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Executives

Howard Ungerleider – VP, IR

Andrew Liveris – Chairman and CEO

Bill Weideman – VP and Interim CFO

Dave Johnson – Director, IR

Analysts

P.J. Juvekar – Citigroup

Hassan Ahmed – Alembic Global Advisors

John McNulty – Credit Suisse

Paul Mann – Morgan Stanley

Don Carson – UBS

Robert Koort – Goldman Sachs

David Begleiter – Deutsche Bank

Frank Mitsch – BB&T Capital Markets

Bill Young – ChemSpeak

The Dow Chemical Company (DOW) Q4 2009 Earnings Call Transcript February 2, 2010 10:00 AM ET

Operator

Good day everyone and welcome to The Dow Chemical Company fourth quarter 2009 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're making this call available to investors and the media via webcast. This call is the property of The Dow Chemical Company. Any redistribution, retransmission or rebroadcast of this call in any form without Dow's expressed written consent is strictly prohibited.

On the call with me today are Andrew Liveris, Dow's Chairman and Chief Executive Officer, Bill Weideman, Vice President and Interim Chief Financial Officer and Dave Johnson, Director of Investor Relations.

Around 6.30 this morning, February 2, our earnings release went out on PRNewswire and was posted on the Internet on Dow's website, dow.com. We have prepared some slides to supplement our comments in this conference call. The slides are posted on our website on the presentation 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 would 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. And I would like to point out that in our prepared remarks today in order to provide the best information regarding our results, our sales comparisons are on a pro forma basis, excluding completed divestitures and our EBITDA comparisons exclude certain items. A reconciliation of 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 our recent SEC filings are also available on the Internet at dow.com.

The agenda for today's call is on slide three. Now I would like to hand the call over to Andrew.

Andrew Liveris

Thank you, Howard. Good morning everyone and thank you for joining us to discuss our results. What a difference a year makes. As you recall this time last year, we were facing unprecedented demand destruction and of course, steep declines in manufacturing activity across virtually all sectors.

If you look at slide four, you will see we responded by taking decisive actions throughout the year. And the results of those actions are clearly demonstrated in the fourth-quarter results. Here, Dow grew earnings year-over-year in the quarter. And we delivered the fourth consecutive quarter of positive operating earnings in highly challenging economic conditions.

But the big story of the quarter is top-line growth driven by year-over-year volume gains. We achieved 4% top-line growth and 10% higher volumes versus the same quarter last year. This is on a pro forma basis, excluding divestitures which is really the best way to view the underlying performance of our operations. This was driven by strengthening demand across many of our key segments.

Sales increased sequentially each quarter of the year and even accelerated during the fourth quarter. The power of our strong geographic footprint manifested itself once again, specifically in the emerging geographies of Asia Pacific, Latin America, Eastern Europe, India and the Middle East, which all had double-digit volume growth over the fourth quarter of last year. Overall, emerging geographies posted volume growth of 33%.

EBITDA increased by 809 million in the quarter and in all operating segments except Health and Agricultural Sciences, which declined primarily due to increased investment in R&D as we continued to fund growth in this exciting segment of our company.

EBITDA in the combined performance segments was up 88% versus the fourth quarter of last year. Overall, EBITDA was at a $6 billion annualized run rate for the third consecutive quarter.

Equity earnings were very strong at $284 million and back to normalized levels not seen since prior to the economic downturn, led by strong performance in Dow Corning and EQUATE. These joint ventures will continue to be important elements of our growth strategy going forward.

We continued our focus on cash flow generating $1.4 billion of cash from operations in the quarter and $2.1 billion for the full year. We are also well ahead of our goals on cost reductions. We ended the year with a run rate of $1.7 billion in savings from structural cost reductions and cost synergies related to Rohm and Haas. We are now 70% of the way towards our two-year goal of $2.5 billion in savings.

We completed the divestment of Morton Salt in the quarter. This was the fourth non-core divestment of 2009, all with strategic buys and all at favorable multiples. We paid off the balance of our bridge loan well ahead of plan. And we also repaid our revolver. In total, we reduced our debt by $2.5 billion since April 1, reducing our net debt to cap to 48% ahead of our goal through a number of actions I'm going to highlight later.

Now this is a very impressive list when taken on its own. But when you consider that we did all of this while continuing the integration of Rohm and Haas, cutting costs, reducing our Basics footprint, divesting non-core assets while continuing our many investments for growth, all of which was done during the worst recession in decades, these accomplishments are even more extraordinary. I am also proud that the Dow team continues its focus on serving customers well and driving top-line growth.

Looking at slides four and five and turning to the outlook for industry demand, here again is the tracking tool we showed you last quarter. We saw improvements across many of our end-use industries throughout the year. This underscores the unique view we have into the economic recovery based on our participation in the value chains of a vast array of industries and end markets.

On slide six, you can see our broad geographic reach also gives us insights on overall global demand trends. Emerging geographies once again lead our growth in the fourth quarter with volumes up 33% over the fourth quarter of last year.

Volumes in China, for example, were up nearly 60%. And India and Russia were up around 30%. Brazil was up 20%. Globally, North America was the only region that we did not see volume growth but even here there were some bright spots.

Automotive demand was improved. And the demand for packaging remained resilient. Broader growth, however, continued to lag as high unemployment and reduced consumer spending dragged on the progression of the U.S. recovery.

Conditions were similar in Europe for many of the same reasons. And the higher value of the euro further impacted exports out of that region. These trends, along with our fourth-quarter results, represent clear and positive steps forward in the global economy and in our operating segments.

We begin 2010 well-positioned to take advantage of strengthening economic conditions in key areas of the world. Our new portfolio, our R&D engine, our strong geographic presence, our ability to remain financially disciplined will be all key drivers to earnings growth well into the future.

I am going to speak more about these points in a moment, but first I would like to turn the call over to Bill for a review of the fourth quarter. Bill?

Bill Weideman

Thank you, Andrew. I will begin with a review of our fourth-quarter results on slide seven. Reported sales were 12.5 billion, an increase of 15% over the same period last year and 3% over the third quarter of 2009. On a pro forma basis and excluding divestitures, year-over-year sales were up 4%, driven by volume growth of 10%.

EBITDA, excluding certain items, was up on a year-over-year basis in the fourth quarter by 809 million. It was basically flat sequentially in what is traditionally a seasonally weak quarter. Earnings, excluding certain items were $0.18 per share, ending the year with four quarters of positive results. The current quarter included $0.10 per share unfavorable impact for certain items. Details for these items are included in the appendix.

Our tax rate was lower this quarter due to higher earnings in emerging geographies and strong joint venture results. We expect a lower tax rate to continue in 2010 and would estimate a rate between 15 to 20% for modeling purposes.

As Andrew mentioned, we saw strong volume in the quarter. As you can see on slide eight, we saw year-over-year improvement in virtually every operating segment and across all geographies, except North America. Strong growth in Electronic Materials of 14% was, however, offset by lower demand in Specialty Materials, driven by lower capital spending in industrial water applications. We see this as just a temporary pause and remain confident in the long-term fundamentals in the demand for clean water.

Emerging regions also clearly performed very well versus last year while growth in the more developed economies is lagging. On a sequential basis, as you can see on the next slide, volumes rose 3%. This is in spite of normal seasonality in segments such as Electronic Materials and Coatings and Infrastructure. Once again, emerging geographies led the volume gains.

On slide 10, you can see that price rose sequentially in every operating segment, except Health and Agricultural Sciences in every geography. These gains were largely offset by more than $525 million. These gains largely offset the more than $525 million increase in purchased feedstock and energy costs. As you know, energy prices rose significantly in the last half of December and we have responded quickly to pass on these increased costs.

Now, let's take a look at how the company performed at an operating segment level on slide 11. In Electronic and Specialty Materials, as I just mentioned, volume was up 14% in our Electronics business versus last year. Foundry utilization rates remained strong and we did not see the typical seasonal pause. The semiconductor industry also continued to see solid downstream demand.

In Specialty Materials volume was somewhat muted during the quarter in industrial water end markets and demand for cellulosics used in construction applications was weak in North America and Europe.

We continue to see growth in our Coatings and Infrastructure segment as emerging regions continued to drive increased demand. Significant growth in China was driven by stimulus programs which strengthens construction and residential end markets.

In North America and Japan, we are beginning to see improvements. However, commercial construction continues to be slow in these geographies and in Europe.

Now turning to Health and Agricultural Sciences on slide 12, the fourth quarter produced double-digit sales growth in ag chem as farmers in Brazil resumed plantings after a temporary pause last quarter.

Seeds, Traits and Oils volumes grew 24% as the business continues to reap rewards of its technology-rich pipeline and recent seed acquisitions. These drove sequential and year-over-year volume growth.

We remain focused on investing in this segment given its robust long-term fundamentals. Both R&D and SG&A investments increased in the quarter to support product launches and recent seed acquisitions.

One example of this, just last week Dow AgroSciences announced regulatory approval from Mexico for the importation of corn grain produced from SmartStax. This is an important approval because Mexico is among the world's largest importers of U.S. corn and this ensures they will have access to this world-class technology.

Now let me turn to Performance Systems. Performance Systems continued to show strong operating performance in the quarter. Demand for wind energy applications in China drove growth in our Formulated Systems business while demand in food packaging and automotive applications strongly benefited our Elastomers business.

While there was double-digit increase in light vehicle production within the automotive industry versus last year due to government stimulus, visibility remains unclear in this sector as their programs come to an end.

Moving to Performance Products. Our polyurethane building block business delivered a solid quarter due to tight supply, increasing demand and further penetration on our unit technologies in the appliance industry. We also saw increased demand for oxygenated solvents. These products go into a number of growing healthcare applications such as hand and surface sanitizers.

Lastly, we saw increased demand in Europe for heat transfer fluids used in new concentrated solar power installations.

As you can see on slide 13, our Basic Plastics franchise delivered another outstanding quarter. Continued demand for polyethylene drove double-digit volume growth versus the fourth quarter of 2008. This is the fourth consecutive quarter of polyethylene volume growth, due in part to an open export window from North America due to relatively low gas prices into the weak U.S. dollar.

I would also like to point out that the Basic Plastics segment, which is comprised primarily of polyethylene, generated 1.7 billion of EBITDA in 2009 in one of the worst economic climates in decades. This is truly an impressive performance.

Finally, I'm pleased to report that after facing headwinds throughout most of 2009, our Basic Chemicals business showed signs of strengthening. Caustic soda prices improved after bottoming in the third quarter and vinyl chloride monomer prices rose for the third consecutive quarter on increasing demand. Aggressive economic stimulus efforts in China drove improved performance in EO/EG of polyester fiber mills -- as polyester fiber mills saw an uptick in production.

On slide 14, equity earnings, excluding certain items were $284 million which is up 27% sequentially. Once again, this is back to levels we last saw before the economic downturn. Notable contributors to the improvement were Dow Corning and EQUATE.

Turning to our actions on cost control on slide 15 and in keeping with our long-term heritage of financial and operating discipline and we delivered on our structural cost reductions achieving more than 215 million in the fourth quarter.

On a pro forma basis, SG&A was down 4% in the quarter versus the fourth quarter of 2008, even with a 15% increase in ag to support new product launches and commercial activities.

On a pro forma basis R&D spending was up 6% continuing our investment in growth, despite the economic conditions led by increased investments in Dow AgroSciences.

Lastly, we made significant progress in our commitments related to cost synergies in our restructuring efforts. On slide 16, you can see that we are well ahead of our plan to capture the cost synergies related to the acquisition of Rohm and Haas in our restructuring program. And we expect to deliver an additional $650 million of savings in 2010 versus 2009.

Now, let me hand you back over to Andrew.

Andrew Liveris

Thank you, Bill. So let's look at slide 17 and turn to a review of the full year. Exactly a year ago I ended my discussion by asking you to judge us by our actions. Despite 2009's unprecedented demand destruction and the traumatic failure of PIC of Kuwait to close the legally binding joint venture transaction, we acted decisively to reposition ourselves to our new realities.

We quickly reduced cost and rightsized our asset footprint to reduce exposure to commodity products in low growth locations and we increased our presence in high-growth products in fast-growing geographies. We also closed the Rohm and Haas transaction and moved quickly on the cost synergies.

As a result, we improved volumes and profits from these actions sequentially throughout the year. And we are benefiting from the pivotal step we took in actually acquiring Rohm and Haas. By year's end, our pace of improvement was increasing as shown by the results in the quarter. We are ahead of all of our operating and financial milestones that we had promised you in early '09.

Let me review each of these milestones in turn. On slide 18, our strategic accomplishments this year were many. As I stated, we acquired and integrated Rohm and Haas which I believe will be remembered as the singular strategic acquisition that transformed Dow into a higher growth and higher margin business portfolio with significantly improved earnings power.

We shed $3 billion of non-core assets at very attractive multiples. This was done ahead of our divestment plan and gave us the proceeds to strengthen our capital structure. We reviewed and recommitted ourselves to our strategy. And after an enterprise-wide review, we remain committed to ongoing and active portfolio management to improve profitability and focus resources on higher growth, higher margin opportunities.

We have a deliberate and well thought out plan with $12 billion of divestment options as well as targeted areas for growth. To me, the best proof of our renewed commitment to grow and deliver shareholder value is our record year of R&D investment, reinforcing our focus on market-driven science-based innovation.

On slide 19, our financial milestones were also an overachievement in a very difficult year. As I mentioned earlier, we delivered four consecutive quarters of positive operating earnings. And we achieved improved sequential sales throughout the year reflecting quarterly demand improvement as volume increased, particularly in emerging markets.

Since the close of Rohm and Haas on April 1, we have taken a number of actions to strengthen our balance sheet. We eliminated the high cost Series B and C preferred shares at par. We successfully raised equity in an oversubscribed offering and turned our near-term maturities with oversubscribed debt offerings. And we completely paid off the bridge loan ahead of schedule and paid off the remaining balance on the revolver.

In addition, we reduced long-term debt maturities through 2011 by 80% and lowered total indebtedness by more than $2.5 billion. All of these actions brought our net debt to total cap down to 48%, which is ahead of our plan. And we lowered our financing costs by $500 million per year.

And lastly, as I mentioned at the outset of my talk, we generated $2.1 billion in cash from operations in 2009.

On slide 20, you can see that we also exceeded our operating goals in every respect reflecting our commitment to operational discipline and our very strong focus throughout the year.

Our actions to reduce structural cost delivered more than $1.2 billion in savings in 2009. And we ended the year with a $1.7 billion run rate, ahead of our plan and 70% of the way towards our two-year goal of $2.5 billion in savings. And we also are well ahead on the cost synergies related to Rohm and Haas. We accelerated our actions and have now achieved 140% of the 12-month costs synergy run rate target. Finally, we took quick steps to rightsize our Basics manufacturing footprint, reducing ethylene consumption on the U.S. Gulf Coast by 30% and repositioning our Basic Chemicals portfolio to more efficiently feed our higher value, higher margin downstream performance businesses.

On slide 21, you can see that overall this was an amazingly active year, with a tremendous number of accomplishments, all of which were made possible because of the hard work of Dow's people around the world. Slide 22, as we look ahead, Dow has all the elements in place to move forward aggressively on three distinct fronts, delivering consistent earnings and cash flow, a higher rate of growth and an improved return on capital while doing so.

First, we are positioned to be able to drive growth across the board. We have businesses tied to markets that are growing at a multiple of GDP, as well as being present in developing geographies that are providing us tremendous growth opportunities and driving our earnings trajectory. In fact, we currently project our revenues will grow by greater than 10% with our new portfolio, driven by science and technology.

We expect EBITDA margins to increase from 12% in 2008 to 20% over time with our new portfolio powered by our ability to provide customers with science-based, technology-rich solutions. And we will accelerate these earnings with our new reduced cost structure, which will provide us $2.5 billion in savings by 2011.

Also, fueling this growth is our innovation engine. In 2009, the $1.6 billion we invested in R&D as a combined entity, which as an aside is more than the combined R&D budgets of all of the University chemistry programs in the United States, is paying off.

During the last three years, we have nearly tripled our pipeline valuation to $28 billion by making targeted investment in higher value, higher margin products and businesses. At the same time, as already stated, we have implemented a rigorous cross company system of portfolio management to ensure every research dollar is well spent. All of this leads to tremendous earnings power which will generate significant cash flow that we are committed to both reinvesting in our businesses for growth, while at the same time rewarding our owners.

And On slide 23, you have heard me speak throughout this past year of a new Dow. The decisions we made in 2009, along with the speed and decisiveness of the actions we took. We believe that we have firmly delivered the Dow of tomorrow. Today, we have the right portfolio, the right geographic position and the right pipeline as indicated by all the points on this slide.

And On slide 24, you can see the right portfolio is in place to define how we will grow. This portfolio is supported by three integrated business models, Basics, performance and market-driven.

And On slide 25, you can see we now have a robust portfolio of businesses exposed to high-growth industries, such as electronics, coatings, infrastructure, personal care, water, energy, food and agriculture, all with higher EBITDA margins and higher growth.

You can see this across our Advanced Materials, AgroSciences and performance businesses. And these represent two-thirds of our overall business portfolio and almost all of them have leading industry positions.

On slide 26, we also have the right geographic position. Dow's volume from emerging geographies grew at 33% year-over-year. And actions we took this year further strengthened our geographic presence and positioned the company for even greater success.

Sales in emerging geographies now represent 32% of our total sales, up from 28% last year. We will continue to expand in these fast-growing geographies.

On slide 27, you can see that we also now have the right pipeline. At our investor day in November, we highlighted the power of our innovation engine. This is an engine that today has a potential value of $28 billion, five times higher than in 1997.

The more than 500 projects in our innovation playbook are strategically aligned with four global megatrends, health and nutrition, energy, consumerism and infrastructure and transportation. The $1.6 billion that we plan to invest annually in R&D will continue to be aimed squarely at the intersection of society's greatest needs and business opportunity.

A further proof point on innovation is the growth synergies we are gaining from the integration of Rohm and Haas. These growth synergies will produce $2 billion in revenue by the end of 2012 on a run rate basis and cut across our portfolio, geographies and pipeline. They are focused on new commercial activities, such as cross-selling to increase our share of products with existing customers, leveraging the new product portfolio and creating new and innovative solutions for customers.

In our coatings business, for example, we realized a number of successful cross-selling opportunities between our architectural and industrial coatings portfolio. In our ion exchange business, we delivered additional growth opportunities for industrial water purification.

And in adhesives our expanded product line was able to capture new business with a global packaging converter. These are just some of the many examples that by the end of the fourth quarter of this year that delivered last year that delivered more than $340 million in new annual revenue. So, with the right portfolio, the right footprint and the right pipeline the Dow of tomorrow is here today.

On slide 28, let me address the outlook for 2010. From a geographic perspective the sustained demand growth we are witnessing in emerging geographies bodes well for global growth. The recovery in regions such as China is creating positive volume opportunities, which have helped us through much of 2009. However, we continue to closely monitor China's overheating manufacturing engine and the potential for the creation of asset bubbles.

The Brazilian economy fared better than most during the global economic recession and we have seen strong demand rebound there as well. We feel better about the North American and the European economies today than we did one year ago, or even one quarter ago.

Certainly the U.S. GDP numbers released last week point to an economy that is recovering. The impressive 5.7% annualized number in the fourth quarter shows that the U.S. economy grew at its fastest pace in more than six years, although over half of this was inventory restocking.

These much stronger than expected numbers provide yet another data point that a recovery is taking hold. This number also shows that U.S. inventory destocking has ended. And the good news is that we see supply chain inventory levels remaining low. So the potential for growth and a rebound is there. But high employment and questions about the sustainability of government stimulus spending continued to mute the possibility of a strong rebound like the one we saw in '03 and '04.

Therefore, in our view in the U.S. this recovery looks more like a 'U' than a 'V'. And the opposite is true in the emerging world, which gives us a view that the recovery on the global basis this year is probably shaped like a lazy 'V'.

Our portfolio is perfectly positioned for such an outcome. On our performance side of the business, we have the right exposure to fast-growing sectors, such as electronics, water, coatings, energy, consumer goods and agriculture. And our powerful Basics Plastics franchise now has a relatively low cost position with the increased supply demand dynamic in U.S. natural gas.

Our investments in feedstock flexibility in this region, coupled with our low cost positions in Canada, Kuwait and Argentina, mean we will continue to generate strong profits in this business as economic recovery takes hold and the cycle turns. Finally, as I just mentioned, our growing presence in emerging geographies will fuel earnings growth, as witnessed by our 33% year-over-year growth from these regions in the fourth quarter alone.

On slide 29, you can see our tracking tool. And this time it shows the first-quarter outlook, where we see continued improvement across many of our end-use industries, as you can see from the predominance of green boxes.

However, despite the sequential revenue and volume growth for our 2009 and even the acceleration of our results in the second half of last year, we believe the economic environment continues to warrant caution because of the potential for uneven growth.

That's why our plan does not count on a material improvement in economic activity form end-of-year 2009 levels.

Accordingly, we will keep a tight rein on costs and capital, while maximizing cash flow, just as we did last year. This disciplined focus, when coupled with our higher margin, higher growth portfolio, strong geographic presence and invigorated pipeline really positions us well to benefit from an economic recovery.

On slide 30, you have seen, our clear path to earnings growth. And this slide, which you'll recall from our investor day, sets the framework to achieve this goal. We have all the elements in place.

Our new portfolio, our R&D engine, our strong geographic presence, our ability to remain financially disciplined, as well as our ongoing portfolio management, plus the full retention of our powerful Basics Plastics business, all add up to this new earnings profile. One with significant upside potential and one that we will realize over these next few years with force and rigorous execution, something that Dow is known for.

So on slide 31, that brings me to my priorities for 2010. From a strategic perspective we will maintain our commitment to innovation-based science and plan to invest a further $1.6 billion in our world class R&D capabilities to accelerate our future growth on multiple fronts. We will also continue to invest in emerging geographies to further expand our market and asset presence in these high-growth regions.

We will continue our focus on portfolio management by divesting non-core assets. Our target in 2010 is $2 billion. Styron represents the largest portion of that.

I am pleased to report the Styron divestment process has continued to move forward on a very timely basis. As with any strategic process, we will update you when we have an announcement. The business is now running in a separate structure and is doing very well.

And we will seek to deliver on the right asset-light strategy. And we will only do so if it creates a long-term growth enterprise that creates value for our shareholders. We remain in an active process of exploring our strategic asset-light joint venture. Financially, we'll continue to take the appropriate steps to maintain optionality and financial flexibility. We will remain focused on cash generation, with a goal of generating free cash flow of $1.5 billion.

As I mentioned before, we'll further pay down debt in 2010, with a goal of reaching a net debt to total cap of 45%. We will protect and enhance our investment grade rating. To that end, our intention is to use our excess cash to repay debt.

And lastly, on operational priorities, we will maintain our commitment to fixed cost reductions and cost synergies at a run rate of $2.5 billion by year-end.

We will capitalize on the growth synergies related to the integration of Rohm and Haas, delivering greater than $0.5 billion on a run rate basis by the end of the year. We will continue to deliver on our working capital discipline to the tune of $0.5 billion.

These priorities are a balance, a balance between appropriate caution and therefore maintaining cost and operating discipline and focus, especially with the uncertainty around the U.S. consumer and a balance with growth, given our exciting new portfolio and our broad opportunity mix and our transformation into a consistent earnings growth enterprise.

And just to repeat one more time, this enterprise is here today. I will now turn 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 will move on to 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

(Operator instructions) And our first question will come from P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup

Yes, hi, good morning.

Andrew Liveris

Andrew, with nine months of significant cost-cutting under your belt, do you have an estimate of how much of these costs are falling to the bottom line?

Andrew Liveris

Yes, P.J. Obviously, the balancing act that you are touching on here is, as we see improving volumes and as we lift our operating rates and as we obviously take the costs that go with that and obviously that's good costs, right, because you're basically are funding your ability to grow and to restore margins but you have to obviously tolerate those costs increases. We are looking at structural cost decreases of $1.2 billion year-to-date or end of '09 and another $650 million in 2010 that will drop to the bottom line versus '09.

So that gives you a sense of the two-year number that is true cost reductions. And we will let costs go up on the good cost side but if those costs start to rectify the 1.85, then we will find other ways to mitigate those. And that is basically our commitment to make sure that 1.85 hits the bottom line.

P.J. Juvekar - Citigroup

Okay. And then at this point how are you managing price versus volume priorities? And I would imagine that the strategy differs between Basics and performance. Can you just provide some details on it?

Andrew Liveris

Correct. And so look, the volume momentum through the fourth quarter and we are not unique in this regard, built up as the quarter went by. And December was a strong month and very unusually so. Of course, what was happening through the quarter also on the Basics side is price increases were being put in place, but the hydrocarbon run-up occurred faster than the price increases were allowed.

Now we have now have price increases out there on the Basics side. Hydrocarbons are attenuating a little bit, so we are playing a price-volume titration. But polyethylene has got $0.04 a pound out there already. They have got another $0.06 a pound planned for February. So we really, when you look at the price momentum on Basics, it is all about the operating rates being in the mid-to low 80s. And certainly with the United States having an export window and China showing robust demand, there is room for price.

Now we expect in terms of hydrocarbon run up another $500 million quarter to quarter. And a lot of that is going to flow through not just on the ethylene side, but also on the propylene side, which will hurt the performance businesses, unless than they can get price momentum.

Now we do, as you know, it is harder on the performance side to get prices to stick, but we have about a 90-day lag. And with price increases announced in semi-commodities, like Oxygen and Solvents is a good example of that and amines, some of that should start to stick in the first quarter. So that 90-day lag, if you like, started in December.

We are watching very carefully. Our operating rate is still a little lower than we want it. It is in the high 70s, as we see things. As a company, we would like it to be in the 80s. So we are not going to lose volume with these price increases, which is why this whole year is a little tenuous at the beginning. We have Chinese New Year in February, so we have got to be careful about that. There will be some shutdowns of factories in Asia and China.

But in the end, your question is really the story of the quarter. There is price momentum. There is good volume momentum. We saw it in the fourth quarter. We saw it run into from December to January. We are out there pushing price hard.

Operator

Okay. We will go to our next question. That will come from Hassan Ahmed with Alembic Global Advisors.

Hassan Ahmed – Alembic Global Advisors

Good morning, Andrew.

Andrew Liveris

Good morning.

Hassan Ahmed – Alembic Global Advisors

Quick question on the commodity side of the business and the cycle as well. If I were to take a medium-term view, it kind of seems to me that there is a bit of a capacity addition vacuum that seems to be developing. And what I mean by that is, you take a look at the Saudis and they haven't allocated any ethane at all since 2006. The Qataris seem to have extended the moratorium on gas. Now on top of that some of these new crackers that we see coming online seem to be mixed feed crackers as well. So, now as I sort of sit there and try to piece all these things together, it appears to me that the cycle actually may turn around fairly quickly. And the other side is that in terms of pricing, if I look at Henry Hub prices right now, that seems to suggest that the U.S. producer is actually fairly, fairly well-placed. How do you see all these pieces fitting together?

Andrew Liveris

I think this whole discussion is a really critical one certainly with plastics being a key part of our portfolio and I believe and we have studied this extensively, some of the points you make, the base case. There is a bear case or the base [ph] case. And one of your colleagues just recently put out a very bearish case. We don't believe that case at all because of a couple of points you made. Number one, the supply side of this will be constrained coming out of the Middle East. It has been constrained for several years. Even though there will be capacity adds, it won't come on when people think it will come on. We are one of the best operators out there and we had a slow start up of our Kuwait assets and we are very good at this. So I would tell you, you have not as much supply coming on as people think.

The second thing is, if you take a normalized GDP globally this year of roughly 3%, the typical multiplier in polyethylene is 1.4, 1.5. That is a 4.5% demand growth that could happen this year and inventory restocking. Inventory is very low at the moment in the entire chain. So there is a case out there where you could go higher than 4.5% which is in our base case. Then you have 6 to 9 million tons of high cost liquids rationalization 3 of which is already permanently down. Then you have, in fact, your point, which is gas is not as freely available in the Middle East as people think and then you have your extra point which is the advantage in the United States which is now the second lowest cost producer on ethane which is an advantage versus naphtha because of where gas is.

We have flexi-crackers, so we are one of the few that can take advantage of that. 20% of our production in the fourth quarter was exports out of the United States to China and Asia. So when you put all that together, I think there is a case for a trough-like environment in '10 with the excess capacity, a recovery in '11 and a peak environment in the '13 timeframe.

Hassan Ahmed – Alembic Global Advisors

Super. Thanks so much Andrew.

Operator

Okay. And next we’ll go to John McNulty with Credit Suisse.

John McNulty – Credit Suisse

Yeah. Good morning. Just two quick questions and one is actually tied to the last question. You make a pretty bullish case for the Basic Plastics business. I guess I'm wondering how that factors into your at least short and intermediate term asset-light strategy versus the long, long term?

Andrew Liveris

So look, John. Thank you for your question. We know we have a very, very, very high performing business. It actually generated in all of '09 as Bill said an incredibly impressive EBITDA of 1.7. That is in a trough, demand led trough and great recession of all time. So we know we have a very high performing asset. We have our flexi-crackers as I indicated. We also have premium technology in the metallocene solution and polyethylene. We are a preferred partner. So we are not going to let this asset go at multiples that are reflected out there to by less than high-performing businesses that have transacted in the last six to twelve months.

The partners we are talking to are all strategic. There is three of them. They are all very, very keen on being our partner, so we can grow this business in a JV construct. JV construct is our strategy for us in the Basics because we can believe, we believe like our equity earnings already showed that we can generate money for the Dow Chemical Company's shareholders on a different construct in a different ownership structure that will come in below the line and it will generate like you saw $284 million of earnings, a good chunk of that coming from EQUATE last quarter. So we believe we are on strategy. We are not in a hurry. We are very patient. The people we are talking to are very, very deliberate and understanding how we put such a venture together. I still believe, like my priorities indicated, we will do something sometime this year. But I am not in a hurry to get it done at the wrong valuation.

John McNulty – Credit Suisse

Okay. Thanks a lot and just as a follow-up on the cost cuts that are coming in and it looks like they're coming a lot faster than you expected is that a function of you having more things to cut and finding more things to cut than maybe what you thought or is it just better execution? How should we think about the potential for maybe cost cuts that are better than what you expected over the long term?

Andrew Liveris

So really structural cost reductions and Dow's ability to get those, we have a whole track record, a whole history of being operationally excellent. When you give Dow people targets they achieve and then they jump even higher and overachieve. So we have a deliberate portfolio management strategy that should help us continue to work this hard. Why? Because we do have businesses that we won't fund for long-term growth. They might be good cash generators or we could divest them or over time we could just decide like we have on the Basic Chemical side that we won't be in those businesses and we will take those assets down rather than reinvest in them. Then on top of that we have increasingly found different ways to provide low cost services. Our recent announcement we made in November with the Tata Consulting Group to set up a business shared services here, center here in Midland which will take transactional costs and even lower than them one more time again. You can continue, expect to continue to see us develop those sorts of ways to reduce costs.

John McNulty – Credit Suisse

Thank you.

Operator

we’ll go to our next question which comes from Paul Mann with Morgan Stanley.

Paul Mann – Morgan Stanley

Thanks. Just a couple of financially related questions. Perhaps you could talk about the currency effect on earnings and revenues in the fourth quarter and at current rates what would you expect the currency effect to be in 2010? Then also just on the tax rate, you just guided, I think, to a fairly low tax rate for 2010. How do you see the tax rate developing longer-term say in 2011 and 2012? And is this tax rate purely driven by higher equity income or is it other factors that are changing the tax structure of the Group?

Bill Weideman

This is Bill Weideman. Let me touch on that. The currency impact this year which is relevant to price is roughly, same quarter last year is roughly about 3% and sequentially it is 1%. So fourth versus third but as you know currency also, that is on the revenue side the impact. As you know currency also impacts our cost. So on a net margin basis the currency didn't have a material impact on our earnings for the year.

Going forward and to answer your question going forward into 2010, our condition is that the dollar is going to remain weak and so we see the same conditions that we've got existing today. To answer your question about the tax rate, as I mentioned in my prepared comments, the reason the tax rate is lower is because of the significant growth that we have had in the emerging geographies. And as you know, the emerging geographies have a lower tax rate than the more developed countries. Also, the quick rebound in our equity earnings which as you know, on the financial statements are reported on an after-tax basis.

If you look at the underlying tax rate for Dow this year it was about 15%. We see that continuing for 2010. As I mentioned we think the tax rate will be between 15% and 20%. And probably continuing into probably 2011 because I think, again until the U.S. and Europe catch up which are higher tax areas that our overall tax rate will be lower. I hope that answers your question.

Paul Mann – Morgan Stanley

That's great. Thank you.

Operator

And next we will go to Don Carson with UBS.

Don Carson – UBS

Thank you.

Andrew Liveris

Hi. Don.

Don Carson – UBS

Hi. Andrew. A follow-up on the asset-light strategy. I mean, obviously you want to get the right price for Basic Plastics if you sell it at all. But what about the chlorine envelope and where do you stand in rightsizing that business because recovery looks somewhat further out there?

Andrew Liveris

Actually Basic Chemicals had a decent quarter compared to history. Now it is still a long way to go in terms of its recovery but the chlorine side, the ECUs, started to find the bottom which is great. Now if you look at our positioning, to your point, we are not going to be in the merchant market on EVC/VCM long-term. And our partnership in 2011 with Shintech is obviously over. We have re-rightsized our asset footprint to really fundamentally get down in the U.S. Gulf Coast, where we are advantaged especially on the gas side. That advantage we want to parlay directly into our performance businesses.

So today a good chunk of our chlorine capacity in Louisiana and Texas will feed our downstream chlorine envelope for performance businesses and be advantaged. Because it is integrated. We have all the utilities, the infrastructure and the gas et cetera. You can expect us though to continue to find meaningful partnerships with people who want to be in PVC. So in essence, we will use our competitive advantage to partner with others because you have to have scale in the chlorine side obviously because it is obviously a very capital-intensive business. That should help us create an asset-light strategy for chlorine. We are determined to do that. We feel we can get it done. It hasn't been top-tier. We did EO/EG first and then we did Styrenics. We have STYRON up for divestment. We've got polyethylene ethylene to do asset-light but chlorine is the next one.

Don Carson – UBS

Then just to follow-up on Ag, your R&D is up quite a bit. At what point does, I mean, this year you're going to start seeing some licensing income from SmartStax but does your licensing income start to cover that increased R&D burden or do you still think perhaps you could partner with somebody to give you scale in R&D? Andrew Liveris

I think we are developing scale through this build and collaborate model that you just indicated. You should start to as '10 becomes '11, '12 with DHT and SmartStax, we will start to see licensing income start to mitigate some of those R&D increases. But to be truthful with you, we still see Ag as a spender or investor in the next several years to help build up its pipeline not only on the season trade side as the two I just indicated but also on the chemical side. They've got some pretty exciting launches going on.

So we will preferentially keep feeding Ag R&D dollars because they can generate high-margin businesses. We have good news. We have high-margin businesses in electronics, a lot of the Advanced Materials businesses Specialty Materials and Ag. We will keep prioritizing the 1.6 billion but my estimate is in the next several years you'll see that $1.6 billion increase in R&D spending a lot because of Ag and Electronics.

Operator

Okay. We’ll take our next question that will come from Robert Koort with Goldman Sachs.

Robert Koort – Goldman Sachs

Thanks. Good morning.

Andrew Liveris

Good morning, Bob

Robert Koort – Goldman Sachs

Andrew, the Rohm and Haas asset you acquired, clearly the electronic side is doing a terrific job 30% plus margins but the coating side continuing to limp along a bit with single-digit margins. Can you give us some sense on f what you see is the path for those normalized margins around 20%?

Andrew Liveris

Yes. Certainly on coatings the real synergy play that has already begun, it certainly has happened on the cost side but on the margin side has yet to begun, begin really is between industrial coatings where we, epoxy urethanes, Dow's traditional strengths and then Rohm and Haas' traditional strengths on acrylics. There is some exciting stuff happening on, on cost synergies there. I have already mentioned the low to no VOC, no odor coating is a good example of a first business out of the chute. So one way is through the growth synergies. The second is their presence in the emerging geographies and synergizing the footprints between Dow's businesses and their businesses. We see their markets in the emerging geographies beginning to rebound, especially on the, if you like, the construction side where the coatings are being used in infrastructure, in particular.

Really the drag for our results so far that you are indicating is a lot to do with U.S. residential U.S. commercial, our architectural side of one, the industrial side of the other and the inability for the cost cuts to have a meaningful effect on the margin because the price lag has occurred because propylene has had a run up and we are lagging a bit on price. All that to tell you that we believe a lot of that recovery will happen mid to second half of this year. And you will start to see a very strong performance in coatings back half of the year.

Robert Koort – Goldman Sachs

On the tax rate guidance of 15% to 20% was that factored in when you threw out the 350 to 550 normalized earnings power at Dow or were you using some other rate?

Bill Weideman

We had factored that in because our projections assumed significant growth in the emerging geographies.

Robert Koort – Goldman Sachs

Got it. If I could just sneak one last one in. Andrew, you mentioned the very strong U.S. GDP in the fourth quarter. You gave a very helpful grid of regional and industry growth rates. I guess we didn't see that echoed in that grid for the fourth quarter. So is there some reason you would expect to lead or lag with GDP versus your own trends? Thanks.

Andrew Liveris

Well, if I understand your question fundamentally if you take the real consumption in the fourth quarter and then translate it into the first quarter and then beyond the U.S. consumer which is, just to remind you the U.S. consumer is one-fifth of global GDP. So the U.S. consumer any sign of rebound in the U.S. consumer, we should be a lead indicator in that. We think the restocking events that happened in the fourth which seems to be continuing, albeit [ph] we had a challenging year, in the first, is a good lead indicator to some confidence returning from a U.S. consumer point of view. What mitigates that and I think one of the reports that came out this morning, we gave about three words that maybe contradict each other. We don't see that as driving a rebound yet in the first half but it could drive it in the second half. Thanks Bob.

Operator

we move to our next question will come from David Begleiter with Deutsche Bank.

David Begleiter – Deutsche Bank

Thank you. Good morning.

Andrew Liveris

Hi. David.

David Begleiter – Deutsche Bank

Andrew, could you update us both on the Ras Tanura project as well as the China coal to olefins project?

Andrew Liveris

Ras Tanura is moving ahead nicely on its milestones. The reduction on EPC contracts have come out of the Middle East. We have slowed it down to take advantage of that. Our partners are now (inaudible). Saudi Aramco has some very big refinery projects that just let that saw substantial decreases in EPC contracts that they let. So we have delayed the letting of anything until we get a full understanding of that. But that is still on track 2014, 2015, startup of the first units. We will have a lot more to say about all of that by the middle of the year. China coal to chemicals still very much proceeding through a very slow Chinese process. But having said that we are first cab off the rack in terms of taking low-cost power and low-cost inputs and converting them into plastics and chemicals in the middle of the country.

David Begleiter – Deutsche Bank

Could you update us also on equity earnings in 2010 specifically Dow Corning, EQUATE and MEGlobal?

Bill Weideman

Without giving you, again, this is Bill Weideman, without giving you very specifics on each of those, we view that the equity earnings will continue on the track that we have got. And those will be in the $1 billion to slightly above $1 billion in total for 2010. Thanks David.

Operator

Okay. Thank you. We’ll move to our next question will come from Frank Mitsch with BB&T Capital Markets.

Frank Mitsch – BB&T Capital Markets

Good morning, Andrew and thank you for taking a look at the note this morning.

Andrew Liveris

Not at all. I was very tempted to send you a note about the Jets but I didn't.

Frank Mitsch – BB&T Capital Markets

That is hitting below the belt now. I'm still not over it. Just to follow up on that outlook statement in your slide 30 you referenced $1.25 run rate at the end of the third quarter. Here we are at the end of the fourth quarter. I believe that that November meeting you talked about $0.25 of additional cost savings that you expected in 2010. I believe, if I'm not mistaken that Bill gave some numbers this morning when he was talking about slide 16 of another $0.10 or so in terms of cost synergies that would drop to the bottom line. Care to take a swag at where you are on a run rate basis as we stand here today?

Andrew Liveris

The way I'll answer you is to highlight some of the things that I have already said. But firstly, our EBITDA run rate is now over the $6 billion mark. So that is the first thing I will say to you. The momentum in the fourth quarter is continuing into the first. The high growth rate that we have seen and the early look at a GDP that a previous question that was asked, I believe by Dave, we see an early GDP look here and frankly our Basic Plastics franchise, if you take what I said earlier is one of the early indicators of that. Look at the Basic Plastics results in the fourth quarter and look at our price increases out there. So that is all on the margin side.

And we believe that $1.25, if you look out as the year progresses is not just a cost savings number but at a 3% GDP number with the early recovery that is going on with Basic Plastics and our ability to have a greater than $6 billion run rate because of margin and cost, will satisfy your question.

Frank Mitsch – BB&T Capital Markets

All right. Thank you. If you could take a second and just respond. There were some press reports that suggested that you would have the STYRON transaction completed by the end of the first quarter. That seems to be in my opinion relatively aggressive since nothing has been announced at this point. Was that accurate? Also, there was a press report regarding negotiations with the Kuwaitis in terms of a settlement of the litigation from the collapse of the K-Dow deal. Can you comment on where that stands?

Andrew Liveris

The second one is completely erroneous and a missed [ph] report, so that deals with that one on the Kuwait deal settlement. That arbitration is continuing. On the first question, STYRON is on track. It has been very robust, a very robust process. We have more than a handful of people in the process still. They are going through, we gave them a second round because we liked what we were hearing and they liked what they were hearing and seeing. So it is probably very likely we will have something to say in the next month or two but I don't want to commit to a particular date. But the press reports were part accurate as most press reports are.

Operator

Okay. We’ll take our next caller that will be Bill Young with ChemSpeak.

Bill Young – ChemSpeak

Hi. There. Good morning. I went to follow up on another question, Andrew, please. It is the North American volume. You talked about downstream inventory building. The ISM numbers continue to do really well. I just didn't see that, just didn't see that in your North American volume numbers. And also of course, you've got to consider autos were doing a little bit better as well. May be give us an expansion on that please.

Andrew Liveris

The weak spot in volumes is North America. We wouldn't say it any other way. I think the vulnerability you just spoke about is one of the reasons. And that is the third-quarter Cash for Clunkers weren't there. That is on the negative side of the volume, so fourth quarter was a decline for us. We had the coatings issue we talked about which is seasonality. So that was another reason the North American volumes was not as good as maybe the rest of the world. Certainly even Europe was better than North America. But I would say this, the tire companies are coming back and they are building, so that is a positive. Housing starts are coming back so residential is looking better. I would say there is a case to say North America will start to get better in the next six months. And the drag happens to be the U.S. consumer spend. So I would say to you though some of the indicators are that the North American volume issue in the fourth quarter, if you can call it there, was not a severe one.

Bill Young – ChemSpeak

Okay. Great. Last but not least, you mentioned debt reduction as a prime use of cash. What can we expect ahead for dividends, even modest dividend increases in the coming year or two?

Andrew Liveris

We are going to be very cautious. I would like a lot of more traction on economic recovery before we get firm on that sort of question.

Bill Young – ChemSpeak

Okay. Thanks.

Howard Ungerleider

Thanks very much, Bill. Thanks very much to all of you. We are going to have to end of the call at this point. I would like to turn it over to Andrew just to say a couple of closing comment before we do though.

Andrew Liveris

Yes and so I just want to thank you. We didn't get to all of you. I just would like to say as we close out '09, I would tell you that the portfolio we have in terms of growth, growth synergies and the R&D investment on Ag, on electronics, some of these businesses we acquired from Rohm and Haas and the synergies, we will deliver the cost. It is really the growth synergies that we will start talking to you all about as economic recovery takes hold.

Howard Ungerleider

All right. Thanks very much. We look forward to speaking with each of you soon.

Operator

Thank you. That does conclude today's conference call. We do thank you all for your participation.

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Source: The Dow Chemical Company Q4 2009 Earnings Call Transcript
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