Ecovyst Inc. Q1 FY2022 Earnings Call

Good morning. My name is Catherine, and I will be your conference operator today. Welcome to the Ecovyst First Quarter 2022 Earnings Call and Webcast. Please note today's call is being recorded and should run approximately one hour. Currently, all participants have been placed in a listen-only mode to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. I would now like to hand the conference over to Mike Feehan, Chief Financial Officer. Please go ahead.

Thank you, Catherine. Welcome, everyone, and thank you for joining us for our first quarter 2022 earnings call. I would first like to introduce Kurt Bitting, our new CEO, who will be joining me today. In addition, Tom Schneberger, our new President of Ecovyst, will also be joining us and available during our Q&A session should any questions need to be directed his way. We will start today with formal remarks, then followed by a Q&A session. Please note that some of the information shared today is forward-looking information, including information about the Company's financial and operating performance, strategies, our anticipated end-use demand trends and our 2022 financial outlook. This information is subject to risks and uncertainties that could cause the actual results and the implementation of the Company's plans to vary materially. Any forward-looking information shared today speaks only as of this date. These risks are discussed in the Company's filings with the SEC. Reconciliations of non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures can be found in our earnings release and presentation materials posted on the Investors section of our website at www.ecovyst.com. Now I'd like to turn the call over to Kurt.

Thank you, Mike, and thank you to everyone joining us today. First, I'd like to say how excited I am to be taking the reins as CEO of Ecovyst. I have been with the Ecoservices business for more than 15 years, serving in several capacities, most recently as President of the business, but I have never been more confident in the growth potential of this company than I am today. Ecovyst provides products and services critical for the production of clean fuels, polymers and the growing technologies that will aid in decarbonization efforts. We are uniquely positioned to play an important role in the green energy transition and to help our customers achieve their own sustainability goals. As you have seen in today's press release, the Ecovyst Board has decided to make a leadership change to accelerate the growth of the Company. This includes my promotion to Chief Executive Officer and the promotion of Tom Schneberger to President. In addition, Kevin Fogarty has joined the Board as a Nonexecutive Chairman. We are happy to welcome Kevin to the team, and we are fortunate to be able to draw on his vast experience in the chemical industry following his retirement from Kraton. I also want to thank Belgacem Chariag for his past three years of leadership. The year has kicked off on a positive note. The end markets we supply have demonstrated resilience and growth during this period of inflation and geopolitical conflict. As you know, we are a critical supplier for the production of transportation fuels and many industrial applications. But we are also uniquely positioned to support sustainability trends. In fact, we provide critical materials and services that support sustainability enabling technologies, including sulfuric acid supply into mining for metals and minerals production essential to electrification as well as catalysts and activation services used for renewable fuels production. I am very proud of the Ecovyst team's ability to deliver strong sales and adjusted EBITDA this quarter, following closely on the heels of our stellar financial performance in 2021. The confidence we have in our growth momentum gives us the flexibility to continue to pursue accretive bolt-on acquisitions similar to the addition of Chem32, while returning value to our shareholders through the share buyback program we have announced. Mike will elaborate on our capital allocation strategy in a few minutes. I would like to highlight several key financial, operational and safety metrics that we track closely. Our strong performance this quarter on all fronts is a testament to the team as well as the key strategic partners that we have built, our long-term customer contracts for critical products and services, and our robust production and logistical operations that allow us to reliably deliver our solutions to our valuable customers. We continue to outpace industry growth rates and peers as evidenced in our Q1 2022 results, with year-over-year gains of 34% in sales, 40% growth in adjusted EBITDA and a strong 74% cash conversion ratio. Profitability also increased amid inflationary pressures as we were able to pass through rising raw material, freight and energy costs to customers. The growth trends of our products are expected to continue through the remainder of the year and into 2023. With the need for sustainable solutions front of mind for many investors, customers and employees, we continue to invest in technology that supports and advances these trends, with 85% of our research and development focused on sustainable solutions. We value the health and safety of our colleagues above all else. Our safety record has shown consistent improvement year-over-year, but our work in this area is not complete, and we remain committed to continuous safety improvement. There is a lot of concern around the current inflationary and geopolitical environment. I want to take a moment to highlight how well Ecovyst is performing through this period of volatility. First, Ecovyst has had success in more than offsetting the inflationary pressures in raw materials and transportation as a result of contractual cost pass-throughs and price increases to our customers. From a demand standpoint, many of our customers are located in the U.S., particularly on the Gulf Coast, and their advantage to access to energy and raw materials has allowed them to benefit from a strong global pool for their refined products and petrochemicals, which rely on supply from eco services and catalyst technologies. And finally, because of order timing and transportation issues, primarily in catalyst technologies, we have built up an order backlog that we will fulfill in the coming months, which gives us confidence for the remainder of the year. Moving to a discussion of our industry demand drivers. I would, again, like to highlight that Ecovyst supplies numerous customer segments that have proven critical in today's geopolitical environment, including clean fuels, industrial and polymers. This alignment, along with our support of sustainable technologies, has enabled us to deliver strong results. The recent geopolitical events have created the strong need for exports of additional refined products from the U.S. The return of U.S. gasoline demand, coupled with the global demand for U.S. gasoline exports, has led to healthy refining margins and increased refinery utilization in the U.S., which is projected to increase by 5% in 2022. This has continued to benefit regeneration, which supports alkylation, one of the highest value processes in a refinery. On the industrial side, we see strong sentiment continuing for the materials that are used in the automotive industry, such as lightweight vehicle parts, fuel-efficient, low-rolling resistance tires and lead acid batteries. Mining sector growth remained strong as the supply of metals and minerals is critical for the production of electric vehicles and green energy infrastructure such as solar and wind. Renewable fuels demand continues to grow in the high double digits year-on-year as government policies push to reduce emissions in heavy-duty transport and aviation fuel. As a reminder, the expanding production of renewable fuels benefits both catalyst technologies and our Chem32 catalyst activation business because renewable catalysts generally require more frequent catalyst bed change-outs. We are well prepared to handle increasing customer needs in the coming quarters as the renewable sector continues to expand. Polyethylene continues to play an expanding role for Ecovyst as well as the global economy. We had strong growth through the pandemic. With the current geopolitical uncertainties, demand for polyethylene remains strong, similar to what we experienced during the pandemic. In traditional fuels, where hydrocracking units are operating at high production rates, our sales of HCC catalyst materials increased by more than 90% versus the prior year. The strong refinery utilization also resulted in orders placed for niche custom catalysts in line with our expectations. Our development of novel catalysts for sustainable solutions continues to progress, with the receipt of orders for manufacturing trial quantities of catalysts for novel biomaterials. Our exposure to both established and developing segments of our customer base gives us confidence in our growth momentum through 2030. Transitioning to sustainability. On our previous quarterly call, we talked about our sustainable solutions in three key areas: clean air by reducing sulfur and nitrogen oxide emissions in heavy-duty transport; plastic circularity, enabling the reuse of lightweight durable plastics; and renewables to transform biomass into fuel and other materials. The pool for our renewable solutions is strong. In fact, our sales to renewable fuels tripled in 2021 and represent more than 10% of sales at our Catalyst Technologies business. We expect further growth in 2022. We will continue to partner with our customers in providing innovative solutions to industry problems that will transform our world in the coming decades. I will now turn the call over to Mike for a review of our Q1 2022 results.

Thank you, Kurt. As mentioned during our fourth quarter earnings call in late February, we expected the strong sales and adjusted EBITDA growth that we experienced in 2021 to continue into the first quarter. Today, I'm pleased to report that we delivered in line with those expectations. During the quarter, total sales, including our 50% share of ZI, increased 34% year-over-year, with adjusted EBITDA increasing by 40%. Demand for regeneration services and virgin sulfuric acid in our Ecoservices business led the way, along with strong demand for polyethylene catalysts in our Catalyst Technologies segment. We continue to implement price increases, which more than offset higher variable costs such as sulfur, natural gas and freight, allowing strong earnings growth to continue despite cost pressures. Adjusted EBITDA margins increased 120 basis points to 28.4%. Moving to the next slide, we'll take a look at the key components of our earnings growth in the quarter. Adjusted EBITDA increased $17 million to $59 million on two key drivers. First, strong demand in various product lines led to higher volumes. Second, our business fundamentals have allowed us to raise prices to offset the impact of inflation on input costs, creating a positive price to cost dynamic. In Ecoservices, changes in sulfur costs are passed through in price on a dollar-for-dollar basis. As other costs change, including labor, natural gas and freight, contractual index provisions offer price protection, further shielding this against inflation. Moving to our Ecoservices results. Sales increased $54 million, or 54%, driven by higher regeneration services and virgin sulfuric acid volume and increased pricing to cover higher input costs, including the pass-through of $21 million of higher sulfur costs. Adjusted EBITDA increased $16 million, or 50%, on the drop-through of favorable pricing and higher volume as well as the impact from the Chem32 acquisition. Earnings growth of 50% in this segment was exceptionally strong. However, margins were negatively impacted by 510 basis points related to the pass-through of higher sulfur costs. Adjusting for the impact of the higher sulfur cost pass-throughs, adjusted EBITDA margins for Ecoservices would have been just over 37%. In our Catalyst Technologies business, silica catalyst sales were down slightly, while sales in our Zeolyst joint venture were flat with the prior year. While demand for polyethylene catalysts continues to remain strong, we experienced delayed shipments and an impact from the timing of niche custom catalyst sales. Within the Zeolyst joint venture, sales growth in both hydrocracking catalyst and niche custom catalysts were offset by order timing within the year for our pressure product catalysts. Adjusted EBITDA of $17 million decreased $1.5 million with reduced margins on lower volumes due to order timing and shipping delays and higher production costs. Given the strong demand environment across our key markets, we expect improved performance in the second quarter. On this next slide, we are reiterating our guidance for nearly all of our metrics as we continue to benefit from the strong growth momentum experienced by our key demand drivers. With the recent spike in sulfur costs, we're increasing our GAAP sales guidance by $80 million from a range of $730 million to $750 million to a range of $810 million to $830 million. This leads to our expectation that sulfur costs will be higher by approximately $140 million year-over-year. As a reminder, this contractual pass-through of higher sulfur costs does not impact our adjusted EBITDA, but would have a negative impact on adjusted EBITDA margins. We are reiterating our adjusted EBITDA guidance, which is expected to be up 16% at the midpoint of our range compared to the prior year, and our adjusted free cash flow expected to improve 30% year-over-year. With respect to the second quarter of 2022, we anticipate continued sales and adjusted EBITDA growth in both businesses. Earnings are expected to be up compared to the prior year and the first quarter of 2022, but slightly lower than the fourth quarter of 2021 in both businesses. On the top line, Ecoservices sales in the second quarter are expected to continue to increase related to the pass-through of higher estimated sulfur costs and other input costs. Shifting to our financial position. Ecovyst's strong cash generation continues to drive the reduction in leverage and increase in available liquidity. Since the recent sale of our Performance Chemicals segment in August of 2021, we have reduced our leverage by more than half a turn and are now just above 3x. During the same time frame, available liquidity, which we define as cash on hand plus the availability under our revolving credit facility, has increased 24% to more than $200 million. This strong financial position allows us the flexibility to provide our updated capital allocation strategy on the next slide. With our strong cash generation and lower leverage position, Ecovyst is positioned to increase shareholder value through return of capital and opportunistic bolt-on acquisitions. We will continue to use cash from operations to support organic growth initiatives, then look for opportunities to target accretive and strategic M&A with a focus on sustainable technologies, aligning our goals to create a more sustainable future. This flexibility allows the Company to return capital to shareholders, including negotiated transactions with our sponsors, while keeping our leverage level in an appropriate range. We expect to use our available cash on hand and free cash flow generated from operations to fund the program. This strategy represents an attractive use of our cash as part of our balanced approach to capital allocation. With that, I'll turn the call back to Kurt for some closing remarks.

Thanks, Mike. In summary, our business has delivered great results in the first quarter. We have long-term customer contracts that help to protect against inflation. Our North American customer base appears to be well positioned to manage through the current geopolitical situation. And we have the demonstrated ability to generate strong cash flow. This, along with a strong balance sheet, gives us the confidence in our new capital allocation strategy, including our newly approved stock buyback program, which we believe will increase shareholder value. We expect to have a strong second quarter and keep the positive momentum for the rest of the year. I'd like to reiterate that I am truly honored to be taking on the CEO role at Ecovyst at such an exciting time for the Company. I also want to take the opportunity to thank all of our dedicated Ecovyst employees who deliver these outstanding results. They are intently focused on continuing to serve our long-term customers as well as developing the solutions that will enable low-carbon technologies and green infrastructure in the future. In the coming weeks and months, I look forward to hitting the road to meet many of you who are on this call. Thank you for your time and interest in our great company. This concludes our prepared remarks, and we will now open it up for Q&A.

We'll take our first question today from John McNulty with BMO Capital Markets.

Congratulations on the new role, Kurt. So I guess my first question really is to that. I think, look, it's great to see you kind of in the seat at this point. I guess when you think about what changes you may bring as a leader to Ecovyst, I guess how should we be thinking about what those might be? Is it more of a capital allocation change or a shift in direction? Is it strategic in some of the businesses? I guess, how would you characterize it?

Thank you, John. As President of Ecoservices, I have been deeply involved in shaping our current strategic plan. Ecovyst is crucial in the production of clean fuels and sustainable technologies. Our portfolio, technology assets, and our highly skilled team are well-positioned to take advantage of growth in sustainability trends. We will continue to explore our organic opportunities, which are plentiful, in addition to pursuing bolt-on M&A opportunities.

Got it. Fair enough. And then maybe just a question with regard to the capital allocation strategy. I guess can you help us to frame your comfort with leverage and what you think kind of the right leverage level would be given that you have a large buyback program in place, but it's over a four-year period? So I guess, how should we be thinking about leverage levels and the velocity at which you might enact that share repurchase program?

John, it's Mike. I'll answer that one. So great question. And what we were able to do is we have a long-term financial plan where we have a very strong free cash flow profile over the next three to four years. We've been demonstrating over the past several years our ability to generate cash flow. We've reduced our leverage about half a turn every year. Just in the last six months, from the end of the third quarter, we've reduced leverage over 0.5 a turn. We're down at just over three now. So we're starting to get into that sweet spot where we have a lot of flexibility and knowing the cash on hand that we have today, the available liquidity that we have under our credit facility and the ability of free cash flow generation in the future that will be adequate to do a few things. One, first, take any excess cash that we have and reinvest it back in the Company through growth projects. As Kurt mentioned, we do have a pipeline of great organic growth opportunities. Then we'll look to see what do we want to do next, whether it continues with another bolt-on acquisition like a Chem32, something that's accretive or strategic or has the right technology. And then we also have this new buyback program. So we're very comfortable with our plan, our forecast and what we'll be able to do to support this program. I was just saying in the follow-up, that leverage position that you asked, I mean, your base question, we're going to be comfortable with the leverage in the 3s, right? That's where we'll be comfortable with.

Good luck. Congratulations on the new position.

Our next question comes from Aleksey Yefremov with KeyBanc.

Congratulations on new roles for everyone. Just if I may follow up on this buyback question. Is it safe to assume that if you're not making bolt-on acquisitions, the majority of your free cash flow in any given year going forward would be dedicated to buybacks?

Yes, Aleksey, it's Mike. The plan is to focus on our capital allocation strategy. Any initial cash from operations will be reinvested, with the first dollar going into organic growth opportunities. If there aren't any immediate bolt-on acquisitions available, we will consider implementing a buyback program to determine the most effective use of cash. Our goal is to identify the best way to use our funds to enhance shareholder value, and we believe this approach is the most advantageous for us right now.

And just on the results, it sounded like there were some delayed shipments in various areas in Q1. Any thoughts on whether you'll catch up on those in Q2? And if so, what's the approximate size in terms of EBITDA or sales for those shipments?

Yes, Aleksey, it's Mike. We are very pleased with our results, with our EBITDA increasing by 40% year-over-year. We did experience some order timing and shipping delays in the Catalyst business. As mentioned in previous calls, our hydrocracking catalyst can shift between months, and we saw that shift from March to April. All planned shipments are on their way and already sold, meaning we will see a movement of orders from the first quarter into the second quarter. There were shipping delays and supply chain challenges that created an order backlog, but we expect that backlog to resolve over the next few months. We are confident in our plan and are reaffirming our guidance for the full year. We believe that the demand drivers we've seen, which have provided significant support over the past several months and into this year, will help us achieve our goals by year-end.

We'll go next to David Begleiter with Deutsche Bank.

Kurt, congratulations on the new role. Kurt, going back to leverage, if you thought we were heading into a period of slower growth or even a recession, would you look to take down your leverage below 3x?

Yes, this is Mike. Our goal is to bring leverage down below 3x. We are aware that we have a buyback program that will utilize some of that cash over time, and we will aim to maintain leverage in the low 3s.

Thank you for your comments, David. I want to emphasize that our business demonstrates strong consistency, particularly in the cash flows generated over time. We feel confident about the program's flexibility and the ability of our portfolio to sustain that program.

Got it. And Kurt, I think you mentioned maybe that growth has lagged in certain areas of the business. Where has that been, in your view, most pronounced? And what plans do you have to perhaps accelerate that growth going forward?

We're really excited about the growth across all aspects of the business. Some areas, particularly those focused on sustainable technologies and green infrastructure, are likely growing faster than others. Renewable fuels, for instance, have seen significant growth since 2019. We currently have a strong investment in this area with our catalyst technologies making notable advancements, along with our recent investment in Chem32, which specializes in catalyst activation. Additionally, we're involved in other green technologies through our Ecoservices business. The mining sector, in particular, is crucial for the future of green infrastructure, and our market position is excellent due to the locations of our plants and our capacity to serve these customers. The demand for polyethylene continues to grow robustly as well, driven by trends like lightweighting and the use of single-use plastics, which is a positive indicator for polyethylene.

We'll go now to Angel Castillo with Morgan Stanley.

Congratulations on your new role, Kurt. Could you provide us with more insights into what you're observing regarding the strong demand you mentioned in packaging, as well as in MMA and some of the more specialized areas of your Catalyst business? More details would be appreciated.

Yes. I'm going to actually pass that question to Tom Schneberger, who runs our Catalyst Technologies business.

Angel, thanks for the question. In terms of polyethylene, we're seeing polyethylene as a clear choice as the preferred material in packaging and films as we saw even during the COVID downturn consistent mid-single-digit growth overall for polyethylene. Because they're trying to get to circular plastic, polyethylene is being used more so with the intent to recycle. But also we're starting to see recovery as the refineries start to increase rates and the HCC catalyst change-out, as well as niche custom catalyst change-outs start to pick up again as we expected. So we've got good tailwinds, not only in polyethylene, but in some other areas in our business as well.

That's very helpful. I wanted to ask if you could share any insights on logistics or supply chain issues that you've encountered or are currently addressing.

No, we've done a really good job of passing on transportation costs. In many instances, customers are either paying the freight directly or in prepaid and ad-type situations. Therefore, we have a high pass-through rate on transportation, so there are no issues there.

Next question comes from David Silver with CL King.

Congratulations. I have a couple of questions. First, regarding the capital allocation strategy, there's a statement in today's release attributed to Kurt where he mentions support for increasing the float and liquidity of the stock. You also discussed the accelerated buyback program. Could you elaborate on how you balance directing more cash flow towards repurchases while also preserving the significant increase in float and trading liquidity that has been achieved over the past year? How do you strike that balance between these two objectives?

David, it's Mike. So from our strategy with the capital allocation, I mean there are a couple of different mechanisms to use with the buyback program. Our initial usage will probably be geared more towards directed programs in conjunction with our sponsor selling down such that we are not going to reduce the float. It would actually help increase as they do sell downs and we participate. And then down the road, we would have more open market traditional buyback programs that we would decide whether that's the optimal use of cash at the time given all the market dynamics and the power. So we're actually helping reducing the overhang and helping increase the float over this program.

I would like to ask Kurt a question about the sulfur market, specifically focusing on sulfur itself, rather than Ecoservices. With this release, you have significantly raised your revenue guidance, but this increase is solely based on the expected rise in sulfur pass-through costs. Although I’m not doing it now, I have been following the fertilizer industry for quite some time. Kurt, considering your lengthy experience with Ecoservices, can you recall that the last time the sulfur market really froze was back in April 2008, when there were no clearing transactions? I believe the sulfur market is likely to become just as tight, if not tighter, this time around. I would argue that the demand for fertilizer will surpass the supply of fuels for several quarters, possibly even for a couple of years. I know your business operates smoothly when the supply/demand balance is within normal parameters. However, do you think this market is going to tighten up similarly to how it did in 2008 when normal business transactions were disrupted? How does Ecoservices plan to continue operating or even take advantage of the unusual tightness that appears to be developing in the global sulfur market?

Thank you for your question, David. I always value discussions about sulfur since it's not commonly addressed and I have significant experience in that field. Yes, I experienced the last surge in 2008, and you're correct in pointing out the current driving factors, particularly the high demand for fertilizers. During the COVID period, many refineries reduced capacity, and a winter storm further diminished sulfur inventory. We are in a strong position to navigate this for a few reasons. First, many of our regeneration customers are also our sulfur suppliers, placing us in close proximity to them. We maintain long-term agreements with multiple suppliers, positioning us better than others who may be hundreds of miles away from their sulfur sources. Additionally, our virgin acid business has a high pass-through rate for sulfur costs, with over 90% of our contracts automatically adjusting to reflect any changes in sulfur prices. The remaining contracts typically adjust on a 30-day or quarterly basis. Furthermore, overall pricing in the market has been favorable due to robust demand and supply disruptions, allowing us to increase our prices beyond the changes in sulfur costs. I hope this addresses your question.

Yes, I completely agree with your earlier comment. Not many people discuss sulfur. If you don't mind, I have one more question about that. In your standard contracts for sulfur handling with customers, are there any restrictions or escape clauses? Are there parts of the contract that let customers opt out of taking their normal asset volumes, especially if they would be responsible for the high pass-through costs? In cases where customers decide not to take their contracted volumes or reduce them, how flexible are you in turning to other markets? What kind of flexibility is built into those contracts, particularly in extreme market conditions that I believe we are approaching?

Well, I would say most of our customer agreements, the overwhelming majority of them are 100% requirements agreements, so we match what their requirements are. But I would also state that there is a very healthy opportunity to sell excess sulfuric acid elsewhere if our customers aren't taking it because, again, the market, the supply is, I would say, has been impacted with numerous things, so the supply is not great. And demand really across all sectors for sulfuric acid here in North America is strong. You've got, again, mining, which is heavily linked to the green infrastructure that I talked about before with copper and different minerals drawing a lot of sulfuric. A lot of the industrial segments, things like polyethylene or PVC, lead acid batteries, really everything is a strong pull on it right now. So there are lots of opportunities to place sulfuric acid if one would need to do that.

We'll go now to Hamed Khorsand with BWS Financial.

I just want to get an understanding of why now, as far as the management change, the Board additions, what's the inflection point that you're seeing in the business that requires these changes?

Hamed, this is Kurt. The decision was made by the Board, but I want to express how pleased I am to lead this outstanding company. We have an impressive portfolio of businesses that are well positioned to align with sustainability trends, which are essential for providing services and materials for clean transportation fuels and other green technologies. I want to emphasize that we have a highly experienced executive leadership team in whom we have confidence to execute the strategic plan we've outlined and ultimately deliver strong value for our shareholders.

Okay. The other question I had was about the renewable fuel side. Does it matter to you if the feedstock is soybean oil, or are you neutral to it?

Yes. From our perspective, we are indifferent to the type of feedstock. With the increasing momentum in renewable fuels, both from new projects and converted refineries, this trend benefits our business as these renewable fuel plants typically require significantly more catalyst. This leads to more frequent catalyst replacements, which is advantageous for both new catalyst sales and our Chem32 business, which activates the catalyst prior to use. Overall, we are not particular about the feedstock, but it is certainly a highly growing area.

We'll go next to Laurence Alexander with Jefferies.

This is Kevin on for Laurence Alexander. You mentioned that a strong order backlog could drive momentum going forward. And I guess I was just wondering if you could share to what degree the order backlog was growing and maybe to what degree is the supply chain issues contributing to that. So any detail there would be helpful.

Yes. Sure, Kevin, it's Mike. The order backlog was really a result of some of the supply chain challenges that we saw in the last few months, but it's starting to already unwind, and we're expecting that to come back over the next couple of months. So it's more of just a timing aspect than anything else.

We have no further questions in queue at this time. This does conclude the Ecovyst first quarter 2022 earnings call and webcast. Thank you for your participation and you may disconnect at any time.