Ashland - Earnings Call - Q1 2016
January 26, 2016
Transcript
Speaker 0
Good day, ladies and gentlemen, and welcome to Ashland First Quarter Earnings Conference Call. At this time, participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference is being recorded. I will now turn the call over to your host, Seth Merozic, Director of Investor Relations.
Please go ahead.
Speaker 1
Thank you, Stephanie. Good morning, and welcome to Ashland's first quarter fiscal twenty sixteen conference call and webcast. We released preliminary results for the quarter ended December 3135, at approximately five p. M. Eastern Time yesterday, January 25, and this presentation should be viewed in conjunction with the earnings release.
Additionally, we posted slides and prepared remarks to our website under the Investor Relations section and have furnished each of these documents to the SEC in a Form eight ks. On the call today are Bill Wilson, Ashland's Chairman and Chief Executive Officer Kevin Willis, Senior Vice President and Chief Financial Officer Luis Fernandez Moreno, Senior Vice President of Ashland and President of the Chemicals Group, which includes Ashland Specialty Ingredients or ASI and Ashland Performance Materials or APM and Sam Mitchell, Senior Vice President of Ashland and President of Valvoline. As shown on Slide two, our remarks include forward looking statements as such term is defined under U. S. Securities law.
We believe any such statements are based on reasonable assumptions, but cannot assure that such expectations will be achieved. Please also note that we will be discussing adjusted results in this presentation. We believe this enhances understanding of our performance by more accurately reflecting our ongoing business. In addition, when discussing ASI, we also refer to core markets. Those are the highly differentiated markets of Personal Care, Pharma and Coatings, which we identified during our November 2015 Investor Day as core platforms for targeted growth.
I will now hand the presentation over to Bill.
Speaker 2
Thank you, Seth, and good morning, everyone. As we entered our fiscal year 2016 in October, we established four core investor related priorities for the year. I will now quickly walk through these priorities and our relative performance against these objectives in our first quarter. Our first investor related priority is to continue to drive the operational and strategic improvements needed to meet targeted earnings and margin gains. In our first fiscal quarter, we made significant progress in this area.
While overall sales were down, the ASI team realized gains in several of their core strategic growth markets including pharma, personal care and coatings. Additionally, the Composites team improved profit margins through effective cost management and with pricing discipline in a volatile raw material cost environment. Finally, the Valvoline team delivered record Q1 earnings, delivering strong performance across virtually all of their core performance metrics, including driving unit volume growth. At the same time, as anticipated, we continued to feel the negative impact of FX, divested product lines and reduced demand for oil and gas related products. Fortunately, we are beginning to lap these headwinds and expect to feel their impact less moving forward in our fiscal year.
That said, ASI began to see softer demand in the quarter for portions of their industrial products, especially in China and Brazil. To help mitigate the impact of these challenges, the Ashland team responded aggressively in areas we could control. More specifically, Ashland drove solid gross profit margin improvements by driving productivity gains and by maintaining pricing discipline. In addition, with a strong focus on cost control, Ashland's SG and A was down year over year on an absolute dollar basis. Net net, while overall revenues declined, the Ashland team drove a two forty basis point improvement in EBITDA margins versus prior year.
This combined with a reduction in our share count due to our expanded share repurchase activities resulted in adjusted EPS of $1.41 per share in line with our overall earnings expectations. Sam, Luis and Kevin will describe the dynamics leading to these results along with some of their strategic and operational gains in a couple of moments. Moving to our second investor related core priority, we are increasing our focus on effectively converting earnings to cash. In this area, we experienced normal seasonality during the quarter and we remain on track to generate approximately $325,000,000 of free cash flow during the fiscal year. Our third core investor related priority is to maintain our disciplined capital allocation strategy to drive shareholder value creation.
To that end, in the quarter, we entered into a $500,000,000 accelerated stock repurchase program. We also announced the acquisition of the Oil Can Henry quick lube business, which is expected to close in this current quarter. And finally, we continued our growth related capital investment to incremental capacity for a number of ASI's key differentiated product lines where demand exceeds supply. Moving to our fourth and final core priority, we are working hard to complete the previously announced separation into two great independent companies, Valvoline and the new Ashland Specialty Chemical Company. On this front, I'm pleased to report that we remain on track to complete the separation consistent with the previously stated separation to So in summary, net net in the quarter, we made targeted progress on all four core priorities.
And with that said, we recognize there's much work to be done to meet our full year targets, especially in the context of changing emerging region market dynamics. I'll now turn the call over to Kevin to provide you with a more complete update on the quarter and our forward outlook. Kevin? Thanks, Bill, and good morning.
Speaker 3
Yesterday, we reported GAAP earnings from continuing operations of $1.38 per share. When adjusted for key items, earnings per share was $1.41 a 3% decline from prior year. In the aggregate, Ashland's adjusted EBITDA margin increased by two forty basis points when compared to a year ago. Specialty Ingredients saw good growth in some of the core markets offset by lower emerging market growth as certain customers reduced their inventory levels due to uncertainty in near term global demand. Performance Materials delivered another solid quarter due in large part to the strength of composites margins amid a favorable raw material cost environment.
Valvoline continues to execute at a high level and turned in yet another record quarter of profitability. As you can see on this slide, combination of foreign currency and divestitures together reduced EBITDA by 14,000,000 when compared to a year ago. We continue to expect to lap the headwinds we've been facing as we head into the June. We're pleased with the results at APM, Valvoline and certain core growth markets of ASI. However, in line with recent macro dynamics, we are seeing lower than expected March demand in industrial specialties products in emerging regions.
In this context, as Bill indicated, ASI is accelerating productivity and sales pipeline initiatives. So while Q2 will be impacted based on the actions we're taking, we're not changing our perspective on our internal estimates for the second half of the year at this time. Now for a few corporate items. Our adjusted effective tax rate during the quarter was 25%. During fiscal twenty sixteen, we continue to expect our full year tax rate to be 24%.
Capital spending in the quarter totaled $53,000,000 We continue to expect capital spending this year to be in the range of $320,000,000 to $340,000,000 driven by our previously announced capacity expansions at Hopewell, Virginia and Nanjing, China to support growth in our value added cellulosic technologies. In addition, we are also continuing the investments to upgrade Valvoline's digital marketing and infrastructure. Free cash flow in the quarter totaled $13,000,000 which is consistent with normal seasonality and customary calendar year end payment practices. We continue to estimate free cash flow of approximately $325 to $350,000,000 during this fiscal year. As I stated on the conference call last quarter, our intention was to execute on the first $500,000,000 of our existing $1,000,000,000 share repurchase authorization early in fiscal twenty sixteen.
In November, we announced a $500,000,000 accelerated share repurchase agreement and took an initial delivery of 3,900,000.0 shares. That agreement is in place until May 2016 and we will provide an update when it has been completed. With that, I'll now hand the presentation over to Luis to provide more color on results for the Chemicals businesses for the quarter.
Speaker 4
Thanks, Kevin. ASI's results were mixed in the first quarter, which is typically our slowest seasonal period. We made continued gains in several of our core growth end markets, including pharmaceutical, hair care and coatings, where our differentiated products and strong relationships continue to deliver value for our customers. However, these gains were offset by a number of broader headwinds, which continues to weigh on sales and volumes. Overall, sales declined 15% to $476,000,000 largely due to the same factors that we have been talking about during recent quarters, weak energy markets, foreign currency and exited product lines.
However, overall results were lower than expected as weaker demand in some end markets and customer destocking contributed to the overall shortfall. As expected during the quarter, we also completed maintenance turnarounds at more than a half a dozen manufacturing facilities, which added $10,000,000 in incremental costs versus last year. This work largely completes the planned turnarounds at ASI's manufacturing facilities for fiscal twenty sixteen. The combination of those four factors, weak energy markets, foreign currency, exit product lines and planned turnarounds resulted in an estimated $25,000,000 headwind to EBITDA. That's equal to the decline in ASI's adjusted EBITDA during the quarter.
Within Consumer Specialties, overall sales declined 7% or a currency adjusts 2% when compared to the prior year. We are seeing good penetration of our value added product lines sold into the core growth pharmaceuticals market with sales growing 3% after adjusting for currency. We continue to gain share in our key technology platforms where we have capitalized on some of our more differentiated controlled release chemistries. Within our Personal Care end markets, sales fell by currency adjusted 7%. Our results were negatively affected by weaker than expected global demand and customer destocking, particularly within oral and skincare.
These results were offset by improved demand for Ashland's hair care products, where we saw robust volume growth driven by new product introductions. We have introduced a number of technological innovations over the past year to continue delivering value to our hair customers. Thanks to this pipeline of new products, we have been able to improve our competitive position and strengthen relationships with new and existing customers. On the Industrial and Specialty side, sales fell 23%, largely due to weak energy markets and exited product lines. Within the core growth coatings end market, we continue to see growth in our HCC and related products.
We are supporting that growth through the ongoing expansion of manufacturing facilities in Virginia and China. On a similar note, during the first quarter, we completed an expansion of our paint and coatings applications laboratory in Wilmington, Delaware to help our customers create new formulations and accelerate product development. The new facility provides paint formulators with expansive resources for testing new or modified formulations, understanding consumer preferences and optimizing their products for success. Sales into the energy market declined 75% versus the prior year as rig activity in North America remained weak during the quarter. Volumes in other industrial end markets including adhesives, performance specialties and construction reflected weaker than expected demand across many regions of the globe.
Looking to the 2016, we expect to see continued growth from the higher margin core growth end markets. We expect the headwinds from currency, energy and divested product lines to begin moderating assuming foreign exchange rates remain at the current levels. As we deal with a lower than expected demand environment, we are accelerating productivity and sales growth initiatives. We estimate second quarter sales to be in the range of $515,000,000 to $535,000,000 and EBITDA margins are expected to be in the range of 23.5% to 24.5. These results incorporate the impact of normal seasonality patterns.
Let's turn to the next slide and I'll walk through the first quarter results for Performance Materials. APM reported results that exceeded our expectations at the beginning of the quarter. Strong margin growth driven by good pricing discipline within composites and a continued focus on product innovation and applications development drove these results. Overall, EBITDA margin rose three sixty basis points to 16%. This performance was offset by weaker results within Intermediates and Solvents, where volumes and pricing negatively affected sales and earnings.
These factors combined with the effects of divestitures and foreign exchange led to a 12% year over year decline in EBITDA. Composites posted a strong year over year margin growth driven by good pricing over cost and its strategic focus on product innovations and application development. Over the past year, we have launched a number of new products to help our customers meet new regulatory challenges and demands of the customers. From a volume perspective, we saw better penetration in Europe from the value added products sold into the residential construction markets. That strength was offset by softness in other regions, notably China and Brazil, where industrial growth is low.
In addition, sales to North American energy markets also remained weak. Overall, composite sales declined 23% for the quarter. The majority of this decline is due to lower pricing, reflecting lower raw material costs and currency translation. Our teams continue doing a good job of managing margins in a fairly volatile raw material environment. Within Intermediates and Solvents, overall results reflected lower volumes and pricing for BDO consistent with previous expectations.
When compared to the prior year period, total I and S sales declined 20%. Looking to the second quarter, we expect APM sales to increase sequentially consistent with normal seasonality. The underlying performance of composites should remain strong. However, we believe that industrial weakness, particularly in China and Brazil will persist in Q2. Strained video volumes and pricing are also expected continue to see lower demand and more aggressive pricing in the marketplace.
A planned shutdown of an AMS plant will also contribute to sequential headwinds in the quarter. In total, we expect sales of between $35,000,000 to $255,000,000 in EBITDA and a margin of 10% to 11% for the second quarter. Longer term, we expect to see continued improvement in the profitability of composites, while I and S market dynamics should continue throughout the year as we operate close to the bottom of the cycle. To ensure we maintain our strong position and continue to participate in growth, we continue to develop new and existing product applications to drive both sales and earnings expansion. I now hand it over to Sam for a summary of Valvoline's first quarter.
Speaker 5
Thanks, Luis. Valvoline posted record first quarter earnings as our teams continue to execute at a high level. The Valvoline incident oil change team had another exceptional quarter with each of the key metrics improving from prior year. Oil changes per day were up nearly 5%, average ticket increased 1% and same store sales for company owned sites rose almost 6%. Premium oil changes accounted for more than 58% of all oil changes, up from roughly 56% a year ago.
Our franchise system also delivered similarly strong results, evidence of consistent execution of our customer service model and marketing programs. During the year, we continue to expand our overall store network adding 26 new sites. At the end of 2015 calendar year, we had nine fifty six stores system wide. In December, we announced a definitive agreement to acquire Oil Can Henry's, which operates and franchises 89 Quick Lubes stores in six states. In a moment, I will share some additional details regarding this exciting acquisition.
Within the DIY channel, volume was largely flat, although mix improved due to successful branded promotions with a number of key customers. Within the international channel, volume grew 8% driven by good execution of channel building efforts. Our international team continues to do a good job of developing key channels and marketing strategies, which is fueling higher growth across the regions. Premium product sales remained strong across Valvoline and accounted for 43% of total branded lubricant sales. This strong operational performance coupled with good margin management led to EBITDA growth of 10% from prior year.
This performance marks our ninth consecutive quarter of year over year EBITDA growth. EBITDA margin rose three forty basis points to 22.1%. Looking to the second quarter, we expect continued solid performance across all channels. Typical seasonal pattern should result in a sequential increase in sales. We expect sales to be in the range of $480,000,000 to $490,000,000 and EBITDA margin to remain healthy at around 23%.
Let's turn to the next slide and I will share some more details about Foil Can Henry's. As I stated before, in December, we announced the signing of a definitive agreement to acquire the Oil Can Henry's network of Quick Lubes centers. Oil Can Henry's is the fourteenth largest Quick Loop network in The U. With 47 company owned stores and 42 franchised owned locations. The Quick Loop centers are located primarily in The U.
S. Pacific Northwest. This is a great fit for us as it will expand Valvoline's geographic footprint into an attractive growth market. As With this acquisition, we are accelerating our store growth in fiscal twenty sixteen. Once closed, the addition of Oil Can Henry's company owned and franchised network will increase our store total store count by approximately 10%.
Furthermore, the acquisition highlights the strength of our Quick Lubes model. First, we will be able to leverage the unique benefit gained from our vertical integration by introducing industry leading Valvoline branded lubricants into the Pacific Northwest Quick Lubes market. Second, we can further develop our ability to own and operate stores and support franchisees in a new market for Valvoline. The acquisition is expected to be completed in our fiscal second quarter. We look forward to working with the team at Oil Can Henry's to grow the business and build on their success.
I'll now hand the presentation to Bill for his closing remarks. Thank you, Sam, and congratulations
Speaker 2
to you and your team on delivering a record first fiscal quarter and also on the announced acquisition of Oil Can Henry's. I think this is a really attractive and strategic opportunity for Valvoline and will accelerate the expansion of Valvoline store network. Looking forward, we will stay focused on our four core investor related priorities. Our first priority remains to drive the operational and strategic gains in our businesses so as to enhance their competitiveness and achieve targeted earnings growth. From an earnings perspective, we have some good news as we expect to lap the ASI FX divestiture related and oil and gas headwinds in the June.
That said, as Luis explained, we are currently seeing softer demand in some portions of the ASI business largely in emerging regions and the industrial specialties end markets. This dynamic emerged towards the end of the first quarter and will continue to put pressure on ASI earnings in the March. While we can't control the global economy, we are taking actions in the areas we can control. More specifically, the Chemicals team is taking actions to control cost and accelerate its sales pipeline. The Valvoline team continues to hit on all cylinders and the planned acquisition of Oilcan Henry's should increase Valvoline's strong momentum.
As for our second core priority, as previously stated, we expect to generate approximately $325,000,000 of free cash flow this fiscal year. We made great strides last year to reduce the cash required to support legacy liabilities with the establishment of the asbestos trust, which together with insurance receivables, we hope will eliminate the need to tap future operating cash flow for years to come. And in addition, with last year's $500,000,000 voluntary payment to The U. S. Qualified pension plans, we do not expect to make required contribution to the plans in fiscal year twenty sixteen.
This action is expected to improve year over year cash flow by approximately $70,000,000 While we continue to make those strategic investments required, including an approximately $75,000,000 year over year capital investment gain required to support demand growth for ASI's core growth pharma, personal care and coatings markets and Valvoline's digital capabilities. At the same time, we are increasing our focus on working capital management to help offset to ensure high levels of cash conversion during the next roughly twenty four months until we begin to ramp down total capital spending. As for our third priority, which is focused on effective capital allocation, we expect to close the Allcan Henry's acquisition in the quarter and we'll move forward and move towards closing out the $500,000,000 accelerated stock repurchase announced this first fiscal quarter. Finally, as for our fourth core investor priority separating Ashland into two great companies, we remain on track with our previously stated timeline. To that end, we expect to make further announcements regarding the separation in the coming months.
So in conclusion, we feel great about putting the FX, oil and gas and divestiture related headwinds behind us by the June. Also for expanding our positions in our core chemicals growth, end markets of personal care, pharma and coatings, sustaining operational and profit growth momentum in Valvoline while welcoming the Oilcan Henry network to the company and continuing to make the needed progress to successfully separate Ashland into into two great companies. At the same time, recent market weakness in some end markets and in emerging regions has made us cautious with our outlook for near term ASI performance. In the end, we have a great team, which is aligned around a clear strategy with a proven track record of execution and we are driven to take the actions required to drive the operating, financial and shareholder value creation. With that, I will turn the call over to the operator to take your questions.
Speaker 1
As a reminder
Speaker 6
go ahead, Stephanie.
Speaker 0
Thank you. Our first question comes from Brian Maguire with Goldman Sachs. Your line is open.
Speaker 7
Hey, good morning, everybody.
Speaker 2
Good morning, Brian. Good morning, Brian.
Speaker 8
Think if I heard you right,
Speaker 7
you said that despite some of the market weakness, you're reiterating your full year targets as you expect some of the productivity and sales growth initiatives at ASI to offset some of that weakness. Can you kind of confirm that? And then also maybe give some examples or do you have any kind of financial targets for those productivity and sales initiatives?
Speaker 3
Brian, what we expect is that Q2 will be impacted as we've indicated due to the destocking and the emerging market dynamics that we're seeing. However, based on our current internal view of Q3 and Q4, we're not changing our point of view on the second half of the year. But we do believe Q2 will be impacted as we've indicated. So that would impact the full year number, but just on the Q2 basis. Does that clarify?
Speaker 7
Got it. So you think you can basically course correct by the time you get to 3Q, but 2Q is too near on the horizon to be able to do much about it?
Speaker 3
Yes, we're working on that and Luis can talk a little bit about that as well. But yes, I think that's fair.
Speaker 4
So I mean, that's a very good point. There's a couple of things that we're doing. First and foremost, I mean, we do expect to lap the headwinds from both energy and FX, assuming the current state at the current level by Q3 and Q4. So we will see earnings growth for Q3 and Q4. And as I mentioned, we are accelerating a variety of productivity initiatives that will allow us to compensate for what we're seeing as lower demand in Q3 and Q4.
And that's what we are expecting to do. It's that's pretty much the forecast that we have.
Speaker 7
Okay, great. And just on the Oil Can Henry acquisition, I know you mentioned it's about a 10% increase in your stores. And I think the stores channel is about 20 of your sales. So should we expect about a 2% annualized benefit to revenues and what kind of margins above or below segment average would kind of expect on that?
Speaker 5
Yes, the margin impact Valvoline and Snow Change carries a stronger margin contribution than the balance of the portfolio. And the Oil Can Henry system is very profitable. And with the synergies that Valvoline brings to the system, it will certainly be accretive in the long term. It won't have a significant impact on fiscal twenty sixteen.
We do expect to close as I mentioned There'll be some transitional costs and then the benefits really ramp up for us in fiscal twenty seventeen and beyond.
Speaker 7
Great. Thanks very much.
Speaker 0
Our next question comes from Laurence Alexander with Jefferies. Your line is open.
Speaker 9
Hi, this is Jeff Schnell on for Laurence. As you look at the operating levers within ASI heading into the
Speaker 10
back half of the year, what kind
Speaker 9
of conditions would you need to see to lift margins in the back half, say more than 200 basis points over the first half? Or can it occur on productivity alone?
Speaker 4
Yes, actually that's a very good question. In terms of our margins, our gross margins continue to be very strong. If you consider actually the fact that we have $10,000,000 planned expenses compared to last year and that our gross margins were pretty flat with last year, we continue to make progress when it comes to our overall gross margin as we grow on the higher margin portions of the portfolio. So that's one of the levers that we continue to use, continue to grow in the high margin parts of the portfolio, which is one of the levers we have as we introduce new products. But obviously, when it comes to productivity improvements, there are things that we can continue to do when it comes to managing our plant operations effectively in the case of a slower demand as well as certain initiatives on our productivity and SG and A, mostly on the back office functions, not on the front office.
And we're accelerating those to compensate the lower demand and to reduce our fixed cost, let's put it that way. So those are the levers that we're moving.
Speaker 2
And I would just add, this is Bill, a couple of things. As Luis highlighted, the gross profit percent has been strong. So that's important right there. But secondly, the first half of the year, as was discussed earlier, this is the period which not only is slower, but also the period in which there were the plant turnarounds, the scheduled turnaround. So those weigh a little bit heavily on the first half of the year.
And without having those in the second half that will also help to the margin improvement on the EBITDA level.
Speaker 8
Great. Thank you.
Speaker 0
Our next question comes from David Begleiter with Deutsche Bank. Your line is open.
Speaker 11
Thank you. Good morning. And Louis, on ASI, when do you expect volumes to turn positive? Would that be in Q3?
Speaker 4
Yes, David. That's again a good question. As we lap the energy fundamentally, that's the other thing that is impacting volume the most is the energy situation. We definitely expect volumes overall to go up. Having said that, I mean, me highlight that on Pharma, we continue to see volume growth.
In Coatings, we continue to see volume growth and different than in the past. We actually have the capacity to support that volume growth because of the investments that we've done. And in certain elements of our Personal Care business, we continue to see volume growth. So when you do that, you compare the fact that we are growing those four segments and eliminate the negative impact of energy because we will have those effects definitely we'll start seeing volume growth in the June.
Speaker 11
Very good. And Bill and Kevin on the buyback after the what's your thinking on the remainder of the
Speaker 8
$1,000,000,000 buyback program in terms of being completed?
Speaker 3
Yes. We'll evaluate that after the current ASR has been closed out, which is really at the option of the bank, but no later than May 2016. So we'll continue to evaluate our options as that winds down.
Speaker 11
Do you think it will be done before the spin is affected?
Speaker 3
Couldn't really say at this point. I mean, we'll just have to see how things play out over the course of time.
Speaker 11
Thank you.
Speaker 0
Our next question comes from John Roberts with UBS. Your line is open.
Speaker 3
Good morning, guys.
Speaker 12
Good morning, John. Good morning, John.
Speaker 3
Sam, are there any metrics on Oil Can Henry that you could compare for us with the IOC? Are your average tickets materially higher or are your average raw material costs materially lower? I'm just trying to get either a sense of how good you are at the IOC or how much you might be able to improve them?
Speaker 5
Yes, we think there's well, first of all, they're very well run system and that was one of the things that attracted Bavelength to it. So it's certainly not a turnaround situation. But there are a lot of capabilities that we have in our model that they don't have as a smaller regional system. And so the team there is very excited. We've begun the transition process, the planning process and getting ready for the close.
And some of these tools we definitely expect are going to benefit them from a marketing perspective that can help drive car counts. Again, they do have healthy car counts today, but we think there's opportunity for upside. They definitely have a healthy ticket to quite comparable to Valvoline and Snow Change. But the key for us in transaction is in addition to the capabilities that we bring to operating their stores is the fact that they'll be selling valving products. And that gives us tremendous leverage and opportunity for profit impact when we look at the impact that this acquisition is going to have on valving our total valving business.
But also it's a great market. We like the Northwest for when you look at that map and you see where valvines developed today, we've really not had a presence in the Northwest. So this is really helping us become fully national chain in a very attractive market. So really just couldn't be more excited about this acquisition and the early work that the teams are doing points to a very successful transition too.
Speaker 3
Okay. And then Luis, why is the new product activity so much stronger in hair care than oral and skin care? Is it just normal lumpiness as customers work on different areas? Or is there some divergence going on between those two markets?
Speaker 4
No. It's more the lumpiness of how we work on the different projects and the fact that we just launched a significant amount of new products in hair care. So that's what we're seeing the benefit of those. We also have new products that are launching for skin care that we expect to start picking up in the near term. And the same thing in oral care, there is nothing specific that is natural to the markets rather than on how we introduce the new products as we have the different projects and the different collaborations.
As you said, it's somewhat lumpy.
Speaker 8
Thank you.
Speaker 0
Our next question comes from Mike Sison with KeyBanc. Your line is open.
Speaker 10
Hey, guys. Just curious, last quarter you gave us your thoughts on your outlook for 2016 It certainly seems that 2Q will be weaker. Are you still you signaling that the second half you're still comfortable where I guess the Street is set up for the second half of the year?
Speaker 2
This is Bill. Based upon the discussions we had last quarter, we are seeing as we've discussed a weaker profile in Q2, but we are not changing our outlook for the second half of the fiscal year.
Speaker 10
Okay, great. And then Sam, organic growth and organic volume growth in Valvoline continues to be impressive given the environment here. How does that look as you head into the second, third and fourth quarters? And can you sustain that level of growth?
Speaker 5
Yes, we're confident we're going to see continued volume growth through the balance of the year. Certainly, the first quarter was impressive at 4% and with the strong international growth. But when we take a look at the international business and across the different regions, we really had solid volume growth in every one of the regions in which we operate. So there's some good momentum there. And then even in The U.
S. Market, the number of initiatives that we have with some of our key customers we feel are going to help us drive volume growth in second half of the year too. So team is definitely really performing at a high level and confident that we're going to be able to continue the pace that we're on.
Speaker 10
Great. Thank you.
Speaker 0
Our next question comes from Dmitry Silverstein with Longbow Research. Your line is open.
Speaker 12
Good morning. Just wanted to follow-up on a couple of things. Number one, did I hear you right that adhesive sales were also down in the quarter on year over year basis as part of the industrial weakness and inventory correction?
Speaker 4
No. What I did say was below our expectations. So obviously, as we enter the quarter, we have certain expectations for growth. When it comes to Adhesives, we expected to see growth. And the fact of the matter, they were flattish versus last year, but below definitely of our expectations.
Speaker 12
And the reason that they were sort of below expectations, is that mainly sort of North American construction or is it still China and Brazil that are driving the results in adhesives?
Speaker 4
No. For adhesives, I mean, our exposure is most to North America. We have very little exposure outside of North America. And it's we again believe it's mostly around the stocking on certain segments of the market. Some of it is construction, some of it is packaging.
But again, is that we expect it to grow rather than a reduction.
Speaker 12
Okay. And the anniversary of all the divestitures as far as elastomers and biocides, that's all going to come to an end in the March. So June and September quarters are going to be pretty clean on year over year look back comps.
Speaker 4
Yes. Elastomers actually is done in Q1. So for Q2, we will not see any elastomer issues. The closure of Re Disposable Powders will come out of the results in Q1 and Biosize will be until Q4.
Speaker 12
Biosize will be okay. So but that's a relatively small business if I remember.
Speaker 4
That is correct. And that's why for all purposes by the June we expect to lap both divestitures and Energy Markets.
Speaker 12
Got it. Secondly in Valvoline, besides the top line growth that earlier callers commented you on and my congratulations on that as well. Your margins seem to have benefited significantly even though you're passing through lower pricing. Part of that is continuing declines in base oil, but is part of that also that you're seeing some declines in the additive portions or your other cost buckets within the Valvoline? Can you talk a little bit about sort of the cost environment outside of base oil in Valvoline?
Speaker 5
Yes, and additive costs have also been moving down impacted by the energy markets too. And so we've worked with our key suppliers there to also benefit from lower additive costs moving forward.
Speaker 12
Got it. And then just finally, again, a point of clarification. When you talk about sort of lapping the foreign exchange headwind, I can see that happening clearly in the euro part of the exchange. But if you look at some of these other currencies, whether it's Chinese or Canadian or Australian, where I think you have a pretty good Valvoline business. All of those currencies really softened in the 2015 calendar.
So should that continue to impact you for much of 2016 calendar or fiscal, I'm sorry?
Speaker 5
Yes, for the Valving business there's additional impact mainly because of the Australian dollar, we have a good sized business there and certainly Canada too. Those would be our two major impacts. So that will continue for the next couple of quarters.
Speaker 2
And this is Bill, just adding that there will of course always be currency fluctuations and there has been change or there were changes last year and the rate of exchange with the euro. But really what we're talking about is moving it to the point or getting to the point where it's not as meaningful of an impact on our overall results where we're not needing to speak to that as part of what's driving our our business. And so that's really in the aggregate what we're talking about. There will still be impacts, some plus some minuses as we go forward. But we can focus more on the fundamentals of the business.
Speaker 3
By far the biggest impact on an overall basis is the euro and the biggest impact specifically around that is within ASI, primarily because the high value polymers are mostly manufactured in The U. S. And then exported around the world. So strong dollar has a negative impact on that. And again, the euro is by far the largest part of that impact.
Speaker 12
Okay. I appreciate that granularity. Thank you very much. Sure.
Speaker 0
Our next question comes from Jim Sheehan with SunTrust Robinson Humphrey. Your line is open.
Speaker 9
Good morning. First on the energy end market, could you update us on what percent of ASI consists of energy in 2015? And also talk about the impact that the energy market has had on your nutrition business. Is there still a crossover impact going on there?
Speaker 4
Yes. So at this time, I mean, you remember before the energy market crisis started, energy represented 8% of our sales. For total fiscal twenty fifteen, it's about 3%. And you can imagine that for fiscal twenty sixteen, it's going to be slightly lower than that, just from what we saw in Q1. So it's got a significant impact.
And yes, I don't think that we are seeing much more of what we've seen in the past when it comes to the nutrition markets. I think it had a significant impact when it comes to the volumes available for nutrition, when it comes to certain cellulosics and war. And I think that volume has been transferred to those segments. So there's no further impact in terms of more volumes going to that market. I think that we're going to what we've seen is what we will continue to see in the future.
Speaker 9
Great. Bill, can you offer your thoughts currently on where you see leverage in the new Ashland versus Valvoline after the separation?
Speaker 2
Sure. And I think it's very consistent with what we have said before that we are looking to essentially keep the same basic financial ratings that we have today with our current Ashland with the two respective independent companies.
Speaker 9
Thank you.
Speaker 0
Our next question comes from Mike Harrison with Seaport Global Securities. Your line is open.
Speaker 6
Hi, good morning.
Speaker 2
Good morning. Morning.
Speaker 6
Louise, can you give us a little bit more color on what's going on in the skincare market? How much were volumes How does that compare with the trend that you had been seeing? And I know there have been some competitive dynamics going on there, but how much is the is it competitive dynamics and how much is inventory destocking?
Speaker 4
Yes, a couple of comments there. I mean, there's definitely a difference in the regions. We saw in Latin America, specifically in Brazil, a significant reduction, a significant destocking as people face challenges with their currency. Now we don't necessarily get impacted by the currency impact because our prices are in dollars, but what we saw is that the customers in Brazil immediately protected their balance sheet by reducing inventories and there's certain level of reduced demand. So I would say that would be the place where we saw more of an impact and we had a significant presence in that market.
We saw some destocking in North America in certain categories. Some of them are related to pending technology changes. So it's really destocking rather than other things. I cannot necessarily comment on the details of that. And we did see slightly lower demand when it comes to the sunscreen materials.
And that has an impact on competitive reasons. So those will be the areas in terms of having a little bit more be more specific of what the situation is in skincare. On the Oral Care, I mean, really, what we saw was a significant destocking from our major customers. We would confirm that. And again, in the regions that I mentioned before, but it's mostly a destocking.
Impact to me, the question is how much of that destocking is just destocking and how much is they are seeing a slightly lower demand in their own markets. That's where we're a little bit more cautious in forecasts.
Speaker 6
And then on the Coatings side, Luis, can you talk about where you are relative to your capacity constraints? I know you mentioned the HEC volumes were up 3%. Are you pretty much sold out at this point? And where are we in terms of the timing of new capacity coming on stream?
Speaker 4
So at this time, we have now started all of the Nanjing expansion. And we're working on an expansion hopeful that will come on stream next year. With the expansion of Nanjing and assuming that the growth continues to be in the market between 3% to 4% and we'll be growing slightly ahead of that. We are good for 2016 and 2017. So at this time, normal growth, we are capable of supplying the market, which is very If the market were to grow slightly faster, we would need to get back to buying material as we've done in the past.
And obviously, if the market were to grow slightly slower, we would have a small amount of capacity left over, but again, it will come back in 2017. Bottom line at this time, what we see is we have a very balanced perspective on our HCC capacity. And it's not going only into coatings, it's going into coatings, it's also going into personal care. And both of those markets are growing and we feel that we have now cut off when it comes to the current demand. And as we continue to do investments, we will be catching up to the growth of those markets.
Speaker 2
And just to add, I would happen to be at the Nanjing facility last week. And while they've ramped up the new capacity addition, they're working on productivity enhancements to get more out of the existing capacity or the new capacity that's been put in, which also give us a little bit more headspace or headroom for growth.
Speaker 6
All right. Thanks. And then, Bill, there's been a little bit of discussion around the strategy involving the Valvoline spin, whether it might make more sense to sell the Specialty Ingredients business. Is that an option that was under consideration by the Board? And if an offer did emerge for Specialty Ingredients, how would you guys approach it?
Speaker 2
Well, to begin with, look at all options in terms of what's the best way to create value for the shareholders. And clearly, we believe that the separation is the primary mechanism right now to create that value and it's incumbent upon us to drive the value of the two new independent entities. So we're more in the position to acquire than to be acquired. But I think if you look historically and you look at our tax basis and so forth, I think acquisitions would have been challenging in the past from a tax effectiveness. So our objective is to separate into two great companies that grow, but it would have been more challenging in the past, we'll say that.
Speaker 6
Thanks very much.
Speaker 0
Our next question comes from Roger Spitz with Bank of America Merrill Lynch. Your line is open.
Speaker 10
Thanks very much. Perhaps I'm trying to pin you down a little further on any clarity on the leverage of new Ashland? I think you've said in prior documents it might be over three times, but should we think about that in terms of a little bit over three times or leverage flat currently? And what debt at Ashland might you consider repaying upon separation?
Speaker 4
Yes.
Speaker 3
As we look at creating the balance sheets for these two companies, it's our objective to maintain a rate of leverage that will achieve a mid to high BB credit rating from the agencies. That's our stated objective. And as we continue to develop our plans for separation, that hasn't changed. And in terms of what that leverage will look like for each company, I'd say more to come on that as we get more specific internally around that as well. But again, the is to create two balance sheets, two capital structures that will warrant a mid to high BB credit rating.
Speaker 10
Thank you very much.
Speaker 0
Our next question comes from Jeff Zekauskas with JPMorgan. Your line is open.
Speaker 8
Hi, good morning. Thanks very much.
Speaker 5
Good Good morning.
Speaker 8
Hi. Were valvoline prices up sequentially? And if they were, how did you do that? Is it all mix?
Speaker 5
Our prices up
Speaker 8
sequentially, not year over year?
Speaker 3
No.
Speaker 5
The improvements in our profitability driven primarily by mix with some benefit of the reduced base oil costs. But as we've explained before with our pricing model, some of our volume is purely market based where we adjust based on market conditions. Some of the model some of our volume is based on index pricing. We do private label business that also adjust fairly quickly. And so in those parts of the business, we've made price adjustments to customers according to the model.
Speaker 8
What I mean is, did the mix benefits lead to a higher average price sequentially?
Speaker 5
Okay. I see what you're asking. The mix benefits did not offset the price adjustments in the first quarter.
Speaker 8
Okay. So when you take a step back and you look at Valvoline, in 2014, I think your gross margin was, I don't know, something below 32%. And in 2015, maybe it was something below 36%. And now where you are is 38%. And obviously, raw materials have come down and your prices have come down, but not as much.
So when you think about what's a normal average gross margin for Valvoline, is it 40 or 30 or 35 or you can't tell?
Speaker 2
Sam's reflecting upon your question there. I mean, think one of the concepts that we need to begin to talk more about is really the contribution or profit per unit, because if the price of oil goes down substantially or the price of oil goes up substantially, the question is our profitability per quart per gallon per barrel, however you want to look at it, how has that fundamentally changed along the way. So the percentage could change just based upon the underlying price of oil either plus or down. So that's something I think we'll reflect upon and probably talk a little bit more about in the future just to make it easier to see what's really going on in terms of the dynamics of profitability versus the cost of the underlying materials.
Speaker 5
And certainly you've seen Jeff some pretty big adjustments obviously in base oil costs and that means our selling prices have adjust fairly significantly to when you're talking about going back a couple of years where crude was versus where it is today. So it definitely has a big impact on our gross profit margin percentage and certainly EBITDA. So those are higher to say that they're normalized or what is normal level really is dependent on where crude is. The key thing when you look at our profitability is that Valvoline
Speaker 2
has
Speaker 5
a very strong brand and as we bring value to our customers, we benefit and protect our margins really in both a rising cost environment and a falling cost environment and we're confident of that.
Speaker 8
So from the level that we're at now is the direction of gross margins for the remainder of the year up or down, if you can tell?
Speaker 5
Yes. Well, as I mentioned in my earlier comments is that for Q2, we're projecting an EBITDA margin of 23%.
Speaker 8
Right. So I guess that means the direction is up.
Speaker 5
Yes, relatively stable to what we just reported. So we're still going to be in that range. So as our base oil costs continue to be in this relatively low range, we would expect our EBITDA margins to continue to be solid and we continue to look for opportunities to drive our mix and certainly we're making good progress there.
Speaker 8
Okay, great. Thank you so much.
Speaker 0
And I'm showing no further questions. I will now turn the call back over to Seth Merozic for closing remarks.
Speaker 1
Very good. Thank you all for your time and participation this morning. Look forward to further discussions. Thank you.
Speaker 0
Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect and everyone have a great day.