Avient Corporation (AVNT) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the PolyOne Corporation Investor Conference call. My name is Shannon, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. At this time, I would like to turn the call over to Joe Di Salvo, Vice President and Treasurer and Investor Relations. Please proceed.

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

Well, thanks, Joe, and good morning to everyone. When we announced our first quarter results on April 21, we were just over a month into what was becoming a global lockdown due to the coronavirus pandemic. While essential businesses remained open, many did not, and demand has been significantly impacted. And so have the lives of just about everyone in one way or another. Our sympathies are with those who lost loved ones, contracted the virus or are experiencing hardship during this time. At PolyOne, the preponderance of our facilities were and continue to be deemed essential. Our materials are enabling food, beverage and medical supplies, to continue to be produced, packaged and used. This includes masks, protective garments, medical tubing and packaging for personal care products. Other materials include those critical to infrastructure, electronics and telecommunications. However, during the quarter, we have had to temporarily cease operations at 5 of our facilities for various lengths of time, either due to local government regulations or to help ensure the health and safety of our associates. As of today, all of our facilities are operational. And for our associates who are reporting to those facilities, we are adhering to strict social distancing and preventative health protocols. I'm very proud of our team for this. We have put safety first and quickly implemented new procedures. We adapted well and remain disciplined following these new procedures, all while keeping our plans and our customers running. For our other associates who can work from home, they are still doing so. And I think we've adapted well here too. Functionally and commercially, we're continuing to run our business. And these associates will continue to work remotely in accordance with local governmental guidance, which we monitor closely. The purpose of our call today is twofold: first, we want to provide comments on current business performance in light of the pandemic; and second, we want to provide an update on the Clariant transaction. Our prepared remarks today are brief, following those, we'll be happy to take questions. As you know, we had a very solid first quarter. Although sales were down 5%, adjusted EPS expanded 23%. This was driven by improved margins in all segments, cost containment actions and improved mix. Of course, we hadn't really yet felt the global impact of the pandemic. In addition, we hadn't been able to really process the extent of measures that would be taken to prevent its spread, many of which were still evolving. Accordingly and like just about everyone else, I suppose, we didn't provide good guidance for the upcoming quarter or the year. We did, however, say that orders for the month of April were down 15%, and as it turned out, sales for April were down just about 15%. In April, the key drivers were the shutdown of the automotive sector and a reduction in demand for consumer describe unfortunately, as the pandemic spread and reached additional locations such as Brazil, India and Mexico, we experienced a steeper decline in demand in May, and we now expect sales for the quarter to be down 20% overall. Although automotive-related sales only make up about 10% of our total sales, auto accounts for nearly 40% of the total year-over-year second quarter sales decline. The balance is due primarily to a decline in demand for consumer discretionary items such as screen printing inks for athletic apparel and off-road vehicles to name 2 specifically. Other markets, such as industrial, construction and oil and gas have also been negatively impacted, just not to the same extent. On the positive side, we think and hope we're at a bottom as June looks sequentially better than May. In addition, we continue to see strong demand for packaging in health care applications, which have proven to be our best 2 performing markets throughout the pandemic response and recovery. For the quarter, they should be up 5% and 8%, respectively. Margins are holding up well, all things considered, although still down from the prior year. And this is partially due to lower raw material costs, but also due to cost containment actions. Perhaps more significantly, margins have benefited from mix as our previous actions to strengthen our positions in health care and packaging are helping us during these challenging times. Some of this is application-specific in health care as we have been able to serve our customers rush orders and new product development for personal protective equipment, such as face masks, ventilators, hospital beds and test kits to both protect those on the front lines and treat those who have contracted the virus. For food and beverage packaging, increasing shelf life of products and availability of fresh healthy food has never been more important. Our performance additives are essential in this regard, as they provide barrier attributes to help protect the perishable contents inside. From a regional perspective, we expect sales in Europe to be down 27% in the second quarter, and America is down about 20%. These 2 regions are those that have been impacted the most significant during the quarter by the pandemic and where we also have the highest concentration of automotive business. Asia, which for us is primarily China, is expected to be up about 10%, which is hopefully a good sign for the global economy. So with all that being said, and with only a couple of weeks left in the quarter, we estimate adjusted EPS will be approximately $0.36 compared to $0.48 in the second quarter of last year. Now this is on an apples-to-apples basis for how we presented last year. If you include the additional shares we issued in February and interest expense from the recent senior note offering, second quarter adjusted EPS is expected to be $0.26. We expect strong free cash flow generation of $65 million in the second quarter, and we should end the month with $1.95 billion in cash on the balance sheet. This includes the successful issuance of the $650 million debt offering we completed during the second quarter. As you know, $1.45 billion of this is earmarked for the Clariant acquisition, which we expect to close on July 1. We have received all necessary regulatory approvals, and we are working through the remaining other conditions to close. And when we do, as you heard us discuss since December, we will officially join our 2 teams in creating a preeminent leader in specialty color and additives. Combined with our engineered materials and distribution expertise, we will have created a company that generates over 85% of EBITDA from specialty applications. It is less cyclical and aligned with the mega trends of the future; is financially strong, with consistently high free cash flow generation; is committed to the emerging sustainability challenges of our customers and our planet; and it is a great place to work for all of our current and soon to be new associates who will join us from Clariant. We're excited to begin this next chapter with the Clariant team, but make no mistake. We have to continue to take care of our associates and each other in this current pandemic. This isn't just about returning to normal. It's also about figuring out what the new normal is. And I know everyone on the call gets it, I just don't want us to forget it. The health and safety of our associates is our first priority, always has been, always will be. We'll now open up the call for questions.

[Operator Instructions] Your first question comes from Frank Mitsch with Fermium Research.

Just for housekeeping purposes, for that $0.26, what is the actual share count and interest costs that you guys are modeling in?

Share count is about 92 million shares, Frank, and about $5 million of interest costs for the quarter.

$5 million additional interest costs?

Yes. Additional.

Yes, additional. Yes.

Okay. All right. Cool. And is your thought process in terms of closing the Clariant deal, July 1? Is that still a good day to use?

Yes.

Awesome. And lastly, given what's been going on this quarter, how do we think about the raw material basket versus your end product pricing? How has that been trending?

Yes. So overall, I'd say the raw material costs were down or a slight benefit, probably about $5 million overall, if I exclude distribution and I just look at Color and EM, pretty comparable to what we had in the first quarter. There's a lot of noise in there with respect to mix. But if we take that out, we think overall pricing is down about that much.

Our next question comes from Vincent Andrews from Morgan Stanley.

Could you talk a little bit more on the segment -- at the segment level about how sales progressed during the quarter? And maybe let us know what the -- what you think the exit rate is going to be in June?

Yes. Let me -- here's what I'll give you, actually, just as a starting point. We talked about sales being down about 20% for the quarter. I'll just give you our estimate for what we think that will look like when we get to the end of the quarter, Vincent. So Color, it will be down about 16.5%, EM down 18%, and distribution will be down about 23%. So there is a more significant weighting on distribution, which is largely driven by their connection to automotive and consumer discretionary items in the U.S.

Okay. And just the exit rate for June?

Yes. I mean -- so when I look at June, June is still going to be down probably about 19% or so. So I don't have that right off the top of my head here for each of the segments for the month of June, but it is trending up slightly from what we saw in May.

Okay. And if I could just ask you on Clariant. Given the COVID environment, can you talk about what type of contingency planning you've done or preparation planning you've done in terms of going after the synergies, given there might be some challenges in terms of travel or bringing consultants in? Or is any -- you think anything is going to be impacted in terms of achievement and timing of achievement of synergies because of the COVID environment?

No, I don't really -- I would say, look, first of all, I believe that PolyOne like probably many other companies has become quite adept at using video technology to connect with our associates around the world. We have been doing that already with some of the regional business leaders from Clariant, although we are not permitted to talk about synergies and things until the deal closes. So mostly, it's been just about how we'll interact on day 1. But look, my expectation is that we're going to be able to hit the ground running as soon as the deal closes. We'll be able to work with the Clariant team on the synergies, and maybe I'll just sort of address the 3 buckets there. So with respect to a sourcing standpoint, we're able to do that really working remotely with each other in terms of combining our spend and working with our suppliers. So I don't see issues there. There are some modest synergies that begin day 1 with respect to the headcount that starts with the company. And then we'll start working towards back office stuff here over the course of the second half of the year. And then lastly, on some of the manufacturing ideas, again, I think we'll be able to interact with -- between our 2 teams. But the thing I'd say, look, that is starting to help or will help is that while we still do have some international travel restrictions, they are starting to relax within regions. And for the most part, when I look at these operational synergies we have, they are very region specific, which means our European team will be able to work together. Our U.S. team will be able to work together and so on. So thankfully, things are starting to ease some inside of the various comments where we're going after those synergies, and I think that will help.

Next question comes from Colin Rusch with Oppenheimer.

Guys, can you talk a little bit about how cash cycles are trending so far through the quarter, particularly in the distribution side?

We couldn't hear you very well, Colin. Can you say that again?

Sure. Can you give us an update on how cash cycles are trending, given what's happening on the distribution side or specifically what's happening on the distribution side?

Cash cycles?

Yes.

Correct.

Look, I mean, so as a general rule, look, when sales start to trend down, we free up working capital. That's nothing new from the quarter. We're expecting that across all of our businesses. And maybe there's a little bit of a lag there with respect to distribution, picking up on that versus Color and EM, but we do expect strong free cash flow this year, and some of that is due to working capital release. The easiest way to model that is our working capital as a percentage of sales is about 12%. So if you model sales down, use 12%, that can give you an estimate of how that's going to impact cash flow for this year.

Okay. That's helpful. And then in Latin America, can you just give us a sense of how things are trending, given the later spread of the virus there? And just remind us of total exposure in the region.

Yes. So I mean if I look at Latin America and for the second quarter, I mean, that actually is -- region is down more than any other as we're forecasting it right now. So as I said for the quarter overall and for PolyOne, we kind of viewed May as a bottom. But I don't know that we can say that yet about Latin America, and June is still going to be down. I don't have the June numbers sitting right in front of me. But I would not say that we are at that same inflection point. But hopefully, we'll be soon.

Next question comes from Mike Harrison with Seaport Global Securities.

Just to kind of expand on the Latin America question. You mentioned that is something that impacted your May result and maybe some slower automotive recovery in Europe and North America. What else could you point to that was kind of a negative relative to your expectations going into May?

Well, look, we had projected that consumer discretionary would be down. I just think it was down more than we expected in the month of May. And look, for us, I think everybody do that auto was going to be down, and we said it was going to be down, but it's possible that, that was another few points as well. But look, when you look at just our inks business, for example, I mean, that's down 80%. Keep in mind, it's a relatively small business but very profitable. So that's a big impact for us from the bottom line standpoint.

All right. And I guess in terms of that consumer business, obviously, being piece is one that we may not think about. But I also think about kind of recreational exposure. I walk around the neighborhood. I see COVID trampolines. I see people who have bought treadmills and boats and other stuff that they haven't -- that they didn't have back in March. Are you seeing some onetime pickups in certain areas, and it's just a very mixed bag in consumer? Or would you say the consumer discretionary overall is still quite depressed?

I'm sure there are some items in there that are up for the reasons that you just described with people sheltering in place at home. The thing that has impacted us the most, of course, we just said, inks. But secondarily would be off road vehicles, which are down significantly, like the automotive manufacturers, candidly, they just closed. And they are just beginning to reopen now. So any of those slight positives in there, I'd say, pales in comparison to that. And for us, if I look at Marine, that was actually down too. People may have gone out and bought boats, Mike, but they weren't making any boat. So for us, that was down also.

Next question comes from Jim Sheehan with SunTrust.

Can you talk about raw material costs? How they're flowing through the quarter? And how you expect that to trend going forward?

Yes. We didn't really see a significant change from Q1 to Q2. This quarter, we had maybe a $5 million benefit, if you neutralize all the mix noise. So just looking at where things landed from a raw material pricing standpoint. And that's not too dissimilar. We might have been $6 million or $7 million in Q1. We're pretty close to the same number.

Our next question comes from Rosemarie Morbelli with G. Research.

I was wondering if you could touch on what you see at your customers. Meaning any customers being in financial trouble. And are you -- do you think you are going to have to raise your reserves, that debt return?

Well, we do have some customers who are in financial trouble right now. And in the second quarter, we have had to raise our reserves. That's included in the $0.36 estimate that we provided today. But we had to make some additional accruals. Nobody who has outright filed for bankruptcy, but some customers that we know are in precarious position because of the pandemic and that's why we booked those additional reserves. So that certainly is the case. I would say they number in the few and not the many.

Okay. And then as the new cases are increasing in China, do you see that triggering any changes? Any closure? Should we anticipate that, well, next quarter? China is going to offset the benefit from reopening here, although we don't know how long we are going to be reopening.

Well, I think that is a big question, right, which is how will reopening impact all of us and the virus itself. And that is a great fear that many of us have that by reopenings, use your word, that we actually do see an increase in those contracting the virus and kind of have a maybe a second lockdown period or a second time frame in which we pulled back economic demand here. I think that could happen. And so I do. I share that as a concern. I'm not given any other sort of forecast for the year, how I think things are going to play out. But I think we should certainly have that on the concern list.

Sure. And is it too early to have seen any change in the way China is operating in Beijing, for example. If that is impacting your operation?

Too early to see a change in -- and can you repeat that for me, please, I'm sorry?

Well, there are new cases in Beijing, and they are instituting some regulations, let's call it, for lack of a better word on my part. So do you see that already showing that an impact is coming, meaning that the benefit in the second quarter may go away in the third?

Yes. So we haven't seen any impact from that. Things move fast in China, though. And so it wouldn't surprise me if there are initial or additional protocols that are put in place for other cities, if that happens, then we would certainly be impacted. But nothing that's happened so far in June. If it does, we could see a similar effect as we saw. And look, for us, the primary impact from China was in Q1. And so it's possible we could see something like that again in Q3 if China takes additional actions to lock down.

Okay. And then if I may, and I apologize for that. I missed the areas where you saw an increase of 5% and 8% in June.

That was packaging and health care, and that's what we're expecting for the second quarter on the whole.

Okay. So that was the 5% and the 8%?

Right. It was packaging and health care, respectively.

Oh, separately. Sorry. Okay. Got it.

Okay. I think that is our last call. We appreciate everyone spending some time with us this morning to get a further update. Of course, we'll provide more details in July when we issue our second quarter results. For now, thank you very much. Stay safe, stay healthy.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.