Cabot Corporation

Good morning. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 2020 Cabot Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Mr. Steve DeLaHunt. Please go ahead, sir.

Steve DeLaHunt Thank you, and good morning, and welcome to the Cabot Corporation Third Quarter Earnings Teleconference. With me today are Sean Culhane, CEO and President, and Erica McLaughlin, Senior Vice President and CFO. Last night, we released results for our third 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. It 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. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and potentially inaccurate assumptions and other factors, some of which are beyond our control and difficult to predict. If known or unknown risks materialize, or should underlying assumptions prove inaccurate, our actual results could differ materially from those expressed or implied by our forward-looking statements. Importantly, as we cannot predict the duration or scope of the COVID-19 pandemic, the negative impact to our results cannot be predicted. Factors that will influence the impact on our business and operations include the duration and extent of the pandemic, the extent of imposed or recommended containment or mitigation measures, and the general economic consequences of the pandemic. Other important factors that could cause our results to differ materially from those expressed or implied in the forward-looking statements are discussed under the heading Forward-Looking Statements in the press release we issued last night and in our last annual report on Form 10-K for our fiscal year ended September 30, 2019, and our quarterly report on Form 10-Q for our fiscal quarter ended March 31, 2020. And in subsequent filings we will make with the SEC, all of which are 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 measures 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 provide an update on third quarter results, along with an update on our financial position, a market overview, and our progress on sustainability. Erica McLaughlin will then review the business segment results in our corporate financial details. Then Sean will provide some call on the fourth quarter and open the floor to questions.

Sean? Thank you, Steve, and good morning, everyone, and welcome to our third quarter earnings call. As expected, the impact from COVID-19 in the third fiscal quarter was significant, as we faced an unprecedented level of demand disruption. I'd like to begin by recognizing the entire Cabot team for the way they responded to ensure that we remain safe, support our customers and communities, and adjust to a new set of priorities around cash preservation and cost management. I am specifically very proud that our extensive protocols to ensure that our people and suppliers are safe have worked well. and pleased to report that we've had no instances of work-related COVID transmission among our employees. In the third fiscal quarter, volumes in product mix across our businesses declined by over $100 million as compared to the prior year quarter, driven primarily by lower demand in the tire and automotive sectors as manufacturers temporarily halted production in response to the COVID-19 pandemic. As a result, Total segment EBIT was $18 million, and adjusted earnings per share was a loss of 7 cents for the quarter. Despite the challenging environment, we're extremely pleased with our cash flow performance in the quarter, as we generated operating cash flow of $149 million. This puts us on track to deliver the operating cash flow that we communicated last quarter of $200 million in the second half of the fiscal year. In addition, we continued our commitment to return cash to shareholders with $20 million in dividends paid in the quarter. We also made progress on a key strategic initiative by completing our acquisition of Shenzhen Sanshun Nano. The acquisition of this leading carbon nanotube producer to the lithium-ion battery sector will complement our range of conductive carbon blacks and strengthen our position in this fast-growing application. We also continue to strengthen our already solid debt and liquidity position. Cabot has consistently generated strong operating cash flow, and since 2015, we've generated over $2.1 billion cumulatively. We remain confident that our cash flow from operations will be sufficient to fund our current dividend and support the capital expenditure needs of our businesses. The strong cash flow generation in the quarter allowed us to fund the Sanchon acquisition while at the same time increasing our cash and bringing our debt balance down. On the liquidity side, as of the end of June 2020, we had $1.4 billion in cash and committed facilities and a debt to EBITDA ratio of 2.9. Out of an abundance of caution, we increased our leverage covenant from 3.5 times to 4.5 times for the four quarters starting in September 2020. which we believe provides ample cushion in these uncertain times. The COVID-19 pandemic is having a far-reaching impact on the global economy, with global GDP forecasted to decline approximately 5% in 2020. In terms of the impact of the pandemic on Cabot's business, we expect the June quarter will be the low point in terms of financial results. April demand proved to be the low point for us, and we saw month-over-month improvement throughout the quarter, with further strengthening in July. Additionally, we are seeing the broad mobility data continue to strengthen. Looking a bit deeper at our end markets, developments are mixed. Automotive production represents approximately 25% of our sales, ranging from tires on new cars to a host of applications in performance chemicals, such as structural adhesives, coatings, and engineered plastic compounds. This market has suffered in 2020 and is projected to decline about 20 percent in the calendar year, with year-over-year declines in all regions. We expect to see improvement in the September quarter based on external forecasts, which are projecting a year-over-year decline in global light vehicle auto production of only 10 percent in that quarter, as compared to a decline of 45 percent in the June quarter. Now moving to tire production. The global replacement tire industry is also expected to decline for the full calendar year of 2020 by approximately 15% based on estimates from LMC, with contraction occurring across all regions. Similar to auto production, the September quarter is expected to show improvement sequentially, with total replacement tire sales projected to be down 10% year-over-year, compared to a decline of 34% for the June quarter, according to LMC. We have also seen clear and steady upward trends in terms of mobility and miles driven, and this bodes well for the replacement cycle for tires, both in terms of passenger vehicles as well as truck and bus. The replacement tire market has historically been more resilient compared to other parts of the broader transportation sector. Beyond automotive and tires, which are large and important end markets for us, we also serve a diverse range of applications across the infrastructure, packaging, and agriculture sectors, and these end markets have held up well during this time. Additionally, PMI has rebounded sharply as we exited the June quarter, a further sign that economies are recovering from the low point in April. In times like these, it's important to remain committed to long-term strategy. A key tenet of our strategy at Cabot is built on sustainability. We believe our ability to develop innovative technologies to meet our customers' sustainability challenges, conserve resources across our value chain, and grow our position in the circular economy is a key to our shared future and provides us with a competitive advantage. For more than a decade, we've consistently published a sustainability report to highlight our progress in this area, and we recently released our 2019 report. As is typical for us, the report was published in accordance with the Global Reporting Initiative. And in an effort to further our commitment to transparency and to provide important information to our shareholders, we have aligned our disclosures with the Sustainability Accounting Standards Board, or SASB framework, which sets forth standards for the chemical industry. We also remain a proud signatory of the United Nations Global Compact, and are committed to reporting our progress as a key component of our sustainability report. I'm also excited to share our expanded 2025 sustainability goals. We have a long history of focusing intensely on the environmental impacts of our operations and the safety of our employees, partners, and communities. We also recognize that long-term success requires a commitment to sustainability in its broadest form, as well as a balanced approach to stakeholder engagement. Our 2025 sustainability goals demonstrate our steadfast commitment to this broad definition of sustainability. This expanded set of goals reinforces our broadened view of sustainability and extends beyond our strong foundation in safety, health, and environment to include areas such as product development, supplier sustainability, diversity and inclusion, and community engagement. In our reinforcement material segment, we're pleased to report that as of June 2020, all major emission control equipment has been received and placed into final position at our Franklin, Louisiana site. This project has completed 90% of the estimated person hours required and remains on track to finish ahead of the industry's April 2021 EPA deadline. Additionally, we've launched another new product within our Cabot engineered elastomer composites business. The new E2C DX9640 solution is specifically engineered to improve the performance, safety, and lifespan of tires while reducing the cost and environmental impact of production. The E2C product line was recently named European Rubber Journal's inaugural list of top 10 elastomers for sustainability, which ranks projects that contribute most to raising the environmental profile of the elastomers and rubber industry. We were the only carbon black company recognized in this top 10 list. I will now turn it over to Erica to discuss the results of the third quarter. Erica.

Thanks, Sean. I'll start with reinforcement materials. Even reinforcement materials for the third quarter of fiscal 2020 decreased by $77 million compared to the prior year, primarily from lower volumes due to the impact of COVID-19. Globally, volumes declined 42% in the third quarter, primarily due to the temporary tire and automotive customer shutdowns in Europe and the Americas, where volumes were down 51 percent and 59 percent, respectively. We were also impacted in Asia, where volumes were down 26 percent. The unfavorable impact of lower raw material costs on margins was $16 million as compared to the prior year, driven by a slower turn of inventory, less benefit from yield projects, and lower energy center revenue. Cost mitigation efforts partially offset the impact from lower volumes and margins. Looking ahead, we expect that half of the lower raw material cost headwind will not repeat in the fourth quarter. We anticipate a significant sequential improvement in demand and reinforcement materials, given that customer plans have come back online. July volumes improved sequentially from June and were 9% below July of last year, and we believe this includes some level of restocking at our customers. Therefore, we expect volumes to be down in the range of 15% compared to last year's fourth quarter. Now turning to performance chemicals, EBIT decreased by $16 million year over year, primarily due to lower volumes from the impact of COVID-19, a more competitive pricing environment, and a weaker product mix in our few metal oxides product line, and a weaker product mix in our specialty carbons product line from lower demand in automotive applications. In the third quarter, volumes decreased 5% year-over-year in performance additives and 8% in formulated solutions. COVID-19 impacted volumes in both businesses, primarily in automotive and construction end markets, while the infrastructure market, including wire and cable and pipe applications, continued to hold up well in all regions. As we moved through the third quarter, we did see signs of recovery begin to take hold in all regions, led by China, which has returned to growth in many key end markets, such as automotive. Looking ahead to the fourth quarter, we expect modest sequential improvement in volumes and performance additives as end markets begin to recover from the impact of COVID on demand, offset somewhat by seasonal patterns and formulated solutions. The benefit of the higher volume and more favorable product mix that we are expecting in performance additives in the fourth quarter is is expected to be largely offset by higher fixed costs associated with the startup of our new North American fume silica plant and synchronized turnarounds driven by our fume silica fence line partners. Now moving to purification solutions, in the third quarter of fiscal 2020, EBIT increased by $1 million compared to the third quarter of fiscal 2019. This was driven by higher margins from improved pricing and product mix in our specialty applications and reduced fixed costs in the quarter, driven by savings from the previously announced transformation plan. Partially offsetting these benefits were lower volumes in specialty applications related to the impact of COVID-19 and weaker mercury removal demand. Looking ahead to the fourth quarter, we expect to see seasonally higher volumes and some COVID-19 recovery, which will be more than offset by lower margins due to an unfavorable product mix. I will now turn to corporate items. We ended the quarter with a cash balance of $162 million and our liquidity position remained strong at $1.4 billion. During the third quarter, cash flows from operating activities were $149 million and year-to-date operating cash flow is $278 million. Total capital expenditures for the third quarter of fiscal 2020 were $43 million and we're still expecting capital expenditures to be in line with the $200 million forecast we provided last quarter. Also in the quarter, we paid $20 million in dividends. Given the uncertain business conditions, we did not repurchase shares in the quarter and don't expect to purchase any shares for the remainder of this fiscal year. Our year-to-date operating rate is 29%, and we anticipate the operating rate for the fiscal year to be in the range of 29% to 30%. I will now turn the call back over to Sean.

Thanks, Erica. As we talked about last quarter, about 40% of our sales are tied to the replacement tire end market, 25% driven by new autos, and 35% linked to consumer and infrastructure-related applications. With this mix of end market participation, the decline in volumes in the third quarter was as anticipated, primarily related to the temporary suspension of customer production in the tire and automotive sectors. We are pleased to see that there is recovery underway in the tire and auto end markets from the low production levels in April, leading to what so far has been a V-shaped recovery for demand in our reinforcement materials product line. Given the longer value chain in most of the performance chemicals applications, the decline and recovery was more muted, leading to a flatter curve overall. In addition, many of the applications in the consumer and infrastructure space held up reasonably well during the third quarter, and you can see that the diversification of our performance chemicals portfolio led to a more resilient volume level overall. With these consumer and infrastructure applications expected to continue to perform well, we expect our volumes to remain solid. With this backdrop of the shape of recovery in our underlying end markets, we anticipate a significant sequential improvement in reinforcement materials demand and a more modest recovery in performance chemicals. We are pleased to see the improving demand pattern and the strengthening underlying drivers, but uncertainty remains given the current state of COVID-19 in different parts of the world. Cost reduction remains a key focus for us, and we are on track to deliver an excess of $60 million of savings across our base operations, which is helping to partially mitigate the impact of lower volumes and costs associated with in-flight growth projects. We expect solid cash flow in the fourth quarter as profitability increases, and we continue to manage networking capital tightly. Therefore, we are reaffirming our guidance of operating cash flow of approximately $200 million in the second half of the year. Thank you for joining us today, and I will now turn it over to Lisa for the question and answer session.

At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from the line of David Baker with Deutsche Bank.

As for the cash flow guidance, can you give a little more insight into the Q4 metric? Because it looks like it's only about $50 million of cash flow in Q4. What does that imply for working capital markets? in Q4. Thank you.

Sure. Well, as we said, we are feeling good about our cash flow and reaffirming that outlook that we talked about last quarter. I think the composition will change in the fourth quarter as we start to see recovery. So certainly the profit contribution to cash flow will be much higher in the quarter. And as demand recovers. We'll see receivables balances beginning to build. We have seen oil prices move up from the low point that we saw in this past quarter, so that will lead to an increase in some working capital. However, we're continuing to manage our feedstock and finished product inventories very tightly here to try to constrain the level of working capital build, just given the uncertainty around demand. And so I think the composition will change in the fourth quarter, where we will see some negative impact from working capital, but more than offset by an improved earnings profile, leading to solid cash flow in the quarter.

And just like cost savings, it looks like you did increase it from $45 to $60 million. Is that still half permanent, half structural, and what drove the increase from the 45 to 60? Thank you.

Sure. Yeah, so obviously cost reduction, cost management is important right now, and we had a number of efforts already underway heading into the COVID situation, many of which were structural as we created a global business service organization and have been making some moves to improve the cost and efficiency of our shared service activities and consolidation around our site in Riga and Latvia, for example. So many of those activities were already underway, and we have added to that with aggressive cost containment measures across across all of our businesses. I think the right way, so we've just been more intense about it, and that's what has led to the increasing level to, you know, around $60 million expected on a full year basis. And I think it's still reasonable to think about half of that as structural and about half of it as general belt tightening, elimination of discretionary spend, and deferral of spending. I think in the lower volume periods, we're deferring and pushing out maintenance and things like that to try to sync it up better with volumes, but those are certainly costs that will come back in as the volume recovers. So I think about half-half is still a reasonable way to think about it. Thank you.

Your next question comes from the line of Mike Lighthead with Barclays.

Good morning, guys.

Hi, Mike.

Hi. I guess first, too, on the reinforcement business, I guess first in Asia, can you talk about how volumes have trended in your Asian business, particularly as we kind of go into July? I assume China's in some ways led a bit of this recovery. And then just as we think about EBIT recovery into the fourth quarter, The comments from Erica were helpful about getting some of that cost impact back. But if we do hit, let's say, that down 15% volumes, how should we think about the margin profile or the incrementals or decrementals on that?

Sure. Well, let me make a few comments first, Mike, about the recovery in Asia and what we're seeing there. And then maybe Erica can comment on the... the incremental analysis of that topic. So, you know, we're definitely seeing China rebound, which is positive. Of course, they came out of COVID first and by, you know, all reported statistics seem to be managing things pretty well and life on the ground has somewhat returned to normal. So they seem to be containing things pretty well. And if you look at general economic activity, PMI has moved up, you know, very sharply and over 50 now in China. And we've seen our end market sectors respond accordingly. So, you know, automotive has swung back, and the domestic tire market has as well, and our volumes have. So I think that's been that's been a real positive. I think where there has been some delay, I would say, in seeing a full recovery in China relates to the export markets. So China does export a lot of tires. They make up close to 40 percent of the world's tire capacity. And of course, with the the more delayed recovery and the delayed onset and delayed recovery in the Western markets, that export market has been, I think, slower to recover. But that is beginning, and we are beginning to see that. So I would say overall volumes have improved, I think, pretty nicely in China and are on a pretty good trajectory. And hopefully, if there is sustained recovery in the Western markets, that export sector of the market, you know, continues to gather strength. I think in terms of the incrementals, maybe I'd ask Erica to pick up on that one, Mike.

Sure. So obviously, as you look at the incremental or decremental margin, a bit different depending on what segment you look at. So in terms of a percentage for Q3, you could look at reinforcement materials roughly about 30%. If you look at performance chemicals, a bit higher in the low 40s. And so, you know, that's a Q3 figure. When you think about this, though, I'd say, remember, given the nature of our business and the link between oil and how it moves through the revenue line, that these percentages can move quarter to quarter just based on the movements in feedstock prices. So we think about this, I think, more in terms of incremental EBIT dollars based on the change in volumes And so if you're going forward to think about Q4, I think looking at the dollar impact of the Q3 volume change is important. And so we talked about reinforcement volumes dropping 42% year-on-year, and that was a $75 million impact to EBIT in this segment. And so a dramatic change in results, obviously, with the operating leverage in that business from the significant change in volumes. As we said, Q4, the expectation would be only 15% below prior year. And then for performance chemicals, the impact was much less on volume. We talked about 5% decline in performance additives and 8% in formulated solutions. And the total EBIT impact of that was $7 million in the quarter. So here, the more diverse set of applications and customers has resulted in a much lower level of overall volume decline. and so not nearly as significant in terms of dollars as reinforcement materials. And we talked about for Q4 that there'd be a modest improvement in volumes expected in this segment. So it gives you, you know, the magnitude we'd be talking about in performance chemicals in terms of dollars as well.

Great. That was super helpful. And then, Sean, could you maybe just level set where we are in terms of the fume metal oxides market? It seems like pricing's been a bit of an issue the past few quarters. You guys are still bringing on a bit of new supply. Can you just level set where we are today and hopefully how you see that recovering over the next six to 12 months?

Sure. Yeah, so, you know, definitely the environment in FMO has been a bit more challenging because we faced in 2019, even pre-COVID, the first year where we actually saw some decline in global fume silica levels. volumes at a point when some capacity was coming on stream. So that has led to, I think, more competitive price intensity in the near term here. Of course, that's been exacerbated a bit by the COVID situation for sure. I think as we see demand recovering, then that will be much more supportive of getting prices, moving them back up to the historical levels. And Historically in this business, you have seen that feedstock and fume silica demand have been very well in balance. And of course, because this is a feedstock, you can't just go out on the market and buy. There are, I think, sort of structural barriers to entry here. But historically, the feedstock balance and the fume silica demand has been has been in a very good state of balance, and that has led to, I think, the strong margins for this industry. And I think the combination of demand recovering and there's a shakeout happening right now globally in the PCS industry, and that industry is one of the feedstock sources into the fume silica market. And I think as that shakeout takes hold and becomes more clear, our view is that things will come back into balance here. So I think what we should see, Mike, over the coming year as demand improves is that pricing kind of incrementally begins to climb back up. And I think the shakeout on the poly industry is a little bit more difficult to call, but we can clearly see see that it's happening. If you look at, for example, you know, Varkar's announcement where they took a significant impairment on their poly assets, and you saw the same from OCI in Korea, you can clearly see that there's a rebalancing or a kind of a realignment that's happening here, and our view is it's a little bit difficult to call exactly when that comes into balance again, but I can certainly see the signals of that happening. So I think we'll see incremental improvement as we progress through the year with demand improving, giving support for pricing, and then the next tranche of recovery coming as the poly industry stabilizes and the feedstocks that come out of that industry stabilize as well and get back into that historical balance that we've always had. Great. Thank you.

Your next question comes from the line of Josh Spector with UBS.

Yeah, hi, good morning. Related actually with that prior question, just curious where you talk about sequential mix in performance overall, is that mostly fume silica is getting slightly better or is that mixed within the rest of that portfolio?

Yeah, so it's a little bit of both, Josh. So what we will see for sure is as automotive begins to improve in the September quarter, a lot of the higher value products are associated with that industry sector. And that's true in both across carbons, specialty compounds, as well as fume silica. So we should see some improvement from a rise in auto production levels. It's possible that there's a slight delay in when we experience it because the value chains are a bit deeper in this segment, but that will be a driver over the coming one or two quarters here, assuming that the auto build's improved. So I would say that's certainly a significant one, probably the most significant one in this business. Our view on the infrastructure-related applications is those should continue to hold up pretty well. So I would say that'll be fairly consistent with what we saw in Q3 here. And then as the economic recovery takes hold, some of the consumer-driven applications should should improve. Some of these products go into consumer durables, and those have been, I think, more impacted recently. And so as the recovery takes hold, some of those applications should improve. For example, things like fume silica are used in vacuum insulation panels in refrigerators and things like that. So there are some of these products go into consumer durables that should start to pick up.

Thanks. That's helpful. I guess last quarter you talked about maybe a $15 to $20 million impact in this quarter from lower oil and feedstock costs. So there's a bit of a lag with pricing there. I'm just curious, how much of that did you actually realize in this quarter? Was it better or worse than what you expected? And with energy prices moving the way they have, is there any type of impact that we should consider for the next quarter?

Yes. So, you know, with respect to the impacts from oil last quarter, we did project a range of 15 to 20 million, and we came in right inside that range at 16 in the third quarter. And again, the drivers, just to remind you, were slower turn of inventory as demand dropped very quickly and oil prices collapsed, and so a bit of a timing mismatch. And then the other drivers are when oil prices drop, we get less benefit from our yield projects, and then the energy centers have a negative impact, both driven by the lower oil prices and the lower production volumes in our plants. So the 16 was right in the zone of what we had talked about. Now, as we go forward here, Erica commented that About half of that will not repeat in the fourth quarter. That's basically the slow turn of inventory does not repeat. And so we feel that we're back in balance there. So that's good. And there is some recovery in the energy center and yield front because volumes are higher, energy center utilizations are higher. And then oil prices have bounced off the bottom. They're still down on a year-over-year basis, but have certainly bounced off the bottom that we saw in the, you know, kind of April time period. So those will be improving. But the right way to think about it is about half of that 16 is expected to not repeat in the next quarter. Great. Thank you.

Your next question comes from the line of Jim Sheehan with Truist Securities.

Thanks. Good morning. Can you talk about the reinforcement material contracts with tire customers? I know you usually finalize those negotiations toward the end of the year. Can you talk about your expectations where you sit today? And also, give us a sense for inventory levels and reinforcement materials and where your utilization rates are as of July. Thanks.

Yeah, good morning, Jim. So let me say three questions there. Let me try to tackle them in the order that you pose them. So in terms of the contracts, as you know, we typically negotiate the annual agreements with our major customers in the back half of the year, starting about now is when those discussions begin. And so I think the schedule is no different this year. We're just at the beginning stages of those discussions. It's hard to say how our negotiations will play out between now and finalizing the agreements later in the calendar year. We're certainly looking at external indicators such as miles driven data and seeing some positive signs there for the tire and carbon black industry. So this is good. but there is still some uncertainty with regard to the COVID pandemic. So I think much of the answer will depend on the timing and shape of the recovery that's expected into 2021. But the recent signs of improvement in terms of mobility certainly are encouraging for us. I think the other factor at play here is that of costs and what our costs and those of our competitors, which are going up driven mostly by the increasing environmental and regulatory costs. And so in order for Cabot and other carbon producers to support our customers in a sustainable way, we need to earn a fair return on these required investments and the higher costs that are associated with them. And so in order to do that, additional price increases are necessary, especially in those places where costs are going up most quickly. And that's how we're approaching our negotiations here. So this is an industry-wide issue and the one that we've been working on hard over the last few years and continue to be a central theme in terms of providing stability for long-term stability for our customers. We're working hard to make sure that our air pollution control compliance investments come on stream so that we can give our on time so that we can give our customers the supply security that they desire. And in return for that, we need to have a fair price for these higher costs. So I would say that's it's early in the process, but that's how we're thinking about it. And I think it's quite important that as an industry, we work with our customers to get a recovery for these higher investments. Let me just try to comment quickly on the inventory question that you asked. And so our sense is that we've just come through a really, really weak period of demand, and we think inventory levels are quite low. And following some of the tire manufacturers' recent earnings calls, you can see that they commented specifically about that. So I think inventory levels had been taken down across the chain. And of course, we took ours down aggressively. And so I think we were in sync with what was happening across the value chain. So I think as demand levels improved, We should see that improvement flow through pretty directly to us. I don't think there'll be a big distortion here. But given that inventories are very low, there probably will be some restocking, some of which we may have likely already seen in July. It's hard to tell, but I wouldn't be surprised if there was a bit of that beginning in July. But it should be a fairly... There should be more visibility, Jim, I would say, on that front because inventories are low. And then finally, I guess your last question on utilization. Our utilization levels are going to track, of course, what the expectation is for tire production. Now, we more aggressively, our utilizations were lower in the last quarter than You know, our volumes were down 42%, but our utilization rates or our operating rates in the plant were probably down more in the 50% range across the quarter because we were pulling inventories down aggressively. And so I think now with inventories down, our utilization levels going forward should reflect the expectation of volumes. That's sort of how I see it at this point.

Very helpful. Thank you. And could you also comment on your conductive carbons business, given the state of the electric vehicle market?

Yeah, sure. So as I commented in the prepared remarks, we were really pleased to close the Sanshun acquisition in the quarter. So I think that's a real positive. I mean, the EV market, you know, has been impacted just as the broader automotive market was in the most recent quarter here. But as recovery takes hold, you know, the auto plants are back up, that too should recover. Our underlying view of the EV market hasn't changed in terms of the expectation of significant growth. over the next five to ten years as EVs capture a bigger share of the market. And we're really excited about the Sanshun acquisition because they're a leading CNT producer in China serving this market with a number two market share position. And our view, certainly China's the biggest EV market in the world. And so this investment was quite strategic on that front. And we think there's a lot of synergy here over time between their CNTs and their ability to formulate dispersions with conductive carbon additives and then our conductive furnace blacks. The formulation, the combination of these we think is going to be important in next generation product development. And so You know, you may follow one of our key competitors here in China, a company, C-Nano, you know, recently IPO-ed within the past year and, you know, with about $50 million of revenue. So, you know, maybe 40%, you know, maybe close to double what ours is with our Sanxun acquisition. They're currently sitting with a valuation of $1.7 billion in China right now. So, You know, I think we feel really good about this long-term strategic investment in Sanshun. But, you know, there is some short-term impact here as the auto plants were shut down.

Thank you very much.

Our next question comes from the line of Lawrence Alexander with Jefferies.

Good morning. Two questions please. One is can you give a sense of the scope of the resources you're putting into the CTC marketing effort and how any drawn talent or capital should evolve over the next few years? And then can you talk a little bit about mix? As your end markets recover, how should mix evolve and how should that then flow through to your price and margins over the next three, four quarters?

Lawrence, just on the first one on CEC and the marketing efforts, the second part of that question, would you mind just repeating that for me?

Well, there's the personnel component, and then there's just the longer-term capital component, working capital, investment in infrastructure to help customers with their research efforts, development efforts, and so forth.

Yeah. No, got it. Okay. So, yeah, we're very pleased with continued progress here on the CEC front. It is still immaterial in relation to the broader reinforcement materials business, so it's something that is going to build over time, and the adoption of this by the tire makers and building that to materiality will take some time here. But we are in an investment phase here where we're investing in both marketing and as well as further technology development to further build out and extend the product line here. So if you think about it on a sort of a cash basis, there's some cash burn right now in this business as we make these investments for the longer term. but it's in the low single millions kind of a number in terms of the burn. Of course, there's revenue and margin from sales, but we're also investing in the longer term development. And so when you net all that together, you know, that gives you just a sense. So something very important, some modest cash burn, but I think the right balance here, because I think this This one has transformational potential for this business. It'll take some time, but it does now as we see the importance of sustainability in our customer base and the role of materials to drive sustainable products in tires is really critical. It's going to be a materials question. With respect to mix, how that should evolve, I think the single biggest drag on mix for us has been a weak auto because many of the most high-value products are in the portfolio, particularly in performance chemicals, are specified products into the automotive chain. And so I think as that improves, then we should see mix flowing through, positive mix flowing through, you know, over the next three, four quarters. It should follow, maybe with a slight timing offset, it should basically follow improving numbers out of the auto industry in terms of production levels. And then I commented a bit earlier, I think as demand improves, In the fume silica side, of course, this is a high-margin product line, and so as demand improves, we should get some further pricing support there, and I would expect that that would be incrementally ratcheting up over the coming three to four quarters as well. So those would be a couple of the major drivers, Lawrence, with respect to price and mix.

Thank you.

Your next question comes from the line of Jeff Dukakis with JP Morgan.

Thanks very much. Will all of your emissions spending in the United States be completed by April of 2021? And in the aggregate, how much do you think you will have spent and how much will you have spent in 2020, fiscal 2020?

Yeah. So, Jeff, with respect to the EPA consent decree, we now have the industry under a similar implementation timeline. The next plant to come online for Cabot and all of the competitors are obligated to have a plant online by April of 2021. And that leaves us with a final completion date in 2022, where we have one final plant in 2022. And so the implementation schedules are now synchronized for the industry, and all players are obligated to meet those or sign deal with the consequences and penalties and impacts from the EPA and DOJ. With respect to our cost, we have had an estimate out there that in total this will be in the range of $175 to $200 million once all plants are implemented, and we continue to feel that that is the right range for completion of these projects. So that'll be the capital cost range once all of them are completed. How much have you spent so far? About half, about half right now.

How did the specialty block business behave in the quarter and how did it behave in July? That is, what was the volume decrement in the June quarter, and what was the volume decrement in that July?

Yeah, so in our reported numbers, we have performance additives, which is both specialty carbons and FMO. We report performance additives down 5% in the quarter. So, you know, a more modest decline, certainly, than reinforcement materials. and what we saw there was that certain infrastructure, packaging, ag-related, as well as just our specific book of business with customers held up better, was more resilient. We certainly had the impact from auto being extremely weak in the quarter, but when you balanced it out against some of those other things, it was a more modest decline of in that sort of 5% range for performance additives. And I think what we're seeing in July is and what we would expect over the balance of the quarter is some modest improvement off of that and maybe down a few percentage points over last year, same quarter. Again, the same Largely the same factors driving it, Jeff. We will see some improving auto, but it'll probably be a little bit delayed in terms of how it hits us because of the depth of the value chain. We might be seeing that a little bit more beginning in Q1. But we will see some improvement from auto. And then the infrastructure-related packaging, ag-related, should continue to hold up well. And our specific customer book of business and who we're aligned with, they seem to be doing pretty well. So I think those are helping us also.

What percentage of performance additives does specialty block? Does specialty block all of it, or is it a part of it?

No, it's a part of it because we have in performance additives, we have fume silica.

Right, that's what I wanted to know. What happened to specialty block?

Yeah, I would say specialty box moved in about the same direction as the overall performance additive. So my commentary is reasonable for that.

Okay. And then lastly, have you been monitoring what's been going on or research developments in the pyrolysis of natural gas, whether in Russia or in Europe, and different drives to produce hydrogen and and there would be results in carbon black produced. Have you reached out to any of these companies or have you looked at what's going on there? And do you think it will touch the carbon black industry over time?

Yeah. We certainly follow this very closely. And in a long ago time, Cabot had production capacity tied to natural gas. In fact, our plant in Pampa, Texas was originally built on a gas-based feedstock. So we certainly understand the technology well and are tracking various developments across the spectrum of reinforcement materials, everything from alternative feedstock sources like natural gas conversion to alternative producers like monolith to things like people trying to take recycled tires and reclaim carbon black from them. So we track all of these very closely to inform our point of view around either new entrants or potential substitutes. I think each of them, it's probably a conversation for another day, but I think each of them, based on our analysis, have real challenges in terms of either economics or scale-up or making product that actually performs in the application. You get a very different product in its performance and application is quite different. And I think this is one of the strengths of our company is our deep application knowledge here and our ability to take what is, in theory, a carbon black and see how it performs in application. So something we watch very closely, Jeff, and we've put our bets on the formulation angle around uh cec or what we now call e2c because we think it's going to be the formulation handles uh that are going to drive performance uh here you know carbon black is uh uh is a great product and but it's really hard to realize its full potential uh because when you try to disperse it it's you have to apply a lot of shear and you degrade the underlying polymer and so this is where the the formulation handles of things like CEC are quite compelling. So we have put our money and effort around that angle, but we do track closely the emerging technologies. Okay, great. Thank you so much.

Our next question comes from the line of Chris Ketch with Loop Capital Markets.

Yeah, good morning. So my first question, you touched a little bit upon the expectations you have around pricing and the reinforcement materials business going into this contract season. But my question is really more about just, you know, bigger picture, the overall competitive intensity of the carbon black industry as we're coming through this pandemic. Have you seen any shifts that you've noticed by region? And then maybe a little bit more specifically on pricing. How has that been in the PC segment? That's not dependent on, you know, annual contracts or supply agreements. I'm just wondering how that pricing has held up against the weaker demand backdrop.

Yeah. So, you know, Chris, in terms of pricing in RM with so much of it under contract, certainly in the West and the more mature economies, there hasn't really been any change because that's been agreed and honored. Now, in the more spot markets, like China, for example, with very weak demand as they were working through the COVID phase, that certainly resulted in more price intensity, more price competition here because people were fighting for volumes that had dropped precipitously. As we see demand coming back, then we're starting to see pricing power restore. And so I would say that If that trend continues, then we should see incremental restoration of pricing in China, which is the biggest spot market. So that's how I would sort of characterize reinforcement materials. On the specialty carbons side of things, we have not had any impact in pricing So with respect to price and the relationship of price and raws, you know, of course, in this business, it's more performance and application driven, but the feedstock is an important input factor. And when it moves up, we've got to deal with that. And when it moves down, there's normally some room for margin expansion. So we look at this relationship between price, raws, and I think that's been that's been holding up quite well. I think the challenge has been a bit more mix-oriented rather than pricing-oriented, just because the exposure to auto and the very high-margin stuff that comes with that.

That's helpful. And then a follow-up. You mentioned China, and actually in response to another question you talked about, at least qualitatively, the trends in China. I was just wondering if you could get a little more granular on on China, at least in the RM segment, the magnitude of the demand degradation you saw there and how those comparisons have looked on a monthly basis, quantitatively, on a monthly basis, sequential through the June quarter and how that's looked so far into July. Thanks.

Yep. Yeah. So, well, certainly at the low point, you know, volumes were down, you know, very sharply, but the low point in China was experienced significantly. a little bit earlier than we saw in the West. But I would say volumes have come back pretty strongly, and they're within spitting distance of where we were a year ago. So I think that is positive. And if that continues to sustain itself and the export market continues to improve then I think the capacity utilization in the industry should move up and pricing, you know, should incrementally tick up as well. So, you know, I think from a volume standpoint, things are recovering, you know, fairly well in China, but the competitive intensity is still somewhat high because the export market is... is only in the early stages of recovering, and so people fight for volumes a little bit more. But we see that trend incrementally improving here.

Thank you. One last one. In China, at your last investor day, you spelled out what your exposure there was by OE and replacements. And, Mark, I know the car part there has matured. Is there a way you can update that OE versus replacement tire, but also versus export? Because you mentioned how that sort of the export-related demand is lagging. So just what your exposure is over there by those sort of buckets. Thanks.

Yeah, well, I'll try to help you a bit here, Chris. So, I mean, if you look in China in total, about 60% of the tires in China are domestic and about 40% get exported. So there's a heavy component of tire exports. And again, about, they make, you know, they have almost 40% of the world's tire capacity. So that's sort of at the, at the top of the house level. Now, what you see in China is that the truck and bus market is bigger in China in relative terms versus the passenger car. The passenger car park has been building, of course, over the last five to 10 years with quite a bit over the last five years. And so that is not yet at the proportion or relative to where we see the rest of the world. So it's a little heavier on the truck and bus side of things. So our exposure into truck and bus is a little higher in China as a result of that. But as the passenger car fleet or car park continues to build and they get to the replacement cycle, then you'll probably see that balance in China, that makeup in China start to look a bit more like the rest of the world. So that's kind of how it's structured and how we see it. Thank you.

Once again, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from the line of Kevin Osovar with North Coast Research.

Hope, can you guys hear me? It sounded like it was cutting out there for a second.

No, we're still here. I wasn't sure because it's gone past top of the hour if they were shutting us off here, but no, we're still here. Okay, great.

Quick question on the... Sean, you mentioned costs going up related to the EPA spend. Curious if you could help us frame up how much those costs will impact... how much operating costs go up as a result of installing this equipment? Because from what we've been able to gather, it doesn't seem like it's immaterial. So I'm curious your thoughts in terms of how much those costs go up once you flip the switch on this equipment. And you mentioned all players having some plants supposed to be coming compliant April 2021. Do you know... my understanding is it's, you know, the cost will be different associated with if it's stocks, Knox, if it's just Knox. Um, so, so curious how you, when you look at the consent decrees, you know, with the other companies or, or, you know, what you're aware of that the other companies are becoming compliant in April 21, it will, your costs be going up similar to the other companies or more or less, just kind of curious how you're thinking about all that.

Yeah, sure. Um, So I think in general, the shape of each producer's consent decree, the shape is similar, Kevin. And so you have a mix of some plants that have a smaller investment. So, for example, the first plant that we did had – certain NOx and feedstock restrictions. So it was a lower capital investment. And then what you find is that the consent decree also has certain plants that require more complete controls, both SOX and NOx. So I would say the shape of the consent decree across the producers is effectively identical. And the timeline of implementation is synchronized as well. And so with respect to if you just take a plant that has to have, for example, full SOX and full NOX controls on it, I think you'll see costs in a fairly similar range. Although I have seen some reports from competition recently that their cost estimates are going up. We've reaffirmed ours, but in general, they should be in the same zone because while the technology has to get adapted for our particular gas stream, it is more generally known technology. So that's what I would say about that. Now, in terms of operating costs, there's two types of costs here. There's the capital cost of putting in the control equipment and getting a recovery and a return on that capital cost, and then there's the operating costs of running the equipment, and that is an important cost that we need to also get recovery for here, and so hence we've been We've been working hard at this for the last couple of years as we've been bringing plants on and incurring these costs, and we need to continue that in our pricing negotiations with customers here because we simply won't be able to be a sustainable supplier for them without this. We're doing our part. We're going to have our plants online, and we're going to have them ready, and we're going to provide that supply reliability to customers. I can't speak for others, but we need to have a fair return on that. Okay, great. Thank you very much.

At this time, there are no further questions. I would now like to turn the call over to Mr. Sean Cohane.

Great. Thank you, Lisa, and thank you all for joining today. I hope you're all remaining safe and beginning this journey back to some sense of normal here. But thanks for your time and attention and support of Cabot, and look forward to talking to you again next quarter.

This concludes today's conference. You may now disconnect.