Minerals Technologies Inc Q4 FY2022 Earnings Call

Good day, everyone, and welcome to the Fourth Quarter 2022 Minerals Technologies Earnings Call. Today's call is being recorded. At this time, I'd like to turn the call over to Lydia Kopylova, Head of Investor Relations for Minerals Technologies. Please go ahead, Ms. Kopylova.

Thank you, Anna. Good morning, everyone, and welcome to our fourth quarter 2022 earnings conference call. Today's call will be led by Chairman and Chief Executive Officer, Doug Dietrich; and Chief Financial Officer, Erik Aldag. Following Doug and Erik's prepared remarks, we'll open it up to questions. As a reminder, some of the statements made during this call may constitute forward-looking statements within the meaning of the federal securities laws. Please note the cautionary language about forward-looking statements contained in our earnings release and on this slide. Our SEC filings disclose certain risks and uncertainties which may cause our actual results to differ materially from the forward-looking statements. Please also note that some of our comments today refer to non-GAAP financial measures; a reconciliation of GAAP financial measures can be found in our earnings release, which is posted on the website. Now, I will turn it over to Doug.

Thanks, Lydia, and good morning, everyone. Thanks for joining the call. First off, I'd like to welcome and congratulate both Lydia Kopylova and Erik Aldag on their new roles. Lydia is Vice President of Investor Relations and Erik is Senior Vice President, Finance and our Chief Financial Officer. Many of you have met Erik over the past few years, and I know Lydia looks forward to meeting our investors and coverage analysts in the coming months. Okay. Got quite a bit to go over today, so let's get started. Quick outline for today's call. I'll begin by giving you some context on the fourth quarter and then review the highlights of our full year. Erik will take you through the details of our financial results by segment and give you a look into the first quarter. As you saw from our press release, we'll be reporting on new segments and product lines starting in the first quarter. I'd like to take you through this change and how this structure better defines the Minerals Technologies of today. After that, I'll give you some perspectives on the year ahead and open it up for questions. Let's start with the quarter. As you saw in our press release, this was a challenging one, with several acute factors that impacted our results. On the positive side, sales levels remained healthy in most of our end markets, and compared to last year, sales increased 13% on a constant currency basis. We saw continued strong sales in Metalcasting and PCC, driven primarily by strength in North America foundry and paper markets. We also saw continued growth across our consumer-oriented product areas. These areas of strong demand were offset by a few markets that slowed through the quarter. You'll recall, we saw signs of weakness at the end of the third quarter in our construction and steel end markets, plus generally slow economic conditions in China and Europe. The slowing trend continued through the fourth quarter, and in the case of China, deteriorated further in December. As the quarter progressed, we also began to see orders in a few other businesses begin pushing into January. Our customers' inventory levels are healthier now than they were last year, which gives them more flexibility to manage the timing of their orders to us and we believe they exercised some of this flexibility in December. In addition to these market changes and the dynamics taking place in our order book, the most significant impact on our quarter came from three other areas. First, the cold weather experienced in the U.S. in December impacted our mining and processing plant operations and shipments, leading to increased costs and delayed sales. Our operations managed through these issues and have since recovered, but we still have some catching up to do on mining. The bottleneck of rail transportation that was created is now beginning to return to normal. Second, was the rapid increase in COVID infections in China in December. COVID swept through our facilities and our customers' operations, which slowed demand and created significant operating and shipment challenges. Thankfully, our employees in China have all recovered, persevering through a challenging few weeks. At this point, we've not yet seen volumes recover in China, and our outlook is for market conditions to remain weak for most of Q1 and to see more meaningful recovery to begin late in March or early in the second quarter. Third, we experienced a significant increase in energy and sea freight costs in Europe. The level of these increases was higher than expected and we absorbed them in the quarter, and are adjusting pricing to recapture them. Despite these challenges, our teams around the world did an amazing job, swiftly navigating these issues to keep our plants operating safely and our customers supplied. This quarter was an unusual one for MTI as we faced some unique challenges. Except for the continued slow conditions in China, these issues were isolated in the quarter. We've made the necessary adjustments and demand remains relatively healthy across most of our markets. As a result, we see a significantly improved first quarter, which Erik will take you through in a moment. Outside of the fourth quarter, 2022 was an otherwise strong year for MTI. We posted three record quarters and our teams around the world demonstrated their agility, perseverance and focus on our priorities through 2022. We continue to execute on our growth strategy, positioning our businesses in faster growing markets and geographies, accelerating the development of new products and technologies, acquiring companies that fit our core markets and which position us in higher growth markets. This year was somewhat a tale of two halves. The first half started with extremely robust demand across each of our businesses, customer orders hitting record levels. The second half of the year, demand began to moderate in a few of our end markets and inflation pressures became a bigger weight. It was a robust sales year for MTI with growth of 14%; it was 20% on a constant currency basis. We saw continued organic growth in our consumer-driven product lines, like cat litter, edible oil purification and health and beauty products. We expanded our core positions in growing geographies, securing two satellite contracts in China, one is a traditional PCC filler satellite and the other for a GCC packaging application. The Metalcasting business continued to grow in India and we've established ourselves as the green sand bond technology leader there. The Refractories business secured $100 million in sales over the next five years to deploy our new SCANTROL refractory application technology. Our Environmental Products business continued to grow through several large settlement capping projects and the continued trial and commercialization of our FLUORO-SORB, our unique PFAS water remediation technology. New product development continues to have a larger impact on our sales growth. We commercialized 63 new products this year, and sales of new products commercialized over the past five years increased 42% to over $300 million. We completed the integration of Normerica, establishing ourselves as the largest private label cat litter manufacturer in North America. We acquired Concept Pet, establishing ourselves as a leader in Europe. As I mentioned, inflation was a major factor this year, and it will continue to be through the first half of 2023. We absorbed $190 million of inflationary increases in 2022. We worked diligently to offset them with $210 million of price increases. Margins were impacted as a result, but higher margins will return as inflation flattens and lagging contractual price adjustments kick in. Our ability to change prices reflects the value that we deliver to our customers every day and is a testament to having the right technologies and applications to enhance our customers' products and help them generate higher value in their markets. In addition, as we always do, we continued our focus on maintaining the highest level of productivity and on diligent cost and expense control. As an organization, we gained a lot of speed and agility this past year. Our teams overcame several challenges and reacted decisively to maintain strong momentum. This momentum will serve us well as we go into 2023. And with that, I'll pass it to Erik to review the financials in more detail. Erik?

Thanks, Doug, and good morning, everyone. I'll go over our financial results for the fourth quarter and full year 2022, and I'll also give an outlook for the first quarter. After my remarks, Doug will discuss our recently announced reorganization and provide additional insights on our expectations for the upcoming year. Now, let's take a look at our financial results. As Doug mentioned, we faced a challenging conclusion to an otherwise strong year. Fourth quarter sales reached $508 million, which is 6% higher than last year and 13% higher on a constant currency basis, mainly due to $63 million from increased pricing. Our overall sales volumes remained relatively flat, as strong performance in our consumer-oriented markets was counteracted by weaknesses in Europe and China, along with production and shipping constraints caused by severe cold weather in the Western U.S. We also saw late quarter inventory destocking by our specialty PCC and processed minerals customers in the U.S. Fourth quarter operating income fell short of our expectations, largely due to the sales volume pressures mentioned earlier, as well as increased freight, energy, and production costs. The operating income bridge on the left shows we absorbed $60 million in inflation during the quarter, the highest we faced all year. While we offset the entire inflation cost increase with $63 million in higher pricing, we anticipated a more favorable comparison between price and cost this quarter. We have additional pricing actions planned to recover the extra costs absorbed during the quarter, and we expect the price versus cost benefit to improve in the upcoming quarters. The unfavorable other costs in the bridge relate to higher mining and production expenses due to severe weather in the U.S. and COVID-related production shutdowns in China. As we reflect on the full year operating income bridge, these fourth quarter events had a major impact on our overall other cost category as well. Continuing on the right side of the slide, full year sales totaled $2.1 billion, marking a record for MTI. Despite a $100 million headwind from foreign exchange, total sales grew 14%, driven by the successful execution of our strategic growth initiatives and pricing actions totaling $210 million. Full year operating income increased by 5% to $253 million. Our pricing actions exceeded inflationary costs by $20 million for the full year. It's worth noting that in 2021, we were approximately $20 million behind inflation in pricing that year. Therefore, even though our pricing actions aligned on a dollar margin basis in 2022, this two-year adjustment has led to a percentage margin dilution of 150 basis points. We have adequate pricing actions in place for the first half of the year to recover on a percentage margin basis by the second half, and this timeframe may accelerate depending on inflation trends. From an earnings per share standpoint, our full year operating income growth contributed approximately $0.28 to EPS improvement. However, full year EPS was $4.88 compared to $5.02 in the previous year, largely due to $0.42 in unfavorable below-the-line items, mainly from foreign exchange and increased interest expenses. Now, let's take a closer look at our segments, starting with Performance Materials. Fourth quarter sales reached $266 million, up 4% from the previous year. Sales in Household, Personal Care and Specialty Products grew 8%, fueled by the acquisition of Concept Pet and growth in personal care and edible oil purification. Metalcasting sales declined by 5%. We continue to see strong demand in North America, where sales in our green sand bonds business increased by 13% compared to last year. This growth was more than offset by declining sales in China, where volumes were impacted by COVID-related restrictions and shutdowns. Operating income for the segment was $19 million, significantly below last year and our expectations for several distinct reasons. Firstly, severe weather in the Western U.S. forced us to halt mining activities for weeks and implement cold weather safety protocols at our processing facilities, which reduced production and shipping capacity. We also faced rail congestion, leading to substantial costs for transporting our products via truck instead of rail. Additionally, we had anticipated a slight rebound in China, but our volumes were lower sequentially due to COVID-related restrictions and shutdowns at our facilities and those of some customers. Lastly, volatile energy prices in Turkey and bulk sea freight on the Black Sea led to significantly increased raw material costs for our European pet care business. We are raising prices to compensate for these heightened costs, although pricing adjustments typically carry a 90-day contractual lag in this sector. Fortunately, shipping rates on the Black Sea have stabilized, and we have nearly sold through most of this higher-cost inventory. As a result, we do not expect similar cost pressures in the first quarter, and margins will benefit further when our pricing adjustments take effect in the second quarter. Looking at the full year, segment sales rose by 16% to $1.1 billion. Sales in Household, Personal Care and Specialty Products surged by 22%, thanks to acquisitions, higher selling prices, and sustained strong demand for consumer-oriented products. Metalcasting sales increased by 5%, as robust demand in North America and higher selling prices compensated for sluggish volumes in China. Sales in our Environmental Products business climbed by 28% due to increased project activity. Full year operating income stood at $131 million, a 4% increase compared to the previous year. Notably, this segment absorbed $84 million in inflationary costs through pricing actions during the year. As we look ahead to the first quarter, we anticipate significant improvement given the isolated challenges faced in the fourth quarter. We expect overall market conditions to remain similar, with improvement anticipated in our China Metalcasting business beginning in the latter part of the first quarter, and our mining and processing operations have returned to normal. New pricing actions will come into effect throughout the first quarter and into the second, and we are seeing a decrease in the inflationary cost factors that affected us in the fourth quarter. Overall, we expect operating income for this segment to rise by $8 million sequentially, nearly 40% above the fourth quarter. Next, I'll discuss the Specialty Minerals segment. Fourth quarter sales for Specialty Minerals increased by 10% compared to the previous year to $155 million. PCC sales went up by 13% thanks to the ramp-up of new satellites and higher selling prices. Operating income grew by 17% compared to the prior year, reaching $16.9 million, as contractual price adjustments in this business begin to align with inflationary cost increases. For the full year, sales rose by 12% to $648 million, mainly due to new satellites, higher selling prices across all product lines, and strong demand for our specialty mineral additives in various consumer and industrial markets throughout North America. The full year operating income was $72 million, down 2% from the previous year, as this segment faced significant raw material and energy inflation during the year. It's also worth mentioning that this segment has the majority of our contractual pricing mechanisms, which will continue to improve margins as the pace of inflation decreases. Looking ahead to the first quarter, we expect demand in Europe and China and residential construction activity in the U.S. to stay at relatively lower levels. Despite similar market conditions, we anticipate operating income will improve due to price adjustments that took effect in January. Additionally, while energy volatility may persist in the winter months, this segment could see further margin recovery early in the year if natural gas and electricity rates remain stable in Europe and the U.S. Overall, we project operating income for this segment to increase by $300 million sequentially, roughly 20% higher than the fourth quarter. Moving on to the Refractories segment. Fourth quarter sales increased by 10% from the prior year to $87 million, driven by higher selling prices and increased laser equipment sales. Operating income rose by 1%, reflecting solid execution amidst softer steel market conditions and rising raw material and energy costs. Full year sales reached $349 million, a 15% increase compared to 2021. Steel market conditions were strong in the first half of the year, with utilization rates in North America around 80%. Although conditions softened in the second half, with utilization rates closer to 70%, this business performed well, driven by contract execution, higher selling prices, and increased laser equipment sales. Consequently, operating income rose 17% to $58 million, a record for this segment. In the first quarter, we expect additional laser equipment sales and pricing adjustments that should improve operating income sequentially, with market conditions expected to remain stable. Overall, we aim for operating income in this segment to increase by $200 million sequentially. Now, let’s move to our balance sheet and capital deployment highlights. We closed the year with total liquidity of $432 million and a net leverage of 2.4 times EBITDA. In 2022, our capital deployment priorities were balanced between sustaining operations, investing in high-return growth and cost-saving initiatives, and returning cash to shareholders. Looking toward 2023, we anticipate higher cash from operations as the inflationary impact on our working capital begins to diminish. Our primary use of cash flow will remain investing in our operations to maintain high performance. We also plan to utilize a portion of cash flow to strengthen our balance sheet and target around 2 times EBITDA for net leverage. Furthermore, we will continue to invest in high-return opportunities, both organic and inorganic. We always rigorously assess our market assumptions for growth capital across various economic scenarios. In times of increased economic uncertainty, this assessment plays a crucial role in ensuring responsible capital deployment. Overall, we expect free cash flow to return to a more normalized level of approximately $150 million for the full year 2023, with capital expenditures projected in the range of $80 million to $90 million. Now, let me share our outlook for the first quarter. For MTI, we anticipate a much-improved performance in the first quarter as we move past some acute challenges. Specifically, our mining and processing operations in the U.S. are back to normal conditions and ramping up production. The logistics disruptions on the railways have mostly been resolved. We've implemented several pricing actions and contractual pricing adjustments throughout January, with more planned for the first half of the year. While we expect inflationary cost pressures to continue, the most severe inflation impacts from the fourth quarter have diminished, particularly in sea freight and energy costs in Europe. Additionally, we expect our China business to show modest improvement later in the first quarter. We begin 2023 facing softer market conditions than we did at the start of last year. We anticipate the construction and steel markets to remain soft at least through the first quarter. Nevertheless, our more balanced portfolio is demonstrating resilience and strength, as demand for our consumer-oriented products and specialty additives remains robust. We see most of our end markets staying strong through the first quarter, with a few areas of uncertainty. As a result, we expect first-quarter operating income to rise significantly to a range between $55 million and $60 million, which would represent a 25% to 35% increase from the fourth quarter. Now, I'll turn it back to Doug to explain how our reorganization offers a clearer view of our current operations and enables greater performance moving forward.

Thanks, Erik. Over the last 18 months, you've heard me speak about how we've transformed MTI's portfolio of businesses. I've been highlighting how we've built a larger portion of our portfolio directed toward consumer-oriented products and how we've been developing new technologies for more specialized, higher-margin, and sustainable products. As a result, MTI is much different now. We're a more balanced, faster-growing technology-advanced company, and our organization and reporting structure should better reflect who we are today. With that in mind, we felt that this was the time to present ourselves differently. Beginning in the first quarter, we'll be reporting in two new segments; one named Consumer & Specialties and the other Engineered Solutions. The Consumer & Specialty segment, which generates 53% of our sales, combines all of our businesses that directly serve consumer-driven end markets and our mineral-based solutions and technologies that become a functional part of our customers' products. The two product lines that we will report on within this segment are: Household & Personal Care, our mineral-to-shelf products and Specialty Additives, the products which will become a functional additive in a variety of consumer and industrial goods. This business group is being led by D.J. Monagle. The Engineered Solutions segment, 47% of our sales, combines all of our engineered systems, mineral blends, and technologies that do not become part of our customers' products but rather are engineered to aid in their manufacture. The two product lines that we will report on within this segment are: High-Temperature Technologies, combining all of our mineral-based blends, technologies, and systems serving the foundry, steel, glass, aluminum, and other high-temperature processing industries; and Environmental & Infrastructure, which contains all of our environmental and remediation solutions such as geosynthetic clay lining systems, water remediation technologies, as well as our drilling, commercial building, and infrastructure-related products. This business group is being led by Brett Argirakis. This new organization moves us away from our past legacy-oriented structure into one where we are organized around common technologies and applications expertise, as well as common market and customer characteristics. It will streamline our reporting structure, speed up decision-making in the organization, and enable stronger collaboration. It also enables us to drive synergies through the alignment of our technologies with customer needs, accelerate innovation, and further drive operational efficiencies. Our first quarter 2023 results will be reported along these new segments and product lines, and we'll be sharing further details over the next couple of months. Following our earnings call in April, we plan to hold an Investor Day where we can provide an in-depth view of each of these product lines, their associated technologies, strategies, and resulting synergies. Please stay tuned for more details on that as well. Before we close the presentation, let's talk about our focus areas for 2023 and what we are seeing in our end markets as we start the year. In general, demand in the U.S. remains relatively healthy. Cat litter, Metalcasting, paper, automotive, and environmental products remain strong. Residential construction, as well as the steel market, are slower than last year and similar to the fourth quarter levels. Outside of the U.S., Europe demand remained strong in cat litter and specialty consumer products, but relatively slow in our industrial markets. We expect China to remain slow for the majority of the first quarter, but indications from our customers are that activity and demand will likely pick up in the second. Further out, the second half of the year is harder to see right now. Our order books typically strengthen in March and April in our more seasonal construction and environmental markets and we are watching automotive build rates. Early spring will be a telling period for these businesses on the strength of market demand going into the second half of the year. For our consumer-oriented businesses, we expect demand to remain resilient and for them to continue on their growth trend throughout the year. Internally, we have a clear set of priorities for 2023, focused on three pillars: financial performance; organization and people; and continued execution of our growth strategy. Our focus is on recapturing margins through both cost improvements and pricing actions. Contractual pricing will catch up and margins will further improve as we make other necessary adjustments and take advantage of lower input costs. We'll maintain a strong balance sheet and improve cash flows. As inflation plains over, we'll see the release of the working capital that has built over more than a year. We will continue our balanced approach to capital deployment, funding high-return internal projects with a priority this year on debt repayment. We have a very global organization, which is now better aligned with our customers and markets through common technologies and applications know-how. The reorganization of our businesses and segments improves alignment and creates more speed. We'll continue to drive growth, expanding our positions in our core markets and geographies, focusing on the development of sustainable solutions for the markets we serve, investing in product development and evaluating inorganic growth opportunities. These initiatives have transformed MTI, and we see more opportunities ahead. MTI is a less cyclical and more resilient company than in the past. Regardless of what the markets bring us this year, our balanced and higher-growth portfolio of businesses enables us to deliver more stable sales and earnings growth. I'd be remiss if I didn't tie all this together and mention the foundation that supports everything we do; our dedicated employees and the MTI culture built on operational excellence and an unwavering adherence to our values. It's the foundation that sets MTI apart from others. 2022 marked our 30th year as a public company and 2023 will be a pivotal year as we move into a new era. Looking back, we note the dedication and commitment of all MTI employees for the past 30 years who helped form who we are today. As we now turn and look forward to the next 30, we see many more exciting chapters to write for our company. Now, let's go to questions.

And we'll now take our first question from Daniel Moore with CJS Securities.

Thank you. Good morning, Doug. Good morning, Erik. Thanks for taking the questions.

Hi, Dan.

Let me start by saying you provided a lot of helpful insights regarding the various challenges that affected margins and results in Q4. Is the order in which you presented those three challenges—weather first, COVID and China second, and energy inflation and Europe third—how we should think about them in terms of significance? Or were they relatively equal in their impact?

Yes. Thanks, Dan. I can take that for you. So, I mean, as you know, heading into the quarter, we said we would do around $60 million of operating income. And so, we missed that by about $16 million. And so, I can put that into some buckets for you. About a third of that impact was associated with lower volumes, related to sales, so about $5 million or $6 million. And that was really from three areas: the China COVID situation impacted our volumes; the production and logistics challenges that we were facing in North America impacted volumes; and we did see some softness in the steel and residential construction markets that we mentioned. I'll note, we've moved through those production issues in North America. From a China perspective, we do expect improvement there. The timing of that improvement is still a little bit of a question mark, but we expect that to improve. The one aspect we don't see changing at least in the near term is the softness in the steel and construction markets. So that is the sales side of things. The larger piece of the impact was on the cost side, so both manufacturing costs and inflation costs. So, let me give you a little color on the inflation that we experienced, that was more than we were expecting heading into the quarter. So, most of this was specific to our European pet care business, as we mentioned. And first of all, so the bentonite that we use in that business comes from Turkey. And we've got mining and processing facilities there. And as an example, energy rates in Turkey have been very volatile. In September, we got hit with a 50% increase on natural gas. Electricity rates have been up over 200%. And then, sea freight also on the Black Sea has been very volatile. So, we've had to deal with price spikes up to €90 per ton when we're used to dealing with sea freight costs from the €25 to €50 range. So, this all contributed to this wave of inflation that we've described, absorbing in the fourth quarter. Now, we've adjusted prices. We adjusted pricing in the fourth quarter to pass this through. And as I mentioned, this business has a 90-day lag in terms of pricing adjustments typically. And we're going to be adjusting prices again in the first quarter. The good thing is that these costs have moderated since these spikes in the fourth quarter, and that's going to help our margins going forward as well. Just one note on the higher manufacturing costs. These are related to the challenges we had in December, mainly related to the weather, the severe cold weather at the West, and much of that was around the lower fixed cost absorption at our plants. The production challenges in China also had a cost element to them there, but that was the manufacturing side of things.

Got it. Sorry, excuse me. That's helpful. Based on the pricing actions you've taken in 2022, as well as what is expected for the first quarter of 2023, what would the incremental revenue look like for the full year of 2023 if volumes remained flat compared to the previous year?

Yes. Currently, we anticipate a mid-single digit impact on our revenue from pricing in 2023. While we expect inflation to continue in 2023, it should be at about half the rate we experienced last year. Much of this inflation is likely to be felt early in the year. We've observed moderation in areas such as energy and energy-related raw materials like packaging. However, we still expect to see inflation in labor and transportation, especially regarding rail and some raw material purchases, though it should be at a significantly lower rate than in 2022. We have implemented pricing measures in response. I previously mentioned the 150 basis points of margin dilution due to inflation and cost passthrough over the last two years; we aim to recover that at the very least in 2023, and we are optimistic about achieving even more.

Really helpful, Erik. That just leads to my next question, which is making sure we're working off the right base. So, you mentioned 150 bps of margin impact over the last two years. So, are we looking at 2021 in terms of margins as getting back to those levels? Is that the way to think about it?

Yes. So, I would just say for the full year 2022, we did just under 12% operating income margins. And so, the pricing that we have in place and what we see today from an inflation perspective should get us 150 basis points on that in 2023. So, we're looking at 13.5% to 14% margins by the second half on a run rate basis for this company.

Perfect. That's exactly what I wanted to confirm. I'll return to the queue with a few follow-up questions. Thank you very much.

We'll now take our next question from Mike Harrison with Seaport Research Partners.

Hi, good morning.

Hi, Mike.

I want to extend my congratulations to Erik and Lydia. Regarding the challenges with European sea freight, I am trying to gain a better understanding of the timing of when these issues arose. The impact of COVID in China and the winter weather in the U.S. both occurred in December. However, the costs of natural gas and power in Europe were already well-known and had raised significant concern, which we discussed in previous calls. I'm looking to understand why this seemed to catch you off guard and to learn more about when these issues became significantly more pressing compared to your expectations.

Yes, Mike, let me take that one. I think there's a piece of it that was absolutely known. It's been volatile all year, energy in Europe and Turkey in particular, it's gone up almost 200% over what we experienced at the beginning of the year and about three different government-mandated jumps. That latest one happened kind of late in September. We did have that in our forecast, and we had some pricing adjustments to cover it. I would say the bigger surprise is some of the freight, the shipping costs that were more spot-based for us that kind of increased significantly as a result of that as well. I'm not going to say though that I'd look back in hindsight 2020, we probably could have been a lot faster with our pricing increases at least in that business. We probably could have been more aggressive. And so, I think when we look back on the same, what did we see, what didn't we see, I think part of it was known and we made some pricing adjustments; part of it was a surprise to us. We probably should have been quicker and more aggressive on our pricing adjustments in the fourth quarter. Those adjustments have been made. We're moving through the first quarter. We have some catch up to do. But again, as Erik mentioned, we have 90-day kind of notification periods. So, being very aggressive and very timely with our going-forward pricing is where we are now. So, I'd say that's the hindsight 2020 kind of look. We probably could have been a little bit faster on that pricing.

All right. And I guess just given the significance of the shortfall relative to the $1.20 in EPS that you guys were guiding in the quarter, did you consider making a preannouncement to call out these unexpected headwinds that you were seeing? Or, I guess, help us understand the thought process there?

Yes, as we evaluated, many issues continued into December. To start, we don’t see any major changes in our markets. The business fundamentals, operations, and cost positions remain stable, with the exception of China, which is already well-known. Our market positions were relatively stable compared to what we observed in the third quarter. December presented significant challenges for the company due to issues in our plants in the United States and China, many of which arose late in the month. We believe these acute challenges were specific to that quarter and do not reflect any structural changes or significantly alter our forecasts from a market or operations standpoint. That was our line of thinking.

All right. And then, a couple of quick ones on the PCC business. First of all, in terms of the new Asia satellite ramp-ups, it's good to see that flowing in. Can you give us maybe an update on how much additional volume has come on as of the end of the year? And maybe how much additional volume is still to come?

Sure. Let me pass that to D.J., who can take you through that.

Yes. Hi, Mike. So, right as we closed the quarter, we brought two new satellites on that are roughly 70,000 tons of PCC business. And then, going into, through the course of next year, we've got, mostly in the second half, several satellites coming on. Two of those are PCC satellites, little over 100,000 tons there. And then, we had announced some time ago, and Doug had highlighted it, the penetration into GCC and that is a couple hundred thousand tons as well. So, as we come out of next year, you'll see something in the neighborhood of 400,000 tons, that sort of a run rate going forward.

All right. And then, in terms of the pricing in the PCC business, obviously, you've called out that most of that is contractual pass-through. Maybe help us understand what you've seen going on with lime and other raw material costs? Are they stabilizing? Are they starting to come lower? Maybe just help us understand kind of where we are in that lag in the contracts catching up to your input costs?

Certainly, glad to share that with you. So, what we are seeing is, lime is mitigating, so it's starting to plateau and our pricing is catching up on that. So, we'll see some incremental increases as we go into next year, but they're not nearly the rate that we saw in the prior periods. So, I would say that our contractual mechanisms seem to be holding through this process and it's something that still provides a very collaborative relationship with our customers as we work through these things together. Further, I would say that the value equation of our PCC in these markets stands strong, as our customers are experiencing energy increases. For instance, part of the value contribution we bring is reduced energy consumption in their paper-making process. So, it's getting better. Contracts are working, and we seem to be holding up our value pretty well.

I think the only thing I would add is that we get a significant amount of electricity from our customers since we operate on their facilities. This year, key inputs have included lime cost, which is related to energy and the energy used in its production, as well as the direct electricity and energy from our customers. As energy costs have stabilized in the first half of the year, we have experienced a lag, but as they continue to stabilize, we will catch up quickly. This is similar to what happened with SMI in the fourth quarter, where we began to see margin expansion. We need energy costs to remain stable, and if they start to decrease, the improvement in our margins will accelerate.

All right. Very helpful. Thanks very much.

Yes.

We'll now take our next question from Steve Ferazani with Sidoti.

Hi, good morning, Doug, Erik. I wanted to follow up on a few other questions. Regarding your outlook for 2023 and guidance for Q1, it appears that China improves significantly as the year progresses. With inflationary pressures easing, I’m looking at your market conditions for guidance. As those pressures decrease, you will see more of the lagging price effect. Considering everything, do you think it’s reasonable to say that Q1 will be the lowest point of the year in terms of EPS?

I guess that's a little bit hard to predict. I would say that yes...

Sure. Of course, it is.

Yes, the first quarter is likely to be a slow period for us, and traditionally, the second and third quarters are our strongest. I expect Q1 to be the lowest of the next three quarters. As we continue to address pricing issues, as Erik mentioned, we aim to drive our margins toward a 13% or 14% run rate. We have several new satellites in PCC that will come online later this year, which will contribute positively. In our consumer businesses, which are expected to grow in the mid to upper single-digit range, we anticipate continual top-line growth throughout the year. However, we are being cautious regarding the construction and steel markets and their implications for the latter half of the year. We believe that one part of our business will maintain its growth trend, while the other part looks strong at least for the first half. The back half’s performance will depend on the U.S. economy. If inflation levels off and our pricing strategies take effect, we anticipate improving margins. This combination of top-line growth and margin improvement indicates a solid year ahead. I acknowledge this requires various factors to align, including inflation management and addressing the uncertainties in demand within the economies. Nevertheless, I am optimistic about the first half of the year, with Q1 expected to be the lowest quarter. I feel confident in this assessment.

Okay. Thanks, Doug. Just help me out on that, because I'm looking at the household and personal care results for 4Q versus even 3Q, and some of this tough to sort of pick through. I know you lapped the Normerica acquisition by the end of 2Q. When I look at the growth 4Q versus 3Q annually, it looks lower on both the percentage and dollar terms. If you can help me through that.

I think some of the shipment challenges we faced in North America contributed to that. A couple of our pet care facilities are located in Canada, and due to the cold weather, we experienced significant shipping difficulties in December. As a result, some shipments were delayed and moved into the first quarter. We haven't lost those orders, so you can expect to see them picked up. Additionally, there tends to be higher seasonal demand in the fourth quarter compared to the summer, which could have also influenced the situation. However, I believe the primary reason for this quarter's impact was the shipment delays we encountered in North America at the end of December.

So, you're feeling as we go into 2023 in a slowing economy, a lot of your bigger acquisitions in that area were just generally not that cyclical. Your expectation is demand is there and with new products, you still can get reasonable growth even in this environment.

Yes, we do...

Am I characterizing that right?

Yes. And so, we're going to highlight that to you in that Consumer & Specialty segment. I guess I go back to the last semi or small cycle we had in 2020. That pet care business, which was a little bit smaller at that point, grew at almost 8%. Now the dynamics of going through the pandemic were a little bit different, but I will tell you in terms of cat litter products, fabric care, edible oil purification, these products, they're consumer driven. They're a little less discretionary in some specs, right? Folks are going to continue to purchase them through economic times, and we're the largest private label cat litter manufacturer globally. And so therefore, that positions us well in a downturn to be the more economical choice. And so, I think, the exact level of demand is going to be hard to predict, but the fundamentals of this business that we've built should withstand to be really resilient and continue to grow as we've seen with kind of GDP plus cat litter and pet ownership around the world. Other things that we are working on, we've got some online channels that we're now selling through and some new business developments in Asia, as we start to build out our presence in that region. So, pretty bullish on that consumer business and its growth. And as we see margins expand, we think it becomes a really big earner for the company.

Great. Thanks, Doug. Thanks, Erik.

We'll now take our next question from David Silver with CL King.

Yes. Hi, good morning.

Hi, David.

Several questions. I think I'll start with this one. So, Doug, you talked about a lot of things regarding the fourth quarter. There was one thing I didn't really hear that I have heard from every other industrial company that's reported to date. And that would be inventory destocking on the customer side. So, in some of your slides, I could see that the volume change year-over-year 4Q versus 4Q was roughly flat. I could kind of point to some of the pluses and minuses within the individual product lines. But just broadly speaking, how much did inventory destocking typically impact your customers, and might we see more of that come through in the first quarter? Thank you.

Yes, thank you, David. We observed some destocking, particularly in the process minerals business as Erik noted. Last year, customer inventory levels were quite low, and orders continued to flow through our plants even during traditionally slow periods like December and January. This year is different, as we see customers, especially in the construction market, holding higher levels of inventory. We noticed some orders were shifted from December to January. We believe this reflects some destocking or at least inventory management; a similar trend occurred in our steel businesses. While we experienced some destocking, those orders transitioned to January, and we expect that to increase. Erik mentioned that about a third of our impact this quarter came from destocking in process minerals, with a sales impact from transportation, logistics, and China amounting to approximately $6 million for the quarter. So, yes, there has been some destocking.

Okay. My apologies for missing that. I wanted to follow up with D.J. You laid out the new satellite plant startup timeline very well. I was wondering if you could also just maybe reflect on the new project or the new opportunity funnel that you see. And in the past, you've been very good about not just the number of projects, but maybe which innovation or which technology they're relying on. So, in the last couple of years, packaging grades have been introduced, the deinking technologies and I guess the PCC, GCC project. But if you could just talk about the outlook for the new project funnel as you see it here? And in particular, is there a particular new or expanding innovation that seems to be gaining more traction with potential customers? Thank you.

Thank you for the question, David. I mentioned the projects that are starting and the ones coming online in 2023. The commercial activity remains strong worldwide, with most opportunities in Asia. Additionally, the standard PCC continues to be in demand. Currently, our pipeline shows a shift, where previously we focused 90% on growth in printing and writing grades, but now it's about 50-50 between printing and writing versus packaging. In the fourth quarter, we made significant progress with full-scale trials on two new products in brown grades. One trial involved a significant brown box manufacturer in the United States. The second product we are excited about is NewYield, which repurposes a papermaking waste stream. We designed it for printing and writing grades and are optimistic about modifying it for packaging grades, with successful trials conducted in Asia. Both developments show promise for upcoming activities, and we're enthusiastic about that. Additionally, there is still a strong demand for standard PCC products, especially from those considering an upgrade in paper quality or new machinery. We're often one of the first calls they make due to our brand strength. That's my summary, David.

Great. Thank you for the color there. Appreciate it. Last question. I did want to ask about the CapEx budget. So, I think it was bracketed at $80 million to $90 million as we start the year. And I would ask Erik if he could just focus on the discretionary portion of that $80 million to $90 million? And whether you could call out what are the top couple of priorities in there? What's getting the most discretionary capital out of your original budget for 2023? Thank you.

Thank you, Dave. Each year, we allocate between $30 million to $40 million of our capital expenditures to sustain our operations and enhance our facilities. This amount is essential and not discretionary. We expect to spend that $30 million to $40 million in 2023 for sustaining and maintaining our operations. The remainder of our budget typically goes toward growth and cost-saving initiatives. However, we will closely examine the market assumptions we use to justify these projects. If there is any discretionary spending, it falls into that category. Should economic conditions change, that is where we will make adjustments.

Okay. Thanks. I'm going to get back in the queue. Appreciate it.

Thanks, David.

We'll now take a follow-up from Daniel Moore with CJS Securities.

Thank you again. Just thinking about revenue for the next quarter or two, obviously, pricing is a bit of a tailwind, but FX continues to be a significant top-line headwind. Do you expect a similar impact in Q1? Or, based on today's kind of exchange rates, how does that taper off over the next couple of quarters?

Yes. So, Dan, I would say in 2022, FX was a significant headwind for us. We said $100 million on revenue for the full year. If you look at current rates now versus what we had in 2022, it's still, I would say, moderately unfavorable on a full year basis, '23 versus '22, but not to the extent that we experienced last year.

We expect that foreign exchange will likely have a similar negative effect on us in the first quarter. However, we anticipate a pricing lift and see improvements in volumes compared to the fourth quarter. Overall, we expect our revenue to increase in the first quarter, and we believe growth in our consumer-oriented businesses will continue throughout the year. It's too early to determine how the industrial segment will perform in the latter half of the year, but we are optimistic about a strong first half.

That is helpful. Thank you.

We'll now take a follow-up from David Silver with CL King.

Thank you for the opportunity to ask a question. I have a topic that wasn't directly addressed today. In my research on related industries, I noticed significant momentum surrounding PFAS removal, particularly regarding new restrictions. For instance, California is planning to eliminate all PFAS from personal care products within a few years, and there appear to be increased penalties and responsibilities for PFAS producers at the federal level. While this is not an exhaustive overview, I'm curious if you believe there has been a qualitative or meaningful improvement in the business case or customer interest in your remediation strategies as a result of recent legislative and regulatory developments. Are there any specific aspects that relate to your remediation strategies and targets? Thank you.

Certainly. Let me break that down. PFAS is just a part of our remediation capabilities. We also address industrial wastewater, slurry wall cleanups, and groundwater cleanup systems. Our services include contaminant removal in the oil and gas sector as well, showcasing our diverse water remediation technologies. Our FLUORO-SORB media is specifically designed for PFAS removal. It's encouraging to see regulations reducing its usage, but the persistent presence of PFAS presents numerous opportunities for us that are just beginning to unfold. We've conducted successful trials and continued our commercialization efforts this year, gaining traction in terms of effectiveness compared to other media, with our solution being a cost-effective option for significant PFAS removal from water. However, the key factor will be the regulation of cleanup standards. There's a great potential in cleaning water, groundwater, and drinking water systems. Until clear cleanup regulation levels are established, the true catalyst will be uncertain. Once the requirements are known, it will guide the systems that need to be used. This will create substantial opportunities for us. Currently, we are engaging in specific cleanup projects across the U.S. and globally, but in the long run, given the enduring nature of these chemicals, our technology's capability to permanently bind them will be a strong solution, particularly as regulations evolve. I hope that clarifies things. PFAS is one aspect, but our scope of water remediation goes beyond that.

Okay. So, no landmark legislative or regulatory development in the last few months. No, that's great. Thank you for that help.

Yes. Not that's going to change the opportunity for us; regulation on cleanup levels will accelerate the opportunity for us.

Got it. Thanks very much.

Thanks, David.

We'll now take a follow-up from Mike Harrison with Seaport Research Partners.

Hi. Just a couple more for me. Can you hear me okay?

Yes. Hey, Mike.

Thanks. Sorry about that. I was looking for an update on the talc litigation. I know there will be something in your filing, but presumably that won't be out for a little while. Any update on the number of cases relative to the last time you reported? And do you expect to have to add to the reserve at any point during 2023? I noticed there was not a special charge related to the litigation in the fourth quarter.

No, there hasn't been any change. The level of cases is stable. There has been no change in the litigation, and the reserve we established continues to be adequate to cover the liability from the third quarter's caseload. So, there is no change.

All right. And then just a quick one on the Refractories business. You mentioned that kind of second half utilization rates were lower and things were stronger in the first half. But as I look at kind of the year-on-year change, I know this is sales, not volume, but the revenue number, at least, looks pretty consistent first half and second half. So maybe just help us understand, is there something that's changed that your Refractories business is maybe less sensitive to utilization rates than it had been in the past? I think in the past, we used to think of 80% as utilization as a number where your business would really be performing well, and if it was lower than that, that would be a headwind. But it doesn't seem like that has been the case more recently.

Yes, Mike. Thanks for that question. This business is very different than it used to be. And so, you referenced having to be at 80% this to be a profitable business and we're generating higher profits at even 70%. So, directly the market is down from where it was last year. But this business is able to generate income due to a number of different things. I'm going to turn it over to Brett to let you know, but the technologies that it's been developed, the systems it's developed, the new refractory formulations, all of that is combined to change the real profile, the profit profile of this business. Brett, do you want to give some color on that?

Sure. Thanks, Mike. I appreciate that question and glad it's noticeable. This is a business that we've been working on for a long time, especially in my 36-year career. We have changed and started to change going back to 2009 when that big market dropped, and it really hurt us. We resized the business. We reorganized the business. Every so many years, we just took a look at it and did that even further. It's a combination of our steel mill service groups that are embedded into our steel plants, our customers. But those people, although they've been there for many, many years, we're increasing that technology of what we do and increasing their ability to operate more higher-tech equipment. We've also moved into different product lines where we're driving similar costs or, in some cases, could be lower costs where we can work with our customers on pricing, but it's all about value. Our value is driving the lowest cost opportunity on an installed basis for our customers, so that they can run their steel plants more efficiently and more effectively. The other thing that we've done is really driving that automation of our application equipment and signing in five-year deal contracts. We have now, over the last couple of years, about 13 new automated application units. A couple of those are in Europe, and the majority right now are in North America. We're really happy about that, excited. Those are all going to be rolling out. The other thing is, you see the utilization rates going down. As they're coming down, we have five new steel plant customers that are expanding in 2023. So, we're riding with them and we're helping them in their expansion. So, as Doug said, it truly has evolved to a much different higher-tech business than it has been looking back in the past. So, we're really proud of that.

All right. Thank you for the additional color there.

Thanks, Mike.

And it appears there are no further telephone questions. I'd like to turn the conference back over to Mr. Dietrich for any additional or closing comments.

Thanks everybody for joining the call today. Again, please look out for some more information on our new segments that we'll be reporting on, and we look forward to reporting under it in our first quarter and then further to an Investor Day, probably scheduled in May. So stay tuned for that as well. Thanks for joining today.

And once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.