Cabot Corporation (CBT) Q3 2020 Earnings Report, Transcript and Summary

Good morning. My name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 2020 Cabot Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Steve Delahunt. Please go ahead, sir.

Thank you and good morning, and welcome to the Cabot Corporation third quarter earnings teleconference. With me today are Sean Keohane, CEO and President; and Erica McLaughlin, Senior Vice President and CFO. Last night, we released results for our third 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. It 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 our 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 our forward-looking statements. Importantly, as we cannot predict the duration or scope of the COVID-19 pandemic, the negative impact to our 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, and our quarterly report on Form 10-Q for our fiscal quarter ended March 31, 2020, and in subsequent filings we will make with the SEC, all of which are 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 measures 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 Keohane, who will provide an update on third quarter results, along with an update on our financial position and market overview and our progress on sustainability. Erica McLaughlin will then review the business segment results and our corporate financial details. Then Sean will provide some color on the fourth quarter and open the floor to questions. Sean?

Thank you, Steve, and good morning, everyone, and welcome to our third quarter earnings call. As expected, the impact from COVID-19 in the third fiscal quarter was significant as we faced an unprecedented level of demand disruption. I’d like to begin by recognizing the entire Cabot team for the way they responded to ensure that we remain safe, support our customers and communities and adjust to a new set of priorities around cash preservation and cost management. I am specifically very proud that our extensive protocols to ensure that our people and suppliers are safe have worked well. I’m pleased to report that we’ve had no instances of work-related COVID transmission among our employees. In the third fiscal quarter, volumes and product mix across our businesses declined by over $100 million as compared to the prior-year quarter, driven primarily by lower demand in the tire and automotive sectors, as manufacturers temporarily halted production in response to the COVID-19 pandemic. As a result, total segment EBIT was $18 million and adjusted earnings per share was a loss of $0.07 for the quarter. Despite the challenging environment, we’re extremely pleased with our cash flow performance in the quarter as we generated operating cash flow of $149 million. This puts us on track to deliver the operating cash flow that we communicated last quarter of $200 million in the second half of the fiscal year. In addition, we continued our commitment to return cash to shareholders with $20 million in dividends paid in the quarter. We also made progress on a key strategic initiative by completing our acquisition of Shenzhen Sanshun Nano. The acquisition of this leading carbon nanotube producer to the lithium-ion battery sector will complement our range of conductive carbon blacks and strengthen our position in this fast-growing application. We also continue to strengthen our already solid debt and liquidity position. Cabot has consistently generated strong operating cash flow. And since 2015, we’ve generated over $2.1 billion cumulatively. We remain confident that our cash flow from operations will be sufficient to fund our current dividend and support the capital expenditure needs of our businesses. The strong cash flow generation in the quarter allowed us to fund the Sanshun acquisition, while at the same time increasing our cash and bringing our debt balance down. On the liquidity side, as of the end of June 2020, we had $1.4 billion in cash and committed facilities and a debt to EBITDA ratio of 2.9. Out of an abundance of caution, we increased our leverage covenant from 3.5 times to 4.5 times for the fourth quarter starting in September 2020, which we believe provides ample cushion in these uncertain times. The COVID-19 pandemic is having a far-reaching impact on the global economy, with global GDP forecasted to decline approximately 5% in 2020. In terms of the impact of the pandemic on Cabot’s business, we expect the June quarter will be the low point in terms of financial results. April demand proved to be the low point for us and we saw a month-over-month improvement throughout the quarter, with further strengthening in July. Additionally, we are seeing the broad mobility data continue to strengthen. Looking a bit deeper at our end-markets, developments are mixed. Automotive production represents approximately 25% of our sales, ranging from tires on new cars to a host of applications in performance chemicals, such as structural adhesives, coatings and engineered plastic compounds. This market has suffered in 2020 and is projected to decline about 20% in the calendar year, with year-over-year declines in all regions. We expect to see improvement in the September quarter based on external forecasts, which are projecting a year-over-year decline in global light vehicle auto production of only 10% in that quarter as compared to a decline of 45% in the June quarter. Now, moving to tire production, the global replacement tire industry is also expected to decline for the full calendar year of 2020 by approximately 15% based on estimates from LMC, with contraction occurring across all regions. Similar to auto production, the September quarter is expected to show improvement sequentially, with total replacement tire sales projected to be down 10% year-over-year, compared to a decline of 34% for the June quarter according to LMC. We’ve also seen clear and steady upward trends in terms of mobility and miles driven, and this bodes well for the replacement cycle for tires, both in terms of passenger vehicles as well as truck and bus. The replacement tire market has historically been more resilient compared to other parts of the broader transportation sector. Beyond automotive and tires, which are large and important end markets for us, we also serve a diverse range of applications across the infrastructure, packaging and agriculture sectors, and these end markets have held up well during this time. Additionally, PMI has rebounded sharply as we exited the June quarter, a further sign that economies are recovering from the low point in April. In times like these, it’s important to remain committed to long-term strategy. A key tenet of our strategy at Cabot is built on sustainability. We believe our ability to develop innovative technologies to meet our customer sustainability challenges, conserve resources across our value chain, and grow our position in the circular economy is a key to our shared future and provides us with a competitive advantage. For more than a decade, we’ve consistently published a sustainability report to highlight our progress in this area, and we recently released our 2019 report. As is typical for us, the report was published in accordance with the global reporting initiative, and in an effort to further our commitment to transparency and to provide important information to our shareholders. We have aligned our disclosures with the Sustainability Accounting Standards Board or SASB framework, which sets forth standards for the chemical industry. We also remain a proud signatory of the United Nations Global Compact, and are committed to reporting our progress as a key component of our sustainability report. I’m also excited to share our expanded 2025 sustainability goals. We have a long history of focusing intensely on the environmental impacts of our operations, and the safety of our employees, partners and communities. We also recognize that long-term success requires a commitment to sustainability in its broadest form, as well as a balanced approach to stakeholder engagement. Our 2025 sustainability goals demonstrate our steadfast commitment to this broad definition of sustainability. This expanded set of goals reinforces our broadened view of sustainability and extends beyond our strong foundation and safety, health and environment to include areas such as product development, supplier sustainability, diversity and inclusion, and community engagement. In our Reinforcement Materials segment, we’re pleased to report that as of June 2020, all major emission control equipment has been received and placed into final position at our Franklin, Louisiana site. This project has completed 90% of the estimated person hours required and remains on track to finish ahead of the industry’s April 2021 EPA deadline. Additionally, we’ve launched another new product within our Cabot Engineered Elastomer Composite business. The new E2C DX9640 solution is specifically engineered to improve the performance, safety and lifespan of tires while reducing the cost and environmental impact of production. The E2C product line was recently named European Rubber Journals Inaugural list of top 10 elastomers for sustainability, which ranks projects that contribute most to raising the environmental profile of the elastomers and rubber industry. We were the only carbon black company recognized in this top 10 list. I will now turn it over to Erica to discuss the results of the third quarter. Erica?

Thanks, Sean. I’ll start with Reinforcement Materials. EBIT in Reinforcement Materials for the third quarter of fiscal 2020 decreased by $77 million compared to the prior year, primarily from lower volumes due to the impact of COVID-19. Globally, volumes declined 42% in the third quarter, primarily due to the temporary tire and automotive customer shutdowns in Europe and the Americas, where volumes were down 51% and 59%, respectively. We were also impacted in Asia, where volumes were down 26%. The unfavorable impact of lower raw material costs on margins was $16 million as compared to the prior year, driven by a slower turn of inventory, less benefit from yield projects and lower energy center revenue. Cost mitigation efforts partially offset the impact from lower volumes and margins. Looking ahead, we expect that half of the lower raw material cost headwind will not repeat in the fourth quarter. We anticipate a significant sequential improvement in demand and reinforcement materials, given that customer plans have come back online. July volumes improved sequentially from June and were 9% below July of last year. And we believe this includes some level of restocking at our customers. Therefore, we expect volumes to be down in the range of 15% compared to last year’s fourth quarter. Now turning to Performance Chemicals, EBIT decreased by $16 million year-over-year, primarily due to lower volumes from the impact of COVID-19 a more competitive pricing environment and a weaker product mix in our fumed metal oxides product line and a weaker product mix in our specialty carbons product line from lower demand in automotive applications. In the third quarter, volumes decreased 5% year-over-year in Performance Additives, and 8% in Formulated Solutions. COVID-19 impacted volumes in both businesses primarily in automotive and construction end markets, while the infrastructure market including wire and cable, and pipe applications continue to hold up well in all regions. As we move through the third quarter, we did see signs of recovery begin to take hold in all regions led by China, which has returned to growth in many key end markets such as automotive. Looking ahead to the fourth quarter, we expect modest sequential improvement in volumes in Performance Additives as end markets begin to recover from the impact of COVID on demand, offset somewhat by seasonal patterns in Formulated Solutions. The benefit of the higher volume and more favorable product mix that we are expecting in Performance Additives in the fourth quarter is expected to be largely offset by higher fixed costs associated with the startup of our new North American fumed silica plant and synchronized turnarounds driven by our fumed silica fence-line partners. Now moving to Purification Solutions. In the third quarter of fiscal 2020, EBIT increased by $1 million, compared to the third quarter of fiscal 2019. This was driven by higher margins from improved pricing and product mix and our specialty applications and reduced fixed costs in the quarter driven by savings from the previously announced transformation plan. Partially offsetting these benefits were lower volumes in specialty applications related to the impact of COVID-19, and weaker mercury removal demand. Looking ahead to the fourth quarter, we expect to see seasonally higher volumes and some COVID-19 recovery, which will be more than offset by lower margins due to an unfavorable product mix. I will now turn to corporate items. We ended the quarter with a cash balance of $162 million and our liquidity position remained strong at $1.4 billion. During the third quarter, cash flows from operating activities were $149 million and year-to-date operating cash flow is $278 million. Total capital expenditures for the third quarter of fiscal 2020 were $43 million, and we’re still expecting capital expenditures to be in line with the $200 million forecast we provided last quarter. Also, in the quarter we paid $20 million in dividends. Given the uncertain business conditions, we did not repurchase shares in the quarter, and don’t expect to purchase any shares for the remainder of this fiscal year. Our year-to-date operating rate is 29%, and we anticipate the operating rate for the fiscal year to be in the range of 29% to 30%. I will now turn the call back over to Sean.

Thanks, Erica. As we talked about last quarter, about 40% of our sales are tied to the replacement tire end market, 25% driven by new autos and 35% linked to consumer and infrastructure-related applications. With this mix of end market participation the decline in volumes in the third quarter was as anticipated, primarily related to the temporary suspension of customer production in the tire and automotive sectors. We are pleased to see that there is recovery underway in the tire and auto end-markets from the low production levels in April, leading to what so far has been a V-shaped recovery for demand in our Reinforcement Materials product line. Given the longer value-chain in most of the Performance Chemicals applications, the decline and recovery was more muted, leading to a flatter curve overall. In addition, many of the applications in the consumer and infrastructure space held up reasonably well during the third quarter. And you can see that the diversification of our Performance Chemicals portfolio led to a more resilient volume-level overall. With these consumer and infrastructure applications expected to continue to perform well, we expect our volumes to remain solid. With this backdrop of the shape of recovery in our underlying end-markets, we anticipate a significant sequential improvement in Reinforcement Materials demand and a more modest recovery in Performance Chemicals. We are pleased to see the improving demand pattern and the strengthening underlying drivers. But uncertainty remains given the current state of COVID-19 in different parts of the world. Cost reduction remains a key focus for us and we are on track to deliver in excess of $60 million of savings across our base operations, which is helping to partially mitigate the impact of lower volumes and cost associated with in-flight growth projects. We expect solid cash flow in the fourth quarter as profitability increases and we continue to manage net working capital tightly. Therefore, we are reaffirming our guidance of operating cash flow of approximately $200 million in the second half of the year. Thank you for joining us today and I will now turn it over to Lisa for the question-and-answer session.

[Operator Instructions] Your first question comes from a line of David Begleiter with Deutsche Bank.

Just on the cash flow guidance, could you give a little more insight into the Q4 metric, because it looks like it’s only about $50 million of cash flow of Q4, what does that imply for working capital in Q4? Thank you.

Sure. Well, as we said, we are feeling good about our cash flow and reaffirming that outlook that we talked about last quarter. I think the composition will change in the fourth quarter as we start to see recovery. So certainly, the profit contribution to cash flow will be much higher in the quarter. And as demand recovers, we will see receivables balances beginning to build. We have seen oil prices move up from the low point in – that we saw in this past quarter, so that will lead to an increase in some working capital. However, we’re continuing to manage our feedstock and finished product inventories very tightly here to try to constrain the level of working capital build, just given the uncertainty around demand. And so, I think the composition will change in the fourth quarter, where we will see some negative impact from working capital, but more than offset by an improved earnings profile, leading to solid cash flow in the quarter.

And just in the cost savings, looks like you did increase it from $45 million to $60 million. Is that still half permanent and half structural and what drove the increase from the $45 million to $60 million? Thank you.

Sure. Yeah. So, obviously, cost reduction, cost management is important right now. And we had a number of efforts already underway heading into the COVID situation, many of which were structural as we created a global business service organization and have been making some moves to improve the cost and efficiency of our shared service activities and consolidation around our site in Rīga in Latvia, for example. So, many of those activities were already underway. And we have added to that with aggressive cost containment measures across all of our businesses. I think the right way to – so, we’ve just been more intense about it and that’s what has led to the increasing level to around $60 million expected on a full-year basis. And I think it’s still reasonable to think about half of that as structural and about half of it as general belt-tightening, elimination of discretionary spend, and deferral of spending. I think in the lower volume periods, we’re deferring and pushing out maintenance and things like that, to try to sync it up better with volumes. But those are certainly costs that will come back in as the volume recovers. So I think about half/half is still a reasonable way to think about it.

Thank you.

Your next question comes from the line of Mike Leithead with Barclays.

Good morning, guys.

Hi, Mike.

I guess, first, 2 on the reinforcement business, I guess, first in Asia, can you talk about how volumes have trended in your Asian business, particularly as we kind of go into July? I assume China has in some ways led a bit of this recovery? And then, just as we think about EBIT recovery into the fourth quarter, the comments from Erica were helpful about getting some of that cost impact back. But if we do hit, let’s say, that down 15% volumes, how should we think about the margin profile or the incrementals or decrementals on that?

Sure. Well, let me make a few comments first, Mike, about the recovery in Asia and what we’re seeing there. And then, maybe Erica can comment on the incremental analysis, so that topic. So, we’re definitely seeing China rebound, which is positive. Of course, they came out of COVID first and by – all reported statistics seem to be managing things pretty well and life on the ground has somewhat returned to normal. So they seem to be containing things pretty well. And if you look at general economic activity, PMI has moved up very sharply and over 50 now in China. And we’ve seen our end-market sectors respond accordingly. So automotive has swung back and the domestic tire market has as well and our volumes have. So I think that’s been a real positive. I think where there has been some delay, I would say, in seeing a full recovery in China related to the export markets. So China does export a lot of tires. They make up close to 40% of the world’s tire capacity. And, of course, with the more delayed recovery and delayed onset and delayed recovery in the western markets, that export market has been I think slower to recover. But that is beginning and we are beginning to see that. So I would say overall volumes have improved, I think pretty nicely in China and are on a pretty good trajectory. And hopefully, if there’s sustained recovery in the western markets, that export sector of the market continues to gather strength. I think in terms of the incrementals, maybe I’d ask Erica to pick up on that one, Mike.

Sure. So, obviously, as you look at the incremental or decremental margin, a bit different depending on what segment you look at. So in terms of a percentage for Q3, you could look at Reinforcement Materials, roughly about 30%; if you look at Performance Chemicals, a bit higher in the low 40%s. And so, that’s a Q3 figure, when you think about this, so I’d say remember, given the nature of our business and the link between oil and how it moves through the revenue line that these percentages can move quarter to quarter, just based on the movements in feedstock prices. So we think about this, I think more in terms of incremental EBIT dollars based on the change in volumes. And so, if you’re going forward to think about Q4, I think looking at the dollar impact of the Q3 volume change is important. And so, we talked about reinforcement volumes dropping 42% year-on-year and that was a $75 million impact to EBIT in this segment. And so, dramatic change in results, obviously with the operating leverage in that business from the significant change in volume. As we said, Q4, the expectation would be only 15% below prior year. And then, for Performance Chemicals, the impact was much less on volume. We talked about 5% decline in performance additives and 8% in formulated solutions. And the total EBIT impact of that was $7 million in the quarter. So here, the more diverse set of applications and customers has resulted in a much lower level of overall volume decline, and so, not nearly as significant in terms of dollars as reinforcement materials. And we talked about for Q4 that there’d be a modest improvement in volumes expected in this segment. So it gives you the magnitude we’d be talking about in Performance Chemicals in terms of dollars as well.

Great, that was super helpful. And then, Sean, could you maybe just level set where we are in terms of the fumed metal oxides market? It seems like pricing has been a bit of an issue the past few quarters. You guys are still bringing on a bit of new supply. Can you just level set where we are today and hopefully how you see that recovering over the next 6 to 12 months?

Sure. Yeah, so, definitely the environment in FMO has been a bit more challenging, because we faced in 2019, even pre-COVID the first year where we actually saw some decline in global fumed silica volumes at a point, when some capacity was coming on stream. So that has led to I think more competitive price intensity in the near-term here. Of course, that’s been exacerbated a bit by the COVID situation for sure. I think as we see demand recovering, then that will be much more supportive of getting prices, moving them back up to the historical levels. And historically in this business, you have seen that feedstock and fumed silica demand have been very well in balance. And, of course, because this is a feedstock, you can’t just go out on the market and buy. There are I think sort of structural barriers to entry here. But historically, the feedstock balance and the fumed silica demand has been in a very good state of balance and that has led to, I think, the strong margins for this industry. And I think the combination of demand recovering and there’s a shakeout happening right now globally in the PCS industry and that industry is one of the feedstock sources into the fumed silica market. And I think as that shakeout takes hold and becomes more clear our view is that things will come back into balance here. So I think what we should see, Mike, over the coming year as demand improves is that pricing kind of incrementally begins to climb back up. And I think the shakeout on the poly industry is a little bit more difficult to call. But we can clearly see that it’s happening. If you look at, for example, Wacker announcement, where they took a significant impairment on their poly assets, and you saw the same from OCI in Korea. You can clearly see that there’s a rebalancing or a kind of a realignment that’s happening here. And our view is it’s a little bit difficult to call exactly when that comes into balance again. But I can certainly see the signals of that happening. So I think we’ll see incremental improvement as we progress through the year with demand improving, giving support for pricing, and then the next tranche of recovery coming as the poly industry stabilizes and the feedstocks that come out of that industry stabilize as well, and get back into that historical balance that we’ve always had.

Great, thank you.

Your next question comes from the line of Josh Spector with UBS.

Yeah. Hi, good morning.

Good morning.

Related to actually with that prior question, I’m just curious where you talk about sequential mix in performance overall, is that mostly fumed silica getting slightly better or is that mix within the rest of that portfolio?

Yeah, so it’s a little bit of both, Josh. So what we will see for sure is as automotive begins to improve in the September quarter, a lot of the higher value products are associated with that industry sector. And so – and that’s true in both across carbon specialty compounds as well as fumed silica. So we should see some improvement from a rise in auto production levels. It’s possible that there’s a slight delay and when we experience it, because the value chains are a bit deeper in this segment. But that will be a driver over the coming 1 or 2 quarters here, assuming that the auto builds improve. So I would say that’s certainly a significant one, probably the most significant one in this business. Our view on the infrastructure-related applications is those should continue to hold up pretty well. So I would say that’ll be fairly consistent with what we see saw in Q3 here and then as the economic recovery takes hold, some of the consumer-driven applications should improve. Some of these products go into consumer durables and those have been I think more impacted recently. And so, as the recovery takes hold, some of those applications should improve. For example, things like fumed silica are used in vacuum insulation panels in refrigerators and things like that. So there are as some of these products go into consumer durables that should start to pick up.

Thanks. Yeah, that’s helpful. I guess, last quarter, you talked about maybe a $15 million to $20 million impact in this quarter from lower oil and feedstock cost, as there’s a bit of a lag with pricing there. Just curious, how much of that did you actually realize in this quarter? Was it better or worse than what you expected? And with energy prices moving the way they have, is there any type of impact that we should consider for the next quarter?

Yeah. So with respect to the impacts from oil last quarter, we did project a range of $15 million to $20 million. And we came in right inside that range at $16 million in the third quarter. And again, the drivers, just to remind you, were slower turn of inventory as demand dropped very quickly and oil prices collapsed, and so a bit of a timing mismatch. And then, the other drivers are when oil prices drop, we get less benefit from our yield projects. And then the energy centers have a negative impact both driven by the lower oil prices and the lower production volumes in our plants. So the $16 million was right in the zone of what we had talked about. Now as we go forward here, Erica commented that about half of that will not repeat in the fourth quarter, that’s basically the slow turn of inventory does not repeat. And so we feel that we’re back in balance there. So that’s good. And there is some recovery in the energy center and yield front, because volumes are higher, energy center utilizations are higher. And then oil prices have bounced off the bottom, they’re still down on a year-over-year basis. But have certainly bounced off the bottom that we saw in the kind of April time period. So those will be improving, but the right way to think about it is about half of that $16 million will – is expected to not repeat in the next quarter.

Great. Thank you.

Your next question comes from the line of Jim Sheehan with Truist Securities.

Thanks. Good morning.

Good morning.

Can you talk about the Reinforcement Material contracts with tire customers? I know you usually finalized those negotiations toward the end of the year. Can you talk about your expectations where you sit today? And also give us a sense for inventory levels in Reinforcement Materials and where your utilization rates are, as of July? Thanks.

Yeah. Good morning, Jim. So let me – 3 questions there. Let me try to tackle them in the order that you posed them. So in terms of the contracts, as you know, we typically negotiate the annual agreements with our major customers in the back half of the year starting about now is when those discussions begin. And so I think the schedule is no different this year. We’re just at the beginning stages of those discussions. It’s hard to say how our negotiations will play out between now and finalizing the agreements later in the calendar year. We’re certainly looking at external indicators such as miles driven data, and seeing some positive signs there for the tire and carbon black industry. So this is good. But there is still some uncertainty with regard to the COVID pandemic. So I think much of the answer will depend on the timing and shape of the recovery that’s expected into 2021. But the recent signs of improvement in terms of mobility certainly are encouraging for us. I think the other factor at play here is that of costs and both our costs and those of our competitors, which are going up driven mostly by the environmental – the increasing environmental and regulatory costs. And so in order for Cabot and other carbon black producers to support our customers in a sustainable way, we need to earn a fair return on these required investments and the higher costs that are associated with them. And so in order to do that additional price increases are necessary, especially in those places where costs are going up most quickly, and that’s how we’re approaching our negotiations here. So this is an industry wide issue and the one that we’ve been working on hard over the last few years and continue to be a central theme in terms of providing stability for – long-term stability for our customers. We’re working hard to make sure that our air pollution control compliance investments come on stream, so that we can give our on-time, so that we can give our customers the supply security that they desire. And in return for that, we need to have a fair price for these higher costs. So I would say that’s – it’s early in the process, but that’s how we’re thinking about it. And I think it’s quite important that as an industry, we work with our customers to get a recovery for these higher investments. Let me just try to comment quickly on the inventory question that you asked. And so our sense is that – we’ve just come through a really, really weak period of demand. And we think inventory levels are quite low and following some of the tire manufacturers’ recent earnings calls, you can see that they commented specifically about that. So I think inventory levels had been taken down across the chain and, of course, we took ours down aggressively. And so I think we were in sync with what was happening across the value chain. So I think as demand levels improve, we should see that improvement flow through pretty directly to us. I don’t think there’ll be a big distortion here. But given that inventories are very low, there probably will be some restocking, some of which we may have likely already seen in July. It’s hard to tell, but I wouldn’t be surprised if there was a bit of that beginning in July. But it should be a fairly – it should be more visibility, Jim, I would say on that front, because inventories are low. And then finally, I guess your last question on utilization. Our utilization levels are going to track, of course, what the expectation is for tire production now. We more aggressively – our utilizations were lower in the last quarter. We – our volumes were down 42%. But our utilization rates or our operating rates in the plant were probably down more in the 50% range across the quarter, because we were pulling inventories down aggressively. And so I think now with inventories down, our utilization levels going forward should reflect the expectation of volumes. That’s sort of how I see it at this point.

Very helpful. Thank you. And could you also comment on your conductive carbons business given the state of the electric vehicle market?

Yeah. Sure. So as I commented in the prepared remarks, we were really pleased to close the Sanshun acquisition in the quarter. So I think that’s a real positive. I mean, the EV market has been impacted just as the broader automotive market was most recent – in the most recent quarter here, but as recovery takes hold that – and the auto plants are back up that that too should recover. Our underlying view of the EV market hasn’t changed in terms of the expectation of significant growth over the next 5 to 10 years as EV’s capture a bigger share of the market. And we’re really excited about the Sanshun acquisition, because they’re a leading CNT producer in China serving this market with a number 2 market share position. And our view, certainly, China is the biggest EV market in the world. And so this investment was quite strategic on that front. And we think there’s a lot of synergy here over time between their CNTs and their ability to formulate dispersions with conductive carbon additives, and then our conductive furnace blacks, the formulation, the combination of these, we think, is going to be important in next generation product development. And so you may follow one of our key competitors here in China, a company, Cnano, recently IPO-ed within the past year, and with about $50 million of revenue. So maybe 40% – well, maybe close to double what ours is with our Sanshun acquisition. They’re currently sitting with a valuation of $1.7 billion in China right now. So I think we feel really good about this long-term strategic investment in Sanshun. But there is some short-term impact here as the auto plants were shut down.

Thank you very much.

Your next question comes from the line of Laurence Alexander with Jefferies.

Good morning. 2 questions, please. One is can you give a sense of the scope of the resources you’re putting into the [CTC] [ph] marketing efforts? And how – any drawn talent or capsule should evolve over the next few years? And then can you talk a little bit about mix? As your end markets recover, how should mix evolve? And how should – would that then flow through to your pricing margins over the next 3, 4 quarters?

Yeah. Laurence, just on the first one CEC in the marketing efforts. The second part of that question, would you mind just repeating that for me?

Well, there’s the personnel component, and then there’s just the longer-term capital component, working capital investments in infrastructure to help customers with their research efforts, development efforts and so forth.

Yeah. No. Got it. Okay. So yeah, we’re very pleased with continued progress here on the CEC front. It is still immaterial in relation to the broader reinforcement materials business. So it’s something that is going to build over time and the adoption of this by the tire makers and building that to materiality. We’ll take some time here, but we are in an investment phase here, where we’re investing in both marketing as well as further technology development to further build out and extend the product line here. So if you think about it on a sort of a cash basis, there’s some cash burn right now in this business as we make these investments for the longer term. But it’s in the low-single millions kind of a number in terms of the burn. Of course, there’s revenue and margin from sales, but we’re also investing in the longer-term development, and so when you net all that together, that’s a – gives you just a sense. So something very important, some modest cash burn, but I think the right balance here, because I think this one has transformational potential for this business. It will take some time, but it does now as we see the importance of sustainability in our customer base and the role of materials to drive sustainable products in tires is really critical. It’s going to be a materials question. With respect to mix, how that should evolve. I think the single biggest drag on mix for us has been a weak auto, because many of the most high value products are in the portfolio, particularly in Performance Chemicals, are specified products into the automotive chain. So I think as that improves, then we should see mix flowing through – positive mix flowing through over the next 3, 4 quarters, it will be – it should follow. Maybe with a slight timing offset, it should basically follow improving numbers out of the auto industry in terms of production levels. And then I commented a bit earlier, I think as demand improves in the fumed silica side, of course, this is a high margin product line. And so as demand improves, we’ll – we should get some further pricing support there. And I would expect that that would be incrementally ratcheting up over the coming 3 to 4 quarters as well. So those would be a couple of the major drivers, Laurence, with respect to sort of price and mix.

Okay. Thank you.

Your next question comes from the line of Jeff Zekauskas with JPMorgan.

Thanks very much.

Good morning, Jeff.

Will all of your emissions spending in the United States be completed by April of 2021? And in the aggregate, how much do you think you’ll have spent? And how much will you have spent in 2020 – fiscal 2020?

Yeah. So, Jeff, with respect to the EPA consent decree, we now have the industry under a similar implementation timeline. The next plant to come online for Cabot and all of the competitors are obligated to have a plant online by April of 2021. And that leaves us with a final completion date in 2022, where we have one final plant in 2022. And so the implementation schedules are now synchronized for the industry, and all players are obligated to meet those or deal with the consequences and penalties and impacts from the EPA and DOJ. With respect to our costs, we have had an estimate out there that, in total, this will be in the range of $175 million to $200 million once all plants are implemented, and we continue to feel that that is the right range for completion of these projects. So that’ll be the capital cost range once all of them are completed.

How much have you spent so far?

About half right now.

How much – how did the specialty black business behave in the quarter and how did it behave in July? That is – what was the volume decrement in the June quarter? And what was volume decrement in July?

Yeah. So in our reported numbers, we have performance additives, which is both specialty carbons and FMO. We report Performance Additives down 5% in the quarter. So a more modest decline certainly than Reinforcement Materials. And what we saw there was that certain infrastructure, packaging, ag related, as well as our – just our specific book of business with customers held up better. It was more resilient. We certainly had the impact from auto being extremely weak in the quarter. But when you balanced it out against some of those other things. It was a more modest decline of – in that sort of 5% range for Performance Additives. And I think what we’re seeing in July is – and what we would expect over the balance of the quarter is some modest improvement off of that and maybe down a few percentage points over last year, same quarter. Again, the same – largely the same factors driving it, Jeff, we will see some improving auto, but it’ll probably be a little bit delayed in terms of how it hits us because of the depth of the value chain. That might be – we might be seeing that a little bit more in – beginning in Q1. But we will see some improvement from auto and then the infrastructure related packaging, ag related, should continue to hold up well in our specific customer book of business and who we’re aligned with, they seem to be doing pretty well. So I think those are helping us also.

And what percentage of Performance Additives is specialty black? Is specialty black all of it or is it a part of it?

No, it’s a part of it, because we have – in Performance Additives, we have fumed silica and specialty…

Right. That’s why I wanted to know what happened to specialty black?

Yeah, I would say, specialty blacks moved in about the same direction as the overall Performance Additive. So my commentary is reasonable for that.

Okay. Yeah. And then lastly, have you been monitoring what’s been going on for research developments in the pyrolysis of natural gas, whether in Russia or in Europe? And different truck drives to produce hydrogen. And there are – there would be resultant carbon black produced. Like have you reached out 20 of these companies or have you looked at what’s going on there? And do you think it will touch the carbon black industry overtime?

Yeah. We certainly follow this very closely. And in a long-ago time, Cabot had production capacity tied to natural gas in fact our plants in Pampa, Texas was originally built on a gas-based feedstock. So we certainly understand the technology well and are tracking various developments across the spectrum of Reinforcement Materials, everything from alternative feedstock sources like natural gas conversion to alternative producers like monolift to things like people trying to take recycled tires and reclaim carbon black from them. So we track all of these very closely to inform our point of view around either new entrants or potential substitutes. I think each of them it’s probably a conversation for another day, but I think each of them based on our analysis have real challenges in terms of either economics or scale up or making product that that actually performs in the application. You get a very different product and its performance and application is quite different. And I think this is one of the strengths of our company is our deep application knowledge here and our ability to take what is, in theory, a carbon black and see how it performs in application. So something we watch very closely, Jeff. And we’ve put our bets on the formulation angle around CEC or what we now call E2C, because we think it’s going to be the formulation handles that are going to drive performance here. Carbon black is a great product. And but it’s really hard to realize its full potential, because when you try to disperse it, it’s – you have to apply a lot of sheer and you degrade the underlying polymer, and so this is where the formulation handles of things like CEC are quite compelling. So we’ve put our money and effort around that angle, but we do track closely the emerging technologies.

Okay, great. Thank you so much.

Your next question comes from line of Chris Kapsch with Loop Capital Markets.

Yeah, good morning. So my first question, you touched a little bit upon the expectations you have around pricing in the Reinforcement Materials business going into this contract season. But my question really more about just bigger picture, the overall competitive intensity of the carbon black industry as we’re coming through this pandemic. Have you seen any shifts that you’ve noticed by region, and then maybe a little bit more specifically on pricing? How has that been in the PC segment? That’s not dependent on annual contracts or supply agreements. I’m just wondering how that pricing is held up against the weaker demand backdrop.

Yeah. So Chris, in terms of pricing in RM with so much of it under contract, certainly in the West and the more mature economies, there hasn’t really been any change, because that’s been agreed and honored. Now in the more spot markets like China, for example, with very weak demand over – during – they were working through the COVID phase. That certainly resulted in more price intensity, more price competition here, because people were fighting for volumes that had dropped precipitously. As we see demand coming back, then we’re starting to see pricing power restore. And so, I would say that those – if that trend continues, then we should see incremental restoration of pricing in China, which is the biggest spot market. So that’s how I would sort of characterize Reinforcement Materials. On the specialty carbons side of things, we have not had any impact in pricing. So with respect to price and the relationship of price and raws, of course, in this business, it’s more performance and application driven. But the feedstock is an important input factor and when it moves up, we’ve got to deal with that. And when it moves down, there’s normally some room for margin expansion. So we look at this relationship between price raws, and I think that’s been holding up quite well. I think the challenge has been a bit more mix oriented rather than pricing oriented just because the exposure to auto and the very high margin stuff that comes with that.

That’s helpful. And then a follow-up. You mentioned China and actually in response to another question, you talked about, at least qualitatively, the trends in China, I was just wondering if you could get a little more granular on China at least in the RM segment, the magnitude of the demand degradation you saw there? And how that’s – how those comparisons have looked on a monthly basis, quantitatively, on a monthly basis sequential through the June quarter and how that’s looked so far into July? Thanks.

Yeah, yeah. So, well, certainly at the low point, volumes were down very sharply, but the low point in China was experienced a little bit earlier than we saw in the west. But I would say volumes have come back pretty strongly. And they’re within spitting distance of where we were a year ago. So I think that is positive and if that continues to sustain itself and the export market continues to improve, then I think the capacity utilization in the industry should move up and pricing should incrementally tick up as well. So I think from a volume standpoint, things are recovering fairly well in China. But the competitive intensity is still somewhat high, because the export market is is only in the early stages of recovering. And so, people fight for volumes a little bit more, but we see that trend incrementally improving here

Thanks. One last one, in China, you’ve at your last Investor Day you’ve spelled out what your exposure there was by OE and replacement end-market. Is there – I know the car park there’s matured. And is there a way you can update that OE versus replacement tire? But also versus export, because you mentioned how that sort of the export-related demand is lagging. So just what your exposure is over there by those sort of buckets? Thanks.

Yeah. Well, I’ll try to help you a bit here, Chris. So, I mean, if you look in China, in total, about 60% of the tires in China are domestic and about 40% get exported. So there’s a heavy component of tire exports. And again, about – they make – they have almost 40% of the world’s tire capacity. So, that’s sort of at the top of the house level. Now, what you see in China is that the truck and bus market is bigger in China in relative terms versus the passenger car. The passenger car park has been building, of course, over the last 5 to 10 years with quite a bit over the last, kind of 5 years. And so, that is not yet at the proportion or relative to where we see the rest of the world. So it’s a little heavier on the truck and bus side of things. So our exposure into truck and bus is a little higher in China, as a result of that. But as the car – passenger car fleet or car park continues to build and they get to the replacement cycle, then you’ll probably see that balance in China that that make up in China start to look a bit more like the rest of the world. So that’s kind of how it’s structured and how we see it.

Thank you.

[Operator Instructions] Our next question comes [Technical Difficulty]

Hello, can you guys hear me. Sounded like you’re just cutting out there for a second?

No, we’re still here. I wasn’t sure if – because it’s gone past top of the hour if they were shutting us off here. But, no, we’re still here.

Okay, great. Yeah, quick question on the – Sean, you mentioned cost going up related to the EPA spend, curious if you could help us frame up how much those costs will impact – how much operating cost go up as a result of installing this equipment? Because – what we’ve been able to gather, it’s not – it doesn’t seem like it’s immaterial. So I’m curious your thoughts in terms of how much those costs go up once you flip the switch on this equipment? And you mentioned, all players having some plants supposed to becoming compliant April 2021. Do you know – my understanding is it’s – the costs will be different associated with if it’s SOx and NOx, if it’s just NOx. So curious – how you – when you look at the consent decrees with the other companies or what you’re aware of that the other companies are becoming compliant April 2021. Will your costs be going up similar to the other companies or more or less? Just kind of curious how you’re thinking about all that?

Yeah, sure. So I think, in general, the shape of each producer’s consent decree, the shape is similar, Kevin. And so, you have a mix of some plants that have a smaller investment. So, for example, the first plant that we did had certain knocks and feedstock restriction. So it was a lower capital investment. And then, what you find is that the consent decree also has certain plants that require more complete controls both SOx and NOx. So I would say the shape of the consent decree across the producers is – it’s effectively identical. And the timeline of implementation is synchronized as well. And so, with respect to – if you just take a plant that has to have, for example, full SOx and full NOx controls on it, I think you’ll see you know, costs in a fairly similar range. Although, I have seen some reports from competition recently that their cost estimates are going up. We’ve reaffirmed ours. But in general, they should be in the same zone, because the – while the technology has to get adapted for our particular gas stream, it is generally known technology. So that’s what I would say about that. Now, in terms of operating costs. So there are 2 types of costs here. There’s the capital cost of putting in the control equipment and getting a recovery and a return on that capital cost. And then, there’s the operating costs of running the equipment and that is an important cost that we need to also get recovery for here. And so, hence, we’ve been working hard to – at this for the last couple of years as we’ve been bringing plants on and incurring these costs. And we need to continue that in our pricing negotiations with customers here, because we simply won’t be able to be a sustainable supplier for them without this. Now, we’re doing our part. We’re going to have our plants online and we’re going to have them ready and we’re going to provide that supply reliability to customers. But I can’t speak for others, but we need to have a fair return on that.

Okay, great. Thank you very much.

This time, there are no further questions. I would now like to turn the call over to Mr. Sean Keohane.

Great. Thank you, Lisa, and thank you all for joining today. I hope you’re all remaining safe and beginning this journey back to some sense of normal here. But thanks for your time and attention and support of Cabot and look forward to talking to you again next quarter.

This concludes today’s conference call. You may now disconnect.