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Edited Transcript of ALB earnings conference call or presentation 8-Aug-19 1:00pm GMT

Q2 2019 Albemarle Corp Earnings Call

BATON ROUGE Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Albemarle Corp earnings conference call or presentation Thursday, August 8, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Ryan

Albemarle Corporation - VP of Corporate Strategy & IR

* Eric W. Norris

Albemarle Corporation - President of Lithium

* Luther C. Kissam

Albemarle Corporation - Chairman, President & CEO

* Raphael Goszcz Crawford

Albemarle Corporation - President of Catalysts

* Scott A. Tozier

Albemarle Corporation - Executive VP & CFO

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Conference Call Participants

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* Arun Shankar Viswanathan

RBC Capital Markets, LLC, Research Division - Analyst

* Christopher John Kapsch

Loop Capital Markets LLC, Research Division - MD

* Colin William Rusch

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* David L. Begleiter

Deutsche Bank AG, Research Division - MD and Senior Research Analyst

* Dmitry Silversteyn

The Buckingham Research Group Incorporated - Director

* Jeffrey John Zekauskas

JP Morgan Chase & Co, Research Division - Senior Analyst

* Joel Jackson

BMO Capital Markets Equity Research - Director of Fertilizer Research & Analyst

* Joshua David Spector

UBS Investment Bank, Research Division - Equity Research Associate - Chemicals

* Luke Emerson Washer

BofA Merrill Lynch, Research Division - Research Analyst

* Matthew Stephen Skowronski

Nomura Securities Co. Ltd., Research Division - Research Analyst

* Michael Joseph Harrison

Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst

* P.J. Juvekar

Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD

* Robert Andrew Koort

Goldman Sachs Group Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Albemarle Corporation Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Mr. Dave Ryan, Vice President of Corporate Strategy and Investor Relations. You may begin.

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David Ryan, Albemarle Corporation - VP of Corporate Strategy & IR [2]

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Thank you, and welcome to Albemarle's Second Quarter 2019 Earnings Conference Call. Our earnings were released after the close of the market yesterday, and you will find our press release, earnings presentation and non-GAAP reconciliations posted on our website under the Investors section at www.albemarle.com.

Joining me on the call today are Luke Kissam, Chief Executive Officer; Scott Tozier, Chief Financial Officer; Raphael Crawford, President, Catalysts; Netha Johnson, President, Bromine Specialties; and Eric Norris, President, Lithium.

As a reminder, some of the statements made during this conference call about our outlook, expected company performance, planned joint ventures as well as lithium production capacity and demand may constitute forward-looking statements within the meaning of federal securities laws. Please note the cautionary language about forward-looking statements contained in our press release. That same language applies to this call.

Please also note that our comments today regarding our financial results exclude nonoperating, nonrecurring and other unusual items. GAAP financial measures and reconciliations from those to the adjusted numbers discussed today may be found in our press release and the appendix of our earnings presentation, both of which are posted on our website.

Now I will turn the call over to Luke.

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [3]

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Hey, thanks, Dave. Good morning, everybody, and thanks for joining us on the call today. In the second quarter, excluding currency impacts, Albemarle grew revenue and adjusted EBITDA by 6% and adjusted diluted EPS by 20% compared to the second quarter of 2018. Volume and pricing contribute to the year-over-year growth in lithium and bromine while pricing was up year-over-year in catalysts. Scott will go into more detail on our quarterly performance and outlook for the rest of the year in a minute.

I want to focus my comments on why we are adjusting our lithium capital expansion plans to significantly reduce capital expenditures in the medium term. The potential impact of EV subsidy changes in China, possible shifts in cathode chemistry, excess inventory held in spots along the supply chain and the current oversupply of lithium carbonate in the market has caused some caution in the energy storage value chain. All of this has put downward pressure on price, and we expect to see this pressure on carbonate pricing continue in the near term, but we also expect supply/demand dynamics to tighten in 2020.

We have always stated that we would add production capacity to meet demand. As you can see on Page 8 of our earnings presentation, Albemarle has decided to delay all work related to planning, engineering and construction of approximately 125,000 metric tons of previously announced additional conversion capacity. We anticipate that these changes will reduce our capital expenditures by approximately $1.5 billion over the next 5 years and allow Albemarle to become free cash flow positive in 2021.

As part of this strategic pivot, we recently announced amendments to the transaction with MRL. The joint venture will now be owned 60% by Albemarle and 40% by MRL. Albemarle will pay $820 million in cash and contribute a 40% interest in the 50,000-tonne lithium hydroxide facility currently under construction by Albemarle in Kemerton, Western Australia. This facility is still on track to be commissioned in stages, commencing in the first half of 2021. We had previously announced that the first phase at Kemerton would be a 75,000 metric ton hydroxide facility, but we are scaling the total capacity back to 50,000 metric tons at this time. The Wodgina mine will still have the ability to support at least 100,000 met tons of lithium hydroxide. However, any additional conversion capacity expansions in this joint venture will be based on market dynamics, and we would expect a lower capital intensity per metric ton of capacity.

This transaction still unites the mining expertise of MRL with the lithium expertise of Albemarle. And the modification accelerates the joint venture's ability to bring lithium hydroxide to the market. Albemarle will continue to have responsibility for marketing all of the product produced by this joint venture.

In China, our 20,000 met ton Xinyu II lithium hydroxide facility continues to ramp production and is on pace to reach the full capacity run rate by year-end. With several large customer qualifications complete, we continue to anticipate meaningful sales growth supported by this facility during the second half of 2019.

In Chile, our 2 existing operating units in La Negra remain on track to produce close to 40,000 metric tons of lithium carbonate this year. The 40,000 tonnes of La Negra III and IV remains on schedule for completion in the first quarter of 2021. Based on what we are seeing in the carbonate market and to better manage our cash flow, we have decided to delay all work on the Salar yield improvement project at this time. This will likely limit our ability to operate La Negra III and IV at nameplate capacity initially and will delay our ability to build a safety stock of concentrated brine for a rain event or similar issue. However, we are confident we will still be able to meet our commitments to our carbonate contract customers.

While we are pulling back on previously announced conversion capacity expansions, I want to point out that Albemarle has access to the best lithium resources in the world; the Salar de Atacama, Greenbushes in Australia; and, upon closing the MRL transaction, Wodgina. No other lithium company can match the quality, size or diversity of those resources. Albemarle will be cash flow positive in 2021, and our balance sheet will get stronger and stronger as we grow EBITDA and operational cash flow over the next few years. This will give us the flexibility when market conditions dictate to build or buy additional conversion capacity that will use feedstock from the world's best lithium resources.

In closing, as we promised we would do, we are adjusting our capital expansion plans to respond to market conditions. We will still be able to meet all of our commitments to our contracted customers, but we'll reduce capital expenditures significantly in the medium term, allowing Albemarle to be free cash flow positive in 2021. We have access to large, high-quality, low-cost lithium resources and the financial flexibility to build or buy conversion capacity in the future if doing so creates value for our stakeholders. In short, we are well positioned for and excited about the future.

With that, I'll turn the call over to Scott.

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Scott A. Tozier, Albemarle Corporation - Executive VP & CFO [4]

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Thanks, Luke, and good morning, everyone. For the second quarter, we reported unadjusted U.S. GAAP net income of $154 million or $1.45 diluted earnings per share. We reported adjusted earnings per share of $1.55, an increase of about $0.19 or 14% compared to second quarter of 2018 or 20% excluding currency effects.

Growth in bromine, lithium and fine chemistry services resulted in an increase of about $0.19. Earnings per share also benefited $0.06 from our 2018 share repurchase programs and $0.10 from a more favorable effective tax rate than was the case in 2018. These gains were partially offset by unfavorable currency exchange of about $0.08 and unfavorable results in the catalyst business compared to second quarter 2018, which was a particularly strong quarter for catalysts.

Now I will cover a few financial details. Based on current geographic sales and production mix year-to-date and our expectations for the rest of 2019, we currently expect our full year effective tax rate to range between 20% and 22%, excluding special items, nonoperating pension and OPEB items.

Corporate costs in the second quarter were $39 million, an increase over the same period in 2018 primarily driven by an increase in unfavorable currency losses of approximately $8 million. Full year 2019 corporate costs are now expected to range from $130 million to $140 million.

For the first half of the year, net cash from operations was $199 million, down $25 million from last year, impacted by higher cash taxes and increased working capital to support increased sales in lithium in the second half of 2019.

Capital expenditures during the first half were $416 million, and we now expect full year CapEx for 2019 to range between $900 million and $1 billion.

Expenditures for the Kemerton project remain on track. However, some expenditures that were planned for 2020 are now expected to occur in 2019. This is largely driven by increased activity in Australia and a requirement by vendors for higher upfront payments.

At the end of the quarter, our net debt-to-adjusted EBITDA was 1.5x. After the MRL deal closes, we expect our gross debt-to-adjusted-EBITDA ratio to be around 2.7 and net debt-to-EBITDA to be around 2.2 and expected to improve going forward. We will secure new debt to finance the joint venture and for general corporate purposes. Initially, a delayed drawdown -- draw term loan will be put in place. This may ultimately be converted to long-term debt.

Turning to the details of our business performance now. In the second quarter, lithium delivered sales of $325 million. Excluding unfavorable impact of currency, lithium sales were up 5% compared to the second quarter of 2018 driven by increased volume of 3% and increased price and mix of 2%. Pricing was up 1% primarily in specialty products such as butyllithium and battery-grade materials.

Adjusted EBITDA of $142 million was flat compared to the second quarter of 2018, and adjusted EBITDA margin was 44%. In bromine, second quarter net sales and adjusted EBITDA grew year-over-year by 17% and 20%, respectively, excluding the impact of currency. Adjusted EBITDA margins were strong at 32%. Although we have seen some weakness in our connectors business that serves the automotive and construction markets, we have been successful to date in shifting our bromine to other end markets where demand remains more robust.

Volume growth in the second quarter was aided by our JBC expansion that is running well and was brought online in the third quarter of 2018.

Catalysts reported second quarter net sales of $266 million and adjusted EBITDA of $67 million. The decline in results was caused by a volume shortfall in fluid catalytic cracking or FCC catalysts due to delays in the start-up of new units and changes in customer mix. This was partially offset by favorable pricing in FCC and higher sales volume and a favorable product mix in clean fuel technology or HPC. Insurance payments related to weather received during 2018 were also an unfavorable factor in the adjusted EBITDA comparison.

Let me turn to the rest of the year now. In lithium, we continue to expect year-over-year volume growth of 15,000 to 20,000 metric tons and an adjusted EBITDA growth rate in the mid- to high teens. With multiple customer qualifications complete, hydroxide volume from Xinyu is expected to drive a stronger second half. We are seeing pricing pressure on some technical-grade products and expect second half pricing to be flat to slightly down compared to 2018. However, we still expect full year pricing to be flat to slightly up versus 2018 and to see sequential adjusted EBITDA growth in the third and fourth quarters.

In catalysts, the FCC customer start-up delays are expected to impact full year volumes. We are working to mitigate the short-term impact by placing volume at other accounts where the pricing meets our profitability targets, but it is unlikely we will fully replace the delayed volume. To be clear, we have secured this FCC business, so it is a matter of when, not if, we ship FCC catalysts to these refineries. For HPC, the full year remains on track, although timing of orders has shifted around a bit.

Putting all of this together, we now expect full year adjusted EBITDA of the catalyst segment to be down mid-single digits on a percentage basis excluding divested businesses. Second half results are expected to be spread fairly evenly across the third and fourth quarter and flat to first half.

The downside in catalysts is offset by an improved outlook in bromine and fine chemistry services. Our 2019 order backlog in bromine remains healthy, and we now expect full year adjusted EBITDA growth in the range of 10%. Global economic weakness is always a risk for this business, although signs are pointing toward a potential 2020 impact on bromine rather than 2019.

For the total company, excluding divested businesses, we are reaffirming the full year guidance of net sales growth in the range of 9% to 15% and adjusted EBITDA growth in the range of 7% to 14%. We are increasing guidance for adjusted diluted earnings per share to $6.25 to $6.65, a pro forma growth rate of 15% to 22% over 2018.

Now I'll turn the call back over to Dave.

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David Ryan, Albemarle Corporation - VP of Corporate Strategy & IR [5]

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Thanks, Scott. Before we get to Q&A, I want to call your attention to our press release of August 6, announcing that we will host an Investor Day in New York City on the morning of December 12, 2019. Additional details will be forthcoming, but we look forward to the opportunity to provide a detailed update on Albemarle and the strategy and priorities for the company and each of our global business units.

Operator, we are now ready to open the lines for Q&A. (Operator Instructions) Please proceed.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Josh Spector with UBS.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [2]

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Can you hear me?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [3]

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Yes, we can hear you.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [4]

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Okay. Great. Yes, sorry, it is a patchy connection. Just a question on CapEx kind of over the next 5 years. So I understand you took down the number, and I -- so I wonder, if demand does materialize kind of over the next 2 or 3 years, either at or ahead of your expectations, do you see some of that CapEx coming back into your planning? So I guess I'm thinking, if you're adding new capacity in the mid-2020 time frame, you probably need to start building or spending on that in early 2020. Kind of how do you balance that versus what you've said on the release earlier?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [5]

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Yes. Great question. If you look, what you see is we are building out Kemerton, which would add another 50,000 met tons of lithium hydroxide. And then in the chart, we show that we are assuming we will build out another 50,000 metric tons with our partner, MRL, once that deal closes. So that will reduce the capital that we will have to expend for that next 50,000 metric ton of capacity. We're essentially sharing that capacity with our partner. So we believe that when we look at the demand, that it would be out further past that 2021 time frame where we would have to commit any more capital. So we're very comfortable with the free cash flow number that we say and being free cash flow positive in 2021. And then as our EBITDA grows, we will selectively buy or build additional capacity if the market demands it at a lower capital intensity than what we are seeing today.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [6]

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Okay. Great. And just on -- so first, Mineral Resources and the spodumene availability, how does the change in the JV impact any of the plans there to the extent you can provide any color of what's going to happen with the capacity, which you aren't going to be allocating to Kemerton at the start?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [7]

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Yes. Upon the closing of that transaction, we'll work with MRL to determine the best approach on that spodumene. But it certainly appears to us today that the market is adequately supplied with spodumene today.

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Operator [8]

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Our next question comes from David Begleiter with Deutsche Bank.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [9]

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Luke, just following up on that situation, the additional Talison spodumene, where will that be processed? Or how will that be allocated going forward?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [10]

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Under the Talison agreements, we have the rights to 50% of the offtake, and our partner, Tianqi, has the rights to 50% of that offtake, so that won't change in any way going forward, David. I'm not quite sure I understand the question.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [11]

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With the reduced capacity in Kemerton, will you be processing any of the Talison spodumene in the 50,000 tonnes of initial Kemerton capacity?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [12]

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No. That'll be used with Wodgina rock. We would expect to do that, but we certainly have flexibility to allow us in the future to -- with these resources to do whatever makes the most sense from a financial perspective.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [13]

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Pretty good. And just on second half lithium EBITDA guidance, Luke, it is a big ramp-up. You do have Xinyu coming in. But any other drivers for the big second half versus first half in terms of lithium EBITDA guidance range?

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Eric W. Norris, Albemarle Corporation - President of Lithium [14]

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David, this is Eric. So it is -- as you depicted, it's 2 things. It's the Xinyu II ramp-up now that we are -- have 6 months of experience under our belt and are ramping towards full rates, have 4 major customers qualified that can really drive that plant. There's another 6 plus that we'll probably qualify or are in the process of qualifying, but we have sufficient now to fill that plant in the second half of this year. And then the other factor is the ramp-up of -- similarly of La Negra II in Chile and the volumes we expect there. And of course, the underlying factor is strong demand growth in the EV markets, which we -- our demand outlook continues to be as it was 3 months ago for strong growth going forward.

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Operator [15]

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Our next question comes from Arun Viswanathan with RBC Capital Markets.

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Arun Shankar Viswanathan, RBC Capital Markets, LLC, Research Division - Analyst [16]

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Just trying to, I guess, understand your comments and put them in context in the prepared remarks. So obviously, there -- we're going through a little bit of a period of oversupply in carbonate and spodumene, and you've halted CapEx partly as a result. So are we supposed to, I guess, interpret that some of your decisions to not bring as much tonnage to market would help kind of stabilize the market? And do you think we would see some similar responses from your peers in the industry?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [17]

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Yes. I have no way of knowing what our peers in the industry will do, first of all. What we are looking at is we have always told our stakeholders that we were going to invest capital to meet our contracted customers' demand where we could get an attractive return on invested capital. And our stakeholders have been clear. When I talk to shareholders, the #1 thing I hear is, when are you going to be free cash flow positive? It's critical that we adjust our capital to allow us to meet our stakeholders' demand while at the same time driving towards a positive free cash flow. And we put a stake in the ground that we're going to be free cash flow positive in 2021. We believe that will create more value for our stakeholders, and we will have the financial flexibility, if the market conditions call for it, to build or buy additional conversion capacity to meet any increased needs in the market.

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Arun Shankar Viswanathan, RBC Capital Markets, LLC, Research Division - Analyst [18]

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Okay. And as a follow-up, just curious on your customers' acceptance of the long-term contracts. Are you still seeing increased contracting? You mentioned 10 years previous -- on previous calls. Are you still able to extend those agreements? And if so, what's kind of the magnitude or the level of acceptance that you're seeing out there?

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Eric W. Norris, Albemarle Corporation - President of Lithium [19]

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This is Eric Norris. We ended 2018 with largely all of those major contracts extended out in -- somewhere in the 3- to 5-year range, some 5 plus. And that is what is -- we're operating against today. And those contracts are holding. They are all largely outside of China, those types of contracts, and we continue to move forward against them.

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Operator [20]

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Our next question comes from Jerry Zekauskas (sic) [Jeffrey Zekauskas] with JPMorgan.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [21]

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You said that over a 5-year period, you would drop your CapEx by $1.5 billion. So what was your 5-year CapEx expectation? And what is it now?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [22]

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Scott, you have that number off the top of your head?

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Scott A. Tozier, Albemarle Corporation - Executive VP & CFO [23]

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I don't have it off the top of my head. But...

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [24]

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Yes, we'll get back to you with that number. I don't have it off the top of my head. What we did was we went in and looked exactly what we were taking it down. I can tell you by -- we looked at '19 being right around $1 billion, '20 being right around $1 billion and then '21 dropping to around $500 million or so or something like that. Am I right, Scott?

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Scott A. Tozier, Albemarle Corporation - Executive VP & CFO [25]

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Yes. The new is around $500 million, but it was up around $800 million or so.

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [26]

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Yes. So it's about $300 million to $400 million drop, so -- in that 1 year alone. So we'll get that number for you. I'm sorry, I don't have it off the top of my head, Jeff.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [27]

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No, it's okay. Okay. And then just for my follow-up, originally, once your Wave II capacity was done, I think you would have had something like 350,000 or 340,000 tonnes of LCE. And what you're now going to do is you're not going to build 125,000 tonnes of LCE. So basically, what you've done is you've curtailed your longer-term capacity to the mid-decade by about 35%, 35% or 36%. So that must correspond to a diminished expectation for either lithium growth rates overall or lithium profitability overall. Can you give us a sense of why your curtailments are so large and how you got there?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [28]

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Yes, Jeff, certainly can. First of all, we will still have the capability out in the years to either buy or build additional capacity if that's met. I don't -- you should not view this in any way as seen that we don't believe demand is still going to be where it is. We're still bullish on demand. We're at, I think, 1 million metric tons, in that range, by 2025. And we still see that based on all of the data that we have coming in. So it's not demand.

From an actual dollar perspective, I think it's too soon to say whether there's going to be a reduction in EBITDA or not. When the supply/demand has got to have an impact, you -- one would think over time on price. What this will do at 1 million metric tons is it will reduce our market share unless we build more over time. So while it's not on demand, I understand how you do the math on the EBITDA and earnings, but I'm not 100 -- I'm not ready to concede that point yet. If you'll -- we're just going to need to let see how this plays out.

But I want to be clear, we're going to meet the commitments that we have to our customers. We're going to be free cash flow positive in 2021. As we go out through the years and our EBITDA and our volumes do grow, you will continue to see us generate significant free cash flow, and we'll have the balance sheet and the flexibility to invest, either in buying or building additional conversion capacity if it means it makes sense to our stakeholders. And that's probably -- once we say go, if we're building it, it's probably 24 to 36 months.

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Operator [29]

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Our next question comes from P.J. Juvekar with Citi.

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P.J. Juvekar, Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD [30]

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Luke, now that you've delayed a big chunk of your hydroxide capacity, you are going to be more exposed to spodumene concentrate from both Wodgina and from Talison for a longer period of time. Why is that a better economic decision when you know that there is going to be excess rock capacity in the market?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [31]

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Well, you're assuming that I'm selling it. And I'm not saying that they were going to sell it. So we're not going to be more exposed to spodumene rock. We're not going to sell it if there's not a market for it.

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P.J. Juvekar, Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD [32]

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Okay. So you're saying you won't operate the mines if there is no demand for it?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [33]

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I'm saying we will discuss -- after the deal closes, we will discuss with MRL what the best approach is to take on the spodumene rock from that mine.

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P.J. Juvekar, Citigroup Inc, Research Division - Global Head of Chemicals and Agriculture and MD [34]

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Okay. And then most of your canceled capacity is in Australia. Is Australia not competitive either because of higher labor or building costs or whatever or is it because demand is lower, and you're just matching it to demand, has nothing to do with Australia?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [35]

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It doesn't have anything to do with Australia, although I will say -- and it's clear, if you're going to build an asset in China versus you're going to build an asset in Australia, you've got a much higher capital intensity in Australia. It'd be the same thing if you built something in the U.S. You've got a higher capital intensity than you do in China. But what we're delaying is simply what we had on the drawing board, and we're taking that capacity out. And you ought to not read anything more than that into it.

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Operator [36]

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Our next question comes from Robert Koort with Goldman Sachs.

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Robert Andrew Koort, Goldman Sachs Group Inc., Research Division - MD [37]

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Maybe a question for Eric. I'm trying to reconcile Albemarle's unique supply capability. I think you guys have talked in the past about customers have been narrowing or tightening their specifications and your ability to supply their given legacy supply arrangements, qualifications and whatnot. And Luke, you're suggesting maybe you could cede some share. So are the Tier 2 and Tier 3 converters beginning to be able to meet those specifications? Are they narrowing the distance to -- and performance capabilities that you have? And then secondly, are we seeing those goalposts narrowing by the customer base? Are the specs getting tighter or tougher, requiring more out of their suppliers that are lithium suppliers?

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Eric W. Norris, Albemarle Corporation - President of Lithium [38]

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It's Eric. So I would say that this is all about EV growth, right, for our strategy. And first of all, that may be obvious but an important point because where we see that going is largely a high nickel base increasingly, and what we see that needing therefore is hydroxide, lithium hydroxide. When you talk about the types of quality specifications, they are tightening. And you talk about the ability, the supply pace to meet them, it's a handful or less of companies that can do that. So I wouldn't -- I would say that, that is -- today, that is not the nonintegrated producers. It is the integrated major producers in the marketplace.

And so our strategy is one simply around creating flexibility that you're hearing on this conference call for growth while continuing to meet needs, not any statement around what we see competitively in this high-growth market or the continued need for more specialized or high-quality products.

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [39]

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Yes. Bob, this is Luke. As a leader in the lithium business, we feel like we need to put a stake in the ground, and that's what we're doing. We're pivoting our strategy to address the major concern we hear from our shareholders, which is, when are you going to be free cash flow positive? We're going to do -- we're going to be free cash flow positive in 2021, and we're still going to be able to meet the commitments we have to our customers. And we will also have the flexibility in the future using the world's best resources to build or buy additional conversion capacity.

So don't hear me -- please don't hear me say that I'm willing to cede share or I'm happy with a lower EBITDA or I'm not looking for earnings growth. Don't hear any of that. What you ought to hear is we're going to be very responsible in how we are managing our cash to drive shareholder value and meet our customers' demand.

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Robert Andrew Koort, Goldman Sachs Group Inc., Research Division - MD [40]

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And if I could follow up, Luke, that there seems to be an ongoing anxiety in the market about spot prices. And relevant to your portfolio, I think you guys have obviously demonstrated consistently your pricing is not in any way correlated to that spot market. But I am curious, as you think about renewing contracts, I assume some roll in, some roll off, and you're writing a new contract today. Does that still have a price uplift from where it may have been written, the expiring contracts? Or how do you sort of characterize the contract pricing dynamic as you look forward from here?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [41]

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Yes. I'm going to let Eric talk about that. But I think you've got to separate it between what you're seeing today in carbonate and what you're seeing today in hydroxide from a battery grade standpoint, okay? So Eric?

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Eric W. Norris, Albemarle Corporation - President of Lithium [42]

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Yes. So it is different by the 2, yes. I mean first of all, in our mix of business, as I said in the previous question, we are not seeing a lot of -- or we don't have a lot of contracts expiring within the next -- this year or next year. We have a number, a large volume committed on the hydroxide side of that. That is where we see the growth certainly for EVs, but it's also where we see considerable tightness from a supply standpoint both today and into the future.

And so while there might be excess in carbonate, carbonate is also a product that is not the preferred product line going forward for EVs. And as a result, you will see pricing pressure there. And any contract that renews, you'll see more there on carbonate than you would on hydroxide. And so that's really the dynamic we're facing right now.

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [43]

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I mean, Bob, that's the question, is as these contracts enter, we've got to look to see, is a steady price, a set price on that minimum volume the way it makes sense? Or do we go to a band of pricing? How are we going to do this in this evolving market? And that's something that there is a significant amount of focus on, not only internally with Albemarle but on discussion with our major customers, the major battery suppliers and some automotive OEMs because what we're seeing today is that buying decision is moving further to the right of that supply chain. And we are engaged in those discussions at the right levels, and we're going to hopefully reach an arrangement that makes sense for us and for our stakeholders and allows our customers to also meet their demands that they have to the OEMs. That's our goal.

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Operator [44]

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Our next question comes from Aleksey Yefremov with Nomura.

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Matthew Stephen Skowronski, Nomura Securities Co. Ltd., Research Division - Research Analyst [45]

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This is Matt Skowronski on for Aleksey. Given the price volatility you've seen so far this year, are your lithium contracts being executed as expected? Or were there any change in terms midyear?

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Eric W. Norris, Albemarle Corporation - President of Lithium [46]

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Eric Norris here again. So we see a mix of things, right? The vast majority of our business is battery grade. The vast majority of that is located outside of China. And that's where our contract sweet spot has been for years and where it continues to be, where we renewed a lot of our contracts last year for the duration of a number of years going forward. So those -- all those contracts are performing as expected.

We have some technical-grade products that are sold under more shorter-term nontraditional or not traditional for these battery-grade contracts. They are seeing pressure, and Scott referenced that we'll see some of that in the second half of this year. The volume that we have in China today, which is strategic to maintain a position within that supply chain, is also not a traditional sort of contract. It's been shorter term. Some expired this year. And in some cases, we are able to reach a price agreement with some, and others we weren't willing to go where they felt they wanted them to go. And so we walked away from some contracts, but we've kept a foothold in China. So it really would be China, which is less than 10% of our volume; and tech-grade, which is another -- depending on how you count it, 10% to 20% of our volume, that's where there might be some pressure. But in the vast majority of our business and certainly our battery-grade portion of the market that's growing, we're -- those contracts are performing.

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Matthew Stephen Skowronski, Nomura Securities Co. Ltd., Research Division - Research Analyst [47]

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That's helpful. And then what are your early kind of views on demand for lithium in China in July and August so far? Has there been any change or deterioration from June levels?

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Eric W. Norris, Albemarle Corporation - President of Lithium [48]

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Again, it's Eric here. It's a question that I ask my team, and I think it's really way too early to know. You ask it in the spirit of, I think, the fact that the new subsidies went into effect as of July 1. Very often there's a run-up before any subsidy change of buying behavior. And so we don't know what it's going to mean going into July or August. I could speculate one way or the other. The market for EVs remains robust, but subsidies do distort behavior. And so it's possible that July or August could be weak, weaker than they otherwise would be without the subsidy. On balance, though, we see a strong year for China going forward from a demand standpoint.

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Operator [49]

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Our next question comes from Stephen Byrne with Bank of America.

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Luke Emerson Washer, BofA Merrill Lynch, Research Division - Research Analyst [50]

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This is actually Luke Washer on for Steve. So given your decision to reduce hydroxide capacity, could you provide some more detail on what you're seeing on the demand side that's changing your tone? Are you seeing a slowdown in optimism perhaps for the timing and the shift to 811 and the NCA technologies?

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Eric W. Norris, Albemarle Corporation - President of Lithium [51]

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Eric again. So as Luke said, first of all, there's nothing that's changing the next 2 to 3 years, right? The capacity that we have opted to not pursue is in that 3- to 5-year time frame. In that same 3- to 5-year time frame, we'll have certainly the resources and the cash should the market warrant it to go after that opportunity. So it's putting a stake in the ground, as Luke referred to.

In terms of now your question of demand, demand is unchanged from what we thought 3 months ago, from what we thought 6 months ago. It remains strong and probably stronger than -- for hydroxide than we would have expected maybe 6 months ago. So there continues to be that edging towards hydroxide that is supported by NCA chemistries and 811 chemistries.

But I will reiterate what I said 3 months ago, we never expected 811 to be a big player in EVs in the next couple of years. There are technology and processing challenges yet for that technology to be safely used on a large-scale format in the battery for an EV. It is being used experimentally in some -- in China in some consumer goods products. It is being blended with 622 to sort of, if you will, supplement the energy within that battery at a small level. But it is not -- there are today really no -- we don't see any 811 full EV batteries for some time yet. NCA continues to grow, and it's driven by a few automotive producers in particular. And so that continues on.

But again, going back to the original point, nothing has really changed in our demand view in the next couple of years or, for that matter, 5 years out.

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Luke Emerson Washer, BofA Merrill Lynch, Research Division - Research Analyst [52]

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That's helpful. And then on the La Negra III and IV, you expected to add 40,000 metric tons of carbonate to the market, and you're -- now you're delaying that project a bit. What do you believe the effective capacity of those increases will be now?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [53]

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Yes. I think we always intended to bring that capacity on. As 2021 is when we would have mechanical completion in the first quarter, we have to have 4 to 6 months' worth of qualifications. So I wouldn't expect much in 2021. We always talk about bringing these units on 1/3, 1/3, 1/3. So we're confident we can still bring that on. And we could probably have the Salar yield online and have the brine ready for -- by 2023 when we'd need that last 1/3 of that project there. So I would look at it as 15,000, 15,000, 10,000, something like that, something in that range.

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Operator [54]

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Our next question comes from Joel Jackson with BMO Capital Markets.

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Joel Jackson, BMO Capital Markets Equity Research - Director of Fertilizer Research & Analyst [55]

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Luke, you clearly said that being free cash flow positive in 2021 is a key thing for you when considering the changes in the JV with Min Res. And I understand the optionality, I guess, of spodumene for you here. So maybe you could talk a little bit about the rationale about deciding to give over $1 billion of consideration for spodumene resource where maybe in the future, you could go and get that resource later when you need it?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [56]

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Yes. That's a great question. They were running an auction, and it was going to get sold. If you go back to the very beginning of it, MRL was running a process, we were engaged in the process, it was a top-tier asset. If you take Talison out of the equation, you take out Greenbushes, that is the best rock resource in the world. The -- when you look at Wodgina, the size of that resource, the purity of that resource and the skill that MRL brings to the table from a mining standpoint and, I believe, from a capital execution standpoint that can help us, it just made for a perfect fit. Ultimately, you're going to need that volume, and we thought it was best that we had it. We saw it as a good asset. And now when we've restructured it, we have 60% of that joint venture. So that gives us some rise that we didn't have in the past.

So all in all, quality asset. We're going to use that rock for Kemerton. We will also partner with MRL on our next installment of capital, which will further reduce our capital outlay and still allow us to meet our customer demand. So quality resource, quality people, ability to reduce our capital outlay and still have 100,000 met tons' worth of lithium hydroxide coming onboard, it all makes sense to us from a return standpoint.

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Joel Jackson, BMO Capital Markets Equity Research - Director of Fertilizer Research & Analyst [57]

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A little more on the yield improvement program deferral. Is that just matching some of the conversations you've talked about earlier today? Is there anything else going on with the government on getting proper quota increases or maybe [it will cut more on these] type of technologies?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [58]

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Yes. No, this is nothing involved with the government. Our quota system is fine. There have been no changes in any of the regulatory issues and no changes with any of our contracts. This is purely a decision where we saw an opportunity to delay the implementation of capital to allow us to get free cash flow positive more quickly than we were. So we decided that we were going to take the step to do that. Because when we calculate it, we believe we can still meet all of the commitments we've made to the carbonate customers that we have under contract.

So it's all about free cash flow, has nothing to do in any way -- our relations with the government in Chile are fine.

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Operator [59]

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Our next question comes from Colin Rusch with Oppenheimer.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [60]

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Can you tell us what you're looking for from your customers or from the demand environment to think about reanimating these projects? And then can you just update us in terms of your thinking on targeted return on capital? Are you looking at evolving that? Or are you looking for higher returns as you see this market evolve and see the strategic moves play out a little bit more in advance?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [61]

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No. We -- for return on invested capital, we still shoot for 2x our weighted average cost of capital for return. That's what -- and that's always been the case, and we continue to see that as our case.

As what we're looking for, for our customers, at -- if people are going to sell carbonate at the cash costs of that marginal producer, it doesn't make sense for us to add new capacity, and we won't. We can -- because of our position in Chile, because of our cost position in Chile, we can still make very good margins at that level. But we don't see the need to put new capacity in the ground.

So it all comes down to what's the pricing going to be, how is that pricing going to be, how are the contracts coming with the customers, what or how are those going to evolve over time. And those are all decisions that need to be made in the context of a company that needs to make a commitment to our stakeholders on free cash flow, which we're doing.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [62]

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Okay. Great. And then just with the kind of changing trajectory here in the operating expenses, are you -- is the organization rightsized at this point? Do you need to make any adjustments there?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [63]

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Yes. I think as we look at -- as we look out into 2020 and you start looking across our portfolio, we've been operating -- bromine has grown almost double digits for 3 or 4 years in a row. That's not happened before. And we can see some weakness in automotive. We can see some weakness in construction. As we talked about, we've been able to reallocate that bromine molecule to date very successfully.

So those continue to grow. But I don't know how much longer that's practical to expect that business to grow at that. So we are undertaking in the second half of the year a view of our overall costs in a way to try to reduce our overall costs and gain efficiencies going forward. And we'll share more of that with you at our December Investor Day presentation.

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Operator [64]

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Our next question comes from Mike Harrison with Seaport Global Securities.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [65]

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Luke, as you've commented several times about this build-versus-buy decision that you could have looking out a few years when it comes to conversion capacity, does this reflect the view that you think there's going to be excess conversion capacity available when you might need it?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [66]

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Yes. I think there's excess conversion capacity available today and there's more coming online. So I think that it's going to provide perhaps an opportunity for people that are interested in conversion assets. So as an integrated player with the best resources in the world, we believe that, that could be an opportunity for us. And we are always mindful of making sure we're getting the best return on the dollars we invest in that regard.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [67]

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And then I wanted to actually ask you a question about catalysts. Can you just maybe give a little bit of color on the changes in customer mix that you mentioned and the start-up delays, maybe what's causing them and how those play out in the second half?

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Raphael Goszcz Crawford, Albemarle Corporation - President of Catalysts [68]

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This is Raphael. So in the second quarter, the mix in the second quarter was different. Mainly, we had a very strong second quarter in hydroprocessing catalysts in 2018. That is a refill, rebid -- rebed business. So sometimes those projects or those refills shift from 1 quarter to the next. And it just so happened that last year, we were very strong in hydroprocessing.

With regard to FCC, as Scott had mentioned in his commentary, there are some delays in some projects that we have won. It is not a matter of if but when. So we have in 2019 -- coming into 2019, we shed some low-priced, low-margin business to make room for those orders. Some of those have now been delayed. So that gives us a little bit of a gap in 2019, but we fully expect that we will have that business in 2020 and beyond.

So fundamentally, FCC catalysts and catalysts overall in the refining space is very strong for Albemarle.

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Operator [69]

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Our next question comes from Chris Kapsch with Loop Capital Markets.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [70]

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Question probably for Eric, maybe Luke. In your formal comments, you'd pointed to expectation that you'd see tighter supply/demand in the industry in 2020. Just wondering if that's just based on sort of top-down math? Or are you seeing anything specifically from a bottoms-up standpoint, either customer order patterns, inventory levels, anything that -- any acceleration in demand that is pointing to that? If you could just characterize that, that would be appreciated.

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Eric W. Norris, Albemarle Corporation - President of Lithium [71]

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Sure. It's Eric here. So a couple of factors. One, demand is, as we've said on prior questions, continues to be strong, and we see it based on electric vehicle launches, commitments from EV producers to battery producers. We see that demand will continue to step up again in 2020 to a greater degree. We'll give more specific guidance, but it's consistent with our demand model that we articulated of 50,000 tonnes to 60,000 tonnes this year and 1 million by 2025. So it's a natural step-up there. So that's on the demand side.

On the supply side, we are seeing a couple of projects on the resource side be delayed, take longer to come to market and/or, under current economics, we believe may be challenged to operate.

And then finally, inventory, which has been a big factor in the marketplace, this year, we believe, hard to quantify. A lot of it is in China. Within China, that's largely been depleted, we think, from the supply chain on the carbonate/hydroxide side. And what's being enhanced, it's not outside of China. There continues to be some excess rock in inventory outside of China in Australia. And there continues to be some excess salt in some of the battery producers outside of China.

So maybe the balance of this year, that would be drawn down. And when you put that formula together, we see a pretty tight 2020.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [72]

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And then my follow-up is really to the expansion curtailments. And really, the question is, does that strategic pivot juxtapose against a couple of your slides you used in prior investor presentations regarding your lithium hydroxide and lithium carbonate that you have under contract over the 2021 and 2025 period? The question is like, it looks like this decision doesn't influence those metrics on 2020 intended production, but this is really all about not having visibility on the longer-term commitments from customers out to 2025. So if could you just -- is that one way to think about you -- maybe characterize the decisions against those slides.

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [73]

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Yes. So we've made commitments to people out through 2025 in some instances. And in all of these scenarios, we're able to meet those commitments with the capacity that we've announced and that we have under construction today. And we know what the price is on those, and we're able to calculate the return based on what that capital is going to be. But we'll be able to meet everything that is under contract today.

What we're doing now, again, is driving to a free cash flow positive in 2021 with the ability to flex up if necessary to build or buy additional capacity if the market demands it and if we have customers that are prepared to enter into contracts with us for those volumes that we will be producing. But we don't think it makes a whole lot of sense for us to build a lot of capacity if we're not going to have contracts that we can place against those or -- and it doesn't have to be the exact same contracts we have today. We just need to know within the range what that return is going to be, and we can make an intelligent economic decision about what that'll be. So if you see our long-term agreements change a little bit, all these agreements are a little bit different. What we're looking for is a -- not a guarantee but a surety of a return based upon the capital we put in the ground.

But we're going to meet our commitments to our customers. We have enough. What -- this is a pivot to make sure that we're also focusing on free cash flow for our stakeholders, not just a potential for customers to come.

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Operator [74]

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Our next question comes from Dmitry Silversteyn with Buckingham Research.

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Dmitry Silversteyn, The Buckingham Research Group Incorporated - Director [75]

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Can you hear me now?

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [76]

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Yes, we can hear you now, buddy.

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Dmitry Silversteyn, The Buckingham Research Group Incorporated - Director [77]

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Okay. Great. Quickly, on the -- you mentioned higher upfront payments that your vendors are requiring for the expanded capacity that you are undertaking, and that was one of the reasons that your CapEx is staying where it is. I'm just trying to understand sort of why. I mean, are they less -- I mean are they concerned about the rapid lithium expansion across the world by many players? And just want to make sure that you guys are sort of serious about these longer-term orders.

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Luther C. Kissam, Albemarle Corporation - Chairman, President & CEO [78]

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No, Dmitry. This is Luke. It's just a matter of the Australian market is heating up for construction. So you're seeing a lot of activity in mine. You're seeing a lot of activity in Australia. And they got a book of business that there is now -- they are kind of -- they got a good market. I mean they got a good seller's market. And what they're doing is if you wanted to get in line for the time that we wanted to get in line in the shops, we had to pay more upfront to get that preferred space in line, so we could get it to the market when we said we would in that time frame. So that's all it is.

And the cost didn't -- the overall cost isn't changing. It's a matter of we're having to pay a little bit more upfront sooner than we originally thought we would. That's all it is. It's just a market heat-up. It's got nothing to do with Albemarle. It's not -- got nothing to do with lithium, in particular. It's the construction market in Australia.

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Dmitry Silversteyn, The Buckingham Research Group Incorporated - Director [79]

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Got you, okay. That's helpful, Luke. And then just as my follow-up question, on the volume growth that you saw in the second quarter in lithium, I think you talked about 3% volume growth. I mean it doesn't sort of jive well with the market that's growing 60% or whatever, the EV megawatt market -- battery market is growing at. So was this constraint on your capacity that prevented you from delivering a better volume number? Or is there something else going on that's going to go away in the second half, and you're going to get to the growth that is more reflective of what the EV market is growing at?

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Eric W. Norris, Albemarle Corporation - President of Lithium [80]

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This is Eric. So we're selling everything we can make, right? We are ramping up Xinyu II that has natural limitations just on the ramp experience curve, and it has a limitation on customer qualification. But I can tell you that both for that plant and for Chile, which was impacted in the first quarter by a rain event, everything we can make, we can sell.

Where we were limited in the first half of the year on sales growth was opportunistic sales. That will be enabled by tolling of the -- of spodumene capacity we have. Those opportunistic sales were -- are off-contract by nature given that they're opportunistic. A lot of them -- given that half of the market is in China, all of them are in carbonate. And with the excess carbonate market, with prices where they are in that $8 to $9 marginal cash cost range, we just -- it doesn't make sense economically for us to do that. So we've pulled back on that. We've maximized the growth we can get from our internal assets. And what happens in the second half of the year is we get the full benefit of full qualification at Xinyu II, running to full ramp rates on Xinyu II, which is -- nameplate on that facility is 20,000 tonnes. And the same on La Negra, both the benefit of both units running at full tilt as well as seasonally better brine. We have now opportunity to really recover from the headwinds we had from rains in the first quarter. And those are the factors that drive the comparison first to second half.

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Dmitry Silversteyn, The Buckingham Research Group Incorporated - Director [81]

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Got you. So there was a little bit of a capacity constraint that's going to resolve itself in the second half of the year. That's what I wanted to make sure. Okay.

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Operator [82]

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At this time, I'm showing no further questions. I would like to turn the call back over to Mr. Dave Ryan for any closing remarks.

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David Ryan, Albemarle Corporation - VP of Corporate Strategy & IR [83]

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We just wanted to thank everyone for your questions and participation in today's conference. As always, we appreciate your interest. And this concludes Albemarle's Second Quarter Earnings Call. Thank you.

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Operator [84]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.