Good day, and welcome to the PQ Group Holdings Third Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operators 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, Elissa. Welcome to everyone joining us for our third 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. Good morning, everyone, and thank you for joining us this morning. On our last earnings call, we discussed our expectations for another consecutive quarter of strong results, largely driven by our Catalyst business. We are extremely pleased to have delivered significant growth in adjusted EBITDA, margins and adjusted free cash flow, which positions us well to deliver on our free cash flow and leverage targets for the year. This performance demonstrates the benefit of our diversified portfolio and the operating leverage within our specialty businesses, which underpins the resilience to changing macroeconomic environment. This is evident from our positive pricing across all our businesses and the year-to-date financial performance in three of our four businesses. That said, and as you know, there has been numerous reporting of global economic slowdown. We are not completely immune and are experiencing softer demand in some pockets of our businesses, mainly in Performance Chemicals. With that as a backdrop, I’d like to briefly cover what we’re seeing in the markets underlying our businesses. Starting with Refining Services. Despite the numerous unplanned refinery customer outages in North America, overall, alkylate utilization rates are high. This favored our regeneration services line. As for virgin sulfuric acid product lines, the diversity of end uses is a strength. When there is demand weakness from one end market, we work to shift focus to another end markets, such as mining, batteries and the other general industrial applications. Turning to our Catalysts business. Demand drivers are largely insulated from global macroeconomic fundamentals. For example, demand for our catalyst products that serve the polyethylene industry is driven by increased capacity expansions. And our hydrocracking and specialty catalysts benefits from timing of refining customer change-outs, coupled with capacity expansions. In our Performance Materials business, we had a soft start…

Well, thank you, Belgacem, and good morning. We are pleased to review another quarter of strong financial performance. We delivered significant growth in adjusted EBITDA, margins and free cash flow and have increased our debt repayment target for the year. Beginning on Slide 4 with a discussion of our consolidated results. Sales of $424 million were in line with the prior year as higher pricing across the businesses and higher demand in Silica Catalysts offset lower revenues from the pass-through of lower sulfur costs and softening demand within Performance Chemicals. Adjusted EBITDA rose 17% to $138 million. This is largely attributable to the increased demand in the Catalysts business across the product portfolio, along with favorable pricing and sales mix in Refining Services and Performance Materials. Adjusted EBITDA margin increased 310 basis points to 29%, driven by margin expansion in three of our four business segments. This was the second consecutive quarter that we achieved a margin above 28%. Moving to a more detailed discussion by business segment and for Refining Services on Slide 5. Sales declined 4% to $118 million. In addition to lower sulfur cost pass-through, slowing orders from certain virgin acid customers reduced sales, which was partially offset by higher demand in regeneration services. Adjusted EBITDA increased 3% to $51 million, largely unfavorable customer and product sales mix, which increased adjusted EBITDA margin by more than 300 basis points to 43%. Next on Slide 6 for a review of Catalysts. Silica Catalyst sales increased 57% to $26 million. We continue to deliver double-digit growth as new polyethylene production capacity favors Silica-based technologies. Additionally, we benefited from higher methyl methacrylate orders related to customer refills and top-offs. Zeolyst JV sales were up 68% to $54 million. This quarter marks the strongest quarter of the year in terms of…

Thank you, Mike. Over the course of the last few quarterly calls, we have been providing a series of in-depth reviews of each of our business units. We have addressed their competitive advantages and growth drivers. And on today’s call, I will focus on our fourth specialty business unit, Performance Materials. Turning to Slide 11 for an overview. Performance Materials, also known as Potters, is the global leader in glass microsphere technology products. The business has innovated for more than 100 years, providing customer solutions for transportation safety and industrial and consumer applications. Demand growth and the business benefits from global trends towards increased transportation, safety standards and material substitutions. We have a highly efficient and innovative global production network. We have built a strong reputation for a broad array of differentiated high-performance products that meet quality specification and ensure reliability of supply for more than 2,000 customers around the world. In the area of transportation safety, our retroreflectivity microspheres enhance brightness and visibility performance on markings for both highway lanes and airport runways, guardrails, barrier and sign markings. We are the number one road marking solid bead supplier in North America, Europe and Latin America. Our logistics and supply chain position support quality and specification requirements by country, state and region. It also offers the ability to meet customer demand on short order time frames, given the variability of weather conditions and lack of storage and inventory capacity. In industrial applications, we utilize our engineering expertise and production know-how to efficiently co-produce with our highway product lines. We are the number one or two provider of microspheres for a number of highly specialized industrial applications and uses. These include strengthening our lightweighting in plastics, cement and surface coating, conductors for mobile electronics and environmentally-friendly substitutes for cleaning metals. In…

Thank you. We will now begin the question-and-answer session. [Operators instructions] The first question today comes from John McNulty of BMO Capital Markets. Please go ahead.

Yes. Good morning. Thanks for taking my question. So I guess, the first one on – with regard to the Zeolyst catalysts business, you obviously had a lot of strength there in the hydrocracking and the specialty catalysts side. I guess, how much of that was lumpiness or a pull forward from Q4 versus just the overall strength in total demand?

Hi, John, this is Mike. The third quarter, we said was going to be the strongest quarter of the year. So for hydrocracking catalysts, it was pretty much in line with what we expected. The pull forward would have been more on the Silica Catalysts side, where we had some specialty catalysts orders that came through and our methyl methacrylate orders were strong in the quarter as well.

Got it. Thanks. And then with regard to the CapEx reduction, I guess, a question on that. With regard to the cut, is it more a function of the lack of need for investment, just given kind of the – with the squishy macro environment, or is it greater efficiency and actually what you’re spending on? Like what actually drove the cut to CapEx?

There’s a couple of components there. Some is, we had one large project of about $5 million that we’ve decided to defer and do a little more work on. Some is a bit of a deferral, given the macro environment, some maintenance CapEx that we – we have a pool every year, where there’s a certain amount that we generally can figure out what needs to get done that’s critical this year. And if something is a lower priority, we can push it out a bit to improve free cash flow in a given year. So it’s a combination of those.

Great. Thanks very much for the color.

The next question today comes from David Begleiter of Deutsche Bank.

Thank you. Good morning. Bel, I got some mental notes. I know it’s early for 2020, but given now you have Q4 guidance out there. Any early thoughts on how 2020 might look for you on an EBITDA basis?

Well, look, we are planning to give you explicit guidance in our February call. But let me run through a few kind of guidances business-by-business and how we see the market right now. First, let me start with the Performance Chemicals environment. As you know, there is an accelerated weaknesses that we are seeing. We have revised our guidance for Q4 and we’ve taken actions. We believe that this weakness will continue through at least the first-half of the year, and the recovery in that environment will probably depend on when the destocking activity will reverse. On the Performance Materials, the highway business, given its replacement value, is expected to continue, probably offsetting some minor softness in the industrial application, particularly in Europe and in Asia. In the Catalysts part, we see the PE catalyst continuing to be strong on new capacity. 2019 was a very strong year for HCC due to the timing of a turnarounds. While we still expect a good year on hydrocracking, it is likely to be slightly down from this year, next year. On the Refining side, 2019 was a solid year, but we were impacted by customer and our own turnarounds for regenerations. We actually expect a nice rebound in volumes next year. Overall, on margins and expectations, I think we’re working very well to get our margin up to speed on efficiency and everything. We don’t expect to see any change in the way we run our margin performance in 2020. And David, that’s as much as I can tell you at this stage.

Very, very helpful. And just lastly, on some of these non-core asset sales, you did announce one last quarter. Any further progress you’ve made on some of these non-core asset disposals?

We did one last quarter, as you rightfully mentioned. We, as I said, we’re working on several opportunities and there’s nothing obviously this quarter. But we continue laser-focused on making sure that our portfolio is scrutinized and opportunities would not be missed. Yes, we are very active. But we shall see what happens in the future.

Thank you very much.

The next question comes from Vincent Andrews of Morgan Stanley.

Hi. This is Angel Castillo on for Vincent. Thank you for taking my question. So just a follow-up on the portfolio review, just curious as to what the environment looks like. So as you mentioned, you haven’t announced anything, and you remain laser-focused, but what are you seeing in terms of what’s holding up, perhaps, any further divestitures? Is it in terms of valuation? Is it the environment getting a little bit tougher? And how is that impacting timing?

That’s a great question. You know, that you do your part and then the rest is absolutely out of your control typically, in these cases. I think, we have been and we continue to do our part of understanding what opportunities we are interested in and how we want it and what is the value of that opportunity. I’ve mentioned a couple of times that the value of the smaller components of the assets or the assets is important. And then we will do – we will make transactions when it makes sense. We are ready. We know what we want, but the opportunity has to match a few other conditions and the market is still okay. We’re just not pairing up with the right opportunities at the right time.

That’s very helpful. Thank you. And then in terms of debt repayment, if you do another half turn next year, that should put you kind of towards the higher-end or at least slightly below your targeted range. Curious, as you start to gain that 3 to 3.5 times, how should we think about capital allocation? I mean, this is perhaps a little bit to an advanced 2021 question. But in the event that you do asset sales, and are you able to do more next year, curious what that means for capital allocation?

Yes. I think that’s a good point. Once we get into that range, I think that gives us a lot more financial flexibility, whether it be more bolt-on M&A to assist with our organic growth with further inorganic growth, we’ll be looking at dividends potentially. So I think, everything would be on the table at that point in terms of capital allocation, because clearly you have to take a balanced approach. And our first priority right now is getting down into the appropriate leverage level. But once we do that, we’ll have a lot more flexibility.

Thank you.

The next question comes from Christopher Parkinson of Credit Suisse.

Thank you. Most of my questions have been answered, but just real quick on the margin front. Can you just kind of walk us through the key external and internal variables that have been driving some of the expansion over time? And just how we should be thinking about the intermediate to long-term factors that we should be closely monitoring as we enter 2020 and even on to 2021? Thank you.

Hey, Chris, it’s Mike. On the margin front, we did say we expect some slight improvement in this year versus the prior year. Part of that is because of the strong contribution that we see from the Catalysts group, which is at higher average margins relative to the portfolio. At the same time, we’ve seen some really nice margin expansion out of the Performance Materials business. So why we may be down on volume there. We’ve had two things, strong pricing and also very favorable mix. So we’ve had good margin expansion there. And while we’ve seen a bit of a drag on the Performance Chemicals side, I think it’s been outweighed by those factors. So as we get into next year – and this is what we’ve talked about previously is we do expect our margins to blend up over time as the Refining Services and the Catalyst group become a larger portion of the overall EBITDA contribution.

Got it. And just regarding the portfolio composition question, just out of curiosity, when you go out to your shareholders and kind of have the dialogue, is their perception of the portfolio in the intermediate to long-term? Does that more or less accurately reflect those managements, or are there kind of key differentials on how you perceive your portfolio versus the investment community? Any color on that would be appreciated. Thank you.

I think, when we go out and talk about the portfolio, one of the hallmarks of PQ is really our diversification, whether it’s by product or by geography. And I think that resonates with investors. And you see that even in times where we may see some economic slowdown in certain pockets of end markets or geographies that three of our four businesses were up this quarter. And I think it’s a testament to the resilience of the business, the lack of cyclicality that we see in our portfolio, and I think people appreciate that.

Thank you.

Thank you.

The next question comes from Bob Koort of Goldman Sachs.

Hi, everyone. This is Tom Glinski on for Bob. So a quick question on the implied Q4 guide. So the guidance for EBITDA is at or slightly below the bottom-end of the range, which implies a touch under $100 million of EBITDA. So what is incrementally getting worse from 3Q to 4Q to bring growth down from around 15% to a decline of 10%? Thank you.

Yes. This is Mike. So if you look at where we came out in the third quarter, some of that was a pull forward. We had some orders that accelerated in the Catalysts group. So while we had some outperformance in the third quarter that impacts the fourth quarter. And the other is that some of the volume weakness and demand weakness that we’ve seen in Performance Chemicals in Q3 is expected to carry into Q4.

Awesome, thanks. And then real quickly on Refining Services in the Zeolyst JV. Is there going to be any impact from IMO 2020 there, or is it mostly other factors?

The – let’s talk about Refining Services and IMO, because that’s the connection. The Zeolyst JV is a different story. So on the Refining, we – there isn’t any impact on the IMO right now. There is always a shift between diesel and gasoline. And that is not – we’re not seeing that. Alkylation demand is higher, at least, that’s what we’re seeing right now. Capacity is limited at the moment in terms of – for refiners. And we see next year as an increase in volumes with all these unplanned issues that were taking place this year out of the way. On the Zeolyst JV, on the hydrocracking side, capacity has been increasing, and therefore, production has increased. And you see that reflected in some of the results that we’ve had this year. We’ve had a pretty strong year this year. The only change – and that will continue, but the only difference in continuity and sustainability of this level of production in hydrocracking is the timing and how that fits the schedule of the refiners. That’s why we’re saying – I’ve said earlier that next year, we anticipate that with the movements between quarters that we might be slightly lower. But it’s not a weakness, it’s just a timing and scheduling challenge for their refiners.

Awesome. Thank you.

The next question comes from Laurence Alexander with Jefferies.

Hi. Good morning. Two questions. One, on the efficiency programs, how should we think about the net tailwind versus cost inflation in 2020? And then on Catalysts, could we pin down a little bit what you think the sustainable run rate EBITDA is for the business? And I guess, in terms of – is Q4 going to be below the first-half run rate? And is 2020 expected to be above or below 2019?

Yes. This is Mike. I’ll take the second part first. So the Catalyst runway, we had a very strong quarter in the third quarter as we expected. So clearly, we expect to be down in the fourth quarter just due to timing, because we had such a high concentration of hydrocracking catalysts sales in the third quarter. And quarter-over-quarter in 4Q, we would expect to be down. As you look into 2020, I think what Belgacem had noted is, on the polyolefin catalyst front, we still expect that demand, which has been strong this year to continue to be strong as those capacity additions come in. That being said, on the Zeolyst side, because it’s been such a strong year for hydrocracking catalyst that we would expect that to be down year-on-year as we get into 2020.

I guess maybe just to clarify that then, do you think the second-half Catalysts in 2019 is better than the first-half Catalyst in 2019 in total?

Well, we had a pretty strong second quarter. So they’re fairly close. I think second-half, we’re probably going to be down a bit.

Thank you.

[Operators instructions] The next question today comes from PJ Juvekar of Citigroup.

Yes. Hi, good morning.

Good morning.

Good morning, PJ.

So on your Performance Materials for microspheres and traffic paint, you mentioned that most of their funding is from gasoline taxes, but I believe local spending is also important. So can you talk about trends there in government spending? And also a surprise, you didn’t mention much about ThermoDrop. Can you give us an update on that?

Okay. The – first of all, let’s talk about the funding, tax funded. It’s always been like that. The local spending is happening state-to-state, county-to-county based on their plans on activity, volumes and new infrastructure. So that spending is happening, and then quality and specifications. That’s why I said the specifications of the products vary from region-to-region from state-to-state depending on what the local authorities would prefer to do, how fast they do it and the quality of what they want to spend. Therefore, extensive – or maybe value products like ThermoDrop, for instance, is not in every state. It’s only in states or applied in states, where they value the quality, they value the product efficiency and they value the placement efficiency. And they are willing to pay a value price over some of the states that they want volume on the regular placements. So that transitions me to the ThermoDrop. ThermoDrop has been picking up in terms of pricing lately. We decided, as I told you before, we decided that we’re going to make sure that we focus on creating value with the products. We limited our expansions to the current capacity, so that we can sell the product at the right value before we expand. The uptake in the market has grown with time. Our price increase efforts this year has been very aggressive, because we wanted the product to be better and very well valued. Some customer accepted it and they’re really running with it and coming back and reordering and some limited that based on pricing. So ThermoDrop growth remained strong versus the past and the pricing is tremendously better than what it was a year ago. And while we’re controlling that, we’re preferring value than volume at this stage.

Would you say that ThermoDrop is behind your expectations in terms of sales?

ThermoDrop is behind my expectation personally on total value, not in volumes, because volume of sales can go really high. The reason we choke the volume of sales is we want to make sure that it generates the return that we anticipated to do. And at the beginning, it didn’t, and that’s why we try to manage that now. So my expectation is that this will pick up with time.

Thank you. And then secondly, in Performance Chemicals, your sales dropped with weak economies and your margins were down as well. A lot of these products go into consumer sort of products and some in industrial economy. Where are you seeing the weakness? Is that more on the consumer side, or is it on the industrial side? Thank you.

It’s primarily industrial more so than the consumer. And I mentioned a few industries where there is kind of a slowdown, which – a slowdown translates into destocking activity or inventory depleting activity, which results into an impact for us. The main product that has been impacted for our portfolio has been sodium silicate, which goes into like four or five different applications. And the way we sit in the value chain, PJ, we’re kind of lower on the value chain, because some of our customers start destocking a bit late and we see that effect. So we are bound to see later effect. And it’s on a couple of products, primarily sodium silicate. And then when – even when this is going to rebound, we’re going to be probably later to rebound because of the value chain position as well and it’s one product. Our capacity is capable of ramping up fast. We’re taking advantage of optimizing the portfolio through maintenance and making sure that we optimize our efficiency and we’re ready to flex up again when the time comes.

Thank you.

You’re welcome.

The next question today is a follow-up from John McNulty of BMO Capital Markets.

Yes, thanks. I just was hoping to get a little bit better color on the INEOS agreement? And when you think you might see demand getting pulled from this? I know it’s kind of early stages at this point, but I guess, how should we be thinking about that?

Hey, John. Let me give you a backdrop on the INEOS agreement and why it’s so critical and important for us, even though the value is probably going to be later, but I will explain that. We operate in the chrome-on-silica catalyst market, which is a smaller component of the total catalyst market. The agreement is to get involved in operating in this Ziegler–Natta market, which is the largest in out of the three, the Ziegler–Natta, the single site and the chrome-on catalyst. And the agreement is going to allow us to not only continue to sell support to that market, but now we’re going to be able to sell final products to customers that we didn’t sell those products to. So it’s an organic growth opportunity to expand our portfolio to expand our customers. It will also allow us to – as we start talking about Ziegler–Natta, we will be able to increase our exposure to sell further products to the new customers on the chrome side. To me, this is a great opportunity to participate in a different bigger market. The way it works, John, is you take these products and then you start qualifying, because these are new customers. You qualify the products and that process takes six to nine months at least. Once they qualify and they like the product, you start producing for that application. That’s why I think by the end of the year of 2020, we’re going to start seeing a revenue stream and then 2021 should mature up and we start to see a ramp-up of a nice chunk of growth that didn’t cost PQ any capital.

Got it. That’s hugely helpful. And I guess, maybe to that, you spoke, I guess, in the release to not only multiple opportunities to optimize, but you spoke to broadening out your product portfolio. I assume this is an example of that. But do you have other ones out there that you’re close to? And I guess, at the same time, this one requires no capital. Would you consider ones that do require capital, even given the leverage on your balance sheet if the opportunity was right, or is it really just leverage is the number one priority right now?

Well, to be honest, leverage today is the number one priority at a larger scale, but opportunity to broaden our growth for – growth channels, I call them, where we can increase the number of channels where we could sell, because that’s important for growth. If those opportunities are there and if they make sense, we will find a way to deal with them. I mean, we increased our capacity by tolling in Korea with catalyst. We just created a new opportunity in China to toll for the emission-controlled product. We introduced this concept of collaboration with INEOS to increase our portfolio of sales and we are looking at a few other opportunities. So just to let you know that we’re looking at the portfolio improvement from a costing and reduction and selling. But also we’re looking at our portfolio enhancing through a stronger ability to grow through various channels that require the least possible capital.

Great. Thanks very much for the added color.

The next question today comes from Silke Kueck of JP Morgan.

Good morning. How are you?

Good morning.

Good morning.

You’ve done a nice job controlling your SG&A costs with sales probably being more flattish this year. If it turns out that the first-half of the year also see more flattish growth, do you have other levers to control your SG&A costs next year? And then what might those be? And second, I was wondering which capital expenditure projects might have gotten postponed? And would you expect your CapEx requirements to be next year?

Yes. On the SG&A front, we have taken a pretty tight approach to controlling our SG&A costs be it open positions that may be deferred or we take a hard look at what discretionary projects we may have. So as we get into the budgeting process for 2020, we would have similar levers to pull, should the market not be where we want it to be. On the other – what was your second question? I’m sorry. Oh, on the capital side, yes, we had mentioned earlier, we had one – about a $5 million project that was just not ready for prime time at this point. We’re going to do some more economic analysis and may look to add that back in 2020 and the rest has really been tight control on maintenance. Some of that would probably get deferred into 2020. I would say, a normal run rate you can assume in any given year is $140 million to $150 million. And then as we get closer to providing guidance, we can update that.

Thank you.

If there are no more questions, this concludes our question-and-answer session. The conference has now also concluded. Thank you for attending today’s presentation. You may now disconnect your lines.