Cabot Corporation Q2 2023 Earnings Call

May 9, 2023

Okay.

Thank you for standing by and welcome for Cabot's second quarter 2023 earnings Conference call. At this time, all participants are in a listen only mode.

After the speaker presentation, there will be a question and answer session to ask a question. During the session you will need to press star one one on your telephone.

Remove yourself from the question queue Press Star one one again.

I would now like to hand, the call over to the Vice President Treasurer Investor Relations Steve Delight. Please go ahead.

Good morning, I would like to welcome you to the Cabot Corporation earnings teleconference.

With me today are Sean Keohane, CEO , and President and Erica Mclaughlin Executive Vice President and CFO .

Last night, we released results for our second quarter of fiscal year 2023 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 in the press release, we issued last night and in our 10-K for the fiscal year ended September 32022, and in subsequent filings, we make with the SEC all of 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.

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 who will discuss the second quarter highlights, including progress against our sustainability strategy and an update on our battery materials business.

Eric will review the company and business segment results, along with some corporate financial detail.

Following this Sean will provide a strategic summary, and closing comments and open the floor for questions.

Yes.

Thank you, Steve and good morning, ladies and gentlemen, and welcome to our call today.

I am pleased with results in the second quarter and the tremendous effort of the Cabot team to execute against the challenging macroeconomic backdrop.

In the second fiscal quarter, we delivered adjusted earnings per share of $1 33 in line with our expectations and up 35% sequentially.

Reinforcement materials delivered a record quarter with EBIT up 21% year over year.

The outlook for this business remains strong driven by our leading market position. The long term resilience of the replacement tire market and favorable structural dynamics in this business.

The performance chemical segment had a challenging quarter as we experienced lower demand in China due to significant levels of COVID-19 outbreak.

Softness in key end markets and continued inventory destocking.

As expected cash flow was strong in the quarter with operating cash flow of 162 million and free cash flow of $111 million of which we returned $37 million to shareholders through dividends and share repurchases.

Given the strength of our underlying business fundamentals and conviction in the long term cash flow generation of our portfolio yesterday, we announced an 8% increase in our quarterly dividend.

Cabot has a long history of growing the dividend and it would be our expectation to continue increasing the dividend over time as the earnings and cash flow of our business grow.

On the strategic front, we continued to make important long term progress in battery materials with volumes growing 45% in the quarter. Despite a sharp sequential slowdown in electric vehicle sales in the March quarter.

Additionally, we secured another key customer win in the quarter and now head of sales to nine of the top 10 global battery manufacturers.

Diving a bit deeper into battery materials. The electrification of mobility represents a significant growth opportunity for Cabot and we continue to invest behind this macro trend.

While we believe the long term trend of electric vehicle penetration is undeniable market developments from quarter to quarter can be uneven.

This is certainly what the electric vehicle sector experienced in the March quarter.

Electric vehicle sales declined sequentially by 27% in the March quarter, driven principally by Covid impacts in China, and a sharp decline in prices of key raw materials for batteries, such as lithium carbonate, which drove a sharp destocking across the industry value chain.

While cabot's volumes for battery materials continued to reflect strong year over year growth of 45% sequential.

Sequential sales volumes decreased by 11%.

We expect these impacts to be short term in nature and anticipate sequential improvement in the coming quarters in line with the Bloomberg EV forecast.

So far through April our volumes are aligned that this improving trend.

The temporary loss of market momentum sequentially in the second quarter and the projection for recovery of EV sales over the next two quarters puts us behind where we expect it to be year to date and sales volumes for battery materials.

Additionally, we are seeing some delays in battery production scale up of our key U S Auto OEM.

Based on these factors and our continued investment profile to support long term growth. We now anticipate fiscal year 2023, EBITDA to be in the range of 30% to $35 million for battery materials.

We continue to believe that electrification will transform the mobility sector and are very pleased with our commercial progress to date.

We have been qualified and are selling commercially to nine of the top 10 battery producers and are well positioned with key auto Oems as they build out battery production capability.

Cabot's value proposition built on our unique product breadth global footprint and ability to scale capacity to meet the industry's regionalization needs is resonating with customers.

While the growth pathway may be uneven at times, we are investing to win over the long term and remain confident in our investor day projections of 50% plus EBIT growth between 2021 and 2024.

Sustainability is at the core of our purpose and are creating for tomorrow strategy and during the quarter. We made important progress on several strategic fronts.

At the recent tire technology Expo in Hanover, Germany, we launched our evolve sustainable solutions technology platform, which is focused on advancing sustainable reinforcing carbons or.

Our goal through this technology platform is to develop products for our customers that offer sustainable content with reliable performance and importantly at industrial scale.

We plan to do this by leveraging circular value chains and materials recovered from end of life tires used.

Using renewable or bio based materials, and enabling processes that reduce greenhouse gas emissions.

As part of the evolve platform. We also launched Cabot's first Ias Cc plus certified solutions, which are enabling our tire customers to bring demonstration products to the market made from circular materials.

Our market leadership global footprint, and broad evolve and <unk> technology platforms.

<unk> Cabot to partner and win with leading customers as the mobility sector transitions to meet society sustainability demands.

In addition, last week, we announced the launch of our new and Tara aerogel particles portfolio and.

And Tara aerogel particles are with thermo installation additive targeted for thermal barrier solutions for electric vehicles lithium ion batteries.

We believe thermal management will be an important design feature of safe batteries and expect there will be a variety of application forms that serve this market.

Cabot's aerogel products provide customers with formulation flexibility to develop very thin forms, including blankets pads sheets films phones and coatings.

Over time, we believe that aerogel solutions can develop into a meaningful addition to our battery materials addressable market and further position Cabot as a critical material supplier to support the global transition to vehicle electrification.

And finally, our sustainability leadership continues to gain recognition from leading ESG rating services. Most recently cabinet received a platinum rating from Echo Vegas, the highest recognition available for the third consecutive year.

The platinum rating recognizes cabot's environmental social and governance efforts in places Cabot among the top 1% of companies assessed by Echo Vegas.

Echo Vegas is one of the world's leading sustainability ratings platforms and one that many of our customers rely on to evaluate their supply chains.

I'll now turn the call over to Erica to discuss the segment and financial performance Erica.

Thanks, John .

Chart with discussing results for the company and then review the segment results.

Adjusted EPS for the second quarter of fiscal 2023 was $1 33 compared to $1 69 in the second quarter of fiscal 2022 with growth in the reinforcement materials segment offset by declines in the performance chemicals segment.

Quarter was also impacted by higher net interest expense of $7 million year over year, and unfavorable foreign currency exchange impact of $7 million.

Year to date impact from increases in net interest expenses are $14 million and our expectation for the fiscal year is unchanged from last quarter at approximately $20 million.

Year to date unfavorable impacts from foreign currency exchange were $19 million and we expect the year over year impact to be somewhat minimal going forward for the second half of the year.

Discretionary free cash flow in the quarter was $76 million and we ended the quarter with $205 million of cash.

Cash flow from operations was 162 million, which included a reduction in networking capital in the quarter of $59 million.

The reduction was in line with what I highlighted in our expectation last quarter and looking ahead, we expect a further reduction in net working capital in excess of $50 million over the two remaining quarters of the fiscal year based on the current and future expectations for oil prices.

Capex in the quarter with $51 million and we expect full year capex to be between 250 and $300 million.

Balance sheet remains strong with total liquidity of $1 2 billion and net debt to EBITDA of one eight times as of March 31st.

Our operating tax rate was 25% for the quarter and we anticipate the fiscal year rate will be between 24 and 26%.

The increase was driven by improved unit margins from higher pricing and product mix and our 2023 calendar year customer agreements, partially offset by 7% lower volumes and higher fixed costs.

Globally volumes were down in all regions in the second quarter as compared to the same period of the prior year with declines of 2% in the Americas, 2% in Europe and 12% in Asia.

Our volumes in Asia were driven by the effects of the Covid outbreak in China.

Looking to the third quarter of fiscal 2023, we expect the reinforcement materials EBIT to increase sequentially as volumes are expected to improve particularly in Asia as demand strengthens after the impact from the COVID-19 outbreak.

Year over year volumes in the third quarter are expected to be slightly down as compared to the prior year aligned with external market expectations.

Also anticipate margins to be maintained as pricing in our calendar year agreements are set for the rest of the year.

On a fiscal year basis, we continue to expect strong double digit EBIT growth as compared to last year, largely due to the improved unit margins from higher pricing and product mix and our 2023 calendar year customer agreements.

Now turning to performance chemicals, EBIT decreased by $42 million in the second fiscal quarter as compared to the same period in fiscal 2022.

The decrease was principally driven by our fume metal oxides product line that we.

We experienced a 22% volume decline year over year, and lower unit margins lower volumes driven by weaker demand in silicones applications and the impact from the Covid outbreak in China.

Lower margins were driven by the comparison to the prior year, where we experienced temporary margin expansion from pricing ahead of raw materials last year.

In addition, the segment also experienced lower volumes in our specialty carbons product line as well as the negative impact from Unabsorbed costs, as we reduced inventory levels and unfavorable foreign exchange impact.

In summary year over year, the decline was driven by $18 million of lower volumes $15 million of lower unit margins $4 million from the impact of reducing inventory levels and 4 million of unfavorable foreign currency impact.

Looking ahead to the third quarter of fiscal 2023, we expect EBIT to be up sequentially due to higher volumes across all of our product lines as demand in our key end markets improved and margins remained relatively stable.

We have seen improvement in segment volumes month to month as we move through the second quarter.

We have also reduced costs across the segment given the weaker demand environment, which we expect will help improve EBIT levels in the second half of the year.

I will now turn the call back over to Sean.

Thanks, Erica moving to the 2023 outlook I feel very good about the continued progress we are making as a company. Despite the short term macroeconomic headwinds at.

At a strategic level the key drivers of earnings growth remain unchanged.

The impact from our calendar year 2023 reinforcement materials customer agreements is driving the record second quarter EBIT in this segment and the replacement nature of the tire market provides a certain resilience in this business we.

We expect volumes to pick up in the second half of the year with regional supply demand dynamics expected to remain tight.

All of which drives our expectation for another year of strong double digit EBIT growth in the reinforcement materials segment.

And while performance chemicals has been impacted by the weak external demand environment in the first half of our fiscal year, we expect volumes in all product lines to pick up in the second half of the year.

We also expect our growth vectors to be strong contributors to this segment recovery in the second half of the year as sequential volumes improve in battery materials, and inkjet volumes accelerate driven by penetration in our targeted growth applications.

However, given the slower than expected recovery across our performance chemicals end markets, particularly in China, and a temporary slowdown of sequential momentum in battery materials, we're adjusting our full year guidance to be in the range of $6 10 to $6 50.

The midpoint of our guidance would imply modest growth of adjusted earnings per share for the fiscal year, which for us given our fiscal year includes a very weak December destocking quarter.

As we think about the quarter, we shape of earnings for the full fiscal year, we expect a significant step up in the second half relative to the first half providing strong momentum heading into fiscal year 2024.

As the earnings increase in the second half of our fiscal year and based on the anticipated working capital release, we expect operating cash flow and free cash flow to be very strong.

In closing we are confident in our strategic position and believe the cap. It offers a unique growth opportunity reinforcement materials as a structurally improved business with strong earnings and cash flow generation.

Performance chemicals is comprised of industry, leading positions with exposure to long term macro tailwind.

Battery materials offers the potential for breakout growth and we have the conviction and the balance sheet to invest behind this transformational shift in mobility.

Our portfolio has strong cash flow characteristics, which can fund our advantaged growth investments and return cash to shareholders.

And finally, we are a recognized leader in sustainability and this strength underpins our purpose and are creating for tomorrow strategy.

With these value drivers firmly in place we remain on track to achieve the targets outlined in our December 2021 Investor day.

Thank you very much for joining us today and I'll now turn the call over for our Q&A session.

As a reminder to ask a question you will need to press star one one on your telephone.

Again, Thats Star one one on your telephone to ask a question.

Please standby, while we compile the Q&A roster.

Our first question comes from the line of John Roberts of Credit Suisse.

Western please John .

Thank you.

In reinforcement.

<unk> got more price in the U S and elsewhere could you at least give us a qualitative discussion or the regional price trends.

Sure John .

I would say.

The pricing trends across the western market.

Western regions were pretty consistent actually.

That.

Lines up with.

The.

Pretty consistent.

Structural dynamics in the regions in terms of supply demand.

Growth in <unk>.

Entire production the importance of regionalization of supply chain all those factors, so I would say they're actually quite.

Quite consistent across the western markets.

And then within.

The performance segment could you talk about master batch versus fume metal oxides, and within fume metal oxides I didn't hear any discussion about the semiconductor market weakness.

Yes, So let me let me touch on the fumed metal oxides.

First because that certainly the single biggest driver of the weakness in performance chemicals now.

This the fumed metal oxides market.

Serves principally applications in the silicone space. This is by far the largest.

Volume space in the market.

In silicones, where were down very very sharply.

In this quarter there.

There are several public company comps in the silicone space and you can see that their results were down sharply. So I think our dynamic is similar to the overall market and as Eric said volumes were down 22% year.

Year over year in this in this product line and as you might recall from from the past or Investor Day. This this product line is the highest margin business in the in the segment. So when you combine that with the high operating leverage in the business. It's a pretty it's pretty significant now there are.

There are also silica sales fumed silica sales into the semiconductor space those have.

Diminished over time as next generation nodes have moved to <unk>.

Other forms of abrasive particle either colloidal silica or Syria.

So.

Our products that we don't participate in that being said, we do still have.

A meaningful legacy tail.

Silica into the CMP or semiconductor space in that too.

Was declining but the largest driver here John was the contraction or the.

The the lower demand in the overall silicones space.

Thank you.

Again to ask a question press Star one one our next question.

Comes from the line.

Josh Spector UBS your question please Josh.

Yes, hi, thanks for taking my question.

In your slides you have a comment on performance chems that margins are expected to remain stable from <unk> 23 levels I wanted to really understand that more I mean, your margins were about 9% in the quarter you talked about cost savings you talked about improvement.

Do you mean that theyre going to be stable at that level or are they going to improve from those levels.

What we mean, Josh is that the unit margin so price minus variable cost.

We'll remain stable, obviously, the EBITDA margins.

Will improve over the quarter as we get higher volumes and more coverage of the of the cost base.

And then some of the cost actions that we're talking about flow through so when we say margins we're talking about.

That that sort of price minus raw spread.

That's what we mean.

Okay got it that makes sense and just on your battery materials business, where you talk about the new win we announced early on in the 10 largest producers I was wondering if you can give some context around there are any of those exclusive are you supplying the majority of the conductive carbons into those formulations or.

Are you more qualified for that platform. So how much of that materializes into sales specifically for Cabot versus giving you the optionality to do so.

Yes, so the way it typically works in battery materials as you get qualified into.

Battery program or a battery platform.

And then as that platform grows and Proliferates, then you grow with it.

So thats typically how it how it works. So for example legacy platforms that cabinet may not have been in <unk>.

Typically those.

Don't get switched out it has much more to do with winning new programs. So as the program ramps.

Then we would expect our.

Our sales volumes to.

To ramp up with that.

Now typically because these are going into automotive applications.

There is usually a primary and a secondary supplier to a program because the auto OEM require that sort of supply redundancy.

But it's really program driven Josh and so as the program ramps.

Assuming the success that the customer.

Intense than than we would see the flow through of that.

Okay. Thanks, Sean.

Thank you.

Our next question.

Comes from the line.

Jeff Zekauskas of Jpmorgan. Your line is open Jeff.

Hi, Good morning, this is lidia on for Jeff It.

It seems from the current truck Randy Hi, I think the contract renegotiation for rubber Black has started early this year what are you seeing across different regions.

Sorry, Lydia could you just say that again, I said something about contracts and in region sorry.

Yeah. It's just we've heard that the contract renegotiation for rubber Black has started early this year. So.

Just wondering what are you seeing for pricing across different regions.

Yes. So it is it is early in the process. So.

Normally the contract discussions began over the course of the summer.

And then progress into the fall period.

And so certain customers have approached us to start negotiations for 2024.

I think there are a lot of moving parts. However, I think what happens is the Russia sanctions date nears in 2024, and and how to China feedstock economics as potential replacement for the Russian material for example in Europe . These are.

These are important dynamics to watch.

So I would say it's early in the process here I would remind you that we did close some negotiations in 2023 that were multiyear agreements with incremental pricing in 2024. So I think this does give us some momentum.

Heading into 'twenty, four and it does set.

Our market reference, but I would say while certain conversations have begun.

It's early in the process.

That said I would say the structural supply demand dynamics in the western markets remain.

Unchanged and favorable and so we'd expect that to continue.

Thank you and your cash flow from operations. This quarter is higher than for your full year last year. So can you talk about the changes here and maybe talk more about your expectation for the rest of the year.

Sure So operating cash flow was strong this quarter.

The EBITDA improved from earlier in the year, that's part of it and then I would say, it's really working capital and so last year, we had increasing raw material costs that cause.

Increasing levels of investment into the working capital, we see that those raw material costs are coming down this year and so you see a positive contribution or source of cash from working capital in the second quarter, we expect that to continue as we move through the year. So that goes to the comments I made where we were.

Think another.

In excess of $50 million would be released out of working capital in the back half of the year and so expect continued very strong cash flow from operations.

As we go through the rest of 2023.

Thank you.

Our next question.

Comes from the line of Laurence Alexander of Jefferies. Please go ahead Laurence.

Hi, it's Dan Rizzo on for Laurence.

You mentioned the <unk>.

Ocular tires, the new product I was just wondering how we should think about the growth within that product.

Is it going be something I assume not.

Gross same growth trajectory is as battery materials could there be something of that magnitude or.

It will be maybe a longer timeline.

Yeah, you're referring to the evolve sustainable solutions product.

Technology launched shutdown.

Yes, that's correct.

Yes, yes, yes.

Great position to do that and so we'll be we'll be leveraging the circular value chains and materials that are recovered from end of life tires, as well as any renewable or bio based material options feedstock options.

And processes that can reduce the greenhouse gas emissions. So these are the these are the levers that we're pulling under the evolve.

That form and so if you think about over time, how this should develop we anticipate driving revenue starting in this year.

And we expect to see.

Material impacts from the evolve sustainable solutions over a five to 10 year period is how you ought to think about it. This is driven by the speed of adoption of new technologies in the rubber industry.

As well as how our entire customers.

Greenhouse gas goals set up between here and 2050 carbon neutrality, which they all have.

Our goals for that but how they're how exactly they are interim goals in 2030 and between 2030 in 2050, how those lineup will drive things too but.

I would think about this as.

A longer term play that's really getting at.

The sustainability needs of our customers and frankly societies pressures around.

Around sustainability, so we're excited about it.

We think we bring.

And the ability to to commercialize develop and commercialize these technologies and do it at scale, which.

There are startups and the like that play in this space, but can't really.

Bring things to market at scale the way, we can so thats, how I would think about it that alright.

Alright, Thank you and then.

You mentioned or it was mentioned that.

Those are.

Improvement in working capital because of the drop in oil prices I was wondering if there's a rule of thumb with oil and its relation to working capital such as a $10 movement in oil translates into an X X movement in working capital or how we should think about that.

Sure Dan So I can answer that the general rule of thumb is about a $1 change in oil is about $5 million in working capital and so it does usually happen over.

Really two quarters, usually as youll see the inventory reprice quickly and then the accounts receivable might move into the following quarter, but thats the rule of thumb.

Alright, Thank you very much.

Thank you once again to ask a question. Please press star one on your telephone.

Okay.

Our next question comes from the line of Chris Capps Loop capital. Please go ahead Chris.

Well good morning so.

Ralph Good morning, Dan.

So if I think about.

The guidance.

Modest guidance reduction it sounds like it's predominantly attributable to trends.

The performance chemicals segment.

You mentioned.

So it goes into the silicones ensures the biggest I don't know.

If you can rank order the other contributors with especially maybe specialty carbons, maybe the residual destock for I don't know if that second demo with slower momentum will be temporarily in raw materials. You also mentioned that I'm clear.

If thats the kind of the right way to think in terms of order of magnitude, but also just you mentioned improving.

Demand trends for this segment on a monthly basis, just wondering if you could characterize if that's if that's characteristic of each of the different businesses and how it persisted how those trends persisted thus far into the third quarter.

Through April .

Maybe on the on the first question Erica will take that and then I'll come back on the second one Chris.

Yes, Chris I think if you think of the impact in the quarter fumed metal oxide is by far the largest majority of the decline.

Next I would say it would be our specialty carbons business.

Volumes were down about 5% in that in that business, which Joe.

Reduction in most of the inventory or unabsorbed costs because of the inventory reduction is also in carbon so that would probably be secondary and then as John talked about battery materials.

Temporary.

Decline here in EV sales in Q2 was also impactful so I would probably say it's in that order.

As we think about the volume recovery I would say it is through.

Q2 pretty broad based in terms of month to month improvement.

As we move through the quarter I would say battery materials also improved in April so so from the exiting Q2 into April volumes in battery materials have improved so I think that's good.

Some of the other businesses I would say April was a bit weaker than March, but I would characterize it as stronger than kind of a January February run rate. So.

That's what we've seen in April and then I'd say the order books for May looks pretty strong across the businesses.

And so that's what our outlook takes into consideration.

Okay.

And then and maybe Chris just.

Couple of additional comments there so again.

The midpoint of the range.

As would be roughly flat to fiscal 'twenty two.

But that was a record and up 25% over fiscal 'twenty one.

And so a couple of things here, one is that would be a risk.

Solved after offsetting about 50, EPS headwind from interest and unfavorable FX and then also.

Important to remember that given our fiscal year end.

September 30, we're pulling in that very weak December quarter. So when you look at second half momentum.

I think that.

That that's an important picture to look at there I think the monthly trends Erica Eric touched on well I don't have anything more to add on that one.

Got it and then my follow up is focused on the battery materials space.

A key theme here has been more broadly than just the security of supply concerns for really a variety of battery materials.

To the extent that youre, having tremendous success.

Less than lithium ion battery producers globally.

Partnering with them supply and I'm just curious how.

That plays into your relationships with those customers.

Obviously, you're supplying those now but are they.

Do they have expectations for for you to partner with them globally, how is that playing out.

Do you have visibility to what their demand requirements are going to be in different regions is that was that.

Play into your.

Our growth capital plan. Thank you.

Yes sure.

Well certainly I think a couple of things are going on in the battery market. It's been principally a China market up until now as you know well I think some 75 ish percent of that.

<unk> I think are are made in China. So outside of China is relatively small, but there are significant battery investments that are being constructed as we speak and coming online over the next.

Two three years in through the end of the decade, and so I think a couple of things are going to happen.

Chris first of all.

Youre seeing.

A lot of non <unk>.

Chinese battery players building outside of.

<unk>.

China, and I think Youll probably see.

Some sort of a bifurcation between battery market for China.

Rest of rest of world and so certainly the the customers that we're working with in Europe and the U S.

Really value regional supply.

And so.

The ability to.

Provide that to them.

Is is is very important now typically what what happens here is that you get qualified in a program.

Given battery maker, and then as that particular program or platform.

Proliferates, then you grow you grow with that.

So as you get qualified and begin to win.

There is a ramp schedule, sometimes hard to predict that's why I think there can be some unevenness.

In the way this market develops but that's that's how.

That's how you ought to think about it and I think cabot's global scale, our footprint our ability to build out capacity regionally for these customers.

As this market bifurcate and.

Thank you.

I think an advantage for for Cabot and so we're investing behind that.

And.

Our building out capacity to meet that.

Thank you.

Thank you at this time I would like to turn the conference back to Sean Keohane for closing remarks, Sir.

Great well. Thank you very much for joining today. Thank you for your continued support of Cabot Corporation and hope you have a safe day B well.

This concludes today's conference call and thank you for participating you may now disconnect.

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Thank you for standing by and welcome to Cabot's second quarter 2023 earnings Conference call. At this time all participants are.

Or are in a listen only mode. After the speaker presentation. There will be a question and answer session to ask a question. During the session you will need to press star one one on your telephone.

To remove yourself from the question queue.

Press Star one one again.

I'd now like to hand, the call over to Vice President Treasurer Investor Relations, Steve <unk>. Please go ahead.

Good morning, I would like to welcome you to the Cabot Corporation earnings teleconference.

With me today are Shawn Cohen, CEO , and President and Erica Mclaughlin Executive Vice President and CFO .

Last night, we released results for our second quarter of fiscal year 2023 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 in the press release, we issued last night.

And in our 10-K for the fiscal year ended September 32022, and in subsequent filings, we make with the SEC all of 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.

I will now turn the call over to Sean who will discuss the second quarter highlights, including progress against our sustainability strategy and an update on our battery materials business.

Eric will review the company and business segment results, along with some corporate financial detail.

Following this Sean will provide a strategic summary, and closing comments and open the floor for questions.

<unk>.

Thank you, Steve and good morning, ladies and gentlemen, and welcome to our call today.

I am pleased with results in the second quarter and the tremendous effort of the Cabot team to execute against the challenging macroeconomic backdrop.

In the second fiscal quarter, we delivered adjusted earnings per share of $1 33 in line with our expectations and up 35% sequentially.

Reinforcement materials delivered a record quarter with EBIT up 21% year over year.

The outlook for this business remains strong driven by our leading market position. The long term resilience of the replacement tire market and favorable structural dynamics in this business.

The performance chemical segment had a challenging quarter as we experienced lower demand in China due to significant levels of COVID-19 outbreak.

Softness in key end markets and continued inventory destocking.

As expected cash flow was strong in the quarter with operating cash flow of $162 million and free cash flow of $111 million of which we returned $37 million to shareholders through dividends and share repurchases.

Given the strength of our underlying business fundamentals and conviction in the long term cash flow generation of our portfolio yesterday, we announced an 8% increase in our quarterly dividend.

Cabot has a long history of growing the dividend and it would be our expectation to continue increasing the dividend over time as the earnings and cash flow of our business grow.

Additionally, we secured another key customer win in the quarter and now head of sales to nine of the top 10 global battery manufacturers.

Diving a bit deeper into battery materials. The electrification of mobility represents a significant growth opportunity for Cabot and we continue to invest behind this macro trend.

While we believe the long term trend of electric vehicle penetration is undeniable market developments from quarter to quarter can be uneven.

This is certainly what the electric vehicle sector experienced in the March quarter.

While cabot's volumes for battery materials continued to reflect strong year over year growth of 45% sequential.

Sequential sales volumes decreased by 11%.

We expect these impacts to be short term in nature and anticipate sequential improvement in the coming quarters in line with the Bloomberg EV forecast.

So far through April our volumes are aligned with this improving trend.

Additionally, we are seeing some delays in battery production scale up of our key U S Auto OEM.

Based on these factors and our continued investment profile to support long term growth. We now anticipate fiscal year 2023, EBITDA to be in the range of 30% to $35 million for battery materials.

We continue to believe that electrification will transform the mobility sector and are very pleased with our commercial progress to date.

We have been qualified and are selling commercially to nine of the top 10 battery producers and are well positioned with key auto Oems as they build out battery production capability.

Cabot's value proposition built on our unique product breadth global footprint and ability to scale capacity to meet the industry's regionalization needs is resonating with customers.

While the growth pathway may be uneven at times, we are investing to win over the long term and remain confident in our investor day projections of 50% plus EBIT growth between 2021 and 2024.

Sustainability is at the core of our purpose and are creating for tomorrow strategy and during the quarter. We made important progress on several strategic fronts.

At the recent tire technology Expo in Hanover, Germany, we launched our evolve sustainable solutions technology platform, which is focused on advancing sustainable reinforcing carbons.

Our goal through this technology platform is to develop products for our customers that offer sustainable content with reliable performance and importantly at industrial scale.

We plan to do this by leveraging circular value chains and materials recovered from end of life tires used.

Using renewable or bio based materials, and enabling processes that reduce greenhouse gas emissions.

Our market leadership global footprint, and broad evolve and <unk> technology platforms.

<unk> Cabot to partner and win with leading customers as the mobility sector transitions to meet society sustainability demands.

In addition, last week, we announced the launch of our new and Tara aerogel particles portfolio and.

And Tara aerogel particles are with thermo installation additive targeted for thermal barrier solutions for electric vehicles lithium ion batteries we.

We believe thermal management will be an important design feature of safe batteries and expect there will be a variety of application forms that serve this market.

Cabot's aerogel products provide customers with formulation flexibility to develop very thin forms, including blankets pads sheets films foams and coatings.

The platinum rating recognizes cabot's environmental social and governance efforts in places Cabot among the top 1% of companies assessed by Echo Vegas.

<unk> is one of the world's leading sustainability ratings platforms and one that many of our customers rely on to evaluate their supply chains.

I'll now turn the call over to Erica to discuss the segment and financial performance Erica.

Thanks, Sean.

Art with discussing results for the company and then review the segment results.

<unk> was also impacted by higher net interest expense of $7 million year over year, and unfavorable foreign currency exchange impact of $7 million.

Year to date impact from increases in net interest expenses are $14 million and our expectation for the fiscal year is unchanged from last quarter at approximately $20 million.

Year to date unfavorable impacts from foreign currency exchange were $19 million and we expect the year over year impact to be somewhat minimal going forward for the second half of the year.

Discretionary free cash flow in the quarter was 76 million and we ended the quarter with $205 million of cash.

Cash flow from operations was 162 million, which included a reduction in networking capital in the quarter of $59 million.

The reduction was in line with what I highlighted in our expectation last quarter and looking ahead, we expect a further reduction in networking capital in excess of $50 million over the two remaining quarters of the fiscal year based on the current future expectation for oil prices.

Capex in the quarter was $51 million and we expect full year capex to be between 250 and $300 million.

<unk> remained strong with total liquidity of $1 2 billion and net debt to EBITDA of one eight times as of March 31.

Our operating tax rate was 25% for the quarter and we anticipate the fiscal year rate will be between 24 and 26%.

Now moving to reinforcement materials during the second quarter EBIT for reinforcement materials increased by $21 million as compared to the same period in the prior year to a record EBIT of 122 million. The increase was driven by improved unit margins from higher pricing and product mix and our 2023 calendar year customary green.

That's partially offset by 7% lower volumes and higher fixed costs.

Globally volumes were down in all regions in the second quarter as compared to the same period of the prior year with declines of 2% in the Americas, 2% in Europe and 12% in Asia.

Lower volumes in Asia were driven by the effects from the Covid outbreak in China.

Year over year volumes in the third quarter are expected to be slightly down as compared to the prior year aligned with external market expectations.

Also anticipate margins to be maintained as pricing in our calendar year agreements are set for the rest of the year.

Now turning to performance chemicals, EBIT decreased by $42 million in the second fiscal quarter as compared to the same period in fiscal 2022.

The decrease was principally driven by our fumed metal oxides product line, where.

While we experienced a 22% volume decline year over year and lower unit margins.

Lower volumes driven by weaker demand in silicones applications and the impact from the Covid outbreak in China.

Margins were driven by the comparison to the prior year when we experienced temporary margin expansion from pricing ahead of raw materials last year.

In summary year over year, the decline was driven by $18 million of lower volumes $15 million of lower unit margins $4 million from the impact of reducing inventory levels and.

$4 million of unfavorable foreign currency impact.

Looking ahead to the third quarter fiscal 2023, we expect EBIT to be up sequentially due to higher volumes across all of our product lines as demand in our key end markets improved and margins remained relatively stable we.

We have seen improvement in segment volumes month to month as we move through the second quarter.

We have also reduced costs across the segment given the weaker demand environment, which we expect will help improve EBIT levels in the second half of the year.

I will now turn the call back over to Sean.

Thanks, Erica moving to the 2023 outlook I feel very good about the continued progress we're making as a company. Despite the short term macroeconomic headwinds at.

At a strategic level the key drivers of earnings growth remain unchanged.

We expect volumes to pick up in the second half of the year with regional supply demand dynamics expected to remain tight.

All of which drives our expectation for another year of strong double digit EBIT growth in the reinforcement materials segment.

The midpoint of our guidance would imply modest growth of adjusted earnings per share for the fiscal year, which for us given our fiscal year includes a very weak December destocking quarter.

As the earnings increase in the second half of our fiscal year and based on the anticipated working capital release, we expect operating cash flow and free cash flow to be very strong.

In closing we are confident in our strategic position and believe that cap. It offers a unique growth opportunity.

Enforcement materials is a structurally improved business with strong earnings and cash flow generation.

Performance chemicals is comprised of industry, leading positions with exposure to long term macro tailwind.

Battery materials offers the potential for breakout growth and we have the conviction and the balance sheet to invest behind this transformational shift in mobility.

Our portfolio has strong cash flow characteristics, which can fund our advantaged growth investments and return cash to shareholders and.

And finally, we are a recognized leader in sustainability and this strength underpins our purpose and are creating for tomorrow strategy.

With these value drivers firmly in place we remain on track to achieve the targets outlined in our December 2021 Investor day.

Thank you very much for joining us today and I'll now turn the call over for our Q&A session.

As a reminder to ask a question you will need to press star one on your telephone.

Again, Thats Star one one on your telephone to ask a question.

Please standby, while we compile the Q&A roster.

Our first question comes from the line of John Roberts of Credit Suisse. Your question. Please Sean.

Thank you.

In reinforcement I assume you've got more price in the U S and elsewhere could you at least give us a qualitative discussion or the regional price trends.

Sure John .

I would say.

The pricing trends across the western market.

The western regions were pretty consistent actually.

That.

Lines up with.

The.

Pretty consistent.

Structural dynamics in the regions in terms of supply demand.

Growth in entire production the importance of regionalization of the supply chain all those factors. So I would say they are actually quite.

Quite consistent across the western markets.

And then within.

The performance segment could you talk about master batch versus fumed metal oxides in within fumed metal oxides, I didn't hear any discussion about the semiconductor market weakness.

Yes, So let me let me touch on the fumed metal oxides.

First because thats certainly the single biggest driver of the weakness in performance chemicals now.

This the fumed metal oxides market.

Serves principally applications in the silicone space. This is by far the largest.

Volume space in the market.

In silicones, where were down very very sharply.

In this quarter there.

Year over year in this in this product line and as you might recall from from the past or Investor Day. This this product line is the highest margin business in the in the.

So when you combine that with the high operating leverage in the business. It's a pretty it's pretty significant now there are there are also silica sales fumed silica sales into the semiconductor space those have.

Diminished over time as next generation nodes have move too.

Other forms of abrasive particle either colloidal silica or Syria.

So.

Products that we don't participate in that being said, we do still have.

A meaningful legacy tail.

Silica into the CMP or semiconductor space in that too.

Was declining but the largest driver here John was the contraction or the.

The lower demand in the overall silicones space.

Thank you.

Again to ask a question press Star one one our next question.

Comes from the line.

Josh Spector UBS your question please Josh.

Yes, hi, thanks for taking my question.

In your slides you have a comment on performance chems that margins are expected to remain stable from <unk> to 'twenty three levels.

To really understand that more I mean, your margins were about 9% during the quarter you talked about cost savings you talked about improvement.

Do you mean that theyre going to be stable at that level of dividend improve from those levels.

What we mean Josh is that.

Unit margins, so price minus variable cost.

We'll remain stable, obviously, the EBITDA margins.

Will improve over the quarter as we get higher volumes and more coverage of the of the cost base.

And then some of the cost actions that we're talking about flow through so when we say margins we're talking about.

That that sort of price minus raw spread.

That's what we mean.

Okay got it that makes sense and just on your battery materials business, where you talk about the new win we announced theyre going on in the 10 largest producers I was wondering if you can give some context around there are any of those.

Exclusive are you supplying the majority of the conductive carbons into those formulations or are you more qualify for that platform. So how much of that materializes into sales specifically for Cabot versus giving you the optionality to do so.

Yes, so the way it typically works in battery materials as you get qualified into.

Every program or a battery platform.

And then as that platform grows and Proliferates, then you grow with it.

So thats typically how it how it works. So for example legacy platforms that Cabot may not have been in.

Typically those.

Don't get switched out it has much more to do with winning new programs. So as the program ramps.

Then we would expect our.

Our sales volumes.

The ramp up with that.

Now typically because these are going into automotive applications.

There is usually a primary and a secondary supplier to a program because the auto OEM require that sort of supply redundancy.

But it's really program driven Josh and so as the program ramps.

Assuming the success that the customer.

Intense than than we would see the flow through of that.

Okay. Thanks, Sean.

Thank you.

Our next question.

It comes from the line.

Jeff Zekauskas of Jpmorgan. Your line is open Jeff.

Hi, Good morning, this is lidia on for Jeff.

And the current truck Randy Hi, I think the contract renegotiation for Robert Black has started early this year what are you seeing across different regions.

Sorry, Lydia could you just say that again, I said something about contracts and in <unk>.

Region sorry.

Yes, just we've heard that the contract renegotiation for rubber Black has started early this year. So just wondering what are you seeing for pricing across different regions.

Yes. So it is it is early in the process. So.

Normally the contract discussions began over the course of the summer.

And then progress into the fall period.

And so certain customers have approached us to start negotiations for 2024.

Heading into 'twenty, four and it does set a market reference, but I would say while certain conversations have begun.

It's early in the process.

That said I would say the structural supply demand dynamics in the western markets remain.

Unchanged and favorable and so we'd expect that to continue.

Sure. So operating cash flow was strong this quarter as.

As the EBITDA improved from earlier in the year, that's part of it and then I would say, it's really working capital and so last year, we had it.

Increasing raw material costs that caused.

<unk> another.

In excess of $50 million would be released out of working capital in the back half of the year and so expect continued very strong cash flow from operations as we go through the rest of 2023.

Thank you.

Our next question.

Comes from the line of Laurence Alexander of Jefferies. Please go ahead Laurence.

Hi, it's Dan Rizzo on for Laurence.

You mentioned the <unk>.

Circular tires, the new product I was just wondering how we should think about the growth within that product.

Is it going be something I assume not produced the gross same growth trajectory as his battery materials could there be something of that magnitude or.

It will be maybe a longer timeline.

Yes, you're referring to the evolve sustainable solutions product.

Acknowledged lawn shut down yes, that's correct.

Yes, yes, yes.

The technology platform that we launched our goal here is to develop products that offer sustainable content with reliable performance and I think most importantly at industrial scale and I think we're in a great position to do that and so we'll be we'll be leveraging the circular value chains and materials that are recovered from end of <unk>.

<unk> tires, as well as any renewable where bio based material options feedstock options.

And processes that can reduce the greenhouse gas emissions. So these are the these are the levers that we're pulling under the evolve.

Platform and so if you think about over time, how this should develop we anticipate driving revenue starting in this year.

And we expect to see a material impact from the evolve sustainable solutions over a five to 10 year period is how you ought to think about it. This is driven by the speed of adoption of new technologies in the rubber industry.

As well as how our tire customers.

Greenhouse gas goals set up between here and 2050 carbon neutrality, which they all have.

Our goals for that but how they're how exactly they're interim goals in 2030 and between 2030 in 2050, how those lineup will drive things too but.

I would think about this as well.

Longer term play that's really getting at.

The sustainability needs of our customers and frankly societies pressures around.

Around sustainability, so we're excited about it.

Because we think we bring.

And the ability to to commercialize develop and commercialize these technologies and do it at scale, which.

There are startups and the like that play in this space, but can't really.

Bring things to market at scale the way we can so that's how I would think about it that.

Alright. Thank you and then you mentioned or it was mentioned that debt.

There was.

Improvement in working capital because of the drop in oil prices I was wondering if there's a rule of thumb with oil and its relation to working capital such as with $10 movement in oil translates into an X X movement in working capital or how we should think about that.

Sure Dan So I can answer that the general rule of thumb is about a $1 change in oil is about $5 million in working capital and so it does usually happen over.

Really two quarters, usually as youll see the inventory reprice quickly and then the accounts receivable might move into the following quarter, but that's the rule of thumb.

Alright, Thank you very much.

Thank you once again to ask a question. Please press star one on your telephone.

Okay.

Our next question comes from the line of Chris <unk> of Loop capital. Please go ahead Chris.

Hello, Good morning, so thanks Ralph.

Good morning, Dan.

So if I think about the guidance.

The modest guidance reduction it sounds like it's predominantly attributable to trends.

The performance chemicals segment.

You mentioned.

<unk> silicones into the silicones ensures the biggest I don't know.

Can you rank order the other contributors, especially maybe specialty carbons, maybe the residual destock or I don't know about second demo with slower momentum.

These temporarily in battery materials.

You also mentioned.

Im curious if thats the kind of the right way to think in terms of order of magnitude, but also just you mentioned <unk>.

Proving.

Demand trends for <unk>.

This segment on.

On a monthly basis, just wondering if you could characterize if thats.

Characteristics of each of those businesses.

And how it's persisted how those trends have persisted thus far into the third quarter.

Through April .

Maybe on the on the first question Erica will take that and then I'll come back on the second one Chris.

Yes, Chris I think if you think of the impact in the quarter fumed metal oxide is by far the largest majority of the decline.

Next I would say it would be our specialty carbons business.

Volumes were down about 5% in that in that business, which drove a reduction in most of the inventory or unabsorbed costs because of the inventory reduction is also in carbon so that would probably be secondary and then as John talked about battery materials.

Temporary.

The decline here in EV sales in Q2.

Also impactful so I would probably think it's in that order.

As we think about the volume recovery I'd say.

Q2 pretty broad based in terms of month to month improvement.

As we move through the quarter I would say battery materials also improved in April so from the exiting Q2 into April volumes in battery materials have improved so I think that's good.

And some of the other businesses I would say April was a bit weaker than March, but I would characterize it as stronger than kind of the January February run rate. So.

That's what we've seen in April and then I'd say the order books for May looks pretty strong across the businesses.

And so that's what our outlook takes into consideration.

Okay.

And then and maybe Chris just a couple of additional comments there so again.

The midpoint of the range.

As would be roughly flat to fiscal 'twenty two.

But that was a record and up 25% over fiscal 'twenty one.

And so a couple of things here one is that would be a result, after offsetting about 50 EPS headwind from interest and unfavorable FX and then also.

Important to remember that given our fiscal year end.

September 30, we're pulling in that very weak December quarter. So when you look at second half momentum.

I think that.

That that's an important picture to look at there I think the monthly trends Erica Eric touched on well I don't have anything more to add on that one.

Got it and then my follow up is focused on that.

Materials space.

Key theme here has been more broadly than just the security of supply concerns for really a variety of battery materials.

To the extent that youre, having tremendous success.

Then lithium ion battery producers globally.

Partnering with them supply and I'm just curious how.

That plays into your relationships with those customers.

Obviously, you're supplying those now but are they.

Do they have expectations for for you to partner with them globally, how is that playing out.

You have visibility to what their demand requirements are going to be in different regions is that does that play into your.

Growth capital plan. Thank you.

Yes sure.

Well certainly I think a couple of things are going on in the battery market. It's been principally a China market up until now as you know well I think some 75 ish percent of.

Batteries, I think or are made in China. So outside of China is relatively small, but there are significant battery investments that are being constructed as we speak and coming online over the next.

Two three years and in through the end of the decade, and so I think a couple of things are going to happen.

This first of all.

Youre seeing a lot.

A lot of non.

Chinese battery players building outside of.

Of China, and I think Youll probably see.

Some sort of a bifurcation between battery market for China, and our <unk>.

Rest of rest of world and so certainly the the customers that we're working with in Europe and the U S.

Really value regional supply.

And so.

The ability to.

Provide that to them.

Is is is very important now typically what what happens here is that you get qualified in a program.

Given battery maker, and then as that particular program or platform.

Proliferates, then you grow you grow with that.

So as you get qualified and begin to win.

There is a ramp.

<unk> will sometimes hard to predict that's why I think there can be some unevenness.

And the way this market develops but that's that's how.

That's how you ought to think about it and I think cabot's global scale of our footprint our ability to build out capacity regionally for these customers.

As this market bifurcate and.

Thank you.

I think an advantage for for Cabot and so we're investing behind that.

And and are building out capacity to meet that.

Thank you.

Thank you at this time I would like to turn the conference back to Sean Keohane for closing remarks, Sir.

Great well. Thank you very much for joining today. Thank you for your continued support of Cabot Corporation and hope you have a safe day, if you will.

This concludes today's conference call. Thank you for participating you may now disconnect.

Cabot Corporation Q2 2023 Earnings Call

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