Minerals Technologies Inc.

Good day, everyone, and welcome to the third quarter 2020 Minerals Technologies Earnings Call. Today's call is being recorded, and at this time, I'd like to turn the call over to Erik Aldag, Head of Investor Relations of Minerals Technologies. Please go ahead, Mr. Aldag.

Thanks, Ciara. Good morning, everyone, and welcome to our third quarter 2020 Earnings Conference Call. Today's call will be led by Chief Executive Officer Doug Dietrich and Chief Financial Officer Matt Garth. Following our prepared remarks, we will open it up to questions. I'd like to remind you that beginning on page 14 of our 2019 10K, we list the various risk factors and conditions that may affect our future results. And I'll also point out the safe harbor disclaimer on this slide. Statements related to future performance by members of our team are subject to these limitations, cautionary remarks, and conditions. I'll now turn the call over to Doug. Doug?

Thanks for the introduction, Erik, and good morning, everyone. We appreciate you taking the time to join today's call, and I hope you are all staying safe and healthy. Let me outline a brief agenda for the call. I'll begin by taking you through our third quarter highlights, including improving trends in our sales results, our strengthened operational and financial profile, and progress made on the business development front. I'll then turn it over to Matt to provide a more detailed look at our third quarter performance by business segment. I'll conclude our prepared remarks by discussing trends in our end markets and highlighting new business that will contribute to our volume growth next year. First, I want to comment on the 8K we filed this week related to a ransomware attack we recently experienced, which impacted access to some of our company's IT systems. We have procedures and protocols in place for situations like this. And immediately after detecting the incident, we implemented our comprehensive cybersecurity response plan, including taking steps to isolate, then carefully restore our network to resume normal operations as quickly as possible. We've notified law enforcement and have been working with industry-leading cybersecurity experts to conduct a thorough investigation. Throughout this situation, we operated our facilities safely and met our customer commitments. Before going through the third quarter review, I'd like to note that I'm very pleased with how our global team and businesses have performed in what continues to be a complex and challenging environment. We remain focused on managing our company with an unwavering commitment to keeping our employees safe, operating our plants efficiently, and serving our customers with value-added products. Dedication, engagement and resilience of our employees has been nothing sort of exemplary during these times, and I want to thank them for the perseverance they've shown over the past several months. Let me take you through how our third quarter unfolded. As we previewed in July, we anticipated that demand conditions in our end markets would improve, with the second quarter having the most acute impacts from COVID-19. and that's largely how the quarter played out as we were prepared to respond to the volume recovery which led to sequential sales growth in nearly all of our product lines. Overall, we had a solid quarter from an operational and commercial standpoint. These results reflect our team's disciplined execution related to cost control, pricing and productivity which resulted in higher sequential and year-over-year operating margins. We also demonstrate how our strong product portfolio and End Market Mix has enabled us to capture opportunities with existing and new customers. From a financial perspective, total sales in the quarter were $388 million, an increase of about 9% sequentially, but still at lower levels compared to last year. As we indicated on our last call, our July sales were trending upwards and demand conditions in several markets continued to strengthen throughout the rest of the quarter. We generated $52 million of operating income, and earnings per share were 92 cents. In addition, we delivered $54 million in cash from operations, continuing our solid cash generation profile. After experiencing volatile conditions in our businesses that serve industrial-related end markets through the second quarter, we saw considerable demand improvements in the third quarter, along with continued strength in our consumer-oriented product lines. Let me touch on some of the highlights. Metal casting business continued to rebound as our foundry customers in North America ramped up production to meet the demand increase in the automotive sector. By the end of the third quarter, our metal casting facilities were operating at about 95% of last year's levels, noticeable improvement from the reduced levels seen earlier. In addition, penetration of our pre-blended products remains on a strong growth trajectory in China as sales increased 20% over last year, and this momentum should continue moving forward. Sales in our portfolio of consumer products, which includes pet care, personal care, and edible oil purification, remained resilient, led by an 11% year-over-year growth in pet care. We continue to strengthen our robust private label pet care portfolio in North America and Europe, and have expanded our presence through partnerships with several new customers. Another area to highlight is our global PCC business, which benefited from satellite restarts in India and North America, combined with an improved demand environment from the low levels in the second quarter. As we indicated on our last call, July volumes were trending approximately 15% higher compared to June, and these dynamics continued through the third quarter. Of note, paper PCC sales in China continued to deliver a solid performance with 18% growth over last year. In addition, specialty PCC sales increased sequentially as automotive and construction demand strengthened through the quarter and food and pharmaceutical applications remained at strong levels. Other pockets of strength came in our talc and GCC business as demand improved for our products used in residential and commercial construction as well as automotive applications. And in our refractories business, where steel utilization rates increased in the U.S. from a low of 50% in the second quarter to 65% at the end of September. While many of our businesses return to a positive trajectory, we've had some challenges in our project-oriented businesses, such as environmental products, building materials, and energy services, which are still experiencing volatility in order patterns and timing delays. Energy services was further impacted by several hurricanes that occurred in the Gulf of Mexico during the quarter. As our volumes began to trend upward through the quarter, we were able to leverage these sales into income, resulting in overall operating and EBITDA margin improvement on both a sequential and year-over-year basis. We've maintained our focus on operational efficiency, including variable cost adjustments and structural overhead savings, as well as on continued pricing increases, capturing favorable raw material costs, and increasing sales of higher value products. As markets continue to recover, we are well positioned to expand margins further on increased volumes. Our focus on strengthening our financial position also remains a priority, with an emphasis on tightly controlling our cash generation cycle and creating more flexibility around our capital structure. We delivered another quarter of strong cash flow generation, the majority of which was used to pay down debt. While navigating through the current environment, We've remained focused on advancing our growth initiatives and made further progress this quarter on several fronts. Let me go through some of these highlights in more detail. The commissioning of two new PCC satellites scheduled for the fourth quarter continue to move ahead. Currently ramping up production at our 45,000 ton facility in India. The 150,000 ton satellite in China should be operational by December. We will also be resuming production in November at our previously closed satellite in Wycliffe, Kentucky to support Phoenix Paper's restart of that mill. During the quarter, we made a small acquisition of a hauling and mining company to further strengthen our vertically integrated position at our Bentonite mines in Wyoming. This transaction improves our cost position and enhances our flexibility with our mining and ore transportation in the region. In our refractories business, we signed two new five-year contracts to supply our refractory and metallurgical wire products in the US. These contracts total approximately $50 million, or about $10 million of incremental revenue on an annual basis. Our new product development efforts are progressing well, as we look to accelerate the pace of commercialization and drive new revenue opportunities. We've commercialized 36 value-added products so far in 2020, and many more. All in all, there are a number of positives about our performance in the quarter, especially how we've executed as a company while navigating through difficult conditions. There are still some challenges ahead. We have strong momentum across many of our businesses, and with an enhanced cost profile, we expect to continue to deliver improved profitability as volumes recover. With that, I'll turn it over to Matt to discuss our results in more detail. Matt? Thanks, Doug.

I'll now review our third quarter results, the performance of our four segments, as well as our cash flow and liquidity positions. I'll then turn the call back over to Doug for some additional perspective on our current operating environment and the visibility we have going forward. Now, let's get into the review of the third quarter results. Third quarter sales were $388.3 million, 9% higher sequentially and 14% below the prior year. Gross margin, EBITDA margin, and operating margin all improved sequentially and versus the prior year, driven by our continued pricing and productivity actions. SG&A expense was flat with the second quarter and also contributed to the margin expansion. Earnings per share excluding special items was $0.92 and we incurred special charges of $3.2 million after tax in the third quarter for $0.09 per share. Our effective tax rate for the quarter was 19.8% versus 19.1% in the prior year and 16% in the prior quarter. Going forward, we expect our effective tax rate to be approximately 20%. Now let's review the changes in sales and operating income in more detail. On this slide, we are presenting the year-over-year comparisons of sales and operating income on the left side and the sequential quarter comparisons on the right side. Third quarter sales were 13% lower than the prior year on a constant currency basis. The slowdown in economic activity brought on by the COVID-19 pandemic continued to impact our volumes on a year-over-year basis in the quarter. The operating income bridge on the bottom left shows we were able to significantly offset the impact of lower sales versus the prior year with favorable pricing and cost performance driven by the actions we have taken over the last year. These actions resulted in higher operating margin versus the prior year despite the lower volume. On a sequential basis, we saw significant improvement in demand with sales up 7% adjusting for currency and up 9% overall. conditions improved across most of our end markets and we maintained pricing levels across the company. On our last call, we told you that sales rates in July were trending approximately 5% higher than June and this trend accelerated through the rest of the third quarter. Daily sales rates in August were 6% higher than July and September was 7% higher than August. Operating income increased 18% sequentially on a constant currency basis primarily due to the improvement in our end markets and continued cost control. Operating margin was 13.3% in the quarter versus 13.2% in the prior year and 11.8% in the second quarter. Now let's take a closer look at the operating margins and how they have improved on the next slide. On this slide, we are showing year-over-year and sequential operating margin bridges for the third quarter. Starting with the prior year comparison, Our pricing and cost actions contributed to 190 basis points of improvement, which more than offset the unfavorable volume impact. On a sequential basis, we leveraged additional volume into 60 basis points of margin improvement, and our continued cost control contributed another 70 basis points of favorability. The actions we have taken on pricing, productivity, cost control, and New Product Development have positioned us well to leverage incremental volumes into improved margins going forward. Another margin-related highlight for the third quarter was that EBITDA margin improved by 70 basis points versus both the prior year and the prior quarter. Now let's turn to the segment review, starting with performance materials. Performance materials sales increased 10% sequentially and were 8% lower than the prior year. Metal casting sales grew 26% sequentially as foundry production improved in North America and demand remained strong in China. The improvement in North America was primarily driven by the ramp-up of automotive production. China metal casting sales grew 11% sequentially and 20% versus the prior year on continued strong demand from our customers and continued penetration of our specially formulated blended products. Household, personal care, and specialty product sales remained resilient up 7% sequentially and flat with the prior year on continued strong demand for consumer oriented products. Meanwhile, environmental products and building materials continued to experience COVID-19 related project delays and sales remained below prior year levels. Operating income for the segment was $28.2 million, up 34% sequentially and up 5% versus the prior year. Operating margin was 14.8% of sales, up 270 basis points from the second quarter, and up 180 basis points from the prior year. Continued pricing actions, strong cost control, and expense reductions more than offset the operating income impact of lower sales versus the prior year. The chart on the bottom right shows daily sales rates by month this year compared to the prior year. This segment experienced a clear rebound in demand and sales increased steadily throughout the third quarter. We would normally expect a seasonal decrease in sales for this segment between the third and fourth quarters, driven by our construction and environmental end markets. However, this year we expect to offset the typical seasonality with continued positive momentum in our other markets. We expect fourth quarter sales to be similar to the third quarter, despite the typical seasonal effects. I'd also like to note that we experience higher mining and energy costs while operating in colder months, and this will temporarily impact segment margins in the fourth quarter. Now let's move to specialty minerals. Specialty mineral sales were $125.1 million in the third quarter, up 14% sequentially, and 13% below the prior year. PCC sales increased 14% sequentially as paper milk capacity came back online in the US and India following temporary COVID-19 related shutdowns. Paper PCC sales in China grew 11% sequentially and 18% over the prior year on continued penetration and strong customer demand. Specialty PCC sales increased 16% sequentially as automotive and construction demand improved through the quarter and consumer-oriented products remained strong. Processed mineral sales increased 13% as end markets steadily improved through the quarter. Operating income excluding special items was $18 million, up 18% sequentially and 17% below the prior year, and represented 14.4% of sales which compared to 13.9% in the second quarter and 15.2% in the prior year. The impact of lower volume versus the prior year was partially offset by continued pricing actions and cost control. Daily sales rates charts for this segment also shows improving conditions through the third quarter and we expect this trend to continue into the fourth quarter as paper production in the US, Europe, and India continues to ramp up In addition, we are bringing online new capacity in the next several months, and most of this capacity will come online late in the fourth quarter. The sequential improvement in paper PCC will offset the typical seasonality we experience in the residential construction markets served by the other product lines. Overall for the segment, we expect fourth quarter sales to be similar to the third quarter. Now let's turn to refractors. Factory segment sales were $59.3 million in the third quarter, up 6% sequentially as steel mill utilization rates gradually improved from second quarter levels in both North America and Europe. Segment operating income was $7.3 million, up 24% from the prior quarter, and represented 12.3% of sales. Again, you can see improvement in the daily sales rates through the third quarter, We expect continued improvement in the fourth quarter as steel utilization rates improve and laser equipment sales pick up. Overall for this segment, we expect a modest sequential improvement in sales in the fourth quarter versus the third quarter. Now let's turn to energy services. The energy services segment experienced significant customer project delays in the third quarter. These delays were related to COVID-19 restrictions, as well as several weather related shutdowns on the Gulf of Mexico in what has been a very active storm season. As a result, sales were 13.3 million and operating income was break even for the third quarter. Now the daily sales rates chart shows the solid start to the year followed by sales levels that have remained low relative to the prior year. Continue to see a strong pipeline of activity and we expect sequential improvement for this business in the fourth quarter. Now let's turn to our cash flow and liquidity highlights. As Doug noted, third quarter cash from operations totaled $54 million, and free cash flow was $40 million. We continued our balanced approach in deploying cash flow, paying down $30 million of debt, and we resumed our share repurchases, acquiring $3 million of shares in the quarter. We continued to repurchase shares in October, and completed the expiring program with $50 million of shares under the $75 million authorization. As noted earlier, the Board of Directors has approved a new one-year $75 million repurchase program. Our net leverage ratio is 2.1 times EBITDA and we have $682 million of liquidity, including over $375 million of cash on hand. Before I hand it back over to Doug for the market outlook, I'd like to summarize my comments on what we are expecting for the fourth quarter in each of our segments. In our minerals businesses, we expect continued improvement in many of our markets to offset the typical seasonality, and we expect sales to be similar to the third quarter. Margins will remain strong on a year-over-year basis, though sequentially margins will be impacted by seasonally higher mining and energy costs. In our services business, We expect continued gradual improvement in refractories as utilization rates improve, and we expect sequential improvement in energy services as delayed projects resume and activity levels pick up. Overall, we expect MTI sales in the fourth quarter to be similar to the third quarter. With that, let me turn it back over to Doug to discuss our current end market conditions and outlook in more detail.

Doug? Thanks, Matt. Before beginning the Q&A portion of the call, I wanted to take some time to provide a little more insight into the conditions across each of our businesses and where we see opportunities to drive incremental growth. The improving market trends experienced across most of our businesses will likely extend through the rest of the year, while our project-oriented businesses may continue to face persistent challenges with uncertain customer order patterns. as we build on the momentum from the third quarter. We're also executing on a wide range of attractive growth projects, which will accrue to revenue in 2021. Let me now take you through what's happening by business segment, starting with the performance materials, our largest and most diverse segment. Our household and personal care product line will continue on its strong sales trajectory as demand for these products stays high and we leverage our expanded channels and presence with new customers. Specifically, we're growing our portfolio of premium pet care products in both North America and Europe with the expansion of new online retail channels with larger customers and the introduction of new products, such as our 100% carbon-neutral EcoCare product in Europe, an example of how we're satisfying customer preferences while also contributing to our sustainability efforts. In addition, sales of our edible oil purification products have more than doubled since last year as we grow this business through an expanded global customer base. In our metal casting business, we expect to continue to benefit from the automotive demand rebound in North America. Noted earlier, we expanded our customer base in China through the continued penetration of our higher value blended products, which led to sales growth of 20% over last year. Our solid growth trend there will continue for the rest of the year and into 2021. I'll touch on environmental products and building materials together as they're both experiencing similar dynamics. While each maintains a robust and active pipeline and continues to introduce more specialized products, these businesses have been impacted by timing delays around when customers will commence larger remediation and waterproofing projects. Switching to the specialty minerals segment, where I'll begin with paper PCC. With paper demand in North America and Europe gradually improving, We expect sequential volume growth in all regions in the fourth quarter. Asia, and China more specifically, will continue its solid growth trajectory. We'll also benefit from the ramp-up of our satellite in India, and our new satellite in China should be operational in December. On the horizon, we have two new facilities coming online in the first half of 2021, one for a packaging application in Europe and another for a standard PCC facility in India. Overall, we're bringing online 285,000 tons of new PCC capacity over the next three quarters. We also maintain a very active business development pipeline across our broad portfolio of PCC technologies, including high filler, packaging, and recycling. Each of these opportunities could add to our overall volume total next year. And our specialty PCC, GCC, and telc businesses Sales for our pharmaceutical and consumer products, including food applications, will remain strong. Demand for our high performance sealant and plastic products that are used for automotive applications should strengthen as build rates continue to improve in North America and Europe. And sales for products used in residential and commercial construction applications should stay steady. For the refractory segment, current steel utilization rates in North America and Europe are around 70% and 65% respectively, and we expect these rates to gradually improve in the upcoming quarters. In addition, our order book for laser measurement equipment remains strong in the fourth quarter. As I mentioned earlier, we've recently signed two five-year contracts totaling $50 million to supply our broad portfolio of refractory and metallurgical wire products, which will start to accrue to revenue growth in 2021. Finishing up the discussion with Energy Services, where we maintain an active pipeline of offshore services. While COVID-19 and adverse weather conditions have led to some early demobilizations or postponements from our larger offshore projects, some of these projects have been rescheduled to resume in the fourth quarter. In addition, we've recently been awarded new large projects in the Gulf of Mexico, which we expect to commence over the next few quarters. We're focused on navigating through a highly dynamic environment, and our culture of continuous improvement positions us to do so. Over the past six months, we've been successfully implementing virtual tools to help improve productivity, efficiency, and connectivity with our employees and customers, and I've been impressed with how quickly we've adapted to the changing environment. These tools have enabled us to run our business smoothly as we connect seamlessly with our operating facilities for meetings and site visits, conduct problem-solving Kaizen events, and collaborate and communicate efficiently with our global customer base. Many of these new ways that we're operating on a daily basis will become permanent, and we'll balance them with in-person activities. As we look ahead into 2021, I'm confident in the direction we're heading and the solid foundation we have in place to leverage improved market conditions and the growth projects we have in hand. While COVID related uncertainties still persist, our end market conditions continue to show signs of improvement. With the operational actions we've taken, we are well positioned to drive improved profitability. In addition, strength and flexibility of our balance sheet provide solid resources to support both organic and inorganic growth opportunities. Before taking your questions, I want to say to our team at MTI how proud I am of the way they've executed and performed and what has been an incredibly complex, dynamic environment. And thank them again for their dedication and engagement. With that, let's open the call to questions.

All right, if you would like to ask a question, you may signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off so that your signal can reach our equipment. Again, that is star one to ask a question. and we'll pause for just a moment to allow everyone an opportunity. All right. The first question is from Daniel Moore with CJS Securities.

Doug Mack, good morning. Thanks for taking questions.

Hi, Doug. Good morning.

I wanted to start with PCC. Can you just refresh us and break down the revenue by geography in Q3? where we are today as a baseline and where do you see that by the end of 21 given all the new scheduled capacity coming online?

Let me start now and give you kind of the bridge to the new capacity and volumes that we see for 2021. And then Matt, maybe you can help me with some of the revenue by geography. As I mentioned, we're bringing on about 285,000 tons of capacity. 200 of that will be here in the fourth quarter. ramping up this quarter and into the first, and then another 85,000 tons in the first half of next year. That's two facilities of packaging and another facility in India. This year, we experienced shutdowns. If you remember last call, Verso Paper and Domtar Mill in Ashdown, Arkansas, totaling about 100,000 tons of volume came out this year. were up about 185,000 tons next year. By the middle of next year, we'll have installed about 185,000 tons of incremental. Given the timing of when they come on and as they ramp up, we see probably 125,000, 150,000 tons of new volume in 2021, kind of on an annualized basis. So when you get to the second half of next year, you should be on an annualized run rate of about 150,000 tons of additional volume.

Very helpful, given all the puts and takes we've had over the last couple of quarters. And then just trying to get a sense for what the new baseline looks like as Asia and China continue to grow, India as well, while North America has been on a bit of a different trajectory. Any update there?

Yeah, so let me go back and pick the right baseline. So if you look at our 2019 volumes, before going into 2020 with all the puts and takes I just gave you, are about 2.9 million tons of PCC. You know, we've had, you can see the chart, the big dip in volumes through the second quarter and the gradual improvement through the third and we think into the fourth. With this additional volume, we should probably by the end of next year be back to that level, right? And then with the additional volume accruing into the next year. So again, you know, look, there's a lot of demand conditions that have to continue continue through the fourth quarter and into the first and seeing where we are with kind of COVID-related uncertainties. But if you take like on a 19 base with the puts and takes from this year, we should be able to get back to that level on a run-right basis by the end of next year.

Okay. I'll do some of the math offline on geography. Go ahead. Sorry.

No, no. And Dan, I was going to give you actually that rough breakdown on a geographic basis. And let's do it on a revenue basis as you asked for. roughly 40% in North America region. You're going to have the rest fairly split between Europe and Asia. There's a small bit in there called 5% that exists in Latin America, but that's the way we'd break it down.

Perfect. That's helpful. Okay.

I'll add to that, Dan. I'm sorry. Go ahead. I'll add to that. That's what we have in hand. So if things kind of stop today, that's how that's going to shake out. There are, you know, we always talk about we have a pipeline of opportunities that we continue to work on. They're in different stages. Technologies in terms of our high filler, our new yield products, recycling, and those, many of those are in, you know, advanced stages of discussion, which also should accrue to, could accrue to volume next year as well.

That was my follow-up was, you know, some of the new, it seems like the dam is breaking a little bit for new contracts. are you seeing increased momentum there? And sounds like you are at least with some of the new technologies.

Yeah, let me give you, DJ, are you there? You want to give a little color about some of our new technologies and some of the trials we're running?

Yeah, sure. Glad to. And Dan, just to further the conversation on regional breakdown. For the standard PCCs, I would say that, you know, of the contracts we're chasing on standard PCC in the printing and writing grades, Most of that is India and China and the rest of Southeast Asia. So that shift will continue to happen. And then if we look at the new technologies, it's kind of a balance. The new yield technology that we've got where we've run some pretty successful machine trials and we're into the commercial discussions. That's a little bit more in Europe and the Americas, kind of balance between those two. If I look at the new products in packaging, the most momentum we have right now for the white grades, the white board packaging would be North American packaging. And then we've got a couple of products in brown grades that Newer technology, one being New Yield, others being a new product designed for brown paper, those would be in the Americas too. So standard PCC, clear path for growth and a good pull in Asia. And then the new products seem to be getting more momentum in the Americas and a little bit in Europe.

Perfect. That's helpful. A lot of really good work done on the cost side and a lot of discussion in the prepared remarks about the opportunity for margins to move higher. Just remind us either across the businesses or consolidated what incremental margins typically would look like and whether we see upside to those kind of historical typical incremental margins over the The next 12 plus months, given some of those cost reduction initiatives as volumes do recover.

Yeah, Dan, and what we've typically told you, and if you remember in the beginning of the year, as revenues were tracking down, we talked about the decremental margins being in that 30% range, and that's been proved out as you looked at the second quarter. What's come back on the incremental margins has also been in that 30% range. Now, it's a little bit north of there. and we would expect with the cost control that we've been seeing and the effort on our fixed cost expenses that we would be able to move that incremental margin as the volumes are coming back. So I'd use those two numbers around 30%, either decremental or incremental, you know, for now and we'll prove it out as it's expanding over the next coming quarters.

And then to answer your... Your initial question, there's absolutely room for margins to move north. If you take a look at the margin chart in terms of the volume impact we've absorbed and offset, that volume at those incremental margins really accrue to income, but also those margins as well. We're always looking at opportunities to become more efficient with our culture in terms of productivities and looking for ways to do things better. We've captured a lot of that over the summer and in these months, but that's part of our DNA. We do that constantly, and so we're always looking for ways to continue to hold costs or reduce costs so that those new products, those higher margin products, and that volume as our markets continue to recover all drop right to the bottom line and help that margin story. So I think we always talk about 15%. If you take that volume from the first quarter or even just from last year, we'd be north of that right now.

Perfect. Last for me and I'll hand it over. You give very good color on Q4 and then some color on some of the margins for the individual segments overall. If we put all those together, margins flatter slightly down from Q3 sequentially based on how we see the world today. Is that the right takeaway or is there a better conclusion?

What we told you, we basically laid out the trajectory for revenues to be essentially the same. Now, the mix of revenues is going to change. One item we also called out for you, Dan, was the higher mining and energy costs. There's going to also be some other incremental costs that will be in there, and those are going to be in that $2 million to $3 million range. So you are going to see the margin impact taking place just based on sort of those seasonal temporary effects of the mining and energy costs. All right. Once again, if you would like to ask a question, please press star 1.

If you'd like to remove yourself from the queue by pressing star 2. Excuse me. The next question is from Soke Kuik with JP Morgan.

Hi. Good morning. How are you? Good, Soke. How are you? Good. Do you have any view on on auto bills going into the fourth quarter. Have your customers signaled anything about whether there'll be shutdowns in the U.S. in December or there won't be and what the trajectory looks like? It looks like there's some COVID shutdowns coming in Europe. Often there's some seasonal shutdowns that happen in the U.S. in December and the Asian markets are really strong. I was wondering what you hear from your customers.

Sure, let me start it off and then, you know, I think we'll talk more about the automotive, the impacts, just to remind everyone, the impacts on automotive have primarily in North America and Asia for our metal casting business. We supply more of the automotive industry and our minerals businesses, especially PCC, a little bit more of North America and Europe focus. So just to give you the breakdown of those impacts. John Hastings, do you want to talk a little bit about metal casting? What we're hearing from customers going into the fourth quarter?

Sure, Doug. Hi, Silke. How are you? Good. Let me touch base on North America. I'll talk about China and then also Southeast Asia. But what we're seeing in North America is everybody's running pretty well, pretty strong. As you know, auto production went south in Q2, rebounded in Q3. But inventories are remaining low, and everybody's looking to restock the pipeline, and auto sales remain pretty strong. all of our customers are telling us that they're running fairly strong throughout the remainder of the year. Again, we'll see what happens around the end of year holiday season with shutdowns, but we don't expect any major impact. We see it fairly strong. China, about 40% of our business is in auto and heavy truck in China, and we've seen a very, very strong year. The build rate, The customers have come back extraordinarily strong in Q3. We expect that to continue into Q4. What we see is not only domestic production and consumption, but then also the exports, exports of parts and also of vehicles going into both the US and Europe. Those continue to rebound, and as a result, the demand has been very strong. The last region in the world that's rebounding is Southeast Asia. and what we're seeing is that they're currently running at about, you know, our business is about 80% year on year. That's a relatively small piece of our medical system business worldwide, but we do see that increasing on a sequential basis. And that's because the auto production in Thailand, Korea, Indonesia, you know, they're on the rebound coming off the COVID shutdown. So that's the last region. And overall, you know, we continue to look pretty strong going through Q4.

So the only thing I'd add to that is, look, I think, you know, our visibility in the middle of the third quarter was, you know, probably a little bit stronger going into looking into the fourth. I will, you know, addressing, I think, where your question is coming from with the shutdowns, recent news in Europe and what we're seeing around the world. Yes, it's a bit of cautious. But right now, what we can see through the fourth quarter is, Thank you. Thank you.

You know, begin to buy back, you know, share so meaningful. Like, what do you, you know, what are your capital allocation plans?

I think our capital allocation has remained, you know, similar to what it was. We talked about that on the last call. Look, I think going into April, you know, ensuring that our balance sheet was in, you know, solid shape was a priority. And making sure that liquidity was there and our debt maturities were Thank you very much. and so we continue to put that cash on the balance sheet. I think right now our priority is making sure our debt positions, we paid $30 million in the third quarter, I think we'll continue to steer our capital more to that direction. But as you know, we have a $75 million authorization that we intend to execute on and we have some cash on the balance sheet for opportunities. We're gonna support these growth projects that I mentioned today and do things like, we have our small hauling business that we acquired We have a nice portfolio and profile of potential companies we think work for us. And so I think our balance sheet is in a good position for all of that. Repay debt, execute on our share repurchase program, and ensure that we have resources to support our growth initiatives.

And Silke, let me just add the free cash flow dimension to that. And Doug talked about the strength of the story, and you saw here in the third quarter generating another $40 million of free cash flow. If you listen to the call from last quarter, we told you that we were going to generate about $100 to $120 million of free cash flow in the year. Based on what we're seeing now through the rest of the year, we're in the $140 to $150 million range of free cash flow generation in 2020 for the company. And that includes continuing to invest in the company from a sustaining EHS and growth perspective. It seems like you'd like plenty of cash to buy back, you know, $70 million worth of stock. Seems like a good investment.

Yeah, we think it is a good investment, Silke. But that's not to say that, you know, we've always talked about our approach and making sure that our debt levels are down to target levels, first investing in ourselves and our growth opportunities where we see the returns and fit our strategy. And then, yes, we will balance returning cash to shareholders and also as acquisitions potential are there. As those change, we can steer more toward share repurchases and as those opportunities we'd steer more toward our inorganic opportunities so we'll continue that approach but I think the point is that making sure that we're in solid footing regardless of what economy we're in I think we have that position and being able to take advantage of opportunities be it in the market for returns to shareholders or in the market for things that we think fit our core capabilities from an inorganic standpoint.

Thanks very much.

gives us a lot of options.

All right. And the next question is from Rosemarie Morbelli with G Research.

Thank you. Good morning, everyone.

Hi, Rosemarie.

So just finishing up on the cost side, how much of, first of all, do you have a dollar amount in terms of How much do you have been eliminating in terms of cost? And then how much of that do you think is only temporary and will come back?

Yeah, Silke, if you take... Sorry, Rosemary.

It's okay, we both have an accent.

Yeah, thank you very much, Rosemary. If you take a look at what we just showed you on a year-over-year basis with the effort of costs that we have taken out in terms of expenses, fixed costs, starting with the restructuring that took place in the middle of last year, where we told you that would be about $12 million. Since that time, we've also seen expenses related to T&E and also other costs, meaning other headcount costs coming out that we haven't been backfilling and that we've been finding a way to be more efficient overall in our system so that we would not need to backfill those heads. When we talk about what's permanent and what's not permanent, we say that about two-thirds of the overall cost benefit that we've been experiencing on a year-over-year basis is going to stay in place. And so we showed you here in the third quarter that that was about 180 basis points worth of and so you could expect that to continue on about a two-thirds basis going forward.

Thank you. That's helpful. And then still on the quick questions type of answers, this last year of your $75 million of authorization, you only bought back $50 million worth of stock. Do you think I think Rosemary we were on track to do the full $75 million authorization.

We suspended that in March after the first quarter given the conditions. Our pace and our intent was to fully fulfill that authorization. So we took a pause over the summer, making sure we preserved cash, making sure that we were in the right position, as I mentioned earlier, in our balance sheet. And then when we saw as the cash flow in our balance sheet resumed it with the remaining time that we had. So we ended up with $50 million due to a bit of a pause. We have the cash on hand to be able to do that $75 million, and I think we'd intend to do that going forward.

All right, thank you. And still on the cash note, I thought that with your debt level as low as it is right now, you had kind of posed debt repayment. I suppose I was wrong. And if I heard properly, you are still planning in reducing your debt. So what is the net leverage target then?

We've maintained kind of a target level of two times. Rosemary, we've been around that 2.1 times for a while. I think as we went through the second and the third quarter, as we viewed kind of the economy and what was happening, We felt prudent, as I said, to make sure that we had a very strong balance sheet, and the priority was that. And so we put most of the free cash flow, the $40 million in the third quarter, to debt repayment, a bit to shareholders. We're comfortable with where our debt position is. We could make some additional debt payments going forward. But again, that balance sheet that we have gives us a lot of options to make sure that our debt's in the right position, we can steer our cash to shareholders, but also Thank you very much.

are now 25%, and you are targeting that level to grow to 35% to 40%, if my memory serves me right. And that would include pests doubling, going from 200 million to 400 million. So can you talk about the timing and whether most of that growth is going to come from internal growth or whether M&A is actually the biggest chunk getting you to your goal?

I think you're referring to a question maybe from the last call. I think we answered, you know, how big could our consumer-oriented businesses be? Look, I think it could grow to that size. I think we're certainly our strategy around creating balance in the company from an industrial and consumer standpoint. As you mentioned, we're currently about 25% consumer-oriented. and we look to grow some of our core positions. I think we're vertically integrated in our pet care business and a couple of years ago we added to that with an acquisition called Sivomatic which doubled that pet care business. I think you saw that the organic growth of that business is at 11% and so we think that a large portion of those businesses are edible oil purification, our animal health business, our pet care business, our fabric care businesses, Those will continue to grow, and we continue to develop new products and ensure that we have the right capital base there to have healthy returns. We will continue to grow those organically, and I think there's opportunities out there for us to continue to add to our consumer-oriented product base to expand that. I think could it get to 35%? Sure. That's going to be both a combination of growing our current core positions organically and adding to them inorganically. Over time, I think that's a possibility to get to those types of levels, but we're certainly focused on growing those product lines, these core product lines that we have in those consumer-oriented products.

Could you get to that level faster just by reshuffling your portfolio of businesses, meaning that divesting some non-consumer-related operations?

On a percentage, Grace, yes, that would do it. I think at the moment we're looking more toward adding and growing those businesses organically and potentially inorganically.

Okay, thanks.

All right, and your next question is from Mike Harrison with Seaport Global Securities.

Hi, good morning. I was wondering if we could talk about the HPC business. You said pet care was up 11%, but the business was flat overall on a year-over-year basis. So what's going on outside of pet care? Was there some destocking or maybe declines from surge buying that was happening earlier in the pandemic?

Yeah. Business product line is household personal care and specialty. And in that specialty segment, there are some kind of high-end additives for drilling products, so both in construction drilling and oil and gas drilling. And that was the one product line that has been off, mostly that oil and gas drilling, those additives for oil and gas drilling. So I believe every other portion of that product line had grown over last year with the exception of that.

All right. And then within the paper PCC business, have you seen your printing and writing paper customers getting some benefit from colleges and schools, getting back to some in-person learning? Or is that not provided much pickup and until we get to fully in-person, we don't see that improvement?

I think that's some of what's behind the demand growth. I think the majority of our growth from the third through the third quarter was really due to restarts. We had a number of shutdowns in the second quarter for entire months. India, government restrictions and shutdowns for almost part of April and May. We had some shutdowns in South Africa and some of our plants in Europe. Those restarted in the third quarter, which was really driving through that growth. I do think there is some demand improvement. I'll let DJ Monagle talk more to that about our conversations with customers. DJ, you there?

Yeah, I am, Doug. So, Mike, the way we're, you know, to generalize the statement, Doug is spot on that what we've been seeing is really just restarting and coming up from the shutdown. There's a general optimism there. that as more and more schools come online and more businesses get to work, that operating rates will improve. To just give you a perspective on this, the operating rates as we went into 2020 were in the neighborhood of just below 90%, so somewhere between 85% and 90%. North America was right at 90%. Europe was a little bit lower than that. So as things are coming back up, Most people feel that North America is going to be back into that 80 plus percent operating rate. Europe seems to be a little bit slower. And the big question on everyone's mind is they know that going back to work or they feel that as people return to the offices and more and more people go into the schools, because a lot of schools are working on these hybrid things, that paper consumption will grow. What the question mark is, is how do the How do the long-term habits change based on this pandemic? And there's a school of thought that says the longer that this lasts, the more likely people are going to be transitioning to more, I guess, electronic methods of keeping their data or doing their work. So there's a big question. But what we've seen is about getting people back to work and having the shutdown stop. but there's still a big question on long-term demand, especially in North America and Europe. And then in Asia, the demand picture is the same, but for us, our growth story is more about penetration and that continues to move forward. Does that help, Mike?

Absolutely, very helpful. And then last question I have is on the refractories business. It seems like utilization rates are starting to approach the 70% level. I feel like 80% is more the magic number where these mills feel like they can run efficiently and profitably. Do you guys see 80% or 70% or any specific utilization rate as a magic number in terms of a pickup in your refractory sales?

Let me start that and then I'll ask Brett Argirakis to comment. Historically in this business, we thought that an 85% rate was necessary for this business to be really strong in terms of operating income. We've changed this business tremendously over the past couple years from a margin, contribution margin, technology, its portfolio of products. I think you saw last year in the mid-'70s, late in the first quarter, mid-'70s, this business is still very profitable. We've changed the profile of the business over time. Brett, why don't you talk a little bit about what you see in the marketplace and where you think operating rates are going based on what you're from our customers?

Sure, sure. Thanks, Mike. Yeah, as right now, looking at the market conditions, all regions, of course, are showing reduced rates from prior year, but all showing gradual improvements. Doug and Matt both pointed out automotive is improving rapidly. really to pre-COVID levels in NAFTA. We're seeing steel and scrap prices in North America and Europe increasing, which is definitely beneficial to the steel industry. And right now, the U.S. continues to show signs of getting back up to the better levels. Right now, it's just under 70%. For the past couple of years, we've seen 80%, which was very healthy. At 80%, it gives the steelmaker plenty of time to do maintenance, but also at a very healthy rate. I would anticipate that these rates will continue to gradually improve, but as Doug pointed out, 80 would be great to get back to, and I think we can get there, assuming no further setbacks from COVID. But overall, we are positioned pretty well to operate even if we don't hit the 80% rate and continue on. There's also still capacity that's coming on, new plants. These new plants are starting up between the fourth quarter and through 2021, which we're very well aligned to continue to expand with them. They've both, Doug pointed out, some of the new business growth that will be moving along with them in both refractory and metallurgical wire. So, yeah, I think we have a really good chance to get back to some reasonable rates, and if not 80%, we're positioned well, Mike.

All right. Thanks very much.

All right, and we'll take the next question from David Silver with CL King.

Yeah, hi, good morning. Thank you. Actually, I should say good afternoon. So I had a couple of targeted questions here. Early on in your comments, Doug, you mentioned... regarding the 11% increase in pet care, you know, pet care sales this quarter, year over year, and sequential, you made a reference to partnering. And I have to confess, I've never, you know, come across that before, and also, sorry, come across that before in your commentary, and, you know, the 11%, I think, is significantly higher than maybe the three to five or four to six percent kind of numbers you've been targeting for that business for a long time. So maybe just a little bit of color on are you doing anything differently? Are these partnerships a little bit different? And what would be the ultimate potential to increase partnering opportunities in terms of growing that part of your pet care business? Thanks.

Sure. Thanks, David. I think when I refer to partnering, we talk about, you know, we are a private label pet care supplier. And so partnering is producing brands for others, for their shelves. And so we talk about partnering. We've been partnering with new customers around the world. You know, we have a growing business in China. Our business in Sivomatic continues to grow. at SolidRates in Europe and continuing to supply new brands to new partners there as well. I think the other comments were as we move and as you see the consumer buying behavior to be more online, we're also looking at and have started some online channels for our sales. So there's a number of different partnering things that are going on, and that's around the world. Those online channels are global. in our main region. So when I talk about partnering, it's that. It's being able to partner by being able to provide brands for those who want to work with us and our vertically integrated position as a supplier.

Okay. Sorry, I didn't associate partnering with private label. Thank you for clarifying that. I wanted to maybe shift over to the PCC business in particular and in particular the volume growth that you cited in China this quarter. I think it was 18% or so. But I was scratching my head and I'm trying to kind of relate that growth this quarter with the upcoming new project for Tianming, which I guess has not started up. And I was wondering if you could characterize the full growth, all of the growth in China as related to the legacy satellite units you have there? Or might there have been some product produced at other locations but maybe shipped over to the Chen Ming location maybe to get things started there ahead of your full scale startup? So in other words, was the growth in China all related to legacy plants? was this somehow part of the growth related to Chen Ming, I guess maybe pre-production or pre-startup volumes that are maybe required?

The year-over-year growth in China was all from our legacy operating facilities there. So we saw some strong demand year-over-year from our legacy. So to give you an example, the Chen Ming facility will be about 150,000 metric ton facility coming online. That has not come online, so none of those volumes came from that facility. That should be commissioned in December and ramping up through kind of the first quarter of next year. To give you an idea, our installed base capacity in China is probably 850,000 tons and Chen Ming will represent another 150,000 tons. So bringing us to close to a million tons of capacity in Asia and China. So when you see that 18% growth and we're adding another almost 16, 17% to our capacity base, which we think ramps up next year, that's why we're very enthusiastic about our growth in Asia and the paper business because that penetration story and then also in India as we're building, ramping up one and another facility next year. So as DJ talked about, those opportunities and penetration really driving our growth in this business in Asia, that's where it's coming from. So we see those type of growth numbers continuing through next year in Asia. David, hopefully that helps a little bit.

Yeah, no, thank you. So one million metric, sorry, one million tons installed Out of, you know, you'll have a little bit over 3 million total. That's kind of China's share of your overall installed base.

I think the million tons installed is kind of our Asia base, a million tons in Asia. And the majority that's been in China, however, India has been growing very quickly over the past five years.

Okay. And then just maybe one other question, this time on the foundry issue. for many quarters now you've been highlighting the growth in China related to the custom blends that you offer there. Again, just probably a gap in my understanding, but should I assume that the types of products, the custom blends that you sell in China are similar to the ones that are marketed regularly to, let's say, North America or Western Europe? Or is it the case where customers in other regions maybe like to blend their own? In other words, is the value proposition the same in China as it is in North America and Europe, or either due to custom or the types of products you're selling? Is it qualitatively or quantitatively different as you go region to region?

It's very much the same in terms of concept. I guess they're not exactly the same formulas. The reason behind that is because we are tailoring a formula to that customer's equipment. What they're trying to make, the quality requirements and dimensions of that cast product. But being able to develop a system and a blend and an additive blend that meets the requirements to help them, whether it's through reduce their scrap rates to very low levels, to improve the throughput through those casting machines, We're able to tailor that. So, you know, the blends may not be exactly the same, but that is our value proposition of being able to, from a technical standpoint, go in, really deeply understand and help that foundry, you know, improve many aspects, reduce cost, improve quality, and then be able to deliver that blend kind of real time. I mean, in North America, we're delivering trucks on an hourly basis to our customers, our foundry customers. It's that, and if they have an issue, Thank you very much.

and once again that is star one to ask a question.

All right, it appears there are no further questions at this time. I'd now like to turn the conference back to Mr. Dietrich for any closing remarks.

Thank you very much. I do appreciate everybody joining the call today and I hope everyone and your families remain safe. Thank you again.

This concludes today's call. Thank you for your participation. You may now disconnect