Ashland - Earnings Call - Q3 2016
July 27, 2016
Transcript
Speaker 0
Good day, ladies and gentlemen, and welcome to the Ashland Third Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and As a reminder, call is being recorded. I would now like to introduce your host for today's conference Mr. Seth Mirozek, Director of Investor Relations.
Sir, you may begin.
Speaker 1
Thank you, Ronnie. Good morning, everyone, and welcome to Ashland's third quarter fiscal twenty sixteen conference call and webcast. We released preliminary results for the quarter ended June 3036 at approximately five p. M. Eastern Daylight Time yesterday July 26 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 Wolfson, Ashland's Chairman and Chief Executive Officer Kevin Willis, Senior Vice President and Chief Financial Officer and Luis Fernandez Moreno, Senior Vice President of Ashland and President of the Chemicals Group, which includes Ashland Specialty Ingredients and Ashland Performance Materials. As previously communicated, Sam Mitchell, Senior Vice President of Ashland and President of Valvoline is currently engaged in separation related activities and will not be joining us on the call today. 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 our it enhances understanding of our performance by more accurately reflecting our ongoing business. When discussing the Chemicals Group, we also refer to the following: core markets.
These 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 niche markets where we deliver unique value propositions based on our technology platforms and foundational businesses that provide cash and critical mass. In addition, in April, we announced an update to our separation plans, including our plan to IPO up to 20% of Valvoline in the 2016 subject to sufficiently attractive market conditions. We understand you may have additional questions about our plans. However, we continue to be in registration under U. S.
Securities law and there are strict limitations on the information we can share. I will now hand the presentation over to Bill, Luis and Kevin. Bill?
Speaker 2
Thank you, Seth, and good morning, everyone. While we have our challenges by and large, this is a very exciting time at Ashland. As you're aware, at the beginning of the fiscal year, I established four core priorities for Ashland. As I will describe, we have made great progress against these priorities, but still have more work to do to meet our targeted performance objectives. The first core priority has been to drive the operational and strategic gains needed to meet our financial expectations.
The good news is that overall, we grew our year over year earnings per share in the quarter. In this area, both Ashland Performance Materials and Valvoline reported sales and earnings results that were consistent with our expectations for our third fiscal quarter. Results in ASI were more mixed. On one hand, we drove positive sales or volume growth in five end markets. We also continued to aggressively and effectively manage the businesses sales mix and overhead costs.
Yet in the aggregate, the business results came in below prior year and our outlook. Later in the call, we will speak in greater detail about the shortfall and what we are doing about it. Our second core priority has been to effectively convert earnings to cash. During the quarter, Ashland generated $107,000,000 of free cash flow. For the first nine months of fiscal year twenty sixteen, we generated free cash flow of $254,000,000 $60,000,000 more than the first nine months of last fiscal year.
Our third priority has been the effective allocation of capital. To that end, in July, we raised $375,000,000 of 5.5% notes. This action was in support of our fourth priority, which is to complete the planned separation into two great independent companies. As in the past, the Ashland team is proving its strength related to effectively completing large complex transactions as key separation related milestones continue to be met on time and on budget. So in summary, we've made great progress across each of our four core priorities, albeit we clearly have some further progress to return ASI to year over year earnings growth.
With that, let's transition the discussion to describe the quarter in greater detail and I'll turn the call over to Kevin.
Speaker 3
Thank you, Bill and good morning everyone. In the quarter, we reported GAAP earnings from continuing operations of 1.55 per share. When adjusted for key items, earnings per share rose 2% to $1.95 In addition, adjusted EBITDA rose 1% to $294,000,000 This represents the first year over year growth in both adjusted EBITDA and earnings per share in fiscal twenty sixteen. As expected, the impact we have faced from a for a number of quarters from foreign exchange, weak energy markets and divested product lines receded significantly. The year over year impact to sales from these was approximately $40,000,000 roughly two thirds of what it was in the second quarter.
We continue to expect to largely lap the earnings impact from these in Q4. Turning now to a few corporate items. During the quarter, our effective tax rate adjusted for key items was nearly 28%. For the fiscal fourth quarter, we expect the adjusted effective tax rate to be approximately 28%, bringing us to the high end of our expected range of 25% to 26%. Capital spending in the quarter totaled $78,000,000 We continue to monitor demand in our key end markets and compare those trends to our manufacturing footprint.
To that end, we are actively managing our capital spending this year to the low end of the range of $320,000,000 to $340,000,000 Free cash flow in the quarter totaled $107,000,000 We now expect free cash flow for the full year to be in the range of $260,000,000 to $280,000,000 This new range incorporates lower overall expected earnings in fiscal twenty sixteen, the timing of separation related payments, plus the timing of an environmental related payment, partially offset by improved working capital management. With that, I'll hand the call back over to Bill.
Speaker 2
Thank you, Kevin. Before I turn the call over to Luis, I would like to make a few high level remarks on the ASI portion of the business. As we all know, this is a great business founded on highly differentiated technology platforms. Leveraging our strong commercial and technical teams, we drive innovative value creating solutions for our customers. Over the last several years, the ASI team has driven significant gains.
One, with a strong focus on commercializing innovative new products, value selling and managing our costs, the ASI team has improved EBITDA margins from approximately 21% to nearly 23% during the period. Two, the team has made great gains in terms of improving our supply chain performance. Once again in the quarter, the ASI team was able to deliver on time at a rate over 95% versus less than 85% just a couple years back. The team has also improved the mix of projects in our new technology pipeline. They've enhanced our Innova stage gate process and built new global application labs to support commercialization in our customers.
We have also dramatically enhanced our focus on building the systems and infrastructure to deliver pharma quality products from our entire network of production facilities. Still, we must and will take further actions to drive the business as sales in our Personal Care market and most specifically emerging regions were less than anticipated at the start of the quarter. I will now turn the call over to Luis to share more details on ASI and APM's performance in the quarter. Thanks, Bill, good morning.
Speaker 4
I would like to spend a few extra minutes on ASI this morning. As Bill said, we all recognize that this is a great business and we have a clear strategy to win. In the quarter, we made great progress implementing this plan. From a revenue perspective, this strategy led to gains in five of our key end markets. As expected, the combined impact from divestitures and reduced fracking related oil and gas demand reduced sales by approximately $18,000,000 or three percentage points over the 5% year over year decline in ASI sales.
But more importantly, the impact from the Energy business is now largely behind us as we expect to lap the year over year impact in the fourth quarter. Still, even with these dynamics, overall results for sales and EBITDA were below the targets we outlined at the beginning of the quarter. Quite simply, the overall demand for our products, most notably in Latin America and China was lower than what we expected. The lower demand had a related impact on manufacturing costs as we worked to better manage inventory. During the quarter within ASI, we maintained our disciplined focus on enhancing gross profit as a percentage of sales.
This is evident through our prioritized investment approach to ASI's three portfolio categories: core, niche and foundational. It also reflects disciplined price management and value selling. It also demonstrates our ability to drive manufacturing efficiencies through a focus on lean processes and quality. The ASI team also did a good job of managing overhead costs. In summary, for ASI, I would like to specifically address what happened with demand in the quarter.
The fact is that currently we have unusually low visibility in demand, especially in emerging regions due to the current economic environment. Visibility has been impacted by consumer demand and the related order pattern by our customers. As I mentioned, this has been especially impactful in Latin America and China. While there are always share shifts, we do not attribute the results in the quarter to any fundamental share shift. That said, we did choose to walk away from so low margin sunscreen business in order to deploy our talented team toward our higher value market segments, offering differentiated products and technologies.
As we enter the fourth quarter, overall our overall position in core markets remains strong and we intend to build on the gains we achieved in the third quarter. In Pharma, we expect to see continued good penetration of our controlled release technologies at our excipients customers and are opening a new manufacturing facility in China. In coatings, we expect to continue to see the benefit from new product introductions. As well in food and nutrition, we will continue to see the benefit of share gains. Furthermore, we have substantially lapped the headwinds that negatively affected our results over the past four quarters.
In Personal Care, we expect the demand trends will begin to normalize, especially in Oral Care where we see improved order patterns. That said, we're taking a cautious approach given the current state of demand in emerging markets. We will continue to aggressively manage our overhead costs. And in his closing remarks, Bill will talk about broader initiatives taking place across the broader Aslan organization. We have also strengthened our leadership team by bringing two new leaders with a track record of growth and performance to manage our industrial specialties business and Personal Care end market within Consumer Specialties.
We also named an internal leader to manage pharma. The leadership changes will also provide an enhanced focus in these two core markets within Consumer Specialties. Sales in the fourth quarter are expected to be in the range of $520,000,000 to $540,000,000 Growth of our higher value categories of products selling to higher margin core growth end markets should lead to another strong margin performance with expected EBITDA margins of 24% to 24.5. Turning now to APM, I am pleased to report that third quarter results were consistent with the outlook we shared in late April. Sales totaled $238,000,000 down 14% from prior year, while EBITDA rose 11% to $30,000,000 Composites posted another quarter of year over year margin expansion.
In total, composite sales were down 11% for the quarter with much of this decline due to lower pricing reflecting lower raw material costs when compared to the prior year end period. Sequentially, pricing adjustments more than offset the impact of some rising raw material costs during the quarter. We also saw the impact of slowing industrial growth in emerging regions, particularly China and Brazil, reflected in lower volumes in these regions. Within I and S, overall results were generally consistent with our prior outlook that VDO margins will decline reflecting more aggressive pricing. Overall, INS volumes and sales declined when compared to prior year.
Aslan did announce price increases in certain regions effective July 1. While it is too early to tell what impact these increases will have on the fourth quarter results, we are beginning to see the signs of some traction developing. Overall, the fourth quarter, we expect APM sales to be in the range of $220,000,000 to $240,000,000 We expect another quarter of solid margin performance within composites to be offset by I and S pricing and volumes that remain well below prior year levels. In addition, due to lower demand, we have decided to pull forward a planned plant turnaround that was previously scheduled for the 2017. As a result, we expect EBITDA margin to be in the range of 9% to 10% in the quarter.
I will now turn the call back over to Bill.
Speaker 2
Thank you, Luis. As Seth previously mentioned, typically Sam would be here to speak to Valvoline's performance in the quarter. However, he is engaged with separation related activities today. As such, I will speak to Valvoline's results. In summary, Valvoline reported another strong quarter.
The business delivered excellent results driving 3% volume growth leading to a 3% EBITDA increase to $119,000,000 on an adjusted basis. Valvoline's EBITDA margin was 23.8% in the quarter, which represents 110 basis point increase over the same period prior year. These results were driven by solid lubricant volume growth with particular strength in the Do It For Me channel, which we serve both through installers as well as through Valvoline's Instant Oil Change Network or VIOC. Same store sales within our VIOC network remained strong, rising 7% at company owned stores. At the end of the third quarter, the VIOC business had a total of ten fifty five company owned and franchised stores within the network, a gain of 116 stores versus a year ago.
This growth includes the addition of the Oil Can Henry's network of stores in The U. S. Pacific Northwest. Within the international channel, volume grew 6% driven by continued strong execution of channel building efforts. Overall sales mix also continued to improve with U.
S. Premium Branded volumes increasing to 45.3% representing solid gains both sequentially and versus last year. While we would customarily provide an outlook for Valvoline's results in the upcoming quarter due to security law restrictions associated with the planned separation, we are not providing a fourth quarter outlook for the Valvoline business segment. Before we take your questions, I'd like to make a few concluding remarks to put things in broader perspective. During the quarter, we have made great progress versus our four core objectives.
Overall, we increased our year over year EPS. As just discussed, we are pleased with the performance of Valvoline this year. In addition, APM performed per our expectations and showed year over year EBITDA improvement even in a tough I and S pricing environment. We increased our cash flow from operations. We completed the financing related to the planned separation of Valvoline and we are well on our way to creating two great companies.
In each of these areas, we delivered at or above the targets we set for ourselves as we enter the quarter. At the same time, we expected better results from ASI in quarter three. Furthermore, as Luis referenced, we anticipate that emerging markets will continue to be weak impacting both ASI and APM in the fourth quarter. In this context, our Chemicals group is taking the following four core actions. One, in an effort to improve our mix, we will retain our strong strategic focus on our core and niche markets.
We are focusing our technical and capital investments in these targeted areas. Two, in an effort to accelerate the pace of share gains, we have onboarded several new experienced commercial leaders, established dedicated leadership positions for the pharmaceutical and personal care end markets with a goal of improving focus, visibility and accountability. And we are taking a renewed look at how we leverage our global best practices throughout the organization. Third, to better leverage our technical scale and global capabilities and drive faster movement of our pipeline to market, we have created the position of Chief Technology Officer. With more than 125 PhDs on staff and 2,800 active patents around the world, we believe that innovation is a competitive strength for the new Ashland and we intend to capitalize on Four, to ensure we establish the new Ashland with a competitive cost structure, we have developed plans to take out at least $25,000,000 of cost over the next eighteen to twenty four months.
These savings are expected to be driven largely by a redesign of our IT support infrastructure, the implementation of an enhanced global supply chain system and the expansion of our global business service center in India. In conclusion, we've made great progress and we are taking action to further drive the business forward. In the end, we're fortunate that we have a talented team and this team is aligned around a clear strategy to leverage our technical innovation and applications expertise and we're taking additional actions to return the ASI business to profitable growth. Finally, we remain confident that we are well on our way towards creating two great independent companies on time and on budget. Thank you for participating in this call.
I will now turn the call over to the operator to take your questions. Thank you.
Speaker 0
Thank you. And our first question comes from the line of David Begleiter from Deutsche Bank. Your line is now open.
Speaker 5
Thank you. Good morning. Bill and Luis, just on Personal Care,
Speaker 6
I think last quarter you
Speaker 5
had referenced that the demand may have been improving late in the quarter in Personal Care by the customers. How when did that reverse during this quarter?
Speaker 4
Hi, David. This is Luis. Yes, that is right. We did see an improvement on demand at the end of the second quarter. And that was what I mentioned in terms of the lack of visibility.
I think that consumer demand, especially in the emerging markets, it's been a little bit spiky and that has caused our customers, our direct customers to also have a somewhat of a spiky demand. So what we saw in this quarter is again lower demand from our customers, but driven again, but the variability of that consumer demand in emerging markets. And I do expect that that variability will continue or that's what we're planning for in the fourth quarter. And I would
Speaker 2
just add that, because you bring up a really good point and that is that we did see an uptick at the end of Q2 and that gave us, if you will, the confidence in our outlook that that would continue, if you will, related to normal seasonality. As it turned out, we didn't see that, if you will, uptick sustain itself into Q3. And as Luis mentioned, we're taking a cautious outlook as a result of that going forward.
Speaker 5
Very good. And Louis, just on market share, how confident are you that you're not losing share or share is not eroding on the margin here?
Speaker 4
Yes. One of the key things is that our products are specified in our customers. So in that regard, we don't think that we're losing market share. I will make a note of the exception on the sunscreen actives. Definitely there has been a significant reduction in pricing, grades and more commoditized grades of sunscreen and we decided to participate in those segments.
And except for the sunscreen, some set of the sunscreen segment, we do not see market share loss because again we are specifying the products of our customers.
Speaker 5
Thank you very much.
Speaker 0
And our next question comes from the line of Mike Sison from KeyBanc. Your line is now open.
Speaker 7
Hey guys, good morning.
Speaker 2
Good morning.
Speaker 7
Sorry, can you hear me? I apologize. Luis, when you think about EBITDA for ASI, you've been able to hang in there the last couple of years, a little bit above five hundred million in that. And this year with the guidance, you're going to be kind of well below that. What do you think needs to happen to get back to those levels?
And how soon do you think you can get on that trajectory?
Speaker 4
Yes, definitely. I mean, we have been improving on a quarterly basis our performance and we are lapping the headwinds from currency, from energy. And every quarter we've made improvements. If you remember in Q1, we were $25,000,000 below last year, then we were $15,000,000 we're $8 Definitely, I think about a quarter behind where I wanted to be. I wanted to be at flat EBITDA this quarter.
And as I mentioned, we were feeling optimistic at the end of Q2 based on the uptick in demand that we saw in March and the demand obviously was not as strong as we expected. But we continue to make progress on a quarterly basis in terms of improving the EBITDA getting to the right level.
Speaker 2
Mike, it's Bill. I'm just going to add in there because you're referencing I think a little bit longer term perspective. And when I step back and look at the business, the team's done a great job in the areas that we've highlighted improving the supply chain and being dependable, providing pharma quality products for our customers in terms of retooling our innovation pipeline and how we support customers in the field. I think that, there's further opportunity as we put more effort behind our innovation pipeline with the establishment of the Chief Technology Officer to drive our greater global scale and drive more momentum in terms of increasing the percentage of our sales that will come from new products. And secondly, we are really sharpening the tools, if you will, on the commercial front in terms of driving a high performance organization, which we have today, but leveraging our global practices, trying to make sure we have clear visibility into key segments like Personal Care versus Pharma and really make sure that we are driving the value selling and share shift that's appropriate for the types of activities we have.
So from my perspective, I would just add that to me those are key parts of our engine, which we do well on today and we are working on and I think will become, if you will, towering strengths for us in the future. And with that in mind, that will help to drive and propel, if you will, greater growth more or less irrespective of what's going on in specific regions or to at least a reasonable degree in specific market spaces.
Speaker 3
And Mike, this is Kevin. While I don't want to oversell it as Bill mentioned, we've identified approximately $25,000,000 of cost improvement opportunities through several projects that we discussed here, Bill mentioned. And we're going to continue to be very, very focused on the cost structure of this business and we'll take every available opportunity to continue to make improvements to that. We've committed to cost neutrality. That has not changed as part of the separation process.
And we see opportunities over and above that as Bill discussed and we'll continue to focus on that as well to provide the business overall, both ASI and APM or New Ashland going forward with a better cost structure incrementally.
Speaker 2
And Mike, you're going to get a full answer here to your question and then some. But these are important points. And so just to emphasize, as we're separating and I'm going to speak specifically to the Chemicals business, what we're seeing is that we have an opportunity to really customize aspects of how we support that business, which will provide better service in terms of supporting the business and our customers, but really in a more cost effective manner. And so we are looking at this not as simply a cost reduction exercise. In fact, there are areas in Lean Six Sigma and the commercial teams in innovation where we're excited about the investments we're making.
And you hear about those and those things we want to continue to invest in. But the good news is that for the Chemicals business through the separation, we do see ways that we can drive the back office aspects of the business in a way which is more cost efficient. And so I just want to emphasize that, it was part of our hypothesis associated with the separation. And for the Chemicals business, we're seeing that today as we set our plans for the future.
Speaker 7
Okay. Appreciate that. And then as a follow-up, you did talk about five key end markets that are growing. Could you flush those out a little bit, why they're growing, how strong they're growing? And then and I did I think pricing was down.
So is that an issue? Is that more on the other side that's been more aggressive than usual?
Speaker 4
So two comments. Let me start with the pricing one. Yes, in the more commoditized portion of the portfolio, we do have pricing down mostly following raw materials. So obviously, raw materials start increasing those prices should go up and that's on the pricing side. In terms of the markets that grew, I mean, continues to grow, that has continued to grow every quarter as we introduce further technologies and further products that enter into new drugs or new generics.
Coatings continue to grow and that's mostly because of new product introductions. Again, if you follow some of our customers, they also had very difficult comparisons in emerging markets. But our coatings business was able to grow through new product introductions and business gains. Hair care is another segment where because of introductions that we did last year, we continue to see the traction of those. We reverted a trend in the nutrition segment and we are now showing growth.
And finally, our TSYS business has continued to show tremendous stamina in terms of delivering growth on a quarterly basis for a variety of quarters except for Q1 of last year. So those segments, even with the situation in emerging markets through new product introduction and again products that tend to be at higher margin improving the mix, they continue to grow.
Speaker 7
Great. Thank you.
Speaker 0
And our next question comes from the line of Christopher Parkinson from Credit Suisse. Your line is now open.
Speaker 6
Thank you. Can you hit on the emerging market weakness a little more? Is this deriving mainly from customer trade down, destocking both? And as far as the potential for customer trade down, whether it's in the past or potentially in the future, have you increased your exposure to some of the lower price point products? Just any color there would be appreciated.
Thank you.
Speaker 4
Yeah, that's a very good question. And as I think I mentioned in the previous call, the trade down that we see and we see some trade down is happening. Having said that, I don't think that is a long term trend in my experience. As soon as the consumer starts feeling more confidence, they are accustomed to the better products and they will get back to buying them. But we have seen some trade down.
And again, that's what has made our customers, not the consumer, being a little bit spiky on what to make. To your second point, yes, we do work with them in terms of finding ways to reduce the cost of their final product, so they are more accessible to their customers. And as we do that, we tend to do it again with high quality products that enable them to provide the similar properties, but at lower cost. And we've been successful, but it's not immediate, but we've been successful in a variety of places, Mostly in coatings just because of new product introduction for our customers is faster than in the regulated spaces, but we're working in every space to do that.
Speaker 6
Perfect. Luis, as long as I have you, just you hit on this at the end of your remarks, but just overall, where does ASI stand relative to its long term target for new product growth as a percent of revenues? And can this be achieved in fiscal year twenty seventeen? And also how integral is that relative to your long term ASI margin guidance? Or will the benefits of sales mix from pharma and other end markets be enough to get you a few 100 basis points higher?
Thank you.
Speaker 4
Yes. Our long term target for ASI continues to be the same one as before in the 25% to 27% EBITDA margin for the future. Clearly, the energy and FX headwinds that we saw last year have delayed us in that delivery. And both of the elements that you mentioned are the reason where we see the improvement. Actually three elements I would mention.
The first one is what you described, just a better mix in the markets that we serve. Our core markets are higher margin overall than the rest of the business. So just by selling more in those segments, our margin improves. The second one is what you mentioned in terms of introduction of new products. Our new product introduction process allows us to bring products that are more valuable to our customers.
And as we do that, we introduce new products or in some cases we replace other products that are at lower margin. The third element of our EBITDA improvement program is as we reenergize growth moving forward, the overall absorption of our overall fixed cost infrastructure on SG and A, on manufacturing, etcetera, will bring those margins up by virtue of the capacity that we have established in the business. Those are the three levers that we have to continue to improve margins and get us to that expectation.
Speaker 2
And just to emphasize the comment or the comments around new products introduction, it is amazing the people that we have, the infrastructure support resources that we have, the whole portfolio of highly differentiated and often patented technologies. And we I believe that for the future to get us to a more sustainable and higher growth rate, we really need to capitalize more on that. That's a core reason for establishing the Chief Technology Officer role. And we are bringing that individual together with our commercial team to really talk about how we can accelerate the pipeline or the impact. Because as a specialty chemical company, we need to see our sales of new products be in excess of 25% of our sales.
And we are below that today. We have platforms which not just specific technologies, but platforms related to bridging our core technologies, we call them our hybrid platform, which really have outstanding potential. They're highly differentiated. They're proprietary and protected. And we need to accelerate driving that innovation stream into the marketplace.
So to me, from my perspective, I'd just say that this is our opportunity to move from strength to great strength and make sure that this is what is driving and leading to our ultimate results. So it's just the team has done a great job if you think about it over the last year, for example, in improving the supply chain. And that's great because if you don't have a dependable supply chain, then your customers can't depend upon you and it's tough to be differentiated in that respect. I think that we are strong in the areas of innovation, but we really just need to redouble our efforts and make that a bigger part of our end result stream. So I'm excited because to me that's the next phase of, if you will, becoming a more focused operating company is focusing on really trying to be the benchmark in areas like innovation and commercial excellence.
Speaker 6
It's very helpful. Thank you.
Speaker 0
And our next question comes from the line of Laurence Alexander from Jefferies. Your line is now open.
Speaker 8
Good morning. I guess first of all, can you for the five growth platforms you highlighted earlier, could you give us a sense for what the aggregate sales is and how fast they're growing?
Speaker 4
Hi, Laurence. How are you? This is Luis. I mean, we obviously on purpose decided not to provide the specifics on those specific segments, but they are obviously a significant and important part of our portfolio. I mean, clearly coatings and adhesives are the majority of our industrial specialties business and pharma together with the hair care also represent a significant proportion of our consumer specialties business.
Speaker 8
And then can you maybe tie the commentary around the R and D pipeline and commercialization initiative with the cost cuts you did a couple of you've done over the last couple of years and the realignment you did in the R and D staff? You know, that is this building on the market relevance initiative you were pushing? Or is it or is this sort of do you or did you go too far and you need to then ratchet it back? Because I know that was one of the risks you had flagged when you started out.
Speaker 2
Right, so this is Bill and I saw the implementation, if you will, of the reductions that you're referencing. And from my perspective, the team did an outstanding job of assessing the needs of the business and really moving fundamentally to decentralized aspects of the business, which we'll say are should be more closely aligned with the businesses. Yes, there were cuts that went, we'll say across all our areas of the organization. But to me, I think that the work that was done was spot on and spot on in the sense that we have retained the strength that we needed in our technical areas as well as our commercial areas. And we're looking to ultimately just strengthen what we think is already a core part of our strength and ultimately invest more as we go forward and kind of build a stronger growth engine.
So as we make comments about the future and what we want to do and focus on, I'm commenting because I want to be cautious. We are not trying to solve a problem that exists or exists because of a past restructuring, but really move forward in terms of making sure that we're driving, if you will, top quartile results in the specialty chemical industry, which will always be dependent upon your pace and rate of innovating into the marketplace and your ability to build trust based relationships with your customers, ultimately solve their problems and then solve the value with premium pricing. So I hope that addresses your question. I think the restructuring was in the past was very well done. Just have an opportunity to focus as an operating company more on these types of aspects to make sure that, our overall strength is greater for the future.
Speaker 8
And then lastly, you made a comment about being on the way to integrating the two companies. How much farther do you think you have to go? And when you get there, so to speak, would the lumpiness in the portfolio diminish? Or do you think you need a little bit of something else in the mix of the portfolio to smooth out the lumpiness?
Speaker 2
Yes. So I think just to make sure I'm clear, when you talk about integrating, are you talking about the chemical side of the business, basically establishing the new Ashland?
Speaker 8
Yes. Yes, exactly. You made a
Speaker 4
comment about how you are well on the
Speaker 8
way to integrating two companies and creating the new culture and
Speaker 9
just
Speaker 8
trying Sure. To tease that out a little
Speaker 2
Well, clearly the business will still have different segments with different value propositions and different market spaces that we focus on. And yet really as we look at it, the back office aspects of the business, we can drive based upon the commonality that's associated with chemical production to make sure that we are leveraging that across the broader scale. So I think the supply chain enhancements that we're putting in place now, the global supply chain is a great example of that where clearly by taking one approach across all of the respective businesses, they will benefit within the Chemicals group. But there are other aspects of the business from market facing sales and technical support people and marketing people where they should stay, if you will, focused on their respective markets. And we're not going to try to bring those together.
In fact, as I mentioned, we're going to try to increase our specialization or focus on the imperatives within those market spaces. And so yes, we want to leverage our global scale. To me, this is a great opportunity as we're going through the separation. We are we're looking at everything that we do. Most specifically, I'll say in this context in the back office.
And we're saying, okay, is this the most competitive and the most effective way to drive a specialty chemical company forward? And the answer is for the most part, yes. At the same time, we do see some opportunities and I think we'll continue to see additional opportunities as time goes on. And that'll be part of creating the great specialty company, the premier specialty company that we intend to be.
Speaker 8
Thank you.
Speaker 0
Our next question comes from the line of John Roberts from UBS. Your line is now open.
Speaker 10
Thank you. When does Valvoline drop to discontinued ops? And after the IPO of Valvoline have you decided yet whether the remainder will be an exchange offer or just a distribution?
Speaker 3
Valvoline would go to DISCOP sometime after the planned, IPO and then the full separation. In terms of our intent as we stated, has been and is currently our and currently remains our intention to distribute the remaining shares of Valvoline not included in the IPO process after an appropriate lockout period is agreed with the underwriters that would be distributed to existing Ashland shareholders as of some record date.
Speaker 10
Okay. So no exchange offer then as part of that distribution?
Speaker 3
Not currently planned.
Speaker 10
Okay. And then in ASI, one of the key themes in the consumer markets have been the global major customers losing share to smaller local customers. Is there a way to think about how much of your consumer specialties are the global CPG firms and how much are smaller local customers that might be gaining share?
Speaker 4
Yes. I mean, really depends on the geography and the location. Obviously, we have to play with both. In the past, the local customers have been gaining share in places like China, like Brazil, like India, all of the emerging markets. That's probably less true in the developed markets of Europe or The U.
S. Where the global established customers are still gaining share and they are the significant players. We just try to keep a very good balance in between both of them depending on the region of the world where we are participating. I normally don't share exactly what our sales are for each of the different venues.
Speaker 2
At the same time, this dynamic is you can see it in the actions that we're taking. We recognize that we need to be global and at the same time be local, which is why we're building out the infrastructure in the regions to effectively support whether they be global or regional customers. And we're working to, as I mentioned in the technology area, make sure that we're bridging our global scale and wherewithal to leverage that network to really make sure these innovations we have as well as our ability to support our customers is from the full Ashland even when we're providing it for a local customer in the local region.
Speaker 4
Thank you.
Speaker 0
And our next question comes from the line of Jeffrey Zekinos from JPMorgan. Your line is now open.
Speaker 9
Hi, good morning.
Speaker 4
Good morning, Jeffrey.
Speaker 9
I think that there's normally seasonally stronger profitability in AFI in your fiscal fourth quarter in that your revenues tend to drop sequentially and your EBITDA margin tends to lift. Can you describe why the mix seems to be better in the fourth quarter? What is it that you sell less of or what is it that you sell more of to get higher returns?
Speaker 4
Yes. Hi, Jeff. This is Luis. The reason why our Q4 profitability is higher than Q3 is because we have in a specific product line every time during Q3, a maintenance shutdown of one of our facilities that it's relevant. And that's just one specific asset where we take a maintenance shutdown every Q3.
And it has significant impact on the margin when it comes to manufacturing costs. So it's not necessarily a change or mix or anything, it's just the way our cost flow through our system in Q3 versus Q4.
Speaker 9
Okay. And secondly, last year your SG and A in Specialty Ingredients really blipped up in the fourth quarter. You sequentially went from something like 115,000,000 to 121,000,000 Are we going to see that kind of jump up again in SG and A or last year was unusual and it's likely that that would be missing this year?
Speaker 4
No, at this time I'm not forecasting any significant increases on the quarter. I mean sometimes we have specific adjustments, but I don't expect that blip in
Speaker 2
Q4.
Speaker 9
Okay. And then lastly, it's true raw materials have moved lower, but your prices just sort of have inched lower a little bit faster. And so it seems that there's a little bit of a margin squeeze going on. And not a lot, but some. Is that the kind of thing that's a little bit difficult to reverse in the environment that we're in because demand is so soft?
Speaker 2
Yes. I don't know, Jeff, that that's accurate. Actually the case, I mean, there's been a great effort and in the gross profit area, can see that we're doing a pretty good job of managing, at least if we're referencing in the ASI business, the relative profitability in the changing raw material environment. I think the same has been true within the composites area. Certainly, the INS and BDO market that would really be just more fundamentally driven by global supply demand really less so by raw materials, but more so by supply and demand and the related pricing impact that that has or margin impact I should say that that has.
Speaker 9
Okay, great. Thank you so much.
Speaker 0
And our next question comes from the line of Mike Harrison from Seaport Global. Your line is now open.
Speaker 11
Hi, good morning.
Speaker 2
Good morning. Good morning, Mike.
Speaker 11
Louise, within the skincare business, we've talked in the past about some of the competitive dynamics that have been impacting you and you mentioned seeing some weakness in pricing there and some business that you just felt like walking away from. Can you talk about how you see that playing out over the next few quarters? Any improvement on the horizon in that competitive environment? And then maybe also talk about just what you're seeing in the overall sunscreen market in terms of demand Has that been better?
Or are you still seeing some weakness in overall market demand for sunscreens?
Speaker 4
Yes. There's both. I mean, we definitely have seen some weakness in sunscreen market, especially in Europe. But having said that, there is also been a lot more active pricing in that area. I would like to distinguish two things, though.
Not all of our Personal Care business is sunscreens. So we do have very relevant high margin portions of our skincare business that continue to grow. And we're investing a fair amount of money like in our biofunctionals and we're seeing progress on our acquisition of the Zetta Fraction technology from Axo. So that portion of the business is doing well. And then within the sunscreen molecules themselves, there are some that are more commoditized.
That's the area where we decided not to participate. While there are other sectors in the ones that we make where we have a technology, again, they tend to be in the higher value sunscreen market and those continue to do well, except that the consumer demand is a little lower. So a long winded explanation, but that's the dynamic. So Personal Care has more than sunscreens on the more commoditized end. It's been a price competition and I don't think that's going to change in the short term, but we have differentiated aspects of that business that do well.
Speaker 11
All right. And then you've talked quite a bit about new products in ASI. Is there any way that you can provide some examples of recent introductions or what we might be looking at in fiscal twenty seventeen that could move the needle? I know you've mentioned hybrid technologies. I think those came up several quarters ago.
And I'm just not really clear that those have had the commercial impact that you might have expected or whether that's still yet to come or still in very early stages?
Speaker 2
Well, and thank you for that question and because it also helps an important clarification. The hybrid technology is really, really exciting And yet, don't mean to in any way create any confusion. While we'll have some impact of that in the near term, really this is essentially a new technology platform. And in fact, there was a substantial amount of work before we really started introducing it to customers to make sure that we have adequately protected the intellectual property. So this is something that will be built into, for example, some of the personal care sales over time.
It's exciting for the future, but I wouldn't try to suggest that that will move the needle in the next quarter or two. It's really creating the engine for our growth over time. Now that being said, are a lot of exciting introductions that have taken place and are having impact today. Luis, you may want to reference a couple of those.
Speaker 3
Yes. So a couple of
Speaker 4
the new products, I mean, Clears and Hair Care, we were able to introduce new products both with what I would call our first hybrid technologies. Those new products now are in a variety of branded shampoos and conditioners. And again, I cannot just because of confidentiality tell you which ones, but definitely that has been a great success. We have introduced new products on the skin care side very recently. Those tend to be a year away from our customers being able to put them into their final products.
But the excitement is there and we actually got a couple of recognitions at the different trade shows because of the innovations that we provided. In the coatings arena, we've brought a fair amount of new products to our customers. Again, that's allowed us to grow and you encounter them in some of the newer paints both in The U. S, Europe and in China. So as I described in the past, it's not like we introduce a new product for every market every quarter, but every quarter we introduce new products for the different markets.
And depending on the cycle, some take three months to get there for our customers to implement them, some take a year before they are actually in the marketplace, especially in the regulated space, it takes a little longer.
Speaker 11
All right. And then Kevin, I was hoping that you could walk through the details again on the reduction in your free cash flow guidance?
Speaker 3
Yes, sure, Michael. First of all, we're expecting somewhat lower earnings and that will have an impact on the number. We are pulling forward some of the separation related cash payments. So those are going to happen sooner than we thought they would. It doesn't change the quantum.
We're still on target in terms of what we believe separation costs will be. And the third item is also a pull more of a pull forward of an environmental issue that we paid out. So it's really those are the three primary items offset somewhat by some improvements in working capital. And there are other puts and takes in that mix obviously, but those would be the call it the four primary impacts.
Speaker 11
All right, got it. Thank you very much. Sure.
Speaker 0
And our next question comes from the line of Dmitry Silverstein from Longbow Research. Your line is now open.
Speaker 12
Good morning. I just wanted to clarify your comments regarding Performance Materials with respect to raw material costs. In your prepared remarks, you talk about composites being impacted a little bit by rising raw material costs and you're getting pricing above that. But then later on in that same paragraph, talk about 11% decline in revenues was driven primarily by price pass through on lower raw material costs. So our raw material costs in Performance Materials composite portion of the business going up or going down sequentially or year over year?
Can you help us clarify that?
Speaker 4
Yes, sure Dmitry. Glad that you asked the question. On a year to year basis, there's a significant reduction both in raw materials and on the prices, but as we were able to keep margin up as the raw materials declined, we've seen improvement of margin on a year to year basis. Sequentially, for the first quarter in a long time, we started to see raw materials start to go up. And my comment was related to the fact that as we started to see those raw materials go up on a sequential basis, we have been able to pass price increases that are slightly above that.
So the idea that I'm trying to convey is we were able to capture margin as the raw materials came down. And so far, we have been able to preserve and in fact improve a little bit upon those as the raw materials finally in this quarter start to go up. I don't know if that clarifies the comments.
Speaker 12
It does, Luis. Thank you. So basically, the rising raw material prices and costs is sequential commentary versus the declines being a year over year commentary?
Speaker 4
That is correct.
Speaker 12
Okay. When you talked about coatings in China continuing to do well, and you have for a while, even as the Chinese economy and construction and coating demand has slowed down a little bit, obviously, on that continued penetration of water based technologies. Now that the government is actually in China actually sort of gotten serious about VOC emissions, it looks to accelerate conversion from solvent based technologies to water based and coatings specifically. Do you look for your business in China on the HEC side to accelerate as a result of this or basically maintain the rate that you've been growing at?
Speaker 4
Yes. What we're seeing in China Dmitry is twofold. Number one, the market itself is not necessarily growing and in fact if you with some of our some of the global manufacturers you've seen that they've reported declines on Chinese architectural coatings market. The reason why we're growing in China is because introduction and continuous gain both of new products and existing products. And I would highlight that in coatings, we are more than HCC.
We provide a battery of products that include surfactants that are very good for low VOC formulations. So yes, we continue to expect to see growth in China as we gain market share both by the introduction of water based products, but even in the water based products lower VOCs. And we're seeing that already in our results and we expect to continue to see that.
Speaker 12
Okay, very good, Louise. Then final question on adhesives. That
Speaker 4
business continues
Speaker 12
to do very well for you. My understanding is it's mostly construction related and mostly U. S. Based. So can you talk about whether or not you're gaining share, whether you're reflective of the market performance overall for construction in North America?
Or is it something outside of construction that's driving your adhesive sales?
Speaker 4
Yes, it's both. I mean, the North American market overall has been a good market for us. Our adhesives business, we continue again to gain some share. But it is a combination of markets. Yes, it has some construction in it.
It has some automotive in it, which has been good in North America, but also has a fair amount of packaging for consumer goods and that also has been very good both in terms of labels as well as flexible packaging. So in that regard, being a North American based business where the one economy that continues to do well is North America, We're seeing the benefits of those and our ability to continue to grow with new products at our customers.
Speaker 12
Got it. Thank you, Luis. That's all I have.
Speaker 4
Thanks, Dmitry.
Speaker 0
And our next question comes from the line of Jim Sheehan from SunTrust. Your line is now open.
Speaker 13
Thank you. On your free cash flow target and the reduction in the free cash flow you're expecting for the full year, you broke out some of the you talked about different elements of that. Could you just discuss in percentage terms how much of that is attributable to lower earnings expectations for the year?
Speaker 3
No Jim, we really can't break that out.
Speaker 13
On your ASI, your SG and A costs that you expect, you talked about cutting some SG and A. What is the cadence of cost savings that you expect to generate from that program?
Speaker 3
We'd expect full run rate in eighteen to twenty four months and not unlike what we've done in the past. We'll update each quarter in terms of number one, what our expectations of the overall quantum continue to be and number two, what kind of run rate activity that we're seeing?
Speaker 4
Just want to make one difference here. I mean, obviously, we've been very cautious on our spending on ASI. But the savings that Kevin is related, even though we'll continue to be cautious and conscious in the case of ASI, a lot of these reductions are coming from the infrastructure to service the business as we separate into two companies and we can focus the services that are provided within the back office to the benefit of the chemical business. So the vast majority of these savings are happening not on the commercial end, not on the innovation end, whereas Bill said, we continue to invest in certain areas to make sure that we deliver the growth that is needed.
Speaker 13
Great. And on the sunscreen topic, you've got a great product that you have working well outside The U. S. You haven't gotten FDA approval to introduce it in The U. S.
Yet, ESCOLAL. Could you give us an update on when you expect to get that product approved?
Speaker 4
Yes, that is the biggest question that I have. And we continue to work as hard as possible with the FDA to make sure that our product is approved. That is the one clearly differentiated product that is working for us very well. And, I I just wish that I could give you a date other than, the industry, not only us, the Melanoma Society. A lot of people are working to to to make sure that the FDA approves what are much better products for sunscreens.
But, unfortunately, I cannot give you a date just because it's been just work in progress.
Speaker 2
It's driven by the government.
Speaker 4
Yes.
Speaker 13
Thank you very much.
Speaker 0
And this concludes the Q and A session for today. I would like to turn the call back over to management for any further remarks.
Speaker 1
Ronnie, thank you. Thank you all for your time this morning and for your interest in Ashland. Hope everyone has a great day.
Speaker 0
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a wonderful day.