W. R. Grace & Co.
Q1 2012 Earnings Call Transcript

Published: 25 Apr 2012

[Operator:]

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 W.R. Grace & Company Earnings Conference Call. My name is Keith, and I will be your operator for today. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. And I would now like to turn the conference over to your host for today, Mr. Mark Sutherland, Vice President, Investor Relations. Please go ahead, sir.

[J. Mark Sutherland:]

Thank you, Keith, and good morning, everyone. And thank you for joining us today, April 25, 2012, for a discussion of Grace's first quarter 2012 results released this morning. Joining me on today's call are Fred Festa, Grace's Chairman and Chief Executive Officer; and Hudson La Force, our Senior Vice President and Chief Financial Officer. Our earnings release and the corresponding presentation are available on our website. To download copies, go to grace.com and click on Investor Information. Links are available on the upper right-hand corner of the page. As you know, some of our comments today will be forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied, due to a variety of factors. Please see our recent SEC filings for more detail on the risks that could impact Grace's future operating results and financial condition. We will also discuss certain non-GAAP financial measures, which are described in more detail in this morning's release and on our website. Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures are contained in our earnings release and on our website. Our comments on forward-looking statements and non-GAAP financial measures apply both to the prepared remarks and to the question and answer. We want to remind everyone that this webcast contains time-sensitive information that is accurate only as of today. Any redistribution, retransmission or reproduction of this call without company consent is prohibited. With that, I'll turn the call over to Fred.

[Alfred E. Festa:]

Good. Thanks, Mark. Hello, everyone. Thank you for joining us this morning. We're off to a good start in 2012. We performed well in the quarter led by the results in our Catalyst Technologies and Construction Products segments. For the quarter, sales increased 8% to $754 million, gross margins improved 40 basis points to 36.7%, adjusted EBIT increased 16% to $111 million and adjusted EBITDA margin improved 70 basis points to 18.7%. We also saw good sequential improvement across our businesses. Hudson will walk you through the details shortly. It was a busy first quarter. First, we divided the Grace Davison business into 2 operating segments; Catalysts Technologies and Material Technologies. We are now reporting our financial results in 3 operating segments, these 2, plus the Construction Products group. Catalysts Technologies is now the home for all of our catalysts businesses, including refining catalysts and additives, polyolefin catalysts and chemical catalysts. Our ART hydroprocessing joint venture is managed in this segment as well. By combining all of our catalyst activities into a single unit, we have enhanced our critical mass in terms of research, innovation and customer reach. And this will enable us to do what we do best

[Hudson La Force:]

Thank you, Fred. Please turn to Page 5 and we'll start with a quick review of Grace's overall results for the quarter. Sales increased 8% due to improved pricing and higher sales volumes, while currency translation was unfavorable. Six points of the improved pricing was due to base price increases achieved across all 3 of our businesses with 2 points due to the rare earth surcharges in our Refining Technologies product group. This is one of the strongest pricing quarters we have had in some time. Gross profit increased 10% year-on-year, and gross margin was 36.7%, up 40 basis points year-on-year and up 180 basis points sequentially. Adjusted EBIT increased 16% to $111 million driven by higher sales, improved gross margins and higher equity income from our ART joint venture. Adjusted EBIT margin increased 100 basis points to 14.8% and adjusted EBITDA margin improved to 18.7%, an increase of 70 basis points year-on-year and 190 basis points sequentially. Adjusted free cash flow was $32 million for the quarter, compared with a $20 million use of cash in the prior-year period. The year-over-year increase in cash flow was due to lower income tax payments, improved working capital performance and increased earnings. Adjusted EBIT return on invested capital was 35% on a trailing 4-quarter basis, compared with 28% in the prior-year quarter. Adjusted EPS increased 13% to $0.88 per diluted share. As detailed in the Appendix to this presentation, we adjusted EPS for Chapter 11 and asbestos-related costs and for restructuring charges incurred during the quarter. This is the first quarter we have reported results using our new operating segments structure. We provided an 8-K on April 2, which included quarterly and annual financial results for 2010 and 2011 for the new segments. We provided a minor update to this information in an 8-K A filed April 19. This information is the basis for all prior period comparisons in our discussion today. So let's begin with Catalyst Technologies on Page 6. Catalyst Technologies includes the Refining Technologies Product group and the Specialty Catalysts Product group. Our share of our churnings is included in this segment. First quarter sales for Catalyst Technologies were $313 million, up 14% from the prior-year quarter. The increase was due to improved pricing, which more than offset lower sales volumes and currency. Our FCC catalysts business achieved a double-digit increase in sales driven by higher base pricing for our lower rare earth FCC catalysts. As you know, these products have higher base prices and better margins than the products they have replaced. We saw weaker volumes in Refining Catalysts due to the slowdowns in North American refinery operations during the quarter, particularly on the U.S. East Coast and some lumpiness in customer order patterns. We also had a tougher than usual compare against 11% volume growth in the prior-year quarter when we launched our lower rare earth FCC catalysts. Sales volumes and pricing for our polyolefin and Chemical Catalysts business increased during the quarter. Polyethylene catalyst sales volumes increased 5% with strong demand in all regions. Polypropylene catalyst sales volumes increased 13% due to increased penetration with key customers. In part, our hydroprocessing catalyst joint venture performed very well on the quarter. Demand for ART catalysts was strong, driven by continued diesel demand and increased processing of resid feedstock. ART sales, which are not consolidated, increased 19% due to better sales volumes and product mix. Our share of ART's net income grew to $6 million, up $2 million from last year. Catalysts Technologies gross profit increased 19%. Segment gross margin was 42% compared with 40% last year and 38% in the 2011 fourth quarter. Segment operating income grew 27% on higher sales and improved gross margin. Segment operating margin was 31.7%, an improvement of 340 basis points compared with last year and 530 basis points sequentially. Let's turn to Page 7 to discuss the impact of rare earth on our catalyst sales for the rest of the year. The chart on the left shows the average China export price for rare earths, and the chart on the right shows the year-over-year change in rare earth prices. As we've said in our February call, lower rare earth surcharges will be a headwind to sales this year. Based on current rare earth prices, we expect the full year sales headwind to be about $170 million, and we expect Q1 to be the last quarter of favorable impacts to sales from the surcharges. Starting in Q2, we expect the surcharge to be unfavorable to sales and significantly so in Q3. As a result, it is possible that we will report negative year-on-year sales growth for Catalyst Technologies in Q2, and it is likely that we will do so in Q3. With the decline in rare earth costs, we are often asked about customers switching back to previous generation product technologies. We have not seen this yet. Approximately 85% of our customers continue to use at least one of our lower rare earth products. While rare earth costs have declined, they are still 3x to 4x their previous levels. Also, customers are reporting performance improvements from the new products compared with the previous generation technology, so there are performance reasons to continue with the newer technologies. Let's move to Materials Technologies on Page 8. Materials Technologies includes 3 product groups

[Operator:]

[Operator Instructions] And your first question is from the line of Laurence Alexander with Jefferies.

[Robert Walker:]

This is Rob Walker on for Laurence. I guess the first question, just to clarify, do you still expect Q1 though to be -- typically, it's been around 20% of annual earnings. Is there any reason that should not play out this year as well?

[Hudson La Force:]

Well, Rob, we have our Q1 actuals. And we've given you the full year outlook. I honestly haven't done the percentage math myself, but the full year outlook is the $510 million to $530 million.

[Robert Walker:]

Okay. And then qualitatively on the outlook. It sounds like raw materials might be slightly higher headwind than you expected. But pricing this quarter seems to be stronger than your expectation for the year.

[Alfred E. Festa:]

Yes, Rob, this is Fred. I mean, we're getting a little bit of headwind from the petrochemical base as a result of oil. But our position in our value-based pricing is, what was very good in Q1. So there's no reason to think that we won't -- not be able to sustain that going through the year.

[Robert Walker:]

Okay. And then on the Refining Technologies side. I guess do you still expect -- I guess, in terms of volume growth, do you expect to see volume growth in FCC this year? And do you think that base price increasing -- increases you're seeing are sustainable over the course of the year in terms of percentage?

[Alfred E. Festa:]

Yes, on a volume basis, we -- again, as you know that the first quarter has been a tumultuous quarter. And we'll see what happens in the second quarter based on the refinery turnarounds and shutdowns and so on. But we're expecting the global, our global FCC volume to increase year-over-year. It be in the single-digit range. And we expect the base pricing continue -- to continue to increase as well as we continue to roll out these new products. They're having better performance, and we've got that factored in, in our thinking in our outlook.

[Robert Walker:]

Great. And then just the last question I had was on Materials Technologies kind of weakness this quarter. I guess how much profit growth roughly are you expecting from new wins, in the life science area this year and next year? And I guess are those being offset by increased competition? Is that why we're not maybe not seeing those right away?

[Alfred E. Festa:]

No, what you're seeing in the Materials side is you're seeing some of the -- especially on the silica side. What you're seeing is the result of 2 factors

[Operator:]

And your next question is from the line of Mike Sison with KeyBanc.

[Michael J. Sison:]

In terms of the normal seasonality 2Q versus 1Q, it's tended to have pretty strong growth over the last couple of years. Is there any reason that delta -- that type of strength would not occur or maybe could it be stronger? Can you give us a little bit more of a feel how 2Q versus 1Q will be?

[Hudson La Force:]

Mike, we've said what we're going to say this morning. It's -- we're not expecting anything changing in terms of our business operations, but the way currency and rare earth is running through the P&L, it is causing a different pattern. But it's about these kind of nonoperating factors, not operating factors.

[Michael J. Sison:]

Got it. No, I understand. In terms of -- in Catalyst Technologies, the base pricing continues to be pretty impressive there in the first quarter. When does that start to see the sort of tougher headwinds? Is that in the second quarter and third quarter?

[Hudson La Force:]

On base pricing?

[Michael J. Sison:]

Yes.

[Hudson La Force:]

We don't expect to see headwinds on based pricing yet.

[Alfred E. Festa:]

I mean, Mike, this is Fred. I mean it really is about the technology. We really truly believe that the value we bring to these new catalysts and continued development of these new catalysts, we can continue to increase our base price for these catalysts. Now as Hudson said, you got this big whipsaw on the revenue side. On the surcharge, it's particularly in the third quarter. But on the base price, no, we think there's still opportunities.

[Michael J. Sison:]

Okay. So that will still remain a positive as the year unfolds?

[Hudson La Force:]

Yes, it will, Mike.

[Michael J. Sison:]

Okay. And then in terms of Grace Materials Technologies, Fred, when you think about that business as we head into the next couple of years, where would you like to see those margins improve to based on what you're trying to do this year to rightsize some of the costs then?

[Alfred E. Festa:]

Yes, it's really not even about rightsizing the costs. It's really about growing the volume into the expansions we've had. Historically, this business has been in the 34% to 36% margin, gross profit margin range. I would expect us moving toward that path by the end of this year. It's a couple of factors. If you look at it on the renewables where we put in the volume expansion in Serocabo. I mean in Brazil, as you know, they cut back on bioethanol dramatically as the sugar cane crop was curtailed last year. That's had an impact. However, in the first quarter, the Brazilian government announced they will subsidize to get that ethanol back in February. So it's a timing of those events. I'm not concerned about the first quarter. We've got good products, we've got good applications, the investments are put in there, and we'll catch back up.

[Michael J. Sison:]

Great. And last question, on the last call you noted, 2014 goal of 815 EBITDA based on what your -- I know it's a little bit early. But based on what you did in the first quarter and your outlook for the rest of the year, do you still feel pretty good about that progression over the next couple of years?

[Alfred E. Festa:]

Yes, I mean, we feel that we do. We feel very good about it. I mean we put that out there with all the insight that we had at that point in time. Listen, as you know, as we go through the year, we'll continue -- we'll give you updates on how we feel. It's traditionally in the third quarter. But I like how we started. There's still a lot of volatility out there as you know in the general economic climate and -- but I like how we started.

[Hudson La Force:]

There are a lot of the long-term growth opportunities that are starting to come together for us, Mike. And some of those, you solved this quarter with our catalyst joint venture in the Middle East and some of the other things we've talked about.

[Operator:]

[Operator Instructions] And your next question is from the line of Chris Shaw with Monness, Crespi, Hardt.

[Christopher L. Shaw:]

I guess the first question, outside of Construction Products, those margins I would expect to increase those sequentially. But the margins you saw in the other 2 segments, Catalysts and Materials, are they -- do you believe they're sustainable throughout the year?

[Alfred E. Festa:]

Yes, this is Fred, and Hudson, I'll ask you to jump in if you want. Yes, I mean in the Catalyst business. Absolutely. And we're expecting to increase our margins throughout the year in the Materials segment.

[Christopher L. Shaw:]

And then, I guess, talking about FCCs again and then the new products, the pricing seems like it's coming from the new low rare earth and such. But are there new price again for this year or is it just that family of low rare earths are sort of flowing through this year or new ones that are coming on as well?

[Alfred E. Festa:]

Obviously, the lower rare earth products were a major new product launched last year. But the business model we have in this business is continuously improving our product portfolio. And so there is a constant introduction of new products and new formulations for individual customers. And that engine is working very well for us right now.

[Christopher L. Shaw:]

So you will just tweak them again this year and improve the efficiency and then be able to price them higher again?

[Alfred E. Festa:]

It's a continuous process. And we do use that as an opportunity to keep our technology fresh, and we do use that as an opportunity to sustain our margins.

[Christopher L. Shaw:]

Okay. And then just finally, what is the Canadian government's appeal on the bankruptcy?

[Alfred E. Festa:]

It's more of a procedural appeal on how much recovery they can get initially from the trust on their claims. So it's -- as I said, it's really a procedural appeal. What percentage of a claim they can get reimbursed immediately versus over time.

[Hudson La Force:]

It doesn't affect economically Grace, but it is a process issue that we're having to deal with.

[Operator:]

And ladies and gentlemen, we have no other questions. So I'd like to turn it back over to Mr. Sutherland for closing remarks.

[J. Mark Sutherland:]

Thank you, Keith. And I just wanted to thank everyone who dialed in this morning. And remind you that if there are any follow-up questions, my contact information appears on our website and on the, one of the pages of our PowerPoint presentation. So thank you very much, and we'll be glad to wrap up this morning's call.

[Operator:]

Ladies and gentlemen, that concludes today's conference. Thank you for joining us today. And you may now disconnect. Everyone have a great day.