Celanese Corp - Series A (CE) — Q1 2017 Earnings Call Transcript

Thank you, Annette. Good morning and welcome to the Celanese Corporation first quarter 2017 earnings conference call. My name is Surabhi Varshney, Vice President, Investor Relations. With me today are Mark Rohr, Chairman and Chief Executive Officer; Chris Jensen, Executive Vice President and Chief Financial Officer; Scott Sutton, Chief Operating Officer; and Pat Quarles, Executive Vice President and President, Acetyls Chain. Celanese Corporation's first quarter 2017 earnings release was distributed via business wire yesterday after market closed. The slides for the call and our prepared comments for the quarter were also posted on our website, www.celanese.com in the Investor Relations section. As a reminder, some of the matters discussed today and included in our presentations may include forward-looking statements concerning, for example, Celanese Corporation's future objectives and results. Please note the cautionary language contained in our posted slides. Also, some of the matters discussed and presented include references to non-GAAP financial measures. Explanations of these measures and reconciliations to the comparable GAAP measures are included with the press release and on our website in the Investor Relations section under Financial Information. The earnings release and non-GAAP reconciliations have been submitted to the SEC on a Form 8-K. The slides and prepared comments have also been submitted to the SEC on a separate Form 8-K. This morning, we'll begin with introductory comments from Mark Rohr and then open up for your questions. I'd like to turn the call over to Mark now.

Thank you, Surabhi. Welcome to everyone listening in today. Our prepared comments were released with earnings yesterday, so I will limit my comments, then open the line for your questions. In the first quarter of 2017, we generated GAAP earnings of $1.30 per share, and the second-highest ever adjusted earnings of $1.81 per share. In the Acetyl Chain, raw material prices were sharply higher sequentially and the Chain business responded well by implementing price increases globally. We remain aggressive in our commercial approach and selective about when and where we place our Acetyl molecules. This has allowed us to expand core income margins every month this quarter, up 200 basis points sequentially to 13.6% overall. For the first quarter, the Acetyl Chain generated core income of $108 million. Materials Solutions had another record quarter generating core income of $243 million. Advanced Engineered Materials segment income of $143 million was an all-time high and volume grew 35% sequentially driven by double-digit organic growth and contributions from the SO.F.TER acquisition. We also closed 513 projects in the quarter, which puts us well on track to achieve our targeted 1,900 projects for the year. The SO.F.TER integration is progressing well, and we expect to close the previously announced Nilit Plastics acquisition in May. Consumer Specialties' segment income in the quarter was $100 million, with a 46% segment income margin. Tow volume increased sequentially due to unique carryovers from 2016 as we transition contracts, but was offset by a decline in pricing due to lower industry utilization rates previously discussed. We continue to expect 2017 earnings from Consumer Specialties to reset at $0.40 per share lower than 2016 and stabilize from there. During the quarter, we invested $128 million to repurchase shares, and along with dividends, we returned $179 million to our shareholders. I also want to congratulate our team this quarter for the results and their tireless efforts and support of customers and shareholders. Looking forward to the rest of the year, Advanced Engineered Materials will contribute meaningfully to sales and earnings in 2017 through growth from new project commercialization and emerging benefits of SO.F.TER and Nilit integrations. The Acetyl Chain is strategically positioned to take advantage of evolving industry and raw material environments and also to advance growth. While we are facing headwinds from muted industrial demand and uncertainty in raw materials, we are off to a very good start for the year and we expect earnings per share growth of 8% to 11% this year with the second half about $0.20 higher than the first half.

Thank you, Mark. I’d like to request everybody on the phone to limit your questions to one and then a follow-up. Anita, let's go ahead and get started with a Q&A, please.

Good morning.

Good morning.

Two quick ones. How much of a drag was VAM year-over-year, and do you expect the lost volumes or the volumes that you sacrificed to come back in the back half of the year or in 2018? And then on acetate tow, can you speak to your relative leverage to regular cigarettes versus heat-not-burn cigarettes? And what those products might have as an impact?

Yes, I will start, and maybe have Pat who is here make a few comments on VAM, but if you look at the wall quarter-to-quarter, the VAM impact was pretty material for us. Fourth quarter and the first quarter were probably half of the downside we saw on a margin basis. So when I think through that, and the other half being TSO and some other things that are going on. So VAM was pretty material. Pat, do you want to comment maybe on a forward look for VAM?

Yes, sure. Hi, Laurence. This is Pat Quarles. Mark is right. I mean, it was fairly material versus last year. If you think about what happened to us in China, with the extraordinarily strong ethylene, which we based on for VAM process versus carbide producers more tied to coal, we had very strong ethylene in the first quarter. This puts us in a situation where we'd rather just not participate in the market in China during that period and take a little pressure off of other people's drive to export, which we think benefits us in the rest of the world. So that was really what drove our decision-making in the first quarter. As we get into the second quarter, ethylene remains high in China. That dynamic really hasn't changed. What’s changing of course is the overall utilization of the system, because of the multitude of outages that we and others were having in the market and where we're actively meeting customer demand, both through our Western Hemisphere assets as well as actually bringing molecules in from China to meet those commitments we have elsewhere.

Well, Laurence, the other question, if I understood correctly, is really around e-cigarettes and maybe smokeless tobacco and the trends there. Is that what you're asking?

Exactly, more in the smokeless tobacco side. I think e-cigarettes have been flogged almost to death?

So I will let Scott Sutton, if you will, take a shot at that.

Yes. Hi, Laurence. Look, I mean the reality today is that a small part of our tow business actually goes into heat-not-burn devices. It's something on the order of 1%. Most of our business goes into traditional cigarettes and superslim cigarettes. However, what’s going into heat-not-burn is growing very quickly and on top of that we have quite a number of projects in our engineered materials pipeline or thermoplastics to go into those heat-not-burn devices.

Okay. Thank you.

Thanks, Laurence.

Thank you. For Mark or maybe Pat, you guys had mentioned previously an acceleration in AI profits in the second half. I’m wondering if you can help us if that cadence still holds and what causes the uplift in the second half? Thanks.

Yes, we do. I mean, we’re seeing profits accelerate now as we go through this raw material inflation that's going on really driven by China, but around the world. So we are expecting that to continue as we go through the year. Pat, do you want to maybe…?

Yes, sure. So if you think through market dynamics, you heard me say before, a variety of outages going on that we’re in the middle of that, we and others. That is actually continuing throughout the second quarter and into the third quarter. So our expectation is from our business results, we will see margin expansion as we’re currently seeing into the second quarter. But we’re constrained on the supply, right, because our Clear Lake unit is out for a period of time and as that returns in the third quarter we expect to still have pretty good market dynamics and we will get the benefit of volume contribution in the back half of the year, and that’s what gives us that profile, Bob.

Thanks. Is there anything specific to the SO.F.TER. earnings stream this quarter that lowered the margin significantly, or should we expect this to continue at a similar level going forward?

Yes. Hi, Bob. This is Scott. So, yes, I mean, SO.F.TER. is getting to the point where it is closer to being fully integrated. So you do see some depression on margin percentage for a while. Over time, we will be able to bring those up, but that is primarily what was responsible for the little lower margin percentages in our Advanced Engineered Materials business in the first quarter.

Yes, Bob, I’m not sure if we didn’t communicate it clearly enough, but we have mentioned that the businesses you’re referring to are initially operating at very low double-digit margins. For this quarter, contributions from SO.F.TER. might be around $0.10, and significantly less from Nilit, likely around $0.10 next year. It will take several years to improve these businesses to margin levels that align more closely with our expectations in this field.

Got it. Thanks.

Thank you, Bob. Anita, let’s take our next question, please.

Hey, guys. This is actually Mike Leithead sitting in for Duffy.

Hey, Mike.

I guess, Mark, there's clearly been a strong start to the year, but you've pointed out several moving pieces regarding raw material volatility and mixed signals on global demand. When you look at your overall portfolio, do things feel better now than they did at the beginning of the year, or are there still some additional challenges you need to overcome?

No, they feel better. The raw material movements have been sharper than we anticipated. If you look at it on a full-year basis, we’re expecting as much as $200 million, maybe $250 million of inflation year-over-year. So far in the first quarter, we’ve had less than $40 million of gross raw material inflation. We're in a pretty volatile raw material environment, and that's okay. We don’t mind volatility; we actually like it. As we go through this year, we expect to see some movement in margins quarter-to-quarter, which may reflect that volatility, but we’re pretty excited about how the year is shaping up.

Great. And then just one more quickly on the volume growth in AEM. Can you help size for us the impact of SO.F.TER. this quarter? I guess I'm just trying to get a better idea of how well the base business performed in the quarter for AEM?

Yes, sure. I mean, one thing here, Mike, I don’t want to get too specific on continuing to break out SO.F.TER because it is becoming integrated. But what I will say is that without SO.F.TER, the number of projects is still an all-time record. The growth in volume is still double-digit regardless of whether you look a year ago or the quarter before. So SO.F.TER contributed right on plan, but still the organic business is the big driver. So, less is more is what I would say.

In terms of volume and projects, clearly the organic business is the big driver. In terms of profit contribution, SO.F.TER probably contributed 30% of the profit growth.

Great. Thanks, guys.

Okay.

Thanks, Mike. Let's take our next question, Anita.

Hey, good morning.

Good morning.

You mentioned some of the outages at Clear Lake, both I guess the acetic acid unit and the methanol unit are offline, and I saw that you guys are also running your Singapore facility at reduced rates here in Q2. Can you talk a little bit about what you’re sizing the financial impact of these outages are?

No, we’re not going to break it down that way. What we will say is that it’s a six-week outage. I think the gross expenditures will approach $50 million. The entire complex is down, affecting not only the Celanese sites here but also the other site partners. By any measure, it's a very significant outage as we are replacing our utility pipeline, utility systems, and the process. We haven't broken that down in there, Frank.

Well, so it's six weeks and you’re saying the capital cost about $50 million?

In expense.

In expense.

And at this point, with reduced production of VAM, I mean, I’m guessing that the market is going to be pretty tight when you come back in. Is that not how we should be thinking about AI, once we get past these outages, because you also have some major outages over in Asia, not you per se, but the industry?

I think the market is becoming a bit tight, and while I can't say it's extremely tight, it is tightening up some.

Frank, this is Pat. I mean, I think you see that expressed in the profile that we’ve talked about, the cadence across the quarters, right, and that’s exactly those dynamics we’re talking about that are reflected there.

Yes.

Thank you so much.

Thank you.

Thanks, Frank. Let's take the next question, Anita.

Yes, hi, good morning.

Good morning, P.J.

Mark, China has been shutting down a lot of coal-based capacity in various chemicals, whether it's urea, caustic. How is that impacting the Acetyls Chain, given the backward integration into coal? And could that suggest sort of a turning point in Acetyls in the future?

Yes, I believe there is some clarity to be gained here. At a high level, China seems to be maintaining its stance that coal gasification related to our business is not expected to increase. We're witnessing early signs of this trend. Additionally, China is indirectly supporting higher coal prices, likely to fund necessary investments for cleaning up coal technology. This sets a higher cost foundation for raw materials in China, which is a positive development. We've also previously mentioned the introduction of MTO in China and its effect on methanol. As MTO becomes fully operational, China will become a net importer of methanol, indicating that it will come from outside the country and not be produced within China. From my perspective, this sourcing dynamic is poised for a reset over the next few years, leading to a higher base cost for these materials in China, which overall benefits the industry.

Thank you. And just secondly on filter tow. Your prices are down 8%, volume is down 2%. Do you believe that 2017 could be sort of the final year of de-stocking and then you could see at least volumes begin to improve in 2018, or is that too optimistic?

I think we’ve said 50-50 on average at $0.40 between volume and price. So you can see a little bit of movement around when that settles as we go through this year. I don’t know how to really answer your question. I think we do really believe that it is going to set the foundation, and we hope that next year it doesn't. There are early signs to deteriorate next year. They shouldn't, but that's kind of where we are. I don’t know if Scott had anything?

No, I think that that’s right. I mean 2017 is at or near our floor, and we’re working actions to help that.

Yes. Thank you.

Thank you, P.J. Let's take our next question, Anita.

Thank you. Good morning.

Good morning, David.

Hey, Mark, in Q1 you beat expectations, but you did not raise full-year guidance. You mentioned there were some challenges on raw materials. Was anything else besides raw that held you back from perhaps raising guidance for the full-year?

No, I just didn’t want to roll it out there; but I think our year is back-end loaded and if you look at that there is a lot more loaded in the back-end of the year, and that means that just increases your risk. So I thought it was prudent not to roll it in. Let's see how we perform this quarter and our view from there and we would be in a better position to call the full-year then.

Understood. And a question for Scott. Scott, just on the auto exposure in AEM given some weakness in that end market, can you discuss your exposure and how you might offset that end-market weakness going forward?

Yes, I mean, we’re certainly less exposed to auto than we used to be. It's still a critical segment to us; maybe it's a third or less of our exposure there; but again our big driver is our model and our project pipeline system and we’ve a tremendous number of projects that are in the auto area that aren't necessarily dependent on overall auto volume growth.

Thank you very much.

Thanks, David.

Thanks, David. Anita, let's take our next question.

Hi, good morning. Thanks very much.

Good morning, Jeff.

Last year, you had a really strong quarter in Acetyl Intermediates where your volumes grew mid-single-digits and this year in the first quarter they were down low-double digits. And methanol prices also really lifted year-over-year, and I think you transfer raw materials at cost from AI to AEM. So with some of the margin deterioration in AEM due to higher raw material costs that were embedded in Acetyl Intermediates, both from the change in volume and from the change in methanol prices.

I will let you know that our transfer prices are very close to market, Jeff.

Okay.

So, we work hard to avoid shifting things around; there is probably a slight curve, but…

Okay. You took a $27 million charge for a contract cancellation in ethanol. Can you explain what that was about? Did the cash flow impact occur in the first quarter, or will it affect future quarters?

So, the cash did not go out, and many of these contracts in the Acetyl Chain on the supply side, well I wouldn't say many, but there are a handful of very key supply streams where your vendor is really setting up shop there for you and making a huge investment. So, if you think of the industrial gas company business model, that's what it is. So you’re signing long-term contracts that allow them to recover their capital that they incurred for you or for us. So that number is essentially the present value of what we owe them over time. So it will be paid over time.

Okay, great. Thank you so much.

Thanks, Jeff. Anita, let's move to our next question, please.

Thanks and good morning. Just, Scott, you mentioned that you’re working on some unlisted projects or some things to, I guess help the consumer acetate tow business. And I guess, what you're talking about maybe some production reductions of your own; number one. And then this is a follow-up, you guys think that the stability can take place in tow in 2018 without any production coming out from yourself or from other industry parties?

Yes, I mean, Vincent, what I will say is, we’re always working on a number of things, but specifically there is a lot of productivity work going on in the tow business and that can involve assets, it can also involve co-producer arrangements too.

Okay. And just as a follow-up, on AEM the JV income was a bit stronger than we expected. Was there anything specific to this quarter and in terms of the balance of the year? I think you will have a turnaround in Q2, but is there anything we should think about as we model the JV income for the balance of the year?

Yes, I mean, I don’t think there is anything to really highlight. It was a stronger quarter sequentially than before; it probably won't be quite that strong in the next couple of quarters coming up, but it's not far off.

Okay. Thanks very much.

Thanks, Vincent. Anita, we will take our next question.

Great, thanks. So you guys have pointed to about 8% to 11% growth in 2017 on EPS. If we take a similar look at '18, we get to about $8. In the past, you’ve talked about $8 to $8.50. So, would you need additional M&A to get to the upper end of that range, or are you still looking at that as achievable? And maybe you can just talk about the pipeline a little bit.

Yes, when we provided those figures, the $8 to $8.50 range did not include mergers and acquisitions. However, we did not expect the significant drop of over $100 million in value from the cellulosics business. Therefore, we need M&A to help us, and I would estimate that it should contribute around $0.50 to $0.60 for us to have a chance at reaching that target. As a result, we are likely to pursue additional M&A to ensure we achieve that.

And then, maybe you can just, as a follow-up talk about your cash use plans and the pipeline a little bit. Are you still looking at splitting that between M&A and buybacks? Thanks.

So, we have an authorization that would allow us to do about $500 million this year, and that’s currently our intention is to do $500 million of share repurchases in 2017. At that point, that authorization ends, so we will be talking more soon about changing uses of cash and what that looks like, but if we’re successful on executing continued bolt-on acquisitions, it will be difficult to sustain that kind of pace of share repurchases.

Thanks.

Thank you. Anita, we will move on to the next question.

Hi. This is Matthew Stevenson on for Jim. Is the demand environment in China following the Chinese New Year sufficient to support the recent price movements, the favorable price developments in Acetyls there, or is it purely a result or only being supported by the tight supply due to outages there?

Hey, Matthew. It's Pat. I would love to tell you that the demand is driving a big change in margin performance in China, but the reality is it's an oversupplied market today. So we’re really watching kind of short-term dynamics in our ability to make choices in our chain, in our plans to kind of benefit ourselves and influence as much as we can. We’ve been talking about the higher coal cost environment that really started in the second half of last year and continued into the first quarter. And that put many of our competitors in a position where they want to drive price, and they’ve been doing that; we've been doing that, and that’s benefited us ultimately on margin as well. I think the dynamics that we talk about in terms of outages is primarily a Western Hemisphere dynamic, and as we've said we’ve seen that developing throughout the first quarter in a very positive way, and we feel good about where we’re headed in the second quarter.

Understood. Regarding the timing of earnings throughout the year, when you announced your Q4 results, you mentioned that earnings in the second half of 2017 would be $0.35 to $0.40 higher compared to the first half of 2017. Now that estimate has been lowered, and it appears that the reduction is primarily due to consumer-related issues. Can you elaborate on that?

I’m sorry. Can you repeat the first part of your question? I missed it.

Sure. So, I believe the guidance now is for the second half of 2017 to see earnings per share of about $0.20 higher than the first half of '17, and that’s less of a step-up in the second half than we had previously been anticipating.

Right.

And so, I wonder if you could elaborate on that and just based on your performance versus consensus by segment, it seems like that came out of consumer, like out of the tow business. So I’m not sure, if that’s accurate to some extent or if you can elaborate on what is driving those dynamics?

I believe you're being a bit too analytical about this process. We began the year with an understanding that to achieve our targets, certain conditions needed to be met; we anticipated raw material inflation, which is happening, and we're taking advantage of it. This is mainly anticipated to impact the latter part of the year. We're expecting this inflation to increase as the year progresses. We've seen approximately $40 million so far, and we believe it will exceed $200 million by the end of the year, indicating it's more concentrated in the latter half. Therefore, we were aiming for around $0.40 of earnings in that period. Now that we have one quarter's results, I want to clarify that I'm not claiming sole credit for this. We need to continue into the year a bit more to assess how inflation plays out and ensure we can realize the expected value. At that point, we can discuss how to adjust our projections at the end of next quarter, but that's the extent of it.

Understood.

It's just a high level haircut for the back half of the year.

Understood. Thank you.

Yes.

Anita, please go ahead.

Good morning. Thank you. Could you quantify any benefit of productivity initiatives that that you achieved in the first quarter?

Yes, yes. We’ve a $100 million in for the year and we were roughly on pace that might be a little bit higher than that in the first quarter and that’s pretty evenly split between the groups.

Got it. Thank you. And then, just turning back to Acetyls, could you help us understand the total EBIT impact of the outages in the second quarter if we look sequentially versus the first quarter, including the missed opportunity and the actual cost that will not be capitalized?

Yes, we don’t really break it down that way. So I’m not trying to withhold that. I just don’t have it in front of me, Alex, to break it down that way. I mean we will have …

And we have some expense in the first quarter already.

Yes.

We were already spending money in the first quarter as we entered it. Therefore, you see both volume metrics and higher expenses in the second quarter.

But I guess, directionally, is it going to get worse in the second quarter, or stay at about the same level?

Yes, it's going to stay roughly the same level, I'd say going through the quarter, maybe a little better.

Okay. Thank you very much.

Yes.

Thanks, Aleksey. Anita, we will take our next question.

Thank you. Just to triangulate a little more on the AEM earnings growth, you mentioned double-digit organic growth in AEM or the earnings from the legacy wholly-owned AEM operations also up double-digit?

Yes, this is Scott. The legacy earnings growth from quarter to quarter is not quite double-digit when excluding the affiliates. However, I want to point out that in our first quarter this year, there is a significant charge for inventory adjustments, about ten million dollars, due to our inventory reduction from sales. If we exclude that charge, our earnings growth would definitely reflect double-digit growth, which aligns with our double-digit volume growth.

Last year, we were building inventory for a significant turnaround. This year, due to strong sales and our observations in the marketplace, we are depleting a lot of that inventory. So, there was a notable charge related to that, which somewhat overshadows what Scott mentioned.

And then, Scott, you gave us these project count numbers in terms of new projects launched and backlog. Is there a way to qualify the quality of the backlog? I’m sure there are long-cycle projects, short-cycle products; there are higher profitability and lower profitability. Is it homogenous enough that we can use the raw project count as a good metric?

I believe that the increase in closed projects is a positive indicator. Our current pipeline includes approximately 4,000 to 5,000 projects, which supports our ability to grow the closure rate consistently each year.

Okay, but you wouldn't expect much mix effect that the raw count will actually be a good metric?

Well, I think the number of closes of projects is a good metric to judge how the business is doing.

You bet.

Thanks, John. Anita, we will take our next question.

Good morning. Just a question on the raw material spike. Given the increased raw materials in Q1 and subsequent price initiatives that you’ve gone after, to what extent do you see the potential for actual margin expansion in Q2 and as we progress through the year, or are the increases that have been announced sort of merely intended to catch-up with the increase in raws?

Yes, the inflation of raw materials started late in the fourth quarter, and we discussed this in the first quarter earnings call a few months ago. This trend has continued, and we have been successful in navigating these increases more effectively than anticipated. We have managed to expand margins across nearly all product lines in Acetyls, with the exception of the earlier mentioned China VAM situation. We feel that we are just beginning our efforts in many respects, as the significant tightness caused by outages in the Western Hemisphere started to impact the market in late March and into April. Therefore, we expect further margin expansion in the second quarter and are optimistic about our current position.

Okay. And just one clarification question. Earlier you mentioned there is a $250 million sort of full-year headwind from raw materials. Are you saying that about $40 million of that you had experienced in Q1?

Yes, those are gross numbers. So, I’m not giving you the net; some of that is past due, some of that we have to really fight to cover, but yes we had about $40 million, I think it was $38 million to $40 million of gross inflation in major raw materials and energy through the first quarter.

Thank you.

Thanks, Bobby. Anita, let's move on to our next question.

Good morning, Mark.

Good morning.

Mark, obviously a lot of sort of conversations around the spikes in raw material prices that we’ve seen. Obviously, it seems that methanol at least, as I take a look at the spot market and certain new sort of contract pricing that’s coming out, there seem to be signaling some methanol pricing declines. Now similarly on the ethylene side, there is a perception in the marketplace that as turnaround season is over and more capacity comes online, ethylene pricing may come under pressure as well. So obviously, I mean cutting through all of this, it seems that raws may continue to be volatile at least in the near-term. So my question really is, as we’re seeing all of these ups and downs in product pricing, are you seeing buyer patterns change, meaning are you seeing people holding leaner levels of inventory or destocking or any of those elements?

Yes, you see all those things every day. I mean that’s everybody tries to guess what raws are going to do and take an advantage of anywhere they can. What we see with raws is that if you look at year-over-year, so just from a year-over-year basis, I'm pretty confident we will be several hundred million dollars higher, but when we end this year than last year, how that actually rolls out quarter-to-quarter. We had a spike up in methanol. We had a major outage of the world's largest MTO plant, and they dumped ...

400.

KT is navigating the market dynamics today, and you're likely to observe some fluctuations. However, the overarching trend shows increasing inflation, and there's a limit to what can be done in the long term to address it. Ultimately, it needs to be integrated into the value chain. In the short term, you might postpone purchasing decisions or build inventory, among other strategies.

Fair enough. Now on a different topic, you've mentioned that throughout this year, you're essentially planning to use the entire $500 million share buyback authorization. My question is, as I look at the 52-week trading range of your shares, they have been in the low 60s and low 90s, and today they are closer to the higher end. Does this affect your approach towards buybacks? Do you still anticipate completing the full $500 million, or might that slow down a bit?

I don't change the calculations; earnings have been growing within the Corporation alongside the equity base. We anticipate continued earnings growth, projecting to reach $8 or $8.50 by the end of next year. You can forecast what you believe the share price will be next year based on that, but we expect both earnings and share prices to rise. From an intrinsic value perspective, we believe the shares are currently priced attractively. We are on track to reach $500 million this year.

Very helpful. Thanks so much, Mark.

Thanks, Hassan. Anita, we will move on to our next question.

I just wanted to follow-up a little bit more on the margins for AEM segment. I know we talked about this a little bit already, but I wanted to get some more clarity around if we saw any margin compression in that legacy business or was it mostly due to SO.F.TER? I’m just trying to get a sense of that 3% kind of looks like year-on-year pricing decline. Do we see that in which segment of the AEM business?

Yes, this is Scott. There are really two main factors. First, SO.F.TER has been integrated into our operations, which has resulted in lower margins. The second key factor is the double-digit millions inventory charge we faced in the first quarter, which wasn't present in the other quarters. These two aspects primarily contributed to the decline in margin.

Yes, last year we were building up inventory in anticipation of a significant turnaround. This year, due to strong sales and market trends, we are depleting a lot of that inventory. As a result, there was a significant charge that somewhat obscures what Scott was referring to.

Thanks, John. Anita, we will take our next question.

Hey guys, good morning. Mark, just going back to your comments on inflation and just to clarify in the $200 million plus in growth inflation. In your 8% to 11% earnings guidance, are you assuming that you fully offset that growth inflation number for 2017?

Oh, yes.

Yes.

Good. Okay, great. And then also in terms of the VAM pricing environment in China, can you just give us a sense as to the difference in production cost during the first quarter and has there been any improvement into Q2 thus far?

Yes, so the dynamic in VAM in China really changed towards the end of the year beginning of this year, when essentially the relative competitiveness of the carbide VAM producers and the ethylene VAM producers switched and changed both our behavior as well as theirs. So it was towards the end of the quarter, really just that light switch flipped on us. So as a result, then we really minimized rates early in the first quarter backed away from influencing the market with production in the market if needed, and the carbide guys kind of filled that space. That dynamic still exists today. I mean, ethylene remains very strong. It's pushing over $1,200 a ton again. So we will need to monitor ethylene that's going to judge what we need to be doing inside China. That capacity is still competitive on an export basis to fill in some supply commitments that we’ve made, so we do move a little bit out of China to ensure we keep our customers supplied.

Okay. Thanks so much.

Thanks, Ghansham. We will wrap up the call now. Thank you, everyone for your questions and for listening in this morning. We will be around if you’ve any further questions. Anita, I will turn the call over to you now.