Earnings Call Transcript - ECVT Q4 2020

Operator, Operator

Good morning. My name is Nikki and I will be your conference operator today. Welcome to the PQ Group Holdings Fourth Quarter and Full Year 2020 Earnings Call and Webcast. Please note today's call is being recorded and should run for about one hour. All participants' lines have been set to listen-only mode to avoid any background noise. After the speaker's remarks, there will be a question-and-answer session. I would now like to turn the conference over to Nahla Azmy, Vice President of Investor Relations. Please go ahead.

Nahla Azmy, VP of Investor Relations

Thank you, Nikki. Welcome to everyone joining us for our fourth quarter and full year 2020 earnings call. We will start today with formal remarks from Belgacem Chariag, Chairman, President and Chief Executive Officer; and Mike Crews, Executive Vice President and Chief Financial Officer. Then we will follow with the Q&A session. Please note that some of the information shared today is forward-looking information about the company’s results and plans, including with respect to the sale of our Performance Chemicals business, and our anticipated end-use demand trends in light of the challenges presented by COVID-19 and our 2021 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. 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.pqcorp.com. With that, I’m pleased to turn the call to Belgacem.

Belgacem Chariag, Chairman, President and CEO

Thanks, Nahla, and good morning, everyone. 2020 can be characterized as a year of accomplishment and transformation for PQ. I'm proud of and thankful to our entire PQ team for their Herculean efforts and achievements while managing through unprecedented pandemic disruption and significant headwinds at the macro level. Beginning on slide 3 with safety as always. Even with the backdrop of COVID challenges and business transformation activity, we had significant improvements year-on-year with a more than 45% reduction in our total incident rate and nearly a 50% increase in the number of HSC perfect days. This is a direct indication of the engagement and commitment of everyone and the shaping of a sustainable, safe and compliant culture. For our operations, we swiftly and actively managed costs at production levels while working closely with our customers to meet demand changes. This enabled us to maintain our high EBITDA margin of more than 27%. Within commercial activities, we had many notable achievements adding new customers and volume demand, commercializing new products, and most of all protecting pricing. Perhaps no area demonstrates our accomplishments as much as the strategic moves executed in the recent months through our simpler and stronger portfolio transformation. I could not be more excited about the pace and quality of our team's execution. In a five-month timeframe, we completed the sale of Performance Materials, announced the sale of Performance Chemicals, and closed on a niche catalyst business for refining services creating real value at every step. Through these actions, we have repositioned PQ as a pure play catalyst and services growth company with two leading businesses driving our target company to higher top-line growth, expanding margins and strong free cash flow potential. Finally, on the strength of our fourth quarter results, we delivered on all our financial objectives, with the key one being adjusted free cash flow of $153 million. With this free cash flow and the performance materials business net sales proceeds, we reduced debt by $465 million and returned capital to our shareholders through a special dividend. And we expect to do more of this in 2021 with the completion of the Performance Chemicals transaction. I will now turn to slide 4 for a discussion focused on the core target PQ business end users. Beginning with refining services, this business segment was impacted the quickest by COVID-19 as stay-at-home mandates, especially during the second quarter, led to significant reductions in gasoline demand in the US. The second half of 2020 began to see a rebound with consumption recovering to approximately 90% of 2019 levels. Apart from weather events such as the recent Texas storm that heavily impacted refinery production and overall gasoline stocks, we expect refinery utilization trends to recover and continue improving through 2021. Once demand is restored to 2019 levels, we believe alkaline production will continue to grow, if not accelerate, driven by the higher octane fuel mandate. Virgin sulfuric acid demand from industrial and mining customers began to rebound during the third quarter and reached 2019 levels by year-end, and we expect this growth in demand to continue in 2021. Next on Catalysts: we experienced strong demand for hydrocracking catalysts sold through our Zeolyst joint venture during the first half of 2020. During the second half, most customers deferred catalyst bed change-outs due to lower refinery utilization rates. We expect to see recovery in 2021 as the year progresses, especially in the second half. Emissions control catalyst volumes used in heavy-duty diesel vehicles decreased during the second and third quarters of 2020 as our customers temporarily curtailed production. Demand began to rebound near year-end, and we expect improvement to continue into 2021. In our silica catalysts product line, polyethylene catalysts demand strengthened in 2020 and remains robust due to increased consumer demand for films and packaging. In 2021, we expect this trend to continue throughout the year. To summarize, we are expecting good growth prospects ahead for our core businesses from the global recovery, our continued successful operational and commercial execution, and from seizing the opportunities of favorable secular trends. Now, I'll turn the call over to Mike for an in-depth discussion of our results and outlook.

Mike Crews, Executive VP and CFO

Thank you, Belgacem, and good morning. I’m pleased to report we achieved solid fourth quarter and full year financial results despite the impact from the pandemic, delivering healthy adjusted free cash flow and an adjusted EBITDA margin of 27%. Furthermore, we completed multiple debt refinancing during the year to optimize financial flexibility, actively reshaped the portfolio by divesting two businesses, and closed on a strategic acquisition. I would like to note our discussion of the fourth quarter and full-year 2020 reflects continuing operations with performance materials now reported as a discontinued operation. Beginning with slide 5, we were pleased with our fourth quarter results that were in line with our expectations. This was due to rebounding demand in many of our end users and the benefits delivered from the Performance Chemicals Transformation Plan. Next, I will review each business segment and then the outlook, beginning with Refining Services on slide 6. For the quarter, sales of $103 million and adjusted EBITDA of $41 million were down modestly. Regeneration services saw rebounding volumes as refinery utilization rates rose, while virgin sulfuric acid volumes benefited from higher industrial demand. Most notable is the continued segment adjusted EBITDA margin of nearly 40%, achieved primarily through effective cost containment actions. Turning to Slide 7 for catalysts, for the quarter, Silica Catalysts sales of $21 million declined by $3 million, mainly due to lower metal sales versus the prior year. Zeolyst joint venture sales of $29 million were down 39% as customers deferred hydrocracking catalyst change-outs. Lower emissions control catalyst demand for heavy-duty diesel trucks also impacted results, although the trend is improving. Adjusted EBITDA was up $15 million, and margins of 30% declined from the prior year, largely driven by the lower sales volumes and unfavorable product mix. Moving to Slide 8 for Performance Chemicals, fourth quarter sales increased by 2% versus last year due to demand growth and specialty silicones for surface coatings and demand recovery and customer restocking of sodium silicate. Adjusted EBITDA of $36 million was up 7%, and margins expanded by 120 basis points to 22%. As a reminder, the team launched a business transformation plan in March with a target of $10 million to $15 million in annualized savings. This project delivered $3 million of savings in the fourth quarter and $7 million for the full year. Turning to Slide 9 for adjusted free cash flow and leverage. For the third year in a row, we generated high adjusted free cash flow with $153 million in 2020, which includes the cash generated by performance materials through the closing date ended December. Over $10 million in cash interest savings from our refinancings earlier in the year and $20 million of lower capital spending helped to offset lower adjusted EBITDA due to the pandemic. The net proceeds from the sale of performance materials, along with cash on hand, were used to pay a special dividend to shareholders and also to reduce debt by $465 million. As a result, our leverage ratio improved to 3.8 times at year-end despite lower year-on-year adjusted EBITDA. Shifting to slide 10 for the 2021 outlook. With the pending sale of performance chemicals, our sales and adjusted EBITDA outlook is based on the remaining target PQ businesses: refining services and catalysts. We are projecting GAAP sales at $555 million to $565 million and Zeolyst Joint Venture revenue to be $150 million. Adjusted EBITDA is expected to be in a range of $215 million to $225 million. At the midpoints of these ranges, this would represent an approximately 13% increase in sales and adjusted EBITDA for 2021, well above recent growth levels. Adjusted EBITDA margins are projected to be approximately 31%, or 400 basis points above 2020 levels. As the timing of the closing of the Performance Chemicals sale and the related refinancing is uncertain, we have made certain assumptions in our guidance for adjusted free cash flow and corporate costs. For now, we have assumed the sale closes on September 30, and we would achieve one quarter of our expected annual corporate cost savings of $10 million to $15 million, or $3 million, with the rest of the savings expected to be realized in 2022. Adjusted free cash flow is projected to be in the range of $75 million to $85 million, including cash generated by Performance Chemicals through the as-yet-closing date. With respect to the first quarter of 2021 for Target PQ, I would note that GAAP sales and Zeolyst Joint Venture sales in the first quarter of 2020 were approximately $125 million and $30 million respectively. In 2021, we expect sales to be at a similar level. Adjusted EBITDA is targeted to be down by approximately 25% versus last year's result of $49 million, largely due to lower hydrocracking and especially catalysts sales at the Zeolyst joint venture and the impact of the winter storm in Texas. The storm event took down US Gulf Coast refinery production volumes by 25%, bringing utilization levels to the lowest recorded level of approximately 55%. We estimate that the direct impact on refining services adjusted EBITDA will be in the range of $5 million to $6 million, including repair costs. Also, as Belgacem mentioned earlier, we anticipate a stronger second half overall with Target PQ adjusted EBITDA approximately 45% higher than the first half of 2021 due to the anticipated recovery for transportation fuels and refinery utilization and catalysts changeouts. And finally, we intend to use the net proceeds from the sale of Performance Chemicals to pay a special dividend in the range of $2.50 to $3.25 per share, with a corresponding reduction in debt of $450 million to $550 million. We expect leverage to be in the mid- to high-3s at the end of 2021, pro forma for the sale. To summarize, we had a solid finish to the year with strong margins and adjusted free cash flow demonstrating the strengths of our businesses and the flexibility of our cost structure. We successfully completed multiple refinancings and portfolio activities despite macroeconomic headwinds, and we returned cash to shareholders in the form of a special dividend while also maintaining leverage at a sustainable level. With that, I will turn the call back to Belgacem.

Belgacem Chariag, Chairman, President and CEO

Thank you, Mike. Turning to Slide 11. On our last earnings call, we committed to fast-track the reshaping of our portfolio toward better margins and improved growth potential and the expanded multiple valuation that it should result in. With this latest round of significant milestones, we have done just that. As a reminder to drive value for shareholders, we embarked on our simpler and stronger journey in 2019 by first improving the performance at all of our specialty businesses, realizing that the sum of the parts is greater than the whole. The next steps we took were to simplify the portfolio. We sold two businesses at attractive values and are now positioned to accelerate returns for our investors as a high-growth pure play catalyst and services company. What makes the target businesses more compelling is their selective participation in the end use of supporting growth market drivers and their enabling capabilities for clean energy transition and the circular plastics economy. Closing on slide 12, I would like to give you a preview of future target PQ’s growth potential projecting from 2020 into the 2025 timeframe. Focusing here on the organic side only, we expect top-line growth to be in the high single-digit range. With high operating leverage, we would anticipate adjusted EBITDA growth to also be in the high single-digit range with margins in the mid to high 30s range and cash conversion higher than 75%. Additionally, we anticipate actively seeking tuck-in opportunities to complement our businesses and reinforce our growth trajectory. We are extremely excited about the future of target PQ for all our constituency and particularly our investors. We look forward to you joining us again in a few weeks for our virtual investor conference, where we will be able to share more on the strategy, the businesses, and growth outlook plans. This concludes our formal remarks. And with that, we will be happy to take questions.

Operator, Operator

We'll take our first question from David Begleiter with Deutsche Bank. Please go ahead. Your line is open.

David Begleiter, Analyst

Guys, I'm back on slide 12. What are you thinking – what do you think the organic growth would be by segment? Are they both in that same range of high single digits?

Belgacem Chariag, Chairman, President and CEO

Hi David. Yeah, both businesses will be growing at about the same level.

David Begleiter, Analyst

Why is there no operating leverage in this model?

Belgacem Chariag, Chairman, President and CEO

The operating leverage is the synergies, the efficiencies, particularly in some areas like the refining services business. The new acquisition that we've brought in has the potential synergies in terms of feedstock with sulfuric acid capabilities. The synergy with the distribution and logistics that refining services is going to give Chem32. That's the sort of the operating leverages that we’re talking about in catalysts. The growth potential in the market, the demand in the market, plus some of the technology that will be brought into the market as well. So all of those will ensure that our margins stay at that level.

David Begleiter, Analyst

Would you expect EBITDA to grow faster than sales just in line with sales growth?

Belgacem Chariag, Chairman, President and CEO

I do anticipate it and want it to grow faster than sales growth.

David Begleiter, Analyst

Thank you very much.

Operator, Operator

Next, Roger Spitz with Bank of America. Please go ahead.

Roger Spitz, Analyst

I think H1 2019 earnings call, I think you gave the split of Silica Catalysts as 80% polyolefin and 20% MMA. Had that changed much in 2020? And given that ratio, how is this catalyst down so much? Or did M&A catalysts just drop off fairly hard in Q4?

Belgacem Chariag, Chairman, President and CEO

Hi, Roger. The MMA sales are in specific purchase orders since the last couple of years, and the quarter where you have a large sale of $5 million to $6 million has an impact on the ratio. What happens when the difference between the quarters and the years is usually where that sale occurs. We also had a large sale of chemical catalysts into INEOS last year that was a one-off sale that inflated the numbers. Speaking of MMA because it's always been unclear, I want to take the opportunity to discuss the potential of the MMA business because this trend that we have with being connected to the leading producer with MMA presents a future growth opportunity as we see some of the frequency of change-outs going from a five-year frequency to a three-year frequency in the next couple of years. We expect to see accelerated growth in MMA sales much more than we've seen in the last couple of years due to the slowness in refineries and operations being held a little bit. So it's a positive component of growth in the next three to five years.

Roger Spitz, Analyst

Okay. Interesting going from a three-year to five-year change-up. And can I ask, does the unfavorable catalyst mix suggest that polyolefin catalyst margins are below either your MMA or your ZI catalyst margins?

Belgacem Chariag, Chairman, President and CEO

Not really. The higher margin support products that we sell for hydrocracking and catalysts are higher margin, but the rest of the margin across catalysts is pretty much around the same level, all very strong by the way. On volume, the drop you see is actually in volume. It's volume absorption and inventory that causes the market to shut down, which is pretty much what happened in the second half of last year.

Roger Spitz, Analyst

On realized support catalysts, do you actually have higher margins for the support than the actual catalyst? That's interesting. Okay. Thank you very much.

Operator, Operator

We'll move next with Alex Yefremov with KeyBanc. Please go ahead. Your line is open.

Alex Yefremov, Analyst

Thank you, and good morning, everyone. I wanted to go back to your target of high single-digit growth through 2025. So you're forecasting sales growth of 10% to 15% in 2021 and then possibly above trend recovery growth in 2022. So does your projection imply that growth kind of slows down, perhaps to mid-single digit after 2022? Or do you think this high-single-digit is really the objective for the most part in this forecast period?

Belgacem Chariag, Chairman, President and CEO

Hey Alex. Yeah, you're right about the numbers looking like we're going to slow down growth. The 2021 numbers are on the back of 2020, so it's natural to see that tremendous recovery happening, particularly in our second half of the year where you're going to see a significant rebound. I believe that the next five years, from 2021 all the way to 2025, we’re going to see at least high single-digit growth across the board. There is no concern about fluctuation; of course, this is catered data. Right on average, you might see ups and downs, like in 2023 for instance, where we expect to have a peak in catalysts, hydrocracking scenarios, so you may see that a bit higher. In 2024 it may drop a little, but on average, it’s going to be high-single-digit.

Alex Yefremov, Analyst

Understood. Thank you, Belgacem. And then based on your 2021 guidance on a pro forma basis, it looks like you’re still below 2019’s high watermark, which makes sense. How long do you think it might take you to actually reach or exceed this 2019 level? Could you get there in the back half of this year, perhaps, or first half of 2022?

Belgacem Chariag, Chairman, President and CEO

Well, as we noted earlier, our adjusted EBITDA margin and our adjusted EBITDA in the second half of the year is expected to grow north of 40%. So you see there is a strong recovery and all the reasons for that. First of all, if you look at the business of Refining Services, with what's going on in Q1 with a freeze and the drop in inventory that is unprecedented, demand is planning to be increased, definitely based on what’s going on with the vaccine rollout with COVID-19 going into the driving season in Q2, late Q2, and Q3 in the summer. All these are indications that we’re going to see a nice return. Also regarding refining, note that exports were at 750,000 barrels a day in 2019 and in 2020, that average fell to 650,000 barrels, especially in the first part of the year where it went as low as 500,000. We anticipate that to recover to about maybe closer to 700,000 in 2021, particularly in the summer and towards the end of the year. On the Catalyst side, the way the refineries have been run, the way that they delayed change-outs and with cash being scarce, there's no way with the current oil pricing trends that there is not a great rebound. On top of that, we have demand signatures from customers, and we have new customers knocking for additional requirements. We have potential inventory built by customers, so we definitely see that H2 is going to be a completely different story. You combine those two and have a very strong H2 going into a potentially even strong H1 next year based on economic recovery and everything else. That’s how we feel about the transition.

Alex Yefremov, Analyst

Thank you very much.

Operator, Operator

Next question comes from the line of David Silver with CL King. Please go ahead. Your line is open.

David Silver, Analyst

Yeah. Hi. Thank you. Good morning. I'd like to start with a question on taxes. So, in the fourth quarter, I mean, even if I exclude the foreign tax credit that was there, I still get a negative tax rate for the fourth quarter. So, I'm just wondering how to think about that. And then, more to the point for projecting forward, I noticed there was a pretty sharp drop in deferred taxes, and with the recognition of the foreign tax credit, will you or will your tax accrual rate change markedly going forward, and will your cash tax rate be meaningfully different than your tax accrual rate? Thank you.

Mike Crews, Executive VP and CFO

Hi David. It's Mike. That's a good question. Taxes are really complicated this time with the discontinued operation for performance materials. So, the biggest mover, first you have the foreign tax credits. We recognize that we talked about in the release that's about $56 million or $0.42 a share. Beyond that, it's a lot of puts and takes and allocations between continued and discontinued operations. So, it's really not reflective of what we expect our rate to be. You're right; the deferred taxes went down due to the booking of foreign tax credit benefits that we expect to utilize with the sale of Performance Chemicals. Previously, we've guided on taxes to be in the 25% range. We think that as a US–virtually US-only tax payer, it's going to tick up toward a 30% range, and that's the best estimate right now to use for both cash and book.

David Silver, Analyst

And then I just had a more strategic question, thinking about the decision to purchase Chem32 and kind of how it fits into your refinery services strategy. I'm just wondering if this is a signpost or a harbinger of what's to come. In other words, in your opinion, are there related services that PQ, with your people already inside the plant gate, can cross-sell or provide in addition to your base sulfur services? Is this a harbinger of further niche acquisitions that would leverage your current positioning inside the plant gate and perform these value-added services for the refiners? Thank you.

Belgacem Chariag, Chairman, President and CEO

Hi David. It is actually how you described it. Let me just take you through the rationale behind Chem32. We've been stamped and have become very experienced and strong in our sulfuric acid capability. The growth of that sulfuric asset-based market goes two ways: one is on the regeneration side, which goes up and down with refinery margins, and the other side is the virgin market, which serves a lot of other industries. You still consider that as limited in terms of growth potential. So you've got to add some branch-out opportunities which kind of bridge the gap between our catalyst business and our refining business. What we do best in refining services is services. This is the arm of PQ. We have one of the best logistics capabilities, the best distribution capability, and we want to capitalize on that. Chem32 is the actual improvement for the customers. As we go forward, I picture this being more and more off-site utilization of the fighting technology. Chem32 has such a unique patented technology that has shown us steady growth and is projected to grow at double digits going forward, with even higher margins than our refining services business. If we plug that together and capitalize on our service capabilities and customer portfolio with refining, we can create nice synergy. We will diversify our offerings and continue looking at such capabilities going forward, whether through technology or service. We believe our refining services capability deserves to take on more. We're looking at other areas, such as treatment services, which is a small component of our business that could be a good M&A target in the future. We’re also considering opportunities on the virgin sulfuric acid side, which we haven't tapped into a lot so far because we've been focused on regeneration. We’re very excited about what we've done with Chem32; this acquisition for refining services is the first in many years in the history of eco-services. We look forward to integrating more of this approach.

Operator, Operator

There appear to be no further questions at this time. Thank you all for your participation. This concludes today's conference, and you may disconnect at any time.