Good morning, ladies and gentlemen, and welcome to the Avient Corporation Third Quarter 2020 Conference Call. My name is Crystal, and I'll be your operator for today. [Operator Instructions]. At this time, I would like to turn the call over to Joe Di Salvo, Vice President, Treasurer and Investor Relations. Please proceed.

Thank you, Crystal. Good morning, and welcome to everyone joining us on the call today. Before beginning, we'd like to remind you that statements made during this conference call may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements will give current expectations or forecasts of future events and are not guarantees of future performance. They're based on management's expectation and involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statement. Some of these risks and uncertainties can be found in the company's filings with the Securities and Exchange Commission as well as in today's press release. During the discussion today, the company will use both GAAP and non-GAAP financial measures. Please refer to the earnings release posted on the Avient website, where the company describes the non-GAAP measures and provides a reconciliation for the most comparable GAAP financial measures. Joining me today is our Chairman, President and Chief Executive Officer, Bob Patterson; and Senior Vice President and Chief Financial Officer, Jamie Beggs. Also joining us for his last earnings conference call is Brad Richardson, our previous Executive Vice President and Chief Financial Officer, who announced his retirement a couple of months ago. Now I will turn the call over to Bob for some opening comments.

Well, thanks, Joe, and good morning, everyone. I'd like to start with words of support for those who've been impacted by the coronavirus. The pandemic is far from over, and we remain mindful of the many ways it is impacting people around the world. Our heartfelt appreciation goes out to the countless frontline workers and first responders as they continue to play such an important role in the response and recovery effort. This is our first quarter that we are reporting results that include the Clariant Masterbatch business, which we acquired on July 1. At that time, we welcomed over 3,500 associates to our newly named company, Avient. And we took a big step forward in our specialty transformation journey. It's created tremendous energy internally with our associates. Our customers are viewing us as a specialty partner, and our performance in this challenging environment is demonstrating the strength of our diverse and resilient portfolio. I'm pleased to report that we delivered third quarter adjusted EPS of $0.54, excluding the impact of purchase accounting step-up depreciation and amortization. Inclusive of the step-up D&A, we reported adjusted EPS of $0.46, and this is $0.03 better than we expected in our pre-announcement in September and exceeds the $0.44 we reported last year. The $0.03 improvement from when we met or talked a month ago was driven by a strong finish to the quarter with September sales growing 6% over the prior year. And particularly encouraging was that the increased demand in September wasn't isolated to 1 segment or region, all grew sales for the month. The last couple of quarters have been challenging for sure. But we, our customers and our shareholders have clearly benefited from the execution of our strategy to reposition our portfolio in recent years. Through our divestiture of PP&S…

Thank you, Bob. I'm extremely excited and proud to have joined Avient, and my first few weeks have been fantastic. It's great to be back in the specialty space, one that I know well, and part of a company that has tremendous growth opportunities. Most importantly, I moved across the country with my 2 kids and my dog for the culture that Bob has built, a culture that has both an intense focus on winning and excellence as well as one that is fostering a great place to work for its employees. I've met several of you already on the call and look forward to working with each of you in the future. Let's jump into the specifics of the third quarter. We reported GAAP earnings per share from continuing operations of $0.02. Special items in the quarter resulted in a net after-tax charge of $40 million. Special items were primarily associated with acquisition-related costs and an adjustment to environmental reserves. Acquisition-related costs primarily consist of inventory step-up and the financing commitment associated with the Clariant Masterbatch's acquisition. Adjusted EPS for the quarter was $0.46 compared to $0.44 in the prior year third quarter. Excluding the impact of the step-up depreciation and amortization associated with the Clariant Masterbatch acquisition, adjusted EPS was $0.54. Total company revenue increased $219 million to $925 million, primarily due to the Clariant Masterbatch acquisition, which closed on July 1. On a pro forma basis for the acquisition, third quarter sales declined 5% compared to the prior year, primarily due to COVID-related demand weakness. The impact of foreign currencies on total company sales was very minimal, at less than 0.5%. While the pandemic continues to have an impact on revenues, overall demand improved significantly from the second to the third quarter across all end markets. The…

Thanks, Jamie. I'm very proud of our team's accomplishments this quarter and for the entire year for that matter. Most importantly, we kept our people safe, healthy, engaged and inspired. This has allowed us to effectively run the business and serve customers during these challenging times. And despite the pandemic, we are off to a fantastic start with Clariant. While synergy capture is a priority for us and key to value creation from the acquisition, I'm even more excited about what the business brings to us in terms of long-term innovation and the resulting revenue growth. In early October, we published a new investor relations presentation to help articulate the story. The presentation remains available on our website, and if you have not had a chance to review it, please do so. In it, you will find important messages about Avient, who we are, what we do and why we win. And just last week, we published our latest sustainability report. It is a comprehensive account of our performance on ESG matters. It is our second report, and we have significantly increased the amount of information, data and transparency on topics that are important to all of our stakeholders. Our position in the value chain is a special one, but as a material science leader, formulator and designer, we're in the early stages of our customers' new product development, and we help them achieve their sustainability goals. At the same time, we are running our facilities as an ACC Responsible Care certified company, operating safely for our employees while protecting the environment in our communities. Further as a founding member of the Alliance to End Plastic Waste, we have joined in the global effort to eliminate plastic waste and build awareness and infrastructure to leverage the inherent benefits of plastics.…

Well, thank you, Bob. And I do appreciate that final comment about do it for Brad. I did want to just say a big thanks for the support and friendship over the last 7 years. I've had a little bit of time to reflect, and I have great memories of our travels together with the sell-side community. There are a lot of smiles around the table right now as I'm talking about this. Frank and Aziza, the annual Christmas dinner in New York, I will miss that. Some of those went into the wee hours of the night, but just great memories. Mike Sison, I remember traveling with you after the Calves won the national championship. There was no suit to be found, just Calves' gear, and some of the stares that we got in the elevator are just priceless. Dinner with Ben Kallo in Portland, I can't really say more about that. And Mike Harrison, I still want to understand how at an important dinner in Chicago that we got off on an hour-long discussion on whose cheesy potatoes were better, yours or Bob's. So anyway, I just want to thank you so much for the great memories and support. Some of you know I like to boat, and there's a favorite quote of mine about a sailor. And it goes like this, "The pessimist complains about the wind, the optimist expects it to change and the realist adjusts the sails." And though our -- although our 4-pillar strategy remains the bedrock, it remains our beacon, our true north, we have adjusted the sails, with extensive portfolio changes over the last 7 years, with Specialty Solutions focused on consumer, packaging and health care, which, as Bob mentioned, makes up over 60% of our portfolio. Think about where we were…

Thanks, Brad. You're absolutely going to be missed. We really appreciate all your contributions to the company over the years. Thank you very much. So we now have time to take calls and who knows, maybe Brad will take 1 or 2 of those.

[Operator Instructions]. And our first question comes from Bob Koort from Goldman Sachs.

Best wishes, Brad.

Thank you, Bob.

Bob, that was quite an impassioned bit of enthusiasm for the company and what you see. I guess I'm curious, your free cash flow looks pretty darn robust. Do you think you could flip to buying back some of that undervalued equity sometime in the next couple of quarters?

Yes, I think the primary goal is to get net debt leverage down below 3x. And we're just above that as of September 30, expect to be below it by year-end. So I think once we pass that threshold, we could be in a place to consider doing that again.

I'm curious, the fourth quarters traditionally are pretty unkind to the chemical industry. You tend to see destocking and inventory management by customers. And 2020 is obviously a very different year. You guys have thousands of customers. Do you have any sense, should these lockdowns accelerate through the end of the year, is there a big drawdown risk at your customer level, at your own level? How do you assess sort of the channel inventories at the moment?

Yes. I mean December has always been a wild card. And I've always said it's difficult to draw a conclusion from December and/or January by itself. But if you put the two together, you get a sense for how well things are going. Look, with an increased level of lockdowns or conservatism related to the pandemic, anything, I think, could happen in December, and it's very difficult to predict. With respect to our own projection to grow EBITDA year-over-year, we've got a conservative estimate in there for the last month. So if that doesn't happen and things go better, we could do better. I'll tell you, it's also been a challenge to think through a forecast for this fourth quarter because to some extent, the recovery is offsetting historic seasonality. So some of the things that we would have perhaps modeled in the past and said, "here's how I think Q4 will look," just simply don't seem to be playing out, at least with respect to what we've seen in October, which was a really good month. So that's as clear as we see things right now, Bob. Obviously, the COVID pandemic is still to be determined how that impacts the year.

Our next question comes from Frank Mitsch from Fermium Research.

Congrats, Brad, don't be surprised if Fermium pays a visit to you out west down the line. So yes, man, we'll miss you. And of course, nice to meet you again, Jamie. Bob, if I want to come back to the Clariant business, the EBITDA in the second quarter, I believe you said was $37 million for the third quarter -- $33 million, and based on your guidance, it looks like the fourth quarter is $29 million or something like that. How do we think about the seasonality of that business on a more normalized basis? Number one. Number two, the pandemic obviously has played some havoc with the top line. How do we think about the top line of that -- trending for that business as well?

Yes. So the fourth quarter, there is some seasonality in the Clariant business in the fourth quarter. I'd say it looks very similar to our own Color business. So as you -- if you look back historically at how we performed in Q4, that's how I think you can think about Clariant performing in a normal year. I mean, obviously, there is some COVID-related impacts this year that could offset some of that seasonality in Q4, but that's probably the best way to think about it. And then from a revenue standpoint, I'd say the same thing from a seasonality perspective. So it was down a little bit year-over-year in Q3, I expect that could be about the same in Q4.

Okay. All right. Great. And Jamie, I believe you said that the free cash flow for 2020, you're targeting $270 million. I assume that that's just a have half a year of Clariant in it. If Clariant had been part of the portfolio from January 1, where do you think that free cash flow number would have gone to?

Frank, this is Joe. Clariant probably adds around $30 million to $35 million of free cash flow. We got a big benefit this year coming from working capital, obviously, with declining sales, so that's been helping us this year. So that's where you'll see the Clariant half year next year should offset some of the benefit we got in the working capital improvement this year.

All right. That's very helpful. And Joe, just remember, do it for Brad.

Our next question comes from Mike Sison from Wells Fargo.

Nice quarter, and Brad, congratulations. I do have a nice Browns outfit if we ever do get to the Super Bowl. But Bob, in terms of 2021, can you maybe help us frame what the growth potential could be next year? How much synergy comes into place? You do have other cost-saving programs, and then if there's continued momentum in EM, how do you think we see EBITDA growth next year?

Yes. I'm going to put specific guidance related to 2021 kind of in the parking lot for now, Mike. I feel comfortable with what we just said about Q4, but want to give a little bit more time to pass. So I expect us to say more about the full year when we come out with our end of year results. But I can answer, I think, maybe the last part of your question, which is synergy expectations. So we have sort of talked a little bit about run rate achievement over periods of time and have said, let's call that $30 million of run rate by the end of next year. And I think that, that means that about, let's say, $15 million to $20 million could actually benefit the bottom line next year calendar wise. So maybe that's a good estimate or a way to think about a starting point with that level of Clariant synergies.

Great. And then when you announced the deal, I think you all talked about a $500 million EBITDA potential. Synergies are coming better. You sound inly enthusiastic on the combination. Is that still the marker? Or has that potentially gone up as you have spent more time with the company -- with the new company?

I missed the very first part of that was, what's still the marker, I'm sorry?

The $500 million EBITDA that you all talked about when you announced the deal.

Yes. Okay, that was a pro forma number looking at putting '19 together.

Pro forma.

Yes, that's right. So yes, -- I mean I think with the increased synergy estimate, I think we've got an ability to get to that faster than what we previously projected. We haven't said anything else yet with respect to timing, but you can see where the numbers are coming out this year. I think we're going to be ahead of that on a timing perspective.

And our next question comes from Vincent Andrews from Morgan Stanley.

This is Angel Castillo on for Vincent. Just a quick question regarding the fourth quarter. I was wondering if you guys could give us a little bit more color on -- as you look at the guidance that you provided in terms of how much of that might be synergies and as we think about October, you talked about things continuing to improve. I think you said sales grew 6% in September. So is that then high single digits? Or could it be better in October? And how are you looking at it in terms of November as well?

Yes. I'm not -- we're not forecasting 6% of sales growth for the fourth quarter to be clear. While September was strong, October is up probably about 1%. And I think for the fourth quarter, you can consider sales to be down, probably around flat to down 1%. Something close to that, okay, I think about sales overall. And then I think with respect to synergies, we do have some administrative costs that have already been -- basically, there were some associates that didn't come with a deal that were synergies from day 1, we'll still see the benefit of that here in the fourth quarter. But the real benefit is going to start coming in, in the first quarter of next year. So I mean, you can model in probably like $2 million or so in Q4.

Great. And then in terms of -- as we look at 2021, so as you noted earlier in a previous question, I guess, you start considering buybacks as you get below 3 turns of leverage. How should we think about bolt-on acquisitions and potential to do some of that?

Yes. I mean, look, our priorities from a cash flow standpoint have always been, obviously, to invest in what we need to in the business first, then we'd like to be able to do acquisitions, increase our dividend. And of course, then we've opportunistically bought back shares. What I'd say about the M&A market right now is that there's some real challenges with looking at acquisitions outside the U.S. because, candidly, our leadership team here can't travel, and we like to see everything in person. So there are some things in the U.S. that we're continuing to look at, but I do feel like there's some challenges just with respect to moving some things along. We got two that candidly are just kind of on a back burner until we could find a time to travel. So we do hope that next year, we can get back to doing some bolt-ons. And as you've seen historically, we've been able to do all that and buy back shares, and I think next year could be a really good illustration of that.

And our next question comes from Mike Harrison from Seaport Global Securities.

And yes, I don't know if the -- I still like my recipe, but the Patterson potatoes are family -- new family favorites here. So -- wanted to ask about the Clariant synergies. If you maybe just talk a little bit more about the integration process so far. Where have you seen things exceed expectations? And if you could break down kind of that $15 million increase to the synergy number, where does that come from? And is there any further upside?

So for the most part, the $15 million next year is going to come from sourcing savings. There'll be some administrative cost reductions. But I think the cadence in terms of when we get after the three buckets that we've previously published is really unchanged with sourcing really coming first. And as you -- and I think we put out in the investor deck when we went from $65 million to $75 million, Mike, we increased really our estimates in all three areas. So we see opportunities within each. And that was, one, I think, just a factor of having a conservative estimate of what we could do when we first announced the deal. But then also the Clariant leadership team coming forward and saying that there were other ideas we should consider and we now are. So I think it's a really good combination of our ability to validate what we thought initially, but then also get some new ideas from their team, which is how we came up with that new number.

All right. And then I wanted to ask you about the Engineered Materials business and the margin strength there. That 30%-plus gross margin number, I think, is the best you guys have done since 2016. You mentioned the improvement that you've seen in the market performance of Composites, is that the main driver there? Or kind of how do we think about that gross margin sustainability versus what you guys delivered in Q3?

I mean it really is the main driver in Q3. We -- I'm sure -- we are benefiting for sure and an uptick in demand for outdoor applications. Some of that may have been that there were challenges with customers being able to get product in Q2 and companies being able to supply that and so then that has a pickup in Q3. So there may be some uptick there that's taking place. But either way, if you just smooth it out over Q2 versus Q3 or however you looked at that, the margins in the Composites space have improved dramatically from where we were a couple of years ago. So no doubt, Composites is playing a big role in the margin improvement. If I looked at the rest of the business, sales are down slightly and the story kind of resonates with everything else we've said, which is that automotive is still down. Industrial applications are still down. There's still some pandemic effect, and that plays a factor in the rest of the business for EM.

And our next question comes from Ben Kallo from Baird.

Congratulations, Brad. Your [indiscernible] is more important than Facebook to me.

Thank you.

Can we talk about the margins on Color? I imagine this has step down just related to the acquisition. But can you talk us through that and kind of where target margins on the operating side go? I'll leave it there. And thanks again, Brad, for everything.

Yes. I think everyone was aware that the starting point with the legacy Masterbatch -- Clariant Masterbatch business is certainly lower than our own. And so when you look year-over-year at EBIT or EBITDA margins, obviously, they're both down about 2 points. And that's mostly just putting the businesses together. So when -- I'd also point out, though, that year-over-year, our Inks business is still down quite a bit. So that's playing a factor in margins organically for us. Look, as we've said, we think that we can get the Clariant Masterbatch margins up to our legacy Color margins and ultimately above 20% EBITDA return on sales. So that's where we think we can get to here in the near term. As we capture these synergies, that should come to fruition.

Our next question comes from Colin Rusch from Oppenheimer.

Thinking about recycled and renewable materials and the availability of those relative to some of your customers' demand. Can you talk a little bit about both price dynamics for sales and sourcing and then also your process for evaluating the viability of some of these newer processes that are starting to try to ramp?

I think your question was really about recycled content and evaluating the sort of the viability of that going forward. Is that right?

Yes, as well as just an update on the pricing dynamics in and around the spaces.

Okay. So I mean, as a starting point, I think that all of our customers are looking at using an increasing level of recycled content. That's going to happen. It's moving forward. As you know, there's a challenge with respect to getting it. And for everyone who has set goals out there for the future, they can't be achieved with the present level of recycled content that exists. So a lot's got to be done there. From a pricing standpoint, in a lot of cases, recycled content is actually more expensive and therefore, create some challenging dynamics around that. Look, this year, that just hasn't played a big factor in our margins. But certainly, it is in the conversations that we have with our customers. At the end of the day, we're providing a formula. And that base resin, if it's recycled or virgin, is really we want to do what's best for the customer, best for the environment, and we'll price accordingly. So look, overall, I view the sustainable solutions platform as a really good margin, good guide for us. And one of the reasons why we should see margin expansion on top of the revenue growth that we have projected for that area.

Okay. And then the second question is really about capacity and how you guys think about the incremental capacity? What do you need to see? How do you think about repurposing some of your existing capacity for higher-margin opportunities? And then how should we think about CapEx on a go-forward basis?

Yes. So I mean, from a capacity standpoint, I think one of the great things about bringing Clariant together with us is that we can take some capacity out. It's a unique business in that each of our plants is a relatively small footprint, often with its small lines, quick-turn batch processing. But there are opportunities for synergies there, which we'll go after. And we really want to harmonize things on a product line basis and go to those locations that are the best of the best. So from a CapEx standpoint, I think close to $60 million this year is a good figure for us plus Clariant. And if you want to look forward and we think about some CapEx that will take place related to achieving some of these synergies, that may add about $20 million next year, but it's still a little early on the -- figuring out the timing of that CapEx. So that's just a rough estimate of where to start.

Our next question comes from Laurence Alexander from Jefferies.

I guess, first a near-term question. In terms of the improvement in trends that you're seeing in Q4, are you seeing any significant areas of softening outside normal seasonality?

I don't think anything is softening. I do think that in the third quarter, we saw a little bit of change because in the second quarter, there was some higher dynamics for, let's say, health care and packaging, and that moderated in Q3. Probably, we'll see the similar effect in Q4. But again, that is completely dependent on what happens with respect to coronavirus, right? So I'm basically just sharing with you what I've seen so far in Q3 and in October. That's the best way I can describe that.

And in the end markets where you have longer qualification cycles or qualification campaigns or technical campaigns to be accepted into new customers, what's your confidence level on market share gains next year?

Well, look, I think, first of all, this year, customers have focused very much on meeting demand for their essential businesses. And I'd say probably in the last month or so, we started to see some pickup with respect to next-generation projects, which is encouraging. We're finding a way to do that virtually between our sales folks, our technology teams and our customers. But I don't really see anything changing with respect to maybe the timing of approval, except that for sustainable solutions, I think that moves faster because everyone is trying to get better solutions in that regard. So if I just kind of think about -- that's probably one of the biggest trends that's out there as I think that stuff moves faster.

And then just lastly, can you flesh out a little bit your ambitions for your presence in Asia? So what percentage of sales in 5 years? Or how much additional resources you feel you need to put into the region to get to where you want to be?

Yes. And as you -- I think -- I don't know that we've mentioned it in the last quarter or two, probably because of everything going on with the pandemic, but we have continued to invest in and build a new manufacturing facility in Suzhou, China. It'll be our largest facility. And it's really going to serve as an important area of growth. In 2019 or at the beginning of that year, we were really starting to bump into some capacity constraints. So with that new facility, with Clariant part of the team, I think we'll have the footprint that we want. Look, from an organic perspective, I think sales can continue to grow at 8-plus percent or more. And for us to do more than that, we probably have to look at acquisitions.

And we'll take our final question from P.J. Juvekar from Citi.

Congratulations both to Brad and Jamie. Quick question on EM products. What was the impact of 5G as the networks are getting rolled out? Was there any significant impact in the quarter? Or is it just getting started and you should see that, I'm just curious?

Yes, yes, for us -- so first of all, I mean, the fiber optic business that we support with our Composites platform supports all the technologies, including legacy generation. So that has been, by far and away, the majority of our sales so far. 5G is really getting started for us in that particular space because we have the largest presence in the U.S. and in Europe. What we serve in Asia, for example, is outside of that particular Composites space. So I'd say 5G was pretty small for us in Q3. But obviously, as more and more locations begin to adopt and put that into place, that's going to grow. That particular business, we have an expectation will grow at 10% sales annually.

Great. And then you sounded a little cautious on Europe in your comments. Was that an automotive-specific comment? I know the COVID cases are going up everywhere. And then secondly, on North American auto production, I think you sounded positive for 4Q. Typically, these auto companies take downtime around holidays. But there are -- there is some thinking that inventories are so low that maybe production will be -- they won't take downtime and production will continue to ramp up. Can you just give your comments on auto production in U.S. and Europe?

Yes. I mean with what we've seen so far in October, the U.S. is a positive. It seems to be -- or North America is a positive. You're right in terms of thinking about how the industry has historically navigated the fourth quarter. I guess anything could still happen, but what we've seen so far has been a positive. And I guess my observation on Europe is just relatively weaker than that. We just have not seen a recovery in Europe to the same extent that we have in the U.S. So maybe -- and this won't just be all automotive, but to put things in perspective, I mean sales in the second quarter in the U.S., North America were down about 14%. In the second quarter, they were down about 5% in Q3, which in Europe was still down about 10% in Q3. So things just haven't recovered at the same pace. I guess that's the best way I can describe the relative performance in the two regions. Great. Thanks. Listen, I understand that was our last question. I appreciate everyone joining the call today. We're obviously very excited about the business. We're excited about our growth prospects. But we also want to keep in mind that the unmistakable reality here that we are still in a pandemic. And at Avient, we're going to continue to keep health and safety first and hope everyone else does the same. So thanks, and everyone, have a great day.

Ladies and gentlemen, thank you for your participation in today's call. This does conclude the conference, and you may now disconnect. Everyone, have a wonderful day.