Ladies and gentlemen, thank you for standing by. And welcome to the Q2 2020 Cabot Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Steve Delahunt, Vice President, Treasurer and Investor Relations. Please go ahead, sir.

Thank you. Good morning. I'd like to welcome you to the Cabot Corporation Earnings Teleconference. With me today are Sean Keohane, President and CEO, and Erica McLaughlin, Senior Vice President and CFO. Last night, we released results for our second quarter of fiscal year 2020, copies of which are posted in the Investor Relations section of our website. The slide deck that accompanies this call is also available in the Investor Relations portion of our website and will be available in conjunction with the replay of the call. During this conference call, we will make forward-looking statements about our expected future operational and financial performance. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, potentially inaccurate assumptions and other factors, some of which are beyond are control and difficult to predict. If known or unknown risks materialize or should underlying assumptions proved inaccurate, our actual results could differ materially from those expressed or implied by forward-looking statements. Importantly, as we cannot predict the duration or scope of the COVID-19 pandemic, the negative impact or results cannot be predicted. Factors that will influence the impact on our business and operations include the duration and extent of the pandemic, the extent of imposed or recommended containment or mitigation measures and the general economic consequences of the pandemic. Other important factors that could cause our results to differ materially from those expressed or implied in the forward-looking statements are discussed under the forward heading Forward-Looking Statements in the press release we issued last night and in our last annual report on Form 10-K for our fiscal year ended September 30, 2019, our quarterly report on Form 10-q for our fiscal quarter ended March 31, 2020 or subsequent filings we make with the SEC, all of which are also available on the company's website. In order to provide greater transparency regarding our operating performance, we refer to certain non-GAAP financial measures that involve adjustments to GAAP results. Any non-GAAP financial measures presented should not be considered to be an alternative to financial measures required by GAAP. Any non-GAAP financial measures referenced on this call are reconciled to the most directly comparable GAAP financial measure in a table at the end of our earnings release issued last night and available in the Investors section of our website. I will now turn the call over to Sean, who will provide an update on the impact of COVID-19 on our business and operations. Erica will review the key highlights of the company's performance, business segment results and corporate financial details. Then Sean will provide some context for how we are seeing the second half of the year developing in light of the COVID-19 pandemic. We will then open the floor to questions. Sean?

Thank you, Steve. Good morning, everyone, and welcome to our second quarter earnings call. First, I hope you and your families are all well at this time. To start the call, I want to share an update on the COVID-19 situation. First, I'd like to express my thanks to our first responders, healthcare professionals and all those who are working tirelessly on the front lines of the coronavirus response effort. I would also like to thank the entire Cabot team for the way they have adapted to these unusual working conditions and have maintained the focus on protecting our employees, serving our customers and supporting our communities. We have a long tradition of community engagement and we are inspired by the many countless acts of kindness and community support from our Cabot team during this time, from donating personal protective equipment and contributing raw materials for the production of hand sanitizer to helping supply food to children who are without access to school meals. Thank you. The COVID-19 pandemic is having a significant impact on the world and our first priority is the health and safety of our employees, customers and all stakeholders. We were quick to take steps to ensure the safety of our employees, including halting travel, requiring work from home where possible, implementing social distancing measures, restricting access to our facilities to critical personnel, providing guidelines for self-monitoring and screening, increasing sanitation procedures, following strict hygiene rules, and providing the appropriate protective equipment and procedures to ensure the safety of our people at our sites all around the world. Additionally, we've implemented leave policies to help support our employees impacted by COVID-19. The chemical and materials industry has been deemed an essential industry by most governments around the world. For Cabot, this means that our production facilities…

Thanks, Sean. We delivered solid results in our second quarter despite the impact from COVID-19. Total segment EBIT was $95 million and adjusted EPS was $0.77 for the quarter. The estimated total impact from COVID-19 in the second quarter was $21 million of EBIT, driven by lower volumes primarily in China. We were pleased to see EBIT in the Reinforcement Materials segment increase 30% sequentially and volumes in the Performance Chemicals segment increase year-over-year. As a reminder, our second quarter of fiscal 2019 included $12 million of EBIT from our Specialty Fluids business, which did not repeat given the divestiture of the business in June of last year. Finally, we continued our commitment to return cash to shareholders with $20 million in dividends and, as Sean mentioned, $10 million of share repurchases. Now moving to the segments, I will start with Reinforcement Materials. EBIT in Reinforcement Materials for the second quarter of fiscal 2020 was unchanged as compared to the second quarter of fiscal 2019 even though the segment saw lower volumes, largely due to the impact of COVID-19. Globally, volumes declined 14% in the second quarter as compared to the same period of the prior year, primarily due to a 20% decrease in Asia where we saw the biggest impact from COVID-19. We also were impacted in Europe, where volumes were down 13% and in the Americas where volumes were down 8% as March was impacted by the spread of COVID-19 in those regions. Offsetting the lower volumes were higher margins due to pricing and mix benefits in both our tire and industrial products product line. Feedstock protection mechanisms in our customer agreements that were designed to cover MARPOL-related effects worked as expected to ensure that our feedback pass through principles were upheld. Looking ahead to the third quarter,…

Thanks, Erica. As we look ahead, there is significant uncertainty as to how demand will develop over the coming months. I would like to share with you some of the indicators we are watching that help guide us. First, from a portfolio standpoint, Cabot's business is exposed to three high level sectors, automotive production, replacement vehicle tires, and consumer and infrastructure related applications. With roughly 25% of our sales linked to new vehicle production, we are looking to industry analysts such as IHS, LMC, and others as we model what the shape of recovery could look like. With the exception of China and North Asia, April auto demand globally was down over 50% in each sub region that IHS tracks and as much as 80% in Western Europe. China is a more positive story as April demand was actually up slightly and provides one view of how quickly we might see a recovery in other regions once economic activity opens back up. While signs point to April being the bottom as automakers in Europe, Middle East and Africa and the Americas restart production, it is still difficult to predict the specific timing and magnitude of such a recovery. Approximately 40% of our revenue is linked to replacement tires for cars, trucks, buses, and off-the-road vehicles, and demand for the June quarter is expected to be significantly lower than the prior year, given the shelter in place orders across the world and the temporary closures of many of our customers' tire plants. While LMC forecasts show that the China market for light vehicle replacement tires is expected to be down only 3% as the industry in that country continues to come back online, Europe and North America are expected to be down over 30% year-over-year in the June quarter. Replacement tire…

[Operator Instructions]. Our first question comes from the line of Michael Leithead from Barclays. Your line is now open.

Thanks, guys. And good morning. Hope you're all staying well and healthy.

Same to you, Mike. First question, just on the Reinforcement Materials side to start, a few questions around the trends heading into the third quarter. First, you called out 54% volume declines in April. But can you maybe just give us some color on how the regional dynamics between China and the rest of the world? And second, just the $15 million to $20 million EBIT that you called out, was that just a margin effect or was that incorporating the volume hit as well?

Mike, I hope you and your family are all well also. So, in terms of the April volumes, it was certainly most pronounced in the Americas and Europe, Middle East, Africa. And so, that significant decline was very pronounced there. And no surprise, I'm sure, given what you've read about the tire manufacturers having temporarily closed plants in those regions pretty much across the board. Now, in China, we saw plants coming back online throughout the month of March, week by week getting a bit better and the domestic market for tires has bounced back pretty well. Of course, the export market is impacted by what's going on in the West. And then, with respect to North Asia, the declines were a little less pronounced. So, it varies a bit by region, but I would say most pronounced in the Americas and Europe, Middle East, Africa, given again what the majors have done in terms of temporary closures. And I think the shelters in place that really restricted mobility during the period of April. Now, in terms of the margin impact of $10 million to $15 million that we mentioned here, roughly about half of that will be a one-time impact in the quarter. And these are these are margin impacts, so not reflecting volume declines. So, when you look at dramatically lower oil, as you know, there are really three effects on our business. First, when feedstock prices are lower, we see some compression as the benefits from our yield projects are less valuable at lower oil prices. And second, our energy center revenue is typically linked to energy prices where they operate, and so lower feedstock prices generally correlate with lower energy center prices. And then the third impact comes when prices fall very suddenly as we a very sharp drop in combination with a simultaneous demand drop that we saw this sort of a shock drop, if you will. When this happens, we see a mismatch in feedstock inventory that we've purchased to meet our customers' forecast and when they finally take those volumes. This is certainly an unusual situation and we're working closely with our customers to keep the spirit of our matching principle intact. So, the combination of these three margin factors is the impact of $15 million to $20 million that was quoted for the third quarter, but that is not including the impact of lower volumes. And again, we'd expect about half of that impact to be one time in the third quarter.

Got it. That's really helpful color. And then second, I just want to dig in a bit into the fumed metal oxides business, which I think should be [Technical Difficulty] segment, but it seems like that's kind of one of the main weak points right now. So, can you just walk through some of the dynamics of what's going on in that market? And how you think the market balances itself out over the next one to two years?

Sure. So, let me start, I think, first and foremost, Mike, by talking about demand. The demand environment has been softer, particularly in Europe and China. And we have a significant presence in both regions, and in particular in China. China makes around 40% of the world's silicones and, of course, fumed silica is tightly linked to that chain. So, weaker demand in Europe and China and in key end markets like automotive and construction has been a significant impact. In calendar 2019, we estimate the market in fumed silica globally actually contracted. So, this is a market that over time has grown pretty consistently 4% or 5% a year. It actually contracted in 2019, and that was, of course, pre-COVID. So, the further demand weakness is, I think, exacerbating things and driving up competitive intensity in the region. In addition, some supply has come onstream recently, and so the combination of weaker demand and supply coming onstream, which tends to be somewhat lumpy in terms of when it comes on, thereby pressuring the near term pricing. So, while these factors certainly present near-term challenges, I think the fundamentals of the business remain attractive. The business, as you point out, has historically been a business with very strong profitability and high EBITDA margins. And again, demand has grown in this business over time above GDP and that sort of 4% to 5% level because silicones have pretty strong performance characteristics in terms of demand substitution. And then, finally, feedstock access and strategic integration, I think, will continue to determine long-term growth and profit levels. And on this front, I think we're really well positioned with our strategic fence line partners, Dow Silicones. This industry has historically been well balanced between feedstock in Wuhai and silica demand, leading to pretty limited new entrant risk. Now, I think feedstock, as you know, is a byproduct of both silicones production and polycrystalline silicon production. And so, these fence line relationships are pretty critical. You can't just go to the market and buy this feedstock. But capacity additions can definitely be a bit lumpy, given the economic scale of investment here, and demand growth has historically soaked that capacity up in a relatively short period of time. So, I think it's a question of how demand responds, but the sort of industry structure and industry fundamentals remain intact from our perspective. So, it's a demand question, Mike.

Great, thank you.

Thank you. Our next question comes from the line of Josh Spector from UBS. Your line is now open.

Yeah. Hi, thanks for taking my question. So, just a follow-up from the prior question about the margin impact in Reinforcements in the quarter. You talk about half of that being temporary, half of that maybe being ongoing. I guess, if oil were to stay in this around $30 range, will you expect around that $10 million EBIT impact per quarter to persist through the rest of this year? Or another way, would you expect around a kind of a $40 million annual impact based on where prices are?

So, you're right, Josh. About half, we would expect to be one time and that's the sort of the amount related to this sort of very sudden or shock drop in terms of both oil and demand. And then, the other factor is really dependent on where oil is. And now, it's rebounded a bit here, certainly from the lows that we saw in April. But it really comes down to where those oil prices and what the absolute dollar value is then on the yield projects that we do and the energy center benefits that we have.

Okay. Do you guys share any sensitivity to your EBIT for every dollar move in feedstocks at all?

We don't because it's a pretty difficult one to. There are so many variables here. I think it's driven by – which grades you're making can have significantly different sort of fundamentals. And then the feedstocks, where you are in the world, they're quite different in China than they are in other parts of the world where one market is coal tar and disconnected at times from global oil prices and then rest of the world tends to be a little bit more on global fuel oil. So, there's just so many factors that are impacted here. It's difficult to reduce it to a rule of thumb. But I think the key thing to understand is that when the price is lower, we do see those yield and energy center effects. By the same token, we see a significant offsetting working capital benefit as the balance sheet deflates and significant operating cash flow generated. So, this pattern, I think, has been demonstrated over a very, very long period of time. If you go back 20 or so years, you'll see that operating cash flow profile pretty consistently.

Okay, thanks. If I could, one more just on Reinforcement price mix in the quarter. That was really strong at the EBIT level. Wondering if you could just break that down between how much of that was a benefit of your new contracts in Western markets versus maybe other effects within China and the rest of Asia?

Yeah, so definitely the arrangements, both in terms of pricing and mix from our contracted customers around the world, both in tire and industrial products, contributed materially in the quarter. And so, despite a pretty significant volume decline in the quarter on a year-over-year basis, results were flat. So, a pretty strong result there. And the offset was basically – to that was basically margin and pricing in Asia, principally China. So they were sort of offsetting.

Thank you. Our next question comes from the line of James Sheehan from SunTrust. Your line is now open.

Thank you. Good morning. Can you just talk about, in performance chemicals, what kind of decremental margins can we expect in the fiscal third quarter?

Say it again, Jim.

I'm curious about decremental margins in Performance Chemicals in the third quarter and rest of the fiscal year.

And so, when you say decremental margins, Jim, I want to make sure I understand what you mean by that.

Well, you're expecting the top line to come down significantly. I'm just trying to think about the margin impact of that. You gave some color on that in Reinforcement Materials, but not in Performance Chemicals.

So, I think the most significant thing that you'll see is a continuation of what was occurring in Q2 and in the prior quarter as well around FMO. If you look across both carbons and specialty compounds, margins have performed and held up there. So, I would say the margin profile sort of at the unit margin level would be fairly consistent with what occurred in the most recent quarter that just happened. And now the question will be, how do volumes perform. In the most recent quarter, we had impacts from an already weak auto and we certainly would expect that to persist, but that negative mix has been running through the business for over the past year, almost year-and-a-half as weaker OEM auto builds have played out. So, I think in terms of the Q2 to Q3, the fundamentals that drive margin will be largely unchanged. It's just a question of where the volumes come out.

Okay. And question on purification solutions. You talked about your specialty volumes being down. And I want to know specifically on your specialty business in Europe, did you lose any business in that region? And once the economy normalizes, do you expect to recover that specialty business or have you changed your approach to that market?

No change to approach here, Jim. The specialty market remains a focus and there were certainly some impacts, but I would call them COVID-related impacts rather than any fundamental changes in market or competitive activity or any change in strategy from our side. That all remains the same. So, I think it's really just some COVID impacts that began coming through in the month of March across Europe. So, nothing new to really speak of there.

Thank you.

Thank you. Our next question comes from the line of Jeff Zekauskas from JP Morgan. Your line is now open.

Thank you very much.

Hey, Jeff.

Hi, how are you? In fumed metal oxide, you talked about negative pricing because of increased competitive activity. I thought fumed metal oxides were mainly an over the fence relationship. And so, I'm puzzled as to where increased competitive activity can come from. I can understand how, at lower volumes, maybe your returns are lower, but I don't understand the increased competitive activity characterization.

Sure. So, Jeff, two things on fumed metal oxides. And you may refer back at some point – I know, certainly, in Investor Day 2018, we talked through this. It's important to remember there are two types of feedstock [Technical Difficulty] fumed silica market globally. One is a byproduct out of the silicones chain. And you're right, a significant portion of that volume, though not all of it, is over the fence, back to the silicones producer, who then uses that fumed silica in their field compounds, so their downstream finished compounds. So, that tends to largely be in balance, although there is a certain amount of the silica produced from that feedstock that goes into what we call the merchant market. So, it's not self-consumed. The other big source of fumed silica feedstock is from the polycrystalline silicon market. So, when you produce PCS, there is a byproduct called sil tet, which is used to produce fumed silica, and there's no corresponding downstream offset. A poly producer doesn't consume any silica in the making of their PCS, so that material then goes out into the merchant market. Now, over time, both feedstock from silicones and the feedstock from poly have been in balance with overall silica demand. There are, I think, two factors that are playing out right now around competitive intensity. One is related to demand, and so that poly-based fumed silica is still trying to find a home. And with lower demand, that can lead to competitive intensity. And then, the other thing that's going on is, I think, a shift in the polysilicon market. As China continues to expand its poly capacity, I think at the expense of Western poly producers, people like Wacker and OCI. So, you may have seen recently, both of them took pretty significant impairments on their recent poly expansions because they're finding it difficult to compete in the poly market with the Chinese producers who are building plants in the northwest of China and have low cost silicon metal and very low energy cost. These are the two big inputs for making poly. And of course, most of that poly is consumed in solar panels, which are fabricated in China. I think the western market poly players are suffering. And you're seeing that in some of these impairment announcements. But that's the other factor here. While that shakeout is going on, people are still trying to compete in the poly market and they are producing some byproduct feedstock, and they're trying to sell into the fumed silica market. Again, over time, the fumed silica market needs feedstock from both silicones and poly to support its sort of 4% to 5% long-term growth rate. But in the short term, these two factors are playing out. So, I hope that helps give a little more color on the near term competitive intensity.

Yes. Thank you for that. With oil coming down as much as it's come down and coal prices moving lower, is Cabot more advantaged or less advantaged in producing carbon black in China when you look at your cost dynamics today versus, say, where it was three months ago?

Yeah. I would say, with respect to China, so our view and the way this industry has played out is China is for China. That's basically how we participate. And so, our coal tar feedstock dynamics are very competitive, and we benchmark against all of the players there in China in terms of profitability. And so, I think no real change there. I think where perhaps your question is going is sometimes the dynamics of coal tar and global fuel oil can diverge and that can cause some flows of carbon black out of China. Again, traditionally not Cabot. We've been more of a China is for China model, but you've seen some competitor material flow out into places like Southeast Asia or at times when the arb was at its peak in terms of how wide open it was, there was quite a bit of material flowing into Europe. We're not seeing that now for some time. That arb has closed. And so, we're not seeing any significant changes in that relationship.

Prices were higher in Reinforcement Materials in the quarter. Was that all US-based positive pricing or was there positive pricing in other regions?

It was positive pricing in all of the other regions, with the exception of, I would say, China, which is a spot market for us. But, no, there was pricing and mix improvements in all regions.

And then lastly, you talked about difficulties with your energy centers. I never exactly understand what that is. Is that you produce maybe power by cogen and you sell power to the grid, and so it's worth less. What exactly is the energy center hit you're speaking of?

Yeah. No, that's exactly right, Jeff. So, we have cogeneration facilities at many of our plants, and we use the BTU content in what's called our tail gas to produce productive energy to either offset our own needs, but most of the time we're selling that energy to an industrial partner. But those arrangements have a link to underlying energy prices because the alternative is a different fuel to produce the energy. We're using our tail gas. But the competitiveness of that is linked to energy prices because someone can produce the same power with an alternative energy input. But that's what we're saying. So, as we've mentioned a number of times over the years, I think the impact of lower oil on the energy centers, they're still above cost of capital projects for us, but in absolute dollars, they earn less when oil was lower.

Okay, thank you very much. Stay safe. Thank you.

You too.

Thank you. Our next question comes from the line of David Begleiter from Deutsche Bank. Your line is now open.

Hi, good morning. This is Katherine Griffin on for David. Thanks for taking the questions. I'm curious about the $45 million of cost savings. It sounds like some of it may be temporary, reduced travel expenses, salary reductions and things of that nature. But some of them may be more permanent, such as sharing service centers. Could you just talk about or characterize how much of that saving is structural and permanent versus temporary?

Yeah, I think we're certainly pulling all levers right now, Katherine. And some of that is cuts in discretionary spend that, as demand returns and visibility improves, some of that will naturally come back in in order to sustain our operation over time. And some of it is structural. So, things like our creation of global business services and the management structure changes that we implemented within the past year, those types of things would be structural. And so, you could probably think about it in the zone of half-half as about half of it being structural and about half of it being sort of temporary pullbacks to try to manage costs. And, of course, these structural actions, we initiated those before COVID and we did those in order to help us fund some of the investment in long-term growth projects that we're excited about, like our energy materials activity as well as our elastomer composites activity. But that's roughly a way to think about it.

Great, thank you. And I know you already sort of talked about this, but just want to make sure I understand. Could you just talk about the extent that you realize benefits from lower raw material costs, given that volumes are expected to be much lower? Would you expect to see a greater tailwind in fiscal Q4 versus fiscal Q3 from lower raws?

So, it depends which business you're talking about. If you're talking about…

Maybe on an overall basis.

Well, it depends which business you're talking about. If you're talking about Reinforcement Materials, then the feedstock costs are effectively a pass-through to customers, but you would see at lower oil prices impacts on our margins from our lower benefits from our yield projects and energy center. So, that's the dynamic, but you get a working capital release. In specialty carbons, part of our Performance Chemicals business, there's less formula exposure in that business. It tends to be more sort of spot market pricing driven. And so, as raw materials decline historically across major parts of that application space, we've been able to retain prices while raw materials decline. And so, we would expect that to happen, though there's a lag there at currently lower demand. That could take a quarter or two before we see that. But those are the two impacts to lower raw material prices.

Thank you.

Sure.

Thank you. Our next question comes from the line of Laurence Alexander from Jefferies. Your line is now open.

Good morning. Should we factor in any degree of inventory reduction that would then help incremental margins sort of in the recovery?

Hi, Laurence. I'm sorry. Could you repeat the question about inventory reduction? I didn't quite hear it.

Sorry. Should we be factoring in some degree of Cabot reducing its own inventories sharply this summer, which would obviously hurt margins this summer, but then help in the fall and next winter?

Well, it definitely – right now, the focus is on bringing inventories down and driving that cash flow in the second half. And so, that will come with a negative EBIT impact. Basically, the under absorption is the way to think about it. And then, as demand improves, then you would see the sort of reversal of that. As inventory and working capital begins building back up, then you would see that sort of reverse itself. So, I think directionally, that's right, Laurence. And the question is exactly that the timing of how that demand recovery looks, but that's the dynamic that will play out.

And then, does that under absorption factor included in or separate from the $15 million to $20 million you called out?

In terms of the $15 million to $20 million that we called out, that is not included in that. So, those are just margin effects from lower oil prices, affecting both the yields as well as the energy center benefits, and then that sort of temporary mismatch from that very sudden drop in both oil and demand. So, those would be margin effects. But the under absorption would be an independent factor. So, not included in that number.

And then could you help – I guess the shift in name from CEC to E²C, can you give us a sense for where we are with the commercialization of that product and what the timeline might be to be able to sell to third parties, apart from your original development partner?

Yeah, sure. So, maybe just a bit of a refresh here because we're building momentum. And so, speaking about this perhaps a bit more. So, you'll remember the elastomers composite technology that we licensed to Michelin some time back and they have been building that out in their product portfolio. And so, while that has continued, that's a royalty type arrangement. We have an ability to develop this outside of that. And so, we've continued to do that over the last several years and have been building out both the customer portfolio as well for this. And so, we have launched what we're calling our new brand for elastomer composites, and that's called E²C. So, the product offering in this range where we actually make and sell product as opposed to the original licensing agreement to Michelin, this product is called E²C. And we've launched products here for the heavy mining equipment space, where our investments in efficiency and automation create strong demand for high performance rubber materials. And so, I think this is going well and we're generating sales now with this E²C offering. And I think the question will be how does it ramp up over time. And, of course, this is very difficult to predict. Certainly, we think the potential here is significant. If you look at the overall market for rubber compounds in both the tire and industrial products industry, it's pretty significant, of course. The question will be which applications is this a fit for and the early space is certainly in heavy mining equipment tires, but we're also in development for long-haul trucking and performance tires for electric vehicles. So, these are in play as well. But this industry, from a development standpoint, understandably doesn't move at a really quick pace because it's got to go through its own tire testing and there are safety and liability issues here. So, a question of pace, but we're pleased with the way revenue is beginning to build with this E²C offering.

Thank you.

Thanks, Laurence.

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

Good morning, everybody.

Hey, Kevin.

Curious, with lower prices, mentioned it should be favorable to working capital. How should we think of that in the back half of the year? I think you mentioned that you expect all of cash from operations to be $200 million in the back half, but what does that imply for the working capital benefit?

Yeah. So, the working capital release will be significant, Kevin. And if you look back at previous recessionary periods, whether it's in 2009 or even 2015, for many in the chemical sector was somewhat recessionary because of weakening in China and other factors there. And what you saw in that period was a very significant working capital release. And that, of course, comes from the lower oil prices flowing through, as well as in a recessionary period, we're very aggressive in terms of our operating dynamic and how we run our plants and how we bring working capital down. And so, we have confidence in that profile that's been demonstrated over time is going to show through here in the third quarter and the fourth quarter. And it's going to be a material contributor to that roughly 200 million-ish operating cash flow number that we talked about.

Okay. And then, I don't know, a couple of quarters ago, maybe a year or two ago, you announced some debottlenecking and an expansion in – I want to say – Indonesia or Thailand. But, curious – it looks you're scaling back CapEx a little bit. Curious how these – if you're slowing any of these debottleneckings or if you're delaying the expansion, just curious if any of those are being affected by your slowing CapEx.

Yeah. Important question. The answer is yes. We're scrutinizing the growth projects very aggressively right now and deferring progress on those until we have more visibility into demand. Just as a reminder, our hierarchy in terms of capacity expansion always starts with OEE first, so overall equipment effectiveness, and driving the uptime and rates of our units is, of course, the most efficient capital we can – capacity we can unlock. The second would be low cost debottlenecks in our existing plants. And then the third option would be brownfield expansion, like we've announced in Cilegon. But I think, right now, all growth capacity projects are being slowed and aggressively scrutinized. And we'll have to see how the demand picture unfolds here. And as we have more visibility into what that looks like, that will dictate how we throttle those projects. But, certainly, right now, the environment looks, at least in the short term here, sort of different than what was assumed when those were launched. But it's really a question of demand visibility, and we need to see how things unfold here. Historically, the replacement tire market has been quite robust. And we would expect that same dynamic to continue as the lockdown begins to release and people start moving again.

Okay, perfect. Thank you.

Thanks, Kevin.

Thank you. Our next question comes from the line of Christopher Kapsch from Loop Capital Markets. Your line is now open.

Good morning. So, my first question is going to focus on that unit cost headwind that you alluded to. In other words, the impact from lower fixed cost absorption. Is there any way you could quantify what you expect that impact might be or how long you anticipate that headwind? I guess that's sort of the $64,000 question. Or at least, could you qualitatively talk about what your strategy is in terms of your operational curtailment? Like, are you doing it across the board? Or is it selective operating rate reductions, any way to sort of qualify or quantify how you're navigating the lower demand environment? And, obviously, this is focused on Reinforcement Materials.

Sure. Yeah. Yeah. Thanks, Chris. So, in terms of the inventory change impact or the under absorption, we've historically referred to it as inventory change impact, that, of course, is tied to whether we're building or depleting inventories, and we'll be aggressively bringing inventories down over the back two quarters here. And so, we'll see effects of that flowing through the last two quarters. And I think then, the shape of that after that is going to really depend on how demand is responding. And if demand is beginning to pick up again, then naturally you would see some reversion there. So, that's the phenomenon and we definitely expect there to be significant cash release from inventory in both back quarters of the year, Q3 and Q4, but a corresponding impact on the under absorption on the P&L. Now, in terms of our curtailments, it really depends, I would say, generally across the board. We're significantly curtailed right now with the exception of China, which is in a little more advanced state of domestic recovery here. Now, the specific curtailments, they do vary by plant because the customer portfolio by plant and by reactor line is a little bit different. But I think it's safe to say that with volumes down in the range that we've talked about and where LMC is calling for, our curtailments sort of at a system-wide level match that, but they do vary. They do vary by client.

Okay. And just as a follow-up to that, with early signs of China approaching normal economic – or the new normal economic conditions maybe, what are your utilization rates currently at your various facilities in China?

So, the utilization rates across the company right now are kind of managing in and around kind of half, so 50 percent-ish, of course, as we're pulling down inventories to match the demand outside of China. China is certainly much better than that. But it's not back to utilization levels that it was before the pandemic because a certain amount of the tire market in China is supporting exports, and that export market is impacted by the weakness because those tires are going to the west. So, we're certainly much higher than our system average in China, but we're still not at the very high utilizations that we were operating at. We won't see those return in China until the export tire market begins to begins to show some improvement. So, the domestic market in China definitely is recovering. But export market is going to be, I think, looking for that signal from the west before that improves.

Got it. That's helpful. And then, one of your peers disclosed that it seemed meaningfully higher CapEx needs to complete their EPA compliance projects. I'm just curious if you're seeing a similar increase in spending needed to accomplish what you need to do under the consent decree. So, you've seen that for yourself or other players in the industry?

Hi, Chris. This is Erica. So, we still believe the range that we've been given most recently, the $175 million to $200 million of spend, is the right range. This would be spending for us through calendar year 2022 to meet the timing and the consent decree. So, we don't see any change from that right now. We started this a bit earlier. We were one of the first to sign the consent decree with the EPA. And so, at this point, we have roughly about half of that spent and we'd spend the rest through 2022.

Okay. But if I can just follow-up on that, given that the industry clearly is deploying more capital for these SOx and NOx compliance projects, the narrative generally has been that the pricing, certainly domestic pricing, just hasn't been adequate to earn a return on that capital. And so, that's been an impetus for affirmative pricing actions that have been achieved in these annual pricing contracts. So, is there any way to talk about kind of like – that sort of more secular need for the industry to earn that return on capital juxtaposed against the current weaker environment. Any way to think about how those conversations might look like later this year? Because the fact is, even though there's a weak demand environment that's going to persist probably in the second half, the returns still aren't adequate, right? So, any way to talk about that juxtaposition? Thank you.

Yeah. So, let me take that one, Chris. So, certainly, we have spent a lot of time – and I think broadly this is an important industry issue where in order to provide long-term supply reliability and surety to our customers and to do it in a way that is ever more sustainable, and all of our customers care about sustainability and have their own goals related to that, and so these investments are clearly lined up to support the sustainable and consistent supply of carbon black over time. And that does mean that pricing has to move higher in order to get a cost of capital on that and return on that. And ultimately, that will have to get pushed down the chain to us as tire consumers who will pay some small increment for a more sustainable tire. And so, that's the narrative. And that's what we've been pushing and stressing with our customers. And it's been an important underpinning of pricing in this industry. Now, does that change with COVID? No, I don't think it does. We'll have to see how demand responds here and begins to recover. And that's always a factor in the sort of rhythm of the business. But that necessity has not changed and our conviction around that has not changed and we'll continue to advance that narrative and make progress with our customers on this run because it's the only way that we can provide sustainable supply to them over a long period of time. And I think they know that.

Thanks for the color.

Yep.

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

Great. Thank you all again for joining us today. And I hope you and your families remain healthy and safe. Thank you again for your support of Cabot and we'll look forward to seeing you and speaking again soon, hopefully, maybe in some more traditional forums like investor conferences and the like. But in the meantime, stay safe. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.