Q2 2020 Earnings Call
The press Star one on your telephone please be advised that today's conference is being recorded if you're acquiring to further assistance. Please press star zero I wouldn't Alexander Congress or what's your speakers that today, Steve Delahunt, Vice President Treasurer and Investor Relations. Thank you. Please go ahead, Sir. Thank you good morning, I'd like to welcome you to the category.
Ration earnings teleconference with me today, our Sean Keohane, President and CEO, and Erica Mclaughlin Senior Vice President and CFO.
Last night, we released results for our second quarter fiscal year 2020 copies of which are posted in the Investor Relations section of our website.
The slide deck that accompanies this call is also available on 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.
Forward looking statements are not guarantees of future performance in are subject to risks uncertainties potentially inaccurate assumptions and other factors some of which are beyond our control and difficult to predict.
If known or unknown risks materialize or should underlying assumptions prove inaccurate or actual results could differ materially from those expressed or implied by forward looking statements.
Importantly, as we cannot predict the duration or scope of the cobot 19 pandemic.
The negative impact to our results cannot be predicted.
Factors that influence the impact on our business in operations include the duration and extend to the pandemic. The extent of imposed a recommended containment we're mitigation measures in the general economic consequences of the pandemic.
Other important factors that could cause our results to differ materially from those expressed or implied in the forward looking statements.
I discussed under the Ford heading forward looking statements in the press release, we should last night and in our last annual report on form 10-K for our fiscal year ended September 32019, our quarterly report on form 10-Q for our fiscal quarter ended March 30, Onest 2020.
For subsequent filings, we make with the FCC, all which are also 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.
The non-GAAP financial measures referenced on this call are reconciled to the most directly comparable GAAP financial measure.
The table at the end of our earnings release issued last night and available in the Investor section of our website.
I will now turn the call over to Sean Who'll provide an update on the impact of Cobot 19 on our business and operations Erika will review the key highlights of the company's performance business segment results in corporate financial details.
Then Sean will provide some context for how we are seeing the second half of the year developing in light of the cobot 19 pandemic.
We will then open the floor to questions Sean.
Thank you Steve Good morning, everyone and welcome to our second quarter earnings call first I Hope you and your families are all well at this time.
To start the call I want to share an update on the cobot 19 situation.
First I'd like to express my thanks to our first responders healthcare professionals and all those who are working tirelessly on the front lines. The Corona virus response effort I.
I would also like to thank the entire Cabot team for the way they have adapted to these unusual working conditions and maintain the focus on protecting our employees, serving our customers and supporting our communities.
We have a long tradition of community engagement and we are inspired by the many countless acts of kindness and community support from our Cabot team. During this time.
From donating personal protective equipment and contributing raw materials for the production of hand, sanitizer to helping supply food to children, who without access to school meal.
Thank you.
The Kobin 19 pandemic is having a significant impact on the world and our first priority is the health and safety of our employees customers and all stakeholders.
We were quick to take steps to ensure the safety ever from our employees, including halting travel requiring work from home where possible implementing social distancing measures restricting access to our facilities to critical personnel, providing guidelines for self monitoring and screening increasing sanitation proceed.
Features following strict hygiene rules and providing the appropriate protective equipment and procedures to ensure the safety of our people at our sites all around the world.
Additionally, we've implemented leave policies to help support our employees impacted by Cobot 19.
The chemical and materials industry has been deemed an essential industry by most governments around the world.
For Cabot this means that our production facilities have remained open.
Chemical products are essential building blocks for virtually everything and cabot's products, specifically support such important sectors as the transportation of goods the production of medical supplies.
The manufacturer of key infrastructure products, such as power distribution cables consumer packaging and the agriculture sector broadly.
That said many of our plants are operating at significantly lower rates due to the temporary halting of operations by many of our key customers, notably most higher in automotive manufacturers in the Americas and Europe Middle East Africa.
Serving our customers. During this dynamic time requires that are supporting functions of customer service and supply chain operate flawlessly, despite our remote work environment.
Im pleased to report that all of our business processes I T systems and technical service teams are performing consistent with the high level of service that customers have come to expect from Cabot.
Now if I move to the impact of Cobot 19 teen here is what we have seen to date in our business.
We first experience the impact of Cobot 19 in China with extended lunar new year holiday closures at the end of January and into February.
Many of our customers plants in China were closed or running at low rates for most of February.
We began to see week by week improvement as we move through March, but China volumes in the second quarter, we're still down 26% for reinforcement materials compared to the same quarter in 2019.
In terms of the other countries, where we operate in Asia, namely, Japan, Indonesia, and Malaysia, We experienced limited impact in the second quarter.
We have seen more of an impact in these locations in April as the virus has spread to other parts of the region.
We continue to operate our plants in those countries. However, most at significantly reduced rates.
Moving to Europe, and the Americas throughout January February in early March we experienced solid demand across our businesses as the impact of Cobot 19 was pretty limited up to that point.
By the end of March many of our tire and automotive customers across these regions began to stop operations and demand was reduced over the last two weeks of the quarter.
This led to weaker volumes, mainly in our reinforcement materials segment.
At this point all of our facilities remain open but they are operating at significantly lower rates to align to lower customer demand.
While supply chain and logistics logistics disruptions have been cited by some companies we have not experienced any material issues at this point.
In this uncertain economic environment, ensuring strong cash flow and protecting access to liquidity is our top priority.
Our management team has experienced having worked through several recessionary periods over the last 20 years in we know in times like this we must act quickly to generate cash.
On this front, we are taking aggressive actions to reduce inventory levels and accounts receivable, which combined with lower oil prices will result in a significant release of working capital in the second half of the fiscal year.
This counter cyclical cash flow profile is a distinguishing feature of Cabot.
In the 2009 financial crisis Cabot generated strong cash flow from operations. Despite the significant short term reduction in volumes, which allowed US response to respond quickly as demand returns.
We've also taken timely and prudent steps to lower cost in the near term, while balancing our ability to respond quickly when the demand for our non discretionary products returns.
We eliminated all discretionary spending stock travel curtail production tighten plant spending and I temporarily suspended my salary in the third quarter.
In addition cost reduction actions they were underway prior to the cobot pandemic such as the move of our shared service center in the us to Latvia, and the streamlining of our management structure, a now providing significant cost savings in the back half of the year.
We anticipate these efforts will yield a reduction of $45 million of cost in fiscal year 2020.
These cost reductions will partially offset the negative impact from cobot 19, and the cost associated with growth investments.
Finally, we have further reduced our capital expenditure forecast by another $25 million, we've deferred capex, where possible, including the delay of some of our growth projects and this will reduce our capital expenditures to approximately 200 million for this fiscal year.
In terms of capital allocation, we remain committed to our current dividend level and are confident in our cash flow outlook to support this.
During the second quarter, we repurchased $10 million of shares early in the quarter, but we have since halted our repurchase activity as part of our prudent cash flow management actions, we do not anticipate repurchasing shares for the remainder of the fiscal year.
These actions will continue to strengthen our already solid debt and liquidity position.
Our operating cash flow generation has been consistently strong and since fiscal 2015, we have generated over $2 billion in cash.
We are confident that our operating cash flow will be sufficient to fund the dividend and support the capital expenditure needs of our businesses.
In terms of our debt maturity profile. It is staggered with no maturities until fiscal 2022.
On the liquidity side as of the end of March 2020, we have 1.3 billion in cash and committed facilities and we were well below our debt to EBITDA covenant in our revolving credit agreement, which we believe provides ample liquidity cushion for these uncertain times.
We anticipate strong operating cash flow in the second half of the year, resulting in a stable debt profile.
I'll now turn it over to Erika to discuss the results of the second quarter Erica Thanks, Sean.
We delivered solid results in our second quarter. Despite the impact from covert 19 total segment EBIT was 95 million and adjusted EPS of 77 cents for the quarter. The estimated total impact from covert 19 in the second quarter was $21 million EBIT given by lower volumes primarily in China.
We were pleased to see EBIT in reinforcement materials segment increased 30% sequentially and volumes in the performance chemicals segment increased year over year.
As a reminder, our second quarter fiscal 2019 included 12 million of EBIT specialty fluids business, which did not repeat given the divestiture of the business in June of last year.
Finally, we continued our commitment to return cash to shareholders with $20 million in dividends and as John mentioned $10 million of share repurchases.
Now moving to the segments I will start with reinforcement materials EBIT in reinforcement materials for the second quarter fiscal 2020 was unchanged as compared to the second quarter fiscal 2019, even though the segments are lower volumes largely due to the impact of coated 19.
Globally volumes declined 14% in the second quarter as compared to the same period of the prior year, primarily due to a 20% decrease in Asia, where we saw the biggest impact conclude the 19.
We also impacted in Europe, where volumes were down 13% and in the Americas with volumes were down 8% as March was impacted by the spread of covet 19 in those regions.
Offsetting the lower volumes were higher margin due to pricing and mix benefits in both our tire and industrial products product line.
Feedstock protection mechanisms in our customer agreements that were designed to cover a remarkable related effects worked is expected to ensure that our feedstock pass through principles were upheld.
Looking ahead to the third quarter, we expect results in reinforcement materials to be severely impacted bankova 19, as the temporary tire and auto customer shutdowns in Europe in the Americas will significantly impact volumes.
We also expect Asia Pacific volumes to be week as a significant part of that regions tire production is export related.
Current expectation for the third fiscal quarter is for volumes to be down in the range of 40% as compared to the same quarter last year.
We expect margins in the segment to be unfavorably impacted by the rapid drop of feedstock prices as the combination of lower yield and energy center benefits as well as a temporary feedstock timing mismatch due to the southern gap of customer demand will result in an estimated EBIT impact of $15 million to $20 million in the third quarter.
[music].
Now turning to performance chemicals, EBIT decreased by 7 million year over year due to less favorable pricing and product mix and our metal oxides product line, the lower pricing and metal oxides continues to be due to a slowdown in the key transportation and industrial end markets, primarily in Europe in China and an.
Increased competitive intensity exacerbated by the impact of covert 19 in China.
In the quarter volumes increased 6% year over year in performance additive and 8% in formulated solution.
Performance additives volumes benefited in the quarter from higher sales in specialty carbons and from our new China seems silica plant.
Formulated solutions volumes increases were driven by our specialty compounds product line as we realize the benefit from our recent acquisition in Southeast Asia.
Looking ahead to the third quarter, we expect the sequential volume.
From the impact of covert 19 in Europe, and the American However, demand is expected to remain more resilient for products sold into consumer and infrastructure application.
We also anticipate the challenging pricing environment in the metal oxides business will continue.
Now moving to purification solutions in the second quarter fiscal 2020, EBIT increased by $2 million compared to the second quarter fiscal 2019.
This was driven by higher margins from improved pricing and product mix in our specialty applications.
The business also reduced fixed cost in the quarter given my savings from the previously announced transformation plan.
Looking ahead to the third quarter, we expect covert 19 to have a negative impact on volumes and our specialty application, which also negatively impacts product mix in the segment.
Fixed costs are expected to be lower due to asset curtailments, which partially offset the volume and margin headwinds.
I will now turn to corporate items, we ended the quarter with a cash balance of 142 million and our liquidity position remained strong at over 1 billion.
During the second quarter cash flows from operating activities were $24 million and year to date operating cash flow was 129 million.
Capital expenditures for the second quarter fiscal 2020 were 51 million and as Sean mentioned earlier, we're now expecting capital expenditures to be approximately $200 million for the full year down from the forecasted 225 million last quarter given current business conditions.
Also in the quarter, we returned $30 million to shareholders through $20 million in dividends and 10 million of share repurchases.
We have halted share repurchases for the remainder of the fiscal year, given the current business conditions.
Our year to date operating tax rate was 29% and we anticipate the fiscal year rate will be between 29 and 30%.
The increase in the operating rate from our guidance last quarter is largely due to the impact from Covidien 18 on the projected geographic mix of earnings.
I will now turn the call back over to Sean Thanks.
Thanks Erica.
As we look ahead, there is significant uncertainty as to how demand will develop over the coming months.
I'd like to share with you some of the indicators, we are watching that help guide us.
First from a portfolio standpoint, cabot's business is exposed to three high level sectors automotive production replacement vehicle tires, and consumer and infrastructure related applications.
With roughly 25% of our sales link to new vehicle production, we are looking to industry analysts such as I Hs LMC and others as we model what the shape of recovery could look like.
With the exception of China, and North Asia April auto demand globally was down over 50% in each sub region that Hs tracks and as much as 80% in Western Europe.
China is a more positive story as April demand was actually up slightly and provides one view of how quickly we might see a recovery in other regions once economic activity opens back up.
While signs point to April being the bottom as automakers in Europe Middle Eastern Africa, and the Americas restart production. It is still difficult to predict the specific timing and magnitude of such a recovery.
Approximately 40% of our revenue is linked to replacement tires for cars trucks buses and off the road vehicles and demand for the June quarter is expected to be significantly lower than the prior year given the shelter in place orders across the world and the temporary closures of many of our customers tire plants.
While LMC forecasts show that the China market for light vehicle replacement tires is expected to be down only 3% as the industry in that country continues to come back online.
Europe, and North America are expected to be down over 30% year over year in the June quarter.
Replacement tire demand typically rebounds more quickly than OEM tire demand. So we would expect to faster rebound in the replacement tire market just as we're seeing in China right now.
In order to understand the pace of recovery in the near term there are some real time miles driven indicators that we are tracking closely.
Apple is publishing daily information on their mobility trends page that show searches for driving directions on their map SAP by city state and country.
In addition, inrix publishes similar data about miles driven trends.
While we are still far from where we were prior to the pandemic. These data sources are showing positive trajectory in the last few weeks as many countries are starting to ease the social distancing recommendations.
The remaining 35% of our sales is tied to consumer and infrastructure related applications, which had been resilient, thus far, particularly where they are supported by clear consumer needs and government stimulus. These types of applications tend to be less cyclical and provide diversification in our performance additives and formulated solutions.
Businesses.
With this backdrop of external indicators I will provide some color on what we expect to see in our businesses.
While the second fiscal quarter results were solid we did experience a significant demand decline in Europe in the Americas in late March related to covert 19 that we expect to continue and to have a pronounced effect on the third quarter results.
At the segment level, we expect a significant reduction in demand in reinforcement materials in the third quarter due to temporary tire and automotive customer shutdowns in Europe in the Americas.
Walliams in April were 54% below the prior year April.
We are seeing many customers restart plans at the end of April and into May, albeit at low utilization rates and we would expect April Pete to be the low point to volumes for the quarter.
In Asia Pacific, We see a mixed picture as Chinas domestic market has substantially recovered, though exports from China and southeast Asia are impacted by weakness in western economies.
In performance chemicals, we expect product mix and specialty carbons and compounds to be negatively impacted by a further decline in underlying automotive demand globally.
In April volumes were down 3% in performance additives and up 1% in formulated solutions compared to April of the prior year.
Strengthen packaging agriculture, and infrastructure applications, partially offset continued weakness in automotive and building and construction.
So the volumes in this segment have held up quite well in March and April we expect to see some weakening from these levels in may and June although not to the same magnitude as we would expect as we expect in reinforcement materials.
While demand is expected to be weaken the quarter due to cope with 19 related restrictions are operating cash flow is expected to remain strong as net working capital should be a significant source of cash in the second half of the year.
I anticipate operating cash flow to be approximately 200 million in the back half of the fiscal year.
I hope this helps provide some color in terms of what we are seeing in our markets given the lack of visibility into underlying demand due to co benign team, we will not provide adjusted EPS guidance for the balance of the year. This time.
We will continue to update you as we have more information and as visibility improves.
With the current uncertainty we have focused our efforts on stress test scenarios, we know that the underlying demand for many of our products, particularly the replacement tire market has proven to be quite resilient through recessionary periods and that the cash flow tends to be bolstered by an oil related working capital release.
Looking back to the 2009 financial crisis, we experienced volume declines in the range of 25% to 30% across our businesses during three consecutive quarters.
Demand recovery quickly however, in 2010 with volumes returning to pre 2009 levels.
This experience demonstrates the robustness of our end markets and the non discretionary nature of many of our products.
While the length of a downturn is difficult to predict.
Our view is that there will not be a fundamental reduction in demand for our products from cobot 19.
Furthermore, we expect to realize the counter cyclical cash flow profile that we have experienced in previous recessions.
In addition to analyze into 2009 financial crisis, we ran various stress test scenarios to determine the impact on cash flow generation.
These scenarios included volume reductions of up to 40% below the prior year.
In each scenario the working capital release was significant due to lower feedstock prices and aggressive working capital actions, there, probably thereby underpinning solid operating cash flow.
In all scenarios are expected strong cash generation allows us to fund the dividend and capital expenditures and maintain relatively consistent debt levels.
So while we are managing the near term impact on demand from the Cobot 19 pandemic I feel very good about the long term future of Cabot.
First and foremost Cabot is a market leader in each of our businesses holding either the number one or number two global market position across all businesses.
Our global footprint is unparalleled, allowing us to serve our global customers in all regions optimize our supply chain and deploy innovation and best practices on a scale that many competitors cannot replicate.
Cabot has a long technology heritage and we are excited about the potential of key growth investments in transformative applications, such as batteries elastomer composites now called easy to see and the emergence of the packaging sector for our inkjet business.
In each of these cases, we are leveraging favorable market fundamentals and are making prudent investments to create long term earnings potential for Cabot.
Our recent acquisition of San Sean a leading carbon nanotubes producer for the battery sector will strengthen our position in conductive carbon additives.
In the most recent quarter, we announced the commercial deployment of the first easy to see solutions to help tire manufacturers unlock superior performance sustainably and economically.
Both developments position us to capitalize on the transformational potential of these markets.
Cabot's portfolio also has some enduring financial characteristics, our revenue basis geographically diverse and we have generated consistently strong cash flows even during recessionary periods, given the counter cyclical nature of our working capital.
And we have always maintained a prudent approach to balance sheet management with the long term commitment to our investment grade rating and the ample liquidity.
This posture serves us well in times like this allowing us to weather the storm and accelerate into the recovery with our assets and strategy intact.
While the cobot 19 pandemic is certainly challenging all companies, we have conviction in our advancing the core strategy and we have the financial strength to navigate the storm.
Thank you for joining us today, and I will now turn the call over to the operator for our question and answer session.
As a reminder to ask a question you wanting to press star one on your telephone as.
Press the pound Kane, please standby will we compile the Q and a roster.
Our first question comes from the line of Mike, Let Nick from Barclays. Your line is now fair.
Thanks, guys and good morning, hope, you're all stay enroll unhealthy.
Hi, Mike.
First question just on the reinforcement materials side to start a few questions around the trends heading into the third quarter first you called out 54% volume declines in April but can you maybe just give us some color on how the regional dynamics between China and the rest of World Ed second just the $15 million to $20 million EBIT you called out.
Was that just the margin effect or is that incorporating the volume hit as well.
Yes, Mike I Hope I Hope you are you in your family are all well also.
So in terms of the.
The April volumes.
It was certainly most pronounced in the Americas and Europe Middle East Africa.
And so that that significant decline was very pronounced there and no surprise I am sure given.
What you have read about the tire manufacturer is having.
Temporarily closed plants in those regions, but pretty much across the board.
No in in China, we saw plants coming back online throughout the month of March week by week getting a bit better end the domestic market for.
Tires has bounced back pretty well of course, the export market is impacted by what's what's going on.
In the west.
And then with respect to North Asia.
The declines were.
We're we're a little less pronounced so it varies a bit by.
By region, but I would say most pronounced in the Americas and Europe Middle East Africa, given again, what the majors have done in terms of temporary closures and I think the shelters in place have really.
Restricted.
Mobility for during the during the period of April.
Now in terms of the margin impact.
Of 10 to 15 million that we.
We mentioned here.
Roughly about half of that will be a onetime impact in the quarter and these are these are margin impact so not not reflecting.
Volume declines so when you look at dramatically lower oil.
As you know there are really three effects on our business first win win feedstock prices are lower we see some compression as the benefits from our yield projects are less valuable at at lower oil prices and second our energy Center revenue is typically linked to.
To to energy prices.
At where they operate and so lower feedstock prices generally.
Correlate with lower energy Energy Center prices and then the third the third impact when it comes when prices fall very suddenly as we as we saw very sharp drop in combination with a simultaneous demand drop.
We saw this sort of a shock drop if you will when this happens we see.
Mismatch in feedstock inventory that we've purchased to meet our customers forecast and when they finally take those volumes I think this is certainly an unusual situation and we're working closely with our customers to keep the spirit of our matching principal intact. So the combination of these three margin factors is the is.
The impact of $15 million to $20 million that.
Was quoted for for the third quarter, but that is that is not.
Including the impact of lower volumes and again, we'd expect about half of that impact to be one time in the third quarter.
Got it Thats really helpful color and then second I just wanted to dig in a bid into the fumed metal oxides business, which I think should be among the most profitable in the performance segment with seems like Thats one of the meet the main weak points right. Now. So can you just walk through some of the dynamics of what's going on in that market and how you think the market.
Balances itself out over the next one to two years.
Sure.
So let me.
Let me start I think first and foremost Mike by talking about demand the demand environment has been softer, particularly in Europe, and China, and we have a significant presence in both regions and in particular in China.
China makes around 40% of the worlds silicones and of course fumed silica is tightly linked to that.
Chain, so weaker demand in Europe and China.
And in key end markets like automotive and construction has been a significant impact in fact in in calendar 2019, we estimate the market and fumed silica globally actually contracted. So this is a market that overtime has grown pretty consistently four or 5% a year it actually contract.
Did in in 2019 and that was.
Of course pre co bid so.
The further demand weakness is I think exacerbating.
Things and driving up competitive competitive intensity.
In in the regions. In addition, some supply has come on stream recently and so the combination of weaker demand in and supply coming on stream, which tends to be.
Somewhat lumpy in terms of when it comes on thereby pressuring the near term pricing. So while while these factors certainly present near term challenges I think the fundamentals of the business remain attractive the business as you point out has historically been a business with very strong profitability and high EBITDA margins in it.
Again demand is growing in this business overtime above GDP and that sort of 4% to 5% level, because silicones have pretty strong performance characteristics in terms of demand substitution.
And then finally feedstock access and strategic integration I think we'll continue to determine long term growth and profit levels and on this front I think we really well positioned with our strategic fence line partners Dow Silicones, Chem, China, and most recently H. why see in move high.
And I think this industry has historically been well balanced between feedstock supply and silicon demand.
Leading to pretty limited new entrant risk.
Now I think feedstock as you know as a byproduct of both silicones production and and poly Crystal and Silicon production.
And so these these fence line relationships are are pretty are pretty critical you can't just go to the market and by this feedstock.
But capacity additions can definitely be a bit lumpy.
Given the economic scale of investment here and demand growth is historically sold to that capacity up in a relatively short period of time. So I think it's a question of how demand response, but the sort of industry structure in industry fundamentals.
Remain intact from our perspective, so it's a demand question Mike.
Great. Thank you.
Thank you. Our next question comes with a line of Josh Spector from you.
Your line is now open.
Yes, hi, thanks for taking my question.
So just a follow up from the prior question about the margin impact or reinforcements in the quarter you talk about half of that being temporary half of that maybe being oncology I guess, if oil were to stay in this around $30 range would you expect around that $10 million EBIT impact per quarter to persist through the rest of this year.
Or another way weighted would you expect around kind of about 40 million annual impact based on where prices are.
So you're right Josh about about half, we would expect to be onetime and that's the sort of the amount related to this sort of very sudden are shocked drop in terms of both oil.
And demand and then the other factor is really dependent on where where oil is.
And now it's it's rebounded.
A bit here.
Certainly from the lows that that we saw in April.
But it really it really comes down to two aware, where those oil prices are and what the the absolute dollar value is then on.
On the yields projects that we do and the energy the energy Center.
Benefits that we have.
Okay. I mean, do you guys share any sensitivity to your EBIT for every dollar movement feedstocks at all.
We don't because it's a pretty difficult.
It's a pretty difficult one too.
Two there is so many variables here I mean, I think it and it's driven by.
Which which grades you're making can have significant maybe different sort of fundamentals and then the feedstocks and where you are in the world there are quite different in China than they are in.
In other parts of the World, where one markets coal tar and and disconnected at times from from global fuel oil prices and than rest of the world.
Tends to be a little bit more on global fuel oil. So there's just so many factors.
That are that are impacted here, it's difficult to reduce it to a rule of thumb, but I think the key.
The key thing to understand is that when the prices lower we do see those yield and energy center effects by the same token we see significant offsetting.
Working capital benefit.
As the balance sheet, Deflates and significant operating cash flow generated. So this pattern I think has been demonstrated over a very very long period of time. If you go back 20, or so years, you'll you'll see you'll see that operating cash flow profile.
Pretty consistently.
Okay. Thanks, and then I mean, if I could one more just on reinforcement price mix in the quarter I mean that was really strong at the EBIT level wondering if you could just break that down between how much of that was a benefit of your new contracts in western markets versus maybe other effects within China and the rest of Asia.
Yes so.
Definitely the.
The arrangements.
Both in terms of.
Pricing and mix from our contracted customers.
Around the world, both entire and industrial products contributed.
Materially in the quarter and so despite a pretty significant volume decline in the quarter on a year over year basis results were.
We're we're flat so a pretty strong result, there and the offset was basically.
To that was basically margin and pricing in Asia, principally China.
So they were sort of offsetting.
Thank you. Our next question comes from the line Jim Sheehan from Suntrust. Your line is now open.
Thank you. Good morning, Okay, just talk about hey, good morning in performance chemicals will kind of decremental margins can we expect in the fiscal third quarter.
Say it again Jim.
I'm I'm curious about decremental margins in performance chemicals.
In their third quarter add rest of the.
Fiscal year.
And so when you say decremental margins, Jim I want to make sure I understand what you mean by that.
While you're expecting the topline to come down significantly and just.
Trying to think about the margin impact to that you sort of.
Gave some color on that.
Forcing that materials, but not in performance chemicals Yep Yep. So I think the most significant.
The thing that you'll you'll see is a continuation of what was occurring in Q2 and in the prior quarter is well around.
Fair MAU, if you if you look across.
Both carbons and specialty compounds.
Margins have have have performed and held up there so.
I would say the margin profile.
Suit of at the unit margin level would be fairly consistent with what what occurred in the the most recent quarter that just that just happened.
And now the question will be.
How to volumes how to volumes perform I mean in the in the most recent quarter, we had the impacts from an already weak auto and we certainly would expect that to persist, but that that negative mix has been.
Has been running through the business for over the past year, almost year and a half as.
As weaker OEM auto builds.
Have have have played out so I think in terms of the Q2 Q3.
You know the fundamentals that drive margin.
You know will be largely unchanged. It's just a question of where the volumes were the volumes come out.
Okay and question on purification solutions.
Talking about your specialty volumes being down and and I want to know specifically on your specialty business in Europe.
You lose any business in that region and once the economy normalizes, you expect to recover that specialty business or have you changed your approach to that market.
No no change to approach here, Jim the specialty market remains a focus and there was certainly some impacts, but I would call them co we'd related impacts rather than.
Any fundamental changes in market or competitive activity or or any change in strategy from our side that all remains the same so I think it's really just.
Some covidien packs that began coming through in the month of.
March across across Europe.
So no nothing nothing new to really speak of there.
Thank you.
Thank you. Our next question comes from the line of Geoff Nichol go from JP Morgan. Your line is now open.
Thank you very much.
Hey, Jeff Hi, how are you.
In in Fumed metal oxides, you talked about negative pricing because of increased competitive activity I thought fumed metal oxides were mainly in over the fence relationship and so puzzled as to where.
Increased competitive activity can come from I can understand how at lower volumes may be your returns are lower but I don't understand.
Increased competitive activity characterization.
Sure.
So Jeff to two things on.
On fumed metal oxides and.
You may refer back at some point I know, it's certainly an investor day 2018, we we talk through this it's important to remember there are too.
Two types of.
Feedstock that support.
The fumed silica market globally, one is a by product out of the silicones chain and Youre right a significant portion of that volume, though not all of it.
Is over the fence back to the silicones producer, who then uses that fumed silica in their field compounds. So theyre downstream finished finish compounds. So that tends to largely be imbalance. Although there is a certain amount of the silica produced from that feedstock that.
It goes into what we call the merchant market. So it's not self consumed the other big source of fumed silica feedstock is from the poly crystal and silicon.
Markets. So when you produce tcs there is a.
A by product called Siltech, which is used to produce fumed silica and there is no corresponding downstream offset of poly producer doesnt consume any silica in the making of their tcs so that.
That material then goes out into the merchant market now.
Over time, both the feedstock from silicones and the feedstock from poly have been in balance with overall silica demand.
There are I think two factors that are playing out right now around competitive intensity one is.
Related to demand and so that.
That Paul we based fumed silica.
Is still trying to find a home and with lower demand that can lead to competitive intensity and then the other thing that's going on is I think a shift in the poly silicon market.
As China continues to.
Expand.
It's poly capacity I think at the expense of Western Poly producers people like Walker in OCI. Sir you may have seen recently both of them took pretty significant impairments on their recent poly.
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Expansions because they are finding it difficult to compete in the poly market with the Chinese producers, who are building plants in the northwest of China and have low low cost silicon metal and very low energy cost and these are the two big inputs for making qawi and.
Of course, most of that Polys consumed in solar panels, which are fabricated in China. So I think the western market Holly players are suffering.
And you're seeing that in some of these.
Impairment announcements, but that's the other factor here, while that shakeout is going on people are still trying to compete.
In the poly market and they are producing some byproduct feedstock and they're trying to sell that into the fumed silica market again over time.
The fumed silica market needs feedstock from both.
Both silicones and poly to support its sort of 4% to 5% long term growth rate.
But in the short term. These two factors are playing out so hope that helps give a little more color on the near term competitive intensity. Yes. Thanks. Thank you for that.
With oil coming down as much as its come down.
And coal prices moving lower is cap it.
More advantaged or less advantaged in producing carbon black in China. When you look at your.
When you look at your cost dynamics today versus say, where it was three months ago.
Yes, I would say.
With respect to.
China I mean, so our view and the way. This industry has played out is China is for China, That's basically how we participate and so.
Our coal tar feedstock dynamics are.
Our very competitive and we benchmark against all of the.
The players there in China in terms of profitability and so I think no no real change there I think where perhaps your question is going is sometimes the dynamics of coal tar.
And global fuel oil can diverged and that can cause some flows of carbon black.
Out of China, again, traditionally not Cabot, we've been more of a China is for China model, but you've seen some competitor material flow out into places like southeast Asia or at times. When the Arb was is at its peak in terms of how wide open. It was there was quite a bit immaterial flowing into.
Europe, we're not we're not seeing that now for some time that that that arb has closed and.
And so we're not seeing any.
Any significant changes in that in that relationship.
Prices were higher in reinforcement materials in the quarter was that all us based positive pricing or was there positive pricing in other regions. There was positive pricing in all of the other regions with the exception of I would say, China. So I do which is a spot market market for us so.
But no there was there was there was pricing.
And mix improvements in all regions.
And then lastly, do Leslie you talked about difficulties with your energy centers I never exactly understand what that is that you produce maybe power by coach and you sell power to the grid and so it so it's worth less what exactly is the energy center hedge speaking.
Yes, so no thats exactly.
Exactly right, Jeff So we have cogeneration facilities at many of our plants and we use the BT you content in what's called our tail gas to produce productive energy.
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Offset our own needs, but a lot of times, where most of the time, we're selling that energy.
Okay and industrial partner.
Those those arrangements have a link to.
Underlying energy prices because their their alternative of course, the alternative is a different fuel to produce the energy, we're using our tail gas.
But the competitiveness of that is linked to energy prices because someone can produce the same power with with an alternative energy input, but that's that's what we're saying so Ed as Weve mentioned, a number of times over the years I think the impact of lower oil on the end.
Org centers they are still.
Above cost of capital projects for us, but but in absolute dollars. They earn less when oil was lower okay. Thank you very much Stacey. Thank you you to dip.
Thank you all our next question comes from the line of David Begleiter from Deutsche Bank. Your line is now open.
Hi, Good morning. This is cash congrats again on for David Thanks for taking the question.
Curious about.
What do you.
Cost savings it sounds like some of that maybe temporary.
Travel expenses salary reductions and things of that nature, but some of that may be more permanent switches.
Sharing service centers.
Could you just talked about or characterize how much of that saving.
Structural and permanent versus temporary.
Yes, I think we're certainly pulling all levers right now Kathryn.
In some of that is.
Cuts in discretionary.
Spend that as demand returns and visibility improves than some of that will.
Naturally come back in in order to sustain our operation overtime and then.
And some of it is is structural so things like our creation of global business services and.
The the management structuring structure changes that we implemented within the past year those types of things would be would be structural.
And so you could probably think about it in the zone of half half.
As about half of it being structural and about about half of it being.
So at a temporary pullbacks to try to.
Try to manage costs and of course. These fees. These structural actions, we initiated those before covidien and we did those in order to.
Help us fund some of the investment in long term growth projects that we are.
We're excited about like our.
Energy materials activity as well as our.
Composites activity, but that's a that's that's roughly a way to think about it.
Great. Thank you and I know you're already.
We've talked about this is just make sure I understand could you just talked about.
Thank you realize benefits from lower raw material cost on given that volumes are expected to be much lower would you expect to see a greater tailwind in fiscal Q4 versus fiscal Q3's Brendler Rod.
So.
It depends which business you're talking about if you're talking about ramping.
Okay.
Well, it depends which business you're talking about if you're talking about reinforcement materials.
Than than the feedstock costs are effectively a pass through to customers and.
But you would see at lower oil prices.
Impacts on our margins from our lower benefits from our yield projects and energy centers. So that's the dynamic, but you get a working capital release in specialty carbons part of our performance chemicals.
Business, there's less of formula exposure in that business it tends to be.
More suit of spot market pricing, driven and so as raw materials decline historically across.
Major parts of that application space.
We've we've been able to retain prices, while while raw materials declined and so we would expect that to happen, though there's a there's a lag there.
At currently lower demand you know that debt that could take a quarter or two before we before we see das but that's those are the two those are the to the too.
Impacts to lower lower raw material prices.
Thank you.
Sure.
Thank you. Our next question comes from the line of Laurence Alexander from Jefferies. Your line is now open.
Good morning, how should we factor in any degree of inventory reduction.
That was then help incremental margins and.
Sort of in the recovery.
Hi, Lawrence Im sorry could you repeat the question about inventory reduction I didn't quite here.
Sorry.
Should we be factoring in us some degree of cabot's, reducing its own inventories sharply.
This summer, which would obviously hurt margins. This summer, but then help in the fall in next winter.
Well indefinitely.
Right now that focuses on bringing inventories down and driving that cash flow in the second half and so that will come with.
And negative EBIT impact basically the under absorption is the weight of the way to think about it and and then as demand improves.
Jan you would see the the sort of reversal of that as as inventory and working capital begins to begin building back up and you would see that debt SUTA reverse itself. So I think directionally that's right.
Laurence and the question is exactly that the timing of of how that demand recovery looks but thats. The the dynamic that that will play out.
And then desire to Underabsorption soccer include as in or separate from the assisting the 20 million you called out.
In terms of the $15 million to $20 million that we called out.
That is not included in that so those are just margin effects from.
Lower oil prices.
Affecting both the yields as well as the energy center benefits and then that that's sort of temporary mismatch from that very sudden drop in both oil and demand.
So those those would be margin effects, but the.
The under absorption would be an independent factor so not not included in that number.
And then could you help from I guess, the this shift in may come from Ccgts to LTC.
Can you give us a sense for where we are with the commercialization of that products and.
What the timeline might be to be to sell to third parties part from your original development partner.
Yes, sure. So maybe just a bit of a refresh here because we're building momentum and.
So.
Speaking about this perhaps a bit more so you'll you'll remember the elastomers composite technology that we licensed.
To to Michelin some sometime back and they have been building that out.
In there in their product portfolio and so while that has.
Continued thats a royalty type arrangement we.
We have an ability to develop this outside of that.
And so we've continued to.
To do that over the last several years and have been building out both the the customer portfolio as well.
For for this and so we have launched what we're calling our our new brand for elastomer composites and thats called to see so the product offering.
In this range, where we're actually making cell product as opposed to the original licensing agreement to Michelin. This product is called easy to see.
And we've launched products here for the the heavy mining equipment space, where our investments in inefficiency in automation create strong demand for for high performance.
Mateer rubber rubber materials and so I.
I think this is this is going well and we're generating.
Sales now in this.
In this with this easy to see offering and I think the question will be how does it how does it ramp up over time and of course. This is this is very difficult to.
To predict.
Certainly we think the potential here is is significant if you look at the overall.
Market for rubber compounds in both the tire and industrial products industry. It's it's pretty significant of course, the question will be which applications is this a fit for and the early space is certainly in heavy mining equipment tires, but.
We're also.
In development for long haul trucking.
And and performance tires for electric vehicle. So these are these are in play as well, but this this industry from a development standpoint, understandably doesn't doesn't move at a really quick pace because it's got to go through its own tire testing and there was safety and liability issues here. So it's a question of pace, but we.
We're pleased with.
The way revenue is beginning to build with this easy to see offering.
Okay. Thank you.
Thanks Lawrence.
Thank you. Our next question comes from the line of Kevin whole Keever from Northcoast Research. Your line is now open.
Good morning, everybody. Thanks.
Curious.
Lower priced mentioned it should be favorable working capital how should we think of that in the back half of the year. I think you mentioned that you expect all of cash from operations be $200 million in the back half, but what does that imply for the working capital benefit.
Yes, so the working capital release will be significant Kevin and if you. If you look back at at previous recessionary periods, whether it's in all nine or even 2015 for many in the in the chemical sector was somewhat recessionary.
Because of weakening in China, and other other factors, there and and what you. What you saw in that period was a very significant working capital release and that of course comes from the lower oil prices flowing through as well as you know.
In a recessionary period, we're very aggressive in terms of our operating dynamic and how we run our plants and how we bring.
Working capital down and and so we have confidence in that profile. That's been demonstrated over time is going to is going to show through here in the in the third quarter and.
In the fourth quarter and is going to be a material contributor to that roughly 200 million ish operating cash flow number that we that we talked about.
Okay and then on the.
No.
A couple of quarters ago, maybe a year or two ago, you announced some de bottlenecking and an expansion and I want to see Indonesia, Thailand or or.
But curious.
It looks like you're scaling back capex, a little bit curious how the.
If you are slower than any of these de bottlenecking zohr as you are delaying the the expansion just curious.
If any of those are being affected by your.
Slowing capex Yep Yep.
Important question in the the answer is yes, we're scrutinizing the growth projects.
Very aggressively right now in.
And deferring progress on those until we have more visibility into demand and just as a reminder, you know our our hierarchy in terms of.
Capacity expansion always starts with.
Oh, we first so overall equipment effectiveness and driving the.
The uptime and rates of our units is of course, the most efficient capital we can.
Capacity, we can unlock the second would be low cost de bottlenecks in our existing plants and then the third option would be a brownfield expansion like we've announced in Chile gone, but I think right now all growth capacity projects are being slowed and.
And aggressive we scrutinized and we'll have to see how.
How the demand picture unfolds here and as we have more visibility into into what that looks like that will.
That will dictate how we how we throttle.
How we throttle those projects, but but certainly right now.
The environment looks.
At least in the short term here sort of a different than what what was what was assumed when those were were launched but it's really a question of demand visibility and we need to see how things unfold here.
Historically, the replacement tire market has been quite robust and and we would expect that same dynamic to continue as this the lockdown begins to release and people start moving again.
Okay perfect. Thank you.
Thanks, Kevin.
Thank you. Our next question comes from the line of Chris cash from low capital markets. Your line is now open.
Yeah. Good morning. So my first question is kind of focused on that unit cost headwind that you alluded to in other words the impact from lower fixed cost absorption is there any way you could quantify what you expect that impact might be or how long you anticipate that headwind I guess, that's the $64000 question or at least could you quality.
Actively talk about what your strategy is in terms of your operational curtailment like.
Are you doing it across the board or is that selective.
Operating rate reductions any way to swear to qualify or quantify what how you're.
Navigating the lower demand environment.
Yes, Thanks, and obviously this is focused on reinforcement materials sure Yep Yep. Thanks, Chris.
So in in terms of the.
Tory change impact or you know the under absorption, we've historically referred to it as inventory change impacts.
That of course is tied to whether we're building or depleting inventories and we'll be aggressive we.
Bringing inventories down over the back two quarters here.
And so we'll see we'll see effects of that flowing through the last two quarters and I think then the shape of that after that is going to really depend on how demand is.
Is responding and if demand is beginning to pick up again and naturally you would see.
Some some reversion.
They are so so that's that's that's the phenomenon and we definitely expect there to be significant cash release from inventory.
In the both back quarters of the over the year Q3 in Q4.
And put a corresponding impact on the under absorption on the personnel now in terms of our curtailments.
It really depends I would say generally across the board when.
Significantly curtailed right now.
With the.
With the exception of China, which is is that is in.
A little more advanced state of.
Of domestic recovery here now the specific curtailments, they do vary by plants, because the customer portfolio by plant in by reactor line is is a little bit different but I think it's safe to say that with a with volumes down in the range that we have.
We've talked about and we are we're LMC is calling for.
Our curtailments sort of data at a system wide level match that but they do vary.
They do vary by.
Bye Bye plant.
Okay, and just as a follow up to that the with.
Early signs of China approaching.
Our normal economic newer than new normal economic conditions, maybe what's what are your utilization rates currently at your various facilities in China.
So the utilization rates across.
Across the company right now, we're kind of managing our you know in and around.
Half so 50 Percentish of course, as we're pulling down.
Inventories to match the demand outside of China, China is certainly.
Much better than that.
But it's not back to.
Utilization levels.
That it was before the pandemic because a certain amount of the tire market in China is supporting exports and that export market is impacted by the weakness because those tires are going to the west so.
You know, where we're certainly much much higher than our system average in China, but we're still not.
At the very high Utilizations that we were operating at be into we won't see those.
Return in China until the export tire market begins to.
Begins to show some some improvement so the domestic market in China. It definitely is recovering.
But export market is gonna be I think looking for that signal from from the west before.
Before that.
That improves.
Got it Thats helpful. And then one of your peers disclose that seeing meaningfully higher capex needs to.
Complete their EPA compliance projects I'm, just curious if you're seeing a similar increase in spending needed to accomplish what would you need to do under the consent decree so you've seen that for yourself or or other players in the industry.
Hi, Chris This is Erica.
We still believe the range that we've been given most recently the 175 million to 200 million spend is the rate range.
This would be spending first through calendar year 2022.
To meet the timing in the consent decree, we don't see any change in that right now.
We started this a bit earlier, we will enter the first Q.
A sign that consent decree with the EPA and so at this point, we have roughly about half of that spend and we spend the rest FY 2022.
Okay, and then but I can just follow up on that given that the industry clearly is deploying more capital for these.
Sox, and Nox compliance projects and and.
The narrative generally has been that.
The pricing certainly domestic pricing just hasn't been adequate to reach to earn a return on on that capital and so that's been an impetus for affirmative pricing actions that had been achieved in these annual pricing contracts. So.
Is there any way to talk about China like that sort of more secular.
Need for the industry the earn that return on capital juxtaposed against the current weaker environment any way to think about how.
Those conversations might look like it later this year because the fact is even though theres a weak demand environment, that's going to persist probably in the second half the returns still aren't adequate right. So any way to talk about that juxtaposition. Thank you.
Yeah. So.
Let me, let me take take that one Chris so.
Certainly we have spent a lot of time.
And I think.
I think broadly this is the this is an important industry issue where in order to provide long term supply reliability and surety to our customers and to do it in a way that is ever more sustainable in all of our customers.
Yeah.
Care about sustainability and have their own goals related to that and so this this these investments are clearly.
Lined up to support the sustainable.
And consistent supply of carbon black overtime and that does mean that pricing has too.
Has to move higher in order to get a cost of capital on that and return on that and ultimately that we'll we'll have to get pushed down the chain to to us as tire consumers, who will pay some small.
Increment for.
A more sustainable tire and so thats the narrative.
And that's what.
We have been.
Pushing and stressing with our customers and it's been an important underpinning of.
Of.
Of pricing in this in this industry.
Now how does that change with Covidien no I don't think it does we'll have to see how demand response here and begins to.
Begins to recover and that's that's always a a factor in.
In the sort of rhythm of the business, but that necessity has not has not changed in our conviction.
Around that has not changed and we will continue to.
To to advance that narrative and make progress with our with our customers on this front because it's the only way that we can provide sustainable supply to them over long period of time, and I think I know that.
Thanks to the color.
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Thank you at this time showing no further questions I would like to turn the call back over to Sean Paul Lang, President and CEO for closing remarks.
Great. Thank you all again for joining us today and I Hope you and your family's remain healthy unsafe. Thank you again for your supportive Cabot and we'll look forward to.
Seeing and seeing you and speaking again soon hopefully maybe in some more traditional forums like investor conferences, and the like but in the meantime, Stacey. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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