E. I. du Pont de Nemours and Company (DD) Q3 2013 Earnings Conference Call October 22, 2013 9:00 AM ET
Carl J. Lukach – Vice President-Investor Relations
Ellen J. Kullman – Chair of the Board and Chief Executive Officer
Nicholas C. Fanandakis – Executive Vice President and Chief Financial Officer
Vincent Andrews – Morgan Stanley & Co. LLC
John E. Roberts – UBS Securities LLC
Neal P. Sangani – Goldman Sachs & Co.
Jeffrey Zekauskas – JPMorgan Securities LLC
Don D. Carson – Susquehanna Financial Group LLLP
Kevin W. McCarthy – Bank of America Merrill Lynch
David I. Begleiter – Deutsche Bank Securities, Inc.
P.J. Juvekar – Citigroup Global Markets Inc.
Mike Ritzenthaler – Piper Jaffray, Inc.
John P. McNulty – Credit Suisse Securities LLC
Laurence Alexander – Jefferies LLC
Mark W. Connelly – CLSA Americas LLC
Chris J. Nocella – RBC Capital Markets LLC
Duffy Fischer – Barclays Capital, Inc.
Mark R. Gulley – BGC Financial LP
Frank J. Mitsch – Wells Fargo Securities LLC
Good morning, my name is Jon and I will be your conference operator today. At this time, I would like to welcome everyone to the DuPont Quarterly Investor Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks there will be a question-and-answer period (Operator Instructions)
In the interest of time, management requests that you limit yourself to one question and one follow-up question, and please pick up your handset to allow optimal sound quality. If you have additional questions, you may re-enter the queue. Thank you.
It’s now my pleasure to turn the call over to your host, Carl Lukach, Vice President of Investor Relations. Carl, you may begin the conference.
Carl J. Lukach
Thank you. And good morning, everyone and thank you for joining us to cover DuPont's third quarter 2013 performance. Joining me are Ellen Kullman, Chair and CEO, and Nick Fanandakis, Executive Vice President and CFO.
The slides for today's presentation can be found on our website along with our news release. Please note that we also posted our third quarter segment performance slides and outlook commentary this morning.
During the course of this conference call we will make forward-looking statements. And I direct you to slide two for our disclaimers. All statements that address expectations or projections about the future are forward-looking statements. Although they reflect our current expectations, these statements are not guarantees of future performance but involve a number of risks and assumptions. We urge you to review DuPont's SEC filings for a discussion of some of the factors that could cause actual results to differ materially. We will also refer to non-GAAP measures and request that you review the reconciliations to GAAP statements provided with our earnings news release and on our website.
For today's agenda, Ellen will start with opening comments. Nick will review our third quarter financial performance and near term outlook. And I’ll provide business segment insights. We’ll conclude with Ellen’s comment followed by your questions.
With that introduction, it's now my pleasure to turn the call over to Ellen.
Ellen J. Kullman
Great. Thank you, Carl, and good morning everyone and thank you for joining us. I am pleased to begin today by highlighting DuPont’s third quarter performance. Our segment results were generally in line with our July expectations, double digit earnings improvements from Performance Materials, Electronics & Communications, Safety & Protection and Industrial Biosciences paired with ongoing productivity initiatives across the company helped to offset the expected earnings decline from our Performance Chemical segment.
Operating earnings of $0.45 per share were above our guidance due to a one point reduction in the annual tax rate, gains related to our Pannar acquisition and a joint venture asset both of which we expected in the fourth quarter. However, the strength of the dollar were greater headwinds than we expected.
As a result we realized a higher portion of the second half operating earnings in the third quarter in the 40% we anticipated in July. Third quarter net sales about $7.7 billion increased 5%, largely due to 9% higher volumes first at the week prior year.
As you may recall, more depository operating priorities is to drive growth in developing market. Against that metric, we delivered solid third quarter results. In developing Asia, we increased sales by 14% compared to last year’s difficult economic environment. Our investments in Research and Development and marketing facing resources continue to pay strong dividends.
To illustrate that point, our Performance Materials business delivered 29% higher automotive sales volumes in China this quarter. This progress was due in part to insights from our innovation centers, our local application development capability and our customer focused teams.
We also delivered a 24% revenue increase in developing Europe, Middle East and Africa which was broad-based and aided by the acquisition of a controlling in script in Pannar Seed in Africa. This acquisition is another positive step to enhance agricultural productivity and improve total security while accelerating the development of higher performing products for Africa’s farmers.
Looking more broadly the macroeconomic environment and in particular global industrial production is improving sequentially, but on a slower pace than we expected three months ago. As a result we recently lowered our global industrial production outlook for 2013 from 2.5% growth to slightly under 2%.
Despite the slow growth macroeconomic environment, we continue to capitalize on our unique scientific capabilities to develop differentiated high value solutions that respond to growing global market demand.
In summary, our strong and diverse global footprint positioned us well to deliver strong volume growth compared to last year and we’re executing well against our strategic and operating priorities.
Nick will now explain in more detail our third quarter financial performance and our outlook for the remainder of the year. Nick?
Nicholas C. Fanandakis
Thank you, Ellen and good morning everyone. Let’s start with the details of the quarter on Slide 3. Our operating earnings for the third quarter were $0.45 per share slightly better than expectations and $0.02 better than 2012. The improvement primarily reflects the acceleration of two events which were expected to occur in the fourth quarter of this year, and equity re-measurement gain related to the Pannar acquisition of about $0.03 per share and a benefit of about $0.02 per share relating to an asset revaluation in a joint venture. These positive items along with the benefit of a one point reduction in our full year base tax rates were some what tempered by a stronger U.S. dollar and the anticipated lower Performance Chemicals operating earnings of about $0.13 per share.
The lower Performance Chemical earnings are largely due to the decline in global TiO2 prices versus prior year. We are seeing clear signs that this market has stabilized and we are encouraged by the improving industry fundamentals. Consolidated net sales of $7.7 billion increased 5% versus the prior year. Volume increased 9% led by our Electronics & Communications, Performance Chemicals, and Agricultural segments, which each add double digit volume growth versus a weak third quarter last year.
On a sequential basis volumes were up only slightly compared with the second quarter. Local selling prices declined 3% primarily due to lower TiO2 and flour product prices and lower pass-through of precious metal costs in Electronics & Communications, partially offset by innovation driven price increases in our Agricultural segment.
Currency also had a negative 1% impact on our top line as the dollar continued to strengthen against most currencies, particularly the Brazilian Real, Japanese Yen, and the Indian Rupee, partially offset by a weaker dollar versus the Euro.
For the full year, we now expect a negative $0.18 currency impact which is higher than our previous outlook of $0.12 to $0.14 because during the year the dollar has strengthened considerably versus every key currency except the Euro.
In addition to our business performance, our base tax rate for the quarter was seven points lower than last year, contributing $0.04 to operating EPS. For the full year, we now expect a base tax rate of about 22%.
Now let’s turn to Slide 4 for more information regarding the Company sales by geographic region. In every region of the world, we had increased sales volumes. However, lower local prices were an offsetting factor. The decline in prices in the quarter generally reflected the impact of our Performance Chemicals businesses in the regions, particularly in developed Asia.
Our growth in developing EMEA reflects our acquisition of controlling interest in Pannar Seed, which significantly increased our footprint in South Africa during the quarter.
In the second quarter earnings call, we communicated our expectations that industrial markets would gradually recover. As Ellen noted, we still expect to see industrial production improvements, but they are coming at a slower pace. In the third quarter, we saw a growth in Europe and Japan after 2011 and 2012 recessions and we saw some positive signs of growth in China. Overall, we see the global economy improving, but slowly.
Now, let’s take a deeper look into our operating earnings for the third quarter. Slide 5 provides a segment operating earnings variance analysis. From this waterfall chart, you can see clearly the large impacts of decline in Performance Chemical segment earnings had on our overall earnings compared to last year.
Operating earnings for Performance Chemicals declined $159 million this quarter, the $0.13 per share was in line with our expectations. Performance Materials, Electronics & Communications, Safety & Protection, and Industrial Biosciences each had strong performance and double-digit percent growth versus the prior year, offsetting much of the decline in Performance Chemicals segment earnings. Carl will cover more of our operating segment results in a few minutes.
Moving to Slide 6, in total, segment earnings were down $0.05 per share. Segment results include the Performance Chemicals decline we just covered and they also include $0.04 due to currency, which was higher than we anticipated. A change in the base tax rate expectation for the full year also provided a $0.04 benefit in the quarter. The $0.01 benefit from lower corporate expenses that you see on Slide 6 reflects this quarter savings from cost control in our business support functions and the restructuring program we announced last year.
We are on track to deliver the $300 million in savings we targeted for 2013. Beyond this restructuring program, we continue to execute ongoing cost productivity initiatives throughout all of our businesses. We are well on our way delivering on our commitment, but more than $300 million for the full year from these initiatives. In total, both initiatives will contribute significantly to offsetting inflation and helping to fund our growth investments.
Now turning to the balance sheet and cash on Slide 7, our current free cash flow is about $2 billion greater use of cash versus the prior year. As you know, cash flows are highly seasonable from our growing Ag segment and with sales up more than $1 billion in the segment this year, cash and working capital investments have increased to support that growth year-over-year. The timing of production grower compensation payments, which reflected higher contract commodity prices from last year and the timing of customer prepayments contributed to the working capital increases. The decline in Performance Chemicals earnings also had a negative impact on free cash flow versus last year.
Before I close, let me offer a few insights regarding our balance sheet and pensions. First, a reminder; maintaining a strong balance sheet that provides the financial flexibility to fund ongoing operations and compelling growth opportunities remains a key priority for DuPont. Second, our current unfunded pension balance is declining. Given today’s rising interest rate environments and if all other pension related variables, which remain constant. Our unfunded pension liability should decline significantly by about $2 billion to $3 billion by year-end.
In summary, third quarter results were in line with our expectations and our lower base tax rate offset the currency headwinds. With these results we are today reaffirming our full year outlook of $3.85 per share. We expect an improved fourth quarter compared to last year’s weak operating results and also anticipate that our Ag segment will have positive earnings, reflective of the seasonal shifts that Carl will discuss in more detail.
Additionally, our outlook also reflects a year-over-year currency headwind of about $0.07 per share and dials in a full year base tax rate of about 22%, lower than our previous assumption of 23% to 24%.
In closing, we have delivered strong results in the quarter and for the year. We will overcome more than $0.80 of headwinds due to Performance Chemicals earnings and currency. Our teams continue to execute well against our plans and we continue to create increased value for our shareholders. In the coming months we expect to deliver a strong finish to the year.
With that, I’ll turn it back over to Carl.
Carl J. Lukach
Thanks, Nick. I’d like to now provide some brief segment insights. As a reminder, the slides in the complete segment commentary are posted on the Investors in our website at dupont.com.
Please turn now to Slide 8 and let’s begin with Agriculture segment. We feel great about our results and our performance in this competitive environment. Year-to-date we’ve grown sales 12% and operating earnings 8% over last year’s strong performance. Our right product, right acre strategy in seeds and our innovation focus is delivering value to customers.
In the third quarter sales grew 15% based on strong demand for our industry-leading insecticides and higher seed revenues. Our typical seasonal loss lower than last year as sales growth and a gain of $26 million from the Pannar Seed acquisition more than offset higher seed costs.
In crop protection, third quarter sales were up 21% with volume growth in Latin America led by strong demand for Rynaxypyr. Expectations for higher soybean hectares also drove demand for fungicides, particularly for picoxystrobin. Rynaxypyr continues to perform well and we are on pace to exceed $900 million in sales this year. Our fungicide portfolio also continues to show solid growth with the highly successful launch of approach our picoxystrobin fungicide product in the United States this year.
Moving to the seed business, we had a solid start to the Latin America sales season despite the negative impact of currency and growers reducing corn hectares in favor of soybeans. Pricing gains were led by the continued adoption of Intrasect, our dual-mode of action, insect protected hybrids which will represent about a third of our Brazil corn volume this year.
Likewise recent investments in soybeans are paying off as growers in Brazil are increasing demand for locally developed high yielding, high-quality pioneer brand soybeans. The USDA did not issue an October crop report and won’t issue its final 2013 acreage report until January 2014. So it’s too early to be definitive about market share. However, we are pleased with the competitive performance of the pioneer business growing sales 11% through the first three quarters based on the strength of price gains and higher corn volumes in North America.
Moving to the fourth quarter outlook for agriculture, we expect a substantial increase in sales on expectations of continued strong performance in both seeds and crop protection in Latin America. Earlier shipment of safrinha corn seed enabled by a recent investments in Brazil and really start to North America seed shipments and a benefit from including our Pannar acquisition.
As a result of sales increases in seeds, continued growth in crop protection and lower anticipated seed input costs for the fourth quarter North American sales we expect to achieve a small fourth-quarter profit in our Agricultural segment for the first time. For the full year, we now expect operating margins will be about flat over coming the impacts of the higher seed input costs earlier in the year.
Looking forward to 2014, we are watching closely corn and soybean markets and implications for the upcoming safrinha and Northern Hemisphere planting seasons. Several important events will play out between now and when growers put seed in the ground next spring in North America. Specifically, we will see the completion of the North American harvest this year, the harvest of the summer crop in South America and the planting of the safrinha corn in Brazil.
Turning to Electronics & Communications on Slide 9, the demand environment strengthened versus the prior year in photovoltaic and this was reflected in our improved results. Operating earnings increased 67% due primarily to higher demand for our Solamet and Tedlar materials in PV. Overall PV market fundamentals are gradually improving, module prices have been stable due to improved utilization rates and the settlement of trade disputes has provided a more stable environment.
Global PV demand continues to be led by China, Japan and the United States partially offset by lower demand in Europe. While the PV market is still challenged by the weak underlying financials of many players in the industry, the long-term outlook is positive because PV prices are reaching grid parity in more of the world.
Our strategy is to continue to build our position as the premier PV material supplier by stressing the importance of selecting high-value high efficiency materials to extend the life of PV systems which will assist the industry in its drive towards grid parity.
For our Industrial Biosciences segment on Slide 10 this year, our sales and operating earnings have grown each quarter and third quarter operating earnings of $45 million were up 13%.
On Slide 11, from Nutrition & Health, we continue to see strong demand for cultures and probiotics and we delivered good results in protein solutions.
Moving ahead to Performance Chemicals on Slide 12, the 25% year-over-year TiO2 volume growth in the third quarter was another positive step in the recovery. We have now recorded three consecutive quarters of year-over-year and sequential volume growth. Additionally, all regions delivered double-digit volume improvements. Europe and Asia were particularly strong.
While fourth quarter segment earnings are still expected to be modestly lower, this represents a significant improvement compared to the 51% decline we experienced to the first three quarters. We see industry fundamentals improving and our strong manufacturing technology advantages remaining intact.
For Performance Materials on Slide 13, third quarter results benefited from higher volumes in automotive, electronics and packaging markets. Year-to-date we have delivered three consecutive quarters of earnings growth accompanied by increases in operating margins.
Finally, in Safety & Protection on Slide 14, we are seeing volume improvements in U.S. ballistics military protection, certain industrial segments, garments and construction. Our targeted efforts to drive demand generation coupled with ongoing productivity measures are delivering results and improving our financial performance. Third quarter earnings were up 16% versus last year and we now have delivered three consecutive quarters of operating margin growth in this segment.
With that, I’ll turn it back to you, Ellen.
Ellen J. Kullman
Great. Thank you, Carl. Now I’d like to provide some insights on our earnings expectations and I’ll conclude with an update regarding the strategic evaluation of Performance Chemicals.
As Nick highlighted, we do anticipate our full year earnings will be about $3.85 per share. To put that in perspective we expect to have a full year headwind from the combined impact of lower Performance Chemicals earnings and negative currency of more than $0.80 per share. Excluding these factors, our full year earnings per share increase will be 24% higher than last year in a slow growth global economy. While we maintain a cautionary macroeconomic stance it’s noteworthy to highlight that we do expect fourth quarter earnings should more than double from last year’s weak results.
For 2014 planning we are now beginning our business by business goal studying and execution review work. Across the portfolio we initiate this process with a macro assumption that global economies will continue to gradually improve from this year’s sluggish industrial production base. To meet our future commitments we will drive performance across the company by remaining focused on our three strategic operating priorities. They are: increasing return on research and development, capitalizing on our global reach and driving execution while delivering on our productivity commitment.
First, we will deploy our science to meet today’s customers’ needs, build a strong and balanced pipeline of new products and increase the return on our research and development investment.
Second, we will build on our strong third quarter performance in emerging markets and capitalize on our global reach. And third, we will execute against our commitments to drive productivity and deliver cost savings that will help offset inflation and fund growth initiatives.
On the innovation front we successfully delivered 470 new products to meet customer needs in the third quarter alone. Examples of our innovation, this quarter included new applications of Kevlar aramid fibers for high strength, durable, conveyor belts for safety and protection. New branded probiotics designed for pediatric nutrition from our Nutrition & Health segment and new product blends of extra enzymes from Industrial Biosciences designed to reduce cost and improve nutrition in animal feed applications.
Now turning to Performance Chemicals, I’d like to provide a brief update on our evaluation of strategic alternatives. Since our July announcement we’ve made significant progress in our effort to evaluate a wide range of options. Our primary objective is to identify the alternative that creates the most value for our shareholders.
Comprehensive evaluations have progressed well and we’re carefully reviewing key considerations including future CapEx growth, dividend, debt levels, pensions and taxes along with a host of other key variables that we know are important to our shareholders. We are moving with a sense of urgency.
In the interim, we remain focused on delivering results today. Our strategy is clear and it’s working. We have created and are strengthening world leading positions in agriculture and nutrition, biobased industrial and advanced materials. We’ve made good progress with the first three quarters despite challenging conditions that are executing successfully against our strategy.
So with that, Carl back to you.
Carl J. Lukach
Thanks, Ellen. Okay. Let’s open up the line now for your questions.
Earnings Call Part 2: