DOW INC. quarterly report, Q2 FY2020

Dow Inc. 2020 Second-Quarter Form 10-Q Summary

Business context and reporting period

Dow Inc. and The Dow Chemical Company filed a combined unaudited Form 10-Q for the quarter and six months ended June 30, 2020. Results reflect Dow’s materials-science portfolio following the April 1, 2019 separation from DowDuPont. Agricultural sciences and specialty products are presented as discontinued operations in applicable prior periods. Continuing operations comprise Packaging & Specialty Plastics, Industrial Intermediates & Infrastructure, Performance Materials & Coatings, and Corporate.

The second quarter was materially affected by the COVID-19 pandemic, lower crude oil and energy prices, weaker demand in durable-goods end markets, and related margin compression.

Financial performance and key metrics

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Net sales	$8,354 million	$11,014 million	$18,124 million	$21,983 million
Income from continuing operations, net of tax	$(217) million	$90 million	$41 million	$246 million
Net income available to Dow Inc. common stockholders	$(225) million	$75 million	$14 million	$631 million
Basic and diluted EPS	$(0.31)	$0.10	$0.01	$0.84
Cash provided by operating activities	Not provided for the quarter	Not provided for the quarter	$2,829 million	$2,256 million
Operating cash flow from continuing operations	Not provided for the quarter	Not provided for the quarter	$2,835 million	$2,003 million
Capital expenditures	$273 million	$470 million	$668 million	$912 million
Free cash flow	Not provided for the quarter	Not provided for the quarter	$2,167 million	$1,091 million

Cost of sales was 91.1% of net sales in the second quarter, compared with 85.5% in the prior-year quarter. For the six months, cost of sales was 87.4% of net sales, compared with 84.4% in 2019. Operating EBIT was $57 million in the second quarter, compared with $1,059 million in the prior-year quarter, and $900 million for the six months, compared with pro forma Operating EBIT of $2,202 million in the prior-year period.

Packaging & Specialty Plastics: Q2 sales of $4,001 million, down 23%; Operating EBIT of $318 million, down from $768 million.
Industrial Intermediates & Infrastructure: Q2 sales of $2,417 million, down 28%; Operating EBIT loss of $220 million versus income of $154 million.
Performance Materials & Coatings: Q2 sales of $1,855 million, down 21%; Operating EBIT of $27 million, down from $214 million.
Corporate: Q2 Operating EBIT loss of $68 million, compared with a loss of $77 million.

Liquidity, debt and balance sheet

Cash and cash equivalents were $3,724 million at June 30, 2020, up from $2,367 million at December 31, 2019.
Gross debt was $17,592 million, compared with $16,996 million at year-end 2019. Net debt was $13,866 million, compared with $14,608 million.
Net debt as a percentage of total capitalization was 51.4% for Dow Inc. and 50.0% for TDCC, compared with 50.9% and 49.6%, respectively, at December 31, 2019.
Total committed credit facilities were $8.7 billion, with $7.4 billion available at quarter-end. Management reported approximately $12 billion of committed liquidity, including cash.
There were no substantive long-term debt maturities until the second half of 2023. TDCC was in compliance with its debt covenants; its defined indebtedness-to-capitalization ratio was 0.53 to 1.00 versus a 0.65 to 1.00 limit under the relevant facility.
In February 2020, Dow issued €2.25 billion of notes with an approximately 1.0% weighted-average coupon and redeemed $1.25 billion of 3.0% notes due 2022.
Dow paid $1,034 million of dividends to Dow Inc. stockholders during the first six months and repurchased $125 million of stock. No shares were repurchased in the second quarter, and management did not expect additional repurchases in 2020 at the filing date.

Material changes versus the prior comparable period

Second-quarter net sales declined 24%, driven by a 14% decline in local price, a 9% volume decline, and a 1% unfavorable currency impact.
Six-month sales declined 18%, with local price down 12%, volume down 5%, and currency unfavorable by 1%.
Demand remained relatively strong in food packaging, health and hygiene, home care, and pharmaceutical applications, but weakened substantially in automotive, construction, furniture and bedding, oil and gas, and other durable-goods markets.
Equity losses from nonconsolidated affiliates increased to $95 million in Q2 from $15 million, primarily because of margin compression at Kuwait joint ventures and higher losses from Sadara.
Integration and separation costs fell to $46 million in Q2 from $348 million for Dow Inc. and $324 million for TDCC in the prior-year quarter. These activities were expected to be substantially complete by year-end 2020.
Interest expense declined to $200 million in Q2 from $237 million for Dow Inc. and $249 million for TDCC, primarily because of prior debt redemptions.
Operating cash flow from continuing operations increased to $2,835 million for the six months from $2,003 million, principally from working-capital improvements, lower performance-based compensation payments, the Nova-related tax refund, and customer advance payments.
Free cash flow increased to $2,167 million from $1,091 million, despite lower earnings, primarily because of stronger operating cash flow and lower capital spending.

Guidance, outlook, commentary and unusual items

Dow expected third-quarter net sales to increase 5% to 10% sequentially, with improvement across all geographic regions and operating segments.
Management expected third-quarter margins to expand as sales increased, energy prices recovered, and polyethylene price increases took effect. The outlook assumed continued economic reopening and no significant COVID-19 resurgence.
The 2020 capital expenditure target was reduced to approximately $1.25 billion. Dow also targeted $500 million of operating-expense reductions, increased from the previously announced $350 million.
Dow planned a third-quarter restructuring program targeting more than $300 million of annualized Operating EBITDA benefit by the end of 2021, including a 6% reduction in the global workforce and exits from uncompetitive assets.
Dow expected to loan Sadara up to $500 million in 2020; $236 million had been provided during the first six months. Sadara-related losses and funding needs remain material.
Unusual Q2 items included a $6 million gain related to the Nova ethylene asset matter, $6 million of asset-related charges, and $46 million of integration and separation costs. The first six months included a $86 million loss on early debt extinguishment and $90 million of restructuring charges.
On July 2, 2020, TDCC agreed to sell rail infrastructure assets for expected cash proceeds exceeding $310 million. The transaction was expected to close in the fourth quarter of 2020, subject to customary conditions, with an expected gain.

Risks, contingencies and other matters

COVID-19 could further reduce demand, disrupt supply chains and manufacturing, increase customer credit risk, impair assets, raise borrowing costs, and create workforce, cybersecurity and foreign-exchange risks. The ultimate severity and duration were not reasonably estimable at filing.
Environmental remediation accruals were $1,118 million at June 30, 2020. Management stated that ultimate costs for the accrued matters could be approximately twice the recorded amount.
Union Carbide asbestos-related liability was $1,133 million, including projected claims and defense costs through 2049. The Company could not estimate the full range of potential additional costs.
Dow Silicones estimated an additional $160 million of funding obligations for breast implant and related product-liability claims after the Settlement Facility’s remaining balance is exhausted.
Dow had guarantees of $3,788 million, primarily related to debt of nonconsolidated affiliates. The guarantee exposure for Sadara could reach approximately $3.8 billion until project-completion conditions are satisfied.
Dow recorded disputed portions of the Nova Chemicals judgments in other noncurrent obligations, including $341 million related to a polyethylene patent matter and $875 million related to the ethylene asset matter. Appeals remained pending.
Fitch maintained a negative outlook and S&P downgraded Dow’s long-term rating to BBB- and short-term rating to A-3, while Moody’s rated TDCC Baa2/P-2. Further downgrades could increase borrowing costs or restrict capital-market access.
Management concluded that disclosure controls and procedures were effective and that there were no material changes in internal control over financial reporting.

Investor verification checklist

Verify the pace of recovery in automotive, construction, furniture and bedding, oil and gas, and other durable-goods markets.
Assess whether the projected 5% to 10% sequential sales growth and third-quarter margin expansion were achieved.
Track progress toward the $500 million operating-expense reduction target and the planned restructuring benefits exceeding $300 million of annualized Operating EBITDA by the end of 2021.
Monitor Sadara’s operating performance, equity losses, funding requirements, and the potential release of the related guarantees.
Review cash conversion, working-capital trends, capital expenditures, dividend funding, and the suspension of share repurchases.
Evaluate debt-rating developments, refinancing requirements, covenant headroom, and available committed liquidity.
Follow the Nova appeals, asbestos and environmental matters, breast implant funding obligations, and the potential range of unrecorded liabilities.
Confirm completion, proceeds and gain recognition from the announced rail infrastructure asset sale.