GRA (GRA) 2020-10-28 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2020 W.R. Grace & Co. Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jeremy Rohen, Vice President, Investor Relations. Thank you. Please go ahead, sir.

Thank you, Takane. Good morning and thank you for joining us today for Grace’s third quarter 2020 earnings call. With me this morning is Hudson La Force, our President and Chief Executive Officer and Bill Dockman, our Senior Vice President and Chief Financial Officer. Our earnings release and presentation are posted on our website under the Investors section at grace.com. Please note that some of our comments today will contain forward-looking statements based on our current view of our businesses and actual future results may differ materially. Please see our recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. We will discuss certain non-GAAP financial measures, which are described in more detail in this morning’s earnings materials. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our website. This morning, Hudson will discuss our focus on value creation, highlights from the third quarter, key end-market trends and sustainability. Bill will provide an overview of our financial results and key planning assumptions. We will then open the call for questions. So, with that, please turn to Slide 4 in our earnings presentation and I will turn the call over to Hudson.

Thank you, Jeremy. Good morning, everyone. I hope you and your families are all safe and healthy. We delivered solid financial results in the third quarter, including strong sequential growth in gross margin and earnings and strong cash flow. We are encouraged by improving demand trends in many of our end-markets and believe the worst of the recession is behind us. Before we discuss our third quarter results in detail, I want to address Kathy Reiland’s recent resignation from our board, which followed a difference of opinion about our strategic direction. While I won’t discuss the details, I think it is important to underscore that there was no disagreement about Grace’s business unit strategy or operations. We have a portfolio of high value specialty businesses. Over the years, we have often pursued opportunities to drive the most value from them. This open-minded approach to creating value led to the spin-off of GCP and the successful acquisitions that built our leading Specialty Catalyst business. Today, our business is significantly impacted by the pandemic. Our board working with management and our financial advisors is carefully evaluating and thoroughly discussing our value creation opportunities, consistent with our longstanding practices and commitment to all shareholders. At the same time, we are focused on executing our growth plan and advancing our investments to accelerate growth, improve our competitive advantages and strengthen our portfolio. I am confident our growth strategy and capital allocation discipline will create significant long-term value for shareholders. Now, let’s turn to our third quarter highlights on Slide 5. Third quarter sales were down 11% year-over-year in line with our Q3 planning assumptions. We are encouraged by the improving demand trends in each business and believe Q2 was the trough of the recession. Materials Technologies sales grew 4% year-over-year on strong pharma consumer demand and solid coatings demand. Improved demand in higher production rates drove sequential adjusted gross margin improvement of 410 basis points. Adjusted EBIT was up 9% sequentially. Adjusted EBIT would have been up more than 30% sequentially without the financial impacts of Hurricane Laura. We delivered another quarter of strong cash flow driven by our aggressive actions to lower capital spending, improve working capital and reduce operating costs to improve cash flow by $125 million in 2020. We have captured the full year benefit of the capital spending and working capital actions and are on track to deliver the operating cost reductions. Year-to-date, operating cash flow was $259 million and adjusted free cash flow was $170 million. Year-over-year, adjusted free cash flow was up 4% even though adjusted EBIT was 37% lower. I would like to thank Grace’s 4,000 employees around the world for their continued focus on health and safety during the pandemic. Their discipline has ensured that we have consistently met our customer commitments throughout the year. In addition, I want to recognize the extraordinary efforts of our employees in Lake Charles and throughout the company who worked tirelessly to maintain supply to our customers and to safely restart our Lake Charles manufacturing operations after Hurricane Laura and again after Hurricane Delta. Their commitment to our customers at a time of significant personal hardship is truly exceptional. Please turn to Slide 6. In Specialty Catalysts, polyolefin catalyst demand is improving in all regions and segments. Non-durable end-markets continue to show strength, particularly in hygiene and packaging applications. Durable end-market applications show signs of recovery, but certain segments will likely remain below 2019 demand levels next year. We expect Specialty Catalyst sales to continue to improve. We have recently introduced 15 new products and are seeing a strong increase in customer trial activity after significant delays due to the pandemic. These trials are important steps in accelerating sales growth next year. This week, we announced our fifth license of 2020 and have a robust pipeline for Q4 in 2021. Our licensing business provides a consistent and visible revenue stream and positions us well for significant future catalyst sales. Our lifetime plant performance service offering helps our customers maximize the profitability of their polypropylene production operations. Please turn to Slide 7. In Refining Technologies, demand for transportation fuels has stabilized and we have seen recovery from a deep bottom in the second quarter. Still, transportation fuel demand and refinery utilization remain about 10% below normal levels. The effects of the pandemic will continue to be a headwind until global transportation fuels demand more fully recovers next year. We remain strongly focused on selling the value of our technology to our customers as they optimize their refinery operations in a difficult environment. Some customers have switched to lower performing catalysts to minimize their operating cost until demand recovers, but the vast majority of our customers continue to use the high-performing catalyst they use before the pandemic. This has the effect of lowering our average sales price and we now expect average FCC prices to be flat to slightly up this year. Given the weak conditions in this end-market, we proactively reduced 2020 operating costs by about $20 million as part of our overall cost savings effort. We are driving additional productivity in our manufacturing plants and managing capital spending to ensure our costs and capacity are in line with current market demand. Please turn to Slide 7. Materials Technologies has performed well during the pandemic, outperforming many of its end-markets in Q2 and Q3. Q3 sales grew 4% year-over-year due to better demand in pharma consumer and coatings. Strong pharma performance has been led by Grace’s product technologies used in the fight against COVID-19. We expect pharma consumer markets to continue to perform well. And we are encouraged by the rapid recovery in our coating segment. In chemical process markets, demand continues to improve, but the recovery has been slower in markets tied to the hard hit automotive and aerospace sectors. Our commercial excellence and customer-driven innovation continue to position MT for higher growth and improved profitability going forward. Please turn to Slide 9. For more than 20 years, Grace has been focused on achieving the highest levels of EH&S performance. But today, customers, investors, employees and other stakeholders expect more. They want to know what else we can do to improve sustainability for everyone. We are doing a lot already. Last year, 44% of our sales directly contributed to our customer sustainability objectives. Our technologies help reduce plastics content in consumer packaging, water use in manufacturing processes, and harmful materials in consumer products. Our technologies also help improve fuel economy, reduce energy use and reduce refinery emissions. For example, our technology is used by customers to reduce SOx emissions in their operations. With Grace Technology, our customers eliminate more than 20,000 metric tons of SOx emissions each year. This is two orders of magnitude greater than the SOx emissions from our own manufacturing operations. We are not satisfied with these contributions and know we can do more in the future. Today, 65% of our R&D projects are tied to at least one customer sustainability driver and we expect our positive sustainability impact to increase as these technologies commercialize. Please turn to Slide 10. We see two additional opportunities to link sustainability trends and our customer-driven approach to innovation to create growth opportunities for Grace. These are game-changing technologies in the areas of advanced plastics recycling and renewable fuels. So, these are very small markets today. They have the potential to become significant in the long-term. Most exciting for me is our opportunity in advanced plastics recycling. Our catalyst technologies and know-how can contribute significantly to the long-term technical and economic viability of this solution for recycling plastics in reducing plastics waste. Mixed plastic waste streams are hard to recycle today. And this challenge needs to be addressed before plastics can be recycled economically at scale. For us, this looks a lot like problems our FCC team works on everyday, how to turn a challenging complex carbon feedstock into useful valuable products. Our scientists are working to develop the technologies and business models to make advanced plastics recycling scalable and economic. Significant sales are still years away, but the long-term opportunity is compelling. Similarly, renewable fuels, is an opportunity - is an important sustainability opportunity, where our existing technologies and applications know-how help our customers at multiple points in the value chain. This is a small business for us today, but one with high growth potential as our customers invest more in this application. With that, I will turn the call over to Bill.

Thanks, Hudson and good morning. Please turn to Slide 12. As Hudson noted, we are very pleased with our solid results for the quarter, which reflect strong execution in our businesses by what is still a challenging operating environment. So, we are seeing positive demand trends in most of our end-markets. Looking back to Q1, when we highlighted the potential impacts of the pandemic, we took early actions to reduce inventory levels, production rates and operating costs to generate cash and maintain our strong financial position. As a result, the mitigation actions have positioned us well to exit the recession, a stronger company and fully prepared to capture the recovery. Now, turning to the third quarter results, sales were down 11% year-over-year, primarily due to the effects of the pandemic on global transportation fuels demand and refinery operating rates. On a sequential basis, sales were up slightly from Q2. Adjusted gross margin was up 410 basis points from Q2. The strong sequential improvement was driven by improved demand and higher operating leverage. Sequentially, adjusted EBIT was up 9% and adjusted EPS was up 14%, which included $12 million or $0.13 per share of hurricane-related costs in the quarter. While this was an insured event, the total costs do not exceed our deductible, so we do not expect any insurance recoveries. Regarding cash flow, our year-to-date adjusted free cash flow was up 4% over the prior year, reflecting our team’s strong execution and focus on reducing working capital and capital spending. In addition, we received a $10 million dividend from our ART joint venture and are expecting additional dividend from ART in Q4. As you may recall, in mid-2017, ART stopped paying a dividend to the parents in order to self-fund the hydroprocessing catalyst plant at Lake Charles. Now that the plant is complete, we expect ART will return to paying annual dividends. We have made excellent progress in our mitigation actions and are confident we will deliver our full year target of $125 million in cash flow improvements. At this point, we have achieved our targets to improve working capital by $45 million to $50 million and lower capital spending by $40 million and we are on track to deliver our targeted operating cost reductions of $35 million to $40 million. As a reminder, most of these cost reductions are temporary and will return as demand recovers. While the $125 million of cash flow actions will benefit 2020, these actions will not limit our ability to generate strong cash flow in 2021. Now, let’s turn to Slide 13 and look at the segment results. Catalyst Technologies sales were down 1% sequentially versus Q2. Specialty Catalyst sales were down 2% versus the prior quarter primarily due to order timing. Refining Technologies sales were essentially flat sequentially over the prior quarter as the decline in transportation fuels demand stabilized, but remains well below normal operating levels, as the ongoing effects of the pandemic continue to impact global demand, global operating, refining rates and miles driven. For the trailing 12 months, FCC catalyst pricing improved approximately 150 basis points. Third quarter segment gross margin improved 260 points sequentially reflecting significant inventory reductions in Q2, not repeating. Operating income was down 7% versus the prior quarter, which included $12 million of costs related to Hurricane Laura. Income from our ART joint venture in the quarter was down sequentially $2 million. While some refinery turnarounds have shifted from the second half of 2020 into 2021, we expect ART’s fourth quarter sales to be up significantly as compared to Q3. Now, let’s turn to the Materials Technology on Slide 14. Third quarter sales were up 4% on both a year-over-year and sequential basis versus the prior quarter. Coatings and chemical process applications saw improved end-market demand and were both up sequentially from Q2 to Q3. Demand in pharma and consumer end-markets remain strong in Q3, so below the Q2 levels that benefited from strong demand from materials used in customer’s COVID-19 diagnostic kits. Gross margin for the quarter was up 880 basis points over Q2 as a result of higher sales and higher production volumes as well as significant Q2 inventory reductions it did not repeat in Q3. Operating income for MT was up over 90% versus the prior quarter on improved demand and strong sequential gross margin improvements. Now, let’s turn to Slide 15. As I mentioned a moment ago, we had strong cash flow performance driven by our actions to maximize cash flow since the pandemic began. The results speak to the strength and resiliency of our businesses. At the end of the quarter, our total liquidity was over $700 million, including $269 million of cash on hand. From a debt perspective, we have not drawn on our revolver and have no significant debt maturities until 2024. Our net leverage was 3.8x at the end of Q3 and outside of our target range of 2x to 3x, reflecting the temporary impact the pandemic has had on adjusted EBITDA. But we have a strong record of de-leveraging quickly and expect our balance sheet to de-lever as markets recover. Now, let’s turn to Slide 16. We remain committed to our long-term capital deployment framework. But as we have discussed, we have temporarily shifted our near-term priorities to focus on cash flow and liquidity and funding targeted growth and productivity investments. Importantly, our investment decisions were made with a focus on maximizing near-term organic growth opportunities and accelerating our technology and innovation to support customer-driven innovation. These decisions will not impact our ability to grow in 2020 or beyond. Regarding shareholder returns, we expect to resume share repurchases in 2021, while continuing to prioritize investment in our businesses and reducing net leverage. Finally, let’s turn to Slide 17. For the fourth quarter, we expect sales to be up 10% to 13% versus Q3, led by a solid recovery in Refining Technologies sales as well as solid growth in both Specialty Catalysts and Materials Technologies. In Specialty Catalysts, we expect sequential sales growth in Q4 as end-markets are showing signs of improvement and we expect lower impact from customer inventory draw-downs. Demand for transportation fuels and refinery utilization are both expected to continue to improve sequentially in Q4, which will drive an increase in demand for FCC catalyst in Q4. For Materials Technologies, we are expecting sequential sales growth from Q3 to Q4 driven by the continued strength of our pharma business and recovery and consumer and coatings offsetting weaker demand in certain industrial end-markets, particularly automotive. We expect continued sequential improvement in gross margin of approximately 100 basis points from Q3 to Q4. Our gross margin will also continue to improve beyond this year and we are confident it will return to pre-pandemic levels of 40% to 42% as demand more fully recovers from the pandemic. We expect adjusted EPS for the quarter to be in the range of $0.84 to $0.88 per share, reflecting an increase of 50% to 57% versus Q3. And as a reminder, this range includes the impact of the remaining hurricane-related costs of $6 million to $8 million or approximately $0.08 per share. Now, I will turn the call back to Hudson.

Thank you, Bill. Please turn to Page 19. We delivered solid financial results in the quarter and we are really encouraged by better demand trends. Our team is executing well in a challenging environment. Throughout the pandemic, we have remained focused on executing our growth strategy. The investments we have made in growth, commercial excellence and operating excellence are showing results and we will payback and will - excuse me, are showing results and we will payback strongly as demand fully recovers. I am confident our growth strategy will create significant value for our shareholders. Let’s open the call for your questions.

I will turn the call back over to the presenters for closing remarks.

Thank you everyone for your time today and your interest in Grace. We look forward to engaging with you over the coming months. Thank you.

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

[Operator Instructions] Your first question comes from Chris Parkinson of Credit Suisse. Your line is open.

Good morning. This is Kieran on for Chris. I was just wondering if you can give me a little bit more color in terms of what you have done in pricing this quarter specifically, how many customers - not how many customers, but the patterns you have seen in terms of I guess splitting down to a lower quality catalyst or different catalyst and how you expect that to recover into 4Q or 2021 as demand recovers? Thank you.

Hi, Kieran, this is Hudson. Thanks for the question. What we are seeing is customers, making a decision to use a lower performing catalyst is the way to save operating costs at a time where their profitability is challenged. This is something that we work on closely with our customers. We help them determine an alternative catalyst. And oftentimes, we are reformulating a catalyst for them to make sure it meets their needs in the current economic environment. Now, this is a small number of customers that have made this decision. The vast majority of our customers are still using the same high performing catalysts they were using before the pandemic began, but when the customer wants to make a change with like this, obviously, we will work closely with them to help them make that change. We do believe this is temporary. We think it will continue into next year for the customers that have made this choice. And as their operating rates begin to improve next year, we think they will switch back to the high-performing catalyst that they were using before.

Great. And then just a quick one on Specialty Catalysts, I mean, it’s close, it’s been a little bit of customer de-stocking that continued into 3Q, can you just give us a high sense of what amount of de-stocking you expect is still remaining into 4Q and as demand comes back for most of these chemical end-markets how you view I guess such catalyst demand trending into 4Q and then any preliminary thoughts on 2021?

Sure. So, we saw the greatest amount of customer de-stocking in the second quarter. As you may recall from that discussion, we had customers that had made a decision to reduce their safety stock of catalysts. These were decisions that they made for their own - their own cash flow management reasons. Most of that de-stocking occurred in Q2, some did occur in Q3 as well as you noted. We think that we are close to the end of the de-stocking on a sequential basis and we expect Specialty Catalyst sales to improve from Q3 to Q4 in part, because that de-stocking will be coming to an end. On a year-over-year basis, we do still expect Specialty Catalyst to show negative year-over-year growth in the fourth quarter, because of the comparison to last year’s fourth quarter, where customers were still building safety stock inventories. And so we think that will be a headwind on a year-over-year basis. As we head into 2021, Kieran, I feel pretty good about the growth opportunity that our Specialty Catalyst business has. As we highlighted in some of our prepared materials this morning, the team has done an exceptional job over the last couple OF months, getting new products into the hands of our customers in working through the trialing activity that’s necessary for our customers to test these products and ultimately introduce them into their regular commercial operations. This is a routine part of this business. It’s an important element of driving growth long-term for this business, but it had gotten disruptive because of the pandemic. Trial activity dropped to close to zero during the first 6 months of the pandemic and now it’s really starting to pick back up. And that’s very encouraging for us as we look into next year.

Thank you very much.

Your next question comes from John McNulty of BMO Capital Markets. Your line is open.

Yes, thanks for taking my question. I guess maybe first a high level one, you highlighted at the beginning of the presentation around how you look to create value for shareholders and kind of the strategic methodology around driving a portfolio for growth. I guess - and look at middle, you have done a good job with that, especially with some of the Specialty Catalyst adds, but I guess looking forward, it looks like some of the evolutionary changes that have been happening in refinery maybe even kind of getting more of a revolutionary kind of period where you have got big oil companies kind of saying peak of oil consumption is going to be the end of this decade, you have got refineries closing. So, I guess can you speak to how all of that maybe changing how you and the board are thinking about the opportunities for growth and maybe the directions that you move in growth?

John, this is a great question and I appreciate you asking it. Let me address it in two parts. Let me talk about how we are thinking about our refining businesses today. And then I will touch on the second part of your question about what this means for our strategic discussions as a company. As we look at the refining markets over the long-term, it’s clear that there will be a peak demand for transportation fuels. When we first looked at this data a few years ago, we thought the peak would be in the 2035 to 2040 area. With the pandemic in the advanced in some technologies, that peak may come sooner, it maybe as early as 2030 or 2035 as you indicated, but I don’t think that corresponds with the peak in demand for FCC catalyst. The FCC unit is a very important part of refinery operations. It is the - it’s a very important part of producing gasoline for the gasoline pool. And maybe more importantly, it’s one of the most economic ways to make gasoline that by itself only accounts for about 40% of the gasoline fuel. FCC units are also used to make petrochemical feedstocks, primarily a propylene which will remain in high demand even after transportation fuel demand reaches its peak. And so the role of the FCC unit in the refinery remains important beyond just its role in producing transportation fuels. The other part of this is the technology in our ART hydroprocessing catalyst joint venture. Hydroprocessing catalysts are used primarily to make cleaner transportation fuels, to take sulfur out of fuels and other benefits. And that demand will remain strong in the years to come. We are seeing customers make significant investments in their operations and hydroprocessing capabilities to meet the increasingly stringent fuel standards and so that - we expect that business to continue to grow in the near-term. That said this is a slow growth business. And at some point, growth will reach its peak, as I have commented, but we are looking at other ways to continue to make sure that Grace achieves its growth objectives. Part of that is investing in our specialty catalyst business. Part of that is investing in our Materials Technologies business. Both businesses have good long-term demand growth prospects. Grace throws off a lot of cash flow as a company. And there are opportunities for us to reinvest that cash flow in our existing businesses into add smart bolt on acquisitions, like we have done historically, those acquisitions built our Specialty Catalyst business and investors have heard us describe this year, we have looked at opportunities to add on to our Materials Technologies business. And when we find the right opportunities with the right financial profiles and the right returns, we would want to continue to pursue those opportunities.

Got it. That’s helpful and thanks for all the color on that. I guess maybe one other question, just maybe a smaller nuanced question. But when you when you look at the ART business, I know you were you were excited about the potential for growth, obviously, before the pandemic came in, and things got pushed out a bit. That said, they can only push these things out for just so long, I assume so I mean, are we are we looking at it 2021 year, where we could see almost a doubling of that business just based on how much it’s come off in 2020? And also how much pent-up demand or maybe pushed out demand maybe as we work out, is that the right way to think about it or is that maybe a little bit on the aggressive side?

Well, let me - I am going to address that in two parts. John, the catalyst supply to existing operations has been delayed because of the pandemic. Customers that had turnarounds planned in the fourth quarter, primarily have made decisions to push those turnarounds out into 2021 and they can do that because of their operations. They have not run as hard as they normally would have. And so the catalyst effectiveness is still high and they can delay the turnaround to change out that catalyst in a fixed bed application. But by the same time, the turnaround that was planned in Q1 might get pushed to Q2 the one planned in Q2 might get pushed to Q3. For the same reason, just the life of the catalyst bed has been lengthened, because our customers have not been running as hard. That said I fully expect 2021 to be a stronger demand year for then 2020 was in our ART business. And that is partly because of the second growth driver, which is new startups, new unit startups. We have got very good visibility to our customers plans to start up new units. And we expect those to startup in 2021, 2022 and 2023. There are a number of new investments that customers have made that will come online in the next 3 years.

Great, thanks very much for the color guys.

Your next question comes from the line of Kevin McCarthy of Vertical Research. Your line is open.

Good morning, Hudson. How do you characterize the magnitude and the timing of the opportunity related to advanced plastics recycling technology for Grace?

This is something that is in really just the developmental stages. At this point, Kevin, there are a lot of experiments happening by Grace and by other industry participants with technology and with business models. There are technical challenges to be addressed. There are also business model challenges to be addressed in terms of capital requirements, feedstock availability, and things like that. And so I think this will take some time to sort out, there are some knowns, the Pyrolysis process is a well understood process, but there are some unknowns around feedstock availability and the pace of capital investment. And so I do think this will take some time, Kevin.

Okay. Then secondly if I may, in your press release, you called out an increase in your projected liability for the environmental work that is proceeding in Montana and can you talk about what the aggregate spend is likely to be and how you would expect that to flow-through the financials in coming years?

Kevin, hey, it’s Bill. Yes, the adjustment we took this quarter was related to the spillway at the Libby Mine dam. And we did increase that estimate now to $95 million, which will get spent over the next 4 years. But as we kind of alluded to in the release, this is an important part of our strategy at Libby, getting this project done and getting it done right with this as the overall potential risk of that mine site remediation being a higher cost, you might recall, we had a separate charge for that of $70 million, a couple of years ago as we still work through that finalizing that solution with the EPA, the work we are doing around the dam and the spillway will help to ensure that we can keep the cost within the ranges that we have estimated. So, it’s a long-term process. And we are making progress here. I think we are also well-aligned with the town of Libby and the Lincoln County where it’s located. They support the approach that we are taking as well. So, still a lot of work to be done to finalize all this. It will not have any dramatic casual implication in any single year. I said this $95 million be over 4 years, the other $70 million that we accrued will be over even a longer period of time and not starting for a couple of years from now.

I see. That’s helpful. Thank you very much.

Sure.

Your next question comes from Mike Harrison of Seaport Global Securities. Your line is open.

Hi, good morning. I was just wondering with regard to the Hurricane Laura and Hurricane Delta impact, did the timing of that impact differ from your initial thoughts and at this point, do you have pretty good visibility on when the grid grew back up and running and you guys stop incurring costs or are there still some question marks there?

Yes, at this point - Mike, the grid is backup we are back on the utility. We are getting our energy from Entergy, the local utilities, so the plants back up and running. We are still finishing some of the cleanup on the site, but the site is back up and running, the plants are running, the energy is being supplied locally. And so I think, we have got a - we are well on our way to wrapping up the cleanup efforts.

Alright. And then in terms of the refining catalyst business, as you look at refinery operating rates around the world, can you give some color on what you are seeing from a regional perspective, are there regions where you were doing quite a bit better than that 24% decline that you posted overall and regions that were maybe a little bit worse than that?

Mike, it’s Hudson. We do see some regional variations. Operating rates in the Asia region have been higher than they have been in other parts of the world just given the conditions in those markets around the pandemic and so forth. If we look at this, over time, what we have seen is back in Q2, we saw real, a real trough, everybody is aware of that. Rates came back sequentially better throughout Q3, July, August, September and then in September, they stopped improving at the same rate and October has been roughly flat against September. And so we are watching this develop closely as the second wave of illnesses has started to affect North America and Europe. We haven’t seen any significant change in demand, but we haven’t seen real progress in demand improvement.

Alright. Thanks very much.

The next question comes from Mike Sison of Wells Fargo. Your line is open.

Hey, guys. The Specialty Catalyst business, I think you almost doubled that business over the last several years. And so when you think about strategically going forward, are there opportunities in different parts of the chemical industry that you can maneuver the business into that maybe kind of correlates with your current technology? And can you do that organically or do you have to do some acquisitions to sort of maybe broaden that part of the portfolio which has grown nicely over the last several years?

Mike, it’s Hudson. On the Specialty Catalyst business, the acquisitions that we have made have given us all of the technologies that we needed to have. We have got a broad technology footprint right now. We are able to supply the needs of our customers across polyethylene and polypropylene. And so there is nothing that we would have to do in that business. If there was an opportunity to add an additional technology, or maybe some additional manufacturing footprint, we would certainly look at it. But it’s not that there is nothing that we would have to do at this point. Outside of the polyolefin catalysts market, we have commented over the years about our interest in investing in chemical catalysts, they are attractive chemical catalysts businesses that we think would be nice complements strategically and financially to our current catalyst portfolio. And, that is something that that we remain interested in. It’s not likely that we would make significant organic investments in those markets. These tend to be niche markets and not a lot of room for a new entrant, but if an asset became available to us, we would certainly be interested.

Got it. And then as a quick follow-up, I think you noted in the slides and prepared comments that, post pandemic, you can get back to a 40% to 42% gross margin. And, when I look at your global refinery, crude run chart and look at the blue line, it looks like now you sort of get to those post pandemic levels of the second half of ‘21 versus the first half. So is it challenging to get there in the first half of ‘21? I know it’s maybe a little early to guidance given that forecast and as it maybe implied in the second half of ‘21 assuming that forecast unfolds it’s a doable sort of number?

Well, Mike, we are not going to comment that specifically on 2021. This morning, we will certainly share our views when we give our full year ‘21 thinking in February. But I think your analysis makes some sense and, the driver for gross margin is a combination of things. There is productivity that we do in our plants on a day to day basis, we have made a lot of effort to improve productivity of our operations that obviously improves our cost position and improves our margins. But there are other factors as well, including operating leverage. And that is why we have tied, getting all the way back to our historical levels, to getting back to historical side. That is why we have tied getting all the way back to historical gross margin levels, to getting back to historical volume levels, because of the importance of volume leverage to our margins, and that is added something that we work on everyday, to make sure we are as productive as possible, that we are managing raw material costs and other inflationary items to try to do as well as we can.

Okay, thank you.

Your next question comes from John Roberts of UBS. Your line is open.

Thank you. The big increase in the pharma sales within Materials Technology, was that new wins that will be sustainable or is that just a cyclical increase from the pandemic that then cycles back down?

John, just touched on, thanks for your question. It’s a combination of both. There is an important part of this that is driven by the pandemic. We are supplying a specialty silicas technologies, that are used in pandemic, I should not say pandemic COVID-19 test kits and we are also providing specialty silica technologies that are used in therapy and treatment of COVID-19 patients. And so that demand has increased significantly. It’s remained strong, which is, good for us financially. But it’s unfortunate in the sense that the pandemic is continued. But underneath that is also a strong improvement in the underlying pharmaceutical business. The team has done a nice job, developing new business with new customers, new business with existing customers and I remain optimistic about our pharma business in the next year.

And then secondly, assuming refinery runs get back to pre-COVID levels in the back half of 2021, will you have to replace the lost share from PES by then or do you still have some work to do on that?

Yes, John. We believe we have replaced the share already not on a volume basis, but on a percent of the market basis. And so as refinery rates improve, we obviously expect our volumes to improve, but our intent is to maintain our market share. That’s been our strategic intent in this business for a couple of years. And we are focused on that. We want to maintain our market share and drive profitability growth in this business by focusing on value selling our technology to our customers. That’s our basic strategy and that really hasn’t changed.

Great. Thank you.

Your next question comes from Laurence Alexander of Jefferies. Your line is open.

Good morning. I guess first of all on Material Technologies, how is your segment mix shifting this year? I mean, as you think about exiting this year going into next year, where is pharma consumer as a percentage of the total compared to where it was in 2018-2019? And then the other question I had was just developing new platforms, can you give a sense whether on the renewable fuel side, the revenue per gallon or per ton is significantly different for grades than a comparable traditional diesel or gasoline? And similarly, for the catalyst opportunity and the cycles process, is there a technical reason why the catalyst sale per ton of plastic produced would be materially different than the current catalyst sales going into [indiscernible]?

Thank you, Laurence, for those questions. Let me start with the MT question and then I will shift to the future - to the other questions. On MT, our segment mix, if you went back a year ago, we were roughly a third, a third, a third between a pharma consumer, coatings and industrial or process chemicals. That mix shift has been changing as we have been focused on the faster growing and more profitable parts of our portfolio. And even setting the pandemic aside, we expected to see pharma consumer, the pharma consumer segment to grow faster than the other segments although we did expect good growth in the chemicals, the chemical process segment. That’s where a lot of our new colloidal demand is classified. And so over time, what we were doing was driving mix shift among those three segments and within those three segments towards the faster growing more profitable end-markets and we had seen a lot of progress. At the sub-segment level, we had seen about 10 points of mix shift over the last 2 or 3 years. Now, with the pandemic, it’s accelerated that mix shift in favor of consumer pharma. That will continue as we move forward. The mix shift may not be quite as strong next year as the COVID - as the pandemic hopefully winds down, but in the long-term, we absolutely expect to continue to drive that mix shift. On your question about the sustainability growth opportunities, let me touch on advanced plastics recycling for a moment. There are two catalysts - actually there are three catalyst opportunities for us in this end-market. The first is in the pyrolysis process itself. This is where the plastic waste stream is converted into an oil, that can be a process that’s done with heat and pressure. It can also be a process that’s catalyzed. It’s a lot like an FCC catalyst. It’s very similar application, very similar technical challenges. That is one commercial opportunity for us as this technology evolves. The second opportunity is in an FCC unit, if the product of the pyrolysis process, this oil is fed into an FCC unit to be co-processed with crude oil. That is going to require a different type of catalyst, still an FCC catalyst, but a reformulated catalyst. That creates an opportunity for us. And then in terms of the polyolefin catalyst itself, it to your specific question, it doesn’t matter on a on a unit basis, whether the feedstock is from a cracker a PDH unit or this pyrolysis process, you need the same amount of catalysts to convert a unit of propylene into a unit of polypropylene.

And then just lastly just touching on the renewable fuels, is there a significant difference in the revenue opportunities compared to traditional fields on a per gallon or per ton processed basis?

This, the renewables uses a similar technology to what we are selling into our hydro processing in markets today and the economics are in line with our existing economics.

Okay, fantastic. Okay thank you.

Your next question comes from Chris Kapsch of Loop Capital Markets. Your line is open.

Yes. Good morning. Hopefully you can hear me. So curious about agreeing a little bit of this from conversations with Jeremy but Hudson, I was wondering if you could address their decision to cancel effectively your project in your FCC capacity in the UAE at one point. this was deemed strategic given the pipeline of refinery builds in the broader Middle East and the Southeast region, Southeast Asian regions and, and presumably your visibility in, getting stepped into those designs and processes. So, a little bit of a pivot, I am just wondering if this is a function of a revised view of the markets, longer term potential or if you could just elaborate that would be helpful? Thanks.

Sure, Chris, happy to. This project was conceptualized in 2012 as an opportunity for us to add a new capacity in an important region in the world. And at that time, we had a view on long term demand for FCC catalysts. We also had a view on how our technology would evolve over time. And in the intervening years, two things have developed the long term outlook for refining catalysts demand has moderated the growth opportunity today is not what we thought it would be back in 2012. And so we had to factor that into our decision making. But the bigger issue, quite honestly, Chris was around how our technology has evolved. The pace of technology advance in the FCC catalyst business has been pretty fast over the last few years. We have invested in that business our customers are demanding more and more sophisticated catalysts from us, particularly as the demand for petrochemical feed stocks in refinery units has increased over the last few years. And what that has led us to is a decision that it’s better to keep our refining our manufacturing capability in our big plants. We have got three big plants, one in Europe, two in the United States, that have a lot of capability and a lot of flexibility. And because of that flexibility, we are able to efficiently manufacture new technologies as they are commercialized without a lot of new capital investment. And, that’s the better manufacturing strategy for us. And it ensures that we are able to continuously provide our best technology to our customers from an efficient global footprint, wherever those customers are based.

Okay, fair enough. And that answer, the second part sort of dovetails into a follow-up I had on this trade dynamic in your FCC catalyst business and, and having that flexibility in your bigger plants probably helps in the situation where these customers, each refinery customers are drifting and we have certainly seen this in prior cycles when their profitability is under pressure. What I am curious about is, when tracking became a thing, you were able to innovate and develop some FCC Catalysts that could get the iron out of that, that light type feedstocks for the refinery and in this instance, with the refineries, that their demand, the yield play, their demand picture has changed dramatically. And in some areas more pronounced others diesel probably holding up like gasoline down obviously, the worst is probably kerosene. So I am just wondering, other than just, providing a lower cost Catalysts for and again, this is in - I know, I understanding, this is not all your customer base to some, but other than just sort of providing lower cost operations, is there an opportunity to help them change the yield play to better addressed this hysteric end market demand of these refined products or is - are they just trying to get through this and hope for the recovery, any color on that would be helpful?

It’s thoughtful analysis, Chris, and you are spot on. The vast majority of our customers are using the high performing technology. And a lot of that is because they want to be able to maximize the value of what they are producing at their refinery. Our technical teams have spent an enormous amount of time with our customers since the pandemic began, working with them to identify how do they optimize their profitability? How do they optimize their refinery margins, in an environment where demand is changing dramatically, relative demand is changing, and the value of their products have been changing. And so this is what our teams do best. They are superb at working with our customers, to identify strategies for maximizing our customers profitability and then turning that into a catalyst formulation. And the vast majority of our customers are still pursuing that exact strategy.

Alright, thanks, Hudson. I appreciate the color.

Your next question comes from David Silver of CL King. Your line is open.

Yes. Hi, good morning. I was hoping to just follow-up and get a little bit of background on the revenue dynamics, earnings dynamics when you are awarded UNIPOL polypropylene license. So I guess there is multiple ways to pay for a technology award maybe all upfront or over a period of time or related to production. And I noted you made a comment, when you touched on that that particular award that it would create a longer term revenue stream. So if you wouldn’t mind to just walk me through kind of the revenue flows? In other words, is there an upfront payment? Is it a longer term pain and tied to either a lapse of time or level of production or is it the case where you can maybe get an upfront payment for the technology that the longer term revenue stream you have referenced? Is really would be accompanying sale a catalysts? And then finally, I mean, is there in the quarter, was there a payment received for the technology award or if not, when might that payment for that award show up in your results? Thank you.

David. Hi, it’s Bill. Regarding the UNIPOL business, the way that our typical arrangement works, is we will sign a contract with a licensee. And from the time we sign the contract till the unit is up and running might be anywhere from 3, 4 or 5 years depending on the project and what happens as we get a number of milestone payments during that time, so there will be cash when they sign a license and other cash at different milestones. And then, but from a revenue recognition standpoint, we straight line the revenues, so the time we sign the contracts, we estimate the value of the contracts that we straight line it over the period from signing the license until the unit is up and running. So this provides a steady, fairly predictable revenue stream for us, at any point in time, if we are signing, 4, 5, 6 licenses a year, and they are taken 3 to 5 years, you could do the math 10, 20 plus licenses, in various stages of revenue recognition, and you have got milestone payments coming in, throughout the year on a number of open licenses at any given time as well. So that provides, steady stream of revenue, cash flow, throughout the period of the construction. And then, beyond that, then we have the catalyst sales which then provides a longer term, sales opportunity beyond that, and, we do generally have a long term catalyst supply arrangement with our licensees. We have also, continue to provide technical service, as I think Hudson mentioned during his remarks, as well provide, service to continue to help the units run most effectively, from startup and for years to come beyond that. So, these are very long term relationships. And, once we sign the license, it provides us, long term opportunity.

Okay, thanks very much. That’s it for me. Appreciate it.

Okay, I think we have time for one final question.

Okay. And your last question comes from Chris Shaw of Moness, Crespi. Your line is open.

Hey, good morning, everyone. Thanks for taking me in. Just given the 4Q guide for sequential gross margin improvement of 100 basis points, given that I think you are also forecasting at 10% or a little bit above that sequential growth in sales. I thought the gross margin benefit was less than expected, is there some sort of seasonality or mix going on that you expect for 4Q?

Yes, Chris. It’s really driven by the recovery, right. We are still not back to our historical rates volumes both on sales and production. And so, we will continue to see this incremental improvement. We saw it from Q2 to Q3. We will see it Q3 to Q4. And assuming continued recovery into 2021, we will continue to see the margins improve there. So, there is really - it’s not a seasonality issue, it’s really tied to our overall operating leverage.

But a 10%, sequential sales increase doesn’t generate a higher gross margin improvement, that’s just a better math?

That’s the math. And you have got to factor the mix of the businesses and so forth as well, but that’s the math and we feel pretty, pretty confident. That’s where we will land for Q4.

Got it. And then I know, part of the growth strategy in the past has been, and then finally, catalyst has been in other geographies see where the growth is in actual new refineries and you have done that. I am just curious, new refinery has a broad scale refinery in the Middle East relative to, I don’t know, it’s the PES when that closed recently. Is there - does one use more catalyst than the other or are they basically the same? I mean, is it a newer, more efficient one that use less or did they use more, because I am not sure, I mean, what is there any sort of change in that besides just the volume?

Chris, it’s Hudson. The biggest difference is really in the value of the catalyst that they are using. The new refineries that are being built in the Middle East and Asia, Africa, they are focused on petrochemical feedstocks in addition to transportation fuels. And to achieve their output objectives around maximizing propylene, they need a very high performing catalyst and that’s the biggest difference.

Thanks. That’s all I had.