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Edited Transcript of CBT earnings conference call or presentation 7-May-19 6:00pm GMT

Q2 2019 Cabot Corp Earnings Call

BOSTON Jul 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Cabot Corp earnings conference call or presentation Tuesday, May 7, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Erica McLaughlin

Cabot Corporation - Senior VP & CFO

* Sean D. Keohane

Cabot Corporation - President, CEO & Director

* Steven J. Delahunt

Cabot Corporation - VP of IR & Treasurer

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Conference Call Participants

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* Christopher John Kapsch

Loop Capital Markets LLC, Research Division - MD

* Daniel Dalton Rizzo

Jefferies LLC, Research Division - Equity Analyst

* David L. Begleiter

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

* James Michael Sheehan

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Jeffrey John Zekauskas

JP Morgan Chase & Co, Research Division - Senior Analyst

* Kevin William Hocevar

Northcoast Research Partners, LLC - VP & Equity Research Analyst

* Michael James Leithead

Barclays Bank PLC, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Cabot Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to Steve Delahunt, Vice President, Treasurer and Investor Relations. Sir, you may begin.

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Steven J. Delahunt, Cabot Corporation - VP of IR & Treasurer [2]

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Thank you. Good afternoon. I'd like to welcome you to the Cabot Corporation earnings teleconference. With me today are Sean Keohane, CEO and President; and Erica McLaughlin, Senior Vice President and CFO.

Last night, we released results for our second quarter of fiscal year 2019, copies of which are posted in the Investor Relations section of our website. The slide deck that accompanies this call is also available in the Investor Relations portion of our website and will be available in conjunction with the replay of the call.

During this conference call, we will make forward-looking statements about our expected future operational and financial performance. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements.

Additional information regarding these factors appears under the heading Forward-Looking Statements in the press release we issued last night and in our last annual report on Form 10-K that is filed with the SEC and available on the company's website.

In order to provide greater transparency regarding our operating performance, we refer to certain non-GAAP financial measures that involve adjustments to GAAP results. Any non-GAAP financial measures presented should not be considered to be an alternative to financial measures required by GAAP. Any non-GAAP financial measures referenced on this call are reconciled to the most directly comparable GAAP financial measure in a table at the end of our earnings release issued last night and available in the Investors section of our website.

I will now turn the call over to Sean Keohane, who will discuss the key highlights of the company's performance. Erica McLaughlin will review the business segment and corporate financial details. Following this, Sean will provide closing comments and open the floor to questions. Sean?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [3]

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Thanks, Steve, and good afternoon, ladies and gentlemen.

In the second quarter of 2019, we have navigated a number of challenges in the business environment. Despite this, we delivered solid results with adjusted earnings per share of $0.99.

During the quarter, we delivered strong cash flow performance, and we advanced our strategic portfolio objectives with the signing of an agreement to divest the Specialty Fluids business. But before we get into more details on the financials, I'd like to take a moment to discuss the themes of the quarter.

Similar to other global chemical companies, we were impacted by soft automotive production, a weak environment in China and higher raw material costs during the quarter. These high-level themes impacted both our Reinforcement Materials and Performance Chemicals segments.

For Reinforcement Materials, we saw a more competitive intensity in Asia relative to the same quarter last year driven by market softness and more modest levels of environmental curtailment across the chemical space in China. Looking outside of China, we benefited from strong pricing in our 2019 global customer agreements, but this benefit was offset by feedstock headwinds in the quarter. While we are pleased with the results of the customer agreements, continued strong attention to pricing actions is necessary to address the cost of environmental compliance and the trend of widening feedstock differentials. While the macroeconomic environment was not very supportive, our volumes held up relatively well due to the importance of the replacement tire market.

In Performance Chemicals, soft automotive production and the challenges in China can be seen in the weaker volumes for the segment. While Performance Additives experienced a minor 1% decline overall, the product mix was materially weaker in Specialty Carbons as demand for higher-margin automotive and fiber products declined. In Formulated Solutions, we experienced a 16% decline year-over-year due to softer automotive production and destocking across the auto and plastics value chains.

EBIT in our Purification Solutions segment increased $7 million year-on-year as we saw improvement from volume growth, strong specialty pricing and lower cost as a result of the transformation program we launched in the first quarter. While we continue to explore strategic options for the business, we are pleased with the performance improvement in the quarter and the outlook for the remainder of the year.

As I look at things in our end markets across the globe, this looks to be more of a slow and steady recovery as opposed to the bounce-back we had been anticipating after the Chinese New Year. Clearly, we are experiencing a demand environment that is not reflective of underlying fundamentals as destocking and a very weak automotive production has impacted volumes and mix in the recent periods. The lack of visibility on U.S.-China trade has also reinforced a more cautious tone among our customers.

As we build our way to a more normal environment across the balance of the calendar year, we expect steady improvement in performance. Looking at the start of our third quarter, we are seeing the shoots of a recovery and expect a stronger end market environment by our fiscal fourth quarter. While the current environment is choppy, we are committed to the long-term growth plans in our core businesses and have conviction around the fundamentals of our markets and our strategy. We will continue to balance growth investments with a philosophy of tight cost management and a sustained focus on working capital to drive strong operating cash flow. We also remain committed to returning cash to shareholders. And in the quarter, we repurchased shares of $50 million and paid $20 million of dividends. We have now repurchased $238 million of shares over the last 12 months.

I will now turn the call over to Erica McLaughlin to discuss the business results in more detail.

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Erica McLaughlin, Cabot Corporation - Senior VP & CFO [4]

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Thanks, Sean. I'll now discuss the segment results beginning with Reinforcement Materials.

EBIT from Reinforcement Materials for the second quarter decreased by $18 million as compared to the same quarter last year. While we delivered significantly higher pricing related to our 2019 customer agreements, this benefit was offset by the impact of lower margins in Asia from a more competitive pricing environment. In addition, we experienced higher raw material costs from both higher feedstock differentials and the timing of the flow-through of raw material costs. Globally, volumes declined 1% in the second quarter as compared to the same period of the prior year primarily due to a 6% decrease in volumes in EMEA from softer automotive demand. Despite the lower margins in Asia, we delivered volume growth of 2% driven by higher volumes in China as we remain a preferred supplier of carbon black in the country.

Looking ahead to the third quarter, we expect a sequential improvement in margins as the raw material flow-through challenges we experienced in the second quarter are not expected to repeat in the third quarter, the impact of which was roughly $10 million in our second quarter. During the third quarter, we also have a scheduled downtime for one of our U.S. EPA-related investments, which will result in higher fixed costs, and the negative impact from the inventory drawdown. While the expected sequential improvement is a positive sign, we anticipate that the third quarter will remain below the prior year as the pricing environment in Asia will take some time to fully recover. With the expectations for stronger auto demand in the back half of the calendar year, particularly in China and Europe, we continue to expect a strong fourth quarter for the segment.

Now turning to Performance Chemicals. EBIT decreased by $19 million year-over-year largely due to lower volumes and a less favorable product mix. Weak automotive production and destocking resulted in volumes declining 1% in Performance Additives and 16% in Formulated Solutions. Weaker demand in the more profitable automotive and fiber end markets resulted in a less favorable product mix. The mix challenges primarily impacted the specialty carbons and specialty compounds product lines in the quarter.

Looking ahead to the third quarter, we expect volumes and margins to increase sequentially. Volumes are expected to improve as automotive and plastics demand recovers and destocking abates, which will result in a margin improvement due to a mix benefit. As well, we expect to benefit from lower raw material costs flowing through.

The Performance Chemicals segment will also be impacted by the scheduled downtime for the U.S. EPA-related investment, which will result in higher fixed costs, and the negative impact of inventory drawdown related to this event in this segment as well. Similar to Reinforcement Materials, our expectation is for a strong fourth quarter as automotive production improves and destocking comes to an end.

Now moving to Purification Solutions. In the second quarter, EBIT increased by $7 million compared to the same quarter of last year. This was driven by higher volumes in our specialty applications, including automotive, pharma and catalyst, in addition to improved margins as our price increases in the Specialty Applications took hold. The business also reduced fixed costs in the quarter driven by savings from the previously announced transformation plan.

Looking ahead to the third quarter, we also expect to see sequential improvements from seasonally higher volumes and further benefits from actions being taken in our transformation plan.

For our Specialty Fluids segment, second quarter EBIT increased by $15 million as compared to the prior year due to an increase in project activity. We expect to complete the divestiture of the business in the third quarter, and we anticipate minimal EBIT contribution from the segment going forward.

I will now turn to corporate items. We ended the quarter with a cash balance of $176 million, and our liquidity position remains strong at $630 million. During the second quarter, cash flows from operations were $90 million, which included a decrease in net working capital of $22 million from a reduction in inventory. We expect to see a further reduction in working capital for the next 2 quarters, and working capital should be a source of cash for the full fiscal year.

Total capital expenditures for the second quarter were $43 million, and we're expecting the full year spend to be in the range of $250 million to $270 million driven by growth projects, including the 2 new fumed silica plants in the U.S. and China and sustaining and compliance capital, which includes EPA-related capital investments.

As previously discussed, we returned cash to shareholders through $20 million in dividends and $50 million of share repurchases. Our operating tax rate was 24% for the quarter, and we anticipate the fiscal year rate will be between 23% and 25%. The increase in the tax rate from 21% in 2018 is driven by U.S. tax reform, and as we noted last quarter, this additional tax cost is a significant headwind to the year in the amount of roughly $0.20 of adjusted EPS.

I will now turn the call back over to Sean.

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [5]

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Thanks, Erica. Now I'd like to give you an update on our outlook for 2019.

Despite a challenging first half of the year driven largely by a weak China environment, we are beginning to see signs of improvement in that market. Stimulus measures appear to be taking hold. Automotive production in China is projected to improve in the third calendar quarter. China's PMI for March was above 50 for the first time since October of 2018, and our March and April order books are showing signs of pickup. We have also seen favorable commentary recently from President Xi about the importance of continued environmental enforcement. Based on these positive indicators, we are projecting a gradual improvement in pricing and volumes for the second half of fiscal 2019.

As discussed, we anticipate improving sequential results in our Reinforcement Materials and Performance Chemicals segments driven by volume and margin recovery. The sequential improvement in Reinforcement Materials and Performance Chemicals will largely be offset by the impact of our Specialty Fluids segment, which remains on track for divestiture in the third quarter. Our outlook for the fourth quarter remains strong based on projected improvement in automotive production and a strengthening environment in China.

Based on this, we expect full year adjusted EPS to be in the range of $4.05 to $4.30. We are confident in the fundamentals of our core businesses, our leadership positions and unparalleled geographic footprint and the robustness of the industries we serve. Our Advancing the Core strategy seeks to balance growth and leadership in our core businesses with robust cash return to shareholders. We have conviction that this is the right strategy for Cabot, and we are committed to delivering another year of earnings growth while investing for the future, divesting non-core businesses and returning cash to our shareholders.

Thank you very much for joining us today. And I will now turn the call back over for our question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Mike Leithead with Barclays.

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Michael James Leithead, Barclays Bank PLC, Research Division - Research Analyst [2]

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I guess, first, if I look at the first half, reinforcement and performance businesses combined are earning about $100 million a quarter in EBIT. So can you just talk a little bit more about the magnitude of the step-up you're expecting in 3Q and then what that implies for 4Q? It sounds, from the commentary shown, that the 3Q pickup is slightly above the $10 million in EBIT you're losing this quarter from spec fluids. Am I reading that correctly?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [3]

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Well, we expect that we won't have any further contribution from Specialty Fluids in the quarter. That's right. So that will largely offset the sequential improvement that we're expecting to see across both Reinforcement Materials and Performance Chemicals in the quarter. So that's the right high-level picture.

If you think about the progression, Mike, through Q3 and Q4, we are seeing, today, what looks to be sort of a slower and steadier improvement rather than a sharper uptick that we had to anticipate in coming out of Chinese New Year and with resolution of U.S.-China trade. So I think what we're going to see is more of a step-by-step improvement here, and the results expected in the third quarter, I think, are evidence of that.

Now as we look to the fourth quarter, we are expecting a further step-up based on a couple of key things. One, that we will -- if projections around the automotive improvement materialize, that will certainly help. Continued steady improvements in China, which we're beginning in sort of March and April, to see some modest price increases. And so as those continue throughout the balance of the year, that will be a positive. And then in the fourth quarter, we won't have a repeat of the EPA project, which is quite substantial in the third quarter. And the non-repeat of that means that the impact from unabsorbed cost or inventory change, as we call it, is -- doesn't occur in the fourth quarter. And then finally, as you know, we have our Wuhai project coming onstream in China during the fourth quarter, and we would expect to have some contribution from that as it begins to ramp up. So these are the key drivers of how we see progression across Q3 and 4.

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Michael James Leithead, Barclays Bank PLC, Research Division - Research Analyst [4]

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Got it. That's a helpful bridge. And then on capital deployment, there's obviously been a step-up in buybacks over the past 3 quarters. Can you just talk about the extent you're willing to use your balance sheet here at current share price levels for repurchases? Or I guess how do you think about the appropriate leverage levels in the current macro backdrop?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [5]

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Yes. Well, I think a couple of things here, Mike. One is that share -- cash return to shareholders is an important part of our capital allocation framework, and so we believe that's the right long-term way to drive TSR for the company, that along with earnings growth. Now more recently, we have been more aggressive in share buybacks because of where we view the stock price as well as how we see the current cash flow situation. So we'll continue to look at that and evaluate as we go forward. And you have seen some step-up in using the balance sheet to do this. But I think in light of the current environment, I think we want to be prudent here, and so we'll continue to do that. We've always had a view that maintaining investment-grade credit rating is important for Cabot, and I think that's proven out over the long term, so we'll maintain that posture.

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Operator [6]

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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 [7]

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Sean, just to get on the pricing in China, can you discuss the dynamics in this quarter and exactly why you think it will get better by Q4, demand will get better, but still, some of those competitive intensities, I suspect, will be sustained going forward?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [8]

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Yes. Sure, David. So I think we've seen quite a sharp reversal in China, and I think it's really a confluence of a number of factors as we were -- well, clearly, China, in terms of the macro numbers, has been quite weak over the past 9 months or so. And they have been working to sort of regain their footing in terms of overall kind of macroeconomic picture, number one. Number two, the auto numbers, auto OEM, has been really weak. I think we had probably about 9 months, I think, where we had negative year-over-year comps, and so they were quite pronounced. And at the same time, while there was demand softening, there was a pretty sharp drop late in the calendar year in Chinese coal tar prices. And so as coal tar prices were coming down, people had high-cost inventory in a weak demand environment, and so there was a certain flushing of inventory type of a behavior. As we look at that, our view is that it's not sustainable and not representative of where the market has been recently. So more of a temporary phenomenon and reflecting this confluence of factors.

Now as we go forward, if we're not going to see a real sharp snapback in demand but more of a steady rise in economic activity there, then we're expecting that the pricing recovery in that market will also be more steady, and so that's what's implied in our outlook at this point. And if you look at where we were in both March and April, we were able to get pricing up in both months, although somewhat modest. But I think 2 months in a row of moving prices back up, I think, is reflective of where the market needs to go to restore back to the right levels.

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

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That's very helpful. And just one more thing. Just -- you mentioned the feedstock differentials impacting the raw material issue. Could you just -- a little more color on that point?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [10]

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Yes, sure. So I think this topic has been an important one and we've touched on a little bit over the last year. There are clearly a number of factors in the feedstock environment that are converging today, some of them related to MARPOL and the change in sulfur spec. And then some of them actually related to the change in the crude slate as you have less heavy crude from places like Venezuela and Mexico than your -- the quality, let's call it, of the carbon black feedstock is lower, and so that leads to differentials or differences between the actual costs we're experiencing and our pricing mechanism to pass these through. And so our view on this is -- remains consistent that these costs have to be passed through down the value chain. That's our model. It has been for a long time in terms of these formulas. And we have been working through mechanisms, both contractual mechanisms as well as spot market mechanisms, when we find that there's a disconnect. And while we're making good progress on that, there's more work to be done here, David, and so I think that will -- that is setting up further pricing action as well as that will inform -- is informing the conversations we're having with customers around next round of negotiations.

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Operator [11]

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Our next question comes from Jeff Zekauskas with JPMorgan.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [12]

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When you divest the Specialty Fluids business, are there stranded costs that remain? And if there are, how large are they? And how much do you have to spend to eliminate them?

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Erica McLaughlin, Cabot Corporation - Senior VP & CFO [13]

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Jeff, it's Erica. So there's very minimal stranded costs that will still be with the business, so there's not anything, I think, to worry about in that case.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [14]

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Okay. You talked about price decreases in China in Reinforcement Materials. If you looked at the magnitude of those price decreases on profits in the segment and you compare them to the benefits that you got by pricing up in Europe and the United States, how would those 2 numbers compare?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [15]

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Yes. So the numbers, Jeff, would be roughly equal if you look at the pricing gains that we got from both our contract and spot markets outside of China and Asia South, so call it kind of rest of the world, or you could think about it as Americas, EMEA and Japan. So those are typically more of our contract markets. And so the benefits there were around $20 million up in the quarter, so I think this is positive and indicative of the core strength of the business.

Now the situation in China and Asia South, as I've said before, you can kind of think about these markets as sort of behaving as one. And so the impact in the quarter there on the negative side was about roughly the same, roughly the same number.

So as we think about going forward here, we'll see a steady improvement in the pricing environment in China as we sort of work off this sort of temporary bottom that we're at. But we think it's going to be more of a steady climb back rather than a snapback.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [16]

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So prices in China must have been down a lot because maybe the non-China businesses are twice the size of the China business. Is that right?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [17]

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Well, so prices were down pretty sharply because feedstock, you remember, dropped very sharply, and so the combination of that and weaker demand left people holding high-cost inventory. And so the behavior was to try to move it fast and clear it out, and so I think that exacerbated the situation, for sure. Now if you look at where we are now, we have seen not all but a substantial portion of that coal tar price decline rebound and rebounded pretty quickly. And that is providing that, along with the fact that those sort of dumping or clearing prices aren't sustainable. So the combination of those is causing prices to appropriately start moving back up, and we saw progress against that in both March and April. So I think as the demand environment continues to firm up from the very sort of unusual and confluence of negative factors here to a more normal level, then we expect the restoration of profit margins there in China.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [18]

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So maybe I didn't ask my question right. So was the decrease in China profits equal to the increase in the profits in the other region in the quarter?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [19]

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Well, I think there's 3 -- there are 3 factors in terms of the Q2 profits, Jeff, so in terms of the decline, and so you can think about them as roughly equal. There was the positive pricing up outside of China and Asia Pacific South. There was the pricing down in China and Asia Pacific South, and then there was the feedstock challenges. Those -- all 3 of those were roughly equal in sort of approximately the $20 million range. And then all that $20 million that was related to feedstock, about half of that was timing flow-through, which we do not expect to repeat.

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Jeffrey John Zekauskas, JP Morgan Chase & Co, Research Division - Senior Analyst [20]

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Okay. That's pretty clear. And then lastly, you talked about the strength in the fourth quarter. And would you see that strength if auto production in Europe and in China were flat year-over-year? Or do you actually need higher year-over-year auto production to achieve that strength that you see?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [21]

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Yes. So if you think about the range that we have, Jeff, so certainly, to hit the top end of that range, we would need to see pretty solid, positive year-over-year comps. Now that's what IHS is calling for in calendar Q3 and calendar Q4, and now of course, our fiscal will only pick up one quarter of that. But we would need to see what they're calling for, and the impact there is principally a mix improvement. I mean the volume increase is not that big of a driver but more the favorable product mix that comes there. So I think that's one important factor. I think we also would need to see that, with polymer prices lifting, the destocking in the plastics chain starts to shift to a bit more of a restock position. And that would impact both our -- the plastics side of specialty carbons as well as our specialty compounds business. So we need to see a couple of those factors starting to kick in to think about the upper end of the range. And so if you think about kind of a balanced view, I would say, yes, we need to see some improvement, but we don't have to have the factors swing as positively to hit the top end as we would hit the top end. So...

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Operator [22]

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Our next question comes from Jim Sheehan with SunTrust.

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James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [23]

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Could you give us more detail on the green shoots you're seeing? Is it more in the auto area or the plastics or exactly where?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [24]

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Yes. So we're seeing -- in terms of looking at the order book, we're seeing some positive signals there and, in certain applications, beginning to see volumes look a little firmer than we had been seeing. So I think that's probably an indication that destocking is coming to an end and beginning to turn. If you look across the plastics value chain and you just look at underlying polymers you saw in April, it's pretty much all of the polymer -- polymers began to tick up in terms of pricing. And so I think that also has historically been a signal that starts to firm up demand and, depending on how sharp that is, can begin the restocking process. I wouldn't say those moves have been significant enough yet to do that but positive in that each of them turned up in the month of April.

I mean the other things that we are seeing is across China. While I think it's still early days, the momentum around stimulus measures beginning to take hold is positive. For the last 2 months, PMI has been over 50, which it hadn't been for a while. And I think most recently, President Xi, again, has been public about returning to a more aggressive posture around environmental enforcement. And probably, that kind of commentary wouldn't be happening if there wasn't some confidence on his side around stimulus beginning to firm things up in terms of the economy.

So I think there are a range of things that we look at here, Jim, that I would put in this category of green shoots.

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James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [25]

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Okay. And on that subject of environmental inspections, there was an accident, an explosion in Jiangsu, and we've heard reports about increased safety inspection activity. Are you seeing any impact in terms of your facilities being inspected or others in the industry?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [26]

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So you're right. There was a terrible accident there that resulted in pretty significant loss of life and has, in fact, resulted in an increase in the intensity around inspections. And so we definitely see that, less so at our sites, but just sort of observing what's happening across the industry, we definitely see that. So I think the combination of things like that as well as China's long-term commitment to improving air quality mean that the environmental agenda, I think, remains important here. Although over the last 6 months or 6 to 9 months, it seems that they did take their foot off the accelerator a little bit as they were trying to work through global trade issues with the U.S. and regain their footing in terms of economic growth. But we definitely are seeing that across the chemicals sector, Jim, but no direct impacts on us.

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James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [27]

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And on the subject of differentials, is this only happening in raw materials in China? Or is it more of a global phenomenon? And I think you had actually fixed this problem earlier in Europe a few years ago. Is this just a matter of applying the same fix you did before? Or is it more complicated than that?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [28]

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Well, it's always more complicated than that, but I think, Jim, you're directionally right here. So at a high level, the differentials are because of what's happening in the U.S. Gulf Coast. Since that's the biggest pool for carbon black feedstock, it not only supports the U.S. but also supports parts of Europe and significant parts of Asia, excluding China. So what you're seeing here is with -- probably some early movements as people are preparing for MARPOL that's causing some movements, as well as the crude slate, again, is not as heavy because of quantities of crude that are not coming out of places like Venezuela and Mexico is sort of degrading the quality somewhat of the carbon black feedstock slate. So all of that is resulting in differentials that need to be passed on down the chain.

Now you're right. We have been working through a combination of contractual mechanisms, so things like the deliberate cost adjustment in our contracts as well as mechanisms where, when we see cost diverge, we have an opener in our agreements with customers to discuss this and attempt to get recovery for. And so we need to stay the course on this because it's an important factor, and it's clearly one that has to get managed in our business model as these need to get passed on. So we're spending a lot of time educating our customers on this and making sure that they understand this is a critical part of us providing long-term viable supply to them.

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Operator [29]

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Our next question comes from Kevin Hocevar with Northcoast Research.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP & Equity Research Analyst [30]

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I want to -- I think it was around this time last year that you started negotiations for the 2019 rubber carbon black contracts. So curious if you're starting to see that again at this time this year for 2020 contracts.

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [31]

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Yes. So Kevin, I think we have, indeed, started some preliminary discussions with customers, I think, in response to their requests to do so. I'd say they're at a very early stage, and we're definitely being selective here to make sure that we engage in the right way and have the right deals. I think particularly with respect to providing mitigation of feedstock risk due to any impacts that may emerge over the balance of the year related to MARPOL, I think this is, as you know, a bit of a moving target, and this kind of a spec change across the refining industry is a really big deal. So I think we want to tread carefully here and make sure that we manage this in the right way. If there's a -- this year, I would say, and last year as we started addressing these MARPOL risks in any differentials, this will remain an important part of annual contract negotiations. And so we're spending a lot more time with customers on this in preparation. So the answer is yes. It's a little more complex because of the education required, but I would say we're making very good progress in this regard.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP & Equity Research Analyst [32]

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Okay. And then can you comment -- so you've talked in the past about potentially -- strategic alternatives for Norit. And curious, any updated thoughts there? It seems like the business has stabilized a bit and actually getting better here and something you expected to get sequentially better from here. So curious if you can just update us on your thoughts around that.

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [33]

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Yes. So my thoughts haven't changed here, Kevin. In terms of the long-term view on this, we don't view it as a strategic part of the portfolio and, therefore, have been and will continue to aggressively pursue alternatives here. I can't speak more specifically than that at this point, but I do want to be clear that the strategic intent and our motivation has not changed at all. Now in the meantime, we've been aggressively working to improve results. We're pleased to see that, that is beginning to show itself here, which is, I think, a really positive signal. And the efforts by the team on all of the different levers of our transformation plan are certainly beginning to pay off.

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Operator [34]

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Our next question comes from Laurence Alexander with Jefferies.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [35]

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This is Dan Rizzo on for Laurence. How does IMO 2020 going to affect the raw material cost differential that you guys are kind of describing?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [36]

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Well, I think it's difficult to exactly project, Dan, because, again, this level of a spec change across the refining sector is somewhat unprecedented. And so I think everyone is really working hard to understand what the impact could be and put the right mechanisms in place to deal with it. Our view remains unchanged here, that our business model is about providing high-value, high-performance carbon blacks to our customers, and the movements around feedstock are intended to be passed through and passed down the value chain. And so that remains unchanged. The only difference here is that the traditional indices may not, with the advent of MARPOL, reflect exactly the way we're experiencing costs. And so I think it's going to be very important that we continue to educate our customers here and that we get the right mechanisms in our contracts to reflect this so that we can really focus our attention on how we create value for our customers, which is around the quality of the product, the performance and the application and the overall supply reliability and environmental stewardship, which -- these are the elements of the value proposition that customers pay us for.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [37]

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Okay. And then one other. So with all the headlines we're seeing about, potentially, a step-up in Chinese tariffs, I was wondering if you guys have a view on how that would affect you if things were to go -- if the talks were to end and higher tariffs were installed as early as this Friday?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [38]

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Yes. So we're certainly being kept on our toes with the regular tweaks here back and forth between the 2 sides. The way I think about it is a bit more at a structural level, Dan. If you look at the tire industry today, you're getting close to 40% of the world's tires are made in China. And so this is across both passenger cars, truck and bus tires as well as a whole host of off-the-road tires. And so in effect, the world is structurally dependent on Chinese tires. And so as tariffs, if they get implemented, that would certainly cause some short-term price impacts that ultimately are going to flow right through to consumers. But the ability for the structural supply chain to sort of pivot quickly outside of China is pretty limited because of just the absolute size and the fact that these are structural value chains, not like textiles or something they can move and chase low labor and other things very quickly. That's not the case here.

So there would certainly be some short-term impacts just around consumer sentiment and everything else if, in fact, those aggressive tariffs come in. But I sort of look through that and think about the structural aspect of it, and I think that structural view is pretty -- is real.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [39]

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Okay. And then one more if I may. So you mentioned improved pricing in Purification Solutions. I thought competitive pressures would make it kind of difficult. I was wondering if there's been competitors who've left the market or how things improved just in general, I guess.

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [40]

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Yes. No, fair question, Dan. So we have called out, in the past, competitive pressure, especially around what we call the North American powder market. And so this is a market where activated carbon is used in mercury removal and some other applications, and I would say that situation remains largely unchanged. But where we're seeing pricing strength right now is across our specialty portfolio. And so one of the key elements of our transformation plan is built around market choices and applications that we want to serve. And so a greater emphasis on selected specialty applications is an important part of that transformation plan, and we're seeing pricing support there as we focus.

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Operator [41]

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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 [42]

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I had a couple of follow-ups. First, on the green shoots, I'm assuming that your commentary is that you're seeing green shoots primarily or most pronounced, at least, in China. Are you also seeing any improvement maybe into April -- into May, I guess, now in Europe? Or could you just talk about the trends you see in Europe and how you see that moving forward?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [43]

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Yes. It's more related to China, Chris. I mean there are some selected areas where we're seeing some firming in Europe. I would say in reinforcement, it's kind of status quo, I would say, no significant bounce up. But if you look across our plastics value chain as polymer prices are starting to move up, then we've been seeing an improving volume picture in our specialty compounds business, where we produce black masterbatches and compounds for the plastics industry. And so you saw in our numbers that Formulated Solutions volumes were down about 16% in the quarter. I think that's obviously reflecting a pretty significant destocking, and that often does happen in the plastics chain. And in the last couple of months, we've started to see those volumes trending back to more normal levels. I would not say they've tripped the point of kind of restocking, but they have solidified. And the movement of polymer prices up a bit, I think, is helping there.

So principally China, a few selected markets where we're seeing some positive momentum in Europe. But on the reinforcement side, I would say kind of status quo in Europe.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [44]

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Got it. Okay. And then I think it was in your formal comments. You mentioned in Reinforcement Materials that your volumes were up 2%, I think, in China, not just greater Asia. And so I'm assuming that's a better performance than the carbon black market over there, which would imply market share gains. So is that an accurate depiction of what's happened? And can you just talk about, if that's the case, visibility around sustaining those share gains as we move forward through the balance of, say, calendar '19?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [45]

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Sure, Chris. Erica is going to jump in here and provide a bit of color on that specific point for you.

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Erica McLaughlin, Cabot Corporation - Senior VP & CFO [46]

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Yes, sure. So the increase of 2% was in Asia, so total Asia includes our South Asia and Japanese business as well. But the driver of the increase was China, so China did improve year-over-year as well. I would say that is better than market performance, where we -- the market, I think, was down overall for the quarter. I think the reason it is, is really because of our leadership position in the country, and so I do think we're still a preferred supplier. And so we saw still pretty good volumes, and I think people prefer to have Cabot supply them. China, for us, on the reinforcement side, the pressure came more in the pricing.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [47]

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Was it -- but the reason for the share gain -- I understand your competitive position, but was it -- was anything tactical about your business decisions there that led to the share gain? And just in terms of the sustainability of the market share gain, could you just speak to that?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [48]

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Yes. I mean I think -- maybe I'll add a couple of things here, Chris. I think as people navigate their way in China through this sort of period of uncertainty, I think a supplier like Cabot, a bit of a safe harbor kind of supplier, I think it's important and really valued by our key customers. And so while that didn't -- that didn't immunize us from having to deal with some pricing pressures, I think that's pretty clear, as we were heading into the winter period and customers not knowing exactly how things were going to play out, having the strength and reliability of Cabot in their portfolio, I think, is really important to them. And now what we have to do is build from that position and restore the pricing and margins back to levels that we feel are more appropriate for this business and where they've been historically, and we're making progress on that. And it will be a step-by-step process, but we're making progress on that. And I'm optimistic that as we build through the year, we'll demonstrate that pricing and margin recovery, and the share will remain pretty firm.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [49]

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Got it. And then just one additional follow-up if I could. I think you said in the Performance Chemicals business, you were going to experience a shutdown associated with the installation of the necessary EPA equipment. I'm just wondering if that is a dedicated specialty black facility. Or is it also double as a Reinforcement Materials production facility? And is that impact confined to your fiscal third quarter? And then where are you in terms of the other plans in terms of retrofitting to achieve -- or to meet the EPA Consent Decree?

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [50]

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Thanks, Chris. Yes, Erica will pick up on this one here.

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Erica McLaughlin, Cabot Corporation - Senior VP & CFO [51]

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Yes, Chris. So this is a plant that serves both Reinforcement Materials and specialty carbons, so you'll see the impact in both segments. I'd say it's a pretty substantial downtime for us, so almost about half the quarter, the plant will be down to do a first-phase implementation for this investment. And so total magnitude for Cabot is probably around $7 million in Q3, and you can split that kind of half and half to each segment. It's a pretty substantial carbon -- specialty carbons facility as well as reinforcement.

And your second part of your question, largely about the EPA spend. So you are right. We were the first to settle with the EPA in terms of this pollution control equipment consent decree, and so we implemented one plant, and that's been completed. This is our second plant, and this plant will come in 2 phases. So this is the first phase that we're doing now. We got an extension to the consent decree, so then we will do a second phase at a later date. And then we have our third plant, which will have to come online by 2022.

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Operator [52]

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And I'm showing no further questions at this time. I'd like to turn the call back over to Sean Keohane for closing remarks.

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Sean D. Keohane, Cabot Corporation - President, CEO & Director [53]

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Great. Thank you, Shannon, and thank you all for joining us today, and thank you for your continued support of Cabot. And we look forward to speaking with you next quarter or somewhere out on the road during the next quarter. Thanks very much.

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Operator [54]

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Ladies and gentlemen, this concludes today's conference. Thanks for your participation, and have a wonderful day.