BOSTON Nov 4, 2015 (Thomson StreetEvents) -- Edited Transcript of Cabot Corp earnings conference call or presentation Tuesday, November 3, 2015 at 7:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Erica McLaughlin Cabot Corporation - VP of IR * Patrick Prevost Cabot Corporation - President & CEO * Eddie Cordeiro Cabot Corporation - EVP & CFO ================================================================================ Conference Call Participants ================================================================================ * Jim Sheehan SunTrust Robinson Humphrey - Analyst * Laurence Alexander Jefferies LLC - Analyst * Eugene Fetotoff KeyBanc Capital Markets - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Hello, and welcome to the fourth-quarter 2015 Cabot Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Vice President of Investor Relations, Erica McLaughlin. -------------------------------------------------------------------------------- Erica McLaughlin, Cabot Corporation - VP of IR [2] -------------------------------------------------------------------------------- Thank you. Good afternoon. I would like to welcome you to the Cabot Corporation earnings teleconference. Last night we released results for our fourth quarter and full FY15, 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 e-mail. 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. Also, as we typically do each year, I would like to remind you that over the next several weeks in connection with the vesting of restricted stock awards issued under our long-term incentive equity program, officers of the Company may sell shares to pay tax obligations related to their awards. I will now turn the call over to Patrick Prevost, who will discuss the key highlights of the Company's performance. Eddie Cordeiro will review the business segment and corporate financial details, and following this Patrick will provide closing comments and then open the floor to questions. Patrick? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [3] -------------------------------------------------------------------------------- Thank you very much Erika, and good afternoon, ladies and gentlemen. I will start the discussion today with the results for the full fiscal year. In FY15, we achieved mixed results across the segments. We faced macroeconomic headwinds related to oil prices, foreign currency, and weak demand in emerging markets. These headwinds resulted in a challenging year for our Reinforcement Materials segments, where we experienced margin pressure from negative feedstock effects and a very competitive pricing environment. (Inaudible) as a result of the low energy prices the oil and gas energy reduced investments focused on cash management and delayed projects, all of which impacted us and the use of our cesium products. In addition, our expectations for our Purification Solutions were diminished, due to the uncertainty around the MATS regulation, resulting in an asset impairment charge. On the positive side, we delivered a second straight year of record EBIT results for performance chemicals driven by expanding margins, launching new products, and lower fixed costs. We also delivered significant improvement in operating results in our Purification Solutions segment, with EBIT increasing $24 million in 2015 as compared to 2014. The improvement was due to our efforts to increase prices and upgrade our mix of products, as well as from lower costs as we realigned the cost structure of the business. In response to the challenging business conditions, as well as a $28 million foreign currency headwind, we put cost management high on our agenda and achieved savings for the Company of $54 million. We also remain intensely focused on cash flow, which resulted in cash flow from operations of $489 million. We used our strong cash flow generation for capital expenditures of $141 million, we repurchased $96 million in shares, and paid $56 million in dividends. This was no doubt a challenging year for us. We responded by managing costs and capital spending, continued to implement our value pricing and product differentiation strategy, and focused on cash generation, as well as returning cash to shareholders. Our execution in these areas helped to offset some of the headwinds we faced and positions us well as we look ahead into 2016. I will now turn it over to Eddie Cordeiro to discuss the financial results in more details. Eddie? -------------------------------------------------------------------------------- Eddie Cordeiro, Cabot Corporation - EVP & CFO [4] -------------------------------------------------------------------------------- Thank you, Patrick. During the fourth quarter, we saw many of the same trends continue from previous quarters. As compared to the prior year, we delivered EBIT improvement in our Performance Chemicals and Purification Solutions segments. However, margin pressure in Reinforcement Materials and lower project activity in specialty fluids continued. We generated strong cash flows from operations and repurchased 460,000 shares for $16 million. We also had a couple positive impacts that contributed to adjusted EPS of $0.78. These included a lower operating tax rate, which contributed $0.07 per share as we adjusted the full-year rate during the fourth-quarter. In addition, oil prices continued to decline and we recorded an $8 million benefit from LIFO accounting. I will now discuss the fiscal year performance at the segment level beginning with Reinforcement Materials. Fourth-quarter FY15 EBIT in Reinforcement Materials decreased by $25 million compared to the fourth quarter of FY14. The decline in EBIT was principally driven by lower unit margins from lower contract pricing, negative feedstock effects, lower benefits generated from energy efficiency investments, and the competitive environment in Asia. The negative feedstock effects and lower pricing impacted us by approximately $20 million, and the lower benefits from energy efficiency investments impacted us by roughly $5 million. Volumes also declined by 4% during the fourth quarter of FY15, as compared to the fourth quarter of FY14, from lower contractual volumes in North America and lower demand in China, which was partially offset by lower fixed costs. Moving to FY15 for Reinforcement Materials, the segment EBIT decreased by $113 million, as compared to the FY14. The decline in EBIT was principally driven by pressure on unit margins, including lower contract pricing and increased competition in Asia, negative feedstock effects from lower raw material purchasing savings, lower benefits from our energy efficiency investments, and the impact of high cost inventory that moved through our supply chain during the first half of the year. We also experienced a less favorable sales mix, with lower sales in North America and higher sales in Asia. Volumes declined by 2% in FY15 driven by lower contractual volumes in North America and weakened demand in China and South America, partially offset by increases in other regional volumes. To partially offset the negative effects, we reduced costs during the year through our efforts to operate more efficiently and lower our discretionary spending. The cost savings were mainly in the back half of the year and we're expecting further cost reductions in 2016. In addition, we experienced $10 million lower elastomer composites earnings in FY15, as compared to the prior year, as we transitioned from a fixed to a variable royalty arrangement and received lower technology milestone payments. While the year was challenging, our segment EBITDA margins remain robust at 15%. Now turning to Performance Chemicals, the fourth quarter was a record quarter and EBIT increased by $8 million compared to the fourth quarter FY14, due to improved margins in the specialty carbons product line from lower raw material costs and lower fixed costs. These impacts were partially offset by 5% lower volumes in metal oxides from weaker demand in construction applications and a more competitive environment in China. Volumes also declined 1% in the specialty carbons and formulations business, which was driven by lower demand in the specialty compounds product line as falling polymer prices during the quarter impacted the master batch value chain. Specialty carbons volumes increased year over year in line with market growth, partly offsetting the decline in specialty compounds. Foreign currency exchange was a headwind again this quarter, with a $5 million unfavorable impact. For the full fiscal year, Performance Chemicals EBIT improved by $10 million over FY15. The improvement was driven by expanding our margins in the declining raw material environment and carefully managing our fixed costs. These benefits were partially offset by unfavorable foreign-currency impacts of $16 million. Despite the significant foreign currency headwind and relatively flat volumes, we delivered the second straight year of record results for this segment. The EBITDA margin for the segment was 25%, which is an improvement from 22% in the prior year. Moving to Purification Solutions, fourth-quarter EBIT in Purification Solutions increased by $1 million compared to the fourth quarter of FY14. Excluding a one-time insurance payment of $9 million received during the fourth quarter of FY14, EBIT would have improved year over year by $10 million. The improvement was due to higher margins from a more favorable product mix and higher volumes sold to our mercury removal customers. In addition, we had lower fixed costs from the work we have done to improve our operational performance and from the benefit from lower depreciation and amortization. For the full fiscal year, EBIT in Purification Solutions improved by $24 million, as compared to FY14. The increase was driven by price increases and an improved product mix, as we pursued our value over volume philosophy. While overall volumes for the segment declined slightly from the effect of increasing prices and upgrading our product mix, we saw volumes sold to mercury removal customers increase by over 30%. This was due to the first wave of customers adopting the MATS regulation in April of 2015 and through our success to date of securing in excess of 40% of the overall activated carbon volumes for mercury removal products in North America. In addition, we reduced costs as we worked to improve our operational performance and to realign our cost structure for this business. The lower fixed costs also included the benefit of $5 million from lower depreciation and amortization. Fourth-quarter EBIT in Specialty Fluids decreased by $9 million, compared to the fourth-quarter of FY14, due to lower project activity levels as the business continues to be impacted by the downturn in the oil and gas industry. In response to the environment we commenced cost reduction efforts that will have a favorable impact in 2016. For the full year, Specialty Fluids EBIT decreased by $33 million, compared to FY14. Lower project activity levels resulted in lower rental and sales volumes for our drilling fluids. As Patrick noted, the downturn in the oil and gas industry resulted in fewer investments made by our customers, project delays, and stringent cost management by oil and gas companies. All of which impacted our performance. In response, we improved our product mix and reduced costs to help partially offset the lower volumes. I will now turn to corporate items. We ended the year with a cash balance of $77 million. Our liquidity position remains strong at $813 million. During the fourth quarter, we generated $115 million of adjusted EBITDA and reduced net working capital by $124 million. Uses of cash during the fourth quarter included $38 million for capital expenditures and $16 million for share repurchases. We recorded a net tax provision of $2 million for the fourth quarter, which included $11 million of benefits for tax related certain items. We also recognized a LIFO benefit of $8 million due to lower feedstock costs. During FY15 we generated $473 million of adjusted EBITDA and reduced net working capital by $190 million. The reduction of net working capital was driven by the impact of lower feedstock costs and foreign currency exchange rates. Uses of cash during the year included $141 million for capital expenditures and $96 million for share repurchases. We also recorded a LIFO benefit of $22 million due to lower feedstock costs. The net tax benefit was $45 million for the fiscal year, which included $107 million of benefits for tax related certain items, primarily due to the tax effects from that asset impairment in the Purification Solutions segment. Excluding the impact of certain items, our operating tax rate on continuing operations for the full fiscal year was 25%. As we look towards 2016, we expect capital expenditures of approximately $150 million, which is below our D&A levels. We anticipate our operating tax rate for FY16 will be between 26% and 28%, and we do not anticipate benefits from LIFO accounting in 2016. I will now turn the call back over to Patrick. -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [5] -------------------------------------------------------------------------------- Thank you, Eddie. While FY15 has been a challenging year, including the impact of a number of macroeconomic headwinds and business specific issues, we believe that the actions that we are taking and the fundamental strength of our businesses will drive improved performance in 2016. Looking at the drivers of 2016 performance by segment, I will start with Reinforcement Materials. The FY15 level of earnings for Reinforcement Materials was impacted by lower oil prices, utilizations that remained in the 75% to 80% range for the year, and weak demand in emerging economies like China and Brazil. As we look ahead, we have taken action to offset some of the headwinds we've been facing. First, we're executing a restructuring plan that will reduce costs by approximately $15 million in 2016, and this will start in the second fiscal quarter. We are continuing to look for ways to make Cabot more efficient and to reduce our cost structure. Second, we're implementing price increases in the contract and spot markets for 2016. The price increases are being met with mixed results, depending on the respective region or customers. While we remain driven by value over volume approach, we will look to balance volume growth with this philosophy and expect to realize our share of market growth. Third, we expect a modest level of global volume growth in 2016 driven by North America, Europe, and China. Thus, overall, we're optimistic that the segment will deliver significantly improved results in FY16 with a higher level of earnings starting in our second fiscal quarter. For the first quarter, we will work to manage the increasingly competitive environment in Asia, as well as to manage our capacity and inventories in light of the normal seasonality impacts that come with a December quarter. We move to Performance Chemicals, we are pleased with the record-setting performance this year, and looking ahead, we expect to see growth in 2016 from our differentiated product offering into our high-value applications. We expect to see a benefit from our commercial and technology excellence efforts and a contribution from our cost reduction efforts. The cost reduction contribution in this segment is expected to be approximately $15 million in 2016, and it will also start in the second quarter. For the first quarter of FY16 we expect a similar earnings profile to the recent quarters, adjusting for normal seasonal demand patterns. For Purification Solutions we anticipate a ruling from the US Court of Appeals by the end of the calendar year on next steps for MATS. Until that ruling can provide some clarity, we expect that Purification Solutions will operate at roughly breakeven EBIT run rates in the near term. We continue to work on realigning our cost structure, which should contribute an incremental $12 million of cost savings. And we plan to reduce our inventory levels that have been mainly built in anticipation of the MATS adoptions. This will result in approximately $5 million of EBIT headwind per quarter, compared to last year. If there's a favorable outcome to the court ruling on MATS, there could be potential upside to this outlook. In terms of Specialty Fluids, we continue to work on strengthening the project pipeline, but the short-term outlook remains challenging for the segment. The level of project activity is expected to improve in the second half of FY16, and we will be achieving cost reductions of approximately $5 million for the fiscal year. In terms of our corporate focus, we're targeting an improvement in adjusted EPS of $0.75 in FY16, as compared to FY15. To respond to the current environment we're executing a restructuring plan that is expected to result in $50 million of cost savings on a company-wide basis year over year. Barring a substantial shift in oil prices, we expect to continue to generate strong cash flows. We are comfortable with our debt levels, and we'll prioritize returning cash to shareholders and investing in the existing businesses. Value creation for our shareholders remains the key objective of our short- and long-term strategy. Thank you very much for joining us today. I will now turn the call back over for our question-and-answer session. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Jim Sheehan, SunTrust. -------------------------------------------------------------------------------- Jim Sheehan, SunTrust Robinson Humphrey - Analyst [2] -------------------------------------------------------------------------------- Thanks for taking my question. You referenced the pricing increases that you've got in the spot market, mixed results there. Could you just give us a little more color on where you're seeing the price increase and where you're not? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [3] -------------------------------------------------------------------------------- Yes. So as I mentioned, Jim, last quarter we were driving towards getting price increases and had implemented a price increase and reinforcement [jolt] on September 1. As you remember, this was in the spot market. As you know, the contracts are set for the calendar year. We've seen some positives in this respect, but also we've seen some resistance in various places. Because we're in the midst of contract negotiations, I'm sorry. I won't be able to provide you more detail than that. -------------------------------------------------------------------------------- Jim Sheehan, SunTrust Robinson Humphrey - Analyst [4] -------------------------------------------------------------------------------- Okay. On the operating rates, you talked about high 70%s to 80% operating rates. Is this high enough to sustain higher pricing in the next contract season? Or do you have to actually see higher operating rates first? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [5] -------------------------------------------------------------------------------- Well, again, the utilization rates that I quoted, 75% to 80%, are an average across the various geographies. Depending on the geographies we are seeing more supportive environments for price increase in certain geographies than in others. So we will be, of course, focusing on those geographies for price increases, and in the other geographies we will be trying to match on balance, volume and price. -------------------------------------------------------------------------------- Jim Sheehan, SunTrust Robinson Humphrey - Analyst [6] -------------------------------------------------------------------------------- All right. Thanks a lot. -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [7] -------------------------------------------------------------------------------- Thank you. -------------------------------------------------------------------------------- Operator [8] -------------------------------------------------------------------------------- Laurence Alexander, Jefferies. -------------------------------------------------------------------------------- Laurence Alexander, Jefferies LLC - Analyst [9] -------------------------------------------------------------------------------- Good afternoon. Couple of questions. First, can you give a sense for if the inventory headwind in Q1 is in line with or worse than what you normally have seen? Secondly, on the cost cutting program, which looks like it's mostly targeting the reinforcement blacks, is that correct? Because, if so, it looks as if you're angling for about a 13%, give or take, run rate margin in 2017. That would be much higher than your historical performance from the segment. Is that the right way to look at what you're trying to do? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [10] -------------------------------------------------------------------------------- Lawrence, good afternoon. I'm not sure I fully understood your first question. Do you mind repeating that? -------------------------------------------------------------------------------- Laurence Alexander, Jefferies LLC - Analyst [11] -------------------------------------------------------------------------------- Sure. There was a quick comment in your remarks about a more typical seasonal inventory headwind affecting the bridge for reinforcement blacks in Q1, in December quarter. Wanted to make sure that that was normal seasonality and not worse than normal seasonality. -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [12] -------------------------------------------------------------------------------- Yes. That's normal seasonality, Laurence. Concerning the second question, I believe you were asking about the application of the restructuring program to the Reinforcement Materials segment. We've indicated that of the $50 million of cost savings that we're expecting in the restructuring program, that about $15 million would be affecting Reinforcement Materials. Again, I think it's important also to note that the impact in terms of the effect on the bottom line will only start in the second quarter of FY16. -------------------------------------------------------------------------------- Laurence Alexander, Jefferies LLC - Analyst [13] -------------------------------------------------------------------------------- Lastly, on the target for EPS improvement in 2016, is any of that in your target from taxes or share count? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [14] -------------------------------------------------------------------------------- I'll ask Eddie about -- -------------------------------------------------------------------------------- Eddie Cordeiro, Cabot Corporation - EVP & CFO [15] -------------------------------------------------------------------------------- Well, we have a bit of a headwind as it relates to taxes, Laurence, since we ended 2015 at an operating rate of 25% and we are forecasting 2016 to be in the 26% to 28% range. We have a little bit of a headwind there. As it relates to share count, since we bought back a fair number of shares already in 2015 on averaging basis, I think that accounts for about $0.05 benefit in 2015, and it will account for another $0.05 in 2016. We have that going forward. And that's before buying back any further shares in 2016. -------------------------------------------------------------------------------- Laurence Alexander, Jefferies LLC - Analyst [16] -------------------------------------------------------------------------------- Thank you. -------------------------------------------------------------------------------- Operator [17] -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc. -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [18] -------------------------------------------------------------------------------- Good afternoon. Thank you for taking my question. To follow up on pricing, I was wondering what is your view of pricing in specialty blacks going forward given that raw materials have declined throughout the year? Are you seeing any pressure on pricing, and do you expect any declines in specialty pricing in 2016? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [19] -------------------------------------------------------------------------------- We've certainly seen some benefit -- in that business we've seen some benefit from the oil price declines. This has been certainly helping in terms of expanding our margin. In addition to that, we've been actually increasing prices and have been successful and certainly more in the specialized and differentiated part of the portfolio. Now, what's important to understand is that we've got about 25% of our business in specialty carbons that's in a formula type structure, more similar to what we have in Reinforcement Materials. So these businesses are kind of set in terms of ability to achieve benefits from margin through feedstock. But their's resets on an annual basis, and we're looking right now at the possibility to increase prices into, and are negotiating right now, to see if we can increases increase prices into 2016. I'm sure we'll be getting some varied results here depending on the application and the geographical environment. -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [20] -------------------------------------------------------------------------------- Great. Thanks. A follow-up on the demand in China, you're expecting some recovery. I believe one of your customer source also said that they're seeing strong pickup in local demand in China. I was just wondering if you can provide some more color on what are you seeing in the region? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [21] -------------------------------------------------------------------------------- Yes. We're still looking at China as an important part of the Company, and we have a fairly bullish perspective on China in the long run. In the short-term, we are, however, seeing some decline in demand. We're seeing the impact of the slowdown of the economy. That is affecting us through the businesses that are related to automotive and construction and building industry. We, however, look at the Chinese tire market as being critical for the world. We're seeing about 35% to 40% of global tires made in China. Even though there is a slowdown, let's say, that is related to local demand, certainly on heavy commercial vehicles, and also a bit of slowdown in terms of exports for personal car tires. We're still looking at and expect to see somewhere in the range of 1% to 2% on heavy commercial vehicle growth in terms of tire production and consumption and about 5% on the personal car tire side. If you take all of that in, where that leads to growth of approximately 3% to 5% for carbon black in 2016. So let me put it this way. I think in the short-term, we're seeing a slowdown. But it's all relative, of course, to what we've seen in the past and also relative to what we're seeing in other countries around the world. So still a fairly attractive long-term environment in China. -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [22] -------------------------------------------------------------------------------- Thanks for this color. I was wondering, several companies in the industry recently announced their exposure to Venezuela and currency devaluation impact from the region. I was wondering if you could comment on your exposure to the region? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [23] -------------------------------------------------------------------------------- I'm sorry. I didn't totally understand. Did you talk about currency exposure or --? -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [24] -------------------------------------------------------------------------------- Yes, in Venezuela. -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [25] -------------------------------------------------------------------------------- For China or --? -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [26] -------------------------------------------------------------------------------- Venezuela. -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [27] -------------------------------------------------------------------------------- Oh, Venezuela. Venezuela is a very small part of the Company's portfolio. We have a minority joint venture position there. We've been adjusting our reporting to deal with the currency situation on a regular basis, but it's immaterial in terms of the impact it has. -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [28] -------------------------------------------------------------------------------- Okay. Great. A last question, clarification on Purification Solutions. I'm sorry if I missed that. I thought you said that you're expecting your depreciation and amortization to be down in the segment, and then you're taking some costs out, at the same time you're expecting breakeven performance. What is offsetting that? -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [29] -------------------------------------------------------------------------------- So the drive in terms of what's happening there is really related to the MATS environment. As you can imagine with the demand expected to grow very rapidly, we have been building inventory to meet the customer demand there. With the ruling a few months ago, things have gone into a situation where we have uncertainty in terms of the MATS timing. We're expecting a ruling from the court in the next couple of months. But we've got to manage the situation and because of that, we have decided to reduce our inventory position. And as we plan forward, then assuming that there is no pickup in demand for mercury removal, we expect to see approximately a $5 million a quarter impact from the reduction in inventory. And this is, of course, depressing the profitability of the Purification Solutions business in the near term. -------------------------------------------------------------------------------- Eugene Fetotoff, KeyBanc Capital Markets - Analyst [30] -------------------------------------------------------------------------------- I see. Thank you. -------------------------------------------------------------------------------- Operator [31] -------------------------------------------------------------------------------- I will now turn the call back over to Patrick Prevost for closing remarks. -------------------------------------------------------------------------------- Patrick Prevost, Cabot Corporation - President & CEO [32] -------------------------------------------------------------------------------- Thank you very much for joining us today, and we'll be looking forward to speaking with you again next quarter. Thank you.
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