Ashland Inc. Q3 FY2024 Earnings Call

Good day and thank you for standing by. Welcome to the Ashland Inc. Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, William Whitaker. Please go ahead.

Thank you, Deedy and hello, everyone. Welcome to Ashland’s third quarter fiscal year 2024 earnings conference call and webcast. My name is William Whitaker, Vice President of Finance and Director of Investor Relations. 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. Ashland released results for the quarter ended June 30th, 2024, at approximately 5:00 PM Eastern Time yesterday, August 6th. The news release issued last night was furnished to the SEC in a form 8-K. During today’s call, we will reference slides that are currently being webcast on our website, ashland.com, under the Investor Relations section. We encourage you to follow along with the webcast during today’s call. Please turn to slide 2. As a reminder, during today’s call, we will be making forward-looking statements on several matters, including our financial outlook for our fourth quarter and full-year fiscal 2024. These forward-looking statements are subject to risks and uncertainties that could cause future results or events to differ materially from today’s projections. We believe any such statements are based on reasonable assumptions, but cannot assure that such expectations will be achieved. Please refer to Slide 2 of the presentation for an explanation of those risks and uncertainties, and the limits applicable to those forward-looking statements. You can also review our most recent Form 10-K under Item 1A for a comprehensive discussion of the risk factors impacting our business. Please also note that we’ll be referring to certain actual and projected financial metrics of Ashland on an adjusted basis, which are non-GAAP financial measures. We will refer to these measures as adjusted and present them to supplement your understanding and assessment of the financial performance of our ongoing business. Non-GAAP measures should not be considered a substitute for or superior to financial measures calculated in accordance with GAAP. The most directly comparable GAAP measures, as well as reconciliation of the non-GAAP measures to those GAAP measures are available on our website and in the appendix of today’s slide presentation. Please turn to slide 3. Guillermo will begin the call this morning with an overview of Ashland’s performance and results in the third quarter. Next, Kevin will provide a more detailed review of the financial results for the quarter, followed by commentary related to Ashland’s outlook for our fourth quarter and full-year fiscal 2024. Guillermo will then provide an update related to Ashland’s strategic priorities and then we will open your line for questions. Please turn to slide 5. I will now turn the call over to Guillermo for his opening comments.

Thank you, William and hello, everyone. Thank you for your interest in Ashland and for your participation today. Let me start with a few of the headlines driving our performance. We delivered continued progress on all our portfolio actions. We had strong Personal Care sales growth across markets, and we saw improved Specialty Additives volumes and we showed disciplined price management and high-quality margin performance. Headlines were driven by lower life science, VP&D volumes mostly in Europe, softening Specialty Additives volume momentum versus our expectations and increased price pressure. While improving sales trends continued during most of the quarter, June was weaker than expected and this trend has continued into July. Our Q3 sales were roughly in line with our prior year at $544 million. Note that our portfolio improvement initiatives reduced sales by approximately $15 million or 3% during the third quarter. Sales volumes improved 5% led by 22% growth in Personal Care and 5% growth in Specialty Additives. Excluding the portfolio improvement actions, overall sales volume grew by 8%. Looking at the businesses. Personal Care had one of the strongest quarters on record. The strong performance was broad based across markets and regions, particularly in strategic markets such as biofunctionals, microbial protection, as well as the Asia region. Specialty additives volumes continued to improve versus our prior year and the business sustained its strong margin expansion delivering 810 basis points on a sequential adjusted EBITDA margin improvement. Although volume demand improved, it was below our expectations. The regional recovery has been mixed with lower demand and increased competition in Asia, as well as the Middle East and Africa. In life science, the biggest headwind was VP&D. Overall, VP&D market demand was softer than expected in pharma and crop care. And we reduced exposure to the lower margin nutrition business. However, the largest impact for the quarter was the VP&D Pharma, where share loss and some demand weakness weighed on overall results. Overall impact has been most acute in Europe. We will discuss actions we’re taking to improve our results later in the call. The Intermediates Merchant Business continues to see weak demand in EV battery and crop care markets. Pricing was down low single digits versus the prior-year quarter when excluding the impact of our intermediates business, which was down double digits. Pricing impact was partially offset by lower raw material costs. Production volumes were up mid-single digit versus last year and generally in line with quarterly sales volumes as inventories were sequentially stable. Ashland continues to prudently manage production and inventory levels to increase our future operating flexibility. Adjusted EBITDA margin sequentially increased 370 basis points to 25.6% in line with our second-half target of mid-20s. Overall, adjusted EBITDA for the quarter increased to $139 million, which was at the lower end of our expectations. We continue to believe the current share price does not reflect our expectations for long-term profitable growth and enhanced capital return. Following another quarter of strong free cash flow, we repurchased $130 million of shares. We also increased the dividend in the quarter as we have done every calendar year since 2009. Our strong balance sheet and healthy free cash flow generation enables us to pursue a balanced capital allocation approach. Please turn to slide 6. Year-over-year sales growth was very strong for Personal Care, but mixed overall for the company due to the factors I’ve referenced earlier. These results reflect portfolio optimization in the quarter including an 8% impact on Specialty Additives. Volume improvements were partially offset by lower pricing in some product lines. While sales growth was mixed, all businesses-maintained discipline and delivered strong margin performance in line with our expectations. All business units were at or above adjusted EBITDA margins of 25%. Our portfolio optimization activities remain on track. Actions around rightsizing our MC and CMC businesses have been implemented. In May, we announced the signing of a purchase agreement for the nutraceutical business and expect the transaction to close in fiscal Q4. We’ve already started to take initial actions on our Avoca business, which is also part of the Pharmachem acquisition. And now, let me pass over the call to Kevin to review Q3 in more detail.

Thank you, Guillermo, and good morning, everyone. Please turn to Slide 8. Total Ashland sales in the quarter, $544 million, or roughly in line compared to prior year. The previously-announced CMC and MC portfolio optimization initiatives reduced overall sales by approximately $15 million or 3% during the third quarter. Year-over-year quarterly volumes increased 7% as demand recovered within the Personal Care and Specialty Additives segments. These volume gains were partially offset by unfavorable Life Sciences volumes. Regionally, overall sales into our largest markets, North America, Europe and Asia, were stable to improving. This was offset by weakness in Latin America and Middle East Africa. Gross profit margin increased 290 basis points to 36.2% in the quarter, which is one of our higher margin quarters over the last five years. Several factors contributed to this improvement, primarily sales and production volume increases, as well as product mix. This was partially offset by unfavorable pricing versus raw materials, approximately half of which is associated with Intermediates. When excluding key items, SG&A, R&D and intangible amortization costs were $110 million in the quarter, down from $113 million in the prior year. In total, Ashland’s adjusted EBITDA for the quarter was $139 million, up 5% from the prior year. Ashland’s adjusted EBITDA margin for the quarter was 25.6%, up from 24.4% in the prior year. Adjusted EPS, excluding acquisition amortization for the quarter, was $1.49 per share, up 21% from the prior-year quarter. Now, let’s review the results of each of our four operating segments. Please turn to Slide 10. As Guillermo mentioned, VP&D was the largest impact in the quarter for Life Sciences. Overall, VP&D demand was softer in pharma, as well as in crop care, and we also reduced our exposure to low margin nutrition business. The largest impact was related to share loss and softer demand in PVP pharma, particularly in Europe. pharma cellulosics has been stable year-to-date, offsetting a softer demand environment with share gain. Life Sciences sales declined by 11% to $195 million. Adjusted EBITDA decreased by 18% to $59 million, primarily reflecting lower VP&D volumes, as well as lower pricing that was partially offset with favorable raw materials. Adjusted EBITDA margin decreased 260 basis points to 30.3%. Please turn to Slide 11. Stronger demand positively impacted Personal Care volumes within all end markets. Skin and hair care demonstrated the greatest recoveries versus the prior year. Strong revenue growth was regionally broad based across Asia, Europe and North America. As expected, oral care sales were positively impacted by order timing with a key customer. Avoca’s continued weakness moderated on sequential improvement and a weaker prior-year comparison, generating flat year-over-year revenue performance. Overall pricing versus raw material dynamics were balanced for Personal Care. Personal Care sales increased by 20% to $175 million. The portfolio optimization initiative reduced Personal Care sales by approximately $3 million, or 2% during the third quarter. Adjusted EBITDA increased 46% to $51 million, primarily reflecting increased sales and production volume with favorable product mix, partially offset with variable compensation resets. Adjusted EBITDA margin increased 510 basis points to 29.1%. This marks one of the most profitable quarters for Personal Care over the last five years. Please turn to Slide 12. Specialty additives volumes improved within coatings and performance specialties, partially offset by lower energy end market volumes. To unpack the demand trends a bit, regional sales growth was mixed. We generated revenue growth in Europe, rest of Asia and Latin America with weakness in China and Middle East Africa. North America was stable in the quarter, but has generated positive sequential momentum throughout the year. Overall pricing for Specialty Additives was lower, primarily reflecting increased competition in Asia, but was partially offset by favorable raw materials. For the quarter, Specialty Additives sales declined by 1% to $150 million. The portfolio optimization initiative reduced Specialty Additives sales by $12 million or 8% during the third quarter. adjusted for portfolio optimization, sales volumes were up 13% versus the prior year. Adjusted EBITDA increased by 31% to $38 million, reflecting higher sales and production volumes with favorable product mix, partially offset with unfavorable pricing versus raw material and variable compensation reset. Adjusted EBITDA margin has recovered very well throughout the year, up approximately 2,000 basis points since Q1 to more typical profitability at 25.3%. Please turn to Slide 13. Total merchant and captive sales were $36 million, down 16% from the prior-year quarter. Merchant sales totaled $24 million, down from $29 million, in the prior-year quarter, driven primarily by lower NMP pricing. Lower NMP pricing is primarily a result of weaker demand in the EV battery and crop care end markets. Captive internal BDO sales were $12 million, down 14% compared to the prior-year quarter due to lower volumes and pricing. Intermediates reported adjusted EBITDA of $9 million, or a 25% adjusted EBITDA margin, compared to $16 million in the prior year, primarily reflecting lower pricing. Please turn to Slide 14. Ashland continues to have a strong financial position. As of the end of June, we had cash on hand of $399 million with total available liquidity of roughly $1 billion. Our net debt was $926 million, which is about 2.3 turns of leverage. We have no floating rate debt outstanding, no long-term debt maturities for the next three years, and all of our outstanding debt is subject to investment grade style credit terms. As Guillermo noted, we continue to believe Ashland stock is an attractive use of capital and deployed $130 million to repurchase 1.3 million shares during the quarter. Our balanced and disciplined capital allocation approach has deployed roughly $1.2 billion to share repurchases over the last three years. We have $770 million remaining under current share repurchase authorization. We are continuing to invest in our existing businesses and technology platforms to grow organically, while pursuing our strategy of targeted bolt-on M&A opportunities focused on Pharma, Personal Care and Coatings. Please turn to Slide 15. Ashland prudently managed production and inventory levels throughout the quarter. Inventory levels have decreased $156 million when compared to the prior-year quarter and increased modestly by $6 million sequentially. Our actions should better position us for more resilient performance going forward. Overall, ongoing free cash flow for the quarter was very healthy at $112 million, up 15% versus the prior year. For the fiscal year, we expect to generate a free cash flow conversion of 50% to 55%. Our progressive dividend policy remains an important part of our capital allocation strategy and is reflective of our confidence in the company’s long-term profitable growth and cash flow generation outlook. The quarterly dividend increased to $40.05 per share this quarter and is reflective of our commitment to increase the dividend annually as we’ve communicated and demonstrated. With that, I will now provide an update on the execute pillar of our strategic priorities in addition to an updated outlook. Please turn to Slide 17. We have five primary portfolio actions underway. As Guillermo noted, our latest advancement is the May signing of a definitive agreement to sell our nutraceuticals business to Turnspire Capital Partners. Our teams are working diligently on the transaction closing process and expect to complete the transaction in the September quarter. I would like to acknowledge and thank the nutraceuticals team, which performed well while supporting the transaction process. In connection with the signing, we recognized a non-cash impairment, as well as an offsetting tax benefit, which were key items in the quarter. The business will remain in continuing operations until the transaction is closed. The exact impact of the sales production in Q4 will be dependent on the specific closing date. In addition, Ashland continues to reduce its CMC and MC volume exposure to several lower value, more cyclical segments. As noted earlier, these efforts reduced overall sales by $15 million during the third quarter, primarily within Specialty Additives and Personal Care to a lesser extent. We expect the quarterly sales impact to increase to approximately $20 million, across the three core businesses during Q4. Ashland continues to advance its work to improve the productivity of its HEC business and specific actions will be communicated in due course. Looking ahead to fiscal year 2025, we expect these actions to reduce revenue $160 million to $170 million versus 2024. Most of the impact is within Life Sciences due to the expected nutraceutical sale and nutrition exits, which ramp up in Q4 of this year. Wes will act with appropriate urgency to deliver on our commitments, including the reduction of all stranded costs to drive an EBITDA neutral outcome and improve overall margins for the company. We continue to evaluate our strategic options with respect to our Avoca business line and recently started to take action. We recently closed one of Avoca’s smaller facilities and are reducing personnel at a larger facility in response to lower demand. Please turn to Slide 18. As noted in our press release last night, we have revised our sales and adjusted EBITDA outlook for the fiscal year. There are two primary drivers: slower-than-expected VP&D recovery and softer-than-expected coatings demand growth. Guillermo will discuss our VP&D action plan in more detail later in the call. Recent market developments have increased uncertainty around demand trends in select markets and regions. Lower sales trends experienced in June have continued into July. Overall, end market demand growth is estimated to be flat to low single digits. Personal Care and Specialty Additives are expected to benefit from favorable Q4 comps on demand normalization. The continued demand recovery from Personal Care and Specialty Additives is expected to be partially offset by softer VP&D volumes within Life Sciences. While lower-than-expected pharma sales are forecasted to be roughly stable with improving Life Sciences margins versus the prior year. Overall, year-over-year sales volume growth, excluding portfolio optimization volumes is expected to be mid-single digit in the fiscal fourth quarter. We are expecting softer overall pricing, which is forecasted down low single digits versus the prior year, partially offset with raw material deflation. The CMC and MC portfolio optimization is expected to reduce sales approximately $20 million, versus the prior year and drive margin expansion. We expect significant year-over-year absorption favorability as we continue to produce the demand and we compare against last year’s inventory corrective actions. For the fiscal fourth quarter, the company expects sales in the range of $530 million to $540 million and adjusted EBITDA in the range of $130 million to $140 million. This yields full-year sales of approximately $2.1 billion and adjusted EBITDA in the range of $465 million to $475 million. Key risks and opportunities are listed on the slide. Demand, plant loading and price versus raw material balance continue to be most critical for the Q4 financial results. And now, let me turn the call back to Guillermo to provide an update on our strategic priorities.

Thank you, Kevin. Please turn to slide 20. Our strategic priorities remain consistent and continue to guide our actions, investments, and expectations for profitable growth. As we have previously discussed, these priorities involve initiatives to execute, globalize, innovate, and acquire. We are making good progress on our execution priorities and expect this momentum to continue in Q4. We are aiming to complete our current portfolio optimization efforts by the end of the calendar year. In addition to CMC, MC, and Nutraceuticals, we are finalizing plans to exit the Avoca business due to fundamental changes in the market dynamics for the sclareolide business and because the tolling activities are not aligned with our strategies. We acknowledge that we are operating in uncertain times. Therefore, we will maintain a disciplined approach, focusing on what we can control to drive near-term performance. In order to exceed market demand dynamics, Ashland needs to prioritize and advance its growth catalysts. This means making progress on our execute, globalize, and innovate strategies. Looking ahead to fiscal year 2025 within our execution initiatives, we will concentrate on strengthening our core areas. We have started a focused effort to enhance our competitive position in both VP&D and HEC. We are working to gain market share in VP&D, especially within the pharmaceutical sector, which requires careful volume and pricing management. We are investing in globalizing and innovating our priorities while also strengthening our team and our execution capabilities. I'm very encouraged by Ashland's progress and the investments being made, which are laying the groundwork for future profitable growth. Please turn to slide 21. We are actively working to globalize four of our highly attractive businesses, which currently account for 10% of Ashland’s sales. These globalized business lines grew significantly in the quarter, achieving double-digit sales growth through market share gains and new product developments. The gross profit margins for these lines were also substantially above the company average for the quarter. Here are some highlights from our recent globalization initiatives. In the pharmaceutical sector, the injectables team successfully advanced opportunities with long-lasting excipients, with new product launches performing very well. To enhance our injectable business globally, we have expanded our business development team in North America and Europe, with plans to grow our resources in Asia and Latin America. In the OSD film coatings sector, we are globalizing our manufacturing and technical capabilities. We are also investing in our workforce by filling key roles to meet our growth expectations. These efforts are bringing us closer to our regions and customers, while also strengthening local technical services and customer relationships. Additionally, our TBO technology has the potential to significantly enhance productivity for our pharmaceutical customers. We are moving through the initial phases of our stage gate process following very positive customer feedback on our value proposition. Shifting to Personal Care, the biofunctionals segment is rapidly accelerating the commercialization of new products, with adoptions rising threefold compared to the previous year. After commissioning our new facility in China, the team has developed a regional sourcing strategy. We are now innovating, sourcing, producing, and supplying locally. We continue to see strong sales recovery in the region. Tailored products with local supply will distinguish us and help sustain our growth momentum in biofunctionals. The preservatives segment is progressing with various projects aimed at enabling local supply, which supports our ongoing market share gains. For instance, we are nearing completion of local production development in Brazil, with plans to expand later this year, enhancing our position in this growth market. Furthermore, we have completed the development of our regional commercial teams and are investing in assets, personnel, and technology to accelerate our globalization strategy. We are pleased with the recent momentum and remain highly focused on scaling these valuable business lines. Please turn to slide 22. We continue to advance our new technology platforms, with a growing list of product launches backed by multiple development programs. During last year's innovation day, we expressed our excitement about the scalable and adjustable nature of these technologies. Since then, we have discovered disruptive opportunities across various market segments, as highlighted in the chart. This expands our overall growth opportunities and reduces our portfolio risk profile. We have conducted over 50 key customer meetings and technology sessions, which continue to validate our enthusiasm. Among our new technology platforms, our transformed vegetable oil or TBO technology is currently the most advanced. We have recently received local approval to sell one of our early launches in China, building on our strong global sales opportunity pipeline. TBO holds potential value propositions across various attractive end market segments, including personal care, metallic coatings, architectural coatings, industrial coatings, adhesives, and other industrial markets. We see many promising applications for our innovative super wetter technology, and the next variant targets the crop care market. We plan an exciting launch at the end of the year, which will enhance our existing coatings opportunities. Additionally, we have numerous new product development programs in progress for our novel cellulosics and expect to launch several variants in coatings, personal care, and pharmaceuticals over the next two years. Our total addressable market is expanding as we advance the pipeline of impactful, scalable platforms across markets. Interest in collaboration opportunities remains very high across the board. Our current focus is on developing several Joint Development Agreements with key industry leaders to validate and de-risk commercialization. We are making progress and anticipate formalizing our efforts with strategic customers soon. We recognize that innovation may take time, but we look forward to sharing continued momentum and financial progress as our launches gain commercial traction. Please turn to slide 23. In conclusion, I want to reiterate the key takeaways from this quarter. The global personal care business performed exceptionally well. Our business units have returned to high-quality margins following another successful quarter of Specialty Additives margin improvement. Portfolio optimization is on track, and we are advancing our growth catalyst opportunities. We delivered adjusted EBITDA within the outlook range despite a challenging sales environment. The adjusted EBITDA was primarily converted to free cash flow, which was used for share repurchases. Overall demand trends are improving, but uncertainty remains high in specific industries and regional dynamics. We have adjusted our Q4 outlook to account for challenges in our VP&D life science products and a softening market demand in Specialty Additives, especially in Asia. Our teams are leveraging commercial excellence, productivity initiatives, and strategic pricing actions to ensure we are well-positioned in the market for our core technologies where we have technical and market leadership. We are confident in our ability to deliver differentiated solutions and innovate in our core areas to achieve market share gains. We will prioritize our investments and manage margins in light of near-term challenges, while remaining focused on maximizing results for 2024 and advancing our long-term growth potential. I want to thank the Ashland team for their leadership and proactive ownership of their businesses in a dynamic environment. Lastly, I would like to mention that Ashland plans to host an Investor Day on December 10 in New York City. The event will highlight our financial and strategic objectives for delivering long-term profitable growth for the company. Additional details and registration information will be provided, but for now, please mark your calendars. We look forward to sharing more with you later this year. Thank you, and Deedy, let's move on to Q&A.

And our first question comes from Christopher Parkinson of Wolfe Research. Your line is open.

Great. Thank you so much. Guillermo, I feel like we're moving in the right direction and yet there's still a little bit of complexity to the story. Can you just help us think about the 2025 bridge? Just in terms of some of your previous quarterly commentary around the $40 million of total fixed cost absorption, the $20 million of fiscal first half destocking, Kevin's prior quarter comments about market growth off of lower levels, that seems a little bit more muted now perhaps, and as well as the kind of the new product intro outlook. I feel like those are the four main things, obviously partially offset by portfolio optimization efforts. So, could you help us just kind of simplify how the buy side should be thinking about the perceived EBITDA bridge as we enter fiscal year 2025? Thank you so much.

Thank you, Chris. This is clearly an important question. The main focus for us this quarter is VP&D and pharma, and we're actively addressing it. The biggest concern is the dynamics of our market share, which we've discussed in previous quarters. So, what has changed in our outlook? We need to assess the two resets: the normalized forecast for 2024 and what to expect in 2025. For 2024, we are providing guidance of 465 to 475. The only change is our outlook for VP&D market share, while everything else remains constant. We are still evaluating what regaining that share will entail, which involves balancing price and volume. I want to emphasize that we are performing well in terms of pricing and our margins are strong. As market leaders, we are at a critical transition point—similar to handling inflation, we need to adjust prices gradually, and we are managing that process carefully. We can't simply lower prices indiscriminately without considering the implications of our actions.

I own that.

We have been deliberately managing our direction regarding volume. It's essential to balance our share price; if we gain volume but lose pricing, we are not making progress. There's a concept I’ve encountered in various companies that goes, "you sell out and sell up" in commodities, while in specialties, we promote selling up first and then selling out. Although they seem similar, they differ significantly. As market leaders, we must control pricing, product positioning, and how we respond to various products. Our focus is on long-term management; we are not only looking at the current quarter but also planning for the future, and we will navigate through this transition. Our team is actively addressing this, and we are already gaining market share. What we need to assess for 2025 is the timing, especially concerning quarterly and annual contracts with different customers, which presents the most significant change. Other factors remain relatively stable. For 2025, another aspect we are currently evaluating, though still uncertain, is within the coding sector. We have noticed a slowdown in China, which we are incorporating into our planning, but we don’t have specific numbers for 2025. In Europe and the U.S., we are focused on growth rates, which could fluctuate based on interest rates and the home resale market's conditions. There are many variables at play, and between now and our next call about 2025, we should be able to provide more clarity. Currently, the key challenge we face is managing the transition in VP&D pharma share.

Got it. And just as a quick follow-up. Sorry, go ahead.

Just to be in terms of the Q1-Q2 recess that we've been talking about, there is no change to any of that. Those are still just as they have been. Internally, we don't view them any differently and they shouldn't be viewed any differently by the buy side or the sell side. Normalized Q1 and Q2 are still right, where we think they have been.

I appreciate the clarification. Regarding personal care, I don't want to dwell too much on the pharmaceutical side given your detailed comments. However, on the personal care side, you have experienced double-digit growth in skin, hair, and oral categories. Considering the market trends over the past four to six quarters, is this growth simply a normalization process as your customers stop destocking due to easy comparisons? The demand seems relatively stable from end users. How should we view this situation? Is there any restocking happening? I'm trying to focus on the outlook for fiscal year '25, given that performance is indeed improving. Thank you.

Yes, Chris, I want to avoid using the terms normalization and destocking because that is behind us. We don't want to rely on that moving forward. The only area where we know customers still have high inventories and are gradually reducing them is in pharmaceuticals, particularly in Europe, where it's more about their own risk management. In all other areas, based on what we can assess, the destocking phase has concluded. Now, the focus shifts to demand and the core needs of our customers. When we discussed normalization last year, we were referring to the destocking phase, not the overall market. The markets have remained relatively stable across several segments in recent years. For many of our customers, growth in personal care and coatings has been centered around pricing rather than volume. Recently, we have started to observe an increase in volumes in personal care, which likely reflects consumer spending habits shifting away from hard goods and moving towards other activities that support the personal care sector. We will need to monitor the coatings and construction markets separately as they exhibit different dynamics, but we are optimistic about personal care. Regarding China, we are pleased with its current performance. It seems like there are two distinct environments in China: multinational companies are facing more challenges while local businesses are thriving. Therefore, we need to take a careful look at specific markets and customers.

Thank you.

Thank you. Our next question comes from John McNulty of BMO Capital Markets. Your line is open.

Yes. good morning. Thanks for taking my question. So, Guillermo, in your prepared remarks, you spoke to June having softened and that actually carrying through July. What are the markets that are actually seeing that bit of a downtick? It seems like coating has been a little bit rough to start anyway. So maybe, you can just help us to think about what might be fading a bit?

Yes, if you consider Specialty Additives, coatings are the largest segment we're focusing on. In our prepared remarks, we mentioned expectations compared to the previous year, and we're seeing growth. The market is recovering, and that gives us confidence in production, especially regarding what Kevin mentioned about Q1 and Q2. However, the question is about the growth rate. North America and Europe are performing slightly below our expectations for a stronger recovery, which could change based on interest rates and residential housing trends. In China, we've noticed a significant slowdown. We're assessing the implications of this situation in China, especially with how competitors there may adapt. Those factors are the main concerns we have regarding the downturn. In pharmaceuticals, particularly in Europe, there is destocking, but we’re not receiving direct feedback from customers. Everyone seems to be cautious about their volumes and demand forecasts. Although we are observing a slight improvement in August, we prefer not to overreact at this stage; we believe three points can establish a trend. We anticipate gaining better insight into macroeconomic conditions in the next quarter as elections and actions from the Fed and others unfold across various markets.

Got it. Okay. That makes sense. And then when looking at Personal Care and Specialty Additives, you spoke to at least a little bit of price weakness there. I guess, maybe, two questions on that. Is that primarily a reflection of the raw materials having faded or is there also, I think at least on the Asia part it sounds like maybe a competitive issue as well. But I guess, can you add some color to what's driving that? And then I guess the other question would just be sequentially has the pricing got worse? I know last quarter; you spoke to some pricing degradation across a couple of the businesses. Is it kind of roughly the same as where we were a quarter ago? Has it worsened? I guess how should we be thinking about the trajectory?

I would like to mention that pricing is influenced by two key factors, which you touched on. One factor is deflation, and the other is competitive dynamics. On the deflation side, raw material costs are decreasing, which we anticipated. As prices increase, we aim to maintain our margins. In 2022, when we raised prices, we did not increase margins; we kept them steady and improved our margins through productivity and better product mix. Our current challenge is to continue managing margins in a deflationary environment, and this won't happen all at once. Regarding competitive dynamics, particularly in Asia and China, we are closely monitoring developments as they may be more disruptive. The major shifts occurred earlier in the year, mainly in the second and first quarters. At present, we are still observing a deflationary trend that aligns with raw material prices, although the situation is stabilizing. As mentioned, we will continue to keep an eye on the competitive aspects and provide updates.

Got it, thanks very much for the color.

In the quarter, Johns, for personal care, price and raws were perfectly imbalanced. There was no benefit, no pain. And just to be specific, we have not seen acceleration from a pricing decline perspective. It's basically stayed fairly flat in terms of what we've experienced earlier in the year.

Got it, very helpful. Thank you.

Thank you. Our next question comes from David Begleiter of Deutsche Bank. Your line is open.

Thank you. Good morning. Guillermo, on the VP&D pharma issue, can you actually size that for us? Is it in the $5 million to $10 million range? Is it higher or lower?

Okay. It was probably if you look at versus prior year, in this quarter, it was the biggest delta probably around $14 million versus Q4, our outlay is probably more flattish. So, it was mostly in the in the Q3 in terms of a prior-year comparison.

Very well. And just on that issue, I believe what happened was a competitor had an outage you gained, you picked up business while they were out. They came back on stream. and I guess, they're taking more than their fair share with pricing, even though historically, they're not really a big price competitor, they tend to keep you on value is that, what's happened here? They're just being more aggressive than usual and you're reacting to that? Thank you.

I have two comments. First, regarding the volume loss, it accounts for about a third of the shortfall due to the market offsets; the recovery in Europe hasn't met our expectations. The remaining two-thirds can be attributed to the pricing dynamics you've mentioned. We discussed the competitive situation previously, and we have an old competitor re-entering the market while production has normalized. We must be realistic about keeping them at bay, as the cost of doing so would be too significant. We've been navigating through these challenges. As for pricing, I suggest you direct that question to them in another earnings call, as I can't provide insights on their actions. However, we are observing very aggressive pricing. It's important to note that this involves BASF in Europe, as well as supply issues from China and other regions like Latin America. BASF's absence has opened the door for more competition. We are handling these challenges, but it has been quite aggressive. Different European companies face their own issues; for instance, VP&D isn't a primary driver of their cost structures. Whatever strategies they adopt may have downstream effects on larger commodity companies. In China, we're witnessing similar trends in export markets. As the market leader, we'll manage these dynamics with our customers. We haven't lost customers, but we've experienced a decrease in volume from existing customers. We need to manage pricing effectively. We still retain significant business with the same customers at higher prices. Our relationships remain intact. There are no major problems in the market; it's more about how we position ourselves. From an ERM standpoint in pharmaceuticals, the global supply won't fully shift to sourcing everything from China due to the high risk. We need to proceed cautiously and manage through these transitions. This quarter has been impacted, but it's not an unprecedented situation for us or others to navigate. However, the pricing dynamics have proven a bit more aggressive than anticipated.

Thank you.

Thank you. Our next question comes from Michael Sison of Wells Fargo. Your line is open.

Hey, guys. Good morning. I just wanted to make you understand the VP&D share loss from a guidance perspective. So, I think you said that, the outlook is reduced to 465, 475. A prior outlook was 485 in the midpoint. So, is the share loss, everything else is the same. Costing $10 million to $15 million EBITDA and if you decide not to go after that volume, because of pricing, is that kind of the fundamental lower EBITDA that you'll have to deliver going forward?

Thank you for the question, Mike. There are two main factors to consider. First, we are actively managing the transition by balancing pricing and volume gains, which is reflected in our margins. We are still in a strong position. One aspect contributing to the gap is the loss of market share. The second aspect, which will be more evident in Q4, is the recovery process. We are currently negotiating with customers, gaining share in Asia and parts of Latin America. However, many of these customers have either quarterly or annual contracts. Most of the negotiations are occurring this quarter, with annual contracts likely to be addressed next quarter. Therefore, this quarter, which is our fiscal fourth quarter, and the first quarter of next fiscal year are critical periods for these discussions. We anticipate that volume will start to return in Q1 and Q2 of next year, depending on contract outcomes. Our perspective on timing has also shifted; we initially expected to take certain actions, but pricing has turned out to be more aggressive than we anticipated during our guidance in April. This has altered our calculations. It’s important to note that it's not solely about the loss; we are also adjusting our growth rates. However, we will not be able to recover certain aspects of that loss. Looking ahead to 2025, we need to consider the balance between regaining volume and understanding the associated pricing implications. There are various scenarios we're evaluating, but we can’t discuss specifics at this time due to ongoing negotiations and competitive dynamics.

Got it. And then, I mean, if you do hit your Q4 outlook, and I annualize the third and the fourth quarter EBITDA, the run rate looks pretty good, kind of close to that 5.50 level as you head into 2025. I know it's a little bit early to give us sort of a thought on 25, but maybe, any way you can give us a couple of bridges that might help us understand what the potential EBITDA run rate is for next year and going forward?

Yes. So, Mike, as you look at your model, the two issues to factor in, and I won't give you specific numbers. But it's the VP&D pair and how we manage that. So that's a factor. And we're saying that one's probably going to be net a little bit lower than we what we thought about before. And then the other one is this whole dynamic in China and just the overall market rate of recovery, that could change positive or negative for next year. We're not ready to talk about. Those are the only two things that have changed. And I want to make it very clear. Everything is moving as we thought and as we plan and execute it. We have one big issue. It's clear. It's transparent. We've been talking about it several quarters. It's how we manage the VP&D. We're managing it. You can see it in the margins. There are trade-offs that we make and that's the biggest issue. Everything else other than just macro market dynamics, nothing really has changed from what we said before.

Thank you.

Thank you. Our next question comes from Mike Harrison of Seaport Research Partners. Your line is open.

Hi. good morning. I was hoping, Guillermo, that maybe, you could talk a little bit about what you're seeing on the cellulosic side within life sciences. It sounds like that is performing a little bit better. What's driving the divergence, I guess, between what you're seeing there and what you're seeing on the PVP side?

Mike, thanks for the question. because I think that's an important one to remind everybody. This market is stable. It's growing. It's moving well. So, life science business overall, the market is okay. Our cellulosic business has been growing, it's been stable. I think probably, the growth we would have liked a little bit more especially in Europe, because the market recovery also impacts that a little bit. but it's been net positive overall. We have a very rich portfolio of innovations in Klucel, Benecel that are moving very well. So, I think that part of the portfolio is holding up in very strong position. The issue with in pharma is really about a re-entrance and a rebalancing of supply within an industry that had a lot of change in 2022, and that's what we're working through it. So, it's more of a competitive dynamic than really a market dynamic. as you can see by the difference between cellulosics and VP&D.

All right. And then I was hoping that we could also talk about the portfolio optimization, maybe, just kind of at a high level. How is that optimization progressing within CMC, MC and HEC relative to your expectations? Have you seen any negative impacts or stranded costs that you weren't expecting relative to those initiatives?

They are all progressing well. We communicated the changes, and we have implemented most of the direct changes in the plants on CMC and, to some extent, on the MC, which we announced a bit later. We are continuing to work through some aspects there. Both areas are advancing nicely. We are not leaving the markets; we are ensuring the size aligns with our strategic intent. We want to balance out our production volumes, although these are not the core businesses we intend to grow. Overall, this process is going well. We still have some adjustments to make after the nutraceutical sale to rebalance other costs outside the plant. We are still working on this, but our plans and outlook remain unchanged. It won’t be immediate, but by 2025, the impact on EBITDA from these areas should be neutral. Ideally, we aim to create a positive outcome, allowing us to redirect resources toward more promising activities. I am particularly excited about the CMC assets in Hopewell, which we can now repurpose at much lower capital intensity to support new novel cellulosics. These products are performing well, particularly our starch-based, guar-based, and cellulose products, which require facilities for production. This should be an exciting development, though conversion in 2025 may not be feasible. We will provide more updates as we finalize our plans, which hold significant upside potential and mitigate risks associated with technology development and investment in this area. On another note, we are also addressing the Avoca business, which has significantly decreased since its acquisition in 2017-2018, currently generating about $50 million in revenue but no EBITDA. We are making progress, having shut down one facility related to tolling, which we aim to exit. We are also managing the two larger facilities that produce sclareolide and handle tolling. We expect to make clean improvements and concentrate our efforts effectively. For 2025, I am paying close attention to executing our plans, especially in VP&D and HEC. We are market leaders in these sectors, and we must focus on driving productivity and optimizing our portfolio. We have started some of these efforts in HEC, addressing our communication and portfolio optimization. A similar initiative is underway in VP&D. We are making headway in HEC, but our recent performance did not meet expectations—partly due to the exits we have implemented. We are also investing in completing the HEC expansion and running trials to enhance product productivity. There are numerous activities taking place, all of which look promising, positioning us well for 2025.

Thanks very much.

Thank you. And our next question comes from Jeff Zekauskas of JPMorgan. Your line is open.

Thanks very much. In Specialty Additives and operating income, you were in $22 million in the third quarter and you were in $10 million in the second and your revenues were down $7 million sequentially. Can you just provide a bridge to, so that we can understand the improvement from $10 million to $22 million?

Yes. It's going to be primarily in volume and the way the plants operated during Q3 versus Q2, Jeff. So, we produced more, we had higher absorption, we sold more volume, you have a price cost dynamic in there as well, but it's primarily volume related. If you remember, we've been running slower, because of all the inventory actions and now this year we're starting to pick up as we move forward.

Okay. And in terms of the VP&D issue, so the meaning of the $14 million hit in the Q3 versus your expectations, does that mean that you over-earned by $14 million also in the second quarter in VP&D?

I mean, the share didn't happen overnight on some of the things. So, you got to look at we took pricing actions. I mean, it's not just to defend what we had. Also, there were other puts and takes. So, it's not just, carry it back. I mean, some of these things we talked about actually last quarter about share in VP&D. I think the issue is more the outlook now. It has been more aggressive than we had expected and that's the part that we're taking action on.

I think also, Jeff, just for clarity, the $14 million is a sales number, not an EBITDA number for the quarter.

Oh, it's not an EBITDA. because I thought it was an EBITDA number, because I think earlier, you said your original guide was $470 million to $500 million, and then $465 million to $475 million. And so, when you bridge that, there's a $15 million reduction in the midpoint of EBITDA, and I thought that you guys had described that change to the…

Yes, I believe the $14 million relates more to the third quarter. When considering the entire year, the $15 million decline in EBITDA is not solely due to the pharmaceutical sector, but also because Specialty Additives, although still experiencing growth, is unlikely to grow as much as we initially anticipated. Therefore, the $15 million is a result of these factors affecting each of those businesses.

Okay. Thanks so much.

Sure.

Thank you. Our next question comes from John Roberts of Mizuho. Your line is open.

Thank you. I understand that internal BDO consumption volume has decreased by 14%. The majority of this reduction likely pertains to VP&D, which may be down by more than 14%. Is there another way to gauge this?

The bonds are down. The internal consumption primarily relates to the VP&D business, which serves the pharma sector, but also includes Personal Care and Specialty Additives. While we do have product sales in other areas, pharma represents the largest volume. The actual volumes are influenced by both demand and our inventory management. It's not solely attributable to the 14% sales decline; inventory management plays a significant role. I want to emphasize, as mentioned in the last call, that we identified greater risk on the revenue side compared to the EBITDA side due to manufacturing. However, I want to highlight that we have not increased inventory levels excessively; our inventories are under control. We are focused on managing our balance sheet responsibly. BDO is a significant inventory area for us, and we are handling it with caution.

And then is the only action that you're taking in VP&D price or is there going to be some cost-saving program or rationalization actions as well?

So, I would say there's different things we're doing. Price obviously is one, mix, which products we position to against competitors. We're not trying to match a premium product versus a commodity product. So, we're managing the mix. But as I said, the big area is that we're taking actions on cost, productivity, we're looking across our entire chain around the two plants that we have in Calvert City and Texas City. So, there's a lot of work that's going on there, more to come, but that's a big area. The environments change and we need to take action also in-house to make sure that we strengthen our business as market leaders. We want to make sure that we're in that leadership position both on quality, on reliability, but also on cost.

Thank you.

Thank you. And our next question comes from Josh Spector of UBS. Your line is open.

Yes. hi, good morning. I had a few questions on volumes that I'll kind of combine here in one. So, if I understand your guidance correctly for Q4, I think Kevin said mid-single-digit percent volume growth that obviously includes the headwind from VP&D. I think that excluded the volume exits, but correct me if I'm wrong. So that's 5% or so growth in profit producing volumes. I guess, if we look over the next year, you have a couple quarters of that to go, so maybe no demand growth, your volumes grow 2%, 3% against profit producing volumes. I guess, one, is that a reasonable starting point to think about? And then two, some of these other things that you've talked about over the last couple of years, so specific new capacity investments, you talked about some new wins a couple of years ago. We haven't really seen that. And then two, the new product pipeline you've talked about, do you expect that to be additive on top of that base rate and what we see that next year, or would that take a lot longer to materialize?

Let me make a point before asking Kevin to discuss the volume in the guidance. We haven’t excluded the nutraceutical numbers yet because we aren’t certain about the closing date. We believe it will happen before the year’s end. If we close the deal sooner, we’ll update you and adjust the guidance accordingly. Kevin can address the other questions related to innovation and growth afterward. Regarding our global portfolio, it’s growing at a much faster rate than the rest of our offerings, with significantly higher gross profit margins compared to our average cost structures. We are also focused on optimizing costs and margins and producing locally. This approach allows us to be close to the markets while enhancing service and supply flexibility in the region. These segments represent about 10% of our portfolio, and we aim for double-digit growth at higher margins, and we’re seeing good momentum. On the innovation front, we have launched numerous products, especially in Personal Care, which has seen the majority of our significant innovations in recent years. Encouragingly, some of our recent introductions, like TBO, are gaining traction, and we will showcase this at our Investor Day. Securing registration for personal care products to be sold in China is crucial, as global brands need this to operate effectively. This creates numerous growth opportunities. In Personal Care, we have many launches and even more in the pipeline. The most significant shift for us, both now and looking ahead, is in Specialty Additives. Our innovation portfolio is increasingly focused on core construction, and the team has made considerable pivots. I’m excited about the prospects and discussions we’re having with customers that extend beyond our traditional strengths in rheology, revealing many exciting opportunities that we’ll share with the team. In the pharma sector, the most promising growth dynamics currently are on the cellulosic side, with the new Benecel’s and Klucel’s we’ve launched gaining solid traction. I anticipate these will continue to drive growth over the next two years. Additionally, I’m thrilled about the progress we’re making in injectables. We will discuss our pipeline at Investor Day, and I believe this segment represents a very healthy long-term portfolio with many premier customers collaborating with us, which is very exciting for our business.

And Josh, regarding volume growth, we expect mid-single-digit organic volume growth for Q4 overall, excluding the optimization work. This expectation is reflected in our outlook. Initially, we anticipated a slightly higher growth rate, which is why there was a change in our outlook. Looking ahead to fiscal '25, as Guillermo mentioned, we are not yet ready to discuss specifics. We will provide more details during the Q4 earnings call. To reiterate, for Q1 and Q2, we expect to return to more typical performance compared to fiscal '24. This primarily involves operating our plants at average levels in Q1 and Q2, in contrast to fiscal '24. There is also a volume impact, which may be more noticeable in Q2 than in Q1. So, the return to typical results in Q1 and Q2 stems from running the plants at normal levels and includes an expectation of normalized volume, without anticipating year-over-year growth or market growth. As we approach the Q4 earnings call and begin discussing fiscal '25, we will provide more details, especially regarding the impact of the exits, as there seems to be some confusion about what that will mean for fiscal '25. Our plan is to offer more clarity during the Q4 earnings call to help everyone understand what we expect based on the actions taken in fiscal '24 and their outcomes. So, more information will be available, but this encompasses our current understanding of Q1 and Q2, which is part of the overall reset number we've been discussing.

Okay. Thank you.

Thank you. I'm showing no further questions at this time. I'd like to turn it back to Guillermo Novo for closing remarks.

I want to thank everybody for your participation and interest. Looking forward to connect with all of you. I just want to reiterate although a tough environment in the external, I think, the team has been doing very well on the core things. We have some specific issues that had a big impact. We're working through that. I think it's manageable and it's specific, rather than broad-based. So, we'll be managing and updating you on those activities. But I look forward to also sending you more communication on our Investor Day in December and we look forward to seeing you soon. Thank you so much.

This concludes today's conference call. Thank you for participating and you may now disconnect.