our product mix. And there’s no question that semiconductor technologies are on their way up as well, and [interconnect] technologies. So look, I’d say it’s a positive momentum play, not flat.

Operator

We’ll go next to Don Carson with Susquehanna International.

Don Carson - Susquehanna Financial

Andrew, I want to go back to July 18, and chlorine derivatives, is the only solution there a carve-out? Or, given that you’ve got some new very low cost capacity you’re about to start up in the second half at Freeport, is there also some closures that you might do as well to improve the profitability of this business?

Andrew Liveris

I’d say both of those are on the table, and both are available, and I think we know that we have to do some action there, and we’ve been working on that. And DMCA, as you know, was one of those actions that was from three years ago. As that starts up, it will be new low cost capacity, right down our sweet spot, because we take the [Corning] for our value add, our partners take it for their business and downstream [EDC/VCM] etc. You can expect that type of innovative answer as well as rationalization. And all options are on the table.

Don Carson - Susquehanna Financial

And a follow up, completely different business, but South America and licensing opportunities. [unintelligible] has a big advantage in Brazil, because 24D is already registered, [unintelligible] isn’t. And I also saw from your regulatory filings earlier this year that you got a two mode of action VT for insect protection in soy. So are there some licensing opportunities or imminent announcements about to come for the South American soy market for Dow Agrosciences?

Andrew Liveris

I wouldn’t use the word imminent, but I would definitely agree with you opportunity. I mean, there’s no question. Remember, the Enlist soybean license with DuPont is global. And of course, to your point, incredibly valuable in the Latin American market for the reasons you’ve stated. But look, there are other opportunities, and I think of course what you said about the registration, it’s going to be a powerful positive for our presence down there, whether it be direct or through licensing.

Operator

Our final question will come from PJ Juvekar from Citi.

PJ Juvekar - Citi

Andrew, [coatings] and infrastructure seem to be underperforming. Any [unintelligible] business down between the old [Roman and Haas] acrylic business versus your industry in [coatings] and epoxy coatings, etc.?

Andrew Liveris

There’s no question that if you tear the oxy piece out, which we’ve done on slide 18, you already see the acrylics business, which is mostly the legacy Roman and Haas that’s on that slide, almost touching green. So that should tell you straight away that where the problem child has been in coatings and infrastructure. Not to mention, of course, that in that unit we report Dow Corning, right? So you’ve got to correct the segment for that in addition.

But acrylic margins are moving upwards. They’re moving upwards because of the recovery in the housing market, as well reported from our downstream customers, and frankly the year or two ago issues that we’ve had in performance monomers out of Deer Park, we’ve put a lot of money into Deer Park to upgrade it, and to have it reliable, and it’s running as good as it’s ever run, in fact way better, safely.

And our [unintelligible] integration in Saudi Arabia, as that starts up, that’s well-positioned for low cost inputs for the downstream emulsion businesses in the emerging countries. So look, I think we’ve got the right parameters, not to mention of course the propylene back integration of [PDH] will be helpful to acrylics. So those things will make that yellow bubble on slide 18 cross the green threshold.

PJ Juvekar - Citi

And then secondly, you talked about overcapacity of [ECU] in China, which is leading to excess production of [epi] and epoxies and all that. Are you seeing more exports out of China? And are those exports showing up in Europe? How is that flowing through?

Andrew Liveris

It’s definitely showing up in the United States. Europe, as you know, is a very troubled downstream consuming market, but it certainly is affecting Europe. But mostly it’s showing up in the United States.

Doug May

Maybe Andrew, do you want to close with a few comments?

Andrew Liveris

Yeah, look, thanks everyone for listening to us today. I would say there’s no question that it was a strong quarter for us. We put self-help in place late last year. The weak macros is our prevailing assumption. The self-help is turning up in our results, and we’re very strongly pleased with that.

It’s showing up in our cash flow story too, the question that was asked. The cash flow story means that we are prioritizing uses of cash, as you saw with the K-Dow award to the balance sheet, and that is liberating more opportunities to reward shareholders. We are poised to keep improving the ROC of the company. We’re giving you more granularity in slide 18, as already indicated by all the questions.

That said, we’re going to be taking more action, and with the share buyback program we’ve already announced, and as we take more actions, since the shareholders are our singular focus. We are taking out costs in a weak macro. We’re not counting on tailwinds. But we’re investing in technologies that help in this macro-environment, like packaging, like advanced materials, like Dow Agriculture. And those investments are paying off

And as you look at our next couple of years, our path to $10 billion is very, very short, $10 billion of EBITDA. So our focus is on the shareholder, and our ability to keep growing earnings, in our view, is in our control, and if there’s a tailwind out there that eventually happens, that’s all a bonus. So thank you, Doug, and thanks everyone for listening.

Doug May

And thank you everyone for your questions and for joining us this morning. 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, and we look forward to speaking with you again soon. Thank you.

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