Good morning, and welcome to the PQ Group Holdings Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded.

I would now like to turn the conference over to Nahla Azmy, Vice President of Investor Relations. Please go ahead..

Thank you, Chad. Welcome to everyone joining us for our second quarter 2019 earnings results call. We will start today with formal remarks from Belgacem Chariag, President and Chief Executive Officer; and Mike Crews, Executive Vice President and Chief Financial Officer. Then we will follow with a Q&A session.

Please note that some of the forward-looking statements that we make today about the company's results and plans are 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. And now with that, I'm pleased to turn the call to Belgacem..

Thank you, Nahla, and good morning, everyone, and thank you for joining us this morning. I'll begin on Slide 3 with the progress we have made during the second quarter in the key areas of our business.

First, on safety, and through active and frequent global communications, interactions and recognitions, we are continuing to drive heightened awareness in order to create a fully interdependent and safe work environment.

The executive team, the business leaders and the employees are well aligned and focused on our target of reaching top quartile performance. Second, on our commercial activities. This quarter reflects another outstanding result from the team executing on price actions for our value-added products and services across our entire portfolio.

Further, in Refining Services, we extended 2 meaningful contracts covering approximately 15% of our volumes to 2023 and 2025 on favorable terms, and in silica catalysts, our polyolefin sales grew by double digits for the fourth consecutive quarter as polyethylene plants continue to come online, predominantly in the U.S.

and China, and new business we gained for existing capacity in the Middle East. Additionally, we also recently won new business in Europe and the U.S. as a result of our Korean towing partnership. Third, on our portfolio optimization strategy, and having concluded our assessment of the portfolio, we are now in the process of executing on our plans.

On our previous call, we indicated that these plans include the sale of specific non-core assets at the product line level that could be of more value outside PQ. I'm pleased to share that we recently completed the sale of a portion of our nonstrategic sulfate salt product line from within our Performance Chemicals business for $28 million.

This transaction value implies a multiple of 10 times 2018 adjusted EBITDA, which is an indication of the minimum value proposition for many of our business components. We have other actions underway within the businesses and the portfolio overall. And we expect to update you on our progress as we execute on them.

Finally, on the second quarter financial results. We delivered strong results with adjusted EBITDA growth resulting in margin improvements of 150 basis points versus the same period last year.

Our team's execution on the commercial and operational front drove the outstanding financial performance, even against the backdrop of slowing global demand growth, unfavorable weather and foreign currency headwind. Our portfolio not only benefits from a diversity of secular demand drivers but also the strength of our customers' positions.

That does and will continue to provide stability and sustainability through changing macroeconomics conditions. We are reaffirming our 2019 adjusted free cash flow guidance to a range of $125 million to $145 million, excluding proceeds from the recent sales transaction.

And we remain committed to using free cash flow to repay debt in the second half of 2019. We have already repaid $100 million of our term loan facility this month and we expect we will repay at least a total of $150 million for the year. With that, I will turn the call to Mike for his financial review..

Well, thank you, Belgacem, and good morning. We are pleased to report solid operational and financial performance for the second quarter that led to higher adjusted EBITDA and margins and strong cash flow generation, coupled with proceeds from an asset sale, allowed us to repay the $100 million of term loan in August.

So beginning with Slide 4 with a review of our consolidated related results. Sales of $432 million were in line with the prior year period. On a constant currency basis, sales increased 1.4%, driven by price increases across the portfolio, which helped to offset lower volumes.

Adjusted EBITDA of $132 million increased 2.8% or 4.6% on a constant currency basis. Improved operational performance in both Refining Services and Catalyst drove most of the upside, offsetting the impact of weaker demand in Performance Chemicals. Adjusted EBITDA margin of 28% increased approximately 150 basis points.

Shifting to a discussion by business segment and for Refining Services on Slide 5, sales rose 5% to $117 million. We benefited from favorable mix and higher average pricing, with the rolloff of a legacy contract for virgin asset that was at below market levels.

Volumes were lower, driven mainly by unplanned customer outages that extended into the second quarter from the first quarter. Adjusted EBITDA was up 3.6% on higher sales to approximately $43 million and adjusted EBITDA margin remains strong at 36.5%. Turn next on Slide 6 for a review of Catalyst.

Silica catalyst sales of nearly $21 million rose 21%, driven by continued strong demand for polyolefin catalyst, coupled with an order that accelerated into the second quarter from the second half of 2019. Zeolyst Joint Venture sales of approximately $39 million were down 21%.

This was attributable to order timing for hydrocracking and specialty catalysts, as expected, and shipment delays due to flooding in the Midwest. Adjusted EBITDA of $29.6 million was up 25%, resulting in a margin of 49%.

The outperformance was driven by favorable product mix and higher absorption of fixed cost as we built inventory to meet shipments planned for the third quarter.

Some of this benefit will reverse as we sell through inventory in the second half of 2019, and along with a higher proportion of hydrocracking catalyst sales, we expect margins in this segment for 2019 to approximate prior year levels. Now for Performance Materials on Slide 7. Sales of $119 million were down 6% or 3.5% on a constant currency basis.

Continued higher pricing for Highway Safety products, coupled with a favorable mix, was more than offset by lower volumes.

This volume decline was largely attributable to poor North America weather conditions that impacted our Highway Safety product sales, lower ThermoDrop volumes as we selectively focused on customers who recognized the premium value of this product and a slowdown in Europe for weaker industrial and automotive end uses.

Adjusted EBITDA of $29.2 million increased 2.1% or 3.9% on a constant currency basis and margins improved by 200 basis points to 24.6%. This was the result of capturing price increases, favorable product mix and lower freight costs with better utilization. Turning to Slide 8 for Performance Chemicals.

Sales of nearly $178 million were down 3.3% but were flat on a constant currency basis as higher prices mitigated slowing demand in Europe and Mexico and for consumer cleaning products, globally. Adjusted EBITDA was $41.2 million, down 8% or 4.8% on a constant currency basis, resulting in a lower margin.

While our price increases covered higher raw material cost, lower adjusted EBITDA margin were largely due to weaker demand, higher maintenance costs and an unfavorable currency impact of $1.5 million. Moving to Slide 9 for our 2019 guidance.

With our solid first half performance and expectations for continued portfolio stability despite some pockets of softness in Europe, we are well positioned to meet our key financial objectives for 2019, specifically adjusted EBITDA and adjusted free cash flow.

With respect to our sales outlook, through the first half of the year, we've experienced headwinds from the pass-through of lower sulfur costs and lower volumes and expect further deterioration in sulfur pricing.

We are, therefore, adjusting our sales outlook to be in the range of $1.58 billion to $1.6 billion from $1.64 billion to $1.67 billion to reflect the estimated full year impact of these factors.

However, based on higher pricing, favorable mix and effective cost management, we are maintaining our 2019 adjusted EBITDA guidance in the range of $470 million to $485 million, with adjusted EBITDA margins similar to 2018 levels.

For depreciation and amortization, we now expect to be in the range of $185 million to $195 million, down from $190 million to $200 million, given some capital spending has shifted to the second half of the year.

As a result of the lower depreciation and amortization, we are raising the lower end of our adjusted diluted EPS guidance to be in the range of $0.77 to $0.93 per share. As a reminder, amortization expense for acquisition-related intangibles is not added back as part of our definition of adjusted diluted EPS.

This represents approximately $0.28 per share for 2019. Moving to the outlook at the business segment level. For Refining Services, we expect sales to be down slightly by low single digits, reflecting lower sulfur pass-through while adjusted EBITDA is expected to increase in the low single-digit range, driven by higher average pricing.

For Catalysts, we expect silica catalysts and the Zeolyst Joint Venture sales and segment adjusted EBITDA growth in the double-digit range from expected robust sales demand for polyolefin, MMA and hydrocracking catalyst.

Performance Materials sales are expected to be down slightly year-over-year on lower volumes but expect high-single digit adjusted EBITDA growth on pricing drop-through, favorable mix and improving logistical cost.

Finally, for Performance Chemicals, we expect sales to be flat and adjusted EBITDA down low single digits due to anticipated weaker demand in Europe, unfavorable foreign exchange and that the benefits of higher prices are only offsetting higher raw material costs.

For the third quarter 2019, we anticipate GAAP sales largely in line with Q2 levels on the pass-through pricing of lower sulfur costs. Zeolyst Joint Venture sales are expected to be strong on higher hydrocracking catalyst sales.

Adjusted EBITDA is expected to be in line with the second quarter but up low double digits versus the prior year third quarter, given the timing of orders for hydrocracking and specialty catalyst sales in the Zeolyst Joint Venture and improved results from Performance Materials as higher demand and lower costs are expected to drive growth over prior year.

So to reiterate our key financial objectives, we are on track to generate adjusted free cash flow in the range of $125 million to $145 million, which excludes the sale proceeds from the sulfate salts product line.

We continue to dedicate free cash flow to debt repayment as evidenced this week with our recent reduction of our term loan by $100 million. It is our expectation that by year-end, our net debt to adjusted EBITDA leverage ratio will fall to approximately four times.

With that overview of our second quarter results, I will now turn the call back over to Belgacem..

our differentiated portfolio businesses has proven history of delivering stable results through changing macroeconomics environment. We had solid first half performance that positions us to deliver on our 2019 key financial objectives.

Given the first half performance, coupled with order commitments in our Catalyst business, we anticipate that our second half result will be stronger than the first half of the year. We will continue to execute and communicate on our plans to optimize our portfolio and streamline our businesses to be simpler and stronger.

And finally, we are fully committed to driving shareholder value through capital efficiency, generating strong free cash flow and progressing towards our leverage target. That concludes our prepared remarks, and we're now ready for questions..

Thank you. We will now begin a question-and-answer session. [Operator Instructions] The first question will be from John McNulty with BMO Capital Markets. Please go ahead..

Thanks for taking my question and congratulations on a solid quarter in what's looks like a tough environment out there. With regard to the portfolio, look -- you've made a good solid move, it looks like this past quarter, I guess.

What can we see or -- it sounds like there are other sales to come or other tweaking of the portfolio to come? I guess do you think any of that can be done before the rest of the year is out? Or is this something that really kind of pushes into 2020 as we look out?.

Hi, John. Thanks for the question. Let me quickly walk you back to what happened in the last 3 quarters. In the last year, we went into this announces of our portfolio. We studied the businesses. We started to look at how they fit together and how the portfolio can remain strong and be even stronger.

We made a decision to delay the organization and enable the businesses to be stand-alone so that we can dig deeper and understand the components of the business.

Step 3 is we went into each business and we looked at the components of the business and sub-product lines and we made an evaluation based on future growth potentials, capability and impact on the current portfolio. And then we started -- we built a list of elements that we will follow up on.

One of them was what we just actioned on, on the salt business that we managed to execute on time and at a very, very good value that I believe was the right thing to do for us. What's next would be a continuation of the similar exercise that we started. As I said in my remarks, we're looking at many other things.

We're looking at the portfolio as a whole, and we believe there will be some things going on. I can't give you the right time but I think we're very, very active today and I expect to see some things happening in the future, and we will definitely keep you up to speed..

Great. Thanks for the color on that. And then I guess in the Refining Services segment I guess maybe two questions there.

How many other asset contracts would you say you currently have that are below market that will eventually roll off? And then I guess the second one would be, just given the condition of their refining market right now, which looks difficult, are you seeing any incremental interest in those refiners possibly shifting their captive asset production to outsourcing it to companies like yourself?.

Hi, John. This is Mike. So with respect to the repricing, there's a lot that has taken place over the last few years. We tend to do 20% to 25% per year. This one was different in particular. It was a legacy contract that came over with the acquisition of Eco Services.

And you may recall that we had a gain in the fourth quarter of last year because that contract terminated and we wrote off the deferred contract liability that we had for that. So that went away in the fourth quarter. So as that capacity became available, it got replaced with higher price business.

That's why we talk about having higher average pricing year-over-year. With respect to the refiners, we are not really seeing anything in terms of major shifting. There has -- there's probably 10% of the population that is considered to be captive. We have converted some captives over the last couple of years. I think 2015, '16 was the last one.

So they are episodic. It's whenever the refiners decide, they have to make that capital commitment and whether they want to tie themselves to just one asset plant versus the advantage we have with the network. So don't see anything in the near term horizon on that, particularly, as it relates to current market conditions.

But it's something we look at very closely because we can provide a lot of value in those conversions..

Got it. Thanks very much for the color..

Our next question will be from Christopher Parkinson with Credit Suisse. Please go ahead..

Great. Thank you. It sounds like you've done a true bottom-up analysis on the sub-segment basis. So when you look at your business mix, respective growth rate assumptions and subsequent working capital needs.

What should we expect on the cash conversion front versus what assumptions are -- you are currently making into the $125 million to $145 million this year? Just any big changes over the next 2 years? Thank you..

Yes. This is Mike. Across the segments, the cash conversion -- I mean, if you're talking about EBITDA minus CapEx over EBITDA tends to run from the upper 60s to the low-70s. Refining Services, in particular, has gotten to the upper end of that range as we continue to put in some good debottlenecking projects.

So I think probably not a step change in that cash conversion.

I think what you'll see is, for some of these smaller potential divestment items, it's going to be something that can be separated, that doesn't have the growth rate that we're looking for relative to other opportunities in the portfolio, that we maybe a crossroads in our own side, that says, do we really want to recapitalize for this market, and if it's got value in somebody else's hands, we can do that.

But that's more of a monetization rather than a significant rating in the cash conversion ratio..

Okay. Thanks. And just a quick follow-up. There's been a few moving parts in Catalysts and the silica and the Zeolyst JV. Can you just comment on the additional puts and takes on order timing, et cetera, during the second half? And how The Street should be thinking about your price volume outlooks for '20.

Just any help putting the pieces together for the outlook there would be helpful..

Sure. I'd be happy to. So I mean -- first off, in the second quarter, we had a very strong quarter. There were a couple of moving parts. We didn't know it in the slides, if you saw that than we had. And it's our -- it represents our 50% share with a big gain on the sale of the JV had in the Rive Investment.

But that was less than the 1/3 of the $6 million increase that we had in the quarter. The rest of it really related to that order that shifted out in the second half, into 2Q.

And then I've mentioned some favorable absorption from the inventory build because we're expecting very good sales in the third quarter but that would be net of -- we were quite a bit lower on volume, as you would have noted, on the Zeolyst Joint Venture, where sales were off 20%, which is also just timing.

So we expect -- as you've looked at -- we've got 2 strong quarters in the silica catalysts area with the polyolefin demand, which has been great. We expect the third quarter for the Zeolyst sales to be the strongest quarter of the year.

And that's why what that led us to the sales and EBITDA guidance that I provided you around being in line with the second quarter on sale, not as GAAP sales, and then on the EBITDA, which we include in our share of the Zeolyst JV..

I'll just add that every quarter has a different type of colors because the mix of the products that we produce and ship, changes. And as the mix changes, you'd see emphasis on margins up or down based on that mix. So there is a nuance of the mix that plays a role in the variance between quarters. On volumes, yes, it's growing.

On margins, it's going to be up and down based on the mix. Just keep that in mind..

Thank you..

The next question comes from David Begleiter with Deutsche Bank. Please go ahead..

Thank you. Good morning and very nice quarter. Belgacem, like I know it's early to discuss 2020, but if you assume just similar economic growth, i.e. slow for next year.

How should we think about your EBITDA progression in 2020 versus 2019 on a very high-level basis?.

Well's to be honest, David, it's just -- we're really focused today on delivering on our current plans. We -- as I described, we see our resilience being confirmed in this environment that is unstable and simply it's because of the quality of the businesses that we have.

Like everybody else we are going to be seeing some of the headwinds on volumes every once in a while. I have no concerns, no major concerns about our ability to deliver but the environment will dictate what really happens.

So it's a bit early for me to talk about the EBITDA progression in 2020 but what I can tell you is the fundamentals, the growth drivers, and the fundamentals of our businesses especially as we continue to look for opportunities to maintain good solid business components, should be favorable pending what happens in the market between now and year out..

Understood. And maybe just on Performance Materials.

The weather impacted sales, ThermoDrop, et cetera, are they lost for the year? Or are they caught up in the back half of the year?.

No. It tends to be caught up and when we had weak or poor weather conditions in the first quarter and then ran into this -- in the last 225 years of second-worst rainfall in the U.S. But those orders tend to stack up and get picked up later in the year. We are all -- we had a very good July.

So once the rain stopped, the striping commenced, and we've seen really good flow in the first month of the quarter. So we're happy with that. And it just -- ultimately, it will depend on how long the warm weather goes into the fourth quarter. But we're very happy with the rebound that we've seen here at the beginning of the third quarter..

Great. Thank you very much..

You're welcome..

The next session will be from Vincent Andrews with Morgan Stanley. Please go ahead..

Hi. This is Andrew Casio on for Vincent. Just a question around your guidance.

If you think about the lower end of the guidance, I guess, what are the risks that you see and what is really embedded in that and perhaps just more broadly what are the kind of risks that you see in the broader economy in your business that you'd be worried about?.

Well I'd say we took the midpoint down some $60 million, 1/3 of that would relate to the lower sulfur pricing but you should recall that that's dollar-for-dollar. That has no impact on EBITDA, which is part of the reason why we can we reaffirm our EBITDA target.

So it could be additional deterioration in sulfur pricing that gets passed through via lower sales. As you look at the first half of the year, we talked about weather and materials. That has impacted chemicals as well. We had the unplanned customer outages in Refining Services that had crossed both quarters. So we think that's behind us.

So for Refining Services, I mean we feel pretty good where that sits.

I'd say the bigger risk is probably in chemicals, you've seen the performance be flat to slightly down, not bad given where we are and what others are seeing in this macroeconomic environment, which is a testament to the stability and diversity that we have within that portfolio but I'd say, a little more risk in Europe.

We had a lot more impact for foreign exchange year-over-year in the first half than we're currently projecting in the second half, which is based on FX rates where it sits today, so that could be some additional downside..

Let me add one thing on the Chemical side and it's true that chemicals -- Performance Chemicals is probably the area that has the lot more uncertainty overall. We, as I mentioned in the prepared remarks, the code forward, immediate going forward is we're going to be scrutinizing further our chemicals portfolio.

We are -- we have reorganized the business a while ago so we are now looking at efficiency creation, debottlenecking, we have about 38 facilities that produces products around the world.

Efficiency of the product, capacity increase, debottlenecking, and then efficiency and logistics and distribution further efficiency would be some of the areas where we would use to kind of counter some of the market headwinds and that represents what were the only -- one of the fewer risks that we see between now and year end.

And that's going to be at work to do in Q3 and Q4..

Perfect. That's very helpful. Thank you.

And I guess just following up on that, that work that you will be doing in 3Q and 4Q, when can we kind of expect the benefits of that to start to flow through the P&L?.

Some of the efficiency would be immediate in terms of volume creation and some of it will probably be kind of a tripling into this -- next year. But some of it, what I -- my objective is to get some of that immediately so we can't resist deterioration and hopefully, won't be there for long..

Okay. Thank you. And congrats on a great quarter..

Thank you..

[Operator Instructions] Our next question comes from Aleksey Yefremov with Nomura Instinet. Please go ahead..

Thank you. Good morning, everyone. Do you see rising demand for alkylate following recent refinery closure in the U.S.

and could this benefit PQ directly over the next few quarters?.

Yes, I think when the -- between closures or there's been some other fires that have impacted capacity that's not been huge but where you've seen that geographically, what that does is it shifts demand down to the Gulf Coast where we have a very strong position.

So yes, we do see that as favorable given that, generally speaking, we're going weather its individual events or just the way the market has shifted it. You do see demand shift and pull out of the Gulf Coast and the West Coast, where we have a very strong position..

Yes. And just following up on that. I realize you don't have guidance for 2020.

But will you be able to grow volumes in Refining should there be additional demand?.

Yes. We've been doing several debottlenecking projects over the last 3 or 4 years that have provided additional capacity..

And just if I may follow-up again.

How should we think about that potential demand growth? Is it low single-digit, mid-single digit next year for Refining?.

Yes. I mean, I think, it's a little early to tell but, generally speaking, we would expect Refining to be in the low single-digit, right now -- yes, potentially a little higher. A lot of it just depends on how many turnarounds we're doing in any given year. We have a lot this year, a fewer next year, which means lower cost and more operating days.

So that can be a positive as well..

Great. Thanks a lot..

The next question will be from Robert Koort with Goldman Sachs. Please go ahead..

Good morning. This is Dylan Campbell on for Bob. When you look at the kind of free cash flow guidance for 2019, I think the first half was pretty flat and implies a step up into the second half. I think, it's pretty normal considering that flat seasonality.

But I was just wondering if you could just give some type of bridge first half to second half 2019?.

Well, yes. You're correct. We tend to be pretty flat. We're up $10 million I think on a year-to-date basis versus last year. But we are usually pretty flat in the first 2 quarters, just due to the seasonality of the business.

Particularly as it relates to Performance Materials and when their sales occur starting in the second quarter and start to get collected in the third quarter. So the cash flow guidance is basically all in the second half. The cash flow targets that we have for this year are a little higher, particularly on the operating side than we had last year.

But I think a good view of our visibility into the cash flow is the fact that we've paid down $45 million of term loan at the end of the third quarter last year. And today, we sit here in August with $100 million payments. So we feel good about our cash flow outlook..

Got it. Thank you..

Ladies and gentlemen, this concludes our question-and-answer session..