Cabot Corporation (CBT) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2015 Cabot Earnings Conference Call. My name is Tony, and I will be your operator for today. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host for today, Ms. Erica McLaughlin, VP of Investor Relations. Please proceed.

Thanks, Tony. Good afternoon. I'd like to welcome you to the Cabot Corporation earnings teleconference. Last night, we released results for our second quarter of fiscal year 2015, copies of which are posted in the Investor Relations sections of our website. For those of you on our mailing list, you received the press release either by email or fax. If you are not on our mailing list, and you 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 a replay of the call. I remind 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 also be found in the Investor Relations portion of our website. 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 open the floor to questions. Patrick?

Thank you, Erica, and good afternoon, ladies and gentlemen. We experienced a challenging quarter, as the macroeconomic and competitive environment negatively reflected our reinforcement materials and specialty fluids segments. Our volumes held up relatively well on a global basis in reinforcement materials, but we experienced margin pressure from lower contract pricing and feedstock-related effects. In addition, customer and inventory destocking continued to unfavorably impact our China volumes. Tire production in China was curtailed, in order to reduce tire inventory levels after the 2014 build, in anticipation of the US tariffs. The decrease in specialty fluids EBIT was driven by lower rental volumes, as a result of a lower level of project activity, which was exacerbated by lower oil prices. On the positive side, we had another quarter of strong cash flow from our operating performance and a reduction in net working capital. We continued our focus on return on cash to shareholders and used a portion of our strong cash flow generation to repurchase 300,000 shares during the quarter. This brings our year-to-date repurchases to 1.2 million shares for a total of $56 million, and all of this represents approximately 2% – an approximate 2% reduction in our total share count. So let me now turn it over to Eddie, to discuss the financial results in more detail. Eddie?

Okay. Thank you, Patrick. Adjusted EPS for the second quarter of 2015 was $0.53, and total segment EBIT from continuing operations was $69 million. Volumes were impacted by continued customer inventory destocking in China for the reinforcement materials segment, and in the specialty carbons product line in the performance chemicals segment. As expected, we experienced margin pressure in reinforcement materials, and lower project activity in specialty fluids. On the positive side, we delivered improved purification solutions results from higher pricing and higher volumes sold to mercury removal customers, as compared to last year. In addition, we had strong cash flow during the quarter from the operational performance, and a reduction in net working capital. We also continue to aggressively manage costs, which resulted in $10 million of lower costs as compared to prior year. I will now discuss the details at the segment level, beginning with reinforcement materials. During the second quarter of 2015, EBIT for reinforcement materials decreased by $38 million, as compared to the second quarter of 2014. The decline in EBIT was principally driven by lower unit margins from a number of factors that I will highlight now. First, lower contract pricing and lower raw material purchasing savings. Last quarter, we called out these two items, and noted that we expected them to unfavorably impact the segment by $10 million to $15 million. These two items impacted the segment by approximately $20 million this quarter, as compared to last year. Second, high cost of inventory in Europe that was going to move through our supply chain in the second quarter. Again, last quarter we called this out, and noted that we expected this impact to be in the $5 million to $10 million range. This impacted the segment this quarter at the high end of that range. Thus, the combination of these three items resulted in roughly $30 million of unit margin decline. In addition to these three items, we experienced lower benefits from energy efficiency investments. This is because these investments deliver lower benefits at lower energy prices. So this impacted us unfavorably this quarter, as compared to last year. Also, as you can see in the volumes and as we communicated last quarter, we sold less in North America due to lower contractual volumes in 2015, and sold more in Asia. So while volumes are flat overall, this leads to a less favorable regional mix, which also unfavorably impacted margins as compared to the prior year. The total impact of the energy investments and the regional mix were somewhere approximately $6 million, as compared to the last year. Thus in total margins declined by $36 million, as compared to the prior year. In addition, we experienced $3 million lower elastomer composites earnings in the second quarter of fiscal year 2015, as compared to the prior year, as we transitioned from a fixed to a variable royalty arrangement and received lower technology milestone payments which were partially offset by lower costs. Volumes declined by 1% during the second quarter of fiscal year 2015, as compared to the second quarter of fiscal year 2014, driven by lower contractual volumes in North America, partially offset by increases in other regional volumes. Sequentially, reinforcement materials EBIT decreased $26 million. The decline was by primarily driven by lower unit margins, as a result of a similar set of factors as I have just discussed in the year-over-year decline in unit margins. The decline in unit margins was partially offset by lower fixed costs. Volumes were flat sequentially, as higher volumes in Europe, South America, Southeast Asia and Japan were offset by continued customer inventory destocking in China, and lower contractual volumes in North America. Our global utilization rate remained in the 75% to 80% range in the second quarter. As we look ahead, we expect that some of the temporary effects that have impacted us in the first half of the year will be behind us. We expect volume growth in the second half of the year as customer inventory destocking has come to an end, and the impact from high cost inventory that moved through our supply chain in the second quarter is substantially behind us. However, we continue to see margin pressure in reinforcement materials, including a increasing competitive environment in Asia. Overall, while this year will be challenging for this segment, we see an improving environment for the second half of the fiscal year. Now turning to performance chemicals, EBIT decreased by $4 million as compared to the second quarter of 2014, due to 4% lower volumes in specialty carbons and formulations, driven by customer inventory destocking in the specialty carbons product line, and a less favorable product mix across segments. These impacts were partially offset by 2% higher volumes in metal oxides and improved margins in the specialty products carbon line from lower raw material costs. Sequentially, performance chemicals EBIT increased by $3 million, primarily due to 12% higher volumes in specialty carbons and formulations and 3% higher volumes in metal oxides as a result of seasonal effects. These higher volumes were partially offset by the absence of a $5 million inventory build that had benefited the first fiscal quarter. Looking ahead, we believe that the customer destocking has come to an end, as polymer prices have begun to rise and oil prices have stabilized. We have seen stronger volumes materialize in March and April, and we expect growth in automotive, construction and consumer applications in the second half of our fiscal year 2015. Adjusted EBITDA in purification solutions for the second quarter of 2015 was $13 million, which compares to $9 million for the same period last year. The adjusted EBITDA increase of $4 million was due to higher pricing, improved operational performance at lower costs, and higher volumes sold to mercury removal customers, partially offset by lower volumes sold to other end markets. Sequentially, purification solutions EBITDA increased by $2 million, compared to the first quarter of fiscal year 2015, due to the benefits from price increases and building inventory, which more than offset lower volumes. In the quarter, we built additional inventory in anticipation of the MATS implementation and turnarounds, which resulted in a $4 million benefit relative to the prior quarter. As we look at the remainder of the fiscal year, the implementation of the MATS regulation is expected to increase demand for our mercury removal products, and we continue to be selected to supply additional customer units. At the same time, the benefit from increasing inventory levels seen in the first half of the year is not expected to repeat in the second half of the year, as we fulfill increasing demand. Now moving to specialty fluids, EBIT decreased by $10 million from the second quarter of fiscal year 2014, and declined $7 million as compared to the first quarter of fiscal year 2015. The declines in both comparative periods were driven by lower rental volumes, as a result of a lower level of project activity, which was further impacted by the downturn in the oil and gas energy. As we look ahead, cost management in the oil and gas industry has introduced some near term uncertainty to our business. This has led to project delays, which impacted our second quarter and is likely to continue to impact us for the remainder of the year. Over the long-term, our cesium formate is primarily used in gas wells for drilling and completion. The value proposition for cesium formate is complex, but the key drivers are reducing costs for rig time, and increasing reservoir recoveries. We expect project activity to improve at a modest rate from Q2 levels, and we will continue to stay close to our customers regarding their investment plans, and the use of our products. I will now turn to corporate items. We ended the quarter with a cash balance of $94 million, and our liquidity position remains strong at $720 million. During the second quarter, we generated $105 million of adjusted EBITDA, and reduced net working capital by $92 million. Uses of cash during the second quarter, included $29 million for capital expenditures, and $14 million for share repurchases. We recorded a net tax provision of $14 million for the second quarter, which included $2 million of charges from tax related certain items. Excluding the impact of certain items on both operating income and the tax provision, our operating tax rate on continuing operations for the second quarter was 28%. We also recorded a $7 million benefit related to our LIFO accounting reserve, principally driven by the decline in oil prices. Based on current outlook for feedstock costs and our anticipated inventory levels, we expect a $24 million benefit for the year, with half of that already recorded year-to-date. If feedstock costs move up or down from where they are forecasted to end the fiscal year, this estimate could change. We anticipate capital expenditures for the year to be approximately $150 million, and our operating tax rate for the fiscal year 2015 to be between 27% to 28%. And I'll now turn the call back over to Patrick.

Thank you, Eddie. As we look ahead for the company as a whole, we expect some of the recent challenges, such as customer inventory destocking, and the impact from high cost inventory to be substantially behind us. We anticipate increased volumes throughout our segments, as we move through the second half of our fiscal year. However, we continue to see margin pressures in reinforcement materials and uncertainty in the timing of projects in specialty fluids. I'll now move to purification solutions. We are seeing higher volumes for our mercury removal products, due to the April implementation of the MATS regulation. Since we have moved into the implementation phase, and based on initial customer and industry feedback, we are revising how we expect the industry to evolve. As such, we're on the process of updating some of our estimates regarding the outlook. First of all, the activated carbon demand for mercury removal customers in North America may be somewhat lower than previously expected. With a first wave adoption in April, we're gaining visibility into market demand and it looks like the range may now be £300 to £350 million per year, once all utilities are complying with the MATS regulation. This range is very dependent on the types of products that will be consumed, as certain customers will use more advanced products which require fewer pounds. Based on this industry outlook, we anticipate that there could be enough existing activated carbon capacity to serve customers' needs, and this negatively impacts our pricing assumptions for 2016 and beyond. Secondly, there have been some additional deferrals into 2016, as the appeal of MATS with the Supreme Court has added uncertainty for our customers. With these recent deferrals, we estimate that approximately 70% of power-generating units have deferred into the next year. Thirdly, based on the assessment of industry volumes and dynamics, we believe a more likely assumption for our share of the overall activated carbon volumes for mercury removal products in North America will be between 40% and 50%. The result of these refinements, which are less favorable than previously estimated and are still evolving, is that we now expect the purification solutions segment EBITDA to be in the $100 million range for fiscal year 2017 and growing thereafter. With all of these uncertainties, there's an increased likelihood that we will record a non-cash impairment charge. This charge could be up to $350 million, and assumes the MATS regulation is implemented on its original time frame, or with a very modest delay. However, this is a preliminary view, and we expect that we would be completing our analysis during this third fiscal quarter. Despite the uncertainty around MATS, I still believe we have a business with solid, underlying fundamentals and market leadership positions. Once we improve utilizations post-MATS implementation, I expect solid earning performance with the EBITDA margins in the 20% range. As a company, we remain driven by our performance orientation and our shareholder focus. We'll continue to leverage our global footprint, especially in the emerging markets, and strengthen our cost competitiveness and reliability through operational and technology excellence. Our disciplined capital allocation strategy will drive expansion of our existing portfolio, through high value capital expenditures, and bolt-on acquisitions. Finally, we target free cash flow generation in fiscal year 2015 of $350 million to $400 million, and we will prioritize returning cash to shareholders through dividends and share repurchases. 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] Your first question comes from the line of Mr. Ivan Marcuse [KeyBanc Capital Markets]. Please proceed.

Hi. Thanks for taking my questions. I guess, in light of the likely write-down of the purification solutions business. What is – how did this evolve, and when did you start seeing all these utilities start pushing out until, instead of being 50% to 70%? And is this – or is this still a pretty fluid situation at this point?

So, Ivan, thanks. We are seeing a very evolving and dynamic environment. This is an industry that's really only starting to exist and driven by regulation. So I would say the customer environment is perhaps more on the – in the push, rather than pull mode. And we're, as you know, learning as we go in this respect, and the regulation only came into force a couple weeks ago. And we believe that there's still some learning ahead of us, but as we take stock over the coming weeks, we will be refining our views. But at this stage, as I mentioned in my speech earlier, we believe that there's a likelihood of an impairment based on the evolving analysis of the market environment.

So you've recently added costs, in anticipation of a much stronger ramp-up. What is your capability of, I guess, taking down the solo cost structure of this business to make it – is there room to take down the cost structure of this overall business to adapt to the now much lower expected volumes?

We've worked on costs for some time actually with regard to looking at serving this industry. I mean, one case in point here, is the fact that we developed our own mine for raw materials to actually lower our costs, and improve our – the quality of our raw materials. We've also been, as you know working hard on the asset reliability and performance, so which we have improved. So I believe at this stage, we're in the right mode of operation. I think it is more around the total size of the market and the type of products our customers will be requiring. And as I mentioned, we're seeing the performance of – there's different generations of product developing that may depending on the needs of our customers may require less volumes in the future. So all of this, we're taking in and we're trying to get a better sense of the picture.

Okay. And then, switching over to the reinforcements, with all the different moving parts and I understand the competitive pressure in Asia. But have you – when you step back, and you look at this business with the EPA related costs and the volume, and everything else. What do you look for, is it – what do you believe is sort of a normalized type of margin in this current, I guess, the level of volume that we're looking at for this business over an annual – a one year period?

We – as you heard from Eddie earlier, we have seen a lot of headwinds, and they all are coming at the same time at us, which is quite unusual, and clearly not something that we had expected at this stage. In addition to the fact that growth in demand has been muted. So overall, we believe that the potential of the business is still there. I believe we are working through the various parts, the inventory destocking which has been hurting us over the last six months or so mainly in China, I believe are behind us. We've seen actually volumes improving in March and April, and this is also the case in China, but overall, this has been a positive development. The feedstock headwinds, the ones that we have created, so we've made some mistakes. We're most likely seeing all of that behind us in the third quarter. And then, if you look at energy impact, affecting our energy centers, unfortunately we're – there's not much we can do about that, although hopefully we'll see improvements in the energy price environment. And the last item, which has been affecting our margin has been the feedstock. And here, it's been unfortunate, but we've seen the types of products we buy, the market for those tightening. And when in the past, we were able to achieve discounts on our purchases, these discounts have shrunk quite substantially. And we're, of course, hoping for a positive development. Unfortunately, we're only one player in that feedstock environment and not one player that can move the prices. So we're dependent on other factors as well here. So all in all, I would say the main factor as I look forward are going to be this feedstock environment, then hopefully, we can get that to improve for us. And the volume side of things are improving. Although as I mentioned, the environment in Asia has become more competitive, mainly because the Chinese situation over the last six months was to lessen production of tires, because there was too many tires in the pipeline, due to US tariffs. But I think we've worked through most of that, and the Chinese tire producers are back in action. So hopefully, we'll see some improvement developing in that respect.

Got you. And then, last question and then I'll jump back in. With oil settling down, switching over to your performance chemicals business, with oil settling down and actually sort of moving a little bit higher, do your customers – does the reverse sort of happen in these times, where we saw a little bit of destocking as oil fell? As oil starts to rise, could you see a restocking, or is that probably unlikely, it just goes back to more of a normalized type of demand, demand environment?

Yes. So somewhat differently, in the performance chemicals sector, although we saw the destocking, the issue in the performance chemicals sector is that, the value chain is a broader and deeper one and it takes a little longer to work through that value chain. And we are seeing recovery from that destocking, and have seen it in March and in April. So somewhat similar to what we've seen in the reinforcement material. And we also will be seeing a little bit of raw material tailwind helping us in the coming month. It takes a little longer to work through raw materials in performance chemicals, and here we have, and have had the ability to get some benefit from diminishing raw material prices.

Got you. Thank you very much.

Thank you.

Your next question comes from line of Mr. James Sheehan of SunTrust Robinson Humphrey. Please proceed.

Thanks for taking my question. Could you update us on the status of the EPA discussions with your competitors, with regard to costs they have to incur for environmental controls?

Yes. So this is related to the consent decree that we have reached with the EPA on carbon black controls. And our understanding at this stage, and as a reminder, we have signed our consent decree about a year ago, and we will be spending approximately $85 million over the next 6 years to bring our operations in North America, or in the US into the envelope of the EPA. We understand that one of our – one other of our competitors has now signed as well. And we are – our understanding is that the discussions are continuing with the other players, and we hope that they will reach agreements in the coming months.

All right. Thank you very much.

Thank you.

Your next question comes from the line of Mr. Kevin Hocevar of Northcoast Research. Please proceed.

Hey, good afternoon, everybody.

Good afternoon.

I'm wondering if you could comment on the – give a little more detail on the updated Norit guidance for 2017. You mentioned the new range of £300 to £350 million. Is the lower pounds, a result of just customers mixing up, and getting higher-performing activated carbon? Or is it do they need more – of the more commodity mercury activated carbon, as they – as we learn more about this industry? And if it is that they need the higher – want the higher quality stuff, do you have the mix that they're looking for to meet those needs? Because I'm wondering if – trying to tie to the – that the market share, it sounds like it's less than the 50% that you previously expected. So what's kind of leading to your expectation of having less share, is it overly competitive? Just trying to understand that.

Yes. No. Happy to provide some background here, Kevin. So our current estimate of £300 to £350 million is based on an assumption, with regard to a product mix. We believed that currently there are approximately – there are about three generations actually of materials out there, with a basic material, a high performing, and a top-performing type of activated carbon. And as you move up in that generation range, the performance can rise quite substantially. And we're – as we move along here, we're learning that our customers are of different nature, with certain customers being more price sensitive, other customers being more performance driven. And that understanding is developing to point, where the mix as we see it today leads to a volume that is slightly lower than what we had expected in the past. Now with regard to us, in this whole picture, we have products in all three categories. So we're able to deliver the types of products our customers need, and that we're working closely with them to meet their expectations. Back to the point you made with regard to our share of the market. As we look at a market that is slightly smaller than we had originally planned. This leads to a supply demand environment that may be less tight than we had originally expected, and potentially with some negative impacts on prices. And at the same time, we also believe that this could lead to slightly different level of market share for us, and we're now targeting a range of between 40% and 50% market share for North America.

Okay. And on reinforcement materials side, I guess I want to try and put some numbers to the headwinds that are still being faced. So you mentioned that the contracts and raw materials savings that you had last year aren't going to repeat. Well, lower contract pricing, and that was a $20 million impact here. You mentioned that the $10 million high cost inventory is behind you at this point. So that won't repeat going forward. And then, the mix in lower North America volumes was a $6 million headwind, and the lower CEC was $3 million. So should we still be thinking of about a $30 million of a year-over-year headwind from those variables? And then, it sounds like Asia competitiveness might be getting a little bit bigger of a headwind. Is that how we should be thinking about it?

I'm not sure we – I would agree with the direct analysis here. Clearly, what we're doing is we're working at mitigating all of these here. So we're certainly and you can see it in our volume results in the quarter. We have actually been very active mitigating the North American contract losses that we talked about last quarter for calendar year 2015, and we've been successful at doing that. If I look at the other factors, essentially on the margin side, as I mentioned, we have one piece which I would call the high cost inventory in Europe, which we're essentially going to have behind us in the third quarter. With regard to lower contract pricing and raw material purchasing effects, those will be most likely continuing to be with us during the course of the fiscal, and potentially the calendar year, although we're clearly trying to mitigate those, they will be with us. And as I look further into 2016, we're clearly going to have the chance to renegotiate some of the contracts, and – but against that, we also see some stronger headwinds from competition in Asia. Although as I was mentioning earlier, we've been seeing some good volumes in China in April. So we're able to offset some of that through our commercial capabilities there. So I hope that is giving you a picture. We're looking at a stronger second half, which is from a volume point of view, and we're still looking at a growth in volume for the year of about 1% roughly at this stage.

Okay. Great. And then my final question, on the north – you mentioned with North America, it sounds like you're diverting, because some of the regions surprised me, South America volumes were really good. So are you diverting some of that capacity, some that volume that would have otherwise went to North America to other regions like that? And also, do you expect – my understanding is that North America is likely to get tight over the next couple quarters. Do you expect to regain that 15% lost market share within the US, as that industry gets tighter over the next 18 months or so or how should I think of that?

So let me correct you on one thing. We haven't been moving any material from North America to other parts of the world. We're managing our utilization rates in the various regions as you heard. We're still running on a global basis around 75% to 80%, which is still somewhat low, with regard to our expectation as a company. So this is how – so we're managing our various assets around the world, and our customer relationships to mitigate the headwinds. With regard to North America, we're clearly going to be assessing our options. We're still, and continue to believe in value over volume. But we do want and we'll continue to be focused on participating in the industry, and we have very strong relationships with the top players, and expect that those strategic relationships will pan out and enable us to reposition ourselves in 2016.

Okay. Great. Thank you very much.

Thank you.

Your next question comes from line of Mr. Jeff Zekauskas of JPMorgan. Please proceed.

Thanks very much.

Hi, Jeff.

Hi. What would get you to that high end of your free cash flow range this year, that $400 million, given the earnings pressure that you face? Is it all on the working capital side, or is there something else?

I'll ask Eddie to pick up on that one. Eddie?

Yes, Jeff. I think that would be our biggest lever, apart from any incremental earnings that we could deliver, it would be on the working capital side.

Working capital side, okay. And then, when I think back over time with carbon black margins, and different contracts that try to smooth raw material effects, it seems that this quarter was maybe anomalous, or very different from sort of the plan of the company, and maybe even the plan of the industry in terms of returns. I mean, usually your reinforcement material operating income margin is maybe somewhere between 10%, 12.5% or something like that. Is this an unusual period? And then, maybe by the beginning of fiscal year 2016, we revert back to that range or has the raw material volatility been so eccentric, as to sort of put cracks in the model of trying to have sort of a smoothing of returns over time?

So, Jeff, I think eccentric is a good word. I think, I've been in the business now 7 years, and I haven't seen anything like that. We've got a bunch of factors that, I don't think we've seen happening at the same time. And if you think about the oil price decline, but at the same time a tightness in certain of the raw materials where we're purchasing. So those two things are actually going against us doubly. We've had oil price – ForEx going against us. We're seeing a level of competition which we haven't seen in the past, partially related to disruptions that are happening across the globe. So the US tariff on tires, basically leading to the Chinese tire producers stuffing the pipeline in the middle of last year. And then, basically a total stop or a significant stop of production which has led to a lot of our competitors in China, becoming much more aggressive. These are companies that are highly leveraged and are dependent on cash, and have taken a fairly aggressive approach to capturing market share. So we've had to defend our positions, and that has led to some margin compression in that – in those markets as well. So I think there's a congruence of factors that have been quite unusual at this stage, and are not reflective of the – what I would call the underlying earnings potential of this business.

Okay. Just a couple more. In specialty fluids, is the demand pattern in the second half better than the demand pattern in the first half or worse?

We are seeing some improvement in the second half of the fiscal year, but it's going to be muted. Here again, we're seeing the oil industry environment affecting the – the business has a project nature, as you know.

Yes.

So it is somewhat cyclical and we're tracking project and we're not always sure when they come our way, and sometimes they come in bunches and sometimes they don't. The problem we're seeing now is that, we had actually planned for a lower level of project activities this year. But we're seeing that the oil industry as a whole is taking a much more aggressive look at costs, and you also have seen that most oil, major oil companies have shrunk their CapEx spend by 20%, 30%. So all of that is also having an effect on us and potentially delaying projects more than we had expected. So we're seeing a slight improvement in the second half, but it's certainly not what we would like to see for the business.

Okay. Given that your outlook for activated carbon is now so different than it was before, does that mean that your capital expenditure plans for that business will fundamentally change, or if you can quantify that a little bit, if they are going to change. And will you have to restructure the business, given that you now think that it will have a smaller scope?

Well, we will certainly see an impact on CapEx, as a result of the fact that we believe that, all in all there should be enough capacity to meet the needs of the industry going forward. So that will provide us with some relief on the CapEx front. With regard to the structure of the business, I believe we're properly set up. We have what we need to meet the demands of the industry, be it the coal based fire utility industry, but also the other applications. So I don't see any need to work on any restructuring of the business. However, if we would see further decline in, or driven by let's say, a Supreme Court decision that would go against us, that may lead to a different perspective in that respect.

Okay. And then lastly, will there be a meaningful change in incentive comp in the income statement for 2015, given how difficult a year this is or no?

Well, the year 2015 will most likely see a negative impact on incentive comp, absolutely.

Like can you quantify that?

I think it's quite significant, Jeff. I mean, we're looking at a significant cut in all bonuses for the year.

Okay, great. Thank you so much.

Thank you.

Your next question comes from the line of Mr. Laurence Alexander of Jefferies. Please proceed.

Hi, there. I have a couple of my own, but I think maybe just to help Jeff out with that last one. Can you at least give a sense for how much variable comp across the firm normally runs, so that people can make their own estimates for what the potential earnings benefit might be, as an offset to the other headwinds for the business?

I guess, maybe one way to think about it, Laurence, is that what we would normally do is accrue for incentive comp each quarter, based on how we think the year is going to end up. And so, in the second quarter, for example, after seeing what our first quarter looked like, and what our second quarter results looked like, we've already taken a pretty significant reduction in the short term incentive comp. And then, in the long-term incentive comp, we also do a similar type of estimation of how we think that might pay out, and do those true-ups every quarter as well. So they would already be reflected in through Q2, is the way I would describe it.

Got it. So just a couple of things. Just to understand the slide, the very last slide, you say that you prioritize by Wax [ph]. Did was the use of the past tense intended to signal that you are done, and that the free cash flow will be used for some other purpose or was it intended to be that you have made a commitment to deploying that free cash flow with a priority in the future being buybacks?

So the – I wasn't sure. I didn't pay attention to the tense. But I just want to clarify that we still see a return of cash to shareholders as a priority, an important priority, and we'll continue to be paying dividends, and looking at share repurchases. And as you could see from the last two quarters, those repurchases can fluctuate quarter-to-quarter. But we – but I do want to reinforce the fact, this is an important priority for us going forward as well.

What do you see as a good normalized margin assumption for say, mid-cycle, however you want to look at it for reinforced materials on its own or reinforced and performance together?

Perhaps I think – best I could think about EBITDA margin, as a way to get to that. I believe that over the last few years we have moved our EBITDA margin in the business from below 10% to 16% in 2014. At this stage, I believe in the first two quarters of the year 2015, fiscal year 2015, we have dropped our EBITDA margins to somewhere around 13%, 14%. And if I look forward, I believe this is a business that certainly for us should be able to operate in that 15% or so range of EBITDA margin.

Okay. And then, just as a last one. If we looked back at the last several years, I mean you had a period where you had a fairly detailed, I mean, you had a long-term earnings target, and a fairly detailed list of levers that you were pulling to get there, coupled with a fairly explicit return on capital hurdle that would be applied across all decisions. And then the last few year, it's been a little bit of a more and amorphous [ph] discussion, partly because of the uncertainty around how the process of digesting Norit would go. How is your thinking evolving about having an explicit return on capital target back in place?

Well, I think this is certainly a good point, Laurence. The company is evolving, but perhaps a way to answer this question is to refer back to our – my recent speech at the Annual General Meeting, where we indicated that our perspective with regard to earnings growth was to achieve 10% to 15% earnings growth through cycle in the future. So what we're – what is different now is that we – and we've achieved that in the past, or maybe even in excess of that. What we're recognizing is the fact that the environment has been quite difficult and both at the macro and the micro level, and that we're seeing more cyclicality than we had expected. With regard to a return on capital, we sent the clear message that we would be targeting, and having the goal to achieve in excess of weighted average cost of capital.

Yes. Thank you.

Thanks.

Question comes from the line of Mr. Christopher Butler of Sidoti & Company. Please proceed.

Hi. Good afternoon, everyone.

Hi, Chris.

Could you give us an update what you're seeing on tire demand. I know that you had said 1% through the year on volume and we've heard similar numbers from the tire makers. But at some point with the input costs down for tires and gasoline price down, do we start to see better demand out of this business, and when do we start to see that turn?

I think it's – I've been saying in the past, that underlying demand or long-term demand trends for tires have been around 3% to 4%. I still think that's a reasonable number. I believe that the general economic environment we're dealing with is, has been muddying the water here, and we're seeing a lot of differences between regions. We're seeing a lot of buying behaviors that have been shifting. There are a few signs of positive development in Europe, and yes, in Europe remarkably. In the US, we are seeing miles driven improving. On the other hand, if I look at China, we're seeing an environment where demand is somewhat dropping. We're seeing tire consumption, perhaps now more in the 5% to 6%, when we were used to 10%, 9%, 10% a year. So there's a lot of moving parts here, and that is leading to a somewhat muted perspective on total tire consumption. So I think for the rest of this year, that 1% which I believe we're also hearing from the large tire producers is a good guide. But I do believe that fundamentally there should be high levels of consumption going forward.

As we look at the – your environmental costs that some of your peers don't necessarily have and the surcharge that you've put on. Could you give us a sense on, has that hurt you at all on the margin side, on the volume side, what's been the impact through the first half of the year of that?

I would say that the implementation of the EPA consent decree hasn't really had a negative effect, in terms of its impact on us, because we have only – we're only at very early stages of capital spend ramp up. So that part will only start being materialized as of next year. On the other side, we have been implementing an environmental surcharge in the – to our customers in North America and have been successful with that. So all in all, that we're in a balanced mode, let's put it this way, with regard to the EPA situation. Of course, we're – we would like to see clarity with regard to what the EPA is doing with our competitors, so that we can get a level playing field. And I could tell you, that we're in direct contact with the EPA with regard to that.

And just finally, if MATS gets overturned, what does the purification business look like? What's the EBITDA that that business generates without MATS?

I think there's just too many factors to be taken into account. I think the first point, I would make is, that the state, the existing business in the states, there's 19 states in the US that are already regulated and Canada. That business would continue. I think beyond that, it would be quite difficult to assess the impact. I would say, the volumes would clearly be at a lower level, if it was a long-term decision, but driven by the Supreme Court, and we would need to have a look at the business, and we'd need to look at our resources and how we apply those resources, and though it would most likely lead to some level of restructuring.

But if we were to look at 2014 and the improvements that you've made, could you give us a sense on what that year might have looked like?

I'm sorry. This is – not sure I could do that.

I appreciate your time.

Thank you.

We will now hear from Mr. Patrick Prevost for closing remarks.

Just wanted to thank you for joining us today, and, of course, we'll be looking forward to speaking with you over the coming weeks, and at the next earnings call next quarter. Thank you very much.