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Edited Transcript of PQG.N earnings conference call or presentation 20-Feb-20 4:00pm GMT

Q4 2019 PQ Group Holdings Inc Earnings Call

Mar 4, 2020 (Thomson StreetEvents) -- Edited Transcript of PQ Group Holdings Inc earnings conference call or presentation Thursday, February 20, 2020 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Belgacem Chariag

PQ Group Holdings Inc. - Chairman, President & CEO

* Michael C. Crews

PQ Group Holdings Inc. - Executive VP & CFO

* Nahla A. Azmy

PQ Group Holdings Inc. - VP of IR & Financial Communications

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Conference Call Participants

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* Angel Octavio Castillo Malpica

Morgan Stanley, Research Division - Research Associate

* Christopher S. Parkinson

Crédit Suisse AG, Research Division - Director of Equity Research

* David L. Begleiter

Deutsche Bank AG, Research Division - MD and Senior Research Analyst

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Laurence Alexander

Jefferies LLC, Research Division - VP & Equity Research Analyst

* Roger Neil Spitz

BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst

* Silke Kueck-Valdes

JP Morgan Chase & Co, Research Division - VP

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Presentation

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Operator [1]

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Good morning, and welcome to the PQ Group Holdings Fourth Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Nahla Azmy, Vice President, Investor Relations. Please go ahead.

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Nahla A. Azmy, PQ Group Holdings Inc. - VP of IR & Financial Communications [2]

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Thank you, Kerry. Welcome to everyone joining us for our fourth quarter and full year 2019 earnings results call. We will start today with formal remarks from Belgacem Chariag, Chairman, President and Chief Executive Officer; and Mike Crews, Executive Vice President and Chief Financial Officer. Then we will follow with a Q&A session.

Please note that some of the forward-looking statements that we make today about the company's results and plans are subject to risks and uncertainties that could cause the actual results and the implementation of the company's plans to vary materially. These risks are discussed in the company's filings with the SEC.

Reconciliations of non-GAAP financial measures mentioned on today's call, with their corresponding GAAP measures, can be found in our earnings release and presentation materials posted on the Investors section of our website at www.pqcorp.com.

Now with that, I'm pleased to turn the call to Belgacem.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [3]

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Thank you, Nahla, and good morning, everyone, and thank you for joining us this morning. I am proud of our team's execution in 2019. We believe we delivered solid performance on strategic, commercial and financial fronts, with a focus on driving shareholder value through profitable growth, capital efficiency and free cash flow.

I would like to briefly cover some of these key achievements. Starting with safety, we continue to advance to becoming a top quartile HSE performer. The increased focus of the leadership team in the area, combined with intensified safety training, resulted in a 15% improvement from 2018 and the lowest incident rate and level 3 environmental performance in the last 10 years.

On the commercial front, we had excellent results from both our materials and catalysts businesses. The Performance Materials team not only delivered improved pricing in both highway safety and industrial products, but also executed on significant structure cost initiatives. The catalysts surge in volume benefited from continued polyolefin capacity increases and technology share growth in addition to the increased activity level of hydrocracking and MMA refills.

As for our strategic portfolio optimization efforts, we continued progressing on the pathways we identified to make our portfolio simpler and stronger. Our focus on capital efficiency enabled and improved and lower capital spend program. Additionally, we successfully realized more than $80 million of asset monetization.

Finally, on financial, we are pleased to have successfully delivered on our key measures and commitments. We grew adjusted EBITDA by over 2%, expanded margins by 100 basis points, drove higher operating cash flow and generated record adjusted free cash flow. As we have committed, we reduced our debt by paying back $215 million and improved our leverage ratio by over 0.5x. This improves our financial position and enhances our flexibility to further optimize our portfolio and accelerate future value-enhancing growth.

Next, I will cover some of the diverse end-use drivers affecting each of our businesses in 2019. First, in Refining Services, U.S. refinery utilization rates were down slightly this year, largely due to numerous unplanned outages and heavy turnaround schedule. However, regeneration services continues to benefit from favorable supply and demand dynamics and improving contract terms. The alkylation process is one of the most profitable in the refining complex. There continues to be growing demand for alkylate to produce higher octane gasoline as evidenced by widening spreads between premium and regular gasoline. This has enabled as sulfur regulations for gasoline tightened and market share for turbocharged vehicle sales increases. These favorable trends have helped to offset some of the demand weakness in the virgin sulfuric acid product line on customer destocking related to automotive end users. This demand weakness has also been partially mitigated by new volume to industrial customers with need for high-purity sulfuric acid.

Next, we had record performance in our catalysts business due to several positive drivers. In Silica Catalysts, we continue to benefit from capacity expansions in the polyethylene industry, and a shift to our silica-based catalyst technology. Timing of refill demand by our MMA customers, for whom we are the sole specified supplier, drove additional favorable performance.

In the Zeolyst JV, the timing of refining customer change-outs drove the second strongest year in terms of demand for our hydrocracking and specialty catalyst. As a reminder, change-outs will hit a peak every 3 to 4 years depending on refinery utilization. While this can result in the year-over-year variability, the base number of refineries continue to increase, thereby, driving higher underlying future growth potential.

In Performance Materials, we experienced a shortened highway striping season on higher level of rainfall and an early winter in North America and Europe. Further, there has been some demand softness for our engineered glass products for coating-related applications, such as automotive and construction, slightly offset by metal finishing. And despite the softness, we were still able to capture price increases in both product lines, which helped offset lower volumes.

Let me now update you on a recent transaction in Performance Materials business. This month, we entered into a long-term supply agreement with a leading global thermoplastic producer. And we are acquiring their U.S.-based glass, beads production facilities in exchange for our ThermoDrop product line. This enables us to reinforce our growth through focus on our core operating capabilities in the highway safety market segment.

Finally, on Performance Chemicals, our sodium silicate product line has been impacted by weaker demand. The general industrial slowdown has resulted in a destocking by some of our large global customers. Later in this call, I will review our plan to position this business for improved financial performance.

Looking to 2020, we expect the underlying positive demand trends for our businesses to largely be similar to 2019. In Refining Services, unplanned customer outages have extended into the early part of 2020. But on balance, we will benefit from anticipated strong alkylate production for the year. We expect the catalysts business to be lower due to reduced number of refinery hydrocracking change-outs, following the near-record level in 2019 and lower refill demand for MMA.

We are forecasting a second half improvement for Performance Chemicals, sodium silicate product line, as some of our largest customers seek to restock.

Finally, while the full extent of the coronavirus is still unknown, our direct exposure can be classified as low due to our limited participation in the China market. That said, the secondary effect through the exposure of some of our customers remains an uncertainty that we continue to monitor closely.

Let me now turn the call over to Mike for a more detailed review of the 2019 results and the 2020 outlook.

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [4]

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Thank you, Belgacem, and good morning, everyone. We had a better-than-expected finish to the year, driven by our outstanding results from our catalysts business in the fourth quarter. For the full year, we posted growth in both adjusted EBITDA and margins.

Our strong free cash flow generation, combined with our successful asset monetizations, enabled us to, again, meaningfully reduce our leverage ratio. As Belgacem just reviewed the 2019 highlights, I will focus my comments on the fourth quarter results and our 2020 outlook.

So turning to Slide 4, fourth quarter sales decreased 7% to $352 million, as improved pricing and a focus on higher-margin products across our portfolio were more than offset by lower sales volumes. Adjusted EBITDA of $103 million was down $6 million or 5% on a constant currency basis.

The prior year results included a $4 million gain related to insurance recovery proceeds for Hurricane Harvey. Further, the stronger performance of our catalysts business in the quarter was offset by lower volumes in refining services from additional unplanned customer outages and continued demand weakness from Performance Chemicals.

Adjusted EBITDA margin was 26%, in line with the prior year. For the year, margins expanded 100 basis points.

Moving to Slide 5 for a detailed review by business segment. Refining Services sales of $106 million were down $14 million, largely on the pass-through of lower sulfur pricing of approximately $7 million. Volumes were lower in our Regeneration Services product lines from higher turnaround costs and unplanned customer outages. In addition, virgin sulfuric acid volumes declined due to weaker nylon demand. Adjusted EBITDA declined $8 million to $42 million on lower sales volume and the $4 million insurance recovery gain in the prior year. Adjusted EBITDA margin remained strong at 40%.

Turning to Slide 6 for Catalyst. Silica Catalyst sales of $23 million increased 6%. This was primarily due to accelerated methyl methacrylate sales from 2020. Zeolyst Joint Venture sales increased 30% to $47 million. This was driven by the increased demand for hydrocracking catalyst, which more than doubled versus the prior year fourth quarter.

Adjusted EBITDA increased 51% to $28 million, with margins expanding more than 800 basis points to 40%. Higher Zeolyst Joint Venture sales volume, combined with favorable mix, drove the outperformance.

Next for Performance Materials on Slide 7. Sales of $68 million declined 6% on a constant currency basis. Continued soft demand in Europe and Asia impacted sales for our engineered glass materials. This was partially mitigated by higher pricing within our highway safety product lines.

Adjusted EBITDA grew 9% on a constant currency basis to $11 million, with margins rising 230 basis points to 17%. This improved performance was the result of higher pricing, coupled with lower operating and freight costs as we executed our cost reduction initiative.

Turning to Performance Chemicals on Slide 8. Sales of $159 million were down 5% on a constant currency basis. Lower demand for sodium silicate extended into the fourth quarter as customers continue to maintain lower inventories. Adjusted EBITDA of $34 million declined 13% on a constant currency basis, resulting in a 210 basis point margin reduction to 21%. This was primarily driven by lower sodium silicate sales volume in North America.

For the full year 2019, PQ sales declined $41 million or 2.6%, which reflects unfavorable foreign currency effects of $30 million and the pass-through of $10 million of lower sulfur prices. Absent these items, sales would have been flat as higher sales volume in silica catalysts and higher pricing across all businesses were offset by the lower sodium silicate volumes in Performance Chemicals, due primarily to the economic slowdown in North America and Europe.

Adjusted EBITDA rose 2% to $474 million. Catalyst increased 33% versus the prior year from strong hydrocracking and specialty catalyst demand, along with lower costs as we built inventory to meet 2020 sales commitment. And Performance Materials increased 6%, largely due to higher pricing. Performance Chemicals declined 7% on a constant currency basis on lower sales volumes, coupled with higher maintenance costs.

Next, on Slide 9 for a discussion of our adjusted free cash flow and leverage. During 2019, we delivered higher operating cash flow, reduced capital expenditures and monetized assets. We generated $166 million of adjusted free cash flow, a 24% increase over 2018. This free cash flow, along with a product line sale and currency swap monetization, enabled us to pay down $215 million of debt. As a result, our year-end leverage ratio was 3.9x, more than half a turn below 2018. Building on our stronger financial position, we took the opportunity earlier this month to refinance our term loan facility, lowering our interest rate by an additional 25 basis points and extending the maturity by 2 years.

Turning to Slide 10 to address our 2020 outlook. Sales are expected to be in the range of $1.595 billion to $1.625 billion. This reflects mid-single-digit growth in our Performance Materials and Catalysts businesses. We expect flat to low-single-digit growth in Refining Services due to continued pass-through of lower sulfur pricing, and in Performance Chemicals on weaker demand through the first half of the year.

We are targeting adjusted EBITDA in the range of $470 million to $480 million, driven by low to mid-single-digit growth from Refining Services, Performance Materials and Performance Chemicals, largely on improved volume. Catalyst is projected to be below 2019 in the low double-digit range, given the expectation for fewer hydrocracking catalyst change-outs following a strong 2019 and higher costs as inventories decline to meet sales demand.

Adjusted EBITDA margins by segment are forecasted to be similar to 2019 with the exception of catalyst, which we expect to be more in line with 2018 levels. Overall, consolidated margins are anticipated to be largely in line with 2019.

Adjusted diluted EPS is expected to be in the range of $0.85 to $1.02 per share. This guidance reflects our adjusted EBITDA outlook, along with lower interest costs, offset by higher income taxes.

We are targeting adjusted free cash flow in the range of $155 million to $175 million. This reflects capital expenditures of $130 million to $140 million, offset by lower cash interest and lower working capital needs in 2020.

And with respect to our first quarter, we expect adjusted EBITDA to be below first quarter 2019 in the low single-digit range, largely driven by continued demand weakness in Performance Chemicals.

In summary, we are pleased with our fourth quarter results and completed another year of solid financial performance. We strengthened our financial position through improved free cash flow generation and reduced leverage, and we have demonstrated that our portfolio of diversified and differentiated businesses is largely resilient to a changing macro environment with the potential to be even stronger.

With that, I will turn the call back to Belgacem.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [5]

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Thank you, Mike. Now I'll address our Performance Chemicals transformation plan on Slide 11, please. The competitive strength of this business includes a strong base of customer relationships. Built on a long history of collaboration, we have nearly 200 years of history of innovation successes in silicas, silicates and zeolites. Our other competitive strengths included our mobile network and production knowhow, which allow us to supply key global consumers locally and reliably.

As part of our portfolio review last year, we determined that this business had the potential for significant improvement in capital efficiency, growth and margins. We also saw this potential for strengthened performance could be combined with an ability to flex to change in the macroeconomic environments or conditions. Accordingly, we kicked off a transformation plan to restructure our Performance Chemicals business, focusing on growth and enhanced efficiency through a four-pronged program that is now underway.

Beginning with manufacturing excellence, to improve accountability for productivity and best practices across the network, we realigned and centralized the global infrastructure of manufacturing plants under one leadership team. We expect this to improve reliability and optimize throughput in order to drive incremental growth. It should also reduce cost per plant and across the network.

On network optimization, we are adjusting our global footprint with a deliberate focus on serving key growth customers more efficiently. This will also reduce our ongoing maintenance capital requirements.

On commercial discipline, we are undertaking a differential approach to our engagements with key existing customers and target accounts. Through integrated strategy and planning, we will focus the organization on growth markets and winning product customer combinations. Our key objective is to accelerate growth and improve margins through a combination of value pricing and growing product lines with differentiated end users. This focused approach could also result in our shedding or monetizing additional smaller noncore product lines and assets.

Finally, on integrated business management, we are implementing a business process step change for supply and demand planning to drive improved forecasting accuracy, while enhancing the customer experience. This will result in improved working capital efficiency.

We have already successfully monetized several noncore assets in our Performance Chemicals portfolio. With this comprehensive transformation program being executed over the next 12 to 18 months, we are targeting a run rate improvement in adjusted EBITDA of $10 million to $15 million. We also expect to deliver a cash benefit over the same project period.

Turning to Slide 12. And before I discuss our objectives for 2020 and beyond, I would like to cover some of our accomplishments, and how we got here. Since our IPO a little over 2 years ago, our PQ team has achieved a 7% adjusted EBITDA growth over the 2017 to 2019 period across 3 of our 4 businesses, the Catalysts, Performance Materials and Refining Services. That was mitigating a decline of 5% in Performance Chemicals, while maintaining solid margins despite a slowing macroeconomic environment.

The team has also achieved a free cash flow growth from improved capital efficiency, commercial execution and asset monetization as well as a reduction in our leverage ratio by 1x. Building on this track record, in 2020, our team will continue to successfully execute and win in the performing businesses. Return the Performance Chemicals business to growth by diligently implementing the transformation plan and realizing the initial benefits, continue to generate strong free cash flow and deliver on additional optimization projects, which our portfolio, including improved capital efficiency, commercial intensity and asset returns.

Beyond 2020, and with these ongoing actions well executed, we expect to drive sustainable growth in the mid- to high single-digit range across our Catalysts, Material and Refining Services businesses. We also expect to achieve a sustained GDP-like growth for our Performance Chemicals business. And last, but not least, we expect to enhance our financial flexibility to pursue inorganic investments and enable further growth.

This concludes our prepared remarks. We're now ready to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question will come from Christopher Parkinson of Crédit Suisse.

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Christopher S. Parkinson, Crédit Suisse AG, Research Division - Director of Equity Research [2]

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Great. So you did some solid strides reducing leverage in 2020, and you're now below 4x. Going forward, do your capital deployment priorities changed at all to any degree? Or is that reduction still your primary priority? And then also, when you're reviewing the portfolio, has your view changed on what's truly core? Has that changed at all? And are there any units where you'd consider to grow inorganically?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [3]

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Chris, this is Mike. I'll take the first part. With respect to capital allocation, we've set our stated target on leverage is 3 to 3.5x with a goal of reducing that leverage 0.5x a year, which we've been systematically doing since we went public in 2017. As you look at 2020, I think, again, our primary focus for adjusted free cash flow will be debt repayment with an eye toward getting to the top end of that range by the end of 2020. So that's within striking distance, and we feel good about that.

Once we get there and get solidly into that range, then I think our capital allocation priorities can change, and we'll be looking at whether we're -- have an opportunity for bolt-on acquisitions for some greater inorganic growth to supplement organic growth, or we'll also be looking at return of cash to shareholders with items such as dividends. So that will all be on the table. It's something we'd continue to look at given that we are getting close to our targeted range.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [4]

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And let me just complement the answers -- let me complement the answer on the portfolio, Chris. We have been saying that we consider our 4 components of the portfolio strong components, and we value their contribution to the overall performance. We also said that we're always open to options to create value and unlock value for our shareholders. We continue to deliver on every single business with the exception of chemicals in the last couple of years that we're going to get it back on track. We look for areas in these portfolios where we have slowing growth or lower performance in margin and returns below our desired threshold, and that triggers our attention.

We have been looking at multiple options, and we have been executing on smaller components of our portfolio, you noticed. Whether it means the reallocation or consolidation of resources, a sale or a disposal or even move into some logical adjacencies would be things that we consider. So we're still making sure that each component of our business is operating right, and we're considering all the options, and we're acting on the subcomponents of -- actively of these business units to drive results.

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Christopher S. Parkinson, Crédit Suisse AG, Research Division - Director of Equity Research [5]

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That's great color. Just as the follow-up. Can you just further discuss the expected benefits of your Performance Chemicals transformation in more depth? And how we should think about those initiatives? But specifically, the network optimization opportunity when you refer to growth opportunities, if you could add a little bit more color there, it would be greatly appreciated.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [6]

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Well, the four-pronged components are very complementary, Chris. The network optimization relates to where we operate, how we operate, what value we create. We -- historically, we have been all over the place. We have operations in places where maybe the -- we're producing products that don't make sense anymore, looking at future growth and return, or maybe we're operating in places where we need consolidations. So that is the network. Network optimization is really deciding where we produce and what we produce, and how we can optimize our resources and assets. As I said earlier, this, in turn, will create a critical value in how much we spend on maintenance and how we consolidate productivity without having to invest capital in new facilities and maintenance.

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Operator [7]

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The next question will come from John McNulty of BMO Capital Markets.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [8]

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With regard to the Performance Chemicals transformation, is there any incremental cash flow hit as your -- as part of this restructuring and transformation that we should be thinking about for 2020? And is that -- would that be included in the adjusted free cash flow number that you've put out there?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [9]

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John, yes, there will be a cash cost for the initiatives that we're undertaking, and they are incorporated in the guidance that we provided.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [10]

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Okay. Got it. And then can you give us some clarity on the change around, and I guess the long-term contract that you've signed up with taking on the glass beads assets and then dropping off, it looks like the Thermo -- or swapping the ThermoDrop assets out. I guess how should we be thinking about the change in sales and in margin profile for the business now that, that swap is in place?

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [11]

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John, let me start by kind of bringing things in perspective with ThermoDrop. ThermoDrop was a step-up technology. It was a good technical and commercial success and made good progress in the customers' adoptions. However, the earnings and returns were not where we wanted them to be in the horizon -- time horizon that we had. When we had this opportunity to secure this 10-year contract, actually of glass beads contract with an opportunity to trade that against our ThermoDrop product line, together with the capacity and the facility to produce and to deliver to that contract, we believe that was great outcome -- that would be a great outcome and will enable us to focus on our core operating capabilities in highway safety industry.

Now most of these assets will be -- try to deliver the contract, and actually, it will improve our network with our customers and capabilities. And definitely, with time, when all this is in place, we're going to see an improvement in the bottom line because of the complications we've had with earnings from ThermoDrop. Mike, you want to add anything on that?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [12]

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Yes. And it's going to take us a little time to sort through all the change over here, but we have tried to estimate that as part of our 2020 guidance. And as we think, overall, for Performance Materials, both sales and EBITDA, we see growth in the mid-single-digit range. So that has been incorporated and probably a similar margin profile for 2020 as we would have seen in 2019 with an eye towards potential margin expansion going forward.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [13]

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Absolutely. And John, I want you to take this from -- not from a -- only from a numbers perspective, I mean, I did say 3 quarters ago that ThermoDrop is a great product that it's on the watch because it's either going to be part of the growth portfolio or in the time horizon or we're going to take actions, and we took actions. I think what we're doing is right for our growth. And I believe ThermoDrop still was great technology, but the time horizon didn't work. And I just -- this is a confirmation of how we scrutinize our portfolio and make sure that everything really aligns with the growth trajectory that we want. If that helps.

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Operator [14]

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The next question will come from David Begleiter of Deutsche Bank.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [15]

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Belgacem, looking at the Zeolyst JV this year, I know it will be down year-over-year. But just how much will be down in both the sales and equity in earnings basis, you think, for this year?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [16]

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David, it's Mike. What we've said is for the Catalyst business, the EBITDA will be down low double digit in 2020 as compared to 2019 with margins that will be similar to 2018 levels. So that's a function of the methyl methacrylate sales that came out of '20 into the fourth quarter and benefited 2019. The step-down, just as how many hydrocracking catalyst change-outs we have in 2020.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [17]

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Let me add a color on this.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [18]

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Yes. I'm sorry.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [19]

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Yes. Sorry. Let me add a color on how great was 2019 in hydrocrack. I mean hydrocracking activity was very strong in 2019, our capability to sustain that and deliver that capacity was also very successful. This is the second -- next two, I think last I remember was 2015 when we had the highest hydrocracking capability. We were pushing it, and we were responding, and that's probably part of the reasons why we were positively surprised towards Q4 because we -- the team really delivered on that. So obviously, next year, activity will be lower because this was a very exceptional year. But when you compare next year plans to 2018, we're still higher. So directionally, this is still ongoing. This is a great business. It's just the price of the lumpiness and the POs when they happen altogether. We enjoy it, and we struggle a little bit with the different -- with the comparison, but it's actually a positive trend, and we're very happy with that.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [20]

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Understood. And just on the Performance Chemicals transformation. How much of this $10 million to $15 million benefit do you expect to realize in 2020?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [21]

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So for Chemicals, we're also projecting a mid-single-digit growth in EBITDA versus 2019, and about half of that, we estimate will come from the transformation project.

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Operator [22]

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The next question will come from P.J. Juvekar of Citigroup.

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Unidentified Analyst, [23]

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This is [Karen Amada] on for P.J. So just looking at the Performance Chemicals segment. Volumes were down almost 8% this quarter. And given the outlook for 1Q, I was wondering if you could expand just a little bit on which end markets you're seeing the most weakness in?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [24]

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Yes. For chemicals, it's really -- 2019 was really about sodium silicate, and it was really pretty macro. It's across a wide variety of industrial applications. It has accelerated as we've gotten into the fourth quarter and also the third quarter with some destocking. As we look at chemicals for the first quarter, we expect it to be up sequentially from the fourth quarter, but still below what we had for Q1 of 2019. So there will be a step-down there. I would say 1 month doesn't make a year. We've got a little bit of green shoot around sodium silicates. So we're cautiously optimistic there that we're -- that the rebound is -- we have an opportunity to be rebounding here in the first few months of the year. And that's why we expect that the second half will be better than the first half for Performance Chemicals.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [25]

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Let me add a color here again on sodium silicate because it's just not a regular product. Sodium silicate goes into a variety of industries as this is probably -- I figured this is what you wanted to know more. It serves wide -- a variety of industrial and consumer products, largely in the U.S. and Europe, and that we think that they were lower -- the Performance Chemicals sales were lower on the consumer products and industrial end markets consistently from the -- for the whole second of the year, and then it's still ongoing in parts of the world in the first quarter as we see. And because of a lot of that impact is a destocking impact because this product goes in many industries, we built in our projection that we're going to start seeing some recovery in the restocking. You cannot destock forever. So a bit of recovery and destocking in the second half of the year. And that explains our second half strength versus the first half in chemicals. You add to that the recovery with the project that will start kicking in, in the second half of the year. You will have a very differentiated H2 to H1 in chemicals, but positive in the right direction, part of the longer-term project recovery.

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Operator [26]

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The next question will come from Roger Spitz of Bank of America.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [27]

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On the 2020 EBITDA walk between EBITDA to free cash flow, beyond CapEx and cash interest, there leaves another $70 million to $75 million, presumably, that's taxes and working capital and maybe some other things. I wonder if you could provide some of your assumptions for these other items between the 2.

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [28]

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Sure, Roger. This is Mike. So if you start at the midpoint of our guidance and you can look at our interest expense guidance, but cash interest runs a little lower than that, so that's going to be somewhere around $100 million. Cash taxes are typically in the $25 million range. Working capital usage, which normally would be about $20 million a year, we expect to be a little lower than that. And then for the rest of what you have, there's still a fairly big other -- about $11 million of that relates to pension. It would also include the cash outlay we'll have for the transformation project. And then the rest is really just all other, its prepaid, its accruals, and that's going to get you right in the range of the midpoint of our cash flow guidance, I believe. Net-net of the $135 million at the midpoint capital expenditures.

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Operator [29]

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The next question will be from Vincent Andrews of Morgan Stanley.

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Angel Octavio Castillo Malpica, Morgan Stanley, Research Division - Research Associate [30]

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This is Angel Castillo on for Vincent. Just a quick question around Refining Services. You talked about seeing kind of the unplanned outages continuing kind of into the 1Q. So just curious if you could give us a sense for your expectations for EBITDA in 1Q and then first half versus second half.

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [31]

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We think for both sales and EBITDA and Refining Service is going to be relatively flat compared to last year. We have talked about some unplanned customer outages over a couple of quarters here. Some of that has extended into the first quarter here in January, so that's something that we're managing through. Really not reflective of the underlying demand is just -- it has been a mechanical issue here, a mechanical issue there at multiple plants, but those outages are typically not very long. These are not full on turnaround. So even though we expect to be relatively flat in the first quarter, we do see some growth in -- certainly an EBITDA growth, which, again, would be in the mid-single digits. Revenue will likely be lower. We had a $10 million hit in 2019 on passing through lower sulfur pricing. If you watch that before, there has no net impact on EBITDA, but it does limit top line growth. And sulfur prices have continued to decline. I think they're the lowest in about 10 years at this point. So that's something that we're watching, but that has a little bit of impact on the top line. Again, no impact on the EBITDA, and we expect growing EBITDA for Refining Services we get in throughout the year.

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Angel Octavio Castillo Malpica, Morgan Stanley, Research Division - Research Associate [32]

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Got it. And then just on the catalyst side, I was wondering if you could give us a little bit more color. What you're seeing on the specialty catalyst side, the Silica Catalyst, around the polyolefin catalyst side? And then just in terms of the hydrocracking, I guess, I'd be curious whether your comments are kind of referencing also just what you're seeing in terms of orders at this moment or more so just your experience kind of historically what would be a typical year right now in 2020 and kind of high IMO 2020 fits into that?

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [33]

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Great. So I'll take on the catalyst -- the Silica Catalyst piece is probably the early innings at this stage. Many of the oil companies will continue to invest in downstream into petrochemicals, there is -- while they were going through the energy transition. Nearest term, substantial volumes of this PE capacity continues to come online in 2020 and 2022 with significant expansion in U.S., Russia and possibly China. And we are gaining new business in all these 3 countries.

We see no near-term sign of demand dropping or slowdown for particularly our HDPE catalyst, which is really what we go to the market with. As you probably hear that there is a lot of concern about the LDPE catalyst for single-use plastics, and that is -- market is deteriorating. We're not playing in single-use plastic much, we are HDPE, which is growing. And actually, our polyolefin catalyst sales grew double-digit year-on-year in 2019, and we expect another double-digit growth in 2020. That brings improved value from a margin perspective because a lot of these products are high-margin products.

What was the second half of the question?

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Angel Octavio Castillo Malpica, Morgan Stanley, Research Division - Research Associate [34]

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Just curious on the hydrocracking. That's one of the areas of weakness for -- that you highlighted for 2020. But just, I guess, as I think about both IMO 2020 and how that plays into that. And then also just whether your comments were in reference to what you're already seeing in terms of orders for the year or whether it's more based on kind of historical experience of kind of these peaks and that you see in the refining industry.

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [35]

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Yes. On the IMO, we have seen a definite demand increase, and it's reflected in our results in '19. We still continue to see the demand strong. It's actually the transition is happening a lot smoother than anticipated. The capacity of production is there. The demand is growing, but the lumpiness of demand is really what creating these peaks and troughs. As I said earlier, we don't see 2020 to be a dramatic drop. It's just a relative performance to 2019, which was an exceptional year. We continue to see -- if you draw the average, we continue to see a positive slope to the demand. 2020 -- IMO 2020 implementation is going to happen with cycles and time, and the demand is continuing, and people are only -- refiners are only debottlenecking yet still. So this could get into more interesting activity on assets, change-outs and everything. So we're very positive about hydrocracking. The cycles very easily on 3 to 4 years, you've got a -- 3 years, you've got a cycle peak and everything. But because of the amount of change-outs and the speed at which refineries are running today, that cycle or peaks are getting closer and closer in time frame. So maybe 2022, we're going to see another peak. But between now and then, the growth is still going to be bigger.

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Operator [36]

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The next question will come from Laurence Alexander of Jefferies.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [37]

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Just wanted to follow-up on the virgin sulfuric acid market. To the extent -- if demand recovers more slowly, are there secondary sources of demand that would be incentivized? And how would that play out? Or are you really sort of hostage to the nylon market at this point?

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Belgacem Chariag, PQ Group Holdings Inc. - Chairman, President & CEO [38]

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Let me say a few words on the nylon market just to make sure that we're aligned. The nylon market -- the nylon 6 market, is impacted by basically the destocking happening with one of the 2 major providers. And the destocking as a result of some stronger supply from the Africa market and the Asia market, which we think is not going to be forever. It's going to be temporary. It does impact because there's only a couple of players. It does impact the demand. What we also see that, we see that, that demand on nylon market reduction is compensated by an increase in mining demand for virgin sulfuric acid because people are looking for fresh virgin, good quality sulfuric acid. So it's not balancing out, but it's compensating for some of that. That's on the nylon.

On the rest of the supply of sulfuric acid, primarily on the refinery side -- and alkylation is on demand right now, whether it is for the gasoline treatment or whether for -- whether it is for the Tier 3 gasoline standard implementation, which is going to require additional alkylation processes and additional sulfuric acid demand. So we're optimistic about the sulfuric acid diversity of the market, the demand growth. And I think we're offsetting the nylon drop with the variety of this diversity. The only challenge in that market is the outages, the unplanned outages. Refineries have run very hard right now, and we've started seeing some unplanned outages for our customers that there's really not much to do with. And the sulfuric acid supply is actually tightening simply because of the demand that is going on right now. So we remain optimistic, Laurence, on that. And we believe, should we start seeing a recovery on the inventory, which is probably going to be done by the tightness of the outages that are happening in Q1, the recovery towards the second half of the year will be great.

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Operator [39]

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The next question will come from Jeff Zekauskas of JPMorgan.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [40]

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It's Silke Kueck. Will there be any accelerated D&A from shutting down like the ThermoDrop plants? Like my memory is that there were some capacity expansions that like came on, maybe at the end of 2017. And how much might that be? Or is that what's behind the higher D&A guidance for 2020?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [41]

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Silke, it's Mike. Kueck, that's a good question. We did bring those assets on in that time frame. Since we are not shutting down these assets but are actually swapping them, there won't be an accelerated depreciation. We will have to work through the accounting for this exchange, and we'll be able to provide an update on the next quarter call. But to answer your question, there won't be an accelerated D&A as a result of that transaction.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [42]

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So swapping means you're actually giving the assets to the partner?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [43]

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Correct. We take 2 production facilities for glass beads in exchange for our product line.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [44]

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I understand. Okay. And so that will expand your -- I guess, you sell with tech business. You're just building upon that.

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [45]

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Correct. I mean as you think about glass beads, that's our core operating capability. We already have a rather large network. This improves our network, which we think is good for us and good for our customers.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [46]

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Okay. That's helpful. And secondly, for your capital expenditure guidance, like my memory, I see a maintenance CapEx is sort of like $100 million. What is the $30 million or $40 million for in gross CapEx? And what are you planning to spend that on?

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Michael C. Crews, PQ Group Holdings Inc. - Executive VP & CFO [47]

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Yes. Over the last couple of years, we've taken a very hard look at maintenance capital. So you're correct, it traditionally has been in that $100 million range or perhaps a little more. This year, it's more in the $90 million range. And as you think about the rest, it's really geared toward growth. So we have some debottlenecking opportunities as part of the transformation project in Performance Chemicals where we're trying to unlock some additional capacity, and we have some other expansion opportunities in Silica Catalyst. And then, as you know, we have probably $10 million a year that we spend on cost-reduction initiatives that keep our fixed costs below the rate of inflation. Those would be the primary items.

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Operator [48]

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And this concludes our question-and-answer session, and also concludes today's conference call. We want to thank you all for joining today. Have a great day, and you may now disconnect.