Minerals Technologies Inc. (NYSE:MTX) Q4 2022 Earnings Call Transcript February 3, 2023
Operator: Good day, everyone, and welcome to the Fourth Quarter 2022 Minerals Technologies Earnings Call. Today’s call is being recorded. At this time, I’d like to turn the call over to Lydia Kopylova, Head of Investor Relations for Minerals Technologies. Please go ahead, Ms. Kopylova.
Lydia Kopylova: Thank you, Anna. Good morning, everyone, and welcome to our fourth quarter 2022 earnings conference call. Today’s call will be led by Chairman and Chief Executive Officer, Doug Dietrich; and Chief Financial Officer, Erik Aldag. Following Doug and Erik’s prepared remarks, we’ll open it up to questions. As a reminder, some of the statements made during this call may constitute forward-looking statements within the meaning of the federal securities laws. Please note, the cautionary language about forward-looking statements contained in our earnings release and on this slide. Our SEC filings disclose certain risks and uncertainties, which may cause our actual results to differ materially from the forward-looking statements. Please also note that some of our comments today refer to non-GAAP financial measures, a reconciliation of GAAP financial measures can be found in our earnings release, which is posted on the website. Now, I will turn it over to Doug.
Doug Dietrich: Thanks, Lydia, and good morning, everyone. Thanks for joining the call. First off, I’d like to welcome and congratulate both Lydia Kopylova and Erik Aldag on their new roles. Lydia is Vice President of Investor Relations and Erik is Senior Vice President, Finance and our Chief Financial Officer. Many of you have met Erik over the past few years, and I know Lydia looks forward to meeting our investors and coverage analysts in the coming months. Okay. Got quite a bit to go over today, so let’s get started. Quick outline for today’s call. I’ll begin by giving you some context on the fourth quarter and then review the highlights of our full year. Erik will take you through the details of our financial results by segment and give you a look into the first quarter.
As you saw from our press release, we’ll be reporting on new segments and product lines starting in the first quarter. I’d like to take you through this change and how this structure better defines the Minerals Technologies of today. After that, I’ll give you some perspectives on the year ahead and open it up for questions. Let’s start with the quarter. As you saw in our press release, this was a challenging one, with several acute factors that impacted our results. On the positive side, sales levels remained healthy in most of our end markets, and compared to last year, sales increased 13% on a constant currency basis. We saw continued strong sales in Metalcasting and PCC, driven primarily by strength in North America foundry and paper markets.
We also saw continued growth across our consumer-oriented product areas. These areas of strong demand were offset by a few markets that slowed through the quarter. You’ll recall, we saw signs of weakness at the end of the third quarter in our construction and steel end markets, plus generally slow economic conditions in China and Europe. The slowing trend continued through the fourth quarter, and in the case of China, deteriorated further in December. As the quarter progressed, we also began to see orders in a few other businesses begin pushing into January. Our customers’ inventory levels are healthier now than they were last year, which gives them more flexibility to manage the timing of their orders to us and we believe they exercised some of this flexibility in December.
In addition to these market changes and the dynamics taking place in our order book, the most significant impact on our quarter came from three other areas. First, the cold weather experienced in the U.S. in December impacted our mining and processing plant operations and shipments, leading to increased costs and delayed sales. Our operations managed through these issues and have since recovered, but we still have some catching up to do on mining. Bottleneck of rail transportation that was created is now beginning to return to normal. Second, was the rapid increase in COVID infections in China in December. COVID swept through our facilities and our customers’ operations, which slowed demand and created significant operating and shipment challenges.
Thankfully, our employees in China have all recovered, persevering through a challenging few weeks. At this point, we’ve not yet seen volumes recover in China, and our outlook is for market conditions to remain weak for most of Q1 and to see more meaningful recovery to begin late in March or early in the second quarter. Third, we experienced a significant increase in energy and sea freight costs in Europe. The level of these increases was higher than expected and we absorbed them in the quarter, and are adjusting pricing to recapture them. Despite these challenges, our teams around the world did an amazing job, swiftly navigating these issues to keep our plants operating safely and our customer supplied. This quarter was an unusual one for MTI as we faced some unique challenges.
Except for the continued slow conditions in China, these issues were isolated in the quarter. We’ve made the necessary adjustments and demand remains relatively healthy across most of our markets. As a result, we see a significantly improved first quarter, which Erik will take you through in a moment. Outside of the fourth quarter, 2022 was an otherwise strong year for MTI. We posted three record quarters and our teams around the world demonstrated their agility, perseverance and focus on our priorities through 2022. We continue to execute on our growth strategy, positioning our businesses in faster growing markets and geographies, accelerating the development of new products and technologies, acquiring companies that fit our core markets and which position us in higher growth markets.
This year was somewhat a tale of two halves. First half started with extremely robust demand across each of our businesses, customer orders hitting record levels. Second half of the year, demand began to moderate in a few of our end markets and inflation pressures became a bigger weight. It was a robust sales year for MTI with growth of 14%, it was 20% on a constant currency basis. We saw continued organic growth in our consumer-driven product lines, like cat litter, edible oil purification and health and beauty products. Expanded our core positions in growing geographies, securing two satellite contracts in China, one is a traditional PCC filler satellite and the other for a GCC packaging application. Metalcasting business continued to grow in India and we’ve established ourselves as the green sand bond technology leader there.
Refractories business secured $100 million dollars in sales over the next five years to deploy our new SCANTROL refractory application technology. Our Environmental Products business continued to grow through several large settlement capping projects and the continued trial and commercialization of our FLUORO-SORB, our unique PFAS water remediation technology. New product development continues to have a larger impact on our sales growth. We commercialized 63 new products this year and sales of new products commercialized over the past five years increased 42% to over $300 million. We completed the integration of Normerica, establishing ourselves as the largest private label cat litter manufacturer in North America. We acquired Concept Pet, establishing ourselves as a leader in Europe.
As I mentioned, inflation was a major factor this year and it will continue to be through the first half of 2023. We absorbed $190 million of inflationary increases in 2022. We worked diligently to offset them with $210 million of price increases. Margins were impacted as a result, but higher margins will return as inflation flattens and lagging contractual price adjustments kick in. Our ability to change prices reflects the value that we deliver to our customers every day and is a testament to having the right technologies and applications to enhance our customers’ products and help them generate higher value in their markets. In addition, as we always do, we continued our focus on maintaining the highest level of productivity and on diligent cost and expense control.
As an organization, we gained a lot of speed and agility this past year. Our teams overcame several challenges and reacted decisively to maintain strong momentum. This momentum will serve us well as we go into 2023. And with that, I’ll pass it to Erik to review the financials in more detail. Erik?
Erik Aldag: Thanks, Doug, and good morning, everyone. I’ll review our financial results for the fourth quarter and full year 2022, and I’ll also provide an outlook for the first quarter. Following my remarks, I’ll hand the call back over to Doug to discuss our newly announced reorganization and give some additional perspective on how we’re viewing the year ahead. Now, let’s turn to our financial results. As Doug mentioned, we had a challenging finish to an otherwise strong year. Fourth quarter sales were $508 million, 6% above last year and 13% higher on a constant currency basis, primarily driven by $63 million of higher pricing. Our sales volumes were relatively flat overall as strength across our consumer-oriented end markets was offset by weakness in Europe and China, as well as production and shipping limitations from severe cold weather in the Western U.S. We also experienced some late quarter inventory destocking by our specialty PCC and processed minerals customers in the U.S. Fourth quarter operating income was lower than our expectation going into the quarter, primarily due to the sales volume pressures I noted, as well as higher freight, energy and production costs.
The operating income bridge on the bottom left shows we absorbed $60 million of inflation in the quarter, which was the highest level we experienced all year. While we offset the entire inflationary cost increase with $63 million of higher pricing, we expected a more favorable price versus cost benefit this quarter. We have further pricing actions to recover the additional costs that we absorbed in the quarter and we expect our price versus cost benefit to expand over the coming quarters. The unfavorable other costs in the bridge is associated with higher mining and production costs due to the severe weather in the U.S., as well as COVID-related production shutdowns in China. As you’ll see in the full year operating income bridge, these fourth quarter events had a significant impact on our full year other cost category as well.
Continuing on the right side of the slide, full year sales were $2.1 billion, a record level for MTI. Despite $100 million of foreign exchange headwind, total sales grew 14%, driven by continued execution on our strategic growth initiatives and pricing actions totaling $210 million. Full year operating income grew 5% to $253 million. Our pricing actions exceeded inflationary costs by $20 million for the full year. Recall that in 2021, our pricing was approximately $20 million behind the inflation that we absorbed that year. So, while our pricing actions caught up on a dollar margin basis in 2022, this two-year pass-through of higher costs into our revenue line has resulted in a percentage margin dilution of 150 basis points. We have sufficient pricing actions in place for the first half of the year to catch up on a percentage margin basis by the second half, and that timeline could accelerate depending on the pace of inflation.
From an earnings per share perspective, our full year operating income growth was worth approximately $0.28 of EPS improvement. However, full year EPS ended up at $4.88 compared to $5.02 in the prior year due to $0.42 of unfavorable below the line items, primarily driven by foreign exchange and higher interest expense. Now let’s review the segments in more detail, beginning with Performance Materials. Fourth quarter sales were $266 million, 4% above prior year. Sales in Household, Personal Care and Specialty Products grew 8%, driven by the acquisition of Concept Pet and growth in personal care and edible oil purification. Metalcasting sales were 5% lower. We continue to experience strong demand in North America, where sales in our green sand bonds business grew 13% compared to last year.
This growth was more than offset by lower sales in China, where volumes were impacted by COVID-related restrictions and shutdowns. Operating income for the segment was $19 million, which was significantly below last year and our expectations for a few discrete reasons. First, severe weather in the Western U.S. forced us to pause mining activities for several weeks and implements cold weather safety protocols at our processing facilities, which reduced production and shipping volumes. The weather also resulted in congestion on the rails, and we incurred significant costs shipping our products via truck instead of rail. Heading into the quarter, we had also expected a slight rebound in China. However, our volumes ended up lower on a sequential basis due to COVID-related restrictions and shutdowns at our facilities as well as some of our customers.
Finally, volatile energy costs in Turkey and bulk sea freight on the Black Sea resulted in significantly higher (ph) raw material costs for our European pet care business. We are increasing prices to cover these higher costs. However, pricing changes in this business typically have a 90-day contractual lag. The good news is that shipping rates on the Black Sea have moderated, and we have sold through most of this higher cost inventory. Therefore, we do not expect the same magnitude of cost in the first quarter, and margins will further benefit when our pricing actions take effect in the second quarter. Moving to the full year. Segment sales grew 16% to $1.1 billion. Household, Personal Care and Specialty Product sales were 22% higher, driven by acquisitions, higher selling prices and continued strong demand for consumer-oriented products.
Metalcasting sales increased 5%, as strong demand in North America and higher selling prices offset slow volumes in China. And sales in our Environmental Products business rose 28% on higher levels of project activity. Operating income for the full year was $131 million, 4% higher than the prior year. It’s worth noting that this segment offset $84 million of inflationary cost impacts with pricing actions during the year. Looking ahead to the first quarter, we expect significant improvement given the isolated impacts we experienced in the fourth quarter. We expect similar market conditions overall with improvement for our China Metalcasting business beginning later in the first quarter, and our mining and processing facilities have now returned to normal operations.
Meanwhile, new pricing actions will take effect through the first quarter and into the second, and we are seeing moderation in the inflationary cost elements that impacted us in the fourth. Overall, we expect operating income for this segment to increase by $8 million sequentially, approximately 40% higher than the fourth quarter. Next, I’ll review the Specialty Minerals segment. Fourth quarter sales for Specialty Minerals increased 10% versus the prior year to $155 million. PCC sales grew 13% on the ramp up of new satellites and higher selling prices. Operating income grew 17% versus the prior year to $16.9 million, as contractual price adjustments in this business are starting to catch up with inflationary cost increases. Turning to the full year, sales increased 12% to $648 million, primarily driven by new satellites, higher selling prices across all product lines and continued strong demand for our specialty mineral additives across a wide range of consumer and industrial markets in North America.
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Full year operating income of $72 million was 2% lower than the prior year, as this segment incurred significant raw material and energy inflation throughout the year. This is also the segment with most of our contractual price mechanisms, which will further catch up and improve margins as the pace of inflation slows. Looking to the first quarter, we expect demand in Europe and China as well as residential construction activity in the U.S. to continue at relatively lower levels. Despite similar market conditions, we expect operating income will improve due to price adjustments that went into effect in January. And while there is potential for energy volatility in the winter months, this segment could see additional margin recovery in the first part of the year if natural gas and electricity rates stay around the levels they are today in Europe and the U.S. Overall, we expect operating income for this segment to increase by $300 million sequentially, approximately 20% higher than the fourth quarter.
Now let’s turn to the Refractories segment. Fourth quarter sales increased 10% over the prior year to $87 million, driven by higher selling prices and higher laser equipment sales. Operating income was up 1%, reflecting solid execution amid softer steel market conditions and higher raw material and energy costs. Full year sales were $349 million, 15% higher than 2021. Steel market conditions in the first half of the year were strong, with utilization rates in North America around 80%. Although market conditions softened in the second half with utilization rates closer to 70%, this business delivered a strong performance, driven by execution on new contracts, higher selling prices and increased laser equipment sales. All the above resulted in operating income increasing 17% to $58 million, a record level for this business.
Turning to the first quarter, we have additional laser equipment sales as well as pricing adjustments that should improve operating income sequentially, and we expect market conditions to remain similar. Overall, we expect operating income for this segment to increase by $200 million sequentially. Now, I’ll review balance sheet — now, I’ll review our balance sheet and capital deployment highlights. We finished the year with total liquidity of $432 million and net leverage of 2.4x EBITDA. In 2022, our capital deployment priorities were balanced across sustaining our operations, investing in high return growth and cost savings initiatives and returning cash to shareholders. Looking to 2023, we expect higher cash from operations, as the inflationary impact on our working capital begins to release.
Our first and best use of cash flow will continue to be investing in ourselves to maintain and sustain our high-performance operations. We will also use a portion of cash flow to strengthen our balance sheet and return to our target net leverage of around 2x EBITDA. And we will continue to invest in high-return opportunities, both organic and inorganic. We always stress test our market assumptions for growth capital across multiple economic scenarios. And in times of increased economic uncertainty, this stress testing provides a key governor to ensure prudent deployment of capital. Overall, for the full year 2023, we expect free cash flow to return to a more normalized level of approximately $150 million, assuming capital expenditures in the $80 million to $90 million range.
Now let me summarize our outlook for the first quarter. Overall, for MTI, we see a much-improved performance in the first quarter, as we move beyond some acute issues. Specifically, our mining and processing operations in the U.S. are back to normal operating conditions, and they are catching up on production. And the logistics disruptions on the rails have mostly unwound. We’ve had several pricing actions and contractual pricing adjustments take effect through January, and we have more to come through the first half of the year. And while we expect inflationary cost pressures to persist, the most severe inflationary costs from the fourth quarter have eased, namely sea freight and energy rates in Europe. In addition, we expect modest improvement from our China business late in the first quarter.
We are entering 2023 facing softer market conditions than we experienced at the beginning of last year. And we expect construction and steel markets to remain soft through the first quarter at least. Nevertheless, our more balanced portfolio is proving its resilience and strength as demand for our consumer-oriented products and specialty additives is holding up well. We see most of our end markets remaining strong through the first quarter with a few areas of uncertainty. As a result, we expect first quarter operating income to increase significantly to a range between $55 million and $60 million, which would be up 25% to 35% from the fourth quarter. Now, I’ll pass it back over to Doug to share how our reorganization provides a better view of who we are today and enables higher levels of performance going forward.
Doug?
Doug Dietrich: Thanks, Erik. Over the last 18 months, you’ve heard me speak about how we’ve transformed MTI’s portfolio of businesses. I’ve been highlighting how we’ve built a larger portion of our portfolio directed toward consumer-oriented products and how we’ve been developing new technologies for more specialized, higher-margin and sustainable products. As a result, MTI is much different now. We’re a more balanced, faster-growing technology-advanced company and our organization and reporting structure should better reflect who we are today. With that in mind, we felt that this was the time to present ourselves differently. Beginning in the first quarter, we’ll be reporting in two new segments; one named Consumer & Specialties and the other Engineered Solutions.
The Consumer & Specialty segment, which generates of 53% of our sales combines all of our businesses that directly serve consumer-driven end markets and our mineral based solutions and technologies that become a functional part of our customers’ products. The two product lines that we will report on within this segment are: Household & Personal Care, our mineral-to-shelf products; and Specialty Additives, the products which will become a functional additive in a variety of consumer and industrial goods. This business group is being led by D.J. Monagle. The Engineered Solutions segment, 47% of our sales, combines all of our engineered systems, mineral blends and technologies that do not become part of our customers’ products but rather are engineered to aid in their manufacture.
The two product lines that we will report on within this segment are: High-Temperature Technologies, combining all of our mineral-based blends, technologies and systems serving the foundry, steel, glass, aluminum and other high-temperature processing industries; and Environmental & Infrastructure, which contains all of our environmental and remediation solutions such as geosynthetic clay lining systems, water remediation technologies, as well as our drilling, commercial building and infrastructure-related products. This business group is being led by Brett Argirakis. This new organization moves us away from our past legacy-oriented structure into one where we are organized around common technologies and applications expertise, as well as common market and customer characteristics.
It will streamline our reporting structure, speed up decision making in the organization and enable stronger collaboration. It also enables us to drive synergies through the alignment of our technologies with customer needs, accelerate innovation and further drive operational efficiencies. Our first quarter 2023 results will be reported along these new segments and product lines and we’ll be sharing further details over the next couple of months. Following our earnings call in April, we plan to hold an Investor Day where we can provide an in-depth view of each of these product lines, their associated technologies, strategies and resulting synergies. Please stay tuned for more details on that as well. Before we close the presentation, let’s talk about our focus areas for 2023 and what we are seeing in our end markets as we start the year.
In general, demand in the U.S. remains relatively healthy. Cat litter, Metalcasting, paper, automotive and environmental products remain strong. Residential construction as well as the steel market are slower than last year and similar to the fourth quarter levels. Outside of the U.S., Europe demand remained strong in cat litter and specialty consumer products, but relatively slow in our industrial markets. We expect China to remain slow for the majority of the first quarter, but indications from our customers are that activity and demand will likely pick up in the second. Further out, the second half of the year is harder to see right now. Our order books typically strengthen in March and April in our more seasonal construction and environmental markets and we are watching automotive build rates.
Early spring will be a telling period for these businesses on the strength of market demand going into the second half of the year. For our consumer-oriented businesses, we expect demand to remain resilient and for them to continue on their growth trend throughout the year. Internally, we have a clear set of priorities for 2023, focused on three pillars: financial performance; organization and people; and continued execution of our growth strategy. Our focus is on recapturing margins through both cost improvements and pricing actions. Contractual pricing will catch up and margins will further improve as we make other necessary adjustments and take advantage of lower input costs. We’ll maintain a strong balance sheet and improve cash flows. As inflation plains over, we’ll see the release of the working capital that is built over more than a year.
We will continue our balanced approach to capital deployment, funding high-return internal projects with a priority this year on debt repayment. We have a very global organization, which is now better aligned with our customers and markets through common technologies and applications know-how. Reorganization of our businesses and segments improves alignment and creates more speed. We’ll continue to drive growth, expanding our positions in our core markets and geographies, focusing on the development of sustainable solutions for the markets we serve, investing in product development and evaluating inorganic growth opportunities. These initiatives have transformed MTI and we see more opportunities ahead. MTI is a less cyclical and more resilient company than in the past.
Regardless of what the markets bring us this year, our balanced and higher growth portfolio of businesses enables us to deliver more stable sales and earnings growth. I’d be remiss if I didn’t tie all this together and mention the foundation that supports everything we do; our dedicated employees and the MTI culture built on operational excellence and an unwavering adherence to our values. It’s the foundation that sets MTI apart from others. 2022 marked our 30th year as a public company and 2023 will be a pivotal year as we move into a new era. Looking back, we note the dedication and commitment of all MTI employees for the past 30 years who helped form who we are today. As we now turn and look forward to the next 30, we see many more exciting chapters to write for our company.
Now, let’s go to questions.
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Q&A Session
Operator: And we’ll now take our first question from Daniel Moore with CJS Securities.
Daniel Moore: Thank you. Good morning, Doug. Good morning, Erik. Thanks for taking the questions.
Doug Dietrich: Hi, Dan.
Daniel Moore: Let me start with — you gave a lot of good — a lot of color, which is greatly appreciated on the various challenges that impacted margins and the results in Q4. Is the order in which you sort of presented those three challenges, weather first, COVID and China second, energy inflation and Europe third, is it the right way to think about it from an order of magnitude perspective? Or were they sort of relatively even across the three?
Erik Aldag: Yes. Thanks, Dan. I can take that for you. So, I mean, as you know, heading into the quarter, we said we do around $60 million of operating income. And so, we missed that by about $16 million. And so, I can put that into some buckets for you. About a third of that impact was associated with lower volumes, so sales, related to sales, so about $5 million or $6 million. And that was really from three areas: the China COVID situation impacted our volumes; the production and logistics challenges that we were facing in North America impacted volumes. and we did see some softness in the steel and residential construction markets that we mentioned. I’ll note, we’ve moved through those production issues in North America. From a China perspective, we do expect improvement there.
The timing of that improvement is still a little bit of a question mark, but we expect that to improve. The one aspect we don’t see changing at least in the near term is the softness in the steel and construction markets. So that is the sales side of things. The larger piece of the impact was on the cost side, so both manufacturing costs and inflation costs. So, let me give you a little color on the inflation that we experienced, that was more than we were expecting heading into the quarter. So, most of this was specific to our European pet care business, as we mentioned. And first of all, so the bentonite that we use in that business comes from Turkey. And we’ve got mining and processing facilities there. And as an example, energy rates in Turkey have been very volatile.
In September, we got hit with a 50% increase on natural gas. Electricity rates have been up over 200%. And then, sea freight also on the Black Sea has been very volatile. So, we’ve had to deal with price spikes up to €90 per ton when we’re used to dealing with sea freight costs from the €25 to €50 range. So, this all contributed to this wave of inflation that we’ve described, absorbing in the fourth quarter. Now, we’ve adjusted prices. We adjusted pricing in the fourth quarter to pass this through. And as I mentioned, this business has a 90-day lag in terms of pricing adjustments typically. And we’re going to be adjusting prices again in the first quarter. The good thing is that these costs have moderated since these spikes in the fourth quarter, and that’s going to help our margins going forward as well.
Just one note on the higher manufacturing costs. These are related to the challenges we had in December, mainly related to the weather, the severe cold weather at West, and much of that was around the lower fixed cost absorption at our plants. The production challenges in China also had a cost element to them there, but that was the manufacturing side of things.