Steve Newlin - Chairman, President and CEO
Bob Patterson - EVP and COO
Rich Diemer - SVP and CFO
Cynthia Tomasch - VP, Planning, IR
Frank Mitsch - Wells Fargo Securities,
Laurence Alexander - Jefferies & Co
Mike Sison - KeyBanc
Kevin Hocevar - Northcoast Research
Dmitry Silversteyn - Longbow Research
Christopher Butler - Sidoti & Company
PolyOne Corporation (POL) Q4 2012 Earnings Call January 30, 2013 8:30 AM ET
Good morning ladies and gentlemen and welcome to the PolyOne Corporation Fourth Quarter 2012 Conference Call. My name is [Senal] and I will be your operator for today. At this time, all participants are in listen-only-mode. We will have a question-and-answer session at the end of the conference. As a reminder, this conference is being recorded for replay purposes.
At this time, I would like to turn the call over to Cynthia Tomasch, Vice President of Planning and Investor Relations. Please proceed.
Thank you, [Senal]. Good morning and welcome to everybody joining us on the call today. Before beginning, we would like to remind you that statements made during this conference call, which are not historical facts, may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements will give current expectations or forecasts to future events and are not guarantees of future performance.
They're based on management's expectations and involve the number of business risks and uncertainties any of which could cause actual results to differ materially from those expressed and/or implied by the forward-looking statements. Some of these risks and uncertainties can be found in the company's filings with the Securities and Exchange Commission as well as in today's press release.
During the discussion today, the company will use both GAAP and non-GAAP financial measures. Please refer to the earnings release posted on the PolyOne website where the company describes the non-GAAP measures and provides a reconciliation of them to the most comparable financial measures. Operating results referenced during today’s call will be comparing the fourth quarter of 2012 to the fourth quarter of 2011 unless otherwise stated.
Joining me today on the call is our Chairman, President and Chief Executive Officer, Steve Newlin; Executive Vice President and Chief Operating Officer, Bob Patterson; and Senior Vice President & Chief Financial Officer, Rich Diemer.
Now I will turn the call over to Steve Newlin.
Well thanks, Cynthia and thanks again to everyone who’s joining us on the call this morning. We always welcome the opportunity to speak with our investors and analysts about PolyOne’s recent performance. I’m very pleased to share our fourth quarter results with you as it caps off another record year for PolyOne on many fronts. We delivered fourth quarter record adjusted EPS of $0.21 and that’s a 17% increase over last year, which marks our 13th consecutive quarter of double digit year over year adjusted EPS growth. Each of our four segments improved organic operating profits over last year’s fourth quarter.
As has been the case throughout the year and well documented in the media, the extremely sluggish demand in Europe continues to be a challenge for companies. Our results reflect our effectiveness in moderating year-over-year declines in European business, improving specialty mix and curtailing and pruning of lower margin business. For the full year 2012 sales totaled $3 billion as we delivered record adjusted EPS of $1.20 a share. That’s an 18% increase over our prior record set in 2011. These full year results are particularly encouraging as they were generated by record-breaking performances in each of our three strategic platforms despite the previously referenced European headwinds.
In 2012, 40% of the specialty platform earnings were generated in Europe compared to 52% in 2011 on a pro forma basis. Nevertheless all three platforms delivered record earnings and operating margins. Both our distribution and the specialty platforms achieved record annual revenues.
As evidence of our mix improvement success during 2012 gross margins expanded from 16.6% to 19.5%. Healthcare continues to be one of our best performing areas of growth and it now represents 12% of total company revenues or $350 million in 2012.
For those analysts and investors who know us well, you know we don’t rest on our laurels and there is no complacency here at PolyOne. We hit our targets but we don't do so at the expense of our long-term strategic position. And while we delivered many record performances in 2012, we also accomplished several other achievements, including the successful integration of ColorMatrix, completion of the Glasforms acquisition and the agreement to acquire Spartech.
The first with respect to Spartech, we anticipate a first-quarter close for this deal. Pending shareholder approval, we’re still of course somewhat limited in the discussions that we can have with Spartech team. However, based on the interactions that we have had and the planning meetings that have taken place, we were increasingly excited about the opportunity before us. More than ever we’re convinced the Spartech solutions portfolio provides an impactful complement to PolyOne’s leading specialty presence in the industry and we will apply the same four-pillar strategy that transformed our specialty businesses to the Spartech business and we’re going to do this swiftly and great success.
We remain very confident in our synergy capture projection of $65 million run rate by the end of year three. In addition to synergies related to manufacturing alignment and the elimination of duplicate public company costs, we believe significant technology and cross-selling synergies exist. Our initial review of the Spartech technology and product lines confirmed that these opportunities are abundant. For example, PolyOne’s low smoke and halogen free technology used in our ECCOH and Geon product lines has very interesting application in some of Spartech’s sheet and laminate applications.
We also believe there are (ph) signing developments that can occur by leveraging our ColorMatrix barrier technology to drive further innovation to create additional value in Spartech’s packaging business. In December, we further strengthened our specialty platform through the acquisition of Glasforms, a leading manufacturer of glass and carbon reinforced polymers and advanced composite technology. This acquisition marks PolyOne’s entry into advanced composite for high-growth specialty arena consistent with our proven strategy of providing specialty solutions to deliver high-value to customers. This is really an exciting income (ph) that utilize new processes, materials and technology that fits perfectly with our expertise in offering metal replacement and light weighting alternatives.
Just a few example applications are wind turbine’s stiffening components, earthquake proof bridge decking, commercial truck floors, application for endoscopy wands, and specialty rods used in oil and gas production. So Glasforms clearly broadens our portfolio of solutions to offer our customers and nicely complements our existing global specialty engineered materials offering.
We’re pleased with our financial performance for the year and the quarter and with the exciting acquisition news we shared during the fourth quarter. Rich Diemer and Bob Patterson will discuss the details regarding our financial performance and other 2012 accomplishments. So with that, I am going to turn the call over to Rich Diemer.
Thank you, Steve and good morning. It is my pleasure to provide more detail on our fourth quarter results and the many records that we achieved. We recorded fourth quarter sales of $679.4 million and adjusted net income of $18.8 million versus sales of $640.4 million and adjusted net income of $16.7 million for the fourth quarter of 2011.
Adjusted EPS expanded 17% to a fourth quarter record of $0.21 versus $0.18 last year. These results are driven by earnings and operating margin improvements in all platforms. In fact, we achieved fourth quarter operating record – profit records in all three platforms. Sales increased 6% over prior year with the ColorMatrix acquisition and specialty price and mix offsetting the European demand challenges.
Foreign exchange had an unbearable impact of 1% compared to the prior year. From an end market perspective, we experienced strong growth in healthcare, wire and cable, appliance, packaging and packaging end markets offsetting softness in European automotive and electronics. We continue to attribute this success to our investments in commercial resources, solid growth from new technology launches and the successful integration of ColorMatrix which continued to progress well.
Regarding taxes, the pre-special tax rate in the fourth quarter was 39.4% compared to 30.7% in the fourth quarter of 2011 with the differential largely due to geographic mix in earnings. Also, in accordance with accounting rules, we did not recognize the 2012 R&D tax credit that was enacted in early January of this year which would favourably impact the EPS by a little over a penny.
Special items in the quarter resulted in an after-tax charge of $16.3 million or $0.18 per share and included an unfavorable mark to market pension charge and increased year-over-year estimated earn-out from the sale of SunBelt, environmental charges and acquisition related expenses.
During the first quarter of 2011, we changed our pension accounting policy to the mark to market method. Under this approach, we recognized actuarial gains and losses on pension obligations annually in the fourth quarter as opposed to the previous method of determining and amortizing these gains and losses over future period. As a result of lower discount rates, there was a pension charge of $42 million that we recognized in our fourth quarter.
Our asset performance in our U.S. pension plans registered a 15% gain this year and we contributed over $65 million during the year to boost our funding levels in our qualified plans to the $0.75 mark at year end. As a reminder, the company’s qualified and non-qualified U.S. pension plans are closed to new participants and frozen with respect to grandfather employees. And we expect the pension contribution and remaining obligations to decline over time.
With post retiree healthcare expense increases next year, the $0.13 per share headwinds in 2013 we mentioned in our press release is non-cash and is associated with a planned curtailment action in 2009. We also recorded (inaudible) of the second year earn-out of $23 million from the sale of our equity interest in SunBelt. Recall that we sold our ownership interest in SunBelt to Olin in February of 2011 for an upfront purchase price of $175 million plus a three year earn-out. We received our first year earn-out of $18.5 million in March of 2012 and we expect to receive the proceeds of the second earn-out during the first quarter of 2013.
As a result of our continued focus on success in managing working capital, which averaged 9.9% of sales for the year, we ended the quarter with $210 million of cash and liquidity of $381 million. This included the fourth quarter cash outlays of $34 million for the Glasforms acquisition and $40 million of pension funded.
Capital invested in the fourth quarter was $24.4 million bringing our total annual CapEx of $57.4 million. The largest project in the fourth quarter was driven by continued globalization of our subsea platform, including investment in our joint venture in Saudi Arabia where we expected to begin production of specialty products in April, expansion of GLS capacity in North America and further investment in Brazil.
Our net debt to EBITDA ratio at year end was 1.7 times. We’re comfortable that we continue to have ample flexibility to fund organic growth initiatives, pursue additional strategic M&A activities and return cash to shareholders through dividends and opportunistic share repurchases. We did not repurchase any shares in the fourth quarter due to the pending close of the Spartech transaction and the associated planned issuance of approximate 10 million shares. During the full year of 2012, we repurchased 1.2 million shares at an average price of $13.24 over a 40% discount at yesterday closing price.
With regard to Spartech acquisition, Steve mentioned the transaction is still on track for a late first quarter close. We have filed our S-4 and we’ll update the filing of the date of the shareholder vote when that is established. We also plan to issue new long term debt prior to the closing of the Spartech transaction. As you can tell, we have lot of terrific things going on and I look forward to reporting on them in the coming years.
At this time, I will turn the call over to Bob.
Thanks Rich and good morning. I am very pleased with our fourth quarter performance both with respect to our financial results and our progress in broadening our specialty platform offerings. In the fourth quarter, specialty revenues increased by 14% over the prior year to $282 million driven by the ColorMatrix acquisition, price and mix improvement, new product launches offset partially by European demand weakness and adverse foreign exchange.
Adjusted operating income for the specialty platform increased to a record fourth quarter level of $20.2 million which is a 20% increase over the last year. And as you know, our specialty platform has two segments, global specialty engineered materials and global color, additives and inks. And we break down the performance for each, starting with engineered materials, sales declined 2% versus prior year to $126 million in the quarter due to lower demand in Europe and the weakness of the Europe. However with the positive effects of our mix improvement strategy, engineered materials delivered adjusted operating income of $9.3 million, a 13% improvement over last year.
Global color, additives and inks increased revenue by 30% to $156 million due to organic growth in Asia and the ColorMatrix acquisition and also offset partially by declines in European demand. Adjusted operating income for color reached $10.9 million, a fourth quarter record for the segment and representing a 25% increase over last year. A highlight for this segment is that all regions including Europe contributed to a 33% increase in organic healthcare revenues compared to last year.
Shifting to our distribution platform, volume increases of 9% offset partially by lower prices associated with raw material price declines resulted in increased revenues of 6% over the prior year’s same quarter to $242 million. The most significant growth occurred in the healthcare and appliance end markets.
Revenue and margin expansion through mix improvement resulted in an adjusted operating income increase of 36% over the prior year to a fourth quarter record of $16.2 million for the quarter. Return on sales of 6.7%, a 150 basis points expansion over the last year and also a fourth quarter record. And finally, performance products and solutions demonstrated the importance of execution by delivering a adjusted operating income growth of nearly 40% even as revenue declined by 3% in the quarter versus the year ago period. The revenue decrease was attributable to lower selling prices reflecting lower raw material costs over the same period last year as volumes increased modestly.
The increase in PP&S operating income to $14 million was also a fourth quarter record. This resulted in yet another record return on sales of 7.6%, 230 basis points over the fourth quarter of 2011. Margins expanded in PP&S due to pricing and raw materials dynamics and improved plant efficiencies. These fourth quarter results culminated in record annual performances for all three strategic platforms.
And as we look back at 2012, we remember it as yet another year of delivering out our commitments. We successfully integrated ColorMatrix and investing nearly $3 million in commercial resources and geographic expansion. Organically operating profits increased by 50% in 2012 in Asia reflecting a better mix of products and operational improvements. We began construction on our specialty production capabilities in Saudi Arabia to better serve our customers in the Middle East. We expanded our global footprint at the request of our customers in both South Africa and Costa Rica. We announced our agreements to acquire Spartech and we acquired Glasforms to expand and grow our specialty platform.
In addition, we maintained our focus on innovation. And I would like to highlight a couple of specific examples that occurred last year through close customer collaboration. DENSO Corporation of Japan, a $38 billion revenue leading supplier of automotive systems for all major global automakers selected one of our engineered materials products, GLS OnFlex thermal plastic elastomer for use in HVA system in a new car model. We work closely with Denso to develop a solution that reduced the total system costs by eliminating the production staff, improving our cycle time and reducing scrap rates while meeting their stringent and consistent global supplier requirements. This is a great example of how we provide value far beyond just the polymer.
One of the recent ColorMatrix’s innovation is Excelite which utilizes our patent pending liquid foaming agent technology, engineered lightweight extrude plastics by reducing material density without compromising the static quality. This solution enables customers to dramatically reduce product density resulting in lighter weight end products and lowering their total overall costs. Additionally, because Excelite can be added at the extruder feed throat later in the customer’s process, this solution increases their productivity through improving the flexibility of their manufacturing operations. The accuracy of the ColorMatrix liquid dosing technology also reduces waste for the customer and improves efficiency. And these are just two examples. But what is more important in the few that we were able to discuss on this call is that our innovation pipeline is robust and our associates are constantly engaged with our customers and other collaborative partners to see that it stays that way.
We are an innovation company and solutions like these offer just a glimpse into the work that we are doing and the benefits we are delivering to our customers. But of course, we are not only relying on acquisitions and innovation alone to drive our continued mix improvement strategy. In 2012, we made great strides in cross business unit collaboration resulting in 20% of our new business gains generated from a number of cross-selling initiatives we implemented. For example, one of those leads turned into a multi-million dollar new business flows for GLS, color and distribution for a major consumer brand production. Our sales force is now more efficient and effective than any time in the history of the company.
I’d now like to turn the call over back to Steve for some closing comments.
Okay, thanks Bob. As you heard it was another good quarter to end another record year for PolyOne demonstrating solid execution of what we believe is a well developed strategy. And although we moved on to our 2015 targets which we announced at our investor day last May, since 2012 has concluded I did want to spend just a few moments reflecting on the goals we set back in 2007.
First of all, operating margins. Our distribution platform exceeded our target range of 4% to 5% and achieved 6.4% operating margins for the year. PP&S delivered 9% operating margins nailing the target range of 8% to 10%. Without the help of housing start assumptions that in 2007 were much higher than reality. Specialty platform achieved 9.1% return on sales nearly tripling to almost a 600 basis point improvement over 2007 although just slightly shy of the target.
Secondly, in 2012, we generated 45% of our operating income for the specialty platform, a dramatic improvement from 2007 and if you go back a little bit farther where it was about 2%, it’s a substantial amount of progress. Third, we drove our specialty vitality index to 51%, up from 21% in 2007, and that’s well above our target range of 35% to 40%. What’s really important about this is what it means is over half of our specialty platform revenues, over half were generated from products introduced in the past five years. And we think that’s something to be exceptionally proud of and creates great value for our customers and shareholders.
Fourth, we improved our pretax return on invested capital to 17% from 11% in 2007 exceeding our target of 15%. So all in we're pleased with our performance against these targets especially considering the economic situation in Europe and the U.S. economy and housing – housing and auto market is still yet to make a full recovery, not even close. But like I said we’ve already raised the bar and are aggressively in pursuit of our expectations for 2015.
Our track record of performance is solid but I think what’s even more impressive is what’s driving the numbers now and in the future. Unprecedented levels of innovative new products continue to drive mix improvement. And this coupled with the globalization of existing offerings and expansion into new markets, high-growth markets like composites, machines, position our organization exceptionally well to focus on profitable revenue growth. Much of the pruning we’ve discussed in the past is behind us enabling profitable topline growth to now be a key priority.
In fact, we’ve introduced profitable revenue growth as a significant component of our annual incentive beginning this year. We’ve never been in a stronger position at PolyOne. We made thoughtful investments. Our specialty product portfolio has been largely transformed to value-added solutions. Our customer relationships are rooted in collaboration like never before. Our innovation pipeline is extremely robust and recent and pending acquisitions create additional exciting opportunities.
I’ll also add that we have some strong and growing key end markets, such as housing, auto and healthcare and particularly in North American these markets are growing. Undoubtedly we’re going to continue to face challenges in 2013 and we’re targeting double-digit EPS growth for the year which means we have to overcome the $0.13 per share headwind from the retiree healthcare increase and still incrementally grow double digits. But challenges have never stopped us in the past and they’re not going to stop us as we move forward. And that’s what makes me so proud of this company and this team. PolyOne’s approach to business is what makes my confidence grow in terms of all that we can do and we are doing, to take this company to even greater heights.
So with that, I think we have time for questions.
(Operator Instructions) Your first call comes from Frank Mitsch with Wells Fargo Securities.
Frank Mitsch - Wells Fargo Securities
Steve, you mentioned that 40% of your profits came from the specialty – from Europe in the specialty's region, that's down from where it was a year ago. That can be a function of a couple of things. One is much stronger growth outside of the European region, as well as a disappointing performance within the European region. So can you give us your spin on or your take on what's going on in Europe in your specialties business right now? And how has January trended for you there?
Yeah I will talk about specialty really kind of globally if you will, Frank to try and answer your question. I think it’s a great question. First of all, I am sorry about Asia because specialty business in Asia is doing very well. Next, the North America, the business is doing well. We have stronger markets here, we see auto continuing to improve, the housing improving, medical improving, our penetration into healthcare improving as well. So some really good activities.
I was in Europe a week ago and I spent – it was one of those trips that you plan on and you know you’re kind of walking into a difficult environments, so I was sort of praised for a Debbie Downer type of trip. And I got to tell you I came away really energized with what our people are doing in Europe. In context, the economy is in rough shape, auto is Europe is in tough shape. And I think it's going to continue for some period of time. But what I am excited about is where our people are pursuing new business. We are in some long-term sale cycles and we are making outstanding progress working this collaborative approach that we have. I made a lot of high level calls and these were calls that were high, wide and deep where we’re talking with the right people, not just down in the bottles of purchasing but we’re having strategic discussions, about innovation, and about how we’re progressing on formulating and joint development agreements that we have in place and working.
So I would say that is about Europe. I continue to see a difficult straits for Europe for the economy at least through the first half of this year. I expect some rebound in the second half of the year but despite that I'm really happy with our position and the way we’re working on new applications. There is a lot – these kinds of challenges create lots of opportunities as you well know and light weighting is one of them. And chances for new technology and new innovation, auto industry specifically is looking very quickly, looking to respond more quickly than ever to innovation. So these aren’t the strategy, you have to run years and years of trials to get in now. They are looking to us to work with them and establish applications in a very different manner than we have in the past. So I was excited I came back, I was really fired up about the trip. I feel like the economy itself is one thing, we can’t control but how we participate in it is very positive. I think it came out faster than we thought and has been deeper than we thought. And it takes a little a bit of time to re-arrange your sales force and to get them out there and get them focused on new business. And that’s how you grow out of a problem economy. And our same-store sales are going to be sluggish. So I think that’s how we would view that – the issue with regard to the markets in Europe as well as the rest of the world. And I think the way you framed your question Frank, I think both are happening.
We are having difficult times with same store sales in Europe but we are growing in these other markets. So it’s a combination of both, when you see a blip of that much of a percentage of our income from a region in such a short period of time I think it generally implies both of the elements that you suggested.
Frank Mitsch - Wells Fargo Securities
Well, that’s very helpful. I was also struck -- sticking with specialties, I was also struck that the vitality index went up to 51%. It was 46% in the third quarter. I mean that’s a very large number. And typically, as you're getting new products, you would anticipate higher margins and so forth. Would you envision 2013 being a year where you get to the specialty margin goals that you guys fell just shy of here in 2012?
Well, we’re not making a specific comments about 2013 from a guidance standpoint outside of our guidance we provided in the press release on double digit EPS expansion but we do believe that a big contributor to that expansion will be improving margins in all of our platforms.
Frank Mitsch - Wells Fargo Securities
I’ll take that as a definitive yes. Thank you, Bob. And then lastly Rich, you alluded to the fact that the geographic trends led to a spike in your tax rate. Where specifically were you seeing that movement? And what sort of expectations do you have for 2013 along those lines? Yeah 39.5% is something that you don't typically see out of PolyOne or anybody.
There is no doubt about that Frank. I think we saw an elevated tax rate as the year progressed and it was exacerbated in the fourth quarter, part of that is that little bit of small numbers and that is the weakest quarter for the company and there was a distinct shift from where have forecast our income in the quarter and more of a domestic tilt to it in the fourth quarter. But I would tell you that as we look forward we are saying – giving a range of 34% to 35% for next year and we feel it will be more balanced next year. So I think that was really a December phenomena – fourth quarter phenomena and it was exacerbated. Just in December Europe always shuts down a little bit, early in December but we saw a more of that this year.
Our next question comes from the line of Laurence Alexander with Jefferies & Co.
Laurence Alexander - Jefferies & Co.
I guess first question, can you talk a little bit – obviously still a little bit of a detached relationship from Spartech, but can you talk a little bit about how you think the two businesses compare in their ability to pass through raw material volatility?
I will take that on the first. I think there is – there are couple elements to this. What we had to do, Laurence as you know at PolyOne, there is a lot of training, this is art, there is a science of pricing but then there's art of execution. And that means that we are going to have to spend the same time pitching the Spartech sales force to discipline of selling price in the art on selling price increases. It’s a matter of capturing the full costs, understanding the value proposition, where the touch points are and it’s pretty complex but we’ve got this down to a science and I think we've been demonstrating this as you’ve seen raw material increases really the last five years here and margin expansion through all that. So I think there are two elements of it. One is where – what’s your value proposition to customer and how much uniqueness do you have. And they have a lot of uniqueness, these are often customized formulations that they have. But I think the mindset is something that we will not change. We aren’t about passing through, we’re about – when you sell something and you have a cost associated with it, you’re supposed to an enterprise make profit on that, and that’s how we view our business.
So as costs go up while we try to be lean, while we try to purchase efficiently, we still know that over time we’re going to invest in R&D, we’re going to get increases in compensation, and we will continue to create value for customers that we will have to capture. So a lot of this comes down to execution more than anything else. I don’t think there is any higher degree of sensitivity in the markets that they are serving than they are in the markets that we are seeing serving at PolyOne which is just kind of a long way to answer your question. I think it’s an execution no matter in a disciplined manner and a lot of training is going to have to be put in place to kind of use some of the tools that we’ve developed for our marketing organization for our sales force. And that even goes back into the supply chain when we have visibility into existing and future price increases of raw materials and energy costs et cetera. So It sounds kind of simple but it’s a pretty complex process and we are very confident we have been able to do this in all our markets and all our businesses here at PolyOne and we have every confidence we can do the same thing when we make the completion of the acquisition of Spartech.
Laurence Alexander - Jefferies & Co.
And then can you talk a little bit about, as you give your profit goals for your divisions and for your managers, can you just walk through like, give some flavor for how you bridge between the types of goals you give them and the sort of fundamental or the broad EPS targets you sort of give publicly? What I mean there is, obviously if you have a favorable tax swing in one year, I can't imagine you'd pick up the phone and tell people, okay, you can breathe easy this year.
You’re right about that Laurence. First of all, with respect to that example, our businesses are incented on really a pre-tax basis, and so the tax effect being a corporate matter, you’re right that we don’t breathe easy just based on swing in tax rate but yeah every year, we develop a strategic plan which most of the current year forecasts and adds on four years, and that really is well aligned with the objectives that we outlined in our investor day in May, and aligned with the objectives that we set for 2015. Of course we have an annual budgeting process which develops interim goals to get us there but for our business units those are aligned to profitable sales growth as Steve mentioned tax arena per se.
But what I really like about our internal communication is that it is perfectly aligned with what we tell our analysts and our investors and when you look at our goals as we set them for 2012, they are exactly the same that we set for ourselves internally and they will be again for 2015.
I think the operative element of the compensation and the targeting for the businesses is operating income. Although we are adding top line to that as well, and then the third and lesser element is working capital, and these are activities that are well within the domain and control that the business unit has. And that’s how we encompensate and evaluate, reward and recognize the business unit leaders and their teams. I hope we are answering your answers.
Our next question comes from Mike Sison, KeyBanc.
Mike Sison - KeyBanc
In terms of the outlook for '13, looking for EPS growth double digits, do you expect all your segments to grow double digits? And if you do, can you maybe give us an idea of maybe which ones are going to lead the growth, which ones will lag the growth or some feel how the segments can do in '13 versus '12.
We do expect all of our segments to deliver double digit growth, that’s an internal objective that we have in our own goal setting process, and it aligns well with Laurence’s question on incentives. We’re not giving specific guidance by segments but directionally I think that’s a fair statement to make. Steve made an observation in earlier remarks that we don’t see recovery in Europe any time soon as possible, we could see something towards the second half of the year. So I would expect volume growth and then also the revenue growth to be driven by North America, Asia in the first half and hopefully picking up from that in Europe in the second half.
Mike Sison - KeyBanc
And then I had a specific sort of thought on engineered materials. The business has been a little bit under $50 million for the last three years in terms of op income. You've shown the double-digit growth in the second half of the year. But specifically, to grow that business, to sort of get it back and to broach that $50 million and really grow that business, is it really just relying on Europe? Or are there things within your control next year that could really keep the momentum that you showed in the second half of the year?
I like the question, and I know Bob wants to jump in here but let me go pretty quickly. First of all, we’re not going to rely on Europe really. I can’t let this company be in the hands of some regional economy or even global economy, it’s our job to grow whatever environment that we are in. We have been doing that. So how do you manage that? Well, first of all, what’s going on in Europe right now is we are making unprecedented number of successful sales calls. I had a great trip there, and why it was exciting was who we’re calling on, what the message is, the kind of dialogue we are having and the amount of activity that we have on new technology launches that have taken place in Europe. So those are going to come in. I can’t tell you exactly what but because every sale cycle is a little different, some of these have very protracted trial processes. Others are moving quite quickly, they are reacting to challenges and I think that works in our favour.
So I am feeling pretty darn good about our position in the context of a weak European economy. That said, we do other things to drive our growth in EM and there is a lot of new technology and product launches globally. I would say it’s unprecedented in our engineered materials space. There is so much work being done around light weighting and material change out and displacing metal in blast and aluminium for that matter. The acquisition of Glasforms gives us unique opportunity, this was a – this is a great little company and it’s down in Birmingham, Alabama and they have done a wonderful job with technology. Actually they have – they don’t have critical mass, the market is tough globally, or even throughout the U.S. Again we’ve got a handful of sellers to manage $50 million worth of business, and you have all of our feet on the street out there that can enable and participate in the sales of some high value added products that are unique, they are new, they are fresh, and they are in growing markets, like oil and gas production for example, and wind turbine et cetera. So these are reasons that I feel really excited about, especially engineered materials business.
I think it’s the place in our company where we can demonstrate incredible, it’s one of the place we can demonstrate incredible value add for our customers. And you can very carefully and precisely document and get agreement upon how much quantify the value that we’re creating for those customers. So sorry, Bob, but –
Yeah, I want to point out also for – before anybody becomes one with engineered materials performance, let me just give some highlights. For the fourth quarter operating income as percentage of sales improved from 6.4% to 7.4%, that’s a 13% increase in operating income but when you dig into the P&L little further there, you will see that we actually added $3.5 million of SG&A year over year. So that operating income increase didn’t come at the expense of investment and in fact, we continue to invest in this business to grow, I think it’s a very important observation about the platform and that year over year there is no doubt Europe just had the single largest influence on the results in both engineered materials and in color organically but it hasn’t stopped us from investing in commercial resources and you could see that in the P&L. So when you look at those year over year results that’s just encouraging to look at where we made those investments too.
Just to add one final comment on this and I like Bob’s point because it’s a good one. But every cloud has its silver lining and I think the challenges in Europe have really gotten the attention of our management team there to develop skill sets in average players and to deal with some participants that weren’t really effectively out there selling new business. We have a much more aggressive sales force, they are making the right calls on the right people, they are talking about the right thing. It is very impressive and it’s a dramatic change from even two years ago. So I think our future there will be just fine.
Our next question comes from Kevin Hocevar, Northcoast Research.
Kevin Hocevar - Northcoast Research
Could you talk about ColorMatrix for a second? You've had it now for a year, so just wondering how it's gone compared to your expectations. And as we head into 2013, has there been any change in your outlook there? I think a couple quarters ago you said it might get $0.12 or something like that in terms of accretion next year. So wondering if there is any change to that based on what you've seen.
Hey Kevin, this is Bob. First of all, we’re really pleased with how the integration of ColorMatrix has gone this year in terms of how our two businesses are working together and collaborate on new technology and product launches. We’ve continued to – we’ve invested in the business the way that we certainly would, in fact, we added $3 million in commercial resources and we announced the expansion in South Africa, all that’s really going well. I’d say the one potential surprise for us this year is it’s just been the impact on Europe and ColorMatrix has not been immune to the recessionary conditions there. So when we started the year we guided above $0.04 to $0.06 of EPS accretion from ColorMatrix and they did just get inside of that range. And the real like I said delta being really Europe in terms of the factors keeping us from going above that in terms of what we saw in the summer.
So and at this point we haven’t made any changes to our future estimates on the ability of ColorMatrix to deliver in the future. The only caveat I would say is that Europe continues to remain sluggish for all of our businesses and we need to what we can to stroll outside of that.
Kevin Hocevar - Northcoast Research
And sticking to Europe, I think there was some restructuring that you're going through, or announced maybe a quarter or two ago. How much did you save in 2012? And then how much more incremental savings do you expect to get in 2013?
This is Rich, Kevin. I think we spent 9 or $10 million, that was the plan to get to similar amount of savings. It was substantially done earlier in the year, I think we had $1 million of spending in Q4 and we expect to get the payback that we anticipated when we launched the program.
Kevin Hocevar - Northcoast Research
And then, and finally, distribution closed out the year really strong and what has appeared -- it seemed to be a bit of a seasonally weaker quarter. Operating profits were in line pretty much with the other three quarters of the year. So, just wondering, was there anything incremental that happened in distribution in the fourth quarter that, say, didn't happen? Like any new business wins, mix improvements, cost savings, anything like that, that we should expect to carry forward into 2013 and really get these high 6%, almost 7% type margins going forward?
Well, we continue to believe that mix improvement is an important part of the distribution strategy as well as our other platforms. So I think you can continue to expect improvement in 2013 over ’12 in that regard. And there isn’t really – what I have grown to learn really here in the business is that that can be hard to draw conclusions in terms of what happens in December in any one year. And sometimes you can see some activity having a little faster in one year than the other, just based on where people believe prices are going to go in the next year. And there may have been a little bit of that in December but nothing I would really draw specific attention to.
Our next question comes from Dmitry Silversteyn, Longbow Research.
Dmitry Silversteyn - Longbow Research
A lot of my questions have been answered but I'd like to follow-up on the PP&S business. You talked about the volumes in that division being up modestly in the fourth quarter. But if you look at 2012 overall just on an annual basis, can you talk about how PP&S did with respect to volumes? And also what your expectations are for 2013, given the continuing recovery in housing and automotive and appliance markets? As well as what your pricing expectations are as far as being able to pass through or needing to pass through, lower raw material costs, if you expect the raw materials to decline.
This is Bob. We did see pretty significant improvement in margins in PP&S this year on slightly volume and that really does lend itself to mix improvement in the same way that we talked about in our other businesses. I think what’s an important observation to make is that when we are in the early stages of what we see as a housing recovery I think we are going to continue to be selective about the types of business that we pick up versus what you might have seen PolyOne do back in 2004, ’05, or ’06 the last time housing really picked up and so one observation I would like to make as we got a lot of questions about housing is that while housing starts were up, or in the magnitude of 25% this year. Sales as reported by the analysts were up about 7%.
So it’s not a one correlation on housing starts and vinyl, we still believe there is a high correlation between our business and starts but just not to the extent that what we saw in ’04, ’05, and ’06. So hopefully that helps. Lastly let me just make another observation, PP&S continues to do a great job with lean six sigma executing on a black belt projects and delivering from a sourcing saving standpoint and being disciplined about price management and those have been helpful from a margin perspective as well.
Dmitry Silversteyn - Longbow Research
On the distribution business, you guys were expanding in China and also in Costa Rica, can you update us on where those expansion stand and what kind of expectations do you have for those little outposts and also – I was just going to say broadly speaking, on your expectations for pricing of the resins that you buy and sell through the distribution business?
I will speak to the geographic expansion first. We did greenfield a distribution facility in Shanghai in July of 2011, so this year was really our full year of operation and generated about $10 million of revenue there. So it was actually a really good first year for us and recall that our workers were principally serving that healthcare space for specific customers who asked us to get started in that region. Costs Rica, we actually expect to follow a pretty similar pattern, again being pulled there by the healthcare base and customers that we already have. So I am expecting similar results in the first year, year and a half of operations there, what we saw in Asia.
I’d just add, the question on POD has come up couple of times, the volume for the quarter was up 9% there. They had some raw material declines which were substantially passed through but still had some margin expansion. It looks like key raw materials are going to be up in the first quarter especially propylene substantially beat them to double digits. And we’re getting some reductions in PiO2 but that’s more of a impact on specialty than anything else. So there is still steady state when it comes to raw materials and I think you have to be nimble and adaptable and move quickly on the rise and fall of raws, I think we’re really good at managing this. So good volume growth in the quarter for POD, I think that the investment in number of people that we made for feet on the street in that business is improving and I think our execution is improving in that space as well.
Our next question comes from Christopher Butler, Sidoti & Company.
Christopher Butler - Sidoti & Company
You just touched on my question a little bit, but in terms of raw materials for the rest of the business, could you talk to and what kind of benefits you may have gotten in the fourth quarter that may go away as we see these costs come up?
We’re expecting sort of low, mid single digit type increases in 2013. As you know in our distribution business sometimes there can be a bit of a favourable benefit just on timing but not much of that because we have so low inventory on (inaudible) about 12 times a year. It’s actually really hard to pull that out in the fourth quarter because it’s seasonally our weakest quarter of the year and that’s true for PP&S and distribution. So there is nothing of order of magnitude of a 0.2 in the fourth quarter that we don’t see replicating in 2013.
Yeah I would add that really compared to Q3 we saw a 1% to 2% increase in the raws and that’s driven by some of the large feedstock, PVC was up 70% to 80% on average over the quarter, PCM I think was up high single digits over Q3 and propylene monomer was up 6 to 10%. So I won’t exactly say we had benefits for the quarter, year over year there were some declines certainly that we were able to capture and we share some of this. But I think the fourth quarter saw a little different trend in the year and I think we managed it very effectively as evidenced by our margins.
Christopher Butler - Sidoti & Company
And coming back to Europe, on the third-quarter conference call you sounded a little bit more optimistic on the environment, showing some sequential improvement. That seems to have changed in the rhetoric this time around. Is that just seasonality, not getting as clean a look with the December quarter?
I wish it was seasonality and your observation and comment is correct, Chris. Yes we have been pretty good at sort of seeing challenges ahead of time, it goes back I think the last five, five years sometimes has been early observers in terms of where the economy is going in, and I will tell you we missed the fall in Europe, but I think we have adjusted and handled it as well as we can, I don’t think – it’s always as Bob said hard to segregate seasonality from reality at times and we really don’t want to hang our heads on any – we don’t want to be misled to thinking as seasonality, we are racing for what we think is continued softness. I mean if you look at automobiles, auto builds are very poor in Europe and we’ve got a fairly auto based business. Auto production for the quarter was down over 11% in Q4 and for the full year 6%, so not a really any reversal of a trend. But like I said earlier I love our position right now in Europe. I really am energized by what our people are doing to capture new – exciting new business opportunities and I think the raw material – the new product launches that we have – have just launched and are launching in Europe are spot on for the needs of this economy.
So yeah, we were a little surprised that we thought that Q3 and 4 of ’11 were so below that our base was going up that comps would improve but what we didn’t expect was a further deterioration in especially in auto in Q4. So our mission is to sell plenty of new business to offset that and still grow, and I think we are on the right track to do that.
Christopher Butler - Sidoti & Company
And just, finally, with the acquisitions, can you give us a sense of CapEx and depreciation for 2013?
This is Rich. Excluding Spartech our CapEx for next year will be in the 50 to 55 range, and that continues to run in the two-thirds of our D&A. So D&A is estimated between 75 and 80, and so that includes the Glasforms, excludes the Spartech. On Spartech what I would tell you is that CapEx we would anticipate to be in the 20 to 25 range and once the deal is closed, we will give you more of a feel on that. We get our acquisition accounting in mind, we will give you more of a feel of D&A as it relates to Spartech.
Hey listen, thanks for all the questions. I am sorry, we have to cut this off. We’ve got a pretty tight schedule with the global employee meetings today. We had our full hour here. We appreciate the interest, thank you for your time. Thank you for joining us today and we look forward to updating you on the first quarter results for our call that’s scheduled in early May. Thank you all very much.
Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.
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