Q2 2020 W R Grace & Co Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the W.R. Grace second quarter 2020 earnings Conference call. At this time all participants are in listen only mode. After the speakers presentation, there will be a question and answer session.
Yes. Good question. During this session you want me to press Star one on your telephone. Please be advised that today's conference is being recorded if you acquire any further assistance. Please press star zero I would now like to hand, the conference over to your speaker today, Jeremy Rowan Vice President Investor Relations. Thank you. Please go ahead Sir.
Thank you were killed good morning, everyone and thank you for joining us today for graces second quarter 2020 earnings call.
With me. This morning is Hudson the force, our President and Chief Executive Officer.
Bill documents are senior Vice President and Chief Financial Officer.
Our earnings release and presentation are posted on our website under the Investor section and Grace Dotcom.
Please note that some of our comments today will contain forward looking statements based on our current view of our businesses and actual future results may differ materially.
Please see our recent FCC filings, which identify the principal risks and uncertainties that could affect future performance.
We will discuss certain non-GAAP financial measures, which are described in more detail in this morning's earnings materials reconciliations of non-GAAP financial measures and other associated Discloser disclosures are contained in our earnings materials posted on our website.
This morning, Hudson will discuss Q2 highlights in our views on Q3, and the underlying long term strength of our businesses.
I will provide an overview of our financial results and our through our Q3 planning assumptions well then open the call for questions.
With that please turn to slide four in our earnings presentation, and I'll turn the call over to Hudson.
Thank you Jeremy Good morning, everyone I Hope you and your families are all safe and healthy.
We're proud that our technology plays a role in the pandemic response and I want to acknowledge the contributions our teams are making during this challenging time Grace's specialty silicas provide critical functionality and cobot 19 diagnostic test kits and we expect to supply material for tens of millions of tests this year.
Customers using our Unipol polypropylene process technologies, and catalyst or manufacturing materials for medical supplies, including masks and ventilator bounce and our employees and foundation have given generously to those in need we're grateful to be able to help our communities at this time.
Please turn to slide five.
I'm very pleased with how our teams are managing the unique challenges of the pandemic in recession.
They acted early and effectively to fully implement our pandemic response, including significant new safety protocols throughout our global operations.
Our workforce remains safe and healthy and we have experienced no business continuity issues in our global operations or supply chain.
Q2 sales and earnings were better than we expected, although end demand was down significantly and almost all our markets our customers did not adjust their inventories as quickly as we anticipated.
Our value selling and commercial excellence efforts continue to be robust and our technical teams continue to work closely with customers to deliver the full value of our technologies.
In April we outlined our plans to mitigate the economic effects of the pandemic by lowering capital spending improving working capital and reducing operating costs. We've taken these actions and identified additional opportunities to improve cash flow. This year, we're raising our estimate for the full year benefit of these cash flow improvements.
From 100 million to $125 million.
These actions are starting to pay off.
In Q2, we delivered over $100 million and adjusted free cash flow, including 60 million dollar reduction in net working capital.
Year to date adjusted free cash flow is 60% higher than last year, even though adjusted EBIT is almost 40% lower.
This cash performance is exceptional and shows the resiliency of our operating model.
We reduced inventory $52 million in Q2, beating our original inventory inventory target by more than $25 million.
Because this reduction was higher than we expected the effect on aggressive adjusted gross margin was more than we planned.
This effect is temporary and last only while we're reducing inventory levels.
For Q3, we expect a strong sequential improvement in gross margins to 37% to 38% and we fully expect gross margins to return to normal levels of 40% to 42%.
When volumes returned to normal levels.
Reducing inventory is obviously, great for cash flow, but it also positions us very well is our end markets recover.
Lower inventory levels give us valuable flexibility in our plans to capture growth opportunities because such a high percentage of our products are custom formulated and made to order.
Our integrated supply chain team has done an extraordinary job quickly adjusting our manufacturing operations to reduce production rates inventory levels and operating costs. They also improved product quality set a new record for on time delivery and safely completed construction and startup of our new manufacturing plant.
Yes.
All three plants have turned over to operations and our producing commercial products. We've started invoicing customers and expect these plans to add to earnings this year, even though short term demand is obviously down from originally expected levels.
They provided neat they provide needed growth capacity and I'm very pleased to be at this point.
[music].
Please turn to slide six.
I expect your all working to assess the long term impact of the pandemic on our business.
While the pandemic has significantly disrupted our markets in the short term it has not changed the value of our technology to our customers are long term growth potential or the strategic value of our specialty chemicals franchise.
Simply put our long term strategic framework is fully intact.
We have strong leadership positions in end markets that are critical to consumers and the global economy with more than 80% of our sales and segments, where we are number one or two.
We've made significant investments in capacity capability and talent to strengthen our businesses accelerate our growth and extend our competitive advantages. We are continuing these targeted investments during the recession and maintaining our R&D spending.
The investments are producing measurable results.
For example, our Grace manufacturing system investments added 75 basis points to our margins last year, and we fully expect that value to increase when demand returns to normal levels.
I'd like to give you three examples of how we're positioned for growth and how much customers value our technology, even during a severe recession.
In specialty catalysts, we look to new process technology licenses and new product trials as important leading indicators of the demand for our technology.
We've already signed for Unipol pp process technology license deals. This year that will provide more than 2.2 billion metric tons of capacity.
We're also seeing strong demand for trials for our polypropylene and polyethylene catalysts, although the total number of trials will be well below. This years original plan customers are eager to conduct trials when travel restrictions permit and we're already scheduling trials for next year too.
Customers want the performance flexibility and value our polyolefin catalyst delivered to their operations.
And refining technologies, we've had hundreds of conversations with customers about their refinery operating strategies during the pandemic and what catalyst technology is best for them.
It's an important reminder, that we deliver a lot more than just the physical product.
Our advice and insights into our customers markets and operations are highly valued.
A very high percentage of our customers continue to use the high performing high value catalyst technology, they were using before the pandemic.
And materials technologies, our strategy is to drive our technology into the highest value specialty silica and pharma induces.
We've shifted our R&D and selling focus to higher growth higher value uses added sales and technical service people and invested in new technology to accomplish this we've seen significant progress is growth in high value coatings consumer and pharma and uses has accelerated even as demand in our traditional end markets as declines.
Since the pandemic started.
This strategic mix shift helped empty outperform many of its end markets in Q2, including 15% growth in consumer pharma.
Once the recession subsides I'm fully confident we'll be back on track to deliver mid single digit sales growth adjusted EBIT margins above 30% and strong cash flows and returns on invested capital.
Now please turn to slide seven for an overview of what we saw in Q2 and what we are anticipating for Q3.
Refining technology sales were down 28% year over year versus a 30% decrease in gasoline demand.
We plan for customers to reduce refined product inventories in the quarter, but instead refined product inventories grew in Q2.
This inventory build will have to be worked down through reduced operating rates in the coming months.
We also expect catalyst inventories to be trend as refiners reduced rates and operating costs.
Refinery utilization bottomed in April and started to improve in May and June but rates are still 10% to 15% below typical levels gasoline demand was improving in the U.S. until about two weeks ago when demand started to level off.
FCC catalyst pricing improved in Q2 and remains more than 200 basis points higher on a rolling 12 month basis for the year, we expect FCC catalyst prices to improve about 1%.
Our long term view of the FCC catalyst market hasn't changed.
We continue to expect low single digit annual sales growth, including one to two points of improved pricing, we remain committed to maintaining our global market share and are focused on delivering innovative products and technical services to our refining customers.
Specialty catalyst sales were down 15%, reflecting weaker end market demand in resin and catalyst inventory reductions SC sales were better than we expected as we saw some inventory correction, but not as much as we were planning for as a result, we're anticipating about $10 million to $20 million of customer inventory reduction.
In the second half.
We've signed for Unipol polypropylene process license agreements this year, including two in Q2.
Our licensing pipeline remains strong and we expect another good year, though not as good as last year. Despite the current economic conditions customers continue to invest in our technology to support their future growth.
Materials technology sales were down 7% in Q2 with significant declines in coatings and industrial end uses partially offset by very strong growth and consumer pharma.
Empty outperformed its end markets and coatings and consumer pharma and was in line with industrial end markets consumer pharma growth was led by significant demand for specialty silicas that provide critical functionality and cobot 19 diagnostic test kits.
We expect to supply immaterial for tens of millions of diagnostic tests this year.
For Q3, we're planning for FCC catalyst demand to improve sequentially, reflecting stronger end market demand, partially offset by restrained refinery utilization as customers reduced refined product inventories.
We're planning for specialty catalyst sales to be about flat sequentially, reflecting weaker end market demand, but less impact from customer inventory corrections that occurred in Q2.
And for materials technologies, we are planning sales to be down versus Q2, due to order timing and consumer pharma and mild seasonality in Europe.
We expect continued growth in consumer pharma in Q3, but not to the extent we saw in Q2.
With that ill turn the call over to Bill.
Thanks, and good morning.
Let's turn to slide nine to discuss our second quarter performance.
Salts reflect the impact of the curve in 19 pandemic, but also highlight the strong execution of our mitigation plans and ability to deliver strong cash flow for the second quarter sales were down more than 18%.
The gross margin of 34.1% was down 800 basis points from the prior year the impact of lower production volumes that inventory reductions were offset by lower raw material and energy costs improved pricing and lower manufacturing costs.
As such and discussed we effectively implemented our plans to drive cash and adjust our production to match demand for the full year 2020, we increased the cash flow benefit targets, we communicated on our first quarter conference call in April from 100 million to $125 million.
We have largely completed our working capital initiatives and increase our full year targets by 10 to 15 million to $45 million to $50 million.
Our savings targets of manufacturing costs and operating expenses also increased by $10 million to $15 million.
And are expected to be $35 million to $40 million.
We were very targeted and strategic in reducing operating costs at our confidence that we are well positioned that quickly to capture demand as the recovery occurs.
Turning to our consolidated performance on slide 10.
For the quarter adjusted EBIT was down 50% EPS was down 58% significantly lower sales volumes due to covert 19, and the effect of the lower production volumes and inventory reductions.
Adjusted free cash flow was $100 million for the quarter up over 60% year over year, highlighting the execution of mitigation plans. In addition inventory reductions we continue to see strong results from our credit collection efforts.
Now, let's turn to slide 11, and discuss our segment results.
Catalyst technology sales were down 22% in the quarter.
Refining technology sales were down 28% has refinery operating rates were significantly impacted by government shutdowns and lower economic activity as a result of the pandemic.
In specialty catalyst sales were down 15%.
We saw increased demand in certain non durable end market applications, such as high teen and medical in food packaging, but that was not enough to offset declines and durable end market applications.
Operating income for the quarter was $72 million.
43%, primarily due to lower gross profit, partially offset by improved pricing at $8 million business interruption insurance recoveries.
This now closes out our claims related to the FCC catalyst customer fire.
That occurred in June 2019.
Overall, we received $24 million and recoveries, which reflects approximately eight quarters of impacts from this event.
Turning to slide 12.
Material technology sales were down 7%, primarily due to weakness in coatings and industrial end markets.
Similar pharma sales were up 15% and above our expectations entering Q2, driven by strong demand for customers, Kevin 19 diagnostic tests.
Operating income of 12.6 million for the quarter was down primarily due to lower gross profit.
Now, let's turn to slide 13.
During the quarter, we implemented changes to our refining technologies manufacturing operations and global footprint to support long term global growth as well as drive operating and capital efficiencies.
First we accelerated accretion manufacturing system implementation at our three Hydroprocessing catalysts manufacturing sites.
The project, including key organizational changes and optimization of.
Plant processes.
These actions will support the long term growth global growth and Hydroprocessing catalysts as the plants approve operating rates and capacity driving operating leverage we expect to benefit to operating margins at our joint venture to be in the range of 150 to 200 basis points with with the benefits beginning to be realized in Q3.
Grace will recognize the margin benefits through its equity in earnings in the joint venture.
As a result of these changes Grace has taken a pre tax charge of $20 million in Q2 to write off inventory now deemed obsolete based on process and footprint changes the cash cost implement this change is expected to be approximately $1 million.
Second.
In agreement with our local partner, we have discontinued the project to build a full scale FCC plant in the middle East.
The decision was influenced by the rapid advance of FCC catalyst technology, and the value of flexible flexibility inherent in our existing global manufacturing network to meet the dynamic needs of our customers at a cost and capital efficient way.
As Hudson stated.
This in no way changes our commitment to our customers and partners in the Middle East. We've made significant we have a significant presence in the region today, including stated yard catalyst characterization lab local technical resources.
And strategically located logistics hubs.
With three world class FCC plants in the us in Germany.
The flexibility and capability to produce today's most advanced catalyst platforms.
Based on the decision to discontinue the project, we recorded a pretax charge of $17 million to write off engineering and site costs related.
To costs that were card largely before the second half of 2018.
The expected cash costs to discontinue this project is approximately $1 million.
Now, let's turn to slide 14.
As we've discussed we remain focused on generating cash flow and maintaining our strong financial position to fund our priorities.
In June we announced the intent to issue $750 million of senior unsecured notes to refinance all of our notes due in September 2021 that we completed the redemption in July.
As a result, we have now address all of our near term maturities.
At the ended the quarter, our net leverage was 3.5 times.
This is outside our target range of two to three times adjusted EBITDA.
Which is a result at the decline in earnings due to the pandemic.
We expect our balance sheet to de lever as markets recover.
As we discussed in April our capital.
Capital allocation framework Doesnt change as a result of cobot 19.
However, we have shifted our near term priorities to address today's economic uncertainties and continue to focus on cash generation.
Our top priority is still funding organic growth opportunities.
While it's true we have reduced our capital spending this year, we are making targeted strategic strategic investments to maintain our leadership positions.
To drive growth.
In terms of return to shareholders were fully committed to our dividends, but we didnt repurchased any shares in Q2.
Plan to repurchase shares in Q3, we expect to reinstate our program at appropriate times.
Finally, let's turn to slide 16 to discuss our third quarter planning assumptions.
As Hudson This mentioned our end markets have stabilized.
But we continue to operate with a prudent mindset given the ongoing uncertainty.
We expect third quarter sales to be down 10% to 13% from last year with the largest decline in refining technologies.
We expect adjusted gross margins to improve sequentially from Q2, Q3 by three to 400 basis points to 37% to 38%.
While production remains below prior year levels, we do not expect further inventory reductions in the third quarter.
We expect our gross margins to continue to improve and are confident they will return to pretend that make levels as demand recovers.
Regardless of the timing of the recovery, we are fully prepared to capture the growth as or has the economies recover.
But we also remain focused on executing our mitigation actions.
Generating cash and closely managing discretionary costs.
Now I'll turn it back to Hudson.
Thank you Bill when I assess where we are overall three key points come to mind.
First April appears to have been the weakest month from an aggregate demand perspective demand has improved since then and more importantly customer response to the pandemic in recession has clarified this gives us much better information to plan our operations.
Second uncertainty remains high active cobot 19 cases continue to grow into us and other countries in some governments are reassessing their policy responses to the pandemic. The EU has agreed on a significant stimulus package, but stimulus in the U.S. may decline the shape of the recovery is still unclear, but it is.
It's clear that a full recovery will not occur in 2020.
And third we will continue to manage the pandemic in recession, well with a focus on the recovery.
After more than four months of actively engaging customers in analyzing our markets. We remain fully confident in the long term growth and profitability of our businesses.
We are continuing the investments needed to support our growth and extend our strong competitive advantages.
And we continue to make flexibility a high priority, while we've reduced costs weve been careful not to jeopardize our ability to respond to changes in demand we want to be able to quickly slow production. Further if demand is lower than we planned and we want to be able to quickly respond to capture growth opportunities as the recovery strengthens this.
Balanced approach will serve us well as we manage the significant uncertainty created by the pandemic I look forward to your questions.
As a reminder to ask a question you will need to press star one on your telephone to withdraw your question press the pound key please stand by what we compiled the Q when a roster.
Your first question comes from the line of Kevin Mccarthy with vertical research.
Yes, good morning.
Hudson I was wondering if you update us on where you see inventory levels. Among your catalyst grades at Greece, and where you think inventory levels are.
Downstream in your specialty catalysts business and elsewhere.
Good morning, Kevin. Thank you for your question.
Inside Grace.
Inventory levels, both in catalyst and materials technologies are in good shape.
We made significant progress in Q2 is you as you saw in our report this morning.
And we expect inventory levels to be roughly flat as we go through the balance of this year.
The team really did a super job executing this very quickly.
When I when I look outside of Grace.
If I look at refinery.
Catalysts inventory levels I think they're in line as we as we highlighted on our chart.
Got them colored green.
They'll move within a small level.
But catalyst inventories in refining or are usually pretty lean.
There is not a lot of storage space within a refinery and things like that.
When I look at specialty catalysts.
Inventory levels catalyst inventories were high coming into Q2.
And we expected.
We expected customers to reduce inventory levels during the second quarter and they did.
But not as much as we had thought 90 days ago and so some of that reduction will have to occur in the future. It's why we still have that yellow on the on the analysis. We included in our presentation.
And then in materials technologies, our product levels, our product inventory levels at our customers.
Well good going into this year.
And they were pretty healthy right about where they should be a stupid demicks started I don't have a concern about customer inventory levels in empty.
Okay, and then secondly.
It appears as though you've increased your cost savings.
The by about $25 million said is that correct and if so would you discuss the source of those incremental savings and how they might flow through your financials over the next few quarters.
You bet, Kevin I'm going to ask Bill to respond to your question. Please Kevin.
I think the increases or in the working capital area in the operating expense area relative to what we had put out back in April.
From an expense standpoint, we have identified additional opportunities of 10 to 15 million. So we've got some of that in Q2 and that'll continue through the rest of the year in terms of working capital we've largely achieved that piece already in this in the second quarter.
So we would expect to hold the working capital gains for the rest of the year.
And then on the capital spending we tell the number consistent with where we were at.
$40 million and that'll.
That will be realized ratably throughout the year as well as we as we continue on.
So yes, we've got the $125 million of benefits and Thats not our cash number for the year. We started the year with the forecast of 260 to 80 that obviously came down due to the pandemic, but it didnt go to zero and so now we have 125 on top of that lower number, which we're not trying to give a four year range, which.
Just to make sure it's clear that 125 is not our full year cash flow target.
Okay. Thank you so much.
Your next question comes from the line of John Mcnulty with BMO capital markets.
Yes. Thanks for taking my question. So I guess I guess, maybe two of them on the Capex front and I guess.
On the cash flow side, when we think about okay, you've pulled the middle east expansion out.
And so it seems like and you put a lot of capex into some of the other growth opportunities. So it seems like you're you're getting closer to a point, where youre going to yielding more cash once we get out of the pandemic than than maybe you have in the past I guess, how should we think about the capital allocations like historically about a third it looks like went to went to the shareholder.
Third the Capex and a third to acquisitions I guess, if you're looking out over the next couple of years, how should we be thinking about how that mix plays out going forward.
John This is Hudson and let me, let me touch on the first part of your question.
I think you analyzed it well I think.
With the completion of the three.
The three big plants that are coming online now.
You will see our capital spending start to moderate that'll obviously translate into higher cash flow as we work into 21 and 22 and the recovery.
You know is complete.
Bill will point out that we also expect cash flows to resume our dividends I should say to assume from the joint venture this year.
And continue into next year and that will help us from a cash flow perspective, as well from a capital allocation perspective.
Our our framework is the same.
We prioritize organic investments.
Like the plants that we've recently built that will that we'll continue to be our first priority, including maintenance and environmental spending and things like that.
Next we look at bolt on opportunities and while we've slowed that activity right now because of the.
The pandemic really.
It's still is an important part of our growth strategy.
I don't know how to quantify what quantify it for you readily in terms of that Pie chart, but I want you to know that is still an important part of our growth strategy. When the opportunities are right and when the timing is right.
As Bill said, we do intend to continue our dividend.
We're what we're well committed to that and while we're not doing share repurchase now it is part of our return of capital.
Strategy, and we would expect that to resume when the time as ride.
Bill anything I've missed.
I think that's right I mean, the big capital spending, though those projects are complete now so.
I think as you think about capex spending over the long term it will generally be 70% of sales most years and and we'll make more incremental growth investments in the next couple of years. We've got things that we were thinking of doing later this year before the pandemic and so we have we have projects on the shelf that we'll be ready to start.
As a recovery occurs.
Got it. Thanks, that's helpful. And then I guess, maybe just two quick ones can you speak to the pricing dynamic in FCC catalysts. It sounds like you do expect it to decelerate deep is that something that could actually go negative as we look at the ended the year and I guess, maybe tied to that.
Look theres raw material deflation as well. So is it is it pricing just kind of mirroring that or is it is it may be something where there given the condition of the market. It's just it's just talking to hold price right now.
John It's Hudson I pricing doesn't really follow Ross is you can imagine given the the specialty nature of the of the products that we're manufacturing.
But we do expect our progress on pricing to moderate.
In the second half, we we said at the beginning of this year that we thought our pricing would be it at the low end of our 1% to 2% range. That's still our view is as we sit here in July.
We continue to improve pricing.
In Q2, we've had great conversations with customers over the last 90 days as they've thought about how to reposition their operations and.
And in time and time again, they come back to the value of our technology and helping them operate their refineries, while we continue to sell that value to our customers and I think we'll finish the year at about 1% up.
Got it so it sounds like this current environment isn't isn't necessarily having and.
Incremental impact on pricing and it should be at least stable if not positive going forward is that is that fair are yes. Our view is that in the long term will still be in that 1% to 2% range and.
And as I said, we think will be up about 1% for the year.
Thanks very much.
Your next question comes from the line of Christopher Parkinson with Credit Suisse.
Hi, Good morning does carrying on for Chris.
Okay.
I was just wondering.
Obviously, the implementation of the greatest manufacturing system. They cost measures that provided supporting this weaker environment.
Can you give us a little bit of an idea of what the cadence of those benefits might look like especially kind of in the HPC side of the business throughout the back half this year and it's a 21 and then I guess looking longer term any additional opportunities that you see that you can implement the greatest manufacturing system or cut additional cost that would be helpful. Thank you.
Karen et cetera, and thank you for your question.
Specifically with the work that we've done this past quarter in art those benefits will start in the third quarter, but they will start slow and build overtime. The AD the benefits are driven by volume levels.
And and so we'll need volumes to fully get back to normal to to fully realize.
The value of the 450 to 200 basis points that we talked about.
And then you know more broadly your question about the Grace manufacturing system.
I'm really pleased with the work that our team has done on that over the last couple of years.
We added about 75 basis points to margin last year, our plants were running hard and we got really strong benefit from the changes. We had made we won't get all of those benefits. This year of course with volumes lower but as our volumes return to normal levels I would expect all of the work.
That we did last year to still pay off at the same level.
I will get additional benefits.
Based on the work that we're continuing to do this year and we'll continue to do in the future.
We're not fully implemented Gms, it's a journey, it's not a destination.
What we've done a great deal of work over the last two or three years, and we're well well well down the road on that.
Great.
I guess just quickly when we think about organic and inorganic investments going forward, whether it's in 2021 or further out.
I guess have their strategic priorities shifted at all in terms of how strong some of the end markets, whether it's far mine consumer would then materials tech or specialty catalysts as Ben or is the focus Phil.
Yes relatively in line with how expend the best.
I appreciate that question Karen.
I don't think our framework hasn't changed our focus and priorities are consistent.
We've made a lot of investments in our catalyst businesses over the years and we still look for opportunities there.
Materials technologies has been a significant focus for us over the last year, maybe maybe closer to two years now.
But I think the one thing that has changed just timing.
It's more difficult to do a transaction in this environment.
Just because of the recession, but because of the complications that the pandemic creates around diligence and integration and things like that so timing may move out some.
But this strategic importance of this to us doesn't change.
Great. Thank you.
Your next question comes from the line of Bob Koort. Mr. CT. Please state your company and proceed but your question.
Hi, It's Anthony Walker on for Bob from Goldman Sachs.
Hi, guys could you just provide some color on your expectation for slightly weaker demand for the specialty cattle sequentially. That's some somewhat surprised thats not showing some improvement will sequentially higher industrial production and durable goods demand.
[music].
Anthony its hats, and I think the big thing there is is.
Weaker demand in some of the durable excuse me nondurable end uses.
Q2 was pretty strong in those areas as you can imagine we don't see that strength continuing into Q3.
The bigger question Mark for Us in specialty catalyst is the pace at which customers will reduce inventories.
That's part of what has us yellow on on that circle on on page seven.
Got it and then you noted strength in the pharma segment due to co. Good diagnostic testing is the expectation of expectation of sequentially lower sales anticipate some slowdown in this business or what's driving that sequentially weaker expectations. Thanks.
It's not really a slowdown in that business. We continue to expect that to be strong, but those orders were frontloaded as you can imagine given the speed with which our customers are trying to respond to the.
Pandemic a lot of those orders were frontloaded.
Operator lets prompt for the next question please.
Next question comes from the line of Mike Harrison with Seaport Global Securities.
Hi, good morning.
Hudson I was wondering if you could talk a little bit about what maybe has changed in your long term plans that no longer it makes sense to have the plant in the middle East and do you feel like.
Shifting back to your your other.
Manufacturing location does that impact your competitive position in the middle East at all.
Thank you Mike I appreciate those questions.
What we've experienced in the last few years.
Is a very rapid advance in our catalyst technology and.
The technology that we're focused on today and focused on in the future requires a certain manufacturing configuration and certain manufacturing assets and and we realize that that's going to continue to be the cases, we move into the future.
Our customers are demanding.
Hi, performing catalysts.
Thats given us the opportunity to continue to invest strongly in R&D and our product technology.
And we see the next few years is continuing to be a period of of strong advance and catalyst technology and for that reason, we don't want to have.
A plant that doesn't have the right equipment that doesn't have the right.
Process configuration, we have that equipment, we have those process configurations in our existing plants.
And is they've improved their fungibility as they've improved their flexibility the need for that fourth plant.
Diminished and as we look at our footprint today I feel very good about the flexibility in the capability of those plants in our network and frankly their ability to continue to debottleneck and drive productivity to supply demand growth in the future.
Thanks for that and then also if I could ask on on FCC.
What steps are you needing to take in order to help your customers. I think you mentioned that many of them are having to reposition their operations.
What are some of the key obstacles that they're dealing with.
Guessing that one of those is.
Jet fuel demand.
Being depressed and maybe impacting how they're looking at.
Refined product.
Streams.
Any any thoughts on some of the key changes you're helping your customers work through.
You bet. It's operating a refinery is of is is a challenging undertaking and our customers.
And even in a normal environment have a lot of options about how they.
Operate their refinery.
The optimization for them that gives them the most margin and most profitability and then you throw in the dynamic of the pandemic in it and it just it complicates things you mentioned weaker demand for jet fuel, that's certainly part of it we've seen mix shifts in relative.
If demand between gasoline and diesel.
And we've seen mix shifts in rufrano refined product inventory levels between gasoline and diesel all of these things have occurred in the last few months and in some cases the relative.
Physicians have flipped within a matter of weeks and so.
It's been a particularly dynamic that time period for our refinery customers. They get some optionality in the way they configure their operations.
But they get a lot of optionality from the catalysts that we provide them as well and today.
Most of our customers opt for a high performing catalyst that gives them the maximum optionality and gives them. The maximum results. We've had lots of customer conversations over the last few weeks last few months really.
In time and time again, they come back to we want the high performing high performing catalyst because it gives us the optionality, we need in our operations to achieve our results.
Those conversations have been intense.
In the last few months.
Intense maybe is the wrong word more frequent more frequent is really the point I'm trying to make because of the dynamic environment and as I said in the in the prepared remarks. It just is a good reminder to us of the fact that we're selling a lot more than just a catalyst, we're selling information and knowledge about how customers can optimize with.
Are doing.
Great. Thank you very much.
Your next question comes from the line of David Silver with C.L. King.
Yes, hi, good morning.
A couple of maybe counting type questions and then maybe a more strategic one.
But first I just wanted to ask a couple of things so with your topline revenue decrease of 18 or 19% how much of that might be related to cost pass throughs or things like that as opposed to strictly.
Price and volume.
And then secondly, I did have a question about the big kind of inventory drawdown and significant effect on your.
Cost of sales line and I'm, just wondering about going forward.
Whether the when youre demand rebounds in your rebuild inventories is there going to be kind of a cost to goods sold benefit in other words does the poor absorption in the second quarter reverse or is it really more based on your accounting choices and what Todd.
It really more just a return to historical.
Cost of goods sold trend. Thank you.
Sure. Yes. This is bill I'll address it for you David will take first off on the.
The impact of cost pass is really zero impact at the Grace consolidated sales level.
Our joint venture does have.
Their prices will vary with passthrough of certain metals like molybdenum, but thats not consolidated into our business. So you don't see that on our financial statements. So really zero effect on our sales line from the effect of pass throughs.
On your gross margin question.
We did see obviously, a big decline this quarter right, we had the effects of.
The fact, we're making selling less product that has a negative effect on margins in terms of fixed cost and overhead absorption. But then secondly that was compounded compounded by the fact that we were reducing inventories at the same time, which means we're making even less than what was needed to supply the demand, which creates further negative absorption and.
Did compound the gross margin decrease.
As we as we see the recovery occurred in the third quarter. We don't expect further inventory reduction. So we will see a nice bounce back of margins.
Three to 400 basis points, you had a really take out that inventory.
Reduction factors, so we'll see third quarter come back to 37 38 your longer term, we expect we'll get back into the 40% to 42% range.
Yes overtime and I think thats, the best way to think about as overtime, you may see fluctuations quarter to quarter periodically with with inventory movements, but this was that this was a very short movement this quarter.
In terms the inventory declines you wouldn't typically see our inventories move this dramatically in any any given quarter. So I'd take long term think about the 40 to 42 in Q3 think about the 37 to 38.
Okay. Thank you for that and then.
I did have kind of a more strategic question. So.
You know you your company was extremely proactive and issuing debt and kind of clearing out the near term maturity profile.
And I guess, you know in a more subdued business environment I always think.
Management's thinking strategically kind of look at maybe other ways to add value other than pure operations.
And I'm, just wondering I mean in volume pressure again, and maybe you can correct me, but I kind of view the catalyst business is one that's.
Still quite fragmented globally, where there's a lot of companies that have kind of ones and twos is kind of in particular areas maybe in chemicals or.
Refining and I'm sure you have kind of an acquisition funnel internally, but.
As the landscape changed significantly for identifying targets and maybe finding more more willing partners. You did mentioned the due diligence was going to be extended but im just wondering if this is the environment, where some of the smaller players with maybe.
Attractive, Jason C or something to your existing base of catalyst the products and services.
Whether the opportunities.
The opportunity has increased in the current environment. Thank you.
David This is Hudson. Thank you for the question.
In the catalyst space, we're we're the.
Natural owner of a lot of different catalyst businesses the.
Refining business. Obviously is a is a has been a long part of our portfolio in specialty catalysts. We've made a number of acquisitions in the last few years and helps consolidate that industry as you know and.
When we look at other opportunities in catalysts, what we see.
Most obviously is in chemical catalyst.
Sure and chemical catalyst today and Thats a natural.
Area for us to invest in.
I think if.
There are opportunities in that space.
We would absolutely want to be involved with that.
Not going to try to predict or comment on timing.
But I'd also comment on the materials technology space.
Lots of opportunities for adjacent sees bolt on type opportunities.
So those sorts of investments as well when the timing is right.
Okay. Thank you very much.
Your next question Joe Your line of right John Roberts would you be yes.
Thank you.
The changes at art resulted in some raw material or work in process inventory, becoming obsolete could you talk about the different Ross the different processes that would cause that.
John I'm, not going to comment too specifically for competitive reasons, but.
We've made some changes in.
The way we're manufacturing.
And and and so that resulted in the adjustments that you saw this morning.
Okay.
How are you doing in replacing the lost PS volumes.
And then assume it's relatively hard to try to gain share and other refiners to offset that in this environment.
Yes.
We had.
Made a lot of progress the.
It was something we started doing on June 22nd last year the day after the.
Refinery had its had its incident.
But to your point it is much harder to do.
Do that in this environment it doesn't change our intention to.
Recover that share and maintain our market share, but we want to do that in a way.
That's balanced.
In in a way that allows us to continue to focus on selling high value technology to our customers. It's the exact same strategy, we articulated a year ago about those.
Okay. Thank you.
Your next question comes from the line of Mikes Hassan would wells Fargo.
Hey, guys good morning.
I got the investor gases have been talking a lot about hydrogen and green hygiene and their plans to expand I would imagine you anything hydrogen catalyst to support some of those needs.
Is that an opportunity for you guys longer term I know, it's it's sort of 2025 2030 type event, but just wondering how the hydroprocessing catalyst sort of fits in there.
Thanks, Mike This is Hudson.
Yes, the need for hydrogen in refineries an important part of that is in their hydro processing operations, where our where our hydroprocessing catalysts fit in.
It's been a significant destination for investment for our refining customers and I continue to expected to be a significant source of investment for them in the coming years. When you look at the big refineries that are being built.
In the Middle East in China, a significant part of that capital is being invested in hydroprocessing equipment, and we'll see that demand flow through to us.
We see art growing high single digits in the future, we've talked about that being partly driven by regulatory requirements for low sulfur.
But a big part of it is driven by the use of hydrogen and refineries.
Got it and then the materials technology. It looks like inventories are in good shape in that business seems to be.
Holding up a lot better.
Well when you look at the second half the year, what do you think would need to happen to see that one turn positive.
[noise], you mean positive from a year over year growth perspective.
Yeah.
We need a strong economic recovery.
Something stronger than than.
What forecasters are calling for right now.
We're working very hard to drive the the technology, we have into higher growing segments.
But outside pharma in a few consumer segments demand is still down.
Coatings and industrials.
Hard to see that turning positive before the years over.
Got it thank you.
Your next question comes from the line of Laurence Alexander with Jefferies.
This is Tim this will onslaughts how are you.
Hi, Dan Oh.
Oh, we've seen any customers apparently chains are crushing capacity, particularly in specialty catalyst, whether it's the just shutting down some of the longer term plans.
Dan we've seen some temporary shutdowns.
I have not I'm not aware of any permanent plant shutdowns, but we did see some temporary shutdowns.
In the Q2 timeframe as customers were working to control inventory levels.
And then you mentioned the 125 million.
Savings I was wondering how much of that would be considered more temporary and how much and potentially would be we'll cut to come back just to support a rebound volume recovery.
Yes.
This is bill I think you think about the operating expense and cost reductions. It's for the most part it's temporary in nature. We these are head count deferrals. It's.
Less spending on discretionary items like.
Travel entertainment.
Hi consultants contractors.
So a lot of things are being deferred or just not being spent at this time as well some of the lower cost at the manufacturing plants, we've been able to take down fixed costs. So this is I look at is short term in nature, but these are things we could continue to.
Keep down as long as this.
Slowdown continues but when the recovery occurs.
We can yes, reinstate the hiring and start to spend on some of these areas, where we prefer to today. So it shouldnt affect our ability to recover quickly.
As a recovery occurs we're being cautious here to manage it in the short term without affecting our long term ability to capture the rebound.
Okay that was helpful. And finally, you mentioned I think Capex is generally kind of summed it up sells with some big projects. We've got what I'm just wondering how that some of these will be considered like.
Maintenance versus just since we're select growth projects that are still ongoing.
For continuous.
Yes, I think the.
The 70% would cover maintenance capital.
Each of us spend that we need to make at our plants to keep things safe and can compliant as well as some hi tech capital for necessary investments.
The seven 8% the majority of that would be on the maintenance capital side.
Thank you very much.
Your final question comes from the line of very Tosh Maestra.
Aaron Berg.
Thanks, Hey, let Jeremy I just.
Given the optimization plan.
What you described Andy Hydroprocessing catalyst business, just wondering with regard to the new plant has there been any change in your thinking about the ramp up schedule forgot plant also our that pretty much stays the same versus say three to six months ago.
Thanks for that question the that new plant has started up.
We're making commercial product now.
And.
The demand that we need to supply is reduced the course because of the pandemic, but we expect to ramp that plan up pretty pretty fast.
The plant.
Having the plant online actually gave us some flexibility that allowed us to accelerate it was part of the reason why we were able to accelerate.
The Gms implementation. So there is that connection.
But the plan itself will will ramp up it is certainly come or making commercial product now.
But it will be a little slower than we had thought.
Given the pandemic.
Got it does that make sense and then on the FCC catalyst side I was just wondering if you could talk about the demand side of the question not so much the mix and capacity utilization, but more in terms of the new FCC capacity additions plan over the next went to two years.
How what are you hearing from your customers highlighted those plants progressing just given the volatile environment.
Great. Great question. You are these are extremely important investments for our customers.
They remain.
Very focused on these investments and certainly well committed to these investments and I'll have to let them at tell you about their timing plans that wouldn't be appropriate for me to comment, but I I will say that they remained strongly focused on these investments.
Great. Thanks, guys.
This concludes today's session for today I would now like to turn the call back to Jeremy Rowan for any closing remarks.
Thank you Nicole thank everyone for your time today and your interest in Grace, we look forward to engaging with you over the coming months. Thank you.
Thank you ladies and gentlemen. This concludes today's conference call. Thank you for participating you may now disconnect.
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