Calumet, Inc. /DE Q3 FY2020 Earnings Call

Thank you all for joining us today for the Q3 2020 Calumet Specialty Products Partners, L.P. Earnings Conference Call. I will now turn it over to Joe Caminiti from Investor Relations. Please proceed.

Thank you, Fellis. Good morning, everyone, and thank you for joining us today for our third quarter earnings results call. With us on today's call are Steve Mawer, CEO; Todd Borgmann, interim CFO; Bruce Fleming, EVP of Strategy and Growth; and Scott Obermeier, EVP of Commercial. Before we proceed, allow me to remind everyone that during the course of this call, we may provide various forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Such statements are based on the beliefs of our management as well as assumptions made by them and, in each case, based on information currently available to them. Although our management team believes that the expectations reflected in such forward-looking statements are reasonable, neither the partnership, its general partner nor our management can provide any assurances that the expectations will prove to be correct. Please refer to the partnership's press release that was issued this morning as well as our latest filings with the Securities and Exchange Commission for a list of factors that may affect our actual results and could cause them to differ from our forward-looking statements made on this call. As a reminder, you may now download a PDF of the presentation slides that will accompany the remarks made on today's conference call as indicated in the press release we issued earlier today. You may access these slides in the Investor Relations section of our website at www.calumetspecialty.com. Also, a webcast replay of this call will also be available on our site within a few hours, and you can contact Alpha IR Group for Investor Relations support at (312) 445-2870. With that, I'll pass the call to Steve. Steve?

Thanks, Joe. Good morning, everybody, and thank you for joining us. First of all, I'd like to recognize the efforts of our employees in the third quarter. For all of us, the pandemic has progressed from what was an adrenaline-fueled leap into the unknown during the second quarter to the reality of an ongoing extended campaign. Our team transitioned well, learning to adapt to this new way of working while keeping ourselves and our colleagues safe. The most crucial measures in this business are environmental and safety performance, and I'm pleased to say that we're tracking materially ahead of 2019. This shows that we're keeping our eyes on what really matters and is a testament to the commitment and focus of my colleagues at Calumet. So thank you, team. Thank you very much. We'll start our presentation on Slide 3. Overall, the message of the third quarter is one of recovery, led by the resilience of the U.S. consumer, together with a rebound in the industrial sector. This resilience allowed Calumet to deliver great results in our core specialty business, which was topped off with a record year-to-date performance from our finished lubes and chemicals unit. Overall, July was the bottom for Calumet, and the months since then have shown steady improvement. We're very pleased with our specialty results, with the segment's adjusted EBITDA so far trending ahead of the pre-pandemic 2019. As we've discussed before, this year-over-year outperformance has been led by strength across all of our consumer-facing products and brands. Separately, our more industrial-facing specialty products and brands showed a marked recovery in demand across the third quarter. While some end markets and products still show the impacts of lower demand, total specialty sales volumes are at 90% of last year's levels. And encouragingly, the September month saw industrial volumes return to where they were in September 2019. The recovery in volumes has allowed us to resume our lean supply chain and apply our philosophy of running the business with less inventory, which is conducive to improving margin performance. At an industry level, we believe that the tightness we're seeing across several specialty markets comes from a combination of strengthening demand, restocking post-lockdown, and disruptions from an exceptionally active hurricane season. These factors explain why, as of today, we haven't yet observed the typical signs of the historical seasonal slowdown that we tend to see in our specialties businesses. It could still come, but there are indications that the overall uniqueness of this year has somewhat altered typical seasonal patterns. The fuels market is, of course, grinding along near the bottom of its business cycle. And like everyone else in the refining business, we're focused on what we can control. In the case of Calumet, this focus has been led by deliver actions, specifically maximizing value from our local niche markets, bringing 2021 turnaround work forward into 2020, better spreading our system-wide workload and leveling multi-year spending. And also, we continue to aggressively reoptimize our run rates and yields as the markets evolve. Furthermore, in 2020, we ran a hedge book, which was proportionately larger than many in our industry. Given the tough fuels environment, many have commented that if one is to be in refining right now, then the two best places to be are in the Northern Rockies or to focus on specialties and chemicals, and we are fortunate enough to be both with our assets in Montana and Northwest Louisiana, and we'll take you deeper into our Northwest Louisiana complex later in the presentation. Taking you back to late in the first quarter and the start of the lockdown, Calumet stepped into the unknown of a pandemic and a global economic collapse, carrying a debt load that is relatively high for our industry. As such, it was immediately clear that our financial objective was going to be to get through this pandemic without burning excessive amounts of cash. Extreme disruption and down cycles tend to take out the most leveraged competitor, and we were and are determined that it would not be Calumet. Decisive actions were taken in order to see that challenge through to reality. We reduced our capital budget for the year by 35%, immediately accelerated our planned SG&A reduction strategy, reducing those costs by approximately 20% versus last year, and we removed $30 million of fixed operating costs. We reset yields and inventories for the new operating environment, and finally, in a very short order, we significantly added to our hedge book. Throughout this period of decisive action and throughout this year, we've operated with the foundational thinking that we would not compromise on safe and reliable operations. The net consequence of these decisive actions by the team is that we end the third quarter far from burning cash, but rather cash positive so far this year, which is a good place to be and an extremely credible achievement by our team. So with that, I'll now turn the call over to Todd, who will give you a more detailed look at our financial results for the quarter. Todd?

Thank you, Steve. Let's turn to Slide 4, where we provide third quarter highlights. Calumet generated $25.4 million of adjusted EBITDA in the third quarter. Our core specialty segment produced $56 million, and our fuels business generated negative $13.5 million. Year-to-date, our specialty segment has generated nearly $177 million of adjusted EBITDA, and as Steve mentioned, this business is trending ahead of 2019 levels through the first three quarters of the year. We finished the quarter with cash of $109 million and total available liquidity of $269 million, both figures improving from the prior quarter. Since early in the pandemic, we've focused on ensuring cash flow neutrality, and in the third quarter, Calumet generated $15 million of cash flow from operations and $8 million of free cash flow. We're also encouraged by recent trends we've seen in the credit markets, which indicate investors recognize the value of our specialty business and its ability to succeed even in the most challenging of environments. As you know, improving margins in our specialty business has been a strategic priority over the last two years. Specialty gross profit was $38.32 a barrel in Q3, while specialty adjusted EBITDA margin was 19.9%. These results are due largely to our diverse product offering, management of the volume margin dynamic, and brand recognition in both consumer-facing and industrial markets as quarter-over-quarter specialty gross profit grew, despite crude prices increasing 47% from the second to third quarter. On Slide 5, we provide a bridge to our consolidated adjusted EBITDA totals versus this year's second quarter. An important development in the quarter was the return of industrial volumes. As this occurs, margins on a per barrel basis shrink due to the mix effect, but we are encouraged by the volume increase as total profit will benefit. Slide 6 compares our year-to-date adjusted EBITDA to the same time frame last year. In total, we have a $62 million bridge, of which $116.7 million is the negative impact of fuel margins, fuel volumes, and rents. On the contrary, the combination of specialty margins, volumes, and transportation led to a $4.2 million improvement versus the same time period last year. Lastly, controllable operating costs and SG&A reductions represent a $45.6 million improvement compared to 2019. To reiterate, on an annualized basis, our SG&A expense is $36 million less than 2019. We don't take this lightly, and we are extremely proud of our employees for their bold and proactive response during this pandemic. Let's turn to Slide 7. Third quarter specialty EBITDA of $56 million was a $4.4 million or 8.5% improvement to last year's third quarter. The business continued to demonstrate margin expansion, up 540 basis points compared to the same period last year. This was fueled by consistent growth in our consumer-facing brands and good recovery in our industrial brands. The Finished Lubricants and Chemicals segment, including TruFuel, Royal Purple, and Bel-Ray continued its record pace. The Penreco business has also performed well as food grade and pharmaceutical demand has been robust. And the Paralogics wax business is integrating well and outperforming expectations. Our sales team has been effective managing volumes and margins throughout the pandemic and the laser focus on product placement and industry diversification will continue as industrial demand returns to normal. Slide 8 details the quarterly results in our fuel segment. Third quarter adjusted EBITDA of negative $13.5 million was down compared to both the prior year and the sequential quarter, driven largely by the compression in crack spreads. We continue to benefit from our geographic advantages in this business with a focus on what we can control. For example, this quarter, the fuel business achieved record volumes of rack sales into our local markets, which is an advantage we intend to continue benefiting from when markets recover. Turning to Slide 9. We bridge the sources and uses of cash year-to-date. You can see that our cash position has improved from the $19.1 million, where we began the year. Most importantly, we've produced $53.5 million of cash flow from operations year-to-date. Working capital management and CapEx discipline also contributed to the generation of $30.1 million of year-to-date free cash flow, which led to finishing the quarter with $109.4 million of cash on hand. On Slide 10, we provide a snapshot of our credit metrics. With $109 million of cash I just mentioned, we finished the quarter with over $269 million of total liquidity, up $20 million versus this year's second quarter. We continue to operate the day-to-day business with a focus on cash flows, while leverage reduction and balance sheet improvement remain key components of our overall strategy. With that, I'll turn the call back to Steve.

Thank you, Todd. Let's go to Slide 11. In last quarter's call, we reviewed two focus items: one covering our TruFuel business, and another covering how our specialties margin versus volume envelope has been performing through the pandemic. The deeper dive received a lot of appreciative investor feedback, and so our intent is to continue sharing in order to further help you understand what we are up to and our story. So for today's call, given the recovery in industrials, we thought it might be good to spend a couple of minutes on our interconnected complex facilities in Northwest Louisiana. Calumet's interconnected specialty product sites at Shreveport, Princeton, and Cotton Valley are collectively the largest high-yield specialty petroleum product complex in the U.S. Cotton Valley's focus is the production of solvent, marketed under our Consol and Magiesol brands. Princeton is on a naphthenic base oil production facility, and that includes such industry-known brands as CALTRAN electrical oils and HYDROCAL process oils. Shreveport, our largest Louisiana facility, serves three distinct roles for us: first, Shreveport is focused on paraffinic base oils, particularly our CALPAR brand, which is sold into a variety of industrial specialty applications, together with Orchex, which is our branded agricultural spray oil. Shreveport is also at the heart of our rapidly growing wax business, most well-known through our Titan brand, which is sold into the candle industry. The second role Shreveport plays is, it's the flywheel around which these other sites exchange intermediates for optimization value. And third, Shreveport is a feedstock platform for other Calumet businesses further downstream, which includes our businesses in white oils, blended and formulated waxes, petrol items, and specialty gels, all manufactured at other Calumet locations. The strength of our interconnected Louisiana sites, coupled with Shreveport's extended reach further downstream into other Calumet businesses, provides the operating flexibility to deliver stable performance and growing specialty segment results even in 2020. What brings these facilities together other than their geographical proximity is that collectively, we have an extremely flexible asset base focused on custom distillation, hydro treating across the entire pressure envelope, together with catalytic and solvent extraction, most particularly in dewaxing. Within the specialty petroleum product business, this gives us real scale and flexibility, and we continuously work on how to optimize this unique set of flexible assets. So now on to our outlook on Slide 12. U.S. consumer data remains remarkably good, and as long as that holds up, it is our expectation that our positive trajectory on consumer-facing specialty should hold. Our industrial brands appear to be well into recovery mode. Inventories and supply chains are in a good position, and the seasonal slowdown that we often see is not yet upon us. Fuels is currently near the bottom of its business cycle, and we will continue to focus on controllable actions. Our decisive actions on costs, marketing strategies, and hedging have got us this far through the pandemic without cash burn and have helped Calumet in a good position to emerge strongly once the business cycle turns. And with that, I'd like to turn the call over to the operator to open up the line for Q&A. Operator?

Your first question comes from the line of Neil Mehta with Goldman Sachs.

We do appreciate that incremental color that you provided around Shreveport here. Look, the first question that I have is around lubricants business and of course, we don't enter the world of speculation here, but there were press reports about the potential to monetize, it sounds, your assets for a certain amount of money. Just your thoughts on the lubricants business? How core is it and the potential for monetization to try to unlock value that might not be reflected in the unit price right now?

Great. Neil, it's Steve. As you know, I mean the lubricants and chemicals business has really taken COVID in its stride. It's powered through it, set a year-to-date record, and we believe that the future growth potential of all the brands inside this business is substantial. As responsible stewards of the business, management and the Board continuously review what the value of any product of Calumet is to us. And I think as it would be for any company, Neil, that valuation is a synthesis of cash flows, growth potential, and strategic importance. It's clear from market reaction commentary that people understand this hypothetical situation will potentially change our leverage and debt quantum significantly. And I think, right now, given it's highly speculative, as you hit on, I really can't comment further on speculation beyond that.

Yes. No, very clear. I'm sure there'll be other questions around this today. The follow-up I have is around Great Falls. And it is a good asset in the sense that it runs a lot of WCS, which is a differentiated crude grade right now. Results came in a little softer than I think what most investors were expecting out of that asset. Can you just talk about anything that could have been unusual or one-time? Or if it was just a function of the product and crude environment? And then how do you think about minimizing losses from the fuels business as you go into 2021 at the forward curve? What levers do you have before WCS prices start to widen back out over time?

Neil, this is Bruce. Of course, we're reporting Great Falls and Shreveport fuels together. So I would not want you to leap to a conclusion about either facility, but in aggregate, over the summer, we have had a softer fuels environment for everybody than last year. Great Falls is incrementally affected by that, as you noted. And the WCS business is actually a key contributor to the gross margin environment up there, and of course, it's been narrower, which is adverse. So with all the obvious points being made, that is a good part of the country to be a refiner, and I think the proof of that is that the facility has run full on a volume basis throughout this pandemic.

As we enter 2021, what strategies do you have in place to reduce losses while navigating through the pandemic?

Well, I think the operational levers are the same for us as everybody work pretty nimble, given our two positions on reoptimizing and tracking closely matching output from the facilities to the local market demands and customer demands. It's been very volatile for everybody, but I think we've hung in there pretty well. I'll tell you, most of what you're seeing is the $64.5 million hit from RIN prices skyrocketing in this year as opposed to a fundamental change in our operational competencies.

Your next question comes from the line of Roger Read with Wells Fargo.

Okay. It seems like things are definitely improving in the specialty area, and this appears to be largely driven by volume. I am curious about your pricing strategies, especially considering the significant volatility in crude prices earlier this year, which has stabilized somewhat since midyear. How has this impacted your pricing? Additionally, with the recovery observed across various sectors and the reduction of inventories, there's been a sudden surge in demand. Have you been able to capture any additional margin from addressing the just-in-time issues that have arisen? I realize this might touch on mix, but I’m interested to know if any of this has been reflected in your results.

Roger, Scott here. Let me start and Todd can add if necessary. In terms of the product mix and profit per barrel, as noted in the presentation, we achieved over $38 a barrel. During the quarter, as volume increased, particularly driven by industrials, the margin per barrel returned closer to normalization. For perspective, even two years ago, we were about $10 a barrel lower. So achieving over $38 a barrel represents a solid margin. As we enter Q4, inventories are still relatively low, and there are factors like lower refining rates and hurricane impacts to consider. Overall, the supply-demand balance and the supply chain dynamics in the market remain quite strong.

Yes, I appreciate that. You made several adjustments by reducing low margin or low-priced product offerings to enhance the margin. When I compare the high 30s to the previous high 20s, I'm unsure whether this reflects changes you've implemented or actual market shifts. That's the essence of my question.

Yes, this is Todd. I can add to that because, as you mentioned, crude prices have fluctuated significantly. When comparing Q2 to Q3, we observed a 47% rise in crude prices while margins remained stable as industrial demand rebounded. This indicates the strength of the market and the resilience of consumers. We believe this isn't merely a temporary spike in crude; the specialty markets are performing well right now.

Yes, this is Roger. If I could add to Todd, I have a couple of observations to provide you with more insight into our perspective. First, we recently experienced a significant sell-off in the crude market, yet we did not see price reductions in any of the specialty products from any vendors. This indicates a general perception that supply chains are tight. Moreover, one of the most telling signs of these tight supply chains is the ongoing challenge of securing trucks and drivers, which highlights just how constrained the situation is currently.

Okay. Good. That kind of dovetails from what we've been hearing. And then I guess my completely unrelated follow-up question for you, Todd. Obviously, the company has come through what's been a brutal year for most companies we cover on the cash flow side, you all come through, I'll just say, strong. What, if anything, do we need to look at into the, I'll say, the end of this year or the beginning of next, in terms of expectations on cash flow or cash management? And then is there any potential as an MLP for Calumet to participate under the CARES Act in terms of any tax recoveries? I mean, I know it's generally speaking not a tax business, but I just didn't know if there was anything wrinkling the tax laws or something like that, that could benefit the company.

Sure, thanks, Roger. Regarding what to expect for the remainder of 2020, the situation is quite uncertain, so I am hesitant to predict too far ahead. Our goal remains to maintain cash flow neutrality in 2020, and we are committed to that. What I can share is that so far, as we enter the fourth quarter, we are seeing consistent trends in our specialty sector. The industrial sector continues to perform well, and consumer-facing segments remain strong. We have no reason to believe that this relative strength will change. However, it’s worth noting that we typically experience seasonality effects in the fourth quarter, especially in our industrial brands. That said, we have not observed those effects yet. Overall, things are looking positive, but we will keep an eye out for any changes.

Your next question comes from the line of Jason Gabelman with Cowen.

I wanted to first ask about your long-term plans. The next notes due are $150 million in a couple of years, so how do you plan to address that? Additionally, what is your long-term vision for debt-to-EBITDA levels? Do you believe you can achieve those targets organically, or do you think there might need to be some inorganic strategies? Related to that, there have been many questions about the finished lubes segment of the business. You previously mentioned Great Falls as noncore, yet it appears you will retain it for now due to challenges in executing refining deals. Are there any parts of the specialty segment that you consider less core compared to other areas of the business?

Thanks, Jason. This is Todd. Let me take the first part of your question, if that's all right, on the kind of the upcoming debt, and then I'll turn it over to Steve to talk a little bit more about some of the longer-term questions you mentioned. So as far as the 2022, remember, we did the exchange in Q2, so we're just left with $150 million maturing in 2022. We think that's a very manageable amount, and we have some flexibility. So we just talked about, we got $269 million of liquidity. It's the cheapest debt we have at the moment. We've been generating cash. So we're willing and comfortable to go current as we kind of give ourselves some time to optimize our options. So I guess that would be hopefully part of one of your questions. And then, Steve, do you want to speak a little bit to sort of the longer term?

Yes. Regarding deleveraging, I hope my response isn't taken too lightly. Let me use a golfing analogy. I can express a desire to be a skilled golfer instead of aiming to be a scratch golfer. Thus, I won't set an aspirational target in that regard, but it's clear that Management and the Board are looking at our cost of capital and believe that a mix of deleveraging and clarifying our business model is the way forward. If we reflect back to January and February, there was a clear organic growth path, but currently, that path seems less evident. We are carefully considering how to lower our cost of capital by addressing these two factors. So I hope that kind of covers the second one. And then on the third one, you'll have to refresh me.

I wanted to follow up on the previous question regarding Great Falls, which you described as historically noncore. Are there any areas within the specialties business that you view as not exactly noncore but perhaps less central compared to other segments of the business, particularly in relation to the finished lubes segment?

Yes. Yes, this may not be a very satisfying answer. I mean, we like, I think, pretty much everything we're doing in specialties. We like everything we look at has got some difference in growth opportunity, but we see growth opportunities across all of it. So I just kind of maybe pivot back to what I said earlier and then hand over to Bruce to get his take, which is whenever we look at valuation, it's obviously going to be some synthesis of cash flows, growth potential, and strategic importance. And that strategic importance is a kind of tactical overlay, but I think all of it is particularly has a relative degree of strategic importance. Bruce, you want to add?

Sure. Steve, this is Bruce. I might give a little more context around this. So first of all, the general structure of the company isolates each of our assets legally. We isolate them for P&L purposes internally. We roll that up, obviously, to a high level when we report, but we have the ability to have a very clear look at how the businesses perform. And part of that is we've got absolute arms-length separation if there are molecules moving back and forth. Now the speculative interest in finished lubes is probably getting a little overheated here. But if you want to keep thinking about it as a separable component, everything we've got is separable in that way. Think of it as virtual integration, not physical, and I think you'll be on the right track.

Got it. So it's strategically aligned and integrated. What would be the steps to separate it? Is there anything that's difficult, or is it fairly simple to do?

Gregg, this is Bruce. I might give a little more context around this. So first of all, the general structure of the company isolates each of our assets legally. We isolate them for P&L purposes internally. We roll that up, obviously, to a high level when we report, but we have the ability to have a very clear look at how the businesses perform. And part of that is we've got absolute arms-length separation if there are molecules moving back and forth. Now the speculative interest in finished lubes is probably getting a little overheated here. But if you want to keep thinking about it as a separable component, everything we've got is separable in that way. Think of it as virtual integration, not physical, and I think you'll be on the right track. If I could just add a technical accounting comment, that the numbers, the volume like-on-like we're giving you is pro forma because in '19, we had a processing deal. So if you want to forensically attack the Q, you need to get that in mind.

Got it. And then just last question for me. Actually, maybe I have two more. First one I'll say is RINs headwinds. How should we think about that on a steady state impacting your refining business, if we stay around here for this quarter and thereafter?

Well, we accrue against the shortfall. The system operation blends as much ethanol as we can. We like the blending ethanol. We wish we could do more, but I'll leave you at short. I would not want you to think that we have any insights on where that market is headed. RINs, prices and markets are just absolute chaos, strongly reactive to political or policy developments. So all I can tell you is that we're waiting for the RFS reform like the rest of the world.

Got it. No, I appreciate that. And just a last one for you. So you talked about the substantial SG&A savings you've had this year. Is it your sense that that's sustainable at those levels? Does it need to go up if there is a recovery? Does it kind of go down further?

Yes. No, Gregg, this is Todd. We think mostly, it's sustainable. There's been some kind of structural changes made in the business as far as outside contract services, headcount, those types of things that are sustainable. Naturally, as travel comes back and as we hit the road more and things like that, we'll see a little bit of regression. But I'd say, for the most part, we've made the step change in SG&A, and we expect to keep the majority of it.

Your next question comes from the line of Jason Gabelman with Cowen.

Joe, you want me to wrap?

Go ahead, Steve. It's your call.

Thank you. Okay. Well, again, I appreciate everybody being on the call. I would point out, I was talking about golf earlier, and I can assure you no one at Calumet has time to play golf these days. We're working hard on getting through the pandemic. I want to thank you all again for your interest in Calumet. The team has executed at a high level throughout 2020 in the face of significant challenges and uncertainty. We've taken proactive actions to both protect the business and to position it for long-term success. I'm extremely proud of everybody at Calumet and look forward to seeing what we can do in 2021. I appreciate your time. Have a great day and a good weekend. Thank you.

Ladies and gentlemen, that does conclude today's conference call. You may now disconnect. Thank you for your participating.