Orion S.A. Common Shares

Greetings and welcome to the Orion Engineered Carbon's second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Wendy Wilson, Head of Investor Relations, Thank you, and over to you, ma'am.

Thank you, operator. Good morning, everyone, and welcome to Orion Engineered Carbon's conference call to discuss our second quarter 2022 financial results. I'm Wendy Wilson, head of investor relations. With us today are Corning Painter, chief executive officer, and Jeff Gleit, chief financial officer. We issued our press release after the market closed yesterday and we also posted a slide presentation to the investor relations portion of our website. We will be referencing this presentation during the call. Before we begin, I'd like to remind you that some of the comments made on today's call are forward-looking statements. These statements are subject to the risks and uncertainties as described in the company's filings with the SEC and our actual results may differ from those described during the call. In addition, all forward-looking statements are made as of today, August 6th. The company is not obligated to update any forward-looking statements based on new circumstances or revised expectations. All non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the table attached to our press release. I'll now turn the call over to Corning Painter.

Thank you, Wendy. Good morning, everyone, and welcome to our earnings conference call. I'm going to start with two of the slides from our investor day. First, on slide three, our strategic roadmap remains unchanged. It will continue to be our guide as we shift our capital spending from EPA compliance to financially value-added activities. Our new conductives facility is a prime example of this strategy in action. The conductives facility will expand our production capacity by approximately 12 kilotons per year, quadrupling our capacity for acetylene-based materials. With an investment in the range of $120 to $140 million, we expect sustainable EBITDA levels of $40 to $45 million. Our conductive additive products are in high demand, not only for their purity, but also their performance. We view this specialty material expansion as timely, strategic, and a growth accelerator. With approximately $15 to $20 million of EBITDA generated from our conductives business in 2021, we aim to grow our earnings capacity to the $170 million range when this project is completed. Today's high oil prices only strengthen consumer interest in EVs, further increasing demand for conductive carbons, whatever the business cycle is in 2024. The conductives project is, in addition to our greenfield project in why they China. Here we have had zero recordable injuries and over a million construction hours in the field, we are also ahead of schedule, despite the challenges with coven well done to the team. This plant will produce 65 to 70 kilotons per year of specialty and high performance carbon black starting in 2023. By the end of this year, we expect to have completed the de-bottlenecking work listed on slide 15 and our penultimate air emissions upgrade in the United States, and we should be in commissioning at Y-Bay. This greatly reduces the span of our large capital project work, allowing us to focus next year on the final U.S. Air Emissions Controls implementation, our settling facility in Texas, and consider various plant upgrades. With our value creation mindset and steady progress with our projects, we have the building blocks in place to reach our mid-cycle adjusted EBITDA capacity goal of $500 million by 2025. Despite the macroeconomic outlook, we are on track to increase discretionary cash flow significantly within the next 12 to 24 months As our cash flow improves, we will balance between investing in our strategic projects and returning cash to shareholders. Frankly, I see us as well positioned today, despite a potential slowdown tomorrow. Megatrends like electrification are here, and coupled with a long-term disconnect between tire and carbon black investment, trends are working in our favor. For example, in North America alone, thus far this year, we have turned down over 15 kilotons of spot volume requests, and I think the real need is somewhat larger than that. Let's take a deeper look at the supply-demand balance and the implications for a recession with another slide from Investor Day, slide four in today's deck. The key point is, I don't see the global rubber carbon black supply dynamics on this slide changing dramatically, especially as most of the volume goes into tires and tires wear out. We do see a weakness in China and for lower end specialty applications like master batch, but that is in our guidance and part of the reason why our specialty gross profit per ton is so high. We believe we are entering this period of uncertainty from a position of strength. First, there are few regions where supply and demand are in balance today, and the projections for the next few years does not change that trajectory. Since our investor day, one competitor has announced a 40 kiloton expansion in Europe, and there's a rumor that a plant that was going to close in the U.S. is seeking allowances to keep operating. Neither of these events changes the big picture. As a result of years of subpar returns and underinvestment, The supply-demand imbalance is quite favorable now. Second, unfortunately, there are few signs of peace in Ukraine, and it is unclear what the business relationships will be after the fighting stops. The curve on this slide for Europe excludes Russian production, and in fact, we are aware today a good portion of that production is still being imported to Europe. However, we can ask, for how long will this last? and customers seem to see this as a high risk and an undesirable supply chain. Third, a recession may not further depress production at OEM automotive manufacturers beyond the chip shortage. LCM forecasts for 2022 North American SAAR to be more than 15% below 2019 levels And the Western European car sales forecast remains more than 30% below 2019 levels. In addition, I would remind you that 60% of our tire business is replacement tire, and this market likely remains strong for both truck and passenger cars. This is further strengthened by the used car market, which is very strong. More used cars on the road means more replacement tires are needed. We believe we are in a good position going into this period of economic uncertainty. Yes, we are affected by inflationary costs, supply chain issues, oil price fluctuations, and the threat of natural gas disruptions. However, we are well positioned and are taking action not only to protect that position, but to grow our business and achieve our long-term goals. Having touched on the recession, let's address an elephant in the room, natural gas supply in Europe. First, some context. We use natural gas in Europe and the Americas as the fuel for the combustion zone of many of our reactors. In other locations, such as Asia and Africa, we use other fuels. We use the heat from every one of those reactors in Europe to generate electricity and or supply heating to the local community. Because of this, we have been put into the priority group for preferential treatment by our German gas supplier. However, keep in mind this situation is very dynamic and the final say is with the central German government. I want to be clear. Despite that potential prioritization, we are working to reduce our gas year usage. We expect to meet the European Commission's recent request for a voluntary 15% reduction across the EU. Among other things, we are working to convert European reactors to alternative fuels. Some of these reactors are easier to convert than others, and some specialty customers may need to go through a qualification process, but I think we all see this is the right thing to do. I don't want to convey that we have limited or no exposure to natural gas curtailment. Of course we do. However, we are preparing for it and are making progress. If we had to curtail natural gas by 20%, we believe the EBITDA impact would be $0 to $1 million per month. If it's 40%, that impact could be $3 to $5 million per month. However, we are working to minimize that. Another element of strength going forward is that the 2023 rubber contracting season is well underway, and most customers want to secure more volume and wrap up the negotiations well ahead of normal practice. In fact, we have already verbally concluded several multi-year negotiations. We expect that pricing negotiations will be more favorable than in the past. For our part, we are not looking for a one-year pop or extracting rents. We are looking for partners who are prepared to make a mutual commitment at a fair price that supports investment in the resilience that this industry needs. As I mentioned earlier, the fundamentals are robust, and I believe they will be for years to come. So, on to our quarter results on slide five. Thanks to the operating team for delivering another tremendous quarter and a record first half results despite multiple challenges, while at the same time executing several key initiatives. Second quarter adjusted EBITDA was $83.4 million, up 5.8% year over year, our second consecutive record for the company, as well as for our specialty business. Another key driver of profitable growth will be the completion of our surface-treated gas black capacity expansion in 2023, which we announced during this second quarter. This is an important initiative for us, as we are the only producer of this material, and we have been essentially sold out off and on for years. Customers will be happy to have more capacity available and can now design us into new formulations with confidence. This expansion is core to our strategy to further strengthen our leadership in the premium specialty market. That concludes my opening remarks. For the remainder of today's call, Jeff and I will cover the second quarter results in greater detail and our outlook for 2022. After our prepared remarks, We'll be happy to take your questions.