Cabot Corp (CBT) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cabot Corporation's Q3 2016 earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to turn the call over to Ms. Erica McLaughlin, Vice President of Investor Relations. Ma'am, you may begin.

Thanks, Chelsea. Good afternoon. I would like to welcome you to the Cabot Corporation earnings teleconference. Last night, we released results for our third quarter of FY16, copies of which are posted in the Investor Relations section of our website.

For those on our mailing list, you received the press release by email. If you are not on our mailing list and are interested in receiving this information in the future, please contact Investor Relations. 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.

I remind you that our conversation today will include forward-looking statements which are subject to risks and uncertainties, and Cabot's actual results may differ materially from those expressed in the forward-looking statements. A list of factors that could affect Cabot's actual results can be found in the press release we issued last night and are discussed more fully in the reports we file with the Securities and Exchange Commission, particularly in our last annual report on Form 10-K. These filings can be found in the Investor Relations portion of our website.

I will now turn the call over to Sean Keohane, who will discuss the key highlights of the Company's performance. Eddie Cordeiro 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, Erica. Good afternoon, ladies and gentlemen. Before we get started, I wanted to share with you that Erica McLaughlin will be moving to a new leadership role in the Company, and this will be her last earnings call. I want to thank Erica for her leadership of Investor Relations over the last five years and wish her much success in her new role.

Replacing Erica will be Steve Delahunt, who is here with us today. Steve has been our Corporate Treasurer since 2010 and has a broad financial background that has prepared him well as he takes on the additional responsibilities as Vice President of Investor Relations. I welcome Steve to the new role, and Erica and Steve will ensure a smooth transition over the coming weeks.

Now moving on to the quarter, I'm pleased to see the strong improvement in operating results, both on a year-over-year and sequential basis. Key factors driving the improvement were strong volumes, along with realizing the benefit of our cost-savings initiatives.

We also continue to deliver exceptional results in our performance chemical segment, with higher volumes and margins. This is the fifth consecutive quarter of record segment EBIT.

The improvement in our specialty fluid segment resulted from our sustained efforts to expand our business outside of the North Sea, and the success this quarter validates the value proposition of this unique material, even a low oil price environment.

In addition, due to our strong business results, we generated the over $100 million in cash from operating activities. We used this cash to reinvest in our core businesses, as well as return cash to shareholders through dividends and share repurchases. We increased the dividend by 36% during the quarter, and we continued to repurchase shares, both of which are consistent with our capital allocation framework that was discussed at our Investor Day in May.

Before we dive deeper into the quarter, I'd like to take a step back to remind of you of our new strategy and capital allocation framework. Our strategy going forward of advancing the core provides us with a roadmap of the future.

We aim to extend our leadership in performance materials by driving three key themes: first, investing for growth in our core; second, driving application innovation with our customers; and, third, generating strong cash flows through efficiency and optimization. The aim of our strategy is to generate sustained and attractive total shareholder return. We believe that our strategy will deliver solid adjusted EPS growth in the 7% to 10% range over time.

Furthermore, we are committed to a balanced and disciplined capital allocation framework. As a Company, Cabot generates strong and consistent cash flow, and as we move forward, we will balance the use of cash for reinvestment in our core businesses and returning cash to shareholders, with about half of our discretionary free cash flow going to each. This strategy provides clarity in the direction of the Company, and we are confident that the balance of earnings growth and capital allocation can deliver attractive and sustained total shareholder return.

With this strategic frame as a backdrop, I'd like to spend a little time discussing progress during the quarter against the three strategic themes. Growth in our core requires achieving a balance of volume growth and price management. In the third quarter, we successfully grew volumes across most segments and regions, while also announcing important pricing actions. We are currently implementing price increases in reinforcement materials in North America, Europe, and China, and globally in performance chemicals to recover increased costs.

Also of note during the quarter is the announcement of our plan to open a new Asia technology center in Shanghai. The new facility is evidence of our commitment to developing deeper application understanding and delivering innovative formulation solutions to our customers. As China transitions to a period of more moderate growth, innovating with our customers is an essential element of our growth strategy.

Our work to improve the efficiency of our operations and optimize our performance can be seen in the lower fixed costs this quarter. The reduction of $12 million of fixed cost in the third quarter, as compared to the prior year has improved the competitiveness of our operations and contributed to our earnings growth.

Overall, I am pleased with the progress we are making, and I'm confident in our ability to deliver attractive and sustained total shareholder return based on the execution of our strategy. I will now turn it over to Eddie Cordeiro to discuss the financial results of the quarter in more detail. Eddie.

Thank you, Sean. I will discuss the segment results beginning with reinforcement materials. During the third quarter of 2016, EBIT for reinforcement materials increased by $3 million as compared to the third quarter of 2015.

The increase in EBIT was principally due to lower fixed cost as a result of our restructuring cost-savings initiatives, including the closure of our Merak plant in Indonesia. Lower costs were partially offset by lower volumes in Asia due to the weaker macroeconomic conditions in China and from the closure in our plant in Indonesia. As you may recall, our strategy related to the Indonesia closure was about maintaining higher margin business, with the expectation that we would shed some lower margin business while also consolidating our operations to reduce costs.

Sequentially, reinforcement materials EBIT increased by $1 million compared to the second quarter of FY16 driven by higher volumes, partially offset by less favorable price and product mix. Sequentially, volumes increased by 6% due to higher volumes in the Americas from the full impact of the ramp-up of calendar-year contracts, and from seasonally higher volumes in Asia.

The less favorable price and product mix was primarily due to lower pricing in China, as we are working to balance volume and pricing in this challenging environment. Looking ahead, we expect EBIT to improve sequentially from an improved product mix and from price increases that we are currently implementing in various regions.

Now turning to performance chemicals, EBIT increased by $11 million compared to the third quarter of FY15, due to higher volumes and improved margins from a stronger product mix and lower raw material costs. Volumes increased by 3% in the specialty carbons and formulations business and 9% in the Metal Oxide business, largely driven by stronger sales into plastics applications for the automotive and infrastructure sectors.

Sequentially, performance chemicals EBIT increased by $1 million compared to the second quarter of FY16, primarily due to higher volumes. Sequentially, volumes increased by 7% in specialty carbons and formulations, and by 10% in metal oxides. The increase in volumes was partially offset by a less favorable product mix. Looking ahead, given that we expect a normal seasonal impact in the fourth quarter, we expect results to moderate somewhat sequentially.

Third-quarter FY16 EBIT in purification solutions decreased by $3 million compared to the third quarter of FY15 due to a $9 million unfavorable impact from reducing inventory levels versus last year's inventory build. The segment also saw lower price in product mix compared to the prior year. These effects were partially offset by significantly higher MATS volumes and lower fixed costs from our cost-savings initiatives.

Sequentially, purification solutions EBIT increased by $2 million compared to the second quarter of FY16, driven primarily by higher volumes related to MATS demand. The increase in volumes was partially offset by an unfavorable impact from reducing inventory levels as compared to the prior quarter, and a less favorable price and product mix. Higher volumes compared to both respective periods were driven by command from the MATS regulation. [mercury and mobile] volumes were up 73% in the third quarter of FY16 compared to the third quarter of FY15. We believe that we were successful in capturing about one-third of this market. The benefit from these higher volumes is being masked by the unfavorable impact from reducing inventories. If we strip out these impacts in Q3, the quarter's EBIT would have been approximately $3 million. We anticipate an improvement in EBIT as Q4 is normally our strongest seasonal quarter in terms of volumes, and inventory drawdown should decline a bit.

The third quarter of FY16 EBIT in specialty fluids increased by $7 million as compared to the third quarter of FY15, and $12 million as compared to second quarter of FY16, as we saw an increased level of project activity in both the North Sea and Asia. As we look ahead to the fourth quarter, we expect to see another profitable quarter based on project activities that is underway. However, likely not at the same level that we saw in the third quarter.

I will now turn to corporate items. We ended the quarter with a cash balance of $222 million and our liquidity position remained strong at $1.2 billion. During the third quarter of FY16, cash flows from operating activities were $107 million, including an increase in net working capital of $21 million.

Capital expenditures for the third quarter of FY16 were $28 million, including $21 million for sustaining and compliance capital expenditures. Additional uses of cash during the third quarter included $19 million for dividends and $8 million for share repurchases.

We recorded a net tax provision of $15 million for the third quarter, which included $2 million of benefits from tax-related certain items. Excluding the impact of certain items, our year-to-date operating tax rate was 24%.

Based on the current outlook for feedstock, we also recorded a $3 million charge related to our LIFO accounting reserve, principally driven by rising feedstock costs. We do not anticipate a material impact from LIFO in the fourth quarter; however, if feedstock costs move up or down from where they are forecasted to end the fiscal year, this estimate could change. As we look at the full year, we expect capital expenditures to be approximately $110 million to $120 million. I'm now turn the call back over to Sean.

Thanks, Eddie. With the third-quarter operating results in line with our expectations, we are on track to deliver results in the low to midpoint of the range we communicated last quarter. Looking sequentially, while the performance chemicals and specialty fluids segments are expected to moderate, we anticipate a strengthening of results from our reinforcement materials and purification solution segments.

In addition, we are driving or advancing the core strategy focused on the continuation of the strong profit growth and cash generation we saw this quarter. We are maintaining discipline around our capital allocation framework, which balances reinvesting for growth in our core businesses and returning cash to shareholder.

Thank you very much for joining us today. And I will now turn the call back over for our question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Ivan Marcuse with KeyBanc Capital Markets.

In the reinforcements business in Asia, of the 8% decline, how much of that would be the plant that got shut down? So of the 8% is it half of it? And when do we start to lap that volume or how to think about it in terms of the impact going forward for the next couple of quarters?

Sure. Hi, Ivan. So specifically, on the closure of the Merak plant, I would characterize that as not being a major impact here. As was commented earlier, our strategy here is to focus on the higher margin business and to gain the benefit of a more consolidated and larger scale production site in Indonesia. I think that's playing out as expected.

I think the bigger question, I think, and we need to see how things unfold, is certainly as China moderates its growth rate, how that plays out. And so right now our focus is on balancing both volume and pricing in that environment. And certainly when we do this, it's typically about how we think about the tail of the business and the lower margin end of the portfolio.

Okay. And then moving over to the other side of the world, in the Americas you're up 6%. Was South America a drag or has that business stabilized a bit on a year-over-year basis or sequentially, however you want to think about it?

Yes. So certainly we're pleased with overall the Americas. And as we have commented before, we're seeing the expected volumes in North America. But there's no doubt that the macro situation in South America is a challenge here and continues to be a headwind.

I think what will be interesting in the coming year I think is to see how this plays out with the devaluation of the currencies. But in particular in Brazil, we're hearing some of the tire makers are adjusting their supply chains and trying to take advantage of that as an export platform. How that plays out is not very clear at this point, Ivan, but something to watch for here that could, I suppose, put a bit of a boost into South America over time. But, again, unclear. These are early days as we listen to our customers.

Okay. Thanks. And then in purification, how much of the available -- I don't know how to say it. But of the customers that are going to take your material in the industry, is it fully ramped up now or is it still half industry is now utilizing the mercury removal and then we'll see another big step-up in 2017? How much more to go or is this a run-rate? Like if you look at $3 million a quarter, is that how to think about this business going forward [after] inventory?

Yes. I certainly can imagine, Ivan, with all of the moving parts here, challenging to get a sense for this run rate. And let me try to help a little bit here. I think as we look at this business, volumes in the mercury removal market have increased significantly north of 70% year over year. At this point, we're seeing full compliance. The rule is in and we're seeing full compliance.

Now, offsetting this stronger volume profile was an unfavorable impact from inventory reduction. As you'll remember, these were strategic decisions to build inventory rather than build capital to serve the rising demands. So this was about $9 million compared to the prior year.

So if I look through that and exclude the impact from inventory in the quarter and try to normalize for seasonal variations, I think the run-rate for the business is probably in the $4 million to $5 million range per quarter at this stage, with some quarters being a bit stronger and some being a bit weaker based on seasonality.

Okay. And then the inventory, when does that end? Does that start to tail off, or is this -- like is it $8 million next quarter then $6 million, quarter after that, or does it just stop at one point, and when is that?

Yes. So we built inventory in 2014 and 2015, again, a strategic decision to defer -- to avoid capital investments. And so as we stated last quarter, we expect the full-year impact to be around $30 million this year. And so this means we'll continue to drawdown inventory into [4], albeit at a slower rate. And as we head into next year, there will be further continued drawdown of inventory.

To the same level on a year-over-year basis?

No, no. It will moderate. It will shrink as we head into 2017.

Great. Thanks for taking my questions.

Thank you. And our next question comes from the line of Jim Sheehan with SunTrust. Your line is now open.

Hi, Sean. You mentioned some price increases that you're implementing. Could you talk about how those pricing actions are being received and when you typically raise prices, about what proportion is realized?

Sure. Hi, Jim. How are you? So we have announced a number of price increases. And so maybe I'll comment first on reinforcement materials. So we've announced price increases in North America and the EMEA region as well as in China.

You'll recall from knowing the business and from Investor Day, we have different percentages of business under contract and open for spots. So let me just try to quickly recap a little bit.

In Europe, where we have around 15%, one-five, of our volumes that are not under contract, they have been going pretty well thus far, and we certainly are intending to carry this forward as we head into contract negotiations. We're also working to address some feedstock challenges in Europe in terms of fixing some indices that we base our pricing on to better reflect our actual feedstock cost. So those activities happening there.

For North America, as you know, it's a pretty small percentage of the market that is not under contract. And so we're implementing in those places. But more about carrying into contract negotiations. And then the China market, as you know, is an entirely spot market here. And so we -- we're out in the market every month balancing feedstock cost movements, volume, and pricing to find that optimization.

On the specialty carbon side, we have also announced price increases here and are in the process of implementing, and I would say going reasonably well so far.

Okay, and with respect to those feedstock differentials, how do they stand now? I understand that they've changed in the past, and are they becoming less problematic for you at the moment?

Well, not much has changed in terms of what we've discussed in the last quarter with respect to this. Certainly in terms of the US Gulf Coast in 2015, we saw differentials increase throughout the year due primarily to supply/demand factors. At this time, I would say the US Gulf Coast differentials are in line with the historical long-term norms. If we go back over a number of years I would say they're more back in line with those, although there can be short-term fluctuations here.

For Europe, we continue to face some feedstock challenges, as I mentioned. And I would describe these as a little more structural in nature where our index that we use no longer approximates our feedstock. And so for this, we're working to change those formulas for parts of the business we can address now and for our calendar 2017 contracts.

So overall, I would say a bit of a mixed story, some moderation on the differentials and a few areas that we're working to try to address. But I think it's important to just pull back and recognize that we buy a mix of feedstocks here around the world, and we have a strategy in this business to try to take advantage of the feedstock arbitrages whenever they're available, and sometimes those are favorable, sometimes those are not. But it is a strategic part of the business and one that we're intensely focused on.

Great. And on mercury control, you mentioned you think you've got about one-third market share of the MATS market. Is that above or below your expectations? I seem to remember that you've been targeting something more like 40% in the past.

Yes. Market share here is a tough one, Jim, to nail with any great degree of accuracy here for a whole bunch of different reasons. First of all, it's a new market that's coming into play here. And there are factors in terms of which products are used, where natural gas pricing is, how that impacts the overall energy, the utility fleet and what energy makeup is running which utilities. So it's a difficult one.

As we sit here today, we estimate that we're in about that one-third share position, and we're working to try to balance both volume and pricing as this new market settles out.

Thank you.

Thank you. And our next question comes from the line of Kevin Hocevar with Northcoast Research. Your line is now open.

Hey, good afternoon, everybody.

Hey, Kevin.

Wondering if you could comment on, so specialty fluids obviously had a really good quarter. What's -- could you comment on that? It sounds like maybe you expect a sequential slowing. But is this -- did all of the stars just happen to align this quarter, or should we think of this as with you moving outside of the North Sea a bit more, this will be a more steady earner going forward? How should we think of this segment in the fourth quarter but beyond too? What should we think of profitability here going forward?

So we're certainly pleased with the performance in the quarter, and in part, the result of our sustained efforts here to grow our revenue base outside of the North Sea. So this has been something we've been committed to and sticking to here and beginning to see some contributions from that. So that's very good to see.

The fundamentals of the business haven't changed in terms of the value proposition here. And as I said earlier, I think even in a low oil environment, we're proving that. But that being said, there's a lot of volatility here in terms of the project nature of this business.

And so which wells is this -- is the (inaudible) the right fit for, what's the timing of that completion activity and the duration of any given project? These are all variables that are difficult to predict. And they're actually quite difficult for even our customers to predict, things like duration of projects.

So it's a tough one to give you any more visibility into any, Kevin, I think, but we're pleased to see the progress here. And, again, feel that it's validated, the value proposition, even in this somewhat unprecedented low oil environment. But there will be choppiness given the project nature of this business.

Okay. And then curious about -- there's been -- cash has built up quite a bit on your balance sheet. You're up to $222 million, which it's barely been above $100 million for any quarters for the past couple of -- several years. So curious how you're thinking about that between share repurchases and M&A that you might have in the pipeline. How should we think of your usage of that cash going forward?

I think the best way to think about it is to come back to our messaging and framework at Investor Day where we laid out a framework that we think is going to drive both attractive and sustained TSR. And this is a combination of investing the strong cash flows that we generate, about half back into growth in ourselves and our core and about half of the December discretionary free cash flow back to shareholders, both in the form of dividends and share purchases. And I think over time, that's the right way to be thinking about it.

So I wouldn't get too tied up in the short term. This is how we're thinking about it over the longer term and over time, and this is what we're driving.

Okay. And then in terms of -- a little more into the mercury-activated carbon business, now that MATS is fully implemented, how is utilization rates of plants -- are they relatively tight at this point? And then how does it work with contracts with customers? Do they -- are they pretty standard where they're one year, multi-year, what have you? And kind of like in rubber carbon black they to -- most of them January first? Or how does all of that work?

Well, I think, first, in terms of the typical contract, I think they're more in the two-year duration. And, again, because this is a relatively new market, we'll have to see how that plays out over time. But that's what we've been seeing so far.

In terms of our utilization, we have further unused capacity, so there would be some operating leverage here in the business. And I think over all, the industry still has some excess capacity. So that's been putting a bit of pressure in terms of pricing here. But, again, we'll have to see how this one settles out as it is a new market.

Okay. And then just final question, you mentioned in the press release for guidance that the third quarter was in line with expectations and then you mentioned that you expect your prior guidance to come in at the low to midpoint. So maybe implying that the fourth quarter maybe is going to be a little -- in line to maybe a little softer than you had initially expected, taking away the high end of the guidance range. If I'm reading that right, what factors are there that might be a little bit softer than you previously would have thought? Well, I think as we look into the fourth quarter, we're definitely expecting to see some positive movement or progress versus Q3 in both reinforcement as well as purification solutions. But expecting some moderation in performance chemicals because of seasonality. So normally during this period, we see a seasonal slowdown and we're certainly expecting that.

And then in specialty fluids, some moderation as well off of a pretty high level of activity here in Q3. So I think in some ways, those -- you could think about those as balancing out a little bit. All right. Thank you.

Thank you.

(Operator Instructions)

And our next question comes from the line of Laurence Alexander with Jefferies. Your line is now open.

Seems that there's no one there.

One moment, please.

Can you hear me? Can you hear me?

Mr. Alexander, I apologize. Your line is now open.

Hello. Can you hear me now?

Yes, we can.

Sorry about that. So I think in the past you mentioned that commercial tires in China were somewhat of a headwind. I was wondering if that was still the case, or if things have improved at all?

Commercial tires?

Or just automotive in general.

Well, okay. So I think one of the things that we have talked about in the past is the truck tire market having moderated somewhat in China, and this would stand to reason as the level of industrial activity has slowed down and, therefore, the hauling of steal and cement and things like that has impacted the truck tire market. So that is the case.

We, I think, are seeing that stabilize somewhat. China has continued to inject some stimulus into the economy, and some of that is going into the infrastructure space, which is, I think, helping stabilize the truck tire market. But it certainly had pulled back a little bit. But I would say stabilizing is what we're seeing right now.

Okay, and then just with trends -- just worldwide trends for automotive OEM demand maybe more for your performance chemicals segment, has that moderated at all, or is that still going strong?

It's been pretty strong for us. I think the outlook next year is for it to pull back a little bit. If you just look at people like HIS and others that forecast auto builds, and so we certainly watch that closely. But that's the -- the forecasters are seeing, perhaps, a little bit of a pullback next year.

Okay, and then a final question. You said that -- I think you mentioned $12 million in costs or expense reductions in the quarter. And I think -- and if my math is right, that would translate into around, I don't know $0.13 to $0.16 in potential savings. And I think what you're looking for or you haven't really quantified, but is that -- are you halfway done? Is that half the savings you're looking for? Is there a lot more room for growth? I'm just wondering where we're going from here.

So maybe I'll pull back on that one for a second and just recap what we've been doing on the cost side. So we had committed $50 million of cost savings from our restructuring actions, and we're on track with that as we sit here today in the quarter and did realize about $12 million towards that objective. But on a full fiscal-year basis, we're on track to achieve that $50 million.

All right. Thank you very much.

Thank you. And our next question is a follow-up question from the line of Ivan Marcuse with KeyBanc Capital Markets. Your line is now open.

Thanks. This is a quick question. In terms of investing in growth, your CapEx is about as low as it's been in a long time. Where do you envision that going in 2017, ballpark?

Yes. So we're still working through, Ivan, our slate of projects as we go forward, but we'd certainly expect that number to go up. And we had given some range on that during Investor Day, and I don't recall specifically the number. I thought it was more in the 150 to 175 range. So you can think about that as a reasonable range at this point. And included in that will be a mix, as we've laid out in the capital allocation framework, of both sustaining and compliance, as well as investment for growth.

Great. Thanks for taking my questions.

Thank you, and I'm showing no further questions at this time. I would now like to turn the call back to Mr. Sean Keohane, President and CEO for closing remarks.

Great. Well, 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, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.