Ashland Inc. Q1 FY2022 Earnings Call

Thank you, Josh. Good morning, everyone, and welcome to Ashland's First Quarter Fiscal Year 2022 Earnings Conference Call and Webcast. My name is Seth Mrozek, Director, Ashland Investor Relations. I hope you enjoyed the video that opened our webcast. As we mentioned during our recent Investor Day, Ashland is increasing the pace of our innovations to drive profitable, sustainable growth. Each quarter, we intend to provide a highlight about one of our new differentiated products or technologies. Our new controlled release grades of Benecel respond to our pharmaceutical customers' needs for specialty ingredients for high-speed tableting so they can produce more tablets in less time. New grades of Benecel are also used as a binder in response to the rapid growth of plant-based proteins. Joining me on the call today are Guillermo Novo, Ashland's Chair and Chief Executive Officer; and Kevin Willis, Senior Vice President and Chief Financial Officer. You'll notice that I referenced Guillermo's title as Chair and Chief Executive Officer instead of Chairman. On January 24, 2022, Ashland's Board of Directors adopted amendments to our bylaws to change Guillermo's title from Chairman of the Board to Chair of the Board to avoid gender-exclusive language as we continue our ESG journey for a more inclusive and diverse company culture.

Thank you, Seth, and good morning to everyone. Thank you for your interest in Ashland and for your participation this morning. As you will be hearing during the call, Ashland's financial results in the first fiscal quarter were consistent with the earnings update we issued on January 18. Market demand dynamics in our underlying businesses remained robust, consistent with our commentary in prior earnings calls. Customer order dynamics remain strong across our core end markets, and we're making significant progress on taking appropriate pricing actions across all segments. The teams were able to cover the majority of the forecasted raw material inflation during the quarter through pricing initiatives. However, overall cost inflation, particularly for freight and energy, outpaced our original expectations, and ongoing supply chain challenges linked to logistics and shipping constraints remain persistent. As we discussed in our recent earnings update, roughly $20 million of confirmed orders were delayed in late December. And we have a large backlog of unconfirmed orders that we're working to fill. Despite these challenges, our team operated at a high level to safely deliver products to customers around the world, yielding the strong financial results you see for the quarter. For all of Ashland, sales in the quarter grew by 9% to $512 million, and adjusted EBITDA grew by 5% to $106 million. Our new preservatives business made a strong contribution to results in the quarter as the team is now fully integrated into our Personal Care segment. We sustained gross profit margins in the face of significant cost inflation for raw materials, freight, and energy, again driven by disciplined pricing actions. Thus far in fiscal year '22, we have launched a record 11 new products to better serve our life science, personal care, and specialty additives customers with innovative, sustainable solutions. Our plants continue to run very well despite the challenges presented by the pandemic, labor availability, and the energy curtailment mandatory shutdowns of our production facility in China.

Thank you, Guillermo, and good morning, everyone. Please turn to Slide 7. Total Ashland sales in the quarter were $512 million, up 9% versus prior year. Unfavorable foreign currency negatively impacted sales by 1% in the quarter. As Guillermo previously mentioned, gross margin was a consistent 31.4%, reflecting pricing actions by the commercial teams in the face of significant cost inflation. In total, we saw approximately $43 million of inflation in the quarter versus the prior year across raw materials, energy, and freight. While the team did a great job offsetting raw material inflation with price, energy and freight escalated too quickly to fully capture the inflation in the quarter. Pricing actions have been taken to recover all currently forecasted inflation across the business. Excluding key items, SG&A, R&D, and intangible amortization costs increased modestly to $115 million in the quarter, reflecting the addition of the Schülke & Mayr business. In total, Ashland's adjusted EBITDA for the quarter was $106 million, a 5% increase compared to the prior Ashland adjusted EBITDA of $101 million. Ashland's adjusted EBITDA margin for the quarter was 20.7%, a 90 basis point decline compared to prior year, again reflecting the inflation items just discussed. Adjusted EPS, excluding acquisition amortization for the quarter was $0.88 per share, up 28% on the prior year, inclusive of both a favorable tax rate and lower diluted share count following the initiation of our accelerated share repurchase last fall.

I'm pleased that we continue to see improving demand trends across our core markets. While we continue to operate against a backdrop of macroeconomic uncertainty, we will continue to monitor developments and focus on the things that we can control. As we outlined in detail during the recent Investor Day, our priorities are clear: continue to demonstrate operating discipline and resilience; maintain our strategic focus; continue to drive and accelerate innovation; and maintain disciplined capital allocation. Importantly, our focus on ESG-related principles is not only core to our strategy and priority. It provides continued competitive advantage. I want to thank everybody for your time. Hopefully, we've been able to shed some light on the strength of our business. Even in these uncertain times, we're very excited about where we are, the progress that we're making and we thank you for your time, and we look forward to talking to you in the coming weeks.

The adhesive deal should close soon, and a modest portion has been allocated to an existing ASR environmental trust. It's apparent that a Life Sciences acquisition is a priority. Even with a healthy multiple on something like an injectable deal highlighted at your Analyst Day, you would likely have a few hundred million left, depending on mid-year free cash flow generation. Given your current stock price and confidence in your guidance range, despite facing some cost pressures, why not pursue another ASR? Do you think multiples for other potential deals might decrease? Any insights on how to approach the growing cash balance by the end of the fiscal year would be appreciated.

Okay. So let me make some comments and then I'll ask Kevin to add some additional color. But our basic position is we're going to continue to do what we said we were going to do and be very transparent about it. Obviously, we don't want to go into hypotheticals of different situations, but we remain disciplined. Our first priority is to drive organic growth. So our capital investments, investing in our business on the things that we're driving, there are great opportunities, be it in the CapEx. So we've outlined some of those growth initiatives. But there are also projects where we can put more resources around R&D or commercial capabilities in areas that we want to grow or accelerate growth like injectables in the pharma and some personal care spaces. We clearly want to maintain the capability for strategic M&A in the three areas that we said about life science, personal care and coatings. Those opportunities don't always come at a line time with other activities. So maintaining the capability is the important part so that we can do those deals. And clearly, we want to reward our shareholders. So we balance all of these things out as from the actions we just took last quarter I think we're demonstrating discipline and making sure that all actions reward our shareholders with the outcome.

Sure, sure. Happy to. We have approximately $700 million of prepayable variable rate debt on our balance sheet. I think it's highly likely that most, if not all of that, would be paid down with proceeds just as frankly just good interest management, that's probably $10 million to $12 million of cash interest that would go away as a result of those paydowns. It's all low-interest rate debt. It's term Loan A and AR securitization and revolver that stuff. But so that would probably be a near-term activity you should expect from us. That said, balance sheet is still going to be in really great shape.

Guillermo, what are your thoughts on earnings? Can you hear me?

Yes. Yes.

Great. How should we think about the cadence of earnings over the next 3 quarters to get to the lower half of your full-year EBITDA guidance range?

I believe that as time goes on, conditions are improving for us. Currently, the main challenges we face are supply chain reliability and inflation in costs. On the reliability front, as we approach the end of the year, we have seen an improvement in our situation. This is largely due to strong demand and limited capacity. We are producing goods, and unless we encounter issues at our plants, production will continue. We either produce items for sale, which will be reflected in our invoices, or we produce items that go into inventory if we cannot invoice them immediately. Over time, this inventory will accumulate in our warehouses, closer to our customers. Once we achieve those safety stock levels, the issues related to ocean freight, which we consider our biggest reliability challenge, will diminish. Looking back at 2021, we faced production and supply chain constraints that limited our output and created shipping challenges. Now, as we ramp up production, even if it is inconsistent, there may be a short-term impact on our invoicing. However, if each shipment increases in size and we begin to build our stock, we will ultimately have sufficient safety inventory on hand to avoid operating in a state of constant urgency. This means we can expect normalization in our operations. As we proceed through the latter half of the year, we are either going to maintain strong sales amid ongoing pressures or, hopefully, conditions will improve significantly as we rebuild our inventories on the supply chain side.

Well, it was a pretty significant use of cash in Q1. I think the net was between $45 million and $50 million, and I would say, more than all of that was inventory. There's a couple of dynamics there. Guillermo mentioned and I talked about in my part of the presentation, replenishing inventories. And a big chunk of that is around the idea of kind of what inventory do we have in transit. And where we sit today, we have a lot of inventory in transit, meaning it's on its way from source location to ultimately use location, a warehouse somewhere around the world. A lot of that's on the water, the vast majority of it is on the water. And so as that gets to where it's going and we have sufficient safety stock in some of these locations around the world, we can moderate some of that. I mean working capital is going to be a use of cash. I can't tell you how much it's going to be for the full year, but compared to prior year, it will be. And that will have an impact on ongoing free cash flow. But even so, between that and an increased CapEx these organic capacity expansions, we should still report pretty solid free cash flow for the year based on based on the actions that we're taking.

I understand you prefer not to discuss quarterly guidance, but I'm curious about fiscal Q2. You mentioned that price cost could be favorable. Demand appears strong, correct? If you're able to reconcile price cost, could adjusted EBITDA show a year-over-year increase in Q2?

This is my point regarding our Investor Day. We are not the same company that everyone perceives. Our profile and portfolio are much more resilient. We are targeting the same market and areas, and our behavior aligns with that. Being overly optimistic or pessimistic based on potential scenarios isn't the focus. I can create very positive or negative scenarios, but I can't predict whether they will materialize, and that's the challenge we face. Our models indicate what we've communicated, and we will remain dedicated to delivering results that align with the resilient, consumer-driven markets we've outlined. We won't experience overnight success, but we are committed to consistent, high-quality growth. There are various scenarios to consider. For example, if price inflation doesn't occur and pricing remains stable alongside steady demand, there could be positive outcomes. When I say we're slightly below, I mean we're just under the midpoint, but I can envision scenarios that could fluctuate both ways. Given our belief in the resilience of our company, it seems reasonable to stay focused on our strategy. We prefer not to make drastic changes to our guidance based on overly cautious or optimistic sentiments. We believe we are positioned right in the middle, and we feel confident based on the information we currently have.

Two quick ones. First, the inflationary pressure and the way you're passing it through, is there any visible impact on customer commitment or focus in terms of the R&D projects they're asking you to partner on? We see any ripple effects or changes in behavior? And secondly, can you elaborate on the ramifications of the tightness in the cellulosic, is the overall industry tight? Or is there a share shift? And is the share shift in product categories where they're reasonably sticky or ones that you can capture the share back as when conditions improve or the supply to demand balance improves?

I believe we are approaching our pricing strategy carefully. We are addressing the areas we understand and can clearly forecast, allowing us to communicate effectively with our customers about pricing. We are not alone in this; many others are also adapting. The key now is how we negotiate with our customers and how our supply capability affects that. As we are selling additives, our influence is limited. Therefore, it is crucial to maintain a constructive dialogue with our customers, who understand the challenges as they are experiencing them too. I don’t believe we are doing anything that would negatively impact us in the long run. In fact, our ability to supply is improving, which positions us as a more reliable supplier and helps us meet the demand for materials and stick to our commitments. This reliability supports our efforts in research and development and innovation, reinforcing our status as a key player in the market. Clear and transparent communication is essential for us, not just with you but also with our customers, so they know our intentions and actions.