Orion S.A. Common Shares

Greetings. Welcome to the Orion Engineered Carbons FA Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on the telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Wendy Wilson, Head of Investor Relations and Corporate Communications. You may begin.

Thank you, Operator. Good morning, everyone, and welcome to Orion Engineered Carbon's conference call to discuss our third quarter 2021 financial results. I'm Wendy Wilson, head of investor relations. With us today are Corning Painter, chief executive officer, Lauren Crenshaw, our outgoing chief financial officer, and Bob Rivneck, interim chief financial officer. We issued a press release after the market closed yesterday, and we posted a slide presentation to the investor relations portion of our website. We will be referencing this presentation during the call. Before we begin, I'd like to remind you that some of the comments made on today's call are forward-looking statements. These statements are subject to the risks and uncertainties as described in the company's filings with the SEC, and our actual results may differ from those described during the call. In addition, all forward-looking statements are made as of today, November 5th. The company does not undertake to update any forward-looking statements based on new circumstances or revised expectations. All non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the table attached to our press release. I will now turn the call over to Corning Painter.

Thank you, Wendy. Good morning, everyone, and welcome to our third quarter earnings conference call. Before I get started, I'd like to share a few words about Loren, as this will be his last earnings release with us. You all know that he worked hard to help us weather the steep downturn last year so successfully. What people may forget is that he had only been with us for a few months before COVID-19 surfaced and that he was immediately thrown into that storm. Being a quick study, Lauren was an able partner and leader during that time. Under his leadership, we completed the refinancing of our term loan B facility while adding a sustainability aspect to it. Lesser known to our investors perhaps, was that Lauren revamped how we manage and think about risk, and that he has been integral to our strategy development during this time. Lauren, thank you for your contributions, and I wish you all the best. Thank you for those kind words, Corning. It has been a privilege to serve as Orion's Chief Financial Officer over the past two years, providing financial leadership and partnering with you and the leadership team to refine Orion's strategy and position the company for success. Orion has an extremely bright future. I truly believe that the capital allocation pivot presently underway and its impact on the intrinsic value of this company is not well appreciated, except by a small but growing number of long-term investors. I intend to remain a long-term shareholder myself and look forward to seeing this leadership team execute the strategies that have been developed and realize the great promise of this company given the quality of its people and its assets, its competitive positioning, and core competencies. I want to thank you for the opportunity to serve this organization, Corning, which from a financial leadership perspective will now be in Bob's exceptionally capable hands as the search is conducted. Bob, I'm not sure I have ever made a finer hire, quite honestly. You have made an enormous impact over the past 18 months, and I have thoroughly enjoyed our partnership. I wish you the best and look forward to working to make the upcoming transition as smooth as possible. Thanks so much, Loren. It has been a pleasure working with you, and I look forward to continuing to implement the strategy that you and the leadership team have developed for Orion. I am also excited to lead the finance organization that you have developed, which I believe is very talented and dedicated to Orion's continued success. This company has a bright future, and I am looking forward to the dual role of chief accounting officer and interim chief financial officer to continue the path that has been established. It's going to be an exciting time for Orion now that we are close to finishing our EPA work and focusing on investing for growth. sustainability, and returning capital to shareholders. I am glad to be part of that journey. Corning, let me hand the call back to you. Thanks, Lauren and Bob. I'm pleased to report another solid quarter, continuing what has been an excellent recovery in our business. Specifically, third quarter adjusted EBITDA was $66.4 million, up 20.8% from the third quarter of 2020, which marked the beginning of the recovery in our business last year. Our results were powered primarily by the continued strong specialty performance, which represents 55% of our adjusted EBITDA year-to-date. Overall, against the backdrop of the downturn a year ago, Both of our businesses have demonstrated substantial operating leverage and an impressive recovery amid the surging demand for our specialty products across nearly all end geographies and applications. All that despite the reality that COVID is still with us and global supply chain efficiency is not. As you are aware, we recently reinstated our dividend by declaring an interim dividend to be paid in the first quarter of 2022 in the aggregate amount of $1.25 million, which is equivalent to approximately two cents per common share of the company. Our primary capital allocation objective remains to make prudent investments in differentiated applications that drive profit and raise our long-term earning capacity. The expansions underway in Ravenna, Italy, and Huawei, China, and the future efforts to advance our connectivity franchise are prime examples of this, with expected returns well more than our cost of capital. Reinstating our dividend reflects our high level of confidence in our business. It also reflects our commitment to regularly returning cash to shareholders and maximizing the universe of potential investors in Orion shares. We believe our strategy of balancing capital reinvestment and a prudent capital structure with returning a portion of our capital to shareholders positions Orion to maximize long-term growth and value creation. Aside from delivering solid financial results during the quarter, we also began construction of our second plant in China. The plant, located in a chemical park near Huapei in Anhui Province, will produce both specialty and high-performance carbon black, and it's a key project to help us lay the foundation for a substantial increase in our long-range earnings power. We also achieved mechanical completion at our expansion in Italy and commissioning is now underway. This expansion is focused primarily on specialty applications and will expand our production by about 25 kilotons with Ravenna ramping up next year. Huawei is projected to ramp up in the 2023 to 2024 timeframe and is expected to provide in the order of 65 to 70 kilotons of incremental capacity. As previously shared, we expect these two investments to contribute roughly $30 to $40 million in adjusted EBITDA at steady state levels, representing a substantial increase in the inherent earnings capacity of our business and an excellent example of the sort of value-enhancing investments we intend to make from a capital allocation perspective. We also advanced the air emission controls project at Ivanhoe and brought the systems online last month. Getting this system, our largest and most complicated air emission control project, online in the throes of the ongoing pandemic is a major accomplishment. Although we were behind schedule, I congratulate the team for executing this project safely. The focus now is on working through startup issues and reestablishing normal supplies and inventories. With year-to-date rubber volumes at 90% of 2019 levels, we continue to expect 2022 market conditions to be very favorable for our rubber carbon black business, despite the semiconductor and other supply chain disruptions. We expect driving an automobile to remain the preferred mode of transportation for individuals and families, and commercial traffic to remain robust. These factors are likely to result in higher miles driven, which in turn drives demand for replacement tires, which makes up approximately 60% of rubber carbon black volume. Our positive 2022 outlook is also influenced by the projected tightening of the global supply-demand dynamics as measured by global utilization rates, which are projected to be roughly 300 basis points higher in 2022 versus 2019. Against this backdrop, as of today, we've agreed approximately two-thirds of our EMEA and America's volume. That's roughly in line with normal levels, with new signing pricing being up meaningfully, as it needs to be, with the increasing costs and to take another step towards improving returns on the capital that we have invested in the rubber carbon black business. Finally, during the quarter, we successfully refinanced our existing term debt with a seven-year dual-currency sustainability-linked term loan, which Lauren will discuss in greater detail later in the call. We believe that this is one of only three of its kind ever issued by an NYSE-listed public company. The response that we have received from investors for this sustainability-linked financing was impressive, validating our long-term commitment to responsible growth and reflecting confidence in our financial strength, future business performance, and long-term corporate strategy. Turning to our third quarter results in greater detail, as you can see on slide four, Adjusted EBITDA rose to $66.4 million year over year, primarily driven by our specialty business, with favorable mix and higher volume across nearly all applications and geographies. Our results were partially offset by higher fixed costs, reflecting higher incentive compensation and maintenance costs due to the heavy turnarounds. as we expected heading into the quarter and is expected to persist for the balance of the year. That concludes my opening remarks. For the remainder of today's call, Lauren and I will cover the third quarter results in greater detail and our outlook for the year. After our prepared remarks, we'll be happy to take your questions. Lauren? Thanks, Corning. Revenue increased 39.4% year-over-year, primarily reflecting the impact of passing through higher fee stock costs with higher specialty volume and favorable mix contributing to a lesser extent. Contribution margin increased 18.9% year-over-year, mainly due to strong product mix, higher cogeneration profitability, and the favorable effect of oil price movements. Adjusted EBITDA rose 20.8% year-over-year to $66.4 million, reflecting higher contribution margin, partially offset by higher fixed costs related to incentive comp and maintenance costs, reflecting a relatively heavy quarter for turnaround, as anticipated. Finally, we reported adjusted net income for the quarter of $27.2 million, up 32% year-over-year, on higher adjusted EBITDA, partially offset by higher fixed costs. It is also noteworthy that our effective tax rate year-to-date of 27% is tracking 400 basis points below our guidance heading into the year. This dynamic has also benefited our adjusted net income and reflects excellent planning and execution by our tax and business teams. We project that our full-year effective tax rate will be in the range of 26% and 28%. We will provide 2022 effective tax rate guidance in February. However, I can say that we believe that the drivers of our lower effective tax rate are the results of structural changes that should prove sustainable over time, drive a higher cash flow, and therefore intrinsic value of our company over time. I salute the efforts of both our tax and commercial teams and am pleased with their efforts. On slide six, you will find several useful bridges that provide greater financial details supporting the comments I just shared on our quarterly results. Slide seven details our year-to-date cash generation, which is essentially flat, with a favorable impact of strong financial performance and receipt of the Advanik settlement proceeds largely offset by a surge in working capital and EPA-related investments. As a reminder, when oil prices rise, our working capital increases by roughly $30 million for every $10 change per barrel of oil in our feedstock costs. Of the year-to-date increase in working capital, over 60% has been driven by higher oil prices, about a quarter by higher sales, and the balance by higher inventory levels, in line with the current robust demand dynamics we have experienced to date. Turning to slide eight, the first point I would like to make is that the combination of the strength of our year-to-date operating performance and receipt of the Evonik settlement proceeds earlier this year have resulted in our net leverage being restored back to pre-COVID levels at around 2.3 times, well within our targeted steady-state net leverage range of 2 to 2.5 times. The positive impact of our recent refinancing of our term debt is also evident on this slide. I'll highlight three attributes of the deal. First, it was completed at attractive rates, a blended spread on the euro and dollar tranches of around 238 basis points. Second, it opportunistically pushed our term debt maturity profile out by four years to 2028 from 2024. And third, it represented one of the first sustainability-linked term loans by a public corporate issuer in the United States. The loan is sustainability linked in that it includes an ESG adjustment to the spread that works as follows. We've established certain KPIs related to the combined SOX and NOX emissions of our North American plants with detailed targets for each year of the seven-year term loan. During the first four years of the loan, if we hit both targets, our credit spread declines 10 basis points, and if we miss both targets, our spread rises by 10 basis points. During the final three years of the term loan, we no longer enjoy a 10 basis point benefit from achieving our targets. However, if we miss one or more of the KPIs, our spread rises five to 10 basis points. We were excited to broaden our commitment to responsible growth by securing this first of its kind sustainability-linked term loan, clearly aligning the commitments we have made to our stakeholders with the financing costs of the company. Finally, I would like to highlight that in connection with the refinancing, both S&P and Moody's reiterated their credit ratings, with S&P maintaining a BB rating and Moody's maintaining its BA2 rating and revising its outlook to stable. As we look forward, our strong financial standing and capital structure positions us well to fund and execute the remaining EPA investments as rapidly and safely as possible while also advancing growth initiatives that bolster our earnings capacity. We also anticipate higher discretionary cash flow in the coming years as EPA investments ramp down, while our Ravenna expansion ramps up in 2022 and our WABE expansion ramps up in 2023 and 2024. Moving to slide nine, specialty volumes rose 8.7% year-over-year, showing strength across most end markets and geographies, with strong volume-driven operating leverage and favorable mix, the main drivers of the 47.4% year-over-year increase in adjusted EBITDA. As shown in the trailing 12-month gross profit per ton chart, we are pleased to see that specialty profitability is approaching levels above 2019 and approaching levels not seen since 2018 driven by extremely favorable mix, high loading rates, and the associated operating leverage. The next slide breaks out the major year-over-year drivers of adjusted EBITDA for the specialty business in greater detail, the most significant of which were higher volume and improved mix, partially offset by higher incentive and maintenance-related costs. We have increased prices significantly year-to-date, But these increases have simply allowed us to hold even with rising costs as opposed to expanding our margins. In market-wise, coatings, polymers, synthetic fibers, and wiring cable were particularly strong. Geography-wise, the Western Europe and North America region showed the greatest relative strength. Turning to slide 11. Lower volumes translated into rubber carbon black adjusted EBITDA of $27.4 million, 4% below year-ago levels. Specifically, volumes were down 3% year-over-year. In market-wise, replacement demand was relatively stronger than original equipment demand, reflecting the impact of the ongoing chip shortage on automotive production levels. Geography-wise, volumes in the EMEA and Korea regions were relatively weaker with Korean exports being particularly impacted, partially offset by stronger America's performance. Slide 12 breaks out the major year-over-year drivers of adjusted EBITDA for the rubber business in greater detail, with the unfavorable impact of lower volume and less overhead absorption offsetting mix. With that, I will turn the call back over to Corning. Turning to our outlook, As we approach the end of an exceptional year, we are narrowing our full year 2021 adjusted EBITDA guidance to a range of $265 to $280 million. Shaving the top of the higher end of our range reflects the impact of the delayed startup at Ivanhoe and dynamic market conditions, including supply chain and inflationary pressures. Capital spending continues to be on track towards approximately $190 to $200 million, and our estimate of the full ultimate cost of installing our U.S. air emission controls remains unchanged at between $270 and $290 million. In closing, there are four key messages I would like to reiterate. we're excited to be laying the foundation to deliver substantially higher earnings power in coming years. By the end of 2022, since the time of our IPO in 2014, we will have allocated over $600 million towards debt reduction, dividends, and EPA-related emissions technology. As we approach the next five years, we expect to have the wind at our back from a discretionary cash flow perspective. with net leverage in line with targeted levels, the EPA investments coming to an end, and our dividend rate at a fraction of prior levels, enabling our continued investment in growth opportunities in differentiated applications and sustainable offerings. While we've highlighted the Ravenna expansion and the WABE in recent quarters as one of a very small handful of leading producers of acetylene black, we also see significant growth opportunities in conductive carbons. Acetylene black is an important conductive additive in modern lithium ion batteries and other attractive markets. We have seen considerable traction year to date in getting SPECT in with battery customers and just completed a significant capability upgrade at our plant. This plant, which we purchased in 2018, provided a foothold in this space. Going forward, we look forward to sharing more about our plans to take the next steps towards making this attractive near adjacency a more substantial contributor and growth driver. Rubber carbon black marketing conditions are quite favorable and poised to take another step up in 2022 in terms of our goal to achieve higher returns on capital. Finally, I'm pleased that we have our most challenging air emissions control project commissioned. While I expect some challenges in the early months of operation, it's great that we will have about 70% of the projected EPA spending behind us by year end. We look forward to the ongoing support of our investors as we continue to grow Orion profitably and responsibly in the years to come. With that, operator, please open the line for questions.