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Executives

Herman Betten - IR

Feike Sijbesma - Chairman and CEO

Rolf-Dieter Schwalb - CFO

Analysts

Anna Marij van der Meulen - Dow Jones

Aaron Gray-Block - Reuters

Martijn van der Starre - Bloomberg

Antonio Ligi - Bloomberg

Royal DSM N.V. (OTCQX:RDSMY) Q2 2010 Earnings Call August 3, 2010 10:00 AM ET

Operator

Welcome to the conference call on the second quarter results 2010 of DSM. (Operator Instructions)

Now I would like to turn the call over to Mr. Herman Betten.

Herman Betten

Good morning, ladies and gentlemen, and welcome to the conference call of the second quarter results of 2010 of DSM that we published earlier this morning. Sitting here with me are Mr. Feike Sijbesma, CEO and Chairman of the Management Board; and Mr. Rolf-Dieter Schwalb, CFO, and member of the Management Board. They will elucidate the results and after that answer your questions.

As a reminder, I am obliged to say that today's presentation can contain forward-looking statements. And in that regard, I would like to point you to our disclaimer regarding forward-looking statements, as published on our website and in our press releases.

And now I'll turn over the call to Feike.

Feike Sijbesma

Thank you, Herman. Ladies and gentlemen, welcome to this conference call on the second quarter results of 2010, which were published indeed for this morning.

As you can see in our press release, we are delighted to report a very strong second quarter. Operating profit increased by more than 25% compared with the first quarter. And for the current business portfolio, it was the best quarter in DMS's history. Our outstanding performance in the quarter reflects very good volumes across our business combined with continued disciplined focus on pricing and cost. Compared to the second quarter of 2009, the operating profit almost tripled.

We see a number of general drivers behind this strong performance. Business conditions in most geographic areas and markets further improved, partly due to restocking. Especially, the China business is growing very fast. Sales in China in the first half year increased to $784 million, which is 13% of total DSM sales. A year ago, this percentage was only 9%.

Also, in several businesses, DSM was able to improve market share by maintaining a strong customer focus during the economic downturn. The cost savings program that DSM started in the last part of 2008 is now generating benefits of €200 million on an annual basis. These cost savings had a positive impact on the operating profit for businesses.

Currency developments were favorable as well in the second quarter. Compared to the first quarter, the euro was on average 8% weaker compared to the U.S. dollar. DSM cost basis is still for a large part in euros, whereas sales in U.S. dollars and dollar-related currencies are increasing. Our second quarter results in detail can be found in the press release which we issued today.

Nutrition was benefiting was extra-ordinarily strong trading conditions in Q2. As expected, Pharma business faced difficult challenges. In Materials Sciences, the recovery continues. In some markets, demand is back to or even better than the pre-downturn level, although some downstream restocking is visible too.

Our cash performance was again strong. Net cash from operating activities was €223 million in the second quarter and €360 million of the first half year, which was more than sufficient to fund our capital expenditures and our final dividend paid. Net debt decreased substantially because of the receipt of the DSM Agro and DSM Melamine divestment proceeds.

Now, regarding the outlook, most of the markets that are relevant to DSM saw a continued recovery in the second quarter. DSM expects further end-market recovery for the remainder of the year, assuming no major change in economic conditions. The risk of a slowdown of the economic recovery remains due to macroeconomic uncertainties and a potential disruption of global financial markets. Emerging economies are expected to remain strong throughout the year. The focus on cash generation and cost savings continues to be important.

The growth in food and feed markets will continue in line with long-term trends. Quarterly Nutrition results for the remainder of the year are expected to be at the good level achieved last year and the full year results are now expected to be somewhat above 2009.

Based on (inaudible) Nutrition, in the second quarter, we had an exceptionally strong result. The businesses benefited from good market conditions, favorable product mix, excellent manufacturing performance, good cost control, favorable currency exchange rates and some downstream restocking.

For Pharma, full year results are expected to be positive, but lower than 2009 due to the ongoing challenges at DSM Pharmaceutical Products and relatively low prices at DSM Anti-Infectives, our penicillin-based business. Results in the third quarter might be negative due to the poor business conditions at DSM Pharmaceutical Products.

In Performance Materials, DSM is experiencing good market recovery in automotive and electronics due to market growth in restocking. Demand in building and construction markets will remain at relatively low levels. Overall sales volumes in Performance Materials for the second half year of 2010 are expected to be lower than in the first half year of 2010 due to seasonality and the diminishing impact of re-stocking.

The cluster results are expected to be substantially better than in 2009, though results in the second half 2010 are expected to be lower than in the first half 2010.

Polymer Intermediates is expected to have an outstanding 2010 result. The maintenance turnaround in the third quarter of 2010 will impact production volumes in China. Margins are expected to be healthy, but below the peak in the second quarter of 2010. Operating profit in the non-core Base Chemicals and Materials cluster is expected to be clearly positive in 2010.

Now, before I open this call for questions, I would like to add that DSM emerged from the recession as a stronger company and is now reaping the benefits evidenced by robust results and a very strong balance sheet. We're staying the course, fully committed to customers, innovation, sustainability and continue our transformation towards the life science and materials science company.

We remain vigilant about a broader macroeconomic development. Based on the current positive business environment, we expect 2010 to be a strong year for DSM.

Now I open the lines for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Today's first question is from (inaudible), Dow Jones.

Unidentified Analyst

Could you elaborate a bit more on China? We saw some signs that growth there was slowing down a bit. What do you see happening there? And on restocking, do you already see an end to the restocking effects in the third quarter?

Feike Sijbesma

Well, on China, I think it is one of our major growth markets of course in all sectors and food and feeds, but also in materials. We are doing very well in China. We have a target of $1.5 billion in this year to be achieved. First half year we were about $780 million. So most likely we will achieve our target. And we are benefiting from the Chinese development.

Nobody can look exactly into the future, but at this moment the Chinese market is going well, and we are also performing well in China.

Regarding restocking, yes, especially in the material space we have seen some restocking already in the second quarter. And what we said, restocking is per definition a non-recurring thing. Now, how long, how big, that's always difficult to estimate. But that is also reason why we have said, in our material space, the second half year will be lower than in the first half year.

Unidentified Analyst

So the restocking will come to an end in the third quarter already, or what's going on?

Feike Sijbesma

I don't know. I'm looking here to our CFO whether he has a crystal ball, what's going to help us?

Rolf-Dieter Schwalb

When we say we see some restocking, this is really indirect information. Because directly, you have that information. You have orders, and then you talk with your customers and then you get maybe a feeling that they are building inventories, or they maybe have a feeling that their customers build inventories. But there is no hard data behind that.

Feike Sijbesma

Feeling is also, by the way that almost all industries are careful, like ours also, not to overbuild their stock level. So I do not expect that if I look back to the first half of 2008, many markets had high level of stocks. And what we hear in the industry is that all markets remain careful not to overbuild in stocks.

Operator

The next question is from Anna Marij van der Meulen with Dow Jones.

Anna Marij van der Meulen - Dow Jones

I was wondering, could you elaborate a bit more on in which business you were able to improve market share, and maybe on which competitors you took market share?

Rolf-Dieter Schwalb

Well, it's very difficult to give explicit information, but we have a very strong position in nutrition, you know that. And our whole differentiation policy and innovation policy in nutrition helps our market position.

We are committed to quality improvement. We are committed to develop new forms, new applications, et cetera, and all those elements provide us a very, very strong market position. And that helps sometimes also in gaining some access to some markets we were less exposed before.

Anna Marij van der Meulen - Dow Jones

Could you give an example?

Rolf-Dieter Schwalb

Well, we have said in the past we have secured some of our positions for example in Vitamin C where our quality differentiates, where our products are clearly distincting themselves from competition. In feed, we are establishing our position by strong premix position.

We do not only sell our vitamins straight to end customers, but also premixes ourselves. We continue to expand in premixes also in this first half year, again, in China in other areas. And of course that helps our market position.

But also in Material Sciences, in some of the business, we are doing well. And of course you can look to our engineering plastics and our resins business. But please forgive me, I'm not going to give you exact numbers of market shares of competitors we take away, but the observation we share with you is that we say, hey, doing this helped our market position, further strengthened, and we are doing well. And of course, difficult to give more precise information there.

Anna Marij van der Meulen - Dow Jones

Okay, maybe then a follow-up question on material sciences. You say that were was some margin pressure at the end of the quarter due to increase in raw material prices. To what extent do you expect you will be able to pass those increasing raw material prices on to your customers?

Rolf-Dieter Schwalb

In some markets that will be possible. Sometimes there's always a delay in that in some markets that will be easier than in some other markets.

Anna Marij van der Meulen - Dow Jones

In which markets it will be easier then? Could you just specify that?

Rolf-Dieter Schwalb

Well, I think in Resins the margins were strong, and of course also in polymer intermediates our margins were very strong. In some of the other areas, here and there, we have some delay in imparting on price increases. But overall, I think what we tried to do is of course to protect margins, and so far being successful in that.

Operator

The next question is from Aaron Gray-Block, Reuters.

Aaron Gray-Block - Reuters

To start with, if ODM booked €246 million in EBIT so far, you have €420 million last year, so you're more than halfway to beating it last year. I'm wondering if you could give a concrete EBIT outlook for the full year.

Feike Sijbesma

Well, I'll hand it over to our CFO, but we refrain from exact quantity forecast, and we think the market results are not helped by that.

Rolf-Dieter Schwalb

Well, in fact in the first half, we are already €440 million EBIT, which is already above last year total. But of course, last year, the first half was extremely bad. This was really the low point in the whole crisis. And in the second half the company started slowly but steadily, and then really we saw a strong recovery in the first and second quarter this year.

Now, why don't we give a number outlook there? I think we gave a lot of detailed insight on how we see the various business areas. So our outlook statement is I think pretty extensive. On the other side, we also have to say, I mean, nobody knows exactly how the economies are developed. We are at the moment, taking the assumption that there will be no deep second dip, only a slowdown in recovery. But from the economic assumption, you come to different results.

So release that also a little bit off what your own feeling or insight or knowledge or expectations is for the economy. So that's why we simply refrained already now for two years from giving a real number outlook statement.

Aaron Gray-Block - Reuters

Sure. So you said your assumption is no deep second dip; so you are saying there is going to be a double dip?

Rolf-Dieter Schwalb

No, that's not what I'm saying. I said we expect to continue slow recovery, but slower. Of course the base period also last year is higher now, so the growth rate must come down.

Aaron Gray-Block - Reuters

Okay. So the assumption is, no deep second dip but no double dip?

Rolf-Dieter Schwalb

Yes, that is the same for me. First dip we already had.

Aaron Gray-Block - Reuters

Then just briefly on margin pressure, I know Mark has already asked a couple of questions on that. You're saying you're taking active price management. What is the receptiveness to you raising prices?

Feike Sijbesma

Not always all customers like increase prices, like we also sometimes do not like that for our raw materials. Increase in price is a sign of economic recovery. Why do raw material prices and why do prices increase? Normally due to the fact that there is more demand and that pinpoints to economic recovery. So overall, it's not by definition bad if prices increase. There is always time delay of passing that on. And if you have a strong market position, strong unique products, you must be able to do so.

Operator

The next question is from (inaudible).

Unidentified Analyst

Just to follow on our first question, and what about Q3, can you say anything about that? And why didn't you in the press release?

Feike Sijbesma

Well, we made only a specific remark on Pharma in Q3 and the rest second half of the year, but let me turn to Rolf-Dieter.

Rolf-Dieter Schwalb

Same reason as I said for the full year outlook. I mean this is the next quarter. And we have stopped giving quarterly outlooks already three or four years ago. So we will reintroduce that. What I can say of course is I probably don't have numbers on the August 3, but July more or less continued at a very good level of Q2.

Unidentified Analyst

So do you see further improvement of EBIT in the remainder of the year or at current levels?

Rolf-Dieter Schwalb

Well, versus last year, that is possible or even likely, but not versus the first half. Our indication is clear that it should be lower than the first half.

Unidentified Analyst

EBIT in second half, should be lower than EBIT in first half?

Rolf-Dieter Schwalb

Yes because we said also as Feike explained in the beginning that especially in Nutrition we had quite an exceptional quarter. All potentially positive elements came together in one single quarter. And that you cannot normally expect to continue with these kinds of circumstances.

Operator

Your next question is from (inaudible).

Unidentified Analyst

I have a question on pharma, you expect pharma to be positive for the whole year? Is that all due to the dollar, or any other reason why you expect it to be positive, because pharma this quarter, as far as I can see much better than expected?

Feike Sijbesma

Much better may be a little bit better. But overall for the whole year we say we will be positive, but positive is not positive in that sense that we are not satisfied with that result. We still think that even if pharma results into positive results of the year that is it is underperforming and we know that we need to improve. The reason why that pressure is there is that in Antibiotics and Penicillin business we are confronted with relatively low Penicillin prices of course were helped by the dollar a little bit. But the Penicillin prices are also a major factor and these and pharmaceutical products we have confronted at least the pressure on the pharmaceutical market. As you know, a lot of patents, a lot of products are in there out of patents in the coming five years. And the replacements with new products is not going with the speed and that gives pressure on our pharmaceutical business.

Now, we manage well that we still have a positive result, but we clearly know we need to improve there.

Unidentified Analyst

And do you have any plans how to do that?

Feike Sijbesma

Yes we have actions and plans that have to do with of course cost containment but also working even closer with the pharmaceutical companies. And make more package type of deals more alliance type of deals, which we did last year with a pharmaceutical called Shire, and we are looking to move over those kinds of deals. But the technology transfer in pharma is (inaudible) FDA approval that you don't make those deals overnight. So that will take a little bit of time.

Operator

The next question is from Anna Marij van der Meulen, Dow Jones.

Anna Marij van der Meulen - Dow Jones

I was wondering if you could update us on acquisitions?

Feike Sijbesma

As you know, DSM is transforming itself into what we call a life science and materials science company. We are already busy with that for a longer time. We are continuously divesting business which does not fit. We have announced in 2007, again, divestment program. I think we are well underway. We have sold our Energie business, our Stamicarbon business. We sold our Agro and Melamine business.

In the press release, you read that we have signed an agreement to sell our Specialty Products business. So we are well on the way of those divestments and we have said we will use those proceeds for doing acquisitions. Of course acquisitions in again, that's strategic focus and life science and material science. And we will look for acquisitions and spend the money out of those divestments to further strengthen this portfolio in life science and material sciences.

Anna Marij van der Meulen - Dow Jones

Yes, I know that. But I was just wondering how is it going?

Feike Sijbesma

That's the most important that you should know.

Anna Marij van der Meulen - Dow Jones

What do you expect in acquisition this year? Where are you looking? What's the word just at the moment?

Feike Sijbesma

Well, I think you know the answer on those kinds of questions. We will only tell when we have an acquisition. We will not mention any names. We will not mention the clear timeframe. You're the first one to hear, maybe not the first, but very close when we have something and then we announce it. It's always difficult to plan. It's clear in which area it is in life science and materials science, we will not diversify in that area. It could be geographical. It could be in the east also. But it's always difficult to give you pre-information on that one.

Anna Marij van der Meulen - Dow Jones

But do you think you can announce something more that at your strategy update in September?

Feike Sijbesma

If we have made further progress and there is something to announce, we will. And if not we will not. I know it's not satisfying for you but this is what we can tell.

Operator

The next question is from Martijn van der Starre, Bloomberg.

Martijn van der Starre - Bloomberg

Mr. Sijbesma, earlier on you briefly referred to the vision 2000 targets. Was just wondering whether you could say anything about whether or not you will reach the other targets as well in 2010?

Feike Sijbesma

Well, we set those targets in 2007. And most likely, a lot of those targets will be met, may be not all. We need to see that at the end of this year. But as I said, our China targets, which we increased, by the way halfway, we were €0.5 billion in sales in 2005. We set the target to €1 billion. We increase it to €1.5 billion.

For the first half year most likely we are going to achieve it. We had set the target for €1 billion additional sales innovation in 2010. As we look where we are at the end of 2009 and as we are progressing in 2010, most likely we will achieve that target.

We have set profit targets, for example, in nutrition cluster, most likely going to achieve that or we are even over-achieving that. We have profit targets for Pharma, also most likely we are not going to achieve that target. So some will be achieved, may be Rolf-Dieter can add more to that. We set targets on sustainability, energy savings, ALL-Q plus products and those kind of things we are most likely going to achieve that.

So I think a lot of targets will be achieved maybe not all. We have been questioned a couple of time to during the economic downturn, whether we should revise our targets, we said well that's not the way you should deal with targets. Targets set and if you revise it every time, you will always achieve that, until we revised it into fourth quarter 2010, we will for sure achieve all of the targets. But that's not the way it goes.

We kept the targets of older period, and we report and at the end of 2010 about our achievements, and maybe not all will be achieved like I said, Pharma most likely not. But a lot will be achieved and Rolf-Dieter will add.

Rolf-Dieter Schwalb

I have another one, I can mention this, sales growth, we originally had in 2010 the sales growth target of 3% to 5%. Later we increased that to above 5% and if you look what we achieved in 2006, 2007, and 2008; we achieved above 5%, 2009 obviously not, but that was of course the deep crisis year. If you look at the first half here, where the organic growth was 24%, it looks like also we will achieve above 5% this year.

Martijn van der Starre - Bloomberg

Are you already thinking about how you're vision 2015 targets will look like? How will they look like?

Feike Sijbesma

We will present that in September, as you know.

Martijn van der Starre - Bloomberg

I also have another question about the pension funds; in the analyst presentation you said that the funds are sufficiently funded to meet all of their commitments. Did the funds need any help from these to meet those commitments that you have to inject any money.

Feike Sijbesma

We did not inject any money into the pension fund in the previous period. And of course the pension funds to coverage ratio went down in this whole economic downturn, obviously by not only decreased share prices, but also decreased interest which is even having a bigger impact on the pension fund covering ratios. But we have a strong pension fund, we have a clear arrangement between these and the pension. As we did not inject any money.

Martijn van der Starre - Bloomberg

So you said that the coverage ratio did fall somewhat, but I guess they didn't fall below 105%?

Feike Sijbesma

No, I think there were periods that they were below 105%, I don't know where we are today. But I think somewhere in that area. But once in a while, this is published and I don't know the latest figures, I don't know what Rolf-Dieter knows.

Rolf-Dieter Schwalb

I don't know, but it will be published probably at the end of this week or earlier next week. And the pension fund on their website publishes the funding ratio. And we were below 105%, and the key part of the crisis was more than a year ago, beginning 2009 end of 2008.

Feike Sijbesma

And then like all pension funds, you've come in to so called recovery plan supervised by the Dutch Central Bank. And I think almost all pension funds in an alliance had that situation and we are not an exception there. But overall, we did not inject any money.

Operator

The next question is from Aaron Gray-Block with Reuters.

Aaron Gray-Block - Reuters

Just maybe I'm a little bit slow, but I still don't get your comments on the double-dip scenario. I mean, are you expecting a slowdown, but expecting a strong year, very strong Q1 and Q2. I mean, what I really expect and I know you don't have the crystal ball but, do you expect a double-dip?

Rolf-Dieter Schwalb

At the moment our assumption is there will no double-dip this year, what we mean by slow down is that Feike elucidated on the restocking, if the restocking that was one of the first questions in this call, really finishes or maybe has finished already in most business in the end of second quarter. Then of course that restocking effect would not be there in the third and fourth quarter anymore. So the growth rates would slow down.

Now would the growth rates versus the first half be negative? Our assumption and expectation today is, not. But the growth rates versus the second half year in 2009, of course should be lower than the growth rates in the first half year, because the second half last year already saw a recovery. So the base period is higher.

Aaron Gray-Block - Reuters

And just on Pharma then, how are talks progressing in looking for partnerships? I mean, that question came on just so, but how are talks going?

Feike Sijbesma

We said our Anti-Infectives business is moving more and more to the East, both supply and demand. And therefore a partnership in our anti-infective business is a notable step, a partnership in the East that could be China that could be India by the way. And we said we (inaudible) our attempts to make a deal with North China Pharmaceutical Company, NCPC, and that deal did not continue and we are continuing our discussions and search about that one.

But we said we are not going to update markets on every talk or every progress we made, we'll inform the market when we have something concrete. That's not the situation today, so I don't update you and inform you further. But the moment, at least we will do that. The strategy is unchanged, and the search and the developments to find such partnership are unchanged. And it could be China, like the NCPC, or it could also be India.

Operator

The next question is from Antonio Ligi, Bloomberg.

Antonio Ligi - Bloomberg

Just a couple of follow-up questions. On pricing, could you give a guidance for raw material costs, on average for the year by how much do you expect to increase for DSM, and by how much do you expect to increase your selling prices this year? And on acquisition, can you give an update, how much is at the moment your total firepower you're able to use for acquisition?

Feike Sijbesma

On pricing, of course we again have no crystal ball. Our interest is to keep or improve the margins. The area we have the margin increase, where I talked about, sometimes the delay in price increases, we want to go back to the margins we need and we want to have, and we look at the margins. So whatever happens in the pricing of our raw materials, we try to pass on, and that is our objective. So the crystal ball on what exactly we should expect in raw material pricing, we don't have, but we have to actively manage our prices to really maintain our margins or get back to margins.

Antonio Ligi - Bloomberg

But you can already see now from contracts, what price for some of your most important raw materials are for the second half, right?

Feike Sijbesma

Yes, but a lot of raw materials are still dependant on oil, and then it depends on the oil price. And you know that you don't have fixed contracts there and a fixed price for the future. And this is still, by far, a majority of our raw materials, so oil and gas dependant.

Antonio Ligi - Bloomberg

And the second part, on the firepower for acquisitions?

Feike Sijbesma

That is difficult to say, because there is no standard answer for that. In the past, one of our rating agencies gave indications based on our firepower and that was a number of €2 billion. Now, I mean there is no crystal clear answer. There is not a single number for that and we of course do not like to comment on that ourselves. But you also see on the other side that you have €1.8 billion cash at the end of quarter two.

Operator

(Operator Instructions) The next question is from Aaron Gray-Block, Reuters.

Aaron Gray-Block - Reuters

Just on acquisitions, following up on Bloomberg's question as well, you've referred to firepower and so forth and you're looking for acquisitions, but is a large acquisition among the options?

Feike Sijbesma

Is what?

Aaron Gray-Block - Reuters

Is a large acquisition among the options? Was it mainly bolt-on acquisitions you're looking for?

Feike Sijbesma

Everything is possible. It could be a bigger one, it could be several smaller ones; all are options.

Operator

(Operator Instructions) Gentlemen, no future questions at the moment.

Herman Betten

Then I'm closing this call. Thanks for dialing in. The presentation can be found from our website. And we hope to see you all again soon. Thanks.

Operator

Ladies and gentlemen, this concludes the DSM conference call. Thank you for attending. You may disconnect your line now.

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