Q3 2019 Earnings Call
At this time, all participants are in listen only mode.
Later, we'll conduct a question answer session and instructions will follow at that time.
If anyone should require assistance during the conference. Please press Star then zero on you touched on telephone.
As reminder, this call is being recorded.
I would now like turn the call 30 host Mr., Steve Delahunt, Sir you may begin.
Thank you.
Good afternoon, I would like to welcome you to the Cabot Corporation earnings teleconference.
So I think they're shopping but youre right there.
Erica Mclaughlin senior Vice President and CFO .
Last night, we released results for our third quarter fiscal year 2019 copies of which are posted in the Investor Relations section of our website.
The slide deck. The company. This call is also available in the Investor Relations portion of our website and will be available in conjunction with the replay of the call.
During this conference call, we will make forward looking statements about our expected future operational and financial performance.
Each forward looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements.
Additional information regarding these factors appears under the heading forward looking statements.
The press release, we should last night.
In <unk> annual report on Form 10-K that was filed with the FCC.
No the pullback where transparency regarding <unk> 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.
Acquired by gap.
Any non-GAAP financial measures referred to on this call are reconciled to the most directly comparable GAAP financial measures 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 shot for Hain will discuss the key highlights of the company's performance.
Okay, I will review the business segment and corporate financial details.
Following this Sean will provide closing comments and open the floor to questions Chad.
Thank you, Steve and good afternoon, ladies and gentlemen.
In the third quarter of 2019, we have to navigate a number of challenges and the business environment.
Despite this we delivered solid results with adjusted earnings per share of one dollar.
I was particularly pleased with the performance of our reinforcement materials segment, which generated a sequential improvement in profitability and the highest level of quarterly earnings since quarter three of 2018.
I'm also encouraged by the continued progress of our transformation plan in purification solutions, which resulted in year over year improvement in this segment.
During the quarter, we delivered strong cash flow performance and we closed on the sale of our specialty fluids business, thereby achieving an important portfolio objective.
We did not see an improvement in the macroeconomic conditions in the third quarter and the environment for the chemical industry as a whole was more challenging than anticipated.
P.M. I continue to weaken globally.
Automotive production remained in negative territory in China remained soft.
Exacerbating the situation was a lack of progress on the global trade front between the U.S. in China.
Well the direct impact of tariffs on our results was small the lack of clarity on a global trade framework has created caution across the customer base.
The high level themes impacted our results, particularly in our performance chemicals segment.
Recognizing the current business environment, we took proactive steps to counteract the impacts were seeing across the company.
First we continue to focus on opportunities, where we could grow volumes for example, reinforcement materials volumes in China grew year over year, driven by a stable domestic market for replacement tires.
Second we continue to manage costs through a combination of productivity measures tight management of discretionary spending and structural improvements related to our purification solutions transformation plan.
Third we further tighten capital spending our full year forecast is now 230 to 240 million and well below the full year guidance. We gave at the beginning of the year as we are carefully balancing growth investments with prudent cash management.
Finally, we continued our sustained focus on working capital to drive strong operating cash flow, which was in excess of $100 million in the quarter.
We remain committed to returning cash to our shareholders in the quarter, we increased our dividend by 6%.
Total dividends paid in the quarter totaled $20 million.
We also repurchased shares of $32 million in the quarter and over the past four quarters, we have repurchased 7% of our outstanding shares.
While the current environment remains challenging we are committed to the long term growth plans in our core businesses and have conviction around the fundamentals of our markets and our strategy.
On this front, we completed construction at our new Fumed silica plant and move high China, which will contribute to the performance chemicals segment results starting in the fourth quarter.
Before I turn it over to Erica I would like to take this opportunity to thank the specialty fluids team for their contributions to Cabot over many years and for their strong support during the sale process I wish the business and all of their employees much success in the future.
I'll now turn it over to Erica to discuss the business results in more detail.
Thanks, John I will discuss the segment results beginning with reinforcement materials.
EBIT for reinforcement materials for the third quarter fiscal 2019 decreased by $2 million as compared to the third quarter of fiscal 2018, the pricing and mix benefits that we achieve them by 2019 customer agreements were more than offset by the impact of lower margins in China, and the more competitive pricing environment.
Globally volumes declined 2% in the third quarter as compared to the same period of the prior year, primarily due to a 7% decrease in volumes in Europe from softer automotive production.
In Asia, we delivered volume growth of 2% driven by higher volumes in China as the replacement tire market continues to be for and we remain a preferred supplier.
We have been pleased with the results of the 2019 customer agreements and our continued strong attention to pricing actions has largely addressed the cost of widening feedstock differentials in the quarter.
As a feedstock environment presents a more complex set of issues than a typical annual contract negotiation, we're continuing to spend time educating customers on these topics as part of our 2020 negotiation process.
A view on this remains consistent and that is that our increased cost must be passed down the value chain. This is consistent with the way. The industry has worked for a long time and has been reflected in recent price increase announcements by most of the major carbon black players in North America that are intended to cover EPA surcharges feedstock differentials and higher freight costs.
Looking ahead to the fourth quarter, we expect similar results in reinforcement materials to those of the third quarter with the assumption that the current challenging business conditions continue.
Now turning to performance chemicals.
EBIT decreased by 19 million year over year, largely due to lower volumes and a less favorable product mix a less favorable product mix is largely due to weaker demand and the more profitable automotive and fiber end markets.
Which primarily impacted the specialty carbons product line in the quarter.
Timing of orders and our fumed silica product line resulted in volumes declining 2% in performance additives well volumes are down 2% in formulated solutions due to lower sales in our inkjet product line.
Similar to reinforce it materials. It was a challenge for this segment from feedstock differentials and EPA related compliance costs that we need to recover we continue to implement pricing actions to address these including a global feedstock surcharge that we announced today for all North American produce specialty carbon.
Looking ahead to the fourth quarter, we expect to see sequential improvement in performance chemicals from increased volumes at our fumed silica product line and the startup of our new plant in China, and the timing of off take from our fence line partners. These higher fumed silica volumes, coupled with targeted customer actions in our specialty carbons business are expected to result in an improved segment mix sequentially.
Now moving to purification solutions.
In the third quarter fiscal 2019, EBIT increased by $7 million compared to the third quarter fiscal 2018. This is driven by higher volumes in our specialty applications, including food and beverage chemicals and catalysts. In addition to improved margins from price increases in the specialty application.
The business also reduced fixed costs in the quarter driven by savings from the previously announced transformation plan.
Looking ahead to the fourth quarter, we expect to see sequential improvement in purification solutions, driven by lower fixed cost from the actions being taken in our transformation plan.
Now moving to specialty fluids in the third quarter fiscal 2019, EBIT decreased by $1 million compared to the third quarter fiscal 2018 due to the mix of project activity in the quarter.
As we mentioned earlier, we have completed the divestiture of this business during the quarter and going forward. The segment will no longer be part of our operating results.
I will now turn to corporate items.
We ended the quarter, where the cash balance of $147 million and our liquidity position has improved to 1.4 billion.
In the quarter, we issued 300 million.
Dalibor public bonds, the proceeds of which are used to repay commercial paper.
During the third quarter of fiscal 2019 cash flows from operating activities were $115 million, which include the decrease in net working capital of $16 million largely due to a reduction in inventory levels. We expect to see further improvement in operating cash flow for the fourth quarter as working capital should continue to be a source of cash in the quarter.
Total capital expenditures for the third quarter of fiscal 2019 were $58 million and are now expected to be approximately $230 million to $240 million for the full year.
Discretionary free cash flow was $71 million in the third fiscal quarter of which we return cash to shareholders through $20 million in dividends and $32 million of share repurchases.
The fiscal year to date and forecasted 2019 operating tax rate on continuing operations is 23%.
I'll now turn the call back over to Sean.
Thanks Erica.
Now I'd like to give you an update on our outlook for 2019.
While 2019 has been a challenging year to date, we expect our fiscal 2019 adjusted earnings per share to be at a comparable level with our fiscal 2018 results.
With about one third of our sales going into automotive applications and about a quarter of our sales in China, maintaining our earnings level year over year is the result of actively managing to offset the challenging business and geopolitical headwinds.
The external forecasts for recovery in China, and stronger automotive OEM production have not materialized and we can't say with high confidence that recovery is likely in the fourth quarter.
As a result, we are assuming that both of these markets remain generally in line with what we experienced in our third fiscal quarter.
Against the current backdrop of macro and market trends, we are focused on controllable measures.
Looking at overall company results sequentially, we do expect fourth quarter earnings to be higher than the third quarter driven by increased fumed silica volumes with the startup of our plants in China and the timing of fence line partner orders.
Improved purification results driven by our transformation plan will also contribute and finally, we'll continue to focus on cost measures.
Looking ahead, our priorities are clear.
First we will continue to leverage the strength of our global footprint and market leading positions to manage the balance of volumes and margins and continue to push for pricing recovery of feedstock differentials.
Second we will continue to execute cost and productivity measures to enhance long term competitiveness.
And finally, we will be aggressive stewards of cash as we focus on bringing down working capital levels and prudently managing the pace and timing of growth investments.
We are confident in the fundamentals of our core businesses, our leading positions in unparalleled geographic footprint and the robustness of the industries we serve.
Our advancing the core strategy seeks to balance growth and leadership in our core businesses with robust cash returned to shareholders. We have conviction that this is the right strategy for Cabot and we are committed to delivering strong cash flows investing for the future in our core businesses and returning cash to shareholders.
Thank you very much for joining us today and I will now turn the call back over for a question and answer session.
Thank you.
Ladies and gentlemen, if youd like to ask a question. Please press Star then one when you attach tone telephone again, if youd like to ask a question. Please press Star then one.
One moment for our first question.
Our first question comes from Michael laid it Okay Barclays. Your line is open.
Thanks, and good afternoon, guys, Hey, Mike Thanks.
I guess first on the earnings outlook, if we look at your goals of growing EPS double digits Cagar.
This year is essentially flat so as we start to think about fiscal 2020, and I know, it's early still but are there certain things that should snap back in your mind and get you back on that 10% CAGR trend line off of 2018 or is this year's $4 likely the new base, we need to grow 10% or so off of into 2020, I guess, what are kind of the moving parts in your mind there.
Yeah sure Mike So you're right when we announced our outlook at the Investor day about a year ago, you might recall that.
The build out of a of that pathway one of the key elements was overall volume growth in the 4% to 5% range across the portfolio and I think clearly we haven't seen that this year and 2019 now how much of that is.
De stocking that eventually bounces back is a little bit difficult to tell.
At this point for sure I think the whole chemical sector and ourselves included have seen volumes that are disconnected from what we believe end market demand to be and so generally thats.
That's a a destocking phenomenon and that certainly has played out over the course of the year. So I think the question.
Is how much how much of that comes back and what are the triggers.
For that to come back and I think the biggest question right now is where does the global macro economic.
How did the global macro picture.
Play out here.
Do we see that there are some some settlements around global trade that gives people confidence and therefore, a trigger to.
B be more aggressive in their in their order patterns and replacement then of Destocking or.
Does this situation persists for a period of time and Thats, great its pretty difficult to tell.
At this point here so.
I think what will.
What we'll be doing is over the next quarter is.
Of course evaluating the current environment and then we'll be in the middle of.
The entire customer.
Contract negotiations over the next quarter as well so I think we'll be in a better position to.
Address that that question. After we report the next quarter.
Got it that's helpful color and then.
I think last quarter on the earnings call. When we're talking about the bridge for the back half of the year you discussed the substantial EPA project this quarter that wouldn't repeat in Fourq. Your fourq, you and be a tailwind to Fourq you earnings looking through this stuff I don't seem to see any mention of the EPA projects. So did that occur as anticipated and should that benefit fourq versus threeq you.
We weren't Youre right, Mike we were planning a positive benefit from a rebuilding inventories in Q4 coming out of an extended Q3 EPA related shutdown. So this is one of the shutdowns that is tied to.
The industry consent decree and of course building up to that shutdown, we had build quite a bit of inventory and then we're drawing down.
In this period of time.
But their recent.
Hurricane Barry did impact one of our sites.
And so the impact that we were getting from inventory change benefit.
It was effectively offset here because with the outage at the plant, which is now back online, but with the outage of the plant, we havent been able to rebuild inventories at the level that we had projected a quarter ago. So that's the that's the offset.
Got it thank you.
Thank you.
Our next question comes from Jim Sheehan of Suntrust. Your line is open.
Hi, good afternoon, Thanks for taking my question.
Hey, Jim.
Oh, so could you clarify on the differentials and feedstocks.
Have you been successful in passing that through only in reinforcement materials for.
Am I hearing that wrong did you are you, making progress in both of your business segments or just one of the segments. So far.
Yes, so important question Jim in one that.
He is.
I think can be a source of.
Of confusion and these businesses operate a little bit differently. So let me let me try to clarify for you. So so first let me start with reinforcement materials and I would start by.
Reiterating our under our underlying philosophy in this business that feedstock costs are passed through to customers and we execute this with our customers as you know through a pricing formula that adjusts.
With a market index to basically calculate their price.
About a year ago.
As more pull issue was emerging we saw that there might be challenges to this and so we introduced a delivery cost adjustment or a DCH into many of our contracts and this DC a adjust pricing if the index to our contracts differs from from actual so that this philosophy of pass through is upheld and this year. We have indeed seen increased differentials in the feedstock markets and our GCA has adjusted pricing to ensure that those are our pass through and we've also put in place feedstock surcharges to any customers that did not have a DTA in their contract and we will continue to adjust fees as.
As as meeting so while we have seen differentials widen in reinforcement they did not meaningfully impact our EBIT performance in the third quarter.
Due to this contracting strategy in our implementation of feedstock surcharges of course. This is an evolving situation as you know and so we'll need to continue to ensure that we recover these.
Costs going forward and continue to use the DCH concept with customers in our 2020 contracts in order to manage.
Any further marpol related.
Uncertainty so I think on reinforcement materials that the team is progressing.
Well when our fore sight on on the DC a concept I think has has been has been working well.
In specialty carbons.
It's a different business and the philosophy in specialty carbons is is a little bit different the pricing is not as much tied to cost as it is more of a value in use pricing strategy.
But that said, we do adjust prices as input costs.
Move in in a meaningful way.
And so the differential impact in specialty carbons.
He is a bit more pronounced because this business tends to use low sulfur feedstocks.
More than than than rubber blacks does and of course, the low sulfur is impacted more by the MRO Marple.
Issue so.
What we're seeing currently is that north American feedstock markets have adjusted earlier than expected to Marco and the cost of these low sulfur feedstocks.
His up relative to the index, thus, creating a differential so the focus now is on getting these price.
Adjustments in place.
And so as a result, we have announced today.
Seven cents a pound surcharge.
Effective in September it's intended to cover the cost of.
Of these rising differential so same underlying situation.
But.
Two different two different businesses.
And the approaches are slightly different but.
The intent here is to get these recovered and passed along down the value chain reinforcement.
Further ahead and quite pleased with progress there are still some work to do and stay vigilant.
Specialty carbons.
More work in front of us.
Once you're surcharges are in place do you is that do you think that means that the differential problem.
It is effectively fixed for 2020 or do we still stay tuned on that.
Well the difficult to tell because it's a moving target and.
And where pricing settles out on low sulfur.
I think you need to accumulate enough.
Activity enough trades in order for.
An index to really firm up and so I would say, it's probably still too early for for that and everyone who is in this in this value chain is is I think watching for that but based on what we see today.
If we successfully implement here and we believe we will have coverage.
Terrific and could you just talk about your what do you expect your utilization rates to be on the skin silica plant and we will high for the fourth quarter and where do you expect when do you expect that to be fully ramped up.
Yes, so the the startup of a chemical plant course doesn't reach.
A full capacity instantaneously is always a ramp up there as we get customers qualified.
So I would say that we will be ramping to full production across the next quarter.
That's how I would think about it.
Thank you.
Thank you.
Our next question comes from David Begleiter of Deutsche Bank. Your line is open.
Hi, This is Christine on for David Hi, Christine.
Just two questions on China can you talk a little bit about the pricing dynamics in China This quarter and what your expectations are through the remainder of the year.
Sure.
So I think.
China.
Is is certainly a challenging environment in the short term I think.
It's important to think about this both in the <unk> in the short term and the long term. So maybe a couple of thoughts to to help out and I'll start with the with the short term here.
First of all auto production in China remains very weak and so this.
The month of June was was the 12 month in a row, where auto production was down on a year over year basis.
So pretty significant I think on it on a year to date basis auto production is down about 16%.
In in China, and so you probably are well aware of the factors that are.
That are driving that but that.
Has created a more.
Debt reduction in demand has created a more competitive environment in China and.
As a result.
Pricing has been.
Under under more pressure there over the last couple of quarters I think the other factor that's playing out in the short term is the the trade dispute between the U.S. in China, because it just presents a lot of uncertainty and and companies are.
Unable to really plan properly and so.
As a result, our very cautious on on inventory levels and again that debt debt debt creates.
Well contributes to a more competitive environment and in the carbon black side of things. So we really need to see consumer sentiment a firm up a bit in in China number one I think that would.
Help remove some of the uncertainty and give give customers more more clarity and confidence to.
To to fill out their supply chains and then the second is that we would need to see automotive production improve.
And these significant negative comps.
At least.
You know.
Begin to reverse and with that happening then.
A more firmer demand environment would would begin to provide some some support for pricing I think over the longer term our view here hasnt changed in terms of China, making almost 40% of the world's tires and carbon black.
So important too.
You know to to recognize that I think the second is the China still has the largest.
Car Park in the World and many of these cars have yet to hit their replacement cycle and then our view on the feedstock side is that the coal tar and carbon black production are.
Our failure well balanced here as as steel Virgin steel production has has slowed so we think that.
Picture remains intact, and then finally I think the environmental enforcement in the long term.
We will remain a priority for China. So these factors give us.
Confidence in the long term, but but we certainly have to work through this.
Somewhat unprecedented short term situation.
In China, and where we are doing that while we are not.
We're not thrilled with the level of profitability that we add we are.
Still quite profitable in China, and the overall results of the reinforcement segment.
This quarter, where we're quite strong given that.
Set of circumstances.
Thank you I was Super helpful. And then just one question on Q4 can you elaborate a little bit on what's driving the strong Q4 growth know that you mentioned, obviously, the fumed silica plant and then targeted customer actions, which mostly at any price increases and then on incremental cost measures. What other cost strings are you able to pull in order to hit that year over year in slide 17%.
Right.
Yes, so the sequential path is driven by a few items you've touched on but let me just try to frame it up perhaps a little bit more so I think in performance chemicals we.
Expect increased volumes from.
The the operation of the new plant in China as well as.
Volumes from our offense fine partners that were.
It's weaker in Q3 and.
That weakness not repeating so those two factors drive higher fumed silica volumes and fumed silica.
Tends to be the highest margin product across the performance chemicals portfolio. So.
The mix gets better as a result, we also have a number of targeted.
Actions, both in terms of pricing as well as certain customer mix actions that we expect to contribute.
In the quarter. So is a series of things there across performance chemicals. The second driver would be improvement in purification solutions in Q4.
As they typically see.
Some improvement from seasonality as well as.
Incremental benefits from our transformation plan.
And then finally, reducing.
Spending.
And continuing to drive productivity projects are those those three things.
If I if I give you a rough sense for that I would say the first a series of things across performance chemicals is probably in the $5 million to $6 million range.
The improvement sequentially in Purifications, you know in the in two to 3 million range and then on the cost actions kind of in the four to 5 million range. So hopefully that.
That gives you a sense of the drivers.
And the magnitude and the level of.
Control ability here.
Given the uncertain environment that we're all facing we're really focused on controllable measures as much as possible.
That's great. Thank you.
Thank you.
Our next question comes from Chris Kapsch absolute capital market. Your line is open.
Yes, good afternoon.
A couple of follow ups, I guess focused on China, Sean you mentioned slower purchase steel production, which I.
Assume means a little bit less availability of crude coal tar and so I don't know, if that's causing any movement and the feedstock costs over there, but can you just talk about that Chuck suppose against what the pricing environment.
I understand that since there is no real contracts over there. That's the concept of differentials doesn't really apply to China, but just wondering if youre seeing the need to get pricing.
Against the backdrop of.
Higher costs or is that pretty well.
Our pricing and feedstock cost sort of.
Matched right now.
Yes, so in China, what we're seeing is that the the feedstock costs have been.
Somewhat volatile, but pricing tends to follow that so less of a differential issue and more.
I think what.
What we need to see in China is more demand side support and with that.
Then.
Pricing will improve and move back to levels that we had seen in the past and that we would we would consider more normal for.
For the long term here, so as as demand side.
Pressure.
Begins to pick back up.
And you couple that with the feedstock market being in balance we don't we don't see once that demand situation improves we don't see.
Lots of excess feedstock so therefore.
Pricing on the carbon black side should be should firm up so I think it's more of a demand issue in China Kristen I think it is a.
Differentials issue.
Okay, and then if I could just follow up on the just on the the ramp of the new fumed silica.
Plant there because I think you referenced your sense line customers showing you know softer volumes in this fiscal third quarter.
Im assuming its the same fence line customer I don't know if that's a good assumption but.
So just the confidence level that Youre, you will see the volumes that you need to operate your plan at reasonable levels. If that that fence line customer is has weaker demand and and just what percent im assuming that silica goes back across the fence for.
Elastomer application what percentage of your capacity does that.
10 signed customer represent.
Generally and is it a take or pay arrangement and the and the new production. Thanks, Yeah. So let me let me try to.
Clarify a couple of things there. So first of all the defense mine partner demand impact that I referenced in Q3 is not related to the the China project.
And so it's it's in our our other fence mine network in a in the Western World.
And so we we feel pretty good that that that won't repeat on the on the China side.
We brought the plant up on schedule.
And late in the quarter worked through commissioning and began the process of customer qualifications. This is all a pretty typical stuff and what we'll see is that this will ramp across across the quarter. We feel quite good about the volume ramp up here and have been building the commercial plans for this.
Over the course of.
Of the past year in terms of the the off take over that to our fence line partner versus what we sell in the open market, it's about half half.
And so we feel quite good about the off take from the fence line partner and then the balance of it gets sold into our network.
In.
Open open market customers.
In in both China as well as.
In certain cases can be exported to other parts of.
On the world or other parts of Asia, So we feel pretty good about that assumption.
Chris that's embedded in.
Q4.
Okay. Thank you very much.
Thank you.
I'm showing no further questions at this time I'd like to turn the conference back over to Sean Cohen for any closing remarks.
Okay, well. Thanks, thanks, everyone for for joining today and for your continued support of Cabot and look forward to speaking again with you next quarter. Thank you.
Thank you.
Ladies and gentlemen, this does conclude today's conference. Thank you for your participation have a wonderful day you may all disconnect.