Cabot Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2020 Cabot 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 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker, Mr. Steve Delahunt, Vice President of Treasury and Investor Relations. Please go ahead, sir.

Thank you, and good afternoon. I'd like to welcome you to the Cabot Corporation Earnings Teleconference. With me today are Sean Cohane, CEO and President, and Erica McLaughlin, Senior Vice President and CFO. Last night, we released results for our first quarter of fiscal year 2020, copies of which are posted in the Investor Relations section of our website. The slide deck that accompanies this call is also available in the investor relations portion of our website and will be available in conjunction with the replay of the call. During this conference call, we will make forward-looking statements about our expected future operational and financial performance. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Additional information regarding these factors appears under the heading forward-looking statements in the press release we issued last night and in our last annual report on Form 10-K that is filed with the SEC and available on the company's website. In order to provide greater transparency regarding our operating performance, we refer to certain non-GAAP financial measures that involve adjustments to GAAP results. Any non-GAAP financial measures presented should not be considered to be an alternative to financial measures required by GAAP. Any non-GAAP financial measures referenced on this call are reconciled to the most directly comparable GAAP financial measure in a table at the end of our earnings release issued last night and available in the investor section of our website. I will now turn the call over to Sean Cohane, who will discuss the key highlights of the company's performance. Erica McLaughlin will review the business segment and corporate financial details. Following this, Sean will provide closing comments and open the floor to questions. Sean?

Thank you, Steve, and good afternoon, ladies and gentlemen. Last evening, we announced results for our fiscal first quarter of 2020. As expected, our first quarter results decreased as compared to the prior year. Our first quarter of fiscal 2019 included $10 million of EBIT from our specialty fluids business, which we divested in the third quarter of fiscal 2019. Also contributing to the decrease was lower EBIT in our reinforcement materials segment as compared to the prior year, as we experienced unusual levels of year-end inventory destocking by many of our large customers that impacted volumes, particularly in Europe and the Americas. During the quarter, we finalized the negotiation of our calendar year 2020 customer agreements for the reinforcement materials segment with a positive outcome. We achieved pricing gains and successfully implemented formula adjustments to protect against marco-related feedstock differentials. In the Americas region, we realized price increases while maintaining volumes. This is particularly important given the environmental capital investments we are making in the region to provide reliable supply for our customers. In Europe, the current demand environment is softer, and new carbon black supply has come online from Russian producers, which impacted the negotiations. Despite this, we achieved price increases in the region while making the decision to let go of some lower margin tire business. As a result, volumes in Europe are expected to be about 5 percent lower year on year starting in the second quarter. We believe this was the right action, and as the environment strengthens, this will enable us to supply the spark market and to support the growth of our specialty carbons and compounds businesses. Results in the performance chemical segment increased 14% compared to the same fiscal quarter of 2019. The segment benefited from strong sales volumes in both the performance additives and formulated solutions businesses compared to first fiscal quarter of 2019. While the business environment remained challenging, our management team continued to focus intensely on working capital efficiency, cash flow generation, and balance sheet strength. Operating cash flow of $105 million included a benefit from working capital, which helped to fund our CapEx needs, along with $54 million of cash returned to shareholders. These results demonstrate the strength and durability of the company's cash flow. In the first fiscal quarter, we also continued to aggressively manage costs, and began to implement several actions to enable us to be more efficient and cost-effective. These actions include the reorganization of Cabot's leadership structure, as well as the creation of a global business services function. Global business services is a new strategic function in Cabot that brings together many of our enabling and support services in an effort to drive standardization of our processes, gain scale, and increase efficiency by leveraging the power of digital tools. We have launched a number of priority initiatives, including moving many of our North American shared service activities from the U.S. to Riga, Latvia, where we currently operate our European Shared Service Center. These actions will allow us to streamline our organizational structure and drive expected savings of approximately $10 million this fiscal year, which we will see largely take hold in the back half of 2020. And finally, in the quarter, we announced an agreement to acquire Shenzhen Sanshun Nano, a leading producer of carbon nanotubes. We're excited about the strategic acquisition to accelerate our growth and positioning in the high-growth lithium-ion battery market. Let me give you some details on the deal. Cabot has entered into an agreement to purchase Sanshun for approximately $115 million. As the second largest producer of carbon nanotubes, or CNTs, globally, Sanshun has the capability to manufacture both dry powder CNTs and dispersions and has a proven track record of commercial success in the lithium-ion battery market. The acquisition includes a newly commissioned CNT plant in China, which has sufficient capacity to support growth over the next several years. Their revenue on a trailing 12-month basis is $28 million, and when combined with Cabot's energy materials business, Total sales in the battery application will be approximately $50 million. We believe this is a great addition to Cabot because the lithium-ion battery industry is moving towards blends of conductive carbon additives in order to achieve the optimal performance cost ratio, and CNTs are the fastest-growing conductive carbon additive in energy storage. With this acquisition, Cabot will be the only carbon additive supplier with commercially proven carbon black, CNT, carbon nanostructure, and dispersion capabilities. We believe this acquisition will not only strengthen our global leadership position in carbon additives, but will allow us to deliver new, innovative, conductive formulations to enhance battery performance. This acquisition will be managed as part of Cabot's global energy materials business within the performance chemical segment. The parties are expected to close the transaction in the second quarter of fiscal 2020. Before I turn the call over to Erica, I also want to provide an update on our progress in the area of sustainability. There is no doubt that sustainability is important in our industry and is becoming increasingly important to investors. At Cabot, we strive to be the most innovative, respected, and responsible leader in our markets, delivering performance that makes a difference. We believe that a modern company must balance the needs of many stakeholders in order to sustainably increase the value of the corporation. At Cabot, we achieved this through our commitment to operating responsibly, conserving resources, and developing innovative performance materials that help our customers achieve their sustainability goals. I am proud of our continued leadership and progress in this area. Over the past year, we've been recognized by numerous organizations for our outstanding environmental, social, and governance transparency and performance. Notably, we were recently named to Newsweek's list of America's most responsible companies for 2020, as well as recognized in Corporate Responsibility Magazine's 100 Best Corporate Citizens list for 2019. I'm also pleased that we received a gold rating from EcoVedas for our sustainability program for the fourth year in a row. These accomplishments demonstrate our deep commitment to transparency and continuous improvement. I'll now turn the call over to Erica to discuss the business results.

Thanks, Sean. I'll discuss the segment results beginning with reinforcement materials. EBIT and reinforcement materials for the first quarter of fiscal 2020 decreased by $15 million as compared to the first quarter of fiscal 2019. The decline in profitability was driven by lower volumes. Globally, volumes declined 3% in the first quarter as compared to the same period of last year, primarily due to a 9% decrease in EMEA and a 6% decrease in the Americas, as customers aggressively managed year-end inventory. First quarter volumes were down 9% from our fourth fiscal quarter of 2019 and represented the lowest volume quarter in three years. In addition, margins were negatively impacted by lower energy center revenue as production was reduced and there were slower turns of inventory as a result of lower sales volumes. As we have noted throughout calendar year 2019, the pricing and mixed benefits that we achieved from our 2019 customer agreements were offset by the impact of lower margins from a more competitive pricing environment in Asia. Looking ahead to the second quarter, we expect results in reinforcement materials to improve as compared to the first quarter, supported by pricing gains as customers transition to calendar year 2020 agreements and as volumes return to more normalized levels. January volumes were strong and demonstrate that the customer destocking was short-term in nature at the end of the calendar year. In addition, we feel good that the pricing mechanisms in the customer agreement should mitigate the impact from MARPOL-related feedstock differentials. We expect these improvements to be partially offset by lower European volumes that Sean discussed earlier and higher costs related to our North American environmental compliance investments. Now turning to performance chemicals, EBIT increased by $5 million year-over-year due to higher volumes across the segment, partially offset by a less favorable product mix in specialty carbons and lower pricing in our metal oxides product line. The lower pricing in metal oxides is primarily due to a slowdown in the key transportation and industrial end markets in Europe and China and increased competitive intensity. In the quarter, volumes increased 13% year-over-year in performance additives and 20% in formulated solutions. Performance additives volumes benefited in the current quarter from a non-repeat of the destocking we saw in the first quarter of fiscal 2019, along with additional commercial wins in specialty carbons and higher sales from the new China fume silica plant. Formulated solutions volume increases were driven by our specialty compounds product line, as destocking that we experienced last year did not repeat, and we realized the benefit from a master batch acquisition in Southeast Asia. Looking ahead to the second quarter, we expect sequential volume increases in both our specialty carbons and specialty compounds product lines due to a normal seasonal increase. While we are pleased with the positive outcome to date for specialty carbons pricing to recover rising marco related feedstock costs, margins are expected to be negatively impacted by continued competitive fume silica pricing in China and Europe. Until underlying automotive demand improves, we expect specialty carbons and specialty compounds product mix to remain unchanged, and we also anticipate the volume gains associated with commercial wins from the first quarter in specialty carbons to continue. Now moving to purification solutions. In the first quarter of fiscal 2020, EBIT increased by $1 million compared to the first quarter of fiscal 2019. This was driven by higher margins from improved pricing and product mix in our specialty applications. The business also reduced fixed costs driven by savings from the previously announced transformation plan. These benefits were somewhat offset as the business experienced lower volumes in mercury removal applications. Looking ahead to the second quarter, we expect to see seasonal sequential improvement in the specialty volumes and margin improvement from price increase initiatives. I will now turn to corporate items. We ended the quarter with a cash balance of $173 million, and our liquidity position remained strong at over $1 billion. During the first quarter of fiscal 2020, cash flows from operating activities were a source of $105 million, which included a decrease in networking capital of $50 million, largely due to lower receivables. Total capital expenditures for the first quarter of fiscal 2020 were $68 million, and we're now expecting capital expenditures to be approximately $225 million for the full year. We have reduced this forecast from $250 million given current business conditions. As previously discussed, we returned $54 million to shareholders through $20 million in dividends and $34 million of share repurchases. Our operating tax rate was 26% for the quarter, and we anticipate the fiscal year rate will be between 26% and 27%. The increase in the operating rate from our guidance last quarter is largely due to the impacts of Switzerland tax reform and our projected geographic mix of earnings. I will now turn the call back over to Sean.

Thanks, Erica. This has definitely been a challenging stretch for our industry as the U.S.-China trade friction and a slowing macro economy negatively impacted the global auto industry. However, as we think about the auto industry, it is important to remember the long-term fundamentals are sound and that downward cycles have historically recovered after a relatively short period of time. Historical vehicle production data suggests that a typical down cycle lasts somewhere between four and eight quarters. Current automotive production has shown year-over-year declines for the last six quarters. When auto production does turn positive, we are well positioned and ready for this. We have available capacity across our network of plans from recently completed de-bottleneck projects, and we've continued our strategic growth investments in key businesses and regions to serve the long-term demand of our customers. We've been able to do this while generating strong cash flow, returning a significant amount of cash to shareholders, and maintaining a flexible balance sheet over the last two years. In 2018 and 2019, we generated cumulative $661 million in operating cash flow, repurchased $315 million in shares, and paid $160 million in dividends while maintaining our investment-grade credit rating. Now moving to the segments. For reinforcement materials, we see an environment with reasonable supply-demand balance in most regions. We've completed negotiations and are satisfied with the outcome of the customer agreements for calendar year 2020, with pricing improvements driving higher margins. With the year-end destocking complete and the benefit from the 2020 customer agreements in place, we expect Q2 EBIT results to return to Q2 2019 levels and continue to improve as we move through the year, as volumes demonstrate seasonal improvements in the third fiscal quarter and cost-cutting measures take hold in the second half of the fiscal year. In performance chemicals, we anticipate similar sequential results in the second fiscal quarter as compared to the first quarter, and then strengthening in the back half of the year as volumes are expected to remain solid through 2020 in specialty carbons and compounds. We expect the fume silica market to remain challenging in the near term as the key automotive and industrial end market demand remains soft, leading to higher competitive intensity. However, the long-term underlying fundamentals of this business remain attractive as feedstock access and strategic integration will continue to determine growth and profit levels. On this front, we are extremely well positioned with our silicone fence line partners, Dow Silicones, ChemChina, and HYC. In purification solutions, we expect to see sequential EBIT improvement from seasonally higher volumes and lower fixed costs driven by savings from the transformation plan. Full-year even improvement is expected to come from higher unit margins as pricing and mix initiatives and specialty applications take hold. Based on these factors, we expect adjusted EPS to be in the $3.60 to $3.90 band of our previously communicated range. The midpoint of this range reflects a growth rate of 4% as compared to fiscal year 2019 results, excluding the specialty fluid segment. At this point, the impact of the coronavirus is difficult to predict. Our outlook does not include an impact to our business from this, but we continue to watch this closely and will provide an update should the situation impact our outlook. On the cash side, we expect strong cash flow generation and to continue to return cash to shareholders consistent with our long-term capital allocation strategy. As we manage through this challenging business environment, we remain focused on the long term while taking prudent countermeasures to deal with the dynamic environment. Thank you very much for joining us today, and I will now turn the call back over for our question and answer session.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Josh Spector with UBS.

Yeah, hey, guys. Thanks for taking my question. So I understand you're not quantifying the impact from coronavirus. Just curious at a high level if you could talk about some of the perhaps locations of supply and demand within the region. So if there was a longer-term impact from customers shutting down, would you see production also impacted? So perhaps there would still be a balanced supply-demand, or would things be lopsided one way or another?

Sure. Thanks, Josh. Let me try to provide a few comments around the coronavirus. So I think with respect to that, we're obviously concerned first and foremost about the safety and welfare of our employees in China and around the world, and we've put the appropriate precautions in place. Now, the situation, as I think everyone can appreciate, is very dynamic, and I think the impact is difficult to predict. So as a result, our outlook does not include any impact from this, but we continue to watch it closely, and we'll provide an update as things develop here. I guess to your specific question, maybe a few important facts that will help in terms of Cabot Corp. So we don't have any facilities in Wuhan directly. And we're following the government policies as required, which has extended the Chinese New Year through February 9th. So that's about a two-week extension. You've probably read that that's been mandated by the Chinese government. So this has impacted our office locations. Now, the majority of our production units are running and have been through the Lunar New Year period. This is pretty typical for us because we're a continuous process industry, and so we typically do run through the Chinese New Year, and so the majority of our units have been running through this period, and so we continue to produce. I think the challenge in what we're watching here is inbound and outbound logistics because those are becoming more challenging given the actions by the government to contain the virus. So we're watching that carefully. But it remains overall a pretty dynamic situation, so we'll have to see how things unfold here in the coming weeks. But hopefully that gives you a little bit of a sense for the Cabot specifics at this point.

Yeah, that's helpful. And maybe just if I could kind of around the same thing is what about your competitors? So I guess some local China production, would you say they would take the same approach of continuing to run? I guess where I'm getting at is that is there a risk that you build up some supply in the region from product either not being able to move or customers taking extended downtime, or would there be a different way to think about it?

Well, I think most customers, most competitors would probably take a similar posture through Chinese New Year, some to greater degrees than others, I suppose, but most would continue to operate because what you typically see coming out of Chinese New Year is a jump in demand, and so, you know, that needs to get satisfied. So our expectation here is that, you know, if as soon as, you know, demand returns to normal, then the production gets swallowed up or gets absorbed, basically. So So we wouldn't see normally any sort of an imbalance, but I think a lot depends on how quickly the tire producers get back into full production. So I think that's the thing that we'll have to watch here. All right. Thank you.

Thank you. Our next question comes from David Begleiner with Deutsche Bank.

Thank you. Good afternoon. Sean, looking at the January volumes, was there a restocking in January, do you think, or just a more normalized demand off of the destocking in December?

Yeah, Dave, as we commented in the prepared remarks, we definitely saw a much more aggressive and I would say unusual increase pullback at the end of the calendar 2019. We had some customers comment to us that it was their most aggressive inventory management ever or in recent times. So it was pretty pronounced and more than the usual seasonal slowdown. Now, what we saw in January was quite strong volumes. And so, for sure, there's some, you know, kind of restock there as they corrected very aggressively for their year end. And a lot of these folks are on calendar fiscal year end. So, we definitely did see some of that return in January. in addition to the normal seasonal bump we would expect coming off of the holiday period.

Very good. And just in terms of Europe and the Russian capacity, is this a longer-term threat, i.e., could you see additional volume givebacks by you guys in future years to deal with the Russian lower-cost or lower-priced material?

Yeah, so Russian producers have been operating and supplying into Europe principally for quite some time now. And so... In the grand scheme, the total capacity in relation to needs in EMEA is not overwhelming by any means. As a result, we've been able to generate quite strong profitability in Europe. I think the real challenge here is that you know, they operate under some, I would say, different rules of the game. And I think it's important that we continue to educate our customers who care about sustainability that, you know, while Europe is under, you know, CO2 trading schemes and certain levels of emission controls, the Russian producers are not. And so, in effect, they're their exporting pollution into Europe, and it's important that we continue to educate our customers who care about sustainability to reflect this properly. So it's something that's not new. We've been operating in this dynamic for quite some time. My entire time with the company now, which is starting to push 20 years, there have been Russian producers that have had impact in Europe. So it's something we manage, but I think there is quite a contradiction between what our customers need in terms of sustainability, what we do in terms of sustainability as a company, and the rules that they operate under. And that's something we have to continue to, you know, make clear and advocate for the right thing to do here. Thank you. Very helpful.

Thank you. Our next question comes from Jim Sheehan with Centrist.

Yes, thank you. Regarding your performance additives volume growth, pretty strong 13% number this quarter. Was that growth evenly spread across the world, or was it more pronounced in China? Yeah.

Hey, Jim. So, yeah, pretty strong volume picture in performance additives. I think a couple of things are worth remembering here. The same quarter this time last year, we saw some fairly pronounced destocking, in particular across specialty carbons and specialty compounds. And so the non-repeat of that certainly contributed to the strong numbers. In terms of the distribution of that, I would say it was fairly It was fairly balanced around the world, and we definitely saw destocking all around the world this quarter last year and saw improvement all around the world. So I would say fairly balanced, Jim.

Would you say more of your growth came from the specialty carbons business or from the new fume silica capacity?

We saw volume growth across all of the three major product lines here, specialty carbon, specialty compounds, as well as fume silica. I think there was definitely contribution from all three here in the period.

Thank you. Could you comment on where you stand on your considering of strategic options for purification solutions And if you're maintaining that business for the long term, what is your strategy for taking a larger share of the automotive carbons market?

Yes. So, Jim, nothing's changed here in terms of our strategic portfolio choices. So with respect to the purification solutions business, it is one that we believe – is best in the hands of a more strategic owner that is not us. And so nothing has changed in terms of that posture. And as we've commented in the past, our primary focus here has been around improving the performance of that business so that we're in a in a better position in the future to execute a transaction. And so I think the strategic direction here hasn't changed at all. I think with respect to the automotive application, we've been working in this one for quite some time and having some success. I would say it is It is a little more long-wavelength in nature in terms of getting specified in. So you might recall we're a number two player in the world in this space, but making progress, getting qualified into new applications, and that continues to be an important strategic focus for the business. But the timeline or the onset period is a little longer in terms of the nature of it. Thank you.

Thank you. Our next question comes from Mike Leakhead with Barclays.

Thanks. Good afternoon, Sean. Hey, Mike. I guess first to start in reinforcement materials, I think your commentary was you expect flat EBIT in 2Q year over year, so call it about $15 million better sequentially. Can you just help quantify how much of that is price versus volume recovery? Okay.

Yeah, so, you know, if I look at the results in the quarter, Jim, I mean, Mike, sorry, the results, you know, year over year were down around $15 million, and they were all volume-related. And so we definitely saw weaker volumes because of the aggressive inflation. activity in terms of customers managing inventories, and then what I would call some volume-related impacts in the quarter in terms of our energy centers and the flow-through of inventory. So those three results, Mike, drove about the $15 million decline, and they were sort of roughly equal in terms of So as we roll forward here and we see volumes in Q2 return to a more normalized level, then we would not expect that these things repeat.

I guess what I'm trying to get at, just, I mean, the pricing benefit you kind of know at this point versus volume and the associated costs from that, can be somewhat variable. So I guess what I'm trying to get confidence in is kind of this quarter as we think from the seasonal low in 1Q, just kind of how much is kind of locked in at this point versus what we still kind of maybe are hoping for some more macro pickup in 2Q.

Yeah. I think the customer negotiations are sort of, I would call them, bought in at this point. We know what those new prices are and have been operating and invoicing and shipping under those. The new arrangements around the formulas and the protections, the marco, all that stuff is in and we're operating to it. And we normally see a seasonally higher Q2 than Q1. So I think those are fairly known at this point. I think the wild card here is, of course, Q2, we always have Chinese New Year, which is nothing new. But the question will be, you know, what are impacts, you know, how does the coronavirus play out? And as I commented earlier, it's just too early and uncertain to comment on that. But if I just put that aside for a minute and look at the sort of main drivers here I think they're fairly known at this point if I put that one aside. Got it.

And if I could just squeeze in one quickly on the fume metal oxide business. My understanding is the top three producers, including you guys, make up, call it, 70% of the market, which typically means a fairly constructive, rational market. Right. When you talk about competitive pricing, is it really due to that other 30%? Or I guess any incremental color you can give on what's going on in that market might be helpful.

Yeah, sure. So let me just try to describe a little bit the demand side here and then what we're seeing in terms of the current environment. So the demand environment has definitely been softer, particularly in Europe and China. You know, the key end markets here are are automotive and construction. Those are two big end markets. And so if we look at this business in calendar year 19, you know, we estimate that the market for fume silica contracted versus 2018. So we hadn't seen that in quite some time. So this weaker demand definitely resulted in some more competitive intensity overall. But again, it was more acute in Europe and China, given the negative environment in those regions. And at the same time, some supply has come on stream recently, I think thereby pressuring near-term pricing. I think these factors definitely present a near-term challenge for us, but the fundamentals of the business remain attractive. You commented on sort of industry structure, but if you look at this business historically, it's been one that has had very strong profitability in the sort of 30% EBITDA range. And demand has steadily grown at something above GDP, kind of one and a half times GDP. And this is because silicones, a major application market for fume silica, has really strong performance characteristics. And then finally, feedstock access and strategic integration are critical here. So there isn't sort of a market for feedstock like there is in carbon black where you can buy in the Gulf Coast and and have access to feedstock. The market for feedstock in fume silica is quite strategic and requires strategic integration with a silicones or polysilicon player. So given those factors, you know, we're extremely well positioned here with our fence line partners, Dow Silicones, ChemChina, and HYC. And so the industry has historically been I think very well balanced in terms of feedstock supply and silica demand, which has led to limited new entrant risk here. And again, the feedstock is a byproduct of either the silicones production process or the PCS production process, so these strategic fence line relationships are essential. But the capacity adds can be a little lumpy given the economic scale of investment. but demand growth has historically soaked this up in a relatively short period of time. So I think the combination of some near-term softness in demand and some strategic capacity coming online has created a higher level of competitive intensity. I think China specifically is a slightly different industry structure, while some of the major global players are present there, not all are, and there are some local players. So that kind of 30% that you talked about is more concentrated in China. And again, the weak demand environment in China, in auto, for example, that is providing some pressure in terms of the overall sort of pricing environment in the business. But in the long term, we see the balance of feedstock and demand for silica to be in a good balance as it has been historically. Great. Thank you.

Thank you. Our next question comes from Kevin Hosfar with North Coast Research.

Hey, good afternoon, everybody. Hi, Kevin. I'm wondering... It sounded like the specialty carbons was doing a pretty good job in passing along pricing. So I'm wondering if you could give some color on what you're seeing out of the input costs, especially with IMO 2020 in effect. I think, you know, there's certain product lines that have to use low sulfur fuel oil. So can you talk about what you're seeing on the input cost side there on the raw material side? And, you know, I know some of the volumes this quarter were good, but the end markets overall were good. you know, have generally been challenging in automotive and some of those key higher-end markets that might be using that low-salt fuel oil. So could you describe what you're seeing on the input cost side, how successful you are on the pricing side, and do you expect to be able to continue to largely offset any inflation, you know, with pricing? Do you expect that to, you know, continue to be neutral or, you know, stable? Yeah.

Yeah, yeah, yeah. So the 1% or the half percent of the sort of the lower sulfur indices are definitely climbing and have been climbing as we've moved towards the MARPOL regulations here in the beginning of 2020. And so that... that was pretty sharp in the back part of the year as traders and people were speculating on what was going to happen. In fact, the 1% has moved up quite a bit. Now, the team in Specialty Carbons has been working hard here to manage this and get prices up and have been largely successful here. I think that's a positive. It remains an important strategic initiative for the business to manage this carefully. But between our announced price increases and what we've gotten, plus as we've gone through certain larger customer negotiations, while we don't have the same level of contract business that the reinforcement segment does, there is some in this business. We've been you know, really focused on making sure we get some level of sort of mitigation protection in there in terms of the MARPOL regulations and the impact of that on the low sulfur feedstock. So I think on balance, Kevin, we're doing pretty well and getting the recovery. And the team's done a good job here helping customers understand why this is important. Now, you know, the mix impact on this business, which has been, you know, pretty pronounced over the last kind of year to year and a half, is principally driven by weakness in auto. And so a lot of the higher end applications, you know, those continue to I think, suffer from weak fundamentals in auto, but hopefully that will begin to turn here to my earlier comments. But overall, I feel like we're handling this reasonably well on specialty carbons.

Great. And in terms of the contracts for reinforcement materials, Could you give a little color on the adjusters that you put in? I think you have delivered cost adjustments or, you know, I think every manufacturer, car manufacturer did a little different. What's the – were you able to implement those all over the globe? Was it, you know, just the U.S.? And in terms of how they're going to function, I know that there's been some – I guess what I'm trying to understand is there's been some differential headwinds the last year, you know, a couple of years here. Are these – adjusters reversing out any of those differentials, meaning that there could be a tailwind from these being implemented in the contract, or are they mainly just being implemented and saying, okay, 2019 was the base for what the differentials are. They're not going to get any better or worse from here as this adjustment will eliminate that. Just trying to understand those things.

Sure, sure. So let me provide some sort of Cabot-specific commentary here, Kevin. So you'll recall as we were heading into 2019 where, you know, looking forward, you know, we could see the IMO or the MARPOL regulations coming our way, we took some proactive steps to get DCAs and and similar mechanisms in place. And so as a result, you know, as we look at our 2019 performance, there was not a material impact from that on our business. So we managed it quite well and were, I think, pretty aggressive and out in front seeing what was coming here. Now, as the year progressed and as we got closer and closer to the implementation of the new regulations, you started to see the low sulfur indices climbing and climbing pretty sharply. And as we're now into 2020, you definitely see that the differentials have have moved again. So our mechanisms that we put in place for the new 2020 agreements, you know, we feel good about how they will mitigate that. But we had already covered a lot of ground and done a lot of good work in 2019 to limit the impacts there. So that's perhaps more of a Cabot-specific story, but that's how it has... played out for us. And then, you know, these mechanisms, there are various forms, and so each one is, you know, a little bit customer-specific in certain ways, but the concept of either a delivered cost adjustment or a move to a more appropriate index now that the MARPOL regulation is in and we see what the low sulfur indices are doing we have a range of these. It kind of depends by customer, but we have implemented around the world on these, on our contracted business, and we feel good about where this has come out.

Okay, and then last one for me. I just wondered if you could talk on China's profitability there. I always kind of equate your minority interest line with China profitability is because most of your joint ventures are in China. And that was $5 million this quarter, which was, you know, the lowest it's been in a couple of years. So I'm wondering if you have some comments on, you know, how China is doing. I know there's more in there than just that, so maybe there's some other explanations in there. But I'm wondering, you know, what you're seeing out of China at this point in terms of business conditions there and profitability there. And as you look out, I mean, I know that they use a different feedstock, a coal-tar-based feedstock. And I think I've heard that that hasn't seen the same level of deflation as, say, high sulfur fuel oil feedstocks, which might make China product less competitive on the world stage, which might keep China product within China. So I'm wondering if that's something that could be an impact here, as you think of, like, supply and demand in that region. Is that a challenge, or is that not really something you're seeing or expecting?

Yeah. Yeah. Yeah, so I guess a couple of things, Kevin. First, it is important, while the majority of our joint ventures are in China, we do have a fairly significant joint venture in the Czech Republic that would be in those minority interest numbers that you're talking about. But Your point around the majority of our JVs being in China, that is the case. So a couple of things. I think China, in terms of the macro environment, is definitely more challenging. I mean, we've seen the headline numbers in terms of GDP slowing, and we know that overall automotive production has been really weak. They had 16 straight months of year-over-year declines. And if you look at in total for 2019, I think the industry declined somewhere close to 10%, if my memory is correct here. So it was a pretty challenging environment in terms of overall auto production. And then the impact of the trade friction in particular on the sort of industrial sectors, I think is something that we've been battling here. So the environment hasn't been great. That being said, we are still quite profitable in China, even in this environment. So I think that's an important point and one that I think speaks to our business, our assets, and we know based on you know, publicly available information around the carbon black industry, that that's not really the case for the industry. So we really do feel like we have, you know, strong assets and a business team there. But the environment, no doubt, is weak. Now, you know, we've started to see a couple of positive signals here in auto production in both November and December. Those turned positive. Now, they were off-week comps, but they turned positive. So So that is encouraging, and we'll have to see how that develops here. And then secondly, the trade dispute, at least with a phase one deal in place, does that begin to remove some of the uncertain sentiment that's been kind of clouding things? So these would be positive near-term developments, but I think we'll have to see. And of course, the whole thing is a bit confounded by the uncertainty around the impacts of coronavirus. So it's a dynamic situation here, but we continue to, I think, manage it well. And given the long term, in terms of how much of the world's tires China produces, the feedstock situation in terms of coal tar being pretty much in balance with carbon black, production needs, the continued environmental ratcheting in China over time. We think that having the largest car park in the world, these things are the right long-term fundamentals, and we don't feel that those have changed. So we've got to battle through the near term here. Okay, great. Thank you very much.

Thank you. Our next question comes from Jeff Sikowskis with J.P. Morgan.

Thanks very much. Hi. Was there something unusual that drove up your SG&A costs in that on an adjusted basis, I think your SG&A costs were down a couple of million, maybe 66 to 64, but your revenues were down, I don't know, 95 million?

Sure, Jeff. This is Erica. So if you're looking at the unadjusted figures in there, we had a good amount of restructuring charges that related to what Sean talked about primarily in terms of the global business services move from North America to Europe. So in the unadjusted figure, you have charges there that are offsetting some of the savings programs you would otherwise see.

So when you adjust it, what's the year-over-year change?

So the restructuring charges that you would see would be $8 million in the quarter.

Okay, thank you for that. I think your CapEx last year was supposed to be $250,000 to $300,000, and maybe you came in at about $225,000. Does that mean you have to do extra spending for this year, or what's your CapEx range? And what are your big projects this year?

Yeah. So when we kicked off the year, Jeff, we had articulated a range of between $250 and $275. And as the year, you know, as we've progressed here in the current environment, we're estimating that that will be around 225 for this year. So, you know, we're trying to take, given the current environment, we're taking a hard look in terms of prioritization and, you know, making the right choices here in terms of the environment. And then, you know, we continue to scrutinize every project in terms of capital efficiency and make sure that even if it's a project that it makes sense to do, that we're squeezing it down and being as capital efficient as possible. So that's our current expectation for this year. Now, of that number, you'll see around $150 million of it is in the sort of sustaining and compliance space as we continue to have environmental investment in the U.S. occurring, and then there's a normal amount of what's called sustaining or maintenance capital. So then the balance of it, call it 75-ish, would be growth-related capital, and this would be projects related to the Carrollton fume silica plant, the conversion of the Peugeot carbon black acquisition we did in China where we're converting that to make specialty carbons to have growth capacity over the long term. Some of these projects would be in that 75-ish of growth number. So that's kind of where we stand in terms of the total envelope, how we're thinking about it in terms of the current environment and what the mix is between sort of sustaining compliance and growth.

Okay. And then... Lastly, in your performance business, you've always described in very positive terms these over the fence relationships you have with your fume silica customers. Is it the case that when silicones prices go down that your profitability falls as well or is adjusted downward because of the profitability of your customers? or are your contracts independent of overall silicones pricing?

Yeah, so if we look at the silicones part of it, Jeff, the feedstock that we have to produce fume silica is under long-term, I would call it sort of fixed-price contracts, so that doesn't move with silicones or celloxane prices, whether they're going up or down. So either way, they don't. So the input costs are not moving and are known. And then the silica that we produce, some of it goes back to our fence line customer and they incorporate it into their filled compounds. And that is on a fixed or a known price as well, independent of whether their siloxane or their silicone prices are going up or down. So that is very well known. But then there's a portion of the fume silica that goes into what's called the niche market. So it doesn't go to the over-the-fence customers. It goes out into the open market for non-silicones applications principally. And those markets are more driven by the current environment and how demand looks and how competitive intensity plays out. So that's sort of the makeup of these arrangements.

So year over year in performance chemicals operating income, you were up $5 million. Did that... Both businesses grow, that is the, or maybe you see it three ways, the specialty carbon blacks, the master batches, and the fumed metal oxides. Which ones grew in operating profits and which ones shrank? How did you get the 5 million more?

Yeah, yeah. So we don't comment on the specific profitability of each, but definitely, yeah, you can see that the carbons and compounds businesses saw pretty strong volume growth, and as a result, profitability improved in those over the prior period, and less so in fume silica. That would be kind of how I would say it. Okay, good. Thank you so much.

Thank you. Our next question comes from Lawrence Alexander with Jefferies.

Hi, this is Adam for Lawrence Alexander. Hi, I was wondering how should CEC and battery materials ramp? Will it be like lumpy path or more linear? I'm sorry, Adam, could you repeat that? How should elastomer composites and battery materials ramp? Will it be a lumpy path or more linear?

I see. Okay. So, cavity elastomer composites and energy materials. So, both of these are important strategic growth investments that we've been making over the last several years, and we're very bullish on both of them. So, in terms of CEC, this is a unique elastomer material that drives much better tire wear performance. And we've commercialized this with a major tire producer already and are in the process of further commercialization in the industry. That is something that generally takes some time because the qualification period is is somewhat long, and then, you know, it will be a little bit lumpy because it will be customer by customer, application by application. So I think it's something where we expect to start to see material contribution from it, you know, over the next five years. But in the short term here, we're in more of an investment cycle as we work through customer qualifications and the technical development associated with that. So those are a couple points that just maybe help you understand the shape and the nature of this. And then on energy materials, we have a business today that, you know, is in the $20 million to $30 million of sales range, and now with the Sanchun acquisition upon successful Closing is going to put the combined revenue in the range of $50 million. This one will move a little more linearly because we're already building some significant revenue here. And while there is a qualification customer-by-customer sort of battery application by battery application qualification process here, It's more diversified across a range of customers and applications, and so I think it'll take on a little more linear flow here. So if you look at the market for conductive carbon additives in total, this is a market that for lithium ion batteries that today is between $350 and $400 million of market value for conductive carbon additives. And we expect this is going to grow in the 20% range over the next five years. So that sort of pushes the total market value up somewhere close to a billion dollars. And again, you know, of the $350 to $400 million, Market today, when you combine our business and San Shun's, you know, we'd be in the range of 50. So that kind of gives you a sense for what that looks like. And over time, as we're successful here and grow our position, we'd expect the margin structure in this business to, you know, look something similar to performance chemical segment. So that's kind of a way to think about that one.

Okay, got it. Thank you very much.

Thank you. And our final question will come from Chris Kapsch with Luke Capital Market.

Thank you. I missed some of the initial formal comments, so I apologize. But on the D-stock dynamic that you experienced in reinforcement materials, can you characterize that by geography? Which regions did you feel that more pronounced versus others? And then conversely, the volume snapped back a little bit in January. Was that similar to where you experienced the D-stock, or was that more pronounced in certain regions versus others?

Sure. Hey, Chris. So, yeah, the D-stock that we saw was principally in Americas and Europe. And so, you know, you saw the first quarter year-over-year changes in Europe were down 9%, and the Americas were down 6%. It was very pronounced in those markets and the major customers that operate in those markets. As we saw volumes improve in January and some of that snapped back, it was spread similarly in terms of region and customer.

the MARPOL, the IMO 2020, and the delivered the DCAs, you've expressed confidence that you have those in place now to cover, I guess, differential blowout associated with IMO 2020. And since, I guess, lower sulfur diesel or lower sulfur feedstocks have become more expensive, and since you're comfortable that you're covering that, presumably that's higher raw material costs to your customers. So Just wondering, since they're seeing, you know, effectively price increases there, did that undermine your ability to get base price increases in these annual contracts that you otherwise would have hoped to get if not for MARFL 2020?

Yeah. So, well, I mean, in terms of the feedstock cost, you know, moving up, because of the rising differentials and the issues related to Marple, there's no doubt that that resulted in a higher pricing component for customers here. I think if you take a look at the overall negotiations here, I think we're We're pleased with the outcome. You know, the market was a bit softer than last year, but, again, overall, we achieved price increases in Americas and Europe, and these are the primary, you know, contracted regions. So our overall pricing efforts here had a combination of base pricing actions as well as the strategic objective to include pricing adjustments for MARPOL. and differential risk here that needed to be mitigated. So if you look at all of that, if you just look at sort of straight pricing or invoice impacts to customers, the pricing and mixed top-line benefits were approximately about $15 million per quarter. Now, we needed some of that pricing to cover the forecasted feedstock differentials from the transition to the new MARPOL regulations. And then we did shed some lower-end European volume. So the net of this is somewhere in the order of maybe $7 million per quarter margin benefit from these agreements. That's maybe a way to think about it. So overall, you know, quite a bit of top-line pricing movement, some of it base price, some of it pricing that customers will see that needs to be there to cover the rising differentials.

That's helpful. Thank you. And then finally, just in the performance chemical segment, you alluded to, you referred to especially carbon's market share gains. So that's That part of the market, part of the carbon black market, is generally characterized as a more consolidated competitive landscape with fewer competitors. And so I hadn't really thought about that as much in terms of the competitive intensity and the reinforcement material. So I'm just wondering if you could provide any color on the share gain there. Was it affordable? just a function of expanding the addressable market? Was it specifically taking share on performance of your specialty compounds, or specialty carbon blacks versus competitors? Anything there would be helpful. Thanks.

Yeah. So, a real mix here, Chris. So, while, you know, there are, you know, number of players that participate across the specialty carbon space and especially carbon space is made up of a lot of different applications and a lot of those applications are served by you know I would say kind of a common set of assets there's there's opportunity to move between rubber blacks tire industrial products and specialty carbons and we always look to optimize across that and And so as we were, you know, working through, you know, commercial actions, we have, you know, emphasized some of that capacity towards more specialty carbon. So we try to look at it with a one-cabot view, and the result of that is that we have picked up some targeted share in specialty carbons. But it's pretty spread, both geographically and across the range of applications and customers.

Okay. Thank you.

Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Sean Cohane for any closing remarks.

Great. Thank you very much for joining us today, and I look forward to speaking with you again next quarter. Have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.